8.7. Devising New Scenarios
You can devise new scenarios by varying the slider settings in either 'Oil World 1988' or 'Oil World 1995'. The sliders, which can be seen in Figure 8.18, correspond to the parameters marked in bold in Figures 8.16 and 8.17. The default settings represent a benign oil industry in which demand is stable and OPEC cooperates with independents to fully supply the market. The meaning of each slider is explained below. By understanding the sliders it is possible to create a very wide range of plausible scenarios from low-price to high-price, from stable to volatile, and from OPEC-dominated to independent-dominated.
8.7.1. Effect of Global Economy and Environment on Demand
The effect of global economy and environment is a parameter representing pressure on oil demand from the global economy or from environmental policy to limit carbon emissions. The effect can vary from −0.1 to 0.1 with a default value of zero. When the effect is zero long-term demand is stable. Moving the slider to the right results in growing oil consumption because, at constant price, intended demand (in Figure 8.16) exceeds demand. Conversely, moving the slider to the left results in falling oil consumption. With this versatile slider an Asian boom is portrayed by setting the slider to its maximum value of 0.1, whereas a green world (committed to reducing carbon emissions and using less fossil fuels) is portrayed by setting the slider to its minimum value of −0.1.
8.7.2. Cartel Quota Bias
Cartel quota bias captures the tendency of OPEC to deliberately oversupply or undersupply the market by setting a collective quota that differs from the call on OPEC (the difference between demand and independents' production). The effect can vary from −0.2 to 0.2, with a default value of zero. When the effect is zero OPEC agrees a quota exactly equal to the call. Moving the slider to the left causes an OPEC supply squeeze, a deliberate undersupply of oil that can be as much as 20 per cent of the call. Moving the slider to the right causes an OPEC supply glut, a deliberate oversupply of oil.
8.7.3. Opportunists' Capacity Bias
Opportunists' capacity bias represents the propensity of some OPEC member states to over expand capacity and exceed their allocated quota. There is always a temptation for OPEC producers to cheat on quota, particularly oil nations with underdeveloped economies and large populations that desperately need oil revenues to support social welfare and infrastructure projects. Capacity bias is defined on a scale from zero to 0.2 where zero means no quota busting. The default value is assumed to be 0.02 on the presumption that, no matter how hard OPEC strives for quota discipline, there is naturally some propensity to cheat and over expand capacity. Moving the slider to the right amplifies this natural propensity up to a maximum where opportunists strive for capacity at a level 20 per cent (0.2) above allocated quota.
8.7.4. Oil Price Bias
The oil price bias is a parameter that captures any inclination of OPEC to intentionally increase oil price by setting a target (marker) price higher than the current oil price. The default value is zero and the parameter can be moved in the range −0.2 to 0.2. Moving the slider to the right creates a condition in which OPEC's target price exceeds the current oil price by up to 20 per cent. There is no presumption, however, that OPEC will always pursue a policy of price escalation. Moving the slider to the left creates a condition in which OPEC's target price undercuts the current oil price. Incidentally, the oil price bias does not (and cannot) directly influence oil price. It acts indirectly to restrict or to boost swing producer's production.
8.7.5. Capex Optimism
Capex optimism represents the collective investment optimism of senior management in commercial oil companies. It is defined on a scale 0.5−2 and has a default value of 1. Capex optimism influences the amount of upstream investment undertaken by the independents. When optimism is set to one, senior managers approve all recommended investment projects, in other words all those that satisfy the hurdle rate. Moving the slider to the left makes management more cautious and they approve fewer investment projects than recommended, as little as 50 per cent fewer (0.5 or half the recommended). Moving the slider to the right makes managers more optimistic and less cautious and they approve more investment projects than recommended.
8.7.6. Time to Build Trust in Russia (only in Oil World 1995)
As mentioned earlier, Russian reserves are huge, 225 billion barrels in Oil World 1995. They amount to almost 50 per cent of total non-OPEC reserves. Time to build trust in Russia controls the rate at which commercial oil companies adopt risky Russian reserves into their undeveloped reserve portfolio. The parameter is defined on a scale 5–40 years. When the time to build trust is at its default value of 20 years commercial companies are assumed to adopt 1/20 (5 per cent) of risky Russian reserves per year. In other words, the value of the slider setting (20 years) defines the denominator (1/20) in the adoption rate. Moving the slider to the right captures the effect of a less trusting climate for exploration and production. Adoption of risky Russian reserves slows to as little as 1/40 (2.5 per cent) per year at the slider's maximum setting of 40 years. Moving the slider to the left increases adoption to as much as 1/5 (20 per cent) per year at the slider's minimum setting of five years.