Crude Oil Price Volatility

Michael Giberson

The New York Times observes that crude oil price volatility has been exceptionally high for the last eighteen months.

Daily changes in the spot price of crude oil, 1983-2009
New York Times graphic: Daily changes in the spot price of crude oil, 1983-2009

(Hmmm. Eighteen months ago … January 2008 … the Iowa caucuses … the U.S. presidential primary season gets underway in earnest … nahhh, couldn’t be all due to presidential politics.)  Actually, eyeballing the chart that accompanies the article, it looks like volatility didn’t really take off until the macroeconomic slide later in 2008. From the story:

“To call this extreme volatility might be an understatement,” said Laura Wright, the chief financial officer at Southwest Airlines, a company that has sought to insure itself against volatile prices by buying long-term oil contracts. “Over the past 15 to 18 months, this has been unprecedented. I don’t think it can be easily rationalized.”

Volatility in the oil markets in the last year has reached levels not recorded since the energy shocks of the late 1970s and early 1980s, according to Costanza Jacazio, an energy analyst at Barclays Capital in New York.

Energy price volatility may have implications for various energy policy proposals seeking to dramatically reshape the industry.  Research published in the Energy Journal (“Does oil price uncertainty affect energy use?” Gerard Kuper and Daan van Soest, 2006. Link to abstract.) reported that oil price volatility discourages investment in new energy-using technology:

Volatility clustering implies that high levels of volatility today give rise to the expectation that volatility will remain high in the foreseeable future, and hence the probability of price change reversals is expected to remain high as well. Volatility itself induces firms to respond sluggishly to energy price changes, and this effect is exacerbated if volatility is clustered over time as higher volatility today implies that tomorrow volatility is likely to be high too….

Our results thus give support to the theoretical prediction that energy price volatility renders energy-saving technologies less attractive. The policy implications are that in uncertain times, energy taxes are not expected to be very effective in reducing energy use, and that reducing and managing uncertainty should be high up on the policy agenda.

AN ASIDE: Between when I first read the NYT story yesterday and posting about it this morning, the title of the article morphed from “Volatile swings in price of oil stir fears on recovery” to “Swings in price of oil hobble forecasting.” I wonder if that change is a editorial judgment to minimize negative tone toward the economy, or just an effort to make headlines into statements of the obvious?

ANOTHER COMMENT: The Energy Journal doesn’t make it easy for web-based researchers to locate and link to articles in the journal (as compared to, say, the Electricity Journal or Energy Policy). As research has become increasingly web-based, that is probably not the best long-term approach.


6 thoughts on “Crude Oil Price Volatility

  1. My thought is that the increased volatility of the oil price has little to do with politics or the financial crisis, and a lot to due with decreasing elesticity of supply (while short term elasticity of demand remains low.)

    As excess supply capacity has been eroded over the last decade, the ability of supply to change in order to meet changes in demand leads to higher volatility.

    The implication for policy is that policy should be used to stabilize price, with variable taxes designed to put a floor on oil prices, thus countering any disincentive to invest in alternatives… although I’m not sure I follow the argument: shouldn’t a increase in volitility increase the incentive to seek alternatives, since uncertainty = risk, and most people are risk averse, not risk-sseking?

  2. I half-way agree. A story might be: in the last 15 or 20 years companies have moved to more efficient inventory management, using improved communications, computation, and logistics with a little inventory instead of just holding lots of inventory to support production processes. With less inventory on hand, the system has less slack to accommodate short term increases in demand (or, as Tom says, supply becomes more inelastic), with the result that prices become more volatile.

    But whatever the case over most of the last 15 or 20 years, it would be hard to argue that the industry lacks spare capacity over the last 8 months or so, and that period has seen the highest recent price volatility.

    The election suggestion was mostly tongue in cheek, though I do think that there is a significant policy uncertainty component that emerged as the election progressed and that hasn’t yet been resolved. Cap-and-trade? Maybe soon, maybe sometime, maybe not. It makes a difference to the industry (perhaps not nearly as big a difference as some expect, but not-knowing is part of the problem).

    The economics article cited argued that the policy implication was for efforts to “reduc[e] and manag[e] uncertainty,” which may mean price stabilization, but could mean policy stabilization as well.

    Price stabilization is a tempting goal, but I’m afraid that price volatility is just the messenger and if we shoot the messenger we will have a harder time getting the messages in the future.

  3. Mike,
    My comment was only adddressing the oil market, not the broader economy in general. The supply buffer in the oil market has been mainly in Saudi Arabia for the last few decades, and no one (other than the Saudis) knows how big it really is.

    Not that you have to agree with me, but I realized after your response that I had not used the word “oil” anywhere in my initial comment.

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