Game Theory in Oil Pricing
Source: https://tidingsmedia.org/blog/economic-analysis-of-the-oil-price-drop-using-game-theory
This past week in class I watched in amusement as the professor fielded the dozens of inevitable “what if?” questions about the various game theory scenarios. Eventually, sounding somewhat exasperated, he exclaimed something along the lines of the following: “If you change the conditions then you change the game, and if you change the game then of course you could change the outcome.” This got me thinking. Real life isn’t static, and there had to be examples of altered conditions that changed games and forced different outcomes.
Luckily for me, I had to look no further back than April of 2020. The coronavirus had just hit, halting virtually all forms of industry and causing demand for oil to plummet. For the major players in oil production, the game had changed drastically. Beforehand, countries could gain sufficient profit off of a cooperative strategy where prices were artificially set. However, the pandemic altered the payoff matrix. According to the cited article, oil accounts for 16% of Russia’s GDP, 52% of its federal revenue, and 70% of its export revenue. Needless to say, the stakes were high. Russia would consider its options carefully and react optimally. Ultimately, Russia lowered its oil prices in an attempt to increase demand. This changed the situation for the other countries, causing them to reevaluate their strategies and price their oil competitively. The end result was a price war that led to the lowest oil prices in decades.
The effect of the pandemic on oil prices serves as a reminder that the games played in real life are dynamic. In the global economy, the stakes are high and games are played to perfection. A change in conditions can shatter agreements that have held since the 60s. Asking “what if?” questions is necessary to account for all the outcomes presented by an ever changing world.