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Information and Energy Prices
Energy market participants form expectations about supply and demand conditions, and consequently about current and future prices, based on constantly evolving economic information. The prices of crude oil, heating oil, natural gas and gasoline are thus interrelated. In addition, investors in energy company financial securities affect company value by adjusting those security prices to reflect information revealed about company management and performance. Three recent studies conducted by scholars in the Price College of Business provide insight into the behavior and interrelation of energy prices and information.
Unexpected Information and Changes in Energy Prices
The arrival of unexpected information about energy supply and demand expands market participants’ knowledge, resulting in changes in their beliefs and changes in energy prices.
A recent study commissioned by the U.S. Energy Information Administration (EIA) carried out by Scott Linn, Louis Ederington, Chitru Fernando, and Scott Guernsey of OU, along with Thomas Lee of the EIA, examines the specific ways that information affects energy prices. The study reviews the existing academic literature and provides new empirical evidence about energy price changes associated with various kinds of information that are revealed to energy market participants on a regular or irregular basis, including
- Unexpected changes in energy commodity inventories
- Unexpected changes in key U.S. macroeconomic variables
- Unexpected U.S. monetary policy news following meetings of the U.S. Federal Open Market Committee (FOMC) meetings
- Announcements of planned U.S. Strategic Petroleum Reserve adjustments
The study examines such information’s effect on energy futures prices encompassing oil, natural gas, gasoline, and distillate. The study’s results include the following highlights.
- Energy futures prices respond inversely not only to information about unexpected changes in a product’s own inventory (reflecting supply and demand conditions), but also to unexpected changes in the inventories of other energy products.
- For oil, gasoline, and distillate, energy futures prices’ response to unexpected inventory changes decreased following the advent of 24-hour electronic futures trading in June 2006. Interestingly, the opposite is found for natural gas futures prices.
- The volatility of energy futures prices around the time that the EIA weekly inventory reports are released is positively related to the absolute size of the unexpected change in inventories.
- Energy futures prices respond positively to unexpected information released about key U.S macroeconomic variables around the time of day that the data are released. However, no relation is found when price changes are measured over the full day of the announcement or for periods extending to 20 days after the announcement.
- Changes in energy futures prices are negatively related to surprise changes in the target federal funds rate around the time of day that press releases are issued following conference-call meetings of the FOMC, but not following regular meetings. Conference-call meetings generally are associated with an urgent issue. When assessed over the full day on which the announcement is released, no statistically significant relation to energy price changes is found.
- Announcements of planned increases in the U.S. Strategic Petroleum Reserve are associated with positive and statistically significant increases in energy futures prices on the day the announcement is released. Conversely, an announced decrease in the reserve is associated with a decrease in crude oil prices. However, the small number of cases suggests these results might not be generalizable.
Learn more about these results and read a comprehensive review of the academic literature on these topics by accessing the study (pdf). View the slides (pdf) based upon on the report presented by Scott Linn at the EIA-sponsored Financial and Physical Oil Market Linkages Workshop (September 19, 2017).
Changes in Oil Prices and Changes in Petroleum Product Prices
For years, the connection between changes in oil prices and changes in the prices of refined products has been a topic of interest to researchers and policy makers alike. In a recent EIA-sponsored project, Scott Linn, Louis Ederington, and Chitru Fernando of OU, along with Seth Hoelscher of Missouri State University and Thomas Lee of the EIA, surveyed the academic literature on the behavior of the prices of oil and petroleum products. The study reviews the evidence regarding the general behavior of spot and futures prices for petroleum products, the relation of these prices to oil prices, the ways that product prices respond to oil price changes, the primary market in which price formation occurs (the spot market versus the futures market), and the influence of speculative activity on petroleum product prices. The researchers found several noteworthy results.
- Petroleum product prices and price variations are predominantly caused by oil prices, but some evidence suggests that the prices of petroleum products also feed back and influence oil prices.
- World oil prices are the primary drivers of wholesale gasoline prices in the United States, and the Brent price has in recent years served as the world proxy. Some conclude, however, that the benchmark is best reflected by a weighted average of Brent and West Texas Intermediate. Alternatively, others have argued for what the EIA labels “refiner acquistion cost of crude oil,” or “The cost of crude oil, including transportation and other fees paid by the refiner.”
- In recent years, refined product spot prices have become more interrelated across different global markets, specifically the United States and Europe.
- The majority of studies focusing on gasoline prices (wholesale, retail, and futures) find that they adjust more quickly to oil price increases and more slowly to oil price decreases, a circumstance often called the “rockets and feathers” phenomenon first coined by R.W. Bacon in 1991. However, some studies find that the response is symmetric.
- Refinery outages have a significant and positive impact on refined product wholesale prices.
- Crack-spreads exhibit positive and significant revisions to forecasts of tropical storms and hurricane activity in the Gulf of Mexico, suggesting reactions to anticipated supply effects.
- Volatility spillover occurs among oil, gasoline, and heating oil spot prices and futures prices.
- U.S. evidence regarding the link between futures prices and spot prices of petroleum products tends to favor the conclusion that, on average, price discovery (price formation) occurs in the futures market.
- Petroleum product futures prices are generally found to be unbiased predictors of future spot prices three months out, but not for the six- and 12-month contract horizon.
- Evidence suggests that speculation has increased neither the volatility in petroleum product futures prices nor the excess returns earned from investing in those securities.
These and additional results are discussed fully in the authors’ survey report (Part 1, Part 2 - pdf). View the slides (pdf) for an earlier version of the report presented by Scott Linn at the EIA-sponsored Financial and Physical Oil Market Linkages Workshop (September 19, 2017).
Environmental Risk Management and Company Value
The notions of “corporate social responsibility” and “environmental investment and management” have become lightning rods for both criticism and praise of corporate America, and the energy industry has been on the receiving end of both. Chitru Fernando and Mark Sharfman of OU and Vahap Uysal of DePaul University argue in a recent study that not all socially responsible policies have an equivalent impact on company value. Corporate actions that mitigate the likelihood of adverse environmental outcomes may reduce firms’ risk exposure to accidents, lawsuits, fines, and so forth, thereby appealing to investors and creating company value. In contrast, the use of corporate resources to enhance a firm’s perceived corporate social responsibility beyond both legal requirements and value-enhancing risk management may decrease value and be shunned or penalized by investors. The authors tackle these important questions in a study titled “Corporate Environmental Policy and Shareholder Value: Following the Smart Money,” published in 2017 in the Journal of Financial and Quantitative Analysis (volume 52). Highlights of the study’s findings include the following.
- The authors classify corporate environmental practices into two categories: (1) actions that mitigate the likelihood of negative outcomes by reducing firms’ exposure to environmental risk (e.g., by deploying safer petroleum drilling technologies); and (2) actions that enhance the firm’s perceived “greenness” through investments that go beyond both legal requirements and any conceivable risk management rationale.
- Companies are classified into three groups: (1) toxic companies, which are exposed to environmental risk but have not taken steps to mitigate those risks; (2) green companies, which spend corporate resources to enhance their “greenness” beyond what is necessary to meet legal requirements; and (3) neutral companies, which have taken steps to manage environmental risk within the requirements and restrictions of the law and public policy.
- The authors argue that sophisticated institutional investors will have less interest in toxic companies and green companies and will be more likely to invest in the stocks of environmentally neutral firms rather than toxic firms or green firms.
- The authors also point out that green companies’ spending practices may be value-decreasing because they consume corporate resources in ways that destroy corporate value. This could cause sophisticated shareholders to shy away from these stocks.
- The study finds evidence that both green and toxic companies are associated with less institutional ownership than environmentally neutral companies. This holds for all institutional investor types in the sample.
- The study also shows that corporate value is significantly lower for toxic stocks than for neutral stocks.
- Finally, the study demonstrates that company value is lower for green companies than neutral companies, consistent with the view that companies do not increase their value when they spend corporate resources to enhance greenness beyond what is necessary to mitigate environmental risk exposure.
 From the EIA’s “Definitions, sources, and explanatory notes” webpage, https://www.eia.gov/dnav/pet/TblDefs/pet_pri_rac2_tbldef2.asp.
 Bacon, R. W. (1991). Rockets and feathers: The asymmetric speed of adjustment of UK retail gasoline prices to cost changes. Energy Economics, 13(3), 211-218.
 The authors utilize the KLD Research & Analytics, Inc. (KLD) social performance dataset to classify companies. The dataset is now managed by MSCI, Inc.