The Economics and Geopolitics of the World Oil Market

1. The Economics and Geopolitics of the World Oil Market Severin Borenstein Haas School of Business, UC Berkeley U.C. Energy Institute WARNING: These slides were developed to accompany an oral presentation and do NOT constitute a complete document. Please do not attempt to infer my views or arguments solely from these slides.

2. World Oil Market • A single world oil market is a very good approximate model of this industry • Transportation costs exist, but are small relative to oil price, especially now • Different grades of oil have different properties and product yield, but are still good substitutes on the margin • Oil is storable, so today’s price is closely linked to tomorrow’s expected price

3. The United States doesn’t produce oil in the US, companies do • Some of those companies are owned primarily by US citizens • Those companies maximize shareholder wealth by selling oil for the market price • US government may benefit from lease and royalty payments to the treasury • But effectiveness of that wealth extraction is questionable

4. “US” oil, like all other, is poured into the world oil market • All buyers and sellers trade to and from the world oil “bathtub” • All demand pushes up the world price and enriches Exxon, Chevron, Iran, Kuwait, … • All oil refiners face a (opportunity) cost of using oil that is approximately the world price • Many independent decision makers in world oil supply

5. U.S. Oil Consumption and Production • U.S. consumes about 20m bbl of oil products per day • About 8m bbl/day produced in U.S., remainder is imported as oil or product • U.S. imports 60% of oil consumed, up from 35% in late 1970s • About 2/3 of oil goes for transportation • particularly hard to replace w/alternatives

6. Market Power in the World Oil Market • Market power is the ability to reduce output in order to drive up price and raise profits • Normally difficult to do without a large market share, but there are exceptions • California Electricity Crisis • With oil production capacities constrained, more opportunity to create such artificial scarcity • But real scarcity is also more likely then • Either way, all sellers benefit from high prices

7. Market Power in Oil Production • World oil market is about 86m bbl/day • No private oil company exercises market power in the world oil market • Largest produce 3-4 m bbl/day • Constrained by lease/royalty agreements • Saudi Arabia produces over 10m bbl/day and exports nearly 9m of it • When others are capacity constrained, S.A. can profitably raise world oil prices • OPEC cartel strength is less convincing

9. Profits from Oil • Producers make profits from high oil prices regardless of the cause • Integrated oil companies also refine oil and market gasoline, but most of the profits these days are from oil production • If company planned for $30 and price is $70, they are making an extra $40/bbl in profit (minus some taxes and royalties) • Is this any different from profiting when house prices appreciate?

10. Where the Profits Go • Shareholder-owned companies • Exxon’s $18b in profit goes mostly to shareholders, including our pensions • Troubling effects on wealth distribution • State-owned companies return profits to “government” or autocrat • Iran is now making an additional $40b/year • Very troubling wealth distribution effects • Transparency initiative tries to at least assure wealth is not stolen by autocratic ruler

11. U.S. Policy on Foreign Government Oil Profits • Concerned about ruler looting wealth • Unless ruling power is “friendly” to US • Worrisome: Iran, Venezuela, Libya(?) • OK: Saudi Arabia, Kuwait, Libya(?) • Former Soviet Union????

12. Solving the Oil Problem • But what’s the problem? • Oil costs too much • “Consumers deserve reliable supply at a reasonable price” (translation: unlimited supply at price we get to choose) • We use too much oil (costs too little?) • environmental effects • can’t just switch to a different fossil fuel • congestion effects

13. Solutions • Find more U.S. Oil • Secure energy supplies outside U.S. • “NOPEC” policy of antitrust prosecution • Higher auto mileage standards (CAFE) • Ethanol and Biofuels • Electric / Natural Gas / Hydrogen cars • Increase gasoline tax

14. Find More Oil in U.S. • Nowhere near enough oil in U.S. to meet current U.S. demand (even before growth) • New U.S. oil production would go into the world oil bathtub of 90-100m bbl/day in 2010 • ANWR’s 1m bbl/day would have small effect • Oil in U.S. doesn’t lower consumers’ cost of gasoline more than oil anywhere else • U.S. oil would benefit U.S. treasury if lease/royalty rates are high

15. Secure Oil Supplies for U.S. • “securing oil supplies” is the opposite of a market economy • Subsidize U.S. company acquisition of reserves? Have U.S. govt hold reserves? • Force the company that owns the oil to sell in U.S.? at below world oil price? • e.g., old restrictions on use of Alaska oil

16. “NOPEC” antitrust prosecution • Some in Congress want to prosecute OPEC for colluding to reduce supply • Legally questionable • Politically arbitrary • Economically hypocritical • U.S. is proposing the mirror-image approach, cooperating with China to reduce demand in order to lower prices

17. Raising Fuel Economy • About the same startup delay as ANWR • Potentially bigger effect when it kicks in • use technology to increase MPG instead of size, weight and acceleration • 50% U.S. MPG increase saves 4m bbl/day • BUT addresses just technology not intensity of use • Related Proposal: 55 MPH Speed Limit

18. Ethanol and Biofuels • Ethanol is still an expensive, trade-protected alternative • Does reduce oil use by 70-80%, but small if any reduction of GHG • Next generation biofuels could be made from waste or cheap ag products, but technology isn’t there yet.

19. Alternative Technologies • Natural Gas fuel • replacing one shortage with another • Electric Cars • fossil fuel generation • nuclear powered generation • very expensive from “all green” electricity • Hydrogen Cars • hydrogen isn’t an energy source

20. Gas (or oil) Tax • Affects auto use (intensity) immediately, auto MPG (technology) over time as fleet is replaced • Can be made progressive by offset with reduced payroll of low-income tax • Recognizes explicitly the geopolitical and environmental costs of oil consumption • Encourages alternative fuels without pretending they are inexpensive

21. Gasoline Tax/Subsidy Varies Widely(March 2005 Average Retail Price in $US/gallon)

22. Conclusions • Analyzing oil policy requires understanding the single world oil market • Many proposed policies rely on a misunderstanding of the oil market • “cut imports from the middle east by 75%” • It will be difficult to affect the oil market much in the short run, but a gas tax is the only real possibility