OPEC and Demand Response to Crude Oil Prices

This paper investigates demand response to crude oil price movements before and during the recent global financial and economic crisis. It employs several market power indices to structurally estimate price elasticities. A newly developed market power index for crude oil markets is implemented. In this approach OPEC is the central player and acts as a dominant producer in the global oil market. Although our price elasticity predictions for pre-crisis period fall in a range reported in the literature, our estimates for post-crisis largely deviate from the ones reported before. In fact, we find that demand for crude oil surprisingly changes behavior and turns out to be elastic during the financial crisis. Furthermore, demand response to crude oil prices have almost doubled during the crisis. This severe change in price response can be associated with record price levels caused by supply shortages and surge in alternative energy resources. The key advantages of this methodology over the existing literature are that it estimates price elasticity using a competition framework without specifying demand/supply function(s), and utilizes commonly observable market variables that can be applied to any admissible data frequency.