OPEC's production under fluctuating oil prices: further test of the target revenue theory Ž .Energy Economics 23 2001 667�681 OPEC’s production under fluctuating oil prices: further test of the target revenue theory Harri Ramcharran� Department of Finance, College of Business, Uni�ersity of Akron, 44325, Akron, OH, USA Abstract Oil production cutbacks in recent years by OPEC members to stabilize price and to Ž .increase revenues warrant further empirical verification of the target revenue theory TRT . Ž .We estimate a modified version of Griffin 1985 target revenue model using data from 1973 to 2000. The sample period, unlike previous investigations, includes phases of both price Ž . Ž .increase 1970s and price decrease 1980s�1990s , thus providing a better framework for examining production behavior. The results, like the earlier study, are not supportive of the Ž .strict �ersion of the TRT, however, evidence negative and significant elasticity of supply of the partial �ersion are substantiated. Further empirical estimates do not support the competiti�e pricing model, hypothesizing a positive elasticity of supply. OPEC’s loss of market share and the drop in the share of oil-based energy should signal an adjustment in pricing and production strategies. � 2001 Elsevier Science B.V. All rights reserved. JEL classifications: Q41; C52 Keywords: Oil production; Target revenue theory; Competitive model 1. Introduction Soaring crude oil prices resulting from OPEC’s decisions during the 1970s contributed to the economic recession in many energy-dependent countries. The associated repercussions such as rapid inflation, trade deficit, external debt and � Tel.: �1-330-972-6682; fax: �1-330-972-5970. Ž .E-mail address: ramchar@uakron.edu H. Ramcharran . 0140-9883�01�$ - see front matter � 2001 Elsevier Science B.V. All rights reserved. Ž .PII: S 0 1 4 0 - 9 8 8 3 0 1 0 0 0 8 1 - 0 ( )H. Ramcharran � Energy Economics 23 2001 667�681668 budget deficit reveal the vulnerability of global economy to the price of energy. Ž .These issues are analyzed in many studies, including, Fried and Schultze 1975 and Ž .Marquez 1986 . In response to the energy crisis, many countries developed plans on alternative sources of energy and the possibility of inter-fuel substitution. Ž . Ž . Ž .Griffin and Gregory 1976 , Pindyck 1979 and Apostolakis 1990 discuss the Ž .implications of these strategies. The first oil shock 1973�1974 positioned OPEC as an important force in the world oil market; that triggered a plethora of studies aimed to explain energy pricing and production behavior. Some of these include Ž . Ž . Ž .Blitzer et al. 1975 , Fischer et al. 1975 , Kalymon 1975 , Cremer and Weitzman Ž . Ž . Ž . Ž .1976 , Hnyilicza and Pindyck 1976 , Danielsen 1980 , Newbery 1981 , Verleger Ž . Ž . Ž . Ž . Ž .1982 , Adelman 1982 , Griffin 1985 , Dahl and Yucel 1991 and Gately 1995 . Ž . Ž .The methodology includes: a the theory of exhaustible resources; b game Ž . Ž . Ž .theory; c simulation; d industrial economics; and e economic efficiency hy- Ž .pothesis. Mabro 1992 critically evaluates some of these approaches. An important aspect of OPEC’s production behavior is the propensity for some members to Ž .cheat on quotas; this phenomenon is examined by Griffin and Xiong 1997 . Ž . Ž .The target revenue theory TRT , developed by Ezzati 1976 , Cremer and Ž . Ž . Ž .Isfahani 1980 and Teece 1982 , remains a popular and controversial theory of oil pricing and production. The theory postulates that production cutbacks occur in response to rising oil prices to equate oil revenue with investment needs. If exporting countries try to satisfy target revenue for domestic investment purposes, a backward bending supply schedule is hypothesized, thus the TRT explicitly implies that a fall in prices will result in output expansion. OPEC’s production Ž .behavior in the mid-1970s seemed to be consistent with the TRT. Griffin 1985 estimates an empirical model of the TRT for OPEC with data for the period 1971�1983, a period of rapid price increase and finds little support of the theory. Structural changes in the world oil market, the growth of non-OPEC supply, the Žrapid decline in oil prices the average spot price for crude fell from $36.68 per �barrel in 1980 to $13.07 in 1998 with a record low of $10.41 in December 1998, see Ž . �Table A1 Appendix A and Fig. 1 and over production by some members of OPEC to enhance revenues warrant further testing of the TRT. More importantly, in the series of production cutbacks, OPEC has been able to boost the price of crude beginning March 1999 to a high of approximately $28 per barrel in 2000.1 Ž .The Wall Street Journal March 16, 2001 reports that OPEC, troubled by weaken- ing oil demand the faltering world economy, is moving toward reducing output to Ž .keep the US price of oil near $30 a barrel Bahree and Herrick, 2001 . Ž .This paper uses a modified version of the model developed by Griffin 1985 to 1 The price of crude has increased steadily from $11.59 in February 1999 to $19.94 in July 1999 mainly because of OPEC’s decision in March 1999 to trim output by 4.3 million bpd. Since then OPEC has been very disciplined with very high compliance, however, if price continues to increase the temptation could become intense for some members to exceed their quotas and non-OPEC sources to Ž .increase Stanley, 1999 . https://isiarticles.com/article/17328