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

Strategic Investment in Crude Oil Production Capacity under Demand Uncertainty Combining a Nash Investment Game and a Complementarity Model InfraDay, Berlin 2010 Daniel Huppmann http://dergelbesalon.at/dh e0425524@student.tuwien.ac.at

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 InfraDay, Berlin 2010 2

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 InfraDay, Berlin 2010 3

Difficulty in modelling strategic games InfraDay, Berlin 2010 4

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... InfraDay, Berlin 2010 5

Optimization & Equilibrium: Complementarity Modelling InfraDay, Berlin 2010 6

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 ??? InfraDay, Berlin 2010 7

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 InfraDay, Berlin 2010 8

A Crude Oil Market Model InfraDay, Berlin 2010 9

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 InfraDay, Berlin 2010 10

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) InfraDay, Berlin 2010 11

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 InfraDay, Berlin 2010 12

Methodology of Investment Analysis InfraDay, Berlin 2010 13

Structure of the Investment Game 96-.):-*)+,/+;/(68-,(/ .656./(656.+086,* =)>?/(68-,( '(()*)+,-./01+(23*)+,/ @+A/(68-,( 3-0-3)*4/),567*86,* =)>?/(68-,( <+/-(()*)+,-./01+(23*)+,/ / @+A/(68-,( 3-0-3)*4/),567*86,* !"#$%& !""# !"$! !"$% !"$& From the point of view of one strategic crude oil supplier InfraDay, Berlin 2010 14

Solution Method (I) 96-.):-*)+,/+;/(68-,(/ !" !"#$%&'(%#')*+",+*-%(.#-/ .656./(656.+086,* =)>?/(68-,( !" !"#$%&'(%#')*012*-%(.#-/ '(()*)+,-./01+(23*)+,/ 3-0-3)*4/),567*86,* @+A/(68-,( !" !#1*"#$%&'(%#')*+",+*-%(.#-/ =)>?/(68-,( !" !#1*"#$%&'(%#')*012*-%(.#-/ <+/-(()*)+,-./01+(23*)+,/ / @+A/(68-,( 3-0-3)*4/),567*86,* !"#$%& !""# !"$! !"$% !"$& Numerical solution using market equilibrium model InfraDay, Berlin 2010 15

Solution Method (II) 96-.):-*)+,/+;/(68-,(/ .656./(656.+086,* =)>?/(68-,( ! !" "#$%&'()&$(* E '(()*)+,-./01+(23*)+,/ 3-0-3)*4/),567*86,* @+A/(68-,( =)>?/(68-,( ! !" "$+!#$%&'()&$(* E <+/-(()*)+,-./01+(23*)+,/ / @+A/(68-,( 3-0-3)*4/),567*86,* !"#$%& !""# !"$! !"$% !"$& Compare expected Net Present Value – Input for Nash Game InfraDay, Berlin 2010 16

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 InfraDay, Berlin 2010 17

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 InfraDay, Berlin 2010 18

Countries included in the data set Source: http://commons.wikimedia.org/wiki/File:BlankMap-World-v2.png InfraDay, Berlin 2010 19

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 of Non-Structural model, the Demand-Supply Framework and Informal Approaches. Working Paper 32. Oxford Institute of Energy Studies, March 2007. InfraDay, Berlin 2010 20

Some results InfraDay, Berlin 2010 21

Nash Investment Game Russia ¡ No ¡Investment ¡ Investment ¡ No ¡Investment ¡ Saudi ¡Arabia ¡ Investment ¡ Unique Nash equilibrium for all demand scenarios independent of demand developmen t! InfraDay, Berlin 2010 22

Demand and Price – Speedy Recovery Consumption OECD/non-OECD (MMbbl/d, left) and price (US $/bbl, right) InfraDay, Berlin 2010 23

Demand and Price – Green Rebound Consumption OECD/non-OECD (MMbbl/d, left) and price (US $/bbl, right) InfraDay, Berlin 2010 24

Demand and Price – Long Slump Consumption OECD/non-OECD (MMbbl/d, left) and price (US $/bbl, right) InfraDay, Berlin 2010 25

Demand and Price – Tiger & Dragon Consumption OECD/non-OECD (MMbbl/d, left) and price (US $/bbl, right) InfraDay, Berlin 2010 26

Remaining Reserves after 2030 in % (relative reserve shares are similar in all scenarions) InfraDay, Berlin 2010 27

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 InfraDay, Berlin 2010 28

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 InfraDay, Berlin 2010 29

Import Dependence – Europe Imports and domestic production in MMbbl/d, in 2030 InfraDay, Berlin 2010 30

Import Dependence – North America Imports and domestic production in MMbbl/d, in 2030 InfraDay, Berlin 2010 31

Import Dependence – Asia Pacific Imports and domestic production in MMbbl/d, in 2030 InfraDay, Berlin 2010 32

Conclusion InfraDay, Berlin 2010 33

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 InfraDay, Berlin 2010 34

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! InfraDay, Berlin 2010 35

Thank you for your attention! e0425524@student.tuwien.ac.at dhuppmann@diw.de http://dergelbesalon.at/dh InfraDay, Berlin 2010 36