Long-term implications of oil discoveries for international saving in a DSGE model

Abstract

Possession and production of oil reserves affects the host country’s current account. Throughout the history of the North Sea oil, Norway ran persistent current account surpluses and accumulated public “oil funds.” The other major producer, the United Kingdom did not establish an oil fund. This work models how oil discoveries impact the current account. A small open economy DSGE model with an oil sector expresses the current account as a function of oil discoveries. In this model, an oil discovery creates a long-term borrowing-repayment-saving cycle. Some of the characteristics of the economy that affect oil-related decisions include: the presence of an oil fund, the equity home bias, and the technology of the oil industry. These characteristics are estimated structurally using the North Sea data for Norway and the United Kingdom. The estimation suggests that, upon discovering oil in the North Sea, the populations of Norway and the United Kingdom made similar economic choices but under different circumstances: Norway’s export revenues were amplified by a period of high oil prices in the 2000s, whereas the UK largely balanced its oil trade and did not benefit from the oil price. Similar decisions made under different circumstances led to remarkably different effects of oil discoveries on the current accounts.