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Short-run crude oil price and surplus production capacity.

Article Excerpt
Abstract

This paper shows the effect that surplus crude oil production capacity has on short-term crude oil prices. A simple model using Organization for Economic Co-operation and Development (OECD) industrial inventories and Organization of the Petroleum Exporting Countries (OPEC) surplus production capacity is introduced. This model provides improved forecasts for the post Gulf War I time period over models without the capacity variable. (JEL Q40)

Keywords: Crude Oil Price, Petroleum Inventory, Surplus Production Capacity

Introduction

The economic literature has recognized the impact of surplus production capacity, or capacity utilization rate, on commodity markets in general [Dixit and Pindyck, 1998], and on petroleum markets in particular [Dahl and Yucel, 1991; Powell, 1990]. Recently Kaufman et al. [2004] tested quarterly models of OPEC behavior and found capacity utilization to be an important explanatory variable. Both theoretical and empirical studies indicate that surplus production capacity must be considered when analyzing the petroleum industry, which exhibits a large capital investment cost to develop new reserves and nearly costless production quantity adjustments. However, surplus production capacity has not yet been used for short-run modeling and forecasts of crude oil prices. This is because only until recently, surplus production capacity was large enough to alleviate market fears of shortages and thus have had little effect on crude oil prices; this is no longer the case.

In this study, a surplus crude oil production capacity variable was incorporated into an existing monthly crude oil price model using relative inventories [Ye et al., 2005]. Surplus production capacity was found to play a significant role in a short-run model of crude oil price.

Data

Monthly data for industrial inventories of crude oil and petroleum products...

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