Oil Independence:Oil Independence:Achievable National GoalAchievable National Goal

or Empty Slogan?or Empty Slogan?David L. GreeneDavid L. Greene

Paul N. LeibyPaul N. LeibyORNLORNL

Philip C. PattersonPhilip C. PattersonDOEDOE

Steven E. PlotkinSteven E. PlotkinMargaret K. SinghMargaret K. Singh

ANLANL

LERDWG MeetingLERDWG MeetingFebruary 7, 2007February 7, 2007Washington, DCWashington, DC

OIL DEPENDENCEOIL DEPENDENCE

“The real problem we face over oil dates “The real problem we face over oil dates from after 1970: a strong but clumsy from after 1970: a strong but clumsy

cartel of mostly Middle Eastern exporters cartel of mostly Middle Eastern exporters cooperating as OPEC.” cooperating as OPEC.”

M.A. Adelman, 2004.M.A. Adelman, 2004.

Oil dependence is NOT an Oil dependence is NOT an externality.externality.

Cats are mammals. Socrates Cats are mammals. Socrates is a mammal. is a mammal. Therefore, Therefore, Socrates is a cat.Socrates is a cat.

Externailities are market failures. Externailities are market failures. Monopoly is a market failure. Monopoly is a market failure. Therefore monopoly is an externality.Therefore monopoly is an externality.

If the only tool you have is a hammer If the only tool you have is a hammer (price), then everything looks like a (price), then everything looks like a nail (externality).nail (externality).

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

World Price of Crude Oil

$0

$10

$20

$30

$40

$50

$60

$70

1950 1960 1970 1980 1990 2000U.S. Energy Information Administration, 2006, Refiner Acquisition Cost of Crude Oil, Domestic

First Purchase Price prior to 1968.

2005

$ p

er B

arre

l

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

of conventional oil.of conventional oil.

69%

2%

29%

OPEC

USA

RoW

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

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

1)(

)(1

1 PSP

CP

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

Cartel Market Share and World Oil Prices: 1965-2005

$0

$10

$20

$30

$40

$50

$60

$70

20% 25% 30% 35% 40% 45% 50%

OPEC Core Market Share

20

00

$/B

arr

el

1979

1974

1985

1986

20001990

1998

2005

1965

Short-run

Long-run

The cartel’s market power was strengthened by The cartel’s market power was strengthened by growing world demand, its increasing market share growing world demand, its increasing market share

and…the peaking of US crude oil production in 1970.and…the peaking of US crude oil production in 1970.

U.S. Petroleum Supply, 1950-2005

0

5

10

15

20

25

1950 1960 1970 1980 1990 2000

Mill

ion

Ba

rre

ls p

er

Da

y

Imported

Domestic

Colin Campbell and the ASPO foresee the Colin Campbell and the ASPO foresee the imminent, and probably catastrophic peaking imminent, and probably catastrophic peaking

of oil and gas supplies.of oil and gas supplies.

Projections of just 2 years ago expected peaking of Projections of just 2 years ago expected peaking of non-OPEC supply with OPEC filling the gap. This non-OPEC supply with OPEC filling the gap. This

would increase their market share and market power.would increase their market share and market power.

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

There are direct monetary costs and There are direct monetary costs and important indirect costs of oil dependence important indirect costs of oil dependence

in a non-competitive market.in a non-competitive market.

Wealth transferWealth transfer Long-run GDP lossesLong-run GDP losses Disruption costsDisruption costs Military costsMilitary costs Foreign policy costsForeign policy costs Strategic stockpile costs Strategic stockpile costs

(SPR)(SPR)

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

1.1. Loss of potential GDPLoss of potential GDP due to greater economic due to greater economic scarcity of oil.scarcity of oil.

2.2. Transfer of wealthTransfer of wealth due to monopoly pricing and due to monopoly pricing and price shocks.price shocks.

3.3. Dislocation lossesDislocation losses of GDP due to oil price of GDP due to oil price shocks.shocks.

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

Costs of Oil Dependence to the U.S. Economy, 1970-2006Competitive World Oil Price Constant at $13/bbl

$0

$50

$100

$150

$200

$250

$300

$350

1970 1975 1980 1985 1990 1995 2000 2005

Bill

ion

s o

f 2

00

0 $

Wealth Transfer

Macroeconomic Adjustment

Potential GDP Loss

Can we really achieve “oil Can we really achieve “oil independence”?independence”?

““The U.S. may be addicted to oil, but many of its politicians are The U.S. may be addicted to oil, but many of its politicians are addicted to “energy independence” – which may be among the addicted to “energy independence” – which may be among the least realistic political slogans in American history.” J.J. Fialka, least realistic political slogans in American history.” J.J. Fialka, WSJ, 7/5/2006WSJ, 7/5/2006

““Calls for energy independence are unrealistic, to put is mildly, for Calls for energy independence are unrealistic, to put is mildly, for the foreseeable future; cutting oil consumption to current the foreseeable future; cutting oil consumption to current domestic production would severely derail an economy in which domestic production would severely derail an economy in which cheap and rapid transportation is taken for granted.” I.W.H. Parry cheap and rapid transportation is taken for granted.” I.W.H. Parry and J.W. Anderson, RFF, 2005.and J.W. Anderson, RFF, 2005.

““The voices that espouse “energy independence” are doing the The voices that espouse “energy independence” are doing the nation a disservice by focusing on a goal that is unachievable over nation a disservice by focusing on a goal that is unachievable over the forseeable future and that encourages the adoption of the forseeable future and that encourages the adoption of inefficient and counterproductive policies.” Task Force of Council inefficient and counterproductive policies.” Task Force of Council on Foreign Relations, 2006.on Foreign Relations, 2006.

““Energy Independence: The wrong target for policymakersEnergy Independence: The wrong target for policymakers””The Washington Post, The Washington Post, Sunday, January 21, 2007; Page B06Sunday, January 21, 2007; Page B06

What is oil (energy) independence?What is oil (energy) independence?

Use no oil?Use no oil? Import no oil?Import no oil? A state in which our nation’s A state in which our nation’s

decisions are not subject to decisions are not subject to restraining or directing influence restraining or directing influence by others as a consequence of by others as a consequence of our need for oil.our need for oil.

A measurable goal is needed.A measurable goal is needed.

QUALITATIVE:QUALITATIVE:• For all conceivable world oil market For all conceivable world oil market

conditions, the costs of oil dependence to conditions, the costs of oil dependence to our economy will be so small that they our economy will be so small that they have no effect on our economic, military have no effect on our economic, military or foreign policy.or foreign policy.

QUANTITATIVE:QUANTITATIVE:• The estimated total economic costs of oil The estimated total economic costs of oil

dependence will be less than 1% of GDP dependence will be less than 1% of GDP with 95% probability by 2030.with 95% probability by 2030.

The non-partisan National Commission on Energy Policy The non-partisan National Commission on Energy Policy proposed a comprehensive plan to address oil dependence proposed a comprehensive plan to address oil dependence

and reduce GHG emissions (here modified).and reduce GHG emissions (here modified).

DemandDemand From 35 MPG in 2017 increase light-duty vehicle MPG From 35 MPG in 2017 increase light-duty vehicle MPG

to 43 MPG by 2030 (+75%).to 43 MPG by 2030 (+75%). Displace 2 mmbd of gasoline with biofuel by 2020.Displace 2 mmbd of gasoline with biofuel by 2020. Reduce heavy truck energy use by 0.5 mmbd by Reduce heavy truck energy use by 0.5 mmbd by

increasing fuel economy by 15%.increasing fuel economy by 15%. Reduce rail and water oil use by 0.2 mmbd.Reduce rail and water oil use by 0.2 mmbd. Eliminate the use of #2 distillate fuel to heat Eliminate the use of #2 distillate fuel to heat

residential and commercial buildings.residential and commercial buildings. Cut industrial petroleum use by 0.6 mmbd.Cut industrial petroleum use by 0.6 mmbd.SupplySupply Expand oil drilling to the ANWR and deep offshore Expand oil drilling to the ANWR and deep offshore

areas by 2 mmbd.areas by 2 mmbd. Produce 1 mmbd petroleum fuels from coal with Produce 1 mmbd petroleum fuels from coal with

carbon sequestration.carbon sequestration.

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

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

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

TABLE 1 Estimated Changes in U.S. Oil Supply and Demand in 2030 for the Modified NCEP Oil Independence Strategy (Millions of Barrels per Day) Oil Demand Oil supply Reference Case 27.57 10.42 NCEP Case Changes Light vehicle fuel economy -3.50 Heavy vehicle fuel economy -0.53 Rail and ship energy efficiency -0.20 Eliminate building heating with oil -0.37 Industrial efficiency, substitution -0.62 Coal to liquids 1.00 ANWR and Pacific Offshore 2.00 Biofuel -2.00 Subtotal: Decrease in Demand -7.22 Subtotal: Increase in Supply 3.00 NCEP Case Totals 20.35 13.42 Percent Change from Reference Case -26% 29%

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

Oil Market UncertaintyOil Market Uncertainty• Reference, High Oil Price, Low Oil Reference, High Oil Price, Low Oil

Price AEO 2006 scenariosPrice AEO 2006 scenarios Supply Disruption/Monopoly Supply Disruption/Monopoly

Behavior UncertaintyBehavior Uncertainty• Simulated OPEC supply reductionsSimulated OPEC supply reductions

OPEC Response UncertaintyOPEC Response Uncertainty• Maintain Output/Maintain Price of OilMaintain Output/Maintain Price of Oil

Parametric UncertaintyParametric Uncertainty• Elasticities, adjustment rates, etc.Elasticities, adjustment rates, etc.

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

Randomly ChooseOil Market Scenario• High Oil Price• Reference Oil Price• Low Oil Price• Parameters

Generate StochasticOil 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

Distribution of Oil Dependence Costs as % of GDPBase Case Simulation

0%

1%

2%

3%

4%

5%

6%

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030

Year

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.

Expected oil dependence costs under BAU = 2% of GEP with a Expected oil dependence costs under BAU = 2% of GEP with a 90% C.I. of 0.8-3.5% of GDP.90% C.I. of 0.8-3.5% of GDP.

(Interior interval = +/- 1 std. dev., exterior interval = 5% to 95% C.I.)(Interior interval = +/- 1 std. dev., exterior interval = 5% to 95% C.I.)

Distribution of Oil Dependence Costs as % of GDPBase Case Simulation

0%

1%

2%

3%

4%

5%

6%

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030

Year

% o

f G

DP

% o

f G

DP

A one-time single-focus policy is insufficient: Raising A one-time single-focus policy is insufficient: Raising LDV fuel economy to 35 MPG by 2017, then stopping, LDV fuel economy to 35 MPG by 2017, then stopping,

lowers the cost range to 0.5% to 3.0%.lowers the cost range to 0.5% to 3.0%.

Distribution of Oil Dependence Costs as a % of GDPFuel Economy Case, OPEC Maintains Scenario Oil Price

0%

1%

2%

3%

4%

5%

6%

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030

Year

% o

f G

DP

% o

f G

DP

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

Distribution of Oil Dependence CostsFuel Economy Case: OPEC Maintains Scenario Production

0%

1%

2%

3%

4%

5%

6%

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 2030

Year

% o

f G

DP

% o

f G

DP

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

sustained beyond 2030.sustained beyond 2030.

Distribution of Oil Dependence Costs as a Percent of GDP:

NCEP Strategy Scenario, OPEC Maintains Price

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1%

2%

3%

4%

5%

6%

1970 1980 1990 2000 2010 2020 2030

Pe

rce

nt

of

GD

P

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

Distribution of Oil Dependence Costs as a Percent of GDP:

NCEP Strategy Scenario, OPEC Maintains Production

0%

1%

2%

3%

4%

5%

6%

1970 1980 1990 2000 2010 2020 2030

Pe

rce

nt

of

GD

P

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

Achieve oil independence.Achieve oil independence. Reduce carbon dioxide emissions.Reduce carbon dioxide emissions. Undertake a transition to sustainable Undertake a transition to sustainable

energy sources.energy sources. An integrated strategy is needed.An integrated strategy is needed. A measurable goal for oil independence A measurable goal for oil independence

and a means of testing proposed and a means of testing proposed strategies is a necessary component.strategies is a necessary component.

THANK YOU.THANK YOU.