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Sylvain Chassang on Strategic Energy Purchases: Keeping Oil Prices Manageable

With introductions by Markus Brunnermeier

On Thursday, June 2, Sylvain Chassang joined Markus’ Academy for a lecture on Strategic Energy Purchases. Chassang is a Professor of Economics at Princeton University.

Watch the livestream below. You can also watch all Markus’ Academy webinars on the Markus’ Academy YouTube channel.

Read His White Paper: “Managing Prices through Strategic Procurement”



[0:00] Introductory Remarks
[5:54] Main question
[13:20] Cartel discipline framework
[30:32] Main proposal: strategic energy procurement
[35:55] Using demand
[54:10] Other policies

Executive Summary

  • [0:00] Introductory Remarks. The world consumes a lot of gas, oil, and coal. While total consumption is relatively smooth, price volatility is excessively high. The oil prices have been very volatile, particularly because of price wars, recovery after Covid, and the Russian invasion into Ukraine.
  • [5:54] Main question: how can we manage energy prices through strategic use of purchasing capacity? This is important to understand right now, because of the high energy prices, and the implications for supporting Russia and fueling inflation and related problems. There are also challenges in the resilience of the supply network. Current analyses may be wrong because they do not properly take into account the cartelized nature of the oil market.
  • [13:20] Cartel discipline framework. Oil producers deciding on a supply increase take into account marginal profits, but also, the impact of increased supply on the value of inframarginal production, and it’s impact on future cartel behavior (especially price wars). Due to pandemic and the 2020 price war between OPEC and Russia, threats of punishment loom large, so that cartel discipline is strong. This also means that if OPEC were to follow Western appeals for greater production, it would be effectively defecting on Russia just after reaching a hard earned truce.
  • [30:32] Main proposal: strategic energy procurement. In order to keep energy prices at a moderately high, but stable, price, countries can strategically use their demand to affect market structure. This could be done at the country level, coordinated by a body such as the IEA. By entering into bilateral forward relationships with energy producers, consumers can use their demand to affect industry conduct: encouraging entry, weakening cartel discipline, and encouraging self-regulation by cartel. The coordinating body could strategically guide the allocation of supply to increase the elasticity of residual demand. The board would likely need to have a good understanding of technology, finance, and game theory. This plan could be done reasonably fast, but it would take support from some business in conjunction with infrastructure to be implemented successfully.
  • [35:55] Using demand to encourage entry, deviations, and producer self-regulation. De-risking entry for marginal suppliers is important because with stable prices, potential suppliers may be more willing to enter the market; at moderately high prices, there would still be a benefit from entering the market. This could indirectly relax prices now, and would not increase supply until some point in the future. Scaling up strategic purchase activities only conditional on oil prices being to high would empower  OPEC+ to self-regulate, which would lead to greater economic efficiency.
  • [54:10] Other policies: Russian oil tax or price caps. The cartel (vs competitive) view of the oil market makes a tax on Russian oil less attractive. Supply may be shutdown even if prices net of tax remain above marginal cost; furthermore OPEC need not suitably  increase production; all of this could lead to higher oil prices and little trading of Russian oil. Price caps are intuitively attractive but typically decried by economists. In this case, they are a reasonable response: this is not a competitive market; it is a bilateral bargaining relationship. In a cartelized market price caps could improve the terms of trade without necessarily reducing supply. Price caps could be complemented with price floors to encourage entry, weaken cartel discipline, favor cooperation between buyers and sellers, and support emission goals by keeping the price of energy relatively high.