Ecbwp1855 en PDF
Ecbwp1855 en PDF
Ecbwp1855 en PDF
Note: This Working Paper should not be reported as representing the views of the European Central Bank (ECB).
The views expressed are those of the authors and do not necessarily reflect those of the ECB
Abstract
The aim of this paper is to analyze the impact of the so-called “shale oil revolution” on oil
prices and economic growth. We employ a general equilibrium model of the world oil market
in which Saudi Arabia is the dominant firm, with the rest of the producers as a competitive
fringe. Our results suggest that most of the expected increase in US oil supply due to the
shale oil revolution has already been incorporated into oil prices and that it will produce an
additional increase of 0.2 percent in the GDP of oil importers in the period 2010-2018. We
also employ the model to analyse the collapse in oil prices in the second half of 2014 and
conclude that it was mainly due to positive unanticipated supply shocks.
Keywords: Saudi Arabia, general equilibrium, shale oil.
Oil markets have recently undergone a significant transformation with the unexpectedly strong
rise in the US production of shale oil. The combination of horizontal drilling techniques together
with hydraulic fracturing - developed in the 1970s - and rising oil prices have made the exploration
and exploitation of large volumes of shale oil possible. In the United States, the extraction of
shale oil has grown dramatically over the last few years taking the market by surprise. In 2013,
the United States is estimated to have produced 3.5 mb/d of shale oil, which is three times higher
than the amount it produced in 2010 (EIA, 2014). Going forward, the production of shale oil in
the United States is projected to continue to rise, reaching 4.8 mb/d by 2020, equivalent to about
a third of total US oil supply. More generally, from a global perspective, the fast-rising shale oil
production has been a major factor supporting non-OPEC supply growth which, together with
moderating global oil demand, explains the relative stability of Brent oil prices until mid-2014.
Although the Unites States is expected to remain the dominant shale oil producer for the next
decade, there is potential to replicate the US shale oil success elsewhere, as technically recoverable
shale oil resources are estimated to be abundant also outside the United States (five times the size
of US shale oil resources according to EIA, 2013).
This paper assesses the impact of shale oil on oil prices and economic growth, using a general
equilibrium modeling framework that takes account of the oil market structure, and in particular
of the role of Saudi Arabia. The key advantage of our model is that the reaction of Saudi Arabia is
embedded in the model. Saudi Arabia is the largest OPEC producer and also has the largest spare
capacity which gives it substantial power among OPEC members to influence markets. As a result,
the price impact of shale oil will necessarily depend on the response of Saudi Arabia. In contrast
to other studies which typically make an explicit assumption about Saudi Arabia (PWC, 2013), in
our framework the response of Saudi Arabia is determined endogenously. Our paper complements
existing literature that mostly looked into either estimating the size of shale oil production and
resources (e.g. EIA, 2014, IEA, 2013, and earlier studies) or analyzing the factors which caused the
shale oil revolution to occur in the United States and not elsewhere (e.g. Alquist and Guenette,
2014, Maugeri, 2012). Several studies use global econometric models to estimate wider economic
implications of the shale oil revolution (PWC, 2013), whereas a few focus on the impact on oil
prices, usually gauged by relatively simple methods (e.g. PWC, 2013; Sharenow and Worah, 2013).
We assess the impact of the shale oil revolution under three scenarios about US shale oil
projections by 2018: a baseline scenario using the EIA (2014) projections of US shale oil and two
alternative scenarios to capture the uncertainty surrounding the baseline projections. In all the
three cases we assume that Saudi Arabia maximizes its discounted flow of profits. Our results
suggest that (i) most of the shale oil revolution is already priced in, and (ii) even considerable
changes in the scale of the production will have only a small effect on prices. The oil price impact
3.1 Scenarios
In order to introduce the different scenarios into the model, we calibrate the shocks for the oil
production technology of the fringe producers in order to replicate the increase in supply due
3.2 Results
Figure 3 shows the difference between the long-run path followed by oil production and prices in
the three scenarios and the counterfactual path in the case of no shale oil production. The period
of interest is 2014-2018, but we assume, in line with the data, that shale oil production began in
2010. In the upper left panel we display the alternative scenarios for the production of shale oil
described above.
The model analysis suggests that oil prices in 2014 already incorporated most of the reduction
due to the increase in the oil supply. In the upper right panel of the figure, we display the evolution
of oil prices (relative to the counterfactual path). In the baseline scenario, most of the impact of
7
Notice that we are subtracting 0.8 mb/d in all years in order to remove the “pre-revolution” residual production
of shale oil.
2. Unanticipated demand shocks. During 2014 there were a number of negative surprises
to the global economic growth rate which forced the IEA to revise downwards its oil demand
forecasts. This global slowdown produced a decline in the prices of many commodities,
including metals and foodstuffs, during the second half of the year. In addition, the strong
appreciation of the US dollar increased the real price of oil in other currencies, thus reducing
the demand for oil.
5 Policy implications
The shale oil revolution and the recent decline in oil prices affect economic growth in a country-
specific way, and thus the policy prescriptions should vary accordingly.
The losers are the traditional oil exporters. Figure 8 displays the share of oil exports in GDP for
a sample of major oil exporters. A decline by half in the price of oil may produce GDP contractions
as large as 20-25% for countries such as Kuwait and Venezuela. Some of these countries, such as
Saudi Arabia and Kuwait, have large sovereign wealth funds (SWFs) that may help to cushion the
fall in prices but others are more exposed to this negative shock.
Once again, the important role of Saudi Arabia in the future evolution of oil prices should be
highlighted. In 2014, in contrast with the long-run predictions of the model, Saudi Arabia has
decided not to accommodate the increase in oil supply, in an attempt to defend market share and
to expel some high cost producers from the market. This is a strategy aimed at curbing new
investment in exploration, avoiding demand substitution towards alternative energy sources and
improving its relative position vis-à-vis some of its geopolitical competitors such as Iran. However,
in the short-run the Saudis are facing a major loss of revenues that, if long-lasting enough, may
destroy all the wealth accumulated during the boom years.
12
Due to their negligible short-run effect, we ignore the shale oil shocks. The extension is explained in the
Appendix.
6 Conclusions
Oil markets have recently undergone a significant transformation with the rise in the US production
of shale oil, which is expected to pick up and to reach around 4.8 mb/d by 2020, i.e. about a third
of total US supply, according to the EIA. This paper assesses the impact of the “US shale oil
revolution” on global oil prices and quantities, which ultimately depends on two key factors: 1)
the quantity of oil that is eventually produced, subject to environmental and technological risks
and 2) the response of Saudi Arabia to sustain prices.
To capture the current uncertainty regarding the size of future US shale oil supply, we consider
two alternative scenarios, i.e. a lower and a higher shale oil production scenario; this results in
some bounds around our baseline projections, which are based on EIA forecasts. Regarding the
response by Saudi Arabia to sustain prices, we employ a general equilibrium model that rationalizes
13
The impact of oil prices on inflation and economic activity at the ZLB has been discussed in recent papers such
as Bodenstein et al. (2013) and Wieland (2014).
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mimeo.
Oil-importing region
A representative household has a period utility function which depends on consumption, Ct , oil
Ot , and labor lt , and takes the form
which equates income from labor, wt lt , capital, rtk Kt−1 , and bonds, rt−1 Bt−1 , to outlays on con-
sumption, Ct , capital investment, It , new one-period bonds, Bt , and oil, Pt Ot ; Pt denotes the
real price of oil, while wt denotes the real wage. All oil must be consumed within the period of
production. Capital is accumulated according to
Kt = (1 − δ) Kt−1 + It , (2)
subject to the budget constraint (1), where 0 < β < 1 is a time preference parameter.
Final goods are produced with labor and capital by a representative price-taking firm, according
to
Yt = (Zt lt )α Kt−1
1−α
, (3)
with 0 < α < 1. Aggregate total factor productivity Zt evolves according to a deterministic
z
exponential process: Zt = Zt−1 eg , where g z is a constant.
Utility maximization by households implies the following oil demand curve
ν t Ct = Pt Otη , (4)
wt lt = αYt , (8)
The region’s resource constraint states that total output, Yt , must equal the sum of consump-
tion, Ct , investment, It , and the current account, (Pt Ot + Bt − rt−1 Bt−1 ) .
where consumption, C̃t , and investment, I˜t , are both purchased from the oil-importing region, r̃tk
is the rental price of capital K̃t rented out by the household to oil firms, B̃t are one-period bonds
that pay an interest of r̃t and D̃t are oil firm dividends rebated lump sum to the household.
The household invests in capital according to
1/γ̃−1
Õt
γ̃Pt = 1/γ̃ 1/γ̃−1
. (15)
Z̃t K̃t−1
using an imported intermediate good X̂t and capital K̂t−1 . The dominant supplier’s technology
evolves deterministically according to Ẑt = Ẑ0 exp(g ẑ t) where g ẑ = g z̃ , that is, unlike the fringe, the
dominant supplier’s output is not directly affected by productivity shocks. Capital is accumulated
by purchasing Iˆt units of the investment good from the oil-importing region and the representative
household receives a stream of log utility from consumption Ĉt .
The substantial difference with the competitive fringe is that the dominant oil supplier has
market power: it is aware of the dependence of fringe oil supply, of oil demand, and of the
equilibrium oil price on its supply decision. The dominant supplier chooses a state-contingent plan
which maximizes the expected present discounted utility of its owners, subject to the demand by
the oil-importing region, the supply of competitive fringe producers, and clearing in the oil market.
Thus, the decision problem of the dominant oil producer is to
∞
max Eo β t log(Ĉt )
Ĉt ,B̂t ,X̂t ,K̂t ,Pt t=0
subject to oil demand (4), fringe oil supply (15), its production technology (17), the oil market
clearing condition
Ot = Ôt + Õt (18)
This amounts to assuming that while Saudi Arabia acts as a monopolist supplier of its residual
Ĉt
1 = βEt r̂t ,
Ĉt+1
Ĉt Ôt+1
1 = βEt (1 − γ̂) (Pt+1 + Λt+1 ) + (1 − δ) ,
Ĉt+1 K̂t
where Λt is the Lagrange multiplier associated with equation (18)
Pt Ôt
Λt = − . (20)
1 γ̃
O
η t
+ Õ
1−γ̃ t
Ôt
Λt = − ,
Ot Õt
Φ
Pt D
+ Pt S
Φ
γ̃
where ΦD ≡ − OPtt ∂Ot
∂Pt
= η1 is the short-run oil demand elasticity from (4) and ΦS ≡ ÕPt ∂∂PÕtt = 1−γ̃ is
t
the short-run fringe supply elasticity from (15).
The dominant oil supplier extracts a pure rent by picking the profit-maximizing point on the
residual demand curve, where marginal revenue equals his marginal cost.
The model incorporates secular trends in the growth rate of final goods technology (Zt ), oil
production technology (Z̃t and Ẑt ), and oil efficiency (ν t ). Stationarity of Saudi Arabia’s market
share requires g z̃ = g ẑ . In a steady-state with balanced growth, the ratio Pt Ot /Yt must remain
stationary. Given g z̃ = g ẑ , since Ot grows at rate g z + g z̃ = g z + g ẑ , while Yt grows at rate g z , for
the ratio Pt Ot /Yt to remain stable, Pt should grow at rate −g z̃ .
Calibration
We employ the same calibration as in Nakov and Nuño (2014). The working frequency of the
model is monthly. The secular growth rate of technology of the oil-importing region is set to
exp(g z ) = 1.031/12 , consistent with an average world output growth rate of 3 percent per year for
the period from 1973 to 2009. Given this, the time preference parameter is set to β = 1.01−1/12
equivalent to an average real interest rate of 4 percent per year. Based on the stationary market
share of Saudi Arabia in the data, we impose equality between the growth rates of the dominant
oil producer and the fringe, g ẑ = g z̃ . The average growth rate of total oil production is 0.8 percent
per year in the data. In the model this must equal the sum of the growth rate of the inputs
of oil production, g z , and the growth rate of the oil production technology itself, g z̃ , implying a
value for exp(g z̃ ) = 0.9982 on a monthly basis. The latter implies that the real oil price must
grow at an annual rate of 2.2 percent, which is consistent with the average growth rate actually
observed in the data. Second, the three parameters governing the oil-importing region’s labor
disutility, technology, and capital depreciation are set to their typical values in the RBC literature:
the inverse Frisch elasticity is set to ω = 1, the labor share in the production of final goods is
set to α = 0.67; and the depreciation rate is set to δ = 1.101/12 − 1, consistent with 10% annual
P ∂O
depreciation of installed capital. Third, the price elasticity of oil demand in the model is O ∂P
= η1 .
We set η = 4, consistent with Kilian and Murphy’s (2014) estimates of the short-run price elasticity
of oil demand of about 0.25. Fourth, the parameters of the two oil production technologies and the
efficiency (Z̃0 , Ẑ0 , γ̃, γ̂, ν 0 ) are calibrated as follows: γ̃ = 0.4, Ẑ0 = 1.8740, γ̂ = 0.5, ν 0 = 0.0041.
These values allow the model to match an average “oil share in spending” of 5 percent of GDP,
as well as the following three averages for Saudi Arabia: a global market share of 12.3%, capacity
utilization of 75%, and a price mark-up of 25%.
Regarding the scenarios, the baseline scenario is calibrated so that shale oil production in the
Unites States increases from roughly zero in 2010 to 2.7 mb/d in 2014 and reaches a peak of 4
mb/d in 2018 in line with EIA projections. This scenario assumes that current law and regulations
1. Supply shocks. We recalibrate the process log(ãt ) = ρã log(ãt−1 ) + εãt , with persistence
ρã = 0.8745 (which is equivalent to 0.2 on an annual basis) and a Gaussian innovation εãt
with mean zero and variance σ 2ã = 0.052 .
2. Demand shocks. We introduce a demand shock as a shock to the TFP of oil importers.
z z
We have now thatZt = Zt−1 e(g +ḡt ) , where ḡtz is a stochastic process
log(ḡtz ) = ρz log(ḡt−1
z
) + εzt ,
with persistence ρz = 0.9913 (which is equivalent to 0.9 on an annual basis) and a Gaussian
innovation εzt with mean zero and variance σ 2z = 0.012 .
3. Saudi Arabia shocks. In order to analyze the deviation of Saudi Arabia from its optimal
rule, we modify the objective function of the dominant oil producer
∞
max Eo β t ât log(Ĉt ),
Ĉt ,B̂t ,X̂t ,K̂t ,Pt t=0
by introducing a stationary AR(1) preference shock ât , log(ât ) = ρâ log(ât−1 ) + εât with
persistence ρâ = 0.8254 (which is equivalent to 0.1 on an annual basis) and a Gaussian
14
12 Shale oil
10
6 Other oil
0
1985 1990 1995 2000 2005 2010 2015 2020
Figure 1: US total oil supply (millions of barrels per day). Source: EIA and authors’ calculations.
Table 1: Shale oil projections in 2014 and the size of their revisions with respect to the 2013 and
2012 projections.
Projections AEO 2014 Revision since AEO 2013 Revision since AEO 2012
(mb/d) (%) (%)
2014 4.07 62 343
2015 4.49 70 361
2016 4.67 72 355
2020 4.79 70 300
Source: EIA Annual Energy Outlook reports 2012, 2013 and 2014. Note that for consistency we label the table as
shale oil, although the numbers refer to tight oil projections in the EIA reports.
1
%
-1
Rest of non-OPEC
-2 US
Total non-OPEC
-3
1980 1985 1990 1995 2000 2005 2010 2015
Figure 2: US shale oil contribution to non-OPEC supply growth (annual, y-o-y growth rates).
Source: EIA. Note: the last datapoint referes to 2012; cut-off date 2014H1.
5
-4
USD per barrel
4
mbd
3 -6
2 baseline
-8
1 higher shale production
lower shale production
0 -10
2014 2015 2016 2017 2018 2014 2015 2016 2017 2018
2.5 -1
2 -1.5
mbd
mbd
1.5 -2
1 -2.5
0.5 -3
2014 2015 2016 2017 2018 2014 2015 2016 2017 2018
Figure 3: Differential effect of different shale shale production scenarios. All the figures represent
differences with respect to the counterfactual scenario of no shale production.
29
28.5
Baseline
higher shale production
28
% total capacity
27.5
27
26.5
26
25.5
2014 2014.5 2015 2015.5 2016 2016.5 2017 2017.5 2018
Figure 4: Evolution of the spare capacity of Saudi Arabia (share of total capacity).
4 -6
mbd
3.5 -7
3 -8
2.5 -9
2014 2015 2016 2017 2018 2014 2015 2016 2017 2018
1.5
-2
mbd
mbd
1
-3
0.5 baseline
low demand elasticity
0 -4
2014 2015 2016 2017 2018 2014 2015 2016 2017 2018
Figure 5: Differential effect of alternative elasticity assumptions. All the figures represent differ-
ences with respect to the counterfactual scenario of no shale production.
100
90
80 78
70
77
60
50 76
2014 2014.2 2014.4 2014.6 2014.8 2014 2014.2 2014.4 2014.6 2014.8
9 9
8.5 8.5
8 8
2014 2014.2 2014.4 2014.6 2014.8 2014 2014.2 2014.4 2014.6 2014.8
Figure 6: Evolution of oil prices and oil production in 2014. Source: EIA and Federal Reserve
Bank of St. Louis.
10
-5
m-o-m %
-10
-15
Demand shocks
-20 Supply shocks
Saudi Arabia shocks
-25
2014 2014.1 2014.2 2014.3 2014.4 2014.5 2014.6 2014.7 2014.8 2014.9
Figure 7: Contributions to the growth rate of oil prices. Source: EIA, Federal Reserve Bank of St.
Louis and authors’ calculations.
Canada 8 Brazil 8
Russia 7 US 7
Algeria 6 UK 6
Iraq 4 China 4
Venezuela 3 Turkey 3
Angola 2 Japan 2
Kuwait 1 India 1
0 10 20 30 40 50 60 0 1 2 3 4 5 6
Net oil exports (% of GDP) Net oil imports (% of GDP)
Figure 8: Net oil exports/imports for some of the major exporters/importers. Source: JODI
database and IMF. The value of exports/imports is computed for an average oil price of USD100.
Galo Nuño
Banco de España, Madrid, Spain;
e-mail: galo.nuno@bde.es
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