Oil and the American Way of Life:Oil and the American Way of Life:Don’t Ask, Don’t TellDon’t Ask, Don’t Tell

Robert K. Kaufmann

Fermi National Accelerator Laboratory

June 1, 2005

http://www.bu.edu/cees/people/faculty/kaufmann/index.html

Basic Facts of the Oil Market 2004Basic Facts of the Oil Market 2004

World oil demand 80.47 million barrels per day

OPEC produces 41 percent of the world market

US Consumed 20.5 million barrels per day

US imports 61 percent of its consumption

General “Beliefs” About the Oil General “Beliefs” About the Oil MarketMarket

•A competitive market will solve all problems in a timely fashion

•Higher prices will elicit increased supply

•Technical change has freed us from the resource base

Does The Source of US Does The Source of US Oil Imports Matter?Oil Imports Matter?

Reducing US Dependence on Reducing US Dependence on Imported Oil is a “Good Thing”Imported Oil is a “Good Thing”

The Costs of Increasing US ProductionThe Costs of Increasing US Production

0

0.01

0.02

0.03

0.04

0.05

0.06

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0.08

1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996

Fraction

A Competitive MarketA Competitive Market Prices Oil EfficientlyPrices Oil Efficiently

-60

-40

-20

0

20

40

60

80

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Annual Change in Real Oil PricesAnnual Change in Real Oil Prices

Competitive MarketCompetitive Market

Texas RailroadTexas Railroad CommissionCommission

OPEC

Kaufmann, R.K. 1995. A model of the world oil market for Project LINK Economic Modelling 12:165-178

Does the Market See the Future?Does the Market See the Future?

Future contracts do not predict future prices better than naïve models

Abosedra, S and H. Baghestani, 2004, On the predictive accuracy of crude oil futures prices, Energy Policy 32:1389-1393

Does OPEC Matter?Does OPEC Matter?

OPEC Controls Marginal SupplyOPEC Controls Marginal Supply

199019801970196019500.2

0.4

0.6

0.8

1.0

Cap

acit

y U

tili

zati

on

TRC

OPEC19731973

Kaufmann, R.K. 1995. A model of the world oil market for Project LINK Economic Modelling 12:165-178

Why Are Prices So High?Why Are Prices So High?

WTI near Month Contract--NYMEX

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60

4/4/83 4/4/85 4/4/87 4/4/89 4/4/91 4/4/93 4/4/95 4/4/97 4/4/99 4/4/01 4/4/03 4/4/05

The Determinants of World Oil PricesThe Determinants of World Oil Prices

OPEC Capacity Utilization OPEC production divided by OPEC Capacity

Kaufmann et al. 2004 Does OPEC Matter? An econometric analysis of oil price The Energy Journal 26(4):67-90.

OPEC Capacity UtilizationOPEC Capacity Utilization

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95

1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003

The Determinants of World Oil PricesThe Determinants of World Oil Prices

OPEC Capacity Utilization OPEC production divided by OPEC Capacity

OPEC Quotas Levels of production agreed on at OPEC meetings

Cheating Production beyond quotas

OECD Stocks Days of forward consumption

Kaufmann et al. 2004 Does OPEC Matter? An econometric analysis of oil price The Energy Journal 26(4):67-90.

Fear of Supply Disruptions Iraq, Nigeria, Russia

Can The US Do Anything About Can The US Do Anything About High Oil Prices in the Short Run?High Oil Prices in the Short Run?

Low Levels of StocksLow Levels of Stocks

80

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84

86

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98

100

1986-1 1988-1 1990-1 1992-1 1994-1 1996-1 1998-1 2000-1 2002-1 2004-1

Do Gasoline Prices RiseDo Gasoline Prices RiseFaster Than They Fall?Faster Than They Fall?

Rising Crude Oil & Motor Gasoline Rising Crude Oil & Motor Gasoline PricesPrices

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1 6 11 16 21 26 31

Falling Crude Oil & Motor Gasoline Falling Crude Oil & Motor Gasoline PricesPrices

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1 6 11 16 21 26 31

Gasoline price rise faster than they fall in: Texas, Michigan, Pennsylvania, Florida, Illinois, Minnesota, Ohio, Louisiana, Idaho (not Washington)

Yes…ButYes…But

Effect caused by stocks and refinery utilization

As demand declines, producers slow refining and sell from stocks, which slows the price drop

As demand rises, refinery capacity limits supply responseKaufmann, R.K and C Laskowski, In press, Causes for an asymmetric relation between the price of crude oil and refined petroleum products, Energy Policy

Will the World Run Out of Oil?Will the World Run Out of Oil?

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1900 1920 1940 1960 1980 2000 2020 2040

This Will Never This Will Never Happen….ButHappen….But

1 trillion barrels

2.5 trillion barrels

Mil

lion

bar

rels

per

Day

The Pattern of ProductionThe Pattern of Production

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1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Million Barrels per Day

Dates for a Global PeakDates for a Global Peak

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1899 1919 1939 1959 1979 1999 2019 2039 2059 2079 2099

Mil

lion

bar

rels

per

Day

Can Hubbert’s Bell-Shaped CurveCan Hubbert’s Bell-Shaped CurvePredict The Future?Predict The Future?

The Economic, Geological, andThe Economic, Geological, andInstitutional DeterminantsInstitutional Determinants of Oil of Oil

Production in the Lower 48 StatesProduction in the Lower 48 StatesProd Oil Production in the lower 48 states (billion

barrels)

Price Real wellhead oil prices (1982 dollars per barrel)

Cost Average cost of production in the lower 48 States (1982 dollars per barrel)

Ration Fraction of Texas capacity allowed to operate by the TRC (dimensionless)

Kaufmann, RK and CJ Cleveland, 2001 The Economic, geological and institutional determinants of oil production in the lower 48 States, The Energy Journal 22:27-49.

Oil Production in the Lower 48 StatesOil Production in the Lower 48 States

2000199019801970196019501940-0.2

-0.1

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0.3B

illi

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arre

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Actual

Predicted

Hubbert

Kaufmann, RK and CJ Cleveland, 2001 The Economic, geological and institutional determinants of oil production in the lower 48 States, The Energy Journal 22:27-49.

ImplicationsImplications

Results imply Hubbert was luckyAccuracy of US forecast was spurious Cannot be used for other regions

Government interventionProduction will not change smoothly towards depletionPrices will not increase smoothly towards choke priceMore government intervention that currently envisioned?

Does The Peak Matter?Does The Peak Matter?

Oil Production: Lower 48 StatesOil Production: Lower 48 States

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1.5

2.0

2.5

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3.5

1940 1950 1960 1970 1980 1990 2000

1982

Dol

lar

per

Bar

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1982

Dol

lar

per

Bar

rel

Bil

lion

Bar

rels

Energy Return on InvestmentEnergy Return on Investment

From Cleveland, C.J. 2005, Net energy from the extraction of oil and gas in the United States, From Cleveland, C.J. 2005, Net energy from the extraction of oil and gas in the United States, Energy Energy 30( 5): 555-784

Time to Plan AheadTime to Plan Ahead

Gever, J, R.Kaufmann, D. Skole,, C. Vorosmarty, 1986, Beyond Oil Ballinger Publishing Company, Cambridge, Ma

Will Opening ANWR Solve US Will Opening ANWR Solve US Supply Constraints?Supply Constraints?

USGS Projections For ANWRUSGS Projections For ANWR

United States Geological Survey, 1999. The oil and gas resource potential of the Arctic National Wildlife Refuge 1002 Area, Alaska, Open File Report 98-34.

US Refining CapacityUS Refining CapacityEnvironmental or Market Failure?Environmental or Market Failure?

10000

12000

14000

16000

18000

20000

22000

1970 1974 1978 1982 1986 1990 1994 1998 2002

US Oil DemandUS Oil Demand

US Refinery CapacityUS Refinery Capacity

US Refinery CapacityUS Refinery Capacity

World Refinery Capacity & DemandWorld Refinery Capacity & Demand

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1970 1975 1980 1985 1990 1995 2000

Refinery CapacityRefinery Capacity

World Oil DemandWorld Oil Demand

Where Will the World’s SupplyWhere Will the World’s Supplyof Oil Come From?of Oil Come From?

Remaining Supplies of OilRemaining Supplies of Oil

Figure From The End of Cheap Oil National Geographic 2004Figure From The End of Cheap Oil National Geographic 2004

Will OPEC be Able and Willing to Will OPEC be Able and Willing to Expand Production to Maintain Expand Production to Maintain

Prices?Prices?

Political & Economic Limits Political & Economic Limits On OPEC CapacityOn OPEC Capacity

Multinational firms have the capital needed to increase OPEC capacity significantly, but….

OPEC nations currently prohibit foreign investment in productive capacity, but..

OPEC nations don’t have the capital needed to expand capacity significantly

OPEC Has Little Incentive To OPEC Has Little Incentive To Increase Capacity & Production?Increase Capacity & Production?

Increasing capacity leads to higher productionIncreasing capacity leads to higher productionIncreasing production leads to lower pricesIncreasing production leads to lower pricesLower prices reduce Non-Opec production & Lower prices reduce Non-Opec production &

increase demandincrease demandBut...But...

Increase in OPEC demand is less than price decreaseIncrease in OPEC demand is less than price decrease

So…..So…..

Higher capacity & production reduce OPEC revenueHigher capacity & production reduce OPEC revenueGately, 2004 OPEC’s Incentive for Higher Output Growth, Gately, 2004 OPEC’s Incentive for Higher Output Growth, The Energy Journal, The Energy Journal, 2525(2):(2): 75 75-96-96

Do Increases in Oil Prices Matter?Do Increases in Oil Prices Matter?

Rec

essi

ons

Rec

essi

ons

% Real % Real OilOilPricesPrices

Real Oil Prices & US RecessionsReal Oil Prices & US Recessions

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19471949195119531955195719591961196319651967196919711973197519771979198119831985198719891991199319951997199920012003

Is the US Becoming MoreIs the US Becoming MoreEnergy Efficient?Energy Efficient?

Tho

usan

d K

cal p

er c

hain

ed 2

000

doll

ar

Decline in the US Energy/RatioDecline in the US Energy/Ratio

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1929 1934 1939 1944 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999

Determinants of the Energy/GDP RatioDeterminants of the Energy/GDP Ratio

Fuel MixCoal 1kmDiesel locomotive 3 km

Electric locomotive 15km

Household Energy UseOil personal consumption 310,024 kcal/ 1972 $)Durable personal consumption 13,561 kcal/1972$

Product MixIron ore mining 65,904 kcal/$Wholesale and retail trade 29,302 kcal/$

Energy PricesKaufmann, R.K, 2004 The mechanisms for autonomous increases in energy efficiency: a cointegration analysis of the US energy/GDP ratio The Energy Journal 25(1): 121-144

What Do Americans Need to Know?What Do Americans Need to Know?OPEC will increase its market share, but may not be willing or able to produce enough to keep oil prices low

The world will not run out of oil, but it will run out of inexpensive oil in our lifetime

The depletion of inexpensive oil will have important implications for the US and world economy

There are no simple solutions to avoid these changes, but good policy can reduce the effects while ignoring these changes will make matters worse

The market will not “solve” the impending oil transition in a timely fashion