Shale Revolution, Shifting Crude Dynamics and Implications to the Aviation Industry and Aircraft Purchase Policy
Synopsis
Major events and structural changes induce large variations in the intensity of the shocks and their relative contribution to the oil price movements. Our study proposes a new methodology that allows timely identification of the shifting contribution from the two types of shock through a joint analysis of crude futures options and stock index options. Applying the methodology to historical data shows that crude futures price movements were dominated by supply shocks in the earlier half of our sample from 2004 to 2008, but have since become much more demand driven. The large demand shock following the 2008 financial crisis contributed to the start of this shift in the dynamics, while the subsequent rise of the shale revolution fundamentally altered the crude supply behaviour. The increasing U.S. shale oil production at a competitive cost has undercut the price-setting power of the OPEC, and lowered the OPEC’s incentive to self-regulate its production. As a result of this dynamics shift, investors have shifted from being concerned with crude oil price hikes as a gauge of increasing production cost, to worrying about crude oil price declines as an indication of weakening demand and this will have huge implications for Airlines in their aircraft purchase policies and also for the aircraft manufacturers.
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Shale Revolution, Shifting Crude Dynamics and Implications to the Aviation Industry and Aircraft Purchase Policy
Major events and structural changes induce large variations in the intensity of the shocks and their relative contribution to the oil price movements. Our study proposes a new methodology that allows timely identification of the shifting contribution from the two types of shock through a joint analysis of crude futures options and stock index options. Applying the methodology to historical data shows that crude futures price movements were dominated by supply shocks in the earlier half of our sample from 2004 to 2008, but have since become much more demand driven. The large demand shock following the 2008 financial crisis contributed to the start of this shift in the dynamics, while the subsequent rise of the shale revolution fundamentally altered the crude supply behaviour. The increasing U.S. shale oil production at a competitive cost has undercut the price-setting power of the OPEC, and lowered the OPEC’s incentive to self-regulate its production. As a result of this dynamics shift, investors have shifted from being concerned with crude oil price hikes as a gauge of increasing production cost, to worrying about crude oil price declines as an indication of weakening demand and this will have huge implications for Airlines in their aircraft purchase policies and also for the aircraft manufacturers.
