Crude or Refined? Rationality of Downstream Investment for Oil-Rich Economies
49 Pages Posted: 13 Feb 2018 Last revised: 6 Oct 2018
Date Written: February 1, 2018
Should oil-rich countries aggressively move toward downstream and invest in the oil refinery industry? This is a crucial energy policy question for such economies. We offer theoretical models for a vertical integration strategy (i.e. downstream investment) within an oil-producing economy. The first model highlights the trade-off between return and risk-reduction features of upstream/downstream sectors. The dynamic model demonstrates the volatility of total budgetary revenue of each sector. We motivate the discussion in the context of OPEC countries. Our theory-guided empirical analysis shows that the average markup in the refining sector is significantly smaller than the profits in the upstream; thus, not much economic value-added can be expected through vertical integration. We, however, find that from a hedging prospective the more stable and mean-reverting refining margins may provide a partial revenue cushion when crude oil prices are low. The analysis can inform energy sector investment decisions as well as export diversification policies of oil producing countries.
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