Managing the Oil Market Under Misinformation: A Reasonable Quest?

This paper examines the type and quality of information that OPEC needs to stabilize the oil market. We extend our previous structural model, in which OPEC makes potential mistakes in judging the size of market shocks, to now include the possibility that OPEC misestimates how the market price would react to any given adjustment to its production level. Thus, we present a model that incorporates both observational errors regarding physical market developments as well as potentially erroneous judgments regarding the elasticities of supply and demand. We use the model to determine the counterfactual (unstabilized) prices that would have prevailed if OPEC, acting under a broad range of misinformation, had not attempted to stabilize the price. We find that misestimation of the demand and supply elasticities generally increases the computed counterfactual price volatility. By comparison to historical volatility, these elevated counterfactual volatilities strengthen our previous finding that OPEC has substantially decreased price volatility by regulating production from its buffer of spare capacity. This is true of the OPEC+ period and the period prior to OPEC+.