26.8.08

INCENTIVES TO EXPLORE? An American Thinker article presents a chart that suggests a summertime bubble in crude oil and natural gas prices, the popping of which would discomfit would-be tsars and caudillos.
A major fall of oil prices to pre-run-up levels would severely cut the income of Russia, not to mention the oil states of the Gulf and Hugo Chavez.
To accompany the data, consider two differing perspectives on the incentives to develop new oil sources. First consider Jon Basil Utley in Reason:

In fact, the world oil shortage is political, not geological. In the U.S., the government makes it virtually impossible to drill in new areas offshore. In Nigeria, civil strife has shut down major production. In Libya and Iran, Washington effectively blockaded and isolated the nations for years to inhibit new production. In Iraq, of course, the U.S. destroyed much of the infrastructure since the first Gulf war in 1991 and then blockaded reconstruction. In nations such as Russia and Mexico nationalism and corruption curtail increased production.

Outside of developed Western countries, the single largest reason for oil "shortages" is government incompetence and ownership of the subsoil rights so that landowners don't benefit from oil discoveries. In Patagonia, Argentina (a nation with abundant oil), I was told how it was common for landowners to try to hide any evidence of oil seepages from underground, lest the government oil company come in and ruin their lands with no benefit to themselves. Private mineral rights ownership is the reason some 90 percent of all oil wells drilled have been in the U.S. Scientific advances and innovative engineers keep coming up with ways to both discover new fields and keep old ones in production almost indefinitely.

Note that discovering new fields and extending the production of old ones presuppose permanently higher crude prices, as these reserves are uneconomic to recover at lower prices.

That point escapes former Texas Railroad Commissioner Jim Hightower, who should know better.
Sure, global demand is on the increase, but under free market “law,” supply is supposed to rise to meet that need, thus holding consumer prices stable. However, here comes Oligopoly #1: oil producers. OPEC is the chief monkey wrench controlling the world’s flow of crude, and its members have refused to get off their ample rumps to ratchet up production enough to make a difference. Saudi Arabia alone could expand its output by two million barrels a day, but even presidential groveling has not moved the oil kingdom to take dramatic action. Twice this year, George W. flew there to hold hands with King Abdullah (literally—there are pictures!) and beg him to open the spigots, only to be rejected. Hold hands, yes; play footsie, no.
Cute, but wrong at the beginning and incomplete at the end. The conflation of a movement along a supply curve (increased demand implies excess demand at the old equilibrium price; a higher price is an incentive to buyers to conserve and to sellers to produce more) with a shift of the supply curve, the most charitable interpretation of "rise to meet that need, thus holding consumer prices stable" that I can come up with, is a common error among beginners that is all too often committed by pundits and policymakers. Moreover, the threat of entry can be a powerful inducement for participants in an existing collusion to defect. I think it takes a Texas Railroad Commission to prevent that defection. Mr Hightower appears to have forgotten.
Enter Oligopoly #2: oil refiners. These would be the same gentlemen who sang that free market ode to Congress. Interestingly, the refiners don’t really want crude prices to come down, because they also happen to be oil producers—ExxonMobil, for example, produces more oil than any OPEC member except Saudi Arabia and Iran.
Yes, a seller will be displeased to see the price of its product fall, but so what? Markets are environments in which resources flow to more profitable uses. It's not Exxon-Mobil that's blocking a vote on offshore oil drilling in Congress or maintaining those Iberian land-ownership rules in Patagonia.
While more expensive crude does raise Big Oil’s cost of making gasoline, so what? Thanks to a rash of mergers waved through by Washington in the past dozen years, gasoline refining and marketing are in the oligopolistic grasp of ExxonMobil, Shell, BP, and ConocoPhillips. Even as oil executives were lecturing Congress about how the free market works, they were slashing output at their refineries in order to hold supply down and jack up prices.
Last time I checked, domestic oil refining was a medium-concentrated market, one in which no further mergers would pass muster with the antitrust authorities. It's also a market that's vulnerable to price competition from newly developed sources.

No comments: