A geopolitical theory of oil price behaviour: an econometric evaluation

Abstract

Previous work on crude oil price modelling has generally focused on two theoretical approaches, either the+ optimal control analysis of pricing of a depletable resource or Organization of the Petroleum Exporting Countries (OPEC) as a partial monopolist setting oil prices to maximize net present value. Neither has been wholly satisfactory. We consider a different perspective: a cooperative framework in which political and military factors interacted with economic considerations for oil exporters and importers to define a Target Price Zone (TPZ). We analyse several issues in this context: monthly versus annual average prices, beginning and ending dates for TPZs, degree of stability in several price series (West Texas Intermediate (WTI), Brent, etc.), Free On Board (FOB) and landed prices, real or nominal prices, OPEC behaviour and effect of the Euro exchange rate on dollar denominated oil prices. We conclude that a TPZ system was in operation from 1986 through 2003. The TPZ worked imperfectly but with a substantial degree of predictability for 18 years. In 2004, the TPZ system deteriorated for several reasons and has not been re-established. Perhaps the US government supports the Saudis because it has always believed it had a two-way relation with OPEC generally and the Persian Gulf countries in particular. We give them protection and they supply oil.1 The Bush trip [1986] came as an additional incentive to restore some stability to prices … What they [the Saudis] heard was the Vice President of the United States of America saying that the price collapse was destabilizing and threatened the security of the United States … The Saudis looked to the United States for their own security; surely, they thought in the aftermath of the Bush visit, they would have to be attentive to the security needs of the United States.2 1 See Adelman (2005). Adelman qualifies this quotation by observing that ‘OPEC countries owe us nothing’. 2 See Yergin (1992). This is Yergin's description of then Vice-President Bush's visit to Saudi Arabia in April 1986. In Yergin's view, this explains why Saudi Arabia later that year cut production, subsequently leading to higher prices.