Economic Modelling 42(2014)287-295 Contents lists available at ScienceDirect Economic Modelling ELSEVIER journal homepage:www.elsevier.com/locate/ecmod Identifying the dynamic relationship between tanker freight rates and CrossMark oil prices:In the perspective of multiscale relevance Xiaolei Sun*,Ling Tangb,Yuying Yang Dengsheng Wu.Jianping Li Institute of Policy and Management,Chinese Academy of Sciences,Beijing 100190.China Beijing University of Chemical Technology,Beijing 100029.China University of Chinese Academy of Sciences,Beijing 100049.China ARTICLE INFO ABSTRACT Article history: The tanker shipping market has been treated as the key extension of the world oil market and inevitably,its Accepted 30 June 2014 uncertainty is correlated to volatility of the oil market,besides supply and demand factors.Therefore,for Available online 30 July 2014 improving operational management and budget planning decisions,it is essential to understand the inherent Keywords: relevance between freight rates and crude oil prices.Taking time-dependent features into account,this paper focuses on the multiscale correlation between freight rates and oil prices.Given the complexity and mutability Multiscales Ensemble EMD of tanker freight rate process,this paper first extracts the intrinsic mode functions from the original data using Relevance the Ensemble Empirical Mode Decomposition model and then reconstructs two separate composite functions: Freight rate high-frequency and low-frequency components,plus the residual as the long-term trend.Secondly.correlations Oil price of the multiscale components of freight rates and oil prices are examined based on relevance structure.Empirical results show that tanker freight rates and oil prices exhibit different multiscale properties with true economic meaning and are significantly correlated in the medium and the long term when taking the relevance structure into account.These findings offer some useful information to better understand the correlations between these two markets and more importantly.propose a novel perspective to investigate the dynamic relationship between two markets. 2014 Elsevier B.V.All rights reserved. 1.Introduction decision-making for shipping assets under uncertainty (Batchelor et al.,2007:Engelen et al.,2006:Glen,2006:Kavussanos and Crude oil,as a vital strategic commodity,is traded across the globe Alizadeh,2002:Tvedt,1997).Basically,shipping cycles inherent in the and this involves massive transportation infrastructures,including maritime industry propel freight rates to be mean-reverting in the pipelines,tankers and storage facilities (Rodrigue et al,2006).Interna- long run(Stopford,2008:Tvedt,2003).Moreover,the assumption of tionally,tanker shipping is necessary to address the imbalances inelastic demand and elastic supply can basically explain the phenome- between oil supply and demand in different regions.Moreover,tanker non of both small and large volatilities clustering together because of shipping,as the central logistics,plays a crucial role in the management small changes in the market balance (Strandenes and Adland,2007). of the global supply chain in the oil industry(Alizadeh and Nomikos, Besides,oil is not only the commodity being transported,but is also an 2004:Cheng and Duran,2004).More importantly,tanker shipping is a essential component of the transportation cost.While oil prices may service that provides "special"utility to the oil market and adds value explain some of the variation and dynamics in maritime transport to oil by moving it from surplus to deficit areas (Mayr and Tamvakis costs,other factors are also at play(UNCTAD,2010).Although the 1999).Naturally,tanker shipping market can be treated as the key methods used to model the dynamics of freight rate processes vary in extension of the international oil market and inevitably.its uncertainty extant literature,the consensus is that freight rates are time-varying. is closely correlated to volatility of the oil market,besides tanker supply non-linear and local non-stationary (Adland and Cullinane,2006; and demand.Spontaneously,for improving operational management and budget planning decisions,it is essential to investigate the inherent Summarized in UNCTAD(2010).These factors include.(a)demand for shipping services dynamic relationship between tanker freight rates and oil prices. (e.g.trade volumes):(b)port-level variables (e.g.the quality of port infrastructure): Much effort has gone into the study of modeling the dynamics of (c)product-level variables(e.g value/weight ratios and product prices):(d)industry-level tanker freight rates,in order to better support the operational variables(e.g.the extent of competition among shippers and carriers):(e)technological fac- tors(e.g the degree of containerization,size of ships and economies of scale):(f)institutional variables (e.g legislation and regulation):and (g)country-level variables (e.g attractiveness Corresponding author.TeL:+86 10 59358806 of export markets).This paper focuses on the relationship between oil price and freight rates, E-mail address:xlsun@casipm.accn (X.Sun). and specific analysis on these factors is beyond the scope of the present study. http://dx.doi.org/10.1016/j.econmod.201406.019 0264-99930 2014 Elsevier B.V.All rights reserved.Identifying the dynamic relationship between tanker freight rates and oil prices: In the perspective of multiscale relevance Xiaolei Sun a, ⁎, Ling Tang b , Yuying Yang a,c , Dengsheng Wu a , Jianping Li a a Institute of Policy and Management, Chinese Academy of Sciences, Beijing 100190, China b Beijing University of Chemical Technology, Beijing 100029, China c University of Chinese Academy of Sciences, Beijing 100049, China article info abstract Article history: Accepted 30 June 2014 Available online 30 July 2014 Keywords: Multiscales Ensemble EMD Relevance Freight rate Oil price The tanker shipping market has been treated as the key extension of the world oil market and inevitably, its uncertainty is correlated to volatility of the oil market, besides supply and demand factors. Therefore, for improving operational management and budget planning decisions, it is essential to understand the inherent relevance between freight rates and crude oil prices. Taking time-dependent features into account, this paper focuses on the multiscale correlation between freight rates and oil prices. Given the complexity and mutability of tanker freight rate process, this paper first extracts the intrinsic mode functions from the original data using the Ensemble Empirical Mode Decomposition model and then reconstructs two separate composite functions: high-frequency and low-frequency components, plus the residual as the long-term trend. Secondly, correlations of the multiscale components of freight rates and oil prices are examined based on relevance structure. Empirical results show that tanker freight rates and oil prices exhibit different multiscale properties with true economic meaning and are significantly correlated in the medium and the long term when taking the relevance structure into account. These findings offer some useful information to better understand the correlations between these two markets and more importantly, propose a novel perspective to investigate the dynamic relationship between two markets. © 2014 Elsevier B.V. All rights reserved. 1. Introduction Crude oil, as a vital strategic commodity, is traded across the globe and this involves massive transportation infrastructures, including pipelines, tankers and storage facilities (Rodrigue et al., 2006). Interna￾tionally, tanker shipping is necessary to address the imbalances between oil supply and demand in different regions. Moreover, tanker shipping, as the central logistics, plays a crucial role in the management of the global supply chain in the oil industry (Alizadeh and Nomikos, 2004; Cheng and Duran, 2004). More importantly, tanker shipping is a service that provides “special” utility to the oil market and adds value to oil by moving it from surplus to deficit areas (Mayr and Tamvakis, 1999). Naturally, tanker shipping market can be treated as the key extension of the international oil market and inevitably, its uncertainty is closely correlated to volatility of the oil market, besides tanker supply and demand. Spontaneously, for improving operational management and budget planning decisions, it is essential to investigate the inherent dynamic relationship between tanker freight rates and oil prices. Much effort has gone into the study of modeling the dynamics of tanker freight rates, in order to better support the operational decision-making for shipping assets under uncertainty (Batchelor et al., 2007; Engelen et al., 2006; Glen, 2006; Kavussanos and Alizadeh, 2002; Tvedt, 1997). Basically, shipping cycles inherent in the maritime industry propel freight rates to be mean-reverting in the long run (Stopford, 2008; Tvedt, 2003). Moreover, the assumption of inelastic demand and elastic supply can basically explain the phenome￾non of both small and large volatilities clustering together because of small changes in the market balance (Strandenes and Adland, 2007). Besides, oil is not only the commodity being transported, but is also an essential component of the transportation cost. While oil prices may explain some of the variation and dynamics in maritime transport costs, other factors are also at play1 (UNCTAD, 2010). Although the methods used to model the dynamics of freight rate processes vary in extant literature, the consensus is that freight rates are time-varying, non-linear and local non-stationary (Adland and Cullinane, 2006; Economic Modelling 42 (2014) 287–295 ⁎ Corresponding author. Tel.: +86 10 59358806. E-mail address: xlsun@casipm.ac.cn (X. Sun). 1 Summarized in UNCTAD (2010). These factors include, (a) demand for shipping services (e.g. trade volumes); (b) port-level variables (e.g. the quality of port infrastructure); (c) product-level variables (e.g. value/weight ratios and product prices); (d) industry-level variables (e.g. the extent of competition among shippers and carriers); (e) technological fac￾tors (e.g. the degree of containerization, size of ships and economies of scale); (f) institutional variables (e.g. legislation and regulation); and (g) country-level variables (e.g. attractiveness of export markets). This paper focuses on the relationship between oil price and freight rates, and specific analysis on these factors is beyond the scope of the present study. http://dx.doi.org/10.1016/j.econmod.2014.06.019 0264-9993/© 2014 Elsevier B.V. All rights reserved. Contents lists available at ScienceDirect Economic Modelling journal homepage: www.elsevier.com/locate/ecmod