Forecasting Crude Oil Spot Price Using OECD Petroleum Inventory Levels

By Ye, Michael; Zyren, John et al. | International Advances in Economic Research, November 2002 | Go to article overview

Forecasting Crude Oil Spot Price Using OECD Petroleum Inventory Levels


Ye, Michael, Zyren, John, Shore, Joanne, International Advances in Economic Research


Abstract

This paper presents a short-term monthly forecasting model of West Texas Intermediate crude oil spot price using OECD petroleum inventory levels. Theoretically, petroleum inventory levels are a measure of the balance, or imbalance, between petroleum production and demand, and thus provide a good market barometer of crude oil price change. Based on an understanding of petroleum market fundamentals and observed market behavior during the post-Gulf War period, the model was developed with the objectives of being both simple and practical, with required data readily available. As a result, the model is useful to industry and government decision-makers in forecasting price and investigating the impacts of changes on price, should inventories, production, imports, or demand change. (JEL Q40, C53)

Introduction

Both government and the industrial sector have an interest in forecasting crude oil spot price. Potential changes in world petroleum supply-demand fundamentals, such as quota changes of the Organization of the Petroleum Exporting Countries (OPEC), result in questions on the implications for the crude oil price. Because petroleum inventory levels are a measure of the balance, or imbalance, between petroleum production and demand, they reflect changing market pressures on crude oil prices, and thus provide a good market barometer of crude oil price change in the short run. This paper presents the development of a short-term monthly forecasting model for West Texas Intermediate crude oil spot price using Organization for Economic Cooperation and Development (OECD) petroleum inventory levels. This model was built based on an understanding of petroleum market fundamentals and the observed market behavior during the post-Gulf War period from January 1992 to February 2001. The results from the forecasting model empirically demonstrate that petroleum inventories are a good market indicator of crude oil price change.

The relationship between commodity inventory levels and price has been studied for nearly a century, tracing back to the early published works of Working [1934] and Kaldor [1939], where the classical theory of storage was developed to explain why price backwardation occurred. Empirical studies were also carried out on agricultural commodity markets, see for example, Working [1934], Brennan [1958], and Telser [1958]. In recent publications, Pindyck [1994] empirically studied the relationship between inventories and short-run commodity prices using copper, lumber, and heating oil data. Dale and Zyren [1997] particularly pointed out that energy futures markets behave similarly to futures markets for agricultural commodities. (1)

The literature on crude oil and petroleum product markets is enormous. For example, the book by Horsnell and Mabro [1993] addressed the Brent market and the formation of world oil prices. (2) A recent paper by Pindyck [2001] is most closely related to the analysis. He described the short-run dynamic relationship between commodity prices and inventories, using the petroleum markets for illustrations. Specifically, he explained the equilibrium in two interconnected markets: a cash spot market and a market for storage. Also related is a paper by Considine and Larson [2001], who studied the presence of risk premiums on crude oil inventories.

It was found that the existing models dealing with commodity price and inventory in the general equilibrium framework, or addressing specific theoretical and econometric issues, provide insight into fundamental understanding of the economics behind the market behavior. However, they require too much expertise and specific data to be implemented in a policy environment by professionals without substantial economic and statistical training. As a result, a simple and a practical short-term crude-oil-price forecasting model was developed that is intuitively appealing to decision-makers and can therefore be easily interpreted and accepted. …

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