OPEC’s Crude Game: Strategic Competition and Regime-switching in Global Oil Markets

Abstract

We develop a model of oligopolistic competition under imperfect monitoring and dynamic observable demand. Efficient symmetric equilibria feature disciplined cooperative regimes interrupted by rare but severe price wars. The model predicts that the frequency, duration, and supply schedule associated with each regime may persistently deviate from average behavior. We find evidence for the theoretical predictions of our model in historical Organization of Petroleum Exporting Countries (OPEC) output using a Markov-switching Bayesian vector autoregressive model of the global oil market. The evidence suggests that conventional models without regime-switching of oil supply underestimates the linkages between quantities supplied and oil prices.