                                       
                                                                               
                                                                  Paul N. Leiby
                                                         P.O. Box 2008, MS 6036
                                                       Oak Ridge, TN 37831-6036
                                                                 (865) 574-7720
                                                                               
Factors Influencing Estimate of Energy Security Premium for Heavy-Duty Phase II Proposed Rule
                             Paul Leiby, 11/1/2014
                         Oak Ridge National Laboratory
                                       
The energy security premium for the 2014 HD Rule (Phase II) was estimated based on the displacement of U.S. oil imports, following the same methodology used in the 2012 Light Duty Rule, and utilizing data on projected oil market conditions from the 2014 Annual Energy Outlook (Early Release) from U.S. EIA. 

The results in Table 1 show lower overall security premium levels, and particularly lower estimates of the "monopsony component," or import demand component of the premium, over the nearer-term (2015-2025).  If oil prices and imports conform to the AEO2014 projections, the monopsony premium component over the next decade will be between half and two-thirds of the level estimated in 2012.  The disruption component of the premium is also lower than was estimated in 2012, although to a lesser degree.  

This note presents some of the factors that cause the estimated energy security premium associated with oil import reduction to be lower than it was two years ago.  While certain factors and projected oil market conditions lead to reduced premium estimates, other risk and cost-related drivers remain.  So the oil import premium is still significant in magnitude.

   * Lower oil prices and imports reduce import costs and monopsony premium
         o The principal changes in the AEO projections since 2012 are a general downward revision in world oil price projections in the near term (e.g. 19% in 2020) and a sharp reduction in projected U.S. oil imports in the near term, due to increased U.S. supply (i.e. a 41% reduction in imports by 2017, 36% reduction in 2020) (See Table 2).  Over the longer term the import share is projected to gradually increase after 2020 but still remain 27% below the AEO2012 level in 2035.
         o These changes in oil price and import levels have the most profound effect on the monopsony portion of premium, that is the estimated portion of the security premium related to the change in total import cost that is achieved by a marginal reduction in imports.  Since both the price level for imports, and the quantity of imports are lower, the monopsony premium component is 46% - 57% lower over the years 2017-2025.
   * Diminished influence of marginal (per barrel) U.S. import demand on world price, slightly more elastic world supply
         o The U.S. demand on the global oil market is projected to decline, suggesting diminished overall influence and some reduction in marginal influence on world oil price.  More importantly, projected OPEC supply remains roughly steady as a share of world oil supply compared to the AEO2012. OPEC's share of world oil supply outside of the U.S. actually increases slightly.  Since OPEC supply is estimated to be more price-elastic than non-OPEC supply, this means that under AEO2014 the elasticity of world oil supply to the U.S. is slightly greater.  Together, these factors mean that marginal U.S. oil imports displacement has a somewhat smaller estimated effect on long-run world oil price than it did in the 2012 estimates.  For example, in 2020 the long-run price declines by $1.33/BBL for every 1 MMB reduction in imports under AEO2014 compared to $1.66/bbl under AEO2012 (2012$).
   * Macroeconomic sensitivity to oil to oil price shocks is assumed to be similar to the case in 2012, since U.S. oil consumption levels and the value share of oil in the U.S. economy remain at high levels under AEO2014
         o The level of U.S. oil demand under AEO2014 is essentially unchanged from AEO2012 through 2020, and only 3% lower by 2025.  Demand is projected to be 8% lower by 2035 under AEO2014 than AEO2012. The estimated impact of a given price shock on the U.S. economy is not assumed to change significantly with the level of imports.  It is expected to be more closely related to the importance of oil use in the U.S. economy, measured either by oil consumption levels or the value share of oil use in the U.S. economy.  Figure XX below shows that under AEO2014 projected U.S. real annual oil expenditures continue to rise after 2015, to over $800 billion (2012$) by 2030.  The value share of oil use in the U.S. economy remains between 3% and 4%, well above the levels observed from 1985 to 2005.
   * Macro disruption component is moderately lower due to lower GDP, moderately lower oil prices and slightly smaller price increases during prospective shocks.  
         o Under AEO2014, projected real GDP is very slightly lower than under AEO2012.  But price levels are  19% to 5% lower over the 2020-2035 period, and shock price increases are somewhat smaller given small changes in the average world net elasticity of oil supply.  This leads to disruption component estimates for the oil security premium that are 19% to 2% lower over the same period.
   * However, disruption costs are not reduced greatly since disruption risks are little-changed (the probability of global supply interruptions is assumed unchanged in these estimates, and the supply share from OPEC is little-changed under AEO2014).
   * Most of these effects that decrease the security premium estimate are stronger over the next decade, and diminish after 2025.
            

------------------

  Table 1: Summary Results - Oil Import Premium in Various Years ($2012/BBL)
Component
Statistic
Base case, AEO2014ER, 2012$/BBL
Base case, AEO2014ER, 2012$/BBL
Base case, AEO2014ER, 2012$/BBL
Base case, AEO2014ER, 2012$/BBL
Base case, AEO2014ER, 2012$/BBL
Year
 
                                     2020
                                     2025
                                     2030
                                     2035
                                     2040
Monopsony Component
Mean
                                     $4.96
                                     $5.52
                                     $6.10
                                     $6.57
                                     $7.25
 
Range
                                 (1.65 - 9.54)
                                (1.83 - 10.58)
                                (2.02 - 11.79)
                                (2.13 - 12.82)
                                (2.34 - 14.18)
Disruption Component Total
Mean
                                     $6.42
                                     $7.37
                                     $8.48
                                     $9.61
                                    $10.86
 
Range
                                 (3.1 - 10.26)
                                (3.61 - 11.79)
                                (4.17 - 13.56)
                                (4.75 - 15.37)
                                (5.42 - 17.41)
Total Mid-Point
Mean
                                    $11.38
                                    $12.89
                                    $14.58
                                    $16.18
                                    $18.10
 
Range
                                (6.74 - 16.71)
                                (7.66 - 18.85)
                                (8.63 - 21.36)
                                (9.51 - 23.65)
                                (10.64 - 26.42)
Total Premium, in $/Gallon
Mean
                                     $0.27
                                     $0.31
                                     $0.35
                                     $0.39
                                     $0.43
Disruption Premium in $/Gallon
Mean
                                     $0.15
                                     $0.18
                                     $0.20
                                     $0.23
                                     $0.26
Rate of Price Reduction ($/MMBD)
Mean
                                     $1.33
                                     $1.42
                                     $1.47
                                     $1.50
                                     $1.52



           Table 2: Evolving Oil Market Conditions and U.S. Oil Use
 
                 2012 Study/ LDV-2017 Rule (AEO2012 Ref Case)

                Current Study/ HD-2014 Rule (AEO2014 Ref Case)

                          Current/Previous (% change)
Year
                                     2017 
                                     2020
                                     2025
                                     2030
                                     2035
                                     2017 
                                     2020
                                     2025
                                     2030
                                     2035
                                     2017 
                                     2020
                                     2025
                                     2030
                                     2035
Oil Price (2010$/BBL)
                                   $114.67 
                                   $117.47 
                                   $122.82 
                                   $128.15 
                                   $134.42 
                                    $90.12
                                    $94.76 
                                   $106.95 
                                   $116.76 
                                   $127.33 
                                     -21%
                                     -19%
                                     -13%
                                      -9%
                                      -5%
U.S. Oil Imports 
                                     8.218
                                     7.730
                                     7.670
                                     7.393
                                     7.661
                                     4.873
                                     4.938
                                     5.066
                                     5.384
                                     5.598
                                     -41%
                                     -36%
                                     -34%
                                     -27%
                                     -27%
U.S. Oil Demand
                                    19.738 
                                    19.771 
                                    19.797 
                                    20.034 
                                    20.442 
                                    19.468 
                                    19.527 
                                    19.283 
                                    18.969 
                                    18.814 
                                      -1%
                                      -1%
                                      -3%
                                      -5%
                                      -8%
OPEC Supply
                                    38.532 
                                    39.692 
                                    42.200 
                                    44.266 
                                    46.038 
                                    37.838 
                                    39.565 
                                    40.974 
                                    44.043 
                                    48.001 
                                      -2%
                                      0%
                                      -3%
                                      -1%
                                      4%
U.S. GDP (bill 2010$)
                                   $17,528 
                                   $18,847 
                                   $21,316 
                                   $24,162 
                                   $27,388 
                                   $17,342 
                                   $18,637 
                                   $20,879 
                                   $23,515 
                                   $26,421 
                                      -1%
                                      -1%
                                      -2%
                                      -3%
                                      -4%
Oil Expenditure as Share of GDP
                                     4.71%
                                     4.50%
                                     4.16%
                                     3.88%
                                     3.66%
                                     3.69%
                                     3.62%
                                     3.61%
                                     3.44%
                                     3.31%
                                     -22%
                                     -19%
                                     -13%
                                     -11%
                                     -10%
OPEC as Share of World Supply Outside U.S.
                                      46%
                                      47%
                                      47%
                                      47%
                                      47%
                                      47%
                                      47%
                                      47%
                                      48%
                                      49%
                                      2%
                                      2%
                                      1%
                                      2%
                                      4%
Notes:
Evolving historical and projected oil market conditions influence the premium estimate.  Note that all these parameters are positively related to the size of the import premium, to varying degrees.  (Price is in $/bbl; imports, demand and supply are in millions of bbl/day; and GDP is in $billion per annum.)


Backup: Figure Sources
Table 1: "ES Premium_AEO2014ER_DraftSummary20141103_full.xlsx"
Fig 1 and Table 2: "Mapping and Testing OilPrem1997_to_2014 - Ver1.xlsx"
