Are Markups in Oil Market Caused by Exhaustibility or OPEC Market Power? An Empirical Test Abstract

According to “Hotelling rule” price of an “exhaustible resource” exceeds its marginal cost of production in perfect competition equilibrium by amount equal to the opportunity cost of depleting the resource now rather than next periods. This cost is called “scarcity rent”. Oil price exceeds its marginal extraction costs significantly. This can be attributed two different sources: effect of scarcity of oil on prices or exercising market power by OPEC (collusion). In this paper I use Porter (1983) approach to identify collusive and non-collusive periods in oil market considering that there might be a “scarcity rent” component involved in price-marginal extraction cost observed in the oil market. I use cost of production data in most costly oil wells in USA and calculate margins between price and marginal extraction cost to derive a proxy for scarcity rent. I will employ time series data on world oil production and oil prices to test empirically whether switch between cooperative and non-cooperative periods in fact occurred in oil market. Two benchmark cases, where scarcity rent is either zero (non-exhaustible resources hypothesis (Adelman 1990)) or equal to minimum price-cost margin in oil industry are considered. The results show that in both cases OPEC failed to cooperate effectively and in second case, market conduct estimated is closer to Cournot behavior.