Balancing Energy Security Priorities: A Portfolio Optimization Approach to Oil Imports.

Abstract

his study applies financial portfolio theory to the energy security issues of East Asia's major energy importers: China, Japan, South Korea and Taiwan. We calculate the relative risks associated with the dynamics of oil imports, and the import prices paid, and estimate the efficient frontiers for corresponding import portfolios. Last, we run several scenarios which simulate the effects of restructuring oil import portfolios and external disruptions. We find that: The composition of oil import portfolios determines varying risk levels for given oil import growth rates and average import prices (see Figure 1), pointing to different energy security priorities for the economies studied. Increasing the share of oil imports originating from Saudi Arabia would improve the portfolio performance of China, but result in higher portfolio volatility for the other importers. The short-run impact of a fully enforced Iranian oil export embargo would increase portfolio risk across the board within a 3% to 15% range. However, the subsequent substitution of Iranian oil imports by other suppliers would prove beneficial for Japan and Taiwan. The risk premium associated with passing through the Malacca Straits, 10% of the price of the cargo, would result in a 27.5% increase in price volatility for China's oil imports. The negative impact on its average import price level, however, would be less pronounced-at 2.6% compared with a range of between 5.2% to 5.8% for the other importers.

Energy Security and Portfolio Diversification: The Exporter’s Perspective

“…In general, oil exporters covered in this study seem to demonstrate a balanced approach to minimizing risks associated with both export growth and pricing -unlike some major oil importers that tend to prioritize either the physical supply or price component of energy security (see Galkin, Bollino, and Bigerna 2019). However, the GCC countries vary considerably in terms of the efficiency of their oil export portfolios.…”

“…However, its utilization in the energy sector remains limited, especially in the areas of energy trade and energy security. For a detailed review of portfolio theory, including its applications and limitations, see Galkin, Bollino, and Bigerna (2019).…”

“…Numerous recent studies suggest that the energy security paradigm be expanded to address other issues. These include infrastructure, environmental and societal impacts, energy efficiency, and governance, among others (see Galkin, Bollino, and Bigerna [2019] for a detailed review of relevant literature). However, the security of physical supply and price affordability remain the main pillars of energy security, as evidenced by the definitions of this concept adapted by international organizations, such as the International Energy Agency, 1 the United Nations, 2 and the EU.…”

“…Based on the standard portfolio theory, we assume that agents minimize portfolio variance for a given level of expected return (Galkin et al 2019). In the first case, we consider as return the monthly growth rate in oil export volumes.…”