We could answer this empirically by looking at the correlation between oil stock returns and the quantity of oil consumed. But markets are not perfectly competitive, so that argument might not apply in practice. So we should see no correlation between oil quantity and stock return. In a perfectly competitive market, increases in revenue should incentivize competition, driving down profit margins such that profits don’t change at all.
It’s not obvious that any step is correlated with the next step, much less that the first step correlates with the last. Based on this data, it appears that price and quantity are moderately correlated (r=0.67, p revenue -> profit -> dividends -> stock return] leaves some wiggle room. Energy Information Administration (EIA)’s Short-Term Energy Outlook. What’s the relationship between oil price and quantity in practice? I did about 10 minutes of research and found some data from the U.S. If supply and demand matter about equally, price and quantity will be uncorrelated and we can’t use oil futures as a hedge. If prices are mostly driven by supply, we can hedge by short-selling oil. If oil prices are mostly driven by changes in demand, we can mission hedge by buying oil futures. But if supply changes, price and quantity move oppositely. If demand changes, price and quantity move together. And there’s no obvious relationship between price and quantity. But climate change gets worse when the quantity goes up. If we own oil futures, we make money when the price goes up.
So, can we mission hedge by buying oil futures? If supply decreases, quantity goes down while price goes up.If demand decreases, both quantity and price go down.If supply increases, quantity goes up and price goes down:Īnd, naturally, supply and demand can move in the other direction: For example, supply of oil could increase if oil companies discover a new source of oil. Supply increases when produces are willing to sell more. If demand increases, both the price and quantity of the good go up: These two curves cross over at some point, and that point tells us the actual market price and quantity of a product.Ī poorly-drawn illustration of what the supply and demand curves look like: 1ĭemand for oil might increase if, say, people start owning more cars. Similarly, producers’ willingness to sell gives us an upward-sloping supply curve. In aggregate, consumers’ willingness to buy the product creates a downward-sloping demand curve, which indicates the quantity consumers will buy at any given price-or, conversely, the price they will pay for any given quantity. Producers are willing to sell more of the product if the price is higher.Consumers are willing to buy more of some product if the price is lower.The problem is, the quantity and price of oil aren’t necessarily related.īefore we talk about the economics of oil prices, let’s clarify some terminology. If you buy oil futures, you will make money as the price of oil goes up. You’d like to make money as the quantity of oil goes up. If people burn more oil, that directly contributes to climate change. Suppose you’re considering hedging climate change by buying oil futures. But it might be hard in practice to find a good way to hedge climate change. In worlds where oil companies are more successful and climate change is worse, you make more money-at least in theory. For instance, if you’re working to prevent climate change, you could buy stock in oil companies. The purpose of mission hedging is to earn more money in worlds where your money matters more. But this answer relies on some questionable data (either that, or my methodology is bad). As a motivating example, can we mission hedge climate change using oil futures or oil company stock? Based on a cursory empirical analysis, it appears that we can, and that oil stock makes for the better hedge. Summary: Mission hedgers want to hedge the quantity of a good, but can only directly hedge the price.
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