Oil Games: What is the Nash Equilibrium for Iran and Saudi Arabia? #OilGames #

Dear Pita-consumers:

We are trying to include both the Saudi Arabia stock exchange index, Tadawul (Tasi) and Iran’s stock exchange index, Tepix, within the PITAPOLICY blog so that you can read and critique our posts while getting updated about the biggest stock markets in the Middle East & North Africa region–all in one place!  But we are troubleshooting with some plug-ins that allow Tasi and Tepix to run across our sidebars on the screen.  Currently, we are fumbling with ‘Custom Stock Widget’ and ‘Custom Stock Ticker’.  Soooooo, if you have any suggestions of which widgets or plug-ins to install, please tweet us @PITAPOLICY!  We especially feel that our readers would appreciate these tools on the blog as they read through this week’s post on the oil business spilling into political shenanigans among Saudi Arabia, Iraq, and Iran.

Oil Games

Freezing now at the January level is adequate for the market. We don’t want significant gyrations in prices, we want to meet demand. We want a stable oil price.~Saudi Arabian oil minister Ali al-Naimi

Despite Saudi Arabia’s and Russia’s opposing stances in the Syria crisis, both oil-producing countries believe they will more likely gain if they agree to cut oil output as OPEC members.  Oil prices have dropped to $35 a barrel in contrast to $116 in June 2014.  Their mission: convince other OPEC members (Venezuela, GCC countries, Iraq, and Iran) that they share in this oil production freeze interest. The United Arab Emirates, OPEC’s third largest producer, has already agreed to the Saudi-Russia strategy to cut oil production.

A set of choices to either ‘produce oil’ or ‘not produce oil’ is a clear example of predicting player behavior:  deciding whether the country/’player’ decides to cut oil production or not cut oil production, hence game theory.  So far, Iraq, Venezuela, and the UAE have agreed to play along with the Saudi-Russia strategy.  This is significant since Iraq is the OPEC’s second largest producer and captures quite a bit of the oil market share.  However, Iran remains unconvinced of their strategy providing gains for all OPEC members since they’ve been prohibited from selling oil for decades.  Iran wants to recapture what it believes is its market share of oil before the sanctions took Iran out of the oil game.  Let’s play a round, pita-consumers.

Now, before we play, let’s step back to remember in the movie, a “Beautiful Mind“–about Nobel prize winner for economics, John Nash–where he stands in a bar with his friends and notices a group of women.  Two of the women are physically attractive, two are average-looking, and the last one is considered the most physically attractive.  Nash applies game theory to the problem that he and his friends encounter at the bar.  He questions whether they should all approach whom they feel is the most attractive option and risk all getting rejected–not once, but twice–since they will likely be rejected by her friends after feeling that they are the men’s second choice.

Finally, Nash concludes that the two attractive women–or attractive options with less risk, and higher gain– rather than the ‘most physically attractive”–high risk and chance of zero gain– are more likely to be approached by his friends because each can be paired off successfully and produce no ‘losers’.

We introduce this somewhat crude explanation of Nash equilibrium to illustrate how the choice to cut output by each member depends on how much each OPEC member believes it gains in the short-run.  By cutting output to raise demand, and hence oil prices for pita-consumers, many OPEC members argue that this produces stability in the long-run for them.

Yet, at the same time, if another player/member, like Iran, decides to play the Saudi/Russia/Kuwait strategy, then they must lose out on the opportunity to regain their market share.  Yesterday Iran’s oil minister, Bijan Namdar Zanganeh, said that Iran “supports any measure to boost oil prices” but stopped short of committing Iran to capping its own output, which stands at 2.9 million barrels a day.

Iran Gains After Re-entering Oil Games

As expected, the lifting of the economic sanctions is most beneficial to Iran, where per capita welfare is expected to rise by almost 4 percent.

Since the sanctions on Iran were lifted post-Iran nuclear deal, Iran has re-entered the “Oil Games”.  The World Bank’s Middle East & North Africa Division estimated how much Iran and its neighboring oil-exporting countries would gain or lose with the re-emerging Iran player.  In a nutshell: Iran gains almost 4 percent in per capita welfare.  Furthermore, if Iran implements additional reforms to be more competitive, Iran gains an additional half percentage point “to upgrade their factories and import new technology.”  So Iran can continue to increase its economic gains as it becomes more integrated in other technology sectors.

From Iran’s point of view: all OPEC members playing their dominant strategy to cut oil, is at the expense of their opportunity to re-enter the oil market at their pre-embargo level of participation.  Perhaps Iran is going after the “most attractive” option and ready to risk lower oil prices just to get back into the oil game in the long-run.

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