Dynamics of petroleum markets in OECD countries in a monthly VAR–VEC model (1995–2007)

Abstract

AbstractThis paper contains some results of a study in which the dynamics of petroleum markets in the Organization for Economic Cooperation and Development (OECD) is investigated through a vector auto regression (VAR)–vector error correction model. The time series of the model comprises the monthly data for the variables demand for oil in the OECD, WTI in real term as a benchmark oil price, industrial production in OECD as a proxy for income and commercial stocks of crude oil and oil products in OECD for the time period of January 1995 to September 2007. The detailed results of this empirical research are presented in different sections of the paper; nevertheless, the general result that emerges from this study could be summarised as follows: (i) there is convincing evidence of the series being non‐stationary and integrated of order one I(1) with clear signs of co‐integration relations between the series; (ii) the VAR system of the empirical study appears stable and restores its dynamics as usual, following a shock to the rate of changes of different variables of the model, taking between five and eight periods (months in our case); (iii) we find the lag length of 2 as being optimal for the estimated VAR model; (iv) significant impact of changes in the commercial crude and products’ inventory level on oil price and on demand for oil is highlighted in our empirical study and in different formulations of the VAR model, indicating the importance of the changes in the stocks’ level on oil market dynamics; and (v) income elasticity of demand for oil appears to be prominent and statistically significant in most estimated models of the VAR system in the long run, while price elasticity of demand for oil is found to be negligible and insignificant in the short run. However, while aggregate oil consumption does not appear to be very sensitive to the changes of oil prices (which is believed to be because of the so‐called ‘rebound effect’ of oil (energy) efficiency in the macro level) in the macro level, the declining trend of oil intensity (oil used for production of unit value of goods and services), particularly when there is an upward trend in oil price, clearly indicates the channels through which persistent changes in oil prices could affect the demand for oil in OECD countries.