Journal of Post Keynesian Economics

ISSN: 0160-3477 (Print) 1557-7821 (Online) Journal homepage: http://www.tandfonline.com/loi/mpke20

Energy and market power: an alternative

approach to the economics of oil
Alessandro Roncaglia
To cite this article: Alessandro Roncaglia (2003) Energy and market power: an alternative
approach to the economics of oil, Journal of Post Keynesian Economics, 25:4, 641-659
To link to this article: http://dx.doi.org/10.1080/01603477.2003.11051375

Published online: 23 Dec 2014.

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ALESSANDRO RONCAGLIA

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Energy and market power: an

alternative approach to the
economics of oil
Abstract: After recalling the existence of two competitive approaches to economics, the subjective and the objective one, and the main stylized facts
about the energy sector, the paper critically examines different versions of mainstream economics of oil and sketches an alternative approach, based on the
notion of trilateral oligopoly. Some implications of this approach (dynamic
rather than static substitution, an environmental policy based not on fears of
scarcity but on the notion of sustainable development, the need for antitrust
intervention for stabilizing oil prices) are then examined.
Key words: carbon taxes, dynamic substitution, energy, environment, oil.

Background: contending approaches to economic theory

Analysis of any real-world economic issue implies implicit or explicit
reference to some theoretical scheme, hence to an interpretation of the
functioning of market economies. Such theoretical schemes are necessarily based on a process of abstraction, by which the theorist isolates a
few elements on which to focus attention, as the most relevant ones for
the problem at hand, whereas a myriad of other aspects of reality are left
out of the picture, eventually to be taken up for consideration in successive approximations of the analysis.
As far as the general issue is concernednamely, the interpretation of
market economieswe may distinguish (at least) two contending approaches in the economics literature. The first, and older, subjective
Alessandro Roncaglia is Professor of Economics in the Department of Economic
Sciences, University of Rome La Sapienza. This paper was presented at the Seventh
International Post Keynesian Conference, Kansas City, July 2002. Thanks are due to
the participants, particularly to Harry Bloch, Paul Davidson, and James Galbraith, for
a lively and useful discussion, and to MIUR (the Italian Ministry for universities) for
research funding.
Journal of Post Keynesian Economics / Summer 2003, Vol. 25, No. 4 641
2003 M.E. Sharpe, Inc.
01603477 / 2003 $9.50 + 0.00.

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approach centers on the idea that the economic value of goods and services depends on their utility and scarcity. We can find traces of this
approach in classical antiquity and in the Medieval period, well before
the Marginalist revolution of the 1870s; it achieved a dominant status
in the twentieth century. Within such an approach, the market may be
characterized as a point in time and space where demand and supply
meet. More specifically, both supply and demand are considered as welldefined and independent functions of the price of the commodity under
consideration (and possibly of other variables, in a full-fledged general
equilibrium approach); equilibrium is reached when the market clears, that
is, when supply equals demand. Sraffa characterizes this as a one-way
avenue that leads from Factors of production to Consumption goods
(1960, p. 93): equilibrium prices and quantities constitute the analytical
passage through which the endowments of resources (scarcity) are brought
to satisfy the economic agents tastes and desires (utility).
The second, objective, approach to the interpretation of market economies locates the source of value of commodities in their relative difficulty of production, and focuses attention on the division of labor as the
basic feature for the economic analysis of human societies. This approach grows with capitalism: we may find its origins in William Pettys
writings in the seventeenth century, and it culminated in the golden period of the classical school with Adam Smith and David Ricardo; it has
been revived in the contemporary debate by Piero Sraffa. In this case,
the market is considered as a system of sufficiently regular, repetitive
flows of goods and services that in an economy based on the division of
labor connect the different productive units, each producing a specific
product (or group of products) and each in need of products of other
units in order to continue its activity. More specifically, relative prices
(or exchange values) here stem from the conditions that, in a competitive capitalistic economy, must be satisfied for the regular reproduction
of activity: each sector must recover production costs, and in addition to
this the firms within each sector must earn a rate of profits sufficient for
inducing them to continue their activity, so we may assume that under
fully competitive conditions a uniform rate of profits would prevail in
all sectors of the economy.
The two approaches involve not only different analytical structures, but
also different notions of the market. In fact, the ideal type of the market
for the subjective approach may be found at first in Medieval market
fairs and later in old-style Continental stock exchanges based on auctions.
The objective approach, instead, with its idea of the market as a web of
repetitive flows of means of production and consumption connecting the

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different sectors and economic agents of the economy, focuses attention

on the system of markets for means of production and consumption. In
the first case, equilibrium in the sense of market clearing is the basic
analytical stone; in the second case, market clearing is not required, and
in any case it does not constitute a crucial notion for the analysis.1
We cannot discuss here the developments of the two approaches. However, it may be useful to give a few hints.2 On one side, the crucial analytical difficulty of the classical approachthe erroneousness of the
labor theory of valuehas been solved by Sraffa with his 1960 analysis
of prices of production. On the other side, the subjective approach seems
unable to take into account the multi-commodity nature of any economy
based on the division of labor. In fact, either it relies on aggregate, onecommodity models (as does the whole of mainstream macroeconomics), or it falls into nihilism, with the axiomatic general equilibrium
analysis where definite results cannot be reached (due to multiplicity of
equilibriums and instability).
Background: some stylized facts about the energy sector
The subjective approach and the objective approach briefly illustrated in the previous section lay stress on different aspects of reality.
More specifically, when confronted with energy issues, the first approach
focuses attention on the ultimate scarcity of the natural resources from
which energy is derived, and on the role of energy prices for an intertemporal adjustment process adapting the path of utilization of the scarce
resources to their ultimate availability. Quite differently, the objective
approach attributes great importance to technical progress and, embodying Keyness contributions,3 takes into account the basic uncertainty
that surrounds the future.
1 By market clearing equilibrium we mean the strict condition of equality between
supply and demand brought about by the price mechanism, which characterizes
marginalist theorizing, as opposed to the less strict idea of the classical economy, that
supply and demand adjust to each other, which does not necessarily imply their
precise equality. On this distinction, see Roncaglia (2001).
2 For a reconstruction of the history of economic thought along the lines sketched in
this section, see Roncaglia (2001).
3 On this point, see Roncaglia (forthcoming). Elements of a Keynesian approach
to oil economics have been proposed by Davidson (1963, 1979); however, rather than
considering it an independent, separate approach, it may be useful to utilize such
elements, together with other elements such as Sylos Labinis (1969) notion of the
barriers to entry, as building blocks of a classical Keynesian approach to oil
economics.

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If we look to the history of the energy sector, it seems to agree with the
objective approach much more than with the subjective one.
First, there is the crucial importance of technical progress. Over time,
the energy sector underwent a process of deep change. Contrary to the
scarcity view implying a progressively stricter constraint on growth
stemming from the ultimate scarcity of energy sources and a shift to
inferior, backstop technologies (as Nordhaus, 1973, called them), there
has been a repeated transition to improved energy sourcesfrom wood
to coal, then to hydroelectricity, to oil, to natural gas, and to other, alternative sources embodying increasing technological knowledge4
which ensured at the same time an extraordinarily large increase in the
amount of energy available, currently and in perspective, and an equally
substantial decrease in energy costs. Thus the scarcity forecasts as
advanced, for instance, by Jevons (1865) with reference to the impending exhaustion of coal, or by the Club of Rome (Meadows et al., 1972)
concerning oil among other things, may now be easily dismissed as
wholly misplaced.5 However, the attention these works received is an
indication of the wide diffusion of the scarcity paradigm among policymakers and public opinion at large; it should also be stressed in this
respect that erroneous views are not without consequences, when policy
measures are taken on their basis.6 As a matter of fact, oil proven reserves are now higher, even if expressed in terms of years-consumption,

4 We need not enter here into the complex issue of evaluating nuclear energy. As a
brief hint, while it is clear that it embodies sophisticated technical knowledge, it
should also be stressed that its costs are relatively high, especially when the safety
issue is seriously taken into account (including risk of terrorist attacks) and when the
disposal of nuclear waste is considered. (The latter is now too often overlooked, being
implicitly or explicitly left to fall on the shoulders of the public sector.)
5 The same may be said for another famous forecast, that advanced by Malthus
(1798). According to Malthus, difficulties in expanding agricultural production would
have constrained population and economic growth, and limited the room for improvement in the standards of living of the mass of the population. A small percentage of
the workforcefrom 3 to 5 percentis now sufficient in most advanced countries for
providing agricultural products for the whole population; where famines occur, this is
generally due to problems in the distribution of available resources.
6 The Club of Rome 1972 report, in particular, contributed to the climate of fear of
impending oil exhaustion that led to a reversal of U.S. policy (with the definitive
abandonment, in April 1973, of the Mandatory Oil Import Programme), which played
a crucial role in preparing a favorable ground for the 1973 oil crisis (see Roncaglia,
1985, pp. 99100).

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than they were at the time of the Club of Rome report.7 This is largely due
to improvements in the techniques of exploration and exploitation of oil
reserves: technical progress not only involves a shift to improved energy
sources over the long run, but also important improvements in the production and use of any specific energy source in the medium to long run.8
Second, there is the secular path of crude oil prices. Expressed in terms
of 2000 U.S. dollar values, they were at a peak of nearly $90 per barrel
in the early 1860s; then they fell to between $10 and $30 per barrel,
undergoing wide oscillations (up to +200 percent or 70 percent in a
couple of years) between 1865 and 1935; a period of relative tranquility
ensued, up to 1970, with slowly decreasing prices in the range of $14 to
$10; from here, within a decade that included two oil crises, in 1973 and
197980, the price surged to about $75 per barrel in 1980, dropping
again by 80 percent to about $15 in 1986, after what has been labeled
the 198586 counter-crisis; a regime of strong oscillations again ensued, with prices varying between $12 and $30 per barrel.9 Such price
movements clearly reflect much more the fall in costs brought about by
technical progress over the long run and changes in market structure or
shifts in market power over the medium and short run than the manifold
increase in demand confronted with the ultimate scarcity of oil.
Third, the crude oil market is, by its very nature, an international market where international politics plays a prominent role. It is an international market because of the concentration of oil reserves (especially
low-cost ones) in a few areas of the world, above all the Middle East,
whereas consumption is connected to the degree of economic development of the different countries.10 Furthermore, politics plays a crucial
7

The ratio between world proven reserves and current consumption was 37 years in
2000, while it was 32 years in 1985 (ENI, 2001, p. 28). We may also recall that relying
on 1970 data for proven reserves, and keeping into account an increasing trend in
consumption, the Club of Rome report forecasted exhaustion in a 20-year time span.
8 Huge increases in already localized oil reserves have derived from multifold
increases in recovery rates (the ratio between oil that can economically be lifted from a
reserve and the total amount of oil in the reserve) due to the development of secondary
and tertiary recovery techniques, based on the injection of water into the reserve for
increasing its internal pressure and of chemicals for increasing the fluidity of oil in the
ground. Exploration has taken advantage of tridimensional seismic surveys based on
advanced computer programs and on the new techniques of non-vertical drilling.
9 Compare the useful table by British Petroleum (2001), available at www.bp.com/
centres/energy/world_stat_rev/oil/prices.asp.
10 There is a strong correlation, in particular, between per capita income of the
various countries and their per capita energy consumption; the share of oil in energy
consumption is not uniform across countries, but per capita oil consumption across
countries still turns out to be significantly correlated to per capita income.

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role in oil markets both because of their international nature and because of the strategic nature of oil as an energy source.11
Fourth, because of the importance of international politics in crucial
decisions, such as those concerning the opening of new oil provinces or
the development of new oil fields, there are important elements of segmentation in the international oil market. In particular, there are large
differences in extraction costs among currently exploited oil fields, and
large low-cost oil reserves are relatively under-exploited. Therefore, we
cannot refer to the Ricardian theory of differential rent for explaining
oil prices and the path of exploitation of different oil provinces and oil
fields; rather, it is the relatively high level of oil prices that allows highcost oil fields to remain in the market, though their supply could be
substituted by currently unexploited low-cost oil fields.12
Different versions of mainstream economics of oil and
their critique
The main analytical foundation for the mainstream economics of oil,
and generally of nonrenewable natural resources, is provided by the
Hotelling theorem (Hotelling 1931). According to the Hotelling theorem, the equilibrium price of the scarce resource net of extraction costs
(that is, the rent accruing to its owners) rises over time at a rate that is
equal, year after year, to the interest rate. Over time, such price increases
provoke changes in both production technologies and the consumption
structure leading to substitution of the scarce resource with other, relatively less scarce, resources.
This approach relies on a number of strict, fully unrealistic assumptions. As it is usual within the mainstream marginalist approach, convex
preference and production sets are assumed, together with perfect certainty (or, at most, actuarial uncertainty). Thus, the ultimately available
amount of the scarce natural resource is finite and known to all agents;
they also know both todays and future technologies. Under perfect competition, all this implies that the demand for the natural resource will
become nil simultaneously with its exhaustion. Furthermore, it can be
11

For a recent illustration of the role of oil in international politics, see Rashid
(2001).
12 Costs (net of royalties and taxes) for offshore North Sea oil are currently more
than ten times the average ones for Middle East oil. For specific cost estimates for
different oil fields (and for the difficulties in evaluating costs), see Adelman (1972,
1995).

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shown that when the ultimate exhaustion of the resource is due to take
place in the distant future, crude oil prices should be nearly equal to
production costs (rents should approach zero).13 Some assumptions can
be relaxed, in second-approximation analyses; in particular, unforeseen
changes in the data of the problem (e.g., in the estimates of ultimately
available reserves) may be considered. However, when this is done, the
generalized model becomes empty because everything becomes possible: any real-world event may be explained ex post by introducing
into the model specific ad hoc changes in the parameters.
Whereas the approach summarily illustrated above draws on standard
marginalist theory and constitutes what we may call the received view
in oil economics, different versions of marginalist analysis have also
been used by oil economists.14 In particular, in applied work on oil and
on other energy resources, it is quite common to recur to supplydemand comparisons, especially for short- or middle-period price forecasts. This procedure, however, relies on shaky theoretical foundations.15
In fact, supply and demand schedules here refer to production and consumption flows, leaving out of consideration the stock of ultimate reserves; as a consequence, the two schedules cannot be considered as
independent from one to the other: in the oil sector especially, where
oil in the ground is a less costly form in which to keep reserves needed
in order to adjust supply to demand fluctuations, the flow of production
is more or less continuously adapted to demand. Crude oil stocks over
the ground exist, but if we ignore the strategic reserves held (or financed) by the state in countries heavily relying on imported oil for
their energy needs, these are a small fraction of yearly consumption,
and insofar as they do not depend on logistic requirements are better
explained by speculative behavior (hence, by expectations on the future
path of prices) than as the result of discrepancies between demand and
production. Thus, it is quite common for production to increase (decrease),

13
See Dasgupta and Heal (1979, p. 172). This theoretical result is clearly contradicted by the large amounts of rents systematically accruing to oil-producing
countries and to oil companies, which, moreover, turn out to be particularly large in
specificbut sufficiently longperiods of time.
14 For a survey, and, in particular, for an illustration and a critique of Adelmans
(1972) Marshallian partial equilibrium analysis, see Roncaglia (1985, ch. 3).
15 Even among marginalist theoreticians, such as Hahn or Samuelson, recourse to
these analytical tools is labeled lowbrow economics, and contrasted to the highbrow economics consisting in the use of a general equilibrium approach.

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accompanying an increase (decrease) in demand, indifferently in situations of falling or of increasing prices.16

In principle, tensions in the demandsupply situation should be signaled by decreases in the margins of unused productive capacity. However, these margins are usually too large for allowing us to speak of
tensions in the market, and appear in general (that is, if we exclude
extreme situations that only rarely take place) rather unrelated to price
movements, so much so that models following this approach only rarely
rely on them as the crucial variable expressing the demandsupply situation. Also, the effect of price increases over demand does not take place
through static substitution (or at least only in a small measure), but mainly
through their influence on activity levels in the economy as a whole in
the short run, and through technological change in the long run, as we
shall see in the fifth section: hence, outside of the boundaries of static
demandsupply analysis. Moreover, the approach that relies on the comparison between demand and supply for explaining prices presupposes
competition; when this assumption does not hold (as we shall see in the
following section to be the case in the international oil market), then we
must recognize that it is a common rule of behavior for oligopolistic
producers to adjust production to demand, while price changes are rather
determined by changes in production costs and in the degree of
oligopolistic control over the market.
An alternative approach: trilateral oligopoly
Market forms change over time in any sector, and this is also true for the
oil sector. However, there are a number of technological reasons for
assuming that the oil sector tends to an oligopolistic market structure.17
The crucial element is the high ratio between fixed and variable costs,
which is commonly accompanied by economies of large-scale production.18 This gives rise either to oligopoly or to chronic instability of pro-

16
Let us recall that oil production and consumption are flows, measured per
interval of time, whereas reserves are a stock, measured at a specific point in time.
Reserves can also be bought and sold, but there is not a proper market for these
transactions; in general, reserves are acquired through investments in exploration and
development and, less frequently, through acquisition of the company holding them
on the side of another company.
17 For a wider treatment of this issue, see Roncaglia (1985).
18 Frankel (1946) was the first to point out the importance of this fact for the
economics of oil.

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duction and prices. This is due to the fact that under competition, with a
high ratio between fixed and variable costs, each producer finds it convenient to increase production in the short run up to full capacity utilization whenever the price exceeds the variable cost of production, which
is very low, more or less independent from the individual producers
degree of capacity utilization, and much inferior to average cost; large
losses ensue, inducing a decrease of investments and capacity, until supply becomes scarce and prices start an upward drive. Confronted with
this instability, producers may be induced to collusive behavior, and this
may be favored by public authoritieswhich is in fact what happened
in the United States in the 1920s (instability) and the 1930s (stabilization, with a prorationing scheme supported by public bodies and the
adoption of oil import quotas).
The oil sector may be subdivided into a series of connected but distinct activities: exploration, production of crude, transport, refining, and
distribution. Thus, it is sufficient for an oligopolistic market structure to
get a footing in one of these stages for it to diffuse over the others through
vertical integration; moreover, vertical integration itself may be favored
by economies of scope.19 Again, this is what happened both in the initial
stages of the oil industry (when Rockefeller utilized some leverage over
the transportation of oil from the internal producing areas of Pennsylvania to the refineries on the coast for bringing the Standard Oil Trust into
a dominant position), and after the collusive Red Line and As Is
agreements, signed by the major international oil companies (Exxon,
Mobil, BP, Shell, CFP) in 1928, gave rise to what was commonly called
the international petroleum cartel.20
The strategic nature of oil as a crucial source of energy induces public
interventions. These may take different forms: from antitrust policies (as
when, in 1911, the U.S. Supreme Court decreed the dismemberment of
Rockefellers Standard Oil Trust) to policies favoring collusive behavior
(not only with public support to prorationing schemes and with the import quotas that isolated for decades the internal U.S. market from internal and foreign competition, but also with benign neglect over the

19 The role of vertical integration has been stressed in particular by Edith Penrose
(1968).
20 The Red Line agreement concerned research and development in the extremely
rich, and hence strategically crucial, Middle East oil provinces; the As Is agreement
provided the foundations for a collusive behavior in the final markets for oil products.
For the story of these agreements, see Federal Trade Commission (1952) and Blair
(1976).

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international collusive agreements of 1928); from policies favoring oil

over other energy sources (as when in the second postwar period the
Marshall Plan authorities favored a shift to oil from coal as the main
energy source for the reconstructed industrial plants of Europe) to the
financing of research on alternative energy sources (with an incredibly
large share of public research funding going to atomic energy since the
1950s in all the major countries, both industrialized and underdeveloped
ones). For many oil exporting countries, also, oil revenues have acquired
a crucial relevance, conditioning both their external and internal policies.
Thus, we cannot ignore the role of both producing and consuming countries in analyzing the market structure of the international oil market.
All these elements suggest an interpretation of the oil market as a
trilateral oligopoly. That is, agents in the oil market can be grouped as
(1) producing countries, (2) oil companies, and (3) consuming countries. Within each of these groups we find a number, more or less large,
of individual agents, among which a few, by virtue of their size, have a
direct significant influence on the market, whereas the bulk of the others
can have a real impact only by jointly entering or leaving the market or
changing their strategies.
The geophysical distribution of oil reserves affects the distribution of
market power between producing countries and constitutes an obvious
constraint to competition among them, particularly to the entry into the
market of new producers. The role of geophysical factors, however, is
not absolute. First, strategic decisions over investments in research and
development are a decisive condition for the creation of entirely new oil
provinces. Furthermore, policy decisions are also crucial; for instance,
the foundation of OPEC and the changes in its degree of cohesion are
important factors in the history of the oil sector.
The predominant role of a few consuming countries also cannot be
denied. It is connected to their share of world energy consumption, and
hence, mainly, to their relative economic size. Therefore, an important
role in the oil market is played by the energy policies adopted by these
countries: such policies (for instance, carbon taxes with their differential weight on the various energy sources) contribute to determine oil
consumption or (as, for instance, when the U.S. decision to abandon the
system of oil import quotas in April 1973 generated an import upsurge
that contributed to the 197374 oil price explosion) the demand on international markets. We may also recall in this context antitrust policies
or a foreign policy of agreements with producing countries.
On the side of the oil companies, classical oligopoly theory is clearly
relevant (see, in particular, Sylos Labini, 1969), with its study of the

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factors determining size and evolution over time of the barriers to entry
of new firms into the sector.
Interpretation of the oil market as a trilateral oligopoly is suggested by
the situation prevailing between the 1928 agreements and the 197374
price explosion; it can explain first the rise to dominance of the international petroleum cartel, then the slow erosion of the market power of the
major oil companies during the 1950s and 1960s, with some power shift
in favor of producing countries; it can also help in understanding the
197374 and 197980 oil crises, as well as the 198586 counter-crisis.21 In the subsequent decade and a half, it has been apparently obscured by the rising importance of spot and forward oil markets; however,
as a matter of fact, the indexing of oil prices to the prices registered in
such markets may be seen as a sort of implicit collusive behavior on the
side of oil companies and producing countries, as we shall see more
clearly in the last section.
Dynamic versus static substitution
As we saw in the first section, when we turn away from the scarcity
approach and toward the classical economists objective approach, technological change comes to play a crucial role. In order to take it into
account in our analysis as an at least partly endogenous element, we need
to consider dynamic substitution processes:22 namely, a tendency for
investments in research and development (hence, for technological change)
to be oriented by an evaluation of prospective returns, hence by current and
foreseen prices of the different energy sources. In our case, for instance,
this means that the oil price booms of 1973 and 197980 imparted an energy- (and, in particular, oil-) saving bias to technological change.
Dynamic substitution is different from traditional neoclassical static
substitution in two important aspects. First, it is a process that takes
place in time; in other words, its effects become apparent only after a
certain interval of time has elapsed (and, in general, this time interval
may be rather long: longer, for innovation processes involving radical
changes in technology or the introduction of completely new products).
Second, it is irreversible: when after a period of price increases there is
a phase of price decline, the energy savings brought about by the process of dynamic substitution in the first period are not reabsorbed.
21

On all this, see Roncaglia (1985, 1998).

The term, together with the modern re-proposal of this classical notion, is due to
Sylos Labini (see, e.g., 1992, pp. 140159).
22

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One implication of what has just been said should be stressed. Since
dynamic substitution processes take time, a temporary price change (better, a change in price that is perceived as temporary by agents in the oil
market) is not sufficient for undertaking costly investments in oil saving
technologies.23 What matters is the perception that at least part of a price
rise will persist for a sufficiently long span of timelong enough for
investments in research and development to bear fruit. As a consequence,
a stable policy of carbon taxes may have important effects, provided
that it is adhered to consistently. 24
A second implication concerns the bias, on the side of mainstream
oil economists who rely for their estimates on static elasticities, to overestimate demand:25 following a price increase, by underestimating the lagged
effects of research expenditure on energy-saving technologies; and following a price decrease, by forgetting irreversibility in energy-saving technologies developed and adopted in periods of relatively high prices.
Alternative policy recipes: the environment
A useful way to understand the differences between the subjective and
the objective approach consists in comparing their implications for environmental issues.
23 Thus, for instance, the dynamic substitution that took place following the 1973
and 197980 oil price explosions has been inferior to what one could have expected,
because of the perception on the side of energy companies that it was unlikely for
prices to remain at the immediate postcrisis levels. This perception, that ex post
proved to be a correct one, meant, for instance, renouncing to shift to electricity
production plants not based on oil as an input. Evaluating returns on electricity plants
means forecasting the course of prices over a 2530 year period; clearly, most
practitioners in the field (differently from the experts) were unwilling to betor at
least to bet everythingon static expectations (extrapolation of the last level reached
by the oil price) or on extrapolative expectations (extrapolation of the tendency to
increases in oil prices).
24 This is true from the point of view of the objective approach. On the contrary,
from the standpoint of the Hotelling approach, it can be demonstrated (see Sinclair,
1992) that carbon taxes do not modify the path of use of the exhaustible natural
resource when they are stable, while they provoke an increase in its immediate use
when they are increasing: carbon taxes should keep declining to cut harmful
emissions. The logic of the argument is that it is the price path that determines the
time profile of use of the ultimately available amount of the exhaustible natural
resource, which will finally be wholly used up; increasing prices lead rational agents
to anticipate in time the use of the resource. Given the premises, the argument is
impeccable; in fact, its commonsense unacceptability and the empirical findings
favorable to the effectiveness of carbon taxes should help us in recognizing the
erroneousness of its premises. For a critique of Sinclairs thesis, see Roncaglia (1994).
25 On forecast errors, see Linderoth (2002).

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First of all, there is a basic difference in viewpoints. A subjective

view of the environmental problem implies interpreting it as a problem
of scarcity: risks of exhaustion of natural resources; decreasing returns
because of the use of increasing amounts of capital and labor with a
given amount of the natural environment. The objective view leads,
on the contrary, to lay stress on the environment as an element to be kept
in mind when considering the possibilities for both economy and society to survive and prosper over time: an element commonly not included
in the list of physical costs of production borne by producers, because
of its non-appropriability by individual economic agents, but to be taken
into account by public authorities. Moreover, the environment is not
considered as a scarce resource, but as a set of elements that can be
reconstituted, at least in part, with a sufficient amount of expenditure.
Investments in research may also be useful for making available new
environment-saving technologies, and regulations can help in inducing
economic agents to take into account the environmental implications of
both production and consumption activities.
The different interpretations of the problem translate into different
policy recipes. The scarcity view leads to a policy of taxes for internalizing social costs external to the producer; this implies that social costs
be clearly recognized and specified and that they be quantifiable. Alternatively, insofar as the environment is seen as setting limits to the possibilities of growth (as, for instance, it was thought to do by Malthus,
Jevons, and the Club of Rome), it implies renouncing expansionary
dreams, in particular the dream of overcoming world poverty by presently underdeveloped countries catching up to the production and living
standards of industrialized countries.26
On the other side, the objective approach leads to interpreting environmental issues as connected to the problem of defining a sustainable
rate of growtha notion that is more general than the one proposed in
the Brundtland Report (Brundtland, 1987), meaning more generally social sustainability, which, for instance, includes the absence of excessive
social tensions. Moreover, policies aimed at ensuring a sustainable rate of
growth have more to do with adequately orienting (1) technological change
and (2) consumer behavior, than with setting upper limits to growth. The
crucial role of carbon taxes in this context is clear; it is also clear that they

26 This conclusion is strengthened when it is recognized that, as recalled in note 24,

carbon taxes cannot be considered to be a theoretically valid solution within the
scarcity approach.

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should be accompanied by public support to research, as well as by support to creation of a social consensus for orienting consumer (and producer) behavior that accords a high priority to the environment.27
Quite naturally, the opposition between the two approaches is not so
clear-cut, insofar as the policy measures are concerned. But, for instance,
recognition of the basic uncertainty that surrounds all social and economic issues, including the environmental ones, is typically extraneous
to the scarcity view and leads those accustomed to think in terms of that
approach to leave out of consideration what is outside the horizon of our
knowledge. In contrast, thinking in terms of the social sustainability of
economic growth leads to a more open-minded recognition of the need
to take into account issues surrounded by uncertainty.
Alternative policy recipes: stabilizing oil prices
The mainstream view tends to consider oil markets as characterized,
over recent years, by a marked decrease in the market power of oil majors and producing countries, connected to an increased role of auction
markets (both spot, forward, and future) in establishing equilibrium
prices, that is, prices ensuring market-clearing equilibrium between supply and demand.
This view is based on two elements of fact: first, the decline in the
degree of oligopolistic control over crude oil markets on the side of
major oil companies and OPEC countries since the 1970s;28 second, the
central role acquired by stock exchanges where oil and oil products are
traded. However, the second element is not necessarily either a consequence or one of the premises of the first one. In fact, we may hypothesize that the increased role of stock exchanges in the pricing of crude
oil and oil products constitutes an important element supporting the
27 The Smithian idea that the pursuit of self-interestwhich is distinguished from
sheer selfishnessis moderated by moral sentiments (see Roncaglia, 2001, ch. 5) is
relevant here: what the common understanding of the society (a Humean notion)
evaluates as wrong, most, if not all, members of the society will not selfishly pursue.
Thus a widespread cultural recognition of the environmental problems and their
connection to consumption patterns may have an important practical impactas in
fact it doesin many advanced (civilized) countries.
28 Here we cannot discuss the reasons behind this decline, which include inter alia
the opening of new oil provinces, the role of the new state oil companies of oil
producing countries, more effective antitrust policies within a number of industrialized countries, and competition from natural gas and alternative energy sources. It
should be stressed, anyhow, that the decrease in the degree of oligopolistic control in
oil markets is quite far from bringing them to a fully competitive situation.

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oligopolistic market structure in the face of a decline in the degree of

oligopolistic control over the market. Let us consider these issues in
some more detail.
First of all, stock exchanges play a crucial role in the pricing of oil and
oil products. It is true that these markets are dominated by speculative
activity: only a fraction of all tradings, less than 1 percent, ends up in
physical oil deliveries, whereas most trading is compensated before
the term for delivery expires. It is also true that the two major markets of
this kindthe International Petroleum Exchange (IPE) in London and
the NYMEX in New Yorkdeal mainly in two kinds of crude oil (Brent
for London and West Texas Intermediate for New York), which represent
a small part of the international oil market (West Texas Intermediate is
even not delivered outside the United States). However, most long-run
contracts for crude oil deliveries and even most transfer prices for deliveries between affiliates of the same vertically integrated oil company
are indexed to such reference crudes: the relevance of these markets for
the determination of current crude oil prices is thus ensured. Moreover,
some forms of indexing to such reference prices are also often adopted
for oil products and for related energy sources such as natural gas.29
What the mainstream view does not consider is whether the prices
determined in the stock exchanges can really be interpreted as market
clearing prices for the physical international oil trade. In fact, this
may be doubted. First, there are the limits of these markets already
stressed above: thinking that they are capable of determining equilibrium
prices for the physical international oil market as a whole is equivalent
to believing that it is the tail that is wagging the dog and not the other way
around.30 Second, the shortsightedness typical of speculative markets
29

For an illustration of all this, see Di Benedetto (2001). He states (ibid., p. 48) that
Brent dealings at Londons IPE are used as a benchmark for the pricing of about twothirds of current world crude oil production. He also estimates (ibid., p. 51) that the
financial IPE Brent futures market has a size equivalent to the whole world oil
production, and more than one hundred and fifty times the amount of physical
production of its reference crude (which was less than 500,000 barrels per day in
2001, even considering Brent and Ninian crudes together).
30
The physical Brent market is also shrinking rapidly, due to the decline in Brent
liftings connected to the progressive exhaustion of old North Sea oil fields. According
to Di Benedetto (2001, pp. 5053), the number of deals in the 15-day Brent market
was 752 in 2000, down from 3,248 in 1997, with about 1020 participants to daily
exchanges; the number of deals in the dated Brent market was 199 in 2000, down from
356 in 1997. It is this latter market that gives rise to the benchmark price (ibid., p.
57), mainly through publication in the Platts Oilgram bulletin. It should also be noted
that traders do not have an obligation to communicate their deals to agencies such as
Platts and have no responsibility for erroneous communications (ibid., p. 62).

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656 JOURNAL OF POST KEYNESIAN ECONOMICS

and the rather conventional way in which these markets react to news
are such as to favor some manipulation of price trends, especially when
the purpose is not so much continuous control of the prices but simply
some support to keeping their levels substantially above production costs.
After all, oil companies (including state companies from oil exporting
countries) do operate in such markets, and even if we assume that they
are keen to avoid systematic speculative losses and are not averse to
speculative profits, they may well be interested in adopting strategies
conducive to supporting their industrial profits from what after all is
their main activity. In fact, indexation of international long-run agreements to stock exchange quotations of a few benchmark crudes may be
interpreted as an implicit collusion on the side of oil companies, easily
accepted by producing countries, and allowing them all to bypass antitrust regulations while price competition is limited by acceptance of a
common mechanism for price formation, leading to prices well above
extraction costs.31
The negative aspect of this situation, apart from a relatively high level
of oil prices, is the relatively large price instability, approaching that
which predominated in the more competitive phase of the oil market
before the 1928 agreements (though with a much higher distance between prices and costs). Oil price instability is quite damaging, because
of the importance of oil both for producing and for consuming countries. The instability of revenues for exporting countries translates into
higher uncertainty that affects policies, for instance, decisions on public
investments in infrastructures; repeatedly, exporting countries find themselves facing unforeseen foreign exchange financing difficulties that lead
to the adoption of restrictive policies, with occasional outbursts of disruptive exchange and financial crises. Oil importing countries confronted
with oil price increases experience both higher inflationary pressures
(with the increase in the take of oil producers generating not only direct
cost increases, but also distributive tensions between wages and profits
that reinforce inflationary pressures) and a deterioration in the balance
of payments, which may lead to the adoption of deflationary policies,
thus hindering employment and growth. With oligopolistic market forms
31 Under full competition, high-cost fields should be squeezed out of production by
increased production from less costly fields. Since oil reserves of low-cost Middle
East countries are equivalent to more than 100 years of their current production, it is
difficult to believe that postponement of production stems from their intertemporal
choices concerning oil revenues, rather than from an oligopolistic behavior that
consists in accepting lower current production in favor of higher prices (as OPEC
countries publicly declare they are doing).

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prevailing in developed countries, a decrease in oil prices does not bring

with it spectacular advantages: decline in energy costs only partially
translates into price declines and is easily absorbed by increases in money
wages and in profit margins. As far as the balance of payments is concerned, an improvement in the terms-of-trade may be accompanied by
decreases in quantities exported, due to worsening conditions of oil importing countries.32
In such a situation, stabilization of oil prices is a widely called-for
target. This involves two issues: which policies can lead to price stability and at which level crude oil prices should be stabilized.
The target price level should take into account downward pressures on
crude oil prices likely to prevail in the medium term at least, due to large
current differences between prices and costs and to the tendency to a
decreased share of oil in the overall energy sector, which is favored
through dynamic substitution by an excessively high level of oil prices.
This latter element in particular, namely, external competition from other
energy sources, contributes to a decline in the degree of oligopolistic
power on the side of oil companies and oil exporting countries. Disruption in oligopolistic control over the market may be accelerated by effective antitrust policies, even by a policy limited to forbidding implicit
collusion through clauses indexing all oil prices to IPEs or NYMEXs
quotations for Brent or West Texas Intermediate.
An effective antitrust policy may thus play an important role in inducing the main players in the oil field to accept a level of prices lower than
the average of the recent period, and possibly even slowly declining over
time (which will have the additional advantage, on the side of the main
oil producers, of postponing the decline in the share of oil in the energy
market). Under these conditions, they may be more willing to accept a
policy of price stabilization based on rational foundations.
Under oligopolistic conditions, stabilization does not require a general coordination of all agents operating in the sector. Coordination of
the main players on each of the three sides should be sufficient, provided that their strategies take into account the existence of, and the
competitive pressures stemming from, the multitude of smaller agents,
the potential entrants, and other energy sources. Such a coordination
should be accompanied by antitrust supervision on the side of consuming countries. The results of the stabilization process, in terms of adequately low and stable oil prices, should be the criterion for acceptance,
on the side of antitrust authorities, of the coordination process. But of
32

On the negative implications of instability, see Kaldor (1989).

658 JOURNAL OF POST KEYNESIAN ECONOMICS

course the main requirement for an effective stabilization policy would

be abandonment, on all sides, of any remnant of Hotelling-type culture.

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