A Less Volatile Crude Oil Price:Supply Rotation Control

Huei-Chu Liao

PURPOSE

Smooth the crude oil price

reduce the volatility cost

APPROACH

Find Main Source of VolatilityPrinciple to Solve Problem(Incentive Compatibility) Method: Rotation ControlDetail: Market Situation/Demand ElasticityTechnique: Bootstrapping Method

WHY PRICE VOLATILE

Fundamental (Demand/Supply)(OPEC’s Influence)Financial Market(Technical Analysis/Information Noise)WAR

CRUDE OIL PRICE FORMULAS

Px = Benchmark Price + PremiumBenchmark Price(WTI/BRENT/DUBAI&OMAN)Spot price Futures price (-1) Futures Prices is Selected Due to Transparency Transparency in Futures Market Can’t Guarantee the (Physical Market Clear )

OIL MARKET TRANSPARANCY

Quota

N.E.

Production

Arbitrage

Financial marketOPEC marketWorld market

WHO SHOULD RESPONSIBLE FOR↓↑

OPEC OR FINANCIAL MARKET PLAYERS ?

No Market Imbalance(D/S Gaps or Info Bias)

No Arbitration tradeBetter control for OPEC would

help for less volatility

PERSUASIVE PRODUCTION(Incentive Compatibility)

Privilege Assignment

Responsible for price if I’m the only decision maker

(Each time only 1 member/groupin OPEC has privilege )

Supply Rotation Control

P

P*

0

Q

P

S0

PccS

bcS

Q*=76.9

Figure 1 The determination of market price.

HOW IT WORKS

More Stable Oil Supply Will Flow Into the MarketMore Reliable Information Is Perceived

Fewer Arbitration tradeMore Stable Oil Price

Simulation Techniques

Bootstrapping Method(Market Data Distribution/Simulation)Real Market Situation (Inelastic demand)Supply Rotation Control

Figure 2 Historical WTI Price Trend ( )

0 650 1300 1950 2600 3250 3900

20

30

40 p

10 15 20 25 30 35 40 45

0.05

0.10

Densityp N(s=5.29)

0 650 1300 1950 2600 3250 3900-10

-5

0

5dp

-10.0 -7.5 -5.0 -2.5 0.0 2.5 5.0

0.25

0.50

0.75

1.00

1.25 Densitydp N(s=0.595)

, p p∆

Decide the Data Set of Calculating from 1986/1/2 to 2003/7/22

Equation (1)&(2)

Equation (3)

Market Price Determination

Demand Price Elasticity

Original Equilibrium

With ControlWithout Control

Random choosing 1000 from Data Set Possible Oil Price Path

Random choosing 1000 from Data SetBoom Period 3 ScenariosEach Has

( j =1, 2, 3)

Random choosing1000 from Data SetCollapse Period3 Scenarios Each Has

( j = 1, 2, 3)

Figure 3 Flow Chart of Simulation Process

( ) * ij jp or p p p= +∆

* 24.138p = * 76.9Q =

0.06dε = −

p∆

ip∆⇒

1t t ip p p−= + ∆ip∆

&j jp p

1t t ip p p−= + ∆

j t jp p p≤ ≤

ip∆

&j jp p

1t t ip p p−= + ∆

j t jp p p≤ ≤

Decide the Data Set of Calculating from 1986/1/2 to 2003/7/22

Equation (1)&(2)

Equation (3)

Market Price Determination

Demand Price Elasticity

Original Equilibrium

With ControlWithout Control

Random choosing 1000 from Data Set Possible Oil Price Path

Random choosing 1000 from Data SetBoom Period 3 ScenariosEach Has

( j =1, 2, 3)

Random choosing1000 from Data SetCollapse Period3 Scenarios Each Has

( j = 1, 2, 3)

Figure 3 Flow Chart of Simulation Process

( ) * ij jp or p p p= +∆

* 24.138p = * 76.9Q =

0.06dε = −

p∆

ip∆⇒

1t t ip p p−= + ∆ip∆

&j jp p

1t t ip p p−= + ∆

j t jp p p≤ ≤

ip∆

&j jp p

1t t ip p p−= + ∆

j t jp p p≤ ≤

Equation (1)

where : price elasticity of demand,

: change of supply quantity,

: change of price,

: equilibrium quantity,

: equilibrium price.

dη

Q∆

P∆

*Q

*p

** *

*

d

Qp QQ

P Q PP

η

∆∆

= = ⋅∆ ∆

Decide the Data Set of Calculating from 1986/1/2 to 2003/7/22

Equation (1)&(2)

Equation (3)

Market Price Determination

Demand Price Elasticity

Original Equilibrium

With ControlWithout Control

Random choosing 1000 from Data Set Possible Oil Price Path

Random choosing 1000 from Data SetBoom Period 3 ScenariosEach Has

( j =1, 2, 3)

Random choosing1000 from Data SetCollapse Period3 Scenarios Each Has

( j = 1, 2, 3)

Figure 3 Flow Chart of Simulation Process

( ) * ij jp or p p p= +∆

* 24.138p = * 76.9Q =

0.06dε = −

p∆

ip∆⇒

1t t ip p p−= + ∆ip∆

&j jp p

1t t ip p p−= + ∆

j t jp p p≤ ≤

ip∆

&j jp p

1t t ip p p−= + ∆

j t jp p p≤ ≤

Equation (2)

where : price elasticity of demand,

: change of supply quantity,

: change of price,

: equilibrium quantity,

: equilibrium price.

dη

Q∆

P∆

*Q

*p

* *d

QP QP

η∆ = ⋅ ⋅∆

Figure 4

Figure 4 Possible Crude Oil Price Path (without any control)

Figure 4a

0102030

1 101 201 301 401 501 601 701 801 901T

P(U

S$/b

b

Figure 4b

010203040

1 101 201 301 401 501 601 701 801 901T

P(U

S$/b

b

Figure 4c

0102030405060

1 101 201 301 401 501 601 701 801 901T

P(U

S$/b

b

Table2 Price boom in less production with control US$/bbl

Figure 5c5.39429.24220.68841.228Constraint4

(Loss3 /3.138)

Figure 5b3.01525.49720.08833.923Constraint1

(Loss2 /1.888)

Figure 5a1.63825.53320.70828.698Constraint

(Loss1 /0.779)

FigureStandard errorAveragePriceMin PriceMax PriceScenario

(mb/d)

Note: Loss : the Total Loss Production of oil from OPEC. Loss1: Iraq excess capacity=0, Other Member loss 20%, Nigeria loss 40%, Venezuela loss 10%.Loss2: Iraq excess capacity=0, Other Member loss 20%, Nigeria loss 50%, Venezuela loss 25%.Loss3: Iraq excess capacity=0, Other Member loss 25%, Nigeria loss 90%, Venezuela loss 40%.

Figure 5 Possible Crude Oil Price Path in Boom Period (with control)

Figure 5a

0204060

1 101 201 301 401 501 601 701 801 901T

P(U

S$/b

b

Figure 5b

010203040

1 101 201 301 401 501 601 701 801 901T

P(U

S$/b

b

Figure 5c

010203040

1 101 201 301 401 501 601 701 801 901T

P(U

S$/b

b

Table3 Price collapse in more production with control US$/bbl

Figure 6c3.80915.0667.89825.518Constraint(EC3 /3.101)

Figure 6b4.53319.46610.50325.948Constraint(EC2 /2.150)

Figure 6a1.68823.72217.99827.528Constraint(EC1 /1.075)

FigureStandard error

AveragePriceMin PriceMax PriceScenario

(mb/d)

Note: EC : the Total Excess capacity from OPEC.EC1: Iraq production capacity=2.5mb/d, and quota=2, total OPEC quota=25.401(2003/6/1 level),

Total OPEC excess capacity=5.376, but all used 20%, 1.075mb/d.EC2: Iraq production capacity=2.5mb/d, and quota=2, total OPEC quota=25.401(2003/6/1 level),

Total OPEC excess capacity=5.376, but all used 40%, 2.150mb/d.EC3: Iraq can’t take over, so he’s excess capacity=0, and total OPEC quota=25.401mb/d,

Total OPEC excess capacity=3.101mb/d, all used.

Figure 6 Possible Crude Oil Price Path, in collapse period with Control

Figure 6a

010203040

1 101 201 301 401 501 601 701 801 901T

P(U

S$/b

b

Figure 6b

0102030

1 101 201 301 401 501 601 701 801 901T

P(U

S$/b

b

Figure 6c

010203040

1 101 201 301 401 501 601 701 801 901T

P(U

S$/b

b

Conclusion

Price Around Fair Price

Supply Rotation : Privilege Assignment

Less Volatile Price is Expected

Further Research

(capacity utilization in Bootstrapping simulation)

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