Tyler Davis "The Global Crude Oil Economy"

Staring at the STELLA canvas some five months ago, my thoughts bifurcated into a chaos of possible models. I knew I wanted to focus upon some aspect of the oil economy-it's pertinent to our daily lives, and the data is (I thought) readily accessible-but I had no idea where I wanted to go with it from there. I could focus on OPEC, on consumption, on the Strategic Oil Reserves, on the political implications of oil, on the gain the US might receive from exclusive rights to Iraq's oil, or virtually anything. It was amidst my grandiose daydreaming that I realized I needed focus, to delve into one aspect of the industry; otherwise I would be swamped with a massively complex model with probably inconclusive results. Thus, I decided to reduce the global oil economy, as expansive and cosmic as it is, down to its most basic idea-supply and demand. The skeleton of the model presented here began to form in my mind and thus spawned the thesis of this dynamic mathematical model of the global crude oil economy. I decided to research the relationship between the oil exporting countries and the oil importing countries and create a model of this relationship to determine price based solely on economics terms.

To begin, the model is separated into importing countries and exporting countries. The importing countries (the top half) consist of the OPEC member countries, and the four largest exporting countries, namely, Canada, Mexico, Russia and Norway. The importing countries (the bottom half) consist of the eight largest importers-the United States, China, Spain, Japan, India, France, Germany, and Italy.

Each country has an amount of oil on hand-oil available for consumption or exportation. I refer to this amount as "reserves", but any oil data connoisseur will tell you that reserves refers to the amount of oil not yet drilled and that the amount of oil on hand are called stocks. However, seeing the excessive use of the term stocks in STELLA modeling anyway, I decided to use reserves. Thus, each country's reserves may be increased or depleted by obviously production and consumption, and depending on the country, importation or exportation. Exporting countries send off their excess oil to "OIL AVAILABLE FOR PURCHASE", and importing countries import their oil from there.

One may notice that most of the OPEC member countries consist of simply a production and an exportation value modified only by their quota. I make this assumption based on the scale of their locate economies. The purpose of including consumption would be to modify price, as I'll explain shortly, and their domestic demand simply isn't large enough to warrant treatment similar to that given Saudi Arabia and the non-OPEC exporting countries.

As for the rest of the countries, each of their inflows and outflows are modified by price. Let us first analyze demand, or consumption. The Law of Demand states that, as price rises, quantity demanded falls. Thus, at a price (P), the country is willing to buy a certain amount of oil (Qd). I have determined the amount each country is willing to buy at various prices through research on on-line data websites, such as the Energy Information Administration (EIA) and the International Energy Administration (IEA). Thus, in essence, I have created a demand graph using demand price schedules for each country. The structure of the graphs is reasonable-demand for oil is very inelastic, especially in the US, and thus the curve is rather flat. To see the graph, double click the converter (circle) labeled [COUNTRY] DEMAND PRICE SCHEDULE.

The same logic applies for how much a country is willing to produce at any price, and then accordingly, how much a country may import or export. I collected data and formed price schedules, then input them into this program to make supply and demand graphs.

In order to incorporate some reality into the model, I included some randomness in the production and consumption of each country. The randomness acts with a standard deviation of either 10,000 barrels per day, 50,000 barrels per day, or 100,000 barrels per day, depending on the scale of the market out of which each country operates. The randomness models possible backlogs or surpluses found in inventory, small, day-to-day increases and decreases in demand, and statistical discrepancy.

Thus, consumption, production, imports and exports are determined by price, but price must also be a dynamic figure with the model. Following my goal of producing a basic economic analysis of the oil economy, price is determined by the forces of supply and demand. Thus, demand is a simple comparison between how much is desired for consumption, and how much is currently in the countries reserves. I created a ratio using these two values. Note that a country should want to hold more than it desires in day to day affairs in order to create a buffer to counter a spike in demand so it may compensate later with production or imports. Taking the ratio (modified by the factor of desired reserves), that number, generally between 0 and 2, is used to determine how force that country puts on price. If the ratio indicates that desired reserves are greater than current reserves, upward pressure is put on price. Conversely, if the ratio indicated that the desired reserves are less than current reserves; downward pressure is put on price.

The amount of pressure depends on how much of the market that country controls. Since the United States, for example, controls about 40% of the market for oil in my model, it has a massive amount of pricing power. Thus, I took the desired prices and multiplied them times the amount of the individual countries' market share. These figures are now added together to make the weighted average and globally desired price. This price is then compared to the current price, and the difference is added to the current price, producing the new price. Now, with the new price, the process repeats itself, as we see in each kink in the price graph.

I've included as a bonus the ability to apply supply and demand shifts for every country. One may choose to increase or decrease consumption or production by a factor, at a certain time, and at certain intervals. I'm very pleased with the results, as they are consistent with basic economic principles. An increasing demand shift, for example, results in a decrease in prices. Try effecting supply and demand shifts for multiple countries!

Hence, taking the results of my model, I conclude that, according to basic economics and 2001-2002 data, the price was artificially low. A barrel of oil should have cost around $30.

This concludes the explanation of my model. Conceptually, it is very simple, but the inter-dynamics lead to some very complex results. I am exceptionally pleased with my model.

In summary-

Assumptions Include:

-Price is only determined by supply and demand.
-Production and consumption is only determined by price.
-Small OPEC countries don't contribute enough to global demand to be a factor.
-Since US data of imports + production DNE consumption, used consumption - production to determine imports.
-OPEC member countries export the exact amount of their quotas (included OPEC CHEATING valve).
-All prices the same worldwide (no price discrimination).

Conclusion:

According to basic economics and 2001-2002 data, the price was artificially low. A barrel of oil should have cost around $30, and after a year at these levels, cost around $40 today.