Not all demand oil shocks are alike: disentangling demand oil shocks in the crude oil market

DOIhttps://doi.org/10.1108/17544401111106798
Date08 February 2011
Pages28-44
Published date08 February 2011
AuthorZhuo Li,Hui Zhao
Subject MatterEconomics
Not all demand oil shocks are
alike: disentangling demand oil
shocks in the crude oil market
Zhuo Li
Department of World Economy, Wuhan University, Wuhan,
People’s Republic of China, and
Hui Zhao
China Construction Bank, Qingdao, People’s Republic of China
Abstract
Purpose – The purpose of this paper is to re-examine the structural origins of international crude oil
price fluctuation.
Design/methodology/approach – The paper establishes a structural vector autoregression model
based on the generalized supply and demand analysis of crude oil price fluctuation and performance
the structural decomposition of price shocks with impulse response analysis of those factors.
Findings – It is found that four kinds of structural shocks derived from the generalized supply and
demand analysis are the essential determinants of crude oil prices fluctuation. On one hand, similar to
Kilian’s results, the supply side shocks – both the exogenous geopolitical ones and other oil supply
shocks have little influence. Whereas, the demand side shocks – both the aggregate demand shock
and the oil market-specific demand shock have prominent effects. On the other hand, with the
expanded sample range, it is found that the dynamic characteristic of the impulse response of oil price
to demand side factors is not only incompatible with the basic economic theory, but also clashes with
Kilian’s statement based upon his research. It is conjured that the incompatibility comes from the
ignorance of the finer decomposition of demand side factors. To decompose those demand side factors
further, the US dollar liquidity was added into the model. The results show that the impact of US dollar
liquidity on the fluctuation of oil prices cannot be ignored. The argument that ascribes the soaring
international crude oil price to China’s economic growth lacks theoretical and empirical evidence.
Originality/value – The paper contributes marginally to the research on the structural origins of
international crude oil price fluctuation and sheds light on the possibility of finer decomposition of
demand side oil shocks.
Keywords Mineral oils, Pricepositioning, Economic fluctuations,US dollar, Liquidity, Demand
Paper type Research paper
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1754-4408.htm
The title of this paper comes from Kilian’s (2009) “Not all oil price shocks are alike: disentangling
demand and supply shocks in the crude oil market”, American Economic Review, Vol. 99 No. 3,
pp. 1053-69.
This paper is a part of research on the international oil price fluctuations, strategic oil reserves
and national energy security (ID: 07JC790065) which is a project of the Humanities and Social
Science Fund, the influence of risi ng international oil prices on Chin a and China’s
countermeasures (ID: 08BGJ012) which is a project of National Social Science Fund and the oil
price fluctuation and its impacts on China which is a project of New Century Researcher Plan
(2008).
JCEFTS
4,1
28
Journal of Chinese Economic and
Foreign Trade Studies
Vol. 4 No. 1, 2011
pp. 28-44
qEmerald Group Publishing Limited
1754-4408
DOI 10.1108/17544401111106798
I. Introduction
Since the 1970s of the twentieth century, the international crude oil price has been going
up and down, showing daily volatile oscillation as well as several clear-cut rising and
falling segments. Figure 1 shows the crude oil price fluctuation from January 1974 to
March 2010 and it shows that the price has been rising quickly since 2002. The highest
nominal price jumped to 127.77 US dollars/barrel (monthly average) in July 2008, which
was an increase of nearly 12 times compared to 9.59 US dollars per barrel in January
1974. Meanwhile, the real price rose from 12.27 US dollars per barrel in February 1999 to
113.47 US dollars in July 2008, an increase of nearly nine times. Huge fluctuation in crude
oil price has far-reaching implications on the world economy; many studies have been
done in the literature since 1970s[1].
In recent years, reconsidering the structural origins of crude oil price fluctuation is
one of the hot topics on studies about international oil issues (Hamilton, 2005; Kilian,
2009). During the 1970s and 1980s in the last century, the main causes of oil price
fluctuation was mainly attributed to exogenous factors such as geopolitical issues,
military conflicts, etc. (Hamilton, 1983). There appeared a set of influencing studies, such
as Kilian’s and Hamilton’s, which advocated recently that even restricted in the
macroeconomic structural factors the origins of fluctuation in crude oil market is not
limited to, or even not determined mainly by exogenous (supply) factors. Those macro
demand factors are important driving forces of oil price volatility and the relative weight
of demand side effects increased gradually and significantly since 2002 (Kilian, 2006,
2009). The basic idea of such research (methods) relies heavily upon the integrated
analysis of the impact of demand and supply side factors of oil price fluctuation. There
appeared a theoretical consensus among quite a few of US mainstream scholars that the
demand side shocks not only had been the decisive factor in the rising oil price since
2002, but also the most important explanatory variables of oil price fluctuation since
January 1973[2].
As we know, the Chinese economy has been undergoing a sustained and rapid growth
since the reform and opening up. Entering the twenty-first century, the opportunity to
join WTO made China blend more extensively into the world economic circulation and
the contribution of China’s economic growth to the whole world becomes more and
Figure 1.
Crude oil price movement
(unit: US$/barrel)
0
20
40
60
80
100
120
140
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
Nominal crude price Real crude price
Notes: The oil price is import crude oil price of the US refiners; the nominal price is deflated by the
consumer price index (CPI) of USA with 2005 as the base (CPI in 2005 = 100)
Source: US Energy Information Administration (2010)
Disentangling
demand oil
shocks
29

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