Optimal World Oil Extraction: Calibrating and Simulating the Hotelling Model

Abstract:     
This paper uses data on world oil price and consumption to calibrate a Hotelling model of optimal resource extraction with unlimited potential reserves when costs exhibit stock effects. Numerical solutions are generated for various specifications of the elasticity of demand for both isoelastic demand and linear demand under each of two possible market structures: perfect competition and monopoly. My simulations enable me to examine the following questions. First, how well does the simple Hotelling model appear to explain historical data? And second, how are future world oil prices and extraction rates predicted to evolve? From among the various specifications I tried, the model best fits actual data when the oil market is perfectly competitive and when demand is inelastic. However, even the best-fit specification fails to adequately explain the data, which suggests that a richer theoretical model may be needed.

Keywords: nonrenewable resource extraction, Hotelling, simulation, stock effects, oil, dynamic optimization

JEL Classifications: Q31, C61, E27, D4

Working Paper Series