The impact of supply changes on the relationships between global oil benchmarks

Abstract

The global oil market witnessed considerable supply changes between 2010-2015, most
notably from the USA where vast discoveries in rock formations have catapulted the USA to
be among the top three oil producers globally. This has altered the global oil supply map and
has had major implications for the market. An examination of the existing literature shows that
many of the assumptions made regarding the global oil market do not factor in the new oil
supply map. Another notable omission in the literature is the consideration given to the Russian
oil blends. The new dynamics require a re-examination of the interconnected nature of the
global oil market. This study addresses this by looking at the relationship between globally
traded blends of oil; is there a long-run equilibrium relationship between, for example, oil sold
in the USA and oil sold in the UK and has it changed in light of changing oil supply dynamics?
Oil market transactions price against one or more benchmark blends, notably West Texas
Intermediate, from the USA and Brent, drilled in European waters. Other, less publicly
recognised benchmarks exist based on the quality of oil, where it is drilled and where it is sold
to. These benchmarks also provide important pricing data to the market. Movements in the
price of one benchmark can result in changes in the price of other benchmarks. This is based
upon a long-run equilibrium relationship where the movements in the price of one oil blend are
cointegrated with the movements in the price of one or more benchmark blends.
In the extant literature the cointegration debate posits alternative views of the global oil market
either being a homogenous pool of resources versus a segmented market based upon inherent
qualities and markets served. This study examines the data for evidence of these long-run
relationships and asks to what extent they have changed over time? Do cointegrating
relationships exist in the global market for crude oil between blends of crude with different
properties and how have the changes from 2010-2015 in US oil production affected these
cointegrating relationships? Furthermore, are the relationships static through time or are there
structural breaks that prices adapt to? Do all markets adjust at the same pace to these structural
breaks?
The study was designed around the use of an ARDL bounds test for cointegration using
monthly data for six global benchmarks in the period 1996 to 2018. The results show a
cointegrated market that prices predominantly from the European based blend, Brent. It finds
evidence of the importance of Russian oil to the market. It confirms that US oil decouples from
the cointegrated price relationships at the same time as new discoveries from Texas and the
Dakotas come on stream, around 2011. The growing role of Dubai based oil due to its role in
pricing exports to Asia is supported. There is also evidence of a strategic shift in OPEC and
Saudi Arabian policy in 2014. Moreover, the presence of structural breaks in the relationships
between blends is confirmed with increasing speeds of adjustment to price innovations over
time perhaps due to increased financialisation of the market. Overall, the study finds support
for a global cointegrated oil market but with some relationships stronger than others based on
quality but more importantly on the markets served.

Date of Award	2021
Original language	English
Supervisor	Sushil Mohan (Supervisor)