There is growing interest in the causes and consequences of oil price changes. Various economic factors drive oil prices. Changing oil prices can affect the economy in different ways, depending on the factors driving the change. A better understanding of these drivers would help policymakers decide on the appropriate response to changing economic conditions.
We propose a new method to identify the factors driving changes in oil prices. In particular, we focus on expectations for oil supply and demand. We quantify how much the revisions of these respective expectations contributed to oil prices and to economic activity.
Expectations for oil supply and demand explain about 30-35% of oil price changes. We find that an expected increase in supply initially reduces oil prices, slowing global economic activity. In the long run, however, increases in supply boost global economic activity. Similarly, an upward revision to expected demand for oil raises oil prices. Our results also show that financial factors and shale-oil technology are additional drivers of oil price fluctuations.
This paper proposes a simple but comprehensive structural vector autoregressive (SVAR) model to examine the underlying factors of oil price dynamics. The distinguishing feature is to explicitly assess the role of expectations on future aggregate demand and oil supply in addition to the traditional realized aggregate demand and supply factors. Our empirical analysis shows that identified future demand and supply shocks explain about 30-35 percent of historical oil price fluctuations. In particular, future oil supply shocks are more than twice as important as realized and future demand shocks in accounting for oil price developments. The empirical result indicates that the influence of oil price shocks on global output varies according to the nature of each shock. We also show that the financial factors and the development of shale-oil technology are additional relevant sources of oil price fluctuations.
JEL classification: C32, E44, G12, G15
Keywords: oil demand and supply, oil price, structural vector autoregressive model
Read the full paper at: https://www.bis.org/publ/work725.htm