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Why do oil prices jump (or fall)?

  • Wirl, Franz

This paper discusses theories that can explain the zig-zags of oil prices in general and in particular the recent jump. More precisely, the following explanations are discussed: Homo oeconomicus (pure profit maximization if demand is dynamic and convex), price reaction function (price increases and respectively declines depend on capacity utilization), cartelization contingent on output or revenues of which the latter can lead to backward bending supply segments and multiple equilibria, statistical descriptions (mean reversion), homo politicus, i.e., arguments for price hikes that are rational (Public Choice) despite the (long-run) economic loss. Finally two approaches are presented that emphasize demand uncertainty: one extending the above-mentioned dynamic demand framework and the other considers a dynamic game of non-competitive suppliers with lumpy investments. Summing up, a demand shock seems to be the most suitable explanation of today's high prices (indeed a shock given that International Energy Agency (IEA) and Department of Energy (DoE) were promising just a couple of years ago that we are going to have lots of oil at low prices), while others and in particular politics have surprisingly little or no explanatory power.

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Article provided by Elsevier in its journal Energy Policy.

Volume (Year): 36 (2008)
Issue (Month): 3 (March)
Pages: 1029-1043

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Handle: RePEc:eee:enepol:v:36:y:2008:i:3:p:1029-1043
Contact details of provider: Web page: http://www.elsevier.com/locate/enpol

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