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

- 2025 Light

- Duty Vehicle GHG/Fuel Economy Rule

Paul N. Leiby Oak Ridge National Laboratory (ORNL)

August 6 , 2012

The Environmental Protection Agency (EPA) and the National Highway Traffi c Safety Administration (NHTSA) are implementing 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

– represent 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

.
Energy Security Risks

World crude oil production is highly concentrated, exacerbating the risks of sup ply disruptions and price shocks. Tight global oil markets led to prices of over $1 2 0 per barrel in 2008 and again in

2011
, 2 

### with fuel prices reaching as high as $4 per gallon in many parts of the U.S., causing financial hardship for many families and bus inesses

. Light

- duty vehicles account for about 60 percent of U.S. transportation oil use, which means th at they alone account for about 47 percent of all U.S. oil consumption

. 3



### P otential national and energy security risks exist due to the possibility of t ension over oil supplies. Much of the world’s oil and gas supplies are located in countries facing social, economic, and demographic challenges, thus making them even more vulnerable to potential local instability. For example, in 2010 just over 40 percent of world oil supply came from OPEC nations, and the AEO 2012 projections through 2030 show no decline in this share. 4 

### Approximately 28 percent of global supply is

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 EIA Monthly crude oil spot prices, http://www.eia.gov/dnav/pet/pet_pri_spt_s1_d.htm

. 3 In 2011. Source: EIA Annual En ergy Outlook 2012, released June 25, 2012, Tables 7 and 11.

4 U.S. EIA AEO2012, Table 21, " International Liquids Supply and Disposition Summary ." The projected OPEC share actually rises slightly to 42% by 2035.

### 2

from Persian Gulf countries alone. 5 

### As another measure of concentration, of the 137 countries/principalities that export either crude oil or refined petroleum product, the top 12 have recently accounted for nearly 60% percent of exports (see Table 1a) . Eight of these countries are
members o f OPEC, and Russia is ninth (see Table 1b) . In a market where even a 1

- 2 percent supply loss raises prices noticeably, and where a 10 percent supply loss could lead to a significant price shock, this regional concentration is of concern. Historically, the countries of the Middle East have been the source of eight of the ten major world oil disruptions with the ninth originating in Venezuela, an OPEC member (See Table 2)

. 6

5 Data Source: EIA (2011) Monthly Energy Review, February 28. Data are for 2010, crude oil and lease condensate, excludes natural gas plant liquids. MER Table 11.1b

, http://www.eia.gov/totalene rgy/data/monthly/#international.

6 U.S. Department of Energy, Energy Information Administration, (2004) “Global Oi l Supply D isruptions Since 1951.”

### 3 

### Table 1a: Top 12 Exports (MMBD) Note: Both crude oil and products are in physical barrels. Rank/Year 2005 2006 2007 2008

1 8,699 8,454 8,250 8,669

2 6,798 6,845 7,043 7,044

3 3,132 3,085 2,901 2,791

4 2,791 2,858 2,826 2,722

5 2,714 2,791 2,728 2,503

6 2,494 2,579 2,423 2,488

7 2,403 2,514 2,372 2,157

8 2,305 2,219 2,130 1,947

9 2,108 2,132 1,913 1,880

10 1,815 1,873 1,757 1,767

11 1,637 1,818 1,690 1,751

12 1,617 1,522 1,618 1,581

% of World 60% 59% 59% 59%



### Table 1b: Top 12 Petroleum Exporters Note: Exports of both crude oil and products. Rank/Year 2005 2006 2007 2008

1 Saudi Arabia Saudi Arabia Saudi Arabia Saudi Arabia

2 Russia Russia Russia Russia

3 Venezuela Venezuela Iran United Arab
Emirates

4 Iran Iran Venezuela Iran

5 Norway United Arab Emirates United Arab Emirates Kuwait
6 United Arab Emirates Norway Kuwait Venezuela

7 Kuwait Kuwait Norway Norway

8 Nigeria Nigeria Nigeria Nigeria

9 Mexico Mexico Mexico Angola

10 Canada Canada Canada Iraq

11 Netherlands Netherlands Angola Canada

12 United Kingdom United Kingdom Iraq Singapore
So urce: E IA, International Energy Statis tics website. URLs: http://www.eia.gov/cfapps/ipdbproject/iedindex3.cfm?tid=5&pid=54&aid=4&cid=regions&syid=2005&ey id=2009&unit=TBPD (Products) and http://www.eia.gov/cfapps/ipdbproject/iedindex3.cfm?tid=5&pid=57&aid=4&cid=regio ns&syid=2005&ey id=2009&unit=TBPD (Crude Oil)

### 4



### Table 2: Global Oil Supply Disruptions From 1951 to 2004

Description of Disruption Rank (Average
Gross Shortfall) Dates Average Gross Supply Shortfall (MMBD)

Iraq

- Kuwait War 1 08/01/90

- 10/31/90 4.6

Iranian Revolution 2 11/01/78

- 04/30/79 3.5

Outbreak of Iran

- Iraq War 3 10/01/80

- 12/31/80 3.3
OPEC (ex. Iraq) cuts production 4 04/01/99

- 03/31/00 3.3

October Arab

- Israeli War 5 10/01/73

- 03/31/74 2.6

Venezuelan Oil Strike 6 12/01/02

- 02/28/03 2.1

Suez War 7 11/01/56

- 03/01/57 2
Six Day War 8 06/01/67

- 08/01/67 2
Iraq War 9 03/01/03

- 08/31/03 1.9
Libyan Price Controversy 10 05/01/70

- 01/30/71 1.3

Exxon Valdez Accident 11 03/24/89

- 04/06/89 1
Norwegian Oil Workers Strike 12 05/01/96

- 06/01/96 1

Iranian Fields Nationalized 13 03/01/51

- 10/31/54 0.7
Syrian Transit Fee Dispute 14 12/01/66

- 03/01/67 0.7
Damage at Saudi Oilfield 15 05/01/77

- 05/31/77 0.7
Algerian

- French Nat'l Struggle 16 04/01/71

- 08/31/71 0.6

Continued Unrest in Iraq 17 09/01/03

- 10/31/06 0.5
Nigerian Civil War 18 07/01/67

- 10/31/68 0.5

Lebanese Political Conflict 19 03/01/73

- 05/01/73 0.5

UK Cormorant Offshore Platform 20 04/01/89

- 06/30/89 0.5

Civil War in Lebanon 21 04/01/76

- 05/31/76 0.3
UK Piper Alpha Offsh

. Plat. Explosion 22 07/01/88

- 11/30/89 0.3
Nigeria Unrest 23 03/01/03

- 08/31/03 0.3
Local Protests in Nigeria 24 03/01/98

- 12/01/98 0.3
Local Protests in Nigeria 25 03/01/97

- 04/01/97 0.2

UK Fulmer Float. Stor. Vess. Acc. 26 12/01/88

- 03/31/89 0.2
Unilateral Embargo on Iran 27 08/01/95

- 09/01/95 0.2 Source: U.S. Department of Energy, Energy Information Administration, (2004) “Global Oil Supply Disruptions Since 1951."

### 5

1. 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 com pletion. 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 Vehicles (PHEVs) and Battery E lectric Vehicles (BEVs). To estimate energy security benefits for this 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 cost of oil imports to the U.S. economy beyond the priva te 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, reducing them is a societal benefit. The import premium i ncludes components that account for incremental costs during disrupted and normal oil market conditions. The definition and methodology for estimating the oil import premium are presented in Leiby (2008), 7 

### along with prior estimates. This paper summarize s 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 conditions through 2035 to conform to the latest Annual Energy Outlook of the U.S. Energy Information Administration (AEO 2012 Early Release , Reference case 8 

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

2. Defini tion 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. 9 

### The approach estimates the increm ental benefits to society, in dollars per barrel, of reducing U.S. imports. 10 

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

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

.

7 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.

8 U.S. EIA 2012. Annual Energy Outlook 201 2 with Projec tions to 2035
, Early Release, Jan 23, 2012, http://www.eia.gov/forecasts/aeo/er/index.cfm , accessed 3/30/2012. NEMS case is ref2012.d020112c

. 9 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.

10 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.”

### 6 Omitted from this premium calculation are environmental costs and possible non

- economic or unquantifiable effects, such as effects on foreign policy flexibility or military policy. The LDV rul e may al so 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. 11 

### Also omitted are any spillover

- benefits 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. Methodology for Premium Calculation

The estimation of security premium for the LDV

- 2017 Rule closely foll owed 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 we re 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 pric e 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 analysis.

b) Changes from 2008 Estimation for the L ight

- duty Vehicle Rul e

We develop a revised time path for the light

- duty vehicle energy security premium over a long er horizon, from 20 1 7 to 2050 , under the updated oil market projections embodied in the U.S. Energy
Information Administration’s 201 2 Annual Energy Outlook (AEO201 2 ). This is the primary change from previous estimates. Values after 2035 were based on simple extrapolation, since AEO projections are
unavailable after 2035. Based on the AEO201 2 projection , evolving market conditions alte r some of the factors influencing the oil import security premium . In particular , the Annual Energy Outlook projects 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.

11 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 rule, there may be value to further

- analyzing the energy security implications of these vehicles and the fuels that they consume. Apart from the po tential 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 the st ability and resilience of fuel and electricity markets.

### 7

The following T able 3 compares keys assumptions that differ in these estimates compared to
those used in th e prior fuel economy/GHG rulemak ing.

Table 3 : 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 201 2 Reference Case)

201 7 Current Study/ LDV

2017 Rule (AEO 201 2 Reference Case)

20 20 Current Study/ LDV

2017 Rule (AEO 2012 Reference Case)

2025

Oil Price ( 2010$/BBL ) $57.02 $113.19 $115.96 $121.23
U.S. Oil Imports 12.561 8.218 7.730 7.670

U.S. Oil Demand 22.189 19.738 19.771 19.797
OPEC Supply 34.429 38.532 39.692 42.200
U.S. GDP (bill 2010$ ) $16,297 $17,851 $19,194 $21,710

Oil Share of GDP 2.83% 4.57% 4.36% 4.04%

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 proposed a Directive to alter the

EU

- Emissions Trading Scheme ( ETS ) str ucture 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

. 12 

### While
the Directive is for GHG commitments, 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.

Results

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

### 8

Table 4 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, 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 for 2017 and a t 5

- year intervals between 20 20 and 2035. The oil import premium, measured in $/bbl of imports reduced, is not strongly affected by the estimated volume of oil imports displaced. While substantial in volume, the
reduction in oil use from the LDV

- 2017 

### rul e is under 1 per cent of world liquid fuels demand through 2025, and about 2.1 percent through 2035. It amounts to 4

. 2 % of U.S. liquid fuels demand in 2025, growing to 1 1 % by 2035

. 13



### The total current premium for 201 7 is about 3 7 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 are close to the estimates produced earlier this year for the Heavy Duty Veh icle 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 include 99% per

cent higher projected oil prices, 12 % higher OPEC supply, and a 6 1 % higher value share of oil expenditures in GDP (see Table 3)

. Each of these factors would tend to increase the security premium. Offsetting these drivers are projected reductions in oil consumption and import levels of 11 per cent and

35 per cent , resp ectively, compared to those projected for the prior study period by AEO2007. Under AEO2012, f or years after 201 7 , the EIA

- projected real oil price, GDP, and OPEC supply continue to grow

. Oil consumption grows very slowly and oil imports are projected to decline an additional 4 % by 2025

. Oil value share in the U.S. economy peaks in 2020 and then slowly declines , but stays well above the
levels observed historically between 1985 and 2007

. Together, these conditions yield a n oil security premium that dips s lightly after 2015 but gradually increases from 2020 through 203 5

.

13 Source for projected liquid fuels demand is AEO201 2
, Tabl e 21. International Liquids Supply and Disposition. Estimates of projected fuel savings from the rule are from EPA.

### 9



### Table 4 : Summary Results

– Comparison of Current and 2008 Report

Effect / Study Prior Analysis: ORNL 2008 Report ( 2010 $ /BBL, average for
2006

- 2015) Current Analysis:

LDV 2017 Rule Analysis ( 2010 $ /BBL, for example year

201 7 ) Monopsony Component $8.20 ($3.07

- $14.37 ) $10.7 8 ($ 3.6 1

- $ 18 .38 )

Macroeconomic Disruption/ Adjustment Costs $5.08 ($2.33

- $8.19 ) $ 7.43 ($3. 59

- $10. 76 )

Total Mid

- point $13. 2 8 ($7.38

- $19.87 ) $1 8 .22 ($ 10.02

- $ 2 6.0 0)
Results in 20 10 $ . 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 rule, ORNL estimated energy security premium s fo r the years 201 7 and for 2020 to 20 35
in five

- year intervals . These premiums are presented in Table 5 as well as a breakdown of the components of the energy security premiu ms 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.



### Table 5 : Energy Security Premiums in 2017 through 2050 ($2010/BBL)

Effect 2017 2020 2025 2030 2035 2040 2050 Monopsony Component $10.78 $10.02 $9.77 $9.28 $9.73 $9.73 $9.73

(3.61

- 18.38) (3.35

- 17.09) (3.25

- 16.69) (3.1

- 18.03) (3.24

- 16.68) (3.24

- 16.68) (3.24

- 16.68) Macroeconomic Disruption/ Adjustment Costs $7.43 $7.63 $8.26 $8.77 $9.46 $9.46 $9.46

(3.59

- 10.76) (3.71

- 11) (4.03

- 11.92) (4.33

- 12.6) (4.72

- 13.61) (4.72

- 13.61) (4.72

- 13.61)

Total Mid

- Point $18.22 $17.64 $18.03 $18.05 $19.19 $19.19 $19.19

(10.02

– 26 .0 ) (9.83

– 25 .0 ) (10.15

- 25.47) (10.29

- 25.2) (10.94

- 26.78) (10.94

- 26.78 (10.94

- 26.78) Results in 2010$. Columns report mean estimate and ranges resulting from Monte Carlo Simulation. Optimal premium from AEO2012 Early Release reference path. Ranges span 90% of simulation outcomes. Source: Leiby/ORNL security premium analysis, April 11, 2012 runs.

### 10

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 comp onent of the energy security premium is essentially unchanged

. 14 

### The disruption component is not sensitive to the assumption regarding EU demand elasticity since it is more a function of disruption risk, 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 al l 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 oil demand is inelastic or demand responsive has only a rela tively small impact on the overall energy security benefits of the rule.

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

### 11

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: Theory, Evidence, Policy,” Handbook of
Natural Resource and En ergy 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 Policies,” The Brookings Review

, 20(2):20

- 23, Spring.

U.S. Department of Energy, EIA 2004

. “Global Oil Supply Disruptions Since 1951."

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/

.

U.S. EIA 2012. Annual Energy Outlook 2012 with Projections to 2035, Early Release, Jan 23, 2012, http://www.eia.gov/forecasts/aeo/er/index.cfm, accessed 3/30/2012

### 12

Tables and Graphs