Oil shock simulation shows US losing 2m jobs, the largest drop since 1945

International
Oil shock simulation shows US losing 2m jobs, the largest drop since 1945
By Finfacts Team
Aug 5, 2005, 06:28

The spike in oil prices following the death of King Fahd of Saudi Arabia illustrates how sensitive the oil markets are in a period of high oil demand and very little spare production capacity.

A simulation of an oil shock, engineered by the National Commission on Energy Policy and the advocacy group Securing America's Future Energy, looked at a scenario where 3.5 million barrels of oil were suddenly removed from a global market of more than 83 million barrels.

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Saudi Arabian oil refinery at Yanbu, on the Red Sea coast

Top former US government officials including two former directors of the CIA, participated in the simulation. Participants took on the roles of members of the US cabinet and were asked to advise the president. They were given scenarios of oil supply interruptions via television news bulletins and memos. As events unfolded, economists and former oil executives briefed them on the markets' reaction. The role-play was set in December 2005.

With the price of oil shooting up to $161 per barrel, the average US household petrol bill doubling to $5,214 and the loss of more than 2m American jobs, the largest drop since 1945, the US and the rest of the world would face a real crisis.

Last week Dr. Gal Luft of the Institute for the Analysis of Global Security said in testimony to a Subcommittee on International Terrorism and Nonproliferation of the Committee on International Relations of the US House of Representatives:

What makes oil interesting for terrorists are the unique conditions that have been created in the oil market in recent years. Until recently, the oil market had sufficient wiggle room to deal with occasional supply disruptions. Such disruptions could be offset by the spare production capacity owned by some OPEC producers, chiefly Saudi Arabia. This spare capacity has been the oil market's main source of liquidity. But due to the sudden growth in demand in developing Asia this liquidity mechanism has eroded from 7mbd in 2002 which constituted 9% of the market to about 1.5 mbd today, less than 2%. As a result, the oil market today resembles a car without shock absorbers: the tiniest bump on the road can send a passenger to the ceiling. Without liquidity, the only one mechanism left to bring the market to equilibrium is rapid and uncontrolled price increases.

But one scenario our economy cannot withstand is a major attack on one of Saudi Arabia’s oil facilities. In addition to being holder of a quarter of the world’s oil reserves holder of most of the world’s spare production capacity Saudi Arabia is the only country in the world that has facilities that process more than 3mbd. Over half of Saudi Arabia’s oil reserves are contained in just eight fields and about two-thirds of Saudi Arabia's crude oil is processed in a single enormous facility called Abqaiq, 25 miles inland from the Gulf of Bahrain. On the Persian Gulf, Saudi Arabia has just two primary oil export terminals: Ras Tanura - the world's largest offshore oil loading facility, through which a tenth of global oil supply flows daily - and Ras al-Ju'aymah. On the Red Sea, a terminal called Yanbu is connected to Abqaiq via the 750-mile East–West pipeline.

A loss of 4-5% of supply to the US market can be offset by the 700mb Strategic Petroleum Reserve (SPR). At a rate of 1 million barrels per day the SPR can supply US needs for more than a year and a half. However, but it is not sufficient to tide the global economy over if there is a severe disruption of oil supplies. The mock US cabinet in the simulation, concluded that the SPR was of limited usefulness in such a crisis – it chose to tap it only when prices went to $120 a barrel. Using some of the emergency barrels too early could send prices higher, they said, because traders would worry that less emergency oil would be available if a more serious disruption ensued. The limited size of the stocks – the equivalent of two months of US imports – meant the reserve was useless for longer-term disruptions, such as an evacuation of all foreign personnel from Saudi Arabia, which was one of the scenarios presented in the role-play.

The following is a summary of the simulation:

The dependence of the US on oil creates serious national security vulnerabilities that, if exploited, could result in widespread economic dislocation and increased global instability, according to former top government officials who gathered to examine how the nation might manage an oil supply crisis.

The findings of these leading experts comes amid reports of terrorist threats against oil-rich Nigeria, a state-owned Chinese company's bid for a major US oil firm, and as Congress was considering energy legislation that does little to curb US oil dependence.

In a scenario confronted by the bipartisan panel of intelligence, military, and energy experts, a series of events over several months - unrest in Nigeria, an attack on an Alaskan oil facility, and the emergency evacuation of foreign nationals from Saudi Arabia - drives the price of oil to over $150 per barrel. These events lower expected employment levels by more than 2 million jobs, embolden countries that are major oil producers and consumers to pressure the US on key foreign policy concerns, and cause a variety of other significant economic and security challenges.

The scenario removed only 3.5 million barrels of oil from a global market of more than 83 million barrels, resulting in the following consequences:

• Gasoline prices of $5.74 per gallon;
• Global oil price of $161 per barrel;
• Heating oil prices of $5.14 per gallon;
• Fall of gross domestic product for two consecutive quarters;
• Drop in consumer confidence by 30 percent;
• Spike in the consumer price index to 12.6 percent;
• Ballooning of the current accounts deficit to $1.087 trillion;
• Decline of 28 percent in the S&P 500;
• Aggressive pressure on the US from China to end arm sales to Taiwan, and;
• Demands from Saudi Arabia for changes to US policy regarding the Mid-East peace process.

Participants included:

Robert M. Gates, former Director of Central Intelligence;
Richard N. Haass, former Director of Policy Planning at the Department of State;
General P.X. Kelley, USMC (Ret.), former Commandant of the Marine Corps, member of the Joint Chiefs of Staff;
Don Nickles, former U.S. Senator;
Carol Browner, former Administrator of the Environmental Protection Agency;
Gene B. Sperling, former National Economic Advisor;
Linda Stuntz, former Deputy Secretary of Energy;
Frank Kramer, former Assistant Secretary of Defense for International Security Affairs, and;
R. James Woolsey, former Director of Central Intelligence.

Senators Richard Lugar (R-IN) and Joe Lieberman (D-CT) served as co-chairs of the Oil ShockWave event.

Other key findings:

• Once oil supply disruptions occur, there is little that can be done in the short term to protect the U.S. economy from its impacts, including gasoline above $5/ gallon and a sharp decline in economic growth potentially leading into a recession.

• There are a number of supply and demand-side policy options available that would significantly improve U.S. oil security. Benefits from these measures will take a decade or more to mature, and thus should be enacted as soon as possible.

• Supply-side measures include promoting developing of conventional oil reserves in nations currently off limits to private investment through enhanced U.S. diplomacy, increase research and development into environmentally-benign extraction of unconventional oil reserves such as oil shale and tar sands, and enable siting of new liquid natural gas and other energy facilities.

• Demand-side measures include promoting energy efficient passenger vehicles with incentives for hybrid electric vehicles , strengthen fuel economy standards, and increase research and development into plug-in hybrids and hydrogen fuel cell vehicles.

• Alternative fuel measures include increased research and development that enable ethanol production from plant materials, fischer-tropsch diesel from domestic coal, and hydrogen from coal and eventually from renewable sources.

While not seeking to reach unanimous conclusions, the following key findings and recommendations were embraced by a majority of participants.

The findings are the product of Oil Shockwave, an oil supply crisis simulation co-sponsored by Securing America's Future Energy (SAFE) and the National Commission on Energy Policy. The event was designed to simulate a decline in world oil production due to regional instability and terrorism and, then, present a mock cabinet-level meeting with the task of advising the president on a national response.

To ensure Oil ShockWave presented participants with a credible and realistic set of circumstances, the scenario included substantial input from former members of the oil industry, oil analysts and traders, former and current military officials, intelligence and national security experts, and other specialists. These individuals include David Frowd, former Head of Royal Dutch/Shell Upstream Strategy and Planning Department; and Rand Beers, former Special Assistant to the President and Senior Director for Combating Terrorism.

"This simulation serves as a clear warning that even relatively small reductions in oil supply will result in tremendous national security and economic problems for the country," said SAFE President Robbie Diamond. "This issue deserves immediate attention."

"We can neither drill nor conserve our way out of this problem—we must do both," said Jason Grumet the Executive Director of the National Commission on Energy Policy. "The energy bill pending before the U.S. Senate is a significant step in the right direction but we must do much more to protect our economy from the risks of oil supply disruptions."