Keywords: Oil prices, oil futures, backwardation, convenience yield
Abstract: Recent studies of crude oil price formation emphasize the role of interest rates
and convenience yield (the adjusted spot-futures spread), confirming that
spot prices mean-revert and normally exceed discounted futures. However,
these studies don't explain why such "backwardation" is normal. Also,
models derived in these studies typically explain only about 1 percent of daily
returns, suggesting other factors are important, too. In this paper, I specify
a structural oil-market model that links returns to convenience yield, inventory
news, and revisions of expected production cost (growth of which is related to backwardation).
Although its predictive power is only a marginal improvement, the model fits the
data far better. In addition, I find reversion of spot to futures prices only
when backwardation is severe. Convenience yield behaves nonlinearly, but price
response to convenience yield is also nonlinear. Equivalently, futures are
informative about future spot prices only when spot prices substantially exceed futures.
Full paper (387 KB PDF)
Home | FEDS | List of 2005 FEDS papers
To comment on this site, please fill out our feedback form.
Last update: August 17, 2005