Pirrong WTI Report 091116 - Bauer College of Business · 2010. 1. 7. · Energy Markets Director,...

AnEvaluationofthePerformanceofOilPriceBenchmarksDuringtheFinancialCrisisCraigPirrong

ProfessorofFinanceEnergyMarketsDirector,GlobalEnergyManagementInstitute

BauerCollegeofBusinessUniversityofHouston

I. Introduction

Theeventsoflate‐summer,2008throughthespringof2009haveattracted

considerableattentiontotheperformanceofoilpricebenchmarks,mostnotablythe

ChicagoMercantileExchange’sWestTexasIntermediatecrudeoilcontract(“WTI”

or“CL”hereafter)andICEFutures’Brentcrudeoilcontract(“Brentfutures”or“CB”

hereafter).Inparticular,thebehaviorofspreadsbetweenthepricesoffutures

contractsofdifferentmaturities,andbetweenfuturespricesandcashpricesduring

theperiodfollowingtheLehmanBrotherscollapsehassparkedallegationsthat

futurespriceshavebecomedisconnectedfromtheunderlyingcashmarket

fundamentals.TheWTIcontracthasbeenthesubjectofparticularcriticisms

allegingtheunrepresentativenessoftheMidcontinentmarketasaglobalprice

benchmark.

Ihaveanalyzedextensivedatafromthecrudeoilcashandfuturesmarketsto

evaluatetheperformanceoftheWTIandBrentfuturescontractsduringthe

LH2008‐FH2009period.Althoughtheanalysisfocusesonthisperiod,itrelieson

dataextendingbackto1990inordertoputtheperformanceinhistoricalcontext.I

havealsoincorporatedsomedataonphysicalcrudemarketfundamentals,most

notablystocks,astheseareessentialinprovidinganevaluationofcontract

performanceandtherelationbetweenpricingandfundamentals.Myconclusions

areasfollows:

1. TheOctober,2008‐March2009periodwasoneofhistoricallyunprecedentedvolatility.Byavarietyofmeasures,volatilityinthisperiodwasextremelyhigh,evencomparedtothemonthssurroundingtheFirstGulfWar,previouslythehighestvolatilityperiodinthemodernoiltradingera.Moreover,thebehavioroffundamentalmeasures,includingstocks,washistoricallyextraordinaryaswell.

2. ForbothCLandCB,thepricecollapsethatoccurredinFall2008wasaccompaniedbyadramaticincreaseincontango(measuredbythespreadbetweenthefirstandsecondnearbyprices),andanincreaseinthevolatilityinspreadsbetweenfutureswithdifferentmaturities.

3. Byavarietyofmeasures,thehedgingperformanceofbothWTIandBrentdeclinedforavarietyofcashinstrumentsduringtheperiodofheightenedvolatility.ThisdeclineinhedgingperformancewasmostpronouncedforfrontmonthWTI.

4. HedgingperformanceforfirstmonthWTIwithrespecttoMidcontinentcrudestreamswassound.Byavarietyofmeasures,thehedgingperformanceofbothWTIandBrentdeclinedforavarietyofwaterbornecash‐tradedcrudestreams,includingthoseintheUSGulf,duringtheperiodofheightenedvolatility.

5. TheperformanceofthesecondmonthWTIcontractwascomparabletothatofthefirstandsecondmonthBrentcontracts.

6. Thedeclineinhedgingperformance,andincreaseinspreadvolatility,occurredatthesametimeasanunprecedentedincreaseinthestocksofoilheldatCushing,Oklahoma(20millionbarrels),intheUS(66millionbarrels)andtheOECDasawhole(110millionbarrelsinAugust,2008‐March,2009).

7. Formostoftheperiodstudied,thereisastrongrelationshipbetweenCushingstocksandspreads,andthisrelationshipisthatpredictedbyeconomictheory;namely,thathigherstocksareassociatedwithariseinthedeferredpricerelativetothenearbyprice.Thisisconsistentwithamarketbeingdrivenbyfundamentals.

8. DuringOctober,2008‐March,2009,therelationbetweenWTIspreadsandstocksbecamemorevariable,butthisrelationstillwasconsistentwiththespread‐stockrelationreflectingeconomicfundamentals.Thatis,highercontangoswereassociatedwithhigherstocks.

9. WithrespecttoBrent,duringOctober,2008‐March,2009,therelationbetweenBrentspreadsandUSstockswasoppositethatpredictedbyeconomictheory;stocksandBrentspreadsmovedinoppositedirectionsduringthisperiod.BecauseUSandOECDstocksexhibitedsimilarmovementsduringthistimeperiod,thissuggeststhatBrentspreadsmaynothavebeenreflectingsupplydemandfundamentals(asproxiedforbyOECDstocks).1

10. UScashcrudespreadsexhibitedbehaviorsimilartoWTIfuturesspreads.Theyexperiencedlargemovesatthesametimes.ThissuggeststhatUSmarket‐wideconditions,ratherthanfactorsspecifictotheWTIcontract,werethedecisivedeterminantsofpricingbehaviorduringthisperiod.

11. ThebehavioroftheWTI‐WestTexasSour(WTS)spreadprovidesfurtherevidencethatconditionsintheMidcontinentwerethedecisivefactor.BothofthesecrudestreamsutilizeCushingstorage.DuringtheNovember,2008‐March,2009period,thefrontmonthWTI‐frontmonthWTSspreadexhibitedbehaviorsimilartothatobservedinpriorperiods,butthesecondmonthWTI‐frontmonthWTSspreadwassubstantiallymorevolatile.ThisisconsistentwithphysicalmarketconditionsatCushing(andtheMidcontinentmoregenerally)beingtheprimarydriverofpricerelationsduringthisperiod.

Oneinterpretationoftheseresultsisthat:(a)theunprecedentedincreasein

fundamentaluncertaintycausedadeclineinthehedgingperformanceofboththe

WTIandBrentcontracts,and(b)thesimilarlyunprecedentedsurgeinstocksthat

occurredsimultaneouslycausedasignificantincreaseinthecontango,mostnotably

intheWTImarket.

Inparticular,themetastasizingfinancialcrisiscaused:

• Asubstantialdeclineinthedemandforcrudeproducts(andhencecrudeoil).Inparticular,distillatedemandplummetedduringthisperiod.

• Asubstantialbuild‐upofcrudeinventoriesaroundtheworld,butmostnotablyintheUSMidcontinent;sinceoilsupplydoesnotadjustintheshortrun,thesteepdropindemandresultedinlargeandrapidaccumulationofstocks.

1DuetothelowerfrequencyofOECDinventorydata,itisnotpossibletotestthisconjecturerigorously.

• Alargeandrapiddropinpricesofcrudeoilandrefinedproducts.

Theaccumulationofstockswasaworld‐widephenomenon.Thereare

extensivepublishedreports,includingthosereleasedbytheInternationalEnergy

Agency,thatlargeamountsofcrudewerestoredintankersatsea.Thisishighly

unusual,andreflectsthemarkedlyunusualconditionsprevailingatthetime.The

substantialinventorybuildatCushingwasthuspartofaglobalphenomenon,

althoughtheUSMidcontinentmorereflectedthismore(andmoretransparently)

thanelsewhere.Forthemostpart,thenearbyWTIfuturescontractwasaccurately

reflectingtheseCushingandMidcontinentfundamentals,andwasconsistentwith

thepatternsobservedforOECDstocks.

Theseconditionsdominatedthemarketforseveralmonths.Eventually,

outputcutsreducedthedemandforstorageandpermittedareturnofmoretypical

pricingrelationships,andimportantly,arestorationofthepreviouslyobserved

hedgingeffectivenessoftheprimaryworldcrudepricingmarkers,includingWTI.

Basedonthisinterpretation,andthetotalityoftheextensivedataanalysis,I

concludethatthebehavioroftheWTIfuturescontractduringthefinancialcrisis

reflectedthetrulyunprecedentedconditionsprevalentduringthatperiod.

Fundamentalvolatilitywasextraordinarilyhighduringthisperiod.Moreover,the

collapseindemandcausedbytheacuteworldwideeconomiccontractionmadeit

optimaltoincreasesharplytheamountofoilinstorage.Thesefactorscombinedto

injectvolatilityinfuturesspreadsandcash‐futuresspreads.

However,in2Q09,hedgingperformancesoftheWTIandBrentcontracts

havereturnedtoapproximatelytheirpre‐crisislevels.Thus,thedatadonot

supportageneralclaimthatthehedgingperformanceofWTI(orBrent)has

declinedexceptundertrulyexceptionalcircumstances.

Therefore,itisimportantnottoreadtoomuchintothehedgingperformance

ofthefuturesmarketduringOctober,2008‐March,2009.Thisbehaviorwasquite

explicablebytheextremeshockstofundamentalsthatoccurredduringthis

remarkableperiod,andisnotaharbingerofalong‐termdeclineinperformance.A

returntomorenormalcircumstances,andmostimportantly,arecoveryofdemand

thatleadstothereturnofinventoriestomoretypicallevels,willresultareturnto

thepricingbehaviorexperiencedbeforethecrisis.

Theremainderofthisreportisorganizedasfollows.SectionIIsetsoutthe

statisticalmethodsdeployedandthedatautilized.SectionIIIanalyzesthebehavior

ofvolatility;ofspreadsandbasis;andhedgingeffectivenessoftheWTIandBrent

contracts,withafocusontheNovember,2008‐March,2009period.SectionIV

evaluatesthebehavioroffundamentals,notablyUSstocks,Cushingstocks,and

refiningactivity.SectionVsummarizesthereport.

II. MethodologyandData

Ievaluatethebehaviorofseveralindiciaofoilcontractperformance.Ifirst

reviewthebehaviorofthespreadbetweenthefirstandsecondnearbycontractsfor

theWTIandBrentcontracts.IthenevaluatethebasisbetweenthefrontmonthCL

andCBcontracts,andseveralcashmarketindicators.Thefutures‐cashpairs

examinedare:

• CL‐DatedBrent

• CL‐Dubai

• CL‐GulfCoastGasoline(“GCG”)

• CL‐LouisianaLightSweet(“LLS”)

• CL‐MARS

• CL‐WestTexasSour(“WTS”)

• CB‐DatedBrent

• CB‐Dubai

• CB‐Gasoil

• CB‐SingaporeGasoil

Then,foreachofthesefutures‐cashpairs,Iuseavarietyofmethodsto

estimatethecorrelationbetweenthefuturespricechangeandthecashprice

change.Correlationisameasureofthehedgingeffectivenessofafuturescontract,

thatis,theamountofriskthatcanbereducedbyusingthefuturescontractasa

hedge.Specifically,thefractionofvariancethatcanbeeliminatedbyusingthe

futurescontractasahedgeofaparticularcashgradeequalsthesquareofthe

correlationbetweenthefuturespricechangeandthecashpriceforthatgrade.

Itiswellknownthatcorrelationscanvarythroughtime.Therefore,itis

imperativetoutilizemethodsthatpermitsuchtimevariation.Iusetwoapproaches.

Thefirstistoestimate“rolling”correlations.Thatis,Iestimatecorrelations

betweeneachfutures‐cashpairoverathree‐monthlongperiod,rollingthatperiod

forwardintimebyoneobservationperiodfromthebeginningofthedatasettothe

Thesecondistoestimateabivariate“GARCH”model.TheGARCHmodelisa

timeseriesmodelofvariancesandcovariances.Itpositsthatvariancesand

covariancesvarythroughtimeinaspecificway.Inparticular,variancesatagiven

pointintimedependonvariancesatthepreviousdate,andthesquaredinnovation

(unexpectedpricemovement)ineachprice.Covariancesbehavesimilarly.Thisis

oneofthemostwidelyutilizedmethodsinthetimeseriesanalysisoffinancial

prices.

Inprevious,publishedresearch,Ihaveshownthatvariancesandcovariances

incommoditypricescanvarywithfuturesspreads.Moreover,theorypredictssuch

arelationship.Adeepbackwardationtypicallyoccursundertightsupply‐demand

conditions,andpricesareusuallymorevolatilegivensuchtightfundamentals.A

steepcontangotypicallyreflectsconstraintsonstoragecapacity.Underthese

circumstances,theseconstraintslimittheabilitytoaccommodatefundamental

supplyanddemandshocksbyadjustinginventories,requiringpricestobearthe

burdenoftheadjustmenttotheseshocks.

Specifically,inoilmarkets,variancesandcovariancescandependonwhether

themarketisincontangoorbackwardation,andthemagnitudeofthe

contango/backwardation.2Tocapturethiseffect,Iestimatemodelsthatallow

variancesandcovariancestodependonthelevelsofbackwardationandcontango

2CraigPirrong,Metallgesellschaft:APrudentHedgerRuined,oraWildcatteronWallStreet?J.ofFuturesMarkets(1995).Themodelsestimatedinthatpaper,andherein,havemultipleequations.Foreachcommoditypair,thereisacovarianceequation.Inaddition,foreachelementofthecommoditypair,thereisavarianceequation.Thesethreeequationsallowtheestimationofthetime‐varyingvariancesofpricesforeachelementofthepairandthetime‐varyingcovariancebetweenthem;giventhisinformation,itispossibletoestimateatime‐varyingcorrelation(becausethecorrelationistheratioofthecovariancetothesquarerootoftheproductofthevariances).

inthemarket.Irefertothisas“backwardandcontangoadjustedGARCH”(“GARCH

BCAG”).

Theoryalsopredictsthatcorrelationsbetweenfuturesofdifferent

maturities,andbetweencashandfuturespricescandependonfuturesspreads.For

instance,thecash‐and‐carryarbitragerelationshipisattenuatedwhenstocksare

lowandthemarketisinbackwardation.Underthesecircumstances,thecorrelation

betweennearbyanddeferredfuturespricesislikelytobelow.Similarly,ifthe

marginalcostofstoragebecomesquiteinelasticwheninventoriesbecomelarge,

then(a)themarketwillbeinalargecontango,and(b)nearby‐deferredspreadswill

bevolatile,andcorrelationsbetweenthesepriceslow,becausesmallfundamental

shockscanhavealargeeffectonthemarginalcostofstorage,causingnearbyand

deferredpricestomovedifferentlyinresponsetosuchshocks.

IestimatetwodifferenttypesofGARCHBCAGmodels.Inthefirstmodel,the

covariancebetweenthefuturespricechangeandthecashpricechangedependson

(a)aconstant,(b)thelaggedcovariance,(c)thelaggedproductbetweenthe

unexpectedfuturespricechangeandtheunexpectedcashpricechange,(d)thelag

ofthesquareofthelogdifferencebetweenthenearbypriceandthefirstdeferred

price,ifthatdifferenceispositive,and(e)thelagofthesquareofthelogdifference

betweenthenearbypriceandthefirstdeferredprice,ifthatdifferenceisnegative.

Variable(d)measurestheeffectsofbackwardationonthecovariancebetween

futuresandcash,whereasvariable(e)measurestheeffectsofcontangoonthis

variance.

Thesecondmodelincorporatesvariables(d)and(e),butassumesthatwhen

thenearbyanddeferredfuturesareequal,thecorrelationbetweenthefuturesand

cashpricechangesisaconstant(estimatedbythemodel).

Bothmodelsassumethatthevariancesofthecashandfuturespricesdepend

on(a)aconstant,(b)thelaggedvariance,(c)thelaggedsquaredunexpectedprice

change,(d)thelagofthesquareofthelogdifferencebetweenthenearbypriceand

thefirstdeferredprice,ifthatdifferenceispositive,and(e)thelagofthesquareof

thelogdifferencebetweenthenearbypriceandthefirstdeferredprice,ifthat

differenceisnegative.

Thefuturesdatausedintheanalysisweredailysettlementpricesobtained

fromtheCommodityResearchBureau.ThecashpriceswerefromPlatts,and

providedbytheChicagoMercantileExchange.

Sincethevariouscashpriceandfuturespricemarkersweredeterminedat

differenttimesonagiventradingday,formostoftheanalysisitisimpracticalto

utilizedailypricedata.Forinstance,themeasuredclose‐to‐closepricechangein

Dubaicrudeoccursbetween0430ETand0430ETthefollowingday,whereasthe

measuredclose‐to‐closepricechangeinWTIoccursbetween1430ETonsuccessive

tradingdays.Thus,informationthatcanaffectNYMEXpricechangesonaparticular

dayatatimesubsequenttothedeterminationoftheDubaipriceonthatdaywill

onlybereflectedintheDubaipricedataforthefollowingday.Thistimemis‐match

tendstoreducemeasuredcorrelationsindailydata.Asaresult,tominimizethe

impactoftimemismatch,Iperformallcorrelationanalysesonweeklydata.

III. Volatility,Spreads,andBasis

Thefigurelabeled“CLFront‐LLSVariance(BCAG)”representsthevariance

oftheweekly(log)changeintheWTInearbyfuturesprice,andthevarianceofthe

weekly(log)changeintheLLScashprice.3Thefiguredepictstheweeklyvariances

overtheperiod3January,1990‐14July,2009.

Thefiguredemonstratesthatthevariancesofcashandfuturespricesvary

overtime.Mostnotable,though,isthebehaviorofvolatilityin2008and2009.

Specifically,thesevarianceswerelow,byhistoricalstandards,duringtheperiodof

historicallyhigh(nominal)oilpricesinthesummerof2008.Moreover,these

varianceswereextremelyhighcommencinginthefallof2008,andreachedapeakin

thewinterof2009.Indeed,thevarianceswereapproximately4timeshigherat

theirpeakin2009,thanthehighestpost‐GulfWarIpeaks,andmorethandouble

thelevelsobservedevenduringthefirstGulfWar.

Convertingthesevariancesintoannualizedstandarddeviations(volatilities),

whereastheaveragelevelofvolatilityinthepost‐GulfWar‐pre‐FinancialCrisis

periodwasontheorderof33percentperyear,inFebruary,2009,thisvolatilitywas

over100percent.Thus,theperiodoftheFinancialCrisiswasoneofunprecedented

volatilityinoilprices.

TheFinancialCrisisalsohadadramaticeffectonthespreadsbetween

nearbyanddeferredoilfuturesprices,bothWTIandBrent.Twofiguresillustrate

thebehaviorofthesespreads.

3Thebasicresultsdonotdependonthechoiceofestimationmethod,orthecashpriceindicator.

Thefigurelabeled“CLFront‐BackLogDifference”graphsthedifference

betweenthelogoftheCLfrontmonthandthelogoftheCLbackmonthprice,forthe

July,2005‐July,2009period.Thefigurelabeled“CBFront‐BackLogDifference”

graphsthedifferencebetweenthelogoftheCBfrontmonthandthelogoftheCB

backmonthprice,fortheJuly,2005‐July,2009period.4

Bothfiguresshowthatthespreadswererelativelystablepriortothelate‐

summerof2008,forWTIvaryingbetweenapproximately‐.04(contango)and.01

(backwardation).Then,inOctober,2009,the(log)spreadforbothWTIandBrent

begantodeclinedramatically,beforereturningtopreviously‐observedlevelsinthe

springof2009.Moreover,forbothWTIandBrent,thespreadgraphsexhibitsharp

downwardspikesintheDecember,2008‐February,2009period(forWTI)and

November,2008‐May,2009(forBrent).5

ThegeneraldramaticdeclineinspreadsinbothWTIandBrentcanbe

explainedreadilygiventhesubstantialeconomiccontractionandfinancialcrisis

thatoccurredduringthisperiod.Economictheorypredictsthatasubstantial

declineindemandforacommoditymakesitoptimaltoaccumulateinventories,

especiallywhenitisverycostlytoadjustoutput(asisthecaseinoil).Pricesadjust

intocontangotoprovideafinancialincentivetoengageinsuchaccumulation.

When,asisthecaseinoil,themarginalcostofstorageisincreasingintheamount

4Sincetherearenotimemismatchissuesassociatedwiththesefuturesspreads,thesegraphsareconstructedusingdailydata.Thelogarithmtransformationmitigatestheeffectofpricelevelsonthebasis.Alogdifferenceisessentiallyapercentagedifference.Therelationshipismuchmorevariablewhenthelogtransformationisnotused.5ThereisanupwardspikeintheWTIspreadon22September,2008.ThisoccurredontheexpirydateoftheOctobercontract.

stored(due,forinstance,tooperationalconstraintsinstoragefacilities,orthe

necessitytoutilizeseabornestorage),verywidecontangosmayberequiredinthe

faceofaverylargeeconomicshockthatsharplyreducesthedemandforoil,and

henceincreasessharplytheoptimalamountofoiltostore.Thatis,theverylarge

changeinspreadsduringthefinancialcrisisisexactlythekindofpriceresponseto

beexpectedinthefaceofaneconomicshockthatdramaticallyreducesdemand.It

isalso,toadegree,consistentwiththeincreaseinoilinventoriesobservedoverthis

period;thisissueisdiscussedinmoredetailinSectionIVbelow.

The“spikes”inthespreadsaremoredifficulttoattributetoeconomic

fundamentals,andinsteadaremorelikelyreflectiveoftechnicalfeaturesintheWTI

andBrentmarkets.ThethreelargedownwardspikesintheWTIspreadoccurred

on12/19/2008,1/15/2009,and2/12/2009;therewasalargeupwardspikeinthis

spreadon2/19/2009.The12/19/2008and2/19/2009spikesoccurredon

contractexpirydates.The1/15/2009and2/12/2009occurredafewdaysbefore

contractexpiration.

ThethreespikesinBrentoccurredon11/13/2008,3/16/2008,and

5/14/2009.Thefirsttwoareexpirydates,thethirdadaypriortoexpiry.

Theoccurrenceofthesespikesonornearexpirysuggeststhattheyweredue

totechnicalfactorsassociatedwiththeendoftradingoffuturescontracts,rather

thanfundamentalfactors.

Astatisticalanalysissupportsthisview.Inthe1/3/1990‐6/30/2008period,

thestandarddeviationofthechangeintheCLlogspreadpriortothelastthreedays

intheexpirymonthwas.0022,whereasinthelastthreetradingdaysthisvolatility

was.0085.Thus,evenbeforethefinancialcrisis,thespreadwassubstantiallymore

volatileinthefewdayspriortoexpirationthanintheperiodbetweentheprior

expirationandthefourthtradingdayofthemonth.Thisagainprovidesevidence

thattechnicalfactorsrelatedtoexpirationwereaffectingpricebehaviorasexpiry

neared.

ThedisparitybecameevenmoreextremeinLH2008‐FH2009.Inthatperiod,

thespreadvolatilitypriortothelastthreetradingdayswas.012,butthespread

volatilityinthelastthreedayswas.0334.Thus,duringtheheightofthefinancial

crisis,spreadvolatilitywasextremelyhighduringthelastthreetradingdays,even

incomparisontoitsalreadyelevatedlevelduringthefinancialcrisis,butpriortothe

lastthreetradingdays.Thissuggeststhatthetechnicalfactorsbecameevenmore

importantduringthisperiodoftime.

Brentexhibitedsimilarbehavior,thoughnotquiteassevere.Fortheperiod

priorto30June,2008,thespreadvolatilitywas.0023priortothelastthreedaysof

theexpirymonth(almostexactlythesameasobservedforWTI),and.0051during

thelastthreedays.Thus,technicalfactorsassociatedwithexpirationevidently

affectedtheBrentcontractpriortothefinancialcrisis,butnottothesameextentas

observedforWTI.Duringthefinancialcrisis,LH2008‐FH2009,Brentspread

volatilitypriortothelastthreetradingdaysofagivencontractwaselevated,.0045,

andthevolatilityduringthelastthreedayswasalsoelevated,to.0109.Soagain,

thereisevidenceoftheimpactofexpiration‐driventechnicalfeaturesonBrent;that

thesetechnicalpressuresweregreaterduringthefinancialcrisisthanbefore;but

thattheeffectofthecrisisonthesetechnicalpressureswaslesssevereforBrent

thanWTI.

Myinterpretationofthesefindingsisasfollows.Theunprecedented

economicuncertaintyassociatedwiththefinancialcrisiscreatedunprecedented

volatilityinoilcashandfuturesprices.Moreover,thesubstantialeconomic

contractionassociatedwiththecrisisdramaticallyreduceddemandforoil,making

itoptimaltoincreaseoilinventoriesbyamarkedamount.Naturally,themarket

movedintocontangotorewardsuchinventoryaccumulations.Thecombinationof

volatilityandincreasesinoilstorageexacerbatedthetechnicalfrictionsthat

contributetobasisvolatilitylateinthetradingofanexpiringcontract,leadingto

especiallyelevatedbasisvolatilityfortheWTIcontract.Subsequentanalysis,

notablythatofstocks,willsupportthisinterpretation.

Thiscanbeinterpretedanotherway.Themarketforspreadsbetween

nearbyanddeferredcontractsisessentiallydiscoveringthe(shadow)priceof

storage.ThemarketforstorageinCushingisnotacentralizedmarket,butasearch

market.Onewouldexpectthatadramaticincreaseinfundamentaluncertaintyin

theoilmarket(demonstratedgraphicallybythehugevolatilityspikediscussed

above)andasurgeindemandforstoragecapacity(demonstratedbythedramatic

increaseinoilin‐storeinCushingasdocumentedbelow)wouldleadtoincreased

transactionscostsinthestoragemarketduetothenecessityofnegotiatingmore

transactionsinconditionsofuncertainty(andlikelyinformationasymmetry).One

wouldexpecttoothatinasearchmarket,greateruncertaintywouldleadtogreater

dispersionacrosstransactionsandovertimeinthepriceofstorage.Inturn,these

developmentswouldtendtowidenthespreadandmakeitmorevolatileasthe

marketgropedtodiscoverthepriceofstorageunderconditionsofhistoric

uncertainty.

ItshouldbenotedthatUScashmarketspreadsexhibitedbehaviorsimilarto

thatofNYMEXWTI,althoughtoasomewhatlesserdegree.Thecharttitled“USOil

Nearby‐DeferredSpreads”depictsthenearby‐deferredspreadforLLS,WTIcash,

andWTS,aswellasNYMEXWTIfortheNovember,2008‐February,2009period.

Notethatthecashspreadsspikedownwardeachtimethereisadownwardspikein

thenearbyNYMEXWTIspread;theNYMEXWTIspikesaremorepronounced

(exceptforcashWTI),butthecoincidenceofthesespikesprovidesevidencethat

thesemovementsweredrivenbybroaderfundamentalforcesintheUSoilmarket,

ratherthansomethingpeculiartotheNYMEXCLcontract.Noteparticularlythatthe

cashWTIspreadisalmostidenticaltotheNYMEXWTIspread;thisindicatesthat

convergenceoccurredevenduringtheseexceptionalepisodes.Moreover,with

respecttotheDecember,2008spike,theJanuary‐FebruarycashWTIspread

widenedevenfurtherinthedayaftertheexpiryoftheNYMEXJanuarycontract.6

ThissuggeststhatconditionsintheCushingcashmarket,notsomethingpeculiarto

theNYMEXexpiryalone,drovethepricingrelationsduringthisperiod.

Relatedly,thebehaviorofNYMEXWTI‐WTSspreadssuggeststhat

constraintsinMidcontinentstorage,orfrictionsinthemarketforthisstorage,

playedthemajorroleindrivingpricerelationsduringthisperiod.Notethatinthe

December,2008‐June,2009periodthefrontmonthCL‐WTSspreadwasnot

6ThecashcontracttradesforatleastonemoredaythantheNYMEXfuture.

especiallyvolatile(especiallycomparedwithitsbehaviorinthe2005‐2007period,

andcomparedtothespreadbetweenfrontmonthCLandothercashgrades),but

thebackmonthCL‐frontmonthWTSspreadwasverywideandvolatileduringthe

December,2008‐March,2009period.Moreover,thisspreadspikedupwhenother

frontmonthCLspreadsspikeddown.GiventhatWTS(Midland)isintheregion

tributarytoCushing,thissuggeststhatCushing/Midcontinentphysicalmarket

factorsweredecisiveduringthishighlyvolatileperiod.

Putdifferently,althoughNYMEXfrontmonthWTIpricerelations(spreads)

wereextraordinaryduringthistime,therelationsbetweenWTSandothercash

gradesweresimilarlyremarkable.Thus,ratherthanreflectingsomethingspecificto

thefuturesmarketortheCLfuturescontract,thespreadbehaviorduringtheperiod

ofthefinancialcrisiswasreflectingfundamentalconditionsintheMidcontinent

market.

Theseresultssuggestthatpricerelationscanbestressedbyextreme

fundamentalconditions,andthatthesestressesarelikelytoaffectthefrontmonth

contractmostacutely.Althoughthisfindingisnotimmaterial,itsimportance

shouldnotbeoveremphasized.Bythetimethattheexpiringcontractsmostclearly

reflectedtheextraordinarycircumstancesprevailingattheheightofthecrisis,the

vastmajorityofopeninterestinthecontractshadalreadyliquidated,mostofit

rollingtothefirstdeferredcontract.Thus,mosthedgers,andmostusingthe

contractforspeculativepurposes,werenotexposedtotheeffectsofthesefactors.

Thosemostatriskwerethoseholdingfinanciallysettledpositionswithcashflows

tiedtothesettlementpriceoftheWTIcontractonexpirationday.Moreover,aswill

bedemonstratedinthenextsection,thefirstdeferredcontract(towhichmost

hedgersandspeculatorswillhaverolledpriortothethirdtradingdaybefore

expiration)demonstrablysufferedsubstantiallylessfromtheeffectsofeconomic

volatilityandcontracttechnicalfeatures.

IV. HedgingEffectiveness

Theanalysisofhedgingeffectivenessisbasedonseveralsetsoffigures,each

setcorrespondingtoadifferentmethodforestimatingcorrelationsbetweenfutures

andcashpricechanges.Figureswith“Correlation”inthetitledepictrolling

correlationsbetweenthefuturesprices(frontandbackmonth)andcashpricein

thetitle.Thosewith“BCAG”inthetitlearebasedontheBCAGmethodology,while

thosewith“GARCHBCAG”arederivedusingtheGARCHBCAGmethodology.Each

figuredepictshedgingperformancebeginninginMarch,1990andendinginJuly,

2009.Ipresentthetimeseriesofhedgingeffectivenessoveralongtimeperiodin

ordertoputtheeventsofLH2008‐FH2009inhistoricalperspective.

SomegeneralobservationsareinorderbeforeIpresentamoredetailed

analysis.First,regardlessofthemethodology,correlation/hedgingeffectiveness

variesovertime.Therefore,itisnecessaryandusefultoevaluateperformance

duringaparticularperiodwithreferencetoperformanceoverotherperiods.

Second,thelevelandvariabilityofcorrelationsalsodiffersacrossproducts.Not

surprisingly,correlationsformoreclosely‐relatedcommodities(e.g.,CLandLLS)

tendtobehigher,andexhibitlessvariationthancorrelationsforlessclosely‐related

ones(e.g.,CLandGCG).

Withthoseconsiderationsinmind,firstconsidertherollingcorrelation

charts.

Anexaminationoftherollingcorrelationssupportsseveralfindings:

1. CorrelationsforWTIfrontandbackmonthcontractsdeclinedcommencinginlate‐2008,andreturnedtolevelscomparabletothoseobservedinearlierperiodsattheendof1Q09.Thetimingofthedeclinedifferedamongcashgrades,withtheDubaicorrelationdecliningbeginninginOctober,andtheLLSandBrentcorrelationsdecliningbeginninginDecember.

2. ForfrontmonthWTI,thedeclineincorrelationwaslessseverethanhadbeenobservedatearliertimes,withtheexceptionofDubai,wherehedgingeffectivenessplungedto0beforereboundingsharply.

3. DeclinesinbackmonthWTIcorrelationwerefarlessseverethanforfront

month.Moreover,mostofthedeclinesweremodest,andofamagnitudesmallerthannumerousdeclinesobservedinprioryears.Thus,therollingcorrelationanalysisimpliesthatthefinancialcrisisdidnothavearemarkablylargeimpactonthehedgingeffectivenessofthebackmonthcontract.

4. Brentrollingcorrelationsalsodeclinedduringtheperiodofthefinancial

crisis.Thecorrelationdeclineswereofamagnitudesimilartothoseobservedfrequentlyinprioryears.

5. IncontrasttoWTI,thedeclineinBrenthedgingeffectivenesswas(slightly)

largerforthefirstdeferredcontractthanthefrontmonthcontract.

6. ForbothWTIandBrent,thelargestdeclineinhedgingeffectivenesswasobservedforDubai,andforthiscashgrade,thedeclineinWTIhedgingeffectivenesswasgreater.Thisisnotsurprising,giventhegenerallycloserrelationbetweenDubaiandBrent.

Inbrief,therollingcorrelationdatashowthatthefinancialcrisisandits

associatedeffectsoncrudemarketscausedadeclineinhedgingeffectiveness,but

despitetheunprecedentednatureofthecrisis,thedeclineinhedgingeffectiveness

wasnotunprecedentedlylarge.ThefrontmonthWTIcontractwasmostadversely

affected.ThislikelyreflectsthetechnicalfactorsdiscussedinsectionsIIIandV.In

contrast,thefirstdeferredWTIhedgingeffectivenesswasnotasseriouslyaffected,

andbehavedsimilarlytotheeffectivenessoftheBrentcontracts.

NextconsidertheGARCHBCAGhedgingeffectivenessestimates.

7. WTIfrontmonthandbackmonthhedgingeffectivenessdeclined4Q08,andreboundedtoreachpre‐crisislevelsattheendof1Q09.ThedeclineincorrelationforthefrontmonthwaslargerduringthisperiodthanestimatedpreviouslyforCLFront‐DatedBrent,CLFront‐Dubai,CLBack‐Dubai,CLFront‐GCG,andCLFront‐LLS.7Thus,withtheexceptionofDubai,thedeclineincorrelationforthefirstdeferredcontractduringthefinancialcrisiswasofamagnitudesimilartootherdeclinesobservedinthe1990‐FH2008period.

8. WiththeexceptionofGasoil,Brentfrontmonthandbackmonthhedgingeffectivenessalsodeclined4Q08,andreboundedto(approximately)pre‐crisislevelsattheendof1Q09.Theobservedcorrelationdeclineswerenotunprecedentedlylarge,becausesimilar(orlarger)declinesoccurredinprioryears.

Finally,considertheresultsfortheBCAGanalysis.

9. Again,WTIhedgingeffectivenessdeclinedduringtheperiodofthefinancialcrisisforallcashgradesconsidered.Thedeclineswerelargerforthefrontmonthcontract.Moreover,thedeclinesweretypicallylargerduringLH09‐FH08thanhadbeenobservedinprioryears..

10. Brentcorrelationsdeclinedduringtheperiodofthecrisis,butthesedeclinesweresmallrelativeto(a)thedeclinesthathadbeenobservedpreviously,and(b)thedeclinesobservedforWTI.

11. ThedifferentialperformancebetweenWTIandBrentundertheBCAG

measurereflectsthefactthatinthismodeltheestimatedeffectofcontangooncorrelationissmallerforBrent,thanWTI.ThiscouldreflecttheimpactofconstraintsattheCushingdeliverypointonWTIcashpricedynamics.AswillbediscussedinsectionVbelow,largeCushingstoragelevels(andconsequentlylargeCLcontango)clearlyaffectsWTIpricing.

Overall,thehedgingeffectiveness/correlationresultsdemonstratethatthe

financialcrisisdiddegradehedgingeffectivenessforboththeWTIandBrent

futures.ThedeclinewasmostpronouncedforfrontmonthWTI.Thecorrelation

7TherewasinsufficientdatatoestimatethismodelforMARS.

declinesforbackmonthWTIandthetwoBrentcontractsconsideredwere

comparable,andfortwoofthethreemeasuresconsidered,ofamagnitudesimilarto

declinesobservedinprior,non‐crisisperiods.

OneinterestingfindingisthatthedeclineinCLfrontmonthhedging

effectivenessforWTSwasnoticeablysmallerthanforothercashgradesconsidered.

Thisistrueforallthreemeasuresofhedgingeffectiveness:rollingcorrelation,and

thetwoGARCHmeasures.ThisprovidesevidencethatMidcontinentpricerelations

werelessaffectedthanrelationsbetweentheMidcontinentandotherregions.

GiventhatWTS(basedonMidland,TXprices)istributarytotheNYMEXdelivery

locationatCushing,thissuggeststhatallMidcontinentoilswerereflectingcommon

fundamentalsrelatedtoconditionsattheCushingmarket,andthatthe

Cushing/Midcontinentfundamentalsweresomewhatuniqueandlocation‐specific.

V. FundamentalsandPriceBehavior

Althoughunusualpricebehaviorcansometimesbeidentifiedthroughan

examinationofpricedataalone,quantitydatacangreatlyimprovetheabilityto

identifysuchbehavior,andtoassistinthediagnosisofitscauses.Inthissection,I

examinefuturespriceandinventorydatatogethertoshedadditionallightonthe

performanceofcrudeoilpricebenchmarksduringtheLH2008‐FH2009period.

Theeconomictheoryofstorablecommoditiesimpliesthatfuturesspreads

(e.g.,thedifferencebetweenthenearbyanddeferredprices)shouldcovarywith

inventoriesofthecommodityinaspecificway.Inparticular,thedifferencebetween

thedeferredpriceandthenearbypriceshouldbegreater,thegreaterthequantity

ofinventories.Thisrelationshipshouldbeclosestbetweenspreadsandstocksat

thecontractdeliverypoint(ratherthanamoreaggregatedinventoryfigure),andfor

contractswithrelativelyshorttimestoexpiration.Itisimportanttonotethat

spreadsdonotcauseinventories,orviceversa;pricesandinventoriesare

determinedsimultaneously,andtherelationjustdescribedisanequilibriumone.

Deviationsinthepredictedrelationshipareindiciaofpotentialproblemsin

theperformanceofafuturescontract.Forinstance,highinventoriesinconjunction

withaseverebackwardationisaclassicindicatorofasqueeze.

Thefiguretitled“CLFront‐BackSpreadvs.CushingStocks”depictsthe

relationbetweenthespreadbetweenthefirstdeferredandnearbyWTIcontracts

(verticalaxis)andcrudeoilinventories(inmmbbl)attheCLdeliverypoint,

Cushing,OK.The(weekly)dataextendfrom9April,2004to17July,2009.

Notethatformostofthepointsinthefigure,thetheoreticallypredicted

relationholds;spreadsrisewithstocks.Thesepoints,forthemostpart,correspond

tostocklevelsoflessthan30millionbarrels,andmostofthesepointscorrespondto

datesbefore1October,2008.Indeed,forthe9April,2004‐26September,2008

period,thecorrelationbetweenCushingstocksandWTIspreadsis.7192,indicating

thatthespreadsandinventoriescovariedaspredictedbythefundamentals‐based

economictheoryofstorablecommoditypricebehavior.

Therearesomepointsinthegraphthatareoutliers.Inparticular,thepoint

withaspreadof$8.49/bbl,andaninventorylevelof28.68mmbblisdistantfrom

theotherpointsinthescatter.Thispointcorrespondstotheexpirationdateofthe

January,2009contract(19December,2008).Giventhespreadlevelsofaround

$2/bblforotherpointswithsimilarstocklevels,thislargespreadstandsout.It

shouldbenoted,moreover,thatcashWTIspreadswerealmostidentical,and

remainedthiswidethedayaftertheexpirationoftheJanuarycontract.

Moreover,itisinformativetonotethatthedispersionofspreadsforstock

levelsofapproximately35mmbblissubstantiallygreaterthanthedispersion

observedforlowerstocklevels.Thesespreadsrangefrombetween$.78/bbland

$6.06/bbl.Incontrast,forstocklevelsofabout25mmbbl,thespreadsrangefrom

$.54/bblto$3.16/bbl,andallbutoneofthesespreadsislessthan$2.00/bbl.

Thisgreaterdispersioninspreads,whichcorrespondsprimarilytothefirst

quarterof2009,likelyreflectsatleastinpart,ahighlyinelasticmarginalcostof

storageatCushing.Suchinelasticitywouldbeexpectedasthequantitystoredat

Cushingnearseffectivecapacity.AlthoughnominalcapacityatCushingwasfar

higherduringthisperiod(approximately47.5mmbbl),effectivecapacitycanbe

lowerduetooperationalconstraints,andthefactthatdifferenttypesofoilthat

cannotbemixedareheldininventoryatCushing.

Moreover,asnotedearlier,themarketforspreadsisdiscoveringthepriceof

storage.ThemarketforstorageinCushingisasearchmarket,andanegotiatedone.

Highuncertainty,andasurgeofoilseekingstorageinCushing(reflectedinthelarge

increaseinstocksatCushingdiscussedbelow)wouldtendtoincreasesearchand

negotiationcosts,andleadtogreaterdispersioninthepriceofstorageacross

transactionsnegotiatedatapproximatelythesametime,andovertime.Thus,one

wouldexpectthatthemassiveincreasesinuncertaintyandthedemandforstorage

wouldleadtogreaterdispersioninpricerelationsasthemarketgropedtodiscover

theappropriateshadowpriceofstorageinhighlydynamic,uncertain,andfluid

conditions.

Eventhoughtherewasgreaterdispersioninthespread‐stocksrelationinthe

periodafterthefinancialcrisishitwithitsfullforce,itisevidentthatfundamentals

werestillrelevantindeterminingthisrelation.Thecorrelationbetweenspreads

andstocksduringthe3October,2008‐17July,2009periodwas.4844.Thisisnot

ashighasobservedinprioryears,whichprovidesfurtherevidenceoftheeffectof

storageconstraintsatCushing,butitisstillpositiveastheorypredicts,andis

economicallydifferentfromzero.

ThereisotherevidencethatsuggeststhatCushingconstraintsaffected

pricingoftheWTIcontract.Thefiguretitled“CLFront‐BackSpreadvs.USStocks”

plotsthenearby‐firstdeferredWTIspreadagainstthetotaloilstocksintheUnited

StatesreportedbytheEIAfortheJanuary,2000‐July,2009period.Noteagainthat

mostpointsinthefigureexhibitthetheoreticallypredictedrelation;higherstocks

areassociatedwithgreaterspreads.Indeed,duringtheperiodJanuary,2000‐

August,2008,thiscorrelationwas.6459.Giventhehighdegreeofaggregationof

thestockdata(whereaggregationisacrossspaceandgrades),thiscorrelationis

surprisinglyhigh.

However,thereareasetofpointsintheupperpartofthediagramthat

deviatequitenoticeablyfromthemainbodyofpointsinthescatterdiagram.These

pointswithhighspreadsandrelativelymoderatelevelsofinventories,correspond

totheheightofthefinancialcrisis,October,2008‐March,2009.Theyindicatethat

WTIspreadswerefarhigherduringthisperiodthanonewouldhavepredicted

given(a)thelevelofUSstocksobservedduringthisperiod,and(b)therelation

betweenUSstocksandspreadsfromtheperiodpriortothecrisis.Thisfurther

suggeststhatconstraintsatCushingwereaffectingthepricingoftheWTIcontract

duringtheheightofthefinancialcrisis.

ThecorrelationbetweenUSstocksandspreadsduringthisperiodprovides

additionalevidenceofthis.ThecorrelationbetweenUSstocksandspreadsduring

the1September,2008‐17July,2009periodwasonly.1613(incontrasttothe.6459

correlationobservedfrom2000totheendofAugust,2008).Thisprovides

evidencethatWTIpricesweremoregreatlyaffectedbyCushing‐specificfactors

duringthisperiod,thanhadbeenthecaseinprioryears.

ItisinterestingtonotethatBrentfuturesspreadsalsoexhibitedaweaker

relationwithfundamentals(asproxiedbystocks)duringtheperiodofthefinancial

crisis.Indeed,thedegradationintherelationbetweeninventoriesandspreadswas

morepronouncedforBrentthanforWTI.

Specifically,fromJanuary,2000‐August,2008,thecorrelationbetweenBrent

spreadsandUSinventorieswas.5207.ThisissmallerthantheWTI‐USstocks

correlation,butthisistobeexpectedasBrentismoreout‐of‐positionrelativetoUS

stocksthanisWTI.Nonetheless,thepositiverelationship(whichisalsostatistically

significant)isconsistentwiththeviewthatUSstocksrespondedtoglobalsupply‐

demandfactors,andthatBrentspreadsreflectedthesefundamentals.Duringthe

period1September,2008‐17July,2009,however,thecorrelationbecamenegative:

‐.5536tobeexact.ThisisdiametricallyopposedtothebehaviorofBrentspreads

priortothefinancialcrisis,andisnotwhatonewouldexpecttoobserveifBrent

spreadswerereflectingworld‐widesupply‐demandfundamentals.SinceUSand

OECDstocksexhibitedsimilarmovementsduringthistimeperiod,thisraises

questionsaboutwhetherBrentspreadsreflectedfundamentals(ascapturedby

OECDinventories)duringthisperiod.

Insum,thereisevidencethatthefinancialcrisishadamarkedeffectonthe

performanceofbothoilpricebenchmarks.Themostplausibleexplanationisthat

thecrisissharplycurtailedthedemandforoil.Giventheinelasticityofoil

productionintheveryshortrun,thissharpdemanddeclinecouldonlybe

accommodatedbyasharpdropinprices,andasubstantialincreaseininventoriesof

crude.InventoriesinCushingrosedramatically,apparentlyapproachingthe

effectivestoragecapacitythere.Asinventoriesapproachedeffectivestorage

capacity,themarginalcostofstorageatCushingbecameveryinelastic.Since

spreadswithlargepositiveinventorylevelsequalthemarginalcostofstorage,this

inelasticitymakesspreadsmorevolatile,sinceasaresultofthisinelasticitysmall

changesinstorage,orsmallchangesineffectivestoragecapacity(duetooperational

considerations),leadtosubstantialchangesinspreads.Theseeffectsareamplified

bytheeffectsofgreateruncertaintyandasharpincreaseinthedemandforstorage

ontransactionscostsinthemarketforphysicalstorage.

Thefigurelabeled“CushingStocks”depictsthemarkedincreaseinCushing

stocksstartinginearly‐October,2008.Stocksrosetothelargestabsolutelevel

observedinthesampleperiod,androsemorerapidlythanatanytimeduringthis

period.Moreover,itshouldbenotedthatthefractionofUSstocksheldinCushing

alsoroserapidly,toalevelnotobservedheretofore.Thisisillustratedinthefigure

labeled“CushingStocks/USStocks,”whichshowsthatthisratiorosetoarecord

highbyJanuary,2009,andtherateofincreasetoreachthathighmorewasmore

rapidthanobservedpreviously.

Therefore,thebehaviorinWTIfuturespricesandspreadsduringtheperiod

ofthefinancialcrisismostlikelyreflectedconstraintsontheCushingdeliverypoint

thatwereexacerbatedbyanunprecedenteddeclineindemand,andaconcomitant

unprecedentedincreaseininventories.8

VI. SummaryandConclusions

Thefinancialcrisisof2008‐2009hadapronouncedeffectonthebehaviorof

oilprices,andtheperformancesofthetwoprimarypricebenchmarks,WTIfutures,

andBrentfutures.Thecrisiswasassociatedwithadramaticincreaseinprice

volatility;awideningofspreads;anincreaseinthevolatilityofthesespreads;anda

declineinhedgingeffectiveness.Theseeffectswereevidentforfrontmonthand

secondmonthWTIandBrent,butweremostpronouncedforfrontmonthWTI,

especiallywithinafewdaysofcontractexpiration.

Thefinancialcrisiswasalsoassociatedwithanunprecedentedspikeinoil

inventoriesintheUnitedStatesandaroundtheworld,andattheWTIdeliverypoint

ofCushing,Oklahoma.Theeconomictheoryofstorablecommoditypricing,andthe

data,stronglysuggestthatthisphenomenonisconnectedwiththebehaviorofprice

benchmarksduringthefinancialcrisis.

8ItshouldbenotedthatoperatorsatCushingaddedapproximately8millionbarrelsofcapacityduring2008.

Specifically,inanefficientlyoperatingmarket,asharpdemanddeclinelike

thatcausedbythefinancialcrisisshouldleadtoalargeincreaseininventory.This

largeaccumulationcancausestockstoapproachcapacityconstraintsatapointlike

Cushing.AlthoughstorageatCushingwaslessthannominalcapacitythereeven

wheninventoriespeaked,thedatasuggestthatCushingwaseffectivelyconstrained,

andthatasaresult,thesupplyofstoragewasextremelyinelastic.Since(a)ina

marketwithlargestoragenearby‐deferredspreadspricethemarginalcostof

storage,and(b)whenthemarginalcostofstorageishighlyinelastic,small

fundamentalshockshavelargeeffectsonthismarginalcost,then(c)such

fundamentalshockswillhavelargeeffectsonspreads.Moreover,thedramatic

increaseinuncertaintyandanincreaseinthedemandforstoragelikelyincreased

transactionscosts,andthedispersionandvolatilityofnegotiatedstorageratesat

Cushing.

Thus,thebehaviorofpricingbenchmarksduringtheperiodofthefinancial

crisiswasdrivenbytheextraordinarycircumstancesofthatperiod,andarenota

harbingerofperformanceundermorenormalcircumstances.

Itshouldbeemphasizedthattheseeffectswereconcentratedduringthe

periodofsevereworldwideeconomiccontractionandextremevolatilityinthe

autumnof2008andthewinterof2008‐2009.Theperformanceofthepricing

benchmarkshadlargelyreturnedtopre‐crisislevelsbyearly‐spring,2009.

ForbothWTIandBrent,thereisevidencethattechnicalfactorsassociated

withexpirationinjectadditionalvolatilityintothepriceintheexpiringfuture.

TheseproblemsweremoresevereforWTIduringtheperiodofthefinancialcrisis,

likelyduetothefactthattheaforementionedconstraintsatCushingexacerbatedthe

effectsofexpiration‐driventechnicalfeatures.ThesimilarbehaviorofWTS

suggeststhatthisphenomenonwascausedbyfundamentalconditionsinthe

Midcontinentmarket,ratherthanfactorsspecifictotheNYMEXWTIfutures

contract.Althoughnotimmaterial,theimportanceofthisisdiminishedbythefact

thatmostinteresthasrolledtothenext‐expiringcontractwellbeforetheseeffects

becomemanifest.

Evenduringtheheightofthefinancialcrisis,WTIpricingrelationships

continuedtoco‐varywithfundamentalsaspredictedbyeconomictheory.In

particular,spreadswidenedasinventories(USandCushing)declined(andvice

versa),althoughthisrelationwasweakerthanthatobservedpriortothecrisis.In

contrast,inareversalfrompre‐crisisbehavior,duringthecrisis,Brentspreads

exhibitedanegativecorrelationwithinventories(USandCushing);thisisopposite

fromwhatonewouldexpectedtoobserveinacompetitivemarketthataccurately

reflectsfundamentals.Thissuggeststhatanydivergencesbetweenthehedging

performanceofWTIandBrentarenotclearlyattributabletothelatterreflecting

fundamentalsandtheformernot.Infact,thestock‐spreadrelationsuggeststhatthe

oppositeisthecase.

CL Front-LLS Variance (BCAG)

FrontCash

CL Front-Back Log Difference

CB Front-Back Log Difference

US Oil Nearby- First Deferred Spreads

3-Nov-08

10-Nov-08

17-Nov-08

24-Nov-08

1-Dec-08

8-Dec-08

15-Dec-08

22-Dec-08

29-Dec-08

5-Jan-09

12-Jan-09

19-Jan-09

26-Jan-09

2-Feb-09

9-Feb-09

16-Feb-09

23-Feb-09

WTS LLS WTI NYMEX WTI

CL-Dated Brent Rolling Correlation

0.3000

0.4000

0.5000

0.6000

0.7000

0.8000

0.9000

1.0000

FrontBack

CL-Dubai Rolling Correlation

0.0000

0.1000

0.2000

0.3000

0.4000

0.5000

0.6000

0.7000

0.8000

0.9000

1.0000

FrontBack

CL-LLS Rolling Correlation

0.6000

0.6500

0.7000

0.7500

0.8000

0.8500

0.9000

0.9500

1.0000

FrontBack

CL-MARS Rolling Correlation

0.6000

0.6500

0.7000

0.7500

0.8000

0.8500

0.9000

0.9500

1.0000

FrontBack

CL GCG Correlation

0.0000

0.1000

0.2000

0.3000

0.4000

0.5000

0.6000

0.7000

0.8000

0.9000

1.0000

FrontBack

CB-Dated Brent Rolling Correlation

0.5000

0.5500

0.6000

0.6500

0.7000

0.7500

0.8000

0.8500

0.9000

0.9500

1.0000

FrontBack

CB-Dubai Rolling Correlation

0.0000

0.1000

0.2000

0.3000

0.4000

0.5000

0.6000

0.7000

0.8000

0.9000

1.0000

FrontBack

CB-Singapore Rolling Correlation

0.0000

0.1000

0.2000

0.3000

0.4000

0.5000

0.6000

0.7000

0.8000

0.9000

1.0000

FrontBack

CL Front-Brent Correlation (GARCH BCAG)

CL Back-Brent Correlation (GARCH BCAG)

CL Front-Dubai Correlation (GARCH BCAG)

CL Back-Dubai Correlation (GARCH BCAG)

CL Front-GCG Correlation (GARCH BCAG)

CL Back-GCG Correlation (GARCH BCAG)

CL Front-LLS Correlation (GARCH BCAG)

CL Back-LLS Correlation (GARCH BCAG)

CL Back-Dated Brent Correlation (BCAG)

CL Front-Dated Brent Correlation (BCAG)

CL Front-GCG Correlation (BCAG)

CL Back-MARS Correlation (BCAG)

CL Front-LLS Correlation (BCAG)

CL Back-LLS Correlation (BCAG)

CL Front-MARS Correlation (BCAG)

CB Front-Brent Correlation (GARCH BCAG)

CB Back-Brent Correlation (GARCH BCAG)

CB Front-Dubai Correlation (GARCH BCAG)

CB Back-Dubai Correlation (GARCH BCAG)

CB Back-Gasoil Correlation (GARCH BCAG)

CB Front-Gasoil Correlation (GARCH BCAG)

CB Front-Singapore Correlation (GARCH BCAG)

CB Back-Singapore Correlation (GARCH BCAG)

CB Front-Dated Brent Correlation (BCAG)

CB Back-Dated Brent Correlation (BCAG)

CB Front-Dubai Bag Correlation (BCAG)

CB Back- Dubai (BCAG)

CB Front-Gasoil Correlation (BCAG)

CB Back-Gasoil Correlation (BCAG)

CB Front-Singapore ( BCAG)

CB Back-Singapore Correlation (BCAG)

10 15 20 25 30 35-2

Stocks

CL Front-Back Spread vs. Cushing Stocks

260 280 300 320 340 360 380-4

10CL Front-Back Spread vs. US Stocks

Stocks

Cushing Stocks

40.004/

Cushing Stocks/US Stocks

10.00%

12.00%

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