Understanding the Estimation of Oil Demand and Oil Supply Elasticities

Abstract

This paper examines the advantages and drawbacks of alternative methods of estimating oil supply and oil demand elasticities and of incorporating this information into structural VAR models. I not only summarize the state of the literature, but also draw attention to a number of econometric problems that have been overlooked in this literature. Once these problems are recognized, seemingly conflicting conclusions in the recent literature can be resolved. My analysis reaffirms the conclusion that the one-month oil supply elasticity is close to zero, which implies that oil demand shocks are the dominant driver of the real price of oil. The focus of this paper is not only on correcting some misunderstandings in the recent literature, but on the substantive and methodological insights generated by this exchange, which are of broader interest to applied researchers.

Petrol ve Doğalgaz Fiyatları İle Hisse Senedi Fiyatları İlişkisi: BİST Sinai Sektöründe Ampirik Bir Araştırma(The Relationship Between Oil and Natural Gas Prices and Stock Price: An Empirical Research in BIST Industrial Sector)

“…Ekonomik büyüme ve sanayi üretimindeki değişimler petrole ve doğalgaza olan talebi etkilemektedir. Talepte kısa dönemli değişimler mümkün olmasına rağmen petrol arz esnekliğinin kısa dönemde çok düşük olması arz-talep dengesini etkileyerek fiyatların değişmesine neden olmaktadır (Kilian, 2020).…”

Facts and Fiction in Oil Market Modeling

“…Hamilton relates to the role of crude oil inventories in defining the impact price elasticity of oil demand, as discussed in Kilian (2021). It is useful to elaborate on this point.…”

“…Baumeister and Hamilton (2019a,b) conclude that oil supply shocks are more important drivers of the real price of oil and that they are much more recessionary for the U.S. economy than suggested by earlier oil market studies including Kilian (2008Kilian ( , 2009 and Kilian and Murphy (2014). A number of recent studies including Herrera and Rangaraju (2020), Kilian (2019Kilian ( , 2021 and Kilian and Zhou (2019) have questioned details of their analysis. There has been no comprehensive evaluation of this debate, however.…”

Oil Prices, Exchange Rates and Interest Rates

“…The sign restrictions on the impact responses are strengthened by imposing bounds on the impact price elasticities of demand and supply. Since these elasticities can be expressed as functions of the impact responses to exogenous supply and demand shocks, respectively, elasticity bounds can be written as inequality restrictions on nonlinear functions of the elements of 1 0 B  (Kilian and Murphy 2012, Kilian 2020. In defining the price elasticity of oil demand, we incorporate the response of oil inventories in measuring changes in the use of oil in response to exogenous flow supply shocks, as discussed in Kilian and Murphy (2014).…”

“…We impose the restriction that not only the flow demand shock made at best a minimal contribution to this oil price increase, but that both the flow supply shock and the storage demand shock had some impact. In practice, we 7 Further discussion of the extraneous evidence that motivates this choice can be found in Kilian (2020). The sensitivity of oil market VAR model estimates to this supply elasticity bound has been studied in Kilian and Murphy (2012), Zhou (2020), and Herrera and Rangaraju (2020).…”