External Costs of Oil Use
Prices determine which goods and services are produced in the marketplace. In the absence of government policy (such as taxes or regulations), the price of a good or service accounts for all private costs incurred by those who have produced or purchased the product. In the case of oil, this includes everyone from the oil company that extracts the oil, to the shipper, refiner, retailer, and driver who fuels her car. In the case of oil, the price reflects most of the costs, but there are some costs to society that remain unaccounted for.
Eighty-one percent of the world’s remaining proven petroleum reserves are currently controlled by members of the Organization of Petroleum Exporting Countries (OPEC) (including Iran and Venezuela) and Russia, and nearly all of these reserves are controlled by national oil firms. Since oil trades in a world market, oil consumption anywhere in the world affects the price of oil for Americans. The importance of oil to the world economy gives the major oilproducing countries disproportionate diplomatic leverage in world affairs. Oil resources can also fuel corruption in developing countries. Air pollutants and carbon dioxide from burning gasoline also contribute to concerns about air quality, human health, and climate.
The purchase of a gallon of gasoline imposes these national security and environmental costs on everyone, not just on the buyer and seller. Though State and Federal gasoline and diesel fuel taxes and regulations help account for these other costs, many studies suggest that the total external costs of oil may be higher. Carefully crafted government policy may be a useful way to account for these additional costs. However, this objective should be balanced against additional inefficiencies that government involvement introduces into the market. Once policies are in place that ensure that individuals account for the full costs of the goods and services they consume—e.g., national security and environmental concerns—competitive markets are the most efficient means to determine how goods are produced, as well as which goods are produced in the future.