A model for world crude oil and natural gas markets is estimated. It confirms low price and high income elasticities of demand for both crude oil and natural gas, which explains the market power of oil producers and price volatility following shocks. The paper establishes a relationship between oil prices, changes in the nominal effective exchange rate (NEER) of the U.S. dollar, and the U.S. interest rates, thereby identifying demand shocks arising from monetary policy. Both interest rates and the NEER are shown to influence crude prices inversely. The results imply that crude oil prices should be included in the policy rule equation of an inflation targeting model.

A model for world crude oil and natural gas markets is estimated. It confirms low price and high income elasticities of demand for both crude oil and natural gas, which explains the market power of oil producers and price volatility following shocks. The paper establishes a relationship between oil prices, changes in the nominal effective exchange rate (NEER) of the U.S. dollar, and the U.S. interest rates, thereby identifying demand shocks arising from monetary policy. Both interest rates and the NEER are shown to influence crude prices inversely. The results imply that crude oil prices should be included in the policy rule equation of an inflation targeting model.

This paper formulated a short-run model, with an explicit role for monetary policy, for analyzing world oil and gas markets. The model described carefully the parameters of these markets and their vulnerability to business cycles. Estimates showed that short-run demand for oil and gas was price- inelastic, relatively income-elastic, and was influenced by interest and exchange rates; short-run supply was price-inelastic. Short-run price inelasticity could be a source for high volatility in oil and gas prices, and could confer to producers a temporary market power. Being simultaneous and incorporating interest and exchange rates, the model could be useful in short-term forecasting of oil and gas outputs and prices under policy scenarios.

Global oil markets were roiled by sharp price swings in 2008, and economists are still divided over the reasons for the unusual volatility. Those emphasizing fundamentals point to inelastic supply and demand curves, others view the phenomenon mostly as a result of financial investors flocking into commodity markets. This paper attempts to infer the strength of these competing hypotheses, using a simultaneous equation model that enables us to undertake a separate analysis of supply and demand factors. The model broadly captures both the surge and subsequent fall in prices, with a particularly strong impact of demand factors. The model captures a strong effect of a measure for global liquidity but does not find support for a speculative motive.

We study the optimal oil extraction strategy and the value of an oil field using a multiple real option approach. The numerical method is flexible enough to solve a model with several state variables, to discuss the effect of risk aversion, and to take into account uncertainty in the size of reserves. Optimal extraction in the baseline model is found to be volatile. If the oil producer is risk averse, production is more stable, but spare capacity is much higher than what is typically observed. We show that decisions are very sensitive to expectations on the equilibrium oil price using a mean reverting model of the oil price where the equilibrium price is also a random variable. Oil production was cut during the 2008–2009 crisis, and we find that the cut in production was larger for OPEC, for countries facing a lower discount rate, as predicted by the model, and for countries whose governments’ finances are less dependent on oil revenues. However, the net present value of a country’s oil reserves would be increased significantly (by 100 percent, in the most extreme case) if production was cut completely when prices fall below the country's threshold price. If several producers were to adopt such strategies, world oil prices would be higher but more stable.

This paper presents a simple macroeconomic model of the oil market. The model incorporates features of oil supply such as depletion, endogenous oil exploration and extraction, as well as features of oil demand such as the secular increase in demand from emerging-market economies, usage efficiency, and endogenous demand responses. The model provides, inter alia, a useful analytical framework to explore the effects of: a change in world GDP growth; a change in the efficiency of oil usage; and a change in the supply of oil. Notwithstanding that shale oil production today is more responsive to prices than conventional oil, our analysis suggests that an era of prolonged low oil prices is likely to be followed by a period where oil prices overshoot their long-term upward trend.