The drivers of oil prices : the usefulness and limitations of non-structural model, the demand-supply framework and informal approaches

Working paper

We discuss three main approaches for analysing oil prices: non-structural models, the supply–demand framework and the informal approach. Each of these approaches emphasizes a certain set of drivers of oil prices. While non-structural models rely on the theory of exhaustible resources as the basis for understanding the oil market, the supply–demand framework uses behavioural equations that link oil demand and supply to its various determinants such as GDP growth, prices and oil reserves. The informal approach, on the other hand, analyses oil price movements within specific contexts and episodes of oil market history. We use the latter approach to identify the main factors that have affected oil price movements in recent years, analysing whether these drivers reflect structural changes in the oil market. We emphasize that although all the above approaches provide useful insights on how the world oil market functions, they suffer from major limitations especially when used to make long-term projections. Thus, pushing hard for policies based on the projections of such models defeats their purpose and may result in misguided policies.

Authors: Fattouh, B

• Publication status: Published
• Peer review status: Reviewed (other)
• Series: OIES paper
• Publication date: 2007-01-01
• Edition: Publisher's version
• Paper number: M32
• ISBN: 1901795616
• Language: English
• Keywords: price elasticity; OIES; inventories; oil price behaviour; OPEC; volatile oil prices; speculation; informal approach; spare capacity; supply-demand framework