The SEDS World Oil The SEDS World Oil Market ModelMarket Model
David L. GreeneDavid L. GreeneOak Ridge National LaboratoryOak Ridge National Laboratory
W.T. WilsonW.T. WilsonUniversity of TennesseeUniversity of Tennessee
SEDS ReviewSEDS ReviewMay 7, 2009May 7, 2009
Washington, DCWashington, DC
““The real problem we face over oil dates from The real problem we face over oil dates from after 1970: a strong but clumsy monopoly of after 1970: a strong but clumsy monopoly of
mostly Middle Eastern exporters operating as mostly Middle Eastern exporters operating as OPEC.” Prof. M. Adelman, MIT, 2004.OPEC.” Prof. M. Adelman, MIT, 2004.
World Price of Crude Oil
$0$10$20$30$40$50$60$70$80$90
$100
1950 1960 1970 1980 1990 2000BP Statistical Review of Energy 2008:Crude Oil Prices, 1861-2007; 2008-9 from EIA STEO 2009.
2007
$ p
er B
arre
l
Before OPEC
After OPEC
The past 35 years of oil market experience fit the The past 35 years of oil market experience fit the partial monopoly theory remarkably well.partial monopoly theory remarkably well.
Sour
?Cartel Market Share and World Oil Prices: 1965-2008
$0$10$20$30$40$50$60$70$80$90
$100
25% 30% 35% 40% 45% 50% 55%OPEC 11 Market Share
2007
$/B
arre
l
1979
19741985
1986
2000
2007
1965
2008
You arehere
Source: Price and OPEC market share, BP
Oil demand elasticities: Long-run = -0.7, short-run = -0.105Oil supply elasticities: Long-run = 0.60, short-run = 0.06Assuming linear, annual lagged-adjustment functions, elasticities at $28/bbl.
The keys to a simple world oil market model The keys to a simple world oil market model are representing short- and long-run are representing short- and long-run
responses and the role of OPEC.responses and the role of OPEC.
WORLDOIL
PRICE
EXOGENOUSOPEC
SUPPLYSTRATEGY
U.S.DEMAND
NON-U.S.“ROW”
DEMAND
NON-OPEC“ROW”SUPPLY
A simple oil market model that can be A simple oil market model that can be calibrated to any AEO scenario consists of calibrated to any AEO scenario consists of
four linear equations.four linear equations. US DemandUS Demand
ROW (incl. OPEC) DemandROW (incl. OPEC) Demand
US SupplyUS Supply
ROW (excl. OPEC) SupplyROW (excl. OPEC) Supply
OPEC Supply assumed exogenous.OPEC Supply assumed exogenous.
Model parameters extrapolated 2030-2050.Model parameters extrapolated 2030-2050.
)1()1()( , tQPBAtQ ROWtROWROWtROW
)1()1()( , tQPBAtQ UStUSUStUS
)1()1()( , tqPbatq ustUSUStUS
)1()1()( , tqPbatq ROWtROWROWtROW
The SEDS WOMM simulates future world oil The SEDS WOMM simulates future world oil markets, incorporating key uncertainties.markets, incorporating key uncertainties.
Uncertainty about oil market realities represented by three Uncertainty about oil market realities represented by three alternative EIA AEO projections, chosen at random.alternative EIA AEO projections, chosen at random.• Low oil price – resources more abundant relative to USGS 2000 Low oil price – resources more abundant relative to USGS 2000
mean estimate, OPEC more willing to expand output.mean estimate, OPEC more willing to expand output.• Reference oil priceReference oil price• High world oil price – resources less abundant than USGS 2000 High world oil price – resources less abundant than USGS 2000
mean estimate, OPEC reluctant to expand output.mean estimate, OPEC reluctant to expand output. Simulates potential supply disruptions, with a stochastic Simulates potential supply disruptions, with a stochastic
model calibrated to historical deviations of OPEC supply model calibrated to historical deviations of OPEC supply from AEO projections.from AEO projections.• Probability of disruption in any given yearProbability of disruption in any given year• Probability of length of disruptionProbability of length of disruption• Change in OPEC production in disrupted yearChange in OPEC production in disrupted year
OPEC can have two “response strategies”OPEC can have two “response strategies”• Maintain original (disrupted) price pathMaintain original (disrupted) price path• Maintain original (disrupted) production pathMaintain original (disrupted) production path
Any number of futures can be simulated.Any number of futures can be simulated.
Randomly ChooseOil Market Scenario& Calibrate WOM• High Oil Price• Reference Oil Price• Low Oil Price• Parameters
Generate StochasticOil Supply Disruption
Adjust U.S. Supply & Demand• Reduced oil demand• Increased oil supply• Changes in price elasticities
Select OPEC Strategy Maintain production Maintain price
Compute Oil Market Prices Quantities
Iterate as required
If one calibrates to AEO projections, the If one calibrates to AEO projections, the supply shock model should be calibrated to supply shock model should be calibrated to
deviations from those projections.deviations from those projections.Actual and "Expected" OPEC Production
0
10
20
30
40
50
60
1960 1970 1980 1990 2000 2010
Mill
ion
Bar
rels
per
Day
Historical 1997 AEO 1999 AEO 1989 AEO 1973_High
1973_Mid 1973_Low 1979 High 1979_Mid 1979_Low
The supply shock simulation model creates projections The supply shock simulation model creates projections more consistent with recent history. more consistent with recent history. Supply shocks are Supply shocks are
deviations from AEO projected OPEC supply.deviations from AEO projected OPEC supply.
OPEC Production: 2005 AEO Reference Case & Supply Shock Simulation
0
10
20
30
40
50
60
70
80
1970 1980 1990 2000 2010 2020 2030
MM
BD
Reference caseMinimum ShareShocked
Each oil market future chooses an AEO Each oil market future chooses an AEO Case in which there Case in which there maymay be oil supply be oil supply
disruptions that generate price shocks.disruptions that generate price shocks.
Quartile price trajectories reflect an Quartile price trajectories reflect an expectation of very high future oil prices.expectation of very high future oil prices.
The 3 AEO cases are clearly distinguishable The 3 AEO cases are clearly distinguishable in the disrupted price paths.in the disrupted price paths.
Possible issues for future work.Possible issues for future work.
Explicitly link technological advances to Explicitly link technological advances to elasticities of supply and demand.elasticities of supply and demand.
Explicitly model resource depletion and Explicitly model resource depletion and expansion.expansion.
Enhance representation of OPEC decision Enhance representation of OPEC decision making.making.
Recalibrate and update:Recalibrate and update:• ProjectionsProjections• ElasticitiesElasticities• Supply disruption modelSupply disruption model
THANK YOU.THANK YOU.
Technology changes the price elasticity of MPG, which Technology changes the price elasticity of MPG, which changes the price elasticity of gasoline demand.changes the price elasticity of gasoline demand.
Effect of Technology and Consumer Rationality on Supply and Demand for Fuel Economy
$0
$25
$50
$75
$100
$125
$150
$175
$200
28 30 32 34 36 38 40 42 44 46 48 50
MPG
2000
$
Sierra Res.MIT (Derived)Full Life WTP3-Yr PaybackFull Life $23-Yr $2
Source of Technology Estimates
MPGat
$1.50/gal.
MPGat
$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%
pepecmpf ,,,, ))1((
pfo
fpfpo dPdP
,,, 5.0
Energy Efficient technologyclearly affects the long-run price elasticity of demand. The short-run impact mustbe carefully considered.
The impacts of alternative and replacement fuels The impacts of alternative and replacement fuels on price elasticity can be similarly estimated.on price elasticity can be similarly estimated.
Given VISION program impact estimates of Given VISION program impact estimates of alternative fuel market shares, elasticity changes alternative fuel market shares, elasticity changes over time can be calculated.over time can be calculated.
The time trend in elasticities can be entered into The time trend in elasticities can be entered into the oil market simulation model by modifying the the oil market simulation model by modifying the price slope of the US oil demand equation.price slope of the US oil demand equation.
ggr
g
r
fggr
ggfggr
gfg Pbs
GPRP
PbsPP
sPbsPP
FG
1
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.
The impacts of reducing US oil use, on The impacts of reducing US oil use, on imports and oil prices can be bounded.imports and oil prices can be bounded.The key question is, “What will OPEC do?”The key question is, “What will OPEC do?”
1.1. Maintain productionMaintain production: : • World oil price fallsWorld oil price falls• US imports depend on elasticitiesUS imports depend on elasticities• OPEC market share increasesOPEC market share increases
2.2. Maintain the price of oilMaintain the price of oil• US supply unchangedUS supply unchanged• US imports fallUS imports fall• OPEC market share decreasesOPEC market share decreases
3.3. Increase production?Increase production?4.4. Decrease production more than enough to Decrease production more than enough to
maintain the previous price?maintain the previous price?
The economic theory of the behavior of partial monopolists, The economic theory of the behavior of partial monopolists, like the OPEC oil cartel, was developed more than half a like the OPEC oil cartel, was developed more than half a
century ago by Heinrich von Stackelberg.century ago by Heinrich von Stackelberg.
P = profit maximizing priceC = marginal cost of producing oil = price elasticity of world oil demandS = OPEC share of world oil market ( 0 < S < 1 )µ= non-OPEC supply response ( -1 < µ < 0 )
Oil prices are uncertain because short-run elasticities are 1/10th as large as long-run elasticities.
1)(
)(11 PP
CP
S
