OPEC and the Price of Petroleum: Theoretical Considerations and Empirical Evidence

219 Pages·1989·6.8 MB·English

by  Michael Rauscher (auth.)

Studies in International Economics and Institutions
Editor
Hans-Jilrgen Vosgerau
Advisory Board
John S. Chipman
Elhanan Helpman
Ronald W Jones
Murray C. Kemp
Studies in International Economics and Institutions
H.-J. Vosgerau (Ed.), New Institutional Arrangements for the World Economy
IX, 482 pages. 1989
Michael Rauscher
OPEC and the
Price of Petroleum
Theoretical Considerations
and Empirical Evidence
With 29 Figures
Springer-Verlag Berlin Heidelberg New York
London Paris Tokyo Hong Kong
Michael Rauscher
Sonderforschungsbereich 178
U niversitat Konstanz
Postfach 5560
D-7750 Konstanz, FRG
ISBN-13: 978-3-642-83928-3 e-ISBN-13: 978-3-642-83926-9
DOl: 10.1007/978-3-642-83926-9
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Softcover reprint of the hardcover 1 st edition 1989
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Acknowledgements
I would like to thank my supervisor, Prof. Dr. Horst Siebert, for his advice and critique.
Moreover, I am indebted to Prof. Dr. Gerd Ronning, Prof. Dr. Murray C. Kemp and to my
colleagues Jesko Hentschel, Joachim Keck, Peter Konig, Anke Meyer, Dr. Ernst Mohr, and
Jonathan Thomas for helpful comments, discussions, and criticism. Comments by Dr. Franz Wid
on another paper of mine led me to detect a substantial mathematical error in Chapter 4 in the
first version of this study. I gratefully acknowlege research grants given by the Deutsche For
schungsgemeinschaft in the framework of the SFB 178 programme. My work profitted a lot from
the intellectual atmosphere at the Faculty of Economics and Statistics and the Sonderforschungs
bereich 178 in Konstanz. The responsibility for what became of all the help and good advice is
mine.
Contents
v
Acknowledgements
List of figures XI
List of tables XII
1. Introduction
1.1. Oil price fluctuations and their impact on economic performance 1
1.2. Plan of the study 5
2. The world petroleum market: history and institutions
2.1. Petroleum as an exhaustible resource 8
2.1.1. Some basic concepts 8
2.1.2. Measurement of reserves 9
2.1.3. The development of production and reserves 10
2.1.4. The regional distribution of consumption, production, and reserves 11
2.2. The Organization of Petroleum Exporting Countries 13
2.3. The price of petroleum 15
2.3.1. Long-term contracts with fixed prices 15
2.3.2. The spot market 16
2.3.3. Netback contracts 18
2.3.4. Futures markets for crude oil and petroleum products 20
2.3.5. Petroleum prices and scarcity 21
2.4. A brief history of the world petroleum market 22
2.4.1. The oil market before OPEC 22
2.4.2. Alteration of property rights 23
2.4.3. New contractual relationships 24
2.4.4. OPEC and the oil price in the seventies and eighties: 26
A chronology of events
2.5. Summary of some stylised facts 29
VIII
3. The price of petroleum in economic theory
3.1. Types of oil market models 31
3.2. The economic theory of exhaustible resources 31
3.2.1. The Ricardian approach 32
3.2.2. A simple model of exhaustibility 35
3.2.3. Different market structures 38
3.2.4. The resource-exporting country 41
3.2.5. Uncertainty 45
3.2.6. Testing Rotelling's model 46
3.3. Parameter changes in the standard model 47
3.3.1. The size of the resource stock 48
3.3.2. Changing property rights 49
3.3.3. Cartelisation 51
3.3.4. The backstop technology 52
3.3.5. Additional variables 53
3.4. Approaches without exhaustibility 54
3.4.1. The impact of GDP fluctuations 54
3.4.2. The backward-bending supply curve 55
3.4.3. Static monopoly theory 56
3.4.4. Lagged demand reactions 58
3.4.5. Downstream activities 60
3.4.6. Some empirical models of oil price determination 62
3.4.7. Is OPEC a cartel? 64
3.5. An evaluation 67
4. An intertemporal model of OPEC's pricing policy
4.1. Basic assumptions 69
4.1.1. Consumption, foreign assets, and the resource stock 69
4.1.2. Demand for petroleum 71
4.1.3. Petroleum supply from non-OPEC sources 74
4.1.4. The literature on dynamic monopoly models 77
4.2. Necessary conditions of optimality 79
4.3. The consumption path 80
4.4. Accumulation of foreign assets and the existence of an optimal solution 81
IX
4.5. The price path 84
4.5.1. The long-run equilibrium price 84
4.5.2. The effects of parameter changes 88
4.5.3. Second-order conditions 89
4.5.4. Behaviour near the equilibrium 92
4.5.5. A numerical example 97
4.6. The equilibrium in the long run 102
4.7. An evaluation of the model and its results 104
5. A simplified version of the model
5.1. The assumptions 106
5.2. Optimality conditions 109
5.3. The optimal pricing policy 110
5.3.1. The long-run equilibrium 111
5.3.2. Behaviour near the equlibrium 114
5.3.3. The long-run optimal path 118
5.4. Imperfect information and the occurrence of price shocks 121
5.4.1. The first and second oil shocks 122
5.4.2. Declining oil prices in the eighties 124
5.4.3. Heterogeneity of OPEC and endogenous price cycles 127
5.5. Theoretical results and the empirical oil price cycle: a comparison 128
6. An econometric model of the world petroleum market
6.1. Objectives of the investigation 130
6.2. OPEC and oil price fluctuations 131
6.2.1. A rule-of-the-thumb approach to determining the oil price 131
6.2.2. The interaction of supply and demand 134
6.3. Empirical results 137
6.3.1. Specification of equations 139
6.3.1.1. Demand 139
6.3.1.2. Non-OPEC supply 143
6.3.1.3. The price of petroleum 145
x
6.3.2. Estimation results 147
6.3.2.1. Concavity and convexity 148
6.3.2.2. Demand for petroleum 150
6.3.2.3. Non-OPEC supply of petroleum 155
6.3.2.4. OPEC behaviour and price adjustments 158
6.3.3. Summary of the empirical results 160
6.4. Optimal pricing policies in the empirical model 161
6.4.1. Misspecification of adjustment processes 161
6.4.2. Adjustment processes and long-run demand and supply functions 164
6.4.3. Long-run equilibrium prices and quantities 166
7. Final remarks
7.1. Summary and conclusions 171
7.2. A remark on policy implications 173
7.3. Areas of future research 174
Appendix: Optimal control theory
A. 1. The problem 176
A.2. Necessary and sufficient conditions 177
A.3. Saddle points and the stability of optimal solutions 180
References 190
List of figures
1.1. The spot market price of Saudi-Arabian Light crude oil 1
2.1. Petroleum reserves and production 11
2.2. Income and wealth in OPEC member countries 14
2.3. OPEC production and the real oil price 29
3.1. A Ricardian price path with linear cost function 34
3.2. A Hotelling price path 37
3.3. Monopoly in the extraction of resources 39
3.4. An increase in the discount rate 50
3.5. The impact of the backstop price 53
3.6. OPEC's market shares and the elasticities of demand and non· OPEC supply 58
3.7. Short and long-term effects of the 1979/80 oil shock 59
4.1. Long-run demand and supply functions 76
4.2. A typical debt cycle 83
4.3. Characterisation of optimal paths 101
4.4. The shifting equilibrium 102
5.1. Optimal pricing policies for a constant equilibrium 115
5.2. A discrete change in the cost function 118
5.3. Optimal paths with depletability 119
5.4. An exogenous shift in the demand function 121
5.5. The world petroleum market 1973-1979 123
5.6. Underestimation of the demand elasticity 125
5.7. Underestimation of the adjustment speed of demand 126
5.8. The impact of segmented interest rates 128
5.9. The oil-price cycle in the theoretical model 129
6.1. Oil market adjustments with normal supply 135
6.2. Oil market adjustments with backward-bending supply 136
6.3. Nonlinear price adjustments 146
6.4. Different adjustment processes 162
6.5. Cumulative adjustments 163