Strategic Investment in Crude Oil Production Capacity under Demand - - PowerPoint PPT Presentation

Daniel Huppmann

http://dergelbesalon.at/dh e0425524@student.tuwien.ac.at

Strategic Investment in Crude Oil Production Capacity under Demand Uncertainty

Combining a Nash Investment Game and a Complementarity Model InfraDay, Berlin 2010

Agenda

• Uncertainty in the Crude Oil Market
• Methodology

– Difficulty in Modelling Strategic Games – Complementarity Modelling – Investment Analysis

• Scenarios, Countries and Data
• Results

– Nash Equilibrium of Investment Game – Outlook on the Crude Oil Market

• Conclusion

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Motivation

• Uncertain demand development for Crude Oil

– Economic Crisis – “Risk“ of Climate Change Mitigation Initiatives

• Current situation:

low investment in new production capacity

• Risk:

Capacity Bottleneck in the future (WEO, IEA 2009)

• Question of this work:

Investment Incentives under Uncertainty

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Difficulty in modelling strategic games

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Strategic investment games

• Murphy and Smeers (2005):

Electricity generation capacity investment: Peak-load vs. Base-load generator Solved as open-loop, closed-loop and feedback model

• Yegorov and Wirl (2010):

Natural gas market – investment and transit game: Production capacity vs. Geopolitical power

• Common aspect:

Mathematically complex, numerically (almost) intractable...

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Optimization & Equilibrium: Complementarity Modelling

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Equilibrium Modelling & Energy

• Natural gas:

– GASTALE (Lise et al., 2008) – World Gas Model (Egging et al., 2008) – GasMod (Holz et al., 2008)

• Coal:

– CoalMod (Haftendorn and Holz, 2010)

• Electricity

– Hobbs, 2001; Ehrenmann and Neuhoff, 2009

• Crude Oil ???

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Difficulty in multi-period modelling

• Commonly implemented as open-loop model:

– Implicit assumption of perfect foresight – Stackelberg market not easily tractable due to dynamic inconstistency of strategies – Strategic behaviour:

• Cournot market power in production/sales possible
• Endogenous investment necessarily competitive

(invest if: shadow value of capacity constraint > investment cost)

• Consequence:

Trade-Off between game complexity and model size

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A Crude Oil Market Model

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Crude Oil Market Model (I)

• Earlier version presented at the IAEE European

Conference 2009, Vienna (Huppmann and Holz)

• Specifications of the current version:

– multi-period model with endogenous investment – open-loop and deterministic – hybrid Cournot market power/perfect competition

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Crude Oil Market Model (II)

• Agents:

– Suppliers – Arbitragers located at spot markets (pool hubs) (exploit price differentials between demand nodes) – Final Demand (inverse demand function)

• Implementation:

– Karush-Kuhn-Tucker conditions derived from supplier and arbitrager profit maximization problems – Coded in GAMS (General Albegraic Modeling System) using the PATH Solver (Ferris & Munson, 2000)

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Caveats of this model

• Not a Hotelling model

– Finite time horizon, not necessarily all reserves depleted – Agents consider inter-temporal optimization

• Complex interaction within OPEC neglected
• Production capacity depreciation is neglected
• No explicit backstop technology considered

Implicitely via inverse demand function

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Methodology of Investment Analysis

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Structure of the Investment Game

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From the point of view of one strategic crude oil supplier

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Solution Method (I)

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Numerical solution using market equilibrium model

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Solution Method (II)

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Compare expected Net Present Value – Input for Nash Game

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Demand Scenarios

• Speedy Recovery

Based on World Energy Outlook 2009, Reference Scenario Quick economic upturn, no climate change mitigation policies enacted

• Green Rebound

Based on World Energy Outlook 2009, 450 Scenario Economic upturn, international climate change mitigation

• Long Slump

Continued global recession

• Tiger & Dragon

Continued recession in OECD, upturn in rest of the world

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Suppliers under Investigation

• Saudi Arabia

– High level of unused capacity – Ambiguity regarding market power (Stackelberg leader?)

• Russia

– Political risk for foreign and non-state oil companies – Difficulty of capacity expansion without foreign expertise and funding

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Countries included in the data set

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Source: http://commons.wikimedia.org/wiki/File:BlankMap-World-v2.png

Data Sources

• Consumption and production quantities, reference prices

IEA (2009), BP (2009)

• Production Costs

Aguilera et al., Depletion and Future Availability of Petroleum

• Resources. The Energy Journal, 30(1):141–174 (2009)
• Transport and Investment Costs

OGJ, EIA, IEA, The Economist, etc.

• Demand Elasticity

Fattouh, B. The Drivers of Oil Prices: The Usefulness and Limitations

• f Non-Structural model, the Demand-Supply Framework

and Informal Approaches. Working Paper 32. Oxford Institute of Energy Studies, March 2007.

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Some results

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Nash Investment Game

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Russia ¡ No ¡Investment ¡ Investment ¡ Saudi ¡Arabia ¡ No ¡Investment ¡ Investment ¡

Unique Nash equilibrium for all demand scenarios independent of demand development!

Demand and Price – Speedy Recovery

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Consumption OECD/non-OECD (MMbbl/d, left) and price (US $/bbl, right)

Demand and Price – Green Rebound

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Consumption OECD/non-OECD (MMbbl/d, left) and price (US $/bbl, right)

Demand and Price – Long Slump

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Consumption OECD/non-OECD (MMbbl/d, left) and price (US $/bbl, right)

Demand and Price – Tiger & Dragon

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Consumption OECD/non-OECD (MMbbl/d, left) and price (US $/bbl, right)

Remaining Reserves after 2030

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in % (relative reserve shares are similar in all scenarions)

Remaining Reserves & Future Supply

• Reserves remain substantial after 2030

Global Reserves-to-Production Ratio ~40 years in all scenario

• Even higher concentration of reserves

> 60 % in Middle East > 75 % in OPEC Canada is the only OECD country with reserves Little reserves left in Russia

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Security of Supply & Import Dependency

• Common Wisdom:

„Green revolution leads to higher security of supply and lower import dependence“

• Observation from simulation results:

Import dependency of demand regions higher in „Green Rebound“ scenario than in all other scenarios

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Import Dependence – Europe

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Imports and domestic production in MMbbl/d, in 2030

Import Dependence – North America

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Imports and domestic production in MMbbl/d, in 2030

Import Dependence – Asia Pacific

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Imports and domestic production in MMbbl/d, in 2030

Conclusion

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Conclusion (I)

• Investment game equilibrium:

– Investment by Saudi Arabia – No investment by Russia

• Remark on modelling:

– Implementing multi-level strategic game is a challenge – Compromise between game complexity and model detail – Simulation results depend on many assumptions

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Conclusion (II)

• Outlook on the crude oil market:

– Reserve constraint is not a major issue in the next two decades – Middle East retains and expands its dominant position, both in production and remaining reserves – Consequently, potential for market disturbances and price spikes remains large

• Remark on policy:

Climate change mitigation policies may in the medium term increase crude oil import dependence!

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Thank you for your attention!

e0425524@student.tuwien.ac.at dhuppmann@diw.de http://dergelbesalon.at/dh

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Bibliography (I)

• R. Egging, S. A. Gabriel, F. Holz, and J. Zhuang. A Complementarity Model for the European

Natural Gas Market. Energy Policy, 36(7):2385–2414, 2008.

• A. Ehrenmann and K. Neuhoff. A Comparison of Electricity Market Designs in Networks.

Operations Research, 57(2):274–286, 2009.

• M. C. Ferris and T. S. Munson. Complementarity Problems in GAMS and the PATH Solver.

Journal of Economic Dynamics and Control, 24(2):165–88, 2000.

• C. Haftendorn and F. Holz. Modeling and analysis of the international steam coal trade.

The Energy Journal, 31(4):201–225, 2010.

• B. F. Hobbs. Linear Complementarity Model of Nash-Cournot Competition in Bilateral and

Poolco Power Markets. IEEE Transactions on Power Systems, 16(2):194–202, 2001.

• F. Holz, C. v. Hirschhausen, and C. Kemfert. A strategic model of European gas supply

(GASMOD). Energy Economics, 30(3):766–788, 2008.16

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Bibliography (II)

• D. Huppmann and F. Holz. A Model for the Global Crude Oil Market Using a Multi-Pool MCP
• Approach. DIW Discussion Paper 869, March 2009.
• IEA. World Energy Outlook 2009. Organisation for Economic Co-operation and Development,

Paris, 2009.

• F. H. Murphy and Y. Smeers. Generation Capacity Expansion in Imperfectly Competitive

Restructured Electricity Markets. Operations Research, 53(4):646–661, 2005.

• W. Lise, B. F. Hobbs, and F. van Oostvoorn. Natural gas corridors between the EU and its

main suppliers: Simulation results with the dynamic GASTALE model. Energy Policy, 36(6):1890–1906, 2008.

• Y. Yegorov and F. Wirl. Gas Supply Security, Competition and Geopolitics.

Presented at the IAEE European Conference, Vilnius, 2010.

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