Pandemics and Oil Shocks

Abstract

At the onset of coronavirus in January 2020, crude oil price was around $51.63 per barrel. But the subsequent spread of the virus across countries all over the world adversely impacted the day-to-day functioning of major industries, corporations, and economies. This adverse impact was amplified by the lockdown measures by governments who were justifiably concerned about the potential devastating effect of the pandemic. As the outbreak intensified, so did oil prices plunge into historic lows (at some point, negative). Is the precipitous drop in oil prices due to the COVID-19 pandemic or are there potentially other factors at play? In this paper, we investigate this question using a pentavariate structural vector autoregression (SVAR) model. Specifically, we identify an exogenous oil price shock arising from the pandemic together with the traditional underlying supply, demand, and financial market shocks to global crude oil markets. We find that a pandemic shock causes a delayed adverse effect on oil prices. In addition, our findings lend support to the view that changes in financial market conditions that affect financial investment decisions also play a significant role in oil price movements. There is however no evidence of a strong impact emanating from the brief Russia-Saudi price war. We also compute the forecast error variance decomposition and find that the impact of a pandemic shock together with aggregate demand and financial market shocks are not trivial in the short run. Taken together, the findings underscore the fruitfulness of research aimed at better understanding the effects of a pandemic shock on oil price movements and highlight the need for policymakers and market stakeholders to explicitly consider global health conditions when analyzing the causes and consequences of oil price shocks.