Hedging against Peak Oil Shocks

Many policymakers and pundits have made the case that the United States should become "energy independent." One economic interpretation of energy independence is that increased domestic energy production leads to greater risk sharing in the presence of imperfect capital markets. The wealth effects of energy production increase during peak oil shocks that help energy-producing states hedge against peak oil shocks. I test this hypothesis using consumption and gross state product data for US states for the period 1963-2007. I find that risk sharing is approximately 50 percent higher in energy producing states than non-energy states. The results suggest that oil shocks have different effects on energy and non-energy producing states. I offer two explanations for the finding. First, residents of non-energy producing states do not place enough of the assets in their wealth portfolio in energy stocks that allow them to hedge against peak oil shocks. Second, the wealth effects of energy production increase during peak oil shocks which helps residents (in energy producing states) smooth consumption and income. The analysis has two policy implications: 1) non-energy states should increase the share of energy stocks in their wealth portfolios; and 2) an increase in domestic energy production should increase risk sharing in the United States.

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Marc D. Weidenmier is an associate professor of economics at Claremont McKenna College and a research associate at the National Bureau of Economic Research.

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