Game Theoretic Model of Oil Prices

T he Whiteshield Partners game theoretic model of oil production-prices incorporates the science of game theory to understand the dynamics of the oil market. Notably, the model interlays the strategic behaviour and conditions of the oil market that have been identified in the academic literature with real-world business knowledge. The structure of the oil market is characterised by strategic cooperation and competition where producers – often a nationalised firm or sector – choose the quantity of output, but where global output determines the market price.

The Whiteshield Partners model considers cooperation or competition as an endogenous characteristic of a country’s fiscal position relative to the global price of oil. When oil prices are low, producers may be tempted to either cooperate or compete to drive up the price, especially if their fiscal position is weak. Whether cooperation or competition is the chosen policy depends on factors such as the size of the cooperating group, and the likelihood and scope of punishment for producers that act unilaterally. On the other hand, the country’s fiscal position depends on characteristics such as the cost of extraction/production, its budgeted fiscal spending, and the ability of the country to draw on resources to cushion against volatility in the price of oil.

Finally, several layers of stochastic behaviour are embedded into the model to account for supply and demand shocks that are inherent in the oil market.

Figure 1: Whiteshield Partners Game Theoretic Model of Oil Prices (Brent Crude)

Source: Whiteshield Partners