I tend to get excited when I see familiar things.
At the WSJ, the famed Feldstein explained why prices of crude oil are up. Among the explanation written how the decision to extract oil from the ground comes about and how it affects prices:
Unlike perishable agricultural products, oil can be stored in the ground. So when will an owner of oil reduce production or increase inventories instead of selling his oil and converting the proceeds into investible cash? A simplified answer is that he will keep the oil in the ground if its price is expected to rise faster than the interest rate that could be earned on the money obtained from selling the oil. The actual price of oil may rise faster or slower than is expected, but the decision to sell (or hold) the oil depends on the expected price rise.
There are of course considerations of risk, and of the impact of price changes on long-term consumer behavior, that complicate the oil owner’s decision — and therefore the behavior of prices. The Organization of Petroleum Exporting Countries (the OPEC cartel), with its strong pricing power, still plays a role. But the fundamental insight is that owners of oil will adjust their production and inventories until the price of oil is expected to rise at the rate of interest, appropriately adjusted for risk. If the price of oil is expected to rise faster, they’ll keep the oil in the ground. In contrast, if the price of oil is not expected to rise as fast as the rate of interest, the owners will extract more and invest the proceeds. [We Can Lower Oil Prices Now. Martin Feldstein. Wall Street Journal. July 1 2008]
This is real economics, not a hunt for scapegoats, i.e. blame the speculators.
And oh, it is familiar because that is exactly what my environmental economics professor taught me back in Ann Arbor.
3 replies on “[1706] Of when to extract oil?”
*printing out more money than that ought to
the problem is that we no longer have a sound monetary system.
somehow I feel that the article is missing the point. as friedman puts it, “inflation is always and everywhere a monetary phenomenon” – so the fires of inflation are stoked because central banks have been printing out more money that they ought to. it should be pointed out that speculators can only make obsence profits largely because of the ‘naughty’ behaviour of central banks.
Doesn’t the fact that most “owners” of oil or at least the people making the decision to produce more are governments alter the picture ?
I mean, they’re under pressure from their populations who wants spending NOW.