Abstract
The scope of this study is to provide an understanding of crude oil price determination. The approach to this general problem starts by identifying the key areas that will help us achieve the specific objectives of the research which are the derivation of both a theoretical and an empirical framework of price formation. The areas examined are: depletion theory (chapter one), the evolution of the oil industry's structure and pricing practices (chapter two), the literature concerned with explaining that evolution (chapter three). A critique of that literature enables the derivation of the theoretical framework which can be called the transition period scenario - the transition from the centrally planned industry of the 1950s to the competitive market of the 1980s. Crude oil prices since .1970 have been determined not by a cartel of producers but by an imperfect market, within which inefficiencies, imperfect information, lags in adjustment and uncertainty together with the major oil companies fading power and the OPEC group following rather than leading the market - despite the perception of it as a cartel - have all combined to formulate prices. The attempt to confirm or reject that framework by empirical testing starts by choosing a specific methodology which is believed to be superior to conventional econometric techniques: The Box and Jenkin's approach to modelling time series, testing for causality patterns and determining lead and lag relationships, by thorough empirical investigation of the data rather than by arbitrary specification of causality directions and lag structures (chapter four). Application of that methodology to the data collected yields the results presented in chapters six and seven, which confirm the basic hypothesis and supply the functions which describe the true behaviour of the system and can therefore be used for forecasting. The major conclusion emerging from the study is that OPEC should not be thought of as a cartel. The demand for crude oil being a derived demand, it is the final consumers who will in the end dictate whether or not we are likely to face further price crises or whether spot markets will be calm and orderly. Nevertheless, the high proportion of world reserves in OPEC member countries means that OPEC can assist in the prevention of abrupt price changes by assuming a supervisory role rather than attempting in vain to assume an administrating role.