The Lies We ve Been Told

The Lies We ve Been Told November 18, 2008 Role of Petroleum in U.S. Energy Policy Meeting of the Committee on Earth Resources Board on Earth Sciences and Resources National Research Council of the National Academies Domestic Options for the Next Two Decades Lucian Pugliaresi Energy Policy Research Foundation, Inc. Washington, DC www.eprinc.org 1

EPRINC Fighting Ignorance About Oil Markets Since 1944* * It s taking longer than we thought. 2

High Cost of Pandering Alternative Titles Hey, Am I the Only Person Who was Alive in the 70s? What happens when you ask the wrong questions? Where s the Humility? Everything you think you know about the oil market is wrong The Black Swan 3

THE TAKE AWAYS or EPRINC s UNIFIED THEORY Expectations Matter (and sometimes they come true) Recent Run Up in Oil Prices Was A Supply Disruption (no one saw it because it wasn t in the briefing book) Peak Oil is for Sissies What Things Cost are Important (especially if there are no benefits) Lower Imports Will Not Buy a Lot of Energy Security (within the likely range)

Why Did Oil Prices Climb So High? 5

1973-1974 Arab Oil Embargo NOT AN EMBARGO, but instead a Structural Shift in Ownership and Control of the Resources of the Middle East Fundamental Change in Expectations on Production from Middle East Producers As an Embargo it was a failure, market was integrated (lesson not yet learned by Chavez) 6

Oil Price, Production, Consumption 1970-1990 40 80 35 70 30 60 25 50 $/barrel 20 15 1974-75: production declined 4.85% 40 30 mbd 10 20 5 10 0 0 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 Crude Oil Price (Saudi Light) World Production World Consumption 7

1979 Price Shock OIL MARKET WAS NOT FRAGILE, but instead there was a shift in: expectations regarding regional risk; i.e. more risky Prospects for future output from Iran and Iraq were reduced substantially, i.e., access to those reserves would now be delayed 8

1986 Price Collapse Saudi Arabia abandons role as swing producer at low levels of net demand for SA crude Shift in expectations on Saudi decision making within OPEC and as regulator of world oil market Sustained reduction in oil use as a percentage of GNP in major Western countries 9

1986 Price Collapse 43 42 41 40 39 mbd 38 37 Non OPEC Production OECD Demand 36 35 34 33 1980 1981 1982 1983 1984 1985 1986 1987 1988 Source: EIA Data, 10

A Series of Unfortunate Events Leading to New Expectations Positive Expectations Expectations Shift Negative Expectations 95 Yukos -- Kremlin taking control of Russian oil development Russia takes over Sakhalin II, Chavez Nationalizes Projects 140 Global Production, million b/d 90 85 80 75 70 Outlook positive for expanded output from Nigeria, Mexico, Venez., Ru ssia, North Slope 4.2 5.8 Oil development in Iraq delayed Congress continues ban on ANWR and offshore development OPEC Excess Capacity remains limited Nigeria rebels hurt output Continuing civil strife in Sudan, Nigeria 1.9 1.3 0.95 1.3 2 1.7 0 120 100 80 60 40 20 $/bbl 2001 2002 2003 2004 2005 2006 2007 2008e World Oil Production (EIA) OPEC Excess Capacity (EIA) Expected Production (EIA 2001 Predictions) Crude Oil Price 11

Expectations and Reality 95 140 120 90 100 million bpd 85 80 Supply/Demandrelationship returning to equilibrium 80 60 $/bbl 40 75 70 Source: EIA Data and EPRINC Calculations EIA 2001 price projections (on par with those of PIRA, Deutsche Bank, IEA, etc.) 2001 2002 2003 2004 2005 2006 2007 Q1 2008 Q2 2008 Q3 2008 World Oil Supply - Actual World Oil Demand - Actual Expected Supply (EIA 2001 Predictions) Expected Demand (EIA 2001 Predictions) Actual Price (nominal $/bbl) Expected Price 20 0 12

Country Positive Expectations Negative Events Lost Production (bpd) Iraq A Series of Unfortunate Events, by country: Promise of investment in oil sector after war, increased production. Sustained turmoil drops output below pre-war levels 600,000 Nigeria 4 mbd expected by 2010 Civil strive and attacks on infrastructure, 2005-2007 saw decline to 2.1 mbd 500-700,000 Venezuela Potential for growth after stagnant production Russia Projection seen at 12 mbd by 2010 after privatization of industry brought western influence, $ and new production Nationalization of oil industry, production nosedive Re-nationalization leads to decreased production and investment 800,000 200,000 Sudan Additional proven reserves and access to new fields Civil strife, attacks on infrastructure, new fields remain inaccessible 200-250,000 13

A Series of Unfortunate Events (cont.) Argentina Huge production gains from 1991-2001 Oil industry nationalized in 2004, production and investment dropped 100,000 Kazakhstan Production from Kashagan was expected to begin in 2005 Technical difficulties with some political disagreements TBD US ANWR was part of Bush's energy policy when he took office in 2000 Currently no access to ANWR or OCS up to 1,000,000 Canada (Alberta) Oil sands contain 95% of Canada's 179 billion barrels of reserves In 2007 new taxes and royalty rates helped to reduce lease sale revenues by 50% compared to 2006 TBD Mexico Production expected to reach 4 mbd by 2005 Production in decline since 2004. Cantarell declining and PEMEX needs funding. 500,000 + Estimated loss of supplies to the world market, 2005-2010: 2.5-4.5 mbd 14

Demand Destruction Worldwide Global demand down slightly so far this year, OECD decline has been greater than demand growth in non-oecd countries. 90 80 70 60 2008 world consumption has declined200,000 bpd from 2007. mbd 50 40 30 20 10 Non-OECD Consumption OECD Consumption 2008 OECDconsumption declined 1.5 mbdfrom 2007. 0 2000 2001 2002 2003 2004 2005 2006 2007 Q1 2008 Q2 2008 Q3 2008 15

Global Crude Demand EIA October STEO After summer price rally, demand is currently off, in part due to worldwide economic difficulties. Worldwide economic downturn has removed some crude demand from the market EIA has again revised down 2008 crude demand growth now only +300,000 bbl/d in 2008 over 2007, which is 350,000 bpd lower than last month s forecast, which itself was a downward revision of earlier estimates. OECD Consumption to decline 1.1 mmbbl/d in 2008. However, though some crude supply has rebounded, supply will remain tight. OPEC has cut production in hopes of maintaining high prices 16

World Oil Production - Significant Post-2006 Growth 86 86 85 85 84 mbd 84 83 83 82 Source: EIA Data 82 2004 2005 2006 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008 17

What s Happened Since 2007? 3.5 85 3 2.5 2 1.5 2 mbdswing in 3 quarters 65 45 mbd 1 25 $/bbl 0.5 0 5-0.5-15 -1-1.5 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Q3 2008-35 Source: EIA Data, EPRINC Calculations: All Figures Indexed to 2007 Supply Since Q1 2007 Consumption Since Q1 2007 $/bbl Change Since Q1 2007 18

10 9 Recent Production Declines - 1997-2008 Russiandeclines to continue, some had expected 12 mbdby 2010 8 1997 7 1998 1999 6 2000 2001 mbd 5 Note recovery- 2004-2008 2002 2003 4 2004 2005 3 2006 2007 2 2008 Avg 1 0 Venezuela Mexico Nigeria Iraq Indonesia North Sea U.S. Russia 19

Some Production Bright Spots 12 mbd 10 8 6 Other Notable Gains (mbd) 2007 Average -> July, 2008: Iran: 0.1 U.S.: 0.25 UAE: 0.1 Sudan: 0.06 Total: 0.51 mdb 2003 2004 2005 2006 Q1 2007 Q2 2007 Q3 2007 4 Q4 2007 Q1 2008 Q2 2008 2 Jul-08 0 Saudi Arabia Iraq Kuwait Angola Azerbaijan 20

39..Led by OPEC Production 38 37 36 35 mbd 34 33 32 31 30 29 OPEC 2003 2004 2005 2006 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Jul-08 21

Real Imported Crude Oil Prices 1980-2008 Source: EIA 22

What About Peak Oil The Wrong Question!!!

The Peak Oil Problem: New Supplies Will Be More Expensive, but We Are Not Running Out of Oil 24

San Joaquin Valley Testing Hubbert-Method Predictions for Reserves and Production Cumulative Discoveries Percent Attributable to 1915 (Billions of Barrels) 1964 1982 2000 7.7 11.8 16.1 49% 69% 76% Cumulative production as of 8.0-9.5 11.9-12.1 16.1-16.2 Year 2000 44-112 189 597(actual) production projected in: (mb/d) 189 Source: EPRINC, October 2006. Does the Hubbert Method Provide a Reliable Means for Predicting Future Oil Production, Richard Nehring, October 2006, 25

Permian Basin Testing Hubbert-Method Predictions for Reserves and Production Cumulative Discoveries Percent Attributable to 1950 (Billions of Barrels) 1964 1982 2000 17.6 27.9 35.2 85% 86% 84% Cumulative production as of 19-27.5 28.5-30.5 35.8-37.5 Year 2000 162-479 326-479 910(actual) production projected in: (mb/d) 326-479 Source: EPRINC, October 2006. Does the Hubbert Method Provide a Reliable Means for Predicting Future Oil Production, Richard Nehring, October 2006, 26

Why You Should Stop Worrying About Peak Oil You ll never get the right answer Put your effort into something useful, such as the backstop price Congress has already decided that any alternative fuel, no matter how expensive, is worth supporting as an alternative to petroleum 27

How Not to Transition to the Fuels of the Future Big Oil, Ethanol and Offshore Leasing

A Future of Imports Introduction mbd 25 20 15 10 5 EIA Net Imports EIA Crude/NGL Production 0 2006 2015 2025 2030 mbd 25 20 15 10 5 0 2006 2015 2025 2030 Global Insight, Inc. Net Imports Global Insight, Inc. Crude/NGL Production mbd 25 20 15 10 5 0 2006 2015 2025 2030 Deutsche Bank Net Imports Deutsche Bank Crude/NGL Production All estimates from the EIA s 2008 Annual Energy Outlook. EIA estimates assume EISA2007 biofuel production levels are met. 30

Diesel and Gasoline Demand, 2007-2017 Annual growth in real GDP Annual growth in real GDP Annual change in real diesel price -3%/yr 0%/yr 3%/yr 0% 10 0-10 1.5% 20 13 6 2.5% 29 22 15 3.5% 40 33 26 Annual change in real gasoline price -3%/yr 0%/yr 3%/yr 0% 16 0-14 1.5% 27 10-7 2.5% 33 18 3 3.5% 42 27 12 Assuming worst case gasoline scenario (0% economic growth, 3%/year price increase resulting in 14% demand reduction in 2017) is applied to crude oil and crude oil production remains constant, the U.S. will be importing ~9.5 mbd. If EISA 2007 is met in 2017 and 14% demand reduction scenario is applied, the U.S. will be importing ~7.9 mbd. (Elasticities can be found in http://eprinc.org/pdf/tenyearoutlookfuelsjuly.pdf) 31

Oil s Tax Bill $160 Income Taxes Paid in 2006: Oil Companies vs. The Bottom 75% of Individual Taxpayers $138B $136B $120 billion $80 $40 $0 Source: API Oil Company Income Taxes Paid in 2006 Income Taxes Paid by the Bottom 75% in 2006 (estimate) 32

U.S. Gov t Revenues from Leases In 2007 the MMS received $9.4 billion from oil and gas royalties. FY 2007 lease sales raised over $3 billion. MMS offshore lease sales thus far in 2008 have generated high bids of over $9 billion. Does not include state revenues, delay rental fees, etc. Royalty revenues may be higher if average FY2008 crude price is comes in higher than 2007. Source: MMS 33

National Academies Study on Oil in the Sea Highlights from Oil in the Sea III (2003) Operational discharges from vessels in general and tankers in particular have substantially declined over the last 25 years. Only 1 percent of the oil discharges in North American waters is related to the extraction of petroleum. Although large quantities of VOC (volatile organic compounds) are emitted from tankers and production platforms, these consist of mostly lighter compounds and only small amounts deposit to the sea surface. 34

US Ethanol Consumption: 2006 - Present 8 7 6 5 4 3 2 100 mil. gal./month 1 0 Demand Mandate Requirement for 2008 Mandate requirement assumes 750 million gallons per month for 12 months to reach the 9 billion gallon mandate for 2008. Jan-06 Feb-06 Mar-06 Apr-06 May-06 Jun-06 Jul-06 Aug-06 Sep-06 Oct-06 Nov-06 Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07 Jan-08 Feb-08 Mar-08 Source: Renewable Fuels Association 35

Ethanol and Gasoline 400 8 350 7 300 250 6 5 Ethanol Futures cents/gallon 200 150 4 3 % NYMEX RBOB Futures 100 50 2 1 Ethanol Production's Share of Finished Motor Gasoline Supplied (%) 0 0 Dec-05 Feb-06 Apr-06 Jun-06 Aug-06 Oct-06 Dec-06 Feb-07 Apr-07 Jun-07 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08 Aug-08 Oct-08 Source: EIA Data, Bloomberg, CME Group, EPRINC Calculations 36

Ethanol s Share of Crude Products and Gasoline 25 8 7 20 6 mbd 15 10 5 4 3 % U.S. Finished Motor Gasoline Product Supplied (Thousand Barrels per Day) U.S. Crude Oil and Petroleum Products Product Supplied (Thousand Barrels per Day) Ethanol Share of Finished Motor Gasoline (%) 5 2 Ethanol Share of Crude Oil and Petroleum Products (%) 1 0 0 Jan-2005 Apr-2005 Jul-2005 Oct-2005 Jan-2006 Apr-2006 Jul-2006 Oct-2006 Jan-2007 Apr-2007 Jul-2007 Oct-2007 Jan-2008 Apr-2008 Jul-2008 37

The Cost vs. Value for Ethanol $ 2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 Reflects ethanol s value as an oxygenate and octane booster. Once the gasoline pool hits 10% ethanol, additions must come from E85 sales. Blender s Credit = $0.51, current ethanol RBOB spread = $0.53 1 2 3 4 5 6 7 8 9 10 11 12 13 RBOB (NYMEX Futures) % of Gasoline Pool Ethanol's Value Relative to Gasoline Ethanol (CBOT Futures) Corn Feedstock - $ per gallon of Ethanol Source: Bloomberg, CBOT. Futures prices for front month contracts as of November 17, 2008. 38

Cost of Ethanol Subsidies $7 billion per year (Economist, 2007) About $1.90/gallon. More than 200 types of subsidies $11.2bn+ since 2005 on tax breaks for companies that blend ethanol into petrol (Financial Times) Billions of dollars of subsidies for ethanol producers Tariff on ethanol imports Aimed at preventing imports from Brazil 54 cents/gallon Source: The Economist, Finan cial TImes 39

Synfuels Corp Synthetic Fuels Corp. (SFC) - 1979 Use coal to produce 2 mbdoe by 1992 New jobs and revenues expected, The new Office of Coal Commerce in the Illinois Department of Commerce and Community Affairs calculates that every 4 million tons' annual increase in coal output creates 4,013 new jobs, producing a $76 million annual increase in personal income in the state, $6.7 million of which ends up in state and local tax coffers. Cost would be $88 billion over 10 years, partially funded by a windfall profits tax on oil companies. Reagan eventually ended the project in 1986 as oil prices collapsed. Source: Illinois Issues, University of Illinois, 1982. http://www.lib.niu.edu/1982/ii820420.html TIME Magazine 40

Are We Using Too Much Oil?

Oil Intensity of GDP Source: CFTC Interim Report on Crude Oil, June 2008 42

Cost to consumers.. Source: New York Times, USA Today 43

Oil Prices by Currency Source: CFTC Interim Report on Crude Oil, June 2008 44

Slides for Q s and A s

World Oil Consumption 46

World Oil Consumption Source: CFTC Interim Report on Crude Oil, June 2008 47

World GDP vs. Oil Production Source: CFTC Interim Report on Crude Oil, June 2008 48

Operable Refiners and Capacity 20 350 Operable Refineries 18 16 14 12 10 8 6 4 2 300 250 200 150 100 50 Capacity Operable Refineries 0 0 49 Capacity, mbbl/d 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Source: EIA Data

U.S. Total Gasoline Imports 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 50 mbbl/d 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: EIA Data

U.S. Distillate Fuel Oil Net Imports 800 600 400 200 0-200 -400-600 -800 Currently Exporting 51 Thousand bbl/d 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: EIA Data

Distillate Consumption Growth: 2003-2007 Source: EIA Data 52

Profitability in Refining and Marketing 2007-2008 (with year-over-year change) 14 12 20.94% 10 billion dollars 8 6 4 23.52% -54.98% 2-46.07% -70.88% -86.30% 0 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Net Income for Refining and Marketing Source: EIA Data and EPRINC Calculations 53

Refiner Margins vs. ROI 30 60 25 20 15 10 5 0 50 40 30 20 10-5 0 19 991 19 992 19 993 19 994 % 19 995 19 996 19 997 19 998 19 999 20 000 20 001 20 002 20 003 20 004 20 005 20 006 20 007 cents/gallon ROI U.S. Refining Composite Refiner Margins Source: EIA Data 54

U.S. Retail Prices: Gasoline vs. Diesel 2006-2008 (cents/gal) 500 450 400 350 300 250 200 150 US Regular - All US Diesel -All US Ultra Low Sulfur US Low Sulfur Source: http://tonto.eia.doe.gov/dnav/pet/pet_pri_gnd_dcus_nus_w.htm 55

Real Gasoline Prices 1919 2009 Source: EIA 56