Crude or Re fined: Identifying Oil Price Dynamics through the Crack Spread

Abstract

This paper proposes a new methodology for differentiating oil demand and supply shocks using the information content of forward-looking asset prices for crude oil and refined products. Building upon the industry folk wisdom that demand and supply shocks have asymmetric passthrough dynamics through the product crack spread, the paper provides a new identification scheme without using quantity-based data. Our results suggest that the price rises of the late 1970s had a demand-driven component, the 1990-91 Gulf War shock reacted both to supply and precautionary demand shocks, the price spike in 2008 was driven more by expectations of future supply constraints than immediate demand pressures, and the recent collapse of prices in 2014 had both a demand and supply component. Oil demand and supply shocks, by our decomposition, are also shown to have different impacts on macroeconomic variables such as industrial production, unemployment, core inflation, and the Fed Funds rate, with implications for formulating an effective policy response to oil shocks.