Oilgopoly: A General Equilibrium Model of the Oil-Macroeconomy Nexus

Abstract

Saudi Arabia Is the largest player In the world oil market. It maintains ample spare capacity, restricts investment in developing reserves, and its output is negatively correlated with other OPEC producers. While this behavior does not fit into the perfect competition paradigm, we show that it can be rationalized as that of a dominant producer with competitive fringe. We build a quantitative general equilibrium model along these lines which is capable of matching the historical volatility of the oil price, competitive and non-competitive oil output, and of generating the observed comovement among the oil price, oil quantities, and U.S. GDP. We use our framework to answer questions on which available models are silent: (1) What are the proximate determinants of the oil price and how do they vary over the cycle? (2) How large are oil profits and what losses do they imply for oil-importers? (3) What do different fundamental shocks imply for the comovement of oil prices and GDP? (4) What are the general equilibrium effects of taxes on oil consumption or oil production? We find, in particular, that the existence of an oil production distortion does not necessarily justify an oil consumption tax different from zero.

Keywords: Oil Price, Oil Shocks, Dominant F Rm, Competitive Fringe, Pigovian Tax

JEL Classification: D43, E32, E62, Q43