Oil price uncertainty, risk, and Opec production

Abstract EN

Economic theory suggests that price uncertainty and risk play an important role in production decisions.

In the last two decades, crude oil prices have shown a clear tendency to be volatile.

Unlike other commodities, oil is a non-renewable resource so oil price volatility is augmented with the risk of resource depletion.

Despite this apparent link between oil price uncertainty (price risk) and oil production, scant attention has been paid in the oil market and OPEC behavior literature to the relationship between price risk and oil production.

The aim of this paper is to investigate whether OPEC members exhibit risk-aversion in production decisions.

Utilizing a GARCH model to characterize the conditional mean and variance of expected prices in supply equations of OPEC members, we estimate a two-equation price-production model for each member country.

We use a full information maximum likelihood (FIML) estimator to simultaneously model a price equation with GARCH errors and a structural supply equation with risk.

We account for resource depletion by incorporating the proven reserves of crude oil in the production (supply) equation.

After all, the empirical results fail to identify oil price-risk as a "significant" determinant of OPEC production decision-making process.