Stockpile Strategy for China's Emergency Oil Stockpile Strategy for China's Emergency Oil Reserve: A Dynamic Programming ApproachReserve: A Dynamic Programming Approach

Yang Bai a, Carol A Dahl b, Dequn Zhou a, Peng Zhou a

a Research Centre for Soft Energy Science, College of Economics and Management,

Nanjing University of Aeronautics and Astronauticsb Mineeral and Energy Economics Program, Colorado School of Mines,

Economics, College of Business Administration, King Saud University, Riyadh

IntroductionIntroduction

China now accounts for 12.5% of total world oil imports China imports more than 50% of its petroleum.

consumptionconsumption

ProductionProduction

Net importNet import

Oil import dependency has been over 50%

Source: EIA, International Energy Statistics.

World oil import structure 2010 China’s oil consumption and production, 1983-2010

Source: BP Statistical Review of World Energy, 2011.

Layout of China’s SPR sites for three Phases Layout of China’s SPR sites for three Phases

China aims to hold a capacity equivalent to 90 days90 days of net petroleum import which is 440 million barrels440 million barrels.

The reserve facilities is expected to take 15 years15 years in three phases, with a in three phases, with a total investment of total investment of 100 billion RMB.

Phase I (2004 – 2009) : 102 mln barrels of storage capacity in 4 separate sites.(finished)

Phase II (2009 - TBA) : 169 mln barrels of storage capacity in 8 separate storage sites.(Under construction)

Phase III (finish before 2020) : 169 mln barrels of storage capacity with the number of sites still to be determined. (Planned).

ResearchResearch purposespurposes

Modeling for China’s stockpile and drawdown policy;

Simulate China’s optimal stockpile and drawdown policy with representative numerical examples.

Estimate the influence of stockpile on oil price.

MethodsMethods

To estimate the cost of stockpile, we take into account consumer cost, acquisition cost (or drawdown revenue) and holding cost.

Basic method:

Stockpile for SPR

consumer cost acquisition cost holding cost

oil price

supply demand

Equilibrium condition

Cost function

Additional demand

Planning stockpile period (1 year)Planning stockpile period (1 year)

0 MB0 MB

169 MB169 MB

Inventory sizeInventory size

MonthMonth

Jan.Jan. Feb.Feb. Mar.Mar. Nov.Nov. Dec.Dec.

MethodsMethods

1ts ts 1ts 1Ts

( , , )emand t tD u p t ( , )upplyS i t

1( , , , )T T T Tf u p s r1 1 1( , , , )t t t tf u p s r 1( , , , )t t t tf u p s r`1 1 1 0( , , , )f u p s r 1s

Ts M

1u tu 1tu Tu

tp

Algorithm starts from T, works backward till 1

1p

1tp Tp

ss : :existing capacity (state variable).existing capacity (state variable).

uu : :stockpile acquisition sizestockpile acquisition size (control variable).(control variable).

p p ::oil price.oil price.M M ::planning SPR capacity.planning SPR capacity.

DDemandemand((u,p,tu,p,t)) : :demand function.demand function.

SSupplyupply(i(i,t,t)) : :supply function.supply function.

r r ::discount rate.discount rate.

f f ((u,p,s,ru,p,s,r)) ::The objective functionThe objective function

Dynamic programming algorithm for an oil stockpile Dynamic programming algorithm for an oil stockpile

MethodsMethods

The SPR modelThe SPR model

, 1 1, 0,

1( ) min ( , ) ( ) , ,...,1

1t t tt t t n t t t tu D s Mf s V s u f s t T

r

0

1 1

( , , )

( ) 0

( , , ) , ( , , )

( , ) ( , , )

, 0, .

t

t

T t

p u i t

t t t t t tp

upply emand t t

t t t

f s

V s u t D p t dp u p u i t v s u

S i t D u p t

u D s M

Initial implementationInitial implementation

Market state

normal state (i=0); disruption state (i=1, 2…)

Supply and demand illustration

Demand function:

Supply function:

Price assumptions

The price growth with a certain rate in base case.

Price growth scenarios: Low growth trend; Medium growth trend; High growth trend.

( , , )emand t t t tD u p t q p u

0( , ) (1 )upply iS i t Q

Initial implementation Initial implementation

No. Parameter Value Units Description

1 M 169 Million barrels Planning stockpile capacity

2 T 12 Months Stockpile period

3 Q0 260 Million barrels Supply amount in normal state

4 p0 63 Dollar per barrel Oil price in normal state

5 q 114 Million barrels Minimum short-run level of consumption

6 ν 1 Dollar per barrel Holding cost per unit

7 σ -0.2 —— Price elasticity

8 g

1% —— Medium growth rate

1.5% —— Normal growth rate

2% —— Low growth rate

9 λ5% —— 5% disruption

10% —— 10% disruption

Parameters in the modelParameters in the model

Simulation results Simulation results

In base case, China’s optimal acquisition size varies from 4 to 19 million barrels per month4 to 19 million barrels per month.

1. Result for base case1. Result for base case

Fig. 1 Optimal stockpile and inventory size over time in base case

Simulation resultsSimulation results

Fig. 2 The effect of stockpile acquisition on oil price

The acquisition of stockpile drives the price up by 15% to 48%15% to 48% approximately depending on the acquisition size.

Simulation resultsSimulation results

The stockpile strategy could vary significantly to different price assumptions.

2. Results under various price assumptions 2. Results under various price assumptions

Fig. 3 Optimal inventory trajectories to various growth rate of oil price

Simulation resultsSimulation results

Fig. 4 Optimal stockpile strategy under different disruption scenarios

3.Results under disruption scenarios 3.Results under disruption scenarios

When 5%5% cutback happens, 6 6 million barrels of stocks are suggested to released to the market.

when 10%10% disruption occurs, 1010 million barrels of the capacity should be released.

Simulation resultsSimulation results

When 5%5% cutback of supply happens, the oil price increases by 9%9% and goes up to $95/bbl$95/bbl. With the drawdown of stockpile, the oil price decreases 5%5%.

In the case of 10%10% disruption, the price increases by 31% and surges to $115/bbl$115/bbl. When 1010 million barrels is released to the market, the oil price decreases significantly to $78/bbl$78/bbl.

Fig. 5 Oil price variation in response to disruptions

ConclusionsConclusions

The optimal monthly stockpile acquisition size varies from 4 to 19 4 to 19 million barrels per monthmillion barrels per month. The best acquisition amount and time mainly depend on the oil price.

Stockpiling exerts an upward pressure on priceupward pressure on price. The impact depends on the acquisition size. While our representative example shows the stockpile drives up the oil price by 15% to 48%.15% to 48%.

In a disruption, we find that the drawdown of stockpile dampens the dampens the soaring pricesoaring price effectively. However, the optimal drawdown should leave leave price higher price higher than before the disruption.

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