The Economic Cost of U.S. Oil Conservation

By Brown, Stephen P. A.; Huntington, Hillard G. | Contemporary Economic Policy, July 1994 | Go to article overview

The Economic Cost of U.S. Oil Conservation


Brown, Stephen P. A., Huntington, Hillard G., Contemporary Economic Policy


I. INTRODUCTION

In recent years, increasing attention to global environmental problems, energy security, and declining U.S. oil production have revived calls for energy conservation. The benefits and costs of energy conservation remain controversial. Hall (1990, 1992) provides comprehensive estimates of the externality costs associated with energy consumption. Others estimate the costs of conservation (Brown and Phillips, 1991; Chandler et al., 1988; National Academy of Sciences, 1991).

Previous cost studies tend to assess the costs of holding U.S. oil consumption at a predetermined level and/or rely upon a single supply curve of conservation. The projected growth of oil consumption, as well as individual model parameters, greatly affect cost estimates in these studies. A more general approach involves estimating supply curves of oil conservation using a range of market conditions represented in different models of the world oil market. Varying estimates permit assessing the extent of uncertainty about the cost of conservation and in determining whether specific conservation policies serve economic efficiency.

U.S. oil conservation policy might unintentionally stimulate gains in oil consumption outside of the United States. Reduced U.S. oil consumption lowers world oil prices and triggers offsetting gains in world oil consumption. As a consequence, net world oil conservation is somewhat less than gross U.S. conservation. In concert, countries' international agreements to reduce oil consumption can close the gap between gross and net conservation. However, free riding and uneven costs of participation seem to prevent such agreements. But for a large country such as the United States, unilateral oil conservation policies are a realistic possibility.

Identifying efficient policies for unilateral oil conservation involves examining two types of supply curves of conservation: (i) the marginal cost of gross U.S. conservation and (ii) the marginal cost of net world conservation. The latter may be of particular interest when the externalities associated with oil consumption arise primarily from world oil consumption. (An alternative approach is to make appropriate adjustments when measuring the benefits.)

Estimating supply curves of oil conservation for the United States involves a three-step process: (i) obtaining projected prices and quantities, as well as price elasticities of supply and demand, from five world oil market models that participated in the eleventh Energy Modeling Forum study, International Oil Supplies and Demands; (ii) using parameters from each model in simulation analysis to estimate how U.S. oil conservation would affect prices and quantities on the world oil market under a variety of assumptions; and (iii) combining welfare analysis with the simulation results and the model parameters so as to derive supply curves of conservation for each of the five models.

II. ANALYTICAL FRAMEWORK

Using parameters from each of five world oil market models in a series of simulation analyses provides multiple estimates of U.S. oil conservation's effects on prices and quantities on the world oil market. The simulations assume that U.S. oil conservation is achieved through a tax on domestic oil consumption. (The assumption excludes from the analysis the possibility of directing U.S. oil conservation against specific uses, a policy which would lower oil prices and act as a stimulus to domestic oil consumption in unregulated uses.) World oil market conditions determine how much of the tax is borne by U.S. consumers and how much is seen as lower world oil prices. Because taxation lowers the world oil price, however, achieving any given level of U.S. conservation requires a higher tax.

Welfare analysis serves as a basis to provide estimates of the supply (marginal cost) curves of oil conservation. The welfare-theoretic approach has the advantages of being well grounded in economic theory and relatively straight forward to implement and interpret. …

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