Oxford University study calls for oil market overhaul to curb volatility

Oil futures speculators are exacerbating the already-excessive volatility of oil and damaging global growth prospects, an Oxford University report says.

The Macroeconomic Impacts of Oil Price Volatility: Mitigation and Resilience paper, written by Sir David King, Oliver Inderwildi and Zoheir Ebrahim, supports a financial transaction tax on oil derivatives trades but argues that the latest proposal from Europe is not strong enough.

King, Inderwildi and Ebrahim believe the 1 basis point charge planned by the European Commission would not be large enough to deter speculators.

They concede that such a tax, which is likely to be instituted this year, risks discouraging companies from hedging.

Oil price volatility is a “fundamental barrier to stability and economic growth”, the report says, and speculative trading in derivatives is much of the problem.

The authors believe the amount of speculation has started transferring volatility between stockmarkets and the oil markets.

A series of measures are needed to calm the torrid oil market.

While commodities are intrinsically volatile – and oil historically more so – the turbulence in oil prices has increased more than other raw materials in the past decade.

King, Inderwildi and Ebrahim recommend a raft of measures to bring prices under control, saying the amount of speculative trading taking place in the oil derivatives market is a large part of the problem.

Their study suggests ”the behaviour of speculators compounds existing volatility” and previously unrelated volatility is spilling over from the stockmarket to the oil market and vice versa.

A strategic stockpile of oil, held by the International Energy Association, could be used in times of crisis to smooth price spikes.

Major oil-reliant companies should also be forced to hold stockpiles to ride out short-term supply shocks, the authors say.

States should create incentives for businesses investing in alternative fuel infrastructure or more sustainable energy and institute energy efficiency regimes to lower demand for fossil fuel.

Governments need to strip the subsidies on fuel, particularly in non-OECD nations. 

Inderwildi says unconventional fossil fuel – such as shale gas – is unfortunate for the environment but a boon for the global economy.

While it will give extra time to develop more sustainable energy sources, reducing reliance on fossil fuel is an arduous task and one that needs collective action between oil and gas importing countries, he says. 

“This will require many measures, from extending the strategic oil reserves to the restructuring of derivative markets and large-scale investments in modern, energy efficient infrastructure,” he explains. 

“Reducing our dependence on fossil resource should also increase the energy security of OECD countries and in the long term, as a knock-on effect, this would also be likely to improve relations in areas where there are geopolitical tensions.”