# Presentation: 773480

## Oil Independence:Achievable National Goalor Empty Slogan?

- David L. Greene
- Paul N. Leiby
- ORNL
- Philip C. Patterson
- DOE
- Steven E. Plotkin
- Margaret K. Singh
- ANL
- LERDWG Meeting
- February 7, 2007
- Washington, DC

## OIL DEPENDENCE“The real problem we face over oil dates from after 1970: a strong but clumsy cartel of mostly Middle Eastern exporters cooperating as OPEC.”   M.A. Adelman, 2004.

## Oil dependence is NOT an externality.

- Cats are mammals.               Socrates is a mammal.              Therefore, Socrates is a cat.
- Externailities are market failures.  Monopoly is a market failure.  Therefore monopoly is an externality.
- If the only tool you have is a hammer (price), then everything looks like a nail (externality).

## “The real problem we face over oil dates from after 1970: a strong but clumsy monopoly of mostly Middle Eastern exporters operating as OPEC.”  Prof. Morris Adelman, MIT, 2004.

## OPEC members own 69% of the world’s proven oil reserves and more than half of ultimate resources of conventional oil.

- Source: U.S. Energy Information Administration, 2006.

## The economic theory to understand world oil market dynamics was developed in 1954.

-  = price elasticity of world oil demand (  < 0 )
- S = OPEC share of world oil market ( 0 < S < 1 )
**μ**= non-OPEC supply response ( -1 < **μ** < 0 )
- Short- and long-run elasticities differ by an order of magnitude!

## The cartel’s behavior since 1973 fits remarkably well within the theoretical framework.

- Short-run

- Long-run

## The cartel’s market power was strengthened by growing world demand, its increasing market share and...the peaking of US crude oil production in 1970.

## Colin Campbell and the ASPO foresee the imminent, and probably catastrophic peaking of oil and gas supplies.

## Projections of just 2 years ago expected peaking of non-OPEC supply with OPEC filling the gap. This would increase their market share and market power.

## IEA’s WEO 2006 foresees a non-OPEC plateau with less OPEC supply and unconventional sources filling the gap. This, too would boost OPEC’s market power.

## There are direct monetary costs and important indirect costs of oil dependence in a non-competitive market.

**Wealth transfer**
**Long-run GDP losses**
**Disruption costs**
**Military costs**
**Foreign policy costs**
**Strategic stockpile costs (SPR)**

## The cartelized, volatile oil market produces three direct costs to the U.S. economy.

- Loss of potential GDP due to greater economic scarcity of oil.
- Transfer of wealth due to monopoly pricing and price shocks.
- Dislocation losses of GDP due to oil price shocks.

**Notes:**
Explain US S-D curves. ToW is not surplus loss. Also surplus losses in other markets  multiplier effect.

## The economic costs of oil dependence have been substantial, over $4 trillion since 1970.

## Can we really achieve “oil independence”?

- “The U.S. may be addicted to oil, but many of its politicians are addicted to “energy independence” – which may be among the least realistic political slogans in American history.”  J.J. Fialka, WSJ, 7/5/2006
- “Calls for energy independence are unrealistic, to put is mildly, for the foreseeable future; cutting oil consumption to current domestic production would severely derail an economy in which cheap and rapid transportation is taken for granted.”  I.W.H. Parry and J.W. Anderson, RFF, 2005.
- “The voices that espouse “energy independence” are doing the nation a disservice by focusing on a goal that is unachievable over the forseeable future and that encourages the adoption of inefficient and counterproductive policies.”  Task Force of Council on Foreign Relations, 2006.
**“**Energy Independence: The wrong target for policymakers**”**
- 	*The Washington Post, *Sunday, January 21, 2007; Page B06

## What is oil (energy) independence?

- Use no oil?
- Import no oil?
- A state in which our nation’s decisions are not subject to restraining or directing influence by others as a consequence of our need for oil.

## A measurable goal is needed.

- QUALITATIVE:
- For all conceivable world oil market conditions, the costs of oil dependence to our economy will be so small that they have no effect on our economic, military or foreign policy.
- QUANTITATIVE:
- The estimated total economic costs of oil dependence will be less than 1% of GDP with 95% probability by 2030.

## The non-partisan National Commission on Energy Policy proposed a comprehensive plan to address oil dependence and reduce GHG emissions (here modified).

**Demand**
- From 35 MPG in 2017 increase light-duty vehicle MPG to 43 MPG by 2030 (+75%).
- Displace 2 mmbd of gasoline with biofuel by 2020.
- Reduce heavy truck energy use by 0.5 mmbd by increasing fuel economy by 15%.
- Reduce rail and water oil use by 0.2 mmbd.
- Eliminate the use of #2 distillate fuel to heat residential and commercial buildings.
- Cut industrial petroleum use by 0.6 mmbd.
**Supply**
- Expand oil drilling to the ANWR and deep offshore areas by 2 mmbd.
- Produce 1 mmbd petroleum fuels from coal with carbon sequestration.

## I did not evaluate the cost-effectiveness of the NCEP policies, but they did.

- “In choosing among a large number of potential policy options, the Commission applied several general criteria, including economic efficiency; cost-effectiveness and consumer impacts; ability to provide appropriate incentives for future action; flexibility for adjustment in response to further experience, new information, and changed conditions; equity; political viability; and ease of implementation, monitoring, and measurement.”  (NCEP, 2005, p. viii)

## The AEO Cases represent BAU, a modified NCEP plan a comprehensive energy policy.

## Representing uncertainty about future world oil markets is critical.

- Oil Market Uncertainty
- Reference, High Oil Price, Low Oil Price AEO 2006 scenarios
- Supply Disruption/Monopoly Behavior Uncertainty
- Simulated OPEC supply reductions
- OPEC Response Uncertainty
- Maintain Output/Maintain Price of Oil
- Parametric Uncertainty
- Elasticities, adjustment rates, etc.

## The policies are tested in 10,000 futures.

- Randomly Choose
- Oil Market Scenario
-  High Oil Price
-  Reference Oil Price
-  Low Oil Price
-  Parameters

- Generate Stochastic
- Oil Supply Disruption

- Adjust for Policy Impacts (if any)
-  Reduced oil demand
-  Increased oil supply
-  Changes in price elasticities

- Select OPEC Strategy & Solve New Oil Market Equilibrium

- Compute Oil Dependence Costs
-  Transfer of Wealth
-  Reduced Potential GDP
-  Disruption Costs

- Iterate to 10,000

**Distribution of Oil Dependence Costs by Year**

## Each oil market future chooses an AEO Case in which there may be oil supply disruptions that generate price shocks.

## Expected oil dependence costs under BAU = 2% of GEP with a 90% C.I. of 0.8-3.5% of GDP.(Interior interval = +/- 1 std. dev., exterior interval = 5% to 95% C.I.)

- % of GDP

**% of GDP**

## A one-time single-focus policy is insufficient:  Raising LDV fuel economy to 35 MPG by 2017, then stopping, lowers the cost range to 0.5% to 3.0%.

- % of GDP

**% of GDP**

## The result is nearly unchanged if OPEC chooses to maintain output.

- % of GDP

**% of GDP**

## The NCEP strategy falls just short of the independence goal. More is needed, and progress must be sustained beyond 2030.

## Oil independence works regardless of OPEC’s response strategy.

## The U.S. faces serious energy challenges.

- Achieve oil independence.
- Reduce carbon dioxide emissions.
- Undertake a transition to sustainable energy sources.
- An integrated strategy is needed.
- A measurable goal for oil independence and a means of testing proposed strategies is a necessary component.

## THANK YOU.