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OPEC vs. US natural gas, Prisoner’s Dilemma

OPEC and the US natural gas market have been experiencing the opposite of a commodity bust for the past few years. An increase in the amount of natural gas produced in the US led to a large drop in oil prices in 2014. However, despite the surplus of fuel in the market, both the US and OPEC decided not to lower production. Both parties are keeping production high, and therefore prices low, in hopes that the other will run out of money and have to cut production to raise prices.

A simplified version of this situation can easily be described with game theory, and mimics the classic “Prisoner’s Dilemma” we discussed in class. If both the US gas industry and Saudi Arabian led OPEC could only raise or cut production, we might see a payoff chart like the one below:

The best possible payoff for either party occurs when they raise production, and the other cuts production. That would raise prices, and most of the revenue would go to the industry producing more fuel. However, when both the US gas industry and OPEC increase production, both industries will lose money sharing the low-revenue market. This lose-lose situation is the Nash Equilibrium, because if either party cuts production without the other, they will lose even more money. In the Prisoner’s Dilemma, we also saw how the Nash Equilibrium is for both prisoners to confess, even though they’d be better off if they both didn’t confess (or in this case, if both US gas and OPEC cut production).

http://www.ecquaassociates.com/the-one-armed-economist/-is-opec-caught-in-a-prisoners-dilemma

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