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Detecting West Texas Intermediate (WTI) Prices’ Bubble Periods

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Detecting West Texas Intermediate (WTI) Prices’ Bubble Periods energies Article Detecting West Texas Intermediate (WTI) Prices’ Bubble Periods Theodosios Perifanis Energy and Environmental Policy Laboratory, Department of International and European Studies, University of Piraeus, 18532 Piraeus, Greece; [email protected]; Tel.: +30-210-414-2657 Received: 8 June 2019; Accepted: 8 July 2019; Published: 10 July 2019 Abstract: Oil prices have had considerable surges and bursts since the first oil crisis of 1973. Until then its price was stable, with almost zero volatility. Since then, apart from the two oil crises of 1973 and 1978/9, oil prices had consecutive bubble episodes like the surges up to 2008 and 2014 and their successive bursts, respectively. The trace of these bubble periods is of crucial importance for policymakers, since their drivers and consequences impact global economic developments. Phillips et al. and Phillips et al. methodologies are applied to detect whether West Texas Intermediate prices experienced bubble periods. Both methodologies suggest that WTI prices experienced explosive episodes, which could be fundamentally, speculatively, or politically attributed. Some suggested periods coincide for both methods, but the second methodology seems to be more sensitive than its predecessor is, leading to better bubble detection but also to identification of non-existent bubbles. The identified bubble periods are compared to relevant research in the literature concerning their presence, duration, and explosiveness. The main goal of the research, apart from the detection of bubbles’ presence and duration, is to identify the causal underlying reasons for each explosive episode. Further, we compare the start and endpoints of each bubble episode with time-points when structural changes occurred. The contribution of the paper is that it clearly defines the bubble episodes with their corresponding drivers. The paper identifies the importance of market fundamentals’ swifts in explaining the bubble periods. The findings of the papers can help policymakers and other stakeholders to monitor oil price shifts and their underlying reasons, and then proceed with prompt actions. Since bubble episodes are fundamentally explained, then the practical utility is that by focusing on the market fundamentals, stakeholders can avoid actions that could result in market failures. Keywords: WTI; bubbles; explosive prices; Augmented Dickey Fuller (ADF) test; PWY (2011); PSY (2015) 1. Introduction The global oil market suffered heavy disruptions during many periods in the past. These periods start from the first oil crisis of 1973. The second came a few years later in 1978–1979. In the 80s, it was the OPEC collapse of 1986 [1]. The oil price surged in 1990/1991; time spot coinciding with the Gulf War. The oil price was increasing from 2001 to 2008, when the global financial crisis occurred. From 2011 to 2014, it remained at high levels until a burst occurred, reaching the lowest level in 2016. Since 2016, the price has increased. It is easily understood that the oil price has followed a pattern since 1973, in which a hike is followed by a burst and vice versa. This course with structural breaks, sudden upward or downward, called jumps reflect the high volatility of the market. The duration of these movements is also not the same. It took more than three months for oil price to peak in 1991, but seven years between 2001 and 2008 (Figure1). Energies 2019, 12, 2649; doi:10.3390/en12142649 www.mdpi.com/journal/energies Energies 2019, 12, 2649 2 of 16 Energies 2017, 10, x FOR PEER REVIEW 2 of 16 Figure 1. RealReal Monthly Monthly West West Texas Texas Intermediate Intermediate (W (WTI)TI) Price—Nominal Price—Nominal WTI WTI CPI CPI (Consumer (Consumer Price Price Index) deflated,deflated, Author’s calculations, source: FRED. Testing of bubblebubble episodesepisodes inin financialfinancial marketsmarkets isis thoroughlythoroughly conducted.conducted. The main debate is whether financialfinancial markets are eefficientfficient andand rational,rational, oror driven by speculation and exuberance. Market participants andand experts experts might might be hesitantbe hesitant to explain to explain whether whether a period a period of extreme of extreme increases increases or decreases or hasdecreases to do withhas to rational do with expectations. rational expectations. Regulators Regu are alsolators in are need also for in robust need empiricalfor robusttools empirical to identify tools bubbleto identify periods bubble inorder periods to detectin order them, to detect if not intervenethem, if not during intervene them. Theduring majority them. ofThe literature majority uses of theliterature world uses “bubble” the world to refer “bubble” to periods to refer of explosiveness. to periods of explosiveness. This is the period This ofis the an abruptperiod of asset’s an abrupt price increase,asset’s price that increase, ends with that a ends collapse. with Nevertheless,a collapse. Nevertheless, what is the what fundamental is the fundamental value of oil? value There of oil? are noThere widely are acceptedno widely processes accepted for processes calculating for this calculating kind of value, this kind and itof is constantlyvalue, and changingit is constantly as new informationchanging as entersnew information the market. Apartenters fromthe market. the liquidity, Apart which from isthe present liquidity, in the which market, is oilpresent is a storable in the commodity.market, oil is Storages a storable and commodity. oil glut are playing Storages a crucialand oil role glut in are the playing oil price a formulation, crucial role asin Perifanisthe oil price and Dagoumasformulation, [2 as] suggest. Perifanis Many and Dagoumas use Pindyck’s [2] [sugge3] methodst. Many to reach use Pindyck’s the fundamental [3] method value to of reach oil. Thethe conveniencefundamental yieldvalue is of defined oil. The as convenience the sum of discountedyield is defined oil inflows as the orsum “dividends”, of discounted which oil isinflows the total or benefit“dividends”, of inventory which holdingis the total for benefit the physical of inventory holder, holding in contrast for tothe the physical owner holder, of a financial in contrast contract to the on theowner respective of a financial asset. contract on the respective asset. Furthermore, we we do do not not know know which which the the driving driving caus causalal forces forces are, are, even even if we if we know know that that the theoil oilmarket market runs runs a period a period of ofexplosiveness. explosiveness. Explos Explosiveive prices prices might might be be attributed attributed to fundamental disruptions, or traders’ speculation. Kaufmann and Ullman [4] [4] use the hypothesis that if speculation played a significantsignificant role, then futures prices should drive spot prices, and price innovations should start from future markets. Their results are mixed as price price innovation innovation stem from both spot and futures prices forfor didifferentfferent blends.blends. BidirectionalBidirectional causality causality between between spot spot and and futures futures prices prices is alsois also suggested suggested by Polanco-Martinezby Polanco-Martinez and and Abadie Abadie [5] for [5] intra-weekly, for intra-weekly, weekly, weekly, fortnightly, fortnightly, and biannual and biannual horizons. horizons. Futures onlyFutures drive only spot drive prices spot only prices in monthly only in monthly horizons. ho Irwinrizons. and Irwin Sanders and [Sanders6] support [6] thatsupport Granger that causalityGranger andcausality long-horizon and long-horizon regression testsregression suggest tests no causalsuggest relationship no causal between relationship returns between and volatility returns in and the crudevolatility oil andin the the crude positions oil and of exchange-tradedthe positions of exchange-traded index funds. Kilian index and funds. Murphy Kilian [7] and suggest Murphy that the[7] realsuggest oil price that the soar real between oil price 2003 soar and between 2008 was 2003 entirely and 20 attributed08 was entirely to shifts attributed in the global to shifts demand in the flow global for oil.demand They flow further for oil. add They that, further as soon add as thethat, global as soon economy as the global recovers economy from the reco financialvers from crisis, the financial then the realcrisis, oil then price the will real start oil increasingprice will again.start increasing As a result, again. additional As a result, regulation additional over oilregulation trading willover notoil helptrading anyhow will not avoiding help anyhow price soar avoiding again. price Juvenal soar and again. Petrella Juvenal [8] and suggest Petrella that [8] oil suggest prices are that historically oil prices drivenare historically by the strength driven of by global the demand.strength of On glob the contrary,al demand. speculation On the playedcontrary, a contributory speculation roleplayed in the a oilcontributory price increase role betweenin the oil 2004 price and increase 2008. Thebetween following 2004 declineand 2008. of The the latefollowing 2008 is decline mainly of attributed the late 2008 is mainly attributed to the negative demand shock. Speculation played an additive role again as eroded the financial statements of many market participants, which curtailed their demand for Energies 2019, 12, 2649 3 of 16 to the negative demand shock. Speculation played an additive role again as eroded the financial statements of many market participants, which curtailed their demand for commodity
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