Strategic Energy Purchases
Sylvain Chassang | Episode 94
Sylvain Chassang joined Markus’ Academy for a talk on his paper on strategic energy purchases. Chassang is a Professor of Economics at Princeton University.
Watch the full talk below and download the slides here.
Highlights
[0:00] Markus’ Introduction: Although gas, oil, and coal consumption is relatively smooth, prices have swung from very low levels during Covid to sharply higher levels before and after Russia’s invasion of Ukraine: is energy volatility “excessive”? Can strategic behavior make “more demand” compatible with “lower prices”?
[5:54] Main question: as large buyers, how can we manage energy prices through strategic use of purchasing capacity rather than rather only through demand suppression? Two reasons for urgency:
High prices constrain policy choices (including how the West deals with Russia) and feed inflation expectations because fuel prices are highly salient.
Supply-network resilience, where the failure to coordinate can push countries toward protectionism/autarky.
Many standard policy analyses do not properly take into account the cartelized nature of the oil market. This difference both breaks some “marginal analysis” intuitions and creates room for “free lunches” because the status quo is so inefficient.
[13:20] Cartel discipline framework. Oil producers deciding on a supply increase take into account (1) marginal profits, (2) the inframarginal loss from depressing the world price on its existing output, and (3) it’s impact on future cartel behavior (especially price wars). Due to the 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 through a procurement board (potentially supranational, e.g. the IEA) that can make advanced purchase commitments via bilateral forward contracts at a “high but reasonable” target price (he uses ~$70/barrel illustratively). The board’s demand allocation is meant to (i) de-risk entry for marginal suppliers, (ii) weaken cartel discipline at the margin, and (iii) incentivize cartel “self-regulation” by making cooperation preferable to conflict. A complementary operational piece is to allocate procured supply toward the most inelastic/high-value uses to increase the elasticity of residual demand faced by the cartel. The proposal is explicitly positioned as different from policies that work mainly by cutting demand; instead it treats demand as a strategic instrument in an oligopoly.
[35:55] The mechanism relies on conditional scale and targeted contracts: build a competitive fringe in normal times, but retain the credible ability to scale up if prices become “too high.” For entry, the board would use medium-term forward deals to reduce risk for would-be suppliers who fear volatility and future price wars. Contracts should be targeted to entrants (not simply dumped onto open futures markets) so they actually expand/strengthen the fringe rather than being captured by incumbents. Importantly, the instrument is broader than oil: the same commitment logic can support renewables and enabling infrastructure (e.g., storage/grid solutions) that reduces gas dependence indirectly. On governance, the board should keep a “talk softly, carry a big stick” posture: cooperation with suppliers is preferred, but credibility comes from having real procurement firepower; he notes that at larger scales the relevant bargaining may spill into high-level politics, while at smaller scales a technocratic board could plausibly operate with defined mandates.
[54:10] Other policies: Russian oil tax or price caps. A tax on Russian oil may not behave as competitive logic predicts: Russia can choose to withhold supply for strategic reasons, and OPEC may have little incentive to offset lost barrels—potentially pushing prices up rather than shifting rents cleanly onto Russia. By contrast, price caps—often criticized in competitive contexts—can be interpreted here as a bargaining device (analogous to a reserve price in an auction) that may improve terms of trade in a non-competitive market and does not mechanically imply supply collapse, though rationing and enforcement complexity are real concerns. To mitigate the entry-deterring downside of pure caps and to limit the scope for destabilizing price wars, Chassang proposes pairing caps with floors (illustratively, “not above $90 and not below $60”), arguing this can encourage entry, narrow punishment dynamics, and keep energy prices high enough to align better with emissions goals—while acknowledging that implementing floors/caps requires substantial logistical/market-design capacity.