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Fundamental and Financial Influences on the Co-movement of Oil and Gas Prices

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Abstract:
As speculative flows into commodity futures are expected to link commodity prices more strongly to equity indices, we investigate whether this process also creates increased correlations amongst the commodities themselves. Considering U.S. oil and gas futures, we investigate whether common factors, derived from a large international data set of real and nominal macroeconomic variables by means of the large approximate factor models methodology, are able to explain both returns and whether, beyond these fundamental common factors, the residuals remain correlated. We further investigate a possible explanation for this residual correlation by using some proxies for trading intensity derived from CFTC publicly available data, showing most notably that the proxy for speculation in the oil market increases the oil-gas correlation. We thus identify the central role of financial activities in shaping the link between oil and gas returns.

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Energy Specializations: Energy Modeling – Forecasting and Market Analysis; Energy and the Economy –Economic Growth and Energy Demand; Petroleum – Refining and Products; Natural Gas – Policy and Regulation; Natural Gas – Imports and Exports; Petroleum – Markets and Prices for Crude Oil and Products

JEL Codes: Q41: Energy: Demand and Supply; Prices, Q40: Energy: General, Q02: Commodity Markets, Q35: Hydrocarbon Resources, Q38: Nonrenewable Resources and Conservation: Government Policy

Keywords: Oil Futures, Gas Futures, Common Factors, Speculation, Excess Comovement

DOI: 10.5547/01956574.38.2.dbun

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Published in Volume 38, Number 2 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.

 

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