Oil Price Shocks: A Measure of the Exogenous and Endogenous Supply Shocks of Crude Oil

Abstract The paper introduces a new measure that jointly identifies and disentangles the oil supply shocks of crude oil into exogenous and endogenous, by quantifying the positive and negative shocks to oil production caused by events outside the oil market (exogenous) or as a consequence of the normal functioning of the oil market (endogenous). The objective is to examine how the use of alternative measures of oil supply shocks affects our assessment of the dynamic effects of supply shocks on the real price of oil since 1990. Results show that for most of the 1990s, shortfalls in oil production that were brought about by geopolitical episodes accounted for about 7% of the variability in global crude oil production. However, this pattern reverses after 2000 onwards, as fluctuations in global oil production are largely attributed to market-specific events (6%). We show that oil supply shocks may have very different effects on the real price of oil, depending on the underlying specification of the shock. In particular, the measures that capture market-driven shifts in oil supply are found to be more plausible than the rest in explaining the variability of the real price of oil, especially when compared with flow supply shocks. In fact, analysis suggests that flow supply shocks underestimate the historical contribution of oil supply shocks to changes in the real price of oil, in contrast to total supply shocks that appear to have exerted significant upward pressure in the real price of oil especially between 2003 and mid-2008. Overall, endogenous supply shocks play an increasing important role in the historical evolution of the oil price, but it must be noted that oil price developments after 2010 are largely attributed to exogenous supply shocks. We conclude that historically the supply side of the market has been an important determinant of the real price of oil after all.