Industry restructuring, OPEC response – and oil price formation

Abstract: Increased focus on shareholder returns, capital discipline and return on capital employed (RoACE) caused a slowdown in investment rates and production growth among international oil companies around the turn of the century. Focusing on supply side dynamics of the oil market, we explore a hypothesis that the restructuring in the international oil industry towards the end of the 1990s had long-lived effects on OPEC strategies – and on oil price formation. Based on a partial equilibrium model for the global oil market, we examine the effects of the industry restructuring on oil supply and oil prices, compared with a counterfactual reference scenario characterised by industrial stability and unchanged price ambitions within OPEC. A key result is that important factors behind the currently high oil price can be traced back to the industrial restructuring and to the Asian economic crisis. This suggests that temporary economic and financial shocks may have a long-term impact on oil price formation. Keywords: Oil market, investment behaviour, market power, equilibrium mode