This lecture has two parts.
To hear this part of the lecture, click here.
| Country | Oil Production | Cost per barrel |
|---|---|---|
| Saudi Arabia | 100 barrels | $10 |
| Other | 100 barrels | $30 |
| U.S. | 100 barrels | $35 |
| Other | 100 barrels | $40 |
| Other | 100 barrels | $50 |
Suppose that total world demand is 400 barrels, of which U.S. demand is 110 barrels. What will be the price of oil? Are we self-sufficient in oil? If world demand goes up by 20 barrels, what will be the price of oil?
Next, suppose total world demand is 390 barrels, of which U.S. demand is 100 barrels. Now what is the price of oil? Now are we self-sufficient? If world demand goes up by 20 barrels, what happens to the price of oil?
If the U.S. consumed no oil and the rest of the world consumed 300 barrels, what would be the price of oil?
If the U.S. consumed 100 barrels of oil but refused to consume Saudi oil, what would happen in the world oil market? Assume world demand is 390 barrels.
Conclusion: Saudi foreign policy is a foreign policy issue, not an oil conservation issue
To listen to this part of the lecture, click here.
Congress wants to define price gouging:
any finding that the average price of gasoline available for sale to the public in September, 2005 or thereafter in a market area located in an area designated as a State or National disaster area because of Hurricane Katrina... exceeded the average price of such gasoline in that area for the month of August, 2005, unless the Commission finds substantial evidence that the increase is substantially attributable to additional costs in connection with the production, transportation, delivery, and sale of gasoline in that area or to national or international trends.
Imagine a similar rule for selling your house: you cannot sell it for more than what it cost last year
Or for selling stock: you cannot sell it for a higher price than what you paid for it last week
What if gas stations sold gas for less than what it cost last month? Would that be a crime also?
A sudden drop in supply--price should not go up?
Today is September 1st. You bought gasoline in August for $2.00 a gallon. The futures price of gasoline for delivery on October 1st shoots up to $3.00 a gallon. One month interest rate is 1 percent. What should be the price at which you sell gasoline today?
A rent vs. buy approach: sell now and put money in the bank to collect interest, or wait a month to sell?
Profitability = rental rate + appreciation rate - interest cost
Assume no rental value of holding gasoline, and set profitability = 0
appreciation rate = interest cost = 1 percent
price must be set now to appreciate 1 percent. So price must be $2.97
does not depend on what you paid for gas
If you sold it for $2.50 and put money in the bank, you'd have less than if you waited; you probably cannot sell for $3.50 now, because of competition
Rental rate might be positive--"convenience yield." You would rather have some gasoline around than run out and disappoint customers. Suppose that convenience yield is 2 percent. In that case,
profitability = 0 = 2 + appreciation rate - 1
appreciation rate = -1 percent, so price is $3.03
Could we be about to run out of oil?
Suppose you told me that, as a result of a careful examination of oil reservoirs, you were certain that annual oil production was just about to plummet, and would be 30% below its current level in two years... Oil is going to become extremely valuable under this scenario in a very short period of time. Let's say for discussion we're talking about $200 a barrel two years hence. Then I would like to make the observation that, if the facts were indeed as we just conjectured, oil surely could not continue to sell for $60 a barrel today. Anybody who pumps a barrel out of a reservoir today to sell at $60 could make three times as much money if they just left it in the ground another two years before pumping it out. The same is true for anybody with above-ground storage facilities-- they're throwing away money, and lots of it, for every barrel they sell at $60 that they could have instead stored for two years and sold for $200. If oil producers did respond to these very strong incentives by holding back oil from today's market, the effect would be to drive today's price up. This profit-seeking wouldn't drive the price all the way up to $200, because you have significant interest, storage, and idle capacity expenses from trying to wait around a couple of years before getting your profit. An economist would expect the end result of this profit-seeking to be that the price today is lower than what it will be in two years by an amount that reflects these interest and other expenses, but certainly far less than the difference between $60 and $200 a barrel.
effects on conservation, exploration, alternative energy sources
Oil futures and options markets predict the future price of oil
Note: the market can be surprised (a couple years ago, futures prices were in $40's)
Conclusion: oil prices depend on expectations for the future