Ifo Viewpoint No. 14: The Battle with OPEC

Hans-Werner Sinn
Munich, 20 September 2000

OPEC seems to be risking another power struggle with the industrial countries, following the conflicts of 1973-74 and 1979-81. The high energy taxes of the industrial countries are a great annoyance to OPEC since they either reduce the demand for oil or they lower the net price of the oil that is sold. With a conscious policy of temporary shortages, OPEC is now attempting to mobilise consumers to pressure their governments into reducing energy taxes.

However, OPEC's power to increase prices is only temporary, since the higher the prices are now the less will be sold and the more must be put on the market in future at correspondingly lower prices. A supplier only has the power to defend the producer price when it is advantageous for him to reduce the quantity sold in order to absorb the declining demand resulting from the price increase. This condition, however, cannot be seen as being met for the oil suppliers in the long run since they in any case will want to sell their oil resources at some point in time.

In the final analysis, the energy taxes of the industrial countries must be borne by OPEC in that lower crude oil prices arise than would otherwise be the case. This explains OPEC's nervousness but implies at the same time that neither the C02 problem nor other environmental problems can be solved by this tax. At some time - and sooner than later with announced tax increases - the available oil resources will be burnt, releasing C02 into the atmosphere.

When a single country increases its energy tax on its own, this of course has a noticeable effect on local consumer prices. In this way the country can reduce the quantity consumed and control local environmental problems such as urban air pollution or road congestion. However, by reducing demand, it lowers the world market price slightly and thus shifts the reduced domestic consumption to other countries with all the negative results for their local environmental problems. In this case as well, the world production of C02 remains unchanged, but real income from Germany and from the OPEC countries is then given away to other industrial countries.

In light of this situation, a possible argument for energy taxes by individual states, is transferring pollution to the neighbours and the increase in tax revenue in itself. A better solution is an ad valorem tax imposed on energy by all industrial countries jointly. To be sure, this will not benefit the environment, but it will give the industrial countries the possibility of sharing OPEC's oil revenues, without creating further burdens for local consumers.

Hans-Werner Sinn
President of the Ifo Institute