Petroleum economics is a complicated series of political and economic interactions pertaining to the oil industry. While economics in general is a complex subject, in the case of oil, political concerns add a new layer to the study of economics. People who study petroleum economics need to be familiar with economics generally, but also geopolitical history and the history of the oil industry as a whole. Experts in this field can work for government agencies, oil companies, and private companies interested in the economics of oil production, transport, and refining.
As with economics in general, there are a number of approaches to petroleum economics. Many experts boil down economic activities to a balance between supply and demand. In this case, supply and demand are both influenced by political concerns. Political events can have an impact on oil supply as well as demand, and in turn, oil supply and demand can influence politics.
There are a number of theories to describe economic phenomena in the oil industry, as well as to explore political relationships and social phenomena. This branch of economics also includes a broad number of connected fields, including international shipping, agriculture, manufacturing, transport, and so forth. Understanding of these fields is important, as all of these industries are involved in the global demand for oil.
People interested in this subject study a wide variety of topics, from theories about global oil availability in the future to the environmental costs associated with oil and gas production. They can apply their studies to shaping oil and gas policy, assisting companies with the development of new oil fields, and educating people interested in the economies and politics of oil-producing nations. Alternative energy is also a topic of study for some people in this field, as they are interested in the political push for the development of alternatives to oil, as well as the economic impacts of shifting energy supplies.
Colleges and universities all over the world offer coursework in petroleum economics, and in some cases, provide students with degrees in this field. Many people working in the subject have graduate degrees and have conducted research in this field. Discussions of the oil industry can be found everywhere from the pages of confidential government briefings to the front page of the newspaper, and there are ample employment opportunities available to experts in this particular area of economics.
The problems created by abundant mineral wealth — referred to commonly as ‘the resource curse’ — are mostly political, not economic. If low-income countries were governed by wise and benevolent technocrats, their resource wealth would be an unmitigated blessing. Yet many resource-rich low-income countries suffer — with greater frequency than similar countries without resource wealth — from three notable problems: their governments are highly undemocratic; they face unusually frequent civil wars; and their bureaucracies have trouble investing their mineral revenues productively. Mineral wealth plays a critical role in the economies of many developing countries. In 2009, minerals (including petroleum) made up 64 percent of total merchandise exports in Africa, 68 percent in the Middle East, 62.9 percent in the Commonwealth of Independent States, and 38.9 percent in South and Central America. The fraction of merchandise trade comprised of minerals has been relatively steady over the past 70 years.
There is also good reason to believe that petroleum exports, in particular, will continue to be important in the coming decades. If today’s energy policies do not change, in the next 25 years global demand for oil and other liquid fuels will rise by an estimated 28 percent, and the demand for natural gas will rise by about 44 percent. The US is currently the world’s leading petroleum importer, but most of the new demand will come from developing countries, led by China and India.
This rising demand will likely boost the role of low-income countries in the global energy trade. Historically, oil has been found in countries that are already well-off.
Since the birth of the petroleum age in the mid-19th century, middle and upper income countries have been about 70 percent more likely to produce oil than low-income countries — not because they are sitting on top of more petroleum, but because they have more money to invest in locating and extracting it. Today the rich democracies of North America and Europe have attracted about ten times more foreign direct investment in mining, per square kilometer, than the rest of the world.
There are signs that this is changing. Thanks to booming oil prices, companies are increasingly willing to invest in low-income countries they previously shunned. Since 2004, Belize, Brazil, Chad, East Timor, Mauritania and Mozambique have all become petroleum exporters. In the next few years, at least 15 new countries — all of them relatively poor, and most of them in Africa — have a good chance of joining the list.
In the next few decades, the vast majority of the world’s new hydrocarbon supplies will come from developing countries.
This means that a flood of new revenues is just beginning to hit many of the world’s low-income countries. If there were no resource curse, this would be spectacularly good news — a historically-unique opportunity to escape from poverty. Yet the low-income countries that most desperately need money are also the most likely to be struck by the resource curse. Unless these revenues are better managed, these windfalls could hurt, not help, people who live on the petroleum frontier.
Just as people are affected by the kinds of food they eat, governments are affected by the kinds of revenues they collect. Since most governments receive the same kinds of revenues year after year, it is easy to overlook their significance. Only when there is a sharp change in these revenues — like when oil is discovered — does their underlying importance become clear.
The revenues that governments collect from their petroleum sectors are different from other kinds of revenues in four important ways. The first is their scale, which can be massive: on average, the governments of oil-producing countries are almost fifty percent larger (as a fraction of their country’s economy) than the governments of non-oil countries.
In low-income countries the discovery of oil can set off an explosion in government finances: from 2001 to 2009, government expenditures rose by 600 percent in Azerbaijan and 800 percent in Equatorial Guinea.
Most governments worry about having too little revenue, not too much. But revenue booms can be surprisingly difficult for governments to invest productively. One reason is what might be called “bureaucratic overstretch,” which occurs when a government’s revenues expand more quickly than its capacity to efficiently manage them.
The result can be a drop in the effectiveness of government investments- something that Gelb [1988] documented after the commodity booms of the 1970s. The size of these revenues alone is not necessarily a problem: many peaceful, democratic European countries have bigger governments than many conflict-ridden, autocratic resource exporters. The source of these revenues also matters: mineral-funded governments are not financed by taxes on their citizens, but by the sale of state-owned assets — that is, their country’s subsoil wealth. This helps explain why so many oil-producing countries are undemocratic: when governments are funded through taxes, they become more constrained by their citizens; when funded by oil, they become less susceptible to public pressure. It is also an important reason that mineral wealth can trigger civil wars, by creating a strong incentive for resource-rich regions of low-income countries to establish sovereign governments. Table 1 lists 16 separatist conflicts that broke out in petroleum-rich territories between 1960 and 2006. Other problems can be traced to the stability– or rather, the instability — of mineral revenues. The volatility of world commodity prices, and the rise and fall of a country’s mineral reserves, can produce large fluctuations in the finances of resource-dependent countries.
This financial instability saddles governments with revenue-smoothing tasks they have difficulty achieving, and helps explain why they often find it hard to productively invest their resource wealth. Revenue instability also aggravates regional conflicts, making it harder for governments and rebels to settle their differences.
Economic potential is defined as the total opportunity for efficiency improvement that passes a cost-effectiveness test, assuming all efficiency opportunities that pass that test are adopted without regard to any market barriers or assumptions about how many people would actually choose to adopt them. For this study, cost-effectiveness is defined by the Participant Cost Test, which considers measures as cost-effective so long as the total lifetime cost savings to the energy consumer (based on retail energy costs) exceed the up-front initial efficiency measure investment. Measures are considered to pass the test whenever the benefit-cost ratio is greater than or equal to 1.0.
This section provides a brief overview of the study scope and approaches, with more detail provided in the sections below. The Phase I economic potential study included the following key components:
– A 12-year economic efficiency potential study for the period 2014–2025.
– An estimate of the economic efficiency potential for electricity, natural gas, and petroleum fuels.
– Petroleum fuels included distillate and residual fuel oil, propane, and kerosene, and these were analyzed in aggregate rather than separately.
– An estimate of the economic potential for the residential, commercial (including institutional and government), and industrial sectors. The study was restricted to the buildings sector and does not include transportation efficiency.
The focus of Phase I was to estimate the economic efficiency potential. The economic efficiency potential includes all efficiency that is considered to be cost-effective from a Participant Cost Test perspective. It quantifies an upper-bound of efficiency savings if all cost-effective efficiency opportunities were captured when available. As such, it is a hypothetical upper limit of what could actually be captured with efficiency programs, ignoring the real world market barriers that often prevent people from adopting all cost-effective efficiency. The economic potential assumes 100 % of all efficiency opportunities are captured.. For measures that are not time discretionary, such as adding insulation to a building that is not undergoing any other renovations (hereinafter referred to as “retrofit” or “early retirement” opportunities), we assume these opportunities are captured evenly over the 12-year period. While in theory all these opportunities exist in 2014, constraints such as work force availability would limit the amount of these measures that could actually be captured in any given year. This results in the same cumulative potential savings by 2025, but evens out the annual results. This is more useful in that it reflects annual opportunities more in line with what could be considered during Phase II from actual efficiency programs. For time-dependent opportunities such as new construction or replacement on failure of equipment (hereinafter referred to as “market-driven” or “lost” opportunities), all measures are assumed installed at the time the opportunity is created. The Phase I scope was limited in several important respects:
– Only considers economic potential, based on a Participant Cost Test;
– Relies solely on existing available data, in some cases from outside Delaware;
– Does not include fuel switching measures;
– Does not include combined heat and power (CHP) measures;
– Does not include demand response measures; The Methodology section below provides a detailed discussion of the methods and assumptions used in the analysis. The steps below lay out the basic methodological approach for assessing the economic efficiency potential.
– Identify the baseline energy sales forecasts for each fuel type, and disaggregate the forecasts by building type/segment and end-use;
– Characterize the efficiency measures for their costs and savings;
– Apply the measures to the potential study model and appropriate shares of disaggregated energy forecasts to analyze annual impacts;
– Screen measures for cost-effectiveness in each install year of the 12-year study period, using the Participant Cost Test (a measure “passes” if its benefits exceed its costs);
– Remove any non-cost-effective measures in the years for which they are not cost-effective;
– Adjust all interaction factors between measures to avoid double counting and rerun the subset of measures that pass the PCT;
The efficiency economic potential estimated savings from a wide range of efficiency measures (i.e., efficiency technologies and practices). The study analyzed both technologies that are commercially available now and emerging technologies considered likely to become commercially available over the study horizon.
The study applied a Participant Cost Test (PCT) to determine measure cost-effectiveness. Efficiency measure costs for market-driven measures represent the incremental cost from a standard baseline (non-efficient) piece of equipment or practice to the high efficiency measure. For retrofit markets the full cost of equipment and labor was used because the base case is assumed to be no action on the part of the building owner. Measure benefits are driven primarily by customer lifetime energy bill savings, but also include other benefits associated with the measures, including water savings, operation and maintenance savings, and other non-energy benefits where readily identified and quantified. The energy impacts may include multiple fuels and end uses. For example, efficient lighting reduces waste heat, which in turn reduced the cooling load, but increases the heating load, all of which are accounted for in the estimation of the measure’s costs and benefits over its lifetime.
There are two aspects to electric efficiency savings: annual energy and coincident peak demand impacts. The former refers to the reductions in actual energy usage, which typically drive the greatest share of electric economic benefits as well as emissions reductions. However, because it is difficult to store electricity the total reduction in the system peak load is also an important impact. Power producers need to ensure adequate capacity to meet system peak demand, even if that peak is only reached a few hours each year. As a result, substantial economic benefits can accrue from reducing the system peak demand, even if little energy and emissions are saved during other hours. For this study, we do not quantify the coincident system peak impacts. This was not included in Phase I because the focus was on participant economics, and it would be difficult to accurately model the peak demand contributions for each building and what the economic benefits associated with them might be.7 However, the average retail rates used to assess the benefits of electric energy savings include the costs of both energy (kWh) and peak demand charges (kW-year). For the economic potential, we generally assumed that all cost-effective measures would be immediately installed for market-driven measures such as for new construction, major renovation, and natural replacement (“replace on burnout”). For retrofit measures we generally assumed that resource constraints (primarily contractor availability) would limit the rate at which retrofit measures could be installed, depending on the measure, but that all or nearly all efficiency retrofit opportunities would be realized over the 12-year period. This results in smoother and lower estimates of retrofit potential in the early years, but provide a more realistic ramping up over time that would likely be reflected in any actual efficiency plans Delaware chooses to adopt.
The commercial, industrial, and residential sales disaggregations draw upon many sources, and the discussion that follows is not an exhaustive description of all sources employed or steps in the analysis. The industrial disaggregation is primarily based on the EIA Manufacturing Energy Consumption Survey (MECS) 2010, assuming the “South” census region (MECS data are only available for the four major census regions).The commercial disaggregation relies on a number of sources. First, total forecasted energy sales are divided across building types using data from Optimal Energy’s recent Energy Efficiency and Renewable Resource Potential in New York State study. Unfortunately, reliable data specific to Delaware was not available, so data for Long Island, NY has been used as a proxy. Next, data from the recent Pennsylvania Statewide Commercial & Industrial End Use & Saturation Study was used to develop the electric disaggregation at the end-use level. While a similar study was recently completed for Delaware, that study did not provide estimates of energy-use intensities that would support the disaggregation. The commercial natural gas and petroleum fuels end-use break-outs were estimated using data from the EIA 2003 Commercial Buildings Energy Consumption Survey (CBECS). The residential building type and end-use disaggregation was developed using data from the EIA 2009 Residential Energy Consumption Survey (RECS),the most recent Annual Community Survey from the US Census Bureau, and the EIA 2013 Annual Energy Outlook.
Finally, relative changes in end-use distribution over the analysis period were adapted from the EIA 2013 Annual Energy Outlook. The general approach for this study, and for all sectors, is “top-down” in that the starting point is the actual forecasted loads for each fuel and each sector, which are then broken down into loads attributable to individual building equipment. In general terms, the top-down approach starts with the energy sales forecast and disaggregation and determines the percentage of the applicable end-use energy that may be offset by the installation of a given efficiency measure in each year. This contrasts with a “bottom-up” approach in which a specific number of measures are assumed installed each year.
Various measure-specific factors are applied to the forecasted building-type and end-use sales by year to derive the potential for each measure for each year in the analysis period.
– Applicability is the fraction of the end-use energy sales (from the sales disaggregation) for each building type and year that is attributable to equipment that could be replaced by the high-efficiency measure. For example, for replacing office interior linear fluorescent lighting with a higher efficiency LED technology, we would use the portion of total office building interior lighting electrical load consumed by linear fluorescent lighting. The main sources for applicability factors at the Delaware and Pennsylvania baseline studies.
– Feasibility is the fraction of end-use sales for which it is technically feasible to install the efficiency measure. Numbers less than 100 % reflect engineering or other technical barriers that would preclude adoption of the measure. Feasibility is not reduced for economic or behavioral barriers that would reduce penetration estimates. Rather, it reflects technical or physical constraints that would make measure adoption impossible or ill advised. An example might be an efficient lighting technology that cannot be used in certain low temperature applications. The main sources for feasibility factors are the Delaware baseline studies and engineering judgment. -Turnover is the percentage of existing equipment that will be naturally replaced each year due to failure, remodeling, or renovation. This applies to the natural replacement (“replace on burnout”) and renovation markets only. In general, turnover factors are assumed to be 1 divided by the baseline equipment measure life (e.g., assuming that 5 % or 1/20th of existing stock of equipment is replaced each year for a measure with a 20-year estimated life).
– Not Complete is the percentage of existing equipment that already represents the high-efficiency option. This only applies to retrofit markets.
For example, if 30 % of current single family home sockets already have compact fluorescent lamps, then the not complete factor for residential CFLs would be 70 % (1.0–0.3), reflecting that only 70 % of the total potential from CFLs remains. The main sources for not complete factors are the Delaware baseline studies, and the findings of other baseline and potential studies. -Savings Fraction represents the percent savings (as compared to either existing stock or new baseline equipment for retrofit and non-retrofit markets, respectively) of the high efficiency technology. Savings fractions are calculated based on individual measure data and assumptions about existing stock efficiency, standard practice for new purchases, and high efficiency options.
– Baseline Adjustments adjust the savings fractions downward in future years for early-retirement retrofit measures to account for the fact that newer, standard equipment efficiencies are higher than older, existing stock efficiencies. We assume average existing equipment being replaced for retrofit measures is at 60 % of its estimated useful life.
– Annual Net Penetrations are the difference between the base case measure penetrations and the measure penetrations that are assumed for an economic potential. For the economic potential, it is assumed that 100 % penetration is captured for all markets, with retirement measures generally being phased in and spread out over time to reflect resource constraints such as contractor availability.
The product of all these factors results in total potential for each measure permutation. Costs are then developed by using the “cost per energy saved” for each measure applied to the total savings produced by the measure. The same approach is used for other measure impacts, e.g., operation and maintenance savings.
Consumption in the twentieth and twenty-first centuries has been abundantly pushed by automobile growth; the 1985–2003 oil glut even fueled the sales of low economy vehicles in OECD countries. The 2008 economic crisis seems to have had some impact on the sales of such vehicles; still, the 2008 oil consumption shows a small increase. The BRIC countries might also kick in, as China briefly was the first automobile market in December 2009. The immediate outlook still hints upwards. In the long term, uncertainties linger; the OPEC believes that the OECD countries will push low consumption policies at some point in the future; when that happens, it will definitely curb oil sales, and both OPEC and EIA kept lowering their 2020 consumption estimates during the past 5 years. Oil products are more and more in competition with alternative sources, mainly coal and natural gas, both cheaper sources. Production will also face an increasingly complex situation; while OPEC countries still have large reserves at low production prices, newly found reservoirs often lead to higher prices; offshore giants such as Tupi, Guara and Tiber demand high investments and ever-increasing technological abilities. Subsalt reservoirs such as Tupi were unknown in the twentieth century, mainly because the industry was unable to probe them. Enhanced Oil Recovery (EOR) techniques (example: DaQing, China) will continue to play a major role in increasing the world's recoverable oil.
Peak oil is the projection that future petroleum production (whether for individual oil wells, entire oil fields, whole countries, or worldwide production) will eventually peak and then decline at a similar rate to the rate of increase before the peak as these reserves are exhausted. The peak of oil discoveries was in 1965, and oil production per year has surpassed oil discoveries every year since 1980.
It is difficult to predict the oil peak in any given region, due to the lack of knowledge and/or transparency in accounting of global oil reserves.Based on available production data, proponents have previously predicted the peak for the world to be in years 1989, 1995, or 1995–2000. Some of these predictions date from before the recession of the early 1980s, and the consequent reduction in global consumption, the effect of which was to delay the date of any peak by several years. Just as the 1971 U.S. peak in oil production was only clearly recognized after the fact, a peak in world production will be difficult to discern until production clearly drops off. The peak is also a moving target as it is now measured as «liquids», which includes synthetic fuels, instead of just conventional oil.
The International Energy Agency (IEA) said in 2010 that production of conventional crude oil had peaked in 2006 at 70 MBBL/d, then flattened at 68 or 69 thereafter. Since virtually all economic sectors rely heavily on petroleum, peak oil, if it were to occur, could lead to a «partial or complete failure of markets.
Efforts have already been made to extract oil that was once considered uneconomical to produce. As the world supplies of light, easily extractable crude oil continue to decrease and demand continues to increase, the price people are willing to pay for a barrel of crude will increase as well. As a result, heavier oil that was once uneconomical to extract due to high upfront costs has become profitable to produce.
Countries like Canada and Venezuela and United States all sit atop extremely large deposits of heavy oil and oil shale. In fact, it is estimated that there is more heavy oil in Venezuela then there is petroleum in the entirety of the Middle East. Canada is currently the world’s leading producer of heavy oil and it is estimated that the heavy crude in Canada is enough to supply the entire world at current demand for well over 200 years. Of course, the vastness of the supply is only one of the considerations of extracting heavy oil.
Production methods for heavy oil are discussed elsewhere, but the two things they have in common are decreased energy returned on energy invested and it increased impact on the environment. While world demand for petroleum continues to rise, there has recently been competing interests from environmental lobbies concerned about the long-term impact of extracting heavy crude. Environmental concerns arise not just from the direct impact of the environments, but also from the fact that the decreased energy returned on energy invested for heavy oils means that they produce more greenhouse gases and other pollutants than do same quantities of lighter crudes. In other words, the extraction and use of heavy oil is expected to exacerbate the problem of carbon dioxide and greenhouse gas emissions throughout the world.
What is clear is that heavy oil production will be necessary in the near future unless there is a drastic decrease in demand for petroleum. While techniques are being developed to help reduce the impact of extracting heavy oil on the environment, there is little doubt that utilization of this resource will have substantial negative impact. For this reason, conservation has become more important than ever. The less oil the world uses, then the less the environment is impacted both from current and future oil production activities.
Conservation efforts are less about concern over running out of oil than they are about concern of increasing use of oil. Environmentalists point out that time and money being spent on research and development for the extraction of heavy oil could be better invested into developing alternative energies.
What is clear about petroleum is that it will continue to play a large role in our lives in the near to medium term future. While technologies are being invented to reduce our dependence on fossil fuels, it will be several decades before they become commonplace and affordable. Some of the major car manufacturers across the world estimate that it will be at least 2025 before electric vehicles are competitive in terms of cost and performance with petroleum powered vehicles.
Even if the world the world switched to an energy source independent of petroleum, one must not forget the fact that petroleum is an integral part of modern life in terms of the things it is used to make beyond a gasoline and other fuels. Objects as diverse as plastics, pharmaceuticals, and cosmetics use various aspects of petroleum as foundations in chemical reactions. In fact, our tremendous reliance on petroleum for manufacturing and not for fuel is all the more reason to be conservative about simply burning it to drive across town.
The biggest impact of declining demand could be geopolitical. Oil underpins Vladimir Putin’s kleptocracy. The Kremlin will find it more difficult to impose its will on the country if its main source of patronage is diminished. The Saudi princes have relied on a high oil price to balance their budgets while paying for lavish social programs to placate the restless young generation that has taken to the streets elsewhere. Their huge financial reserves can plug the gap for a while; but if the oil flows into the kingdom’s coffers less readily, buying off the opposition will be harder and the chances of upheaval greater. And if America is heading towards shale-powered energy self-sufficiency, it is unlikely to be as indulgent in future towards the Arab allies it propped up in the past. In its rise, oil has fuelled many conflicts. It may continue to do so as it falls. For all that, most people will welcome the change.
If the price of oil continues its upward journey, most Asian economies will be adversely affected. According to a recently published report, the people from Mumbai to Manila are fearful of the impending danger of inflation. If the governments bring changes in their monetary policies, they will pose a danger to economic growth by making bank credit more expensive and thus pushing up the cost of production. There may be a veritable shortfall in investment. Any appreciable fall in production will, instead of reducing the inflationary pressure, will create shortages in the economy, which will push up the rate of inflation. Thus a vicious circle will be created.
Increasing prices of oil products may produce public resentment and discontent. Governments may try to soften up their impact by reducing import duty and excise in addition to giving subsidies on them. This may restrain for sometime the impending popular anger from bursting but the financial position of the governments will be badly affected. In order to reduce the budgetary deficit, they will have to resort to increasing taxation in other areas and to public borrowings, which will also have harmful consequences.
I argue that peak oil does not mean that petroleum reserves have run out, but that the maximum rate of petroleum extraction has been reached and that subsequent methods of extraction cannot increase the rate further. Over time, the total rate of petroleum output will decrease. This naturally leads people to question what the future will look like. Several scenarios are possible and it seems that all of them will come true to some degree or another, rather than any single one of them coming true alone.
References:
- Jean Masseron «Petroleum Economics»;
- Van Meurs «Modern Petroleum Economics»;
- A. N. Sarkar «Petro-economics».
