The October oil futures case

The AEO2005 reference case assumes that world crude oil prices will decline as consumption slows and producers increase their productive capacity and output in response to current prices. In October 2004, however, NYMEX oil futures prices implied that the average annual oil price in 2005 will exceed its 2004 level before falling back somewhat, to levels that still would be above those projected in the reference case. To evaluate the likely effects of that possible price path on the U.S. energy economy, AEO2005 includes an October oil futures case, which is based on an extrapolation of oil prices loosely corresponding to the recent mid-term profile of prices on the NYMEX futures market.

In the October oil futures case, world crude oil prices are assumed to average $44 per barrel in 2005 (in 2003 dollars) before falling to about $31 per barrel in 2010—about $6 per barrel higher than the reference case projection. Prices are assumed to remain above those in the reference case over the entire projection and to be about $5 per barrel higher than the reference case projection in 2025, at $35 per barrel.

The AEO2005 reference case and October oil futures case are based on different assumptions about oil production by the members of OPEC— higher in the reference case and lower in the October oil futures case—reflecting uncertainty about future levels of production from the Persian Gulf region. OPEC members are assumed to be the principal source of the marginal supply needed to meet increases in demand; consequently, OPEC member country production varies more than non-OPEC production in response to changes in demand requirements. OPEC member country production in 2025 is projected to be about 55 million barrels per day in the reference case and about 50 million barrels per day in the October oil futures case.

U.S. domestic consumption of petroleum in 2025 is projected to be slightly lower in the October oil futures case than in the reference case (27.3 million and 27.9 million barrels per day, respectively). Most of the difference is the result of lower projected demand for transportation fuels in the October oil futures case. In 2025, total demand for petroleum in the U.S. transportation sector is projected to be 19.5 million barrels per day in the October oil futures case, compared with 19.8 million barrels per day in the reference case.

Higher oil prices in the October oil futures case are projected to have a small impact on U.S. economic activity, primarily in the first 5 years of the forecast. From 2005 to 2010, U.S. GDP is a cumulative $194 billion (about 0.3 percent) lower in the October oil futures case than in the reference case. By 2025, however, the GDP projections are nearly identical in the reference and October oil futures cases. The projections for electricity and natural gas prices are not appreciably different in the two cases, which differ primarily in their projections for the delivered price of petroleum products, with impacts mainly in the transportation sector.

In response to higher oil prices, total domestic petroleum supply in 2025 is projected to be higher in the October oil futures case (9.3 million barrels per day) than in the reference case (8.8 million barrels per day), which in combination with the lower demand projection leads to a lower projected level of total petroleum imports in the October oil futures case. Including crude oil and refined products, total net imports in the October oil futures case (18.0 million barrels per day) are 1.1 million barrels per day lower than in the reference case (19.1 million barrels per day in 2025). As a result, the import share of total U.S. petroleum demand is 66 percent in the October oil futures case, compared with 68 percent in the reference case. In 2003, the import share of U.S. demand was 56 percent.

In the U.S. energy market, the transportation sector consumes about two-thirds of all petroleum products and the industrial sector about one-quarter. The remaining 10 percent is divided among the residential, commercial, and electric power sectors. With limited opportunities for fuel switching in the transportation and industrial sectors, large price-induced changes in U.S. petroleum consumption are unlikely, unless changes in petroleum prices are very large or there are significant changes in the efficiencies of petroleum-using equipment. The results of the October oil futures case indicate that sustained increases in world oil prices would have to be significantly greater than those assumed for this case in order to have a major impact on projected U.S. energy use.

Comparison of projections in the reference and high B world oil price cases

Higher crude oil prices spur greater exploration and development of domestic oil supplies, reduce demand for petroleum, and slow the growth of oil imports in the high B world oil price case compared to the reference case. Total domestic petroleum supply in 2025 is projected to be 2.2 million barrels a day (25 percent) higher in the high B case than in the reference case. Production in the high B case includes 1.2 million barrels a day in 2025 from synthetic petroleum fuel produced from coal and natural gas. Total net imports in 2025, including crude oil and refined products, are reduced from 19.1 million barrels a day in the reference case to 15.2 in the high B case. As a result, the projected import share of total U.S. petroleum demand in 2025 is 58 percent in the high B world oil price case, compared with 68 percent in the reference case. In 2003, the import share of U.S. petroleum demand was 56 percent.

With the steep, prolonged rise in crude oil prices in the high B world oil price case, the worldwide potential for natural gas and coal-based synthetic fuels would become viable, with implications for imported U.S. supplies of LNG. In the reference case, the United States is expected to become increasingly dependent on LNG, with imports projected to increase from 0.4 trillion cubic feet in 2003 to 6.4 trillion cubic feet in 2025. In the high B case, GTL conversion of stranded natural gas could compete favorably with liquefaction, thus reducing the potential supply of LNG worldwide. As a result, LNG supplied to the United States is projected to be priced higher in the high B world oil price case, leading to higher average end-use natural gas prices than in the reference case and to a 51-percent reduction in projected imports of LNG in 2025. The projected average delivered price of natural gas in 2025 (in 2003 dollars) is $7.35 per thousand cubic feet in the high B world oil price case, compared with $6.77 in the reference case.

The higher oil and natural gas prices in the high B world oil price case result in a greater reliance on domestic gas supply, along with a reduction in the projected growth of natural gas consumption. Domestic dry gas production in 2025 in the high B case increases to 23.5 trillion cubic feet, 8 percent higher than the reference case projection of 21.8 trillion cubic feet. In addition, the high price of oil in the high B case results in favorable economics for GTL domestically, leading to an additional 0.7 trillion cubic feet of natural gas consumption for GTL in 2025, offsetting some of the reduction in end-use demand that would result from higher natural gas prices.

The higher natural gas prices in the high B world oil price case would promote greater use of coal technologies for new electricity generation plants, leading to an increase in projected coal consumption of 69 million short tons in 2025 compared to the reference case. In addition, CTL technology to produce petroleum fuels is expected to become economical in the high B world oil price case, resulting in additional coal consumption of 209 million short tons in 2025.

CTL plants are assumed to employ integrated gasification and combined-cycle power generation to produce synthesis gas, process steam, and electric power. CTL plants are considered to be combined heat and power plants, supplying surplus electricity as well as power for on-site use. As a result, an increase of 25 gigawatts of generating capacity from CTL plants is projected in the high B world oil price case. In aggregate, CTL plants are estimated to produce 1 million barrels a day of synthetic liquid fuel in 2025 in the high B world oil price case.

U.S. petroleum demand is reduced in the high B world oil price case, but the modest response to the price changes reflects the limited opportunities for fuel switching in the transportation and industrial sectors, which account for about 90 percent of U.S. oil consumption. Total petroleum consumption is projected to change by only 3 percent in 2010, compared to the reference case, despite a 22-percent higher average price of refined petroleum in 2010. In 2025, petroleum demand is 6 percent lower in the high B world oil price case, and average refined petroleum prices are 32 percent higher.

About two-thirds of the difference in projected petroleum consumption between the reference and high B world oil price cases in 2025 is represented by gasoline. There is very little difference between the projections of demand for transportation uses of diesel and jet fuel, which together accounted for one-third of the petroleum used in the transport sector in 2003. The demand for diesel fuel to move freight in trucks, rail, and shipping is relatively insensitive to price changes, as the equipment used is long-lived and the prospects of efficiency improvements for freight carriers are more limited than those for passenger transportation. In addition, there is some projected increase in rail and shipping in the high B world oil price case as a result of increased coal use in the electricity sector, offsetting some of the fuel saved by efficiency improvements in the freight truck fleet. Potential energy savings beyond those projected in the high B world oil price case would be possible if there were greater shifts among modes of travel, such as increased use of rail in place of trucking.

The demand for jet fuel is expected to be insensitive to price increases through 2025, as air travel growth is constrained by the availability of airport capacity in that time frame. The changes in fuel costs are unlikely to bring air travel demand down below the limits imposed by available airport capacity, eliminating much of the expected price response. The reduction in jet fuel between the reference and the high B world oil price cases, 1.6 percent in 2025, occurs primarily due to adoption of technology to increase aircraft efficiency.

Growth in projected gasoline demand in the high B world oil price case is lower than the reference case, as consumers respond to higher increased fuel costs by reducing the number of vehicle miles traveled and by purchasing more efficient automobiles. The projected price of gasoline in 2025 in the high B world oil price case is $2.01 a gallon (2003 dollars), compared to $1.59 in the reference case. As a result, average fuel economy of new, light-duty vehicles in 2025 increases from 26.9 miles per gallon in the reference case to 28.2 in the high B world oil price case. Even greater fuel economy improvements might occur under a high price scenario if consumers and manufacturers departed from recent trends and shifted to smaller, less powerful vehicles, or if there was a greater penetration rate of hybrid and diesel vehicles than is projected. However, at gasoline prices at or below $2.00 a gallon, significant changes in consumer behavior are not expected.

The U.S. economy is sensitive to oil price spikes, and several recessions have followed supply disruptions in recent decades; however, gradual changes in oil prices are less damaging to long-term economic growth, because the economy has more time to adjust. The projected impact on real GDP in the high B world oil price case, compared to the reference case, is $53 billion (2000 dollars) in 2010 (0.4 percent) and $32 billion in 2025 (0.2 percent). The macroeconomic results suggest that the U.S. economy would continue to fare well in the face of rising oil prices, provided that prices rose gradually over a long period of time; however, this analysis does not consider the potential impacts on the United States of worldwide economic disruption that might occur as a result of sustained high oil prices.