Do oil producers act as ‘Oil’igopolists?

Abstract

In this paper, I analyze an oligopoly model of exhaustible resource extraction and develop predictions about relative extraction patterns of different producers. Using the ‘oi’'igopoly model of Loury ( Internat. Econom. Rev. 27, 285–301 (1986)), one can show that producers with large stocks produce a larger amount, but a smaller percentage, of their stocks than producers with small stocks. I extend Loury's model to cases where extraction costs differ among producers and where costs are a function of cumulative extraction. An increase in extraction costs for a producer causes it to produce less relative to its rivals. When extraction costs rise with cumulative extraction, producers with large reserves tend to have lower extraction costs and a smaller ratio of cumulative production to initial reserves than producers with small reserves. I test the predictions of the model using oil industry data and find that the empirical results are consistent with the predictions of ‘oil’igopoly theory. Producers with larger reserves extract a smaller share of their reserves and have lower production costs than producers with smaller reserves. This pattern holds for 73 countries with oil reserves during the time period 1970–1989, and for approximately 400 U.S. oil companies in 1983 and 1984. The observed pattern of production for both OPEC and non-OPEC producers is consistent with ‘oil’igopoly theory. OPEC producers do not appear to restrain production given their level of reserves relative to non-OPEC producers. Thus, viewing the oil market as containing one dominant firm (OPEC) with a competitive fringe may be misleading. Further, the pattern of extraction observed in oil markets is inconsistent with the pattern predicted by competitive theory.