# Presentation: 268042

## The Oil SecurityMetrics Model

- David L. Greene
- Paul N. Leiby
- Oak Ridge National Laboratory
- A presentation to the
- IWG GPRA USDOE
- March 6, 2005
- Washington, DC

## OSMM estimates oil security benefits of changes in the U.S. oil market.

- Based on the NAS Committee’s framework that distinguishes energy security benefits from normal market benefits.
- Includes uncertainty about future oil market conditions via up to four alternative AEO projections.
- Simulates supply disruptions calibrated to historical deviations of OPEC supply from AEO projections.
- Technologies change both the level of demand & its response to oil prices. Both are estimated.
- Security benefits, are estimated as the difference between normal market (AEO Reference Case) benefits and benefits in alternative futures that allow supply disruptions.

## The OSMM does not:

- Predict technological or market success of DOE’s R&D programs or how technology would change w/o DOE R&D efforts.
- Predict impact on U.S. petroleum consumption (the VISION Model is used for this).
- Estimate impacts of DOE R&D on the probability, size or timing of oil market disruptions. It should.
- Estimate defense or foreign policy costs in dollars.
- Incorporate a global demand response to DOE’s R&D achievements.

## The NRC (2005) made a distinction between normal and disrupted market benefits.

- “Economic net benefits are based on changes in the total value of goods and services that can be **produced** in the U.S. economy under normal market conditions,...”  (NRC, 2005, p. 29)
- “Security net benefits are based on changes in the probability or severity of abnormal energy-related events that would adversely impact the overall economy, public health and safety, or the environment.” (NRC, 2005, p. 29)
- At present, the OSMM does not estimate the changes in the probability of supply disruptions.
- The definition appears to omit “insurance costs” of oil security (e.g. SPR, defense costs) during undisrupted periods.

## 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.

- Transfer of wealth is not a loss of GDP but a change in the ownership of GDP.  It can occur in disrupted and undisrupted markets and occurs whether or not OPEC is the cause of the disruption.

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

## The direct economic costs of oil dependence have been greatest during supply “disruptions”.

**Notes:**
Note different dynamics of different components. Note importance of ToW, esp. during price shocks. Economy now 2X size of 1980.

## Implementing as a spreadsheet model with Monte Carlo simulation software allows price shocks, OPEC reaction & parameter uncertainty to be represented.

- Economic net benefits in normal market are obtained by using the undisrupted AEO cases (or Reference Case), with and without DOE program impacts.
- Economic + Security benefits are obtained by running Monte Carlo simulations, with and without DOE programs, using probability distributions for:
- Occurrence of a disruption
- Timing of a disruption
- Size of a disruption
- Security net benefits =
- 			(Economic + Security benefits)
- 					– Economic net benefits

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

- Randomly Choose
- Oil Market Scenario
- & Calibrate WOM
-  High Oil Price
-  Reference Oil Price
-  Low Oil Price
-  Parameters

- Generate Stochastic
- Oil Supply Disruption

- Adjust for Technology Impacts
-  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**

## The impacts of reducing US oil use, on imports and oil prices can be bounded.

- The key question is, “What will OPEC do?”
- Maintain production:
- World oil price falls
- US imports depend on elasticities
- OPEC market share increases
- Maintain the price of oil
- US supply unchanged
- US imports fall
- OPEC market share decreases
- Increase production?
- Decrease production more than enough to maintain the previous price?

**Notes:**
If not somewhere between the two strategies, then initial scenario strategy was inferior. Deserves further analysis because of dynamics.

## The supply shock simulation model creates projections more consistent with recent history.  Supply shocks are deviations from AEO projected OPEC supply.

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

## Expected hybrid vehicle benefits alone = $191B PV, assuming OPEC maintains its production plan (Ref. Proj. = $137 direct oil savings).  By NAS definition, security benefits are $191B - $137B = $54B.

## If OPEC maintains the price path, expected benefits are $120B PV, versus Ref. Proj. $71B direct oil savings.  Security benefits are $120B - $71B = $49B. (Versus $54B)

## In addition to monetary benefits, a number of non-monetary metrics are calculated.

## The OSMM rigorously estimates the prospective oil security benefits of EERE R&D programs.

- Using the NAS definition of security benefits.
- Reflecting key uncertainties.
- Oil market conditions via AEO Cases
- Supply disruptions
- Parametric uncertainties, too.
- Includes price elasticity as well as demand reduction impacts.
- Vehicle technology elasticity impacts included
- Biofuel supply impacts to come.

## THANK YOU.

## U.S. oil imports in the base case, supply shock and EERE impacted cases.

## The impact of EERE technology on world oil price.

## The impact on OPEC’s market share.

## The impacts on OPEC gross revenues.

## The impacts on U.S. oil consumption.

## The impact on U.S. wealth transfer.

## The impact on the size of the SPR.

## And, the impact on the price elasticity of U.S. oil demand.

## One can measure how advanced technologies expand the fuel economy-cost envelope and increase the price elasticity of oil demand.

**Notes:**
Change in total cost curve  change in marginal cost (supply curve) + given demand curve  change in price elasticity.

## Technology changes the price elasticity of MPG, which changes the price elasticity of gasoline demand.

| Source of Technology Estimates | MPG
at
$1.50/gal. | MPG
at
$2/gal. | Gasoline Price Elasticity of MPG | % Change |
| --- | --- | --- | --- | --- |
| Sierra Research Current Tech. | 30.1 | 31.2 | 0.13 | -- |
| MIT 
2020 Technology | 33.0 | 35.4 | 0.25 | +96% |

**Energy Efficient technology**
**clearly affects the long-run **
**price elasticity of demand. **
**The short-run impact must**
**be carefully considered.**

**Notes:**
Graph shows change in fuel economy supply curve at different prices, consumer behaviors. Fuel economy  Fuel elasticity  Oil elasticity.

## The impacts of alternative and replacement fuels on price elasticity can be similarly estimated.

- Given VISION program impact estimates of alternative fuel market shares, elasticity changes over time can be calculated.
- The time trend in elasticities can be entered into the oil market simulation model by modifying the price slope of the US oil demand equation.

- β’s are price elasticities, b’s price slopes, s’s are market shares,
- g, r, and f indicate gasoline, replacement fuels, and all motor fuel.

**Notes:**
This equation assumes a MNL fuel choice function.  First term actually decreases as gasoline share decreases, but second term increases and dominates the effect for any reasonable price slope, b.  KEY ISSUE: these are long-run elasticity changes. Short-run will not respond proportionately.

## Each direct cost component can be estimated by a relatively simple equation.

- Total costs
- Wealth Transfer
- Loss of potential GDP (dynamic)
- Disruption losses (dynamic)

**Notes:**
WT straightforward.
K is multiplier for oil market surplus losses.
Delta is oil price elasticity of GDP, here scaled by oil cost share.

## SPR benefits are readily monetizable either  as a reduction in costs or an increase in insurance value.(Leiby & Bowman, 2000)

## Reduced costs of an SPR sized to replace 57 days of imports are expected to be $2.4B, PV.

## The proposed method doesn’t include dollar estimates for defense or foreign policy costs.

- It should.
- Instead, the model can provide indicators:
- OPEC revenues
- OPEC market share
- US petroleum imports
- US petroleum consumption
- When used in simulation mode, these would be probability distributions.

## OPEC oil revenues are an indicator of monopoly rents to oil producers.

## Net US imports are an output of the oil market model. OPEC or Persian Gulf imports are not.

## The world oil market changed profoundly in 1973.

**Notes:**
Arab-OPEC oil embargo of nations that supported Israel in the 1973 October (Yom Kippur) War. US oil supply peak in 1970.

## OPEC is an imperfect, partial market monopoly cartel.

- It influences oil markets via decisions on:
- Long-run: production capacity
- Short-run: production
- Its ability to collude is limited.
- Its control of markets is limited.
- It has a strong incentive to price above MC

- P = monopoly price
- C = competitive price
- β = demand price elasticity
- σ = OPEC mkt. share
- q = ROW supply
- Qo = OPEC supply
- r = rate of demand growth
- δ = rate of ROW supply
- 	decline

**Notes:**
Explain equation. NOTE difference between long- and short-run elasticities.

## Short- and long-run elasticities bound the region in which OPEC can operate.

| Algeria, Iran, Iraq, Kuwait, Libya, Qatar, Saudi Arabia, United Arab Emirates, Venezuela |
| --- |

- Key Assumptions:
- Linear lagged adj.
- Supply Elasticities:
-   L.R. = 0.60
-   S.R. = 0.06
-   1-lambda = 0.90
- Demand Elasticities:
-   L.R. = -0.70
-   S.R. = -0.10
-   1-lambda = 0.85
- Competitive price =
-     $13/bbl.

**Notes:**
Note uncertainty. Point to parameters. Explain history. Note directional movements & importance of growth rates.

## It is not likely that the problem of OPEC market power will go away soon. (3/11/04).

**Notes:**
Rex Tillerson, president of ExxonMobil. Non-OPEC peak in 2010. OPEC gains market share.

## Dermot Gately has convincingly argued that OPEC will not expand its capacity to meet the world’s demands at a low price.

**Notes:**
These numbers are directly from the 2005 AEO. If OPEC leaves oil in ground for future & if world mobility grows, energy must come from somewhere else.

## If Middle East producers do not increase output by 80%, unconventional oil production may have to expand rapidly. The M.E. can retain a third of the market as the lowest cost producer through 2050.

**Notes:**
OPEC maintains 1/3 market share, but marginal supply from capital intensive, higher cost, environmentally disruptive (riskier) sources. 

## Security benefits can also be estimated for a portfolio of EERE technologies, but this has not yet been done.

## 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.

## A simple oil market model that can be calibrated to any AEO scenario can be constructed with four linear equations.

- US Demand
- ROW (incl. OPEC) Demand
- US Supply
- ROW (excl. OPEC) Supply
- OPEC Supply assumed exogenous.

**Notes:**
Offer to explain equations in detail.  But what about OPEC’s response, that will determine prices & imports. Will come to that.

## National defense and foreign policy costs are controversial, difficult to measure, but not zero.

- Two wars since 1990 not entirely unrelated to oil security.
- Protection of oil supplies has some impact on US military expenditures.
- Transfer of wealth
- Provides surplus that can be spent on military build-up but also support for terrorism.
- A blessing or a curse?
- Assuming these costs to be zero is not defensible but, at present, OSMM does not estimate national security costs.

**Notes:**
“Devil puts a gun to your head” test.

## The OSMM does estimate the effects of EERE’s R&D programs on the:

- Economic costs of oil supply disruptions,
- Wealth transfer
- Potential GDP losses
- GDP dislocation costs
- Potential GDP and wealth transfer costs during normal market periods,
- Levels of US oil imports,
- World oil prices,
- OPEC market share and market power and
- SPR costs or benefits.