Empirical Economics (2022) 62:2285–2305

[Link]

Did OPEC change its behaviour after the November 2014

meeting?

Pål Boug1 · Ådne Cappelen1

Received: 16 May 2020 / Accepted: 8 July 2021 / Published online: 20 August 2021
© The Author(s) 2021

Abstract
We analyse the behaviour of OPEC as a group by formulating a theoretical model
that encompasses the perfect competition model and various forms of the imperfect
competition model. By confronting the theoretical model with quarterly data for the
period from 1992 to 2013 within the context of a cointegrated vector autoregressive
(CVAR) model, we find support for the imperfect competition hypothesis regarding the
output decisions of OPEC. We also find that a dynamic equilibrium correction model
with imperfect competition is stable in-sample. However, a forecasting exercise for the
period from 2014 to 2018 reveals that the model breaks down following the November
2014 meeting at which OPEC decided to keep its supply unchanged despite the huge
oil price drop in advance. The model systematically underpredicts OPEC production
over the forecast period and by as much as 2.5 million barrels per day at the end of
2016. During 2018, however, the model forecasts OPEC production quite well. Our
findings suggest that the behaviour of OPEC did indeed change significantly after the
November 2014 meeting.

Keywords OPEC behaviour · Economic models · CVAR · Dynamic forecasting

JEL Classification C51 · C52 · D43

1 Introduction

The growing importance of OPEC during the 1970s and the increased perception that
the organisation could affect world oil prices initiated a lot of empirical work about
the oil market, and in particular, about the behaviour of OPEC. Yet, there is no clear
consensus in the literature on the exact nature of the behaviour of OPEC and its ability
to influence world oil prices. Some studies rely on a competitive model, while others

B Pål Boug
[Link]@[Link]

1 Research Department, Statistics Norway, P.O.B. 2633 St. Hanshaugen, Oslo 0131, Norway

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specify models of imperfect competition, often assuming that OPEC functions like
a monopoly, an oligopoly or a cartel in some way; see, for example, Smith (2009),
Almoguera et al. (2011), Fattouh and Mahadeva (2013) and Alkhathlan et al. (2014)
for reviews of the literature.
The study of Griffin (1985), which inter alia tests the various cartel models and
the competitive model for the period 1971 to 1983, is the starting point for much of
the empirical work in this field of research. Among the various competing hypotheses
about OPEC behaviour, Griffin (1985) finds some support for a cartel model where
OPEC as a group is a dominant producer setting the oil price, while non-OPEC coun-
tries behave as a competitive fringe. A similar conclusion is reached in Bckem (2004),
relying on data for the 1990s. Other studies find that a core group within OPEC, or
even Saudi Arabia alone, fits the description of a dominant producer; see, for exam-
ple, Dahl and Yücel (1991), Alhajji and Huettner (2000a, b) and Hansen and Lindholt
(2008). Another study by Almoguera et al. (2011) concludes that the behaviour of
OPEC over the period from 1974 to 2004 is best described as a Cournot competition
with a competitive fringe. Recently, Golombek et al. (2018) find support for a domi-
nant firm-competitive fringe model, in which both the demand and the supply side of
the oil market are taken into account, using data over the period from 1986 to 2016.
Smith (2005) argues for a model of the OPEC countries as a “bureaucratic production
syndicate” and finds strong evidence of collusion, but with significant transaction costs
regarding redistribution of output among members of the cartel. By contrast, Spilim-
bergo (2001) finds no support for the hypothesis that OPEC is a market sharing cartel
and Okullo and Reynès (2016) show that heterogeneity within OPEC and non-OPEC
supply create strong incentives against collusion.
The empirical evidence on OPEC behaviour is thus rather mixed. Kaufmann et al.
(2008) argue that the failure to agree on a benchmark model is not a weakness, but
rather a strength, as OPEC behaviour does not fit easily into any single model. The
disagreement and plethora of models may be due to changing OPEC behaviour over
time, as pointed out by Almoguera et al. (2011), Fattouh and Mahadeva (2013) and
Alkhathlan et al. (2014). Several oil market analysts have also argued that at the
November 2014 meeting, OPEC significantly changed its behaviour by deciding to
keep its supply unchanged despite the huge oil price drop in advance. Recently, Behar
and Ritz (2016) argue that this decision was taken by OPEC mainly to limit the role
of competitors like American producers of shale oil.
In this paper, we contribute to the literature by studying the behaviour of OPEC
as a group for the period from 1992 to 2018, with a special focus on the possibility
of changes in actions taken by the organisation before and after the November 2014
meeting. First, we set up a theoretical model of OPEC behaviour that encompasses
several of the possibilities discussed in the literature, among them the competitive
model and various forms of the imperfect competition model. Unlike some related
empirical studies, our model includes a possible role for resource stock to affect OPEC
extraction or production costs. Then, in the empirical analysis, we contribute to the
literature by paying particular attention to time series properties of variables involved
and searching for statistically well-specified underlying models as premises for valid
inference about the OPEC behaviour.

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By estimating a CVAR model based on data running from the first quarter of 1992
to the fourth quarter of 2013, we find support for the imperfect competition hypothesis
regarding the output decisions of OPEC. The implied average estimate of the price
elasticity of demand for OPEC oil is less than minus unity, consistent with the domi-
nant producer model. Moreover, OPEC’s oil reserves seem to affect production costs
positively, implying support for the Arrow (1962) learning by doing hypothesis. We
also find that a dynamic equilibrium correction model with imperfect competition is
reasonably stable in-sample. However, a forecasting exercise based on data running
from the first quarter of 2014 to the fourth quarter of 2018 reveals that the model
breaks down following the OPEC meeting in November 2014. The model system-
atically underpredicts OPEC production over the forecast period and by as much as
2.5 million barrels per day at the end of 2016. A sequence of parameter constancy
forecast Chow tests also reveals a significant structural break around the fourth quarter
of 2014. During 2018, however, the model forecasts OPEC production quite well. We
therefore conclude that the behaviour of OPEC did indeed change significantly after
the November 2014 meeting. Behar and Ritz (2016) also conclude, using a calibrated
equilibrium model of the oil market, that OPEC switched from an accommodation
strategy up to 2014 to a market share strategy thereafter.
The rest of the paper is organised as follows: Sect. 2 outlines the theoretical frame-
work used for estimation purposes, Sect. 3 describes the data, Sect. 4 reports findings
from the cointegration analysis and Sects. 5 and 6 evaluate the empirical performance
of the dynamic model of OPEC behaviour in-sample and out-of-sample, respectively.
Section 7 provides a conclusion.

2 Theoretical framework

Our theoretical framework of the encompassing model of OPEC behaviour builds on

Berg et al. (1997) and Boug et al. (2016). We thus start out by assuming an inverse
demand function, that OPEC faces as a cartel, of the form

Pt = δ0 X tε , (1)

where Pt is the nominal crude oil price per barrel in period t, X t is the supply of OPEC
measured in million barrels per day in period t, δ0 are other factors than the oil price
affecting demand, and ε is the constant inverse price elasticity, where −1 < ε < 0.
OPEC has oil reserves at the beginning of period t, Rt , that is exploited in every period
by extraction or production, such that1

Rt+1 = Rt − X t . (2)

The unit cost function of OPEC’s production in period t, Ct , depends on the oil
reserves, such that

Ct = c0 e−η Rt , (3)
1 Note that we simplify matters by not including additions to stocks in (2) due to new discoveries.

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where c0 incorporates factor prices and η ≶ 0 depending on the hypothesis about

how reserves affect production costs. One such hypothesis is that costs of extraction
are higher with fewer reserves (η > 0). Thus, higher extraction today increases costs
tomorrow and in this sense, there are increasing marginal costs in output. Another
hypothesis is based on Arrow (1962) learning by doing theory. Combining (2) and
(3), the cost function can be expressed as depending on accumulated output (R0 −

X t−1−i ). Letting the initial reserves, R0 , be included in the constant term, unit
costs depend only on accumulated output. Learning by doing is a simple way of
introducing endogenous technological change by assuming η < 0 so that unit costs
fall as accumulated output increases. In this case, access to the reserves and exploiting
it make it more valuable over time.
OPEC is assumed to maximise the present value of the net income, N I , from its
crude reserves taking the supply from other producers (the “fringe”) as given. N I is
defined by

∞

NI = (Pt − Ct )X t (1 + i)−t , (4)
t=0

where i is the interest rate assumed constant. N I is maximised subject to (1), (2) and
(3). The Lagrangian of this intertemporal problem is thus

∞

L= [(Pt − Ct )X t (1 + i)−t + λt+1 (Rt − X t − Rt+1 )], (5)
t=0

where λ is the Lagrange multiplier, which tells us how much the net present value
of N I increases if the resource constraint is relaxed. The first-order condition with
respect to X t (for t = 0, 1, ..., ∞) can be written as

λt+1 = [(1 + ε)Pt − Ct ](1 + i)−t . (6)

Note the difference compared to the simpler static condition saying that the oil price
is a mark-up over marginal costs, which would imply that the term inside the square
brackets in (6) equals zero.2 The first-order condition with respect to Rt is somewhat
more complicated since Rt enters in two terms in the last part of the sum in (5). After
rearranging, we have (for t = 1, ..., ∞)

λt+1 − λt = −ηCt X t (1 + i)−t , (7)

which shows the time path of the Lagrangian or the shadow cost of the resource
constraint. This condition does not apply for t = 0, as R0 is exogenous. Initial reserves
are given by nature and thus not a choice variable. We see from (7) that λ is falling
over time when η > 0 since the term on the right-hand side is negative in this case.

2 In this case, the mark-up is (1 + ε)−1 or e/(1 + e)−1 when e is the standard price elasticity of demand
and e = ε −1 .

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This implies that the scarcity rent of resources is increasing over time. If reserves do
not enter the unit cost function, the change in λ is zero according to (7). This will be
zero as long as the resource constraint is not binding, which means that we have the
standard mark-up pricing formula.
Using (6) and (7) to eliminate λ, we obtain

[(1 + ε)Pt − Ct ] − [(1 + ε)Pt−1 − Ct−1 ](1 + i) = −ηCt X t , (8)

which, depending on the parameter estimates of η and ε, encompasses the following

hypotheses about the behaviour of OPEC and the crude oil market structure:
(a) If both η = 0 and ε = 0, then Pt − Ct = (Pt−1 − Ct−1 )(1 + i). This is the
generalised Hotelling rule stating that “..., the royalty, or the price net of the cost
of extracting the marginal unit of the resource, will grow at the interest rate i.”;
see Devarajan and Fisher (1981). When extraction costs are negligible, this rule
will approach what is often stated as the basic Hotelling rule where the price itself
grows at the interest rate i.
(b) If only ε = 0, but η > 0, then it follows as noted earlier from (7) that the scarcity
rent or royalty of resources is falling over time due to the increase in cost caused by
adding to the stock of cumulative production. This possibility was already noted
and discussed in Hotelling (1931). Our model implies price taking behaviour in
the crude oil market when ε = 0.
(c) If η = 0, but −1 < ε < 0, then it is the marginal revenue net of the cost of
extraction and not the price itself that will grow at the interest rate i. Hotelling
(1931) also discussed this case and suggested that monopoly power would restrict
output and thus lead to a higher price and rent. Our model allows for an arbitrary
sign of η alongside the restriction −1 < ε < 0.
Finally, by solving (8) for X t and letting Ct = (1 + ct )Ct−1 , where ct is the growth
rate in unit costs in period t, we get
 
1 (1 + i) 1 + ε Pt (1 + i) Pt−1
Xt = − − − , (9)
η η(1 + ct ) η Ct (1 + ct ) Ct−1

which serves as a point of departure for the cointegration analysis in this paper. Our
main empirical objective is thus to estimate η and ε, the long-run parameters of interest,
by means of a CVAR model and available data for X t , Pt , Ct and i. We note that (9)
is not a reduced form of a complete model of the crude oil market, but rather an
equilibrium model of OPEC’s supply decision considering how its policy affects the
crude oil price. The choice variable is how much crude to extract and not the oil price
itself. While OPEC during parts of the 1970s and the first part of the 1980s stated a
reference price, the organisation has in recent decades mainly adhered to a production
quota system among the members countries. Since our choice of the starting year of the
sample period does not include the period where OPEC operated with a target price,
but rather a quota system, we think on a priori grounds that the supply model presented
here is a possible approximation worthwhile of empirical investigations. Our choice
of using a CVAR is dictated by the theoretical setup of equilibrium conditions and by

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the need to consider the possibility of several cointegrating or long-run relationships

between prices, costs and volumes in the crude oil market. In addition, the CVAR is
a more general approach to handle non-stationary data than first on a priori grounds
differencing the observations to make them stationary and suitable for using standard
estimation techniques; see, for example, Juselius (2006, 2015, 2019). The CVAR
approach is particularly suitable for our purposes since it combines differences of
variables with cointegration among them so as to enabling a study of both long-run
and short-run effects within the same model.
We end this section by briefly illustrating how (9) can be consistent with the dom-
inant producer model of OPEC behaviour. As mentioned in the introduction, that
model has been studied by Griffin (1985), Dahl and Yücel (1991), Alhajji and Huet-
tner (2000a, b), Bckem (2004), Hansen and Lindholt (2008) and Golombek et al. (2018)
among others. Typically, the dominant producer model involves assuming that OPEC
as a cartel collectively sets the oil price when marginal revenues equal marginal costs.
Non-OPEC producers or the competitive fringe will then supply oil when marginal
costs equal the oil price. The demand for OPEC oil or “call on OPEC” is given by the
residual demand, which is total demand for oil in the world less supply of oil by the
fringe. Assuming a standard world demand function depending on the consumer price
of oil, while the supply of non-OPEC producers depends positively on the producer
price of oil, the price elasticity of demand for OPEC oil, e O P EC , can be expressed as3

ε−1 = e O P EC = eW M S O P EC −1 − s(M S O P EC −1 − 1), (10)

where eW < 0 is the price elasticity of world oil demand, s > 0 is the supply elasticity
of the fringe, and M S O P EC is the market share of OPEC in the world oil market. The
price elasticity in (1) is then simply the inverse of the elasticity in (10). In this sense,
ε is not a single structural parameter, but rather a combination of such parameters.
Because the market share of OPEC is changing over time, ε is also a time-varying
parameter in (10). As pointed out by Alhajji and Huettner (2000a), (10) accommodates
the dominant producer model if the profit maximising OPEC operates on the elastic
part of its demand curve, that is when e O P EC < −1.4 Under the assumption that
−1 < ε < 0, we see that (9) can be consistent with the dominant producer model
of OPEC behaviour. That said, our model can only be consistent with this model as
neither OPEC’s residual demand nor the price setting rule as such are explicit parts of
(9) in the empirical analysis.

3 See Alhajji and Huettner (2000a). Consider world demand for oil, X = a P eW , where other factors than
W
the oil price affecting demand are included in the parameter a, and non-OPEC supply of oil, X N O = b P s ,
where other factors than the oil price affecting supply are captured by the parameter b. The “call on OPEC”
is X = X W − X N O = a P eW − b P s and the market share of OPEC is M S O P EC = X /X W . The
expression in (10) is then found by differentiating log(X) with respect to log(P).
4 Otherwise, the profit maximisation condition, saying that the oil price equals marginal cost times a
mark-up, is rejected because the oil price becomes negative.

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3 Description of data

OPEC was founded in Baghdad with the signing of an agreement in September 1960 by
the five countries Islamic Republic of Iran, Iraq, Kuwait, Saudi Arabia and Venezuela.
These countries were later joined by Qatar (1961), Indonesia (1962), Libya (1962),
the United Arab Emirates (1967), Algeria (1969), Nigeria (1971), Ecuador (1973),
Gabon (1975), Angola (2007), Equatorial Guinea (2017) and Congo (2018). Ecuador
suspended its membership in December 1992, rejoined OPEC in October 2007, but
decided to withdraw its membership again in January 2020. Indonesia suspended its
membership in January 2009, reactivated it again in January 2016, but decided to sus-
pend its membership once more in November 2016. Gabon terminated its membership
in January 1995, but rejoined OPEC in July 2016, while Qatar terminated its member-
ship in January 2019. Hence, OPEC has currently a total of thirteen member countries.
Our empirical analysis is based on all the OPEC member countries at various points
in time during the sample period.
The history of OPEC shows that its behaviour has varied over time due to inter
alia changing market conditions and new oil producers entering the oil market.5 The
previously mentioned quota system, which is still in operation today, was formally
established by OPEC in 1982 in order to coordinate production decisions by the
member countries. Our model thus implicitly assumes that OPEC members coordinate
their production decisions in some way. However, there are some episodes of wars
and conflicts between the member countries after the introduction of the quota system
where coordination does not seem to be a reasonable assumption. The Iraq–Kuwait
war in 1990 and the following US invasion of Iraq in January 1991 are such episodes
where it is hard to justify coordination within OPEC, at least for Iraq and Kuwait.6
For this reason, the empirical analysis is based on quarterly, seasonally unadjusted
data that span the period 1992q1 − 2018q4, of which data for the period 1992q1 −
2013q4 and 2014q1 − 2018q4 are used for estimation and out-of-sample forecasting,
respectively. Because OPEC members have not always been sticking to their quotas
in absence of conflicts, we use recursive methods to investigate whether our estimated
models are stable in-sample. We extend the estimation sample by twenty quarters for
forecasting to shed light on any change in the behaviour of OPEC before and after the
November 2014 meeting.
Figure 1 displays quarterly time series of OPEC crude oil production including
lease condensate (X t ) measured in million barrels per day, OPEC reference basket
spot oil price per barrel (Pt ) measured in US dollars, OPEC supply costs per barrel
(Ct ) measured in US dollars and the US (annualised) ten-year bond yield (i t ), which is
used as the interest rate in the empirical analysis.7 We clearly see that the production

5 See Fattouh and Mahadeva (2013) for a brief history of OPEC.

6 Some studies suggest that Saudi Arabia has acted as a swing producer by stabilising the supply of OPEC,
particularly in episodes of supply disruptions due to conflicts and wars in the region; see, for example,
Nakov and Nuño (2013) and Alkhathlan et al. (2014). We discuss this issue further in Sect. 4.
7 Quarterly time series of crude oil production is downloaded from the web site of EIA, [Link]
[Link]/opendata/[Link]?sdid=INTL.57-1-OPEC-TBPD.Q, and monthly time series of the OPEC refer-
ence basket oil price, which is made quarterly as three months averages, is downloaded from the web
site of OPEC, [Link] (Table 7.1). The time series of supply costs for

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Fig. 1 Time series of OPEC production (X t ), OPEC reference basket oil price (Pt ), OPEC supply costs
(Ct ) and US ten-year bond yield (i t ). Sample period: 1992q1 − 2018q4. Sources: EIA (X t ), OPEC (Pt ),
Hansen and Lindholt (2008) and IHS Markit (Ct ) and Macrobond (i t )

of OPEC, with some significant exceptions, has increased steadily from around 23.5
million barrels per day on average in 1992 to around 33.5 million barrels per day on
average in 2018. The supply of OPEC fell considerably through 2001 and the first half
of 2002 alongside the international economic downturn before gradually picking up
and reaching a high historical level of around 31.5 million barrels per day in the mid
of 2005.
The development in OPEC production coincides periodically rather closely with the
development in the oil price, presumably because the output is held back or reduced by
OPEC to maintain or increase the oil price. For instance, OPEC reduced its production
by somewhat more than 2 million barrels per day following the huge drop in the oil
price from around 145 US dollars per barrel by July 2008 to below 40 US dollars
per barrel at the end of 2008; see Smith (2009). Surprisingly enough, however, OPEC
decided not to cut its production on the November 2014 meeting despite the huge drop
in the oil price in advance. In the aftermath of that meeting the oil price continued
to fall to around 40 US dollars per barrel at the end of 2015 and further to below

Footnote 7 continued
the period from 1992 to 2001 is based on an average of the lower and upper bounds of OPEC supply costs
data applied in Hansen and Lindholt (2008). The supply costs used in Hansen and Lindholt (2008) include
the finding, the development and the production costs. For details about data sources and construction of the
supply costs, see Hansen and Lindholt (2008, Sect. 3 and Appendix A). The time series of supply costs is
extended by means of the IHS Markit upstream capital and operating cost index, downloaded from https://
[Link]/info/cera/ihsindexes/[Link], in order to cover the period from 2001 to 2018. The time
series of the US ten year bond yield is acquired from Macrobond. The data set used in this paper as well
as a detailed description of how the various time series are constructed is available from the authors upon
request.

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Did OPEC change its behaviour after the... 2293

Fig. 2 Time series of composite variables in (9). Sample period: 1992q1 − 2018q4. Sources: OPEC (Pt ),
Hansen and Lindholt (2008) and IHS Markit (Ct ) and Macrobond (i)

30 US dollars per barrel in January 2016. As noted in the introduction, we may see
this as evidence of OPEC having changed significantly its behaviour to reduce supply
of competitors like American producers of shale oil. Rather than cut production to
increase the price, OPEC chose to engage in a price war with these producers given
that the extraction costs of OPEC are much lower than those for the shale producers. 8
The development in the supply costs of OPEC is also much in line with the devel-
opment in the oil price through the most parts of the sample period. Except from a
drop of around 10 per cent in the wake of the financial crisis in 2008, the supply costs
of OPEC increased steadily from about 6 US dollars per barrel on average in 1992 to
about 16 US dollars per barrel on average in 2014. From the second quarter of 2014
to the first quarter of 2016, OPEC reduced its supply costs considerably by somewhat
more than 25 per cent, probably to meet the huge fall in the oil price in the same
period to maintain its oil income. We also see from Fig. 1 that the supply costs are
generally much lower than the oil price, also in low-price periods. As such, OPEC
has a competitive advantage in the oil market as other producers of oil typically have
much higher production costs. Finally, the US ten-year bond yield has fallen steadily
from around 7 per cent on average in 1992 to around 3 per cent on average in 2018.
The sample period average of the interest rate, which is used in the empirical analysis
of (9), equals 4.8 per cent.
We now briefly turn to time series properties. Figure 2 depicts time series of the two
composite variables, (1+i)(1+ct )−1 and [Pt /Ct −(1+i)(1+ct )−1 Pt−1 /Ct−1 ], in (9).
Because the US ten-year bond yield is annualised per definition, Ct /Ct−1 is annualised

8 See, for example, [Link]

declares-price-war-on-u-s-shale-oil-idUSKCN0JC1GK20141128.

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to measure the variable (1 + i)(1 + ct )−1 on the same frequency both in the nominator
and in the denominator. The spikes in (1 + i)(1 + ct )−1 around 2008-2009 and 2015-
2016 are attributed to the above-mentioned drop in OPEC supply costs during these
years. Augmented Dickey–Fuller tests indicate a clear unit root in X t . We thus regard
OPEC production to be a non-stationary I(1) variable. The two composite variables, on
the other hand, are not so clear-cut with respect to time series properties as augmented
Dickey–Fuller tests reveal that these variables may be regarded as borderline cases as
either I(0) or I(1) variables.9 We shall nevertheless assume that a reduced rank VAR
model in line with (9) is relevant as an empirical model. The issue of cointegration is
formally tested for in the next section.

4 Cointegration analysis

Because multiple long-run relationships may exist among the variables included in
the theoretical model of the OPEC behaviour, we employ the (Johansen 1995, p.
167) trace test for cointegration rank determination. We thus start with an unrestricted
p-dimensional VAR of order k of the form


k
Yt = Πi Yt−i + μ + δt + t , t = k + 1, ..., T , (11)
i=1

where Yt = (Y1,t , Y2,t , Y3,t ) , Y1,t = X t , Y2,t = [Pt /Ct −(1+i)(1+ct )−1 Pt−1 /Ct−1 ],
Y3,t = (1+i)(1+ct )−1 , μ represents constants and seasonals (S D1t , S D2t and S D3t ), δ
is a coefficient vector of a linear deterministic trend t, Π1 , ..., Πk are coefficient matri-
ces of lagged level variables, k+1 , ..., T are independent Gaussian innovations with
expectation zero and covariance matrix Ω, and T is the total number of observations.
The initial observations Y1 , ..., Yk are kept fixed.
The question now is how (11) can be reparameterised to a CVAR in which the
OPEC behaviour can be formulated as a reduced rank restriction on the impact matrix
Π = −(I − Π1 − ... − Πk ). When Yt is I (1), the first difference ΔYt is I (0), implying
either Π = 0 or Π has reduced rank, such that Π = αβ  , where α and β are (3 x r)
matrices of adjustment coefficients and long-run parameters, respectively, 0 < r < 3,
and r denotes the rank order of Π . A preliminary analysis of Π = αβ  by means of the
trace test, using (11) as the underlying model with different lag order (k = 2, ..., 5),
shows that there exists one and only one cointegrating relationship between Y1,t ,
Y2,t and Y3,t at the 5 per cent significance level. Testing a zero restriction on the
adjustment coefficient of Y3,t by a standard likelihood ratio test under the assumption
of r = 1 provides strong evidence that Y3,t is weakly exogenous for the cointegrating
parameters. We are therefore motivated to follow Harbo et al. (1998) and move on to
a partial VAR by conditioning on Y3,t without loss of information in the successive
analysis.

9 Results from the augmented Dickey–Fuller tests and other test results commented upon, but not reported
by tables or figures to save space in Sects. 4, 5 and 6, are available from the authors upon request.

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Table 1 Tests for cointegration rank

r λi λtrace 5%Harbo

r =0 0.395 50.144 30.5

r ≤1 0.065 5.915 15.2

Sample period: 1992q1−2013q4. The underlying partial VAR is of order 3 with Yt = (Y1,t , Y2,t ) , Y3,t as a
conditioning variable, a linear trend as a restricted variable and constants, seasonals dummies (S D1t , S D2t
and S D3t ) and a dummy variable (D08q4) which equals one in 2008q4, otherwise zero, as unrestricted
deterministic terms. r denotes the rank order of Π = αβ  , λi are the eigenvalues from the reduced rank
regressions, λtrace are the trace test statistics, and 5%Harbo are the critical values (5 per cent significance
level) from Table 2 in Harbo et al. (1998)

Table 2 Likelihood ratio tests of the OPEC behaviour

Hypothesis LR tests p-values

α1 = 0 χ 2 (1) = 10.70 0.001

α2 = 0 χ 2 (1) = 32.36 0.000
β1 = 0 χ 2 (1) = 3.93 0.047
β2 = 0 χ 2 (1) = 39.43 0.000
β3 = 0 χ 2 (1) = 18.39 0.000
Sample period: 1992q1 − 2013q4. The likelihood ratio (LR) tests with degrees of freedom in parentheses
are based on the partial CVAR with r = 1 and without a linear trend. The exclusion test of Y1,t is based on
normalising on Y3,t , whereas the exclusion tests of Y2,t and Y3,t are based on normalising on Y1,t

According to both Akaike’s information criterion (AIC), likelihood ratio tests of

sequential model reduction and diagnostic tests of the residuals, the partial VAR in our
case should include three lags (k = 3) as the premise for the cointegration analysis.
We note that no impulse dummies other than one in the fourth quarter of 2008 to mop
up the huge drop in the oil price during the financial crisis of around 110 dollars per
barrel are needed to obtain a well-specified partial system. Table 1 reports trace test
statistics for the partial VAR assuming k = 3.
We see that the null hypothesis of no cointegration can be rejected, whereas the
hypothesis of at most one cointegrating relationship between Y1,t , Y2,t and Y3,t cannot
be rejected at the 5 per cent significance level. Assuming the rank to be unity, a
likelihood ratio test of model reduction from a partial CVAR with the linear trend to
a partial CVAR without the linear trend (δ = 0) yields χ 2 (1)=0.25 with a p-value of
0.62. The linear trend is thus insignificant and excluded from the reduced rank partial
VAR when testing the OPEC behaviour further based on the economic model in (9).
Table 2 reports likelihood ratio tests of α = (α1 , α2 ) and β = (β1 , β2 , β3 ) assuming
r = 1.
First, we observe that weak exogeneity of both Y1,t and Y2,t for the long-run param-
eters, in contrast to Y3,t , is rejected. Also, the likelihood ratio tests reject the hypothesis
that the modelled variables Y1,t and Y2,t as well as the conditional variable Y3,t are
excluded from β. Hence, we obtain the following unrestricted cointegrating vector
(normalised on OPEC production)

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2296 Pål Boug , Ådne Cappelen

Fig. 3 OPEC’s market share (M S O P EC) and time-varying ε. Sample period: 1992q1 − 2013q4. The
calculation of ε is based on (10), eW = −0.41, s = 0.2 and time-varying M S O P EC, which is defined as
X t /X W ,t , where X W ,t is world crude oil production. Source: EIA (X t , X W ,t )

Y1,t = const. + 35.326Y2,t + 161.470Y3,t , (12)

(5.4448) (38.271)

with estimated standard errors in parentheses. The associated vector of adjustment

α = (−0.017, 0.029) with corresponding t-values equal to −3.17 and
coefficients is 
5.87, respectively. Because any deviations from (12) are also significantly corrected
through the adjustment of OPEC production, we regard the estimated cointegrating
vector as a long-run relationship of OPEC behaviour consistent with the economic
model in (9). Besides, a plot of eqcm t = Y1,t − 35.326Y2,t − 161.470Y3,t shows
a clear mean reversion property over the sample period, indicating a stationary I(0)
variable over the sample period.
The implied significantly estimates of the parameters of interest are  η = −0.0062
and  ε = −0.781, which are both consistent with case (c) of (8). The negative esti-
mates of η imply that OPEC supply costs depend positively on oil reserves, such that
accumulated production decreases supply costs. Hence, we find support for Arrow
(1962) learning by doing hypothesis. Also, the estimate of the inverse price elasticity,
ε, is well within its interval of having a plausible economic interpretation. To sum up,
our findings support the hypothesis of imperfect competition in the crude oil market
where OPEC has some market power.
We can now illustrate how the estimates of ε are consistent with the dominant
producer model. It follows from the discussion in Sect. 2 that  e O P EC = −1.28 on
average over the sample period when  ε = −0.781. Since  e O P EC < −1, OPEC
operates on the elastic part of its demand curve and  ε can in this sense be said to
accommodate the dominant producer model. Using (10) and assuming s = 0.2 and

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Did OPEC change its behaviour after the... 2297

M S O P EC = 0.41, which is the average over the sample period, we calibrate the
price elasticity of world oil demand, eW , to be −0.41.10 We see from Fig. 3 that
ε ∈ {−0.71, −0.84} when eW = −0.41, s = 0.2 and M S O P EC is allowed to

vary over the sample period. Similarly,  eW ∈ {−0.36, −0.45} when  ε = −0.781
and s = 0.2. As pointed out by Golombek et al. (2018), who estimate the price
elasticity of world oil demand to be −0.35, a comparison of existing estimates of eW
in the literature is difficult because these estimates are based on different data, sample
periods and estimation methods. Nevertheless, the estimates in Dahl and Yücel (1991),
Alhajji and Huettner (2000a), Gately and Huntington (2002), Cooper (2003) and Dees
et al. (2007) range from −0.3 to −0.6. Our estimates of eW are thus well within this
interval.
We end this section by asking if the evidence of dominant behaviour of OPEC
is actually attributed to Saudi Arabia as the largest producer of crude oil among the
member countries. There is no consensus in the literature on the role of Saudi Arabia
within OPEC, see Alkhathlan et al. (2014). A typical result is to find no consistent
pattern for the behaviour of Saudi Arabia within OPEC, as discussed in Smith (2005).
In what can be characterised as normal years, production by Saudi Arabia follows
quite closely production by OPEC as a whole, but in some periods the behaviour of
Saudi Arabia has deviated significantly. In these periods, Saudi Arabia have acted as a
swing producer compensating for cutbacks in production from other OPEC members
to reach the agreed total quota. Two examples in our sample period are the Gulf war in
2003 when Saudi Arabia compensated for the drop in output from Kuwait and Iraq and
again in 2011 due to the war in Libya. This difference in behaviour is made possible
because Saudi Arabia has spare capacity for crude oil extraction which can quickly
be mobilised to compensate for the drop in output by other OPEC members due to
conflicts and political factors. Alkhathlan et al. (2014) find that Saudi Arabia exports
also bear a disproportionate share of the burden in situations of output restrictions
within OPEC. In our view, these features of Saudi Arabia behaviour are not easily
reconciled within the model presented in this paper. Nevertheless, we shed light on
the possibility that the evidence of dominant behaviour of OPEC is attributed to Saudi
Arabia by estimating (9) by means of data for Saudi Arabia alone.
Figure 4 shows the data used for Saudi Arabia together with the data used for
OPEC. The two mentioned periods in which Saudi Arabia acted as a swing producer
are apparent in the upper panel. From the middle panel, it is evident that the OPEC
reference basket oil price and the Saudi Arabia crude light oil price follow each other
closely throughout the sample period. Much the same picture is seen from the lower
panel with regard to the OPEC and the Saudi Arabia supply costs.
Applying the same partial VAR and the same estimation period, we find one
significant cointegrating relationship between Saudi Arabia production and the two
composite variables in (9), just as in the case for OPEC as a whole. We obtain the
following unrestricted cointegrating vector (normalised on Saudi Arabia production)

Y1,t = const. + 6.506Y2,t + 48.853Y3,t , (13)

(1.365) (12.781)

10 Assuming that s = 0.1 and s = 0.3, the latter being in line with results in Golombek et al. (2018), the
estimates of eW become −0.47 and −0.35, respectively.

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2298 Pål Boug , Ådne Cappelen

Fig. 4 Time series of OPEC and Saudi Arabia production (X t,O P EC , X t,Saudi ), OPEC reference basket
oil price and Saudi Arabia crude light oil price (Pt,O P EC , Pt,Saudi ) and OPEC and Saudi Arabia supply
costs (Ct,O P EC , Ct,Saudi ). Sample period: 1992q1 − 2018q4. Data for Saudi Arabia are measured on the
right hand side axis. See footnote 7 for definitions, constructions and sources of the time series

with estimated standard errors in parentheses. The associated vector of adjustment

α = (−0.051, 0.103) with corresponding t-values equal to −3.82 and
coefficients is 
2.84, respectively. The estimates of the parameters η and ε are thus significant and
within sensible ranges. In particular, the estimated value of ε is −0.87 compared to
−0.78 in the case for OPEC as a whole. However, using (10), with M SSaudi = 0.125,
to calculate the implied value of the price elasticity for oil globally, we obtain implau-
sible low (absolute) levels and even the wrong sign unless the assumed oil supply
elasticity is very low (s < 0.16). If the supply elasticity of the fringe (which now
includes also rest-OPEC) is zero, which definitely is a borderline case, the price elas-
ticity of world oil demand becomes −0.14. Thus, an improbably low supply elasticity
produces a very low world oil demand elasticity according to our estimates of (9)
using data for Saudi Arabia alone. These findings lead us to conclude that our model
of output behaviour does not suit the case of Saudi Arabia well. On the other hand, the
fact that Saudi Arabia is the largest producer within OPEC and has significant spare
capacity enables Saudi Arabia to compensate for cutbacks in production by other
member countries. In doing so, Saudi Arabia contributes in an important way to total
OPEC production and OPEC behaviour as we model it in this paper.

5 A dynamic model

We now utilise the findings from the cointegration analysis and evaluate the empirical
performance of an estimated CVAR model of OPEC behaviour in-sample. Our point

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Did OPEC change its behaviour after the... 2299

of departure, following the modelling strategy in Harbo et al. (1998), is the general
partial model written as
   
Y1,t α1
Δ = θ1 ΔY3,t + θ2 ΔYt−1 + θ3 ΔYt−2 +  t−1 + θ0 + εt , (14)
eqcm
Y2,t α2

where θ0 represents the constants, the seasonals (S D1t , S D2t and S D3t ) and the
impulse dummy for the financial crisis (D08q4). Note that (14) is balanced in the
terminology of Banerjee et al. (1993, p. 166) when Y1,t , Y2,t and Y3,t all are non-
 t is a stationary I(0) variable, as verified in
stationary I(1) variables and when eqcm
Sect. 4. Accordingly, (14) is amenable to standard estimation an inference techniques.
We estimate (14) by full information maximum likelihood (FIML) and find that the
resulting model has well-behaved residuals according to standard system diagnostic
tests. A parsimonious model is then found by stepwise exclusion of insignificant vari-
ables in the general system one by one, relying on the Sargan test for overidentifying
restrictions. We obtain the following parsimonious model together with estimated stan-
dards errors of coefficients (in parenthesis), system diagnostic tests11 and the Sargan
test:

1,t = 0.302ΔY1,t−1 − 0.151ΔY1,t−2 − 0.181ΔY2,t−1 − 0.216ΔY2,t−2

ΔY
(0.104) (0.099) (0.118) (0.087)
−0.018eqcm
 t−1 − 2.33 + 0.27 S D1t + 0.43 S D3t − 0.85 D08q4
(0.004) (0.60) (0.13) (0.13) (0.49)
2,t = −0.171ΔY2,t−2 −5.369 ΔY3,t −2.211 ΔY3,t−1
ΔY
(0.072) (0.961) (0.952)
+0.024eqcm
 t−1 + 3.36 − 4.08 D08q4
(0.003) (0.36) (0.45)
F I M L, T = 88(1992q1 − 2013q4)
V ector A R1−5 : F(20, 140) = 1.22[0.25]
V ector N O R M: χ 2 (4) = 6.02[0.20]
V ector H E T : F(57, 197) = 1.51[0.02]
Sargan test: χ 2 (11) = 6.32[0.85] (15)

The diagnostics indicate that (15) is quite well specified. The Sargan test supports
the restrictions imposed on the model, and the variables are significant at conventional
levels. OPEC production seems to be rather persistent as represented by the significant
autoregressive coefficients of ΔY1,t−1 and ΔY1,t−2 . The eqcm t−1 appears with a t-
value of −4.5 in the specification for ΔY1,t , hence adding force to the results obtained
from the cointegration analysis. We do not find any short-run effects on Y1,t from Y3,t ,
only lagged short-run effects from Y2,t . This empirical feature of the model tells us
that OPEC output is not affected by the oil price or the production costs in the current
quarter. No contemporaneous short-run effects and the relatively small magnitude of
the estimated adjustment coefficient of −0.018 together imply rather slow adjustment
in OPEC production.

11 See Doornik and Hendry (2009, p. 172). The numbers in square brackets are p-values.

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2300 Pål Boug , Ådne Cappelen

Fig. 5 Recursive statistics∗ of (15). Sample period: 1992q1 − 2013q4. * See Doornik and Hendry (2009,
p. 75)

The specification for ΔY2,t shows that Y2,t also equilibrium corrects when OPEC
production deviates from its optimal level given by (9). The equilibrium correction
term includes both crude oil prices and OPEC production costs. When OPEC supply
is not in line with (9), the oil price will change according to the demand function in
(1). Furthermore, output will affect OPEC costs according to the oil reserves condition
in (2) and the cost function in (3), which combined relate OPEC costs to accumulated
output. So, the system in (15) basically tells us that the simultaneity of OPEC output
and the price–cost ratio (P/C) inherent in the theoretical model is empirically relevant.
That is why a FIML approach and not a single equation approach is preferable in our
case. Finally, we find some contemporaneous and lagged effects of Y3,t on Y2,t and
large negative effects from the impulse dummy D08q4 due to the aforementioned
huge drop in the oil price during the financial crisis.
We use recursive methods to investigate whether (15) exhibits empirical constancy
in-sample. Figure 5 depicts the recursive residuals with ±2σ̂t and the scaled log-
likelihood function as T increases (i.e. the recursively computed Sargan test) in the
first row, the sequence of one step Chow tests in the second row, the sequence of break
point Chow tests in the third row and the sequence of forecast Chow tests in the fourth
row, all of which are scaled by their 1 per cent critical values; see Doornik and Hendry
(2009, p. 75). We see from the recursive residuals and the one step Chow tests that
there are some minor instabilities in the specification for Y2,t in 2007/2008 during the
financial crisis. That said, there is no clear evidence of instabilities in the specification
for Y1,t and the system as a whole. We therefore conclude that the OPEC behaviour
based on (15) has not changed significantly in-sample.

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Did OPEC change its behaviour after the... 2301

6 Forecasting exercise

We make use of dynamic forecasts to evaluate the empirical performance of the esti-
mated dynamic model out-of-sample, with a special focus on any forecasting failure
around the November 2014 meeting. Because dynamic forecasts are ex ante and based
on reuse of forecasts from previous periods, we need to take account of the lag struc-
ture of the estimated model in order to do dynamic forecasting. To illustrate referring
to Doornik and Hendry (2009, p. 153), consider a simple autoregressive distributed
lag model of the form

yt = ϕ1 yt−1 + ϕ2 z t + t , (16)

where yt is estimated over t = 1, ..., T , z t is a non-modelled variable, and t ∼

i.i.d.N (0, σ 2 ). Using backward substitution for any h in the forecast period h =
1, ..., H commencing at T , we obtain


h−1 
h−1
yT +h = ϕ1h yT + ϕ1i ϕ2 z T +h−i + ϕ1i T +h−i . (17)
i=0 i=0

Letting ŷT +h,h denote the h-steps dynamic forecast made for period T + h, we have


h−1
ŷT +h,h = ϕ̂1h yT + ϕ̂1i ϕ̂2 z T +h−i , (18)
i=0

which clearly shows that dynamic forecasts, as opposed to one-step forecasts, do not
use actual values for lagged y beyond T to form the forecasts. Using (17) and (18),
the forecast error, eT +h,h = yT +h − ŷT +h,h , becomes


h−1 
h−1
eT +h,h = (ϕ1h − ϕ̂1h )yT + (ϕ1 ϕ2 − ϕ̂1 ϕ̂2 )z T +h−i +
i i
ϕ1i T +h−i . (19)
i=0 i=0

When the parameter uncertainty can be ignored, as we shall do in our forecasting

exercise, the forecast error simplifies to12


h−1
eT +h,h = ϕ1i T +h−i . (20)
i=0

As previously mentioned, we employ twenty quarters (2014q1−2018q4) for out-of-

sample observations, including the November 2014 meeting, in order to form dynamic
forecasts in the manner outlined above. Figure 6 depicts actual values of Y1,t together
with dynamic forecasts based on (15), adding bands of 95 per cent confidence intervals

12 See Doornik and Hendry (2009, p. 155) for how parameter uncertainty can be taken into account in
forming dynamic forecasts.

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2302 Pål Boug , Ådne Cappelen

Fig. 6 Actual values and dynamic forecasts∗ of Y1,t ± 2σ̂t . In-sample: 1992q1 − 2013q4, out-of-sample:
2014q1 − 2018q4. Parameter uncertainty is not taken into account in forming the forecasts. *See Doornik
and Hendry (2009, p. 153)

to each forecast. Generally, the out-of-sample forecasting performance is quite poor.

Although the actual values of Y1,t all stay within their corresponding confidence inter-
vals, we see that (15) systematically underpredicts OPEC production over the forecast
period.13 At the end of 2016, the model underpredicts Y1,t by as much as 2.5 million
barrels per day. During 2018, however, the model forecasts OPEC production quite
well, which may not be surprising given the fact that OPEC and other oil producing
countries, including Russia, in November 2016 agreed on a plan starting in 2017 to
reduce production.
Using a sequence of parameter constancy forecast Chow tests, we can detect whether
there are any significant structural breaks in the forecast period; see Doornik and
Hendry (2009, p. 36). We find that these test statistics based on (15) are far from being
significant for the first three quarters of 2014. However, from the fourth quarter of
2014 to the first quarter of 2017, these test statistics are overall significant at the 5 per
cent significance level. Then, from the second quarter of 2017 to the end of the forecast
period no significant structural breaks are detected. Because a significant structural
break is detected around the fourth quarter of 2014, we conclude that OPEC did
indeed change behaviour after the November 2014 meeting. Behar and Ritz (2016)
also conclude, using a calibrated equilibrium model of the oil market, that OPEC
changed behaviour from an accommodation strategy up to 2014 to a market share
strategy thereafter.

13 The RMSE (root-mean-square error) equals 1.47 and is given by [ 1  H (Y 2 1/2 , where
H t=1 1,t − Ŷ1,t ) ]
H = 20 and Y1,t and Ŷ1,t are the actual values of and the forecasts for OPEC production, respectively.

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Did OPEC change its behaviour after the... 2303

7 Conclusions

In this paper, we have formulated a theoretical model of OPEC behaviour that encom-
passes a number of hypotheses discussed in the literature, among them price taking
behaviour and imperfect competition in various forms. By confronting the theoretical
model with quarterly data for the period from 1992 to 2013 within the context of a
CVAR model, we found support for the imperfect competition hypothesis regarding
the supply decisions of OPEC. Our implied average estimate of the price elasticity of
demand for OPEC oil is less than minus unity, consistent with the dominant producer
model. Besides, we found that costs of extraction are significantly affected by the
resource stock through learning by doing effects in OPEC production.
We have also shown that a dynamic equilibrium correction model exhibits constancy
in-sample. A forecasting exercise for the period from 2014 to 2018 revealed, however,
that the model systematically underpredicts OPEC production and by as much as 2.5
million barrels per day at the end of 2016. We have also found evidence of a significant
structural break around the fourth quarter of 2014, which coincides with the November
2014 meeting. During 2018, however, the model forecasts OPEC production quite well.
Our findings suggest that the behaviour of OPEC did indeed change significantly after
the November 2014 meeting, presumably to limit the role of competitors like American
producers of shale oil.
That said, we emphasise that the theoretical model for estimation purposes in this
paper is basically related to the supply behaviour of OPEC. While important, the
demand side of the oil market, that is the residual demand facing OPEC, is not an
explicit part of the empirical model. The question of whether this untested simplifying
assumption is crucial to the conclusions of the empirical analyses is left for future
research.

Acknowledgements We are grateful to Knut Einar Rosendahl, Terje Skjerpen, Anders Rygh Swensen and
two anonymous referees for helpful comments and suggestions on earlier drafts. We are also indebted to
Lars Lindholt for providing us with the data of supply costs of OPEC and Saudi Arabia used in Hansen and
Lindholt (2008). The econometric modelling in this paper is carried out with PcGive 14; see Doornik and
Hendry (2013). The usual disclaimer applies.

Funding Open access funding provided by Statistics Norway.

Declarations

Conflict of interest The authors declare that they have no conflict of interest.

Ethical approval This article does not contain any studies with human participants or animals performed
by the authors.

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appropriate credit to the original author(s) and the source, provide a link to the Creative Commons licence,
and indicate if changes were made. The images or other third party material in this article are included
in the article’s Creative Commons licence, unless indicated otherwise in a credit line to the material. If
material is not included in the article’s Creative Commons licence and your intended use is not permitted

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