Abstract
The paper examines both the time-varying price and volatility transmission between US natural gas and crude oil wholesale markets, over the period 1990–2017. Short iterations suggest that neither commodity determines other’s returns, but sub-periods with very short-lived causal relationships exist. It can be asserted that the markets are decoupled, where unconventional production further enhances the already established commodities’ independence. Using Momentum Threshold Autoregressive (MTAR) cointegration methodology, we find evidence of positive asymmetry from crude oil to natural gas prices, i.e., oil price increases cause faster adjustments to natural gas prices than decreases. We also find that an 1% change of oil price has positive and significantly larger long-term impact (between 0.01% to 0.02%) to the gas price, compared to the negligible impact of gas to oil. Volatility transmission is examined using the Dynamic Conditional Covariance (DCC)-Generalized Autoregressive Conditional Heteroscedasticity (GARCH) methodology, presenting their time-varying correlation. Results show that both commodities influence each other’s volatility at the aggregate level. Finally, we conclude that both regional commodity markets are liquid and integrated, where the market fundamentals drive their price formulation. However, although markets are decoupled and not appropriate for perfect hedging of each other, the existence of bidirectional volatility transmission and their substitutability might be useful for diversified portfolio allocation.
Highlights
Crude oil, as well as its derivatives, such as gasoline and heating oil, are among the most commonly traded commodities for decades
We examine the time-varying relationship with in-sample and out-of-sample methodologies, the asymmetric price transmission, the long-term price impacts and the time-varying volatility transmission among the commodities
Since we examine a regionally integrated gas market and a globally integrated crude oil market, it is understood that oil prices are determined by more global economic fundamentals while gas prices may be affected by more regional factors, such as infrastructure sufficiency, i.e., it is understood that oil prices are determined by more global economic fundamentals while gas prices may be affected by more regional factors, such as infrastructure sufficiency, i.e., infrastructure bottlenecks like lack of distribution systems or low capacity pipelines might affect the supply side [18,19] or lack of exporting facilities might cause local glut and affect regional prices [36]
Summary
As well as its derivatives, such as gasoline and heating oil, are among the most commonly traded commodities for decades. Crude oil price is still serving as a benchmark for the pricing of other commodities, such as natural gas. The initial penetration of natural gas was based on the formation of long-term crude oil linked contracts, aiming at becoming a substitute of crude oil for industrial and heating purposes. The increasing volumes in natural gas trading has created dynamics for fully integrated natural gas markets, triggering the research on unveiling the time-varying linkages between crude oil and natural gas prices. The relationship between crude oil and natural gas prices has been strongly challenged in the US, as the fundamentals of crude oil and natural gas market changed considerably, due to the evolution of shale oil and shale gas. The rise of the unconventional oil production created oversupply conditions, which -together with the strategy of the Organization of the Petroleum Exporting Countries (OPEC)
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