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1/28
References
OPEC Spare Capacity and Oil Price
Volatility
Yaser Faquih
Rice University
June 19, 2017
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
3/28
References
But volatility is also critical!
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
5/28
References
Motivation: Why study oil volatility?
Volatility is also critical
Key source of uncertainty affecting the cost of inputsOil products factor in 98% of all consumer goods’ valuechain in the US (Sadorsky, 2008)Forecasting volatility is fundamental in the pricing ofenergy derivatives such as option
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
5/28
References
Motivation: Why study oil volatility?
Volatility is also critical
Key source of uncertainty affecting the cost of inputs
Oil products factor in 98% of all consumer goods’ valuechain in the US (Sadorsky, 2008)Forecasting volatility is fundamental in the pricing ofenergy derivatives such as option
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
5/28
References
Motivation: Why study oil volatility?
Volatility is also critical
Key source of uncertainty affecting the cost of inputsOil products factor in 98% of all consumer goods’ valuechain in the US (Sadorsky, 2008)
Forecasting volatility is fundamental in the pricing ofenergy derivatives such as option
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
5/28
References
Motivation: Why study oil volatility?
Volatility is also critical
Key source of uncertainty affecting the cost of inputsOil products factor in 98% of all consumer goods’ valuechain in the US (Sadorsky, 2008)Forecasting volatility is fundamental in the pricing ofenergy derivatives such as option
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
6/28
References
Motivation: Why study oil volatility?
Impact on investment decisions
Affects the value of the embedded real option, such asthe option to defer or cancel an oil related investment(Bernanke, 1983), (Dixit and Pindyck, 1994), (Kellogg,2014)
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
6/28
References
Motivation: Why study oil volatility?
Impact on investment decisions
Affects the value of the embedded real option, such asthe option to defer or cancel an oil related investment(Bernanke, 1983), (Dixit and Pindyck, 1994), (Kellogg,2014)
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
7/28
References
Motivation: Why study oil volatility?
Impact on business cycle
Wild price swings harmful to industry and economy,(Moran, 1981)
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
7/28
References
Motivation: Why study oil volatility?
Impact on business cycle
Wild price swings harmful to industry and economy,(Moran, 1981)
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
9/28
References
Variables of Interest
brent vol Volatility of Brent front-month price
rbrent difference of log Brent prices
vix: VIX index for the S&P500
rfw cover: difference of log OECD forward cover
brent 6m: Brent 6th month forward contract minus frontmonth contract price
sa spare share: Saudi idle spare capacity as a share ofworld demand
opec spare share: OPEC (excluding SA) idle sparecapacity as a share of world demand
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
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References
Testing for Stationarity
Variable TestStat CriticalValue10 CriticalValue5 CriticalValue1 Pvalue1 Brent -1.389 -2.571 -2.881 -3.464 0.58762 Brent Vol -3.696 -2.571 -2.881 -3.464 0.0042∗∗∗
3 FW Cover -1.589 -2.571 -2.881 -3.464 0.48924 VIX -3.924 -2.571 -2.881 -3.464 0.0019∗∗∗
5 SA Spare Share -2.849 -2.571 -2.881 -3.464 0.0516∗
6 OPEC Spare Share -2.748 -2.571 -2.881 -3.464 0.0661∗
7 Brent M6 -3.358 -2.571 -2.881 -3.464 0.0125∗∗
Table: ADF Test of Stationarity
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
11/28
References
Figure: Brent 6-month spreads in $ per barrel vs volatility, andBrent 6-month spreads in % of front month price vs volatility
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
12/28
References
Figure: Brent forward cover deviations from 3yr average in days vsvolatility, and Brent forward cover deviations from 3yr average in% vs volatility
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
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References
Special Commodity?
Oil (and gas) need specialized storage facilities
Costly to store relative to other bulk commodities (suchas copper)
Building new storage requires time
Running out of storage capacity induces a sharp pricedrop
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
13/28
References
Special Commodity?
Oil (and gas) need specialized storage facilities
Costly to store relative to other bulk commodities (suchas copper)
Building new storage requires time
Running out of storage capacity induces a sharp pricedrop
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
13/28
References
Special Commodity?
Oil (and gas) need specialized storage facilities
Costly to store relative to other bulk commodities (suchas copper)
Building new storage requires time
Running out of storage capacity induces a sharp pricedrop
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
13/28
References
Special Commodity?
Oil (and gas) need specialized storage facilities
Costly to store relative to other bulk commodities (suchas copper)
Building new storage requires time
Running out of storage capacity induces a sharp pricedrop
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
14/28
References
Figure: IRF: rBrent shock on Brent Vol
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
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References
Figure: IRF: VIX shock on Brent Vol
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
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References
Figure: IRF: Brent M6 shock on Brent Vol
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
17/28
References
Figure: IRF: rFW cover shock on Brent Vol
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
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References
The Historical Saudi Role: Market Stability
Table: Examples of Recent Saudi Usage of Spare capacity toCounter Market Turbulence
Event Year Disruption Saudi Response DurationVenezuela Strike 2002 2 MBD 1MBD 3 monthsIraq Invation 2003 1.2 MBD for 2 months 0.6 MBD 2 monthsChina’s Demand Spike 2004 Demand unexpectedly up by 2 MBD 1.8 MBD 5 monthsHurricane Katrina, USA 2005 Shut down 1 MBD of prod for 4 months 1.8 MBD 4 monthsPrice Spike to $140/bbl 2008 Global concern about supply availability 500 kBD in April 3 months
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
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References
Figure: IRF: Brent M6 shock on SA Spare Share
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
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References
Figure: IRF: rBrent shock on SA Spare Share
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
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References
Figure: IRF: Volatility shock on SA Spare Share
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
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References
Figure: IRF: Brent M6 shock on OPEC Spare Share
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
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References
Figure: IRF: rBrent shock on OPEC Spare Share
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
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References
Figure: IRF: Volatility shock on OPEC Spare Share
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
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References
The Saudi Role vs. Other OPEC Members
The Similarities:
Both tend to produce more after a positive price shock
This is expected as they seek to utilize idle capacity togenerate income, while meeting any market shortage
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
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References
The Saudi Role vs. Other OPEC Members
The Similarities:
Both tend to produce more after a positive price shock
This is expected as they seek to utilize idle capacity togenerate income, while meeting any market shortage
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
26/28
References
The Saudi Role vs. Other OPEC Members
The Differences:
Saudi Arabia aims to manage global inventories
They tend to cut production (i.e. increase idle sparecapacity) when inventories are high
Saudi Arabia also aims to counter high volatility
Increasing production when volatility increases
The rest of OPEC does not seem to be actively engage ininventory management
This highlights the historical swing-producer role of SA
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
26/28
References
The Saudi Role vs. Other OPEC Members
The Differences:
Saudi Arabia aims to manage global inventories
They tend to cut production (i.e. increase idle sparecapacity) when inventories are high
Saudi Arabia also aims to counter high volatility
Increasing production when volatility increases
The rest of OPEC does not seem to be actively engage ininventory management
This highlights the historical swing-producer role of SA
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
26/28
References
The Saudi Role vs. Other OPEC Members
The Differences:
Saudi Arabia aims to manage global inventories
They tend to cut production (i.e. increase idle sparecapacity) when inventories are high
Saudi Arabia also aims to counter high volatility
Increasing production when volatility increases
The rest of OPEC does not seem to be actively engage ininventory management
This highlights the historical swing-producer role of SA
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
26/28
References
The Saudi Role vs. Other OPEC Members
The Differences:
Saudi Arabia aims to manage global inventories
They tend to cut production (i.e. increase idle sparecapacity) when inventories are high
Saudi Arabia also aims to counter high volatility
Increasing production when volatility increases
The rest of OPEC does not seem to be actively engage ininventory management
This highlights the historical swing-producer role of SA
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
26/28
References
The Saudi Role vs. Other OPEC Members
The Differences:
Saudi Arabia aims to manage global inventories
They tend to cut production (i.e. increase idle sparecapacity) when inventories are high
Saudi Arabia also aims to counter high volatility
Increasing production when volatility increases
The rest of OPEC does not seem to be actively engage ininventory management
This highlights the historical swing-producer role of SA
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
26/28
References
The Saudi Role vs. Other OPEC Members
The Differences:
Saudi Arabia aims to manage global inventories
They tend to cut production (i.e. increase idle sparecapacity) when inventories are high
Saudi Arabia also aims to counter high volatility
Increasing production when volatility increases
The rest of OPEC does not seem to be actively engage ininventory management
This highlights the historical swing-producer role of SA
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
27/28
References
Conclusion
Understanding the drivers of oil price volatility is critical
The special storage requirements of oil (and energy)commodities means that volatility may shoot up evenwhen storage is ample
Evidence of shock transmission from the wider economyto oil markets
Saudi Arabia behaves differently compared to otherproducers in response to volatility spikes
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility
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References
Bernanke, B. S. (1983). Irreversibility, uncertainty, and cyclicalinvestment. The Quarterly Journal of Economics 98(1),85–106.
Dixit, A. K. and R. S. Pindyck (1994). Investment underuncertainty. Princeton university press.
Harris, J. H. and B. Buyuksahin (2009). The role ofspeculators in the crude oil futures market.
Kellogg, R. (2014). The effect of uncertainty on investment:Evidence from texas oil drilling. American EconomicReview 104(6), 1698–1734.
Moran, T. H. (1981). Modeling opec behavior: economic andpolitical alternatives. International Organization 35(02),241–272.
Sadorsky, P. (2008). Assessing the impact of oil prices onfirms of different sizes: Its tough being in the middle.Energy Policy 36(10), 3854–3861.
Yaser Faquih OPEC Spare Capacity and Oil Price Volatility