(Department of biotechnology and informatics, University of Toronto, Canada)
VOL 03 ISSUE 12
An examination of over 40 years of information reveals that oil price shocks are invariably followed by 2–3 years of weak economic process and weak economic process is sort of always preceded by an oil price shock. This paper reviews why the price-inelastic demand and provide of oil cause oil price shocks and why oil price shocks reduce economic process through dislocations of labor and capital. This paper also reviews this state of oil-supply security noting that previous episodes of supply instability appear to own become chronic conditions. While new unconventional production technologies have revitalized North American production, there are significant barriers to a world-wide uptake of those technologies. Strategic petroleum stocks could provide an oversized measure of protection to the planet economy during an oil supply disruption if they’re used promptly and in sufficient volume to forestall large oil-price spikes. Despite the massive volume of world-wide emergency reserves, their effectiveness in protecting world economies isn’t assured. Strategic oil stocks haven’t been employed in sufficient quantity or in time to avoid the economic downturns that followed past oil supply outages. Also, the expansion of U.S. drilling has reduced the power of the U.S. Strategic Petroleum Reserve to shield the economy following a future oil supply disruption. The policy implications of those findings are discussed.
Keyword: economic oil process, weak economic process .
1. Plan of the paper.
This paper discusses the vulnerability of the globe economy to unplanned oil supply interruptions and the way strategic petroleum stocks can lessen or entirely avoid the adverse economic consequences of a significant oil supply outage. The paper is organized into fourteen sections beginning with a discussion of the short-term price elasticity of oil demand, the initial reason why oil supply outages can cause oil price spikes. After reviewing the literature concerning the worth and income elasticities of demand for gasoline and oil (Sections 2 The short-term price elasticity and income elasticity of gasoline demand, 3 The short-term price elasticity and income elasticity of crude demand), the second problem is discussed: the very small short-term price elasticity of oil supply (Section 4). The inelastic short-term price elasticities of demand and provide imply that relatively small supply outages can produce large oil price spikes (Section 5).
A history of oil pricing from 1970 to this day (Section 6) is provided as background to an assessment of how each oil price spike since 1970 was followed by an economic downturn (Section 7). Oil price shocks were invariably followed by 2–3 years of weak economic process and weak economic process was nearly always preceded by an oil price shock. Section 8 investigates the explanations why oil price spikes cause recessions and unemployment to verify that there’s a causal relationship between oil price spikes and sharp reductions in GDP growth. Turning towards the long run, it’s observed that the recent geopolitical disruptions in several oil-exporting countries aren’t likely to be passing problems (Section 9). While increased North American drilling has offset these losses, it’s not going that the new technologies answerable for the increase in U.S. production will create inexpensive world oil supplies. Consequently, the worldwide economy is probably going to stay prone to future oil outages (Section 10).
Strategic oil reserves are utilized in response to past oil supply problems. However, had the reserves been released soon after the initial disruption, insufficient volumes to offset the availability loss, the next economic downturns may are avoided (Section 12). Today, reduced U.S. oil import dependence raises questions on why the us should still maintain large strategic stocks. Reduced U.S. oil dependence is additionally restricting the power of the us to release its strategic stocks thanks to recent midstream and shipping bottlenecks (Section 13). Conclusions and policy implications, especially for the U.S. and world-wide stock holding policies, are provided in Section 14.
2. The short-term price elasticity and income elasticity of gasoline demand
If fossil oil demand doesn’t slacken substantially when oil prices rise, we are more likely to determine large increases in oil prices so as to balance the market after an oil supply outage. Since rock oil is an intermediate good, the demand for oil depends on consumers’ purchases of petroleum products. Refiners will still purchase crude when oil prices increase as long as petroleum products can still be sold at a profit. If the demand for petroleum products is inelastic2, then refiners won’t greatly reduce their demand for fossil oil because it becomes costlier. Consequently, it makes more sense to estimate how petroleum product demand responds to changes in price than to estimate how refiners answer changes within the price of crude petroleum. Gasoline is one amongst the foremost important consumer products produced from petroleum and, together with distillate and jet fuel, these fuels constitute the majority of revenues to petroleum refineries. Kilian  noted that an analysis of the economic impacts of energy price shocks benefited from “a direct measure of gasoline prices” as this was “more relevant than a measure of fossil fuel prices.”
Earlier studies found the short-term price elasticity of gasoline to be between −0.1 and −0.3.3 for instance, a survey by Greening, Greene and Difiglio  found that the estimated elasticity of demand for travel, with reference to the worth of gasoline was between −0.1 and −0.25.4 An earlier survey by the Dahl and Sterner  concluded that the common estimated price elasticity of gasoline demand was −0.26 which the typical income elasticity of gasoline demand was 0.48. Espey’s “meta-analysis”  considered many studies of gasoline demand, most of which relied on data from the 1970s and 1980s, and located that the nice majority (over 200) estimated the short run price elasticity of gasoline demand to be between 0 and −0.25. Most estimates of the income elasticity of gasoline demand were between 0.26 and 0.50 (short-term) and 0.76 and 1.00 (long-term). Espey also found that the sooner studies estimated higher short-term price elasticities than the later studies but failed to find any trend within the estimates of income elasticities. However, Espey did note that income elasticities were higher in studies that included data from developing and other countries outside of the u. s. suggesting that countries with lower incomes and fewer saturated auto ownership have the next income elasticity of gasoline demand. If so, this has implications for future oil demand as developing countries have higher growth rates of GDP than developed countries and helps to clarify the rapid climb of oil consumption outside of the OECD.5
Studies that analyzed newer data show a dramatic decrease of the short-term price elasticity of gasoline. Small and Van Dender  estimate a short-term price elasticity of gasoline demand of −0.089 using 1966–2001 data but find that it decreases to −0.067 after they only used data for 1997–2001. Hughes, Knittel and Sperling  estimate that the worth elasticity drops from −0.222 using data for 1975–1980 to −0.034 using data for 2001–2006. They also find that the income elasticity of gasoline demand increases from 0.212 to 0.506 when the later 2001–2006 data is employed. Hughes, Knittel and Sperling attribute the declining short term price elasticity of demand to many factors: suburban development has increased average trip distances; distances between homes and non-discretionary destinations have increased; multiple-income households are more addicted to commuting, public transportation use has declined and motor-vehicle fuel efficiency is substantially higher. Another recent study by Lin and Prince  included a survey of recent studies concluding that “the short-run gasoline price elasticity shifted down considerably from a spread of −0.21 to −0.34 within the late 1970s to −0.034 to −0.077 within the early 2000s.” Lin and Price’s dynamic model, using U.S. data, focuses on the connection between price elasticity and gasoline price volatility. They find that price elasticity is somewhat lower in periods with higher volatility (−0.030) than lower volatility (−0.036).
Contrary evidence by Kilian and Murphy  has to be put into perspective. They concluded that “the median short-run price elasticity of gasoline demand is about −0.26,” an estimate that’s several times larger than the several estimates cited above. Kilian and Murphy derived this estimate employing a model during which oil prices were endogenous. They stated: “earlier studies fail to account for price endogeneity and can’t be interpreted as an elasticity within the textbook sense.” to handle this, Kilian and Murphy embed the elasticity of oil demand with reference to income into their price-elasticity estimate. The simultaneous equation model utilized by Kilian and Murphy explicitly introduces an income-feedback variable (shipping index) that conveys a macro-economic impact on oil demand following an oil price shock. As such, Killian and Murphy’s relatively high oil price elasticity estimate isn’t inconsistent with the very low static price elasticity estimates from the opposite studies cited above farewell as we recognize the macroeconomic feedback isn’t incorporated within the other studies. As noted below, these macroeconomic feedbacks have important impacts on oil prices and economic welfare.
3. The short-term price elasticity and income elasticity of fossil fuel demand
Studies of the short term price elasticity of demand for crude petroleum confirm the results obtained for gasoline demand studies. as an example, Cooper  estimates G7 countries to own a brief term elasticity of demand for oil from −0.024 to −0.069 and, for all 23 countries studied, the range expands to 0.0 to −0.11. Gately and Huntington  estimated a short-run demand elasticity for fossil fuel of −0.05 for OECD countries and −0.03 for non-OECD countries. They estimated a long-run income elasticity of oil demand of 0.56 for OECD countries and 0.53 for non-OECD countries. Baumeister and Peersman  report that the elasticity of demand for fossil oil has sharply decreased from 1970 to 2008. They find that “the price elasticity has decreased [in absolute value] from −0.05 to −0.15 during the 1970s and early 1980s to as small as −0.01 to −0.02 since the mid-1980s.” One factor which will help explain this alteration is that the movement aloof from oil-fired generation within the power sector and space heating from 1978 to 1985 observed by Dargay and Gately . Power generation and other stationary uses of oil fuels have greater opportunities for fuel switching than the transport sector where the opportunities for fuel switching are insignificant.
Using different estimation techniques, Krichene  found a short-term elasticity of demand for crude of −0.005 to −0.02 using data from 1973–1999. For the identical period he found a short-term income elasticity fossil fuel demand of 1.2 to 1.45. Ghouri  estimated, for the us, a long-run income elasticity of oil demand of 0.98 and similar income elasticity’s for Canada (1.08) and Mexico (0.84). Askari and Krichene , estimating the demand for fossil oil, found that “short-run price elasticity’s were very low and insignificant for several time periods between 1970 and 2008. Askari and Krichene’s price elasticity estimates ranged from −0.018 for 1986–2001 data to as low as +0.004 (essentially zero) for 2001–2008 data. The estimated price elasticity for 1970–2008 and 1970–1986 was −0.018. Askari and Krichene conclude that:
“oil demand is very price inelastic, implying that changes in oil prices have a little effect on the demand for petroleum. Large increase in prices will translate into much larger spending on oil and thus, ceteris paribus, a discount of paying on non-oil products.”
4. The short-term price elasticity of oil supply
In the short run, oil supply can answer oil price changes within the following ways:
•Higher oil prices (and backwardation of the forward curve) may stimulate the drawdown of oil stocks.
•Saudi Arabia, and a few of other countries that hold some reserve production capacity, may commit to move reserve capacity into or out of production as oil prices rise or fall.
•If oil prices fall to levels that fail to justify the price of drilling, those wells would be surround operations might be slowed or terminated. Higher oil prices could also stimulate higher tight-oil production more quickly than conventional boring could increase.
Apart from stock draws or increased Saudi production, oil producers are unable answer higher oil prices by increasing production to any significant degree. Oil companies can only answer higher or lower oil prices by increasing or decreasing planned investments in new production capacity. Consequently, the short-term elasticity of oil supply with relevancy price is kind of small. If high income growth increases the world-wide demand for oil faster than the world-wide growth of supply, oil producers cannot quickly answer the resultant increases in oil prices as their maximum production generally depends on investments made years earlier. Baumeister and Peersman  show that the short term response of oil supply has become quite price-inelastic over time, declaring that the decreased price elasticity of supply makes inter-temporal comparisons of the economic impacts of oil supply shocks harder. As Baumeister and Peersman denote, for a given supply-demand imbalance, the worldwide oil increment must be significantly greater now than within the past. this can be borne out as we’ve got seen high price increases during times of high world economic process (for example, from 2002–2008) or unplanned petroleum supply outages (many examples summarized below).
5. Why the underlying short term price elasticity’s of oil supply and demand generate oil price spikes
There are significant consequences resulting from the very low price elasticity of demand and provide. Low price elasticity mean that very large price changes are required to significantly increase supply or decrease demand. Consequently a comparatively small unplanned oil supply outage can produce an oil price spike. additionally, thanks to the relatively high income elasticity of oil demand, rapidly rising world economic process grows oil demand. If rapid economic process grows oil demand faster than are often accommodated by the expansion in oil supply, oil prices can rise significantly. As rising oil expenditures are an outsized enough component of GDP to adversely affect economic process, these interactions can produce the subsequent oil price – economic process – drilling investment cycle:
•Due to: low price elasticity’s, haphazard supply outage spikes oil prices, or
due to relatively high income elasticity, rapid GDP growth drives oil prices to high levels;
•The resulting high share of GDP spent on oil reverses GDP growth;
•With lower GDP growth, high income elasticity reduces oil demand;
•With lower oil demand, low oil price elasticity’s sharply lower oil prices; and
•Lower oil prices and reduced GDP growth discourage boring investment.
World GDP growth and oil prices are periodically engaged within the cycle described above. Kilian  notes that oil price shocks don’t affect the 000 price of oil for very long. The above narrative attributes the worth drop to reduced economic process. Kilian finds that the effect of an oil price shock is delayed: “there is a few indication that [oil price shocks] lower global economic activity within the third year after the shock” and, consequently, Kilian attributes the rapid reduction in oil prices to an oil supply response. However, as are discussed below, after every oil price shock, we observe significantly reduced world-wide economic process within the first, second and third years following the shock. Reduced economic process, combined with a comparatively high income elasticity of oil demand, explains why the value of oil declines so soon after an oil price shock instead of a direct increase in oil supply.
Oil prices also can stabilize at relatively high levels just wanting what would cause a downturn in GDP growth if GDP growth is comparatively modest (e.g., the economic conditions that have persisted during the previous couple of years). The relatively high oil prices, during these circumstances, may reflect oil supplies sufficient to stay the oil market in balance with modest world-wide economic process but oil prices are too high, and oil supplies too inelastic, to support higher economic process.6
6. Oil price history
World oil prices have, from time to time, reached levels that have impaired world economic process like the aftermath of the 1973 oil embargo. This “energy crisis” accompanied a significant change within the way petroleum was controlled and priced. before 1973, world oil prices were managed by the Texas Railroad Commission and a comparatively small number of huge oil companies (super-majors) that enjoyed liberal access to most countries’ oil resources. they might develop large oil fields in host countries with terms that allowed ample world supply at non-competitive but reasonable prices. The super-majors pursued a method of affordable and stable oil prices since the resulting economic process within the industrialized world increased the demand for oil. By 1973, the Texas Railroad Commission was not relevant and reforms within the member-countries of the Organization of Petroleum Exporting Countries (OPEC) ended the super-majors’ control of world oil prices. The reforms moved the control of the world’s largest oil resources from the international oil companies to the OPEC countries and, given sufficient cohesion, allowed OPEC to regulate world oil prices.
OPEC’s control of oil prices was short-lived. The rapid price hikes related to the 1973 embargo and also the 1979 Iranian revolution stimulated new supplies, especially from the North Sea and Alaska. High oil prices also stymied demand as consumers turned to more efficient automobiles. By 1981, oil prices began a gentle decline. Saudi Arabia| Asian country Asian nation} tried to keep up higher prices by cutting production until, by 1985, its output had fallen to three million barrels per day (mmb/d), 70 percent less than it had been in 1980. In 1986, Asian nation adopted netback pricing7 to regain market share. Oil prices collapsed to $12 per barrel8. By 1988, the OPEC pricing regime was replaced by commodity market pricing, a system that continues to be in situ today and for the foreseeable future. The London InterContinental Exchange (ICE) established a contract for Brent, a combination of top quality North Sea crudes9. the value trajectory of Brent since 1987 is shown in Fig. 1. Additionally, the big apple Mercantile Exchange (NYMEX) established a contract for West Texas Intermediate (WTI), a high-quality crude the same as Brent.
Fig. 1. Real and nominal world oil prices
Today, only a little percentage of the world’s crude petroleum is WTI, Brent or other traded “marker” crudes. Nonetheless, these marker crudes affect the contract price of other kinds of oil since most fossil oil contracts are indexed to at least one or more marker crudes. This new pricing regime failed to entirely eliminate OPEC’s price setting role. some OPEC countries maintain spare boring capacity. Saudi Arabia, by far, keeps the most important production capacity in reserve. Kingdom of Saudi Arabia can increase or decrease its drilling in response to world market conditions. If Asian nation believes that prices are too high, it can put spare capacity into production, putting downward pressure on market prices. Conversely, if Asian country believes that prices are too low, it can reduce production (increasing spare capacity) putting upward pressure on market prices. Most other oil producing countries and every one private oil companies are price takers. They only reply to higher or lower oil prices by increasing or decreasing planned investments in new production capacity. Whether or not these investments are made has little impact on current oil supplies or prices, but may have an outsized impact on future oil supplies and costs.
The new pricing regime produced relatively stable, inflation adjusted, oil prices until 1999 (except for a pointy increase in 1990 thanks to the Gulf War). In 1999, oil prices began a pointy upward trend culminating in an especially sharp $40/b rise from January 2007 to June 2008. With record high oil prices, U.S. demand finally slackened and, soon after, failing financial institutions precipitated a world-wide banking crisis. Oil prices plummeted, reversing in one year the gains made since 2005.
Since 2008, there are two rapid increases in oil prices. In early 2011, the Libyan warfare removed 1.5 mmb/d of light-sweet crude from the market. Oil prices spiked again in 2012 because of increased supply outages in Iran, Nigeria, Sudan and Yemen. The 2012 run-up was followed by a major price slide because of a deteriorating economic outlook within the Euro zone and uncertainty whether the EU and also the European financial organization would take the mandatory actions to forestall an unraveling of the euro.
7. Oil prices and GDP growth
Fig. 2 shows oil prices and annual changes in world-GDP. Each spike in oil prices was followed by a pointy call world GDP growth. the worth rise from the 1973 oil embargo preceded a forty five visit world GDP growth. Within two years, world growth slid from over 6% to fifteen. The oil-supply outage resulting from the 1979 Iranian revolution doubled oil prices .Growth slid from 4% to twenty-eight and, later, to below 1%.
Fig. 2. International rock oil prices and global GDP growth. Source: IEA, World Energy Outlook 2011.
The spike in oil prices resulting from the 1990 Gulf War led to a drop by world GDP growth from over 3% in 1990 to fifteen in 1991. GDP growth didn’t return to three until 1994. the value spike from 1999–2000 was followed by a come by world GDP growth from over 4% in 2000 to twenty-eight in 2001. The globe economy perceived to survive the long price rise from 2002 to 2007 until 2008, when the globe suffered the worst financial crisis since the 1930s. World GDP growth dropped from over 4% in 2007 to but 2% in 2008 and so plummeted to −2% in 2009. While the 2008 recession followed a liquidity freeze, high oil prices were a partial reason behind the financial crisis. Excessive construction lending had been made in locations that were hooked in to low automobile commuting costs. Rapidly rising oil prices then reduced the market price of real-estate on the outskirts of cities causing a major rise in under-water mortgages. Sexton, Wu and Zilberman  analyzed the role of rising gasoline prices on the 000 estate crisis of 2007–2008. They found that housing prices first dropped within the suburbs which the foreclosure rate increased with the space aloof from the municipality. With rising gasoline expenses and no home equity, many lower income households defaulted. Sexton, Wu and Zilberman’s model showed why these foreclosures spread throughout the complete overvalued housing market. Rapidly increasing oil prices failed to just affect the housing market. They also reduced automobile sales and economic activity in vacation and entertainment-focused regions. All of those consequences resulted from reduced household income after paying unavoidable fuel expenses. 10 With reduced spending, important economic sectors contracted causing dislocations of labor and capital. The world-wide land bubble enabled the economy to tolerate rising oil prices for variety of years. However, by 2007–2008, the strain of exponentially rising oil prices on income, employment and mortgage defaults contributed to the worst world-wide economic contraction in 75 years.
8. Why oil price spikes cause recessions and unemployment
During the last 40 years, each oil spike has been followed by a pointy come by world economic process. There has been just one sharp annual reduction in world economic process that wasn’t preceded by an oil price spike.11 Otherwise, world GDP growth has remained above 3%, except for the first, 2nd or 3rd years following an oil price spike. Unless these episodes linking oil price spikes to poor world-wide economic process are coincidences, or result from mismanagement of the economy by monetary authorities, there must be a mechanism through which these oil price spikes cause such economic harm. This mechanism has been well-researched with many authors specializing in the multiplier effects that cascade through the economy. Reduced spending on other goods and services has multiplier effects that grow over time. Edelstein and Kilian  found that the reduction of paying resulting from an oil price shock accelerates in later time periods. as an example, Edelstein and Kilian found that a shock causing a tenth spending reduction produces a 2.2% reduction one-year later. Because the economy adjusts to a brand new pattern of expenditures, transitional effects force the economy to work below the potential output until full adjustments are made. These adjustments include inter-sectoral and inter-regional relocations of labor that are displaced by reduced spending within the economic sectors that they’d previously worked.
A major mechanism through which oil price shocks affect the economy involves the car industry. Oil price spikes reduce spending on motorized vehicles out of proportion to their effect on income. The economic harm from decreased automotive sales cascades throughout the economy. Tracing impulses with a 1949–2012 statistical model, Santini and Poyer  showed that real expenditures on automobiles declined immediately following a gasoline price shock, but well before subsequent declines in a job. Santini and Poyer  also showed for 1967 to 2008 that declines in U.S. car output clearly preceded declines within the remainder of GDP in each of the recessions during that point interval. While automobile production is often related to the U. S., Japan, Germany and South Korea (they are the 2nd to 5th largest automobile manufacturers), automobile production is cosmopolitan. the most important current producer is China and, after South Korea, there are 11 countries that produce a minimum of 1 million cars each year. The economic ripple of reduced automobile purchases also extends to countries that produce few or no automobiles via reduction of their exports to the auto-producing countries that have reduced spending and output.
The economic harm caused by oil price increases isn’t linear. Hamilton  showed that oil price changes don’t matter unless they set a replacement high relative to the previous 3-years. This supports the view that economic dislocations are the vector that spread economic harm beyond the share of GDP lost though higher oil prices. Mork  showed that reductions in oil prices can cause economic harm supporting the view that major sectoral dislocations caused by abrupt oil price changes are a key mechanism for economic harm. This might explain why the rapid decrease in oil prices during the 1980s did little to market economic process. This asymmetry might alternatively suggest that it’s the monetary response to grease price changes that affects the economy: Monetary responses to higher and lower oil prices could also be asymmetric or may have asymmetric effects. However, before addressing this question, it’s necessary to review whether monetary policy itself has been a crucial think about causing economic disruptions after an oil price shock.
Well before the recent monetary accommodation from 2001–2008 (and beyond) Bernake, Getler and Watson  suggested that that contractionary monetary policies exaggerated the adverse effects of past oil-price shocks and, with improved monetary policies, oil price increases needn’t have serious economic consequences. Hamilton , however, found that the 2007–2009 recession followed earlier oil price-GDP patterns despite expansionary monetary policies during the uninterrupted rise of annual oil prices from 2001–2007, noting plunging U.S. automobile sales and 1.2% lower real GDP growth in 2007. However, the importance of constructive monetary policy mustn’t be discounted. Wu and Ni  conclude, using symmetric and asymmetric models, “monetary policies still matter, after accounting for the oil prices, the energetic variable.” Askari and Krichene , whose work on oil demand elasticity’s was cited above, conclude that Aggressive monetary policies would stimulate oil demand, however [because of low short term elasticity’s] would be met with rigid oil supply and would turn disruptive to economic process if there was little excess capacity in oil output. We argue that a measure of stability in oil markets can’t be achieved unless monetary policy is restrained and real interest rates become significantly positive. Monetary tightening during 1979–1982 might imply that monetary policy has got to be restrained for a protracted period and with high interest rates so as to bring stability back to grease markets.”
These monetary policy prescriptions are often compared to contrary advice by Bernake, Getler and Watson . Askari and Krichene emphasize that there’s reduced income available to spend on non-oil commodities due to the oil price shock which loose monetary policies won’t increase oil supplies.
Returning to the question of whether monetary policy explains the observed asymmetric effect of oil price changes, Federer  concludes that “the monetary channel cannot explain the asymmetry puzzle“ and “sectoral shocks and uncertainty channels offer a partial solution to the asymmetry puzzle.” Balke, Brown and Yucel  acknowledge that increased oil prices introduce financial stress which “factors apart from monetary policy would seem to contribute to asymmetry on the 000 side” while acknowledging the influence of asymmetric Fed policy and therefore the role of interest rates. Davis and Haltiwanger  note that “employment growth declines sharply following an outsized oil increase but changes little following an outsized oil price decrease.” Hamilton  concludes “empirically, oil price increases appear to harm aggregate economic activity while price declines don’t appear to help” and attributes this disparity to the “costs of sectoral realignments after relative price changes.”
There is evidence that economies became more resilient against the adverse effects of oil price increases (Rasmussen and Roitman , Baumeister, Peersman and Van Robays ). Nonetheless, it goes too far to wonder “whether [oil prices] are really that bad?” (Rasmussen and Roitman ). The decreased elasticity of demand for oil, combined with evolving conditions within the world oil market, can quite offset improved economic resiliency to a given oil increase. As shown in Fig. 2: 1) oil price shocks are invariably followed by 2–3 years of weak economic process; and 2) weak economic growth is nearly always preceded by an oil price shock. Looking forward, there’s little reason to be complacent about the economic damage that would be caused by future oil price spikes considering increased instability of Near East and North Africa (MENA) oil exporting countries and increased non-OPEC production costs12.
9. Looking forward
The world oil market has been subject to unplanned supply outages since its inception. However, since 2011, supply outages have increased considerably from prior years. They also reflect causes that are likely to be chronic conditions, as against one-off events. During 2010, oil supply outages averaged but 1 mmb/d; since 2011, they need averaged ∼ 3 mmb/d. These outages are caused by a range of problems including tribal grievances with the central government, sectarian conflict and piracy. the protection situation has caused private industry to withdraw personnel from regions not deemed to be safe. additionally to loss of trained personnel, insurgent attacks on infrastructure, political disputes concerning sovereignty and disagreements about the validity of oil-related contracts aren’t likely to be passing problems. While these could also be necessary side effects as countries replace autocratic rule with democratic governments, they nonetheless pose an excellent risk for future oil supplies. The International Energy Agency (IEA) recently warned that relatively stable oil prices shouldn’t conceal “an abundance of risk” as “much of the center East and geographic region remains in turmoil.” “The current stalemate between the West and Iran” is “unsustainable” and “sooner or later, something has got to give.” The political situation within the MENA region reflects a “precarious balance” that doesn’t bode well for “clear, stable and predictable oil policies, including supplies” .
The oil-economy problem would be reduced if future oil prices trended significantly lower as results of new discoveries and oil-production technologies. However, there are reasons to believe that we cannot reckon abundant cheap oil as the way out of our oil-economy problem. First of all, there’s an oversized uncertainty about future oil supplies. As detected by Brant, Plevkin and Farrell , “data [for conventional oil supplies] are unavailable for political or economic reasons, reserves reporting practices are poor, and a few regions don’t seem to be yet thoroughly explored.”13
The remaining conventional oil that may be produced at a comparatively low differential cost is probably going to be in MENA OPEC countries (Khatib ). Despite this, OPEC production capacity has grown relatively little for the last 30 years. for instance, OPEC production capacity has risen by just one mmb/d, 2000–2013, while world-wide liquids consumption has increased by 15 mmb/d over the identical fundamental quantity . Over that point, growing oil demand has been met by additions to non-OPEC capacity. variety of disappointing non-OPEC supply developments helped drive the sharp rise in oil prices from 2002 and 2008. During that period, the price of oil and gas drilling equipment and support activities increased by 260% . More recently, the expansion of Canadian oil sands and U.S. tight production has kept the planet oil market in balance. Without increased production within the u. s. and Canada, non-OPEC production would are in decline in recent years.
Sufficiently high oil prices are needed to sustain the expansion on non-OPEC oil. The IEA estimates that the value of oil sands and tight boring ranges from $45/b to over $100/b . As production moves from the foremost productive plays to less promising plays, costs will tend to maneuver to the upper end of the IEA range. for instance, Global Energy Securities estimates that the worth of oil needed to come up with a beautiful internal rate of return increases from $67/b in Eagle Ford to $84/b in Monterey/Santos . While current oil prices are relatively high,14 they’re not that much over what’s needed to motivate the massive investments needed to grow non-OPEC production.15
Tverberg  considers three scenarios of oil supply growth and their impact on OECD economic process concluding “we are reaching limits on the quantity of oil that the planet can extract at a price OECD countries can afford to pay without serious recession.” Hallock, et al  confirm Tverberg’s findings using global and national data. Hallock modeled the longer term growth of conventional oil16 and concluded that “proclamations of enormous future increases of conventional oil…are not supported by empirical data” and “if there are to be to be significantly larger quantities of conventional oil produced, then higher oil prices, or technological innovation will should have a way larger effect within the future than they need had within the last 11 years.”
Robelius  projects that the assembly of oil from giant oil fields will peak from 2008 to 2018 (worst and best case scenarios respectively). As defined by Robelius, a large filed contains 500 mmb of recoverable oil. just one of oil fields are giants but they provided 60% of 2005 production and 65% of total recoverable oil reserves. Large increases of production from other sources are needed to offset the lost production from giants after they peak. While there are ample sources of petroleum available to form up the loss, the investment required to tap these sources are going to be motivated by higher, not lower, world oil prices.
10. Will tight oil flood the globe oil market?
The U.S. Energy Information Administration’s 2014 Annual Energy Outlook Early Release has again projected higher levels of U.S. tight boring. The reference case has domestic overall production growing through 2020, when total production reaches 9.6 mmb/d. Tight production increases to 4.8 mmb/d by 2020, but declines after 2021 .17
Recent projections of high U.S. tight production reflect massive resource estimates and therefore the explosive production growth in American state and Texas that have proven past expectations to be too conservative. Applying the line to past production growth, however, could provide a false picture of what can reasonably be expected. Three U.S. plays are chargeable for rocketing U.S. production: Bakken, Eagle Ford and therefore the Permian. as compared, Niobrara and Anadarko have only achieved modest production growth while the prospects for development within the Monterey are poor. like every major oil field development, initial high production growth doesn’t foretell sustained indefinite growth. For tight oil, the rapidity of change will be even greater. Consider that two-thirds of tight-oil drilling activity is required to take care of constant tight drilling because of the high decline rates related to hydraulic fracturing. Inevitably well productivity must also decline as production expands. Despite high Bakken production growth, as an example, well productivity there has already declined by 15 percent since 2009Q4 to 2012Q4 (Bernstein & Co. ). Likewise, drilling costs cannot still decline. Of the 18% well cost deflation since 2011, Bernstein & Co. distinguishes between cyclical deflation, about 15%, and secular deflation, about 3% . this implies that drilling costs are more likely to rise within the future than decline.
A recent study funded by Advanced Resources International (ARI) and therefore the Energy Information Administration found that only 1 country, Russia, has technically recoverable tight-oil resources larger than those of the us . China has slightly over 1/2 the U.S. resource base, followed in declining order by Argentina, Libya, Australia, Venezuela, Mexico, Pakistan and Canada (at about one-sixth the U.S. resource base). Many of those countries is excluded as likely tight-oil producers, including Russia, Argentina, Libya, Venezuela and Pakistan, unless their current political and economic regimes undergo fundamental change. ARI’s top-10 tight-oil countries include several major oil producing countries (Russia, Libya, Venezuela and Mexico) that might more easily expand conventional boring, something they might likely do if they didn’t have above-ground problems.18
As valuable because the ARI estimates are, they supply no information on tight production costs within the countries estimated to possess significant tight oil resources. There has been little exploration of tight-oil plays round the world other than some exploration in Argentina and China (Vaca Muerta and Chinese Jurassic plays respectively). rather more exploration are going to be needed before an assessment is made from the geological factors that ultimately govern cost and feasibility. These include: oil source quality; extent and homogeneity; pay-zone thickness; existence of permeable beds and maturity. However, even a good outcome on geology could also be insufficient to confirm tight production outside of North America. Above-ground constraints may end up to be the foremost significant reason the U.S. experience isn’t replicated elsewhere, a minimum of for several years. These include: political risk; land access; regulatory processes; availability of an E&P service industry; supply chain; water availability and water management. it’s difficult to overestimate the importance of two factors that have enabled the event of tight oil and shale gas within the United States: private ownership of mineral rights and big service sector/logistical resources. Without land access and an E&P industry, especially in countries with a high political risk, significant tight boring outside of North America is unlikely whether or not geology proves to be favorable. Maugeri  also considers these factors to be important:
there are other factors that may make the world replication of a U.S. shale boom difficult, including an absence of personal mineral rights in most countries, likewise because the absences of the U.S. independent companies whose guerilla-style operational mindset has proven essential to the exploitation of shale formations that (unlike conventional oil and gas fields) required companies to maneuver on a micro-scale, on multiple micro-objectives, and suppleness, leverage short-term opportunities.”
In addition, Maugeri observes that oil development depends on low population density and can be tougher to pursue in additional densely populated areas like the Monterey play in California and face “an insurmountable environmental hurdle in Europe and other parts of the globe that have a high population density and no tradition of intensive drilling.” Maugeri also emphasizes that U.S. oil production could suddenly decline with lower world oil prices:
“…because shale development occurs on a per-well basis and not an a field basis, as in conventional oil activity, and critically depends on short-term oil prices on condition that peak productions is achieved during the primary weeks of a well’s activity and therefore the bulk of production is obtained during the primary and second year of production.” 
11. Using strategic oil stocks to guard the world-wide economy against future oil supply
Disruptions Strategic oil stocks are the most defense governments should protect their economies from oil price shocks. Under normal circumstances, government stocks don’t increase the short-term elasticity of oil supply since their release depends on government actions that are only taken in response to a significant oil supply interruption. reckoning on the quantity of internationally held reserves and therefore the rate at which these reserves may be made available to the market, world-wide emergency reserves have the potential to offset lost oil supplies as a results of unplanned supply outages in major oil exporting countries. Ideally, the prompt release of emergency reserves would prevent an economically damaging oil-price spike until exports are restored or alternative sources of supply are secured.
The world economy is a smaller amount at risk of the economic consequences of an unpredictable oil supply outage when oil prices are relatively low or OPEC spare capacity is comparatively high. Unfortunately, OPEC spare capacity tends to grow when oil prices are falling and declines when oil prices are rising (see Fig. 3). While this relationship isn’t surprising given the explanations why Asian country maintains reserve production capacity, nonetheless, it implies that just when the planet economy’s exposure to the economic damages of an oil supply interruption is greatest, because oil prices are already high, OPEC spare capacity is probably going to be low. it’s under these circumstances that a strategic petroleum stock release would be most important to scale back or prevent an economically-damaging oil price spike.
Fig. 3. US Imported Crude Prices and OPEC Spare Capacity. Source: The Rapidan Group; EIA data.
The IEA treaty requires its Member-countries to carry enough petroleum or petroleum products to switch 90-days worth of their imports. After a declaration of a petroleum supply emergency, an IEA collective action would compel Member countries to release agreed-upon amounts of petroleum or petroleum products from their strategic reserves. The IEA estimated in 2010 that its Member countries could release the maximum amount as ∼10 mmb/d during the primary month following an interruption. this might fall to ∼5 mmb/d within the 5th month following a pause . Information on emergency reserves held by countries outside the IEA is sparse. China may hold the maximum amount as 200 million barrels but reliable information is lacking.
As are going to be discussed below, it’s not always easy to work out whether hit and miss oil-supply outage constitutes an oil emergency of sufficient magnitude to justify the discharge of strategic stocks. In assessing the potential severity of an oil supply outage, primary consideration must incline to the particular or expected changes to the worth of oil for, after all, the value of oil is that the vector by which oil supply disruptions cause economic harm. If a strategic reserve can keep the worth of oil from spiking, it can avoid the economic harm that will well be caused by the disruption. However, the distinction between the traditional ups and downs of the oil market and a petroleum supply emergency that will repeat past episodes of economic harm isn’t always easy to draw. If strategic stocks are utilized in the absence of clearly defined emergency circumstances, they might discourage commercial stock holding and reduce net emergency stocks.
12. Lessons learned from past emergency releases from the U.S.
strategic petroleum reserve (SPR), The U.S. Strategic Petroleum Reserve (SPR) is that the largest stockpile of government-owned emergency petroleum within the world. The SPR features a capacity of 727 million barrels and, as of May, 2014, the SPR held 693 million barrels of fossil fuel. The SPR is comprised of 4 storage facilities connected to a few crude distribution systems: Seaway, Texoma and Capline. the most drawdown rate has been estimated to be as high as 4.4 mmb/d with marine capabilities of about 2.5 mmb/d. However, as are going to be discussed below, changes to the U.S. midstream and commercial activities within the Gulf of Mexico have significantly lowered the utmost drawdown rate of the SPR.
Decisions to withdraw fossil oil from the SPR are made by the U.S. President under the authorities of the Energy Policy and Conservation Act (Pub. L. No. 94-163, 1975). There are three emergency releases of the SPR19:
1) On 16 January 1991, during the 1990/91 Gulf War, President George H.W. Bush ordered the first-ever emergency drawdown of the SPR leading to the sale of 17.3 million barrels of crude. The Iraqi invasion of Kuwait occurred on 2 August 1990 curtailing 7% of world boring. By mid-October, oil prices had doubled. Within days of the Iraqi invasion of Kuwait, the u. s. responded by sending U.S. military forces to Asian country and therefore the gulf. Operation Desert Storm commenced on 17 January 1991, sooner or later after the emergency oil stock release was announced. The Gulf War was concluded on 28 February with the liberation of Kuwait and therefore the retreat of Iraq occupation forces. looking back, the Gulf War release would are rather more effective if it had been announced in early August, 1990, in sufficient volume, to forestall or substantially reduce the doubling of oil prices that occurred within two months. it’s conceivable that an earlier release would have mitigated or prevented the recession of 1991. However, in August 1990, it wasn’t clear how long the oil market would remain disrupted or whether Saudi Arabian production could be affected. Contemporary objections to an August release of the SPR were: 1) SPR reserves shouldn’t be depleted lest they be needed for a extended and bigger supply outage; and 2) other OPEC countries should increase production to assist replace lost Kuwaiti supplies (Taylor and Carl Clinton Van Doren ).
2) In 2005, President George W. Bush ordered a release of 11 million barrels of crude from the SPR after Hurricanes Katrina and Rita caused significant damage to the production facilities, terminals, pipelines, and refineries along the U.S. Gulf Coast. the discharge of fossil fuel replaced supplies lost from oil production within the Gulf of Mexico. However, if the SPR system contained petroleum products, additionally to fossil fuel, it’s likely that the following increase of petroleum product prices would are much smaller as these hurricanes disabled 50% of the refining capacity within the Gulf Coast region, an issue not alleviated by oil supplies from the SPR.
3) On June 23, 2011, the IEA agreed to release a complete of 60 million barrels of petroleum as a results of protests and warfare that erupted February 15, 2011 (the beginning of the “Arab Spring”). 20 Libya had provided about 1.5 mmb/d of light-sweet fossil fuel to the planet market. Despite the little loss of worldwide boring (less than 2% of world oil supplies) and 4 mmb/d of spare production capacity , Brent prices increased by ∼$20/barrel by April 2011 . The Midsummer Eve release was timed to assist mitigate the negative economic impacts that might result from elevated oil prices as refineries were getting back from seasonal maintenance. Brent crude prices fell by $7/barrel on the day the IEA/SPR release was announced. The severe backwardation of Brent was reversed causing Brent and WTI prices to align (in contango). This relief was short lived as tightness returned to the Brent market by August. Nonetheless, independent analysts concluded that the discharge calmed the market preventing a more damaging oil price spike.21 like the 1990/1991 Gulf War release, on reflection, it is questioned whether the Libyan Collective Action would are more practical had it been announced in late February 2011 since peak oil prices were reached in April, two months before the IEA/SPR release. However, in February, it wasn’t clear whether a loss of 1.5 million barrels/day of exports, even exports of sunshine sweet crude that were important to European refineries, was a significant enough disruption to warrant a stock release. there have been also concerns that a stock release would deter a rise of Arab production or give markets the impression that surplus production capacity couldn’t replace lost Libyan supplies (Clayton ).
The 1991 and 2011 SPR releases illustrate the problem when making a decision whether and when to release the SPR. They demonstrate four important issues which will delay a fast response to a supply outage: 1) whether the provision disruption is of sufficient magnitude to justify the employment of the SPR; 2) whether the SPR should be held in reserve lest the disruption becomes more severe; 3) whether the discharge of strategic stocks would discourage employment of OPEC spare production capacity; and 4) the time that’s required to attain a consensus by IEA Member countries to undertake a coordinated drawdown. Even critics of the SPR recognize that the potential benefits of the SPR haven’t been realized because “it has not been used frequently, robustly and quickly enough during the first stages of oil price shocks (Taylor and Van Doren ).” Taylor and Van Doren believe that “there is no reason to believe that the program’s dynamics will change within the future.” They conclude that the oil within the SPR should be sold and also the program packs up. However, the cost-effectiveness of the SPR program can be improved by reforming the decision-making process so SPR stocks would be used quickly enough, in sufficient quantity, to forestall or mitigate future oil-price spikes. Clayton  also recognizes that while the SPR might not be effective in lowering oil prices (they “may have only a modest effect of costs and broader economic process can overwhelm them”) it’s going to “be simpler at preventing harmful price spikes.” Consequently, tardy use of emergency stocks should be avoided. Also, as Clayton concludes, the threat of an oil stock release must be credible and “mixed signals from energy officials a couple of possible future release, as in July 2011, can make oil prices even more volatile” (Clayton ). Avoiding “mixed signals,” or announcing a stock release before prices have spiked, requires that difficult decisions be made before a supply disruption has played out. There needs to be a fast consensus on what quantity the disruption is probably going to boost oil prices. Even then, there are “blurry lines,” as noted by Jaffe and Soligo  before oil prices are high enough to justify a strategic stock release. Nonetheless, as Patron and Goldwyn  show,
“In many cases, the us has did not deploy the reserve despite circumstances that might justify a release. These missed opportunities end in price run-ups which will are avoidable and uncertainty on when the U.S. government would release stocks in future crises.”
13. Implications of reduced U.S. oil import dependence
It is beyond the scope of this paper to estimate the optimal size of the SPR or world-wide strategic stocks. it’s also beyond the scope of this paper to think about different processes for releasing emergency oil reserves. Consequently, the implications of reduced U.S. oil import dependence are discussed within the context of an SPR that’s approximately the identical size because it is today and is governed by current U.S. law and IEA treaty obligations.22 Nonetheless, the many reduction of U.S. oil imports, resulting from declining domestic gasoline consumption and rising domestic production, require that we ask: what’s the aim of an oversized SPR while U.S. oil imports are declining so rapidly?23 U.S. IEA stock holding obligations also are falling, in line with our declining oil imports, since the IEA treaty requires that every Member-country hold 90 days of its petroleum imports.
The growth of U.S. and Canadian boring has also affected the ability of the SPR to distribute oil during a supply emergency. Midcontinent refiners are not any longer looking forward to crude petroleum imports shipped from the U.S. Gulf Coast. Instead, oil is flowing by pipeline, rail and barge to the U.S. seacoast instead of from the seashore. East Coast refining capacity has also declined by 40% from a September 2005 high of 1.7 mmb/d to but 1 mmb/d by November 2013 . These changes affect the utilization of the SPR in two ways: 1) since many U.S. refineries have replaced crude that had been provided by foreign tankers with domestic or Canadian crude, the quantity of refineries that will have to secure SPR oil within the event of a global petroleum supply emergency has declined; and 2) the pipelines that the SPR formerly wont to provide SPR oil to domestic refineries are repurposed. Of major significance has been the reversal of the Seaway and Capline pipelines which had formerly been relied on to maneuver SPR crude north but now move midcontinent and Canadian crude south. Flow was also reversed on the Ho-Ho pipeline so as to produce Bakken and Eagle Ford petroleum to U.S. seacoast refineries. additionally, the surge in U.S. product exports has increased product tanker traffic within the seacoast complicating the logistics of loading SPR oil onto barges or tankers. As a results of these developments, the Department of Energy conducted an SPR test sale in March-April, 2014 to assist evaluate the aptitude of the SPR to expeditiously release emergency oil reserves.24
As the u. s. moves towards “energy independence,” the explanation of the SPR would should shift from replacing lost U.S. oil imports to U.S. refineries, after a world disruption, to reducing the international price of oil, irrespective of which refineries process the oil that may be released from the SPR.25 As discussed above, oil price spikes cause inter-sectoral and inter-regional disruptions of labor and capital and, as a result, reduce U.S. GDP growth. These disruptions to labor and capital markets are caused by higher petroleum product prices and aren’t stricken by the extent of U.S. oil imports. However, if we import less oil, there’s a smaller wealth transfer to grease exporting countries as a results of an oil price spike. With higher domestic production, more of the money spent on fuels by U.S. consumers stays within the U.S. economy. As higher U.S. company profits are recycled through the U.S. economy, through increased upstream drilling, investments and dividends, economic gains are realized. Nonetheless, the initial economic dislocations caused by the oil price spike aren’t avoided. While higher U.S. company revenues may facilitate inter-sectoral and inter-regional relocations of labor and capital, it still takes time for the adjustments to occur. we’ll still experience lower economic process during the primary to 3rd year after an oil price shock. Since oil prices sharply decline after the fall-off in world GDP growth, the rise in U.S. company revenues after an oil price shock could also be short-lived, ending well before they need a major effect on labor and capital market realignment. Consequently, the time required to return to normal-GDP growth after an oil price shock might not be greatly suffering from lower U.S. oil imports.
The specter of an energy-independent us holding the biggest emergency petroleum stockpile makes clear, as identified by William Hogan, that:
“despite the combined force of good judgment and computer studies, oil-importing governments haven’t succeeded in building a reserve of oil that matches the apparent threat of insecure supplies. partly this reflects a scarcity of commitment to the target, and governments have spent an inordinate amount of effort in trying to convince others to try and do their stockpiling for them” (Hogan ).
If the us is to just accept the burden of maintaining the world’s largest emergency reserve, despite declining reliance on oil imports, so as to guard the planet economy (and, of course, its own economy) within the event of an oil supply disruption, there should be corresponding efforts by other countries to create emergency stocks, especially the emerging Asian economies that are largely accountable for the expansion of world oil demand. As world oil consumption shifts from the OECD to emerging economies26, oil-importing countries that are now outside the treaty obligations of the IEA should establish emergency oil reserves as their economies are susceptible to the economic consequences of a world-wide oil-supply interruption.
14. Conclusions and policy implications
Oil price shocks are invariably followed by 2–3 years of weak economic process and weak economic process is nearly always preceded by an oil price shock. If we glance forward, there’s little reason to be complacent about the economic damage that would be caused by future oil price spikes considering the increased instability of geographical area and North African oil suppliers. The investments needed for non-OPEC boring to stay up with the expansion in worldwide demand are challenging and don’t appear to be feasible in an exceedingly low-price environment.
Oil price spikes will remain a threat to world economic process. Strategic oil reserves can protect the world-wide economy, if sufficiently large releases are promptly announced, by preventing the oil price spikes that might otherwise occur as a results of unplanned supply outages. Governments should streamline procedures for a coordinated release of emergency stocks and recognize the important economic benefits to be had by a prompt and sufficient stock release that will eliminate or substantially reduce oil price shocks. due to increased U.S. boring, the repurposing of midstream assets that the SPR had previously relied on and increased U.S. refineries’ processing of domestic petroleum, the potential of the SPR to reply to a significant petroleum supply emergency must be reassessed.27 As U.S. oil imports still decline, so as to avoid a spike of international oil prices after a significant supply disruption, it’s going to be necessary to extend the capacity of the SPR to deliver oil to the U.S. Gulf Coast, increase tanker loading capacity and sell SPR oil on to foreign refineries. because the us is unable to use its SPR to shield its economy without providing similar benefits to the remainder of the globe, and since global oil consumption is just growing outside of the OECD, the emerging economies, especially in Asia, should develop larger strategic oil stocks. this might not only increase the quantity of oil available to reply to an oil supply emergency but aim toward a good sharing of the oil stocks burden in recognition of their collective world-wide economic benefit.
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PRO. CESLIA LONIK