Falling oil prices and chicken game theory

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On December 9, 2015, Posted by , In News, With No Comments

The role assumed by the countries on the world scene and the behavior exhibited by them when addressing global issues sometimes could well be defined by the game theory.

An opinion piece published on Wednesday by the English-language paper Iran Daily, examines the global falling oil prices based on the game of chicken as one of main models of game theories exercised by the OPEC players.

Full text of the article follows:

When choosing conciliation or conflict in a case in international relations, game theories sometimes explain the behavior of the countries as the main actors in the arena of the world.

These days, the behavior of the OPEC and non-OPEC member states on the one hand and that of Saudi Arabia and Iran with the OPEC on the other could be explained based on the assumptions of the game of chicken as one of main models of game theories in international relations.

The game of chicken assumes that two drivers drive towards each other with high speed in which a fatal head-on-collision may take place, taking the lives of both the drivers.

In this game the two drivers face three possibilities: first, one of the drivers decide to swerve away before fatal head-on-collision. In this case the driver who swerves will be named coward or “chicken” and will be the loser of the game. If neither of the drivers swerves away, the outcome will be very costly because it is presumed that both of them will lose their lives in the crash. But still there is another choice: both of the drives decide to swerve while a head-on-collision is nearing to take place which means both of them decide to take a conciliatory stance and avoid mutual destruction.

If one looks at the oil market and the behavior of its main players, in seems that they have started a kind of game of chicken since a year ago and are driving towards each other recklessly.

During the said period oil prices have plunged from nearly 100 dollars per barrel to less than 40 dollars. Despite this, none of the players are ready for cooperation and all of them are determined to force the competitor to swerve away in the road towards head-on-collision.

Despite huge impact of falling oil prices on its economy, Russia as the world’s largest oil producing country has ignored OPEC invitation for cooperation to cut oil production for the sake of improving oil prices in the market.

Similarly, outside OPEC, despite falling trend of oil prices over the past one year, these is no sign showing the US is willing to burden some responsibility in the oil market by cutting part of its production.

Not only non-OPEC but also OPEC’s main players are unyielding as well. Despite heavy losses inflicted on the Saudi economy resulting from falling oil prices, the country, as the world’s largest oil exporting state, insists on market share strategy which means it prefers to compete with other oil exporting countries like Russia and the United States outside OPEC and Iran and Iraq inside the organization to take a bigger share of the market by frequently reducing its official selling price (OSP).

More recently, Saudi Arabia has tried hard to gain access to traditional markets of Russia in Europe including in Poland. However, the falling oil prices has put pressure on Saudi economy and consequently budget deficit has hit unprecedented levels while commodity prices and the resultant public discontent are on the rise.

At the same time, as Islamic Republic of Iran’s Minister of Petroleum, Bijan Zangeneh, has announced repeatedly, Tehran is legitimately determined to retake its market share that it lost due to sanctions over past two years.

After the lifting of sanctions in the early months of 2016, Iran’s oil production is estimated to rise by about one million barrels per day within several months.

Zangeneh has said repeatedly that oil production would rise by 500 thousand barrels per day immediately after the lifting of sanctions and one million barrels per day over just few months.

Zangeneh is right when he says that Iran has thus far played no role in oversupply, oil glut and falling oil prices in the market. However, raising oil production in the near future assures the markets that extra oil will be available in the market and this in turn will adversely affect the market physiologically which could push oil prices further down. Iran is not to blame in this case, rather other OPEC members that have taken chunk of Iran’s quota are to blame.

Up to now, none of the main players in the oil market have shown any sign of conciliation. These drivers, whether in OPEC or Non-OPEC are driving recklessly towards each other while none has revised its decision in the course of driving towards a head-on-collision.

If other OPEC members do not cooperate with Iran to resume its legitimate quota in early 2016, at a time when OPEC and Non-OPEC members have decided to compete, instead of cooperating with each other in the oil market, the threat of a real head to head collision is very much likely.

In case of continuation of current trend in the oil market, the crash is expected to occur in early months of 2016 when oversupply and decline in oil demand due to seasonal reasons will push oil prices to extremely low levels.

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