Reconsidering the scarcity factor in the dynamics of oil markets: An empirical investigation of the (mis)measurement of oil reserves

Highlights

• We study oil market dynamics for OPEC and major oil-exporting OECD countries.

• Oil reserves, oil exports and prices have a long-run relation only for OPEC.

• Causality results depend on which data source is used for oil reserves.

• Differences in oil reserves data tend to be random for the non-OPEC panel.

• OPEC exercises political power at least with respect to the oil reserves.

Abstract

This paper sheds light on the importance of the (mis)measurement of oil reserves in the market dynamics. Using proven oil reserves from three different institutional data sources and for two groups of oil-exporting countries (OPEC members and OECD major oil-exporting countries), we demonstrate that estimates of oil reserves from different institutions are likely to be driven by some common factors for the OPEC panel, which is not the case for the non-OPEC panel. The implications of these results from panel cointegration analysis can be seen in two ways. First, any discussion of the sources of reserves data seems not to be relevant since OPEC has an influence on the measure of its reserves whatever the energy agency that assesses them. Second, the literature dealing with the oil curse and the associated policy responses should consider oil reserves as an endogenous variable for the resource abundance.

Introduction

Modeling oil market behavior has been one of the most commonly studied dimensions of the resource and energy economics literature. Within this dimension, the exhaustibility of fossil fuels has been given special attention as it may have important effects concerning energy market dynamics. This paper investigates how the potential falsification and measurement errors of oil reserves could affect oil market dynamics, which is an approach that has not been addressed so far in the empirical branch of this literature.

Indeed, two major strands of the literature can be distinguished in this field. One strand originates from the seminal paper by Hotelling [19]. The Hotelling's rule, in its basic form, indicates that as the reserves are depleted, fossil fuel price minus marginal cost of extraction should rise at the interest rate. This result, however, relies on several conditions, such as the existence of a perfectly competitive market, perfect information on oil reserves that are supposed to be fixed. Different interpretations of the basic framework of Hotelling, and relaxing some of these assumptions have given rise to an extensive literature (for a survey, see for instance [38]. The other strand mainly grew out of the works of Adelman [1], [2], [3]. Authors in this strand argue that the Hotelling model is not a good fit to oil markets, for a host of reasons. The most important one is that there is very little point to paying attention to reserves, which can be considered as inventories, being depleted through extraction and increased through exploration of new oil fields. In this perspective, the Hotelling scarcity rent will not in general apply, thus, models based on the Hotelling rule cannot provide an appropriate description of oil market dynamics (see for instance [40], [41]).

The difference in opinion in these two strands goes beyond the concept of exhaustibility of oil and that of fixed stock. In fact, one of the major concerns in the oil market is the oil pricing mechanism or, in general, market power of oil producing countries, particularly that of the Organization of the Petroleum Exporting Countries (OPEC). Several studies have therefore questioned to what extent OPEC has cartelized the world oil market, knowing that its share in world proven oil reserves is 81% [28]. A number of answers to this question have been put forth. According to the cartel approach, the scarcity factor can be ruled out, since, unlike the theory of exhaustible resources, there is no stock depletion in perspective, and flows between consumption and supply can be sustained through the discoveries of new oil reserves. Therefore, in the absence of scarcity, if price is above the competitive level, this indicates the existence of monopoly rent [15], [5], [16], [4], [39].¹ More recent studies have also reported significant market power of OPEC. For instance, Hansen and Lindholt [43] studied the period from 1973 to 2001 and found that OPEC has affected the market price of oil. Similarly Bentzen [8] also finds that OPEC has an influence on oil prices. On the contrary, among others, Ramcharran [36] argues that OPEC does not act as a cartel. From the same point of view, Kilian [21]; showing that oil price fluctuations are mainly demand-driven rather than supply-driven, joins Adelman [1], [2], [3]. In contrast, in a more recent paper, Esfahani et al. [14] dispute any strategy that does not account for oil reserves when studying oil market dynamics. The authors claim that if the purpose is to assess whether or not OPEC has a market power, it is necessary to understand the mechanisms underlying the behavior of OPEC countries with respect to their oil reserves.

It is evident that the question of market power is inherently related to the issue of exhaustibility mentioned above. However, while resource economists have been focused on this question, geologists have been concerned about the reliability of the reserves data on which economists base their models. Laherrere [22] argues that the data used by economists, including oil production and oil reserves, which are available from public sources, such as British Petroleum (BP), U.S. Energy Information Administration (EIA), or OPEC, are political data as opposed to technical data held by geologists. Moreover, oil countries do not use the same convention when declaring their reserves. According to Laherrere [22]; there are at least three oil measurement conventions. The Securities and Exchange Commission (SEC) convention from the U.S. has a market orientation. Within this convention, oil firms might be interested to exaggerate on the quantity of reserves in order to positively impact their assets value in stock markets. Russia has a special classification defined in 1979, which takes the theoretical maximum recovery²; the opposite of the U.S. rules, and this may lead to artificially raise the level of reserves. Regarding the OPEC countries, proven reserves determine the quotas. Within this convention, countries have incentives to declare high level of reserves in order to get a high level of quotas. On the contrary, international oil companies may understate discovered reserves in order not to be seen too successful and thus to avoid state intervention in their concessions [27].

It is clear from the literature that, while there is no doubt on the importance of the exhaustible nature of oil resources, as several important questions remain regarding the consistency and reliability of the reserves data, economists may fail to account accurately for this exhaustibility issue when analyzing oil market dynamics. Indeed, the falsification or the measurement errors associated with data on oil have already been mentioned in this literature (see for instance, [11], [35], [25]). Accordingly, based on an analysis of the evolution of world oil reserves, Owen et al. [31] concluded that publicly available oil reserve data provide often contradictory information, and thus they should be considered with caution. However, to the best of our knowledge, it has not been previously investigated in which way these falsification or measurement errors could affect the econometric explanations of oil market behavior.³ More specifically, to offer a step forward in our understanding of oil markets, we should examine whether these errors are random or systematic, and show how these errors can help to explain the oil market dynamics. And this is what this paper does. We propose a novel approach based on the measurement of the divergences between proven oil reserves data reported by three major data sources in this field, namely BP, OPEC and EIA. We explore these divergences through two sets of oil-exporting countries, namely the members of OPEC and the net oil-exporting countries of the Organization for Economic Co-operation and Development (OECD). This approach enables us to compare the behavior of OPEC countries with that of net oil-exporting countries of OECD. This is a relevant comparison both because the net oil-exporting countries of OECD are among the key players in the world energy market (e.g., Norway is the third largest energy-exporting country in the world [17]), and because these countries are shown to be the most democratic ones, among oil countries.⁴ Therefore, one might expect that their statement on oil reserves should be more transparent and more reliable than those of the countries of OPEC (see Ref. [22]. It is important to know whether this is actually the case.

To address the aforementioned issues, we begin our empirical study with an analysis on the dynamic relationships between the most important variables in the oil market, namely oil prices, oil exports, and of course, oil reserves. To do so, we employ the latest panel methodologies, including unit root, cointegration and causality tests. We find that depending on which data on oil reserves are used in the estimation, the results of the analysis and their implications can be quite different. Motivated by this finding, we focus on the reserves data to explore their individual evolutionary properties and their interactions. We show that for the OECD panel, although reserves data from different sources are not analogous, the differences are very likely to be due to non-systematic measurement errors. However, for the case of OPEC, there exists a systematic gap between OPEC's and EIA's reserves data, and that the former is a significant predictor of the latter. Based on these results, we may suggest that OPEC has the possibility to use its reserves data as a potentially useful policy instrument in the oil market.

The remainder of the paper is organized as follows. In the next section, the methodological framework used in this study is described. In Section 3, the results of the econometric analysis are presented, and their implications are discussed. We discuss in Section 4 an extension of our idea to a more conventional setting in which the oil reserves variable is replaced by oil production. Finally, Section 5 concludes the paper.