As discussed previously, the United States is a major buyer of imported crude oil, and its imports represent a large share of the market for internation­ally ‘‘traded’’ oil. Given the large scale of U. S. purchases, incremental U. S. acquisitions of oil affect the overall international market price of oil. Stated another way, the cost of each marginal barrel is higher than the price paid for that barrel given that this additional purchase affects the costs of all oil consumed. From the perspective of the United States, this constitutes an externality in the sense that consumers will base their decisions regarding the quantity of oil (and oil products) purchased on the average, rather than the marginal, cost of oil. On the other hand, the fact that the United States faces a rising supply curve for oil gives it monopsony power. To the extent that the United States—or a group of consuming countries that include the United States or is of a comparable scale—take concrete actions to reduce the size of its purchases, it can lower the market price of oil.

It has been well established that OPEC frequently changes its price targets in response to changes in market demand. Discussion of the size of a mono­phony (power) wedge that is the “difference between the current price of oil and the marginal cost of adding a barrel of demand’’ was the subject of an Energy Modeling Forum working group and other exercises.

OPEC’s response to efforts by the OECD to reduce oil demand has varied over time. Initially, during the 1980s as the OECD demand receded, OPEC main­tained its output path, letting oil prices decline. This result produced the highest buying power wedge size and reinforced the viability of consumer country policies that sought to exercise this monopsony power. However, OPEC can also maintain its price preference path and allow its market share to decline. This appears to be its strategy during recent years. But the continuation of the production sharing discipline needed to maintain this approach may become harder to sustain in the future.

Consuming countries have implemented two key approaches to dealing with OPEC given the increas­ing trend toward oil price deregulation inside the OECD. One is that governments have organized to hold strategic stocks of oil. The second is the imposition of consumer taxes on oil, thereby redu­cing demand for oil. As discussed previously, OPEC has engaged in a public relations battle against Western consumer taxes on oil.

Prior to deregulation, during the 1970s, crude oil was sold mainly through exclusive, long-term, fixed – priced contract arrangements with a handful of major suppliers. Crude prices throughout the world were regulated by national governments at fixed levels. Under this system, oil sellers could pose a clear threat to any individual buyer. A clear thread linked a disruption in supply to the shortfall of actual deliveries. A particular barrel lost in exports was neatly matched to a particular barrel lost to a particular buyer that had a contract for that barrel. Little recourse was available. Barrels were moved around the world like pieces on a chessboard, and there was no other deus ex machina to mitigate or alter the impact of any supply cutoff if one’s particular barrels were lost. Lucky buyers whose supply chains remained intact could continue to receive their oil at prices locked by long-term fixed – price contracts at precrisis levels. In a word, some buyers were safe and others were not. This system created a psychology that enhanced OPEC’s mono­poly power and left individual consuming nations vulnerable to the possibility of a supply cutoff. The oil crisis of 1973 confirmed fears that oil producers might use this leverage to adverse political ends.

Given the high costs of a cutoff under this fixed price system (i. e., regulated price system), large consumers, oil distributors, and middlemen had direct incentives to carry ample inventories of spare supplies. The possibility that oil from any particular supplier could be disrupted without recourse was reason enough to pay the costs to carry extra supplies on hand. Prices that could be passed on to consumers were in many cases inflexible and regulated, and competitors that were not subject to a cutoff would have a clear cost advantage.

Today’s world is radically different. Crude oil prices have been ‘‘deregulated,’’ that is, set by market forces through market auction practices that allocate supplies to the highest bidder. Price arbitrage will ensure that a price increase for one buyer or location will be a price increase for all buyers and locations.

In the new free-wheeling marketplace for oil, buyers cannot insulate themselves from price jumps by holding long-term contracts given that prices in these contracts are pegged to the spot market. But in today’s market, one can always get the oil one desires, even in a major supply disruption, by simply paying a higher price.

At the end of the day, as the market clears, such as it did during the Iraqi invasion of Kuwait in 1990, buyers with imports from countries that were not subject to disruption are in no better position than buyers that had all of their imports subject to interruption. In an unfettered spot market, shortages will manifest themselves not in a physical inability to find supplies but rather in the rising price of oil. The market will ‘‘clear’’ or allocate available physical supplies to the highest bidder.

In this new commodicized market, commercial players such as distributors and middlemen have less incentive to carry inventory, especially if supply disruptions are infrequent. Higher costs during times of supply cutbacks can simply be passed on to end users, reducing the business risks that motivated the accumulation of commercial inventories previously. Although the existence of a large spot market trading at unregulated prices certainly appears to work against OPEC’s ability to ‘‘blackmail’’ any particular buyer, structural reductions in commercial inven­tories can augment the producer group’s power to the extent that alternative supplies from countries out­side of OPEC are reduced.

The ‘‘public goods’’ aspect of oil market stability elevates the accumulation of oil inventories to a domain beyond the commercial industry. Individual players in the oil market will not take into account the externalities of low commercial stocks such as increased energy price volatility and its negative distributive effects on poorer consumers or its aggregate negative macroeconomic effects. Thus, government plays a role in ensuring that adequate inventories are on hand to maintain orderly markets and to counter the temptation of suppliers with monopoly power from taking advantage of short­term tightness in oil markets. To achieve these ends, government-held stock levels must be credible to convince oil producers that efforts to exploit temporary market tightness by further cuts in production to achieve even higher oil prices will not be successful. Such attempts to extract additional rents from consuming countries would be countered by the release of sufficient inventories to offset any cuts in production contemplated by producers. The larger the government-held stocks and the more consuming governments that participate in such a stock holding program, the more effective it is likely to be in serving as a deterrent to OPEC’s monopoly power in deregulated markets.

Market deregulation has left consumers more susceptible to the ill effects of energy price volatility. However, consuming country governments have been able to reduce the negative effects of price variability by increasing energy efficiency and reducing depen­dence on oil through the use of hefty consumer taxes on oil. The net effect of such taxes is to discourage wasteful use of energy by consumers while collecting some of the rents that would otherwise accrue to oil producers. Furthermore, large oil consumption taxes can force OPEC to accept lower prices, as occurred throughout most of the late 1980s and 1990s.

When OPEC’s monopoly power strengthens due to short-term market tightening, the incentive to exploit that power is tempered by the fact that increases in monopoly rents will not accrue entirely to producers but rather must be shared with consum­ing countries that have high energy taxes.

Updated: March 12, 2016 — 11:50 am