Unexpectedly Intriguing!
November 9, 2011

Environmental Economics' John Whitehead greedily sharpened his old pencil following a statement Texas governor and GOP presidential candidate Rick Perry made in New Hampshire:

Rick Perry in the Union Leader:

We can create hundreds of thousands of jobs and increase our oil output by 25 percent if we fully develop oil and gas shale formations in the Northeast, mountain West and Southwest. I also support drilling in Alaska’s Arctic National Wildlife Refuge coastal plain (ANWR), offshore expansion in the Beaufort and Chukchi Seas, and development of the National Petroleum Reserve in Alaska, all of which would maintain the Trans-Alaska Pipeline System. This will create more than 185,000 U.S. jobs. ...

Additionally, our families, communities and employers will benefit from more affordable energy prices as we increase the domestic supply. American manufacturing will experience a tremendous boost if we control electricity prices and get a handle on the cost of fuel for transportation fleets.

Doing the back of the envelope (and not worrying about whether the 25% increase in oil output is realistic) with these data:

daily world oil production = Q = 89,123,026 [barrels]
25% of daily U.S. oil production = dQ = 2,422,000
oil price = P = $90
demand elasticity = ed = -0.1
supply elasticity = es = 0.2
dp = ((P*dQ)/Q)/(-ed + es)

The world price of a barrel of oil would fall by $8.20 as a result of a 25% increase in U.S. production. If gas prices are about 70% due to the price of oil and gas costs $3.35 per gallon, then the oil price share of gas is about $2.35. Cross-multiplication tells me that the oil price share of the price of a gallon of gas would fall to $2.13 and we'd enjoy and $0.22 drop in the cost per gallon. Filling up a 20 gallon tank you'd save about $4. Doing this every week you'd save about $200/year.

In the interest of saving what's left of the pencil nub that John uses for his back-of-the-envelope math, not to mention sparing the world of yet another disturbing display of greed-driven pencil sharpening, we've built our latest tool to do John's quick math for estimating how much the price of a barrel of oil might change if the supply of oil being produced were suddenly changed!

Just update the data below or substitute your own values as you see fit!

Oil Production and Economic Data
Input Data Values
Daily Oil Production Data
Change in Amount of Oil Production [Positive if increase, negative if decrease]
Oil Price (per Barrel)
Demand Elasticity
Supply Elasticity

Estimated Price Change
Calculated Results Values
Projected Change in the Price of a Barrel of Oil

If you're playing along at home, John offered the following updates and insights into his back-of-the-envelope math:

Update at 8:42 a.m.: The price change formula above is for linear demand and supply curves which will lead to an upper bound on the price changes. After reviewing Hahn and Passell, I tried the formula for constant elasticity demand and supply curves and find a similar result. The price of a barrel of oil falls by $7.70.

Also, I used the short run demand elasticity for gasoline, not oil, and made a guess at the supply elasticity for oil. Using the long run elasticities in Hahn and Passell, ed = -0.48 and es = 0.36 and linear demand and supply, yields a price change of $2.60 per barrel, $0.07 per gallon and savings of about $75/year.

Drop your corrections in the comments section!

See, you've been invited! He'd love to hear from you!

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