A long run intertemporal model of the oil market with uncertainty and strategic interaction

This paper describes a model of the long run price uncertainty in the oil market. The main feature of the model is that the uncertainty about OPEC's price strategy is assumed to be generated not by irrational behavior on the part of OPEC, but by uncertainty about OPEC's size and time preference. The control of OPEC's pricing decision is assumed to shift among a set of OPEC-types over time according to a stochastic process, with each type implementing that price strategy which best fits the interests of its supporters. The model is fully dynamic on the supply side in the sense that all oil producers are assumed to understand the working of OPEC and the oil market, in particular, the non-OPEC producers base their investment decisions on rational price expectations. On the demand side, we assume that the market insight is less developed on the average, and model it by means of a long run demand curve on current prices and a simple lag structure. The long run demand curve for crude oil is generated by a fairly detailed static long-run equilibrium model of the product markets. Preliminary experience with the model indicate that prices are likely to stay below 20 dollars in the foreseeable future, but that prices around 30 dollars may occur if the present long run time perspective of OPEC is abandoned in favor of a more short run one. 26 refs., 4 figs., 7 tabs