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Economics of Energy & Environmental Policy
Volume 9, Number 2

Symposium on Geopolitics and the Oil Price Cycle

Geopolitics and the Oil Price Cycle - An Introduction

Amy Myers Jaffe

DOI: 10.5547/2160-5890.9.2.ajaf
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Oil prices experienced record volatility in the spring of 2020 amid two separate, but simultaneous shocks-the largest singular, sudden drop in oil demand in history amid lockdowns across the world to slow the spread of the COVID-19 pandemic and a brief oil price war among the world's largest oil producers. The gyration was the latest in a series of oil price shocks, both upwards and downwards, experienced in recent years. This EEEP symposium on Geopolitics and the Oil Price Cycle brings together leading scholars from three respected academic energy centers, including researchers from Texas and the Middle East, to address different aspects of the question in light of key strategic geopolitical changes since 2000. The symposium considers three papers on important aspects to geopolitics and oil prices: the end to the U.S. ban on crude oil exports; the Arab Spring and geopolitical risk, and OPEC's policies regarding its spare production capacity.

A Regionalized or Unified Oil Market: The Price Spread Between Brent and WTI

Robert. K. Kaufmann

DOI: 10.5547/2160-5890.9.2.rkau
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I evaluate the degree to which local supply/demand conditions and exchange rates affect the price for WTI and Brent and their price spread by estimating cointegrating vector autoregression (CVAR) models and using a saturation indicator technique to identify periods when these long- and short-run relations change. A bivariate CVAR model that includes the price of Brent and WTI changes during seven regimes. Two correspond to a boom and bust in prices associated a speculative bubble while the other regimes coincide with periods when the price spread between Brent and WTI rises and falls. These regimes are eliminated by adding exchange rates and variables that proxy local supply and demand. Of these variables, increased pipeline flows play the biggest role in reducing the price spread. Lifting the ban on U.S. exports of crude oil increases the price spread due to transportation costs and discounts needed to introduce refiners to a new crude. Conversely, there is no clear explanation for the sharp rise in the price difference. Instead, some of the increase may be associated with changes in the supply/demand balance for Brent that are not included in the model. Together, these results suggest that technical changes affect local supply and demand for crude oil and regionalize prices, but regionalization creates opportunities for arbitrage which are realized by investments in new transportation networks and legal changes, and they re-unify the world oil market. Lifting the U.S. ban on exports of crude oil in December 2015 increases the degree to which the global oil market is unified relative to 2011�2014, but does not imply a return to the previous equilibrium; the ongoing increase in the price spread between Brent and WTI could be reversed by investments in transportation infrastructure that allow PADD 3 exporters to load their cargoes on larger ships.

The Ephemeral Brent Geopolitical Risk Premium

Hany Abdel-Latif, Mahmoud El-Gamal, and Amy Myers Jaffe

DOI: 10.5547/2160-5890.9.2.habd
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We study the changing relationship between Brent oil prices and geopolitical risk, conditional on physical oil market conditions. We conduct the analysis at three frequencies, medium (1-3 years), high (2-3 months), and very high (daily), using three complementary techniques at the different levels (respectively, continuous wavelet partial coherence, VAR and GARCH-MIDAS) over the period April 1993 to the end of 2018. At the annual frequency, we find evidence of a sustained positive relationship between oil prices and geopolitical risk over the past decade�with geopolitical risk leading during the Arab Spring, resulting in a substantial geopolitical risk premium, and lagging thereafter by about two months, as oil markets first reacted to and then anticipated geopolitical events. At the monthly frequency, we find the same positive correlation with oil prices anticipating geopolitical risk in both parts of the sample and find that realized geopolitical strife has not led to higher prices in either subsample. At the daily frequency, we find that geopolitical risk has had a positive effect on oil price volatility in later days during the second half of the sample (2005 to 2018). Our findings suggest that some financial market speculators, such as macro hedge funds and algorithmic traders, may amass long positions in Brent in anticipation of geopolitical threats that might potentially lead to oil disruptions.

OPEC’s Pursuit of Market Stability

Axel Pierru, James L. Smith, and Hossa Almutairi

DOI: 10.5547/2160-5890.9.2.apie
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We investigate attempts by the Organization of Petroleum Exporting Countries (OPEC) to stabilize the price of oil during the past fifty years. We first develop a novel decomposition of shifts in global demand and non-OPEC supply. This decomposition provides a fresh perspective on the debate over the relative importance of demand versus supply factors as determinants of previous price movements. When factoring in OPEC's production, the analysis suggests market stabilization efforts by OPEC. Using more detailed monthly data available only since 2001, we extend and refine Pierru, Smith, and Zamrik's (2018) analysis of OPEC's management of spare capacity to offset shocks to demand and supply. Although OPEC's attempt to identify and offset shocks has not been perfect, we nevertheless conclude that, overall, OPEC's use of spare capacity has achieved a significant reduction in the volatility of the price of oil. This has been particularly true during the recent OPEC+ period. We also provide an estimate of welfare gains to the global economy that result from OPEC's effort to reduce price volatility and show how these gains have been distributed geographically.


Resource Adequacy with Increasing Shares of Wind and Solar Power: A Comparison of European and U.S. Electricity Market Designs

Audun Botterud and Hans Auer

DOI: 10.5547/2160-5890.9.1.abot
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We raise the question if improvements to current energy-only markets are sufficient to maintain resource adequacy in electricity markets or whether the rapid increase in wind and solar power gives stronger arguments for additional capacity mechanisms. A comparative analysis between Europe and the United States reveals some fundamental differences, but also many similarities in electricity market design on the two continents. We provide a list of general and specific recommendations for improved electricity markets and argue that lessons can and should be learned in both directions. The key to achieve a market-compatible integration of renewable energy is to focus on correct price formation in the short-term. Increased demand-side participation, improved pricing during scarcity conditions, and a transition from technology-specific subsidies of renewables towards adequate pricing of carbon emissions are important measures towards this end. In contrast, an increasing reliance on administrative capacity mechanisms would bring the industry back towards the centralized integrated resource planning that prevailed at the outset of electricity restructuring more than 25 years ago.

The Impact of Intermittent Power Generation on the Wholesale Electricity Prices of the MIBEL Iberian Market

Paulo Pereira da Silva and Paulo Horta

DOI: 10.5547/2160-5890.9.1.pdas
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This study addresses the effect of intermittent renewable energy generation on the dynamics of electricity prices of the Iberian market (Spain and Portugal) during the period 2010-2015. The results indicate that intermittent renewable energy has a material negative effect on electricity price, consistent with the presence of a merit-order effect. Still, that effect varies with the technology employed: wind power produces a greater impact on price vis-a-vis solar photovoltaic energy. Daily wind supply and daily demand display a higher correlation than daily solar photovoltaic power and daily demand. That implies that wind supply can be used more effectively as a hedging tool for demand variation, thereby bringing about greater price impact. Notably, there is no evidence that the impact of intermittent renewable electricity penetration has been declining over time or that marginal negative returns result from additional installed capacity at this point. Finally, the findings of this study suggest that market coupling weighs (negatively) on the elasticity of price to intermittent renewable energy production. This result is consistent with the notion that further market integration improves risk sharing and efficient resource allocation.

Shale Gas and Oil Development: A Review of the Local Environmental, Fiscal, and Social Impacts

Claudia Hitaj, Irene M. Xiarchos, Roger Coupal, and Timothy W. Kelsey, and Richard S. Krannich

DOI: 10.5547/2160-5890.9.1.chit
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In the early 2000s, advances in horizontal drilling and hydraulic fracturing technologies led to a veritable boom in the extraction of natural gas and oil from shale plays. In this review article, we discuss the local, state, and federal regulatory context in which this shale gas and oil production occurs and review how it affects local communities, the environment, and government income and spending. We find that long-term employment effects are relatively low, while shale development is associated with short-term boom and bust cycles that affect both employment and local and state finances. Environmental and community impacts include noise, light, and air pollution, increased risk of soil or water contamination, increased truck traffic, and increased demand for housing and schooling. The distribution of local costs and benefits hinges on ownership of oil and gas rights. There is variation across states and localities in how resource extraction is taxed and how these funds are used, including the extent to which the funds are targeted to specific purposes and whether they are spent in the short or long term. These policy differences can determine the ability of states and localities to prosper from this resource boom over the long term.

The Synergies Between EU Climate and Renewable Energy Policies-Evidence from Portugal Using Integrated Modelling

Sara Proença and Patrícia Fortes

DOI: 10.5547/2160-5890.9.1.spro
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In the current debate about the cost-effectiveness of the EU climate and energy policy, the coexistence of greenhouse gas (GHG) emissions reduction and renewable energy targets, as well as the EU Emissions Trading Scheme (ETS), have been subject to some criticism. In this paper we explore the interactions between EU climate and renewable energy targets and policies, by assessing the synergies and trade-offs between alternative policy designs and implementation mechanisms to cope with the EU GHG emissions reduction and renewable energy targets for 2030. The analysis is carried out by using the Hybrid Bottom-up General Equilibrium Model (HyBGEM) and taking Portugal as a case study. Results show that the current segmentation of the EU emissions market (between ETS and non-ETS sectors) leads to a costly emissions mitigation. Moreover, imposing a renewable energy target on top of the emissions constraints may attenuate the GHG abatement costs from second-best induced gains in efficiency. Renewable energy subsidies act as a correction of pre-existing taxation on the Portuguese economy, countervailing excess burden on abating carbon emissions. These findings suggest that the cost-effectiveness of climate mitigation and energy policies is interlinked with the country's economic, financial and energy characteristics, emphasizing the need to consider the specificities of each Member State when designing policy mixes.

Beyond the inverted U-shape: Challenging the long-term relationship of the Environmental Kuznets Curve hypothesis

Lars Sorge and Anne Neumann

DOI: 10.5547/2160-5890.9.1.lsor
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This paper empirically tests the validity of the postulated Environmental Kuznets Curve for a panel of 69 countries from 1971 to 2014 which are clustered into all-, high-, middle-, and lower-income groupings. Since the quadratic EKC specification between carbon dioxide emissions and GDP produces highly biased results in favour of an inverted U-shaped pattern, we adopt a cubic formulation and estimate the long-term coefficients signs and significance accounting for country specific slope heterogeneity. Our empirical results rather support a N-shaped than an inverted U-shaped pattern for the pollution income relationship particularly in the all-income panel. We find no evidence of an inverted U-shaped pattern associated with the EKC hypothesis in any panel. Our analysis indicates that promoting economic growth is not a panacea to simply grow out of pollution related problems in the long-term.

Measuring Energy Efficiency: Accounting for the Hidden Costs of Product Failure

Art Fraas and Sofie E. Miller

DOI: 10.5547/2160-5890.9.2.afra
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Several recent studies suggest that minimum energy efficiency standards for appliances have resulted in higher-quality products with little or no increase in price. We have conducted case studies for the two major household appliances-clothes washers and refrigerators-subject to Department of Energy (DOE) energy efficiency standards implemented over the 2001 to 2011 period. We identify three issues plaguing appliances that yielded lower cost savings than projected in DOE's ex ante analyses: (1) product life and reliability; (2) greater energy usage than anticipated; and (3) additional operation and maintenance costs. These two case studies illustrate the need to consider the potentially substantial costs of operation and repair in conducting retrospective analyses of DOE energy efficiency standards. In addition, these case studies identify the limited information available to consumers on repair and replacement rates at the time of purchase and suggest some possible policy responses.

The Economics of Sustainability: Causes and Consequences of Energy Market Transformation

Rabah Arezki

DOI: 10.5547/2160-5890.9.2.rare
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The paper deals with the economics of sustainability associated with the transformation of energy markets. It emphasizes the interrelations between technical changes and energy markets and how in turn the resulting transformations alter the sustainability of economic systems that are dependent on these markets. It also explores how innovation (or the lack thereof) is intimately linked to the ability of energy rich economies to adapt and transform. The agenda is especially relevant for oil rich countries that have announced or already put in place policies to help transform their economies and move away from dependence on oil. The agenda is also relevant for the global community, as it relates to the economic consequences of the needed transformation of energy markets to support the goal of limiting global warming by reducing greenhouse gas emissions.

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