Tuesday, July 22, 2008

Oil everywhere, none to use

Delving a bit into national/global economic politics for the time being, it seems to me there is a substantial disconnect with regard to what exactly drilling for oil off the coast of the United States or up in Alaska could really bring to us, and that when silly talking points with regard to this issue are parrotted, there's little pushback by the national media.

Case in point in John McCain's claim that prohibiting the drilling off our coasts is the reason that our gas prices are so high, which is beyond silly but also flat-out wrong.

Now, listen to me carefully here, I'm not the kind of guy who's going to sit here and tell you that we shouldn't be drilling up in Alaska so we can save artic animals or off our coasts because we'll pollute our oceans. While those issues do factor in my mind, it's also quite clear we have technology that can enable us to explore for oil in targeted areas in an environmentally responsible way.

The problem, though, isn't totally over environmental or aesthetic concerns, but feasibility ones. There is sparse evidence to suggest there is ample supplies buried beneath the continental shelf to make an impact, and what is there would provide minimal, if any, immediate impact on $4-plus gallon gas ...

"Would starting to drill now do anything for consumers in the near future? The answer to this one, again in my opinion, is probably not, since it'll take so long for new oil or gas to come to market. There is some small chance it would have immediate benefits if the current price of oil is fueled by spectators convinced that supply will continue to remain stagnant in the face of growth. They could take a commitment to drill as evidence that supply constraints will loosen, resulting in lower prices (or slower increases), making oil futures a weaker investment that would trade for less."
- Ken Green, an energy analyst with the American Enterprise Institute

"I think it would have an effect, just not a major effect. The odds are you couldn't get any significant amounts of crude from coastal areas within the next decade. Offshore rigs, if you want to go get one, tough luck. They are all leased out. Even if the infrastructure is there, it would be hard, but the infrastructure isn't there... But markets react to future developments and even if the crude is not flowing, the project itself could have an impact on markets."
- Jerry Taylor, a fellow at the Cato Institute

"There are a number of problems with that argument. First of all I don't think anyone thinks that within the time period of futures trading, that there would be enough additional supply to affect global future prices. Second of all, the market will look at this not only in terms of, 'there is more supply,' but also, 'there is more supply at substantial greater costs to recover than current supply, and with substantial new liabilities' - the communities that are going to sue them when they destroy their beaches."
- Rob Shapiro, co-founder and chairman of Sonecon, LLC

In the Artic National Wildlife Refuge, the Bush Administration's Energy Department says it would only be pennies per barrel by 2030, while the same department notes this about offshore drilling potential ...

Based on studies done 25 years ago, the Interior Department estimates that 18 billion barrels of recoverable oil likely will be found beneath coastal waters now off limits. The U.S. consumes about 8 billion barrels per year.

In a report last year, the Energy Department forecasting arm said it would take until 2030 before offshore production really got going. Even then, the report said, "because oil prices are determined on the international market ... any impact on average wellhead prices is expected to be insignificant."

By all accounts, any oil discovered off our coasts would only be deliverable to our markets in the next 10 to 20 years, which is as far off from 'immediate relief' as you could possibly be. If the entire argument for offshore drilling is that we must do something now - thus providing a bridge to an era of alternative fuels - then the argument itself falls apart underneath the weight of its own evidence.

The conclusion, then, is that advocates of offshore drilling are either operating on extremely fautly logic and evidence or shamelessly moving forward with sham of a plan for personal gratification ... and neither option is particularly comforting.

Again, if we're looking to wean ourselves off not just foreign oil, but oil itself, then the more logical approach to building said 'bridge to independence' is by putting measures in place to reduce consumption, thus lowering demand - fuel efficiency standards need to be raised, more fuel efficient vehicles need to be rolled into the market, incentives for consumers to acquire fuel efficient vehicles need to reinstituted, pilot programs for alternative energy need to be put in place, etc.

Drilling off our coasts won't provide a meaningful economic impact for our consumers, which should automatically remove it from the table of options.


Anonymous Darren said...

While you're thinking about energy:


Analysis of Gore's recent speech regarding carbon-free power generation.

9:56 AM  
Anonymous Anonymous said...

No guarantees, granted. Point being: you let the oil companies take the risk--financial and otherwise--to find out. They think there's oil there; if there is, why not let 'em get it out of the ground, refine it, and sell to us?

What's the upside of not doing that?


10:10 AM  
Blogger Ned said...

How about we let the oil companies drill on the land they already own. Off-shore drilling is nothing more than a land grab by the oil companies.

Go out and take a look at a map of the places where oil companies have rights to drill but choose not to. They'd rather grab up more than than tap what they already have.

Mind you all the rigs that can be used for offshore drilling are tied up for years.

1:05 PM  
Anonymous Anonymous said...

"Choose not to?" Perhaps because they think, rights notwithstanding, there's no oil there. Doesn't make sense to drill where there's no oil.

And it doesn't make sense not to drill where there might well be oil.

2:35 PM  
Blogger Ned said...

They know there is oil there. Don't be a moron. They just know they can grab more land now that the public is in a panic about the price of oil.

Pretend you are an oil executive. Your job is to maximize profit, not serve the citizens of this country. When your customers are in a bind and with no where else to go, you start to turn the screws. There is no incentive for oil companies to lower prices - just maximize profits. The key to maximizing future profits is to gain access to additional sources of oil and hold on to them until they are most profitable.

2:54 PM  
Blogger Xon said...

Pretend you are a bloviating "man of the people." Your job is to maximize power, prestige, and perks for you and your ideological partners, not to do what's best for the country. When your constituents are left in desperate need with nowhere else to go, you turn the screws. There is no incentive for politicians and other crisis-mongers to actually help the people; only to maximize their own power by pretending to care. The best way to maximize power is to yell and scream about the latest crisis, point fingers at others, but refuse to take any steps to make it better, even possibly better.

Ned's own analysis is self-contradictory. Oil has already skyrocketed in price. If oil companies are holding onto oil until it is "most" profitable, then wouldn't they be unleashing some of it now? Market forces seem to play no role in Ned's thinking. Any oil exec who could get gasoline to market right now for fifty cents less per gallon than the current rate, would do so in a heartbeat. Because, in the market, lowering prices is how you maximize profits. Underselling competition is a powerful move, indeed.

The notion that oil executives are sitting on oil right now and refusing to use it because they want the price to go even higher is absurd. First, there is no profit right now if they sit on the oil, and they are essentially taking a risk that later on there will be even more money to be made. That's a pretty silly risk to take, if you've got a bunch of highly-profitable stuff sitting around right now. Second, supply and demand are real forces in economic interaction, and not simply theories taught in Econ 101. At higher prices, there is less demand. People are already cutting their demand, at least here in the States, in response to higher prices. (Worldwide demand continues to rise overall, b/c there are huge countries still just beginning to fire up the industrialization machine). If oil got to some extaordinarily higher price, say 8 dollars a gallon, then it's not like all these evil oil execs could THEN cash in by releasing their gas they've built up and sell it for 8 dollars a gallon. Because there won't be nearly as much demand at 8 a gallon. (And the added supply of oil would also lower the price).

The bottom line on this is that if an oil company can find a way to make gas cheaply enough so that they can sell it for a profit at current prices, then they will do so. The idea that you forego profit now in order to make more profit later (not as a marketing plan, where the first one is free, nor as predatory pricing, where you try to run a competitor out of business (though that doesn't really happen the way leftists talk about it, either)) is an insane risk to take, and companies don't do that. There is big money being made in oil right now. Why? Because demand is outstripping supply. We can either increase supply to meet the demand (and ANY means of doing so, no matter how long it is supposedly going to take, is at least SOMETHING and will help); or, we can decrease demand. But guilt-tripping Americans and Euros into buying less fuel isn't going to be nearly sufficient. 2 billion Indians and Chinese are going to be demanding more oil, no matter what we do over here. Trying to decrease demand for oil is simply not likely to do any good. We need oil for anything resembling our modern economy. Maybe one day some other means of providing fuel will be developed that actually is economically efficient, but until it does we're stuck with oil. And like it or don't like it, but we have to have it. Get serious.

There is no need for laws and regulations telling car manufacturers they have to make more fuel-efficient cars. The higher price of gasoline is causing car buyers to demand more fuel-efficient cars, all on their own. It's happening already. Gov't has nothing to add here, frankly.

5:23 PM  
Blogger Ned said...

Any oil exec who could get gasoline to market right now for fifty cents less per gallon than the current rate, would do so in a heartbeat.

If an oil exec was stupid enough to do this you know would buy up that gas, right?

6:19 PM  
Blogger Xon said...

Everybody who could get it would want to buy it, making that oil exec's company very popular and making it more profitable than its competitors.

Current price of gas is x per unit, and it costs some amount y (less than x) to perform all the necessary productive tasks for each unit. To assign arbitrary (but realistic) values, let's say gas is 4/gallon and it costs 3.50 to produce (production includes drilling for it, extracting it, transporting it, refining it, paying taxes on it, paying employees, etc.).

ABC Oil finds a way to produce gas for 3.00/gallon. So they start doing that, and selling it for less than 4/gallon (the current "going" rate).

So, consumers are now faced with a choice between 4.00/gallon gasoline at every other company, or 3.something gas from ABC Oil. What will most consumers choose? Exactly, and so now ABC is making a killing. Finding ways to lower production costs, so that you can lower prices, is one of the surest paths to greater profitability. Higher prices don't necessarily indicate success for a producer (it all depends).

So, what precisely is "stupid" about this oil exec at ABC Oil who decides to produce gas for 50 cents less a gallon than it's costing everyone else?

6:47 PM  
Blogger Ned said...

Oil/Gasoline doesn't work that way. It isn't a hypothetical widget in an economics textbook. When was the last time you saw a gas station that sold gasoline at a discount of greater than 2% compared to competition?

So, what precisely is "stupid" about this oil exec at ABC Oil who decides to produce gas for 50 cents less a gallon than it's costing everyone else?

Because he could sell that gasoline for market price and collect the extra 50 cents. Remember, demand outweighs supply. The oil exec doesn't need to offer any incentives in order to find customers, he just needs to put his product on the market at market price and all of it will be purchased.

In your example, ABC isn't making a killing. They are making 50 cents less per gallon than their competition. I guess is ABC oil has no shareholders and functions a charity then your thesis is correct.

7:38 PM  
Blogger Jmac said...

So, what precisely is "stupid" about this oil exec at ABC Oil who decides to produce gas for 50 cents less a gallon than it's costing everyone else?

I think Ned's response is very valid. While one can concede there might be a marginal amount of motivation to reduce price, it does also defy the basic notion of supply and demand. We have an incredibly high demand and evidence the market can withstand $4 gallon gas.

There is little to any incentive for a company to reduce its price with demand still high and supply still low. Since we're using simplistic economic analogies, my grandmother parks cars for The Masters and we charge $30 a car, and this number is on par with everyone else on the street with similar proximity to the front gate.

When others move their prices up, and we see that cars still flock to their lots, we move our price up because we know they'll come to our lot for the same price too.

9:56 PM  
Blogger Jmac said...

Another thing to consider, assuming demand remains high and supply remains low (which estimates from increased American drilling indicate there would be minimal change), if the market has proven it can sustain $4 gas, why would any company reduce its price if it can lower or streamline production costs?

If you can get $4 on the market for it and it costs $3.25 vs. $3.50 to produce, you have the potential to make more profit by keeping it at the same price. Now demand can fluctuate and new technologies can have an impact on that our supply (fuel efficiency standards for instance), thus meaning that may move the market, but in our given conditions I don't see much incentive to lower the price.

10:08 PM  
Blogger Xon said...

Of course gasoline is not a hypothetical widget in a textbook, but you're confusing a simplification for the sake of clearly explaining a principle with a simplistic argument. Supply and demand interact, and the result is the market price. It's complicated to look at all the factors that really go into it in any given situation (not just with gasoline, but with any other non-hypothetical widget, too). But the principle is what is important.

Even with something like gasoline, demand is not inelastic. We are already curtailing our consumption somewhat in response to the high prices. You cannot simply "put your oil out there" and "know" that everyone is going to buy it. Sure, that's what it might look like on the front end, but supply and demand still do their thing, and eventually there comes a supply that actually outstrips demand and causes the price to come down again.

Furthermore, all else being equal, a lower price will yield a greater demand. So producers, in general, often make more money by selling more goods at a lower price.

Demand, again, is not inelastic, even for something like gasoline. If consumers are buying X gallons of gasoline at 4 dollars a gallon, then at 3.85 /gallon they will buy X + n gallons. They will buy more at a lower price. So the company that can produce it more cheaply can also sell it more cheaply than its competitors, which will draw MORE consumers to its product and allow it to make more money.

Further, you are over-simplifying yourself when you act as though it is just a question of putting the oil out there at whatever the "going" price is. People are paying 4 dollars a gallon right now, so why sell it for less? The reason you sell it for less is because that will make people want to buy MORE gasoline from you. It's not just about the current "batch" of gas. It's about the next batch, too.

Say, the normal profit margin is 50 cents per gallon. But ABC Oil finds a way to make it for fifty cents less per gallon. Well, they COULD just keep selling it at the same price as everyone else, and make a larger margin on each individual gallon. But that won't drive any extra consumer demand in their direction. If, on the other hand, they lower their price so that their gasoline is actually more attractive to consumers than the gas sold by their competitors, then they will sell many MORE gallons than they would have at the "standard" price and so they can afford to not make as high of a margin on each individual gallon. Plus, remember, if they've cut production by 50 cents, then they could also lower the price by 50 cents and still make the SAME margin on each gallon as all their competitors (All other companies spend 3.50 producing and sell for 4.00, let's say; but ABC produces for 3.00 and sells for 3.50).

This is all win and no loss for ABC Oil. Of course, I'm still speaking in large economic generalities, but no more so than you. Your explanation (Ned, and JMac as sympathetic to Ned's explanation) is ad hoc. Successful companies don't generally say "hmm..what is everyone else selling for? Okay, I'll sell for exactly that same amount." They try to find a way to sell for even less than those competitors, while also cutting their production costs to keep their margins about the same. This is where competitive advantage is (often) made.

Simply cutting production costs and then selling for the "standard" price is what's "not how it really works."

4:30 PM  
Blogger Xon said...

When you adjust the price for parking cars at the Masters, JMac, that works because demand really has gone up and you are correctly ascertaining that from the success of the other neighboring lots (who continue to get business when they raise their prices). But, this is still something of a guessing game. And if a new guy came along who wanted to actually become the king of the lot operators, he would probably park 'em for a little less.

Pretend some guy buys up four consecutive lots in National Hills and bulldozes the houses to make one large residential parking lot. Now, first of all, there are now MORE spaces on the market than there were last year, and this will have a downward effect on demand (in relative terms, not necessarily in absolute terms...i.e., people are so Masters crazy that the price may STILL go up...but it will not go up as much as it WOULD have if this guy hadn't built his lot). Eventually, enough new parking spaces WILL lead to a lower "market" price. But in the meantime, competing lot owners (and you and your grandmother aren't really "competing" anyway, right? You're just trying to "get in on" what everyone else is doing. Everybody makes money, and everybody's happy. And it's all really a hobby, not a profession) could very well try to undersell one another in order to draw more people to THEIR lots.

Also, your example is not really analogous b/c you and your grandmother have a fixed supply of parking spaces. It's not like, if you make a bunch of extra money one year, that you are going to knock down one of her bedrooms and add extra parking space in the yard so you can "expand the business" the next year. If a person were actually trying to be the dominant car parker in your grandmother's neighborhood; if he was willing to expend more resources as he made money to expand and add more spaces; if he wanted not just to make his own slice of the pie like everyone else but to actually have MORE people park with him than with other people; and if he wanted to get repeat business from the same people and so forth; then he might very well start up his own parking service, but undersell you all by two dollars a car. That would be a very viable business practice, if he was treating it as a business and not as a fortuitous lark that makes money one week a year due to the happenstance of where his house is located.

4:39 PM  
Blogger Polusplagchnos said...

Underselling competitors is a powerful move, but not when we're discussing Walmart. In that situation, the failure of local businesses to remain open was due to a failure to adapt to a changing marketplace. Here, everyone wants to reduce prices to oversell one's competitors so as to hold a larger market share. Of course, we can also have markets that are non-competitive--grandmas and hobbyists and such--and therefore operate by different market forces than those discussed with competitive markets, which are what oil companies are, by assumption, since oil production, refinement and distribution by assumption are not collusive activities driven by elastic demands. Because, as we all know, we don't really need oil as much as we think we do. People can choose to buy electric cars at any time.

They should just save up the money. Because personal savings is what people do, but corporations never save up for their own droughts.

5:36 PM  
Blogger Ned said...

No matter how much you write you are still wrong. Commodities are not widgets. There are no incentives for oil companies to sell oil for less than market price. None at all.

As long as demand outweighs supply, you sell at market price and you'll sell your entire inventory at maximum profit. Anything else is just bad business.

7:29 PM  
Blogger Jmac said...

Again, while I kinda agree with Ned's latest comment - no offense - it isn't as a lower price of gasoline means you buy more of it. The gas tank of someone is a fixed size, and that gas tank needs to have a full tank in order to operate.

I haven't adjusted how much gasoline I buy with prices rising, but rather adjust my other expenditures to compensate for the increase in spending I have to make for gasoline. Regardless, I still have roughly 14 gallons in my Honda Accord that need to be filled up on a weekly basis.

Undercutting someone's price makes little sense on something that has to be purchased anyway and where there is a fixed amount of gasoline one car can take.

6:58 AM  
Blogger Xon said...

Okay, my mistake. I vowed a few months ago not to talk economics anymore with people. There just isn't much point, especially since our Savior has arrived and is going to lead us to the promised land anyway. Economics is all hypothetical anyway, when it is espoused by conservative/libertarians who DON'T want to get with the program. It can be made up as we go along to justify the latest expansion of government power.

Lower prices increase demand. This is Economics 101. When the price goes down, all else being equal, the demand curve shifts. Duh.

People don't just typically have one gas tank to fill. And even if they do, they might be considering buying a second car, but had been holding off b/c gas prices are too high right now. When gas prices come back down, they buy a second car: a whole second gas tank! (Magic!)

They also have lawnmowers or motorcycles or boats that they might come fill up when the price drops. They also might fill their automobile tank up more often, because they decide to drive more, because the price went down. Lots and lots of ways to demand more gas in response to lower prices. And this is what happens. To deny it is to basically say "I don't know anything about economics and I don't want to." I'm equally sorry for being so blunt.

But, like I said, I'll go back to the shadows now.

10:38 AM  
Blogger Ned said...

But we aren't talking about increasing demand or selling more gas, we are talking about maximizing profits, which is what corporations are supposed to do.

If you went back in time about bought a million dollars worth of gas at $1 a gallon and stored it until now, would you sell it for 50 cents less than everyone else in town or would you sell it for market price?

Bonus question, would you sell all of it at once or would you sell it over a long period of time? Assume you are well off and don't need to make lots of money in the short term but want to maximize your return on investment, but you do need to make enough money in the short term to support a comfortable lifestyle - so you need to make 150k profit a year.

Finally, if for some reason you decide to sell all of it for less than market price, would you let me buy all of it so that I could resell it on the market for market price?

11:26 AM  
Blogger Ned said...

Come out of the shadows. I expect an answer or an apology, but I am not willing to accept a retreat. If you need further education I'd be happy to arrange a meeting with some profs in the business school. It shouldn't be too far from Philosophy, geographically, but it is very grounded in reality.

1:49 AM  

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