Noureddine Krichene

World crude oil and natural gas: a demand and supply model

Abstract This paper examines world markets for crude oil and natural gas over the period 1918–1999; it analyzes the time-series properties of output and prices and estimates demand and supply elasticities during 1918–1973 and 1973–1999. Oil and gas prices were stable during the first period; they became volatile afterwards, reflecting deep changes in the market structure following the oil shock in 1973. Demand price elasticities were too low; however, demand income elasticities were high. Supply price elasticities were also too low. The elasticity estimates help to explain the market power of the oil producers and price volatility in response to shocks, and corroborate elasticity estimates in energy studies.

A Simultaneous Equations Model for World Crude Oil and Natural Gas Markets

A model for world crude oil and natural gas markets is estimated. It confirms low price and high income elasticities of demand for both crude oil and natural gas, which explains the market power of oil producers and price volatility following shocks. The paper establishes a relationship between oil prices, changes in the nominal effective exchange rate (NEER) of the U.S. dollar, and the U.S. interest rates, thereby identifying demand shocks arising from monetary policy. Both interest rates and the NEER are shown to influence crude prices inversely. The results imply that crude oil prices should be included in the policy rule equation of an inflation targeting model.

World Crude Oil Markets: Monetary Policy and the Recent Oil Shock

This paper examines the relationship between monetary policy and oil prices within a world oil demand and supply model. Low price and high income elasticities of demand and rigid supply explain high price volatilities and producers market power. Exchange and interest rates do influence oil market equilibrium. The relationship between oil prices and interest rates is a two-way relationship that depends on the type of oil shock. During a supply shock, rising oil prices caused interest rates to increase; whereas during a demand shock, falling interest rates caused oil prices to rise. Record low interest rates led to high oil price volatility in 2005. Data shows that world economic growth and price stability require stable oil markets and therefore more prudent monetary policies.

Crude Oil Prices: Trends and Forecast

Following record low interest rates and fast depreciating U.S. dollar, crude oil prices became under rising pressure and seemed boundless. Oil price process parameters changed drastically in 2003M5-2007M10 toward consistently rising prices. Short-term forecasting would imply persistence of observed trends, as market fundamentals and underlying monetary policies were supportive of these trends. Market expectations derived from option prices anticipated further surge in oil prices and allowed significant probability for right tail events. Given explosive trends in other commodities prices, depreciating currencies, and weakening financial conditions, recent trends in oil prices might not persist further without triggering world economic recession, regressive oil supply, as oil producers became wary about inflation. Restoring stable oil markets, through restraining monetary policy, is essential for durable growth and price stability.

Recent Dynamics of Crude Oil Prices

Crude oil prices have been on a run-up spree in recent years. Their dynamics were characterized by high volatility, high intensity jumps, and strong upward drift, indicating that oil markets were constantly out-of-equilibrium. An explanation of the oil price process in terms of the underlying fundamentals of oil markets and world economy was provided, viewing pressure on oil prices mainly as a result of rigid crude oil supply and an expanding world demand for crude oil. A change in the oil price process parameters would require a change in the underlying fundamentals. Market expectations, extracted from call and put option prices, anticipated no change, in the short term, in the underlying fundamentals. Markets expected oil prices to remain volatile and jumpy, and with higher probabilities, to rise, rather than fall, above the expected mean.

Purchasing Power Parities in Five East African Countries: Burundi, Kenya, Rwanda, Tanzania, and Uganda

In a case study of Burundi, Kenya, Rwanda, Tanzania, and Uganda, this paper finds that bilateral real exchange rates revert to a long-term equilibrium in line with purchasing power parities, implying that these countries constitute an integrated trading zone, their markets are interdependent and arbitrage works efficiently, and intraregional competitiveness is preserved. These findings are partly explained by the flexibility of nominal exchange rates and prices and the absence of long-term productivity differences among these countries. To strengthen market integration, foster private sector development, and enhance growth prospects, the paper emphasizes the importance of increased trade, competitive labor markets, flexible exchange rates, and convergence of macroeconomic and structural policies.

An Oil and Gas Model

This paper formulated a short-run model, with an explicit role for monetary policy, for analyzing world oil and gas markets. The model described carefully the parameters of these markets and their vulnerability to business cycles. Estimates showed that short-run demand for oil and gas was price- inelastic, relatively income-elastic, and was influenced by interest and exchange rates; short-run supply was price-inelastic. Short-run price inelasticity could be a source for high volatility in oil and gas prices, and could confer to producers a temporary market power. Being simultaneous and incorporating interest and exchange rates, the model could be useful in short-term forecasting of oil and gas outputs and prices under policy scenarios.

Modeling Stochastic Volatility with Application to Stock Returns

A stochastic volatility model where volatility was driven solely by a latent variable called news was estimated for three stock indices. A Markov chain Monte Carlo algorithm was used for estimating Bayesian parameters and filtering volatilities. Volatility persistence being close to one was consistent with both volatility clustering and mean reversion. Filtering showed highly volatile markets, reflecting frequent pertinent news. Diagnostics showed no model failure, although specification improvements were always possible. The model corroborated stylized findings in volatility modeling and has potential value for market participants in asset pricing and risk management, as well as for policymakers in the design of macroeconomic policies conducive to less volatile financial markets.

Deriving Market Expectations for the Euro-Dollar Exchange Rate from Option Prices

Option prices provide valuable information on market expectations. This paper attempts to extract market expectations, as conveyed by an implied risk-neutral probability distribution, from option prices for the dollar-euro exchange rate. Returns volatilities are inferred from observed and interpolated option prices. To address robustness, two distributions, one from actual data and the other from interpolated data, were computed. The main conclusion of the paper is that traders have wide-ranging expectations, and large movements in either direction would not occur as a surprise. The main implication for monetary policy is that should markets become too volatile, then intervention may be required.

Understanding Development in an Islamic Framework

In this paper, the foundational rules governing human, economic and financial development in Islam, as understood from the Qur’ān and from the life and traditions of the Prophet Muhammad (pbuh), are summarized. These rules pave the path to development as the basis of institutional structure, which in turn, underpin the path of economic and social progress. The essential elements in the life of a Muslim—the unity of creation, freedom and freedom of choice, economic and human development, economic system and financial practice—are developed.