Oil futures volatility and the economy

September 20, 2019

The drone strike on Saudi Arabia's oil infrastructure has highlighted the fragile and interconnected relationship between crude oil supply and the global economy, with new research bringing these economic ties into greater focus.

"We shouldn't underestimate the importance of geopolitical events in the oil market, as it has the power to impend the stability of our financial world," says University of Technology Sydney Finance researcher Dr Christina Sklibosios Nikitopoulos.

"On 16 September 2019 the oil market witnessed one of the highest intraday moves, with a 15% increase in Brent oil prices and an 14.7% increase in US WTI oil futures. Oil price spikes are seen as a recession barometer, but it is not just price but also volatility that matters," she says.

In a recently released paper, Dr Nikitopoulos, with colleagues Dr Boda Kang from Lacima Group, and Finance Professor Marcel Prokopczuk from Leibniz University Hannover, examined the connections between oil futures volatility and the global economy.

They looked at 30 years of data to discover economic determinants of oil futures volatility over the short, medium and long-term. These included oil-sector variables, financial variables and macroeconomic conditions.

The research revealed how deeply integrated crude oil markets have become with financial markets.

"Investors increasingly regard commodities as an alternative asset class to equities or bonds, and crude oil derivatives are the most actively traded commodity," says Dr Nikitopoulos.

Oil futures started trading in 1983, and options in 1986, and since then the market has experienced explosive growth. Daily trading volume has leapt from 21,997 contracts in 2012 to 1.6 million in 2016 and this week surpassed 2 million.

"Our study highlighted the importance of risk premiums in this market, and revealed that credit spreads play a significant role in determining short-term and medium-term variation in oil futures prices," she says.

In the bond market, term structure - the rate at which people can borrow or lend over different periods, is seen as an important economic signal - whether the yield term is up signalling growth or down signalling recession.

Term structures in oil markets can be seen in a similar light, where contango (where the futures price of a commodity is higher than the spot price) or backwardation (where the spot or cash price of a commodity is higher than the forward price) provide an economic signal.

Dr Nikitopoulos says the expected supply shortfall following the drone strike would cause oil futures markets to remain in backwardation for a while.

The researchers found that along with hedging pressure and VIX (an equities market volatility index) after 2004 (the beginning of the financialisation of the commodity markets) credit spreads, industrial production and the US dollar index, were all drivers of short-term volatility.

"This supports the notion of volatility spill-overs between equity and commodity markets, which has strengthened in the past 10 years, says Dr Nikitopoulos.

"It also supports the notion that oil volatility acts as a recession barometer, and fears about the impact of oil shocks on financial stability are justified," she says.

Medium-term volatility was consistently related to open interest (a measure of trading activity) and credit spreads, while oil sector variables such as inventory and consumption had a measurable impact after 2004 due to structural changes in the economy and the oil sector.

Dr Nikitopoulos argues that because oil futures volatility is a product of interaction between the oil-sector and the economy, there is a need for mutually consistent policies.

"Oil markets should be the focus of global discussions by policy makers, not just individual decisions from the US Commodity Futures Trading Commission or OPEC," she says.

"Crude oil futures volatility plays an important role in the global economy and has significant implications for market participants - from oil producers and institutional investors, to traders and market regulators.

"And while the US economy can manage this most recent oil shock with its own shale oil production and opening of strategic reserves, it is global markets like Australia that suffer the most through an increase in fuel costs," she says.
-end-


University of Technology Sydney

Related Oil Articles from Brightsurf:

The first battle for oil in Norway
The world's richest man and the world's largest oil company dominated the petroleum market in Norway long before landmark finds on the Norwegian continental shelf and the Norwegian oil fund.

Oil droplet predators chase oil droplet prey
Oil droplets can be made to act like predators, chasing down other droplets that flee like prey mimicking behavior seen among living organisms.

Healthy oil from wild olives
The oil from wild olive trees has excellent sensorial, physicochemical and stability characteristics from a nutritional point of view, according to an article published in the journal Antioxidants.

Oil-soluble transition metal-based catalysts tested for in-situ oil upgrading
The results of the study showed that the good catalytic properties of the new transition metal catalysts, as well as their low cost and easy accessibility, make them a potential solution in the aquathermolysis reaction and heavy oil recovery.

New method for removing oil from water
Oil poses a considerable danger to aquatic life. Researchers at the Universities of Bonn and Aachen and the Heimbach-GmbH have developed a new technology for the removal of such contaminations: Textiles with special surface properties passively skim off the oil and move it into a floating container.

A sustainable alternative to crude oil
A research team from the Fraunhofer Society and the Technical University of Munich (TUM) led by chemist Volker Sieber has developed a new polyamide family which can be produced from a byproduct of cellulose production -- a successful example for a more sustainable economy with bio-based materials.

When grown right, palm oil can be sustainable
Turning an abandoned pasture into a palm tree plantation can be carbon neutral, according to a new study by EPFL and the Swiss Federal Institute for Forest, Snow and Landscape Research (WSL).

Oil futures volatility and the economy
The drone strike on Saudi Arabia's oil infrastructure has highlighted the fragile and interconnected relationship between crude oil supply and the global economy, with new research bringing these economic ties into greater focus.

All-in-one: New microbe degrades oil to gas
The tiny organisms cling to oil droplets and perform a great feat: As a single organism, they may produce methane from oil by a process called alkane disproportionation.

Marine oil snow
Marine snow is the phenomena of flakes of falling organic material and biological debris cascading down a water column like snowflakes.

Read More: Oil News and Oil Current Events
Brightsurf.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.