A class of short-term models for the oil industry that accounts for speculative oil storage

Abstract

We propose a plausible mechanism for the short-term dynamics of the oil market based on the interaction of a cartel, a fringe of competitive producers, and a crowd of capacity-constrained physical arbitrageurs that store the resource. The model leads to a system of two coupled nonlinear partial differential equations, with a new type of boundary conditions that play a key role and translate the fact that when storage is either full or empty, the cartel has enhanced strategic power. We propose a finite difference scheme and report numerical simulations. The latter result in apparently surprising facts: 1) the optimal control of the cartel (i.e., its level of production) is a discontinuous function of the state variables; 2) the optimal trajectories (in the state variables) are cycles which take place around the discontinuity line. These patterns help explain remarkable price swings in oil prices in 2015 and 2020.