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Coping with Oil Price Volatility

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Coping with Oil Price Volatility ENERGY SECURITY Coping with Oil Price Volatility Robert Bacon Masami Kojima Energy Sector Management Assistance Program Energy Sector Management Assistance Program (ESMAP) Purpose The Energy Sector Management Assistance Program is a global technical assistance partnership administered by the World Bank and sponsored by bilateral offi cial donors since 1983. ESMAP’s mission is to promote the role of energy in poverty reduction and economic growth in an environmentally responsible manner. Its work applies to low-income, emerging, and transition economies and contributes to the achievement of internationally agreed development goals. ESMAP interventions are knowledge products including Copyright © 2008 free technical assistance, specifi c studies, advisory services, pilot projects, knowledge generation and The International Bank for Reconstruction dissemination, trainings, workshops and seminars, conferences and roundtables, and publications. and Development/The World Bank Group 1818 H Street, NW ESMAP’s work focuses on four key thematic programs: energy security, renewable energy, energy-poverty, Washington, DC 20433, USA and market effi ciency and governance. All rights reserved Governance and Operations Produced in the United States First printing August 2008 ESMAP is governed by a Consultative Group (the ESMAP CG) composed of representatives of the World Bank, other donors, and development experts from regions that benefi t from ESMAP assistance. The ESMAP Reports are published to communicate the results of ESMAP CG is chaired by a World Bank Vice President and advised by a Technical Advisory Group of ESMAP’s work to the development community with the least independent energy experts that reviews the Program’s strategic agenda, work plan, and achievements. possible delay. Some sources cited in this paper may be ESMAP relies on a cadre of engineers, energy planners, and economists from the World Bank, and from informal documents that are not readily available. the energy and development community at large, to conduct its activities. The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s) and should not Funding be attributed in any manner to the World Bank or its affiliated ESMAP is a knowledge partnership supported by the World Bank and offi cial donors from Australia, organizations or to members of its Board of Executive Directors Austria, Denmark, France, Germany, Iceland, the Netherlands, Norway, Sweden, the United Kingdom, or the countries they represent. The World Bank does not and the U.N. Foundation. ESMAP has also enjoyed the support of private donors as well as in-kind support guarantee the accuracy of the data included in this publication and accepts no responsibility whatsoever for any consequence from a number of partners in the energy and development community. of their use. The boundaries, colors, denominations, and other information shown on any map in this volume do not imply Further Information any judgment on the part of the World Bank concerning the For further information, a copy of the ESMAP annual report, or copies of project reports, please visit the legal status of any territory or the endorsement or acceptance ESMAP Web site, www.esmap.org. ESMAP can also be reached by email at [email protected] or of such boundaries. by mail at: The material in this publication is copyrighted. Requests for permission to reproduce portions of it should be sent to the ESMAP ESMAP Manager at the address shown in the copyright notice c/o Energy, Transport and Water Department above. ESMAP encourages dissemination of its work and will The World Bank Group normally give permission promptly and, when the reproduction 1818 H Street, NW is for noncommercial purposes, without asking a fee. Washington, DC 20433, USA Tel.: 202-458-2321; Fax: 202-522-3018 ENERGY SECURITY Special Report 005/08 Coping with Oil Price Volatility Robert Bacon Masami Kojima Energy Sector Management Assistance Program Contents Acknowledgments ix Abbreviations and Acronyms xi Executive Summary xiii 1 Context 1 Oil Price Trends 1 Effects of Oil Price Volatility 2 Report Structure 3 2 Measurement of Oil Price Volatility 5 Trends, Cycles, and Volatility: Measurement and Statistical Analysis 5 Statistical Analysis of Oil Prices 8 3 Statistical Analysis of U.S. Gulf Coast Prices 9 Are Crude Oil Prices Stationary? 9 Are Oil Product Prices Stationary? 10 Construction of Filtered Series 10 Volatility of Returns 11 4 Application to Prices in Developing Countries 19 Chile 19 Ghana 21 India 23 The Philippines 24 Thailand 25 Observations 27 5 Hedging 29 Role of Hedging 29 Hedging with Futures Contracts 31 Costs of Running a Hedging Program 33 Estimation of Hedge Ratios, the Effi ciency of Hedging, and Returns from Hedging 35 Use of Options 39 Issues in Operating an Oil Hedging Program 41 6 Security Stocks and Price Hikes 47 Supply Disruptions 47 The Operation of a Two-Period Price-Smoothing Security Stock Scheme 50 Simulation of a Security Stock Scheme between 1986 and 2007 52 International Experience with Strategic Petroleum Reserves 56 iii iv Special Report Coping with Oil Price Volatility 7 Price-Smoothing Schemes 59 Setting a Target Price 59 Case Studies in Price Smoothing 65 Assessment 67 8 Tackling Oil Intensity and Diversifi cation 69 Oil Share of GDP and Intensity 69 Relative Price Levels and Price Volatility 72 Energy Diversifi cation Index and Oil Share of Primary Energy 76 Policies for Reducing Dependence on Oil 78 9 Conclusions 81 Statistical Analysis of Price Volatility 81 Hedging 83 Strategic Stocks 84 Price-Smoothing Schemes 84 Reducing the Importance of Oil Consumption 84 Annexes 1 Impact of Fiscal Parameters on Government Oil Revenue 87 2 Statistical Methods 93 3 Statistical Analysis of U.S. Gulf Coast Prices 97 4 Statistical Analysis of Developing Country Prices 115 5 Hedging Parameters 141 6 Price-Smoothing Formulae 145 Glossary 147 References 149 Boxes 5.1 Sasol’s Hedging Experience 29 6.1 Experiences with Other Commodities 47 Figures 1.1 Monthly Average Spot Price of WTI Crude 1 3.1 Weekly Nominal Prices of WTI Crude and HP Filter 11 3.2 Weekly Real Prices of WTI Crude and HP Filter 11 3.3 Weekly Real Prices of Gasoline in the U.S. Gulf Coast and HP Filter 11 3.4 Returns on Weekly Real WTI Crude Prices 12 3.5 Returns on Weekly Real Gasoline Prices in theU.S. Gulf Coast 12 5.1 Spot and Futures Prices of WTI Crude 43 7.1 WTI Crude Monthly and Six-Month Moving Average Prices 61 7.2 Cumulative Cost of Regulating the Price of Crude Oil with Lagged Three- and Six-Month Moving Averages 62 7.3 Thai Oil Fund Financial Status 66 7.4 Actual and Hypothetical Diesel Prices in Thailand, January 2002–September 2007 66 8.1 Historical Oil Share of GDP for Select Countries 70 8.2 Historical Oil Intensity for Select Countries 71 8.3 Historical Oil, Gas, and Coal Prices 72 8.4 Volatility of Historical Oil and Coal Prices 74 8.5 Volatility of Historical Gas and Coal Prices 74 8.6 Historical HHDI for Select Countries 77 8.7 Historical Oil Share of Primary Energy for Select Countries 78 A1.1 Production Profi le of Each Field 87 Contents v A1.2 Aggregate Production Profi le of All Fields 87 A1.3 Oil Prices Used in the Calculations 88 A1.4 Production-Sharing Revenue Flow 88 A1.5 Government Revenue from First Field to Come on Stream 90 A1.6 Government Revenue from Sixth Field to Come on Stream 90 A1.7 Government Revenue from All Fields 90 A3.1 Forecast of Returns of Logarithms of WTI Crude Daily Spot Prices and Variance of Returns, April 4–November 14, 2007 104 Tables 1 Ratio of Price Increase in U.S. Dollars to Increase in Local Currency Units, January 2004–January 2008 xiv 2 Statistics on Monthly Spot Oil and Oil Product Prices xiv 3.1 ADF Test Results for WTI Crude Oil 9 3.2 ADF Test Statistics for Monthly U.S. Gulf Coast Oil Product Prices 10 3.3 Standard Deviation of Returns for Logarithms of Nominal WTI Crude and U.S. Gulf Coast Oil Product Prices 12 3.4 Variance Equality Tests for Returns for Nominal WTI Crude and U.S. Gulf Coast Oil Product Prices 14 3.5 GARCH Analysis of Returns of Logarithms of Nominal Daily Prices 15 3.6 GARCH Analysis of Returns of Logarithms of Nominal Weekly Prices 16 3.7 GARCH of Returns of Logarithms of Nominal Monthly Prices 17 3.8 Runs on Cumulative Cycles of Nominal Prices, September 1995–March 2007 17 4.1 Difference between Percentage Price Increase in U.S. Dollars to That in Chilean Pesos 20 4.2 GARCH Analysis of Returns of Logarithms of Nominal Monthly Prices in Chilean Pesos 21 4.3 Cumulative Cycles of Nominal Monthly Chilean Prices, July 1999–March 2007 21 4.4 Difference between Percentage Price Increase in U.S. Dollars to That in Ghanaian Cedis 22 4.5 GARCH Analysis of Returns of Logarithms of Nominal Monthly Prices in Ghanaian Cedis 22 4.6 Cumulative Cycles of Nominal Monthly Ghanaian Prices, July 1999–March 2007 22 4.7 Difference between Percentage Price Increase in U.S. Dollars to That in Indian Rupees 23 4.8 GARCH Analysis of Returns of Logarithms of Nominal Monthly Prices in Indian Rupees 23 4.9 Cumulative Cycles of Nominal Monthly Indian Prices, July 1999–March 2007 24 4.10 Difference between Percentage Price Increase in U.S. Dollars to That in Philippine Pesos 24 4.11 GARCH Analysis of Returns of Logarithms of Nominal Monthly Prices in Philippine Pesos 25 4.12 Cumulative Cycles of Nominal Monthly Philippine Prices, July 1999–March 2007 25 4.13 Difference between Percentage Price Increase in U.S.
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