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UH Study Links Volatile Oil Markets and Record Inventories
Pirrong’s study concluded that futures markets prices generally reflected the realities in the physical market where oil is bought, sold and stored.
A new academic study from the Bauer College of Business at the University of Houston concludes the unprecedented volatility in the oil markets in late 2008 and early 2009 was predominantly the product of market fundamentals during a time of extreme stress.
The study, An Evaluation of the Performance of Oil Price Benchmarks during the Financial Crisis, was done by Craig Pirrong, Professor of Finance and Energy Markets Director for Global Energy Management Institute, Bauer College of Business at the University of Houston.
It analyzed the behavior of two benchmark oil futures contracts during the period of financial crisis following the collapse of Lehman Brothers. It concluded that futures markets prices generally reflected the realities in the physical market where oil is bought sold and stored.
“The behavior of the WTI futures contract during the financial crisis reflected the truly unprecedented conditions prevalent during that period, which was reflected in market volatility and prices,” Pirrong said. The study also found no instances where the prices set in financial markets had gotten out of whack with the most directly related cash markets.
Pirrong discovered different findings for Brent. “During the period from Sept. 1, 2008 to July 17, 2009, the correlation became negative: .5536 to be exact,” Pirrong said. “This is diametrically opposed to the behavior of Brent spreads prior to the financial crisis, and is not what one would expect to observe if Brent spreads were reflecting world-wide supply-demand fundamentals.”
The volatility of the benchmark oil prices has led to past accusations of manipulation by players in the financial markets.
The study concluded the extraordinarily high fundamental volatility and other price anomalies were connected to the collapse in energy demand caused by the acute worldwide economic contraction. Oil in storage rose to record levels as demand dropped far faster than producers could reduce supplies. The prices based on the contract for West Texas Intermediate (WTI) reflected the high cost of storage at time when inventories rose to record levels. The owners were putting it away hoping for a better price later.
The study, commissioned by CME Group, analyzed the relative prices in the financial markets, cash markets and storage levels in the U.S. and worldwide. It indicated the erratic price movements did cause difficulties for some parties trying to reduce the price risk by using these financial contracts to hedge.
Click here to view the complete study.
By Stephen Rassenfoss
About the University of Houston
The University of Houston, Texas' premier metropolitan research and teaching institution, is home to more than 40 research centers and institutes and sponsors more than 300 partnerships with corporate, civic and governmental entities. UH, the most diverse research university in the country, stands at the forefront of education, research and service with more than 35,000 students.
About the Bauer College of Business
The C.T. Bauer College of Business has been in operation for more than 60 years at the University of Houston main campus. Through its five academic departments, the college offers a full-range of undergraduate, masters and doctoral degrees in business. The Bauer College is fully accredited by the AACSB International - the Association to Advance Collegiate Schools of Business. In August 2000, Houston business leader and philanthropist Charles T. (Ted) Bauer endowed the College of Business with a $40 million gift. In recognition of his generosity, the college was renamed the C.T. Bauer College of Business.