The Oil Market Economics 331b. 1. Basics of oil regulation 2. The integrated world oil market. Major Themes. Standard themes of US oil policy The bathtub model of the Oil Market Some simple econometrics of the law of one price Implications for Oil Policy. Policy Themes of the Oil Market.
1. Basics of oil regulation2. The integrated world oil market
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.
The reason is that the “law of one price” holds for crude oil.
The Law of One Price (LOOP) 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) homogeneous good, (2) perfect competition, and (2) costless transportation
LOOP is often a justification for efficiency of markets (efficient market hypothesis in finance and classical macroeconomics)
Have two markets (1 and 2) and two prices (p1 and p2).
They are linked together by arbitrage:
p1(t) = p2(t) + ε(t)
Where ε(t) is small and represents generalized transportation costs (e.g., transport, insurance, brokerage, …).
John Baffes, “Some Further Evidence on the Law of One Price: The Law of One Price Still Holds,” American Journal of Agricultural Economics, 1991
Source: EIA primarily from Platts.
Regression: ln[p1(t)] = α+β ln[pbenchmark(t)] + other things + ε(t)
Speed of adjustment asks how quickly a market adjusts to disequilibrium.
For example: oil v. autos v. houses v. lumber.
This shows the unusual integration of world oil market
So why are we wasting all this time on an esoteric economic theory about spatial arbitrage, blah, blah, blah?
The reason is that whether the LOOP holds for oil FUNDAMENTALLY changes your view of oil policy.
These are all wrong: The vulnerabilities are determined by the world oil market and not by our imports.
Limit imports to “secure sources” in region A.
Limit import from region B.
But then region B exports to region C which was previously importing from region A.
Net impact: very small increase in global transportation costs (perhaps $0.05 per barrel out of $100).
How about sanctions?
Policies (assuming 1 is met):