Oil Independence: Achievable National Goal or Empty Slogan

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Oil IndependenceAchievable National Goalor
Empty Slogan?

• David L. Greene
• Paul N. Leiby
• ORNL
• Philip C. Patterson
• DOE
• Steven E. Plotkin
• Margaret K. Singh
• ANL
• LERDWG Meeting
• February 7, 2007
• Washington, DC

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OIL DEPENDENCEThe real problem we face over
oil dates from after 1970 a strong but clumsy
cartel of mostly Middle Eastern exporters
cooperating as OPEC. M.A. Adelman, 2004.
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Oil dependence is NOT an externality.

• Cats are mammals. Socrates is a
  mammal. Therefore, Socrates is a
  cat.
• Externailities are market failures. Monopoly is
  a market failure. Therefore monopoly is an
  externality.
• If the only tool you have is a hammer (price),
  then everything looks like a nail (externality).

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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. Morris Adelman, MIT, 2004.
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OPEC members own 69 of the worlds proven oil
reserves and more than half of ultimate resources
of conventional oil.
Source U.S. Energy Information Administration,
2006.
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The economic theory to understand world oil
market dynamics was developed in 1954.

• ? price elasticity of world oil demand ( ? lt 0
  )
• S OPEC share of world oil market ( 0 lt S lt 1 )
• µ non-OPEC supply response ( -1 lt µ lt 0 )
• Short- and long-run elasticities differ by an
  order of magnitude!

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The cartels behavior since 1973 fits remarkably
well within the theoretical framework.
Short-run
Long-run
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The cartels market power was strengthened by
growing world demand, its increasing market share
andthe peaking of US crude oil production in
1970.
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Colin Campbell and the ASPO foresee the imminent,
and probably catastrophic peaking of oil and gas
supplies.
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Projections of just 2 years ago expected peaking
of non-OPEC supply with OPEC filling the gap.
This would increase their market share and market
power.
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IEAs WEO 2006 foresees a non-OPEC plateau with
less OPEC supply and unconventional sources
filling the gap. This, too would boost OPECs
market power.
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There are direct monetary costs and important
indirect costs of oil dependence in a
non-competitive market.

• Wealth transfer
• Long-run GDP losses
• Disruption costs
• Military costs
• Foreign policy costs
• Strategic stockpile costs (SPR)

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

• Loss of potential GDP due to greater economic
  scarcity of oil.
• Transfer of wealth due to monopoly pricing and
  price shocks.
• Dislocation losses of GDP due to oil price shocks.

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The economic costs of oil dependence have been
substantial, over 4 trillion since 1970.
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Can we really achieve oil independence?

• The U.S. may be addicted to oil, but many of its
  politicians are addicted to energy independence
  which may be among the least realistic
  political slogans in American history. J.J.
  Fialka, WSJ, 7/5/2006
• Calls for energy independence are unrealistic,
  to put is mildly, for the foreseeable future
  cutting oil consumption to current domestic
  production would severely derail an economy in
  which cheap and rapid transportation is taken for
  granted. I.W.H. Parry and J.W. Anderson, RFF,
  2005.
• The voices that espouse energy independence
  are doing the nation a disservice by focusing on
  a goal that is unachievable over the forseeable
  future and that encourages the adoption of
  inefficient and counterproductive policies.
  Task Force of Council on Foreign Relations, 2006.
• Energy Independence The wrong target for
  policymakers
• The Washington Post, Sunday, January 21, 2007
  Page B06

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What is oil (energy) independence?

• Use no oil?
• Import no oil?
• A state in which our nations decisions are not
  subject to restraining or directing influence by
  others as a consequence of our need for oil.

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A measurable goal is needed.

• QUALITATIVE
• For all conceivable world oil market conditions,
  the costs of oil dependence to our economy will
  be so small that they have no effect on our
  economic, military or foreign policy.
• QUANTITATIVE
• The estimated total economic costs of oil
  dependence will be less than 1 of GDP with 95
  probability by 2030.

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The non-partisan National Commission on Energy
Policy proposed a comprehensive plan to address
oil dependence and reduce GHG emissions (here
modified).

• Demand
• From 35 MPG in 2017 increase light-duty vehicle
  MPG to 43 MPG by 2030 (75).
• Displace 2 mmbd of gasoline with biofuel by 2020.
• Reduce heavy truck energy use by 0.5 mmbd by
  increasing fuel economy by 15.
• Reduce rail and water oil use by 0.2 mmbd.
• Eliminate the use of 2 distillate fuel to heat
  residential and commercial buildings.
• Cut industrial petroleum use by 0.6 mmbd.
• Supply
• Expand oil drilling to the ANWR and deep offshore
  areas by 2 mmbd.
• Produce 1 mmbd petroleum fuels from coal with
  carbon sequestration.

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

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

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The AEO Cases represent BAU, a modified NCEP plan
a comprehensive energy policy.
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Representing uncertainty about future world oil
markets is critical.

• Oil Market Uncertainty
• Reference, High Oil Price, Low Oil Price AEO 2006
  scenarios
• Supply Disruption/Monopoly Behavior Uncertainty
• Simulated OPEC supply reductions
• OPEC Response Uncertainty
• Maintain Output/Maintain Price of Oil
• Parametric Uncertainty
• Elasticities, adjustment rates, etc.

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The policies are tested in 10,000 futures.

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

• Adjust for Policy Impacts (if any)
• Reduced oil demand
• Increased oil supply
• Changes in price elasticities

Generate Stochastic Oil Supply Disruption
Iterate to 10,000

• Compute Oil Dependence Costs
• Transfer of Wealth
• Reduced Potential GDP
• Disruption Costs

Select OPEC Strategy Solve New Oil Market
Equilibrium
Distribution of Oil Dependence Costs by Year
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Each oil market future chooses an AEO Case in
which there may be oil supply disruptions that
generate price shocks.
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Expected oil dependence costs under BAU 2 of
GEP with a 90 C.I. of 0.8-3.5 of GDP.(Interior
interval /- 1 std. dev., exterior interval
5 to 95 C.I.)
of GDP
of GDP
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A one-time single-focus policy is insufficient
Raising LDV fuel economy to 35 MPG by 2017, then
stopping, lowers the cost range to 0.5 to 3.0.
of GDP
of GDP
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The result is nearly unchanged if OPEC chooses to
maintain output.
of GDP
of GDP
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The NCEP strategy falls just short of the
independence goal. More is needed, and progress
must be sustained beyond 2030.
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Oil independence works regardless of OPECs
response strategy.
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The U.S. faces serious energy challenges.

• Achieve oil independence.
• Reduce carbon dioxide emissions.
• Undertake a transition to sustainable energy
  sources.
• An integrated strategy is needed.
• A measurable goal for oil independence and a
  means of testing proposed strategies is a
  necessary component.

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THANK YOU.