Various individuals have argued for drilling in the Outer Continental Shelf (OCS) as a means to affect the price of oil. This is true despite this recent assessment by the Department of Energy’s Energy Information Administration, the Federal Government’s nonpartisan analytical group on energy issues. From Annual Energy Outlook related analyses (June 2007):
The OCS is estimated to contain substantial resources of crude oil and natural gas; however, some areas of the OCS are subject to drilling restrictions. With energy prices rising over the past several years, there has been increased interest in the development of more domestic oil and natural gas supply, including OCS resources. In the past, Federal efforts to encourage exploration and development activities in the deep waters of the OCS have been limited primarily to regulations that would reduce royalty payments by lease holders. More recently, the States of Alaska and Virginia have asked the Federal Government to consider leasing in areas off their coastlines that are off limits as a result of actions by the President or Congress. In response, the Minerals Management Service (MMS) of the U.S. Department of the Interior has included in its proposed 5-year leasing plan for 2007-2012 sales of one lease in the Mid-Atlantic area off the coastline of Virginia and two leases in the North Aleutian Basin area of Alaska. Development in both areas still would require lifting of the current ban on drilling.
For AEO2007, an OCS access case was prepared to examine the potential impacts of the lifting of Federal restrictions on access to the OCS in the Pacific, the Atlantic, and the eastern Gulf of Mexico. Currently, except for a relatively small tract in the eastern Gulf, resources in those areas are legally off limits to exploration and development. Mean estimates from the MMS indicate that technically recoverable resources currently off limits in the lower 48 OCS total 18 billion barrels of crude oil and 77 trillion cubic feet of natural gas (Table 10).
Although existing moratoria on leasing in the OCS will expire in 2012, the AEO2007 reference case assumes that they will be reinstated, as they have in the past. Current restrictions are therefore assumed to prevail for the remainder of the projection period, with no exploration or development allowed in areas currently unavailable to leasing. The OCS access case assumes that the current moratoria will not be reinstated, and that exploration and development of resources in those areas will begin in 2012.
Assumptions about exploration, development, and production of economical fields (drilling schedules, costs, platform selection, reserves-to-production ratios, etc.) in the OCS access case are based on data for fields in the western Gulf of Mexico that are of similar water depth and size. Exploration and development on the OCS in the Pacific, the Atlantic, and the eastern Gulf are assumed to proceed at rates similar to those seen in the early development of the Gulf region. In addition, it is assumed that local infrastructure issues and other potential non-Federal impediments will be resolved after Federal access restrictions have been lifted. With these assumptions, technically recoverable undiscovered resources in the lower 48 OCS increase to 59 billion barrels of oil and 288 trillion cubic feet of natural gas, as compared with the reference case levels of 41 billion barrels and 210 trillion cubic feet.
The projections in the OCS access case indicate that access to the Pacific, Atlantic, and eastern Gulf regions would not have a significant impact on domestic crude oil and natural gas production or prices before 2030. Leasing would begin no sooner than 2012, and production would not be expected to start before 2017. Total domestic production of crude oil from 2012 through 2030 in the OCS access case is projected to be 1.6 percent higher than in the reference case, and 3 percent higher in 2030 alone, at 5.6 million barrels per day. For the lower 48 OCS, annual crude oil production in 2030 is projected to be 7 percent higher — 2.4 million barrels per day in the OCS access case compared with 2.2 million barrels per day in the reference case (Figure 20). Because oil prices are determined on the international market, however, any impact on average wellhead prices is expected to be insignificant.
Similarly, lower 48 natural gas production is not projected to increase substantially by 2030 as a result of increased access to the OCS. Cumulatively, lower 48 natural gas production from 2012 through 2030 is projected to be 1.8 percent higher in the OCS access case than in the reference case. Production levels in the OCS access case are projected at 19.0 trillion cubic feet in 2030, a 3-percent increase over the reference case projection of 18.4 trillion cubic feet. However, natural gas production from the lower 48 offshore in 2030 is projected to be 18 percent (590 billion cubic feet) higher in the OCS access case (Figure 21). In 2030, the OCS access case projects a decrease of $0.13 in the average wellhead price of natural gas (2005 dollars per thousand cubic feet), a decrease of 250 billion cubic feet in imports of liquefied natural gas, and an increase of 360 billion cubic feet in natural gas consumption relative to the reference case projections. In addition, despite the increase in production from previously restricted areas after 2012, total natural gas production from the lower 48 OCS is projected generally to decline after 2020.
Although a significant volume of undiscovered, technically recoverable oil and natural gas resources is added in the OCS access case, conversion of those resources to production would require both time and money. In addition, the average field size in the Pacific and Atlantic regions tends to be smaller than the average in the Gulf of Mexico, implying that a significant portion of the additional resource would not be economically attractive to develop at the reference case prices. [Emphasis added -- mdc]
Here is Figure 20 from the report, showing the impact on lower-48 production in the baseline and the alternative.
Figure 20 from Annual Energy Outlook related analyses (June 2007).
What exactly is “insignificant”? One can get an idea by doing a back of an envelope calculation. The 3% increase by 2030 cited by the 2007 Annual Energy Outlook analysis works out to 0.163 millon barrels per day (mbpd) incremental production. Projected world output of conventional oil in 2030 is 99.30 mbpd. This means access to the OCS would result in a 0.164% increase in output.
Let’s appeal to a supply-demand framework, assuming log-linearity:
qs = a1 + a2ps + a3X
qd = b1 + b2pd + b3Z
Where q is log quantity, p is log price, X and Z are other shift variables, assumed to be exogenously determined. ai and bi are parameters, a2 > 0 and b2 < 0. Z could be income, for instance.
Solving the simultaneous system of equations for the equilibrium price leads to:
p = (a1-b1)/(b2-a2) + (a3X-b3Z)/(b2-a2)
Taking the total differential and holding constant the shift variables X and Z leads to the following expression:
Δp = (Δa1-Δb1)/ (b2-a2)
Substituting in some parameter values, taking Δa1 as the percentage increase in supply, namely 0.164% (0.00164), and setting the price elasticity of demand equal to -0.4, and and price elasticity of supply to 0.3 (Perloff and Whaples has cited these figures; plausible alternative parameter values would not alter the results in a qualitative fashion) yields the following: The resulting change from baseline in 2030 is -0.00234 (-0.23%). Taking the AEO 2008 baseline estimate of 70.45 2006$/barrel in 2030, the implied reduction in price is 0.165 2006$.
Now let’s conduct some sensitivity analyses/robustness checks.
There have been some assertions that driving down prices in the future will have an impact today (see e.g., EconLog). Since petroleum is durable, there is no doubt that this must be true; the question, as always, revolves around the quantitative magnitudes. Take the 2030 impact on today; one can calculate the present value of the innovation: (1+r)22. Take r = .027 (which is the average ten year constant maturity yield minus the lagged one year inflation rate over the 1976-2008 period), one finds that the 0.165 2006$ decline in 2030 results in a 0.106 2006$ decrease today.
Alternative Estimates of Reserves
As pointed out in several venues , there is some debate over the amount of technically recoverable oil in the OCS that currently not accessible; the CS Monitor editorial argues that there’s been a big revision in estimation technologies. That may be, but here is a quote from the February 2006 report to Congress from the MMS of the Department of Interior (page xii):
Many proponents of domestic energy security consider gaining increased access to Federal resources to be one of the biggest challenges. Part or all of nine OCS planning areas, which include waters off 20 coastal states, have been subject to longstanding leasing moratoria enacted annually as part of the Interior and related agencies appropriations legislation, or are withdrawn from leasing until after June 30, 2012, as the result of presidential withdrawal (under section 12 of the OCSLA). Some of these areas contain large amounts of technically recoverable oil and natural gas resources. The MMS estimates that conventional oil and gas resources (i.e., UTRR) in OCS areas currently off limits to leasing and development total 19.1 Bbo and 83.9 Tcfg (mean estimates). There remains today, considerable uncertainty concerning the resource potential of many of these OCS areas. The availability of additional modern G&G data could reduce this uncertainty. It is instructive to note that perceptions concerning the resource potential of the Central, Western and portions of the Eastern GOM, areas experiencing robust levels of exploration and production effort, have continued to evolve for the better over the years. Critical to the changing perception is the fact that the MMS has acquired approximately 1.75 million line-miles of two-dimensional (2-D) common depth point (CDP) seismic data and nearly 300,000 square miles of 3-D seismic data. However, the additional G&G data and information that become available to assessors between assessments is frequently mixed in terms of having a positive or negative effect on the perception of the overall hydrocarbon potential of the OCS.
This implies that the EIA’s base assumptions do not appear unreasonable, on the face of it.
The calculations rely upon long run elasticities, and a constant elasticity along the curves (Note: linear demand and supply curves do not exhibit constant elasticities.) If the supply curve in log-price/log-quantity space was still backward L-shaped, and the supply enhancement occurred with demand intersecting along the near-vertical portion, then the price change would be larger.
What about short run effects (in 2030 say)? When new suppy comes on line, the resulting deviation in price from baseline will be commensurately larger in the short run. But by definition, over the longer horizon, prices will gravitate toward those indicated by the long run analysis.
The calculations I presented focus on 2030. One could examine the effects of earlier changes in future prices. But as shown in Figure 20 (reproduced above), production does not even begin until 2017 assuming leasing begins in 2012 (less than four years from now!). Even assuming the 2030 effect is achieved in 2020, that would mean the resulting change in today’s prices would only be 0.12 2006$ per barrel.
Reader Anon (in commments to this post) argues against my critique of offshore drilling arguments using a game-theoretic framework:
You are wrong. Opening up more acreage to exploration will affect psychology and markets. let me explain.
A credible threat of increased supply – even ten years away – certainly does have immediate impact to the ruminations of energy policy makers from Russia to Saudi to Mexico.
If you have a large control over marginal supply (Mideast/Russia/Mexico could all do a lot more if they choose to) and you see the glimmer of another North Sea or another ANS then you rightly might adjust your policies. Strategically speaking, if you dominate global oil supply then at some price point you rightly begin to fear Competitive Entrants.
In the case of Oil (by no means a free market), governments control access to resources (sell it like real estate and demand whatever they like or in many cases simply make everything off limits to private capital). However, if you push oil importing nation governments too far with overly high prices then you just might trigger competition.
I hope this makes it clear that the main reason we pay such high oil prices today is the government RESTRICTED ACCESS to reserves (a global phenomenon) that has tended to dominate the oil industry landscape for so long. The secure knowledge that the US Government is EXTREMELY UNLIKELY to open up new reserves for exploitation is enough to keep exporting nations confident that they can safely continue to extract higher rent for their commodity.
So just the credible threat of a surge in new competition (a la Bush statement) may be enough to open the taps a bit more or cause a flurry of counter-competitive increased supply activity to quickly try to KILL the new threat or frighten off competitive capital investment in new supply..
Think Strategically. BTW – I condemn Bush for many things and I sympathize with your attitude towards this administration, however, for once, Bush is actually right this time!
Anon admonishes me to read Barry Nalebuff’s book Thinking Strategically (actually it’s Dixit and Nalebuff); I confess I have not yet done so. But having endured some amount of game theory over the years, I’m going to wade ahead nonetheless.
First, consider this exchange from April 2004, where Nalebuff suggests investing $5 billion to enable Iraq’s oil industry to export a million extra barrels of oil a day, thereby negating OPEC’s monopoly power. One interesting aspect of Nalebuff’s argument is that he doesn’t propose something like exploiting US offshore reserves. I think the reason is quite simple, and is rooted in game theory — Iraq in principle can be a low cost producer (after security is established). Supply from offshore sources in the US would be (and is known to be) a relatively high cost (per unit production) venture relative to, say, Saudi oil production. Hence, it’s not clear increasing US production can have the strategic effect often suggested. (Example, see: )
I do agree with Anon that a lot of world production is undertaken by state owned enterprises, which lack proper incentives for responding to price signals. But I’m unconvinced that foreign state owned enterprises would be privatized simply because the US removed its moratorium on OCS exploitation.
So, opening up production in the currently inaccessible areas of the OCS might have substantial effects (perhaps on trade balance, or oil company profitability, Federal leasing revenue), but in my view is unlikely to have a substantial impact on oil prices (just as in the case of opening up ANWR).
[Update, 17 August 9:30pm] Regarding potential costs.
Radarsat-1 satellite radar image acquired on September 2, 2005, that shows extensive oil slicks in the Gulf of Mexico following Hurricane Katrina. Approximately 2,144 platforms and 15,366 miles of seafloor pipeline experienced hurricane-force winds; an additional 2600 platforms and 12,470 miles of seafloor pipeline were exposed to tropical storm-force winds. Yellow box shows location of area covered by a separate graphic showing details of leaking platforms. Oil slicks are dark patches; oil platforms are visible as bright dots. Land areas are also very bright. Original TIFF file is 200dpi @ 10″x7.5″.
Satellite Image of Oil Slicks With Location of Detail – Leaking Platforms, 9/2/2005