Analysis of Alternative Scenarios in the World Oil Market; OPEC with and without Russia

By Mahbobi, Mohammad; Bezymyannaya, Maria | Journal of International Business Research, April 2013 | Go to article overview

Analysis of Alternative Scenarios in the World Oil Market; OPEC with and without Russia


Mahbobi, Mohammad, Bezymyannaya, Maria, Journal of International Business Research


INTRODUCTION

Since the crude oil price significantly increased in 1973-1974, for companies, organizations, and countries participating in the world oil market, it has become crucial to understand how this market actually functions. For OPEC (The Organization of the Petroleum Exporting Countries), it is also essential to understand how world demand and non-OPEC supply of crude oil reacts to changes in response to the production quota set by OPEC. OPEC was founded in Baghdad, Iraq; with the signing of an agreement in September 1960 by five founder members. These include Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela. These countries were later joined by Qatar (1961), Indonesia (1962), Libya (1962), the United Arab Emirates (1967), Algeria (1969), Nigeria (1971), Ecuador (1973), Gabon (1975) and Angola (2007). From December 1992 until October 2007, Ecuador suspended its membership. Gabon terminated its membership in 1995. Indonesia suspended its membership effective January 2009. Currently, the Organization has a total of 12 Member Countries (OPEC, 2012). The major reserves of crude oil in the world belong to the members of OPEC. Figure-1 illustrates the shares of oil reserves owned by OPEC relative to that owned by other countries in the world. In addition, understanding of the world oil market is also significant in determining OPEC's potential market power (3). For oil producers outside OPEC and for oil importing countries it is equally imperative to know that to what extent OPEC has exercised its market power. Russia, as one of the non-OPEC oil producer with enormous share of proven reserves of crude oil, may benefit and therefore support the idea of strong oil price. Russia pumps about 9.8 million barrels of crude oil a day, the second-largest producer in the world after Saudi Arabia, and exports about seven million barrels of crude oil and refined products, mostly to Europe (Kramer, 2008). The president of OPEC once said that Russia would be of special importance to OPEC if it joined, it would increase OPEC's strength in terms of production share, which would become around 50 per cent of the world output (Russia to Join OPEC, 2008). Therefore, both Russia and OPEC may potentially be willing to explore such opportunity, i.e. Russia's membership to OPEC. Russia, in particular, may be interested in such agreement in order to increase both its political and economic influences. The political aspect of this agreement is beyond the scope of this paper.

Most economic models treat the world crude oil market in terms of demand and supply models. The modeling of world oil supply is complex even though it is not difficult to estimate the world oil demand function. Good body of the literature has been devoted to understand how the world market for crude oil works. However, it became evident that crude supply does not look like a simple model of supply where supply is a function of cost of inputs. This can be explained by the fact that world crude oil supply side is neither fully competitive nor fully monopolistic.

The main objective of this paper is to examine empirical evidence of how Russia's membership in OPEC might influence the allocation of market power in the world crude oil market. The research in this paper makes several important contributions to the existing literature. First, this paper builds upon the work of Alhajji and Huettner (2000b). They applied several theoretical and econometric models to explain behavior of the world crude oil market. The research done by Alhajji and Huettner covers the period of 1973 to 1994. This paper expands their research to present time in order to test if Alhajji and Huettner's findings are still applicable to the oil market over the period from 1976 to 2009. This paper also investigates the possibility of Russia joining OPEC. Adding Russia as OPEC member, under three scenarios, allows testing whether Russia's membership in OPEC will change the current model of OPEC's behavior in the world crude oil market. …

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