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A Risk-Hedging View to Refinery Capacity Investment in OPEC Countries

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Abstract:
Should oil-rich members of OPEC invest in the oil refinery industry? This is a crucial energy policy question for such economies. We extend theoretical models for a vertical integration strategy within an oil-producing economy, based on a risk-hedging view. The first model highlights the trade-off between return and risk-reduction features of upstream/downstream sectors. The dynamic model demonstrates the volatility of the total budgetary revenue of each sector. Our theory-guided empirical analysis shows that though the average markup in the refining sector is significantly smaller than the profits in the upstream, downstream investment can provide some hedging value. In particular, the more stable and mean-reverting refining margins provide a partial revenue cushion when crude oil prices are low. We discuss the risk-hedging feature of the refinery industry when the crude oil market faces supply versus demand shocks.

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Keywords: Refinery Industry, Hedging, Vertical Integration, Downstream Investment, Export Diversification

DOI: 10.5547/01956574.42.1.hgho

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Published in Volume 42, Number 1 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.

 

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