Andreas Economou

OIES-Saudi Aramco Fellow

Andreas Economou is a Doctoral Researcher at UCL Energy Institute, University College London. He also works as an Associate Energy Economist at West Texas Research Group Economics (WTRG Economics). His core areas of expertise are the natural resource and energy economics, with specialisation in oil and gas. His research focuses on the relationship between the oil price and its drivers across different oil market regimes, with a special focus on the supply determinants. Prior to starting his PhD, Andreas worked as Operations and Commercial Analyst in various contractor companies in Cyprus that deal with the physical supply of petroleum finished products and petrochemicals for transport-use, commercial and industrial-purposes and bunkering (ExxonMobil, SKP Enterprises, Primus Oil Supplies). Andreas holds an MSc in Oil and Gas Enterprise Management from University of Aberdeen, with a specialisation in petroleum economics and the international fiscal systems analysis.

Research

Drivers of the oil price: a measure of the exogenous and endogenous supply shocks of crude oil

The conventional approach in the analysis of oil prices using fundamental measures assumes that prices reflect supply-demand equilibrium, where shocks are caused explicitly by exogenous shortfalls in oil supply. However, in the absence of any significant exogenous production disturbances since 2003-onwards, this approach has led to a decrease in the explanatory ability of the supply side of the oil market. As such, recent findings attribute most of the oil price changes to demand-specific shocks. An alternative theoretical view following the 2008 oil price shock postulates that the supply shocks are determined endogenously with respect to the cumulative amount that could eventually be extracted and the projected time path for the demand function. This theoretical premise points towards a structural innovation of the supply determinant from an endogenous perspective that lacks attention from the empirical literature. The research introduces a new measure that jointly identifies and disentangles the supply shocks of crude oil into exogenous and endogenous, by quantifying the negative and positive shocks of 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 develop a structural VAR model of the world oil market that for the first time incorporates the endogenous aspect of oil supply shocks along with other fundamental measures; and to examine the extent to which each discrete category of supply and demand shocks explain changes in the real oil price. Findings from the research are relevant for both academia and market participants, as they will expand the current understanding on the importance of the oil price drivers by tackling important aspects such as the security of supply, the volatile nature of geopolitics, the dynamic intertemporal behaviour of OPEC, and the oil price evolution across different oil market regimes.

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This paper explores how the oil price path could evolve in 2017 by assessing the various oil price risks under alternative forecast scenarios pertaining to future market conditions. It is shown that even without the OPEC-non-OPEC output cut agreement in November 2016, the three-year long price fall would eventually have come to a halt and stabilized at close to $41/b in 2017 based solely on market forces. The agreement, however, helped accelerate the price recovery by stabilising the oil price near $50/b. That said, the current price at above $50/b already incorporates the bulk of the expected gains from the full enforcement of the production cuts and reflects the positive shift of market sentiment that has been building-up in anticipation of the implementation of the output cut agreement. Thus, for the next year, the oil price path is more sensitive to downside risks depending on the discipline of OPEC and non-OPEC oil producers. In fact, for the price recovery to be sustained in 2017, OPEC efforts must be met by favourable market conditions in the form of an unexpected surge in global oil demand amid a moderate expansion of US shale supply. On the contrary, a deterioration of global economic activity, or an aggressive expansion of US shale supply, or both, could reverse the current momentum. Moreover, a return of oil production from conflict inflicted countries Libya and Nigeria could undermine the OPEC agreement from within. Eventually, whatever scenario plays out, OPEC will continue to assess the market conditions and in the second half of 2017, it can decide on whether to extend the agreement to offset any losses to the anticipated oil price recovery that may arise from changes in oil market conditions or to drop the agreement all together. But regardless which way the decision goes, the latest output cut agreement is critical to resolving fundamental uncertainties about the shock hitting the oil market and OPEC behaviour in a more uncertain world.

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