Critique of the mid-range energy forecasting, system oil and gas supply models
This paper examines the Mid-Range Energy Forecasting System (MEFS) oil and gas supply models on the basis of how well their structures and assumptions conform to accepted economic principles. The paper first discusses the structure of the MEFS oil and gas supply models, then analyzes weaknesses of those models, and finally suggests changes in the models to improve their performance. The MEFS oil and gas models are found to be weak, on theoretical grounds, in several respects. First, because
... ling effort is estimated using average rather the marginal production costs, supply projections are high and price projections are low. That estimation method also invalidates the normal assumption that the equilibrium solutions of the MEFS oil and gas models maximize consumers' plus producers' surpluses. Second, drilling effort is allocated over time on the basis of rig availability. Rig capacity is added according to an inflexible schedule that is unaffected by economic variables such as prices and interest rates. The result of the inflexible rig investment schedule is that capacity tends to build up faster than reserves are depleted, so oil and gas production tends to increase over time at each price level, in spite of the fact that both average and marginal production costs are increasing as reserves are depleted. Third, because the rate of oil and gas extraction from reserves is invariant to petroleum prices, there is no wellhead production response to price changes. Finally, because MEFS oil and gas "supply curves" mix long-run and short-run concepts they are not consistant in their implied behavior. Each point on MEFS oil and gas "supply curve" represents the maximum amount of production that is possible, given available rig capacity. By linearly interpolating production response among nine discrete short-run supply points, the MEFS oil and gas "supply curves" implicitly assume that rig capacity can be instantly expanded or contracted in the short-run. This violates the definition of the short-run as a time period in which the level of at least one factor of production is fixed.