Oil Prices & Dynamic Games Under Stochastic Demand

Abstract

Oil prices remained relatively low but volatile in the 2015-17 period, largely due to declining and uncertain demand from China. This follows a prolonged decline from around $110 per barrel in June 2014 to below $30 in January 2016, due in large part to increased supply of shale oil in the US, which was spurred by the development of fracking technology. Most dynamic Cournot models focus on supply-side factors, such as increased shale oil, and random discoveries. However, uncertain demand is a major factor driving oil price volatility. This motivates the study of Cournot games in a stochastic demand environment. We present analytic and numerical results, as well as a modified Hotelling's rule for games with stochastic demand. We highlight how lower demand forces out higher cost producers from producing, and how such changing market structure can induce price volatility.