Re: Oil Economics

From: Steve Davies (steve365@btinternet.com)
Date: Wed Jan 29 2003 - 03:40:14 MST


Robert said
> > > The price of oil is subject to a complex "present value
> > analysis" of both the countries producing it and the
> > consumers. It comes down to a question of "do I gain
> > more by pumping the oil or leaving it in the ground?".

Lee Responds

> Who ever gains more by leaving it the ground? (Besides
> U.S. farmers, I mean.)

Many people I'm afraid. It's a question of time horizons. You compare the
return you would get by pumping the oil now to what you might get in the
future assuming (a) you, your heirs or assigns will still control it (b)
other sources have been depleted in the meantime and (c) there's been no
technological breakthrough in the meantime to cause a slump in demand. This
doesn't just apply to oil the same is true of other resources, above all
land. It can pay not to devlop land but to leave it idle if this leads to a
rise in its capital value or to a rise in rents at a future date.

Robert again
> > You have to assume that (a) the U.S. (or Europe) would
> > act to pump-up-the volume with respect to Iraqi oil
> > production (and there is no useful knowledge with
> > respect to the degree they could do that given a
> > decade of decay in the production capabilities) and
> > that the (b) the Saudis (or other OPEC or even non-OPEC
> > members) would not act in a way to offset the production
> > increase that Iraq *might* be able to achieve.

Lee again

> What? If we assume that Iraqi oil production goes up,
> then you are saying that this would be offset by other
> countries *lowering* their production? Leaving all the
> profits to Iraq? That's not how markets work. Unless
> they achieve a cartel, it forces down the world market
> price of oil, right?

But this *is* what some producers have done in the past
particularly the Saudis. You forgo profits in the short term (let them
accrue to whoever controls Iraq) in the expectation that the income your
resource will generate in the future will be greater than it would otherwise
be. An important consideration here is the time horizon of the Saudi rulers.
If they think they are going to be overthrown in the near future they have
every reason to cash in their chips now but if they are confident of holding
on the incentives work the other way.
Robert
> > Yes, there are disruptions, e.g. Venezuela or perhaps
> > pipelines being blown up (or not built due to political
> > problems), etc. But you are living in a fantasy world
> > if you think most oil producing nations are going to
> > pump oil at $10/bbl). They *know* the supply will
> > eventually decline.

Lee
> Yes, and as the resource "eventually" runs out, the price
> indeed goes up. But it goes up in accordance with the
> laws of supply and demand. Don't you acknowledge that
> the Saudis and everyone else are trying to make as much
> money as they can?

Yes but when - within what time horizon?
>
<snip>
>
Lee concludes

> Why, no. Of course they'll have to change their behavior.
> They'll either have to lower their price or sell less.

Not at all. There's a third option (although you could say it's another
version of the second). The factor that might well make the Saudis behave
the way you predict lee, is the demographics they face. They have a lot of
overqualified young men and not enough jobs for them (jobs they are keen on
that is) so a decline in oil income has sever political implications for
them.

Steve Davies



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