Econometric Modelling of Oil Prices

Chapter 1 Introduction The importance of oil is well known to everyone. It is one of the most important source of energy and it is of critical importance to the maintenance of the industrialised civilisation. Economics, politics and technology are all deeply aected even by slight variations of the price of the crude. According to the EIA 1 its importance has been decreasing over time especially in the last thirdy years, but it still represents the largest energy source with a 35% share over the world total energy demand. Oil market dynamics has therefore a huge impact on all economic activi- ties. Various transmission channels exist through which oil prices may have an impact on economic activity. A higher crude oil price means an higher energy bill for the private consumer and an higher production cost for the industrial producers. Therefore productivity may be aected, causing conse- quences for wages, employment, ination, prots and investments as well as stock market capitalization 2 . From the supply side, higher prices mean reduced availability af an input of production. The consequences are reduced output growth and increasing costs. In this way productivity is slowed. Inationary shocks which are likely to be accompanied by second round eects are often the result of an abnormal increase in oil price. The eects to 1 The Energy Information Agency provides the ocial statistics for the U.S. government 2 Market capitalization: is a measurement of size of a business enterprise equal to the share price times the number of shares outstanding of a publicly traded company. Capi- talization could represent the public opinion of a company net worth and is a determining factor in stock valuation. Likewise, the capitalization of stock markets may be compared to other economic indicators (Wikipedia, Market Capitalization) 9