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baumeister-kilian-2016-forty-years-of-oil-price-fluctuations-why-the-price-of-oil-may-still-surprise-us
Introduction
40 years since the 1973/74 oil crisis.
Emergence of a new regime in the crude oil market where prices fluctuate based on supply and demand.
Price of imported oil quadrupled in 1973/74, leading to major adjustments in oil-consuming countries.
Historical Context
Government Responses
Industrialized countries imposed price ceilings on domestic oil.
Resulted in gasoline shortages, long lines at gas stations.
Implementation of speed limits, Sunday traffic bans, and limited retail gasoline purchases (Ramey and Vine 2011).
Collective memory shaped by images of long gas lines and empty roads.
Price Regulation Pre-Crisis
Prior to 1973, US oil prices were regulated, leading to constant prices interrupted by infrequent adjustments.
Adjustments typically associated with supply disruptions in the Middle East.
Price Dynamics Post-1973
Post-crisis, the US depended heavily on oil imports; regulatory frameworks became impractical.
Price of West Texas Intermediate (WTI) rose from $4.31 in September 1973 to $10.11 by January 1974.
Structural break in the WTI price process recorded in early 1974, leading to fluctuations similar to other commodities.
Ongoing fluctuations noted with no long-term trends in price.
Determinants of Oil Price Fluctuations
Potential causes identified in literature:
Shocks to global crude oil production due to political events, new field discoveries, and extraction technology improvements.
Changes in global demand influenced by unexpected shifts in the global business cycle.
Demand for above-ground oil inventories based on future supply-demand expectations.
Causes of Major Price Fluctuations Since 1973/74
Review of episodes with understanding improved through hindsight.
Some price variations were unexpected, impacting economic models (Baumeister and Kilian).
Oil Price Expectation Measures
Tools Used
Various measures employed by economists, households, and financial entities to gauge future oil prices.
No measure is perfect; all measures are prone to prediction errors.
Understanding how these expectations are formed is crucial for economic modeling and decision-making.
Economic Impacts of Oil Price Shocks
Shock Definition
The gap between expected oil price and reality signals an oil price "shock."
These shocks significantly influence macroeconomic outcomes.
Historical Episodes Analyzed
Initial explanations of oil price hikes based on supply disruptions now seen as too simplistic.
Demand shifts largely responsible for price increases and declines observed historically, notably during:
The 1973/74 oil crisis which stemmed from geopolitical tensions rather than physical destruction of infrastructure.
The 1979/80 oil crisis, primarily attributed to rising global demand.
Consistent Long-Term Trends
Through regression analysis, shifts in global economic patterns largely explain oil price fluctuations since 1973.
Inventory demands and geopolitical tensions influence market behavior, impacting both supply and demand.
Conclusion
Significant learning curve across decades in understanding oil markets.
Oil price behaviors remain difficult to predict, influenced by diverse factors, including supply shocks, demand changes, and geopolitical events.
Continuous need for improved models to better capture the complexities of oil price dynamics.
Introduction
The oil crisis of 1973/74 marked a pivotal turning point in the global crude oil market, setting a precedent for pricing fluctuations influenced primarily by supply and demand dynamics. This crisis occurred amid rising geopolitical tensions and was characterized by a fourfold increase in the price of imported oil, which had profound implications for economies reliant on oil consumption. The repercussions of these changes have persisted for over four decades, reshaping economic policies, energy strategies, and consumer behavior around the globe.
Historical Context
Government Responses
In response to the crisis, many industrialized countries implemented price ceilings on domestic oil to mitigate the impact of skyrocketing fuel costs on consumers. This regulation, however, had unintended consequences such as widespread gasoline shortages, resulting in long lines at gas stations and public frustration. To manage the crisis, governments enacted various measures, including:
Speed Limits: Restrictions on road speeds to conserve fuel.
Sunday Traffic Bans: Limitations on vehicle use during weekends to reduce demand.
Gasoline Purchase Limits: Regulation of how much fuel consumers could buy at a time. These responses, along with collective memories of long gas lines and empty roads, shaped public perceptions and policy decisions surrounding energy consumption.
Price Regulation Pre-Crisis
Before the crisis, the United States maintained a system of price regulation that resulted in generally stable oil prices, occasionally disrupted by infrequent adjustments tied to supply issues, particularly those originating from the Middle East. This regulatory environment created an illusion of predictability in oil pricing, masking the volatility that was poised to surface.
Price Dynamics Post-1973
After the 1973/74 crisis, the United States became increasingly dependent on oil imports as regulatory frameworks began to unravel, leading to a more market-driven pricing regime. The price of West Texas Intermediate (WTI) crude oil surged dramatically from $4.31 per barrel in September 1973 to $10.11 by January 1974. Early 1974 marked a structural break in the WTI price process, with an emergence of price fluctuations akin to other commodities, signifying a new era in oil pricing where long-term trends became elusive and volatility prevalent.
Determinants of Oil Price Fluctuations
Causes Identified in Literature
Scholarly literature identified multiple factors contributing to fluctuations in oil prices:
Global Crude Oil Production Shocks: Catalyzed by geopolitical events, natural disasters, or geopolitical instability that disrupts supply chains.
New Field Discoveries and Extraction Technologies: Innovations that expand resource availability or lower production costs.
Unexpected Shifts in Global Demand: Urgent demands generated by economic cycles, such as recessions or expansions, can cause significant price changes.
Above-Ground Oil Inventories: Market traders' expectations regarding future supply and demand heavily influence investment decisions and price stability.
Causes of Major Price Fluctuations Since 1973/74
Historical Price Episodes
Analyzing historical price fluctuations reveals that many variations were unexpected and disrupt conventional economic models. Noteworthy episodes include:
The 1973/74 oil crisis, primarily driven by geopolitical tensions rather than actual destruction of oil infrastructure.
The 1979/80 oil crisis, largely a result of escalating global demand amidst political upheaval in oil-producing regions. These complex interactions demonstrate the inadequacy of simplistic supply disruption explanations.
Oil Price Expectation Measures
Tools Utilized
Economists and financial entities employ various measures to forecast future oil prices, recognizing that no single measure is flawless and all are susceptible to prediction errors. Key tools include historical price analysis, market surveys, and economic models that account for supply-demand relationships. Understanding these expectations is critical for effective economic modeling and strategic decision-making in both government and private sectors.
Economic Impacts of Oil Price Shocks
Shock Definition
Oil price shocks are defined as the discrepancy between expected oil prices and actual prices, with significant implications for macroeconomic stability. Shocks can have a cascading effect on inflation rates, consumer spending, and overall economic growth.
Historical Episodes
Historical analyses suggest initial assessments of oil price hikes were overly simplistic, primarily attributing changes to supply disruptions. Instead, shifts in demand have played a central role in both price increases and declines observed historically. Key historical contexts include:
The 1973/74 oil crisis linked more to geopolitical strategies than physical supply destruction.
The 1979/80 oil crisis, which was primarily driven by rising global demand and political instability in major oil-producing countries.
Consistent Long-Term Trends
Regression Analysis Insights
Through advanced regression analysis, it becomes clear that transformations in global economic patterns provide substantial explanations for oil price fluctuations since 1973. Factors such as geopolitical tensions and changes in inventory demands have consistently influenced market behavior, affecting both supply and demand dynamics.
Conclusion
The decades following the oil crises have demonstrated a significant learning curve in understanding the complexities of oil markets. Crude oil price behaviors remain notoriously challenging to predict due to the myriad of influencing factors, including supply shocks, demand surges, and geopolitical developments. Therefore, there is a pressing need for improved economic models that can better capture these dynamics to inform policymakers and stakeholders effectively.