Crude oil: Commodity or financial asset?

Abstract

We examine the relation among daily returns to crude oil prices, equity prices, and commodity markets by modifying previous efforts in two important ways; expanding the model to include the equity price for an oil-producing firm, ConocoPhillips, which ameliorates omitted variable bias and estimating the expanded model using the Kalman Filter, which reduces uncertainty associated with OLS estimates from rolling windows. Consistent with the notion of a commodity price beta for oil industry stocks, there is a positive correlation between returns to the spot price of WTI and ConocoPhillips. This correlation indicates not all price changes in crude oil are expected to persist; indeed, some of the price reductions associated with the Asian Financial crisis and the price increase associated with the 2008 price spike are not included in our estimate for long-run prices. In 2008:Q4, the correlations between daily returns to crude oil and equities flip from negative to positive. We hypothesize that this flip is triggered by a large reduction in interest rates in the fourth quarter of 2008, which is associated with a reduction in convenience yields and a change from backwardation to contango in futures markets. These changes increase the returns to holding crude oil as a financial asset relative to holding oil as a commodity.