Crude oil has been refined to make such fuels as diesel and petrol as well as industrial chemicals and lubricants. Transport activity, as a core element of economic development and a precondition of human welfare, is increasing across the globe with the growth of economies. Transport predominantly relies on such fossil resource as petroleum. The literature relevant for this study can be divided into two parts or strands: one that focuses on the demand side and another one that gives analysis to the oil market by focusing on the supply side. This paper absorbs the ideas of both strands and studies the importance of the supply side of the oil market for the effects of transport regulations. Although the transport sector must be considered a major contribution to economic growth, it leads to high costs as well. This study has shown that the effects of different policies to regulate the transportation sector depend on the market structure in the oil market. In a competitive market, a fuel tax and a biofuels requirement will tend to reduce oil demand. If a monopoly supplies the oil market, the impact of transport regulations becomes more equivocal.
1,1 Transportation in the Oil Market 3
1.1 Impact of Transport Regulations on World Oil Markets 5
2.0 Literature Review.. 6
3.0 The Impact of Transport Regulations in a Closed Economy 8
4.0 The Impact of Transport Regulations in an Open Economy. 9
5.0 Conclusions 9
6.0 References List.. 11
LIST OF FIGURES
Figure 1. What Makes Up the Cost of a Gallon of Gasoline 5
Figure 2. Greenhouse Gas Emissions from Different Means of Commuting.. 6
1.0 Oil and World Oil Markets
Crude oil has been refined to make such fuels as diesel and petrol as well as industrial chemicals and lubricants since the 1850s. Industrialization owes its development to oil. According to IEA, (2009), the demand for oil has the following important characteristics:
Demand is increasing in the advanced economies of the OECD countries which make up approximately 66% of total world demand. Between 1980 and 2008, world demand increased by 40%, from 60m barrels per day to over 85m barrels (IEA, 2009).
The demand for oil is comparatively inelastic regarding the price, provided that oil has few direct substitutes (IEA, 2009).
“Similarly, demand for oil is relatively inelastic with respect to income in the advanced, OECD economies. However, income elasticity of demand (YED) in developing economies like China and India is likely to be higher, with estimates suggesting that YED is close to 1”(IEA, 2009).
1.1 Transportation in the Oil Market
Transport activity, as a core element of economic development and a precondition of human welfare, is increasing across the globe with the growth of economies (Ribeiro and Kobayashi, 2007). For world oil markets, the most pressing problems associated with this increasing transport activities are congestion, air pollution and petroleum dependence as according to Ribeiro and Kobayashi (2007). These problems are especially acute in the fastest growing economies of the developing world.
Transport predominantly relies on such fossil resource as petroleum solely that supplies 95% of the total energy used by world transport.
Transport activity is expected to increase in the future as world oil market expansion drives transport demand and the transport availability fuels economic development by promoting specialization and trade.
Demand for transportation is high on the global policy agenda in the oil market, and studies like IPCC (2007) and Stern (2007) have showed the need for long-term international transportation agreements as well strong internal domestic transportation policies. Countries’ early steps include the EU Emission Trading Scheme, the Kyoto Protocol, and the Copenhagen Accord; these and future efforts will have important consequences for the oil market. Moreover, energy-importing countries are occupied with energy security issue and oil dependence. Most developed countries import oil from the Middle East and worry about macroeconomic disruption costs from the risk of oil price shocks, constraints on foreign policy (e.g., questions about human rights and democratic freedom in oil exporting nations), and the possible financing of terrorist attacks by the oil revenues. Europe and the United States will continue to rise their import dependency on oil in the near future as their own supplies are depleted (EIA 2010), whereas the Organization of the Petroleum Exporting Countries (OPEC) may increase its market share and, consequently, its market power.
According to Snorre and Knut (2010), the transport sector is crucial while researching on the demand for oil. According to EIA (2010), transportation accounted for 53 percent of the world total liquids consumption in 2007, and the share is expected to increase to 61 percent in 2035. Also, the world’s transportation systems are more than 90 percent dependent on oil and oil products, so a few alternatives can compete with oil in the transport market today.
Policies to regulate transport may have different impacts in a competitive oil market and a market with a dominant producer as asserted by Snorre and Knut (2010). According to Alhajii (2004), the OPEC cartel dominates the oil market, which can hardly be considered competitive while OPEC exhibits market power. Thus, in this work explains impacts of the different types of transportation regulations on world oil markets. Different types of policy instruments: a fuel tax, some required share of biofuels in the transport market, and fuel efficiency (See Fig. 1).
Figure 1. What Makes Up the Cost of a Gallon of Gasoline
Source: Park, 2011.
1.2 Impact of Transport Regulations on World Oil Markets
Although the transport sector must be considered a major contribution to economic growth, it leads to high costs as well. The environmental costs are estimated at 1.1% of GDP. Road, air and shipping transport are the largest emitters of air pollutants. For instance, greenhouse gas emissions caused by air transport have increased by over 4% per year during the last 5 years (See Fig. 2). Overall, domestic transport accounts for 21% of greenhouse gas emissions; these emissions have gone up by around 23% since 1990, threatening progress towards the Kyoto targets.
Also, noise pollution is another effect of transport that is considered as crucially important according to the purpose of ensuring living quality in the EU. Furthermore the safety aspect must be considered as well.
Among the several aspects of life affected by transportation and its associating regulations is the oil industry – the world oil industry. The role transportation plays in the oil industries cannot be underestimated.
Figure 2. Greenhouse Gas Emissions from Different Means of Commuting
Source: Air Pollution and Greenhouse Gases from Different Commuting Options. British Columbia, n.d.
2.0 Literature Review
The literature relevant for this study can be divided into two parts or strands: one that focuses on regulations in the transport sector in a more detailed manner by mainly focusing on the demand side and another one that gives analysis to the oil market by focusing on the supply side. According to the first part of literature, the majority of studies that focus on transport regulations are demand-side analyses (assuming fixed producer prices) that use a utility function as the starting point to calculate optimal fuel taxes (e.g., Parry and Small 2005; West and Williams 2007; Parry 2009), measure welfare effects of fuel economy regulations (e.g., Fischer et al. 2007), or calculate costs of different regulations to meet specific levels of gasoline consumption (e.g., West and Williams, 2005). Morrow et al. (2010) studied the impacts of different policies to reduce greenhouse gas emissions and oil consumption in the U.S. transportation sector but assumed an exogenous oil price.
The large literature on transportation regulations introduces market power when examining the effects of such regulations under possibilities of price discrimination when consumers have different tastes (Plourde and Bardis, 1999) and the effects of such regulations on prices, and fuel consumption (Goldberg, 1998). But these studies observe market power in the supply of cars but not in the oil market. The economic literature on transportation regulations in the oil market has also emerged the last few years as according to Rajagopal and Zilberman (2007).
De Gorter and Just (2007) studied the effects of transport regulations on oil consumption in the competitive market, while Hertel et al. (2010) analyze the impacts of transport regulations in a global computable general equilibrium model (GCGEM).
A recent paper on transport regulations that makes a link to the second strand of literature is Hochman et al. (2010). It focuses on the impact of transport regulations when OPEC acts as a cartel. Two regions in the world were specified; an oil-exporting and an oil-importing region; and study the different impacts on the oil price in the two regions using a static model. However, the paper does not make comparisons with other policy instruments to reduce oil consumption.
Another relevant paper is by Berger et al. (1992), who studied the impact of international agreements to reduce CO2 emissions on fossil fuel prices based on tradable emissions permits and an international CO2 tax. They found that while the two instruments have the same effect on the producer price of fossil fuels in competitive fossil fuel markets, direct regulation in the form of tradable quotas intends to imply higher producer prices than an international CO2 tax giving the same reduction in total CO2 emissions.
Strand (2009) also studies the impacts of some transport regulations such as carbon taxes and tradable permits, taking into perspective two blocs of countries: an oil-importing region that regulates fossil fuel consumption and produces alternative fuels, and an oil-exporting region without any regulations. However, the study concentrates on strategic planning for rent extraction, such as export taxation, rather than effects of market power.
Some studies of carbon taxation consider intertemporal supply under different market settings as according to Berg et al. (1997), but few studies compare policy instruments in an intertemporal setting when market power is taken into account. Sinn (2008) studies different policy implementations from an intertemporal supply-side perspective for a non-renewable resource but fails to consider market power on the supply side.
This study combines the two strands of literature. Instead of focusing on the preferences of consumers, it studies the importance of the supply side of the oil market for the effects of transport regulations. It does not consider intertemporal maximization on the supply side but rather focuses on market power. Its focus is on the effects on the quantity and the price of oil consumption under different market settings. The price effect is however more important.
For instance, that transport regulations follow from a climate treaty, the signatory states may be more concerned about increased emissions in non-signatory countries as a result of a lower oil price (a phenomenon called carbon leakage according to Felder and Rutherford 1993). It is a common belief that environmental regulations may affect terms of trade (Krutilla 1991), and oil-importing countries may worry about policy measures that can increase the oil price. In light of this, this study compares the effects on the oil price of different regulations under different market settings.
3.0 The Impact of Transport Regulations in a Closed Economy
However, the implications for a single oil-importing country will be discussed as well, and in the next section, an open market will be modelled explicitly. As the substitution possibilities are quite small in the transport market, prices of other energy goods are implicitly held constant.
Different transportation regulations are studied to reduce fossil fuel consumption and hence Carbon dioxide emissions under the assumption that they are widely introduced. If we think of the global oil market, these regulations could be the outcome of international climate agreements. So far it seems more realistic to consider such regulations within a single country or a group of countries than the entire globe as not all countries are likely to sign a climate agreement pertaining to the transportation of oil, and that is why an open economy is examined in the next section. The analysis of a closed market will provide useful information about a situation where a large part of the oil market becomes regulated with regards to transportation.
4.0 The Impact of Transport Regulations in an Open Economy
In the section above, it was known that the price effect of reducing oil consumption is independent of the policy instrument in a competitive market but highly dependent on the instrument choice in a monopoly market. In particular, whereas a biofuel share and, most likely, a fuel tax will reduce the producer price of oil in a monopoly market, increased efficiency will increase the price, given that the instrument leads to lower oil consumption. This section explores this issue further in an open economy with either a monopolist or a dominant firm with a competitive advantage. As the analysis becomes more complicated in an open economy, a number of simplifying assumptions are made and also present some numerical illustrations.
Assume now that two regions in the world are consuming oil: Region P and Q. Region P imports oil from Region Q. Both regions are assumed to have linear transport demand functions.
Moreover, we disregard transport regulations in Region Q, so that qQ = xQ. Consequently, using equation (3), the consuming regions have the following inverse demand functions for oil, whereα1> 0, α2 > 0, β1 > 0, β2 > 0 and subscript i = P,Q represents the variable of region i:
This study has shown that the effects of different policies to regulate the transportation sector depend on the market structure in the oil market. In a competitive market, a fuel tax and a biofuels requirement will tend to reduce oil demand. On the other hand, a fuel-efficiency standard will have uncertain impact on oil demand as it lowers the price and increases demand for transport services, while reducing the oil consumption needed to produce a certain level of transport services.
If a monopoly supplies the oil market, the impact of transport regulations becomes more equivocal. While a fuel tax will definitely reduce oil consumption, a required share of biofuels may actually increase oil consumption with a monopoly if the inverse demand function is very convex. Fuel-efficiency standards also have uncertain impacts on oil consumption, just as in a competitive market.
In an open economy with an oil-producing region as well as an oil-importing region, it was showed that under reasonable assumptions, both taxes and biofuels shares will decrease oil consumption if they are introduced in the oil-importing region. Again, the impact of increased fuel efficiency is ambiguous. With monopoly on the supply side, oil consumption in the importing region is more likely to increase if it is small compared to the exporting region (measured in oil consumption). Existence of a competitive fringe producing oil increases the likelihood of decreased oil consumption in the case of increased fuel-efficiency standards.
It is hard to make policy recommendations based on this analysis because policymakers’ preferences for the effects on the producer price of oil and their own oil consumption may contrast. If it assumed that the prime objective of transport regulations is to decrease oil consumption, a fuel tax may be the safest option because it will always reduce oil consumption. Because the producer price moves in the same direction as the consumption in a competitive market, lower oil consumption always goes hand-in-hand with a lower oil price.
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