Oil Price Dynamics Report: A Sharp Drop in Demand Led To A Decrease in Oil Prices This Week

OIL PRICE DYNAMICS REPORT
Updated: March 5, 2018
A sharp drop in demand led to a decrease in oil prices this week.

∎ Despite a small decline in anticipated supply, a considerable ∎ Developments in global demand expectations since 2017:Q3
decrease in expected demand pushed down oil prices noticeably have reversed the largely supply-induced weakness in oil prices
over the past week. In 2017:Q4, robust global demand throughout the first half of 2017.
expectations continued to exert upward pressure on oil prices.
∎ Overall, since the end of 2014:Q2, both lower global demand
expectations and looser supply have held oil prices down, though
this trend seems to have reversed in 2016:Q2 and 2016:Q4, and
notably since 2017:Q3.
Our analysis of oil price movements does not necessarily represent the views of the Federal Reserve Bank of New York, the Federal Reserve System,
or the Federal Open Market Committee.
New York Fed / Research & Statistics Group ©2018 Federal Reserve Bank of New York Oil Price Dynamics Report / March 5, 2018 1
Cumulative Weekly Decomposition, Oct 06-Mar 02, 2018 Recent Decomposition Data
Percentage change ∎ The chart at left depicts the cumulative oil price decomposition
40
Brent price from October 6, 2017.
Oct 6, 2017
30
$55.62 ∎ The table below presents the most recent cumulative values.
Brent crude
price
20
Demand Cumulative Percentage Changes since October 6, 2017
10 Residual
Demand Supply Rest Brent
Supply Feb 16, 2018 5.7 -0.9 10.5 15.3
0
Feb 23, 2018 6.7 0.4 12.0 19.1
Mar 02, 2018 2.5 0.9 11.2 14.6
-10
Oct 6 Nov 6 Dec 6 Jan 6 Feb 6
Sources: Authors’ calculations; Haver Analytics; Thomson Reuters; Bloomberg L.P.
Notes: Residual reflects price movements unexplained by supply and demand factors.
Supply, demand, and residual sum to Brent crude price.
Cumulative Weekly Decomposition, 2010-Present Longer-Term View of Oil Price Movements

Percentage change ∎ This final chart provides a somewhat longer-term perspective by
100
Brent price means of a cumulative decomposition from 2010 onward.
75 Jan 8, 2010 Residual
$81.37 ∎ The analysis shows that excess supply became a significant driver
50
of oil prices in mid-2012 and generally dominated price dynamics
25 after mid-2014.
0
Demand
-25
-50 Supply
-75
-100 Brent crude

price
-125
2010 2011 2012 2013 2014 2015 2016 2017 2018
Sources: Authors’ calculations; Haver Analytics; Thomson Reuters; Bloomberg L.P.
Notes: Residual reflects price movements unexplained by supply and demand factors.
Supply, demand, and residual sum to Brent crude price.
Oil Price Decomposition Q&A
1. What is the goal of the oil price decomposition? References

Our aim is to determine how much of the observed oil price change has ∎ Groen, J., and P. Russo. 2016. “Lower Oil Prices and U.S. Economic
been driven by demand and supply factors. Activity.” Liberty Street Economics, May 2.
∎ Groen, J., and P. Russo. 2015. “Is Cheaper Oil Good News or Bad News for
2. What is the modeling strategy? the U.S. Economy?” Liberty Street Economics, June 8.
Using a statistical model and a large number of financial variables, we ∎ Groen, J., K. McNeil, and M. Middeldorp. 2013. “A New Approach for
decompose weekly oil price changes into demand effects, supply effects, Identifying Demand and Supply Shocks in the Oil Market.” Liberty Street
and an unexplained residual. Economics, March 25.
Sparse partial least squares regression allows us to construct linear
combinations from the variables in our financial market data set—called
Authors
factors—which have maximum explanatory content for oil price changes.
We first use this procedure to generate factors that best capture the Jan Groen and Max Sterman
patterns in the data, and then examine the estimated factors to determine
how they reflect demand or supply dynamics.
The model is re-estimated every week using weekly data from January
1986 through the close of business on Friday of the most recent week.
Over this sample, the model can explain about two-thirds of the weekly oil
price dynamics.
3. How to interpret the results?

The output of the model is used to decompose weekly changes in an
accounting sense. More specifically, the weekly Brent crude price change
always equals the change explained by demand factors plus the change
explained by supply factors plus a residual (the weekly change
unexplained by the sum of the estimated demand and supply factors).
Given the noise in weekly price changes, we choose to show the results
as a cumulation from a certain starting point (usually the start of the
previous quarter).

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OIL PRICE DYNAMICS REPORT

Updated: March 5, 2018

A sharp drop in demand led to a decrease in oil prices this week.

Cumulative Weekly Decomposition, 2010-Present Longer-Term View of Oil Price Movements

-100 Brent crude

1. What is the goal of the oil price decomposition? References

3. How to interpret the results?

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