A Simultaneous Equation Model for World Crude Oil and Natural Gas Markets

Abstract

This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.A model for world crude oil and natural gas markets is estimated. It confirms low price and high income elasticities of demand for both crude oil and natural gas, which explains the market power of oil producers and price volatility following shocks. The paper establishes a relationship between oil prices, changes in the nominal effective exchange rate (NEER) of the U.S. dollar, and the U.S. interest rates, thereby identifying demand shocks arising from monetary policy. Both interest rates and the NEER are shown to influence crude prices inversely. The results imply that crude oil prices should be included in the policy rule equation of an inflation targeting model.

Is There a Homogeneous Causality Pattern between Oil Prices and Currencies of Oil Importers and Exporters?

“…Yousefi and Wirjanto [2004] analyze five OPEC countries and provide evidence that crude oil export prices respond positively to depreciations against the dollar for the purpose of stabilizing export revenues. Focusing on nominal effective US dollar exchange rates, Krichene [2005Krichene [ , 2006 concludes that an appreciation of the nominal effective dollar exchange rate may lead to both an increase and a decrease in oil prices. Zhang, Fan, Tsai and Wei [2008] and only find a robust explanatory power for the short-run.…”

Limit pricing and the (in)effectiveness of the carbon tax

“…For the price elasticity of the total oil demand, the value used in Hamilton (2009b) is 0.25, in line with Krichene's (2005) long-run estimate for the period 1974-2004. Hamilton (2009b argues that this elasticity should be expected to be even smaller.…”

“…The limit-pricing theory carries over to the case of an extractive monopoly that exploits a finite stock of resource over time: as long as there is some resource to be 1 Krichene's (2005) estimate of the long-run price elasticity of the demand for crude oil is (absolute value) 0.26 for ; a level that almost coincides with the 0.25 elasticity used in Hamilton (2009b). According to Hamilton (2009a, pp.…”

“…217-218), since crude oil only represents about half the retail cost of final oil-based products like gasoline, the demand elasticity of the former is typically much lower than that of the latter (e.g. Hausman and Newey, 1995;Kilian and Murphy, 2014; references in Krichene, 2005, andin Hamilton, 2009a). See Hamilton (2009b, p. 192) on why the price elasticity of the crude oil demand should be expected to be even smaller now than over the last decades.…”

To what Extent Do Oil Prices Depend on the Value of US Dollar: Theoretical Investigation and Empirical Evidence

“…(Alhajji, 2004;Cheng, 2008;Krichene, 2005;Yousefi & Wirjanto, 2004). According to Alhajji, "US Dollar depreciation reduces activities in upstream through different channels including lower return on investment, increasing cost, inflation, and purchasing power.…”