Nesa identified Issues: Strait of Hormuz

2.1Overall approach

estimation of global price responses to a defined reduction in supplies of crude oil and petroleum products resulting from partial closure of the Strait of Hormuz commencing on 1 March 2012 (DRET provided assumptions regarding the extent and duration of reductions in supply of crude oil and petroleum products, including the timing and quantities involved in ramping-up supply after partial closure, and the timing, quantum and mix of internationally coordinated releases from stockpiles)

estimation by ACIL Tasman of speculative demand changes and price elasticities of supply and demand for crude oil and for petroleum products before, during and following the period of interruption to full recovery of supply

modification of the supply and demand elasticities in Tasman Global for the rest of the world and for Australia

application of shocks to the model reflecting price increases in crude oil and petroleum products globally and to Australia and based on two scenarios tested against a reference case

tabulation and reporting of results in terms of aggregate economic impacts for Australia

a qualitative analysis of the likely impact of declaration of a liquid fuels emergency.

2.2Estimation of elasticities

Through the Department, ACIL Tasman consulted with the IEA and other organisations to probe further into supply and demand responses that are likely and the feedback mechanisms that might change demand/supply responses in the months after the initial closure.

An explanation of the concepts of price elasticities of demand and supply and the implications of their interaction is provided in Box below.

Box Price elasticities of demand and supply

The analysis for this report drew on price elasticities of supply and demand to estimate the price impacts of the supply shock. The price elasticity of demand is the percentage change in quantity demanded by consumers divided by the percentage change in the price. This is illustrated in the chart on the left of the diagram below. The chart shows a downwards sloping demand curve. As the price rises by Δp the quantity demanded by consumers falls by Δq. The price elasticity of demand is shown in the diagram. Similarly the price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price. This is illustrated in the chart on the right of the diagram below. The chart shows an upwards sloping supply curve. As the price rises by Δp the quantity producers are willing to supply to the market increases by Δq. The equation for the price elasticity of supply is also shown in the diagram. A hypothetical supply shock removing and amount of (Δq/q) percent of global oil production would require a proportionate increase in the price of (Δp/p) to clear the market. This market clearing process would result in an initial price increase which would cause a decrease in the quantity demanded. The market clearing process would be accomplished by a combination of proportionate change in quantity demanded of (Δp/p) x Ed and a proportionate change in quantity supplied of (Δp/p) x Ed. The proportionate supply shock therefore would be equal to the proportionate change in demand from consumers less the proportionate change in supply by producers = [ (Δp/p) x Ed ] – [ (Δp/p) x Es ] = (Δp/p) x (Ed-Es) Taken another way percentage increase in price (Δp/p) that would arise in the short term as a result of a percentage change in quantity supplied (Δq/q) can be expressed algebraically as (Δp/p)= (Δq/q)/( (Ed-Es). This formula has been used to calculate the percentage price increase that would arise in each week of the shock event in response to changes in supply. Source: ACIL Tasman based on research summarised in Attachment C.

2.3Estimation of price impacts

ACIL Tasman took this shock profile, allowed for changes in speculative demand in the context of uncertainty, and using the price elasticities of demand and supply, calculated movements in crude oil prices prior to, during and after the closure. The amount of refine products passing through the Strait is small compared with crude oil and not material for calculation of Australian economic impacts.

The price impacts for were estimated for two scenarios and two elasticity cases:

• 
  Scenario 1 assumes seven refineries operating
  
  1. 
     relatively low elasticity case (Case A)
     
  2. 
     higher elasticity case (Case B)
     
• 
  Scenario 2 assumes four refineries operating
  
  1. 
     relatively low elasticity case (Case A)
     
  2. 
     higher elasticity case (Case B).
     

Scenario 1, case A and case B were compared with a reference or base case scenario including Australia’s seven existing refineries. Scenario 2, case A and B were compared with a base case involving only four Australian refineries. The reference case scenarios assumed price movements estimated to apply in the absence of concern regarding closure of the Strait of Hormuz.