fuel subsidies and the global oil market (preliminary)

Fuel Subsidies and the Global Oil Market(Preliminary)

Nathan Balke∗, Michael Plante and Mine Yucel

∗Southern Methodist UniversityFederal Reserve Bank of Dallas

July 29, 2013

Balke, Plante and Yucel Fuel Subsidies and the Global Oil Market(Preliminary) July 29, 2013 1 / 24

Introduction

Introduction

I Fuel subsidies used by many developing countries

I Net oil exporters the largest subsidizers

I Fuel subsidies distort consumption and production decisions


Introduction

Top 10 Fuel Subsidizing Exporters

Country Share of GDP Cost ($B)

Iraq 17.8 20.4Iran 8.6 41.4Ecuador 8.2 5.44Saudi Arabia 7.7 46.1Venezuela 6.9 22.0Egypt* 6.5 15.27Libya 6.3 2.26Algeria 5.7 11.26Turkmenistan 3.0 0.83Malaysia 1.9 5.35

Table : 2011 – IEA data


Model

Model

I Analyze fuel subsidies with a two-country modelI Oil importing country, AI Oil exporting country, O

I Country A produces manufactured good

I Country O produces oil

I Households in both countries consume oil and the manufactured good

I Oil exporter has fuel subsidies


Model Oil Importing Country

Oil Importing Country

I Households consume both a manufactured good and oil

I Firms produce manufactured good, using capital, oil and labor

I Both households and firms pay world price for oil, Po

I Households receive wages, return on capital, profits from firm




I Households maximize utility

E0

∞∑t=0

βtU (Ca,t ,Na,t)

I Where β is the discount factor

I Ca,t is aggregate consumption in country a

I Na,t is hours worked




I Aggregate consumption:

Ca,t =[ωcaA

1−µcc,a,t + (1− ωc

a)O1−µcc,a,t

] 11−µc

I Ac,a,t is consumption of manufactured good in country a

I Oc,a,t is consumption of oil in country a




I Household budget constraint:

Aa,c,t + Pot Oc,a,t + Ia,t + φ(K ) = Wa,tNa,t + ra,tKt + Πa,t

I Pot is the relative price of oil

I Ia,t is gross investment in the capital good

I Wa,t is the wage

I ra,t is the return to capital

I φ(k) are adjustment costs

I Πa,t is re-numerated profits from the manufacturing firm




I Capital accumulation follows:

Ka,t − Ka,t−1 = Ia,t − δKa,t−t

I Adjustment costs are given by

φ(K ) =ψk

2(Kt − Kt−1)2




I Production technology:

Ya,t = Z ya,tN

αa,t

(ωyKK

1−νa,t−1 +

(1− ωy

K

)O1−ν

y ,a,t

) 1−α1−ν

I Ya,t is output in country a

I Z ya,t is a productivity

I Oy ,a,t is oil used by the firm in country a




I The firm maximizes profit

Πa,t = Ya,t − ra,tKa,t−1 −Wa,tNa,t − Pot Oy ,a,t


Model Oil Exporting Country

Oil Exporting Country

I Government produces oil using labor

I Oil is sold domestically at subsidized prices, Ps

I Remaining supply is exported at world prices, Po

I Government distributes oil profits to populace, transfer T

I Subsidy lowers transfers




I Households maximize utility

E0

∞∑t=0

βtU (Co,t ,No,t)

I Preferences identical to oil importing country

I β is the discount factor

I Co,t is aggregate consumption in country o

I No,t is hours worked




I The household budget constraint is

Ao,c,t + PstOc,o,t = Wo,tNo,t + Tt

I Pst is the subsidized price of oil

I Wo,t is the wage in the oil sector

I Tt is a lump-sum transfer from the government




I Production of oil is a function of labor:

Yo,t = Z yo,tN

α0o,t

I Yo,t is production of oil

I Z yo,t is productivity

I No,t is labor used to produce oil




I Firm maximizes profit

Πa,t = Pot (Yo,t − Oc,o,t) + Ps

tOc,o,t −Wo,tNo,t


Model Resource Constraints

Resource Constraints

I Oil importer:

Ac,a,t + Pot Oc,a,t + Ia,t + φ(K ) = Ya,t − Po

t Oy ,a,t

I Oil exporter:

Ac,o,t + Pot Oc,o,t = Po

t Yo,t


Model Market Clearing Conditions

Market Clearing Conditions

I Oil market:Oc,a,t + Oy ,a,t + Oc,o,t = Yo,t

I Manufactured good market:

Ac,a,t + Ia,t + Ac,o,t = Ya,t


Model Calibration

Calibration

Parameter or variable Value Source

Risk Aversion (σ) 2 Macro literatureElasticities of substitution 0.75 Graham & GlaisterElasticity of labor supply 1 Macro literatureDiscount factor (β) 0.96 U.S. real interest ratesOil Cons/GDP ratio in ROW 5% IO tablesFirm oil demand in ROW 2% IO tablesSubsidizer oil use 1.1% EIA IES DataLabor income/GDP in ROW 70% Developed country dataLabor income/oil production 50% Guesstimate


Model Cases Considered

Cases Considered

I Steady state with no subsidy

I Steady state with subsidy in OPEC countriesI Oil supply shock in OPEC countries

I OPEC does not subsidizeI OPEC subsidizes

I Productivity shock in non-OPEC countriesI OPEC does not subsidizeI OPEC subsidizes


Results

Change in Steady State with a Subsidy

Subsidy Cost (% of OPEC GDP)Variable 1% 5%

Po 0.99 4.97Ps -6.3 -25.4Yo 0.03 0.24Oc,o 5.24 26.06Oc,a -0.75 -3.64Oy ,a -0.75 -3.63T -0.98 -4.78Ac,o 0.23 1.15Ac,a -0.01 -0.07Na 0.03 0.16No 0.07 0.47


Results

Change in Steady State with an Oil Supply Shock inOPEC Countries

5% decline in OPEC supplyVariable No subsidy Subsidy (∆ from no subsidy)

Po 7.27 1.15Ps 7.27 -6.78Yo -5.00 0.00Oc,o -3.54 5.69Oc,a -5.22 -0.87Oy ,a -5.21 -0.87T 1.90 -1.07Ac,o 1.67 0.27Ac,a -0.10 -0.02Na 0.22 0.04No -0.48 0.07


Results

Change in Steady State with a Productivity Shock inNon-OPEC Countries

5% increase in non-OPEC productivityVariable No subsidy Subsidy (∆ from no subsidy)

Po 8.87 1.33Ps 8.87 -8.15Yo -1.47 0.05Oc,o 0.37 6.92Oc,a -1.75 -1.01Oy ,a -1.73 -1.00T 7.28 -1.31Ac,o 6.98 0.31Ac,a 4.72 -0.02Na -2.08 0.04No -2.91 0.04


Summary

Summary

I Subsidy in oil-exporting countries causes world oil prices to rise

I Oil consumption is crowded out in the oil-importing country

I Terms of trade effect crowds out oil-importing country’s consumptionof its own good

I Subsidies lower oil-exporting country’s transfers to its people

I Oil-exporter substitutes overall oil profits with a subsidy for aparticular fuel ⇒ could have distributional effects.


fuel subsidies and the global oil market (preliminary)

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