BIS: Identifying Oil Price Shocks and their Consquences

The Bank for International Settlements (BIS) has released a study that attempts to identify the impact of oil price shocks on the global energy market. Below I have pasted in the summary abstract of this study. You can read the full study here. Further below are a few added comments.

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 Abstract 

"This paper proposes a simple but comprehensive structural vector autoregressive (SVAR) model to examine the underlying factors of oil price dynamics. The distinguishing feature is to explicitly assess the role of expectations on future aggregate demand and oil supply in addition to the traditional realized aggregate demand and supply factors. Our empirical analysis shows that identified future demand and supply shocks explain about 30-35 percent of historical oil price fluctuations. In particular, future oil supply shocks are more than twice as important as realized and future demand shocks in accounting for oil price developments. The empirical result indicates that the influence of oil price shocks on global output varies according to the nature of each shock. We also show that the financial factors and the development of shale-oil technology are additional relevant sources of oil price fluctuations."
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My added comments: Having worked in the oil and gas production industry my entire life (as an accountant), I have seen a lot of major ups and downs in oil and gas prices over the years. There is no doubt that the price of energy has a big impact on the global economy and pretty much affects almost everyone.

Predicting prices is not an easy task. There are many variables that come into play such as:

- basic supply and demand
- the cost of finding and producing reserves
- market expectations of future supply and demand
- unexpected geo political events that arise from time to time
- politics
- taxation policies

and more.

From the perspective of most oil producing companies that I am aware of, the hope is that prices stay high enough to maintain production, fund finding costs to replenish reserves as they are depleted, and generate enough profit margin to maintain the incentive to continue to search for new reserves. On the flip side, most companies really do not want to see prices get too high for too long because it puts a large burden on the overall economy and makes energy costs high for some who can barely afford it. 

For the long term, the general forecasts I have seen (assuming no major global crisis that craters global energy demand) project that the world will need as much oil and gas production as possible to meet expected future energy demands alongside the expansion of renewable energy sources. The growth in global demand (especially in developing nations) would almost certainly exceed the available oil and gas supplies sometime in the next 20 years so we will need other forms of energy to take on more the load over time.

For our purposes here, oil prices are just one other factor we should keep an eye on that can create systemic risk if they get too high or too low for too long a period of time. For now, a price range between $50 and $75 per bbl is probably in the "sweet spot" to maintain investment to continue exploration while hopefully keeping energy costs contained as best we can. Long term prices below $40 or above $100 need to be watched carefully for their potential for systemic risk.