Uncertainty and the convenience yield in crude oil price backwardations

This study examines why firms hold stocks of crude oil, particularly during price backwardations when spot prices exceed prices for forward delivery. Using a stochastic control model, this paper shows that the equilibrium val ue of inventories contains: the conventional Hotelling principle; the conve nience yield from the classical theory of storage; and an option value rela ted to price uncertainty. Our empirical results suggest that a convenience yield and risk premium are important elements of crude oil price backwardat ions. (C) 2001 Elsevier Science BY. All rights reserved.