Fossil fuels dominate the transmission of shocks along the energy supply chain, with effects amplified during crises. A study examines how these spillovers affect commodity markets and highlights the importance of mitigation strategies to contain instability.

Fossil fuels often act as primary spillover transmitters to energy derivatives, with the interconnectedness among commodities intensifying significantly during energy crises.

A recent study published in the International Review of Financial Analysis by Mattia Chiappari, Francesco Scotti, and Andrea Flori from POLIMI School of Management of Politecnico di Milano analyzes the dynamics of shock transmission within energy commodities describing how spillovers impact commodities along the supply chain.

The study has two main goals: first, to determine if upstream fossil fuels, such as oil, natural gas, and coal, or downstream derivatives, such as gasoline, heating oil, and ethanol, are dominant in shock transmission; and second, to evaluate if these effects vary based on market conditions, especially in times of crisis like the 2014-2015 Global Commodity Crisis, the COVID-19 pandemic, the Russia-Ukraine conflict, and the Israeli-Palestinian conflict.

Findings reveal that fossil fuels are typically the primary transmitters of shocks, while derivatives usually act as receivers, absorbing fluctuations. However, in times of severe crisis, even derivatives can shift roles and become transmitters, amplifying the impact across commodity markets. Within commodities, the oil supply chain drives the spillover transmission. Notably, the analysis of short-term shock frequencies shows that energy commodity markets can absorb shocks within few days, underscoring the efficiency with which these markets incorporate new information.

Key Insights:

– Fossil fuels play a pivotal role in transmitting market shocks, particularly during periods of crisis.

– Energy derivatives, by contrast, mainly absorb shocks but can amplify them during extreme market instability.

– The efficiency of energy markets in shock management opens potential strategies for mitigating the impacts of market crises.

For further insights, the full article is available here: https://www.sciencedirect.com/science/article/pii/S1057521924005970?via%3Dihub