Speculative Storage Research Articles

Nonlinear price transmission and asynchronous price bubbles: empirical evidence from China’s agricultural futures and spot markets

ABSTRACT Previous studies on commodity price bubbles mainly focused on futures markets and ignored the performance of spot markets. Using the price data for corn and soybeans in China, this study identifies the exact bubble dates for the futures and spot markets, and finds asynchronous price bubbles between these two markets. Bubbles are more frequent for commodity spot prices, while the corresponding futures prices still dominate the process of price discovery. Further analysis reveals that, the lack of (immediate) linear transmission between the cointegrated prices may have inhibited bubble synchronization, and caused more spot price bubbles. The nonlinear transmission effects between the futures and spot prices suggest the existence of speculative storage and market power. This may further explain why spot price bubbles cannot be arbitraged away.

A stochastic optimal stopping model for storable commodity prices

In this paper, we propose a continuous time version of the well-known speculative storage model for commodity prices. But from the mathematical point of view this is not a trivial extension and needs careful consideration of the theory of stochastic stopping time combined with fixed point theory. We formulate the problem in a manner that the main objective of the storage model, known as the stationary rational expectations equilibrium (SREE), becomes a fixed-point of an operator which solves a free boundary problem and show that this operator under some conditions is a contraction. We also demonstrate the benefits of our continuous time model through a numerical algorithm.

Endogenous thresholds in energy prices: Modeling and empirical estimation

Spot prices or front-month futures prices for energy commodities can exhibit occasional sharp peaks and drops (even to negative values), accompanied by large backwardations or contangos and unusually low or high levels of working stocks. We present a model of storage arbitrage that rationalizes such episodes, relevant for markets for energy commodities such as petroleum, natural gas, or storable electricity, where free disposal is not available. Based on price data only, we offer an empirical approach to estimate key parameters that determine the dynamics of prices, including endogenous price thresholds that indicate lower and upper bounds on discretionary stocks. Price movements in the regime within these bounds are moderated by responses of speculative storage. In the two regimes where price is respectively above or below threshold prices, sharp price jumps are more likely. We are the first to prove consistency and asymptotic normality of a method of estimating this model on prices with endogenous jumps. We explore the behavior of our estimator for small samples, and illustrate its application using petroleum prices. Although the model structure and the distributions of the disturbances in the Euler equation are quite complex, a nice feature of our estimator is its simplicity; it is straightforward non-linear least squares. Moreover, our estimation approach is robust to the demand functional form and the distribution of the shocks.

Practices and damages encountered by wholesale traders during 'Kponan' yams (Dioscorea cayenensis-rotundata) storage in Abidjan, Côte d'Ivoire

Yam wholesalers who practice speculative storage sometimes suffer significant losses the level of which has been little studied. Thus, this work was carried out to study the practices and deterioration factors of 'Kponan' yam during storage. To achieve this, 51 yam wholesalers in 4 communes of Abidjan (Abobo, Adjamé, Yopougon and Treichville) were interviewed using a survey form. The data showed that according to storage practices, yams are preferentially grouped by variety (100%) and old yams separately (88.2%). Wholesalers (94.1%) regulate the storage temperature either by fans (23.5%), by air openings in the wall (25.5%), or by fans and air openings in the wall (45.1%). Decay was the most common damage among all wholesalers (100%), followed by weight loss (52.9%), mold (35.3%), injury (29.4%), cracking (23.5%), and sprouting (17.6%). Heat was the main cause of yam damage, followed by moisture (82.3%), animals (31.4%), field storage conditions (17.6%), chemical use during cultivation (17.6%) and sprouting (17.6%). This study shows that the storage and temperature control techniques employed by wholesalers are far from mitigating the heat that is the main cause of damage to 'Kponan' yam (Dioscorea Cayenenis-rotundata) during storage.

Commodity Price Modeling by Optimal Storage Time

We propose a modified version of the speculative storage model of Deaton and Laroque (1992) in a continuous-time framework. Unlike most of the literature, where either the demand or the price process are exogenously given, our framework models them endogenously for the storable commodities. This shows that how the commodities' economic characteristics like the demand elasticity and stylized facts like the price volatility can specify the prices. In addition, our model gives rise to the concept of the storage option and the optimal selling time. We prove the existence, and under very mild conditions, the uniqueness of the stationary rational expectations equilibrium (SREE), and introduce practical ways to approximate it. Finally, we conduct some sensitivity analysis to show the impact of the parameters on SREE.

The Financialization of Storable Commodities

I solve a dynamic equilibrium model of commodity spot and futures prices, incorporating an active futures market, heterogeneous risk-averse participants, and storage. When calibrated to data from the crude oil market, the model implies that financialization reduces the futures risk premium and increases correlation between futures open interest and the spot price level. However, there is no long-run increase in the mean spot price, and speculative storage generally attenuates financialization’s effect on spot price volatility. Therefore, financialization’s effect on spot price dynamics through storage arbitrage is likely modest, even if futures positions and risk premia are substantially altered.This paper was accepted by Gustavo Manso, finance.

On the behavior of commodity prices when speculative storage is bounded

This paper investigates the implications of bounded speculative storage, storage bounded from below at zero and above at a capacity, on commodity prices. Binding capacity mirrors the non-negativity constraint on storage and leads to negative price spiking and higher volatility when the market is in deep contango, i.e. low current prices at high stock levels. With bounded storage there is no need to restrict storage to be costly to ensure a rational expectations equilibrium. This allows the model to cover a wide range of storage technologies, including free and productive storage. We also provide an alternative expression for speculative prices that highlights the key role of the storage boundaries. The competitive equilibrium price is the sum of discounted future probability weighted boundary prices. The boundary prices can be viewed as dividends on commodities in storage reflecting the realization of economic profits from storage.

Estimating the Competitive Storage Model with Trending Commodity Prices

We present a method to estimate jointly the parameters of a standard commodity storage model and the parameters characterizing the trend in commodity prices. This procedure allows the influence of a possible trend to be removed without restricting the model specification, and allows model and trend selection based on statistical criteria. The trend is modeled deterministically using linear or cubic spline functions of time. The results show that storage models with trend are always preferred to models without trend. They yield more plausible estimates of the structural parameters, with storage costs and demand elasticities that are more consistent with the literature. They imply occasional stockouts, whereas without trend the estimated models predict no stockouts over the sample period for most commodities. Moreover, accounting for a trend in the estimation implies price moments closer to those observed in commodity prices. Our results support the empirical relevance of the speculative storage model, and show that storage model estimations should not neglect the possibility of long-run price trends. Copyright © 2016 John Wiley & Sons, Ltd.

Stationarity changes in long-run energy commodity prices

Situated at the intersection of the literatures on speculative storage and non-renewable commodity scarcity, this paper considers whether changes in persistence have occurred in long-run U.S. prices of the energy commodities crude oil, natural gas and bituminous coal. We allow for a structural break when testing for a break in persistence to avoid a change in the stochastic properties of prices being confounded by an unaccounted-for deterministic shift in the price series. We find that coal prices are trend stationary throughout their evolution and that oil prices change from stationarity to non-stationarity in the decade between the late 1960s to late 1970s. The result on gas prices is ambiguous. Our results demonstrate the importance of accounting for a possible structural shift when testing for breaks in persistence, while being robust to the exact date of the structural break. Based on our analysis we caution against viewing long-run energy commodity prices as being non-stationary and conclude in favor of modeling commodity market fundamentals as stationary, meaning that speculative storage will tend to have a dampening effect on prices. We also cannot reject that long-run prices of coal and, with some hesitation, gas follow a Hotelling-type rule. In contrast, we reject the Hotelling rule for oil prices since the late 1960s/early 1970s.

A financial engineering approach to pricing agricultural insurances

Purpose – The purpose of this paper is to introduce a continuous time version of the speculative storage model of Deaton and Laroque (1992) and to use for pricing derivatives, in particular insurances on agricultural prices. Design/methodology/approach – The methodology of financial engineering is used in order to find the partial differential equations that the dynamics of derivative prices have to satisfy. Furthermore, by using the Monte-Carlo method (and Feynman-Kac theorem) the insurance prices is computed. Findings – Results of this paper show that insurance prices (and derivative prices in general) are heavily influenced by market structure, in particular, the demand function specifications. Furthermore, through an empirical analysis, the performance of the continuous time speculative storage model is compared with the geometric Brownian motion model. It is shown that the speculative storage model outperforms the actual data. Practical implications – Since the agricultural insurances in many countries are subsidised by government, the results of this paper can be used by policy makers to measure changes in agricultural insurance premiums in scenarios that market experiences changes in demand. In the same manner, insurance companies and investors can use the results of this paper to better price agricultural derivatives. Originality/value – The issue of agricultural insurance pricing (in general derivative pricing) is of great concern to policy makers, investors and insurance companies. To the author’s knowledge, an approach which uses the methodology of financial engineering to compute the insurance prices (in general derivatives) is new within the literature.

A Staggered Pricing Approach to Modeling Speculative Storage: Implications for Commodity Price Dynamics

This paper embeds a staggered price feature into the standard speculative storage model of Deaton and Laroque (1996). Intermediate goods inventory speculators are added as an additional source of intertemporal linkage, which helps us to replicate the stylized facts of the observed commodity price dynamics. Incorporating this type of friction into the model is motivated by its ability to increase price stickiness which, gives rise to a higher degree of persistence in the first two conditional moments of commodity prices. The structural parameters of our model are estimated by the simulated method of moments using actual prices for four agricultural commodities. Simulated data are then employed to assess the effects of our staggered price approach on the time series properties of commodity prices. Our results lend empirical support to the possibility of staggered prices.

Taxing fossil fuels under speculative storage

Long-term environmental consequences of taxing fossil fuel usage have been extensively studied in the literature. However, these taxes may also impose several short-run macroeconomic policy challenges, the nature of which remains underexplored. This paper investigates the mechanisms through which environmental taxes on fossil fuel usage can affect the main macroeconomic variables in the short-run. We concentrate on a particular mechanism: speculative storage. Formulating and using a dynamic stochastic general equilibrium (DSGE) model, calibrated for the United States, with an explicit storage facility and nominal rigidities, we show that in designing environmental tax policies it is crucial to account for the fact that fossil fuel prices are subject to speculation. The existence of forward-looking speculators in the model improves the effectiveness of tax policies in reducing fossil fuel usage. Improved policy effectiveness, however, is costly: it drives inflation and interest rates up, while impeding output. Based on this tradeoff, we seek an answer to the question how monetary policy should interact with environmental tax policies in our DSGE model of fossil fuel storage. We show that, in an environment with no speculative storers, monetary policy should respond to output along with CPI inflation in order to minimize the welfare losses brought by taxes. However, when the storage facility is activated, responding to output in the monetary policy rule becomes less desirable.

Speculative storage in imperfectly competitive markets

Markets for many commodities are characterized by imperfectly competitive production as well as substantial storage by speculators who are attracted by significant price volatility. We examine how speculative storage affects the behavior of an oligopoly producing a commodity for which demand is subject to random shocks. Speculators compete with consumers when purchasing the commodity and then subsequently compete with producers when selling their stocks, resulting in two opposing incentives: on the one hand, producers would like to increase production to capture future sales in advance by selling to speculators; while on the other hand, they would like to withhold production to deter speculation, thereby eliminating the additional supply from speculators in future periods. We find that the incentive to sell to speculators can be quite strong, potentially resulting in prices sufficiently high to drive consumers from the market. Furthermore, these incentives are non-monotonic in the number of producers: speculative storage occurs more frequently in a relatively concentrated oligopoly than in the extremes of monopoly or perfect competition.

The feasibility of a European‐wide integrated CO2 transport network

AbstractThe European Union's ambition to achieve near‐total decarbonization by 2050 suggests a large role for carbon capture and storage (CCS), requiring the transport (mostly by pipeline) of CO2 from source facilities to appropriate sites for geological storage. Here, a network modeling approach is used to test the scale, structure, and estimated costs of an integrated European CO2 transport network for different amounts of CCS deployment. Models are optimized with the sole objective of creating the least cost pipeline network that joins all sources to sufficient storage for a 25‐year period of operation, and assume no restrictions on trans‐boundary transport of CO2, or due to topographical constraints. Results show that extensive CO2 pipeline networks are required to deliver the CCS contribution to decarbonization. Sufficient storage is available but is distributed such that even for low levels of CCS deployment, both offshore storage and trans‐boundary transport of CO2 are needed. Scenarios are run to test pipeline infrastructure requirements should onshore CO2 storage not be permitted, giving an estimated increase in CO2 transport infrastructure cost of 10–30% (€3–7 billion). Scenarios examining the effect of removing the more speculative storage potential in the Baltic, close to central and eastern European CO2 source clusters, reinforce the need to experimentally validate theoretical storage capacity estimates especially in the Baltic and North Sea.

Taxing Fossil Fuels Under Speculative Storage

This paper investigates the mechanisms through which environmental taxes on fossil fuelusage can affect the main macroeconomic variables in the short-run. We concentrate on aparticular mechanism: speculative storage. The existence of forward-looking speculators inthe model improves the effectiveness of tax policies in reducing fossil fuel usage. Improvedpolicy effectiveness, however, is costly: it drives inflation and interest rates up, whileimpeding output. Based on this tradeoff, we seek an answer to the question how monetarypolicy should interact with environmental tax policies in our DSGE model of fossil fuelstorage.

Taxing Fossil Fuels under Speculative Storage

This paper investigates the mechanisms through which environmental taxes on fossil fuel usage can affect the main macroeconomic variables in the short-run. We concentrate on a particular mechanism: speculative storage. The existence of forward-looking speculators in the model improves the effectiveness of tax policies in reducing fossil fuel usage. Improved policy effectiveness, however, is costly: it drives inflation and interest rates up, while impeding output. Based on this tradeoff, we seek an answer to the question how monetary policy should interact with environmental tax policies in our DSGE model of fossil fuel storage.

On Oil Price Shocks: The Role of Storage

Building on recent work on the role of speculation and inventories in oil markets, the paper embeds a competitive oil storage model within a DSGE model of the U.S. economy. This enables us to formally analyze the impact of a (speculative) storage demand shock and to assess how the effects of various demand and supply shocks change in the presence of oil storage facility. The paper finds that business-cycle-driven oil demand shocks are the most important drivers of U.S. oil price fluctuations during 1982–2007. Disregarding the storage facility in the model causes a considerable upward bias in the estimated role of oil supply shocks in driving oil price fluctuations. The results also confirm that a change in the composition of shocks helps explain the resilience of the macroeconomic environment to the oil price surge after 2003. Finally, speculative storage is shown to have a mitigating or amplifying role depending on the nature of the shock.

On the Sources and Consequences of Oil Price Shocks: The Role of Storage

Building on recent work on the role of speculation and inventories in oil markets, we embed a competitive oil storage model within a DSGE model of the U.S. economy. This enables us to formally analyze the impact of a (speculative) storage demand shock and to assess how the effects of various demand and supply shocks change in the presence of oil storage facility. We find that business-cycle driven oil demand shocks are the most important drivers of U.S. oil price fluctuations during 1982-2007. Disregarding the storage facility in the model causes a considerable upward bias in the estimated role of oil supply shocks in driving oil price fluctuations. Our results also confirm that a change in the composition of shocks helps explain the resilience of the macroeconomic environment to the oil price surge after 2003. Finally, speculative storage is shown to have a mitigating or amplifying role depending on the nature of the shock.

The behavior of commodity prices in Ethiopia

In an attempt to identify price stabilization strategies and rationalize public intervention in buffering markets, this article investigates the intertemporal dynamics of commodity prices in Ethiopia. A classical rational expectation model is modified to account for seasonal correlation of shocks. Model predictions are reduced to computable periodic threshold autoregression. Several nonlinearity tests are applied to detect threshold effects. A regime-switching normalized maximum likelihood method is formulated to estimate thresholds and threshold autoregression parameters using monthly data from Ethiopia for the period 1996–2006. The result indicates the presence of periodic price thresholds that could be formed as a result of speculative storage. Comparison of price movements below and above thresholds indicates that prices are more correlated below the thresholds than above them. However, the effect on error variance is not very strong. Temporal arbitrage, which is the gross return from speculative storage, appears to be modest. The long- and short-term implications of the findings are discussed within the context of ongoing policy debates.

Monopoly behaviour with speculative storage

We analyze the effects of competitive storage when the production of the good is controlled by a monopolist. The existence of competitive storers serves to reduce the monopolist's effective demand when speculators are selling and to increase it when they are buying. This results in the monopolist manipulating the frequency of stockouts, and hence the price-smoothing effects of competitive storage. We find that competitive storage affects both the level and the volatility of price under monopoly. The average price level is higher with storage due to the monopolist's desire to induce stockouts by occasionally keeping the price just at the level that induces a stockout. Although storage does reduce the volatility of prices under monopoly production, prices are more volatile than they would be under perfectly competitive production, even though stockouts occur less frequently under monopoly. These results are demonstrated through closed-form solutions of the two-period version of the model and computational solutions to the infinite horizon version of the model.