Application of the Prisoner’s Dilemma in OPEC Oil Production
Oil prices have been falling due to over-production of oil by countries in OPEC and other oil-producing countries such as Russia. Since the price of oil collapsed in 2014, there have been around 6 OPEC meetings in an effort to stabilize the oil market. Russia and OPEC have also recently engaged in talks to freeze production in order raise oil prices. However, even after these meetings and talks the only thing to result has been an increase in oil production and lower oil prices. According to Mr. Hemmelgarn from seekingalpha.com, “Production of crude oil will not slow until prices rise enough to offset lost revenue from lower prices, or until actual supplies begin to fall from current producing wells.” Mr. Hemmelgarn from seekingalpha.com has also been able to model the OPEC producing countries’ and oil-producing countries such as Russia’s behavior through the prisoner’s dilemma.
From the diagram above one can see that two oil producing countries and their payoffs are modeled. To “cheat” in this context is to over produce oil. One can see that if one country over produces while the other doesn’t, the country that over produces will benefit greatly while the other country will be punished greatly. One can also see that if both countries decide to not over produce as opposed to both over producing they would benefit more. However, just like in the confess or not confess model, the threat of the other party confessing is too great to not confess. This leads to both countries over producing oil, and thus not benefiting as much as they would have by freezing oil production. So in this case, the dominant strategy for each country would be to “cheat” or over produce oil. One potential problem this model has in its application in oil production is that the prisoner’s dilemma is a one-time final decision that doesn’t allow either party an opportunity for retaliation while oil production is an ongoing game where either party can engage in reversing their choice or by collaborating through direct communication.
http://seekingalpha.com/article/4004241-game-theory-finest-oil-production-freezes-happen