Shale Revolution and Shifting Crude Dynamics

56 Pages Posted: 26 Jun 2017

See all articles by Malick O. Sy

Malick O. Sy

RMIT University - School of Economics, Finance and Marketing; Financial Research Network (FIRN)

Liuren Wu

City University of New York, CUNY Baruch College - Zicklin School of Business

Date Written: June 25, 2017


Crude prices are subject to both demand and supply shocks. Major events and structural changes can induce large variations in intensities of the two types of shocks, as well as their magnitudes of impacts on crude price movements. This paper proposes a theoretical framework that allows us to extract the time variation in demand and supply shocks through a joint analysis of crude futures options and stock index options. Historical analysis shows that crude futures price movements are dominated by supply shocks in the earlier half of our sample from 2004 to 2008, but have become much more demand-driven since then. The large demand shock from the Great Recession, triggered by the 2008 financial crisis, contributes to the start of the dynamics shift. The shale revolution, on the other hand, has fundamentally altered the crude supply behavior. Since 2010, technology advances in horizontal drilling and hydraulic fracturing, together with other innovations, have enabled rapid increase of U.S. tight oil production from shale at increasingly competitive cost. The increasing tight oil production has undercut the price-setting power of the OPEC, and has lowered the OPEC's incentive to self-regulate its production. As a result of the dynamics shift, investors have also been shifting from worrying about crude price hikes as a production cost gauge to crude price drops as an indication of weakening demand. The shifting dynamics have fundamental implications for optimal fuel cost hedging by heavy crude users such as the airline industry.

Keywords: crude futures; crude futures options; stock index options; supply shocks; demand shocks; crude production; shale revolution; optimal fuel cost hedging policy

JEL Classification: C13, G13, Q41, Q47

Suggested Citation

Sy, Malick O. and Wu, Liuren, Shale Revolution and Shifting Crude Dynamics (June 25, 2017). Available at SSRN: or

Malick O. Sy

RMIT University - School of Economics, Finance and Marketing ( email )

445 Swanson Street Building 80 level 8 Room 58
Melbourne, Victoria 3000
+61399255895 (Phone)
+61399255986 (Fax)


Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane


Liuren Wu (Contact Author)

City University of New York, CUNY Baruch College - Zicklin School of Business ( email )

One Bernard Baruch Way
Box B10-247
New York, NY 10010
United States
646-312-3509 (Phone)
646-312-3451 (Fax)


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