Energy and the economy in oil-exporting countries: A general equilibrium analysis and application to Venezuela

A key energy policy dilemma faced by many oil-exporting countries concerns how to allocate energy resources between exports and domestic use. Standard economic analysis recommends border energy pricing as the optimal solution, given no distortions elsewhere. However, distortions in oil-exporting countries, such as monopoly power in export markets, oil quotas, import tariffs, capacity constraints in domestic energy supply, and import restrictions, have direct consequences on the efficient pricing and use of energy resources. We develop an economy-wide optimization model of an oil-exporting country focusing on optimal resource allocation which is used to calculate the optimal energy prices in the presence of several distortions. The analysis leads to subsidization of the domestic energy market as the optimal second-best policy under representative distortions.; We apply the analysis to Venezuela, a country with very low domestic energy prices and an impressive growth in domestic energy consumption during the last two decades. We derive econometric estimates of aggregate energy demand incorporating prices, economic activity, and the dynamic adjustment of demand to long-run equilibrium. The general equilibrium energy-economy model is used to estimate the optimal prices for oil products, natural gas, and electricity in Venezuela, and to evaluate the impacts of energy price adjustments on energy consumption and the overall economy. We found that subsidies in the domestic energy market have been extremely large and that a substantial reduction, but not elimination, of the subsidies would bring large benefits to the economy. The approach offers a general methodology for energy pricing policy analysis in oil-exporting countries that can be used in practical applications.