Game Theory in the Oil Market
Many people are concerned about recent talks between Russia and OPEC over Labor Day weekend on shaping the oil market together with the goal of raising prices. However, these kinds of talks are not a new occurrence and the previous talks have not resulted in increased oil prices. In fact, the opposite has occurred: a mix of lower prices and an increased supply of oil. The author of this article believes that this can be explained through a classical game theory approach.
In CS 2850 we discussed classical game theory with special attention to the Prisoner’s Dilemma, where the dominant strategy for both parties involved striving for personal gain at the other’s detriment, which in turn leads to selfish actions from both parties ending in a worse result for all involved. In the case of the oil oligopoly, regardless of whatever agreement that OPEC and Russia make to reduce oil supply and raise prices, each of them could individually benefit by producing more oil than had been agreed upon, as they would be selling more oil at higher price. However, clearly both countries want to make more money, so if one country begins to produce more, the other must produce more as well or else face decreasing profit.
In the end, this cycle leads to lower prices and a greater supply of oil overall in accordance with Prisoner’s Dilemma game theory. OPEC and Russia, acting selfishly for their own individual benefit, end up acting against their own interests by competing with each other and both end up with a worse result than if they had followed the agreement and cooperated.
http://seekingalpha.com/article/4004241-game-theory-finest-oil-production-freezes-happen