Gov’t model predicted oil price shock for 2005

U.S. oil imports are at an all-time high, accounting for approximately 57% of domestic consumption. Americans today import some 12 million barrels per day at a cost that in 2004 skyrocketed above $50 a barrel.

ORNL researchers have made important contributions to understanding and addressing the challenge of oil dependence.

Using a scientific approach to define the problem, the researchers have advised the Department of Energy on the appropriate size of the Strategic Petroleum Reserve, contributed to National Academy of Sciences studies of the potential to increase vehicle fuel economy, and produced comprehensive estimates of the costs of oil consumption.

America’s growing dependence on foreign oil represents an interrelated combination of factors that together create economic, political, and security problems of the highest order. Oil supply is increasingly determined by a small number of nations that wield a near monopoly over world production. An insatiable demand, driven in part by the robust growth of Asian economies, makes American industry and consumers even more vulnerable to the recent shock of higher oil prices. Whether America can remove this vulnerability will depend on substantially reducing the volume of oil imported and consumed, an ambitious goal tied directly to making available affordable and practical petroleum substitutes.

After oil prices fell from $40/bbl in 1985 to $20/bbl in 1986, many analysts predicted the end of the Organization of Petroleum Exporting Countries (OPEC). By 1995, some were confident that the problem of oil dependence was a short-term anomaly.

ORNL researchers disagreed. A three-parameter equation published in 1992 by Heinrich von Stackelberg cautioned that a producer’s ability to influence prices depends on: 1) market share, 2) the responsiveness of demand to price and, 3) other producers’ ability to increase supply when prices rise.

The report suggested that the market’s ability to respond to oil prices in the short run (1-2 years) is about one-tenth of a long-run capability. OPEC could double, triple, even quadruple prices for 24 months but could not sustain such high prices for an extended period. Absent events such as military conflict, OPEC’s only recourse to sustaining historically high oil prices is to cut production. Cutting production, however, would mean a loss of market share and thereby a loss of market power.

From 1979 to 1985 OPEC’s share of the world oil market shrank from 50% to 30% as members (especially Saudi Arabia) continuously cut production to maintain high prices. But loss of market share did not alter the fact that OPEC members held 75% of the world’s proven reserves and approximately 55% of the ultimate resources of conventional oil. Unless world oil demand could be curbed or economical substitutes to oil quickly developed, OPEC would inevitably regain lost market share. In 1999-2000, with help from Russia, Norway, and Mexico, OPEC engineered a doubling of world oil prices.

In a 1995 ORNL report, “The Outlook for U.S. Oil Dependence,” Don Jones, Paul Leiby, and I simulated the impact of a two-year supply shock similar to those that occurred in 1973-74 and 1979-80, but starting in 2005 and ending in 2006. The model predicted that the shock would cause oil prices to jump from $20/bbl in 2004 to $50/bbl in 2005, costing the U.S. economy an estimated half a trillion dollars.

If the U.S. thirst for oil continues unabated, Americans increasingly will be forced to extract petroleum from unconventional sources. Oil sands and heavy oils are already in the early stages of exploitation in Canada and Venezuela. Continued demand will lead to oil shale, coal, or methane for liquid fuels. Such a path might allow OPEC to remain the lowest cost producer of oil and to sustain for several decades the capacity to supply a third or more of the world market.

The world could, of course, pursue a different path leading to low-carbon energy sources or even hydrogen fuel. Unfortunately, we do not yet know how to direct future energy transitions on the scale required for a global economy. Developing the right technologies is a critical but probably insufficient solution. These technologies would need to be accompanied by a fundamental rethinking, on an international level, of how we acquire, distribute, and use our planet’s energy resources.

From Oak Ridge National Laboratory

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