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A large number of papers published in the last decade have attempted to show that energy markets have grown more integrated. These articles attempt to infer that various markets have become more "unified" because the correlation (in various forms) of prices between markets has increased during the last several years. This article suggests that a more appropriate modeling technique based on the theory of arbitrage as presented in Spiller and Wood (1988a and b), is better suited to answering this question. In this paper, the arbitrage technique is extended and applied to light crude oil markets in the 1990s. Arbitrage costs between markets are estimated. In addition, the hypothesis that crude oil markets have converged during this period is tested. Substantial though mixed support is gained for this hypothesis.
INTRODUCTION
Over the past decade, several published articles have attempted to show that energy markets have grown more integrated. This literature has grown out of Weiner (1991), who examined whether oil prices were "regionalized" or "unified." The initial motivation for Weiner's analysis was to move toward determining whether the effects of regional oil policies, such as the U.S. Strategic Petroleum Reserve (SPR), could be expected to affect worldwide markets, or have concentrated regional effects. The importance of this motivation returned in the year 2000, as the Clinton Administration authorized the use of the SPR, and Congress approved a bill to create a regional heating oil reserve in the Northeast part of the U.S.
The previous articles in this area generally attempt to infer that, because the correlation (in various forms) of prices between markets has increased during the last several years, markets have become more unified. This paper suggests that a more appropriate modeling technique based upon the theory of arbitrage and extending the approach of Spiller and Wood (1988a and b), is better suited to answering this question.
The present paper is organized as follows: Section 2 analyzes the methodologies that have been used in previous papers to examine the relationship between energy markets. Section 3 presents the arbitrage cost estimator, and discusses the data set to be used concerning post-1990 crude oil prices, an extension of the data used in GUlen (1999). The estimation results are contained in Section 4. Section 5 contains...