Price spread and convenience yield behaviour in the international oil market

This paper examines the price and volatility behaviour of two similar commodities (Brent Crude Oil and West Texas Intermediate) and attempts to identify the variables that affect their relative price differential. Price spreads and convenience yields are estimated in an effort to test a number of hypotheses relating to market segmentation, seasonality and maturity effect. Cash and futures price data covering the period 1991-1995 reveal that: convenience yields are significant and about 2.5% of cash prices on the average; convenience yields exhibit strong yearly and monthly seasonalities due to supply/demand imbalances; convenience yield is a negative function of the level of stocks and behaves like a call option; as maturity of futures contracts nears, their convenience yields get smaller, an indication that the maturity effect exists in futures prices, and crude oil price spreads are affected by convenience yields which act as surrogates for demand/supply conditions and market price behaviour.