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The Oil Market Economics 331b Spring 2010

The Oil Market Economics 331b Spring 2010. 1. Basics of oil regulation 2. The integrated world oil market. Major Themes. What are major sources of concern on oil? The Bathtub model of the Oil Market Some simple econometrics of the law of one price Implications for Oil Policy.

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The Oil Market Economics 331b Spring 2010

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  1. The Oil MarketEconomics 331bSpring 2010 1. Basics of oil regulation2. The integrated world oil market

  2. Major Themes • What are major sources of concern on oil? • The Bathtub model of the Oil Market • Some simple econometrics of the law of one price • Implications for Oil Policy

  3. Reasons for Regulation of Oil-Using Capital • Externalities • Local pollution • Climate change • Congestion • Road accidents • Macroeconomic/trade • Impact of oil price on business cycle • Optimal tariff • Political/military • Imperfect decisionmaking • Discounting • Split incentives • Poor information

  4. First-best policy options

  5. This is not a bathtub.

  6. Basic idea of bathtub model Oil policy can only be considered in the context of world supply and demand. National policies are effective only to the extent that they contribute to total demands or total supplies. Oil policy is a pecuniary “global public good.” Pecuniary v. technological externalities.

  7. The “Law of One Price” The Law of One Price (LOP) is an economic hypothesis stating that the common-currency price of a standardized commodity should be the same in different markets. Conditions to hold are (1) profit maximization and (2) costless transportation, distribution, and resale Get approximate LOP when have low transport and transactions costs. This is case for oil, but very few other goods.

  8. Failure of Law of One Price: All Consumer Prices

  9. A Not-So-Unified Market: Prices of #2 Douglas Fir Logs in Six Regions of the Pacific Northwest Source: Log Lines, various dates.

  10. Prices of Crude Oil in 31 Regional Markets Worldwide Source: EIA primarily from Platts.

  11. Comparison of U.S. and European Benchmark Crude Prices Source: EIA primarily from Platts.

  12. The oil price equation (n=18,169)

  13. Issues Raised by the Integrated World Oil Market • Limit oil imports to secure sources? • Strategic petroleum reserve should make sure that cover 90 days of US imports?

  14. The “Oil Premium” The “oil premium” is the excess of the marginal cost of oil use over its price. What are the sources of the premium? • Vulnerability to import disruption • Technological externalities (pollution, global warming) • Effect of higher use on oil price • Macroeconomic externalities of higher oil prices. Major point is that these all depend upon global market, not on oil imports!

  15. Petroleum Imports as a Share of Total Imports, United States Source: U.S. Bureau of Economic Analysis data.

  16. National Security Concerns 1. Grabbing oil is primarily a wealth transfer and not a pricing issue. 2. The cost of protecting trade routes or going to war over oil is misguided and wasteful. 3. The value of sanctions and embargoes is nil. 4. The competition for access to resources is a misguided worry.

  17. Sanctions and the price of Libyan oil

  18. EEconometrics of sanctions

  19. Appropriate Policies for Oil in the Integrated World Market Objectives: • Oil prices should be low, stable, and sustainable. • Oil policy can only be rational if the price of carbon is appropriately set. Policies (assuming 2 is met): • Encourage production everywhere (no domestic subsidies) • Discourage consumption everywhere (not just at home), particularly with respect to subsidies.

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