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OIL MARKETS

# Non-market forces significantly affect oil prices

### Subjects

Non-market effects, such as strategic decisions by the Organization of the Petroleum Exporting Countries, energy legislation and speculative bubbles, move crude oil prices away from the level implied by supply and demand for extended periods. These effects should be more proactively monitored and regulated to suit national and international objectives.

## Messages for Policy

• Non-market forces — such as strategic moves by key players such as OPEC, political events, panic buying and speculative bubbles — move crude oil prices away from the level implied by market fundamentals by large amounts for extended periods.

• These deviations can transfer billions of dollars between consumers and producers and between oil producing and oil consuming nations.

• It should not be assumed that market fundamentals always determine price in the oil market.

• The role of non-market forces in changing prices should be quantitatively monitored.

• Policy makers should be more proactive in regulation of the non-market forces and their effects, in service of economic, environmental and welfare goals.

BASED ON Kaufmann, R. K. & Connelly, C. Nature Energy https://doi.org/10.1038/10.1038/s41560-020-0549-1 (2020).

## The policy problem

Oil prices are affected by factors other than demand and supply fundamentals. The effects of strategic moves by major players such as the Organization of the Petroleum Exporting Countries (OPEC), panic buying or speculative bubbles are expected by industry analysts to distort markets. These non-market forces are often downplayed or ignored by economists because they are hard to measure. Policy makers thus assume that price changes reflect supply and demand and/or that price deviations are short-lived. They fear that interventions may have negative effects that are larger than the benefits and as a result they do not act. Indeed, there is little policy to discourage panic buying and speculative bubbles. Better quantification of effects from phenomena such as panic buying and speculative bubbles is needed so that policy makers can account for their effects and make active decisions about their regulation.

## The findings

Proxies for supply and demand accurately account for oil prices in 138 of 313 quarters from January 1938 to March 2018. In the other 184 quarters, reduced accuracy creates nine regimes when oil prices deviate from the level implied by supply and demand. Of these nine regimes, two are associated with policy interventions to suppress price increases. The other seven are associated with non-market forces, such as strategic changes by OPEC, panic buying or speculative bubbles. This historical analysis of the oil market indicates that factors other than supply and demand have a large effect on prices for extended periods (with the shortest regime being a year and the longest being more than two decades). By summing the additional price paid for oil consumed in the US, we show that in recent regimes, speculative bubbles transferred US$42.9 billion from US consumers to US oil producers and transferred US$87.4 billion from the US economy to oil exporting nations. This suggests significant economic losses.

## The study

We identify periods when non-market factors move the price of crude oil away from the level implied by supply and demand (that is, market fundamentals) and the size of these price deviations. To do so, we estimate the relation between oil prices and proxies for oil supply and demand, such as production by a dominant producing organization (for example OPEC in recent times), the amount of oil in storage and the rate at which refineries convert crude oil to useful products. This analysis is supplemented with a statistical procedure that identifies periods when the proxies for supply and demand imply values for oil prices that differ from observations in a statistically significant manner. We call these periods price regimes and explain their effects using non-market forces — such as changes in who owns oil fields, panic buying or speculative bubbles — that are described by industry analysts.

## References

1. Hamilton, J. D. Oil and the macroeconomy since World War II. J. Polit. Econ. 91, 228–2248 (1983). Pioneering work that connects changes in oil prices to non-economic factors and how price increases slow economic activity.

2. Yergin, D. The Prize: The Epic Quest for Oil, Money, & Power (Simon & Schuster, 1991). Detailed chronlogy of political events that shape oil prices.

3. Kaufmann, R. K., Dees, S., Karadeloglou, P., Sánchez, M. & Sanchez, M. Does OPEC matter? An econometric analysis of oil prices. Energy J. 25, 67–90 (2004). Statistical analysis of the relation between oil prices and proxies for oil supply and demand.

4. Kilian, L. Not all oil price shocks are alike: Disentangling demand and supply shocks in the crude oil market. Am. Econ. Rev. 99, 1053–1069 (2009). Attributes price changes since the 1970s to unexpected changes in market fundamentals.

5. Kaufmann, R. K. The role of market fundamentals and speculation in recent price changes for crude oil. Energy Policy 39, 105–115 (2011). Evidence for a speculative bubble based on break-downs in previous relations among measures of the oil market.

## Author information

Authors

### Corresponding author

Correspondence to Robert. K. Kaufmann.

## Ethics declarations

### Competing interests

The authors declare no competing interests.

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