We are enormously grateful for the careful review and helpful comments offered by a review panel including Joseph E. Aldy, Resources for 1

the Future, Stephen P. A. Brown, Federal Reserve Bank of Dallas, Dermot Gately, New York University, Hillard G. Huntington, Energy

Modeling Forum and Stanford University, Mike Toman, Nitze School of Advanced International Studies, Johns Hopkins University, and Mine

Yücel, Federal Reserve Bank of Dallas. Additional helpful suggestions were offered by Edmund Coe, Jefferson Cole and Michael Shelby, U.S.

EPA, and Gbadebo Oladosu and David Greene, Oak Ridge National Laboratory. Naturally the views and conclusions offered are the

responsibility of the author.

ORNL/TM-2007/028

Estimating the Energy Security Benefits of Reduced U.S. Oil Imports1

Final Report

Paul N. Leiby

Oak Ridge National Laboratory

Oak Ridge, Tennessee

leibypn@ornl.gov

Revised March 14, 2008

Prepared by

OAK RIDGE NATIONAL LABORATORY

Oak Ridge, Tennessee 37831

Managed by

UT-BATTELLE

for the

U.S. DEPARTMENT OF ENERGY

under contract DE-AC05-00OR22725 
This report was prepared as an account of work sponsored by an agency

of the United States Government. Neither the United States Government

nor any agency thereof, nor any of their employees, makes any warranty,

express or implied, or assumes any legal liability or responsibility for the

accuracy, completeness, or usefulness of any information, apparatus,

product, or process disclosed, or represents that its use would not

infringe privately owned rights. Reference herein to any specific

commercial product, process, or service by trade name, trademark,

manufacturer, or otherwise, does not necessarily constitute or imply its

endorsement, recommendation, or favoring by the United States

Government or any agency thereof. The views and opinions of authors

expressed herein do not necessarily state or reflect those of the United

States Government or any agency thereof.
 For example: “Keeping America competitive requires affordable energy. And here we have a serious problem: America is addicted to oil, 2

which is often imported from unstable parts of the world.” (President G.W. Bush, State of the Union, Jan 2006). “Our dependence on oil creates a

threat to America's national security, because it leaves us more vulnerable to hostile regimes, and to terrorists who could attack oil infrastructure,”

(President G.W. Bush, statement on CAFE and alternate fuel standards Monday, May 14, 2007, in the Rose Garden). The President’s “Twenty in

Ten” proposal (President G.W. Bush, State of the Union, 2007) has the goal of “strengthening energy security and addressing climate change by

reducing gasoline use by 20% in ten years” (http://www.whitehouse.gov/stateoftheunion/2007/initiatives/energy.html). 

 The U.S. has had sustained interest in alternative motor fuels, as codified in the Energy Policy Acts of 1992 and 2005, and AMFA, the 3

Alternative Motor Fuel Act of 1988. In 2007, the U.S. Environmental Protection Agency (EPA) finalized a national renewable fuels program

(more commonly known as the Renewable Fuel Standard, or RFS program). 

Estimating the Energy Security Benefits of Reduced U.S. Oil Imports 

Final Report

Paul Leiby

Oak Ridge National Laboratory

leibypn@ornl.gov

March 14, 2008

Abstract

This update and reassessment of the oil import premium was motivated by renewed

concern about energy security, and interest in policies to promote the reduction of gasoline use in

the United States. To the extent that conservation or fuel-diversification reduces dependence on

any one source, the financial and strategic risk of potential disruption in supply or spike in cost

of that source is reduced. This reduction in risks improves energy security. Reduced oil imports

would also provide sustained benefits over the long run even in undisrupted markets, by

reducing global demand pressure and oil prices during what is expected to be an extended period

of strong global demand growth, substantial OPEC market power and higher world oil prices. 

We consider projected oil market conditions over the next ten years, relying on official U.S.

Energy Information Administration (EIA) projections. A current estimate of the oil import

premium is $12.00 per barrel (in 2005 dollars), with a wide confidence interval ($6.67 - $17.95)

to reflect many of the unresolved uncertainties. While this central value is above some estimates

from the mid-1990s and early 2000s, it is well within the range of prior estimates up to 1993,

many of which were made at times when oil market conditions were more similar to what is now

anticipated. The essential message is that we may have passed through a brief period of

comparatively greater energy security and lower dependence costs, but strong market and

geopolitical forces have returned the societal costs of oil imports to greater prominence. An

important note is that this premium estimate omits any costs for military programs, and the

difficult-to-quantify foreign policy impact of oil import reliance.

I. Introduction 

I.1 Background and Purpose

There is considerable interest in the highest U.S. policy circles with taking action to

improve energy security. There are active proposals to reduce oil consumption and displace oil 2

with alternative and renewable fuels. This study investigates the energy security benefits of 3
 Leiby, Paul N., Donald W. Jones, T. Randall Curlee, and Russell Lee, Oil Imports: An Assessment of Benefits and Costs, ORNL-6851, Oak 4

Ridge National Laboratory, November 1, 1997.

 This paper was cited and its results utilized in previous DOT/NHTSA rulemakings, including the 2006 Final Regulatory Impact Analysis of 5

CAFE Reform for Light Trucks: US DOT, NHTSA, "Final Regulatory Impact Analysis: Corporate Average Fuel Economy and CAFE Reform

for MY 2008-2011 Light Trucks," Office of Regulatory Analysis and Evaluation, National Center for Statistics and Analysis, March 2006.

-2-

reduced U.S. oil imports. A range of approaches have been developed at Oak Ridge National

Laboratory (ORNL) for evaluating the social costs and energy security implications of oil use,

and for evaluating policy measures that alter the U.S. consumption and imports of oil. To help

estimate the energy security benefits of reducing oil imports, we updated and applied the method

used in the 1997 report, Oil Imports: An Assessment of Benefits and Costs, by Leiby, Jones,

Curlee and Lee. This approach estimates the marginal benefits to society, in dollars per barrel, 4

of reducing oil U.S. imports. The “oil premium” approach emphasizes identifying those energy- 5

security related costs which are not reflected in the market price of oil, and which are expected

to change in response to an incremental change in the level of oil imports. 

We acknowledge, as did others before, that oil security and dependence costs are not

strictly a function of imports alone. Other attributes, such as the level of oil consumption, the oil

intensity of the economy, and the flexibility of oil supply and demand are also important

determinants of the societal economic costs of oil use. These points are well made by Toman in

his comprehensive survey pieces on energy security (1993, 2002). To the extent that a reduction

in oil imports is accompanied by a reduction (increase) in oil consumption, or by the introduction

of technologies or fuel sources that increase (decrease) the short-run or long-run priceresponsiveness of energy supply and demand, the incremental benefits to society would be

greater (less) than estimated here.

I.2 Approach

This update and reassessment of the oil import premium is meant to help measure the

energy security implications of new policies to promote the reduction of petroleum use in the

United States. The oil import premium is an informative measure of long-standing interest, but

is not intended to provide complete guidance on oil security policy. The oil premium is not a

measure of the full social costs of oil imports, or the full magnitude of the oil dependence and

security problem. Rather, it is a measure of the quantifiable per-barrel economic costs that the

U.S. could avoid by a small-to-moderate reduction in oil imports. The premium does not

estimate the value of introducing a radical new technology, which may entail a major shift in

supply or demand curves, or a substantial change in the long-run or short-run flexibility of

supply or demand. As estimated, it is most consistent with the benefits of contracting domestic

demand or expanding domestic supply along the existing demand and supply curves through

conventional market incentives. 

It is also important to note that an estimated oil import premium of $5, $10, or $20 per

barrel does not mean that a tax or tariff of that magnitude is recommended as the best policy. 

Nor does it mean that the imposition of such a tax alone would completely solve the energy
 Energy Modeling Forum, Phillip C. Beccue and Hillard G. Huntington, 2005. “An Assessment of Oil Market Disruption Risks,” FINAL 6

REPORT, EMF SR 8, Stanford University, October 3.

-3-

security problem and eliminate the need for any other policy. The multifaceted nature of the

costs measured by the import premium suggests pursuing a combination of policies targeting key

aspects of the problem. Bohi and Montgomery (1981) compellingly made this point. Helpful

policies would promote more competitive oil supply in the long-run and short-run by

diminishing the profitability and power of cartelized oil supply. They would also reduce the

economy’s vulnerability to oil shocks by increasing short-run supply/demand flexibility,

promoting supply-region stability, developing buffer stocks, and diminishing the economy’s

reliance on fuels with unstable supply. 

Since publication of Leiby et al. 1997, changes in oil market conditions, both current and

projected, suggest that the magnitude of the oil premium may have changed. Significant driving

factors that were revised or reconsidered include: oil prices, current and anticipated levels of

Organization of Petroleum Exporting Countries (OPEC) production, U.S. import levels, potential

OPEC behavior and responses, Strategic Petroleum Reserve (SPR) levels, and disruption

likelihoods. We apply the most recently available careful quantitative assessment of disruption

likelihoods, from the Stanford Energy Modeling Forum (EMF) 2005 workshop series, as well as 6

other assessments. We also revisit the issue of the macroeconomic consequences of oil market

disruptions and sustained higher oil prices. Using the oil premium calculation methodology,

which combines short-run and long-run costs and benefits, and accounting for uncertainty in the

key driving factors, we provide an updated range of estimates of the marginal energy security

benefits of reducing U.S. oil imports.

As part of the development of these estimates, the draft report underwent a formal

external peer review by an independent panel. Comments received addressed the basis of the

estimates, focusing on the choice of market elasticities, OPEC behavior, and the potential

magnitude of macroeconomic disruption effects. They also called for updating the base price

and market conditions to newer official projections, suggested language revisions, and called for

some explanatory sections. A summary of the peer review is available (EPA, Coe 2008). This

report embodies modifications and responses to those comments. Some topics were left for

further work, but as a consequence of these very helpful comments, the results have changed in

the following ways. Base price and market projections were updated to conform to the U.S.

EIA’s 2007 Annual Energy Outlook (AEO). This increased the estimated premium modestly

(~$1.4/bbl). Supply and demand elasticities were reviewed, and the non-OPEC supply and

demand elasticity ranges were updated and increased to levels consistent with many recent

estimates, particularly Gately and Huntington 2002 (see the parameter summary Table A4, and

the review of other elasticity estimates in Appendix A of this report). As a result, the net

elasticity of import demand from non-U.S./non-OPEC regions approximately doubled from the

value used in the 1997 study and the earlier draft of this study, in keeping with the

recommendations of some reviewers. Larger elasticities imply a greater market flexibility and

lower effect of U.S. imports on price, in this case decreasing the mean premium by $3-$4/bbl. A

set of sensitivity cases was prepared, displayed in Table 4 of Section V. We used a slightly
 This trend has been attributed in part to higher incomes making consumers less sensitive to fuel costs. 7

-4-

wider range of supply elasticities to parameterize OPEC response, and also, in a sensitivity case,

applied one leading candidate rule for OPEC strategic behavior (i.e., OPEC maintains its market

share through time). 

The magnitude of the macroeconomic effects of future oil disruptions remains a topic of

active debate. However, to consider the possibility, suggested by some but not all reviewers,

that the economy is becoming less sensitive to oil shocks, we applied a reduced Gross Domestic

Product (GDP) elasticity range in the base case results (GDP elasticity ranging from -0.01 to

~-0.05, rather than -0.01 to -0.08). The mean value is ~-0.03, reduced from the mean value of

approximately -0.05 used in the 1997 study, and the earlier draft. Finally, this report includes

further delineation of the nature of some components of the import premium, particularly the

nature of the disruption sub-components, and a more extended technical description of the

estimation methodology in Appendix B and C.

I.3 Concerns About Oil Security

Concerns about oil security stem from three related problems: concentrated supply in a

historically unstable region; the sustained exercise of market power by key oil exporters; and the

continued (although perhaps diminished) vulnerability of the economy to episodic oil supply

shocks and price spikes. Global oil reserves are concentrated in a volatile region of the world,

with 60% of reserves in the Persian Gulf region. Partly as a consequence of this concentration of

low cost reserves, OPEC producers are able to exercise market power, functioning as an

imperfect (“clumsy”) cartel and at times maintaining oil prices well above estimated competitive

levels. The strength and influence of this cartel grows and declines, largely in relation to cycles

of growth in global import demand and OPEC market share (e.g., Gately 2001, 2004; Greene,

Jones and Leiby 1998). Nonetheless, OPEC’s production or pricing decisions can impose

sustained economic costs over many years and can exacerbate, or ameliorate, short-run supply

shocks. In the face of short-run supply volatility most oil consuming nations have limited scope

for flexibly adjusting their oil supply or demand. This is particularly true as oil demand becomes

increasingly concentrated in the transportation sector (IEA 2005), given its low elasticity and

early evidence that the demand for gasoline in the light duty vehicle sector is becoming

increasingly inelastic (Hughes, Knittel and Sperling 2008; Small and Van Dender 2007:40-41).7

Uncertainty, rigidities, and adjustment costs lead to economic dislocation, particularly during

sudden and disturbing oil supply disruptions (Hamilton 2003, 2005; Davis and Haltiwanger

1999, 1999a). 

While evolving market institutions, declines in the energy intensity of the U.S. economy,

and strategic oil stockpiling are expected to mitigate the costs of oil disruptions to the U.S.

economy compared to situation in the 1970s and early 1980s, the problem of energy security has

not been eliminated. Our approach accounts for the benefits of the SPR. The power of the other

two proposed mitigating factors is less well established. As noted by many experts (e.g.
Leiby, Paul N., Donald W. Jones, T. Randall Curlee, and Russell Lee, Oil Imports: An Assessment of Benefits and 8

Costs, ORNL-6851, Oak Ridge National Laboratory, November 1, 1997.

U.S. DOT, NHTSA 2006. "Final Regulatory Impact Analysis: Corporate Average Fuel Economy and CAFE 9

Reform for MY 2008-2011 Light Trucks," Office of Regulatory Analysis and Evaluation, National Center for

Statistics and Analysis, March.

 National Academy of Sciences 2002. Effectiveness and lmpact of Corporate Average Fuel Economy (CAFE)

10

Standards, Committee on the Effectiveness and Impact of Corporate Average Fuel Economy (CAFE) Standards, National

Research Council (Washington, D.C.: National Academy Press).

-5-

Hamilton 2005, National Academy of Sciences 2002:86), according to simple economic

production theory the economic consequences of disruptions are expected to be related to the

U.S. expenditure on oil relative to the GDP, and to decline as that oil factor-share declines. 

However, Hamilton observes that the historical experience does not conform to the simple

factor-share argument. The drop in GDP following the five most notable oil supply disruptions

since 1950 far exceeded the loss predicted by the oil factor share. This and other empirical tests

lead Hamilton (2005:10), Huntington (2005) and Brown et al. (2005) to conclude that the

relationship between oil price shocks and output is more subtle and complex than originally

thought, with shocks working their way through the economy in many sectors by indirect

channels that can be surprisingly powerful. For these reasons, we cannot be certain that the

disruption component of the oil premium declines in direct proportion to oil share. Regardless of

this issue, recent trends have been less favorable. The decline in oil value share has halted and

reversed. The rising expenditure share for oil in U.S. GDP over the past few years alone calls

into question the assertion that the impact of disruptions on the U.S. economy is uniformly

declining. Furthermore, much higher oil prices and growing oil imports also suggest that the

incremental effect of U.S. oil use on world oil price and U.S. import costs could be higher than

in prior years.

I.4 Summary of Method

In order to estimate the energy security benefits of reduced U.S. oil use, we developed an

approach for evaluating the social costs and energy security implications of oil imports. This

approach can be used for evaluating policy measures that alter U.S. imports of oil. For

estimating these energy security benefits, we updated and applied the same oil import security

premium methodology used in the 1997 report Oil Imports: An Assessment of Benefits and Costs,

by Leiby, Jones, Curlee and Lee. This paper was cited and its results utilized in previous 8

DOT/NHTSA rulemakings, including the 2006 Final Regulatory Impact Analysis of CAFÉ

Reform for Light Trucks. It was also cited in the NAS 2002 discussion of CAFÉ. The 9 10

principal updates to the methodology applied for this analysis reflect the substantial changes in

oil market conditions since 1997, as projected by the U.S. EIA for the period 2006-2015. The

results here are based on the average oil market conditions over this period as projected by the

U.S. Energy Information Administration’s Annual Energy Outlook 2007 (AEO2007) Base Case. 

These changes and their individual implications will be further described below. Foremost

among them are substantially higher oil prices and higher U.S. oil consumption and imports than

in previous projections. The net result is that the estimated oil import premium is greater than in

the 1997 study (see Table 1 below). 
 Technically, the oil premium is based on a “marginal” economic analysis (i.e. a differential analysis of the rate of change of costs per barrel 11

change in imports). At times we use the term “incremental” in place of “marginal” here to avoid confusion with marginal in the more common

sense of “fringe” or “close to the limit of acceptability.” 

 Estimates of the oil import premium when counting marginal benefits for all of the Organization for Economic Cooperation and 12

Development (OECD) are typically about 3 times as large as the premium estimated from the perspective of U.S. benefits alone (e.g., Kline

1981).

-6-

Table 1: Summary Results

 Effect / Study ORNL 1997 Report

(2005$/BBL)

ORNL 2007 Updated

(2005$/BBL)

 Monopsony Component $2.64

($1.58 - $3.69)

$7.41

($2.77 - $13.11)

 Macroeconomic Disruption/ 

 Adjustment Costs

$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)

Results in 2005$. Columns report mean estimate and ranges. In the case of the 1997 report, the

ranges reflect the subjectively defined “narrowed range.” In the case of the new study, the ranges

include 90% of results from the risk-analysis simulation.

The approach estimates the incremental benefits to society, in dollars per barrel, of

reducing U.S. imports. This “oil import premium” approach identifies those energy-security

11

related costs that are not reflected in the market price of oil, and that are expected to change in

response to an incremental change in the level of oil imports. Omitted from this premium

calculation are environmental costs and possible non-economic or unquantifiable effects, such as

effects on foreign policy flexibility or military policy. Also omitted are any spillover-benefits

that may accrue to U.S. allies and trading partners who are similarly reliant on oil, and who would

benefit from a reduction in the level or volatility of world oil price. These are expected to be

large.

12
-7-

I.5 Changes Since the 1990s Analysis of Oil Import Premium

Since the 1997 publication of the Leiby et al. ORNL report, changes in oil market

conditions, both current and projected, suggest that the magnitude of the oil import premium may

have increased. Significant driving factors that have been considered in this new analysis are: oil

prices; current and anticipated levels of OPEC production; U.S. import levels; the estimated

responsiveness of regional oil demands and supplies; and the likelihoods of different-size

disruptions in the oil market. In updating the analysis, we applied projections of market

conditions from the U.S. EIA’s 2007 Annual Energy Outlook and the most recently available

careful quantitative assessment of disruption likelihoods from the Stanford Energy Modeling

Forum’s 2005 workshop series, as well as other assessments. The changes in key market

parameters are summarized in Tables 2 and 3 below. 

 

Table 2: Evolving Oil Market Conditions and U.S. Oil Use

1997 Study

Conditions

2006 Conditions 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 Supply 28.4 33.9 34.43

U.S. GDP ($2005) $8096 ~$12100 $14573

Oil Share of GDP 1.76% 3.57% 2.83%

Evolving historical and projected oil market conditions influence the premium estimate. Note

that all these parameters are positively related to the size of the import premium, to varying

degrees. (Price is in $/bbl; imports, demand and supply are in millions of bbl/day; and GDP is

in $billion per annum.) 
-8-

Table 3: Market and Parameter Changes Influencing Premium Estimate

Condition (+ or – Indicates Directional

Impact on Premium)

1997

Analysis

2007

Analysis

Percent Change Since

1997 Analysis*

U.S. Economy Larger (+) 8096 14573 +80%

Share of Oil in GDP (no net impact inferred)

 Value share ($ oil/$GDP)

 Physical share (BBL/$1000 GDP)

1.76%

0.82

2.83%

0.56

Value share +61%

Physical intensity -32%;

U.S. Oil Imports Higher (+) 8.82 12.56 +42% 

World Oil Price Higher (+) $21.45 $50.99 +138%

Estimated Ave. Annual Likelihood of Net Oil

Supply Disruption > 3.0 MMBD (+) 4.2% 5.8% ~+37%

U.S. Strategic Petroleum Reserve Size Larger (-)

600 688 +15%

Long-run Responsiveness of non-U.S./non-OPEC

Net Demand for Imports Greater (-) -0.88 -1.60 +83% **

*The 1997 study relied on 1996 data. Percent changes compare the levels used in the 1997 study with the projected

average level for the next 10 years, 2006-2015.

** This item reflects parameter revision as well as changed regional supply-demand balances. While the actual elasticity

of final demand and oil supply in individual regions may have decreased over the last decade, we considered a modestly

higher range for individual regions than those used in 1997 (based on a review of literature on oil demand elasticities and

on reviewer comments). The quantity-weighted combination of demand and supply elasticities yields the elasticity of net

import demand for the non-U.S/non-OPEC region.
 AEO2007 oil expenditure projections are $358 billion per year for the low price case and $513 billion per year for the low price case. 13

 The higher estimates emerge from a variety of recent time-series analyses of the historical data, focusing on those oil price events that are 14

sudden and outside the range of price experience in the prior 4 to 12 quarters. The lower estimates are generally produced by simulations with

large-scale structural econometric models, whose results are governed by whichever mechanisms for oil prices to affect the economy are

embodied in the model structure.

-9-

One indication that the current oil market situation for the U.S. is different from that of the

mid-1990s is provided by the level of U.S. expenditure on oil imports. Real U.S. expenditures on

crude oil are exceeding historical highs, as shown in Figure 1.

The average annual expenditure on oil projected over 2006-2015, the period of this study, is $413

billion per year (2005$), based on AEO2007.13

We also revisited the issue of the macroeconomic consequences of oil market disruptions

and sustained higher oil prices. There is substantial variation among the estimates of the GDP

loss from an oil price shock. Given the competing influences of a declining physical-intensity

14

Figure 1 Projections of U.S. oil expenditure as a share of GDP hover at the high levels

observed in the late 1970’s, even along the Midcase projection path without supply

disruptions. (Sources: Data through 2005 from U.S. EIA, Annual Energy Review various

editions, and Annual Energy Outlook 2007 Midcase, for projections after 2005). 
 This GDP elasticity summarizes the cumulative loss of GDP expected over 2 years as a fraction of one year’s GDP for a sudden, 15

unanticipated doubling of world oil prices.

 These cases evolved from the draft estimates developed for use in support of the 2006 Renewable Fuel Standard to the case presented here in 16

Table 1. 

-10-

of oil use in the economy (barrels per $ GDP) and a rising value-intensity of oil use in the

economy ($ expended for oil per $ GDP), it is unclear how to modify the oil-macro calculation, if

at all. The net effect of these counter-influences on the oil price-elasticity of the GDP may or

may not be zero. However, it is reasonable to assume that the resulting elasticity level remains

within the relatively wide (-0.08 to -0.01) range currently used in the sensitivity analysis.15

Accordingly, the disruption costs were estimated in the same way as the previous 1997 study. 

That is, the key parameter “GDP elasticity” that relates percentage GDP loss to percentage price

change during a shock, was varied parametrically in a sensitivity analysis over the same range of

values (-0.01 to -0.08), encompassing the estimates of most oil-macroeconomic studies over the

last decade. To account for the possibility that there has been a systematic reduction in the

sensitivity of GDP to oil price shocks we also considered a case where GDP elasticity was varied

over a lower range, (from -0.01 to -0.054), with a mean value of -0.032 (see Appendix A, Table

A4).

When considering the potential economic impacts of future disruptions in this analysis,

two factors were borne in mind.

! The projected base or undisrupted real oil expenditures are already at levels exceeding

those of the highest previous disruptions. The projected oil expenditure as a share of GDP

is comparable to the levels of the late 1970s, above all other historical times save during

the peak years of the Iranian Revolution (1979) and Iran/Iraq War (1980). A hypothetical

disruption which could double prices from this base level would put us in uncertain

territory, certainly a market regime which oil consumers and firms would find very

disturbing.

! The oil market disruptions are simulated based on event sequences posited by the Energy

Modeling Forum led workshops (EMF/Beccue and Huntington 2006). The larger of these

events are typically major geopolitical upheavals (revolutions and wars), the type of

events that are thought to be most alarming to economic actors and to lead to greater

uncertainty and dislocation in the economy. They are not to be confused with routine

price volatility or comparatively gradual demand-driven price rises, which might be

expected to have lesser macroeconomic effects.

Using the established oil import premium calculation methodology, which combines

short-run and long-run costs and benefits, and accounting for uncertainty in the key driving

factors, we developed an updated range of estimates of the incremental energy security benefits of

reducing oil imports shown in Table 1.

In the process of developing these estimates, and in response to comments from the review

panel, a set of alternative cases was developed. They considered: different sets of non-OPEC 16

supply/demand elasticities; alternative ranges of OPEC response, either in terms of the simulated

range of OPEC supply elasticity or using a OPEC strategic behavior rule that preserves OPEC
-11-

market share; and a lower range of GDP losses in response to oil shocks (lower GDP elasticities

with respect to oil price). These alternative cases are presented in Table 4 of Section V, Results.
 Note that non-competitive oil supply in the face of unpriced environmental externalities would lead to offsetting effects (see, e.g. Huntington 17

and Brown 2004).

-12-

II. The Oil Import Premium as a Measure of Energy Security Costs of Imports

II.1 The Issue of a Reference Point: Costs Relative to What?

When assessing the costs of oil imports, we must choose an appropriate reference point,

that is, answer the question "costs relative to what?" Three possible reference points for

comparison with the current levels of oil imports and consumption are: (1) hypothetical perfectly

competitive oil market conditions; (2) optimal levels of imports given market imperfections; and

(3) marginal (small incremental) changes in imports from the current level. Additional points of

comparison might be conditions under the introduction of different technologies or alternative

energy supply/demand systems, or other particular policies. These comparisons would give an

estimate of the value of particular market or policy changes, and are a worthwhile focus of future

work (see, e.g., Greene and Leiby 2006). However, since this study focuses on import levels and

seeks a per-barrel estimate of social costs, we restrict our consideration to these first three

reference points. 

At one extreme, the costs of oil imports can be measured relative to the competitive ideal

(e.g. Greene and Leiby 1993; Greene and Tishchishyna 2000). Such an idealized world would

have competitive supply and demand, no unanticipated price shocks, and no unpriced

environmental damages or other social costs. In other words, the per-barrel costs of oil could be

compared to the costs that would exist in the absence of any market failures. Using the 17

competitive ideal as a reference point would provide a general view of the magnitude of costs that

we might wish to recover. This may be a useful guide for research and motivate the search for

cost-effective solutions. It alone would offer only partial insight, however, on how much

government can or should do about oil use or imports to avoid these costs. It would be a mistake

to treat all costs beyond those of the competitive ideal as avoidable, since that would implicitly

assume the existence of costless government actions that totally eliminate the market failures.

Secondly, the potential costs of oil imports may be defined in terms of the difference

between the costs at the optimal (efficient) level and the current level of imports, recognizing that

complete elimination of social costs is not cost effective, and that some government programs are

already in place to respond to potential market failures. Since corrective action is not costless, the

pragmatic issue is one of balancing the costs imposed by government intervention against the

expected value of that intervention. For example, costs may be estimated relative to optimal U.S.

policy regarding import levels (e.g., Broadman and Hogan 1986, 1988; Huntington 1993). The

goal is to approach an efficient level of oil import costs, not to reduce those costs to zero. This

optimal level is dependent on a host of conditions about the structure of the domestic and world

oil markets, the vulnerability of the domestic and world oil markets to price shocks, and the

relationship between oil markets and the macroeconomy. The efficient or optimal level of import

costs may not be attainable with policies that are cost effective and pragmatically acceptable, but

the concept has the merit of being a desirable reference point. 
-13-

A third comparison point is the cost that would be caused by a marginal (small

incremental) change in oil imports from the current, or alternatively, from the optimal, level. A

small incremental reduction in imports may not be an optimal or adequate goal, but it has the

virtue of being an achievable reference point. The marginal reduction in social costs of a change

in import levels also reveals the amount we should be willing to pay (per barrel) to achieve that

modest change. Hence, marginal cost is a comparatively simple but useful guide for incremental

policy, and is the measure analyzed in this paper.

II.2. Interpretation of the Marginal Premium Approach

The oil import premium estimates the marginal economic benefit to the United States of

decreasing oil imports, beyond the market price of oil. However, it does not imply that the

imposition of a comparable tariff or tax would be either the most efficient or a fully adequate

policy to deal with the entire problem of oil dependence and security. Echoing the NAS

discussion of the energy security benefits of vehicle fuel economy (NAS 2002:86), it also should

be emphasized that:

“[the oil premium] includes neither the entire benefit to the United States of

‘solving’ the problem of noncompetitive pricing by the OPEC nations nor the

entire benefit of increasing international stability in world oil markets (or,

equivalently, the cost of not solving these problems). These problems cannot be

solved completely by changing the amount of oil consumed in the United States.”

II.3. Prior Estimates of the Oil Import Premium

The oil import premium gained attention as a guiding concept for energy policy beginning

in the late 1970s, around the time of the second and third major post-war oil shocks (Plummer

1981, Bohi and Montgomery 1981, EMF 1982). Stobough and Yergin (1979) focuses interest on

the demand or monopsony premium with their widely read estimates of the “buying power

wedge,” which they placed at a minimum value of $25/bbl to as much as three times that level. 

The works in Plummer (1981, 1981a) provided valuable discussion of many of the key

issues related to the oil import premium as well as the analogous oil stockpiling premium. They

also provide a range of premium estimates. 

In a book-length treatise, Bohi and Montgomery (B&M, 1982) carefully detailed the

theoretical foundations of the oil import premium and exposed, through their thoughtful analysis,

many of the critical analytic relationships. Because of its early position in the literature, and its

comprehensiveness, it is informative to consider that work in more detail. They argued for

attention to rigorous efficiency (cost and benefit) considerations and for evaluating what policies

might be appropriate in that context rather than paying undue attention to the level of oil imports

per se. They clearly defined the components of the oil premium as the “demand” or monopsonyrelated component and the “security” or disruption-related component (B&M 1982:5), with the
 B&M1982 and others note that the oil import premium is not synonymous with “optimal tariff,” and does not 18

necessarily call for a tariff of like magnitude, given the complexities of trade policy. Rather it is an estimate of the net

benefits of reducing imports, guiding the amount that we might be willing to spend per barrel to do so. The premium

arises from diverse phenomena, hence “no single instrument” should be expected to adequately address the separate

reasons a premium exists. Multiple instruments may achieve the most efficient/least cost intervention.

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premium measuring how those two cost components vary at the margin with the level of imports. 

In keeping with much of the early work that discussed the optimal oil import tariff as a measure

of the oil import premium, B&M 1982 highlighted the manner in which the incidence and optimal

size of an import tariff depend on the elasticity of U.S. import demand, the elasticity of net supply

of imports to the U.S. and the level of U.S. imports. These same fundamental relationships 18

drive our estimates of the monopsony premium component, since they determine the degree to

which an import reduction would drive down world oil prices or be offset by supply and demand

responses globally with little price change. 

Relying on theoretical arguments, Bohi and Montgomery carefully pointed out the ways in

which market behavior and interactions (involving oil exporters, consumers and firms) could

reduce the social costs of imports below the level commonly estimated by “conventional”

frameworks. While they noted possible indirect (secondary) repercussions and costs of the

import-demand induced oil price increases beyond the direct “wealth transfers abroad” (examples

offered relate to exchange rates, capital formation, income distribution, and productivity), B&M

1982 ruled these out as too speculative, and with possible offsetting considerations. Similarly,

they argued on theoretical grounds that private agents can be expected to respond efficiently to

the risks of oil market disruptions by balancing the marginal costs of protective action with their

discounted expected cost of oil price increases. Possible protective actions cited include reduced

oil use, investment in flexible capital or substitute fuel capability, and stockpiling oil or

substitutes. While they observed that some argue private agents have less complete or less

accurate information about disruptions than the government, and that there may be deficiencies in

private precautionary planning, they reject these arguments in the absence of convincing

empirical evidence. We note, however, that this standard of proof is not applied with uniformity

to all their theoretical arguments for market efficiency.

Overall, Bohi and Montgomery rigorously scrutinized each argument for a cost that

possibly provides a rationale for government intervention. In many cases, they conclude the

argument melts away under the presumption of efficient market behavior, leaving only the most

essential rationales remaining as sources of the oil import premium: the wealth transfer due to

demand power in normal markets, the additional expected wealth transfer or demand component

during disruptions stemming from higher imports, and any marginal effect of imports on “indirect

macroeconomic costs” due to economy-wide dislocations and adjustments during oil shocks. Our

study here generally comes to essentially the same conclusions, and relies on largely the same key

components, which we estimate through an independent formal approach. Like Bohi and

Montgomery, we recognize that economy-wide dislocations during shocks are more properly a

function of oil consumption than imports. We also exclude most marginal disruption costs that

are directly born by private oil-consumers and producers, and which may be anticipated and
-15-

addressed by private precautionary behavior. However, we agree with Parry and Darmstadter’s

(2004) assessment that “Most analysts believe that the full extent of market upheaval is not fully

captured in firm behavior” (p.14, emphasis added), so we consider the possibility that some

fraction of expected price shock increases is not internalized.

Despite their rigorous standards for inclusion in the premium and generally optimistic

assumptions regarding market efficiency in the face of higher oil prices and disruptions, Bohi and

Montgomery still offered what might now be viewed as moderately large estimates of some

components of the oil import premium. They did not provide estimates of the disruption portion

of the import premium. While they noted that “uncertainties... preclude an unambiguous

conclusion about the magnitude of the premium,” they concluded (in 1981) that the long-run

monopsony premium probably lies below $10/bbl (1980$), or $20.91/bbl in 2005$. In their

Appendix they provide a range of estimates of the optimal import tariff usually around $8.08/bbl

(1980$), or $16.90 in 2005$.

Kline (1981) and the EMF (1982) reported on oil import premia calculated from a set of

controlled experiments with nine different models of the world oil market. Unlike many analytic

approaches that are essentially static estimates of the long-run oil premium, these multi-period

models of interacting regional oil supplies and demands allowed the observation of a dynamic

response to changing import levels or tariffs. The premium for each model was then calculated as

the net present value of incremental benefit minus costs divided by the cumulative reduction in

imports over the forecast horizon. One feature of this analysis is that the early years reflect a

short-run premium and the later years trend toward the long-run premium. The 1981 EMF-6

model comparison yielded oil import premia in the range of $10.66 to $35.55/bbl (2005$). The

mean and median premium values for the nine models were $23.33 and $18.82/bbl respectively

(2005$). Two other insights revealed by this analysis were that the disruption premia were

typically about 1/3 the size of the monopsony premia, and that premia counting spillover net

benefits for all of the Organization of Economic Cooperation and Development (OECD) were

about 3 times the size of the U.S. premia (partly by construction).

Hogan (1982), and Broadman and Hogan (1986,1988) revised and extended the

established analytical framework to calculate base and optimal oil import premia with a more

detailed accounting of macroeconomic effects (building on the macroeconomic framework of

Nordhaus 1980). The method explicitly includes indirect costs from balance of payments

adjustments and inflationary effects (for a summary, see Leiby et al. 1997:22-24). Extending

Hogan (1981), they determined the exchange rate variation necessary to restore the trade balance

after an incremental increase in imports occurs and an assumed fraction of the increase in oil

import payments is recycled. They also accounted for the impact of SPR policy on the security

component of the premium. Based on probabilistic simulations, Hogan and Broadman (1988:11

Table 2) reported two ranges of oil import premium, for two possible future reference price paths. 

The median of the two ranges are $14.52 and $17.52/bbl (2005$). The 50% confidence intervals

they provide (i.e. values from the 25 percentile to the 75th percentile) are roughly +/- $3/bbl. th
-16-

The Broadman and Hogan results are unusual in their more equal contributions of the

monopsony and security components than prior studies. Their results also highlight the offsetting

interactions between the oil demand component and the security component of the optimal

premium. The optimal premia indicate the societally-efficient level of marginal cost to reduce

imports. It is generally the case that including policy actions (particularly taxes or tariffs) that

respond to a larger value of one component would reduce the optimal level of marginal

expenditure to address the other component. Bohi and Montgomery (1981) also noted that

conditions and assumptions implying a larger security premium can imply some degree of

reduction of the optimal monopsony premium.

Broadman (1986) revisited the analytics of the oil import premium, offering a typology

that subdivides the monopsony and security components into direct and indirect parts. He also

summarizes a range of oil import premium estimates available prior to 1986 (Table 1, p. 247). 

Including the high and low estimates for multiple studies from 1979 to 1982, the range is quite

large ($3/bbl to over $150/bbl in 2005$, mean $39, median ~$18). About half of Broadman’s

observations were from the EMF 1982 study.

A decade after the Energy Modeling Forum’s 1981-2 study of world oil models (EMF-6),

in 1991 EMF examined another, mostly different, set of models focusing on oil demand and the

prospects for oil demand reduction (EMF 1992, the EMF-11 study). While this study did not

explicitly conduct experiments to elicit the import premium, Huntington (1993) established a

method to roughly infer their values from controlled oil price-path cases. Again, the premia were

estimated from a per-barrel average of the discounted multi-year dynamic responses. Huntington

imputes values for the oil import premium with a range of $11.79 to $21.32/bbl (2005$),

excluding an outlier value of $53.66. The mean and median premium values for the six EMF-11

models were $16.38 and $16.21/bbl respectively (2005$). 

Leiby, Jones, Curlee and Lee (1997) provided an extended review of the literature and

issues regarding the estimation of the premium to date. They also estimated a widely inclusive

range of oil import premium values, showing the variation of each component with key driving

factors such as OPEC behavior, the likelihood of disruptions, and the extent to which those

disruptions induce external shock effects. The analytical framework used is derived from

Broadman and Hogan (1988), but Leiby et al. omitted the explicit indirect costs for balance of

payments and inflationary effects as less-well established empirically or theoretically than other

costs. They used a single measure of macroeconomic dislocation costs during disruptions

parameterized by empirical studies. The Leiby et al. estimates were based on 1994 oil market

conditions, a period of markedly lower prices, comparative stability, and excess supply capacity. 

Under these conditions, a widely inclusive range of premia extended from $0 to $12.67 (2005$). 

Excluding the case of no OPEC market power and essentially no costly disruptions, but assuming

fairly responsive OPEC supply, a narrowed range of roughly $2.70 to $5.88 was also constructed.

Parry and Darmstadter (2004) recently provided an overview of work on the oil import

premium. Based on a review of prior estimates, they offered their summary judgement: “...we put

our best assessment of the quantifiable component of the oil premium at $5/bbl, with a wide range
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of $0 to $14 to account for the diversity of opinion among analysts.” (p. 14, assumed to be in

2003$). Note, however, that while this summary assessment was published in 2004, it makes

reference to data only through 2001, observing “since the mid-1980s prices have fluctuated

between $12 and $25 per barrel.” (p.3).

As mentioned, this paper essentially updates the oil premium estimates of Leiby et al.

1997 with revised EIA projections of oil market conditions and some revision of oil market

parameters (elasticities) to reflect further research. We also perform a probabilistic risk analysis

(following Broadman and Hogan 1986, 1988, and the recommendations of Toman, 1993:1213) to

generate a range of potential premium values. The extreme (optimistic) cases of no exercise of

cartel power and zero probability of future disruptions that induce external costs on society are

omitted as unrealistic and unhelpful in the current oil market and policy environment.

III. Cost Components

The full economic cost of importing petroleum into the United States is often defined to

include three components in addition to the purchase price of petroleum itself. These are: (1)

higher costs for oil imports resulting from the effect of U.S. import demand on the world oil price

and OPEC market power; (2) the risk of dislocations of the domestic economy and reductions in

U.S. economic output caused by sudden disruptions in the supply of imported oil to the U.S.; and

(3) costs of existing policies meant to enhance oil security. Possible examples of the third

component are maintaining a U.S. military presence to secure imported oil supplies from unstable

regions, and maintaining the SPR to cushion against resulting price increases. An important point

is that the policy-relevance of any cost category stems from the degree to which it is generally not

accounted-for in the market decisions of oil consumers or producers, and whether it can be

changed by a particular policy measure under consideration. For this reason the oil security

import premium analysis considers only the incremental changes in such unaccounted costs as the

level of imports changes. To summarize, the premium components include only non-internalized,

marginal costs. 

The following discussion reviews the nature of each of these costs, assesses the degree to

which they are likely to vary in response to changes in the level of oil imports, and provides

empirical estimates of each component drawn from our studies and other recent research. 
 Since there are no oil import limits or tariffs in place, and the domestic oil industry is generally competitive, at the margin payments for 19

domestic oil are equal to the real domestic resource cost of producing that oil.

 Note that if reduced U.S. oil import demand lowers the long-run sustained price of oil by the U.S. exercise of monopsony power, not only 20

will U.S. import costs decline, implying a diminished foreign claim on U.S. GDP, but long run aggregate economic output will also increase. 

This (perhaps small) gain in long-run natural economic output (potential GDP) represents a benefit to import reduction. However, absent other

market imperfections or policy interventions, the marginal change in potential GDP will be equivalent to the marginal benefit of oil demand, and

equal to the domestic price of oil. Thus it is captured in the marginal premium calculation.

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III.1 Demand Costs, or the Longer-Run Monopsony Effect

The first component of the full economic costs of importing petroleum follows from the

effect of U.S. import demand on the long-run world oil price. Because the United States is a

sufficiently large purchaser of foreign oil supplies, its purchases can affect the world oil price. 

This demand or “monopsony” power means that increases in U.S. petroleum demand can cause

the world price of crude oil to rise, and conversely that reduced U.S. petroleum demand can

reduce the world price of crude oil. Thus, one consequence of decreasing U.S. oil imports is the

potential decrease in the price paid for all barrels of crude oil purchased by the United States. 

Purchase costs for both imported and domestically-produced petroleum decline, but the gain from

lower domestic oil cost is offset by a loss of revenue for domestic producers, so it is omitted from

the assessment of net U.S. social gains. A reduction of total purchase costs for the remaining oil 19

imports, however, represents a net welfare gain for U.S. society: the imports are acquired for

lower claim on the output (GDP) of the U.S.

economy. The “monopsony” premium

accounts for the incremental change in the

total cost of petroleum imports, per barrel

change in the level of imports.

20

The extent of U.S. monopsony power

is determined by a complex set of factors

including the relative importance of U.S.

imports in the world oil market, OPEC

behavior and the sensitivity of petroleum

supply and demand by other participants in the

international oil market to world oil price. 

The degree of current OPEC monopoly power

has been subject to considerable debate, but

appears to have increased somewhat since the

mid-1990s as global oil demand has grown. 

The consensus appears to be that OPEC

remains able to exercise some degree of

control over the response of world oil supplies

to variation in world oil prices, so that the

world oil market does not behave

competitively. Similarly, most evidence

suggests that variation in U.S. demand for

imported petroleum continues to exert some

influence on world oil prices. The substantial

The demand or monopsony effect can be

readily illustrated with an example. If the

United States imports 10 million barrels per

day at a world oil price of $50 per barrel, its

total daily bill for oil imports is $500 million. 

If a decrease in U.S. imports to 9 million

barrels per day causes the world oil price to

drop to $49 per barrel, the daily U.S. oil

import bill drops to $441 million (9 million

barrels times $49 per barrel). While the

world oil price only declines $1, the resulting

decrease in oil purchase payments of $59

million per day ($500 million minus $441

million) is equivalent to an incremental

benefit of $59 per barrel of oil imports

reduced, or $10 more than the newlydecreased world price of $49 per barrel. This

additional $10 per barrel “import cost

premium” represents the incremental external

benefits to U.S. society as a whole for

avoided import costs beyond the price paid

for oil purchases. This additional benefit

arises only to the extent that reduction in

U.S. oil imports affects the world oil price.
 Conceivably, there is a more extreme OPEC response, which is to punitively reduce supply by more than the amount of demand reduction to 21

drive prices even higher. Such a strategy is unlikely to be successfully maintained in the long run given competitive oil supply regions, and is

particularly unlikely in the projected situation for the next 10 years where prices are high and OPEC is anticipated to already be exercising

substantial production restraint. Note that if OPEC defends market share to some degree and lets price fall, the framework used here captures

benefits to the United States in the monopsony premium. However, if OPEC instead defends price and sacrifices output and market share, it will

necessarily have diminished long-run cartel pricing power (e.g. Greene 1991, Greene, Jones and Leiby 1998:59). The method here does not yet

include the likely benefits to the U.S. from the diminishment of OPEC power that comes with its declining share, or any benefits during

disruptions from increased slack oil production capacity in OPEC countries if their pre-disruption output is contracted. 

 We are thankful for reviewer comments pointing out this need. 22

-19-

price increases seen over the past few years with expanding global demand also suggest a

comparable decline in prices could be achieved, should demand growth slow or demand decline. 

The key determinants of the magnitude of the monopsony premium are the strength of

influence of U.S. import demand levels on world oil price and the magnitude of U.S. imports

(which are subject to the prospective price change). The change in world oil price depends on the

response of OPEC, and the collective response of competitive oil producers and consumers in the

rest of the world. The response of OPEC countries to the exercise of countervailing market

power by a major consumer such as the United States is a problem of bilateral monopoly, and

essentially indeterminate. However, the problem can be bounded and the assessment can be

guided by consideration of what is in OPEC’s own long-term self interest.

The practical responses to a U.S. import reduction could range from OPEC’s complete

defense of market volume to a complete defense of price. The former case would entail absolute

supply inflexibility, with OPEC maintaining output level unchanged and letting price slide until

all other regions accommodate the market change. The latter case would require unlimited supply

flexibility, with OPEC contracting output to fully offset U.S. import reduction. These polar 21

alternatives correspond to an OPEC supply “elasticity” (the percentage change in supply for a

percentage change in price) of zero and infinity respectively. In keeping with the 1997 study we

bound the range of outcomes with OPEC supply response elasticities in a somewhat narrower

range, in this case from -0.25 to –6.0, and the implied monopsony premium for that range of

values is calculated. 

The net price-responsiveness of the producing and consuming regions other than the

United States and OPEC was reconsidered and constructed from separate elasticity ranges for 22

crude oil supply and demand, weighted by the projected supply and demand quantities for that

region. While the parameters are treated as uncertain, the resulting sample median elasticity for

non-U.S./non-OPEC import 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 net demand for imports by the rest of the world outside of the United States. 

Together, the net response of the two regions is far more elastic than the response of either region

alone. This is because they respond oppositely to price, OPEC being a supplier and the nonU.S./non-OPEC region being a net importer. As a result of the random sampling process in the

simulations executed and the combined response of OPEC supply and non-U.S./non-OPEC

import demand, the net elasticity of import supply facing the U.S. varied from 4.3 to 18.0 (90%
 These statistics pertain to the primary case presented here, that in Table 1. Somewhat different values were observed for the various 23

sensitivity cases.

 Some of the review panel suggested investigating this approach. Others were more skeptical about whether a game-theoretical approach 24

would be practical, improve the realism of the representation, or add further insight. The substantial challenges of applying game theory include

characterizing the objectives of OPEC and its subgroups and selecting an appropriate equilibrium concept for the interactions among OPEC

subgroups, non-OPEC suppliers, and large oil consuming countries exercising countervailing monopsony power. As Karp and Newbery (1991)

observe, the representation needs to account for resource exhaustibility, the market power of larger suppliers, and the market power of the large

oil importers. The behavior of OPEC and its cartel structure have been widely studied with some success (e.g. Griffin 1985, Gulen 1996, Alhajji

and Huettner 2000, Smith 2006 and Kaufmann et al. 2008), but typically yielding only weakly descriptive models. The value of game theory is

explicitly reviewed by Griffin and Neilsen (1994), and revisited more recently in Griffin and Xiong (1997). Many of the approaches seek a NashCournot equilibrium among open-loop intertermporal production plans (e.g. recently Yang 2007), but Newbery (1981), Ulph and Folie (1981)

and Karp and Newbery (1991) have emphasized that many open-loop strategies are unavoidably time inconsistent. While theoretical models

have been developed and yield insights, the high degree of parameter uncertainty (regarding market elasticities, resource bases, etc.) can

overwhelm the descriptive power of such approaches. Given these challenges, we defer the exploration of game theory, such as Karp and

Newbery’s OPEC-large-importer strategic framework, for possible later contributions to the premium calculation. 

 However in some cases its advantage over other strategies was modest. 25

-20-

confidence range). Alternatively stated, the resulting net response of world oil price to a 23

hypothetical one-million barrel per day (1 MMBD) U.S. import demand reduction varied from

$0.25/bbl to $1.31/bbl, with a mean value of $0.71/barrel.

Arguably, an explicitly strategic representation of OPEC behavior might be preferable to

the purely parametric treatment of OPEC supply response described above. The response of

OPEC supply to a U.S. demand reduction could possibly be modeled formally with game theory,

and has been, to some degree. Recognizing the limits of our understanding of OPEC’s strategic 24

behavioral incentives, and the marked complexity of accounting for competing objectives of

OPEC subgroups and dynamic tradeoffs in the short-run and long-run, we set aside such an

approach for possible future consideration. So we chose a parametric approach for the bulk of the

analysis. However, we also considered one representation of OPEC strategic self-interested

behavior, following Gately (2004, 2007), specifically OPEC maintenance of market share. 

Using a market simulation model, Gately (2004) compared payoffs to OPEC for faster and

slower output growth under a variety of OPEC (and OPEC subgroup) behavioral assumptions and

under uncertainty regarding the market’s underlying parameter values. He found that aggressive

output expansion often yielded lower payoffs than maintaining market share. Gately (2007)

further studied various OPEC export strategies and their implications for OPEC profits. He

sought a “robustly optimal strategy” for OPEC that served its interests, performing well over the

wide range of possible market conditions and given the “unavoidable uncertainties that underlie

the world oil market.” He concluded that for the range of cases examined, the constant exportshare strategy yielded the highest possible discounted profits for OPEC, and that it performed

robustly compared to other strategies for reasonable changes in parameters. Based on these 25

results we consider the Constant Market Share strategy for OPEC as one possible representation

of strategic behavior, and as an alternative to the parametric variation of OPEC supply elasticity

used in most of our simulations of the premium value. This is an intermediate behavioral strategy

between strict price maintenance and strict output maintenance. It proves equivalent to OPEC

suppliers matching the elasticity of non-U.S./non-OPEC supply regions. Consequently, it is

comparable to OPEC operating with a fairly low supply elasticity, and this strategy leads to

greater monopsony effects and higher monopsony premia. Incidentally, this general OPEC
-21-

behavioral strategy of preserving market share is also consistent with the EIA’s current thinking,

at least for its AEO2007 reference case:

“The reference case represents EIA’s current judgment regarding the expected

behavior of OPEC producers in the long term, adjusting production to keep world

oil prices in a range of $50 to $60 per barrel, in keeping with OPEC’s stated goal

of keeping potential competitors from eroding its market share.” (emphasis added,

U.S. EIA 2007)

III.2 Disruption Costs

The second component of the oil import premium, the “disruption premium,” arises from

the effect of oil imports on the expected cost of disruptions. A sudden increase in oil prices

triggered by a disruption in world oil supplies has two main effects: it increases the costs of

imports in the short run, further expanding the transfer of U.S. wealth to foreign producers; and it

can lead to macroeconomic contraction, dislocation, and GDP loss. As in all parts of this import

premium analysis, we will focus attention on estimating how these disruption costs change with

the level of pre-disruption imports.

III.2.1 Disruption: Higher Costs of Oil Imports and Wealth Transfer During Shocks

During oil price shocks, the higher price of imported oil causes increased payments for

imports and an acceleration of the transfer of wealth from U.S. society to oil exporters. This

increased claim on U.S. economic output is a welfare loss to the United States that is separate

from and additional to any reduction in economic output due to the shock. For some disruptions

(wars or revolutions) a portion of this increased import cost may also reflect the opportunistic

extension, or simply maintenance, of cartel supplier power in the face of reduced supply. In the

case of other disruptions, such as supply embargoes, strikes, and economic disputes, the bulk of

price increase may be attributable to market power. Regardless of cause, we count the increased

wealth transfer during shocks as a welfare loss to the degree that the expected price increase is not

anticipated and internalized by oil consumers.
 For recent surveys of the literature on oil prices and the macroeconomy, see Brown and Yücel (2002), Jones, Leiby and Paik (2004), and 26

Hamilton (2005).

 Davis, Stephen and John Haltiwanger 1999. “Sectoral Job Creation and Destruction in Response to Oil Price Changes,” National Bureau of 27

Economic Research Working Paper W7095. Hamilton, James D. 2005. “Oil and the Macroeconomy,” Palgrave Dictionary of Economics.

-22-

III.2.2 Disruption Macroeconomic Costs: Potential Output Loss and

Dislocation/Adjustment Costs

Macroeconomic losses during price shocks reflect aggregate output losses and allocative

losses. The former are reductions in the level of output that the U.S. economy can produce 26

when using fully its available resources; the latter stem from temporary dislocation and

underutilization of available resources due to the shock, such as labor unemployment and idle

plant capacity. The aggregate output effect, a reduction in “potential” economic output, will last

so long as the price is elevated. It depends on the extent and duration of any disruption in the

world supply of oil, since these factors determine the magnitude of the resulting increase in prices

for petroleum products, as well as whether and how rapidly these prices return to their predisruption levels. 

In addition to the aggregate contraction, there appear to be “allocative” or “adjustment”

costs associated with dislocated energy markets. Because supply disruptions and resulting price

increases occur suddenly and often involve disturbing news of war or strife, empirical evidence

shows they also impose additional costs on businesses and households that must adjust their use

of petroleum and other productive factors more rapidly than if the same price increase had

occurred gradually (e.g. Hamilton 2005, Davis and Haltiwanger 1999,1999a). Dislocational 27

effects include the unemployment of workers and other resources during the time needed for their

intersectoral or interregional reallocation, and pauses in capital investment due to uncertainty. 

These adjustments temporarily reduce the level of economic output that can be achieved even

below the “potential” output level that would ultimately be reached once the economy’s

adaptation to higher petroleum prices is complete. The additional costs imposed on businesses

and households for making these adjustments reflect their limited ability to adjust prices, output

levels, and their use of energy, labor, and other inputs quickly and smoothly in response to rapid

changes in prices for petroleum products.

While it is widely expected that the macroeconomic costs of oil shocks will decline with

declining share of oil in the economy, so far efforts to demonstrate this from the statistical record

have yielded inconclusive results (e.g. Huntington 2004, Brown, Fu and Yücel 2005). 

Furthermore, as mentioned above, while the physical intensity of oil use in the economy has

declined by 32% over the last decade, the value share of oil in the economy has increased by over

60%. For these reasons there is no certain argument for estimating the macroeconomic impacts of

price shocks in this study with a different range of parameters from that used in the 1997 study. 

Nontheless, to avoid overestimation and to account for the possibility that future oil shocks may

have lower macroeconomic impacts than the full range of historically-based parameter estimates

implies, we considered a somewhat lower range of GDP impacts (per unit price change) in the

primary case. The original 1997 study range is included as a sensitivity case.
 Note that the use of the expected cost measure embodies an assumption of risk neutrality with respect to disruption risk. Risk aversion would 28

imply larger premia.

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III.2.3 Disruption Premium is the Marginal Change in Expected Disruption Costs

Since future disruptions in foreign oil supplies are an uncertain prospect, each of the

disruption cost components must be weighted by the probability that the supply of petroleum to

the United States will actually be disrupted. Thus, the “expected value” of these costs – the

product of the probability that a supply disruption will occur and the sum of costs from reduced

economic output and the economy’s abrupt adjustment to sharply higher petroleum prices -- is the

relevant measure of their magnitude. Further, when assessing the energy security value of a 28

policy to reduce oil use, it is only the change in the expected costs of disruption that results from

the policy that is relevant. In this study we estimate how the expected disruption costs may

change from lowering the normal (pre-disruption) level of oil imports, from any induced

alteration in the likelihood, size or cost of disruption. 

While the total vulnerability of the U.S. economy to oil price shocks depends on both

petroleum consumption and the level of U.S. oil imports, variation in imports alone may have

some effect on the magnitude of the price increase resulting from any disruption of import supply. 

This could occur from the alteration of starting supply-demand balances and altering the short-run

flexibility (elasticity) of petroleum use. In addition, changing the quantity of petroleum imported

into the United States may also affect the probability or size of such a disruption. If the predisruption level of oil imports affects either the probability that oil import supply will be

disrupted, the quantity of the supply loss, the size of the resulting price increase, or the cost of a

given price increase, then the expected value of the costs stemming from supply disruptions will

also vary in response to the level of oil imports. We express this formally in Section IV.4. Each

possible channel of marginal impact is reflected in the premium calculation.

In summary, the steps needed to calculate the disruption or security premium are:

! First, determine the likelihood of an oil supply disruption in the future;

! Second, assess the likely impacts of a potential oil supply disruption on world oil price;

! Third, assess the impact of the oil price shock on the U.S. economy (in terms of import

costs and macroeconomic losses); and 

! Fourth, determine how these costs change with imports.

The expected value of price-spike cost avoided by reducing oil imports becomes the oil security

portion of the premium.

III.2.4 Role of Market Mechanisms in Reducing Costs

When estimating the disruption component of the oil import premium we need to

recognize the availability of market mechanisms that allow the U.S. economy to adjust to oil

supply disruptions. A variety of market mechanisms – including oil futures markets, energy

conservation measures, and some technologies that permit rapid fuel switching – are now

available within the U.S. economy for businesses and households to anticipate and “insure”
 The limited scope of the futures markets is highlighted by the observation that virtually all trading is short term in nature, with contract terms 29

of under 18 months. Over the years 2001 to 2006, on average 43% of the volume of trading for NYMEX light sweet crude futures fell within the

first month (spot) delivery, and 91% fell within 4 months delivery term. The futures markets for products (heating oil and unleaded gasoline) are

even more heavily loaded toward the first three to four months than is the case for crude. Futures trading seems more attentive to short-run

volatility, not strategic shock risk.

 For example, dual and flex-fuel vehicles (FFVs) (notably alcohol FFVs) are beginning to enter the fleet, but up to this point the fuel 30

infrastructure is not widely available and many FFV owners are even unaware that their vehicles have the capability.

-24-

themselves, to some extent, against the effects of petroleum price increases. In principle, by

employing these mechanisms – for example, by investing in added energy conservation measures

in anticipation of shocks, stockpiling oil, or installing technologies that can operate using multiple

fuel sources – businesses and households can reduce their costs of adjusting to sudden increases

in oil prices. 

The availability of these mechanisms has undoubtedly reduced the potential costs to the

U.S. economy that could be imposed by disruptions in the world supply of oil. But the degree to

which markets anticipate and account for the long-run risk of price increases from strategic oil

shocks is not known with much confidence. Nonetheless, the estimates reported here seek to

explicitly account for futures markets and other anticipatory mechanisms. Private firms and

individuals are described as anticipating a large fraction of disruption price increases, and the

direct costs to them of those expected price increases are excluded from the premium. 

However, the existence of private mechanisms like the futures market and energy

conservation opportunities does not assure that the socially optimal level of protection of

disruption risk is attained. The first and most important reason is that private markets do not

automatically take into account the external and non-market consequences of producer and

consumer choices. Even if consumers and firms are aware of and take advantage of measures to

self-insure against disruptions, they can only be expected to protect themselves against the

economic risks that they expect to bear directly (i.e., their own individual, private costs). The

marginal private disruption risk per barrel of imports is equal to the expected oil price increase

due to shocks. Beyond this, it is not plausible that individual firms or consumers account for their

wider effects on the oil import costs of others in the market, on the magnitudes of prices changes,

and on the macroeconomic activity in other sectors and regions, so the level of protection is

necessarily sub-optimal.

Secondly, the scope for private anticipatory protection is limited. The futures market

extends only a limited time into the future, the private cost of long-term petroleum stockpiling 29

by individual consumers or firms against strategic oil disruptions is prohibitive, and dual-fuel

technology is only available and cost-effective in limited applications. Recognizing that private 30

agents use futures to hedge at most only their own private risk, not the social effects (risk) of their

oil market actions, and that only a subset of economic actors participate directly in the futures

market, this study implicitly accounts for futures and other possible precautionary behavior by

assuming that private actors internalize some fraction of their private risk. That is, 0%, 25% or

100% of the expected oil price increase due to shocks is assumed to be accounted for in private

behavior, and excluded from the social premium calculation.
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Consumers of petroleum products are unlikely to take into account the potential costs that

a disruption in oil supplies imposes on other consumers and sectors of the U.S. economy, or the

indirect effect of their investment, consumption, or import decisions on those wider disruption

costs. 

In sum, while the availability of private protective mechanisms has undoubtedly reduced

the potential costs that could be imposed by disruptions in the world supply of oil, a substantial

portion of these disruption costs is probably not reflected in the market price of petroleum or in

the response of economic agents. There are two reasons. First, the availability of cost-effective

mechanisms for private agents to avoid long-term risk is limited. Second, and more importantly,

even if measures are available to self-insure against disruptions, consumers and firms can only be

expected to take protective actions against the economic risks that they expect to bear directly. 

We estimate that under reasonable assumptions about the probability of future disruptions

in world oil supplies the disruption component of the social cost of U.S. oil imports ranges from

less than $2.10 to over $7.40 per additional barrel of oil consumed by the United States, with

adjustment costs accounting for the largest share of this total. An average estimate is $4.59 (in

2005$).

III.3 Policy Costs: Military Security and Strategic Petroleum Reserve Costs

The third and final commonly-identified component of possible external economic costs

of oil imports is the cost U.S. taxpayers bear for existing energy security policies. Chief among

these are maintaining a military presence to enhance the security of oil supply from potentially

unstable regions of the world and to keep trade routes open, and maintaining the SPR to provide

buffer supplies during a supply disruption. This assessment excludes both of these costs from the

reported estimates for the following reasons. 

Military costs are excluded because of the problems of attribution and “incrementality.” It

is difficult to attribute military costs, and specific activities or forces, to oil consumption or

imports per se. Military activities, even in world regions that represent vital sources of oil

imports, undoubtedly serve a broader range of security and foreign policy objectives than simply

protecting oil supplies. Furthermore, these military costs may not vary in any measurable way

with incremental variations in oil use. The scope and duration of any specific U.S. military

activities that were undertaken for the purpose of protecting imported oil supplies seem unlikely

to be tailored to the actual volume of U.S. or world petroleum imports from the regions where

they take place. As a consequence, annual expenses to support U.S. military activities do not

seem likely to vary closely in response to changes in the level of oil imports prompted by

conservation efforts or other policies. This does not mean that there is no relation between

military costs and oil security concerns, but that estimating the magnitude of incremental effects

from changing oil use is problematic. Our contribution here is in calculating other, economic,

components of the oil import premium.
 See Leiby and Bowman (1998, 2003) and U.S. DOE (1990) for comparatively recent studies of SPR expected net benefits and optimal size. 

31

Earlier studies were by, e.g. Teisberg (1981), Hogan (1982), Murphy, Toman and Weiss (1986) and Devarajan and Weiner (1989).

 This analysis does reflect the impact of a larger current SPR (688 million barrels) than was available at the time of the 1997 study (600 32

million barrels). Under the International Energy Agency (IEA) agreement, all signatories agree to hold emergency oil stocks equivalent to 90

days of oil imports, in crude or product form (See e.g. IEA 2007, IEA Response System for Oil Supply Emergencies.) There is some flexibility of

accounting, particularly regarding how private inventories are included along with public stocks. The U.S. DOE’s current assessment is that the

IEA requirements are met and exceeded, since “SPR and private company import protection” is measured as approximately 118 days (U.S. DOE

Fossil Energy website, http://www.fossil.energy.gov/programs/reserves/spr/spr-facts.html).

 Specifically, under Section 3 of the Energy Policy and Conservation Act, the President must ordinarily make a determination of a "severe 33

energy supply interruption". For more details, see the U.S. DOE SPR website http://www.fe.doe.gov/programs/reserves/spr/spr-epca.html.

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While the optimal size of the SPR, from the standpoint of its ability to cost-effectively

reduce expected U.S. costs during supply disruptions, may be positively related to the level of

U.S. oil consumption or imports, its actual size has not appeared to vary in response to changes in

the volume of oil imports. There are two consistent approaches for accounting for SPR policy

when calculating the incremental benefits of reduced oil use. Given lower oil imports and

potentially reduced disruption costs, the analysis could consider the incremental savings from

reducing the size of the SPR while maintaining the same level of expected protection. 

Alternatively, the analysis could include the value of the greater level of overall protection

achieved with the current SPR. Since the past size or budgetary cost of the SPR have not varied

directly with oil imports or consumption, the former approach posits an unlikely policy. It is also

more cumbersome to analyze. Therefore, we adopt the latter approach and assume no change in 31

the SPR from its current size. However, our estimates do explicitly account for the role of the 32

SPR in addressing shock effects and reducing disruption costs. 

SPR use during a disruption requires a Presidential determination of need based on a range

of economic, foreign policy, and national security considerations. Since past use during some 33

disruptions has been cautionary, future use in all possible disruptions is neither assured nor

official policy. The current analysis considers two SPR management strategies: idealized SPR

use, with a prompt and full offset of all major supply shocks, to the extent of SPR capabilities;

and a more cautionary SPR strategy in which the SPR is applied to shocks in half of the events. 

When calculating the premium, a range of shocks is probabilistically simulated and, depending on

the size and duration of the supply loss and the SPR utilization strategy, some or all of shock

price increase may be eliminated. To the extent that the current SPR is able to more completely

buffer shocks and their costs at lower import levels, that marginal cost change is accounted in the

premium.
 Technically, marginal cost is the derivative of total cost, and is based on an infinitesimal change in oil use. Its units are dollars per barrel. 34

 The term “net benefits” means the difference between benefits and costs. Similarly, regional “net import demand” refers to the difference 35

between a region’s oil demand and its supply. Net benefits can be measured relative to an arbitrary reference point, since our interest is in

marginal changes.

 Naturally, net benefit also depends on levels of oil production and consumption, but at first we abstract from these issues. For example, the 36

macroeconomic dislocation losses from disruptions are expected to be more directly a function of oil or energy consumption levels or intensities

than import levels. However, even if the contemplated policies directly target consumption, because of the identity linking supply, demand and

imports a separate examination of the import premium alone is informative. Certain costs, notably the sustained costs of non-competitive oil

supply and the higher import costs borne during disruptions, are directly functions of imports. Others, such as macroeconomic disruption costs

may be indirectly functions of imports to the extent that import levels alter the expected frequency or magnitude of shocks or the severity of their

impact on the oil market. It is these direct and indirect marginal effects of import levels that we focus on here, in keeping with the established

literature on the import premium as an informative guideline for energy security or dependence policies.

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IV.1 Marginal Welfare Changes and the Mathematical Definition of the Marginal

Premium

The principal method used in this paper is the marginal analysis of U.S. welfare,

employing the standard concepts of the economic welfare function and the oil import premium. 

The marginal cost of imported oil (in dollars per barrel) is the incremental cost associated with a

unit change in oil imports. Its estimation does not require that we know total costs, but only 34

how total costs change with the level of oil imports. 

We beg iu in with a functional description of how U.S. economic net benefits N(q ) depend

on iu the level of oil imports (q ). Given the focus on imports, it is convenient to combine the 35 36

domestic oil demand and oil supply curves into a net import demand curve. This corresponds to

combining the private benefits of consumption and the private costs of domestic production into

an import private bene i iufits function B (q ). The net economic welfare function includes import

bene i iu w iu fits B (q ), less the direct costs of imports (P q ), and less all other costs associated with

ex f iuternalities, shocks, and market failures (C(q )), which individual producers and consumers do

not ordinarily consider in their market transactions.

The marginal welfare from a change in imports is then the marginal private benefit of imports less

the marginal direct cost of imports less all the other identified marginal non-private costs:

Here the prime symbol (N) denotes the total derivative with respect to import levels. The oil

import premium is defined as the difference between the marginal private net benefits of oil and

the marginal social net benefits. Since it is generally believed that the social benefits of imports

equal the private benefits, the import premium is the difference between marginal social costs and
 Note that so long as private oil purchasers gain all the benefits of oil consumption (so that marginal private benefit equals marginal social 37

benefit) and there exists no import tax or constraints (so that the marginal private cost of oil equals the world oil price) then the import premium

can be defined as the marginal social costs of imports minus the price of imported oil.

M i w ore generally, for tariff J0, P = P + J

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marginal private costs. The marginal private cost of oil is the prevailing domestic oil price. 37

This equals the world oil pr wice, P , if there are no tariffs or binding import/export constraints. At

any leve iu l of U.S. imports q the oil import premium, B, being the difference between marginal

social and marginal private cost, is:

As will be discussed below, the first term of the premium corresponds to the monopsony or

consumer buying power premium. Strictly speaking the second term includes all other marginal

social losses associated with imports, but in this study we limit our attention to identifying and

estimating the expected economic losses from disruptions. So in keeping with earlier approaches

as far back as Plummer (1982) we divide the oil import premium into two components: the

monopsony premium and the disruption premium: 

The two components are essentially long-run and short-run in nature respectively, since

the first accounts for the effect of a sustained import reduction on the long-run undisrupted oil

price, while the second principally includes the change in expected short-run losses during future

transitory disruptions. A key challenge of this analysis is to identify those costs stemming from

market imperfections which are not accounted for in private behavior, and which vary at the

margin with oil imports (or oil consumption).
 This is because the marginal social costs of imports, beyond price, are an increasing function of the level of imports. 38

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IV.2 The Base Import Premium and the Optimal Import Premium

The premium can be measured under base conditions (of current, essentially free-market

policy) or under conditions where policy has reduced import demand. The former estimates the

per-barrel social gains from a small imports reduction from the current base level, while the latter

estimates the per-barrel marginal social gains after imports have been reduced by a non-trivial

quantity. Once the socially efficient level of imports is identified (that which maximizes social

net benefit), the "optimal" import premium which applies at that level can be estimated. As

imports decline, the premium declines.38

A graphical representation may clarify the concepts of the base and optimal premia. 

Under free-market policy, import demand will adjust until the marginal private benefit equals

world price, and the marginal private net benefit is zero. This is shown by the intersection of the

o o import supply and demand curves in Figure 2, at imports level M . The base premium, B(M ), is

w shown as the difference between the private marginal cost (import supply) curve P and the social

marg social oinal cost curve C' above imports level M . As shown, the premium is greater for higher

levels of oil use if the social costs rise faster with use than privately accounted costs (i.e., than the

world oil price).
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o

If a policy is introduced to reduce imports below the free market level, M , to any other

level, say M, then the marginal private benefits diverge from private costs. When imports are

reduced to the level M , the optimal imports level, the social marginal cost curve intersects the *

private demand curve (Figure 2). Social marginal costs equal social and private marginal

benefits and no further reduction is beneficial:

Note that neither the premium nor the level of imports is necessarily reduced to zero at the

optimal level M*. Many studies of oil import costs seek to estimate the optimal premium, since it

serves as a guide for longer-run policy after a transition to lower level imports has been made. 

On the other hand, the base or "current market" premium provides an estimate of the potential

social gain from reducing imports by a small amount from their current level, and suggests a level

Figure 2: Deviation Between Marginal Social Cost and Marginal Private Cost of Imports Implies

a Premium.
-31-

of societal effort or incentive that may be appropriate for some time until progress in reducing oil

use is achieved. The results presented here focus on the smaller “optimal premium.” For

comparison we present estimates of the somewhat higher “base” or “current premium” in

Appendix A.

The oil import premium is a useful concept for summarizing non-market costs, but should

not be directly interpreted as an instrument of policy (e.g. National Energy Strategy Draft

1990:9). For example, Plummer et al. (1982) and Bohi and Montgomery (1982) make the clear

point that the two basic components of the import premium associated with non-competitive

market costs and disruption costs each may motivate a different policy. The import premium

indicates the marginal social value of a sustained reduction in imports, but does not indicate the

most efficient policy for achieving that reduction. Similarly, the disruption component of the

import premium should not be interpreted as the marginal value of stockpiling against a

disruption, in order to offset imports during a disruption. This value could be estimated

separately, as in the Plummer et al. (1982) "stockpiling premium," or numerous other stockpiling

studies (e.g., Teisberg 1981; Hogan 1982; Leiby and Lee 1988; DOE/Interagency Study 1990;

Leiby and Bowman 1998, 2005).

IV.3 Monopsony Power and Calculating the Monopsony Premium

This section reviews the basis of possible U.S. monopsony power, and discusses some of

the issues involved in the estimation of the monopsony premium. These issues concern how to

represent the response behavior of other agents in the world oil market, particularly non-U.S.

importers and OPEC.

IV.3.1 Monopsony Power

Since the United States is a large consuming nation, in theory it could influence world oil

prices by altering its level of imports. The monopsony premium is the marginal reduction in

excess wealth transfer resulting from imports reduction. The "monopsony cost" of imported oil is

the failure of oil consumers to coordinate and use their market power to recapture monopoly rents

transferred to oil exporters (Murphy, Toman, and Weiss 1986:68). Broadman (1986:243) has

described the monopsony cost effect as follows.

"If an increase in the demand for imports leads to a rise in the world price of oil,

the increase in price affects all imports .... In this case, the demand increase by the

marginal importer produces an external cost by raising total payments abroad for

oil imports by more than the price [it pays]." 

Most analysts agree that the United States has at least limited monopsony power. However, they

disagree about whether that power can and should be exercised. Some argue that the monopsony

power of the United States is, in fact, very small. In the past, others have argued that the explicit

exercise of monopsony power, especially the adoption of an import tariff or quota, could call for

retaliation on the part of oil exporters. Clearly some policies to exercise monopsony power are
is sO The elasticity of net import supply (0 ) can be decomposed into the elasticity of OPEC supply (0 ) and the elasticity of net import 39

d iN emand from non-U.S., non-OPEC regions (0 ):

w U U iu iu iN here F is the share of non-OPEC net imports imported by the United States, that is F = q /(q + q ).

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more visible and provocative than others. The prospect for retaliation may be related to the

manner in which monopsony power is used. The argument that OPEC would fully offset or even

retaliate in response to a U.S. import reduction might have greater plausibility when OPEC is

poorly coordinating its monopoly power and is at best acting as a "clumsy cartel." In this case, the

blatant and prominent assertion of monopsony power could lead to greater solidification of the oil

cartel and result in world oil price increases. On the other hand, the suggestion of OPEC

retaliation becomes less compelling at times (such as the current and projected market conditions)

when OPEC is already exercising substantial supply restraint and maintaining prices at

comparatively high levels.

To the extent that the United States has monopsony power and faces non-competitive

global oil supply, there is an opportunity to act and reduce total U.S. costs. The greater the U.S.

share of the world oil market, the greater the potential of the United States to exercise monopsony

power. 

The impacts of an import reduction depend on the elasticity of net import supply, which is

the subject of some uncertainty. The premium estimates here include a market-based response by

other importers and non-OPEC producers as prices fall, partially offsetting the monopsony power

of the United States. The United States is a net importer of oil, as is the group of all other nations

outside of OPEC, collectively. The monopsony power of the United States and the size of the

monopsony premium increases with the share of world oil trade comprised by U.S. imports. For 39

2006 to 2015, the projected average level of U.S. imports as a share of OPEC net exports (total

non-OPEC net imports) is around 36 percent. (In the mid 1990s the current and projected U.S.

share was near 30 percent.)

IV.3.2 Issues in Estimating the Monopsony Premium

In the above exposition on the import premium, the first term in the premium of Equation

(4) corresponds to the monopsony premium. The monopsony premium is just the incremental

change in world oil price induced by a unit import reduction times the level of imports:
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is If 0 is the price elasticity of net oil import supply to the U.S., then the imported oil monopsony

premium is also expressible as:

The social cos is t exceeds the private cost by P/0 . This formula shows explicitly that the

monopsony premium will vary with world oil price, import levels, and the price elasticity of net

supply of imports to the United States. If the supply of imports is very elastic, the monopsony

premium will be very small, and very large if supply is inelastic. This is illustrated by the

following graph. For any given slope of world oil price with respect to U.S. imports the

monopsony premium is greater for higher U.S. imports. For any given net elasticity of import

supply to the U.S. the monopsony premium is greater for higher world oil price. Thus, by either

of these measures we would expect the monopsony premium to be larger over the next decade

than in the past decade. 
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Estimating the monopsony premium has always been recognized as difficult because it

requires the specification of non-U.S. response behavior, and particularly OPEC response

behavior (Plummer 1981:6). Should the United States reduce imports through some policy

measures, the following categories of response are possible:

! Non-U.S. Importer Responses

- Market-based (some limited increase in demand as price drops, no policy change)

- Joint/coordinated policy effort with United States (amplifying the U.S. effect)

- Contradictory/compensating policy (offsetting the U.S. effect)

! OPEC Supply Responses

- Maintain production at cartel-agreed levels (zero elasticity)

- Partial (inelastic (,<1), unitary elastic (,=1), elastic (,>1))

Figure 3 Relationship of oil monopsony premium to the elasticity of net import supply to

the United States, and the world price of oil.
 Recent examples of global attentiveness to oil imports and energy security are manifold and readily available. For example, for the IEA, see 40

numerous reports and workshops documented at their website including IEA 2007 Oil Supply Security- Emergency Response of IEA Countries. 

For APEC, see e.g. APERC 2007 A Quest for Energy Security in the 21st Century, in which indices of energy security are considered, some of

which focus on oil imports and dependence on unstable supplies. See also their report Energy Security Initiative: Some Aspects of Energy

Security, APERC 2003. For Northeast Asian nations, see http://www.iea.org/Textbase/work/workshopdetail.asp?WS_ID=178 for the “Joint

Conference on Northeast Asia Energy Security and Cooperation (2004). For ASEAN, see, e.g. the 2007 workshop “Oil Security and National

Emergency Preparedness,” joint with IEA (http://www.iea.org/Textbase/work/workshopdetail.asp?WS_ID=331).

 An extreme alternative to joint action by importers is the possibility of contradictory/compensating measures in other importing countries. 

41

Brown and Huntington (1994) note that Hoel's (1991) work on unilateral environmental actions also applies to unilateral oil conservation efforts:

unilateral action by the United States could weaken its bargaining position with other importers who are considering comparable policy. In this

case other countries could relax their efforts and, in theory, world oil imports could increase. It seems especially unlikely that other major oil

consuming countries would take an opportunistic or even non-cooperative strategy given current widespread concern about the need for energy

conservation and climate change.

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- Cartelized - Full offset (perfectly elastic)

- Cartelized - Retaliatory (no supply curve)

Non-U.S. Importer Response Representation

A relevant question in assessing these potential benefits is the response of other importing

countries. Will they act collectively with the United States to reduce consumption, will they not

react, or will they take actions to actually increase their import levels? For the estimates reported

here, we assume all other major oil consuming and importing regions outside of OPEC do not

alter their policies, but respond competitively to any price reduction induced by U.S. policy. 

However, it is worth noting that virtually all oil importing countries are concerned about their oil

consumption and import levels, including the members of the International Energy Agency (IEA),

the Asian Pacific Economic Cooperation (APEC) group, the Association of South East Asian

Nations (ASEAN), and a group of Northeast Asian nations including China. They are actively

exploring new policies to limit oil use, for a variety of environmental, energy security, and

sustainability motivations. Thus, the assumption of a purely free-market, no-policy response by 40

the rest of the world outside of OPEC must be interpreted as an upper bound on the degree to

which other importers would offset any U.S. import reduction by increasing their demand.

The marginal benefits to the United States of a coordinated policy with other oil

consuming nations would be greater than those of a unilateral action, because of the global nature

of the monopsony gains. The estimated import or consumption premium would be

correspondingly higher, when a coordinated policy is compared to the free market outcome. 

Under coordinated policy action, non-U.S. importers are typically assumed to reduce their

consumption in the same proportion as the United States (e.g., Stobaugh 1979). The early Energy

Modeling Study (EMF-6, 1982) considered the base monopsony premium or "buying power

wedge" for both unilateral and joint OECD action. Tests with nine oil models all indicated that

the base monopsony premium was 3 to 3.5 times larger given coordinated OECD action (Gately

1982:46). Joint action by the United States and other importers effectively increases the share of

world oil trade under monopsony control, and increases the monopsony premium faster than

linearly with the share of imports monopsonized (see previous footnote).

41
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OPEC Supply Response Representation

Most estimates of the monopsony premium component assume some positive relation

between price and OPEC supply, or include OPEC supply in a world import supply curve (e.g.,

EMF-6, Gately 1982; Broadman and Hogan 1986; Walls 1990; Huntington 1993). If OPEC is a

true monopolistic supplier, then there is no well-defined conventional upward-sloping supply

curve. A monopolist sets a price in inverse proportion to the elasticity of demand for its product,

so in this case it may be more important for an import demand policy to increase demand

elasticity than reduce the quantity demanded. 

Nesbitt and Choi (1988) offer one polar alternative representation of OPEC supply. They

apply a depletable-resource cartel model of OPEC behavior to estimate the effects of an import

tariff and conclude "the degree of monopsony power that can be exerted by the United States is

small, indeed almost minuscule" (Nesbitt and Choi 1988:46). They estimate that a $10.50 tariff

such as that proposed by Broadman and Hogan would sharply reduce U.S. imports (by 30 percent

in the first year) but would only reduce world oil price by $1.30/BBL. The insensitivity of world

price to demand results from their assumption of a highly elastic world supply, and the treatment

of oil supply according to dynamic depletable resource theory, in which price paths are strongly

driven by the estimated resource base size and backstop price. However, the limits of depletable

resource theory as a positive description of petroleum markets are well established (e.g. Watkins

1992, 2005). Alternatively, viewing OPEC as a von Stackelberg monopolist suggests that while

the elasticity of import supply may be ill-defined, the price charged will depend on U.S.

consumption via the effect of U.S. consumption on OPEC's market share (Greene 1991; Greene

and Leiby 1993). If the world could somehow reduce OPEC's market share enough, there would

be pressure for prices to return toward competitive market levels.

Some critics of the monopsony premium approach question whether the exercise of

monopsony power would be a justifiable interference in oil markets. If monopsony power can

lower monopoly prices, why not use it to lower competitive market prices as well? Why not use

it in all arenas of international trade? According to standard theory, there are two good reasons:

1) competitive market prices produce an economically efficient allocation of resources; and 2) the

indiscriminate exercise of monopsony power would undermine painstakingly negotiated free

trade agreements. In short, there is too much to lose. If free trade in competitive world markets is

the goal, then indiscriminate use of monopsony power against competitive producers would be

counterproductive, but judicious use of monopsony power against monopoly pricing may be a

step in the right direction.
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IV.4 Methodology for Calculating the Disruption Component of the Oil Import Premium

We defined (Eq. 5) the disruption component of the import premium as the marginal

change in expected disruption losses:

Consider representing the uncertain future oil market by a set of possible discrete market states

(disruptions sizes and lengths) indexed by j. Thus, the expected disruption cost over the next

decade is j j taken over a set of possible supply losses )Q each with annual probability N . For each

possible di j i jsruption )Q with an associated increase in imported oil price of )P ()Q ), the

disruption costs are composed of the incremental imports costs (foreign payments) plus the

dislocational GNP losses due to the disruption price. The expected total disruption costs are the

probability-weighted sum: 

The disruption premium is the marginal change of this expected cost expression with respect to

iu the long-run level of U.S. oil imports, q . 

IV.4.1 Disruption Premium - Import Cost Component

Consider the marginal change in the first term, disruption import cost, recognizing that

added import costs during a disruption are given by the change in price times the level of imports

during the di iD sruption, q :

We write the disruption price change )P as a function of both the disruption quantity loss )Q and

the pre-disruption level of imports, acknowledging that the latter may influence market responses

during the disruption. Taking the derivative:

There are many channels by which changing import levels during normal (undisrupted)

periods could influence the import costs during a disruption. These channels are highlighted by

j iD

the each of the three terms in the derivative of the product 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-disruption import levels on the

probability of disruption. This is sometimes called the deterrence effect if reducing import levels

is thought to reduce the likelihood of intentional shocks. While models of this type of effect

could be offered, in which the likelihood of some categories of disruption (e.g. embargoes or

terrorist attacks) might diminish with U.S. import levels, in this analysis we do not include any

effect of import level iu s on disruption probability (i.e., MN/Mq = 0). An alternative, non-zero

assumption about the marginal effect of pre-disruption imports on disruption likelihood, even if

very small, would have a pronounced effect on the premium estimate.

The second term is the direct effect of reducing pre-disruption import levels on the

number of import barrels that are subject to the price increase )P during disruptions. The import

levels during the disruption event will be somewhat different from the long-run pre-disruption

import levels, given short-run price responses, and income responses if GDP contracts. The

reduction of normal-period oil imports by one barrel would reduce the level of oil imports during

random disruptions by roughly, but not exactly, one barrel. If the reduction is one-to-one

iD iu (dq /dq = 1.0), then this term for the cost reduction per barrel of import reduction is just the

expected p {)Q} rice increase due to shocks (E [)P()Q)]). We track this cost component but

recognize that it is not necessarily entirely external to the decision calculus of economic actors

who consume or import oil. This direct price increase that must be paid by those using another

barrel of oil at the time of a (random and presumably unexpected) shock may be partially or fully

accounted-for by foresighted agents when they make oil purchases during the undisrupted

periods. Given our decadal planning period, the key here is the degree to which prospective geopolitical oil disruptions over the next decade are both anticipated and accommodated through

preparatory behavior when oil purchases are made at any time in the decade. We assume that

ordinarily some-to-all of the shock price increase is internalized. As mentioned, this component

of the disruption premium is reduced by the fraction posited to be internalized, based on a

parameter that takes values of 0%, 25%, and 100% internalization.

The third term in the import-cost component of the disruption premium is the expected

change iu in import costs due to the impact of pre-disruption import levels q on the magnitude of

the price increase during each possible disruption. This component can be further decomposed.
-39-

(14)

(15)

Note tha iu iu t this term is an exact analog to the pre-disruption monopsony premium (q dP/dq ),

where in this case we are accounting for the impact of U.S. import levels on the expected

disruption price increase rather than the pre-disruption price level. Again, the monopsony effect

is not likely to be considered by individual economic agents, and again it is powerful by being

multiplied by the entire level of imports.

The expected price increase from shock is governed by the bracketed terms, which are the

indirect effect of pre-disruption import levels on the expected size of the supply loss, and the

effect of pre-disruption import levels on the sensitivity of shock price change )P to the quantity

of j supply loss )Q (that is, the effect of import levels on the short run elasticity of global net

import demand).

IV.4.2 Disruption Premium - GDP Dislocation Cost Component

Analogous to the premium associated with import costs during disruptions, the GDP

dislocation premium component is the marginal change in expected GDP losses during

dis j j ruptions. For a discrete distribution of disruptions sizes )Q each with annual probability N

This formulation highlights the relationship between GDP losses and the disruption induced price

change )Pj, as well as the possibility that the magnitude of GDP loss for any given price change

could also depend directly on the level du of U.S. oil demand q . In this formal analysis we are

examining the marginal effect of an import reduction on societal costs, without positing a

particular change in domestic supply or demand to generate the imports change. Thus, for this

partial du equilibrium analysis, we hold domestic demand levels fixed and drop q from the

equations. More generally, if we know that the policy that causes the imports reduction is an oil

demand reduction, then there would be an additional disruption premium component associated

with the change in GDP sensitivity to oil price changes:

Again, we omit the possible effect of import leve jls on disruption probability N , and expand the

second term:
-40-

(16)

(17)

(18)

These are the terms that must be evaluated to determine the GDP-Dislocation component

of the Disruption import premium. The bracketed terms are the same two components that were

identified for the Disruption Premium Import Cost component, which determine the marginal

effect of pre-disruption import levels on the expected disruption price change. Note that we do

not assume any change in the sensitivity of GDP to price shocks from a change in the level of

yP imports (the GDP elasticity , is held constant), since the GDP losses from oil shocks are

thought to be more properly a function of consumption levels. If the change in imports is also

accompanied by a change in consumption, then the full import/consumption premium would be

larger by that term. 

IV.5 Calculating the Total Optimal Premium

The to iu tal premium at any level of imports q is given by the sum of the monopsony and

disruption components:

These p tot iu remium components and the total premium B (q ) can be calculated for any level of

iu imports q . The optimal premium can be numerically determined by iteratively searching for the

level of imports that equalizes marginal social costs and marginal private consumption benefits

(see Figure 2 and the discussion). The net import supply to the United States is composed of the

posited OPEC supply behavior minus the non-U.S. net import demand curve. The resulting

function for net import supply can be inverted to yield the world price of oil as a function of U.S.

w iu

import demand, P (q ). Similarly, long-run U.S. domestic supply curves and demand curves

combine to yield the U.S. net import demand curve, which can be inverted to yield the marginal

benefits of U.S. oil imports, Bpriv D iu ’(q) = P (q ). By definition, the marginal social cost of oil

imports is the sum of the world price of oil plus the marginal oil import premium:

The opt iu imal import premium B is the premium at the import level q that equalizes * *

marginal social costs and marginal private consumption benefits:
-41-

(19)

V. Results

A range of results was constructed by probabilistic simulation, reflecting uncertainty

regarding the key factors.

! All estimates utilize the Base oil market projection from the 2007 EIA Annual Energy

Outlook (AEO2007). (Otherwise, accounting for uncertainty regarding the future oil price

path by using a combination of EIA High, Base, and Low price outlooks, the range of

estimates is wider and asymmetrically somewhat higher).

! OPEC supply response elasticity varies from 0 to 6, with mode of 1.0 and a mean of 1.76.

! Long-run supply and demand elasticity for non-U.S./non-OPEC regions are on net about

double the 1997 study values, and U.S. supply and demand elasticities are unchanged.

! Disruption probabilities are taken from the Energy Modeling Forum 2005 survey (see

EMF/Beccue and Huntington 2005), aggregated into three discrete disruption sizes (see

Appendix C for more details).

! A wider range of values for the GDP loss elasticity with respect to oil shock price of -0.01

to -0.08 was judged to encompass essentially the bulk of recent econometric and modeling

estimates for the cumulative loss of GDP for 2-3 years after a shock, expressed as a

percentage of one-year’s GDP. This range was used in a sensitivity case. However, for

the base set of results presented in Table 1, the GDP Loss elasticity range was somewhat

shifted down to account for the possibility that the sensitivity of the economy to oil price

shocks may have diminished over time. The range used for Table 1 varied from -0.01 to –

0.054, with a mean of -0.032. Further examination of this issue is merited.

! Short-run elasticity of U.S. import demand ranges from -0.087 to -0.163. This range is

supported by the range of estimates from the literature shown in Appendix A, although an

argument can be made for smaller short-run elasticities.

! Disruption size reduction with imports varies from 0% to 30%, with the upper end

corresponding roughly to the share of world oil trade flows demanded by U.S. imports.

Parameter distributions are generally taken as either discrete over three low-mid-high values

(with probabilities of 25%, 50% and 25% each) or as a continuous triangular distribution.
 As one basis of comparison, the NRC (2002) cited other (EMF) studies in which the oil price would be decreased by between 0.8 percent and 42

2.9 percent per million barrel per day oil import reduction. They noted that “applying that same percentage to current [2001] prices would give a

monopsony component between $2.20 and $8.20/bbl.” Applying the same price sensitivity here to average EIA projected prices for the next 10

years implies price changes (slopes) of -$0.36/bbl/MMBD to -$1.31/bbl/MMBD, and monopsony premia ranging from $4.61/bbl to $16.70/bbl.

 Source studies for this graph included: Bohi & Montgomery 1981, EMF 1982, Broadman 1986, Behrens et al. (CRS) 1992, Huntington 43

1993, CEC 1994, Leiby et al. ORNL 1997, Moore et al. CRS 1998, NRC 2002, Parry & Darmstadter 2004, and Leiby 2006.

-42-

Table 1: Summary Results

 Effect / Study ORNL 1997 Report

(2005$/BBL)

ORNL 2007 Updated

(2005$/BBL)

 Monopsony Component $2.64

($1.58 - $3.69)

$7.41

($2.77 - $13.11)

 Macroeconomic Disruption/ 

 Adjustment Costs

$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)

Results in 2005$. Columns report mean estimate and ranges. In the case of the 1997 report, the

ranges reflect the subjectively defined “narrowed range.” In the case of the new study, the ranges

include 90% of results from the risk-analysis simulation.

The estimated range and mean value for each component of the import premium is shown

in Table 1, reproduced in this section for convenience. The estimated oil import premium for the

United States is composed of about two-thirds monopsony premium and one-third disruption

premium. Over the full range of simulations, the net elasticity of oil import supply to the United

States varies from 3.2 to over 21 (90% fall between 4.3 and 18.0, mean value is 8.9). This

assumes a fairly high degree of market responsiveness to any U.S. initiative, with the monopsony

premium being lower as the market responsiveness is greater. One informative measure is the

implied change in world oil prices from a change in U.S. imports. For the stated elasticity range,

the implied oil price decrease per million-barrel-per-day reduction in U.S. imports ranges from

$0.17/bbl to $2.43/bbl (the 90% confidence interval is smaller), with a value for the mean

premium estimate of about $0.71/bbl/MMBD. This price-sensitivity is well within the range of

other estimates. The disruption premium in turn is about 55 percent macroeconomic losses from 42

dislocation and 45 percent losses from increased oil import costs during shocks.

Generally, the updated import premium estimates are notably higher than those we

produced in 1997. While higher, this result is consistent with many other estimates (e.g. Plummer

1982, Broadman and Hogan 1988, Huntington 1993), which were constructed at times when oil

market conditions were more similar to those currently projected by EIA than the conditions of

the mid-1990s. This is seen in Figure 4, which plots the newest estimates (enclosed in the ellipse

on the right side of the graph) along with estimated ranges from 11 other studies. At least two 43
-43-

of the studies (EMF 1982 and Huntington 1983) also provided ranges derived from multiple oil

market models. Results from each study are plotted according to their publication date. Each of

these study ranges was based on prevailing or projected oil market conditions around the time of

the study. While many oil market conditions contribute to the premium estimate, we have

superimposed the contemporaneous world oil price on the plotted estimates as one important

market indicator. 

Finally, we note that the possible range from our current study is wider still if one

considers the simultaneous combination of all best- or worst-case assumptions. However, the

likelihood of these more extreme combinations should be viewed as remote.

Figure 4 New estimates are consistent with past estimates under

similar market conditions. 
 The mean “base,” or current premium values, which are evaluated at the currently projected base-case level of imports over the next decade, 44

are $1.5 to $3.2/bbl larger than the optimal premia, depending on the case. The uncertainty range is shifted correspondingly higher, and

somewhat widened. All but one of the 95%-ile estimates are above $20/bbl, and 3 are above $30/bbl. See Appendix A, Table A5.

-44-

V.1 Alternate Cases

Table 4 presents a sequence of alternative cases from the one selected as a reasonable

central case for Table 1. The case shown in Table 1 appears in column (6) of Table 4. All of the

values in this table are for the optimal premium (not the base premium), in year 2005 dollars.44

The central values presented are the mean estimates for each case, and they refer to the long-run

premium value per barrel of oil imports, as an average over the next ten years (2006-2015). The

ranges presented for the components and for the total are all 90% confidence intervals based on

the selected ranges for parameter uncertainty and the probabilistic simulation of the premium

model.

Case 0 is the result presented in the July 2007 draft study, developed in support of the

Renewable Fuel Standard (RFS). In this case OPEC response is treated parametrically, with

supply elasticities varying from 0.25 - 5.0. The non-U.S./non-OPEC elasticity adopted the same

value as the 1997 Leiby et al. study, which was -0.876. The combination of the OPEC and nonU.S./non-OPEC elasticities lead to a net elasticity of import supply to the U.S. ranging from 3 to

15. Disruption probabilities are from the EMF 2005 Estimates, and the oil market outlook is

taken from the AEO2006 Base case. This case leads to a premium estimate of $13.97, roughly

two-thirds of which is the long-run monopsony premium, and one-third is the disruption

premium.

Case 1 was run to make a close comparison of the 1997 study with a case based on current

expectations about the oil market. The two principle changes are an update of the oil market

outlook (the future price and regional supply and demand projections) from the AEO1994 Base

Case to the AEO2007 Base Case, and the use of new disruption likelihoods from EMF 2005

(Appendix C). Among other things, this means average crude price rises from $21.45 to $50.99

per barrel (2005$). Other specific changes related to the oil market projection alone are

summarized in Table 2. All elasticities match the values used in the 1997 study (non-U.S./nonOPEC elasticity of import demand is -0.876, the parametric treatment of OPEC response uses a

triangular distribution for supply elasticity ranging from 1.0-5.0 with mode 2.0). The monopsony

premium is much lower in this case than Case 0 or most other cases, because of the assumption

that OPEC supply elasticity is at least unitary or greater. Note that the Leiby et al. 1997 study

also presented cases with OPEC supply responses that were much less than unitary-elastic, but

they were not in the “narrowed range” of estimates that subsequently received greater attention. 

This assumption of a highly flexible and price-responsive supply, which might have been

plausible in the mid-to-late 1990s, is no longer reasonable at a time when OPEC is more

rigorously controlling output and supporting rapid increases of from $5 to $10 per barrel for every

million barrel-per-day growth in demand over the last decade. In the last 10 years since our prior

report was published (September 1997 to September 2007), OPEC output has risen 10% while

real price has risen over 300%. Recognizing that there are conceptual problems regarding

identification, partial adjustment processes are at work, and supply response is likely

asymmetrical; and noting that the supply curve for a cartel is not well defined, nonetheless a
-45-

simple OPEC supply “elasticity” calculation yields a minuscule +0.08 for price increases over 10

years!

Case 2 also uses the AEO2007 Base outlook, but considers a much wider range of

potential OPEC responses, acknowledging greater uncertainty regarding whether OPEC will

respond with elastic (elasticity >= 1) or inelastic (elasticity < 1) behavior. Each of these are

viewed as equally likely outcomes. We note that the OPEC strategy of preserving its market

share, apparently a robust strategy for long-run profit maximization (Gately 2004, 2007), entails a

long-run OPEC elasticity equivalent to elasticity of supply of other, competitive producers. That

is, by all estimates, an elasticity well below 1.0 (e.g. Toman (2007) suggests 0.3 following Greene

and Ahmad (2005); Huntington (1994) suggests 0.2 to at most 0.6). The net result is a premium

estimate similar in magnitude to Case 0, but slightly larger reflecting the changes in outlook

between AEO2006 and AEO2007.

Case 3 extends Case 2 by also revising elasticities of supply and demand in the nonU.S./non-OPEC region with wider, more recent estimates. We generally follow Gately and

Huntington (2002), as interpreted by Gately (2007), applying a range for elasticity of Non-U.S.

Demand from -0.2 to -0.4, with mean and mode -0.3. Gately and Huntington suggest larger

elasticities for non-transportation oil demand, but sharply smaller elasticities for non-OECD

demand, either transportation or non-transportation. Similarly, the non-U.S./non-OPEC supply

follows the same range -0.2 to -0.4, triangularly distributed with mean and mode 0.3. Together

these assumptions imply that the (mode) net elasticity of import demand from non-U.S./nonOPEC regions has roughly doubled to -1.6. This variation is also responsive to the

recommendations of some of the review panel. The effect of this change is to reduce the

monopsony premium, but also, to some extent, the disruption premium. The latter effect follows

from the slightly higher short-run responsiveness of supply outside of OPEC during disruptions. 

Case 4, an alternative to Case 3, considers an even wider (and slightly higher) range of

Non-U.S. Supply/Demand elasticities, to account for greater uncertainty regarding these

parameters. Elasticity of Non-U.S. Demand ranges from -0.3 to -0.7, triangularly distributed with

mode -0.4 and mean -0.467. Elasticity of Non-U.S. Supply is widened to 0.2 to 0.6, with mode

0.3 and mean 0.367. Together these changes imply that the (mode) net elasticity of import

demand from non-U.S./non-OPEC regions is considerably more than doubled from the 1997 case,

to mode -1.92, mean -2.28. If non-U.S./non-OPEC supply and demand are actually this priceresponsive (on average over the next decade), then the monopsony premium would be further

eroded. Greater price responsiveness means those regions would supply a little less oil and

demand a little more oil if the U.S. import reduction lowers price, offsetting a bit more of the

monopsony effect on non-competitive suppliers.

In Case 5 we revised Case 4 further, replacing the parametric treatment of OPEC supplyelasticity with the candidate OPEC strategic behavioral rule: Maintain Market Share (the Gately

2004 paper best strategy). This rough but robust rule implies that OPEC supply elasticity

matches that of all Non-OPEC supply. As a result OPEC supply responsiveness is comparatively

low, as non-OPEC supply is expected to be. As in Case 4, Non-U.S. elasticity of import demand
-46-

ranges from -1.38 to 3.52, with mode -1.92, mean -2.28. Total elasticity of Net import supply to

U.S. then ranges from 4.77 to 8.63, mean 6.47. Note the narrower range of net supply response to

the U.S. exercise of monopsony power under this OPEC behavioral rule. As a consequence, the

90% confidence range or the monopsony component of the premium is much narrowed.

Case 6 is a variant of Case 3. It applies a lowered range of GDP elasticity for future

disruptions (range -0.01 to -0.054, midcase value -0.032), entailing lower disruption adjustment

costs. Mean value GDP elasticity is 0.032, reduced from mean value 0.0495. OPEC-behavior is

treated parametrically, and all other parameters are as in Case 3. We observe that while the mean

GDP elasticity has been reduced 35%, the disruption-dislocation cost component of the premium

has been reduced only 24%. We attribute this to two effects: a slight non-linearity (concavity) in

the adjustment costs with respect to GDP elasticity (and the mean of a concave non-linear

function is greater than the nonlinear function evaluated at the mean); and offsetting effects

among premium components. This offsetting effect occurs in part because a reduction in any one

component of the premium causes an increase in the level of imports (the level at which the

optimal premium is calculated). A more pronounced offsetting effect is visible in the increase of

a different component of the premium, the Disruption Import Costs. The disruption import costs

are a function of the level of imports during a disruption. The level of imports during a disruption

are in turn a function of GDP during the disruption (the income effect on demand). If we assume

a lower impact of disruption price on GDP (a lower GDP elasticity), then imports stay higher

during the disruption and marginal import costs rise. These are all examples of the

interrelationships between the components of the optimal premium.

The final case considered, Case 7, is another case with reduced GDP impacts from shocks. 

It revises Case 5 (the case where OPEC strategic behavior seeks to maintain market share in

response to shifts in demand) with the reduced GDP elasticity range for future disruptions (again,

the range is from -0.01 to -0.054, with a mean value -0.032). The results are qualitatively similar

to Case 6, in that the reduction of disruption dislocation costs of $0.73/bbl are partially offset by a

$0.22/bbl increase in marginal import costs during the shock.

Over all these cases the mean total premium ranges from $11.09/bbl to $15.37/bbl. The

complete range (union) of all the confidence intervals ranges from $6.53/bbl to $25.88/bbl. 

However, even if one viewed all cases as essentially equally likely, the combined 90% confidence

interval would be somewhat narrower than this.

V.2 A Recommended Case

Clearly there is an unavoidable degree of uncertainty about the magnitude of marginal

economic costs from the U.S. importation of petroleum, and the size of the oil import premium. 

We sought to reflect this with probabilistic risk analysis over key input factors, guided by the

available literature and the best judgement of oil market experts. For cases shown in Table 4 that

explore some plausible variations in the ranges of input assumptions, the mean premium estimates

vary in a fairly moderate range, between $11 and $15/bbl. On balance, Case 6 is suggested as a

reasonable assessment of the premium value. This is based on a review of important driving
-47-

factors, the numerical evaluations and simulations over major uncertainties, and taking into

consideration the many comments and suggestions from reviewers, the EPA and other agencies. 

This case, and the premium range resulting from 90% of the simulated outcomes, encompasses a

wide array of perspectives and potential market outcomes in response to a reduction of U.S.

imports. In this recommended case the mean costs 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 relies on the most recent available projections of the U.S. and world oil market for the

next 10 years, the AEO 2007 Reference Case. OPEC-behavior is treated parametrically, with a

wide range of possible responses represented by a wide range of supply elasticities, from small to

quite large. This recognizes that the OPEC response is the most uncertain single element, and

could vary between inelastic defense of output levels, or market share, or could be highly elastic

in defense of price, probably at the expense of longer run cartel power and discounted net profits. 

The balance between possible elastic and inelastic OPEC response is essentially even, over a

fairly wide range of elasticities. This seems the best strategy until greater progress can be made

in synthesizing what insights are available from the evolving strategic game-theoretic and

empirical research on OPEC behavior, and advancing that research. An alternative would have

been to use OPEC strategic response behavior to maximize long-run net revenue. This may well

correspond to market-share preservation behavior (e.g. Case 5), and a somewhat higher premium

value. 

The case in Table 1 uses updated supply/demand elasticities for non-U.S./Non-OPEC

region after considering more recent estimates than those used in 1997 study, and previously

adopted for the 2006 RFS. As a result, the total market responsiveness is substantially greater

than was the case in the draft report, and is overall quite large. The implied net offsetting

response of competitive suppliers and demanders outside the U.S., to any price decline caused by

a U.S. import reduction, is fairly high given that it must occur over the next 10 years, and in a

global policy milieu that is generally quite attentive to conservation and energy security. Only

small changes to the world oil price are anticipated from a substantial reduction in U.S. demand,

on average about $0.70/bbl for every million-barrels-per-day reduction in demand. Finally, the

case uses a GDP elasticity range, the parameter which summarizes the sensitivity of GDP to oil

price shocks, which is reduced compared to earlier estimates, and compared to the full range of

historically-based estimates. This helps address the concerns of those who either question the

conclusions of past empirical estimates or expect that the impacts of oil shocks may well be

declining.
-48-

Table 4: Alternative Cases Examined. Optimal Premium, Mean and 90% Conf. Interval
 For example, the Council on Foreign Relations (2006) high-level panel of energy and foreign policy experts warns that America’s 45

dependence on imported energy increases its strategic vulnerability and constrains its ability to pursue foreign policy and national security

objectives. Stern (2006) makes the strong case that large cartel rents have contributed to the development of rich, radicalized, and militarily more

powerful hostile states. He argues for the exercise of U.S. monopsony power not simply to recover wealth, but because OPEC market power

underwrites terror and other threats to U.S. national security.

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VI. Conclusions

This study assesses the marginal net economic benefits to the U.S. economy of reduced

U.S. imports of oil. “Security” gains stem from reduced exposure to the economy-wide costs of

potential disruptions in oil supply or spikes in oil cost. Reduced U.S. oil imports also provide

sustained “monopsony” benefits over the long run even in undisrupted markets, by reducing

global demand pressure and oil prices during what is expected to be an extended period of strong

global demand, substantial OPEC market power, and higher world oil prices. The monopsony

benefits during normal markets or disrupted markets reflect a recovery of U.S. wealth that would

otherwise be extracted as cartel rents through the non-competitive exercise of market power by

OPEC countries.

In the face of projected higher oil prices, growing U.S. oil imports, a large and slowly

growing role of U.S. imports in world oil trade, a growing economy and a general expectation

that the oil market may be somewhat more risky over the next decade, our estimate of the oil

import premium is notably larger than estimated in 1997. Like our prior estimates, this study

excludes possible effects of imports on U.S. costs whose relation to import levels is difficult to

ascertain or measure, such as military expenditures and foreign policy effects. However, those

costs remain relevant and worthy of more careful consideration.45

Apart from omitting foreign policy, military, and national security considerations from

this economic analysis, three other factors were omitted which, if included, would possibly

increase the economic estimate of the premium:

! Any further premium due to risk aversion (the disruption analysis is based on expected

values);

! Possible “deterrence effects” of energy security and import reduction measures (the

frequency of disruptions might be reduced if greater U.S. energy security reduces the

motivation for intentional shocks (embargoes or terrorist acts)); and 

! Spillover benefits to U.S. allies (some benefits of U.S. import reduction, particularly the

benefit of lower import prices, would spill over to all major oil consuming nations, many

of which join us in a formal International Energy Agency agreement to reduce energy use

and promote joint energy security. Based on prior estimates, including the full OECD

premium resulting from U.S. import reduction would result in a value approximately three

times larger).

This marginal “premium” approach estimates the effect on U.S. society-wide economic

costs of an incremental reduction in imports. It does not directly apply to the effects of a broader

policy change that not only alters the quantity of oil imports, but may also shift other features of

the oil market in important ways. Possible changes in market relationships that are not modeled

but could strongly influence oil security costs include:
-50-

! increased (or decreased) flexibility of demand and supply, in the short-run or long-run;

! decreased cartel power or discipline; and

! coordinated (amplifying or offsetting) policies by other oil importing countries.

While the study estimates the marginal societal economic benefit of a reduction in

imports, it does not argue that an oil tax or import-tariff equal in magnitude to that marginal

societal premium is an efficient policy for addressing oil security. This is because the root market

failures at work are non-competitive global oil supply and the failure of long-term private oil

market transactions to foresee and account for the economy-wide macroeconomic dislocations

that are borne during disruptions as a consequence of the chosen pre-disruption levels of oil use. 

An externality-type (Pigouvian) tax on undisrupted-market oil imports does not directly or

efficiently address either of these imperfections. While the oil import premium does estimate

how reducing oil imports could diminish the costs of non-competitive supply and reduce

macroeconomic losses during disruptions, it does not address the value to society of reducing

these costs through other measures. Individual policy measures need to be evaluated in this

broader context, and this analysis can provide partial insight into their appropriateness and

benefit.
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Appendix A: Parameters for the Updated (2007) Oil Import Premium Analysis

Table A1: Estimates of Demand and Supply Elasticities from Literature

Disruption Probabilities

Table A2: Decadal Probabilities of 1 or More Disruptions of a Given Size

Case 1 Million

Barrels/Day

3 Million

Barrels/Day

6 Million Barrels/Day

1997 Study Low 50% 10% 5%

1997 Study Mid 70% 30% 15%

EMF-2005 25% 36% 13%

See Appendix C for derivation.

Table: Summary of representative estimates of short-run price elasticity of demand and

adjustment rates. (Source: Atkins, Frank J. and S. M. Tayyebi Jazayeri 2004.)
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Historical Disruptions

Table A3: Historical Disruptions in the World Supply of Oil

Type Number Average

Duration

(months)

Average Size

(% of world

Supply

Accidents 5 5.2 1.1%

Internal Political Struggles 9 6.5 2.3%

International Embargos/

Economic Disputes

4-6**

11.0 (6.1*) 6.2%

Wars in Middle East 4-7**

Total/Average 24 8.1 (6.0*) 3.7%

Notes: *Excluding 44 month Iranian Oilfield Nationalization.

**Some events difficult to classify. 

Sources: Event listing from U.S. EIA. Categorization by Paul Leiby, ORNL.

Summary of historical oil disruptions, 1950-2003
-53-

Table A4: Range of Key Assumptions Used in Study

KEY PARAMETERS/ASSUMPTIONS Low Mid High

GDP disruption-loss elasticity 0.01 0.032 0.054

Disruption reduction w/ imports 0% 10% 30%

OPEC LR supply elasticity 6 1.75 0.25

Share of disruption price increase anticipated 100% 25% 0%

Disruption prob case selector 5 5 5

Disruption length (yrs) 1 1 2

SPR policy (disruption fraction offset) 100% 50% 50%

SPR policy (SPR fraction used) 100% 100% 100%

SPR size (million barrels) 688 688 688

Long run elasticity of U.S. oil demand -30% -27% -20%

Long run elasticity of U.S. oil supply 46% 46% 46%

Adjustment rate for domestic oil demand 20% 15% 10%

Adjustment rate for domestic oil supply 15% 15% 15%

Oil market (AEO2007) case 1 2 3

Import oil price ($/BBL, 2005$) $43.61 $50.99 $64.54 

Domestic oil demand (MMBD) 22.521 22.189 21.782 

Domestic oil production (MMBD) 9.656 9.628 9.487 

U.S. oil import level (MMBD) 12.864 12.561 12.295 

Undisrupted GDP ($billion/year, 2005$) $14,637 $14,573 $14,479 

Non-U.S. net import demand (MMBD) 22.125 21.866 17.965 

OPEC supply (MMBD) 34.989 34.429 30.265 

Other non-OPEC supply (MMBD) 48.580 47.466 47.716 

Total supply (MMBD) 93.224 91.523 87.468 

Net import supply to U.S. (MMBD) 12.864 12.583 12.300 

Elasticity: non-U.S. non-OPEC net import demand -2.157 -1.602 -1.262 

Elasticity: non-U.S. non-OPEC supply 0.400 0.300 0.200 

Elasticity: non-U.S. non-OPEC demand -0.400 -0.300 -0.200 

Elasticity: net import supply to U.S. 20.029 7.585 2.459 
-54-

Table A5: Alternative Estimates for Current Oil Import Premium, 

Mean Value and 90% Confidence Interval
-55-

(20)

(22)

(23)

(24)

Technical Appendix B - Calculation of Premium

Monopsony Premium:

Calculation of the elasticity of net import supply

(21)

Disruption Premium - total

Disruption Premium - Import Cost Component

Note that the first sub-component, the deterrence portion of the Disruption Import Cost

Component, can be written
-56-

(25)

(26)

(27)

(28)

This gives some sense of the possible magnitude of that omitted term. If the elasticity of

probability with respect to imports were to be, e.g. 1.0, then this term would be equal to

N,qi the expected price increase. We assume , = 0.

Disruption Premium - elaboration of Disruption Monopsony Premium

For a linear treatment of disruption price change:

Disruption Premium - GDP Dislocation Cost Component

Using a linear approximation for the change in GDP with price, which is accurate given

Yp small elasticity of GDP with respect to oil shocks, , :

Substituting and taking derivatives
-57-

(29)

(30)

(31)

Dropping the possible deter jrence effect of pre-disruption import levels on N and holding

demand leve du l q and GDP elasticity constant for this partial equilibrium analysis of import

changes leaves only the last two terms. 

Three channels remain for the pre-disruption import level to affect the disruption price level and

GDP loss: through the base oil price, through disruption quantity and through the rate of price

change with disruption quantity.

Again, for a linear treatment of disruption price change:
-58-

(32)

(33)

(34)

(35)

Combining Terms

substituting (without deterrence effect terms or terms related to the change in pre-disruption

demand with pre-disruption import levels):

gathering terms
-59-

Appendix C: Details on Calculation of Disruption Probabilities

Disruption probability distributions for four major supply regions were adopted from the EMF2005 study, which focused on the 2005 to 2015 period. For each region, these distributions were

specified for disruptions in terms of percentage loss of supply, typically for 0%, 20%, 50% and

90% losses. (See the following Figure and Table C1 below).

The decadal probabilities were converted to annual probabilities and entered in a simple

probabilistic simulation spreadsheet driven by @Risk. After combined simulation of annual

disruptions with a sample size of 10,000, using the software @Risk, the following cumulative

distribution for annual probabilities of world supply shortfalls (gross and net after excess capacity

utilization) was obtained for the year 2010. This distribution was taken as generally

representative of annual disruptions in the next decade.

Figure 5 EMF 2005 reported decadal, net disruption distributions by region, for short and

long disruption lengths. Their implications for disruption sizes (based on an earlier AEO)

are shown here, and were aggregated and summarized in this analysis. (Source:

EMF/Beccue and Huntington, 2005).
-60-

This distribution of world supply net shortfalls was aggregated into probabilities for 4 discrete net

disruption sizes, to match the size categories used in the 1997 ORNL analysis. The discrete net

disruption sizes were: 0 MMBD (including 0.0-0.999 MMBD), 1 MMBD (including 1.0-3.999

MMBD), 4 MMBD (including 4.0-5.999 MMBD), and 6 MMBD (including 6.0 and larger). It is

recognized that this simple aggregation into bins identified with the lower-bound-value leads to

some understatement of the mean disruption sizes entailed by the EMF study. In fact, the

expected disruption sizes for events within each of the four bins (size categories) are 0.1, 1.5, 4.7,

and 10.0 MMBD, respectively. The annual disruption probabilities for each discrete size were

converted into decadal disruption probabilities (for at least one disruption of that size category). 

That is, Ndecadal annual = 1-(1-N ) . These decadal event probabilities (see Table C2) were used for 10

the premium calculation meant to be representative over the period 2006-2015.

Figure 6 Cumulative distribution for annual probabilities of world supply shortfalls (gross and

net after excess capacity utilization) in the year 2010, after simulation for the separate regions.
-61-

Table C1: EMF 2005 Disruption Probabilities

Primary Source: Energy Modeling Forum, Phillip C. Beccue and Hillard G. Huntington, 2005.

 Saudi Arabia Probabilities

 Saudi Arabia Disruption Length Probabilities

 Length (Months) 3 12 18 

 Length Probability 54.0% 22.2% 23.7%

 Saudi Arabia Disruption Size Probabilities

Size/Length 0.00% 20.00% 50.00% 90.00% Total

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%

 West of Suez Region Probabilities

 West of Suez Disruption Length Probabilities

 Length (Months) 3 12 18 

 Length Probability 37.6% 48.1% 14.3%

West of Suez Disruption Size Probabilities

Size/Length 0.00% 20.00% 50.00% 90.00% Total

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%

 Other Persian Gulf Region Probabilities

 Other Persian Gulf Disruption Length Probabilities

 Length (Months) 3 12 18 

 Length Probability 42.1% 30.2% 27.6%

 Other Persian Gulf Disruption Size Probabilities

Size/Length 0.00% 20.00% 50.00% 90.00% Total

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%

Russia and Caspian Region Probabilities

Russia and Caspian Region Disruption Length Probabilities

 Length (Months) 3 12 18 

 Length Probability 89.5% 8.0% 2.5%

 Russia and Caspian Region Disruption Size Probabilities

Length/Size 0.00% 20.00% 50.00% 90.00% Total

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%

 Work Source: "Oil64 decomposition ByPricePath shortlongvlong.xls", August 16, 2005. For lengths,

see worksheet "oil64codedlengthsbyregion.xls", August 17, 2005.
-62-

Table C2: Discrete Disruption Probabilities Used in Disruption Premium Calculation

Disruption Size (Thousand Bbl/d) 0 1000 3000 6000 

Disruption Size (Million bbl/d) 0 1 3 6 

Gross Disruption Cumulative Annual Probability 75.5% 75.5% 93.9% 95.4%

Net Disruptions Cumulative Annual Probability 77.1% 91.4% 94.2% 98.7%

Net Disruption Annual Discrete Probability 14.2% 2.9% 4.4% 1.4%

Net Disruption Decadal Discrete Probability 78.4% 25.3% 36.4% 12.7%
-63-

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