### 1 Approach to Estimating the U.S. Oil Security Premium for the Proposed 2017

- 2025 Light

- Duty Vehicle GHG/Fuel Economy Rule

Paul N. Leiby Oak Ridge National Laboratory (ORNL)

October 14 , 201 1

The Environmental Protection Agency (EPA) and the National Highway Traffi c Safety Administration (NHTSA) are proposing a program to reduce greenhouse gas (GHG) emissions and improve fuel efficiency in the light

- duty highway vehicle sector in the U.S . This sector

– light

- duty passenger cars and trucks

– r epresent s the largest single contributor to U.S. oil consumption and one of
the largest s ources of GHG emission s. 1



### Setting GHG emissions and fuel consumption standards for the light

- duty vehicle sector will improve the U.S.’s energy security by reducing the U.S.’s dependence on foreign oil and reducing its exposure to oil shocks. This has been a national objective since the first oil price shocks in the 1970s

. World crude oil production is highly concentrated, exacerbating the risks of supply disruptions and price shocks. Tight global oil markets led to prices of over $1 2 0 per barrel in 2008 and again in 2011 , with fuel prices reaching as high as $4 per gallon in many parts of the U.S., causing financial hardship for many
families and businesses

. Light

- duty vehicles account for about 60 percent of U.S. transportation oil use,
which means th at they alone account for about 43 percent of all U.S. oil consumption

. 2



### Background on Energy Security Methodology

To provide a measure of the energy security implications of the Light

- Duty GHG emissions/fuel economy Rule for 2017 to 2025 (“ LDV 2017 Rule”), an oil import security premium was estimated over
the duration of the rule’s phase

- in and for years after its completion. The LDV 2017 Rule will reduce U.S. oil consumption and, to a similar extent, oil imports. It will also encourage the introduction of some new vehicle technologies, including Plug

- in Hybrid Electri c Veh icles (PHEVs) and Battery E lectric Vehicles (BEVs). To estimate energy security benefits for this proposed rule , ORNL focused on the benefits of the reduced U.S. oil import levels. The oil import security premium is a measure of the marginal economic

cos t of oil imports to the U.S. economy beyond the private cost that is paid for oil, that is, beyond the market oil price. Since these costs exceed the market price, and are not fully accounted in the market decisions of private firms and individuals, reduc ing them is a societal benefit. The import premium includes components that account for incremental costs during disrupted and normal oil market

1 See U.S. EIA 2011. Emissions of Greenhouse Gases in the U. S. , March 31, 2011, Report Number: DOE/EIA

0573(2009) http://www.eia.gov/environment/emissions/ghg_report/

. 2 In 2009 Source: EIA Annual Energy Outlook 2010 releas ed May 11, 2010

### 2

conditions. The definition and methodology for estimating the oil import premium are presented in Leiby (2008 ), 3 

### along with prior estimates. This paper summarizes the differences between the premium analysis conducted in support of this LDV

- 2017 Rule and that prior 2008 analysis. The principal
difference was the re

- benchmarking of reference oil market condition s through 2035 to conform to the latest Annual Energy Outlook of the U.S. Energy Information Administration (AEO201 1 final release

, Reference case 4 

### ). In addition, European Union (EU) oil demand assumptions are modified to account for recent EU policies related to the EU Emissions Trading Scheme (ETS).

1. Definition of Oil Import Premium

A useful measure of the energy security benefits of improved vehicle fuel economy is the marginal reduction in economic costs to the U.S. from reduced oil imports. The oil import premium is
defined as the difference between the marginal economic cost to society for petroleum imports and the market price paid . This is measured and reported in dollars

- per

- barrel, for a small change in the number of barrels imported. 5 

### The ap proach estimates the incremental benefits to society, in dollars per barrel, of reducing U.S. imports. 6 

### This “oil import premium” approach identifies those energy

- security related costs that are not reflected in the market price of oil, and that are expec ted to change in response to an incremental change in the level of oil imports

.

Omitted from this premium calculation are environmental costs and possible non

- economic or unquantifiable effects, such as effects on foreign policy flexibility or military p olicy. The LDV rul e may also induce greater use of electric and plug

- in electric vehicles, but the analysis to this p oint does not consider any addition al energy security considerations that may follow from their use. 7 

### Also omitted are any spillover

- bene fits that may accrue to U.S. allies and trading partners who are similarly reliant on oil, and who would benefit from a reduction in the level or volatility of world oil price.

3 Leiby, Paul N. 2008. “Estimating the Energy Security Benefits of Reduced U.S. Oil Imports,” Final Report, Oak Ridge National Laboratory, ORNL/TM

- 2007/028, revised March 14.

4 U.S. EIA 2011. Annual Energy Outlook 2011 with Projections to 2035 , Updated April 2011, http://www.eia.gov/forecasts/aeo/data.cfm , accessed 9/9/2011. NEMS case is ref2011.d020911a

. 5 Additional energy security benefits are derive d from reduced consumption, and from the resulting reduced oil

intensity of the U.S. economy. This can be expected to reduce the sensitivity of the U.S. GDP to global oil shocks (e.g. Leiby 2008, Toman 1993, 2002, and Brown and Huntington 2009). As in the 2008 analysis, t his p articular component of potential benefits is not included here.

6 Technically, the oil premium is based on a “marginal” economic analysis (i.e.

, a differential analysis of the rate of change of costs per barrel change in imports). At times the term “incremental” may be used in place of “marginal” here to avoid confusion with marginal in the more common sense of either “ fringe ” or “close to the limit of acceptability.”

7 Since EPA anticipates that more electric vehicles (EVs) and plug

- in hybrid electric vehicles (PHEVs) will penetrate the U.S. automobile market over time as a result of this proposal, there may be value to further

- analyzing the energy security implications of these vehicles and the fuels that they consume. Apart from th e potential for increased electricity use in vehicles to reduce U.S. oil imports, there are questions of the potential for disruptions in electricity supply and of the overall expected impact, if any, of additional battery and plug

- hybrid vehicle use on th e stability and resilience of fuel and electricity markets.

### 3

2. Methodology for Premium Calculation

The estimation of security premium for the LDV

- 2017 Rule closely followed the methodology used to support the RFS and Light Duty Fuel Economy/GHG emission rule regulatory analyses, as documented in Leiby (2008) , and analyses for the 2011 Heavy

- Duty Vehicle rule

. For comparability and consistency, most of the assumptions were held unchanged.

The primary assumptions made are:

a) Supply/Demand E lasticities

OPEC

- supply behavior is treated parametrically , with a Monte Carlo simulation of possible
future outcomes using elasticities of supply over a wide range (0.25 to 6.0, with a mean of 1.8)

. Combining the Non

- OPEC region demand and Non

- U.S. supply elasticities implies a (mode) net elasticity of import demand from Non

- U

. S

. /Non

- OPEC regions of approximately

- 1.6
, with a wide random
distribution

. T o account for the p ossibility, suggested by some but not yet definitively demonstrated or universally agreed upon , that the economy has become less sensitive to oil shocks over time , we applied
the reduced range for the elasticity of Gross Domestic Product (GDP) with respect to oil price shocks. That is, in the Monte Carlo simulation the GDP elasticity rang ed from

- 0.01 to

- 0.05 4, with a mean value
of

- 0.03 2

. This approach was also taken in the main cases in the 2008 a nalysis.

b) Changes from 2008 Estimation for the L ight

- duty Vehicle Rule

In these estimates of Light

- duty vehicle energy security premiums, the primary change from previous estimates is the development of a revised time path for the premium over a long er hor izon,
from 20 1 5 to 2050 , under the updated oil market projections embodied in the U.S. Energy Information
Administration’s 201 1 Annual Energy Outlook (AEO201 1 ). Values after 2035 were based on simple extrapolation, since AEO projections are unavailable af ter 2035. Based on the AEO201 1 projection
, evolving market conditions alter some of the factors influencing the oil import security premium . In particular : base oil price, U.S. import and consumption levels, U.S. GDP, and OPEC production s hares. These assumptions together also imply an assumption about the value share of oil use in the U.S.

economy.

The following T able 1 compares keys assumptions that differ in these estimates compared to
those used in th e prior fuel economy/GHG rulemaki ng.

### 4 Table 1: Evolving Oil Market Conditions and U.S. Oil Use
2008 Report/ 2012
LD V Rule (AEO2007 Reference Case) Avg. for 2006

- 2015 Current Study/ LDV

2017 Rule (AEO 2011 Reference Case)
2015 Current Study/ LDV

2017 Rule (AEO 2011 Reference Case)
20 20 Current Study/ LDV

2017 Rule (AEO 2011 Reference Case)
2025

Oil Price ( 2009$/BBL ) $55.71 $81.69 $92.81 $101.04

U.S. Oil Imports 12.560 10.338 9.778 9.565

U.S. Oil Demand 22.190 20.758 20.977 21.289

OPEC Supply 34.430 37.298 39.235 40.766

U.S. GDP (bill 2009$ ) $15,343 $15,817 $17,965 $20,645

Oil Share of GDP 2.83% 3.92% 3.96% 3.80%

Evolving historical and projected oil market conditions influence the premium estimate. Note that all these parameters are positively related to the size of the import premium, to varying degrees. (Price is in $/bbl; imports, demand and supply
are in mil lions of bbl/day; and GDP is in $billion per annum.)



### Another change to previous estimates of energy security premiums is to assume that for the OECD

- Europe area , oil demand is inelastic with respect to the LDV

- 2017 

### Rule

. The European Union has committed to achieving a 20 per cent reduction in greenhouse gas emissions by 2020 from 1990 levels. Phase 3 of the EU program begins in 2013 and broadens coverage on GHG emitting sources and establishes EU

- wide rules for allowance availability and allocations . Since the last time that we estimated energy security premiums, the European Commission has p roposed a Directive to alter the EU

- Emissions Trading Scheme ( ETS ) structure for Phase 3 in January, 2008, and the Directive was amended and adopted by the European Parliament and by the Council of the EU in April 2009

. 8


### While the Directive is for GHG com mitments, it is likely that the mix of energ y sources, and the use of oil, would change only by a limited extent under the modest price change s induced by the LDV

2017 rule

. In any event, EU GHG emissions, given the cap , would be unaffected even if EU oil demand changed by a small amount in response to the U.S. LDV Rule under the EU

- ETS.

c) Results

Table 2 compares the premium estimates under the assumptions of the current analysis with those in the prior 2008 analysis. Following the approach of most oil security premium estimates,

8 See Parker, L., “Climate Change and the EU Emissions Trading Scheme (ETS): Looking to 2020”, Congressional Research Service, January, 2010

### 5

these are the long

- run import premiums, reflecting marginal import costs once the market has had time to fully respond to any change in the level of imports. That is, they reflect the long

- run elasticities of regional supply and demand. The current premium estimates are computed at 5

- year intervals between 201 5 and 2035. The oil import premium, measured in $/bbl of imports reduced, is not strongly affected by the estimated volume of oil impor ts displaced. While substantial in volume, the reduction in oil use from the LDV

- 2017 

### rule is under 1 per cent of world liquid fuels demand through 2025, and under 2.1 percent through 2035. It amounts to 3.8% of U.S. liquid fuels demand in 2025, growing to 10% by 2035

. 9



### The total current premium for 201 5 is about 31 per cent larger than the prior premium in the 2008 analysis , which was calculated for average market conditions from 2006

- 2015 , as projected in
2007

. On a per

- barrel basis, these results a re close to the estimates produced earlier this year for the Heavy Duty Vehicle rule , also based on the AEO2011 (Early Release)

. This premium increase
reflects the mixed effects of changes in projected reference oil market conditions . Such changes
includ e 47 per cent higher projected oil prices, 11% higher OPEC supply, and a 3 8 % higher value share of oil expenditures in GDP. Offsetting these drivers are projected oil consumption and import
levels that are 7 per cent and 18 per cent lower, respectively, t han projected in AEO2007. For years
after 201 5 , the EIA projected real oil price, GDP, and OPEC supply continue to grow . Oil consumption grows slowly and oil imports are projected to decline 7 .5 % by 2025

. Oil value share in the U.S. economy peaks in 2020 and then slowly declines

. Together, these conditions yield a gradually but steadily increasing oil security premium through 203 0

.

9 Source for projected liquid fuels demand is AEO2011, Table 21. International Liquids Supply and Disposition. Estimates of projected fuel savings from the rule are from EPA.

### 6 Table 2: Summary Results

– Comparison of Current and 2008 Report

Effect / Study Prior Analysis: ORNL 2008 Report ( 2009$ /BBL, average for
2006

- 2015) Current Analysis:

LDV 2017 Rule Analysis ( 2009$ /BBL, for example year

201 5 ) Monopsony Component $8.11 ($3.03

- $14.21) $10.75 ($ 3.64

- $ 20.38) )

Macroeconomic Disruption/ Adjustment Costs $5.02 ($2.30

- $8.10 ) $6.48 ($3.07

- $10.54)

Total Mid

- point $13.13 ($7.30

- $19.64 ) $17.22 ($ 8.74

- $ 27.3 0) Results in 2009$ . Columns report mean estimate and ranges. Results for 2008 report match those in Leiby 2008, in 2005$. The ranges include 90% of results from the risk

- analysis simulation, with simulations done around the EIA Reference Outlook only.



### For this proposed rule, ORNL also estimated energy security premium s fo r the years
2015

- 2050 in five

- year intervals . These premiums are presented in Table 3 as we ll as a breakdown of the components of the energy security premiums for each of these years. Variations over time reflect changing reference oil price level s , U.S. import level s , and global market balances. There are no assumed changes in global oil market disruption risk.

### 7 Table 3: Energy Security Premiums in 20 15 through 2050

( 2009$ /Barrel)

Effect 2015 2020 2025 2030 2035 2040 205 0

Monopsony Component $10.75 (3.64

- 20.38) $11.12

(3.78

- 21.21) $11.26

(3.78

- 21.48) $10.91

(3.74

- 20.47) $10.11

(3.51

- 18.85) $10.11

(3.51

- 18.85) $10.11

(3.51

- 18.85) Macroeconomic Disruption/ Adjustment Costs $6.48 (3.07

- 10.54) $7.10

(3.4

- 10.96) $7.77

(3.84

- 12.32) $8.32

(4.09

- 13.34) $8.60

(4.41

- 13.62) $8.60

(4.41

- 13.62) $8.60

(4.41

- 13.62) Total Mid

- point $17.22 (8.74

- 27.3) $18.22

(9.53

- 29.06) $19.03

(9.93

- 29.75) $19.23

(10.51

- 29.02) $18.71

(10.3

- 28.2) $18.71

(10.3

- 28.2) $18.71

(10.3

- 28.2) Results in 2009$ . Columns report mean estimate and ranges resulting from Monte Carlo Simulation.



### The EU oil demand assumption doesn’t have a large impact on estimated energy security premiums estimated for the LDV

- 2017 vehicle rule. For instance, for 2020, the total energy security premium with the inelastic EU oil demand is $ 18.22 /barrel. If oil demand in the EU is demand responsive, then the energy security premium is $ 17.63 /barrel. The macro

disruption component of the energy security premium is essentially unchanged at $7. 1 0 /barrel
in 2020. 10 

### The disruption component is not sensitive to the assumption regarding EU demand elasticity since it is more a function of disruption r isk, U.S. oil import level s and import elasticity, and U.S. GDP sensitivity to shocks. The main reasons for this limited effect of inelastic EU demand is that the EU comprises a limited and declining share of world oil demand outside of the U.S., and that the premium is largely determined by supply behavior in all world regions

. 

### Since the LDV

- 2017 rule only counts the macro

- disruption portion of the energy security premium when valuing the energy security benefits of the LDV

- 2017 vehicle rule, whether EU oi l demand is inelastic or demand responsive has only a relatively small impact on the overall energy security benefits of the rule.

10 Small changes of ~$0.05/BBL in the mean can be attributed to random sample variation in the simulation.

### 8

References

Leiby, Paul N. 2008. “Estimating the Energy Security Benefits of Reduced U.S. Oil Imports,” Final Report, Oak Ridge National Laboratory, ORNL/TM

- 2007/028, revised March 14.

Parker, L., 2010, “Climate Change and the EU Emissions Trading Scheme (ETS); Looking to 2020”, Congressional Research Service

.

Toman, Michael A. 1993. “The Economics of Energy Security: Theo ry, Evidence, Policy,” Handbook of Natural Resource and Energy Economics , vol. III, edited by A.V. Kneese and J.L. Sweeney, Chapter 25. (New York: Elsevier Science Publishers B.V.).

Toman, Michael A. 2002. “International Oil Security Problems and Policie s,” The Brookings
Review , 20(2):20

- 23, Spring.

### 9

Tables and Graphs



### Table: Summary Results

- Oil Import Premium Under Various Cases ($2009/BBL) Component Statistic 2015 2020 2025 2030 2035 2040 2045 2050 Monopsony Component Mean $10.75 $11.12 $11.26 $10.91 $10.11 $10.11 $10.11 $10.11
Range (3.64

- 20.38) (3.78

- 21.21) (3.78

- 21.48) (3.74

- 20.47) (3.51

- 18.85) (3.51

- 18.85) (3.51

- 18.85) (3.51

- 18.85) Disruption Import Costs Mean $3.21 $3.46 $3.68 $3.78 $3.72 $3.72 $3.72 $3.72 Range (0.95

- 5.71) (1.11

- 6.16) (1.19

- 6.61) (1.03

- 6.49) (1.14

- 6.59) (1.14

- 6.59) (1.14

- 6.59) (1.14

- 6.59) Disruption Dislocation GDP Losses Mean $3.26 $3.64 $4.08 $4.54 $4.88 $4.88 $4.88 $4.88 Range (1.09

- 5.95) (1.31

- 6.61) (1.49

- 7.44) (1.53

- 8.16) (1.65

- 8.6) (1.65

- 8.6) (1.65

- 8.6) (1.65

- 8.6) Disruption Component Total Mean $6.48 $7.10 $7.77 $8.32 $8.60 $8.60 $8.60 $8.60
Range (3.07

- 10.54) (3.4

- 10.96) (3.84

- 12.32) (4.09

- 13.34) (4.41

- 13.62) (4.41

- 13.62) (4.41

- 13.62) (4.41

- 13.62) Total Mid

- Point Mean $17.22 $18.22 $19.03 $19.23 $18.71 $18.71 $18.71 $18.71 Range (8.74

- 27.3) (9.53

- 29.06) (9.93

- 29.75) (10.51

- 29.02) (10.3

- 28.2) (10.3

- 28.2) (10.3

- 28.2) (10.3

- 28.2) Total Premium, in $/Gallon Mean $0.41 $0.43 $0.45 $0.46 $0.45 $0.45 $0.45 $0.45 Disruption Premium in $/Gallon Mean $0.15 $0.17 $0.18 $0.20 $0.20 $0.20 $0.20 $0.20 Rate of Price Reduction ($/MMBD) Mean $1.26 $1.39 $1.44 $1.40 $1.31 $1.31 $1.31 $1.31


### Notes: Results from Oil Import Premium Risk Analysis

- Updates Using AEO2011 (Final Release) . Sept. 9, 2011. 90% confidence intervals.

Base cas e, AEO2011 final, Multiple Yrs with Constr ained OECD Eu rope demand. Values in 2009$/BBL

.

### 10