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Good News on Trade Deficit – Analyst Blog

Dirk Van Dijk — Thu, 10 Dec 2009 17:45:08 +0000

The trade deficit in October fell to $32.9 billion from a revised $35.7 billion in September. The trade deficit in September was revised down by $0.8 billion.

A decline in the trade deficit is unambiguously good news, especially as it comes in the context of both imports and exports rising (indicating that world trade is once again expanding). In October, our imports totaled $169.8 billion, up from $169.0 billion (originally reported as $168.5 billion) while our exports expanded to $136.8 billion from $133.4 billion (revised from $132.0 billion).

While the trade deficit had ticked up a bit in recent months, it is still down very significantly from where it was a year ago, and it now looks like that trend is continuing. Last October the trade deficit was $59.4 billion. Most of the decline, though, came for the "wrong reason," as both imports and exports collapsed. Relative to a year ago, our imports are down 18.8% while our exports are down 8.6%.

To the extent the decline in our imports was due to a lower price of oil, that is a good thing, but to the extent it reflected just the collapse of world trade, it was not so good. The reduction this month in the trade deficit is much healthier in that it reflects a rapid growth of exports.

As can be seen in the first graph below (from http://www.calculatedriskblog.com/), oil plays a huge role in the size of or trade deficit (black line) and currently is responsible for more than half of the total trade deficit. The collapse in oil prices late last year was the principal factor in driving down the total trade deficit. We actually started to make substantial progress on the non-oil side of the trade deficit starting in early 2007, but that progress was masked by oil prices that were shooting up at the time. As oil prices have rebounded, we slid backwards in terms of the total trade deficit.

However, it is not all about price. The combination of the recession, and increased efforts at fuel economy and conservation have started to put a material dent in our oil habit. The decline in the oil trade deficit in October relative to September was due as much from lower quantites imported as it was from lower prices. In October the average price of imported oil was $67.39, down from $68.17 in September (due to quality differences and the time to transport, these prices will not follow crude oil futures exactly). However, even more significantly, we imported an average of 8.349 barrels of oil a day, down from 9.176 million barrels a day in September.

OK, a 2.55% increase in exports does not sound like that much, but remember it is a monthly figure, on an annualized basis -- and that equates to a 35.3% growth rate. Will that be sustained? Probably not, but to the extent that it does, it is very good for the trade deficit and the economy.

Let’s put the decline in the trade deficit into a bit more perspective. On a year-to-date basis, the trade deficit has totaled $303.96 billion. That is less than half the $610.83 billion trade gap we ran in the first ten months of 2008. That is a direct addition of $306.87 billion to GDP, or roughly 2.2% of GDP.

However, the trade deficit came as year-to-date imports shrank by $586 billion (from $2.163 Trillion to $1.577 Trillion) while our exports declined by $279 billion (from $1.552 Trillion to $1.273 Trillion). Yes, some of that is due to paying an average of $52.92 a barrel of oil so far this year, rather than the $102.53 a barrel we paid in the first ten months of 2008.

However, perhaps of even more long-term significance to the trade deficit is that we have imported an average of 9.176 million barrels a day this year, down from 9.865 million barrels a day last year. That is a 7.0% reduction. It will be very hard to separate out just how much of that reduction is due to lower economic activity so far this year, and how much of it is due to long-term improvements in energy efficiency, until we are more fully out of the recession and growing again. The drop in October’s imports relative to September is probably a short-term blip (the numbers can be volatile from month to month), but the year-to-date decline is extremely significant.

To the extent that we can continue to increase or level of energy efficiency, we can start to make a dent in the chronic budget deficits we face. If we are not able to, it will be extremely hard to bring them under control. However, there are a bunch of very encouraging long-term signs in this regard.

For starters, sales of pick up trucks and SUV’s have fallen far more this year than have sales of cars. Sales of smaller, more fuel-efficient cars have fallen much less than sales of larger less fuel efficient cars. While that hurts the profit margins of Ford (F) and General Motors, and even Toyota (TM), it provides long-term hope on the trade deficit. The slowdown in overall vehicle sales though means that the pace of fleet turnover has slowed down.

We will be reaping long-term benefits from the fleet turnover that has occurred. This is an aspect of the "Cash for Clunkers" program that is very much under-appreciated. The administration should consider resuming the program as part of its "Son of Stim" jobs program, but I didn’t see any reference to it in Obama’s speech earlier this week (which was, in any case, very short on details).

Keep in mind that it is the trade deficit, not the budget deficit, that drives our level of external indebtedness. If we really want to control how much of our paper that places like China and the Persian Gulf control, we need to bring the trade deficit down.

Over the long term, that means reducing the amount of oil we burn. It is not just a question of using less energy and using it smarter. It is a question of oil specifically -- not all energy. Most of the natural gas we use comes from the U.S., and to the extent it is imported, it comes from Canada, which due to NAFTA (and geographical proximity), is more tightly integrated with the U.S. economy than that of any other country. While our trade deficit with Canada did increase in October to $2.0 billion from $1.5 billion, it is a relatively small part of the total.

As the domestic shale plays open up, even the amount of gas we import from Canada is likely to decline as a share of the total. Thus any efforts we make to replace oil consumption with natural gas consumption will have a positive long-term effect on the trade deficit and thus the economy. We also export coal, not import it -- but for environmental reasons, relying on more coal usage does not make a lot of sense (an no, there is no such thing as economically viable "clean coal;" while carbon sequestration might be promising, it will be extremely expensive).

While it makes a lot of sense to increase renewable power sources like wind and solar, those sources represent such a small fraction of our current energy portfolio, that it will take years and years of very fast growth to become a significant part of the mix. The sooner we get started, the better, but it is going to be a long-term process.

Oil is primarily used as a transportation fuel, while natural gas is mostly used for heating and to a lesser extent electricity generation. Thus to move towards greater use of natural gas (which incidentally has a much lower carbon footprint per BTU than does oil, and a far lower one than coal -- not to mention the long list of other pollutants like mercury associated with burning coal) we have to find a way of using it for transportation. Technically it is not difficult to produce vehicles that run on natural gas, but we would need an infrastructure for refueling them.

That is not a problem for vehicle fleets that return to the same spot each night, like city buses for example. It is a much bigger problem for family cars, but not one that is insurmountable (after all, most homes do have natural gas service already). The other way to go is to make the shift indirectly and move to electric cars (or plug-in hybrids) and use natural gas (and eventually renewable sources) to generate the electricity. While clearly such a move towards using more natural gas would be good for the big gas companies like Chesapeake (CHK) and EnCana (ECA), it would also be very good for the economy over the long term.

It appears that the weakness in the dollar is starting to have an effect on the trade deficit. As the dollar falls, it makes our exports more competitive versus products made elsewhere, most noticeably in Europe. It also makes what we import more expensive. That is the key downside to weakness in the dollar -- its potential impact on inflation.

However, inflation is still very much under control, and shows no signs of increasing significantly. The weak dollar is only offsetting major deflationary forces in the economy, most notably the huge amount of slack in the system in the form of very high unemployment and very low rates of capacity utilization. Thus, it seems like a very worthwhile trade off right now.

The fact that oil makes up so much of the trade deficit makes it a problem that is very tough to solve, since as the dollar goes down, the price of oil will tend to go up. While higher relative prices for oil will help encourage conservation and switching to other sources, it is a slow process (already, natural gas is selling for the equivalent of oil at $31.55 on a per BTU basis).

The other big problem with the trade deficit is that the dollar has not fallen at all with China, the country that we have the biggest bilateral trade deficit with by a very large margin. While the overall trade deficit declined in October, the trade deficit with China increased to $22.7 billion from $22.1 billion last month. That is a 2.7% increase in just a month, or 37.9% annualized.

Put another way, our trade deficit with the Middle Kingdom was 69.0% of the total in October, up from 61.9% of the total in September. Most of the trade deficit is from goods, not services (we tend to run a service surplus). If we just look at our trade deficit in goods, it totaled 46.1 billion in October, down from 49.6 billion in September. China’s share of the goods trade deficit, though, rose to 49.1% from 44.6% in September.

A year ago, the total trade deficit for goods with China was higher, at $27.95 billion. However it represented just 37.4% of the total gap in goods. Year to date, the share of the goods trade deficit with China has soared to 46.4% from 31.4% a year ago. As long as the Yuan stays fixed to the dollar, no change in the value of the dollar against the Euro or the Yen is going to have that much of an effect. Yes there is an indirect effect, as General Electric (GE) has the playing field tilted in its favor relative to Siemens (SI), but that effect is small versus what would happen to the trade deficit if the Yuan were going up along with the other major currencies.

For the world to regain its balance, not only must the dollar decline in value over time, but the Yuan must go up in value over time. As it stands now, the yuan is actually falling in value relative to the Euro, causing China’s trade surplus with Europe to expand along with its surplus with the U.S.

Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market-beating Zacks Strategic Investor service.
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Tough Times Ahead for Gazprom

Robert Amsterdam — Mon, 07 Dec 2009 19:15:37 +0000

Roderick Kefferputz from the Centre for European Policy Studies has released a new short paper on Gazprom. Below is the introduction. Download the full study here. Gazprom's situation has become increasingly difficult since January's notorious gas crisis. From being ranked...

Zacks Analyst Blog Highlights: Capital One, American Express, The Dress Barn Inc., Tween Brands Inc. and PetroChina – Press Releases

Zacks Market Commentaries — Fri, 18 Sep 2009 14:00:55 +0000

For Immediate Release

Chicago, IL – September 18, 2009 – Zacks.com announces the list of stocks featured in the Analyst Blog. Every day the Zacks Equity Research analysts discuss the latest news and events impacting stocks and the financial markets. Stocks recently featured in the blog include: Capital One (COF), American Express (AXP), The Dress Barn Inc. (DBRN), Tween Brands Inc. (TWB) and PetroChina (PTR).

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Here are highlights from Thursday’s Analyst Blog:

Initial Claims Drop Again

So what are people supposed to do when they have no job and their unemployent benefits have run out? Well, the best thing that could happen, obviously, would be for them to get a new job. However, businesses are simply not hiring.

That is actually a bigger part of the problem right now than busnesses laying off people. What jobs that are available tend to be at the very low end, the "flipping burger" type. Even those are scarce as witnessed by teenage unemployment rates of over 25%. For a middle-aged person with a college degree, taking a menial near-minimum-wage job with no benefits is not exactly a great solution. It sure will not put the kids through college.

Presumably by this point, they have also run up their credit card balances. If they have any equity in their houses, they will have tapped it -- but given the number of people who are underwater on their houses, that is a pretty rare breed these days.

These people are at very high risk of defaulting on their credit cards, leading to higher charge-offs at the major credit card issuers like Capital One (COF) and American Express (AXP). They are also likely to cause a second wave of foreclosures, or people who just stop paying the mortgage and wait for the sherriff to show up at the door, in effect becoming bandos in their own homes (or what used to be their homes).

Still, I suspect the market will see the decline in intial claims as being good news. It is, just simply not yet good enough.

Dress Barn's Q4 Exceeds

The Dress Barn Inc. (DBRN) reported fiscal fourth-quarter results after the closing bell yesterday. The company stated that GAAP net income expanded 19.5% year over year to $26.4 million, or 41 cents per share. Excluding certain items, adjusted earnings per share came in at 39 cents, beating the Zacks Consensus Estimate by 3 cents.

The company recorded a 4.3% year-over-year growth in sales to $398.9 million, driven by a 3.5% increase in net store growth coupled with a 1% expansion in same-store sales. The company said that sales in Dress Barn stores grew 6.5% year over year to $253.7 million, mainly due to 4% growth in same-store sales. Sales in maurices stores rose 1% year over year to $145.2 million, driven by net store growth of 6.5%, partially offset by a 5% decline in same-store sales.

In June of this year, the company announced that it has entered into an agreement to acquire Tween Brands Inc. (TWB) in an all-stock deal. Dress Barn said at the time that it expects the deal to be earnings-neutral during the first full year of operations, and accretive thereafter.

PetroChina Focuses on Supplies

On increasing demand, PetroChina (PTR) plans to increase the quantum of gas supply to Beijing. The company wants to double the gas supply in the pipeline to 12 billion cubic meters (Bcm) from the estimated current years’ figure of 6 Bcm.

Beijing is China’s third largest province in natural gas consumption ( it consumed about 5.6 Bcm of gas last year). There are still a few potential suburban areas in Beijing that lack access to piped natural gas. As more than 80% of China's natural gas is produced by the company, which runs most of the country's gas pipeline networks, it wants to capitalize this favorable supply opportunity.

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Another Natural Gas Build – Analyst Blog

Zacks Market Commentaries — Thu, 18 Jun 2009 21:35:20 +0000

The storage overhang in the U.S. natural gas market shows no sign of easing. With domestic production continuing to outpace recession-hit demand, despite the sharp retrenchment in the rig count, the commodity appears to be on track to exit the summer injection season with an all-time high storage build. Today's bearish report is expected to stall, if not altogether reverse, the emerging strength in natural gas prices over the last few days that pushed it above the $4 mark.

To play this natural gas outlook, we continue to rely primarily on select E&P players such as EnCana (ECA), XTO Energy (XTO) and Chesapeake (CHK), who have the bulk of this year's production hedged at attractive prices and have access to resource-rich assets can be profitably operated in the current low-price environment.

We remain wary of land drillers such Nabors (NBR) and natural gas centric service providers such as BJ Services (BJS), given the extent of excess capacity in the sector that is expected to weigh on dayrates and margins well into next year. As such, we remain unconvinced of the sustainability of recent gains made by the land drillers and other onshore U.S. centric service players.

The Energy Information Administration (EIA) reported today a bigger-than-expected 114 billion cubic feet (Bcf) weekly addition to natural gas stockpiles for the week ended June 12th. This takes the current storage level to 2.44 Trillion cubic feet, which is up 32.1% from last year's level and 22.6% above the five-year range (as clear from the nearby chart from the EIA). Current stocks are 622 Bcf above this last year and 472 Bcf above the five-year average.

Due to the pronounced seasonal nature of natural gas consumption, stockpiles are built in the summer months and consumed in the winter heating months. As such, we have natural injections in the summer, as at present, and withdrawals in the winter. The storage level at the end of summer injection period has a direct bearing on natural gas prices in the winter heating months.

Current expectations are for a reversal in domestic production in the coming months as the lagging effect of the sharp drop in domestic drilling activity. Partly offsetting the production drop is the expected ramp up of LNG imports this year. If weekly injections do not drop materially from the trend established over the last many weeks, then we may actually get to a new record of close to 4 Tcf in storage at the end of the current injection period.
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Exxon Makes Alaska Pipeline Deal – Analyst Blog

Zacks Market Commentaries — Fri, 12 Jun 2009 19:05:16 +0000

Exxon Throws Weight Behind Alaska Pipeline

Exxon (XOM) has finally decided to throw its weight behind the TransCanada Corp. (TRP)-sponsored Alaska Pipeline project that will bring stranded Alaskan natural gas to consuming markets in the U.S. Lower 48. TransCanada's 1,700 mile, 48-inch diameter pipeline has the support of the Alaskan and Canadian governments. The Alaska government passed legislation last year that would subsidize the initial project costs by up to $500 million.

While details of the deal between the two companies were not released, it is expected that TRP will remain the project's operator. This pipeline, expected to cost approximately $26 billion to build, would be the largest civil engineering project in North America. The pipeline would stretch from the North Slope of Alaska through Yukon and British Columbia to the Alberta border, where it would be linked to existing infrastructure reaching the U.S. market.

While a number of companies have natural gas reserves in Alaska, three are the most important; Exxon, ConocoPhillips (COP) and BP (BP). The last two have been sponsoring their own rival pipeline project.

Without the inclusion of BP and COP, it would be difficult, if not altogether impossible for the XOM-TRP project to get off the ground. But with Exxon, the largest natural gas resource holder in Alaska, getting behind the project, its prospects have brightened significantly.

At its maximum capacity, the pipeline would transport 5.9 billion cubic feet per day, roughly 10% of total U.S. demand. Proved reserves in Alaska are around 35 trillion cubic feet (Tcf), but the state's overall resource potential is believed to be much higher. As a comparison, the total U.S. natural gas consumption in 2008 was 23.2 Tcf.

A number of hurdles remain for this long-delayed project. In the next stage, the project needs commitments from companies who would use it to ship their gas before it can get the final go-ahead signal from the Federal Energy Regulatory Commission (FERC). Aside from these procedural/logistical issues has been the question of long-term U.S. natural gas outlook, which has changed materially following the recent discovery of abundant shale natural gas. Exxon's reputation for conservatism and investment savvy goes some way to answering that question. In the best case scenario, the pipeline would begin operations in 2018.
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Natural Gas Prices Could Double as Energy Majors Scale Down Supplies

Contrarian Profits — Tue, 17 Mar 2009 18:57:49 +0000

pAfter an unparalleled fall, natural gas prices could double by next year, as a growing number of idle rigs create a supply crunch./p pNatural gas prices have tumbled by about 30% this year, as a steep drop in industrial consumption has undermined demand. However, many of the traders and hedge funds that placed speculative bets on the price decline are beginning to reverse course and bet on a price spike, as dwindling production is starting to outpace slumping demand./p pTraders trimmed their net short positions on gas by 11% to 114,064 in the week ended March 10, the smallest since last July, strongemBloomberg News/em/strong reported. Also, natural gas futures for delivery in January 2010 are trading at a 49% premium to the April#8230;/p

Drilling Offshore to Affect World Oil Prices… and other Tales from the Iraq-Pakistan Border [0]

Menzie Chinn — Sat, 16 Aug 2008 17:15:18 +0000

Various individuals have argued for drilling in the Outer Continental Shelf (OCS) as a means to affect the price of oil. This is true despite this recent assessment by the Department of Energy's Energy Information Administration, the Federal Government's nonpartisan analytical group on energy issues. From Annual Energy Outlook related analyses (June 2007):

The OCS is estimated to contain substantial resources of crude oil and natural gas; however, some areas of the OCS are subject to drilling restrictions. With energy prices rising over the past several years, there has been increased interest in the development of more domestic oil and natural gas supply, including OCS resources. In the past, Federal efforts to encourage exploration and development activities in the deep waters of the OCS have been limited primarily to regulations that would reduce royalty payments by lease holders. More recently, the States of Alaska and Virginia have asked the Federal Government to consider leasing in areas off their coastlines that are off limits as a result of actions by the President or Congress. In response, the Minerals Management Service (MMS) of the U.S. Department of the Interior has included in its proposed 5-year leasing plan for 2007-2012 sales of one lease in the Mid-Atlantic area off the coastline of Virginia and two leases in the North Aleutian Basin area of Alaska. Development in both areas still would require lifting of the current ban on drilling.
For AEO2007, an OCS access case was prepared to examine the potential impacts of the lifting of Federal restrictions on access to the OCS in the Pacific, the Atlantic, and the eastern Gulf of Mexico. Currently, except for a relatively small tract in the eastern Gulf, resources in those areas are legally off limits to exploration and development. Mean estimates from the MMS indicate that technically recoverable resources currently off limits in the lower 48 OCS total 18 billion barrels of crude oil and 77 trillion cubic feet of natural gas (Table 10).
Although existing moratoria on leasing in the OCS will expire in 2012, the AEO2007 reference case assumes that they will be reinstated, as they have in the past. Current restrictions are therefore assumed to prevail for the remainder of the projection period, with no exploration or development allowed in areas currently unavailable to leasing. The OCS access case assumes that the current moratoria will not be reinstated, and that exploration and development of resources in those areas will begin in 2012.
Assumptions about exploration, development, and production of economical fields (drilling schedules, costs, platform selection, reserves-to-production ratios, etc.) in the OCS access case are based on data for fields in the western Gulf of Mexico that are of similar water depth and size. Exploration and development on the OCS in the Pacific, the Atlantic, and the eastern Gulf are assumed to proceed at rates similar to those seen in the early development of the Gulf region. In addition, it is assumed that local infrastructure issues and other potential non-Federal impediments will be resolved after Federal access restrictions have been lifted. With these assumptions, technically recoverable undiscovered resources in the lower 48 OCS increase to 59 billion barrels of oil and 288 trillion cubic feet of natural gas, as compared with the reference case levels of 41 billion barrels and 210 trillion cubic feet.
The projections in the OCS access case indicate that access to the Pacific, Atlantic, and eastern Gulf regions would not have a significant impact on domestic crude oil and natural gas production or prices before 2030. Leasing would begin no sooner than 2012, and production would not be expected to start before 2017. Total domestic production of crude oil from 2012 through 2030 in the OCS access case is projected to be 1.6 percent higher than in the reference case, and 3 percent higher in 2030 alone, at 5.6 million barrels per day. For the lower 48 OCS, annual crude oil production in 2030 is projected to be 7 percent higher -- 2.4 million barrels per day in the OCS access case compared with 2.2 million barrels per day in the reference case (Figure 20). Because oil prices are determined on the international market, however, any impact on average wellhead prices is expected to be insignificant.
Similarly, lower 48 natural gas production is not projected to increase substantially by 2030 as a result of increased access to the OCS. Cumulatively, lower 48 natural gas production from 2012 through 2030 is projected to be 1.8 percent higher in the OCS access case than in the reference case. Production levels in the OCS access case are projected at 19.0 trillion cubic feet in 2030, a 3-percent increase over the reference case projection of 18.4 trillion cubic feet. However, natural gas production from the lower 48 offshore in 2030 is projected to be 18 percent (590 billion cubic feet) higher in the OCS access case (Figure 21). In 2030, the OCS access case projects a decrease of $0.13 in the average wellhead price of natural gas (2005 dollars per thousand cubic feet), a decrease of 250 billion cubic feet in imports of liquefied natural gas, and an increase of 360 billion cubic feet in natural gas consumption relative to the reference case projections. In addition, despite the increase in production from previously restricted areas after 2012, total natural gas production from the lower 48 OCS is projected generally to decline after 2020.
Although a significant volume of undiscovered, technically recoverable oil and natural gas resources is added in the OCS access case, conversion of those resources to production would require both time and money. In addition, the average field size in the Pacific and Atlantic regions tends to be smaller than the average in the Gulf of Mexico, implying that a significant portion of the additional resource would not be economically attractive to develop at the reference case prices. [Emphasis added -- mdc]

Here is Figure 20 from the report, showing the impact on lower-48 production in the baseline and the alternative.

Figure 20 from Annual Energy Outlook related analyses (June 2007).

What exactly is "insignificant"? One can get an idea by doing a back of an envelope calculation. The 3% increase by 2030 cited by the 2007 Annual Energy Outlook analysis works out to 0.163 millon barrels per day (mbpd) incremental production. Projected world output of conventional oil in 2030 is 99.30 mbpd. This means access to the OCS would result in a 0.164% increase in output.

Let's appeal to a supply-demand framework, assuming log-linearity:

q^s = a₁ + a₂p^s + a₃X

q^d = b₁ + b₂p^d + b₃Z

Where q is log quantity, p is log price, X and Z are other shift variables, assumed to be exogenously determined. a_i and b_i are parameters, a₂ > 0 and b₂ < 0. Z could be income, for instance.

Solving the simultaneous system of equations for the equilibrium price leads to:

p = (a₁-b₁)/(b₂-a₂) + (a₃X-b₃Z)/(b₂-a₂)

Taking the total differential and holding constant the shift variables X and Z leads to the following expression:

Δp = (Δa₁-Δb₁)/ (b₂-a₂)

Substituting in some parameter values, taking Δa₁ as the percentage increase in supply, namely 0.164% (0.00164), and setting the price elasticity of demand equal to -0.4, and and price elasticity of supply to 0.3 (Perloff and Whaples has cited these figures; plausible alternative parameter values would not alter the results in a qualitative fashion) yields the following: The resulting change from baseline in 2030 is -0.00234 (-0.23%). Taking the AEO 2008 baseline estimate of 70.45 2006$/barrel in 2030, the implied reduction in price is 0.165 2006$.

Now let's conduct some sensitivity analyses/robustness checks.

Intertemporal Considerations

There have been some assertions that driving down prices in the future will have an impact today. Since petroleum is durable, there is no doubt that this must be true; the question, as always, revolves around the quantitative magnitudes. Take the 2030 impact on today; one can calculate the present value of the innovation: (1+r)²². Take r = .027 (which is the average ten year constant maturity yield minus the lagged one year inflation rate over the 1976-2008 period), one finds that the 0.165 2006$ decline in 2030 results in a 0.106 2006$ decrease today.

Alternative Estimates of Reserves

As pointed out in several venues [1], there is some debate over the amount of technically recoverable oil in the OCS that currently not accessible; the CS Monitor editorial argues that there's been a big revision in estimation technologies. That may be, but here is a quote from the February 2006 report to Congress from the MMS of the Department of Interior (page xii):

Many proponents of domestic energy security consider gaining increased access to Federal resources to be one of the biggest challenges. Part or all of nine OCS planning areas, which include waters off 20 coastal states, have been subject to longstanding leasing moratoria enacted annually as part of the Interior and related agencies appropriations legislation, or are withdrawn from leasing until after June 30, 2012, as the result of presidential withdrawal (under section 12 of the OCSLA). Some of these areas contain large amounts of technically recoverable oil and natural gas resources. The MMS estimates that conventional oil and gas resources (i.e., UTRR) in OCS areas currently off limits to leasing and development total 19.1 Bbo and 83.9 Tcfg (mean estimates). There remains today, considerable uncertainty concerning the resource potential of many of these OCS areas. The availability of additional modern G&G data could reduce this uncertainty. It is instructive to note that perceptions concerning the resource potential of the Central, Western and portions of the Eastern GOM, areas experiencing robust levels of exploration and production effort, have continued to evolve for the better over the years. Critical to the changing perception is the fact that the MMS has acquired approximately 1.75 million line-miles of two-dimensional (2-D) common depth point (CDP) seismic data and nearly 300,000 square miles of 3-D seismic data. However, the additional G&G data and information that become available to assessors between assessments is frequently mixed in terms of having a positive or negative effect on the perception of the overall hydrocarbon potential of the OCS.

This implies that the EIA's base assumptions do not appear unreasonable, on the face of it.

Alternative Elasticities

The calculations rely upon long run elasticities, and a constant elasticity along the curves (Note: linear demand and supply curves do not exhibit constant elasticities.) If the supply curve in log-price/log-quantity space was still backward L-shaped, and the supply enhancement occurred with demand intersecting along the near-vertical portion, then the price change would be larger.

What about short run effects (in 2030 say)? When new suppy comes on line, the resulting deviation in price from baseline will be commensurately larger in the short run. But by definition, over the longer horizon, prices will gravitate toward those indicated by the long run analysis.

Alternative timing

The calculations I presented focus on 2030. One could examine the effcts earlier. But as shown in Figure 20 (reproduced above), production does not even begin until 2017 assuming leasing begins in 2012 (less than four years from now!). Even assuming the 2030 effect is achieved in 2020, that would mean the resulting change in today's prices would only be 0.12 2006$ per barrel.

Strategic Interactions

Reader Anon (in commments to this post) argues against my critique of offshore drilling arguments using a game-theoretic framework:

You are wrong. Opening up more acreage to exploration will affect psychology and markets. let me explain.
A credible threat of increased supply - even ten years away - certainly does have immediate impact to the ruminations of energy policy makers from Russia to Saudi to Mexico.
If you have a large control over marginal supply (Mideast/Russia/Mexico could all do a lot more if they choose to) and you see the glimmer of another North Sea or another ANS then you rightly might adjust your policies. Strategically speaking, if you dominate global oil supply then at some price point you rightly begin to fear Competitive Entrants.
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In the case of Oil (by no means a free market), governments control access to resources (sell it like real estate and demand whatever they like or in many cases simply make everything off limits to private capital). However, if you push oil importing nation governments too far with overly high prices then you just might trigger competition.
I hope this makes it clear that the main reason we pay such high oil prices today is the government RESTRICTED ACCESS to reserves (a global phenomenon) that has tended to dominate the oil industry landscape for so long. The secure knowledge that the US Government is EXTREMELY UNLIKELY to open up new reserves for exploitation is enough to keep exporting nations confident that they can safely continue to extract higher rent for their commodity.
So just the credible threat of a surge in new competition (a la Bush statement) may be enough to open the taps a bit more or cause a flurry of counter-competitive increased supply activity to quickly try to KILL the new threat or frighten off competitive capital investment in new supply..
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Think Strategically. BTW - I condemn Bush for many things and I sympathize with your attitude towards this administration, however, for once, Bush is actually right this time!
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Anon admonishes me to read Barry Nalebuff's book Thinking Strategically (actually it's Dixit and Nalebuff); I confess I have not yet done so. But having endured some amount of game theory over the years, I'm going to wade ahead nonetheless.

First, consider this exchange from April 2004, where Nalebuff suggests investing $5 billion to enable Iraq's oil industry to export a million extra barrels of oil a day, thereby negating OPEC's monopoly power. One interesting aspect of Nalebuff's argument is that he doesn't propose something like exploiting US offshore reserves. I think the reason is quite simple, and is rooted in game theory -- Iraq in principle can be a low cost producer (after security is established). Supply from offshore sources in the US would be (and is known to be) a relatively high cost (per unit production) venture relative to, say, Saudi oil production. Hence, it's not clear increasing US production can have the strategic effect often suggested. (Example, see: [2])

I do agree with Anon that a lot of world production is undertaken by state owned enterprises, which lack proper incentives for responding to price signals. But I'm unconvinced that foreign state owned enterprises would be privatized simply because the US removed its moratorium on OCS exploitation.

So, opening up production in the currently inaccessible areas of the OCS might have substantial effects (perhaps on trade balance, or oil company profitability, Federal leasing revenue), but in my view is unlikely to have a substantial impact on oil prices (just as in the case of opening up ANWR).

As an aside, John McCain is still supporting a gasoline tax holiday [3], so on this count, I remain puzzled.

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