Analysis of oil market fundamental using a system dynamics approach

Abstract

An unexpected substantial reduction of oil price since June 2014 has drawn a great attention from governments, financial institutions and oil industry because oil supply has been a critical factor influencing the energy markets, economic development and geopolitics worldwide. From a system perspective, oil price results from the interactions of multiple entities and forces in the world oil market, and the impact of the low price has started propagating through the whole value chain of the industry resulting in a reduction of investment plans. Therefore, it is necessary to re-evaluate the key factors of the system and analyze how the oil industry would evolve when those factors vary. System dynamics modeling has been proved to be an efficient tool to capture dynamics of a complex system, such as world oil market, and it is intended to construct a system dynamics model in the thesis to understand how the world oil market would react to various disturbances. Based on a thorough review on oil industry and world oil market, key players are identified for major suppliers (OPEC, US, Non-OPEC, and Rest of the World - ROW) and major consumers (US, China, and ROW), and correlations among those players are established in the system dynamics model. Different scenarios are created and simulated to explore the dynamics of the world oil market. Starting from an initial equilibrium state, different scenarios simulate the impact of changes in OPEC oil production, the US oil demand, and China oil demand, respectively. Then the consequences of the changes combined the previous scenarios together are discussed. The constructed system dynamic model is able to capture the fundamental dynamics of the world oil market. Specifically, simulations addressing the booming of unconventional oil, changing oil production of OPEC, and slowing down of China's economy development that reflect the real situation in the current oil market confirm the reduction of oil price, and estimate how long the low oil price would last in different scenarios. Although the oil price predictions have to be taken with a great degree of caution, the developed mode is able to provide insightful implications for industry analysts and policy makers. The major challenges fall into how to balance the relationship between market shares and financial loss for oil producers, and energy security for major consumers.