The Costs of US Oil Dependency
Ian W.H. Parry and Joel Darmstadter
Paper
prepared for the National Commission on Energy
Policy.
1. Introduction
Energy security may broadly be described as a
state of affairs
characterized by conditions and policies that
safeguard the health of
the US economy against circumstances
threatening significant short- or long-term
increases in energy costs.
It is a concept with many dimensions, only one
of which.the problem of
dependence on a world oil market characterized
by substantial price
volatility and exercise of market power.will
be addressed in this
paper.1 Even the energy security aspects of
oil dependence are
numerous: some are geopolitical (e.g., efforts
to promote the stability
of oil-exporting regimes), while others
revolve around geological or
technological issues (e.g., the payoff from
R&D investments to
expand domestic liquid fuel reserves).
However, the topic addressed
here.the economic costs of US oil consumption
and import
dependence.occupies a central place in energy
security policy analysis
and debate. The exposition proceeds as
follows.
Section 2 sets the scene with a brief statistical background, including trends in US petroleum consumption, imports and where they come from, oil prices, the energy-intensity of GDP, and the world distribution of known oil reserves. We also discuss the potential power of OPEC to manipulate world oil prices, projected trends in US oil dependency, the effect of oil prices on aggregate economic activity, and the potential role of the Strategic Petroleum Reserve in mitigating against price shocks.
Section 3 discusses the components of the oil premium and recent quantitative assessments of them. The premium reflects the extent to which the costs to the US from an extra barrel of petroleum consumption exceeds the private costs paid by oil users; it tells us how much policy intervention to reduce oil dependency is warranted on economic grounds through, for example, energy conservation measures. The premium has two main components, one reflecting US monopsony power in the world oil market and ability to lower oil prices by reducing imports. The other reflects disruption costs from potential future oil price shocks including temporarily higher oil payments to overseas suppliers and a range of adjustment costs throughout the economy as industries respond to higher energy prices. Both monopsony and disruption components are difficult to pin down accurately, as a number of factors are uncertain, such as how OPEC would respond to a cut in US oil imports, the likelihood of future price shocks, and the extent to which the private sector takes into account the risk of price shocks.
Estimates of the oil premium have fallen over time as the oil-intensity of GDP has declined, price volatility and oil market disruptions are less pronounced than twenty years ago, and the private sector can now respond more flexibly to shocks. Recent estimates put the total premium at between around $0 and $14/barrel, equivalent to between 0 and 30 cents/gallon of gasoline; our best assessment is that the premium is around $5/barrel. Whether the premium will increase or decrease in the future is unclear: the share of oil in US GDP will continue to decline while the imported share of US oil petroleum will continues to rise. One caveat is that studies of the oil premium could be biased downwards as they do not account for certain geopolitical factors that are not easily quantified, such as the risk of oil supply sabotage by terrorists or the takeover of Saudi Arabia and other oil rich nations by extremist governments willing to sacrifice oil revenues to inflict economic damage on the US.
A final section briefly comments on some policy implications.
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