Decomposing news shocks
The price of oil never seems to stay the same for long. In the last 15 years, Brent crude has gone from over $140 dollars a barrel to less than $20 a barrel, with cycles of boom and bust in between.
Current oil production at the time of those swings was an important driver, but just as crucial was news about the future supply of oil, according to a paper in the American Economic Review.
Author Diego R. Känzig says that production announcements from the Organization of Petroleum Exporting Countries (OPEC) have a profound impact on oil prices and the US economy, even when current oil supplies don’t change.
OPEC’s 13 member countries account for over 40 percent of the world's oil production. Expectations about its production decisions have moved oil markets for decades, but pinpointing the size of this channel of influence is a difficult task, according to Känzig.
The author combined high-frequency data on oil futures prices and over a hundred OPEC press releases to estimate the role of so-called oil supply news shocks on prices, economic activity, and inflation expectations.
Figure 5 from his paper shows the contribution of these news shocks to the price of oil from 1975 to 2017.
Figure 5 from Diego R. Känzig (2021)
The red dotted line shows the percentage change from the mean of the real price of oil, and the black line is the cumulative historical contribution of oil supply news shocks to the real price of oil. The dark blue bands and light blue bands are 68 and 90 percent confidence intervals, respectively.
Several important events in the history of the oil market (vertical lines) illustrate the role of new information on oil prices.
For instance, lower oil supply expectations amidst tensions in the Middle East leading up to the Iran–Iraq War seem to have caused the surge in oil prices in the late 1970s. More recently, when Saudi Arabia decided not to cut oil production in 2014 during a perceived oil glut, expectations of higher oil production drove prices lower.
In contrast, oil supply news did not contribute significantly to the rapid increase in the real price of oil between 2003 and mid-2008, which appeared to be due to higher global demand instead.
Känzig’s findings help to disentangle the roles of demand, supply, and expectations in driving the price of oil, which still has a profound effect on today’s economies.
“The Macroeconomic Effects of Oil Supply News: Evidence from OPEC Announcements” appears in the April 2021 issue of the American Economic Review.