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I am grateful to Thomas Enger, Zuliu Hu, Mohsin S. Khan, and Blair Rourke for comments. Errors remain the responsibility of the author. The usual disclaimer applies.
The oil producers have often expressed the desire to maintain the mean level of prices stable over time. Hence, OPEC’s declaration of a target price around which they would prefer to see less volatility at relatively high frequencies (quarterly, monthly).
Prior to August 1990, the price data are for oil from the Brent system only. In August 1990, it was decided to commingle oil from the Brent system and the Ninian system at Sullom Voe to reduce specific gravity variations of the oil; the oil is known as Brent Blend. For a detailed account of the emergence and importance of the Brent market, see Horsnell and Mabro (1993).
Once the key marker price in levels is known, the spread to the marker permits determination of the outright price for other crudes.
The basic trading unit or contract is 1,000 barrels and the physical base for the contract is the delivery of West Texas Intermediate or substitute domestic or imported crudes by pipeline at Cushing, Oklahoma.
One of the most-widely reported uses of OTC markets was Mexico’s purchase of put options to protect against a decline in oil prices for its exports below $17 a barrel in 1991. The cost of the put options was reportedly $200 million to ensure that oil export earnings did not fall below $8.5 billion.
In earlier years, since the first development of oil fields in Pennsylvania and Texas until the outbreak of World War II, oil prices exhibited much greater volatility than was subsequently observed in the 1950s and 1960s.
See, for example, the discussion in Newbery and Stiglitz (1981). There are, however, a number of theoretical specifications with results contrary to this prior.
This is not to argue that there may be reasons why, as in other asset markets, there may seem to be undershooting and overshooting (from an ex-post standpoint) as markets react to changes in the information set. The probabilities attached to the likelihood of certain events occurring can change over time as the information set is affected by “news”.
Brent crude futures trading on the IPE started on June 23, 1988.
In fact some other OPEC producers increased their output at the same time as Saudi Arabia was increasing its supplies.