Price dynamics in the oil market: a bond-graph modeling approach

Abstract

Current oil modeling techniques lack a comprehensive approach, as long-term oil prices are qualitatively modeled based on first principles, while short-term price transients are modeled using econometric methods. In this paper we propose a comprehensive bond-graph modeling approach in which price dynamics follow from first principles. The first principles that we use are derived from the recently developed economic-engineering theory in which price dynamics are modeled using Newtonian mechanics and price drivers are identified as forces. We reformulate a qualitative first-principles model developed by the Energy Information Administration (EIA) as a bond graph by modeling six identified price-driving factors as port-elements. The constitutive laws of these port-elements generate the price drivers, which through the interconnection structure of the bond graph yield the price dynamics. We demonstrate the bond-graph model by identifying its parameters and letting it estimate the oil price given historic oil supply data. Compared to a benchmark black-box model, we find that the bond graph has two advantages: (i) it achieves a better performance, and (ii) we know what its parameters and variables represent. The latter advantage allows us to validate the bond-graph model by reconstructing the oil inventory stocks and to manually adjust parameters by expert input.