quantitative e⁄ects of the shale oil revolution on oil prices...

Quantitative Effects of the Shale oil revolution on OilPrices

Cristiana Manescu Galo Nuño

European Central Bank

Oslo - June 2014

Manescu & Nuño (ECB) Shale oil revolution Oslo - June 2014 1 / 23

Introduction Motivation

What is the shale oil revolution?Oil markets have recently undergone a significant transformation with the unexpected rise in theUS production of shale (light, tight) oil

The combination of horizontal drilling techniques together with hydraulicfracturing and rising oil prices have made the exploration and exploitation oflarge volumes of shale oil possible.

The production of shale oil is so far very much concentrated to the US


Introduction Motivation

Significant expansion in US productionUS shale-oil production is expected to reach 4 mb/d by 2018 according to EIA

Figure: United States oil production by type (in mb/d, EIA Scenario)


Introduction Aim of the paper

This presentation: which is the oil price impact of theshale oil revolution?We propose an analytical exercise employing a DSGE

Quantitative assessment under different production scenarios.

A critical issue is the behavior of Saudi Arabia


Saudi Arabia and the oil market

Why is Saudi Arabia so relevant?

“OPEC is Saudi Arabia”

—Mabro (1975)

“The Saudis have acted as what they are:

the leading firm in the world oil market”

—Adelman (1995)



Saudi Arabia is not a price-taker in the oil market

Saudi Arabia is the world’s largest oil exporter and owns the largest known oilfields

Saudi Arabia is the only producer which “shuts in” significant spare capacity(Smith, 2009)

Saudi Arabia’s oil output has been highly volatile despite the lack of domesticshocks



Saudi Arabia maintains ample spare capacitySpare capacity of the four major OPEC producers. In million barrels per day

2000 2002 2004 2006 2008 20100

0.5

1

1.5

2

2.5

3

3.5

Saudi ArabiaIranIraqVenezuela



Saudi Arabia’s oil output has been highly volatile ...Market shares of the four major OPEC producers. Individual production over world production

1975 1980 1985 1990 1995 2000 2005 20100

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

0.18

0.2Saudi ArabiaIranIraqVenezuela



... even if the Kingdom has been an “island of stability”

Instances when Saudi production was directly affected by exogenous events

1977 fire at the Abqaiq facilities

1984 several Saudi tankers destroyed during the Iran-Iraq war

1991 attacks by Iraqi missiles during the Gulf war

“Offi cial Oil Market Chronology”—U.S. Energy Information Administration

Apart from these episodes, changes in Saudi oil output were the result ofproduction decisions; not the consequence of disruptions in its productioncapabilities


DSGE model Overview

We employ the DSGE model from Nakov and Nuño“Saudi Arabia and the Oil Market”(Economic Journal, 2014)

Saudi Arabia is a dominant firm, with the rest of oil producers as acompetitive fringe (Dynamic Stackelberg game)

The behavior of the dominant firm can be seen as a profit maximizingresponse

Spare capacity allows fast adjustment of output as necessary in response todemand and supply shocks


DSGE model Overview

The model in a nutshell

Three regions: one oil-importing and two oil-exporting ones

The oil-importer uses oil in consumption (gasoline)

Oil is a homogeneous commodity supplied by two types of producers: adominant firm and a “competitive fringe”

The fringe takes the oil price as givenThe dominant producer faces a downward sloping “residual demand” curve,picking profit-maximizing points

No borrowing across regions and abstract from monetary and exchange ratefactors)


DSGE model Model performance

The model is able to replicate the main stylized facts ofthe market

Data and model standard deviations*

Oil Oil Fringe Saudiprice output output output

Data 8.5 1.6 1.5 6.6Model High elasticity 8.1 2.2 3.3 6.5

Low elasticity 8.3 1.2 1.7 6.4*Standard deviations, in percentage points, of first log differences.



The volatility in the dominant supplier is consistent withthe response of a monopolistImpulse responses to a supply and a demand shock

0 20 40-2

0

2

4

6Total oil output

0 20 400

2

4

6

8Oil price

0 20 40-2

0

2

4

6GDP of importing region

0 20 40-5

0

5Fringe oil output

0 20 400

0.5

1

1.5Dominant producer share

0 20 40-2

0

2

4Consumption of importing region

0 20 400

2

4

6

8Dominant producer oil output

Months0 20 40

0

5

10

15Dominant producer investment

Months0 20 40

-6

-4

-2

0

2Shock process

Months

Supply shockDemand shock



Event study: the Persian Gulf war of 1990-91The model explains the dynamics of Saudi Arabia production (only 1 shock: fringe supply)

1990.5 1991 1991.5 19924

5

6

7

8

9

10

11Saudi oil production

Mill

ion

barre

ls p

er d

ay

1990.5 1991 1991.5 199245

50

55

60Fringe oil production

Mill

ion

barre

ls p

er d

ay

1990.5 1991 1991.5 19920

10

20

30

40Real oil price

Con

stan

t US

D

date1990.5 1991 1991.5 1992

55

60

65Total oil production

Mill

ion

barre

ls p

er d

ay

date

DataHigh elasticityLow elasticity


Scenarios

We consider three scenariosAnticipated shocks

1 Baseline scenario: shale oil production in the US increases from roughlyzero in 2010 to 2.7 mb/d in 2014 and reaches a peak of 4 mb/d in 2018.Data from EIA May 2014

1 Current law and regulations affecting the energy sector remain in placethroughout the projection horizon.

2 Production of shale oil remains concentrated in the US and does not extendsignificantly to other countries before 2020.

2 Lower shale production scenario: political, technical or environmentalconstraints limit US shale production which remains broadly flat across theperiod 2014-2018.

3 Higher shale production scenario: technological progress, political will andeconomic incentives push up US shale production, which reaches 6 mb/d bythe end of the decade


Results Quantitative effects of the shale oil revolution

Differential effect of different oil shale production scenarios

2014 2015 2016 2017 20180

1

2

3

4

5

6

mbd

Shale oil production

2014 2015 2016 2017 2018-10

-8

-6

-4

-2

US

D p

er b

arre

l

Oil price difference

2014 2015 2016 2017 20180.5

1

1.5

2

2.5

3

mbd

World oil production difference

2014 2015 2016 2017 2018-3

-2.5

-2

-1.5

-1

-0.5

mbd

Saudi Arabia production difference

baselinehigher shale productionlower shale production

Figure: Differential effect of different oil shale production scenarios All the figuresrepresent differences compared to the counterfactual scenario of no shale production


Results Quantitative effects of the shale oil revolution

Take away

1 Most of the shale oil revolution is already priced in.2 Even considerable changes in the scale of the production will have only asmall effect on prices.

1 The oil price impact of the increase in supply under the different scenarios by2018 amounts to changes of less than ±USD4 per barrel. This is smallcompared to the average oil price volatility.


Results Shale oil supply and Saudi Arabia’s reaction

What if Saudi Arabia deviates from its optimal rule?Saudi Arabia lowers its production in order to partially offset the increase in global supply

However, Saudi Arabia can deviate from its profit-maximizing path andinstead maintain or even increase production.

This would preserve its oil revenues and may push shale oil producers off themarket.



Are there similarities with the 3rd oil shock of themid-1980s?Saudi Arabia maximizing revenues instead of profits

Total oil production and oil prices(monthly absolute differences with

respect Jan 1981)Saudi Arabia oil production and oilrevenues (monthly data changes)



We analyze the case of Saudi Arabia maximizing revenuesinstead of profitsIn an alternative scenario

The profit maximizing scenario corresponds to the higher shale productionscenario above (worst-case).

Alternative scenario (revenue scenario): Saudi Arabia deviates from theprofit-maximizing path by keeping approximately constant its revenues (sincethe end of 2013).

Commitment of Saudi Arabia to defend its revenues is public information: therest of agents in the economy are aware of it since 2013 and may formexpectations (and take actions) accordingly



The impact on prices is still moderateLess than USD1 pb by 2018

2014 2015 2016 2017 20182.5

3

3.5

4

4.5

mbd

Shale oil production

2014 2015 2016 2017 2018-6.5

-6

-5.5

-5

US

D p

er b

arre

l

Oil price difference

2014 2015 2016 2017 20181.5

1.6

1.7

1.8

1.9

mbd

World oil production difference

2014 2015 2016 2017 2018-2

-1.5

-1

mbd

Saudi Arabia production difference

baselinerevenue scenario

Figure: Differential effect of alternative Saudi Arabia production scenarios All the figuresrepresent differences compared to the counterfactual scenario of no shale production.



Saudi Arabia’s profits would sufffer in this caseDue to the increase in costs

2014 2015 2016 2017 2018-200

-180

-160

-140

-120

Mill

ion

US

D p

er d

ay

Revenue difference

2014 2015 2016 2017 20189

9.5

10

10.5

11

% W

orld

oil

supp

ly

Market share

2014 2015 2016 2017 2018-10

-5

0

5

US

D p

er b

arre

l

Profit per barrel difference

2014 2015 2016 2017 2018-4

-2

0

2

% o

f GD

P (2

012)

Profit difference

baselinerevenue scenario

Figure: Domestic effect of alternative Saudi Arabia production scenarios.


Conclusions

Conclusions

The shale oil revolution may have a major role in the US economy, but itsimpact on the oil market is expected to be moderate.

Numerical estimates using a DSGE model suggest that it has produced a fallin prices of USD5 per barrel, already priced in.

Looking forward, different scenarios by 2018 imply changes of less than±USD4 per barrel.


IntroductionMotivationAim of the paper

Saudi Arabia and the oil marketDSGE modelOverviewModel performance

ScenariosResultsQuantitative effects of the shale oil revolutionShale oil supply and Saudi Arabia's reaction

Conclusions

quantitative e⁄ects of the shale oil revolution on oil prices...

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