Cost-Benefit Analysis

3.1. Net benefits and optimal level of stockpile of Korea alone

○ According to this analysis under given assumptions, the level of optimal stockpile increase is about 40 MMB, at which the marginal benefits and the marginal costs equalize. Social welfare of Korea is maximized at this level.

- At this level, the GDP loss reduction is about 2.125 billion $, reduced inport costs increases is about 75 million $, and reduced consumer surplus loss is about 3 million $. The total reduced socal losses by holding additional 40 MMB of stockpile is about 2.2 billion $.

- Regarding stockpile sale revenues and 2.673 billion $ of total stockpile costs, the net present value of the net benefits is about 59 million $.

- The net present value of the net benefits per barrel is about 1.48

$/barrel, and the net benefit is not that high.

3.2. Net benefits and optimal level of stockpile of China alone

○ According to this analysis under given assumptions, the level of the optimal stockpile increase is about 200 MMB, at which the marginal benefits and the marginal costs equalize. Social welfare of China is maximized at this level.

- At this level, the GDP loss reduction is about 11.32 billion $, reduced inport costs increases is about 573 million $, and reduced consumer surplus loss is about 73 million $. The total reduced socal losses by holding additional 200 MMB of stockpile is about 11.97 billion $.

- Regarding 2.377 billion $ of stockpile sale revenues and 13.36 billion $ of total stockpile costs, the net present value of the net benefits is about 985 million $.

- The net present value of the net benefits per barrel is about 4.93

$/barrel, which is much higher than that of Korea.

3.3. Net benefits and optimal level of stockpile of Japan alone

○ In case of Japan, because the net present value of net benefits of having additional stockpile is less than 0 for all levels, it does not

have any economic incentives to increase stockpile level alone.

○ The results of this analysis show that Korea has the economic incentive to increase the stockpile level to about 40 MMB, China also has the economic incentive to raise the stockpile level to about 200 MMB, while Japan does not have any economic incentive to hold additional stockpile, when each nation plans stockpile increase separately.

- As a result, the optimal level of stockpile raise in this region under this situation is about 240 MMB in total.

3.4. Net benefits and optimal level of stockpile in case of joint stockpiling

3.4.1. Cost sharing by oil consumption rates

○ According to the estimates in the International Energy Outlook (2005) published by EIA, Korea consumes 2.23 MMBD, China consumes 7.41 MMBD and Japan consumes 5.33 MMBD in 2006.

The share of Korean consumption compared to the total of three countries is about 15%, the share of Chinese consumption is about 50%, and Japan consumes about 35% of the total.

○ Under the assumption of this method of cost sharing, the results of simulation analysis show the following:

- the optimal level of total additional stockpile in the region in case of joint stockpiling is 600 MMB. The total costs for this level of stockpile are 40.09 billion $, and the net present value of the net

benefits in whole region is 12.69 billion $.

- Korea bears 6.014 billion $, which is 15% of 40.09 billion $, and accrues about 440 million $ of net present value of net benefits.

- China pays 20.015 billion $, and its net present value of net benefits is 12.67 billion $.

- About 14.032 billion $ is shared by Japan, but its net present value of net benefits is -220 million $.

○ Although the optimal level of additional stockpile in whole region through this method of the joint stockpiling arrangement is 600MMB, which is much greater than the total level of additional stockpile by separate stockpiling, this method is not feasible when we consider each country separate in this arrangement.

- Bucause the net present value of the net benefits of Japan is less than 0, Japan does not have an economic incentive for participating in the joint stockpiling based on this kind of cost sharing.

3.4.2. Cost sharing by GDP rates

○ The estimate of Korean GDP in 2006 published in International Energy Outlook (2005) of EIA is about 800 billion $, which is about 7% of total GDP of Korea, China and Japan. The estimate of GDP of China is about 7900 billion $, which is about 64% of the total. In case of Japan, it is about 3600 billion $ that is about 29%

of the total.²²⁾

22) The reason that the GDP of China is higher than the GDP of Japan is because each country's GDP in its own menetary unit was converted to U.S. $ using the "purchasing power parity (PPP)' instead of real exchange rates in the International Energy Outlook (2005).

If we use the real exchange rates instead of the PPP, then the result would be different.

○ The simulation result shows that the joint stockpiling by the GDP prorated cost sharing arrangement is feasible and better than the joint stockpiling by oil consumption based cost sharing arrangement, because the former provides better benefit sharing than the latter. As a result, all three countries have insentive for participating in the joint stockpiling.

- Korea shares 2.8 billion $, which is 7% of total costs 40.09 billion

$, and expects to have the present value of the net benefits, 3.795 billion $.

- China pays 25.658 billion $, which is 64% of the total costs, and its net present value of the net benefits is 6.542 billion $.

- The cost sharing of Japan is about 11.626 billion $ that produces about 2.353 billion $ of net present value of net benefits.

○ At this level of additional joint stockpile in the region, marginal benefits and marginal costs of each country (China and Japan) is balanced more or less. However, Korea has incentive to increase the level of stockpile further because the marginal benefits exceed the marginal costs at this level.

3.5. Discussion

○ The reason for remarkable difference between the net present value of the net benefits of the joint stockpiling and the sum of each separated stockpile:

- In case of separate stockpiling, the objective function of each country decision-makers includes benefits accrued only by its own stockpiling.

- As the public good characteristic and the positive externality characteristic of stockpiling mean, the stockpile of one country has spillover effects to other countries and gives benefits to other countries.

- When a group of countries design the joint stockpiling, collectively, the positive external effects are internalized into their objective function, so that the marginal benefits and the marginal costs are balanced at the much higher stockpile level than separate stockpiling.

○ As a result, the joint stockpiling among Korea, China and Japan has an effect of increasing overall stockpile level in the region through cost sharing, and increased level of stockpile provides better energy security in the region.

○ According to this analysis, however, the feasibility of joint stockpiling is sensitive to the methods of cost sharing.

- GDP based cost sharing provides better feasibility than oil consumption based cost sharing, because the stockpile has the most effect in GDP loss reduction.

○ This report does not analyze the best cost sharing arrnagement method, and it is a future research agenda.

Chapter 6. Strategies for Implementation