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OPEC and political considerations when deciding on oil extraction

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  • Kisswani, Khalid

Abstract

Two oil price shocks changed the pattern of cheap oil. The first was the Arab embargo on oil exports in 1973. Oil prices rose five fold. In 1978, the second was the fall of Shah Iran. Prices soared to $80-$100 a barrel in today‘s prices. In 1960, OPEC was established and since then it has been a considerable political and economical force in the oil market. Two thirds of the world‘s oil reserves belong to OPEC members. OPEC is accused of being responsible for most of the price increases due to their production cuts and market power. This paper provides a general framework to examine the role of OPEC in affecting oil prices through the extracted quantities. A mathematical model is developed to explore the objective function of OPEC, which includes economic and political considerations. The idea is that OPEC members consider both the political support of their citizens and profits when determining oil extraction rates. This support is represented by a ―harm function‖ which was added to the objective function of OPEC. The solution of the model lends some support for inclusion of this harm function, through which OPEC benefits from the cuts in production aimed at harming the western countries. For this harm function to be meaningful empirically, OPEC members should have a high harm indicator, αt. With high harm indicator values, OPEC harms itself financially. The results suggest that OPEC appears to be accepting considerable monetary setbacks to appease its citizens‘ taste for harming the West. At different discount rates, the monetary losses range from about 10-20%. Solving the mathematical model required estimation of the residual demand that OPEC faces plus the cost function that applies to OPEC production. This paper reports the results of these estimations.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 27030.

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Date of creation: 11 Nov 2010
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Handle: RePEc:pra:mprapa:27030

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Keywords: OPEC; optimal control; cost estimation; demand estimation; resource economics;

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  1. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, American Economic Association, vol. 80(2), pages 38-42, May.
  2. Blum, U.C.H. & Foos, G. & Gaudry, M.J.I., 1986. "Aggregate Time Series Gasoline Demand Models. Review of the Literature and New Evidence for West Germany," Cahiers de recherche, Universite de Montreal, Departement de sciences economiques 8617, Universite de Montreal, Departement de sciences economiques.
  3. Chapman, Duane & Khanna, Neha, 2000. "An Economic Analysis Of Aspects Of Petroleum And Military Security In The Persian Gulf," Working Papers, Cornell University, Department of Applied Economics and Management 7229, Cornell University, Department of Applied Economics and Management.
  4. D. Chapman & N. Khanna, 2000. "World oil: the growing case for international policy," Contemporary Economic Policy, Western Economic Association International, vol. 18(1), pages 1-13, 01.
  5. Chapman, Duane & Khanna, Neha, 1999. "World Oil: The Growing Case For International Policy," Working Papers, Cornell University, Department of Applied Economics and Management 7232, Cornell University, Department of Applied Economics and Management.
  6. Christensen, Laurits R & Jorgenson, Dale W & Lau, Lawrence J, 1973. "Transcendental Logarithmic Production Frontiers," The Review of Economics and Statistics, MIT Press, vol. 55(1), pages 28-45, February.
  7. Baltagi, Badi H. & Griffin, James M., 1983. "Gasoline demand in the OECD : An application of pooling and testing procedures," European Economic Review, Elsevier, Elsevier, vol. 22(2), pages 117-137, July.
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