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OPEC’s Impact on Oil Price Volatility: The Role of Spare Capacity

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  • Axel Pierru
  • JamesL. Smith
  • Tamim Zamrik

Abstract

OPEC claims to hold and use spare production capacity to stabilize the crude oil market. We study the impact of that buffer on the volatility of oil prices. After estimating the stochastic process that generates shocks to demand and supply, and assessing OPEC’s limited ability to accurately measure and offset those shocks, we find that OPEC’s use of spare capacity has reduced price volatility, perhaps by as much as half. We also apply the principle of revealed preference to infer the implicit loss function that rationalizes OPEC’s investment in spare capacity and compare it to other estimates of the cost of crude oil supply shortfalls. That comparison suggests that OPEC’s buffer capacity was in line with global macroeconomic needs.

Suggested Citation

  • Axel Pierru & JamesL. Smith & Tamim Zamrik, 2018. "OPEC’s Impact on Oil Price Volatility: The Role of Spare Capacity," The Energy Journal, , vol. 39(2), pages 173-196, March.
    • Handle: RePEc:sae:enejou:v:39:y:2018:i:2:p:173-196
    DOI: 10.5547/01956574.39.2.apie
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    References listed on IDEAS

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    1. Lutz Kilian, 2008. "Exogenous Oil Supply Shocks: How Big Are They and How Much Do They Matter for the U.S. Economy?," The Review of Economics and Statistics, MIT Press, vol. 90(2), pages 216-240, May.
    2. Axel Pierru and Walid Matar, 2014. "The Impact of Oil Price Volatility on Welfare in the Kingdom of Saudi Arabia: Implications for Public Investment Decision-making," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
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