How Plausible is the Consensus Projection of Oil Below $25 and Persian Gulf Oil Capacity and Output Doubling by 2020?

Abstract

A two-part consensus in three recent long-term projections of the world oil market states: oil's price will stay below $25 (1999 $/barrel), and OPEC oil capacity and production will increase rapidly over the next two decades to unprecedented levels, more than doubling in the Persian Gulf by 2020. Such are the projections by the International Energy Agency (IEA), by the Energy Information Administration of the U.S. Department of Energy (DOE), and in The New Economy of Oil by John Mitchell and others. Yet such projections are not based on behavioral analysis of Gulf countries' decisions; they are merely the calculated residual demand for OPEC oil, the difference between projected world oil demand and non-OPEC supply, given some assumed price-path. Such projections by IEA and DOE are implausible because they rely on supply behavior by Gulf producers that is not in their own self-interest. The DOE projections of world oil prices could be reasonable, but only if world oil demand and/or non-OPEC supply are much more price-responsive than are represented in their numerical projections. Using an updated version of the model from Gately (1995), I show that the effect of greater price-responsiveness is to make faster output growth - not higher prices - the reliable path to higher OPEC revenue. I also demonstrate the effects of uncertainty about several key parameters (such as price and income elasticities) upon model results when parameter values are randomly sampled 500 times.