Climate Risks and the Realized Volatility Oil and Gas Prices: Results of an Out-of-Sample Forecasting Experiment

Rangan Gupta,Christian Pierdzioch

doi:10.3390/en14238085

Rangan Gupta, Christian Pierdzioch

Open Access

https://doi.org/10.3390/en14238085

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Journal: Energies	Publication Date: Dec 2, 2021
Citations: 15	License type: CC BY 4.0

Affiliation: University of Pretoria, Helmut Schmidt University

Abstract

We extend the widely-studied Heterogeneous Autoregressive Realized Volatility (HAR-RV) model to examine the out-of-sample forecasting value of climate-risk factors for the realized volatility of movements of the prices of crude oil, heating oil, and natural gas. The climate-risk factors have been constructed in recent literature using techniques of computational linguistics, and consist of daily proxies of physical (natural disasters and global warming) and transition (U.S. climate policy and international summits) risks involving the climate. We find that climate-risk factors contribute to out-of-sample forecasting performance mainly at a monthly and, in some cases, also at a weekly forecast horizon. We demonstrate that our main finding is robust to various modifications of our forecasting experiment, and to using three different popular shrinkage estimators to estimate the extended HAR-RV model. We also study longer forecast horizons of up to three months, and we account for the possibility that policymakers and forecasters may have an asymmetric loss function.

Highlights

The current European energy-price crisis is a reminder that the prices of crude and heating oil as well as of natural gas play a prominent role in discussions of the economic consequences of large swings in energy prices, and in debates in policy circles of key issues related to energy security
The importance of climate-risk factors for energy security most likely will increase in the future and for this reason, it is of utmost importance for policymakers to better understand whether climate-risk factors contain useful information for large swings in energy prices
The empirical findings that we have reported in this research can help to develop a better understanding of the link between climate risks and volatile energy prices

Summary

Introduction

A positive supply-shock like the one described above has been shown to negatively impact overall economic uncertainty [5,6], and to translate into lower oil-market volatility based on the well-established “Theory of Storage” [7,8] This theory stipulates that increases (decreases) in uncertainty tend to make the path of future aggregate demand of commodities, and as a result, of aggregate production less (more) predictable. We consider the role of climate-risk factors as predictors of the RV of heating oil and natural gas, given that some researchers have recently highlighted the need to obtain high-frequency forecasts of the volatility of these two energy prices [33,34,35].

Data and Forecasting Models

Forecasting Models

In-Sample and Out-Of-Sample Predictability Results

Implications for Economic Agents

Concluding Remarks