The New Global Oil Market: Understanding Energy Issues in the World Economy

By Siamack Shojai | Go to book overview

Chapter 19
Oil and National Security: An Assessment of Externalities and Policies

Douglas R. Bohiand Michael A. Toman

It is frequently argued that oil imports involve costs and risks to society that are not recognized by buyers and sellers of oil. These additional costs, called externalities, imply that the market price of oil is too low and that the volume of consumption and imports is too high. The recommendation that usually follows is to place a tax on oil imports or on oil consumption to correct the price for these excluded costs.

This chapter critically examines the potential sources of the externalities and assesses their implications for energy policy. We conclude that there are limited externalities that warrant consideration for possible government intervention, and that their quantitative significance is very much in doubt. Consequently, little government action can be justified solely because of energy security considerations.

In keeping with most of the literature on the subject, we consider two broad sources of externalities: those associated with the quality of oil imports, and those associated with the volatility of the price of oil. The issues related to the quantity of oil imports involve excess price and volume of imports and the indirect consequences of these payments for inflation and the international value of the dollar. We also consider the military costs of maintaining access to foreign sources of oil in this category. The issues related to the volatility of the price of oil refer to the economic costs of adjusting to oil price fluctuations. In contrast to the generally longer term nature of the first set of issues, the problems of adjusting to oil price fluctuations are inherently short term in character. The reason is that gradual changes in oil prices are unlikely to generate externalities because markets have the ability to adjust over time without serious efficiency problems, and because externalities associated with rapid price changes will dissipate over time.

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