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The SEDS World Oil Market Model

The SEDS World Oil Market Model. David L. Greene Oak Ridge National Laboratory W.T. Wilson University of Tennessee SEDS Review May 7, 2009 Washington, DC.

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The SEDS World Oil Market Model

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  1. The SEDS World Oil Market Model David L. Greene Oak Ridge National Laboratory W.T. Wilson University of Tennessee SEDS Review May 7, 2009 Washington, DC

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

  3. The past 35 years of oil market experience fit the partial monopoly theory remarkably well. ? Source: Price and OPEC market share, BP Oil demand elasticities: Long-run = -0.7, short-run = -0.105 Oil supply elasticities: Long-run = 0.60, short-run = 0.06 Assuming linear, annual lagged-adjustment functions, elasticities at $28/bbl. Sour

  4. The keys to a simple world oil market model are representing short- and long-run responses and the role of OPEC. EXOGENOUS OPEC SUPPLY STRATEGY NON-U.S. “ROW” DEMAND WORLD OIL PRICE NON-OPEC “ROW” SUPPLY U.S. DEMAND

  5. A simple oil market model that can be calibrated to any AEO scenario consists of four linear equations. • US Demand • ROW (incl. OPEC) Demand • US Supply • ROW (excl. OPEC) Supply • OPEC Supply assumed exogenous. • Model parameters extrapolated 2030-2050.

  6. The SEDS WOMM simulates future world oil markets, incorporating key uncertainties. • Uncertainty about oil market realities represented by three alternative EIA AEO projections, chosen at random. • Low oil price – resources more abundant relative to USGS 2000 mean estimate, OPEC more willing to expand output. • Reference oil price • High world oil price – resources less abundant than USGS 2000 mean estimate, OPEC reluctant to expand output. • Simulates potential supply disruptions, with a stochastic model calibrated to historical deviations of OPEC supply from AEO projections. • Probability of disruption in any given year • Probability of length of disruption • Change in OPEC production in disrupted year • OPEC can have two “response strategies” • Maintain original (disrupted) price path • Maintain original (disrupted) production path

  7. Any number of futures can be simulated. • Randomly Choose • Oil Market Scenario • & Calibrate WOM • High Oil Price • Reference Oil Price • Low Oil Price • Parameters • Adjust U.S. Supply & Demand • Reduced oil demand • Increased oil supply • Changes in price elasticities Generate Stochastic Oil Supply Disruption Iterate as required Select OPEC Strategy Maintain production Maintain price Compute Oil Market Prices Quantities

  8. If one calibrates to AEO projections, the supply shock model should be calibrated to deviations from those projections.

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

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

  11. Quartile price trajectories reflect an expectation of very high future oil prices.

  12. The 3 AEO cases are clearly distinguishable in the disrupted price paths.

  13. Possible issues for future work. • Explicitly link technological advances to elasticities of supply and demand. • Explicitly model resource depletion and expansion. • Enhance representation of OPEC decision making. • Recalibrate and update: • Projections • Elasticities • Supply disruption model

  14. THANK YOU.

  15. Technology changes the price elasticity of MPG, which changes the price elasticity of gasoline demand. Energy Efficient technology clearly affects the long-run price elasticity of demand. The short-run impact must be carefully considered.

  16. 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.

  17. 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?

  18. The economic theory of the behavior of partial monopolists, like the OPEC oil cartel, was developed more than half a century ago by Heinrich von Stackelberg. P = profit maximizing price C = marginal cost of producing oil  = price elasticity of world oil demand S = OPEC share of world oil market ( 0 < S < 1 ) µ= non-OPEC supply response ( -1 < µ < 0 ) Oil prices are uncertain because short-runelasticities are 1/10th as large as long-run elasticities.

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