Well, Oil be damned…
Interdependence In The Global Oil Market
For those of us who drive (or noticed), remember back in April when the price of the ol’ Black-Gold dropped to record lows? What a time to be alive for us consumers. The indisputable reality that the oil commodity is a fundamental driver to most economic activities. Having profound impacts on major economic variables and decision-making processes.
But why should I care?
In the case of Australia, importing roughly 80% of transport oil from overseas (Pearce, 2013). Makes Australia’s fuel prices largely correlated to benchmarks of Asia-pacific. Tapis crude, produced in Malaysia is often used as a price reference for Asia and Australia. The unique blend for Tapis crude is well considered to be the most expensive oil with the highest quality, extra light and with relatively lower sulphur content (Mohd Nasir, Ismail and Abdul Karim, 2018). Heavier, sour crude oils — such as Western Canadian Select — are less expensive than lighter, sweeter oil — such as West Texas Intermediate (WTI).
Okay Okay, by now I’d probably lost some of you. Just so that we are all on the same page, here is roughly how the various oil companies work out to be:
Throughout the 2000, it has been well established that OPEC members controlled much of the oil reserves and global influence. As with the nature of oligopolies, this dominant figure is bound to exert its influence and ignore the interests of smaller companies. Generally, the price of oil is a spot price for a barrel of benchmark crude oil. According to Ji and Fan (2016), after the evaluation of 24 crude oil prices; they found that markets such as the US, Angola, and Saudi Arabia, made up the fundamental global oil market. While those in Southeast Asian countries and those in the East constitutes the secondary market (Zhang, Ji and Kutan, 2019).
To appropriately capture a global overview on oil markets. Today, we will focus on companies such as West Texas Intermediate (WTI), Tapis Crude Oil, Brent Oil, Dubai Petroleum, Bonny Light Oil and Midas Oil & Gas. These companies were selected based on geographic distribution, data availability and the importance of the market, representing America, South East Asia, Europe, the Middle East, Africa and the Asia Pacific respectively.
Market Interdependance
The international oil markets are particularly unique due to their structure of interdependence. In a research conducted by Zhang, Qiang and Juthan, a vector autoregressive model was used to determine connectedness between dynamic behaviour and spillover effects across seven major crude oil prices. Their analysis allowed for the quantifying of systemic risks in financial markets. Results show support of Adelman’s (1984) claim that global crude oil prices tend to move in unison. Suggesting that the global crude oil market can be treated as “one great pool”. Despite evidence from this paper that suggests total connectedness within results in return and volatility, it does not completely rule out regional heterogeneity in the crude oil market.
Connectedness in Returns
Results from this model (Figure 1) depicts a total uniformed connectedness amongst oil companies to be 81.86%. Suggesting a closely knitted international oil market in-line with the “one great pool” hypothesis. The results also enforce the idea that the primary contributors to oil prices originated from Brent Oil, Dubai Petroleum and Bonny Light Oil. While the other four showed to be net receivers (Zhang, Ji and Kutan, 2019).
These figures showed a significant but uniformed spike during key periods of economic distress. Such as the 2008 global financial crisis, as well as future uncertainty in 2016, with oil prices plunging from the start of the year due to overcapacity, as a result of increased shale oil production in the U.S and rising output from OPEC.
Connectedness in Volatility
Similarly, results from this model (Figure 2) depicts a total uniformed connectedness in volatility amongst oil companies to be 73.19%. Providing more evidence that regional crude oil markets are similarly linked. However, it is important to note subtle differences that emerge amongst the structure of volatility spill-over than in the return connectedness. East and Asian groups such as Tapis, Daqing, and Minas remain at the bottom of the volatility mechanism, gaining a much higher share of information from the system compared to the return case. Tapis Crude Oil, for example, had negative net volatility of 5.49%, which is a 134% change from its return system (Zhang, Ji and Kutan, 2019).
Also, the 2008 global financial crisis significantly increased the level of connectedness between markets. With other patterns portraying similar results to the return case, volatility spill-over effects were reduced slightly after the global financial crisis but returned to a high levels after the fact. Showing a level of uncertainty within the international crude oil market.
OPEC is a complicated organisation, with multifaceted influence on international oil markets. Having said that, it does not ignore the impacts of global factors, such as international economic developments, and trade that affects the behaviour of its members and overall oil markets. Besides, inevitable oil demand risks are evident due to improvements in energy efficiency and the mass adoption of renewable energy sources (Qi and Yang, 2018). Additionally, the price premium paid by Asian countries for crude oil and natural gas adds to the price volatility and uncertainty within foreign exchange rate markets, exacerbating instability in supply-side risks in oil markets.
So what does this mean for you and me?
Our global interconnectedness hints to an often dismissed but crucial conclusion, in this little place we call home, we mustn't forget that the prosperity of a nation is largely correlated to that of its neighbours. We spend time and time again focusing on the endeavours undertaken by our cousins to the West, that we often neglect the deep history and intricacies of our own region. No matter how much we would like to cling onto our personal beliefs and ideologies, shouldn’t we not take into account the success of our neighbours?
Article was written and prepared by Richie Dharma.
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Resources:
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Pearce, P., 2013. The role of motor vehicle taxes in shaping Australia’s oil policy. The Tax Specialist, 17(2), p.75.
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