Assignment – 2
For
Petro
Economics
Section A (20 Marks)
Write short notes
on any four of the following:
1.
Fuel-based Differentiation
2.
Key sources of alternative fuel
3.
Role of OPEC in price
structuring
4.
Strategic Petroleum Reserve
5.
Role of E-Business in Petroleum
companies
Section B (30 marks)
(Attempt any three)
- What are the key findings of research made by A. T. Kearney to explore the strategic option for petroleum retailers in India?
- Why petroleum economics is considered as a value chain?
- Discuss the future of oil in the rising demand all over the world.
- What is the role of Middle East in the global oil balance?
Section C (50 marks)
(Attempt all questions. Every question carries 10 marks)
Read the case “Petro Economics”
and answer the following questions:
CASE STUDY: Petro Economics
The dramatic fluctuations in crude
oil prices over the past two years have sparked renewed interest in U.S. oil exploration and
development. Some politicians and commentators argue that an increase in exploration could have a
marked impact on oil prices. Others say the
price impact would be small.
The policy debate currently focuses
on allowing drilling in a small part of Alaska's Arctic National Wildlife Refuge (ANWR). Drilling has
been banned in ANWR due to various
environmental concerns.
The ANWR is a national wildlife
refuge in north-eastern Alaska, United States. It consists of 19,286,722 acres (78,050.59 km2 ) in the
Alaska North Slope region. The coastal plain in the ANWR (often referred to as the
"1002" area) is jointly owned by the federal government, the State of Alaska and Native American
corporations (Energy Information Administration (EIA), 2008a). This region is thought to contain a
relatively large amount of oil that would be
relatively cheap to develop. Environmentalists and others have opposed
drilling in this area because it is a
pristine (but inhabited) area that they believe is ecologically unique. In particular, they are concerned that a spill
or pipeline leak would endanger a key wildlife
habitat.
History
The Trans-Alaska pipeline system got
virtually completed in 1977. The Alaska National Interest Lands Conservation Act, signed by
President Jimmy Carter in December 1980,
created more than 104,000,000 acres (420,000 km2 ) of national parks and
wilderness areas from federal holdings
in that state and also allowed drilling in ANWR but not without prior approval from Congress. Section 1002 of the
act allowed the evaluation of potential
petroleum reserves in the 1002 area from surface geological studies and
seismic exploration surveys. However, no
exploratory drilling was allowed.
In November 1986, a draft report by
the United States Fish and Wildlife
Service recommended that oil and gas development be allowed in all of
the “1002 Area” of ANWR. The report argued that the oil and gas potentials of
the coastal plain were needed for the
country's economy and national security. Conservatives, however, expressed concerns that oil operations would harm the
ecological systems that support wildlife.
No major developments took place
within the next decade. In 1996 the Republican-majority House and Senate voted in favour of allowing
drilling in ANWR, but this legislation
was vetoed and turned down by President Bill Clinton.
In 2000, President George W. Bush
pushed to perform exploratory drilling for crude oil and natural gas in and around the refuge
after the USGS estimation of reserves in 1997.
The House of Representatives voted in mid-2000 to allow drilling. In
April 2002 the Senate rejected it.
On June 18, 2008 President George W.
Bush forced Congress to reverse the ban on offshore drilling in the ANWR in addition to approving
the extraction of oil from shale on federal
lands. President Bush cited the growing energy crisis as a major factor
for reversing the presidential executive
order issued by President George H. W. Bush in 1990, which banned coastal oil exploration and oil and gas
leasing on most of the outer continental shelf.
Estimated Oil Reserves
Technically recoverable oil within
the ANWR 1002 area (excluding State and Native areas), as estimated but the United States Geological
Survey in 1998, lies between 4.3 and 11.8
billion barrel of oil (BBO) (95% and 5% certainties respectively), with
a mean value of 7.7 BBO.
As estimated by USGS, this quantity
of technically recoverable oil is not distributed uniformly. The un-deformed area is estimated
to contain between 3.4 and 10.2 BBO (95%
and 5% certainties respectively), with a mean of 6.4 BBO. The deformed
is estimated to contain between 0 and
3.2 BBO (95% and 5% certainties respectively), with a mean of 1.2 BBO. The oil is expected to occur in a number
of accumulations rather than a single large
accumulation.
Commercial viability of a discovery
depends on factors like oil price, accumulation size, recovery technology, and
proximity to existing infrastructure (pipelines, markets etc.).
Economic analysis of oil reserves of
the “1002 area” includes the costs of finding, developing, producing, and
transporting oil to market (lower 48 West Coast) based on a 12 percent
after-tax return on investment, all calculated in constant 1996 dollars.
Estimates of economically recoverable oil, expressed by probability curves,
shows a directly proportionate relation between quantity of oil and its price.
It was found that at a market price of $24/barrel, there is a 95% probability
of at least 2.0 BB of economically recoverable oil and a 5% probability of at
least 9.4 BB with a mean or expected value of 5.2 BB. At prices less than
$13/barrel, no commercial oil is estimated, but at a price of $30/barrel,
between 3 and 10.4 BB are estimated.
It is interesting to note that the
best estimate of 7.7 BBO in ANWR is very close to domestic consumption in 2005
in the U.S. But still the recovery of the first barrel of crude oil would take
many years. In 2025, it is forecasted that 0.9 million barrels of oil per day
(MBD) would be recovered and the domestic production is forecasted to be 4.6
MBD (EIA 2004). Thus, at its high, ANWR is forecasted to account for 20% of
domestic production. Finally, total supply in 2025, including imports, is
forecasted to be 28.3 MBD, so ANWR at its peak is predicted to account for
approximately 3.2 percent of domestic oil consumption.
Benefits of Drilling
According to Hahn and Passell (2010),
net benefits are estimated for a price scenario of $50/barrel. It is estimated
that at $50/barrel, 7 billion barrels are economically recoverable. The
benefits include the revenue generated, price-reduction benefit and the
reduced-disruption-cost benefit.
The per barrel price-reduction
benefit is generated by reduced world demand for imported oil. It is calculated
as the reduction in the import bill divided by the decline in the number of
barrels of oil imported by the U.S. Leiby (2007) estimated it to be $10/barrel.
The reduced-disruption-cost associated with reducing oil imports is estimated
to be $5/barrel.
These values are applied to the net
decrease in total U.S. imports, which is equal to the increase in U.S. oil
production less the increase in U.S. oil consumption caused by the lower price.
7 categories of costs are considered. These are:
1. Direct
costs that producers incur in extracting the oil and bringing it to the market.
Estimated average direct costs: $19/barrel.
2. Cost
of not being able to use the affected resource for other purposes if drilling
occurred or „Use Value‟. Kotchen and
Burger (2007) estimate it to be 0/barrel.
3. Cost
of valuing a resource but never intending to use it or „Non-use Value‟. It is estimated roughly to be $11 billion (Carson et al. 2003).
4. Global
air pollution or greenhouse gas damage. It is assigned a value 0 as share of
ANWR drillings to the global air pollution is negligible.
5. Local
air pollution. It is estimated to be $22 billion (Parry 2005).
6. Traffic
congestion. It is estimated to be $18 billion (Parry 2005).
7. Traffic
accidents. It is estimated to be $23 billion (Parry 2005).
Thus, Total Benefit= $455 billion.
Total Costs= $203 billion.
Net Benefit= $252 billion.
Under the current tax policy, this
would generate social benefits as industry rents of $90 billion, state of
Alaska tax revenues of $36 billion, and federal tax revenues of $125 billion.
Challenges to Drilling
Drilling in ANWR would lead to
several environmental concerns. Potential adverse effects on the environment
would result from two principal sources: transportation as part of seismic
analyses, and infrastructure for extracting and transporting oil. The US Fish
and Wildlife Service (2001) reports that drilling in ANWR will have “major
effects” on Porcupine caribou herd and musk oxen as well as “moderate effects”
on wolves, polar bears, seabirds and coastal fish. Aside from direct effects on
animal populations, oil spills are a serious concern.
Finally, another environmental
concern that is usually debated is that ANWR oil will promote air-pollution and greenhouse-gas emissions.
The argument is that oil consumption will
increase, causing increased emissions with adverse effects on
environmental quality, human health, and
climate change.
To allow drilling in ANWR, the most
common technique is contingent valuation, which asks people willingness to pay
(WTP) or willingness to accept (WTA) for a proposed policy or change in
environmental quality. While it is natural to think about economic value in
terms of WTP, the conceptually correct measure for the question of drilling in
ANWR is WTA.
In order to calculate the minimum
amount that the individuals will be willing to accept to allow drilling, i.e. breakeven WTA, the
relevant population of the US aged 18 or older in 2005 is considered, which the US Census
estimates as 220,377,406 people. Dividing our best estimate of the oil benefits as calculated
above, $252 billion, by this population yields an average WTA of $1,141/person. These estimates
represent a one-time payment. We can,
however, pay this WTA annually for 30 years, which is the duration over
which ANWR oil is expected to flow. This would yield a present value WTA of $38
per year.
With the best estimate we can make
the following statement: If the average WTA for a onetime payment to permit drilling and
development in ANWR is $1,141 (or $38 per year for 30 years), then the social costs will exactly
equal the estimated benefits. If the true WTA
falls short of this estimate, then economic efficiency recommends
drilling. Alternatively, if the true WTA
exceeds the estimate, then economic efficiency does not recommend
drilling. The question, then, is whether
the estimate falls within the reasonable expectation of what US citizens would be willing to accept in
order to allow drilling in ANWR.
Questions:
1.
Present your views on whether
drilling be allowed or not in the ANWR elaborately.
2.
Illuminate various
environmental concerns due to which drilling has been banned in ANWR.
3.
Analyze the case by using SWOT
analysis and write down the case facts.
4.
Now you are the Chief Operating
Officer (COO) of the company which has been allotted the drilling project in
ANWR, from the management’s perspective suggest suitable steps that you would
take to ensure no oil spill or oil leakage takes place. Also estimate the
economics related to it.
5.
Summarize the case study in
your own words.
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