Will Drilling Offshore Affect World Oil Prices? 18 comments
-
Font Size:
-
Print
- TweetThis
Various individuals have argued for drilling in the Outer Continental Shelf [OCS] as a means to affect the price of oil. This is true despite this recent assessment by the Department of Energy's Energy Information Administration, the Federal Government's nonpartisan analytical group on energy issues. From Annual Energy Outlook related analyses (June 2007):
The OCS is estimated to contain substantial resources of crude oil and natural gas; however, some areas of the OCS are subject to drilling restrictions. With energy prices rising over the past several years, there has been increased interest in the development of more domestic oil and natural gas supply, including OCS resources. In the past, Federal efforts to encourage exploration and development activities in the deep waters of the OCS have been limited primarily to regulations that would reduce royalty payments by lease holders. More recently, the States of Alaska and Virginia have asked the Federal Government to consider leasing in areas off their coastlines that are off limits as a result of actions by the President or Congress. In response, the Minerals Management Service [MMS] of the U.S. Department of the Interior has included in its proposed 5-year leasing plan for 2007-2012 sales of one lease in the Mid-Atlantic area off the coastline of Virginia and two leases in the North Aleutian Basin area of Alaska. Development in both areas still would require lifting of the current ban on drilling.
For AEO2007, an OCS access case was prepared to examine the potential impacts of the lifting of Federal restrictions on access to the OCS in the Pacific, the Atlantic, and the eastern Gulf of Mexico. Currently, except for a relatively small tract in the eastern Gulf, resources in those areas are legally off limits to exploration and development. Mean estimates from the MMS indicate that technically recoverable resources currently off limits in the lower 48 OCS total 18 billion barrels of crude oil and 77 trillion cubic feet of natural gas (Table 10).
Although existing moratoria on leasing in the OCS will expire in 2012, the AEO2007 reference case assumes that they will be reinstated, as they have in the past. Current restrictions are therefore assumed to prevail for the remainder of the projection period, with no exploration or development allowed in areas currently unavailable to leasing. The OCS access case assumes that the current moratoria will not be reinstated, and that exploration and development of resources in those areas will begin in 2012.
Assumptions about exploration, development, and production of economical fields (drilling schedules, costs, platform selection, reserves-to-production ratios, etc.) in the OCS access case are based on data for fields in the western Gulf of Mexico that are of similar water depth and size. Exploration and development on the OCS in the Pacific, the Atlantic, and the eastern Gulf are assumed to proceed at rates similar to those seen in the early development of the Gulf region. In addition, it is assumed that local infrastructure issues and other potential non-Federal impediments will be resolved after Federal access restrictions have been lifted. With these assumptions, technically recoverable undiscovered resources in the lower 48 OCS increase to 59 billion barrels of oil and 288 trillion cubic feet of natural gas, as compared with the reference case levels of 41 billion barrels and 210 trillion cubic feet.
The projections in the OCS access case indicate that access to the Pacific, Atlantic, and eastern Gulf regions would not have a significant impact on domestic crude oil and natural gas production or prices before 2030. Leasing would begin no sooner than 2012, and production would not be expected to start before 2017. Total domestic production of crude oil from 2012 through 2030 in the OCS access case is projected to be 1.6 percent higher than in the reference case, and 3 percent higher in 2030 alone, at 5.6 million barrels per day. For the lower 48 OCS, annual crude oil production in 2030 is projected to be 7 percent higher -- 2.4 million barrels per day in the OCS access case compared with 2.2 million barrels per day in the reference case (Figure 20). Because oil prices are determined on the international market, however, any impact on average wellhead prices is expected to be insignificant.
Similarly, lower 48 natural gas production is not projected to increase substantially by 2030 as a result of increased access to the OCS. Cumulatively, lower 48 natural gas production from 2012 through 2030 is projected to be 1.8 percent higher in the OCS access case than in the reference case. Production levels in the OCS access case are projected at 19.0 trillion cubic feet in 2030, a 3-percent increase over the reference case projection of 18.4 trillion cubic feet. However, natural gas production from the lower 48 offshore in 2030 is projected to be 18 percent (590 billion cubic feet) higher in the OCS access case (Figure 21). In 2030, the OCS access case projects a decrease of $0.13 in the average wellhead price of natural gas (2005 dollars per thousand cubic feet), a decrease of 250 billion cubic feet in imports of liquefied natural gas, and an increase of 360 billion cubic feet in natural gas consumption relative to the reference case projections. In addition, despite the increase in production from previously restricted areas after 2012, total natural gas production from the lower 48 OCS is projected generally to decline after 2020.
Although a significant volume of undiscovered, technically recoverable oil and natural gas resources is added in the OCS access case, conversion of those resources to production would require both time and money. In addition, the average field size in the Pacific and Atlantic regions tends to be smaller than the average in the Gulf of Mexico, implying that a significant portion of the additional resource would not be economically attractive to develop at the reference case prices. [Emphasis added -- mdc]
Here is Figure 20 from the report, showing the impact on lower-48 production in the baseline and the alternative.
Figure 20 from Annual Energy Outlook related analyses (June 2007).
What exactly is "insignificant"? One can get an idea by doing a back of an envelope calculation. The 3% increase by 2030 cited by the 2007 Annual Energy Outlook analysis works out to 0.163 millon barrels per day (mbpd) incremental production. Projected world output of conventional oil in 2030 is 99.30 mbpd. This means access to the OCS would result in a 0.164% increase in output.
Let's appeal to a supply-demand framework, assuming log-linearity:
qs = a1 + a2ps + a3X
qd = b1 + b2pd + b3Z
Where q is log quantity, p is log price, X and Z are other shift variables, assumed to be exogenously determined. ai and bi are parameters, a2 > 0 and b2 < 0. Z could be income, for instance.
Solving the simultaneous system of equations for the equilibrium price leads to:
p = (a1-b1)/(b2-a2) + (a3X-b3Z)/(b2-a2)
Taking the total differential and holding constant the shift variables X and Z leads to the following expression:
Δp= (Δa1-Δb1)/ (b2-a2)
Substituting in some parameter values, taking Δa1 as the percentage increase in supply, namely 0.164% (0.00164), and setting the price elasticity of demand equal to -0.4, and price elasticity of supply to 0.3 (Perloff and Whaples has cited these figures; plausible alternative parameter values would not alter the results in a qualitative fashion) yields the following: The resulting change from baseline in 2030 is -0.00234 (-0.23%). Taking the AEO 2008 baseline estimate of 70.45 2006$/barrel in 2030, the implied reduction in price is 0.165 2006$.
Now let's conduct some sensitivity analyses/robustness checks.
Intertemporal Considerations
There have been some assertions that driving down prices in the future will have an impact today. Since petroleum is durable, there is no doubt that this must be true; the question, as always, revolves around the quantitative magnitudes. Take the 2030 impact on today; one can calculate the present value of the innovation: (1+r)22. Take r = .027 (which is the average ten year constant maturity yield minus the lagged one year inflation rate over the 1976-2008 period), one finds that the 0.165 2006$ decline in 2030 results in a 0.106 2006$ decrease today.
Alternative Estimates of Reserves
As pointed out in several venues [1], there is some debate over the amount of technically recoverable oil in the OCS that currently not accessible; the CS Monitor editorial argues that there's been a big revision in estimation technologies. That may be, but here is a quote from the February 2006 report to Congress from the MMS of the Department of Interior (page xii):
Many proponents of domestic energy security consider gaining increased access to Federal resources to be one of the biggest challenges. Part or all of nine OCS planning areas, which include waters off 20 coastal states, have been subject to longstanding leasing moratoria enacted annually as part of the Interior and related agencies appropriations legislation, or are withdrawn from leasing until after June 30, 2012, as the result of presidential withdrawal (under section 12 of the OCSLA). Some of these areas contain large amounts of technically recoverable oil and natural gas resources. The MMS estimates that conventional oil and gas resources (i.e., UTRR) in OCS areas currently off limits to leasing and development total 19.1 Bbo and 83.9 Tcfg (mean estimates). There remains today, considerable uncertainty concerning the resource potential of many of these OCS areas. The availability of additional modern G&G data could reduce this uncertainty. It is instructive to note that perceptions concerning the resource potential of the Central, Western and portions of the Eastern GOM, areas experiencing robust levels of exploration and production effort, have continued to evolve for the better over the years. Critical to the changing perception is the fact that the MMS has acquired approximately 1.75 million line-miles of two-dimensional (2-D) common depth point [CDP] seismic data and nearly 300,000 square miles of 3-D seismic data. However, the additional G&G data and information that become available to assessors between assessments is frequently mixed in terms of having a positive or negative effect on the perception of the overall hydrocarbon potential of the OCS.
This implies that the EIA's base assumptions do not appear unreasonable, on the face of it.
Alternative Elasticities
The calculations rely upon long run elasticities, and a constant elasticity along the curves. (Note: linear demand and supply curves do not exhibit constant elasticities.) If the supply curve in log-price/log-quantity space was still backward L-shaped, and the supply enhancement occurred with demand intersecting along the near-vertical portion, then the price change would be larger.
What about short run effects (in 2030 say)? When new supply comes on line, the resulting deviation in price from baseline will be commensurately larger in the short run. But by definition, over the longer horizon, prices will gravitate toward those indicated by the long run analysis.
Alternative timing
The calculations I presented focus on 2030. One could examine the effects of earlier changes in future prices. But as shown in Figure 20 (reproduced above), production does not even begin until 2017 assuming leasing begins in 2012 (less than four years from now!). Even assuming the 2030 effect is achieved in 2020, that would mean the resulting change in today's prices would only be 0.12 2006$ per barrel.
Strategic Interactions
Reader Anon (in commments to this post) argues against my critique of offshore drilling arguments using a game-theoretic framework:
You are wrong. Opening up more acreage to exploration will affect psychology and markets. let me explain.
A credible threat of increased supply - even ten years away - certainly does have immediate impact to the ruminations of energy policy makers from Russia to Saudi to Mexico.
If you have a large control over marginal supply (Mideast/Russia/Mexico could all do a lot more if they choose to) and you see the glimmer of another North Sea or another ANS then you rightly might adjust your policies. Strategically speaking, if you dominate global oil supply then at some price point you rightly begin to fear Competitive Entrants...
In the case of Oil (by no means a free market), governments control access to resources (sell it like real estate and demand whatever they like or in many cases simply make everything off limits to private capital). However, if you push oil importing nation governments too far with overly high prices then you just might trigger competition.
I hope this makes it clear that the main reason we pay such high oil prices today is the government RESTRICTED ACCESS to reserves (a global phenomenon) that has tended to dominate the oil industry landscape for so long. The secure knowledge that the US Government is EXTREMELY UNLIKELY to open up new reserves for exploitation is enough to keep exporting nations confident that they can safely continue to extract higher rent for their commodity.
So just the credible threat of a surge in new competition (a la Bush statement) may be enough to open the taps a bit more or cause a flurry of counter-competitive increased supply activity to quickly try to KILL the new threat or frighten off competitive capital investment in new supply...
Think Strategically. BTW - I condemn Bush for many things and I sympathize with your attitude towards this administration, however, for once, Bush is actually right this time!
Anon admonishes me to read Barry Nalebuff's book Thinking Strategically (actually it's Dixit and Nalebuff); I confess I have not yet done so. But having endured some amount of game theory over the years, I'm going to wade ahead nonetheless.
First, consider this exchange from April 2004, where Nalebuff suggests investing $5 billion to enable Iraq's oil industry to export a million extra barrels of oil a day, thereby negating OPEC's monopoly power. One interesting aspect of Nalebuff's argument is that he doesn't propose something like exploiting US offshore reserves. I think the reason is quite simple, and is rooted in game theory -- Iraq in principle can be a low cost producer (after security is established). Supply from offshore sources in the US would be (and is known to be) a relatively high cost (per unit production) venture relative to, say, Saudi oil production. Hence, it's not clear increasing US production can have the strategic effect often suggested (Example, see: [2]).
I do agree with Anon that a lot of world production is undertaken by state owned enterprises, which lack proper incentives for responding to price signals. But I'm unconvinced that foreign state owned enterprises would be privatized simply because the US removed its moratorium on OCS exploitation.
So, opening up production in the currently inaccessible areas of the OCS might have substantial effects (perhaps on trade balance, or oil company profitability, Federal leasing revenue), but in my view is unlikely to have a substantial impact on oil prices (just as in the case of opening up ANWR).
As an aside, John McCain is still supporting a gasoline tax holiday [3], so on this count, I remain puzzled.
Related Articles
|
-
The Seeking Alpha 100
See allThe top 100 stock
market authors
selected for publication
Seeking Alpha 100 » -
Fastest Climbers
Authors with the largestSee all
increase in followers
in the last 7 days
Fastest Climbers » -
Top Commenters
Top commenters,See all
as ranked by their peers
Top Commenters » -
Top Instabloggers
The 100 most active
Instabloggers.-
1
TraderMark
-
2
Don Dion
-
3
Cliff Wachtel
-
4
Mike Havrilla
-
5
James Quinn
Top Instabloggers » -
1
-
Top StockTalkers
TopSee all
StockTalkers.
Top StockTalkers »
This article has 18 comments:
By that time the news media will be able to charter boats to go view the CHINESE rigs already PRODUCING oil between Florida and Cuba.
And we'll have sent another $2 TRILLION we don't have to OPEC and (indirectly) the Russians.
No wonder Boone Pickens calls this the GREATEST EMERGENCY IN OUR NATION'S HISTORY !!!
Congress can't figure out how to raise money from allowing drilling of the OCS. I believe that this is the only hang up.
jegan ;-)
For example, by the time year 2025 oil products from offshore production platforms reach the market, it is very likely the consumer won't notice any price difference at the pump. Whether supply/demand factors will make that happen or be it via manipulation by the oil producers, the outcome will remain the same. Take your pick as per your politics.
1) these estimates of the "undiscovered reserves" are nebulous at best. As a geologist involved in these sorts of studies I can assure you the results could be dramatically different, either with much higher or much lower amounts, and the error bars in those sorts of studies would allow for about an order of magnitude of error in the figures. The amount of data that these sorts of studies are based on would be laughable to most other fields of study. We probably have more data for Mars than we do on some of these areas.
2) that the long period of time it takes to lease and then drill is partially filled with government delays- so the five or ten years it takes to drill- is actually more the result of government than industry. The time delays in drilling leases are often self-fulfilling prophecy by the politicians who are promoting the regulatory morass that exists rather than solving it.
Finally, while I too will be happy to see alternative energy supply a larger share of our energy needs, the biggest lie out there is that any of those alternatives can be developed faster than drilling for oil. If you think oil prices are high now, wait and see how high it is in ten years with continued restrictions on drilling in the US.
It is very conceivable that a large discovery in the offshore area could actually affect the market in advance of production. As it does begin to produce, only a few hundred thousand barrels a day can have a significant impact on market prices (as the frequent small supply interruptions do now), and it is wrong to say that small increments of supply do not affect prices, and do not have significant supply implications over many years. Keep in mind, about 15% of US production today comes from wells that produce less than 10 barrels a day from each well. We actually depend on these small increments for stability in the market.
Your mention of Iraq is something I consider ludicrous. It will very likely still be a decade before anyone is willing to situate a nicely lighted 175 ft tall oil rig motionless in one place for a month at a time like a giant target for attacks in the Iraqi desert. Infrastructure (pipelines, compressor stations, separators, water disposal, etc.) has to be built, since it either does not presently exist or is in disrepair, and that will take years while providing more targets for hostility. Iraq is not going to be any immediate solution (nor is it likely to be cheaper than offshore), and the Iraqis are barely able to supply themselves at present, while still importing large amounts of oil products.
This makes Brian Pursley's little burst of outrage even more inexplicable. Menzie Chinn's essay strikes me as reasonable and hedged, and quite willing to acknowledge that there are unknown factors. His engagement with Anon was polite and reasonable. Excellent post.
(For the record, I think we should open the OCS for geo-political reasons and to help our trade imbalance, and in recognition that fossil fuels will continue to be important for decades, even if new technologies being developed now bear fruit. However, there is little that convinces me that production from the OCS will have a significant impact on the price of energy. Still, better to spend that energy dollar here than there, right?)
Importers as a business benefit and spend money domestically and internationally but I see or understand little value to the American population with such an existing model. If the model is for the few only, then the model should not work for what we call a 'Republic' style government.
At this point, our government should be considering security implications of having our supply shut off from abroad. That the current Administration is unwilling to release SPR is a correct position, this reserve is for emergencies only, not as a political election year stunt to have the Democratic party look like saviors on heating oil when the last two years have shown a repugnant stubborness to even consider drilling our own domestic resources. Actually, this stubborness dates back more like 25 years, but who's counting?
Last, "not in my backyard" syndrome exists here in the United States. This exists because the U.S. political system is broken. It's what occurs when there are no term limits in a government! Corruption and clusters of power brokers block policymaking that benefits the many and benefits only the few. This American government under such a system is considered an Oligarchy or in technical terms, Fascist in operation, as a 'Republic' in name only.
As a business owner, I control very little of my fortunes now through fundamentals only as I should. I must now scan Washington legislation as half my time that will effect my Consumer Healthcare and Higher Education businesses, and the other half being a good business operator.
Spending such time on seeing which direction Washington scales or de-scales an industry based on such clusters of politico power brokers tells me this is a Fascist market, no longer a semi-free market of the 1950's-1980's and certainly nowhere close to a true capatalist market that existed in say, 1900.
That's total BS. Iraq is an OPEC member, continues to be. It increases oil production and AFAIK didn't reach its limit yet. Of course, comparing to 2005, production in Iraq increased by at least 1 million bpd.
Saudi prison?
Affect, effect, who gives a crap!
adamnb. Every oil company I know of, and I've only been in the oil business 47 years, strives to produce every drop of oil it can.
Computers do not find oil or make accruate reserve estimates any more than they can foretell about so called global warming. Only the driller's bit finds oil. If drilling won't increase our oil supply, just how in the hell did we get our current oil supply?
All of you so called experts who are not in the oil business don't know any more than Nancy Pelosi, which is absolutely nothing. Why don't you do something constructive, like operate on Ted Kennedy's brain tumor!