W e a r e e nor m ous l y gr at ef ul f or t he c ar ef

ul r evi ew and he l pf

ul comm ent s of

f er ed by a r evi ew pane l i ncl udi ng J os eph E. A l dy, R es our ce s f or 1 t he Fut ur e, St ephe n P. A

. B r ow n, Fede r al R es er ve Bank of D al l as , D er m ot G at el y, N ew Y or k U ni ver s i t y, H i l l ar d G

. H unt i ngt on, Ener gy M odel i ng For um and St anf or d U ni ver s i t y, M i ke Toman, N i t ze School of A dvanc ed I nt er nat i onal St udi es , J ohns H opki ns U ni ver s i t y, and M i ne Y üc e l , Fe de r a l Res e r ve Ban k o f D a l l a s . A dd i t i on a l he l pf ul s ug ge s t i on s w e r e of f e r e d b y Edmun d Coe , J e f f e r s on Col e a nd M i c ha e l She l by , U

. S. EPA , and G bade bo O l ados u and D avi d G r ee ne, O ak Ri dge N at i onal Labor at or y. N at ur al l y t he vi ew s and c oncl us i ons of f er ed a r e t he res p o n sib il it y o f th e a u th o r. ORNL/TM-2007/028



### Estim ating the En ergy Secu rity Ben efits of Re duce d U .S. O il Im ports 1 Fi na l R ep or t

Paul N. Leiby Oak Ridg e N ati on al L ab orator y Oak Ridg e, Te nn ess ee leibypn@ornl.gov

Revised March 14, 2008

Pre par ed by OAK RI DGE NATI ONA L L ABORA TORY O ak Ri dge, Tennes se e 37831 M anage d by UT- BATTEL LE f orthe U. S

. DE P ART MENT OF E NE RGY undercontr actD E-A C 05- 00O R 22725Thi s r epor t w as pr epar ed a s an a ccountof w or k s ponsor ed by a n age ncy of t he U ni t ed St at es G over nm ent
. N ei t her t he U ni t ed St at es G over nm ent nor any a gency t her eof , nor any of

t hei r empl oyees , m akes any w ar r ant y, expr es s or i m pl i ed, or as sumes a ny l egal l i abi l i t y or r es ponsi bi l i t y f or t he accu r acy , com pl et ene ss, or useful ness of any i nfor m at i on , app arat us, pr oduct , or pr oces s di sc l ose d, or r epr es ent s t hat i t s use w oul d not in frin g e p riv a te ly o w n e d rig h ts. R e fe re n c e h e re in to a n y sp e c ific com m er ci al pr oduct , pr oces s, or s er vi ce by t r ade nam e, t r ademar k, m a n u fa c tu re r, o r o th e rw ise , d o e s n o t n e c e ss a rily c o n stitu te o r im p ly it s endor se m ent , r ecomm endat i on, or f avor i ng by t he U ni t ed St at es G o v ern m en t or an y ag en cy t h ere o f. T h e v i ew s an d op i n i o n s o f au t h o rs expr es se d her ei n do not nec es sa r i l y s t at e orr ef l ectt hose of

t he U ni t ed S t ates G o v ern m en t or an y ag en cy t h ere o f.F o r e x a m p le : “ K e e p in g A m e ric a c o m p e titiv e re q u ire s a ff o rd a b le e n e rg y . A n d h e re w e h a v e a s e rio u s p ro b le m : A m e ric a is a d d ic te d to o il, 2 w h i ch i s o ft en i m p o rt ed fr o m u n st ab l e p art s o f t h e w o rl d

. ” (Presi d en t G

. W

. B u sh , S t at e o f t h e U n i o n , Jan 2 0 0 6 ). “O u r dep en d en ce o n o i l creat es a th re a t to A m e ri c a 's n a tio n a l s e c u ri ty , b e c a u s e it l e a v e s u s m o re v u ln e ra b le to h o s til e re g im e s , a n d to te rr o ri s ts w h o c o u ld a tta c k o il i n f ra s tr u c tu re ,” (P re s id e n t G .W . B u s h , sta te m e n t o n C A F E a n d a lte rn a te fu e l sta n d a rd s M o n d a y , M a y 1 4 , 2 0 0 7 , in th e R o s e G a rd e n ). T h e P re s id e n t’s “ T w e n ty in Ten” pr opos al ( Pr es i dent G

. W

. B us h, St at e of t he U ni on, 2007) has t he goa l of “s t r engt heni ng ene r gy s ec ur i t y a nd addr es s i ng cl i m at e c hange by re d u c in g g a s o lin e u s e b y 2 0 % in te n y e a rs ” (h ttp :// w w w .w h ite h o u s e .g o v /s ta te o f th e u n io n /2 0 0 7 /in iti a tiv e s /e n e rg y .h tm l)

. The U

. S. has had s us t ai ned i nt er es t i n al t er nat i ve mot or f uel s , as codi f

i ed i n t he Ene r gy Pol i cy A ct s of 1992 and 2005, and A M FA , t he 3 A l t er nat i ve M ot or Fuel A ct of 198 8. I n 2 00 7, t he U

. S. E nv i r on m ent al Prot ect i on A gency (EP A ) fi nal i zed a nat i on al r enew abl e f uel s pr og r am (m o re c o m m o n ly k n o w n a s th e R e n e w a b le F u e l S ta n d a rd , o r R F S p ro g ra m ). 

### Estimati ng the E nergy Se curity Ben efits of ReducedU.S. Oil Import s Fi na l R ep ort Paul Leiby Oak Ri dg e N ati on al L ab or ato ry leibypn@ornl.gov March 14, 2008 Ab str ac t Th is u pd ate an d re ass ess m ent of the oilim

po rt p remium

wa s m oti vated

byren ew ed co nc ern ab out en ergy s ecu

rity, an d inter est

in p oli cie s to pro m ote the red uc tio n o f g aso lin e u se i n the United Stat es. To the extentthat conservation or fuel- diversifica tion reduce s dependence on any o ne so urc e, the fi nanc ialan d s trateg ic risk of po tentia l di sru

pti on in s up ply or s pik e in

co st of that so urc e is red

uc ed . T his red

uc tio n in ris ks im pro ve s en ergy s ecu

rity. Re du ced

oilim po rts would also provide sustained be nefits over the long run even in undi srupted markets, by reducing globa l demand pressure and oil prices dur ing what is expec ted to be an ext ended period of strong global demand growth, substant ial OPEC m arket power and hi gher world oil prices. W e consider pr ojected oi l market conditions ove r the next t en years, re lying on official U.S. En ergy In fo rm ati on

Ad m ini str ati on

(E IA ) pr oje cti on s. A c urr ent es tim ate of the oilim

po rt premium is $12.00 per barrel (i n 2005 dollars) , with a wide confidence i nterval ( $6.67 - $17.95) to r ef lec t m any o f t

he unres olv ed

un cer tai nti es. Whil e th is c entra l va lue is a bo ve so m e es tim ate s from the mid-1990s and early 2000s, i t is well within the range of prior esti mates up to 1993, many of which were made at times when oil market conditions were more sim ilar t o what is now anticipa ted. The essent ial message is thatwe m ay have passed through a brief peri od of comparatively great er energy se curity and l ower dependence cost s, but strong market and geopoliti cal forces have r eturned the societal costs of oil imports to gr eater pr ominence. An important note is that this pr emium estimate omits any costs for military pr ograms, and the dif fi cu lt- to- qu antif

y f ore ign po lic y im

pa ct o f oi l im

po rt r eli an ce. I. Introduction I. 1 B ac kgr ou ndan d P ur po se Th ere is c on sid era

ble int ere st i n th e h igh est U. S. po lic y c irc les wi th t akingact ion to im pro ve en ergy s ecu

rity. Th ere are act ive pro po sal s to red uc e o il c on sum

pti on an d disp lac e o il 2 with alternative and r enewable fuels. This study inves tigates the energy se curity bene fits of 3L e ib y , P a u l N ., D o n a ld W . J o n e s , T . R a n d a ll C u rl e e , a n d R u s s e ll L e e , O il Im p o r ts: A n A s s e s s m e n t o f B e n e fits a n d C o s ts , O R N L

- 68 51 , O ak 4 R i dge N at i onal Labor at or y, N ovember 1, 1997.
Thi s pape r w as ci t ed a nd i t s r es ul t s ut i l i ze d i n pr evi ous D O T/ N H TSA r ul emaki ngs , i ncl udi ng t he 2006 Fi nal R egul at or y I m pac t A nal ys i s of 5 C A F E R ef

o rm fo r L ig h t T ru ck s: U S D O T , N H T S A , "F in al R eg u lato ry Im p ac t A n aly sis: C o rp o rate A v era g e F u el E co n o m y an d C A F E R ef o rm f or M Y 2008- 2011 Li ght Tr ucks , " O f f i ce of R egul at or y A nal ys i s and Eva l uat i on, N at i onal C ent er f or St at i s t i cs and A nal ys i s , M ar ch 2006. -2- red uc ed U. S. oilim

po rts . Aran ge of

ap pro ach es h av e b een

de ve lop ed

at O ak Ri dg e N ati on al La bo rat ory (O RN L) fo r ev alu ati ngthe so cia l co sts an d e ne rgy sec uri ty i m

pli cat ion s o f o il u se, an d f or e va luatin g p oli cym eas ure s th at a lte r th e U .S . c on sum pti on an d im po rts of oil . T o h elp estimate the ener gy security benefits of reducing oi l imports, we updated and appli ed the method used in the 1997 r eport, Oi l Im po rts : A n A sse

ssm en t of Be ne fit s a nd Co sts , b y L eib y, Jo ne s, Cu rle e an d L ee. Th is a

pp roa chest im ate s th e m arg ina l be ne fi ts t o s oc iety, in d oll ars pe r barre l, 4 of reducing oil U.S. imports. The “oil premium” approach emphasizes identifying thos e energy- 5 sec uri ty r elated

co sts wh ich

are not reflected i n the market price of oil, and wh ich are expe cte d to change in r esponse to an i ncremental change in the level of oil i mports. W e acknowledge, as di d others before, that oil se curity and de pendence costs are not strict ly a fu nc tio n o f i m

po rts alo ne . O the r attributes , s uc h a s th e le ve l of oilco ns um

pti on , th e o il intensity of the economy, and the flexibility of oil supply and demand are also important de ter m inants of

the so cie taleco no m ic c os ts o f o il u se. Th esepo int s ar e w ellm ad e b y T om anin his comprehensive survey pi eces on energy s ecurity ( 1993, 2002). To the extentthat a re duction in oil imports is a ccompanied by a reduction ( increase ) in oil c onsumption, or by the introduc tion of tec hn olo gie s o r f

ue l so urc es t

hat in cre ase(de cre ase ) th e sh ort -run o r lo ng -run p ric eresponsivene ss of energy supply and demand, the incr emental benefits to soci ety would be gre ate r (l ess ) th anest im ate d h ere . I. 2 A pp ro ac h This update and r eassessment of the oil import premium is m eant to hel p measure the energy secur ity implications of new policies to pr omote the reduction of petrol eum use in the United States . The oil import premium is an informative measure of long-standing i nterest , but is n ot i nte nd ed

to p rov ide co m

ple te guid an ce o n o il s ecu rity p oli cy . T he oilpre m ium is n ot a measure of the full social cost s of oil imports, or the full magnitude of the oil dependence and security problem. Rather, it is ameasure of the quantifiable per -barrel economic costs that the U.S. could avoid by a small-to-moderate r eduction in oi l imports. The premium does not est im ate the va lue of

int rod uc inga ra dic al n ewtec hn olo gy , whic h m ayentai l a m ajo r sh if t in supply or demand curves, or a subs tantial change in the l ong-run or short-run flexibi lity of su pp ly o r de m an d. As estim ate d, it i s m os t co ns ist ent w iththe be ne fi ts o f c ontra cti ngdo m est ic demand or expanding domestic supply along the e xisting demand and supply curve s through conventional market incentives. It i s al so im

po rtant t o n ote that an

est im ate d o il i m

po rt p remium

of $5 , $ 10 , o r $2 0 p er barrel doe s not mean that a tax or t ariff of that magnitude is recomm ended as the bes t policy. Nor does it mean that the i mposition of such a tax alone would completely sol ve the energyE n e r g y M o d e l i n g F o r u m , P h i l l i p C. Be c c u e a n d Hi l l a r d G. Hu n t i n g t o n , 2 0 0 5

. “ An As s e s s m e n t o f Oi l M a r k e t Di s r u p t i o n Ri s k s , ” F I NAL 6 R EPO R T, EM F SR 8, St anf or d U ni ver s i t y, O ct ober 3. -3- security problem and eliminate the need for any othe r policy. The multifaceted na ture of the co sts m eas ure d b y th e im po rt p remium

su gg est s p urs uin g a

co m bin ati on of po lic ies targe tin g k ey aspects of the pr oblem. Bohi and Montgom ery (1981) compellingl y made this point. Helpful policies would promote m ore competitive oil supply in the l ong-run and short -run by diminishing the profitabi lity and power of cartelize d oil supply. They would al so reduce the economy’s vulnerabili ty to oil s hocks by increa sing short- run supply/demand flexibili ty, pro m oti ngsu

pp ly- reg ion

sta bil ity , d ev elo pin g b uf

fe r st oc ks , and

dimini sh ingthe eco no my’s relianc e on fuels with unstabl e supply. Since publica tion of Leiby et al . 1997, changes in oil market conditions, both c urrent and projecte d, suggest thatthe magnitude of the oil premium m ay have changed. Signi ficant drivi ng factors thatwere revise d or reconsi dered incl ude: oil pr ices, curr ent and anti cipated l evels of Organiz ati on

of Pe tro leum

Expo rti ngCo untri es ( OP EC ) pr od uc tio n, U. S. im

po rt l ev els , p ote nti al OPEC behavior and responses, Strategic Petroleum Reserve (SPR) level s, and disrupt ion likeli hoods. We apply the m ost recent ly available careful quant itati ve assessment of disruption lik eli ho od s, fr om

the St an fo rd Ene rgy

Mo de lin g F orum

(E MF ) 20 05 wo rks ho p s eri es, as w ellas 6 oth er a sse ssm ents. W e al so rev isi t th e is su e o f t he m acr oe co no m ic c on seq ue nc es o f o il m ark et disrupti ons and sustai ned higher oil prices. Using the oil premium calculation methodology, which combines short-run and l ong-run costs and benefits, and acc ounting for uncert ainty in the ke y d riv ingfa cto rs, we pro vid e an up dated ran ge of est im ate s o f t

he m arg ina l en ergy s ecu

rity be ne fi ts o f r ed

uc ingU. S. oilim

po rts
. As part o f t

he de ve lop m ent of

the se e sti m ate s, the dra ft rep ort un de rw ent a f

orm al external peer revi ew by an independent pane l. Comm ents rece ived address ed the basis of the est im ate s, fo cu sin g o n th e ch oic e o f m ark et e las tic iti es, OP EC be havio r, and the po tentia l m agnit ud e o f m acr oe co no m ic disr up tio n e ff ect s. Th eyals o c all ed

fo r up datin g th e b asepri ce and market conditions t o newer official proje ctions, sugges ted language r evisions, and c alled for so m e explanator

y s ect ion s. A s um

m ary of the pe er r ev iewis ava ila

ble (E PA , C oe 20 08 ). T his report embodies modifications and res ponses to those comm ents. Some topics were left for fu rth er w ork , b ut a s a c on seq ue nc e o f t he se v ery he lpf ul c om m ents, the res ult s h av e ch an ge d in the following ways. Base pri ce and market project ions were update d to conform to the U.S. EIA’s 2007 Annual Energy Outlook (A EO ). T his inc rea sed

the est im ate d p remium

m od est ly (~$1.4/bbl). Supply and demand elasticiti es were revi ewed, and the non-OPEC supply and demand elasticity r anges were update d and increas ed to level s consiste nt with many recent estimates, parti cularly Gat ely and Huntington 2002 ( see the par ameter summ ary Table A4, and the rev iewof

oth er e las tic ityest im ate s in Ap pe ndix Aof

thi s repo rt) . A s a r esu lt, the ne t elasti city of import demand f rom non-U.S./non-OPEC regions appr oximately doubled from the value used in the 1997 study and the e arlierdraft of this study, i n keeping with the recomm endations of some reviewers. Large r elast iciti es imply a greater market flexibi lity and lower effect of U.S. im

ports on pri ce, in this case decre asing the mean premium by $3-$4/bbl. A set of sen sit ivi ty c ase s w as p rep are d, dis playe d in Ta ble 4 o f S ect ion

V. W e u sed

a sl ightlyT h i s t rend h as b een at t ri b u t ed i n p art t o h i g h er i n co m es m ak i n g co n su m ers l ess sen si t i v e t o fue l co st s. 7 -4- wi de r rang e o f s up ply

ela sti cit ies to p aram ete riz e O PE C r esp on se, an d a lso , in a se ns iti vit

y c ase , ap pli ed on e le ad ingcan did ate rul e f or O PE C s trateg ic b eh av ior (i. e. , O PE C m aintai ns its m ark et share thr ough time). The magnitude of the m acroeconomic effects of future oil disruptions remains a topi c of act ive de bate. Ho we ve r, t o c on sid er the po ssibil ity , s ug ge ste d b y s om e b ut n ot a ll r ev iew ers , that th e ec on om

y is be co m ingles s se ns iti ve to o il s ho ck s, we ap pli ed a re du ced

Gr os s D om est ic Pr od uc t (G DP ) el ast ici ty r an ge in t he ba se c aseres ult s (G DP ela sti city rang ingfr om -0. 01 to ~-0.05, ratherthan -0.01 to - 0.08). The mean value is ~-0.03, reduce d from the mean value of ap pro xim ate ly - 0. 05 us ed in t he 19 97 stu dy , an d th e earli er d raf t. F ina lly , th is r ep ort

inc lud es further deli neation of the nature of some com ponents of the import premium , particul arly the nature of the dis ruption sub- components, and a m ore extended t echnical de scripti on of the estimation methodology in Appendix B and C.

I. 3 C on cer ns Ab ou t Oi l S ecu rity Concerns about oil security stem from three re lated probl ems: concentrated suppl y in a histori cally unst able regi on; the sust ained exerc ise of market power by key oil export ers; and the co nti nu ed (al tho ugh p erh ap s d im ini sh ed) vu lne rab ili ty o f t he eco no my to ep iso dic oilsu pp ly shocks and pric e spikes. Global oil rese rves are c oncentrat ed in a volat ile regi on of the world, with 60% of reserve s in the Pers ian Gulf region. Part ly as a conseque nce of this concentration of low co st r ese rve s, OP EC pro du cer s ar e ab le t o e xe rci se m ark et p ow er, fu nc tio nin g a s an imperfect (“clumsy”) cartel and at times maintaining oil pr ices well above estimated competitive lev els . T he str en gth

an d in flue nc e o f t

his car telgro ws an d d ecl ine s, large ly i n re lat ion to c yc les of gro wth in

glo ba l im

po rt d em an d and

OP EC m ark et s hare ( e. g. , G ate ly 2 00 1, 20 04 ; Gree ne , Jo ne s an d L eib y 1 99 8). No ne the les s, OP EC ’s p rod uc tio n o r prici ngde cis ion s can im po se su sta ine d e co no m ic c os ts o ve r m any y ear s an d c anex ace rbate, or am eli orate, sh ort -run s up ply shocks. In the face of short -run supply vol atili ty most oil consuming nations have li mited scope fo r f lex ibl y a dju sti ngthe ir o il s up ply or d em an d. Th is i s p art icu larly t rue as o il d em an d b eco m es increasi ngly concentr ated in the transport ation sect or (IEA 2005), given i ts low elast icity and early evi dence that the demand for gasoline in the li ght duty vehicl e sector i s becoming inc rea sin gly

ine las tic (Hughe s, Kn itt el and Sp erl ing20 08 ; S m allan d V anDe nd er 2 00 7:4 0-4 1). 7 Uncertainty, rigidit ies, and adjus tment costs lead to e conomic dislocation, particular ly during su dd enan d d ist

urb ingoilsu

pp ly disr up tio ns (H amilt on

20 03 , 2 00 5; D av is and

Ha lti wang er 1999, 1999a). While evolvi ng market institut ions, decli nes in the ene rgy intensi ty of the U.S. economy, and strat egic oil s tockpili ng are expect ed to mitigate the c osts of oil disruptions to the U.S. eco no my c om

pared to s itu ati on

in t he 19 70 s an d e arl y 1 98 0s , th e p rob lem of en ergy s ecu

rity h as no t be eneli m inated . O ur a pp roa chacc ounts for

the be ne fi ts o f t

he SP R. Th e p ow er o f t

he oth er two proposed mitigating factor s is less well establ ished. As noted by many experts (e .g.L eib y , Pa u l N ., D o n ald W . Jon es , T . R an d all C u rlee , an d R u sse ll L ee , O i l I m port s: An A ss es smentof

Benef i t s and 8 C o sts , O R N L-6851, O ak Ri dge Nat i onal Labor at ory , N ovember1, 1997. U

. S. DO T, NH TSA 200 6. " Fi na l Reg ul at ory I mpa ctAnal ysi s : Corpo r at e A ve r ag e Fue l Ec on omy a nd CA FE 9 R ef or m forM Y 2008- 2011 Li ghtTruc ks, " O f f i ce of Regul at ory A nal y si s and Eval uat i on, N at i onal Cent erf or St at i st i cs and Anal y si s, M ar ch. N atio n al A ca d em y of S cie n ce s 2 0 0 2

. Ef f e c t i v e n e s s a n d

lmpa c t o f Co r p o r a t e Av e r a g e Fu e l

Ec o n o my (

CAFE ) 10 Stand ards, Com mitt ee on the Ef f ect i venes s and I mpactof Corpor at e Average Fuel Economy ( C A FE ) St andar ds, N at i onal R esearch C ou ncil (W ashington, D .C.: N ati on al A cad em y Press). -5- Ham ilt on 20 05 , N ati on al A cad em

y o f S cie nc es 2 00 2:8 6), acc ordingto s im ple eco no m ic pro du cti on

the ory theeco no m ic c on seq

ue nc es o f disr

up tio ns are exp ected

to be rela ted to the U.S. expenditure on oil relati ve to the GDP, and to decli ne as that oi l factor-share decli nes. Ho we ve r, H am ilt on

ob ser ve s th at the his torica l expe rie nc e d oe s n ot c on fo rm to t he sim ple factor-shar e argument. The drop in GDP following the five most notable oil suppl y disrupti ons sin ce 1 95 0 f

ar e xc eed ed

the los s p redict ed

bythe oilfa cto r sh are . T his an d o the r em pirica l te sts lead Hamilton (2005:10), Hunti ngton (2005) and Brown et al . (2005) to concl ude that the rel ati on sh ip b etw een

oilpri ce s ho ck s an d o utp ut i s m oresu btl e an d c om

ple x th anori gin all y tho ught, wi th s ho ck s w orkingthe ir w aythr ou ghthe eco no my in m any s ect ors byindire ct channels tha t can be surpr isingly powerful. For these reasons , we cannot be cert ain that the disrupti on component of the oil premium declines i n direct pr oportion to oi l share. Regar dless of this iss ue, recent trends have been l ess favorable. The dec line in oi l value shar e has halte d and rev ers ed . T he ris ingexpe nd iture s hare f or o il i n U .S . G DP ov er the pa st f ewye ars alo ne cal ls int o q ue sti on the ass ert ion

that th e im

pa ct o f disr

up tio ns on

the U. S. eco no my is un if ormly declining. Furthermore, much higher oil prices and growing oil i mports also suggest tha t the inc rem entalef

fe ct o f U .S . o il u se o n w orl d o il p ric e an d U .S . im po rt c os ts c ou ld b e h igh er than in p rio r ye ars . I.4 Summary of Met hod In o rde r to est im ate the en ergy s ecu rity b en ef its of red uc ed U. S. oilus e, we de ve lop ed an ap pro ach fo r ev alu ati ngthe so cia l co sts an d e ne rgy sec uri ty i m

pli cat ion s o f o il i m

po rts . T his approach can be us ed for evaluati ng policy measures thatalter U.S. imports of oil. For est im ati ngthe se e ne rgy

sec uri ty b en ef

its , w e u pd ate d and

ap pli ed the sam e o il i m

po rt s ecu rity pre m ium m eth od olo gyus ed

in t he 19 97 rep ort Oi l Im

po rts : A n A sse

ssm en t of Be ne fit s a nd Co sts , by Leiby, Jones, Curlee and Lee. This paper was ci ted and its results utiliz ed in previous 8 DOT/NHTS A rulemakings, including the 2006 Final Regulatory Impact Analysis of CAFÉ Reform for Light Trucks. It was also c ited in the NAS 2002 discussion of CAFÉ. The 9 1 0 pri nc ipa l up dates to t

he m eth od olo gyap pli ed

fo r th is ana lys is r ef

lec t th e su

bs tantia l ch an ge s in oil market conditi ons since 1997, as pr ojected by the U.S. EIA for the period 2006-2015. The results here are ba sed on the aver age oil market condit ions over thi s period as pr ojected by the U.S. Energy Information Administr ation’s Annual Energy Outlook 2007 (AEO2007) Base Case. Th ese ch an ge s an d th eir

indivi du al i m

pli cat ion s w illbe fu

rth er d esc rib ed

be low . F ore m os t am on g th em

are su bs tantia llyhighe r oi l price s an d h igh er U .S . o il c on sum pti on an d im po rts than in p rev iou s p roj ect ion s. Th e n et r esu lt i s th at the est im ate d o il i m po rt p remium

is greater than in the 1997 study (s ee Table 1 below).T echni cal l y, t he oi l pre m i um i s bas ed on a “m ar gi nal ” econom i c anal ysi s ( i

. e. a di ff er ent i al anal ysi s of

t he r at e of change of cost s per bar r el 11 cha nge i n i m por t s )

. A t t i m es w e us e t he t er m “i ncr ement al ” i n pl ac e of “mar gi nal ” he r e t o avoi d conf us i on w i t h m ar gi nal i n t he mor e c om m on sens e of “f

r i ng e” or “cl ose t o t he l i m i t of acc ept abi l i t y. ” Est i m at es of

t he oi l i m por t pr emi um w hen c ount i ng m ar gi nal bene f i t s f or al l of t he O r gani za t i on f

or Economi c Cooper at i on and 12 D eve l opm ent ( O EC D ) ar e t ypi ca l l y a bout 3 t i m es as l ar ge a s t he pr emi um es t i m at ed f r om t he pe r s pec t i ve of U

. S. bene f

i t s al one ( e. g. , K l i ne 1 9 8 1 ). -6- Ta bl e 1 : S um mary R esu lts Effect / Study OR NL19 97 Repo rt (2005$/BBL) OR

NL20 07 Up dated (2005$/BBL) Monopsony Component $2.64 ($1.58 - $3.69) $7.41

($2.77 - $13.11) Mac roe co no m ic D isr

up tio n/ Ad jus tm ent C os ts $1.06 ($1.06 - $2.11) $4.59

($2.10 - $7.40) Total Mid- point $3.69 ($2.64-$5.80) $12.00

($6.67 - $17.95) R es ul t s i n 2005$. Col umns r eportmean es t i mat e a nd r anges . I n the c as e of the 1997 r eport , the r anges r ef

l ectthe s ubj ect i vel y def i ned “ narr ow ed r ange. ” I n the c as e of the ne w s tudy , the r anges i ncl ude 90% of

r es ul t s f r om t he r i sk- anal y si s si mula t i on. The approach est imates the incremental benefit s to society, in dollar s per barr el, of red uc ingU. S. im

po rts
. Th is “ oilim

po rt p remium ” ap pro ach

ide nti fi es t

ho se e ne rgy -se curity 11 rel ate d c os ts that ar e n ot r ef lec ted in t he m ark et p ric e o f o il, an d th at are e xp ect ed to c hang e in response to an incremental change i n the level of oil imports. Om itted from this premium cal cu lat ion

are envir onm entalco sts an d p os sib le n on -ec on omic o r un qu antif iab le e ff ect s, su chas ef fe cts on fo rei gn po lic y f lex ibi lity o r m ili tar

y p oli cy . A lso omitt ed

are any s pil lov er- be ne fi ts that m ayacc rue to U .S . a lli es and tra din g p artne rs who are similarlyrel iant on oil , and wh o w ou ld benefit from a reduction in the l evel or volatility of world oil price . These are expec ted to be large . 12-7-

I.5 Changes Since the 1990s Analysis of Oil Im port Premium Since the 1997 publi cation of the Leiby et al . O RN L r ep ort , c hang es i n o il m ark et co nd iti on s, bo th c urrent an d p roj ect ed , s ug ge st that th e m agnit ud e o f t he oilim po rt p remium

m ay have inc rea sed . S ign if

icant d riv ingfa cto rs that ha

ve be enco ns ide red

in t his ne w ana lys is are: oil pri ces ; curre nt and

antic ipated

lev els of OP EC pro du cti on ; U .S . im po rt l ev els ; th e es tim ate d res po ns ive ne ss o f r eg ion al o il d em an ds an d s up pli es; an d th e li ke lih oo ds of dif fe rent-s ize dis rup tio ns in t

he oilm ark et. In u

pd ati ngthe an aly sis , w e ap pli ed pro jec tio ns of

m ark et co nd iti on s f

rom the U. S. EI A’ s 2 00 7 Annua l E ne rgy Outlo ok an d th e m os t re centlyav ail ab le careful quanti tative a ssessment of disruption li kelihoods from the Stanford Energy Modeli ng Fo rum ’s 2 00 5 w ork sh op series , a s w ellas o the r as ses sm ents. Th e ch an ge s in ke y m ark et parameters are summarized in Tables 2 and 3 bel ow.

Table 2: E volving Oil Market Conditions an d U.S. Oil Use

1997 S tudy Conditions 2006 C onditions AEO2007 Base, avg. for 2006 -2015 Oil Price ($2005) $21.45 ~$56 $50.99 U.S. Oil Imports 8.82 ~12.3 12.56 U.S. Oil Demand 18.22 ~21.0 22.19 OPEC S upply 28.4 33.9 34.43 U.S. GDP ($20 05) $8096 ~$12100 $14573 Oil Share of GDP 1.76% 3.57% 2.83% Ev olv inghis torica l an d p roj ect ed oilm ark et c on dit ion s in flue nc e th e p remium est im ate . N ote that all these parameters are positi vely related to the s ize of the import premium , to varying de gre es. (P ric e is in $ /bb l; i m po rts , d em an d and

su pp ly are i n mill ion s o f b bl/ day; and GD P i s in $ bil lio n p er annum .)-8- Ta bl e 3 : Ma rke t an d P ar ame terCh an ge s In flu en cin g P rem iu m E sti mat e Co nd iti on (+ o r – I nd icates Di rec tio na l Imp ac t o n P re mium) 1997 An aly sis 2007

An aly sis Pe rce nt C hang e S inc e

19 97 An aly sis *

U

. S. Econom y L a r ge r ( +) 8096 14573 +80% Shar e of O i l i n G D P ( no ne t i m pa c t i nf e r r e d) V a l ue s ha r e ( $ o i l / $GD P) Phys i c a l s ha r e ( BB L/ $1 00 0 GD P) 1. 76% 0. 82 2. 83%

0. 56 V a l ue s ha r e +61% P h y s i c a l i n t e n s i t y - 3 2 %; U

. S

. O i l I m p o r t s H i g h e r ( + ) 8

. 8 2 1 2

. 5 6 + 4 2 % W or l d O i l Pr i c e H i ghe r ( +) $21. 45 $50. 99 +138% E stim a te d A v e . A n n u a l L ik e lih o o d o f N e t O il Suppl y D i s r upt i on > 3. 0 M M B D ( +) 4. 2% 5. 8% ~+37% U .S

. S trateg ic P etro leu m R es erv e S ize L arg er (-) 600 688 +15% Lo n g - r u n Re s p o n s i v e n e s s o f n o n - U. S. / n o n - OPEC N e t D e m a nd f

or I m por t s G r e a t e r (

- )

- 0. 88

- 1. 60 +83% **
*Th e 1 99 7 s tu dy re lie d o n 1 99 6 d ata . P erc ent ch ang es co m

pare t he lev els us ed in

th e 1 99 7 s tu dy w ith

th e p ro jec ted average le vel for the next 10 y ears, 2006-2015. ** Th is it em

re fle cts param ete r r evi si on as w ellas ch ang ed reg io nals up pl y-dem and ba lan ces . Whi le th e a ctu al ela st ici ty of fi nalde m and

an d o il su

pp ly in in di vi du al reg io ns m ay have dec rea se d o ver th e l as t d eca de, w e c on si dered a m od es tly higher range for individual regions than those used in 1997 (based on a review of literature on oil demand elasticitie s and on re vi ew er com

m ent s) . T he qu antity-w eight ed com bi natio n o f d em and

an d s up pl y elas tic iti es yield s th e e las tic ity o f n et import demand for the non-U.S/non-OPEC region.A E O 20 07 oi l expen di t ure proj ect i on s ar e $35 8 b i l l i on per year for t he l ow pri ce ca se a nd $5 13 bi l l i on per year for t he l ow pri ce ca se. 13 T h e h ig h er e stim ate s e m erg e f ro m a v ariety o f rec en t t im e-s eries an aly se s o f th e h istorica l d ata , fo cu sin g o n th o se o il p ri ce ev en ts tha t are 14 s u d d e n a n d o u tsid e th e ra n g e o f p ric e e x p e rie n c e in th e p rio r 4 to 1 2 q u a rte rs . T h e lo w e r e s tim a te s a re g e n e ra lly p ro d u c e d b y s im u la tio n s w ith larg e-s ca le stru ctu ral ec o n o m etric m o d els, w h o se res u lt s a re g o v ern ed b y w h ich ev er m ec h an ism s fo r o il p ri ce s to affe ct th e e co n o m y are em bo di ed i n t he m od el st r uct ure . -9- One indicati on that the c urrent oi l market situati on for the U.S. is different from that of the mid-1990s is provided by the l evel of U.S. expenditure on oi l imports. Real U.S. expenditure s on crude oil are exceedi ng histori cal highs, as shown in Figure 1.

The average annual expenditure on oil proje cted over 2006- 2015, the period of thi s study, is $413 billion pe r year (2005$) , based on AEO2007. 13 W e also revi sited the issue of the macroeconomic consequences of oil market disruptions and sustaine d higher oil prices. Ther e is substantial var iation among the esti mates of the GDP los s f rom anoilpri ce s ho ck

. Gi ve n th e co m pe tin g in flue nc es o f a

de cli nin g p hy sic al- int en sity 14 Fi gu re 1 Pr oje cti on s o f U .S . o il e xp en dit ure as a sh are of GD P h ov er at th e h igh

lev els observed in the late 1970’ s, even along the Midcase pr ojection path wi tho ut su pp ly disrupti ons. (Sources: Data through 2005 from U.S. EIA, An nu al E ne rg y R evi ew various editions, and Annual Energy Outlook 2007 Midcase, for proj ections after2005).Thi s G D P el as t i ci t y s um m ar i ze s t he c um ul at i ve l os s of G D P expe ct ed ove r 2 ye ar s as a f r ac t i on of

one y ea r ’ s G D P f

or a s udden, 15 u n an t i ci p at ed d o u b l i n g o f w o rl d o i l p ri ces. T h e s e c a s e s e v o lv e d fr o m th e d ra ft e s tim a te s d e v e lo p e d fo r u s e in s u p p o rt o f th e 2 0 0 6 R e n e w a b le F u e l S ta n d a rd to th e c a s e p re s e n te d h e re in 16 T a b le 1

. -10- of oil use in the e conomy (barrels per $ GDP) and a ri sing value- intensity of oil use in the eco no my ($ expe nd ed

fo r oi l pe r $ G DP ), i t is un cle ar h owto m odif y th e o il- m acr o c alc ulatio n, if at all. The ne t effect of these counter -influences on the oil pri ce-elas ticity of the GDP m ay or may not be zero. However, it is r easonable t o assume that the resul ting elas ticity level re mains wi thi n th e re lat ive ly w ide (-0 .0 8 to -0. 01 ) rang e cu rre ntly u sed

in t he sen sit ivi ty ana lys is. 15 Accordingly, the disrupti on costs were es timated in the same way as the previ ous 1997 study. Th at i s, the ke y p aram ete r “G DP ela sti city” that re lat es p erc entag e G DP los s to pe rce nta ge pri ce change during a s hock, was varied par ametrically in asensiti vity analys is over the same range of values (- 0.01 to -0.08), encompassing the e stimates of m ost oil- macroeconom ic studie s over the last deca de. To account for the poss ibility that ther e has been a syst ematic reduction i n the sen sit ivi ty o f G DP to o il p ric e sh oc ks we als o c on sid ere d a cas e whe re G DP ela sti city w as v ari ed ov er a low er r an ge , (f

rom -0. 01 to - 0. 05 4), wi th a

m ean va lue of -0. 03 2 (s ee A

pp en dixA, Ta

ble A4 ). Whe n c on sid eri ngthe po tentia l ec on omic i m pa cts of futur e d isr

up tio ns in t

his an aly sis , two factors were borne in mind. ! Th e p roj ect ed

ba se o r un dis ru

pte d real oil expenditure s are alr eady at leve ls exceedi ng those of the highestprevious dis ruptions. The pr ojected oi l expenditur e as a share of GDP is comparable to the l evels of the lat e 1970s, above all other hist orical t imes save during the pe ak ye ars of the Iranian R ev olutio n (1 97 9) and Iran/I raq W ar ( 19 80 ). Ahy

po the tic al dis rup tio n whic h c ou ld d ou ble pri ces fr om

thi s b aselev el w ou ld p ut u s in un cer tai n ter rit ory , c ert ain ly a

m ark et r eg im e whic h o il c on sum ers an d f irm s w ou ld f

ind ve ry disturbi ng. ! The oil market disrupt ions are si mulated based on event sequenc es posited by the Energy Mo de lin g F orum

led wo rks ho ps (E MF /B ecc ue an d Huntin gto n 2 00 6). Th e large r of the se events are typicall y major geopolitical upheavals (r evolutions and wars), the type of ev ents that ar e th ou ght to be m os t al armingto e co no m ic a cto rs and to l ead to greater uncertai nty and disloc ation in the economy. They are not to be confused with rout ine price vola tility or comparatively gra dual demand-driven pric e rises, whic h might be expe cte d to have les ser

m acr oe co no m ic e ff

ect s. Us ingthe est ab lis he d o il i m po rt p remium

cal cu lat ion

m eth od olo gy , whic h c om bin es short-run and long-run cos ts and benefits, and accounting for uncertainty i n the key drivi ng factors, we developed an updated range of est imates of the incremental energy se curity bene fits of reducing oil imports shown in Table 1. In t he pro ces s o f d ev elo pin g th eseest im ate s, an d in res po ns e to co mm ents f

rom the rev iew panel, a setof alternati ve cases was devel oped. They considered: different sets of non-OPEC 16 su pp ly/ de m an d e las tic iti es; alt ern ati ve ran ge s o f O PE C r esp on se, eithe r in ter m s o f t he sim ulated range of OPEC supply elastici ty or using a OPEC strat egic behaviorrule thatpreserves OPEC-11-

m ark et s hare; an d a

low er r an ge of

GD P l os ses in r esp on se t o o il s ho ck s (l ow er G DP ela sti cit ies wi th r esp ect

to o il p ric e). Th ese alt ern ati ve cas es are p res ented in T ab le 4 of

Se cti on V, Re su lts

.N ot e t hat non- compet i t i ve oi l s uppl y i n t he f ac e of unpr i ce d envi r onm ent al ext er nal i t i es w oul d l ea d t o of fs et t i ng ef

f ec t s ( s ee , e. g. H unt i ngt on 17 an d B ro w n 2 0 0 4 ). -12- II. Th e Oi l Im po rt P rem iu m as a M ea su re o f E ne rg y S ecu rity C os ts o f Im po rts II. 1 Th e Is su e o f a Refe ren ce P oin t: C os ts Rela tiv e to Wh at? Whe n a sse ssi ngthe co sts of oilim po rts , w e m

us t ch oo se an a

pp rop riate r ef

ere nc e p oint, that is, answer the quest ion "costs relati ve to what? " Three possi ble reference points for co m paris on wi th t he curre nt l ev els of

oilim po rts an d c on sum

pti on are : (1 ) hy

po the tic al p erf

ect ly competitive oil market condit ions; (2) optimal levels of imports given market imperfections; and (3) marginal (small incr emental) changes in i mports from the curre nt level. Addit ional point s of comparison m ight be condit ions under the introduct ion of different technologi es or alt ernative en ergy s up ply/de m an d s ys tem s, or o the r parti cu lar po lic ies . T he se c om

paris on s w ou ld g ive an est im ate of

the va lue of

parti cu lar

m ark et o r po lic y c hang es, an d are a wo rthwh ile fo cu s o f f

utu re work (see, e.g., Greene and Leiby 2006). However, sinc e this study focuses on import levels and see ks a p er- barre l es tim ate of so cia l co sts , w e re strict

our co ns ide rat ion

to t he se f irs t three reference point s. At on e extre m e, the co sts of oilim po rts can be m eas ure d re lat ive to t he co m pe tit ive ide al (e. g. Gr een e an d L eib y 1 99 3; Gree ne an d T ish ch ishyn a 2 00 0). Su chanide ali zed wo rld wo uld have co m pe tit ive su

pp ly and de m an d, no un antic ipated pri ce s ho ck s, an d n o unp ric ed environmental damages or other soci al costs. I n other words, the per-barr el costs of oil could be compared to the costs that would existin the absenc e of any m arket failur es. Using the 17 co m pe tit ive ide al a s a r ef

ere nc e p oint w ou ld p rov ide a g en era l vi ewof the m agnit

ud e o f c os ts that we m ight wish to r ecover. This may be a useful gui de for researc h and motivate the sear ch for co st- ef fe cti ve so lution s. It a lon e w ou ld o ff er o nly parti al i ns ight, h ow ev er, on ho w m uc h government can or should do about oi l use or imports to avoi d these cost s. It would be a mistake to t reat al l co sts be yo nd

tho se o f t he co m pe tit ive ide al a s av oid ab le, sin ce t hat w ou ld i m

pli cit ly ass um e th e ex ist en ce o f c os tle ss g ov ernm ent ac tio ns that to tal ly e liminate the m ark et f ailure s. Se co nd ly, the po tentia l co sts of oilim po rts m aybe de fi ne d in

ter m s o f t he dif fe ren ce be tw een the co sts at the op tim al ( ef fi cie nt) lev el and

the curre nt l ev el o f i m

po rts , re co gn izi ngthat co m ple te e liminatio n o f s oc ialco sts is n ot c os t ef fe cti ve , and

that so m e g ov ernm ent pr ogram s ar e already i n place to r espond to potent ial market failures . Since corre ctive act ion is not cos tless, the pragmatic issue is one of balancing the c osts imposed by government interventi on against the expected val ue of that intervention. For example, costs may be estimated rel ative to opt imal U.S. policy regarding import levels (e.g., Broadman and Hogan 1986, 1988; Huntington 1993). The go al i s to ap pro ach

anef fi cie nt l ev el o f o il i m

po rt c os ts, no t to red

uc e th os e co sts to z ero . T his op tim al l ev el i s d ep en de nt o n a ho st o f c on dit ion s ab out th e st ruc tur e o f t

he do m est ic and

wo rld oil markets, the vulne rabili ty of the domestic and world oil markets t o price shocks , and the rel ati on sh ip b etw een

oilm ark ets an d th e m acr oe co no my. Th e ef fi cie nt o r op tim al l ev el o f i m po rt costs may not be attai nable with poli cies thatare cost effective and pr agmatically accept able, but the concept ha s the merit of being a desir able referenc e point.-13-

A thir d c om

paris on po int is the co st t

hat w ou ld b e ca

us ed bya m arg ina l (s m all incremental) change in oil imports from the current, oralterna tively, from the optimal, level. A small incremental reducti on in imports may not be an optimal or adequate goal, butit has the virtue of being an a chievable r eference point. The marginal r eduction in s ocial cost s of a change in i m po rt l ev els als o re ve als the am ount w e sh ou ld b e w ill ingto p ay(pe r barre l) t o a ch iev e th at m od est ch an ge . H en ce, m arg ina l co st i s a c om parat ive ly s im

ple but us ef

ul guid e f or i nc rem ental po lic y, an d is the m eas ure an alyzed in t his pa pe r. II. 2. In ter pr eta tio n o f th e Ma rg in al P rem iu m A pp ro ac h The oil import premium

estimates the marginal economic benefit to the United State s of decreasi ng oil imports, beyond the market pri ce of oil. However, it does not imply that the im po sit ion of a co m parab le t ari ff

or t axwo uld b e ei the r th e m os t ef fi cie nt o r a f

ully a de qu ate policy to dea l with the ent ire probl em of oil dependence and security. Echoing the NAS dis cu ssi on

of the en ergy s ecu

rity b en ef its of ve hic le f ue l ec on om

y (NAS 20 02 :86 ), i t al so sh ou ld be em ph asi zed that: “[the oil premium] includes nei ther the e ntire bene fit to the Unite d States of ‘solving’ the problem of noncom petiti ve pricing by the OPEC nations nor the entir e b en ef

it o f i nc rea sin g inter

natio na l st ab ili ty i n w orl d o il m ark ets (or , equivalent ly, the costof not solving these problems). These problems cannot be solved completely by changi ng the amount of oil consumed in the United States.”

II.3. Prior Estim ates of the O il ImportPremium The oil import premium

gained att ention as a gui ding concept for ener gy policy beginni ng in t he lat e 1 97 0s , arou

nd the tim e o f t

he sec on d and

thi rd m ajo r po st- war oi l sh oc k s (P lum m er 1981, Bohi and Montgomery 1981, EMF 1982). Stobough and Yergi n (1979) focuses int erest on the de m an d o r m on op so nypre m ium wi th t he ir w ide ly r ead

est im ate s o f t

he “b uy ingpo we r wedge,” which they plac ed at a minimum value of $25/bbl to as much as three times that level

. Th e w ork s in

Plum m er ( 19 81 , 1 98 1a) pr ov ide d v alu ab le disc us sio n o f m any o f t he ke y iss ue s re lat ed

to t he oilim po rt p remium

as w ellas t

he an alo go us oilsto ck

pil ingpre m ium . T he y also provide a range of premium estimates. In a book-length treati se, Bohi and Montgomery (B&M, 1982) car efully detail ed the the ore tic al f

ound ati on s o f t

he oilim po rt p remium

an d e xp os ed , throu ghthe ir tho ughtf ul ana lys is, m any o f t he cri tic al ana lyt ic r elatio ns hip s. Be cau se o f i ts e arl y p os iti on in t he lit eratur e, an d it s comprehensiveness, it i s informative to considerthat work in more detail . They argued for att entio n to rig oro us ef

fi cie nc y (c os t an d b en ef

it) co ns ide rat ion s an d f

or e va luatin g what po lic ies m ight be ap pro pri ate in t

hat co nte xt r ath er than p ay ingun du e attentio n to the lev el o f o il i m po rts pe r se . They clearl y defined the components of the oil premium as the “demand” or m onopsonyrelate d component and the “security” or disrupt ion-rel ated component (B&M 1982:5), with theB & M 1982 and other s not e thatthe oi l i mportpr emi um i s nots y nony mous w i th “opt i mal t ar i f f , ” a nd does not 18 nece ss ar i l y ca l l f

ora t ar i f f of l i ke magni tude, gi ven the c omple xi t i es of tr ade pol i cy. R atheri ti s an e st i mat e of the ne t benef i t s of r educi ng i mport s, gui di ng the a mount thatw e mi ghtbe wil l i ng t o s pend pe rbarr el t o do s o. The pr emi um arise s fro m div ers e p h en o m en a, h en ce “n o sing le ins trum en t” sh o u ld b e e x p ec ted to a d eq u ate ly ad d res s the sep ara te r eas ons a pr emi um exi st s. M ul t i pl e i nstrument s may ac hi eve the mostef f i ci ent/ l eas tcos ti nt ervent i on.
-14- premium measuring how those two cost components vary at the margin with the level of im ports. In k eep ingwi th m

uc h o f t he early w ork

that di scu sse d th e o pti m al o il i m po rt t ari ff as a m eas ure of the oilim

po rt p remium , B &M 1 98 2 h igh lighte d th e m anne r in wh ich the inc ide nc e an d o pti m al siz e o f an im

po rt t ari ff de pe nd on the ela sti city o f U .S . im

po rt d em an d, the ela sti city o f n et s up ply of im ports to the U.S. and the level of U.S. imports. These same fundam ental re lationshi ps 18 dri ve our es tim ate s o f t

he m on op so nypre m ium

co m po ne nt, sin ce t

he y d ete rm ine the de gre e to which an import reduction would dr ive down world oil pr ices or be offset by suppl y and demand responses gl obally with l ittle price change

. Re lyi ngon

the ore tic al argum ents, Bo hi and Mo ntg om ery

car ef ully p ointed

out th e w ay s in wh ich m ark et b eh av ior

an d inter act ion s (i nv olv ingoilexpo rte rs, co ns um ers an d f irm s) c ou ld red uc e th e so cia l co sts of

im po rts be low

the lev el c om

m on ly e sti m ate d b y “ co nv entio na l” framew orks. While they noted possi ble indir ect (sec ondary) repe rcussions and costs of the im po rt- de m an d in du ced

oilpri ce i nc rea ses be yo nd the dir ect

“w eal th t ran sf ers ab roa d” (ex am

ple s of fe red rel ate to e xc hang e rates , c ap ita l f orm ati on , in co m e d istrib uti on , and pro du cti vit

y), B& M 1982 ruled thes e out as too spe culative , and with possibl e offsetting consider ations. Similarly, the y argu ed

on the ore tic al grou

nd s th at p riv ate ag ents c anbe expe cte d to res po nd ef fi cie ntly to the ris ks of

oilm ark et disr

up tio ns byba lan cin g th e m arg ina l co sts of pro tec tiv e ac tio n w iththe ir dis co unted

expe cte d c os t of

oilpri ce i nc rea ses . P os sib le p rot ect ive act ion s ci ted inc lud e re du ced oil use, inve stment in flexible capi tal or subs titute fuel capabili ty, and stockpi ling oil or su bs tit ute s. Whil e th eyob ser

ve d th at s om e argu e p riv ate ag ents h av e le ss c om ple te o r le ss acc urate i nf

orm ati on ab out di sru

pti on s th anthe go ve rnm ent, and that th ere m aybe de fi cie nc ies in private pr ecautionary planning, they r eject these arguments in the abs ence of convincing em pirica l ev ide nc e. W e n ote , h ow ev er, that th is s tan dard o f p roo f i s n ot a pp lie d w ithun if

ormity to all their theor etical arguments for m arket efficiency. Ov era ll, Bo hi and

Mo ntg om ery

rig oro us ly s crutin ize d e ach argum ent f

or a co st t hat possibly provi des a rati onale for government interve ntion. In many cases, they conc lude the argum ent m elt s aw ayun de r th e p res um pti on of ef fi cie nt m ark et b eh av ior , le av ingon ly t he m os t ess entia l ratio na les rem ain ingas s ource s o f t he oilim po rt p remium : th e w eal th t ran sf er d ue to demand power in norm al markets, the addit ional expect ed wealth tr ansfer or demand com ponent durin g d isr

up tio ns ste mm ingfr om

highe r im

po rts , and any m arg ina l ef

fe ct o f i m po rts on “in dir ect macroeconom ic costs” due to economy-wide dislocat ions and adjustments during oil shocks. Our stu dyhe re g en era llyco m es t o e sse nti all y th e sam e co nc lus ion s, an d re lie s o n large ly t he sam e k ey components, which we estimate through an indep endent formal approach. Like Bohi and Montgomery, we recognize thateconomy-wide dislocations during shocks ar e more properly a fu nc tio n o f o il c on sum

pti on than im po rts . W e al so ex clu de m os t m arg ina l di sru pti on co sts that are dire ctly born by pr ivate oil -consumers and producers, and which may be anticipated and-15-

ad dre sse d b y p riv ate pre cautio nary b eh av ior . Ho we ve r, w e agree wi th P arr y and Darm sta dte r’s (20 04 ) as ses sm ent th at “ Mo st ana lys ts b eli ev e th at the fu ll e xte nt o f m ark et u ph eav al i s not

fu lly captur edinfi rm b eh av io r” (p .1 4, emph as is ad de d) , s o we co ns id erth e p os si bi li tyth atso me fraction of expected pr ice shock inc reases i s not internalized. De sp ite the ir rigo rou s st an dards fo r in clu sio n in the pre m ium

an d g en era llyop timist ic assumptions regarding market efficiency i n the face of higher oil prices and di sruptions, Bohi and Mo nt go mery s ti ll off

er edwha t mi gh t n ow b e v ie we d a s mod er at el y l ar ge es ti mat es of s ome components of the oil import premium . They did not provide estimates of the disrupt ion portion of the import premium . While they not ed that “unce rtaint ies... precl ude an unambiguous conclusion aboutthe magnitude of the premium ,” they conclude d (in 1981) that the long- run m on op so nypre m ium

pro ba bly lie s b elo w $ 10 /bb l (1 98 0$ ), o r $2 0. 91 /bb l in 20 05 $. In t

he ir Appendix they provide a range of estimates of the opti mal im port tar iff usually around $8.08/bbl (1980$), or $16.90 in 2005$. Kline (1981) and the EMF (1982) reported on oil i mport prem ia calcul ated from a set of co ntr oll ed

expe rim ents w ithnin e d if fe rent m od els of

the wo rld

oilm ark et. Un lik e m any ana lyt ic approaches that are es sential ly stati c estimates of the long-run oil premium, these m ulti-pe riod m od els of int era cti ngreg ion al o il s up pli es and de m an ds all ow ed

the ob ser vatio n o f a

dynam ic res po ns e to ch an gin g im

po rt l ev els or t ari ff

s. Th e p remium

fo r ea chm od el w as t

he n c alc ulated

as the ne t pr ese nt v alu e o f i nc rem entalbe ne fi t m inu s co sts div ide d b y th e cum ulativ e re du cti on

in im po rts ov er the fo rec ast

ho riz on . O ne fe ature o f t his an aly sis is that th e earlyye ars ref lec t a sh ort -run p remium

an d th e later

ye ars tre nd

tow ard the lon g-r

un pre m ium . T he 19 81 EM F- 6 model com

parison yie lded oil i mport prem ia in the r ange of $10.66 to $35.55/bbl (2005$) . The m ean an d m ed ian

pre m ium va lue s f or t he nin e m od els we re $ 23 .3 3 and $1 8. 82 /bb l re sp ect ive ly (20 05 $). Tw o o the r in sights rev eal ed bythi s an aly sis we re that th e d isr up tio n p remia w ere typ ica lly ab out 1/ 3 th e si ze o f t

he m on op so nypre m ia, an d th at p remia c ounti ngsp ill ov er n et be ne fi ts f or a ll o f t he Organiz ati on

of Ec on omic C oo pe rat ion

an d D ev elo pm ent (O EC D) we re ab out 3 t im es t

he siz e o f t

he U. S. pre m ia (partl y b y c on str uc tio n). Hogan (1982), and Broadman and Hogan (1986,1988) r evised and ext ended the est ab lis he d ana lyt ica l f

ram ew ork

to c alc ulate b asean d o pti m al o il i m po rt p remia w itha m ore detaile d accounting of macroeconomic effects (building on the macroeconomic framework of No rdh au s 1 98 0). Th e m eth od expli cit ly i nc lud es i ndire ct c os ts f rom ba lan ce o f p aym ents adjustments and inflati onary effects (for a summ ary, see Leiby et al . 1997:22-24). Extendi ng Ho gan (1 98 1), the y d ete rm ine d th e ex ch an ge rat e v ari ati on ne ces sar y to res tor e th e tr ad e b alanc e af ter aninc rem entalinc rea se i n im po rts oc curs and

anass um ed

fr act ion of the inc rea se i n o il im po rt p aym ents i s re cy cle d. Th eyals o a cco unted fo r th e im

pa ct o f S PR

po lic y o n th e se curity component of the prem ium. Based on probabilisti c simulations, Hogan and Broadman (1988:11 Table 2) reported two ranges of oil import premium , for two possible future r eference pric e paths. Th e m ed ian

of the tw o rang es are $ 14 .5 2 and $1 7. 52 /bb l (2 00 5$ ). T he50 % co nf ide nc e inter

va ls the y p rov ide (i. e. va lue s f rom the 25 pe rce nti le t o th e 7 5th pe rce nti le) are rou gh ly +/- $ 3/b bl. th-16-

The Broadman and Hogan results are unu sual in the ir more equal contri butions of the monopsony and security components than priorstudies. Thei r result s also highl ight the offsetti ng int era cti on s b etw een

the oilde m an d c om

po ne nt and

the sec uri ty c om

po ne nt o f t

he optimal pre m ium . T he op tim al p remia i nd icate the so cie tal ly- ef fi cie nt l ev el o f m arg ina l co st t o re du ce im po rts . It is g en era llythe cas e th at i nc ludingpo lic y a cti on s (p art icu larly t ax es o r tarif fs ) th at res po nd to a large r value of

on e co m po ne nt w ou ld r ed

uc e th e o pti m al l ev el o f m arg ina l expe nd iture t o a dd

res s th e o the r co m

po ne nt. Bo hi and

Mo ntg om ery

(19 81 ) al so no ted

that conditions and assumptions implying a larger se curity pr emium can imply som e degree of re du ct io n o f the op ti mal mono ps ony p re mium. Broadman (1986) revisite d the analyt ics of the oil i mport prem ium, of fering a typology that su bd ivi de s th e m on op so nyan d s ecu rity c om po ne nts int o dire ct and

indire ct p art s. He als o summ arizes arange of oil import premium estim ates avai lable pri or to 1986 (Table 1, p. 247). Inc ludingthe high and

low est im ate s f

or m ult ipl e st udies fr om

19 79 to 1 98 2, the ran ge is q uit e large ($3 /bb l to ov er $ 15 0/b bl i n 2 00 5$ , m ean $3 9, m ed ian

~$ 18 ). A

bo ut h alf of Br oa dm an ’s observati ons were from the EMF 1982 study. A d eca de af

ter the En ergy M od eli ngFo rum ’s 1 98 1-2 stu dyof wo rld oilm od els (E MF -6) , in 1991 EMF examined another, mostly different, s et of models focusing on oil demand and the prospects for oi l demand reduction (EMF 1992, the EMF- 11 study). While this study did not explicit ly conduct exper iments to elicitthe import premium , Huntington (1993) e stablis hed a m eth od to r ou gh ly i nf

er the ir v alu es f

rom co ntr oll ed

oilpri ce- path c ase s. Ag ain , th e p remia w ere estimated from a per-barrel ave rage of the discount ed multi-year dynamic responses. Hunti ngton im putes va lue s f

or t he oilim po rt p remium

wi th a ran ge of $1 1. 79 to $ 21 .3 2/b bl ( 20 05 $), excluding an out lier val ue of $53.66. The m ean and median premium values for the si x EMF-11 models were $16.38 and $16.21/bbl respec tively ( 2005$). Leiby, Jones, Curlee and Lee (1997) provi ded an extended r eview of the lite rature and issues re garding the e stimation of the premium to date. They al so estimated a widely i nclusive range of oil import premium values, showing the var iation of each component with key dri ving fa cto rs s uc h a s O PE C b eh av ior , th e li ke lih oo d o f disr up tio ns , and

the extent to wh ich

tho se disrupti ons induce exte rnal shock effects. The ana lytical framew ork used is der ived from Broadman and Hogan (1988), but Leiby et a l. omitted the explici t indire ct costs for bal ance of paym ents and

inf lat ion ary ef fe cts as l ess -w ellest ab lis he d e m piricallyor t

he ore tic all y th anoth er costs. They used a s ingle measure of macroeconom ic disloc ation cost s during disruptions parameterized by empirical studies. The Lei by et a l. est im ate s w ere ba sed on 19 94 oilm ark et conditions, aperiod of markedly lower price s, comparative stabi lity, and exc ess supply capa city. Under these condi tions, a widel y inclusive range of premia extended from $0 to $12.67 (2005$). Excluding the ca se of no OPEC m arket power and e ssential ly no costly di sruptions, butassuming fairly respons ive OPEC supply, a narrowed range of roughly $2.70 to $5.88 was also cons tructed. Parry an d D arm sta dte r (2 00 4) r ece ntly p rov ide d an o ve rvi ewof wo rk o n th e o il i m

po rt premium . Based on a review of priorestimates, they offered thei r summ ary judgement: “...we put our best ass essment of the quantifiable component of the oil pre mium at $5/bbl, with a wide range-17-

of $0 to $ 14 to a cco unt f

or t he div ers ityof

op ini on am on g ana lys ts. ” (p . 1 4, ass um ed to b e in 20 03 $). No te, ho we ve r, t hat whil e th is s um

m ary ass ess m ent w as p ub lis he d in 20 04 , it m ak es ref ere nc e to data o nly

thr ou gh20 01 , o bs erv ing“si nc e th e mid- 19 80 s p ric es h av e f luc tuated be tw een $1 2 and $2 5 p er b arr el. ” (p .3 ). As m entioned, thi s paper esse ntiall y updates the oi l premium estimates of Leiby et a l. 19 97 wi th r ev ise d E IApro jec tio ns of

oilm ark et c on dit ion s an d s om e re vis ion of oilm ark et param ete rs ( ela sti cit ies ) to ref lec t f urt he r re search . W e al so pe rf orm a p rob ab ili sti c ri sk

an aly sis (f oll ow ingBr oa dm anan d H og an19 86 , 1 98 8, an d th e re co mm en datio ns of To m an , 1 99 3:1 21 3) t o generate arange of potentia l premium values. The extr eme (optimistic) cases of no exercise of cartel power and zero proba bil ityof futur e d isr

up tio ns that in du ce e xte rna l co sts on so cie ty are omitt ed as u nre ali sti c an d unh elp fu l in the curre nt o il m ark et and po lic y e nv iro nm ent.

III . C os t C omp on en ts Th e f ulleco no m ic c os t of

im po rti ngpe tro leum

int o th e Unit ed

St ate s is of

ten de fi ne d to include thr ee components in addition t o the purchase price of petrol eum itself. These are: (1) highe r co sts fo r oi l im

po rts res ult ingfr om

the ef fe ct o f U .S . im

po rt d em an d o n th e w orl d o il p ric e an d O PE C m ark et p ow er; (2) the ris k o f disl oc ati on s o f t he do m est ic e co no my and red uc tio ns in U.S. econom ic output caused by sudden disruptions in the supply of imported oil to the U.S.; and (3) co sts of

ex ist ingpo lic ies m eant to enhanc e o il s ecu rity. Po ssible ex am

ple s o f t he thi rd co m po ne nt are m aintai nin g a

U. S. m ili tar

y p res en ce t o s ecu

re i m po rte d o il s up pli es f

rom un sta ble regions, and maintaini ng the SPR to cushion agai nst resul ting pric e increas es. An important point is that the policy-r elevance of anycost cate gory stems from the degree t o which it is ge nerally not accounted-for i n the market decisions of oil consumers or producers, and whether it c an be ch an ge d b y a

parti cu lar

po lic y m eas ure un de r co ns ide rat ion . F or t his rea so n th e o il s ecu

rity im po rt p remium

an aly sis co ns ide rs on lythe incre mental changes in such unacc ounted costs a s the level of imports changes. To summ arize, the premium components include only non-i nternali zed, marginal costs. Th e f oll ow ingdis cu ssi on

rev iew s th e n ature o f e ach of the se c os ts, ass ess es t

he de gre e to wh ich the y are l ike ly t o v ary

in r esp on se t o c han ge s in the lev el o f o il i m

po rts , and pro vid es empirical esti mates of each com ponent drawn from our studies and otherrecent r esearch.Si nce t her e a r e no oi l i m por t l i m i t s or t ar i f fs i n pl ac e, and t he domes t i c oi l i ndus t r y i s gene r al l y c om pet i t i ve, at t he mar gi n pay m ent s f or 19 d o m e s tic o il a re e q u a l to th e re a l d o m e s tic re s o u rc e c o s t o f p ro d u c in g th a t o il. N o te th a t if re d u c e d U .S . o il im p o rt d e m a n d lo w e rs th e lo n g -ru n s u s ta in e d p ric e o f o il b y th e U .S . ex e rc ise o f m o n o p s o n y p o w e r, n o t o n ly 20 w ill U .S . im p o rt c o s ts d e c lin e , im p ly in g a d im in is h e d f o re ig n c la im o n U .S . G D P , b u t lo n g ru n a g g re g a te e c o n o m ic o u tp u t w ill a ls o in c re a s e . T hi s ( per haps sm al l ) gai n i n l on g-r un nat ura l econo m i c out pu t ( po t ent i al G D P) r epr ese nt s a benef i t t o i m po r t r educt i on . H ow ever , absent ot her m ar ket i m per fe ct i on s or po l i cy i nt er vent i on s, t he m argi nal cha nge i n pot ent i al G D P w i l l be e qui val ent t o t he mar gi nal bene f i t of oi l demand, and equa l t o t he domes t i c pr i ce of oi l

. Thus i t i s ca pt ur ed i n t he mar gi nal pr emi um ca l cul at i on. -18- III .1 De man d C os ts, orth e L on ge r-Run Mo no ps on y E ffe ct The first component of the full economic costs of importing petr oleum follows from the ef fe ct o f U .S . im

po rt d em an d o n th e lo ng -run w orl d o il p ric e. Be cau se t he Un ite d S tat es i s a sufficiently lar ge purchaserof foreign oil supplie s, its purc hases can affect the worl d oil pric e. Th is d em an d o r “m on op so ny ” p ow er m ean s th at i nc rea ses in U .S . p etr ole um de m an d c ancau se the wo rld pri ce o f c rud e o il t o ri se, an d c onve rse ly t hat re du ced

U. S. pe tro leum

de m an d c an reduce the worl d price of crude oi l. Thus, one consequence of decreasing U.S. oil i mports is the potential decrease i n the price paid for all barrels of crude oi l purchased by the United State s. Purchase cost s for both imported and domestically-pr oduced petrol eum decline, but the gain from lower domestic oil costis offset by a loss of revenue for domestic produc ers, so itis omitted from the ass ess m ent of

ne t U .S . s oc ialga ins

. A r ed uc tio n o f t ota l pu

rch aseco sts fo r th e re m ain ingoil 19 imports, however, represe nts a net welfare gain for U.S. society: the imports are acquir ed for lower clai m on the output (GDP) of the U.S. economy. The “m onopsony” premium accounts for the i ncremental change in the tot al c os t of

pe tro leum

im po rts , p er b arr el ch an ge in t

he lev el o f i m

po rts
. 20 Th e extent of

U. S. m on op so nypo we r is d ete rm ine d b y a

co m ple x s et o f f

act ors including the relat ive importance of U.S. imports in the world oil market, OPEC behavior and the sensiti vity of petrole um supply and demand by other parti cipants i n the internat ional oil market to world oil pri ce. Th e d egree of

curre nt O PE C m on op oly po we r has been subjec t to conside rable debat e, but appears to have increas ed somewhat since the mid-1990s as global oil de mand has grown. The consensus appear s to be thatOPEC remains able to exer cise some degree of co ntr ol o ve r th e re sp on se o f w orl d o il s up pli es to variat ion in world oil prices, so that the world oil market does not be have co m pe tit ive ly. Si m ilarly , m os t ev ide nc e suggests tha t variat ion in U.S. demand for imp orte d p etro le um co nt inue s t o e xe rtso me inf lue nc e o n w orl d o il p ric es. Th e su bs tantia l The demand or m onopsony effect can be

readily i llustr ated with an example. If the Un ite d S tat es i m

po rts 10 m ill ion

barre ls p er day at a w orl d o il p ric e o f $ 50 pe r barre l, i ts total dai ly bill for oi l imports is $500 million. If a decrease i n U.S. im

ports to 9 million barre ls p er d aycau ses the wo rld oilpri ce t o dro p to $4 9 p er b arr el, the da ilyU. S. oil import bill drops t o $441 million (9 million barrels times $49 per barrel ). While the world oil pri ce only decli nes $1, the res ulting decrease i n oil purchas e payments of $59 million per day ($500 million minus $441 m ill ion) is eq

uiv ale nt t o an in cre m ental be ne fi t of $5 9 p er b arr el o f o il i m

po rts reduced, or $10 more than the ne wlyde cre ase d w orl d p ric e o f $ 49 pe r barre l. T his ad dit ion al $ 10 pe r barre l “i m po rt c os t pre m ium ” repre sents t

he inc rem entalexter

na l benefits to U.S. society as a whole for av oid ed im po rt c os ts b ey on d th e p ric e p aid fo r oi l pu rch ase s. Th is a dditi on al b en ef it ari ses on ly t o th e extent th at r ed uc tio n in U. S. oilim

po rts af fe cts the wo rld

oilpri ce.C o n c e iv a b ly , th e re is a m o re e x tre m e O P E C re s p o n s e , w h ic h is to p u n itiv e ly re d u c e s u p p ly b y m o re th a n th e a m o u n t o f d e m a n d re d u c tio n to 21 d riv e p ric e s e v e n h ig h e r. S u c h a s tra te g y is u n lik e ly to b e s u c c e s s fu lly m a in ta in e d in th e lo n g ru n g iv e n c o m p e titiv e o il su p p ly re g io n s , an d is par t i cul ar l y unl i kel y i n t he pr oj ec t ed s i t uat i on f or t he ne xt 10 ye ar s w her e pr i ce s ar e hi gh and O PEC i s ant i ci pat ed t o al r ea dy be exe r ci s i ng subst ant i al product i on r est r ai nt
. N ot e t hat i f O PE C defends m ar ket shar e t o som e degre e and l et s pr i ce f al l , t he fr am ew ork used her e capt ure s b e n e fits to th e U n ite d S ta te s in th e m o n o p s o n y p re m iu m . H o w e v e r, if O P E C in s te a d d e fe n d s p ric e a n d s a c rific e s o u tp u t a n d m a rk e t sh a re , it w ill necess ar i l y have d i m i ni shed l on g-r un car t el pri ci ng po w er ( e. g. G r eene 199 1, G r eene, Jones and L ei by 1 99 8: 59 )

. T he m et ho d h er e does no t yet i ncl ude t he l i kel y be nef i t s t o t he U

. S. f

r om t he di m i ni s hm ent of O PEC pow er t hat comes w i t h i t s dec l i ni ng s har e, or any bene f i t s dur i ng d is ru p tio n s f

ro m in c re a s e d s la c k o il p ro d u c tio n c a p a c ity in O P E C c o u n tr ie s if th e ir p re -d is ru p tio n o u tp u t is c o n tr a c te d

. W e a r e t hankf

ul f or r evi ew er comm ent s poi nt i ng out t hi s nee d. 22 -19- pri ce i nc rea ses see n o ve r th e p ast fe w y ear s w ithexpandingglo ba l de m an d a lso su gg est a comparable decline i n prices coul d be achieved, shoul d demand growth slow or demand decline. The key determinants of the magnitude of the monopsony premium are the strength of inf lue nc e o f U .S . im

po rt d em an d le ve ls o n w orl d o il p ric e an d th e m agnit ud e o f U .S . im

po rts (which are subj ect to the prospecti ve price change). The change in worl d oil pric e depends on the response of OPEC, and the collect ive response of com petiti ve oil produce rs and consumers in the res t of the wo rld . The res po ns e o f O PE C c ountries to t he ex erc ise of

co unter va ili ngm ark et power by a major consumer such as the United S tates i s a problem of bilateral monopoly, and essentia lly indet erminate. However, the proble m can be bounded and the assessment can be gu ide d b y c on sid eratio n o f what is in O PE C’ s o wn lon g-t erm

sel f i nte res t. Th e p rac tic al r esp on ses to a U. S. im po rt r ed uc tio n c ou ld ran ge fr om

OP EC ’s c om

ple te de fe ns e o f m ark et v olum e to a co m ple te d ef en se o f p ric e. Th e f

orm er c asewo uld

entai l ab so lut e su pp ly i nf lex ibi lity, wi th O PE C m aintai nin g o utp ut l ev el unc hang ed an d le tti ngpri ce s lid e unti l alloth er r eg ion s ac co mm od ate the m ark et c hang e. Th e latte r ca se w ou ld r eq uir e unli m ite d s up ply fl ex ibi lity, wi th O PE C c ontra cti ngoutput to fu llyof fs et U .S . im

po rt r ed uc tio n. Th ese po lar

21 alt ern ati ve s co rre sp on d to anOP EC su pp ly “ ela sti city” (th e p erc entag e ch an ge in s up ply fo r a percentage change in pri ce) of zero and infini ty respect ively. In kee ping with the 1997 study we bo un d th e rang e o f o utc om es w ithOP EC su pp ly r esp on se e las tic iti es i n a so m ewhat narro we r range, in thi s case from -0.25 to –6.0, and the implied monopsony prem ium f or that r ange of values is c alculat ed. The net price -responsi veness of the produci ng and consuming regions other than the United States and OPEC was reconsidered and construct ed from separate elasti city range s for 22 cru de oilsu

pp ly and de m an d, we ighted

bythe pro

jec ted su pp ly and de m an d q

uanti tie s f

or t hat region. While the parameters ar e treat ed as uncert ain, the re sulting sample m edian elas ticity for non-U.S./non-OPEC im

port demand was -1.60, approximately double the value used in the 1997 ORNL study. The total change in world oil price is determined based on combined response of OPEC supply and the netdemand f or imports by the restof the world outside of the Unit ed States. Together, the ne t response of the two regions is far more elast ic than the response of eithe r region alone. This is because they r espond oppositel y to price, OPEC being a suppl ier and the nonU.S./non-OPEC region being a net i mporter. As a result of the r andom sam pling proces s in the simulations execute d and the combined response of OPEC supply and non-U.S./non-OPEC import dem and, the net el astici ty of import supply facing the U.S. varied from 4.3 to 18.0 (90%Thes e s t at i s t i cs per t ai n t o t he pr i m ar y c as e pr es ent ed he r e, t hat i n Tabl e 1. Som ew hat di f f er ent val ues w er e obs er ved f or t he va r i ous 23 sen si t i v i t y ca ses. So m e of t he r evi ew panel sugg est ed i nv est i gat i ng t hi s appr oach. O t her s w er e m ore skept i cal abou t w het her a gam e- t heoret i cal approach 24 w oul d be pr ac t i ca l , i m pr ove t he r ea l i s m of t he r epr es ent at i on, or add f ur t her i ns i ght

. The s ubs t ant i al cha l l enge s of appl yi ng game t heor y i ncl ude c h a r a c t e r i z i n g t h e o b j e c t i v e s o f OPEC a n d i t s s u b g r o u p s a n d s e l e c t i n g a n a p p r o p r i a t e e q u i l i b r i u m c o n c e p t f o r t h e i n t e r a c t i o n s a mo n g OPEC s ubgr oups , non- O PEC s uppl i er s , and l ar ge oi l cons um i ng count r i es exe r ci s i ng count er vai l i ng m onops ony pow er . A s K ar p and N ew ber y ( 1991) obs er ve, t he r epr es ent at i on nee ds t o ac count f or r es our ce exha us t i bi l i t y, t he mar ket pow er of l ar ger s uppl i er s , and t he mar ket pow er of t he l ar ge o il im p o rte rs . T h e b e h a v io r o f O P E C a n d its c a rte l str u c tu re h a v e b e e n w id e ly s tu d ie d w ith s o m e s u c c e s s (e .g . G riff in 1 9 8 5 , G u le n 1 9 9 6 , A lh a jji and H uet t ner 2000, Sm i t h 2006 and K auf m ann etal . 2 0 0 8 ), b u t ty p ic a lly y ie ld in g o n ly w e a k ly d e s c rip tiv e m o d e ls. T h e v a lu e o f g a m e th e o ry is expl i ci t l y r evi ew ed by G r i f f i n and N ei l s en ( 1994) , and r evi s i t ed mor e r ec ent l y i n G r i f f i n and X i ong ( 1997)

. M any of t he a ppr oac hes s ee k a N as hC our not equi l i br i um among open- l oop i nt er t er m por al pr oduct i on pl ans ( e. g. r ec ent l y Y ang 2007) , but N ew ber y ( 1981) , U l ph and Fol i e ( 1981) a n d K a rp a n d N e w b e ry (1 9 9 1 ) h a v e e m p h a s iz e d th a t m a n y o p e n -lo o p s tra te g ie s a re u n a v o id a b ly tim e in c o n s iste n t. W h ile th e o re tic a l m o d e ls have b een devel op ed and yi el d i nsi gh t s, t he hi gh degree of par am et er un cer t ai nt y ( r egar di ng m ar ket el ast i ci t i es, r esour ce base s, et c. ) can over w hel m t he de s cr i pt i ve pow er of s uch a ppr oac hes

. G i ven t hes e c hal l enge s , w e de f er t he e xpl or at i on of

game t heor y, s uch a s K ar p and N e w b e ry ’s O P E C -l a rg e -i m p o rt e r s tr a te g ic f ra m e w o rk , f

o r p o s s ib le la te r c o n tr ib u tio n s to th e p re m iu m c a lc u la tio n . H o w e v e r in s o m e c a s e s its a d v a n ta g e o v e r o th e r s tra te g ie s w a s m o d e s t. 25 -20- confidence range)

. Alternati vely stat ed, the resul ting net r esponse of world oil pr ice to a 23 hypothetica l one-million barr el per day ( 1 MMBD) U.S. im port demand reduction var ied from $0 .2 5/b bl t o $ 1. 31 /bb l, w itha m ean va lue of $0 .7 1/b arr el. Argu ab ly, anexpli cit ly s trateg ic r ep res entat ion of OP EC be havio r m ight be pre fe rab le t o the purely parametric trea tment of OP EC supply response desc ribed above. The r esponse of OPEC supply to a U.S. dem and reducti on could possibl y be modeled form ally with game theory, an d h as b een , to so m e d egree . Re co gn izi ngthe limits of our un de rst an din g o f O PE C’ s st rat eg ic 24 behavioral incentive s, and the marked complexity of accounting for competing objecti ves of OP EC su bgrou ps an d d yn am ic trad eo ff

s in the sh ort -run and

lon g-r un , w e se t as ide su chan approach for possibl e future consider ation. So we chose a par ametric approach for the bul k of the an aly sis . H ow ev er, we als o c on sid ere d o ne rep res entat ion of OP EC str ate gic sel f- int ere ste d be havio r, f

oll ow ingGatel y (2 00 4, 20 07 ), s pe cif ica llyOP EC m ainten an ce o f m ark et sh are . Using a market simulation model, Gately (2004) compared payoffs to OPE C for faster and slower output gr owth under a vari ety of OPEC (and OPEC subgroup) behavi oral assumptions and under uncert ainty regarding the market’s unde rlying par ameter values. He found that aggre ssive output expansi on often yielded lowerpayoffs than m aintaini ng market share. Gately ( 2007) further studi ed various OPEC export strategie s and theirimplications for OPEC profits. He sought a “robust ly optimal strat egy” for OPEC that served it s intere sts, performing well over the wi de ran ge of

po ssible m ark et c on dit ion s an d g ive n th e “u navo ida ble un cer tai nti es t hat un de rli e the wo rld oilm ark et. ” H e co nc lud ed that f or t he ran ge of

cas es e xam ine d, the co ns tant expo rtsh are str ate gyyie lde d th e h igh est po ssibledis co unted

pro fi ts f or O PE C, an d th at i t pe rf orm ed rob us tlyco m

pared to o the r strat eg ies fo r re aso na ble ch an ge s in

param ete rs. Ba sed

on the se 25 results we consider the Constant Marke t Share str ategy for OPEC as one possible r epresenta tion of str ate gic be havio r, a

nd as an a lte rnativ e to the param etric v ari ati on of OP EC su pp ly e las tic ity used in most of our simulations of the premium value. This is an intermediate behavioral strategy between stri ct price maintenance and stri ct output maintenance. I t proves equi valent to OPEC su pp lie rs m atc hin g th e el ast ici ty o f n on -U .S ./n on -O PE C s up ply reg ion s. Co ns eq

ue ntly, it i s co m parab le t o O PE C o pe rat ingwi th a fa irl y lo w s up ply

ela sti city, an d th is s trategy le ad s to greatermonopsony ef

fects and higher monopsony premia. Incidental ly, this gene ral OPEC-21-

behavioral strate gy of preserving market share is also cons istent with the EIA’s curr ent thinki ng, at l eas t f or i ts A EO 20 07 ref

ere nc e ca se: “T he ref ere nc e ca se r ep res ents E IA ’s c urr ent ju dg m ent re gardi ngthe expe cte d be havio r of

OP EC pro du cer s in

the lon g te rm , a dju sti ngpro du cti on to k eep wo rld oilpri ces in a

ran ge of $5 0 to $6 0 p er b arr el, in k eep ingwi th O PE C’ s st ate d g oa l of kee ping p ote nti al c om

pe titor s from ero ding it

s m ar ket sh are .” (emphasis added, U.S. EIA 2007) III .2 Di sru pt ionCo sts The second component of the oil import pre mium , the “disruption premium,” arises from the ef fe ct o f o il i m

po rts on the expe cte d c os t of

dis rup tio ns . Asu dd eninc rea se i n o il p ric es trigger ed by a disrupt ion in world oil supplies has two main eff ects: i t increa ses the cost s of im po rts in t he sh ort run , f urt he r expandingthe trans fe r of U. S. we alth to fo rei gn

pro du cer s; and

it can lea d to m acr oe co no m ic c ontra cti on , disl oc ati on , and GD P l os s. As in a ll p art s o f t his im po rt pre m ium an aly sis , w e w illfo cu s attentio n o n e sti m ati ngho w the se disr up tio n c os ts c hang e w ith the lev el o f p re- dis rup tio n im po rts
. III .2 .1 Di sru pt ion : Hi gh er C os ts o f Oi l Im po rts an d W ea lth Tr an sfe r D ur in g S ho cks During oil pri ce shocks, the hi gher price of im ported oil causes incr eased payments for im po rts an d an a cce ler ati on

of the trans fe r of

we alth f rom U. S. so cie ty t o o il e xp ort ers . T his inc rea sed cla im on U. S. eco no m ic o utp ut i s a w elf are los s to the Un ite d S tat es t hat is sep arate from and additiona l to any reduc tion in economic output due t o the shock. For some disrupti ons (w ars or r ev olutio ns ) a p ort ion of thi s in cre ase d im

po rt c os t m ayals o re fl ect the op po rtunis tic extension, orsimply m aintenance , of cartel suppl ier power in the face of reduced supply. In the case of other dis ruptions, suc h as supply embargoes, stri kes, and economic disputes, the bulk of pri ce i nc rea se m aybe attrib uta ble to m ark et p ow er. Re gardl ess of cau se, we co unt th e in cre ase d wealth transfer during shocks a s a welfare loss t o the degree that the expec ted price increase is not antic ipated

an d inter na liz ed byoilco ns um ers .For r ec ent s ur vey s of t he l i t er at ur e on oi l pr i ce s and t he mac r oec onom y, s ee B r ow n and Y üce l ( 2002) , J ones , Lei by a nd Pai k ( 2004) , and 26 H am il to n (2 0 0 5 ). D avi s , St ephe n and J ohn H al t i w ange r 1999. “Sec t or al J ob C r ea t i on and D es t r uct i on i n R es pons e t o O i l Pr i ce C hange s , ” N at i onal B ur ea u of 27 E co n o m i c R esearch W o rki n g P ap er W 7 0 9 5

. H am i l t o n , Jam es D

. 2 0 0 5

. “O i l an d t h e M acroe co n o m y, ” P al g rave D i ct i o n ary o f E co n o m i cs. -22- III.2.2 Disruption Macr oeconomic Costs: Potential O utput Loss and Di slo ca tio n/Ad

ju stm en t C os t s Macroeconomic losses dur ing price s hocks reflect a ggregate output losses and allocat ive los ses . Th e f

orm er are r ed

uc tio ns in t

he lev el o f o utp ut t

hat th e U .S . e co no my c anpro du ce 26 when using fully its available resources ; the latter ste m f rom tem porary disl ocation and un de rut ili zat ion

of av ail ab le r eso urc es d

ue to t he sh oc k, su chas l ab or u ne m plo ym ent an d idle plant c ap aci ty. Th e ag gre gate o utp ut e ff ect , a red uc tio n in “p ote nti al” eco no m ic o utp ut, wi ll l ast so long as the pr ice is el evated. Itdepends on the ext ent and durat ion of any disrupti on in the wo rld su pp ly o f o il, sin ce t

he se f act ors de ter

m ine the m agnit

ud e o f t he res ult inginc rea se i n p ric es fo r pe tro leum

pro du cts , a s w ellas whe the r an d h owrap idly th ese pri ces ret urn to t he ir p redisrupti on levels. In a dd iti on

to t he ag gre gate c ontra cti on , th ere ap pe ar t o b e “a llo cat ive ” o r “a dju stm ent” co sts ass oc iat ed

wi th disl oc ate d e ne rgy

m ark ets . B eca

us e su pp ly disr up tio ns an d re su lti ngpri ce inc rea ses oc cur su dd en ly and of ten inv olv e d ist

urb ingne ws of

war or strif e, em pirica l ev ide nc e sh ow s th eyals o im

po se a dd iti on al c os ts o n b us ine sse s an d h ou seh old s th at m us t ad jus t th eir us e of pe tro leum

an d o the r pr od

uc tiv e f act ors m orerap idly th anif the sam e p ric e in cre aseha d oc curre d grad

ua lly(e. g. Ham ilt on

20 05 , D av is and

Ha lti wang er 1 99 9, 19 99 a). Di slo cat ion al 27 ef fe cts inc lud e th e u

ne m plo ym ent of

wo rke rs and

oth er r eso urc es d

uri ngthe tim e n eed ed

fo r th eir interse ctoral orinterr egional re allocat ion, and pauses i n capital investment due to uncert ainty. Th ese ad jus tm ents t em

po rarilyred

uc e th e le ve l of

eco no m ic o utp ut t

hat can b e ac hie ve d e ve n be low the “p ote nti al” output le ve l th at w ou ld u lti m ate ly b e re ach ed on ce t he eco no my’s ad ap tat ion

to h igh er p etr ole um

pri ces is c om

ple te. Th e ad dition al c os ts i m po sed on bu sin ess es and households for making these adjus tments reflect thei r limited abili ty to adjustprices, output lev els , and

the ir u se o f e ne rgy , la

bo r, and oth er i np uts qu ickly and

sm oo thly in

res po ns e to rap id ch an ge s in

pri ces fo r pe tro leum

pro du cts
. Whil e it is w ide ly e xp ect ed

that th e m acr oe co no m ic c os ts o f o il s ho ck s w illde cli ne wi th de cli nin g s hare o f o il i n th e ec on om y, so far ef

fo rts to d em on str ate thi s f rom the statis tic al r eco rd have yielded i nconclusive r esults ( e.g. Huntington 2004, Brown, Fu and Yücel 2005). Furth erm ore , a s m entio ne d a bo ve , whil e th e p hy sic al i nte ns ityof oilus e in the eco no my h as de cli ne d b y 3 2% o ve r th e la st d eca de , th e valuesh are of oilin t he eco no my h as i nc rea sed byov er 60%. For these r easons ther e is no cert ain argument for estimating the macroeconomic impacts of price shocks in this study with a different range of parameters from that used i n the 1997 study. No nth ele ss, to avo id o ve res tim ati on an d to acc ount f

or t he po ssibil itythat f

utu re o il s ho ck s m ay have low er m acr oe co no m ic i m pa cts than th e f

ullran ge of

his torica lly -ba sed

param ete r es tim ate s implies, we considered a s omewhat lower range of GDP im pacts (perunit pric e change) in the pri m ary cas e. Th e o rig ina l 19 97 stu dyran ge is i nc lud ed as a sen sit ivi ty c ase .N o te th a t th e u s e o f th e e x p e c te d c o s t m e a s u re e m b o d ie s a n a s s u m p tio n o f r isk n e u tra lity w ith re s p e c t to d isr u p tio n ris k . R isk a v e rs io n w o u ld 28 i m pl y l ar ger pre m i a. -23- III .2 .3 Di sru pt ionPr emi um is t heMa rg in al C ha ng e inEx pe cte d D isr up tio n C os ts Since future disruptions in forei gn oil suppli es are an unce rtain pr ospect, each of the dis rup tio n c os t co m

po ne nts m

us t be we ighted

bythe pro ba

bil itythat th e su

pp ly o f p etr ole um

to the United Stat es will actually be dis rupted. Thus, the “ expected val ue” of these costs – the pro du ct o f t

he pro ba bil itythat a s up ply

dis rup tio n w illoc cur an d th e sum of co sts fr om

red uc ed economic output and the economy’s abrupt adj ustment to sharply highe r petrol eum prices -- is the relevantmeasure of their magnitude. Further, when asse ssing the ene rgy securi ty value of a 28 po lic y to red

uc e o il u se, it i s o nly

the changein the expect ed costs of disrupt ion that r esults from the po lic y th at i s re lev ant. I n th is s tud y w e es tim ate ho w the expe cte d disr up tio n c os ts m ay ch an ge fr om

low eri ngthe no rm al (pre -di sru pti on ) le ve l of

oilim po rts , f rom any in du ced altera tion in the likeli hood, size or cos t of disruption. Whil e th e to talvu lne rab ili ty o f t he U. S. eco no my to oilpri ce s ho ck s d ep en ds on bo th petroleum consumption and the level of U.S. oil imports, variation i n imports alone may have some eff ect on the magnitude of the pri ce increa se result ing from any disruption of import supply. This could occurfrom

the alte ration of starting supply- demand balances and alter ing the short -run fl ex ibi lity (e las tic ity ) of

pe tro leum

us e. In a ddition , c hang ingthe qu antity o f p etr ole um im po rte d int o th e Unit ed

St ate s m ayals o a ff

ect thepro ba

bil ityor s ize of

su cha d isr

up tio n. If the pre disrupti on level of oil i mports affects either the pr obability that oil import supply will be disrupted, the quantity of the s upply loss, the siz e of the result ing price i ncrease, orthe cost of a giv enpri ce i nc rea se, the n th e expe cte d v alu e of the co sts ste mm ingfr om su pp ly disr up tio ns wi ll als o v ary in r esp on se t o th e le ve l of oilim po rts . W e expre ss t

his fo rm all y in

Se cti on IV .4 . E ach possible channel of marginal impact is reflected i n the premium calculation. In s um m ary , th e st ep s n eed ed

to c alc ulate the dis rup tio n o r se curity p remium are : ! Fi rst , d ete rm ine the lik eli ho od of anoilsu pp ly disr up tio n in the futur e; ! Se co nd , a sse ss t

he lik ely im pa cts of a p ote nti al o il s up ply

dis rup tio n o n w orl d o il p ric e; ! Th ird , a sse ss t

he im pa ct o f t he oilpri ce s ho ck

on the U. S. eco no my (i n te rm s o f i m po rt costs and macroeconomic losses); and ! Fo urt

h, de ter m ine ho w the se c os ts c hang e w ithim po rts
. Th e expe cte d v alu e o f p ric e-s pik e co st avo ide d b y re du cin g o il i m po rts be co m es t

he oilsec uri ty po rt io n o f the pr emi um. III .2 .4 Ro le o f Ma rke t Me ch an ism s in Re du cin g C os ts Whe n e sti m ati ngthe dis rup tio n c om po ne nt o f t

he oilim po rt p remium

we ne ed to rec ogniz e th e av ail ab ili ty o f m ark et m ech an ism s th at a llo w the U. S. eco no my to ad jus t to oil supply disrupt ions. A variety of m arket mechanisms – including oil futur es markets, energy conservati on measures, and some technologies thatpermit rapid fuel switchi ng – are now av ail ab le w ith in t

he U. S. eco no my f

or b us ine sse s an d h ou seh old s to antic ipate and “in sure”Th e l i mi t e d s c o p e o f t h e f u t u r e s ma r k e t s i s h i g h l i g h t e d b y t h e o b s e r v a t i o n t h a t v i r t u a l l y a l l t r a d i n g i s s h o r t t e r m i n n a t u r e , wi t h c o n t r a c t t e r ms 29 of under 18 m ont hs

. O ver t he y ea r s 2001 t o 2006, on ave r age 43% of t he vol um e of

t r adi ng f

or N Y M EX l i ght s w ee t cr ude f ut ur es f el l w i t hi n t he first m o n th (sp o t) d eliv ery , an d 9 1 % fe ll w it h in 4 m o n th s d eliv ery term
. T h e f u tu res m ark ets fo r p ro d u cts (h ea ti n g o il an d u n lea d ed g as o li n e) a re eve n m or e he avi l y l oade d t ow ar d t he f i r s t t hr ee t o f

our m ont hs t han i s t he c as e f or cr ude. Fut ur es t r adi ng s ee m s m or e a t t ent i ve t o s hor t
- r un vol at i l i t y, not s t r at egi c s hock r i s k. Fo r exam pl e, du al and fl ex- fuel vehi cl es ( FF V s) ( no t abl y al coho l FF V s) ar e begi nn i ng t o ent er t he fl eet , bu t up t o t hi s poi nt t he fuel 30 i nfr ast r uct ure i s not w i del y avai l abl e and m any F FV ow ner s ar e even un aw ar e t hat t hei r vehi cl es have t he capabi l i t y. -24- themselves, to some extent, againstthe effects of petroleum price inc reases. I n principl e, by em plo yin g th ese m ech an ism s – fo r ex am ple , b y inve sti ngin a dd ed en ergy c on ser

vatio n m eas ure s in anti cip ati on

of sh oc ks , s toc kp ili ngoil , o r in sta lli ngtec hn olo gie s th at c anop erate u sin g m ult ipl e fu el s ource s –

bu sin ess es and

ho us eh old s can re du ce t

he ir c os ts o f a dju sti ngto s ud de n in cre ase s in oil pri ces. The availabi lity of these mechanisms has undoubtedly re duced the potent ial cost s to the U. S. eco no my th at c ou ld b e im po sed bydis rup tio ns in t

he wo rld su pp ly o f o il. But th e d egree to wh ich m ark ets antic ipate and

acc ount f or t he lon g-r un ris k o f p ric e in cre ase s f

rom str ate gic oil sh oc ks is n ot k

no wn wi th m uc h c on fi de nc e. No ne the les s, the est im ate s repo rte d h ere see k to explicit ly account for futures markets and other anti cipatory mechanisms. Private firms and individual s are descr ibed as anti cipating alarge fract ion of disruption pr ice incr eases, and the direct c osts to the m of

those expect ed price i ncreases are excluded from the premium

. However, the exist ence of private mechanisms like the future s market and energy conservati on opportuniti es does not ass ure thatthe social ly optimal level of prote ction of disrupti on risk is a ttained. The fir st and most important reason is that privat e markets do not automatically take into accountthe external and non-market consequenc es of producer and co ns um er c ho ice s. Ev enif co ns um ers an d f

irm s ar e aw are of

an d take advanta ge of

m eas ure s to self-insure against di sruptions, they can only be expec ted to prot ect themselves agai nst the economic risks that they expect to be ar direc tly (i.e ., their own indi vidual, pri vate costs ). The m arg ina l private disr

up tio n ri sk

pe r barre l of

im po rts is e qu al t o th e expe cte d o il p ric e in cre ase du e to sh oc ks . B ey on d th is, it i s n ot p lau sib le that in div idu al f irm s o r co ns um ers acc ount f or t he ir wi de r ef fe cts on the oilim

po rt c os ts o f o the rs i n th e m ark et, on the m agnit

ud es o f p ric es c hang es, an d o n th e m acr oe co no m ic a cti vit y in oth er s ect ors an d re gio ns , s o th e le ve l of pro tec tio n is ne ces sarilysu

b-o pti m al. Se co nd ly, the sco pe fo r private anti cip ato ry p rot ect ion is l im ite d. Th e f

utu res m ark et extends only a l imited time into the future, the privat e cost of long-te rm petroleum stockpiling 29 byindivi du al c on sum ers or f irm s ag ain st s trateg ic o il disr up tio ns is p roh ibi tiv e, an d d ua l-f ue l tec hn olo gyis o nly

av ail ab le and

co st- ef fe cti ve in l im ite d a

pp lic ati on s. Re co gn izi ngthat private

30 ag ents u se f

utu res to h ed ge at m os t on ly t he ir o wn pri vate risk , n ot t

he so cia l ef

fe cts (ri sk) of

the ir oilm ark et a cti on s, an d th at o nly a su bs et o f e co no m ic a cto rs p art icipate dire ctl y in the futur es market, this study implicit ly accounts for future s and other poss ible prec autionary be havior by assuming that privat e actors i nternali ze some fraction of their pri vate ris k. That is, 0%, 25% or 10 0% o f t he expe cte d o il p ric e in cre asedu e to sh oc ks is a ssum ed to b e ac co unted

fo r in pri vate behavior, and exc luded from the social premium calculation.-25-

Co ns um ers of

pe tro leum

pro du cts are un lik ely

to t ak e into a cco unt th e p ote nti al c os ts that a disrupti on in oil suppl ies imposes on other consumers and sect ors of the U.S. economy, or the indirecteffect of their investment, consum ption, or import decis ions on those widerdisrupti on costs. In s um , whil e th e av ail ab ili ty o f p riv ate pro tec tiv e m ech an ism s h as u nd ou bte dly red uc ed the po tentia l co sts that co uld be im po sed bydis rup tio ns in t

he wo rld su pp ly o f o il, a su

bs tantia l po rti on of the se disr

up tio n c os ts i s p rob ab ly n ot r ef lec ted in t he m ark et p ric e o f p etr ole um or i n the response of econom ic agents. Ther e are two rea sons. First, the availabi lity of cost- effective mechanism s for private a gents to avoi d long-term risk is limited. Second, and more importantly, even if measures are avail able to sel f-insure agai nst disrupt ions, consumers and firms can only be expected to t ake protect ive acti ons against the economic risks thatthey expect t o bear dire ctly. W e estimate that unde r reasonabl e assumptions about the pr obability of future disruptions in world oil s upplies the disrupti on component of the social c ost of U.S. oil imports ranges from les s th an$2 .1 0 to ov er $ 7. 40 pe r ad dit ion al b arr el o f o il c on sum ed bythe Un ite d S tat es, wi th ad jus tm ent co sts acc ounti ngfo r th e large st s hare o f t his tot al. An

av era ge est im ate is $ 4. 59 (in 20 05 $). III .3 Po lic y C os ts: Mil ita rySe cu rity a ndSt ra teg ic P etr ole um Re serveCo sts Th e th ird an d f ina l co mm on ly- ide nti fi ed co m po ne nt o f p os sib le e xte rna l ec on omic c os ts of oil imports is the costU.S. taxpayers bearfor existing ene rgy securi ty polici es. Chief among the se are m aintai nin g a

m ili tar y p res en ce t o e nh an ce t

he sec uri ty o f o il s upply

fr om po tentia lly unstable r egions of the world and t o keep trade r outes open, and maintaining the SPR to provide buffer supplies during asupply disrupt ion. This asses sment excludes both of these cost s from the reported e stimates for the following rea sons. Mil itary c os ts are e xc lud ed be cau se o f t

he pro ble m s o f attributio n and “in cre m ental ity .” It is difficult to a ttribut e military costs , and specific act ivitie s or forces, to oi l consumption or im po rts pe r se . M ili tar

y a cti vit ies , e ve n in

wo rld reg ion s th at r ep res ent vi talso urc es o f o il im po rts , und ou

bte dly ser ve a b roa de r rang e o f s ecu rity and fo rei gn po lic y o bje cti ve s th ansim ply pro tec tin g o il s up pli es. Furth erm ore , th esem ili tar y c os ts m ayno t vary i n anym eas ura ble way wi th i nc rem entalvariatio ns in o il u se. Th e sc op e an d d uratio n o f anysp eci fi c U .S . mili tar y act ivi tie s th at w ere un de rtake n f or t he purpo se of

pro tec tin g im

po rte d o il s up pli es s eem

un lik ely to b e ta ilo red

to t he act ua l vo lum e o f U .S . o r w orl d p etr ole um im po rts fr om

the reg ion s whe re they take pl ace. As a consequence , annual expenses to support U.S. military ac tiviti es do not seem likely to vary cl osely in re sponse to changes in the leve l of oil imports prompted by co ns erv ati on

ef fo rts or o the r po lic ies . T his do es not m ean that th ere is n o re lat ion

be tw een m ili tar y c os ts and

oilsec uri ty c on cer

ns , b ut t hat es tim ati ngthe m agnit ud e o f i nc rem entalef

fe cts fr om ch an gin g o il u se i s p rob lem ati c. Our co ntributio n h ere is i n c alc ulatin g o the r, e co no m ic, co mpon ents of the oi l i mport p re mium.S e e L e ib y a n d B o w m a n (1 9 9 8 , 2 0 0 3 ) a n d U .S . D O E (1 9 9 0 ) f o r c o m p a ra tiv e ly re c e n t s tu d ie s o f S P R e x p e c te d n e t b e n e f its a n d o p tim a l s iz e . 31 E arlier stu d ies w ere b y , e.g . T eisb erg (1 9 8 1 ), H o g an (1 9 8 2 ), M u rp h y , T o m an an d W eiss (1 9 8 6 ) an d D ev ara jan an d W ein er (1 9 8 9 ). Thi s ana l ys i s does r ef

l ec t t he i m pac t of

a l ar ger cur r ent SPR ( 688 m i l l i on bar r el s ) t han w as ava i l abl e a t t he t i m e of t he 1997 s t udy ( 600 32 m i l l i on bar r el s )

. U nder t he I nt er nat i onal Ener gy A genc y ( I EA ) agr ee m ent , al l s i gnat or i es agr ee t o hol d emer genc y oi l s t ocks equi val ent t o 90 d a y s o f o il i m p o rt s , in c ru d e o r p ro d u c t f o rm (S e e e .g . IE A 2 0 0 7 , I EA R esponse Syst em f or O i l Supp l

y Em ergenci es . ) Ther e i s s om e f l exi bi l i t y of ac count i ng, par t i cul ar l y r ega r di ng how pr i vat e i nvent or i es ar e i ncl uded a l ong w i t h publ i c s t ocks

. The U

. S. D O E’ s cur r ent as s es s m ent i s t hat t he I E A r e q u i r e m e n t s a r e m e t a n d e x c e e d e d , s i n c e “ S P R a n d p r i v a t e c o m p a n y i m p o r t p r o t e c t i o n ” i s m e a s u r e d a s a p p r o x i m a t e l y 1 1 8 d a y s ( U. S

. DOE F o ss il E n erg y w eb site, h tt p :/ /w w w . fo ss il

. en erg y . g o v /p ro g ram s/rese rv es /sp r/ sp r-fac ts. h tm l)

. S p ec ifi ca ll y , u n d er S ec ti o n 3 o f th e E n erg y P o li cy an d C o n se rv atio n A ct, th e P res id en t m u st o rd in arily m ak e a d ete rm in atio n o f a "se v ere 33 e n e rg y s u p p ly in te rru p tio n " . F o r m o re d e ta ils, s e e th e U .S . D O E S P R w e b s ite h ttp ://w w w .fe .d o e .g o v /p ro g ra m s /re s e rv e s /sp r/s p r-e p c a .h tm l. -26- Whil e th e o pti m al s ize of the SP R, fr om

the stand po int of its ab ili ty t o c os t-e ff

ect ive ly reduce expect ed U.S. costs during suppl y disrupti ons, maybe positive ly relat ed to the le vel of U. S. oilco ns um

pti on or i m po rts , it s ac tua l si ze h as n ot a pp ear ed to v ary in r esp on se t o c hang es i n the vo lum e o f o il i m

po rts . T he re are two co ns ist ent ap pro ach es f or a cco untin g f

or S PR po lic y when calculat ing the incr emental benefits of reduced oil use. Given lower oil imports and potential ly reduced di sruption cos ts, the anal ysis could cons ider the i ncremental savings from reducing the size of the SPR while maintaining the same level of expected prote ction. Alternati vely, the anal ysis could i nclude the va lue of the great er level of overall prot ection ach iev ed wi th t he curre nt S PR . S inc e th e p ast siz e o r bu dg etary c os t of the SP R h av e n ot v ari ed dir ect ly w ithoilim

po rts or c on sum

pti on , th e f

orm er a pp roa chpo sit s an

un lik ely po lic y. It i s al so m ore cum

be rso m e to an alyze. Th ere fo re, we ad op t th e latte r ap pro ach an d a ssum e n o c hang e in 31 the SPR from

its curr ent size. However, our estimates do expli citly ac count for the rol e of the 32 SPR in addressing shock e ffects and reducing dis ruption cost s. SPR use during a disrupt ion requir es a Preside ntial det ermination of need based on a range of e co no mic , fo re ig n p ol ic y, an d n at io na l s ec ur ity c on si de rati on s. Si nc e p as t u se duri ng so me 33 disrupti ons has been caut ionary, future use in all poss ible disruptions is ne ither as sured nor official policy. The current anal ysis conside rs two SPR m anagement strategi es: ideal ized SPR us e, wi th a

pro m pt and fu ll o ff set of allm ajo r su

pp ly s ho ck s, to t

heextent of

SP R c ap ab ili tie s; and a more cautionary SPR strat egy in which the SPR is appl ied to shocks i n half of the events. When calcula ting the pr emium , a range of shocks is pr obabilist ically s imulated and, depending on the siz e an d d

uratio n o f t

he su pp ly l os s an d th e S PR

uti liz ati on

str ate gy , s om e o r al l of

sh oc k pri ce i nc rea se m aybe eli m inated . T o th e extent th at the curre nt S PR is a ble to m ore co m

ple tel y buffer shocks and their c osts at l ower import levels, that marginal cost change is accounte d in the pr emi um.T e c h n ic a lly , m a rg in a l c o s t is th e d e riv a tiv e o f to ta l c o s t, an d is b a s e d o n a n in fin ite s im a l c h a n g e in o il u s e . Its u n its a re d o lla rs p e r b a rre l. 34 T he t er m “net benefi t s” means t he di ff er ence bet w een benefi t s and cost s. Si m i l ar l y, r egi on al “net i m po r t dem and” re fe r s t o t he di ff er ence 35 b e tw e e n a re g io n ’s o il d e m a n d a n d its s u p p ly . N e t b e n e fits c a n b e m e a s u re d re la tiv e to a n a rb itra ry re fe re n c e p o in t, sin c e o u r in te re s t is in m arginal cha n g es. N at ur al l y, net bene f

i t al s o depe nds on l eve l s of oi l pr oduct i on and c ons um pt i on, but at f i r s t w e a bs t r ac t f

r om t hes e i s s ues . For exa m pl e, t he 36 m acr oecon om i c di sl ocat i on l osse s f r om di sr up t i on s ar e expect ed t o b e m ore di r ect l y a f un ct i on of oi l or e ner gy con sum pt i on l evel s or i nt ensi t i es t han i m por t l eve l s . H ow eve r , eve n i f t he c ont empl at ed pol i ci es di r ec t l y t ar getcons um pt i on, bec aus e of t he i dent i t y l i nki ng s uppl y, demand a nd im p o rts a s e p a ra te e x a m in a tio n o f th e im p o rt p re m iu m a lo n e is in fo rm a tiv e . C e rta in c o s ts, n o ta b ly th e s u s ta in e d c o s ts o f n o n -c o m p e titiv e o il s u p p ly a n d th e h ig h e r im p o rt c o s ts b o rn e d u rin g d isr u p tio n s , ar e d ire c tly fu n c tio n s o f im p o rts . O th e rs , su c h a s m a c ro e c o n o m ic d isr u p tio n c o s ts m a y b e in d ire c tly fu n c tio n s o f im p o rts to th e e x te n t th a t im p o rt le v e ls a lte r th e e x p e c te d fr e q u e n c y o r m a g n itu d e o f s h o c k s o r th e s e v e rity o f th e ir i m pact on t he oi l m ar ket

. I t i s t hese di r ect and i nd i r ect m ar gi nal ef fe ct s of i m po r t l evel s t hat w e f ocus on her e, i n k eepi ng w i t h t he est abl i shed l i t erat u re on t h e i m p o rt p rem i u m as an i n form at i v e g u i d el i n e fo r energ y sec u ri t y o r dep en d en ce p o l i ci es. -27- (1)

(2) IV.1 Marginal Welf

are Changes and the Mathemati cal Definit ion of the Margi nal Premium Th e p rin cip al m eth od

us ed in t his pa pe r is the m arg ina l an aly sis of U. S. we lf

are , em plo yin g th e st an dard c on cep ts o f t he eco no mi cwelfare function and the oi l import premium

. The marginal cost of imported oil (in dol lars perbarrel) is the inc remental cost assoc iated with a un it c hang e in

oilim po rts
. Its est im ati on

do es n ot r eq

uir e th at w e k

no w t ota l co sts , b ut o nly 34 how total cost s change with the level of oil i mports.

iu W e b eg in w itha f

un cti on al d esc rip tio n o f h owU. S. eco no m ic n et b en ef its N ( q ) depend
iu on the lev el o f o il i m

po rts ( q ). Given the focus on imports, it is convenient t o combine the

35 36 do m est ic o il d em an d and

oilsu pp ly c urv es i nto a n et i m

po rt d em an d c urv e. Th is c orr esp on ds to co m bin ingthe pri vate b en ef

its of co ns um pti on an d th e p riv ate co sts of

do m est ic p rod

uc tio n into
i i u an import private bene fits function B ( q ). T he ne t ec on omic w elf are fu nc tio n in clu de s im

po rt
i iu w iu be ne fi ts B ( q ), l ess the dir ect co sts of im po rts (P q ), and

les s al l ot

he r co sts ass oc iat ed

wi th f i u exter na lit ies , s ho ck s, an d m ark et f ailure s ( C ( q )), which indi vidual produce rs and consumers do no t or din ari ly c on sid er i n th eir m ark et tran sac tio ns .

Th e m arg ina l w elf

are fr om a ch an ge in i m

po rts is the n th e m arg ina l private b en ef it o f i m po rts les s the m arg ina l di rec t co st o f i m po rts les s al l th e o the r id entif ied m arg ina l no n-p riv ate co sts :

He re the pri m e sym

bo l ( N ) de no tes the tot al d eri vativ e w ithres pe ct t o im po rt l ev els . T he oil import premium is d ef

ine d a s th e d if

fe ren ce b etw een

the m arg ina l pr iva tenet benefits of oil and the m arg ina l social

ne t be ne fi ts. Si nc e it

is g en era llybe lie ve d th at the so cia l be ne fi ts o f i m po rts equal the pr ivate benefit s, the import premium is the difference be tween marginal social costs andN ot e t hat so l on g as pr i vat e oi l pu r chaser s gai n al l t he ben ef i t s of oi l consum pt i on ( so t hat m ar gi nal pri vat e benefi t equal s margi nal soci al 37 bene f i t ) and t her e e xi s t s no i m por t t ax or cons t r ai nt s ( s o t hat t he mar gi nal pr i vat e c os t of oi l equa l s t he w or l d oi l pr i ce ) t hen t he i m por t pr emi um c a n b e d e fin e d a s th e m a rg in a l so c ia l c o s ts o f im p o rts m in u s th e p ric e o f im p o rte d o il.

i w M o re gen eral l y, for t ari ff J 0 , P = P + J

-28- (3)

(4) marginal private c osts. The marginal private c ost of oil is the prevail ing domestic oil pri ce. 37

w This equals the world oil pr ice, P , if there are no tariffs or binding i mport/export constr aints. At
iu any le ve l of

U. S. im po rts q the oil i mport prem ium, B , b ein g th e d if fe ren ce b etw een

m arg ina l so cia l an d m arg ina l private c os t, i s:

As will be discus sed below, the firstterm of the premium corresponds t o the monopsony or co ns um er b uy ingpo we r pr em ium . S tri ctl y s pe akingthe sec on d te rm inc lud es a ll o the r m arg ina l social l osses associ ated with imports, but i n thi s study we limit our att ention to i dentifying and est im ati ngthe expe cte d e co no m ic l os ses fr om dis rup tio ns . S o in

ke ep ingwi th e arl ier

ap pro ach es as far back as Plumm er (1982) we divi de the oil i mport prem ium into two com ponents: the m on op so nypre m ium

an d th e d isr

up tio n p remium :

Th e tw o c om

po ne nts are ess entia llylon g-r un an d s ho rt- run

in n ature r esp ect ive ly, sin ce the fi rst acc ounts fo r th e ef

fe ct o f a su sta ine d im

po rt r ed uc tio n o n th e lo ng -run undisr up ted oil pri ce, wh ile the sec on d p rin cip all y in clu de s th e ch an ge in e xp ect ed sh ort -run lo sse s d

uri ngfutur e transit ory disrupt ions. A key challe nge of this analysi s is to ide ntify those cost s stemm ing from market imperfections which are not acc ounted for in private behavior , and which vary at the m arg in w ithoilim

po rts (or oilco ns um

pti on ).T h i s i s b ecau se t h e m arginal social co st s o f i m p o rt s, b eyo n d p ri ce, are an i n creasi n g fun ct i o n o f t h e l ev el o f i m p o rt s. 38 -29- IV.2 The Base Import Premium and the OptimalImport Premi um Th e p remium

can be m eas ure d und er b aseco nditi on s (o f c urr ent, e sse nti all y f ree -m ark et policy) orunder conditi ons where policy ha s reduced import demand. The form er esti mates the pe r-b arr el s oc ialga ins fr om a sm allim

po rts red uc tio n f rom the curre nt b aselev el, wh ile the latter est im ate s th e p er- barre l m arg ina l so cia l ga ins af ter im po rts have be enred

uc ed bya n on -trivi al qu antity. On ce t

he so cia llyef

fi cie nt l ev el o f i m

po rts is i de nti fi ed

(th at whic h m ax im ize s so cia l net benefit), the "optimal" import premium which applies a t that l evel can be es timated. As im po rts de cli ne , th e p remium de cli ne s. 38 A graphical r epresenta tion may clarify the concept s of the base and opti mal prem ia. Un de r f ree -m ark et p oli cy , im

po rt d em an d w illad

jus t untilthe m arg ina l private b en ef it e qu als world price, and the marginal privat e net benefit i s zero. This i s shown by the inter section of the

o o import supply and demand curves in Figure 2, atimports level M . The base premium, B (M ), i s

w sh own a s th e d if

fe ren ce b etw een

the pri vate m arg ina l co st ( im po rt s up ply ) cu

rveP an d th e so cia l
soci al o m arg ina l co st c urv e C ' ab ov e im po rts lev el M . A s sh own, the pre m ium is greater fo r hi gh er levels of oil us e if the social costs ri se faster with us e than priva tely account ed costs (i .e., than the wo rld oilpri ce)

.-30- (5) o If a p oli cyis i ntr od

uc ed to r ed uc e im po rts be low

the fr ee m ark et l ev el, M , to any o the r level, say M

, th enthe m arg ina l private b en ef its div erg e f

rom pri vate c os ts. Whe n im

po rts are red uc ed to t he lev el M , the optimal imports level, the social marginal c ost curve i ntersect s the

* pri vate d em an d c urv e (F igu re 2 ). S oc ialm arg ina l co sts eq ua l so cia l an d p riv ate m arg ina l be ne fi ts and

no fu rth er r ed uc tio n is be ne fi cia l:

Note that nei ther the pr emium nor the leve l of imports is necessar ily reduce d to zero atthe op tim al l ev el M* . M any s tudies of oilim po rt c os ts s eek

to e sti m ate the op tim al p remium , s inc e it serves as aguide for longer- run policy aftera transi tion to lowerlevel imports has bee n made. On the oth er h an d, the ba se o r "c urr ent m ark et" pre m ium pro vid es an e sti m ate of

the po tentia l so cia l ga in f

rom red uc ingim po rts bya sm allam ount f rom the ir c urr ent le ve l, and

su gg est s a l ev el Fi gu re 2 : D ev iat ion

Be tw een Margin al S oc ialCo st and Margin al P riv ate Co st o f I m po rts Im pli es a P re mium.-31-

of so cie talef

fo rt o r in centiv e th at m aybe ap pro pri ate fo r so m e ti m e unti l pr ogres s in red uc ingoil use is achi eved. The result s presente d here focus on the smaller “opt imal premium .” For co m paris on we pre sent es tim ate s o f t he so m ewhat hi gh er “ba se”or “ curre nt p remium ” in Appendix A. Th e o il i m

po rt p remium

is a us ef ul c on cep t f

or s um m ari zin g n on -m ark et c os ts, but sh ou ld not be direc tly inte rpreted a s an instrument of policy (e.g. National Energy StrategyDraft 19 90 :9) . F or e xam

ple , P lum m er et al . (1 98 2) and

Bo hi and Mo ntg om ery

(19 82 ) m ak e th e cl ear point thatthe two basic c omponents of the im port premium associated with non-competiti ve market costs and disruption costs each may m otivate adifferent policy. The i mport prem ium indicate s the marginal socia l value of a susta ined reduct ion in imports, but does notindicate the most eff icient pol icy for achievi ng that reduc tion. Similarly, the disrupti on component of the im po rt p remium

sh ou ld n ot b e inter

pre ted as t he m arg ina l va lue of

sto ck pil ingag ain st a dis rup tio n, in o rde r to of

fs et i m po rts durin g a

dis rup tio n. Th is v alu e co uld be est im ate d sep aratel y, as i n th e P lum m er et al . (1982) "st ockpiling pr emium ," or numerous other stoc kpiling studies ( e.g., Teisberg 1981; Hogan 1982; Leiby and Lee 1988; DOE/Inte ragency Study 1990; Le iby an d B owm an19 98 , 2 00 5). IV.3 Monopsony Pow er and Calculating the Monopsony Prem ium This secti on reviews the ba sis of possible U.S. monopsony power, and discusses s ome of the iss ue s invo lve d in

the est im ati on

of the m on op so nypre m ium . T he se i ssu es c on cer n h owto representthe response behavior of other a gents in the world oil market, part icularl y non-U.S. importers and OPEC. IV .3 .1 Mo no ps on y P ow er Si nc e th e Unit ed

St ate s is a largeco ns umingnatio n, in t he ory it c ou ld i nf

lue nc e w orl d o il pri ces byalt eri ngits lev el o f i m po rts . T he m on op so nypre m ium is t he m arg ina l re du cti on

in ex ces s w eal th t

ran sf er r esu lti ngfr om

im po rts red uc tio n. Th e "m on op so nyco st" of im po rte d o il i s the fa ilure o f o il c on sum ers to c oo rdi nate and us e th eir m ark et p ow er t o re cap tur e m on op oly rents trans fe rre d to oilexpo rte rs ( Murphy, To m an , and W eis s 1 98 6:6 8). Br oa dm an(19 86 :24 3) h as de scribe d th e m on op so nyco st e ff ect as f oll ow s. "If aninc rea se i n th e d em an d f or i m po rts lea ds to a

ris e in the wo rld

pri ce o f o il, the incre ase in pri ce affects all i mports .... In this case, the demand increase by the marginal importer produces an ext ernal costby raising t otal payments abroad for oilim po rts bym ore than th e p ric e [ it p ay s] ." Mo st ana lys ts a gre e th at the Un ite d S tat es h as at le ast limite d m on op so nypo we r. H ow ev er, the y disagree about whether tha t power can and shoul d be exercis ed. Some argue that the monopsony po we r of the Un ite d S tat es i s, in f

act , v ery sm all . In the pa st, oth ers have argue d th at the expli cit exercise of m onopsony power, especia lly the adopt ion of an import tariff or quota, could ca ll for ret ali ati on

on the part o f o il e xp ort ers . C learlyso m e p oli cie s to ex erc ise m on op so nypo we r ar ei s sO T he el ast i ci t y of net i m po r t supp l y ( 0 ) can be decom po sed i nt o t he el ast i ci t y of O PE C supp l y ( 0 ) an d th e e lasticit y o f n et im p o rt 39

iN d em an d fr o m n o n -U

. S

. , n o n -O P E C region s ( 0 ):

iu iu iN

U U w her e F i s t h e sh are of n o n -O P E C n et i m p o rt s i m p o rt ed b y the U n i t ed S t at es, t h at i s F = q /( q + q ). -32- (6) more visible and provocat ive than othe rs. The prospectfor retali ation may be related t o the m anne r in

wh ich m on op so nypo we r is us ed . T he argum ent th at O PE C w ou ld f ully o ff set or e ve n ret ali ate in r esp on se t o a

U. S. im po rt r ed uc tio n might have gre ate r pl au sib ili ty whe n O PE C i s poorly coordi nating it s monopoly power and is at best ac ting as a " clumsy cartel." I n this case , the blatant an d p romine nt a sse rti on of m on op so nypo we r co uld lea d to gre ate r so lidif

icatio n o f t

he oil cartel and resultin world oil pr ice incr eases. On the othe r hand, the sugges tion of OPEC ret ali ati on

be co m es l ess co m

pe lli ngat t im es ( su chas t he curre nt and

pro jec ted m ark et c on dit ion s) wh enOP EC is a lre ad

y e xe rci sin g s ub stanti al s up ply res tra int an d m aintai nin g p ric es at co m parat ive ly h igh

lev els

. To the extent that the Unite d States has monopsony power and faces non-competitive global oil supply, there is an opportuni ty to actand reduce tot al U.S. costs. The grea ter the U.S. share of the world oi l market, the great er the pote ntial of the Unit ed States t o exercise monopsony power. Th e im

pa cts of anim po rt r ed uc tio n d ep en d o n th e el ast ici ty o f n et i m po rt s up ply , whic h is the subjectof som e uncertai nty. The premium estimates here i nclude a market-based r esponse by oth er i m po rte rs and

no n-O PE C p rod

uc ers as p ric es f

all , p art ial ly o ff

settin g th e m on op so nypo we r of the United States . The United States is a net i mporter of oil, as is the gr oup of all other nat ions outside of OPEC, collective ly. The monopsony power of the United States and the size of the monopsony prem ium increases with the share of world oil trade comprised by U.S. imports. For 39 20 06 to 2 01 5, the pro

jec ted av era ge lev el o f U .S . im

po rts as a sh are of OP EC ne t expo rts (to tal non-OPEC net imports) is around 36 per cent. (In the mid 1990s the current and pr ojected U.S. share was near30 percent.)

IV.3.2 Issues in Estim ating the Monopsony Premi um In the above expos ition on the import premium , the first t erm in the premium of Equation (4) co rre sp on ds to t

he m on op so nypre m ium . T he m on op so nypre m ium is j us t th e in cre m ental ch an ge in w orl d o il p ric e in du ced bya unit im po rt r ed uc tio n ti m es t

he lev el o f i m

po rts :-33- (7) is If 0 is the pri ce elast icity of net oi l import supply to the U.S., then the imported oil monopsony pre m ium is a lso expre ssible as:

is The social cos t exceeds the private cost by P / 0 . This formula shows explicitly that the m on op so nypre m ium

wi ll v ary wi th w orl d o il p ric e, im

po rt l ev els , and

the pri ce e las tic ityof

ne t supply of imports to the United Sta tes. If the suppl y of im ports is ve ry elast ic, the monopsony premium will be very s mall, and very large i f supply is inela stic. This i s illustrated by the following graph. For any give n slope of world oil pr ice with re spect to U.S. imports the m on op so nypre m ium

is greater fo r hi gh er U .S . im

po rts . F or anygiv enne t el ast ici ty o f i m po rt su pp ly t o th e U .S . th e m on op so nypre m ium is greater fo r hi gh er w orl d o il p ric e. Thus , b y e ith er of these measures we would expect the monopsony pre mium to be large r over the ne xt decade than in the pa st decade.-34-

Es tim ati ngthe m on op so nypre m ium ha s always be enrec ogniz ed as dif fi cu lt b eca

us e it req uir es t he sp eci fi cat ion

of no n-U .S . re sp on se b eh av ior , and parti cu larly O PE C r esp on se be havio r (P lum

m er 1 98 1:6 ). S ho uld

theUn ite d S tat es r ed

uc e im po rts thr ou ghso m e p oli cy m eas ure s, the fo llo wi ngcat eg ori es o f r esp on se are p os sib le:

! No n-U .S . Im

po rte r R esp on ses - Marke t-b ase d (s om e li m ite d in cre asein d em an d a s p ric e d rop s, no po lic y c hang e) - Jo int /co ordinated

po lic y e ff

ort wi th Unit ed

St ate s (am

pli fy ingthe U. S. ef

fe ct) - C ontra dic tor

y/c om pe ns ati ngpo lic y (o ff

settin g th e U .S . e ff

ect)

! OP EC Su

pp ly Resp on ses - Mainta in producti on at cart el-agre ed levels ( zero elas ticity) - P art ial(in ela sti c ( , <1 ), u nit ary ela sti c ( , =1 ), e las tic ( , >1 )) Fi gu re 3 Re lat ion sh ip o f o il m on op so nypre m ium to t he ela sti city o f n et i m

po rt s up ply

to the Un ite d S tat es, an d th e w orl d p ric e o f o il.R ecent exam pl es of gl ob al at t ent i veness t o o i l i m po r t s and ener gy secur i t y ar e m ani fol d and r eadi l y avai l abl e. Fo r exam pl e, for t he I E A , see 40 num er ous r epor t s and w or ks hops document ed a t t hei r w ebs i t e i ncl udi ng I EA 2007 O i l Supp l y Securi t

y- E m ergency Respon se of I EA C ou nt ri es . For A PEC , s ee e. g. A PER C 2007 A Q u est f o r E n erg

y S ecu ri t

y i n t h e 2 1 stC en t u ry , i n w hi ch i ndi ce s of ene r gy s ec ur i t y a r e c ons i der ed, s om e of w h ic h fo c u s o n o il im p o rts a n d d e p e n d e n c e o n u n s ta b le s u p p lie s . S e e a lso th e ir re p o rt Energy Se cur i t y I ni t i at i ve : Som e As

pec ts of Energy S e c u r ity , A PE R C 20 03

. Fo r N ort heast A si an nat i on s, see ht t p: / / w w w . i ea . or g/ Text bas e/ w or k/ w or ks hopdet ai l

. as p?W S_I D =178 f or t he “ J oi nt C on fe r ence on N ort heast A si a En er gy S ecur i t y and C oo per at i on ( 20 04 )

. Fo r A SE A N , see , e. g. t he 20 07 w orks ho p “O i l Securi t y and N at i on al E m e r g e n c y P r e p a r e d n e s s , ” j o i n t wi t h I E A ( ht t p: / / w w w . i ea . or g/ Text bas e/ w or k/ w or ks hopdet ai l

. as p?W S_I D =331)

. A n e x tr e m e a lte rn a tiv e to jo in t a c tio n b y im p o rt e rs is th e p o s s ib ili ty o f c o n tr a d ic to ry /c o m p e n s a tin g m e a s u re s in o th e r i m p o rt in g c o u n tr ie s . 41 B row n an d H u n t i n g t o n (19 9 4 ) no t e t h at H o el ' s ( 1 9 9 1 ) w o rk o n u n i l at eral en v i ron m en t al acti o n s al so ap p l i es t o u n i l at eral o i l co n servati o n effort s: u n ila te ra l a c tio n b y th e U n ite d S ta te s c o u ld w e a k e n its b a rg a in in g p o s itio n w ith o th e r im p o rte rs w h o a re c o n s id e rin g c o m p a ra b le p o lic y . In th is c a s e o th e r c o u n trie s c o u ld re la x th e ir e ff o rts a n d , in th e o ry , w o rld o il im p o rts c o u ld in c re a s e . It se e m s e s p e c ia lly u n lik e ly th a t o th e r m a jo r o il cons um i ng count r i es w oul d t ake an oppor t uni s t i c or eve n non- coope r at i ve s t r at egy gi ven c ur r ent w i des pr ea d conc er n about t he ne ed f or ene r gy conser vat i on and cl i m at e change. -35- - C art eli zed

- F ullof fs et (pe rf ect ly e las tic ) - C art eli zed

- R eta liator

y (n o s up ply

curv e) Non-U.S. Im

porter Response Representat ion A relevant ques tion in ass essing thes e potentia l benefits is the response of other importing countries . W ill the y act coll ectivel y with the United St ates to r educe consumption, will they not rea ct, or w illthe y take act ion s to act ua llyinc rea se t

he ir i m po rt l ev els ? Fo r th e es tim ate s repo rte d here, we assume all othermajor oil consuming and importing regions outsi de of OPEC do not alter their poli cies, but r espond competitively t o any price r eduction induc ed by U.S. policy. Ho we ve r, i t is wo rthno tin g th at v irt ua llyalloilim

po rti ngco untri es are c on cer ne d a bo ut t he ir o il co ns um pti on an d im po rt l ev els , in clu din g th e m em be rs o f t he Int ern ati on al Ene rgy

Ag en cy(IE A) , the As ian Pa cif ic E co no m ic C oo pe rat ion (A PE C) gro up , th e A sso ciatio n o f S outh E ast As ian Natio ns (A SE AN ), and

a grou p o f N ort he ast As ian natio ns inc ludingCh ina . T he y are a cti ve ly exploring new poli cies to l imit oil use, for a vari ety of environmental, energy se curity, and sustainabi lity motivations. Thus, the assumption of a purely free-market, no-pol icy response by 40 the res t of the wo rld

outsi de of

OP EC m us t be int erp ret ed

as an u pp er b ound

on the de gre e to which other importers would offset any U.S. import r eduction by inc reasing their demand. Th e m arg ina l be ne fi ts t o th e Unit ed St ate s o f a

co ordinated

po lic y w ithoth er o il co ns umingnatio ns wo uld be gre ate r th antho se o f a un ilater al a cti on , b eca

us e o f t he glo ba l natur e of the monopsony gains. The estimated import or consumption premium would be correspondi ngly higher, when a coor dinated poli cy is compared to the free market outcome. Un de r co ordinated

po lic y a cti on , n on -U .S . im po rte rs are typ ica llyass um ed to r ed uc e th eir consumption in the same proportion as the United State s (e.g., Stobaugh 1979). The e arly Energy Mo de lin g S tud

y (E MF -6, 19 82 ) co ns ide red the ba se m on op so nypre m ium or " buyin g p ow er we dg e" f or b oth un ilater al and

joi nt O EC D a cti on . T est s w ithnin e o il m od els allindicated that the ba se m on op so nypre m ium wa s 3 to 3 .5 tim es l arg er g ive n c oo rdi nated OE CD act ion

(G ate ly 1982:46). Jointaction by the United States and other importers e ffectively incre ases the share of wo rld oiltra de un de r m on op so nyco ntr ol, an d in cre ase s th e m on op so nypre m ium fa ste r th an lin early w iththe sh are of

im po rts m on op so niz ed

(se e p rev iou s f

oo tno te)

. 41-36-

OPEC Supply Response Representation Most esti mates of the m onopsony premium component assum e some positive relation between price and OPEC supply, or include OPEC supply in a world i mport supply curve (e.g., EM F- 6, Gatel y 1 98 2; B roa dm anan d H og an19 86 ; W all s 1 99 0; Huntin gto n 1 99 3). If OP EC is a tru e m on op oli sti c su

pp lie r, t he n th ere is n o w ell -de fi ne d c onve nti on al u pw ard -sl op ingsu

pp ly curve . Am on op oli st s ets a p ric e in inv ers e p rop ort ion

to t he ela sti city o f d em an d f

or i ts p rod

uc t, so in this c ase it may be more im portant for an i mport dem and policy to i ncrease demand elasti city than r educe the quant ity demanded. Ne sb itt an d C ho i (1 98 8) o ff

er o ne po lar

alt ern ati ve rep res entat ion of OP EC su pp ly. Th ey ap ply a d ep let ab le- res ource car telm od el o f O PE C b eh av ior to e sti m ate the ef

fe cts of anim po rt tarif f and co nc lud e "the de gre e o f m on op so nypo we r th at c anbe ex ert ed bythe Un ite d S tat es i s small, indeed almost minuscule" (Nesbittand Choi 1988:46) . They estimate that a $10.50 t ariff such as thatproposed by Broadman and Hogan would sharply reduce U.S. im ports (by 30 per cent in t he fi rst ye ar) but w ou ld o nly

red uc e w orl d o il p ric e b y $ 1. 30 /B BL . T he ins en sit ivi ty o f w orl d price to de mand results from their assumption of a highly elasti c world supply, and the treatment of oilsu pp ly a cco rdi ngto d

yn am ic d ep let ab le r eso urc e th eo ry, in whic h p ric e p ath s ar e st ron gly dri ve n b y th e es tim ate d re so urc e b ase siz e an d b ack sto p p ric e. Ho we ve r, t he limits of

deple tab le resource theory as a posi tive descr iption of petrol eum m arkets ar e well established (e .g. W atkins 19 92 , 2 00 5). Al ter

nativ ely , v iew ingOP EC as a vo n S tac ke lbe rg m on op oli st s ug ge sts that whil e the elast icity of import supply may be ill-defined, the price charged will depe nd on U.S. consumption via the effect of U.S. consum ption on OPEC's m arket shar e (Greene 1991; Gre ene an d L eib y 1 99 3). If

the wo rld

co uld so m eh owred

uc e O PE C' s m ark et s hare e no ugh, the re w ou ld be pre ssu re f or p ric es t o re tur

n to ward c om

pe tit ive m ark et l ev els

. Som e criti cs of the monopsony prem ium approach question whetherthe exerci se of m on op so nypo we r w ou ld b e a j us tif iab le i nte rf

ere nc e in oilm ark ets . If

m on op so nypo we r can low er m on op oly

pri ces , whyno t us e it

to l ow er c om

pe tit ive m ark et p ric es a s w ell ? Whyno t us e it i n a ll aren as o f i nte rnatio na l tr ad e? A cco rdi ngto s tan dard t he ory , th ere are tw o g oo d re aso ns : 1) competitive market price s produce an economically e fficient allocation of resource s; and 2) the indisc riminate e xe rci se o f m on op so nypo we r w ou ld u nd ermine pa ins taking ly n eg oti ate d f ree tra de agree m ents. In s ho rt, the re i s to o m uc h to los e. If

fr ee t rad e in co m pe tit ive wo rld

m ark ets is the goal, the n indiscri minate use of m onopsony power againstcompetitive producer s would be co unter pro du cti ve , b ut j ud ici ou s u se o f m on op so nypo we r ag ain st m on op oly pri cin g m aybe a step in the right dir ection.-37- (8)

(9)

(10)

(11) IV.4 Methodology for Calculat ing the Disruption Component of t he Oil Im port Premium W e d ef ine d (E q. 5) t

he dis rup tio n c om

po ne nt o f t

he im po rt p remium

as t he m arg ina l ch an ge in e xp ect ed

dis rup tio n lo sse s:

Co ns ide r repre sentin g th e unc ert ain futur e o il m ark et b y a

set of po ssible dis cre te m ark et s tat es (disrupt ions sizes and lengths) indexed by j . Thus, the expecte d disrupti on cost over the next j j de cad e is tak enov er a

set of po ssible su

pp ly l os ses ) Q each with annual probabili ty N . F or e ach j i j possible di sruption ) Q with an associ ated incr ease in imported oil price of ) P ( ) Q ), the disrupti on costs are composed of the incremental imports costs (foreign payments) plus the dislocat ional GNP losses due t o the disrupt ion pr ice. The expect ed total di sruption cos ts are the pro ba bil ity -w eighte d s um :

Th e d isr up tio n p remium

is the m arg ina l ch an ge of thi s expe cte d c os t expre ssi on wi th r esp ect

to
iu the long-run level of U.S. oil imports, q . IV.4.1 Disruption Premium - Import Cost Component Co ns ide r th e m arg ina l ch an ge in t he fi rst ter m , disr up tio n im po rt c os t, r eco gn izi ngthat ad de d im po rt c os ts d

uri nga d isr

up tio n are g ive n b y th e ch an ge in p ric e ti m es t he lev el o f i m

po rts
iD during the di sruption, q :

W e writ e th e d isr

up tio n p ric e ch an ge ) P

as a fu nc tio n o f b oth

the dis rup tio n q

uanti ty l os s ) Qand the pre -di sru

pti on lev el o f i m

po rts , a ck no wl ed gin g th at the latter m ayinf lue nc e m ark et r esp on ses durin g th e d isr

up tio n. Takin g th e d eri vativ e:

There are many channels by which changing import levels dur ing normal (undisrupte d) periods coul d influence the i mport costs during a dis ruption. These c hannels are highlighte d by j i D the each of the thr ee terms in the deri vative of the produc t of N , q , and ) P below:-38- (12)

(13) The first term on the right-hand side of Eq. 12 is the effect of pre-disrupt ion import levels on the prob ab ili tyof

dis rup tio n. Th is i s so m eti m es c all ed the de ter ren ce e ff ect if red uc ingim po rt l ev els is tho ught t o re du ce t

he lik eli ho od

of int entio na l sh oc ks . Whil e m od els of thi s ty pe of ef fe ct could be offered, in which the l ikelihood of some categories of disruption (e .g. embargoes or terror ist att acks) might diminish with U.S. import levels, in thi s analysis we do not include any
iu effect of im

port level s on disrupti on probabili ty (i.e., M N /M q = 0 ). An a lte rnativ e, no n-z ero ass um pti on ab out th e m arg ina l ef

fe ct o f p re- dis rup tio n im

po rts on dis rup tio n li ke lih oo d, ev enif ve ry s m all , w ou ld h av e a p ron ounc ed ef fe ct o n th e p remium

est im ate
. The second term is the dir ect effect of reducing pre -disrupt ion import levels on the num be r of im po rt b arr els that ar e su

bje ct t o th e p ric e in cre ase ) P durin g disr

up tio ns . T he im

po rt levels dur ing the disruption event wil l be somewhat different from the long-run pre-disruption import levels, given s hort-run pr ice respons es, and income responses if GDP contract s. The reduction of normal-peri od oil imports by one barr el would reduce the level of oil i mports during random disruptions by roughl y, but not exact ly, one barre l. If the reduct ion is one-t o-one iD iu ( dq /dq = 1.0), then thi s term for the cost reduct ion per barr el of import reduction is just the { ) Q} expe cte d p ric e in cre ase du e to sh oc ks (E [ ) P ( ) Q)]). We track this cost c omponent but rec ogniz e th at i t is no t ne ces sarilyentir ely exter na l to the de cis ion

cal cu lus of

eco no m ic a cto rs wh o c on sum e o r im

po rt o il. Th is dire ct p ric e in cre asethat m us t be pa id b y th os e u sin g ano the r barre l of oilat the tim e o f a

(rand om an d p res um ab ly u

ne xp ect ed) sh oc k m aybe parti all y o r f ull y acc ounte d-f

or b y f ore sighte d a ge nts wh enthe y m ak e o il p urc ha ses durin g th e undisr up ted periods. Given ourdecadal planning period, the key here is the degree t o which prospecti ve geopolitic al oil di sruptions ove r the next de cade are both anticipa ted and accomm odated through preparat ory

be havio r whe n o il p urc ha ses are m ad e at any ti m e in

the de cad e. W e as sum e th at ordinari ly some-to-all of the shoc k price inc rease is internal ized. As mentioned, this component of the disrupti on premium is reduced by the fraction posi ted to be int ernaliz ed, based on a parameter that t akes values of 0%, 25% , and 100% internalizat ion. Th e th ird ter m in t he im po rt- co st c om

po ne nt o f t

he dis rup tio n p remium

is t he expe cte d
iu ch an ge in i m

po rt c os ts d

ue to t he im pa ct o f p re- dis rup tio n im

po rt l ev els q on the magnitude of the price increase during each poss ible disruption. This component can be furtherdecomposed.-39- (14)

(15) iu iu Not e that thi s t erm is anex ac t ana lo g t o the pr e- di srup ti onmono ps ony p re mium ( q d P /dq ), wh ere in t

his cas e w e ar e ac co untin g f or t he im pa ct o f U .S . im

po rt l ev els on

the expe cte d dis rup tio n p ric e inc reaserathe r th anthepre -di sru pti on pri ce lev el . A ga in, the m on op so nyef fe ct is not li kely to be consi dered by indivi dual economic agents, and agai n it is powerful by bei ng m ult ipl ied bythe entir e le ve l of

im po rts
. The expected pri ce increa se from shock is governed by the brac keted terms, which are the indirecteffect of pre-disrupti on import levels on the e xpected siz e of the supply loss, and the ef fe ct o f p re- dis rup tio n im

po rt l ev els on

the sen sit ivi ty o f s ho ck

pri ce c hang e ) P

to t he qu antity j of su pp ly l os s ) Q (th at i s, the ef fe ct o f i m po rt l ev els on

the sh ort run ela sti city o f g lob al n et im po rt d em an d).
IV.4.2 Disruption Premium - GDP Dislocation Cost Component Analogous to the pr emium associat ed with import costs duri ng disrupti ons, the GDP dislocat ion premium

component is the marginal change in expecte d GDP losses during j j dis rup tio ns . F or a

dis cre te distrib uti on

of dis rup tio ns siz es ) Q each with annual probabili ty N

Th is f orm ulatio n h igh lights the rel ati on sh ip b etw een GD P l os ses an d th e d isr

up tio n in du ced

pri ce j ch an ge ) P , as well as the possibil ity thatthe magnitude of GDP loss for any given price change
du could also depe nd directl y on the level of U.S. oil dem and q . In thi s f orm al ana lys is w e ar e examining the marginal effect of an import reducti on on societal costs, without positing a parti cu lar ch an ge in d om est ic s up ply or d em an d to ge ne rat e th e im po rts ch an ge . T hu s, fo r th is

du partial equilibr ium analysis, we hold domestic demand levels fixed and drop q from the eq uatio ns . M ore ge ne ral ly, if we kn owthat th e p oli cythat ca us es t he im po rts red uc tio n is anoil de m an d re du cti on , th enthe re w ou ld b e an ad dit ion al disr

up tio n p remium

co m po ne nt a sso ciated wi th t he ch an ge in G DP sen sit ivi ty t o o il p ric e ch an ge s:

j Again, we omit the possible effect of import leve ls on disrupt ion probabil ity N , and expand the se co ndte rm:-40- (16)

(17)

(18) These are the terms that must be evaluated t o determine the GDP-Dislocati on component of the Di sru pti on im po rt p remium . T he bra ck ete d te rm s ar e th e sam e tw o c om po ne nts that w ere ide nti fi ed fo r th e D isr

up tio n P remium

Im po rt C os t co m

po ne nt, wh ich

de ter m ine the m arg ina l effect of pre-disrupti on import levels on the e xpected disruption pric e change. Note thatwe do not assume any change in the sensi tivity of GDP to price s hocks from a change in the level of yP im po rts(the GDP elasti city , is h eld co ns tant), sin ce t

he GD P l os ses fr om

oilsh oc ks are tho ught t o b e m ore pro pe rlya f un cti on of co ns um pti on lev els

. If

the ch an ge in i m

po rts is a lso accompanied by a change in consumption, then th e full import/consumption premium would be larger by that term. IV.5 Calculating the Total O ptimal Prem ium

iu Th e to talpre m ium

at anylev el o f i m

po rts q is given by the sum of the monopsony and dis rup tio n c om

po ne nts :

tot iu Th es e p re mium comp on ents an d the to ta l p re mium B ( q ) can be cal culated for any l evel of

iu im po rts q . The optimal premium can be numerically det ermined by iterati vely searc hing for the lev el o f i m

po rts that eq

ua liz es m arg ina l so cia l co sts an d m arg ina l private c on sum pti on be ne fi ts (see Figure 2 and the discus sion). The net i mport supply to the United States is composed of the posited OPEC supply behaviorminus the non-U.S. net import dem and curve. The res ulting function for net import supply can be i nverted to yi eld the world pr ice of oil as a functi on of U.S.
w i u import dem and, P ( q ). S imilarly , lo ng -run U .S . d om est ic s up ply curve s an d d em an d c urv es co m bin e to yie ld t

he U. S. ne t im

po rt d em an d c urv e, wh ich can be inv ert ed

to y iel d th e m arg ina l
pr iv D iu benefits of U.S. oil imports, B ’( q ) = P ( q ). B y d ef ini tio n, the m arg ina l so cia l co st o f o il imp orts is th e s um of

th e w or ldpr ic e o f oi l p lu s the mar gi na l o il imp ort p re mium:

iu Th e o pt ima l i mport p re mium B is t he pre m ium

at the im po rt l ev el q that eq

ua liz es * * m arg ina l so cia l co sts an d m arg ina l private c on sum pti on be ne fi ts:-41- (19)

V. Re su lts A r an ge of

res ult s w as c on str

uc ted bypro ba bil ist ic s im

ulatio n, ref

lec tin g unc ert ainty reg ardingthe ke y f

act ors . ! All estimates uti lize the Base oil market projec tion from the 2007 EIA Annual Energy Outlook (A EO 20 07 ). ( Othe rw ise , a cco untin g f or u nc ert ainty r eg ardingthe futur e o il p ric e path by using a combination of EIA High, Base , and Low price outlooks , the range of est im ate s is wi de r an d a symm etrica llyso m ewhat hi gh er)

. ! OPEC supply response elast icity var ies from 0 to 6, with m ode of 1.0 and a mean of 1.76. ! Long-run supply and demand elasti city for non-U.S./non-OPEC regions ar e on net about double the 1997 study values, and U.S. supply and demand elasti cities are unchanged. ! Di sru

pti on pro ba bil iti es are t ak enfr om

the En ergy M od eli ngFo rum 20 05 surve y (s ee EM F/Be ccu e an d Huntin gto n 2 00 5), ag gre gated int o three dis cre te disr

up tio n s ize s (s ee Ap pe nd ix C fo r m ore de tai ls)

. ! A wider range of values for the GDP loss elastic ity with re spect to oi l shock pric e of -0.01 to -0.08 was judged t o encompass essentiall y the bulk of recenteconometric and modeling est im ate s f

or t he cum ulativ e lo ss o f G DP fo r 2- 3 y ear s af ter a sh oc k, expre sse d a s a percentage of one-year’s GDP. This range was us ed in a sensi tivity c ase. However, for the ba se s et o f r esu lts pre sented in T ab le 1 , th e G DP Lo ss e las tic ityran ge wa s so m ewhat sh if ted do wn to a cco unt f

or t he po ssibil itythat th e se ns iti vit y o f t he eco no my to oilpri ce shocks may have diminished over time. The range use d for Table 1 varied from -0.01 to – 0.054, with a mean of -0.032. Further examination of this issue is merited. ! Sh ort -run e las tic ityof U. S. im po rt d em an d rang es f

rom -0. 08 7 to -0. 16 3. Th is r an ge is su pp ort ed bythe ran ge of

est im ate s f

rom the lit eratur e sh own in

Ap pe ndix A , a lth ou ghan argum ent can b e m ad e f

or s m all er s ho rt- run

ela sti cities

. ! Disruption si ze reducti on with imports varies from 0% to 30%, with the upper end co rre sp on din g ro ughly

to t he sh are of

wo rld oiltra de fl ow s d em an de d b y U .S . im po rts
. Param ete r di stributio ns are ge ne ral ly t ak enas e ith er disc ret e o ve r three low -m id- high v alu es (with probabi litie s of 25%, 50% and 25% each) or as a conti nuous triangul ar distr ibution.A s one ba s i s of compar i s on, t he N R C ( 2002) ci t ed ot her ( EM F) s t udi es i n w hi ch t he oi l pr i ce w oul d be de cr ea s ed by bet w ee n 0. 8 per ce nt and 42 2. 9 p er cent per m i l l i on bar r el per day oi l i m po r t r educt i on . T hey no t ed t hat “app l yi ng t hat same perc ent age t o curr ent [2001 ] pri ces w ou l d g i ve a m onops ony c om ponent bet w ee n $2. 20 and $8. 20/ bbl

. ” A ppl yi ng t he s ame pr i ce s ens i t i vi t y he r e t o ave r age EI A pr oj ec t ed pr i ce s f or t he ne xt 10 y e a rs im p lie s p ric e c h a n g e s (s lo p e s ) o f - $ 0 .3 6 /b b l/M M B D to -$ 1 .3 1 /b b l/M M B D , an d m o n o p s o n y p re m ia ra n g in g fr o m $ 4 .6 1 /b b l to $ 1 6 .7 0 /b b l.
S o u rce st u d i es fo r t h i s g raph i n cl u d ed : B o h i & M o n t g o m ery 1 9 8 1 , E M F 1 9 8 2 , B road m an 1 9 8 6 , B eh rens etal

. ( C R S) 1992, H unt i ngt on 43 19 93 , C E C 19 94 , L ei by etal

. O R N L 19 97 , M oo r e etal

. C R S 1998, N R C 2002, Par r y & D ar m s t adt er 2004, and Le i by 2006. -42- Ta bl e 1 : S um mary R esu lts Effect / Study OR NL19 97 Repo rt (2005$/BBL) OR

NL20 07 Up dated (2005$/BBL) Monopsony Component $2.64 ($1.58 - $3.69) $7.41

($2.77 - $13.11) Mac roe co no m ic D isr

up tio n/ Ad jus tm ent C os ts $1.06 ($1.06 - $2.11) $4.59

($2.10 - $7.40) Total Mid- point $3.59 ($2.64-$5.80) $12.00

($6.67 - $17.95) R es ul t s i n 2005$. Col umns r eportmean es t i mat e a nd r anges . I n the c as e of the 1997 r eport , the r anges r ef

l ectthe s ubj ect i vel y def i ned “ narr ow ed r ange. ” I n the c as e of the ne w s tudy , the r anges i ncl ude 90% of

r es ul t s f r om t he r i sk- anal y si s si mula t i on. The estimated range and mean value for e ach component of the import prem ium is shown in Table 1, repr oduced in this section for conveni ence. The esti mated oil import premium for the United States is composed of about two-thirds monopsony premium and one-thir d disrupti on pre m ium . O ve r th e f

ullran ge of

sim ulatio ns , th e n et e las tic ityof oilim po rt s up ply

to t he Un ite d St ate s v ari es f

rom 3. 2 to ov er 2 1 (9 0% f

allbe tw een

4. 3 and 18 .0 , m ean

va lueis 8 .9 ). T his assumes a fairly high degree of m arket re sponsiveness t o any U.S. initiat ive, with the monopsony premium being lower as the market responsivenes s is great er. One informative measure is the im pli ed ch an ge in w orl d o il p ric es f rom a ch an ge in U .S . im

po rts . F or t

he stated ela sti city rang e, the implied oil pri ce decreas e per million-barrel-per -day reduct ion in U.S. imports ranges from $0 .1 7/b bl t o $ 2. 43 /bb l (the 90 % co nf ide nc e inter

va l is sm all er) , w itha v alu e f or t he m ean premium estimate of about $0.71/bbl/M MBD. This price-se nsitivi ty is well within the range of other est imates. The disrupti on premium in turn is about 55 percentmacroeconom ic losses from 42 dis loc ati on

an d 4 5 p erc ent lo sse s f

rom inc rea sed

oilim po rt c os ts d

uri ngsh oc ks

. Generally, the updated import premium estim ates are notably higherthan those we pro du ced in 1 99 7. Whil e h igh er, thi s re su lt i s co ns ist ent w ithm any o the r es tim ate s (e .g . P lum m er 19 82 , B roa dm anan d H og an19 88 , Huntin gto n 1 99 3), wh ich we re c on str

uc ted at tim es whe n o il market conditions were more similar to those current ly project ed by EIA than the condi tions of the m id- 19 90 s. Th is i s se enin F igu re 4 , whic h p lot s th e n ew est est im ate s (e nc los ed

in t he ell ips e on the rightside of the graph) along with est imated ranges from 11 other studies. At least two 43-43-

of the stu die s (E MF 19 82 an d Huntin gto n 1 98 3) a lso pro vid ed ran ge s d eri ve d f

rom m ult ipl e o il market m odels. Results from each study ar e plotted a ccording to their publi cation dat e. Each of these study r anges was based on pre vailing orprojecte d oil market conditi ons around the t ime of the study. While many oil m arket condi tions contr ibute to the premium estimate, we have superimposed the contemporaneous world oil price on the plotted es timates as one important market indicator.

Finally, we note that the possi ble range from our current s tudy is wider s till i f one considers the simultaneous combination of all best - or worst- case assumptions. However, the lik eli ho od

of the se m ore extre m e co m bin ati on s sh ou ld b e v iew ed as r em ote
. Fi gu re 4 Ne w e sti m ate s ar e co ns ist ent w ithpa st e sti m ate s und er similar market conditions.T he m ean “base, ” or cur r ent pre m i um val ues, w hi ch ar e eval uat ed at t he curr ent l y proj ect ed base- cas e l evel of i m po r t s over t he nex t decade, 44 ar e $1. 5 t o $3. 2/ bbl l ar ger t han t he opt i m al pr emi a, depe ndi ng on t he c as e. The unc er t ai nt y r ange i s s hi f t ed c or r es pondi ngl y hi gher , and s om ew hat w i dene d. A l l but one of t he 95%

- i l e e s t i m at es ar e a bove $20/ bbl , and 3 a r e a bove $30/ bbl

. See A ppendi x A , Tabl e A 5.

-44- V. 1 A lte rn ateCa ses Ta ble 4 p res ents a

seq ue nc e o f a lte rnativ e ca ses fr om the on e se lec ted

as a rea so na ble central case for Table 1. The cas e shown in Table 1 appear s in column (6) of Table 4. All of the va lue s in thi s ta ble are fo r th e o pti m al p remium (no t th e b asepre m ium), i n y ear 20 05 do llars. 44 Th e ce ntr al v alu es p res ented are the m ean

est im ate s f

or e ach cas e, an d th eyref

er t o th e long-run premium value per barrel of oil imports, as an average over the next ten years (2006-2015) . The ranges pres ented for the components and for the tot al are al l 90% confidence i ntervals based on the selec ted ranges for par ameter uncertainty and the probabi listi c simulation of the premium m od el. Case 0 is the r esult pre sented in the July 2007 draft study, developed in support of the Re ne wa ble Fu el S tan dard ( RF S) . In thi s ca se O PE C r esp on se i s tr eat ed param etrica lly , w ith supp lyel as ti ci ti es vary in g fr om 0. 25 - 5 .0 . T he no n- U.S ./no n- OPE C e la st ic ity a do pt edth e s ame value as the 1997 Leiby et al. study, which was -0.876. The combination of the OPEC and nonU. S. /no n-O PE C e las tic iti es l ead to a ne t el ast ici ty o f i m

po rt s up ply

to t he U. S. ran gin g f

rom 3 to 15 . D isr up tio n p rob ab ili tie s ar e f

rom the EM F 2 00 5 E sti m ate s, an d th e o il m ark et o utl oo k is tak enfr om

the AE O2 00 6 B ase cas e. Th is c aselea ds to a pre m ium est im ate of

$1 3. 97 , ro ughly two-thirds of which is the long-run monopsony premium, and one-third is the disrupti on pr emi um. Case 1 was run to make a close comparis on of the 1997 study with a cas e based on curr ent expe ctatio ns ab out th e o il m ark et. Th e tw o p rin cip le c hang es are an u pd ate of the oilm ark et outlo ok (th e f utu re p ric e an d re gio na l su

pp ly and de m an d p roj ect ion s) f

rom the AE O1 99 4 B ase Case to the AEO2007 Base Case, and the use of new disruption li kelihoods from EMF 2005 (Appendix C). Among other things, this means average crude price ri ses from $21.45 to $50.99 pe r barre l (2 00 5$ ). O the r sp eci fi c ch an ge s re lat ed to t he oilm ark et p roj ect ion

alo ne are summ arized i n Table 2. All ela sticit ies match the values us ed in the 1997 study (non-U.S./nonOP EC ela sti city o f i m

po rt d em an d is -0. 87 6, the param etric treatm ent of OP EC res po ns e u ses a triangul ar distr ibution for supply e lastic ity rangi ng from 1.0-5.0 with mode 2.0). The m onopsony premium is much lower in this cas e than Case 0 or most other ca ses, because of the a ssumption that O PE C s up ply

ela sti city is at least

unitary orgreater . Note that the Leiby et a l. 1997 study also prese nted cases with OPEC supply responses thatwere much less than unitary-elast ic, but they were not i n the “narr owed range” of estimates thatsubsequently r eceived gre ater attention. Th is a ssum

pti on of a h igh ly f

lex ibl e an d p ric e-r esp on siv e su pp ly, wh ich

m ight have be en pla us ibl e in the m id- to- lat e 1 99 0s , is no lon ge r re aso na ble at a tim e whe n O PE C i s m ore rig oro us ly c ontro lli ngoutput an d s up po rti ngrap id i nc rea ses of fr om $5 to $ 10 pe r barre l f

or e ve ry million barrel- per-day growth i n demand over the last deca de. In the la st 10 years s ince our pri or rep ort wa s p ub lis he d (S ep tem

be r 19 97 to S ep tem

be r 20 07 ), O PE C o utp ut h as rise n 1 0% whil e real price has r isen over 300% . Recognizing thatthere ar e conceptual problems regarding ide nti fi cat ion , p art ialad

jus tm ent pr oc ess es are at w ork , and su pp ly r esp on se i s li ke ly asymm etrica l; and

no tin g th at the su

pp ly c urv e f

or a car telis n ot w ellde fi ne d, no ne the les s a-45-

simple OPEC supply “elasticity” calcula tion yiel ds a minuscule +0.08 for price i ncreases ove r 10 ye ars ! Case 2 also uses the AEO2007 Base outlook, but consider s a much wider range of po tentia l O PE C r esp on ses , a ck no wl ed gin g greater

un cer tai nty reg ardingwh eth er O PE C w ill res po nd wi th e las tic (el ast ici ty > = 1 ) or ine las tic (el astici ty <1) b eh av ior . E ach of the se are vie we d a s eq

ua llylik ely

outco m es. W e n ote that th e O PE C s trategy o f p res erv ingits m ark et sh are , a pp are ntl y a

rob us t strat egy f

or l on g-r un pro fi t m ax im izatio n (G ate ly 2 00 4, 20 07 ), e nta ils a lon g-r un OP EC ela sti city e qu iva lent to ela sti city o f s up ply of oth er, co m

pe tit ive pro du cer s. Th at is, by all e stimates, an elast icity well below 1.0 (e.g. Toman (2007) suggests 0.3 following Gree ne and Ahm ad (2005); Hunti ngton (1994) sugges ts 0.2 to at most 0.6). The net r esult is a premium estimate similar in magnitude to Case 0, butslightl y larger r eflecting the changes in outl ook between AEO2006 and AEO2007. Case 3 extends Case 2 by al so revisi ng elasti cities of supply and demand in the nonU.S./non-OPEC region with wider, more recent e stimates. We generally follow Gately and Huntington (2002), a s interpr eted by Gately ( 2007), applying a r ange for elasti city of Non-U.S. De m an d f rom -0. 2 to -0. 4, wi th m ean

an d m od e -0 .3 . G ate ly and Hunti ng ton

su gg est large r elasti cities for non-transportation oi l demand, but sharply smaller ela sticit ies for non-OECD de m an d, eit

he r tr an sp ort ati on

or n on -tr an sp ort ati on . S im ilarly , th e n on -U .S ./n on -O PE C s up ply fo llo ws the sam e rang e -0 .2 to - 0. 4, tri an gu larly distrib ute d w ithm ean an d m od e 0 .3 . T og eth er these assumptions imply that the (mode) net elasti city of import demand from non-U.S./nonOPEC regions has roughly double d to -1.6. This var iation i s also res ponsive to the recomm endations of some of the review panel. The effect of this change is to re duce the monopsony prem ium, but also, to some extent, the disruption premium. The latter effect follows from the slight ly higher short-run re sponsiveness of supply out side of OPEC during disruptions

. Case 4, an alternative to Case 3, considers an even wider (and s lightly hi gher) range of No n-U .S . S up ply/D em an d e las tic iti es, to a cco unt f or greater un cer tai nty reg ardingthe se param ete rs. El ast ici ty o f N on -U .S . D em an d rang es f rom -0. 3 to -0. 7, tri an gu larly distrib ute d w ith mode -0.4 and m ean -0.467. Elast icity of Non-U.S. Supply is widened t o 0.2 to 0.6, with mode 0. 3 and m ean 0. 36 7. To ge the r th ese ch an ge s im ply that th e (m od e) n et e las tic ityof im po rt de m an d f rom no n-U .S ./n on -O PE C r eg ion s is co ns ide rab ly m ore than d ou ble d f rom the 19 97 cas e, to m od e -1 .9 2, m ean

-2. 28

. If

no n-U .S ./n on -O PE C s up ply an d d em an d are a ctu all y th is p ric eres po ns ive (on

av era ge ov er the ne xt d eca de ), t he n th e m on op so nypre m ium wo uld be fu rth er eroded. Greate r price r esponsiveness means those regions would supply alittl e less oil and demand a little more oil if the U.S. import reduct ion lowers pri ce, offsetting a bitmore of the m on op so nyef

fe ct o n n on -co m

pe tit ive su

pp lie rs. In Case 5 we revise d Case 4 further, repl acing the par ametric treatment of O PEC supplyela sti cit y w iththe can did ate OP EC str ate gic be havio ralrul e: M aintai n M ark et S hare ( the Gatel y 20 04 pa pe r be st s trategy). Th is r ou ghbut ro bu st r ule im pli es t hat O PE C s up ply

ela sti city m atc he s th at o f a ll N on -O PE C s up ply . A s a r esu lt O PE C s up ply res po ns ive ne ss i s co m

parat ive ly low, as non-OPEC supply is expect ed to be. As in Case 4, Non-U.S. elast icity of import demand-46-

ran ge s f rom -1. 38 to 3 .5 2, wi th m od e -1 .9 2, m ean -2. 28 . T ota l el ast ici ty o f N et i m po rt s up ply

to U. S. the n rang es f

rom 4. 77 to 8 .6 3, m ean

6. 47 . N ote the narro we r rang e o f n et s up ply res po ns e to the U.S. exercise of m onopsony power under thi s OPEC behavioral rule . As a consequence, the 90% confidence range or the monopsony com ponent of the premium is m uch narrowed. Ca se 6 is a

variant o f C ase 3. It a

pp lie s a l ow ere d rang e o f G DP ela sti city f or f utu re disrupti ons (range - 0.01 to -0.054, midcase value -0.032) , entaili ng lower disrupt ion adjustment co sts . M ean

va lue GD P e las tic ityis 0 .0 32 , re du ced fr om m ean va lue 0. 04 95 . O PE C- be havio r is tre ate d p aram etrica lly , and alloth er p aram ete rs are a s in Ca se 3 . W e o bs erv e th at whil e th e m ean GDP elasticity has been reduce d 35%, the disruption-dis location c ost component of the premium ha s b een red uc ed on ly 2 4%. W e attribute this to t wo ef fe cts : a s light n on -li ne ari ty ( co nc av ity ) in the ad jus tm ent co sts wi th r esp ect to G DP ela sti city (and

the m ean of a co nc av e n on -li ne ar fu nc tio n is gre ate r th anthe no nli ne ar f un cti on ev alu ate d at th e m ean); and of fs ett ingef

fe cts among prem ium com

ponents. This offsetting e ffect occurs in partbecause a re duction in any one component of the prem ium causes an increase in the leve l of imports (the level at which the optimal premium

is calcul ated). A more pronounced offsetting effect is vi sible in the increas e of a d if fe rent co m

po ne nt o f t

he pre m ium , th e D isr

up tio n Im po rt C os ts. Th e d isr

up tio n im po rt c os ts are a function of the l evel of imports during a disruption. The level of im ports duri ng a disrupti on ar e i n turn afun ct io n o f GDP duri ng th e d is rupt io n ( th e i nc ome e ffe ctonde mand ). If we as sume a lo we r im

pa ct o f disr

up tio n p ric e o n G DP (a l ow er G DP ela sti city), the n im po rts stay h igh er during the di sruption and marginal i mport costs rise. These are all examples of the in te rr el at io ns hi ps be tw ee n the co mpon ents of the op ti mal pr emi um. The final case consi dered, Case 7, is another case with reduced GDP impacts from shocks. It r ev ise s C ase 5 (t

he cas e whe re O PE C s trateg ic b eh av ior see ks to m aintai n m ark et s hare i n response to s hifts in demand) with the reduc ed GDP elasticity range for future disruptions (aga in, the ran ge is f

rom -0. 01 to - 0. 05 4, wi th a

m ean va lue -0. 03 2). Th e re su lts are qu ali tat ive ly s im ilar to Case 6, in thatthe reduct ion of disruption di slocati on costs of $0.73/bbl ar e partia lly offset by a $0.22/bbl incr ease in marginal import costs during the shoc k. Over all the se cases the mean total premium ranges from $11.09/bbl to $15.37/bbl. The complete range (union) of all the confidence i ntervals ranges from $6.53/bbl to $25.88/bbl. Ho we ve r, e ve n if

on e v iew ed

allcas es a s es sentia llyeq ua llylik ely , th e co m

bin ed 90 % co nf

ide nc e int erv al w ou ld b e so m ewhat narro we r th anthi s. V. 2 ARe co mme nd edCa se Cl early t he re i s an un av oid ab le d egree of

un cer tai nty ab out th e m agnit

ud e o f m arg ina l economic costs from the U.S. im portati on of petroleum, and the size of the oil import premium

. W e sought to re flect this with probabili stic ri sk anal ysis over key i nput factors, guide d by the av ail ab le l ite rat

ure an d th e b est

judge m ent of

oilm ark et e xp ert s. Fo r ca ses sh own in Ta ble 4 th at explo re s om e p lau sib le v ari ati on s in the ran ge s o f inp ut a ssum pti on s, the m ean

pre m ium est im ate s vary i n a fa irl y m od erate r an ge , b etw een $1 1 and $1 5/b bl. On

ba lan ce, Ca se 6 is s ug ge ste d a s a reasonable assessment of the premium value. This is based on a revi ew of im portant dr iving-47-

fa cto rs, the num eri calev alu ati on s an d s im ulatio ns ov er m ajo r un cer tai nti es, an d takin g into considerat ion the many comments and suggestions from reviewers, the EPA and otheragencies. Th is c ase , and

the pre m ium

ran ge res ult ingfr om

90 % of the sim ulated outco m es, en co m

pa sse s a wide array of perspe ctives and pot ential market outc omes in response to a reduc tion of U.S. im po rts . In thi s re co mm en de d c ase the m ean co sts are : Monopsony premium

component $7.41/bbl, Disruption component (macroeconomic and import costs) $4.59/bbl, Total midpoint $12.00/bbl +/- ~$6/bbl This case re lies on the most recent available projec tions of the U.S. and world oil market for the next 10 years, the AEO 2007 Reference Case. OPEC-behavior is tre ated parametrica lly, with a wi de ran ge of

po ssible res po ns es r ep res ented bya w ide ran ge of

su pp ly e las tic iti es, fr om

sm allto quite lar ge. This recogni zes that the OPEC response is the most uncerta in single e lement, and co uld vary b etw een

ine las tic de fe ns e o f o utp ut l ev els , o r m ark et s hare, or c ou ld b e h igh ly e las tic in defense of price, probably at the e xpense of longer run cartel power and discounted netprofits. Th e b alanc e b etw een

po ssible ela sti c an d in ela sti c O PE C r esp on se i s es sentia llyev en , o ve r a fairly wide range of elastici ties. This s eems the best strat egy until gr eater pr ogress can be made in synthesi zing what insi ghts are ava ilable from the evolving strategic game-theoretic and empirical research on OPEC behavior, and advanci ng that res earch. An alte rnative would have be ento u se O PE C s trateg ic r esp on se b eh av ior to m ax im ize lon g-r

un ne t re ve nu e. Th is m aywe ll correspond t o market-share pres ervation be havior (e.g. Case 5), and a somewhat higher premium value. The case in Table 1 uses updated suppl y/demand elasticit ies for non-U.S./Non-OPEC reg ion af ter co ns ide rin g m ore rec ent es tim ate s th antho se u sed in 1 99 7 s tud

y, an d p rev iou sly ad op ted fo r th e 2 00 6 RFS . A s a r esu lt, thetot al m ark et r esp on siv en ess is s ub stanti all y greater than was the cas e in the dra ft report, and i s overall quite lar ge. The implied net offsetting response of competitive suppl iers and demanders outsi de the U.S., to any pric e decline c aused by a U.S. import reduction, is fair ly high given that it must occur overthe next 10 year s, and in a glo ba l po lic y mili eu

that is ge ne ral ly q

uit e attentiv e to co ns erv ati on an d e ne rgy

sec uri ty. On ly small changes to the worl d oil pric e are anti cipated from a substantia l reducti on in U.S. demand, on average about$0.70/bbl for every million- barrels -per-day r eduction in de mand. Finally, the cas e u ses a G DP ela sti city rang e, the param ete r whic h s um m ari zes the sen sit ivi ty o f G DP to o il price shocks , which is reduce d compared to earlierestimates, and compared to the full r ange of histori cally-ba sed estimates. This hel ps address the concerns of those who ei ther quest ion the conclusions of pastempirical esti mates or expect thatthe impacts of oil shocks may well be declining.-48-

Table 4: Alternati ve Cases Examined. Optim al Premium, M ean and 90% Conf. IntervalF o r ex am p le, th e C o u n cil o n F o reig n R ela ti o n s (2 0 0 6 ) h ig h -l ev el p an el o f e n erg y an d fo reig n p o li cy ex p erts w arn s th at A m erica ’s 45 d e p e n d e n c e o n im p o rte d e n e rg y in c re a s e s its s tra te g ic v u ln e ra b ility a n d c o n s tra in s its a b ility to p u rs u e fo re ig n p o lic y a n d n a tio n a l se c u rity o b jec ti v es . S tern (2 0 0 6 ) m ak es th e s tr o n g ca se th at larg e c artel ren ts h av e c o n tr ib u ted to th e d ev elo p m en t o f rich , rad ica li ze d , an d m il it arily m o re po w er ful ho st i l e st at es. H e ar gu es f or t he exer ci se of

U

. S. m on op sony p ow er no t si m pl y t o re cover w eal t h, bu t because O PE C m ar ket po w er un der w r i t es t er r or a nd ot her t hre at s t o U

. S. nat i on al sec uri t y. -49- VI. Conclusions Th is s tud y a sse sse s th e m arg ina l ne t ec on omic b en ef its to t he U. S. eco no my o f r ed

uc ed U.S. im ports of oil. “Secur ity” gains stem from reduced exposur e to the economy-wide costs of potential disrupti ons in oil suppl y or spikes i n oil cost. Reduce d U.S. oil imports also provide sustained “ monopsony” benefits over the long run e ven in undisrupt ed markets, by reducing global demand pressure and oi l prices during what is e xpected to be an extended peri od of strong global demand, substantia l OPEC m arket power, and hi gher world oil prices. The monopsony be ne fi ts d uri ngno rm al m ark ets or disr up ted m ark ets ref

lec t a r eco ve ry o f U .S . w eal th t hat w ou ld otherwise be e xtracte d as carte l rents through the non-competiti ve exercis e of m arket power by OP EC co untri es. In t he fa ce o f p roj ect ed

highe r oi l price s, gro wi ngU. S. oilim po rts , a large an d s low ly growing role of U.S. imports in world oil trade, a growing ec onomy and a general expectat ion that th e o il m ark et maybe so m ewhat m ore ris kyov er the ne xt d eca de , o ur e sti m ate of the oil import premium

is notably l arger than estimated in 1997. Like our pr ior esti mates, this study ex clu de s p os sib le e ff

ect s o f i m po rts on U. S. co sts wh os e re lat ion to i m po rt l ev els is dif

fi cu lt t o asc ert ain or m eas ure , s uc h a s m ili tar y e xp en dit

ure s an d f ore ign po lic y e ff

ect s. Ho we ve r, t

ho se costs remain rele vant and worthy of more careful consider ation. 45 Apart from omitting forei gn policy, military, and national s ecurity c onsiderat ions from thi s ec on omic ana lys is, thr ee o the r f act ors we re o m itt ed

wh ich , if inc lud ed , w ou ld p os sib ly in cr ea se th e e co no mic es ti mat e o f the pr emi um: ! Any f

urt he r pr em ium

du e to ris k ave rsi on

(th e d isr up tio n ana lys is i s b ase d o n e xp ect ed va lue s); ! Possible “det errence e ffects” of energy security and import reduction measures (the frequency of disruptions might be reduced if greaterU.S. energy security reduces the motivation for intenti onal shocks (e mbargoes or terrori st acts) ); and ! Spillover be nefits to U.S. alli es (some benefits of U.S. im port reduct ion, parti cularly the benefit of lower import prices, would s pill overto all major oil c onsuming nations, many of wh ich joi n u s in a f orm al I nte rnatio na l E ne rgy Ag en cyagree m ent to red uc e en ergy u se and promote joint energy s ecurity. Base d on prior est imates, including the full OECD pre m ium res ult ingfr om

U. S. im po rt r ed uc tio n w ou ld r esu lt i n a

va lue ap pro xim ate ly t

hre e tim es l arg er)

. Th is m arg ina l “p remium ” ap pro ach est im ate s th e ef

fe ct o n U .S . s oc iety-w ide eco no m ic co sts of aninc rem entalred

uc tio n in im po rts . It doe s n ot dire ctl y a pp ly t o th e ef

fe cts of a b roa de r policy change that not only al ters the quantity of oil i mports, but m ay also shift other features of the oilm ark et i n im

po rtant w ay s. Po ssible change s in m ark et r elatio ns hip s th at are n ot m od ele d but co uld str on gly inf lue nc e o il s ecu

rity c os ts i nc lud e:-50-

! increase d (or decre ased) flexibi lity of demand and supply, in the short-run or l ong-run; ! decreased c artel poweror discipl ine; and ! co ordinated

(am pli fy ingor o ff

settin g) p oli cie s b y o the r oi l im po rti ngco untri es. Whil e th e st

ud y e sti m ate s th e m arg ina l so cie taleco no m ic b en ef it o f a red uc tio n in im po rts , it do es n ot argu e th at an o il t axor i m po rt- tarif f e qu al i n m agnit

ud e to that m arg ina l so cie talpre m ium

is an e ff ici ent po lic y f

or a dd res sin g o il s ecu

rity. Th is i s b eca

us e th e ro ot m ark et fa ilures at w ork

are no n-c om

pe tit ive glo ba l oi l su

pp ly and the fa ilure o f l on g-t erm

pri vate o il market transacti ons to foresee and ac count for the economy-wide macroeconomic dislocations that are borne during di sruptions a s a consequence of the c hosen pre-di sruption l evels of oil use. An externali ty-type ( Pigouvian) ta x on undisrupted- market oil imports does not dir ectly or ef fi cie ntl y a dd

res s ei the r of

the se i m pe rf ect ions . Whil e th e o il i m po rt p remium

do es e sti m ate ho w r ed uc ingoilim

po rts co uld

dimini shthe co sts of

no n-c om pe tit ive su

pp ly and red uc e macroeconom ic losses during disr uptions, itdoes not addres s the value t o society of reduci ng the se c os ts thro ugh o the r m eas ure s. Indivi du al p oli cym eas ure s n eed to b e ev alu ate d in

thi s broader cont ext, and this analysis c an provide partial i nsight int o their appr opriatene ss and be ne fi t.-51-

Ap pe nd ix A : P ar ame ter s fo r th e U pd ate d ( 20 07 ) Oi l Im po rt P rem iu m A na lys is Ta bl e A 1: E sti mat es o f D ema ndan d S up ply E las tic iti es f ro m L ite ra tu re

Di sru pt ionPr ob ab ili tie s

Tab le A2: De ca da l P ro ba bi li ti es of 1 o r M or e D is ru pt io ns of a G iv en Si ze Case 1 Milli on

Barre ls/Day 3 Milli on

Barre ls/Day 6 M ill ion Barre ls/Day 1997 Study Low 50% 10% 5% 1997 Study Mid 70% 30% 15% EMF-2005 25% 36% 13% See Appendix C for derivati on. Table: Summ ary of represent ative est imates of short-run pri ce elast icity of demand and adjustment rates. ( Source: Atkins, Fr ank J. and S. M. Tayyebi Jaz ayeri 2004.)-52-

Histori cal Disruptions

Ta bl e A 3: H ist or ica l D isr up tio ns in th e W or ldSu pp ly o f Oi l Type Number Average Duration (mo nt hs ) Ave ra ge Si ze

(% of w or ld Su pp ly Accidents 5 5.2 1.1% Internal Politica l Struggles 9 6.5 2.3%
Int ern ati on al E m

bargo s/ Ec on omic D isp ute s 4-6 ** 11.0 (6.1 ) 6.2% * W ars in M iddle E ast 4-7 ** Total/Average 24 8.1 (6.0 ) 3.7% *

N ot es : *Excl udi ng 44 mont h I r ani an Oil f i el d N at i onal i zat i on. * * S o m e e v en ts difficu lt to c lass ify

. So u r c e s : Ev e n tl i s t i n g f

r o m U. S. EI A. Ca t e g o r i z a t i o n b y P a u l Le i b y, ORNL. Summary of historical oil disrupti ons, 1950-2003-53- Tabl e A4: Rang e o f

K e y A s s um pt i on s Us e d i n S t udy K E Y PA R A M E T E R S/ A SSU M PT IO N S L ow M i d H i gh G D P di srupt i on- l oss el as t i ci t y 0. 01 0. 032 0. 054 D i srupt i on r educt i on w / i m por t s 0% 10% 30% O PE C LR s uppl y el as t i ci t y 6 1. 75 0. 25 Shar e of di srupt i on pr i ce i ncr eas e a nt i ci pat ed 100% 25% 0% D i srupt i on pr ob ca se s el ect or 5 5 5 D i sr up t i on l eng t h (yr s) 1 1 2 SPR pol i cy ( di srupt i on f r act i on of

f se t ) 100% 50% 50% SPR pol i cy ( SPR f

r act i on us ed) 100% 100% 100% SPR s i ze ( m i l l i on bar r el s) 688 688 688 Long r un el as t i ci t y of

U

. S. oi l demand

- 30%

- 27%

- 20% Long r un el as t i ci t y of

U

. S. oi l s uppl y 46% 46% 46% A dj ust m ent r at e f

or dom es t i c oi l demand 20% 15% 10% A dj ust m ent r at e f

or dom es t i c oi l s uppl y 15% 15% 15% O i l m arket ( A E O 20 07 ) case 1 2 3 I m por t oi l pr i ce ( $/ B B L, 2005$) $43. 61 $50. 99 $64. 54 D om es t i c oi l demand ( M M B D ) 22. 521 22. 189 21. 782 D om es t i c oi l pr oduct i on ( M M B D ) 9. 656 9. 628 9. 487 U

. S. oi l i m por t l evel ( M M B D ) 12. 864 12. 561 12. 295 U ndi srupt ed G D P ( $bi l l i on/ year , 2005$) $14, 637 $14, 573 $14, 479 N on- U

. S. neti m por t demand ( M M B D ) 22. 125 21. 866 17. 965 O PE C s uppl y ( M M B D ) 34. 989 34. 429 30. 265 O t her non- O PE C s uppl y ( M M B D ) 48. 580 47. 466 47. 716 Tot al s uppl y ( M M B D ) 93. 224 91. 523 87. 468 N et i m por t s uppl y t o U

. S. ( M M B D ) 12. 864 12. 583 12. 300 El as t i ci t y: non- U

. S. non- O PE C neti m por t demand

- 2. 157

- 1. 602

- 1. 262 El as t i ci t y: non- U

. S. non- O PE C s uppl y 0. 400 0. 300 0. 200 El as t i ci t y: non- U

. S. non- O PE C demand

- 0. 400

- 0. 300

- 0. 200 El as t i ci t y: neti m por t s uppl y t o U

. S. 20. 029 7. 585 2. 459-54- Ta bl e A 5: A lte rn ativeEs tim ate s fo r Current Oil Im port Premium, Mean Value and 90% Confidence Interval-55- (20)

(22)

(23)

(24) 

### Techni calAppend i x B - Cal cul at i on o f Premium Mo no ps ony P re mium:

Ca lcu lat ion

of the ela sti city o f n et i m

po rt s up ply

(21)

Di sru pti on Pr em ium - to tal

Disruption Pre mium

- Import Cost Com

ponent

No te that th e f

irs t su b-c om po ne nt, the de ter

ren ce p ort ion

of the Di sru pti on Im po rt C os t Co m po ne nt, can

be writt en-56- (25)

(26)

(27)

(28) This gives some sense of the possibl e magnitude of that omitted term. If the elastic ity of pro ba bil itywi th resp ect

to i m po rts we re t o b e, e. g. 1. 0, the n th is t erm wo uld be eq ua l to N , qi the expe cte d p ric e in cre ase . W e as sum e , = 0. Disruption Pre mium

- elabora tion of Disruption M onopsony Premium

Fo r a l ine ar treatm ent of

dis rup tio n p ric e ch an ge :

Disruption Pre mium

- GDP Dislocation Cost Component

Us inga li ne ar a

pp rox im ati on

fo r th e ch an ge in G DP wi th p ric e, wh ich is a ccu rat e g ive n Yp small elastici ty of GDP with respect to oil shocks, , :

Su bs tit uti ngan d takin g d eri vativ es-57- (29)

(30)

(31) j Dropping the possi ble deterrence effect of pre-dis ruption import level s on N and holding

du de m an d le ve l q an d G DP ela sti city c on stant f or t his parti al e qu ilibrium

an aly sis of

im po rt changes leave s only the la st two terms.

Three channels remain for the pre-disruption i mport level to affect the dis ruption pri ce level and GD P l os s: thro ugh th e b ase oilpri ce, thr ou ghdis rup tio n q uanti ty and

thr ou ghthe rat e o f p ric e change with disruption quanti ty.

Ag ain , f or a lin ear tre atm ent of

dis rup tio n p ric e ch an ge :-58- (32)

(33)

(34)

(35) Comb in in g T erms

substitut ing (without de terrenc e effect terms or terms related t o the change in pr e-disrupt ion de m an d w ithpre -di sru

pti on im po rt l ev els ):

gath er in g t erms-59-



### Append i x C: Deta i l s on Cal cul at i on o f Dis rupt i on Prob abi l i ti es Disruption pr obability distri butions for four major supply regions were adopted from the EMF20 05 stu dy , whic h f

oc us ed on the 20 05 to 2 01 5 p eri od . F or e ach reg ion , th esedis tributio ns we re specified for disruptions in t erms of percentage loss of supply, typi cally for 0%, 20% , 50% and 90 % lo sse s. (S ee t

he fo llo wi ngFi gure and

Ta ble C1 be low ).

Th e d eca da l pr ob ab ili tie s w ere co nv ert ed to annua l pr ob ab ili tie s an d e nte red in a sim ple pro ba bil ist ic s im

ulatio n s pre ad sh eet

dri ve n b y @ Ri sk . A ft er c om bin ed sim ulatio n o f annua l disrupti ons with a sample size of 10,000, using the software @Risk, the following cumulative dis tributio n f

or annua l pr ob ab ili tie s o f w orl d s up ply sh ort fa lls (gr os s an d n et a ft er e xc ess cap aci ty uti liz ati on ) w as o bta ine d f or t he ye ar 2 01 0. Th is dist

rib uti on wa s take n a s g en era lly rep res entat ive of

annu al disr

up tio ns in t

he ne xt d eca de

. Fi gu re 5 EMF 2005 reported dec adal, net di sruption di stribut ions by region, for short and long disrupt ion lengths. Thei r implications for dis ruption si zes (based on an earlie r AEO) are sh own h ere , and

we re a ggreg ate d and

summ ari zed

in t his an aly sis . (S ource : EM F/Be ccu e an d Huntin gto n, 20 05 ).-60-

Th is distrib uti on

of wo rld su pp ly n et s ho rtf

all s w as a ggreg ate d into p rob ab ili tie s f or 4 dis cre te ne t dis rup tio n s ize s, to m atc h th e si ze c ate go rie s u sed in t he 19 97 OR

NLan aly sis . T he dis cre te n et disrupti on sizes were: 0 MMBD (including 0.0- 0.999 MMBD), 1 MMBD (including 1.0- 3.999 MMB D) , 4 MMB D ( inc luding4. 0-5 .9 99 MMB D) , and 6 M MB D ( inc luding6. 0 and large r). It i s rec ogniz ed

that th is s im

ple ag gre gatio n into b ins ide nti fi ed wi th t he low er- bo un d-v alu e le ad s to some understatement of the m ean disrupt ion sizes e ntailed by the EMF study. In fact, the expected dis ruption si zes for events within each of the four bins ( size cat egories) are 0.1, 1.5, 4.7, an d 1 0. 0 M MB D, res pe cti ve ly. Th e annu al disr up tio n p rob ab ili tie s f

or e ach dis cre te s ize we re converted i nto decadal di sruption pr obabilit ies (for at l east one dis ruption of that s ize cate gory).

decada l annual That is, N = 1-(1- N ) . These decadal e vent probabil ities ( see Table C2) were us ed for 10 the premium calculation meant to be repre sentati ve over the per iod 2006-2015. Fi gu re 6 Cum

ulative di stribut ion for annual probabi litie s of world supply shortfall s (gross and ne t af ter ex ces s ca

pa city util izatio n) i n th e y ear 20 10 , a ft er s im

ulatio n f or t he sep arate r eg ion s.-61- T abl e C 1: E M F 2005 D i sr upt i on Probab i l i t i es Pr i m ar y Sour ce: Ener gy M odel i ng For um , Phi l l i p C

. B ecc ue a nd H i l l ar d G

. H unt i ngt on, 2005.
Saudi A rabi a Probabi l i t i es Saudi A r abi a D i srupt i on Lengt h Pr obabi l i t i es Lengt h ( M ont hs) 3 12 18 Lengt h Pr obabi l i t y 54. 0% 22. 2% 23. 7%
Saudi A r abi a D i srupt i on Si ze Pr obabi l i t i es Si ze/ Lengt h 0. 00% 20. 00% 50. 00% 90. 00% Tot al

3 93. 38% 5. 07% 1. 15% 0. 40% 100. 00% 12 97. 14% 1. 95% 0. 60% 0. 32% 100. 00% 18 98. 58% 0. 87% 0. 31% 0. 24% 100. 00%
W es t of Suez R egi on Probab i l i t i es W es t of Suez D i srupt i on Lengt h Pr obabi l i t i es Lengt h ( M ont hs) 3 12 18 Lengt h Pr obabi l i t y 37. 6% 48. 1% 14. 3%
W es t of Suez D i srupt i on Si ze Pr obabi l i t i es

Si ze/ Lengt h 0. 00% 20. 00% 50. 00% 90. 00% Tot al

3 85. 83% 11. 90% 2. 19% 0. 07% 100. 00% 12 92. 61% 5. 77% 1. 55% 0. 07% 100. 00% 18 98. 66% 0. 89% 0. 42% 0. 03% 100. 00%
O t her Pers i an G ul f

R egi on Probab i l i t i es O t her Per si an G ul f

D i srupt i on Lengt h Pr obabi l i t i es Lengt h ( M ont hs) 3 12 18 Lengt h Pr obabi l i t y 42. 1% 30. 2% 27. 6%
O t her Per si an G ul f

D i srupt i on Si ze Pr obabi l i t i es

Si ze/ Lengt h 0. 00% 20. 00% 50. 00% 90. 00% Tot al

3 79. 87% 18. 07% 1. 84% 0. 21% 100. 00% 12 92. 60% 5. 96% 1. 28% 0. 16% 100. 00% 18 97. 02% 2. 21% 0. 67% 0. 09% 100. 00%
R uss i a and C aspi an R egi on Probab i l i t i es R uss i a a nd C as pi an R egi on D i srupt i on Lengt h Pr obabi l i t i es Lengt h ( M ont hs) 3 12 18 Lengt h Pr obabi l i t y 89. 5% 8. 0% 2. 5% R uss i a a nd C as pi an R egi on D i srupt i on Si ze Pr obabi l i t i es Lengt h/ Si ze 0. 00% 20. 00% 50. 00% 90. 00% Tot al

3 97. 08% 2. 41% 0. 51% 0. 00% 100. 00% 12 99. 57% 0. 33% 0. 10% 0. 00% 100. 00% 18 99. 87% 0. 10% 0. 03% 0. 00% 100. 00% W ork So urce: "O i l 64 deco m po si t i on B yP r i ceP at h sho r t l on gv l on g.xl s", A ug ust 16, 2005

. For l eng t hs, se e w or kshe et " oi l 64codedl engt hsbyr egi on. xl s" , A ugust17, 2005.-62-

Table C2: Discrete Disr uption Probabiliti es Used in Disruption Premi um Calculation

D i srupt i on Si ze ( Thousand B bl / d) 0 1000 3000 6000
D i srupt i on Si ze ( M i l l i on bbl / d) 0 1 3 6 G r oss D i srupt i on C um ul at i ve A nnual Pr obabi l i t y 75. 5% 75. 5% 93. 9% 95. 4% N et D i srupt i ons C um ul at i ve A nnual Pr obabi l i t y 77. 1% 91. 4% 94. 2% 98. 7% N et D i srupt i on A nnual D i sc r et e Pr obabi l i t y 14. 2% 2. 9% 4. 4% 1. 4% N et D i srupt i on D eca dal D i sc r et e Pr obabi l i t y 78. 4% 25. 3% 36. 4% 12. 7%-63- 

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