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The Impact of Oil Price Volatility on Welfare in the Kingdom of Saudi Arabia: Implications for Public Investment Decision-making

Axel Pierru and Walid Matar

Year: 2014
Volume: Volume 35
Number: Number 2
DOI: 10.5547/01956574.35.2.5
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Abstract:
Since real oil price is positively correlated with real consumption and domestic income in Saudi Arabia, a risk premium needs to be considered when assessing the net present value of oil-related public investment projects. For projects generating additional oil exports, this risk premium quantifies the cost of increased dependence on oil revenues. For projects transforming oil into products whose prices are less correlated with the Saudi economy, it quantifies the benefit from reducing the aggregate risk. The value of this risk premium depends on expectations about future consumption and oil price. By considering alternative assumptions, we show that over a one-year horizon this risk premium could range between 1.3% and 5% of the expected oil-related cash flow, with higher premia for longer planning horizons. We discuss the implications of these calculations for energy-related public projects in Saudi Arabia and, more generally, for public decision-making in resource-rich countries. Keywords: Risk premium, Oil, Public investment, NPV, Domestic income, Saudi Arabia



How do Price Caps in China’s Electricity Sector Impact the Economics of Coal, Power and Wind? Potential Gains from Reforms

Bertrand Rioux, Philipp Galkin, Frederic Murphy, and Axel Pierru

Year: 2017
Volume: Volume 38
Number: KAPSARC Special Issue
DOI: 10.5547/01956574.38.SI1.brio
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Abstract:
China imposes maximum prices by plant type and region on the electricity that generators sell to utilities. We show that these price caps create a need for subsidies and cross-subsidies, and affect the economics of wind power. We model the price caps using a mixed complementarity formulation, calibrated to 2012 data. We find that the caps impose an annual cost of 45 billion RMB, alter the generation and fuel mixes, require subsidies for the market to clear, and do not incentivize adding capacity for a reserve margin. They incentivize market concentration so that generators can cross-subsidize power plants. Depending on the regulatory response, increasing wind capacity can alleviate the distortions due to the price caps. The added wind capacity, however, does not have a significant impact on the amount of coal consumed. We also find that the feed-in tariff was priced slightly higher than necessary.



OPEC’s Impact on Oil Price Volatility: The Role of Spare Capacity

Axel Pierru, James L. Smith, and Tamim Zamrik

Year: 2018
Volume: Volume 39
Number: Number 2
DOI: 10.5547/01956574.39.2.apie
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Abstract:
OPEC claims to hold and use spare production capacity to stabilize the crude oil market. We study the impact of that buffer on the volatility of oil prices. After estimating the stochastic process that generates shocks to demand and supply, and assessing OPEC's limited ability to accurately measure and offset those shocks, we find that OPEC's use of spare capacity has reduced price volatility, perhaps by as much as half. We also apply the principle of revealed preference to infer the implicit loss function that rationalizes OPEC's investment in spare capacity and compare it to other estimates of the cost of crude oil supply shortfalls. That comparison suggests that OPEC's buffer capacity was in line with global macroeconomic needs.



Cooperate or Compete? Insights from Simulating a Global Oil Market with No Residual Supplier

Bertrand Rioux, Abdullah Al Jarboua, Fatih Karanfil, Axel Pierru, Shahd Al Rashed, and Colin Ward

Year: 2022
Volume: Volume 43
Number: Number 2
DOI: 10.5547/01956574.43.2.brio
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Abstract:
Structural changes in the oil market, such as the rise of tight oil, are impacting conventional market dynamics and incentives for producers to cooperate. What if OPEC stopped organizing residual production collectively? We develop an equilibrium model to simulate a competitive world oil market from 2020 to 2030. It includes detailed conventional and unconventional oil supplies and financial investment constraints. Our competitive market scenarios indicate that oil prices first decline and tend to recover to reference residual supplier scenario levels by 2030. In a competitive oil market, a reduction in the financial resources made available to the global upstream oil sector leads to increased revenues for low-cost producers such as Saudi Arabia. Compared to the competitive scenario, Saudi Arabia does not benefit from acting alone as a residual supplier, but, under some assumptions, it benefits from being part of a larger group that works collectively as a residual supplier.



Oil Market Stabilization: The Performance of OPEC and Its Allies

Hossa Almutairi, Axel Pierru, and James L. Smith

Year: 2023
Volume: Volume 44
Number: Number 6
DOI: 10.5547/01956574.44.6.halm
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Abstract:
We examine the influence of OPEC+ on the level and volatility of oil prices. By extending Pierru et al.'s (2018, 2020) modeling framework, we are able to distinguish OPEC's particular role and impact from that of its Allies—those countries who joined with OPEC at the end of 2016 in the attempt to stabilize the market. In addition to corroborating earlier results regarding the impact of OPEC's management of spare capacity prior to 2017, we now present an analysis of how the concerted actions by the larger community of OPEC+ members have affected prices, including during the tumultuous period in which the COVID-19 pandemic took hold. We find that OPEC+'s efforts to stabilize the market reduced price volatility by up to one half, both before and during the pandemic. We attribute most of that reduction to OPEC's own actions whereas the impact of the Allies' efforts was mostly to support the price level. In that vein, OPEC+'s management of spare capacity barely impacted the average price over the pre-pandemic period, but, by countering the price collapse caused by the pandemic demand shock, lifted the average price by $35.70 from May 2020 through August 2021.



Mitigating Climate Change While Producing More Oil: Economic Analysis of Government Support for CCS-EOR

Hossa Almutairi and Axel Pierru

Year: 2024
Volume: Volume 45
Number: Special Issue
DOI: 10.5547/01956574.44.SI1.halm
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Abstract:
By storing CO2 captured from the atmosphere or point sources into oil fields, carbon capture and storage with enhanced oil recovery (CCS-EOR) increases the fields' output by raising reservoir pressures. Since CO2-EOR has been experimented with for decades and the revenues from the additional oil production improve projects' economics, CCS-EOR is the most readily deployable CCS technology. However, government support for CCS-EOR projects is sometimes contested on the grounds that the resulting increase in oil production undermines their environmental benefits. Addressing this concern requires determining the effects of implementing CCS-EOR on global CO2 emissions. This paper presents a simple approach based on a marginal reasoning consistent with economic decision-making. It produces analytical formulas that account for the effects on the global oil market of incentivizing CCS-EOR. In addition, we quantify the volume of oil that can be decarbonized by storing a ton of captured CO2 through EOR from different perspectives. We produce numerical results based on a first-cut calibration. They suggest that, from an economic perspective, CCS-EOR is a technology that mitigates global emissions. However, after accounting for the need to decarbonize the EOR oil, the reduction in emissions is significantly less than the stored quantity of CO2. If fully allocated to oil production, the environmental benefits of capturing a ton of CO2 and storing it through conventional EOR can allow the oil producer to decarbonize 3.4 barrels on a well-to-wheel basis and 14.4 barrels when offsetting its oil-upstream emissions only. Fiscal incentives granted by governments to support CCS-EOR as a climate-change mitigation technology should be sized accordingly. We compare our findings to the size of the subsidy in the revised Section 45Q of the 2022 United States Inflation Reduction Act.





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