Marco Haase Economics Lunch, 31 May 2012

Scarcity, Risk Premiums and the Pricing of Commodity Futures The Case of WTI Crude Oil Futures
Risk premiums of commodity futures are directly related to the physical scarcity of commodities; for this purpose, we propose a simple decomposition of spot prices into a pure asset price plus a scarcity related price component. The economic interpretation of the decomposed asset price component conforms to the steady state price, whereas the scarcity price is related to supply shocks, physical restrictions of stocks and optimal inventory decisions of stockholders. This approach replaces the traditional convenience yield which results from an imperfect no-arbitrage relationship of the term structure of commodity futures prices. Moreover, we derive two distinctive inventory related risk premiums, based on the heterogeneity in the risk aversion of speculative or productive inventory holders, respectively. Our empirical tests conrm that two separate commodity-specic risk premiums affect the pricing of crude oil futures contracts: a net hedging pressure premium and a stock out risk premium. The two premiums show different cyclical characteristics and dominate the more-near-maturity futures contracts and all scarcity prices. We also nd that asset market risk factors such as exchange rates or stock market shocks affect the term structure of oil futures prices in a much more homogeneous way than commodity-specic risk factors. Overall, our ndings provide a decisive contribution to enlighten the ambiguous relationship between the convenience yield and the risk premium, at least for WTI Crude Oil futures. In fact, from the economical point of view, the convenience yield should be understood as a priced economic state variable, indicating times of temporary scarcity in a specic commodity market, rather than a non-monetary yield. Scarcity cycle patterns, reected in the value of the convenience yield, determine the time-varying risk rewards of commodity futures associated with stock out probability and hedging activity.