Reducing U.S. vulnerability to oil supply shocks.

• Author: Yucel, Mine K.

1. Introduction

   The 1990 crisis in the Middle East has raised concern about the United States's vulnerability to oil supply disruptions. In addition, a number of trends point to increased U.S. dependence on imported oil. Oil imports have increased and production has declined in the United States for the last eight years. Imports now comprise 42 percent of total oil consumption and U.S. dependence on oil imports is projected to increase over the next 20 years. The Energy Modeling Forum forecasts imports to be more than twice domestic production by the year 2010 [14].

   Realizing that we will be importing oil from unstable regions of the world, policies have been considered which would lower our dependence on foreign oil. Congress approved legislation in September 1990 to increase the Strategic Petroleum Reserve (SPR) to one billion barrels, which would be released when an oil supply disruption occurred. The gasoline tax was increased 5 cents per gallon in December 1991. More recently, the Clinton administration considered a gasoline tax and an import fee among other energy taxes, and a 4.3 cent per gallon gasoline tax passed Congress in August 1993.

   There are many studies examining the effects of various policies to protect U.S. energy security.(1) Not many consider the SPR, which can be a powerful tool in combating energy supply shocks. After the oil price shock of the early 1970s, several studies analyzed the effects of stockpiles [1; 16; 17; 19; 23; 25]. Tiesberg [22] developed a model for determining optimal acquisition and sale strategies of SPR oil. He showed that the expected cost of an oil disruption declined with the use of the SPR. Tiesberg found that an optimal tariff policy together with an optimal stockpile policy would be more effective than stockpiling alone.

   The SPR can dramatically increase the domestic short run supply elasticity, which has been found to be a key clement in the welfare cost of protectionist policies. Yucel and Dahl [27] find that U.S. vulnerability to oil supply disruptions is lowered with a tariff and the higher the supply elasticity, the lower the vulnerability. To gauge the effects of the SPR on protectionist policies, this paper analyzes five specific policies--a drawdown of oil from the SPR, a 25 cent gasoline tax, an equal revenue per-unit import tariff of $5.92 per barrel, the gasoline tax with drawdown from the SPR and the tariff with drawdown from the SPR. Using a measure of vulnerability to oil supply shocks, I find, as did Tiesberg, that the SPR together with a protectionist policy works best against a supply disruption. However, unlike Tiesberg, when intertemporal depletion effects are factored in, a gasoline tax together with a drawdown from the SPR is the best protection against a supply disruption.

2. Model

   Simulation Model

   The model is a dynamic partial equilibrium model of the international oil market. The supply side of the model captures the interactions between U.S. policies and world oil prices, where U.S. producers are profit maximizing price takers and OPEC is a dominant firm. U.S. demand constitutes 15 percent of total OPEC demand and is satisfied by domestic production, non-OPEC imports and OPEC imports. Both U.S. producers and OPEC own oil reserves and maximize the present value of their total profits over a 30-year time horizon, subject to their reserve constraints. The problem is simulated for a base case as well as a per unit oil tariff [Tau] and a gasoline tax of [Gamma]. The demand for oil is normalized around 1992 product demand.

   After the model is solved numerically, the vulnerability measure is calculated for the base case, the tariff and the gasoline tax with and without a drawdown from the SPR. The SPR enters the model through increased domestic supply in the vulnerability measure in the case of a disruption.

   The general maximization problem for U.S. producers is to choose the production path of Qu that maximizes:

   [integral of] [P - [Beta][Gamma] - Cu(Ru)][Que.sup.-rt] between limits T and 0 (1a)

   subject to the constraint

   [Mathematical Expression Omitted]

   while OPEC chooses the production path for Qo that maximizes

   [integral of] [f(Qu, Qo) - [Tau] - [Beta][Gamma] - Co(Ro)][Qoe.sup.-rt] between limits T and 0 (2a)

   subject to

   [Mathematical Expression Omitted].

   In the above expressions, P is the price of oil, [Beta] is the percent of the barrel going to gasoline, f is the inverted demand function for domestic and OPEC oil by U.S. consumers, Qo is OPEC production going to U.S. markets, Qu is U.S. domestic production, Ru and Ro are reserve levels, r is the real interest rate, and Cu and Co are costs of production.

   The Hamiltonian for U.S. producers is

   H = [P - [Beta][Gamma] - Cu][Que.sup.-rt] + [[Mu].sup.u](-Qu).(3)

   The first order conditions are

   [H.sub.Qu] = [(P - [Beta][Gamma] - Cu][e.sup.-rt] - [[Mu].sup.u] = 0(4)

   [Mathematical Expression Omitted].

   Similarly, for OPEC we have

   H = [f(Qu, Qo) - [Tau] - [Beta][Gamma] - Co][Qoe.sup.-rt] + [[Mu].sub.o](-Qo)(6)

   [H.sub.Qo] = [([f.sup.Qo]Qo + f) - [Tau] - [Beta][Gamma] - Co][e.sup.-rt] - [[Mu].sub.o] = 0(7)

   [Mathematical Expression Omitted].

   The system is solved numerically to obtain optimal paths for U.S. and OPEC oil output. The domestic and world price of oil, producer profits, and tax revenues are calculated given these production levels.

   Vulnerability Measure

   After numerically solving the maximization problem(2) the cost of a supply disruption is calculated for the base case and with the two policies. The vulnerability measure calculates the welfare loss due to a marginal disruption in oil imports. It is assumed that the disruption could happen at any time during the 30 year time horizon with equal probability and is calculated at each point in time as if it had happened at that time. The measure of vulnerability to supply disruptions is the change in welfare, calculated as the sum of losses or gains in consumers' and producers' surplus. At the margin this change in welfare is imports multiplied by the infinitesimal change in price, i.e.,

   dW = -MdP = QudP - QdP (9)

   where Qu is domestic production, Q domestic consumption and M is imports.

   dM = [Q.sub.p]dP - Q[u.sub.p]dP (10)

   Substituting into dW...