Convenience yield, mean reverting prices, and long memory in the petroleum market

Abstract

The paper analyses convenience yields in the petroleum market. The implied convenience yield for petroleum and petroleum products is found to be driven by a non-stationary and mean reverting long memory process. The theoretical implication of this finding is established. It is suggested that this might be attributed to the fact that the market is expecting mean reversion in the spot prices. It is demonstrated that crude oil and unleaded gasoline are driven by similar mean reversion processes whereas heating oil exhibits a more seasonal pattern. This suggests that the market expects a more seasonal fluctuation in heating oil than crude oil or unleaded gasoline prices. Furthermore, the volatility process and its relation with the mean process has been found to be in accordance with the prediction of the theory of storage, i.e. positive convenience yields tend to be more volatile. In addition, it is argued that, consistent with implications of the theory of storage, higher convenience yields tend to cause higher volatility. However, the asymmetric nature of this causality implies that positive convenience yields are more likely to cause higher volatility than negative.