From: Lee Corbin (lcorbin@tsoft.com)
Date: Wed Jan 29 2003 - 22:45:51 MST
Steve writes
> 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 develop 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.
Yes, that makes perfect sense. But (c) supposing that there's no
tech breakthrough, you're gambling that the oil in the ground will
become significantly more valuable over time. Right now, I think
that the Saudis or any other big investor can get quite a return
on their profits, perhaps 5-8% or more, intelligently invested in
the right places.
The only reason I personally understand, then, to leave it in the
ground is that you don't have very much of it. An oil company
that projected that its reserves would run out in a decade or so
might well be better off to forego investing in new equipment, and
continue to extract the oil with its present machinery. But the
*big* oil producers such as Saudi Arabia, Iraq, Russia, Venezuela,
and Mexico won't be running out of oil until the whole world does,
and that's not in the foreseeable future. (The need of money *now*
in these regimes would---it still seems to me---overpower long
term benefit anyway even if it existed.)
> > 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.
I thought that they did this only when their cartel was
working. No?
> 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.
When you say "cash in their chips now", do you believe
that they are afraid of running out?
> > 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?
That's what makes this a difficult but interesting
discussion :-)
> 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.
Sure, a short time horizon, especially for countries less
stable, could indeed (one would think!) cause an increase
in production. That it's not happening in some places,
e.g., Venezuela, is quite bizarre, but shows, I guess, the
inevitable political component.
But what you wrote here---the "third option"---I don't follow.
In my simple minded picture, I suppose that a Western-run Iraq
might within five years or so be producing significantly more
oil. So the world-wide price must fall. Therefore, the Saudis
or anyone else must either obtain drastically less revenue or
raise production themselves. Doesn't this seem right?
Lee
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