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When We Get to Oligopoly…

October 13, 2016 Leave a comment

…remind me, students, of this news item. It’s a great example of the difficulty of getting members of a cartel to stick to their agreements to limit production in order to maximize total profits of the group.

Following yesterday’s latest IEA report which showed that OPEC production had hit an all time high, this morning OPEC released its own estimate of production by OPEC member nations for September and, not surprisingly, the latest report showed that in the month OPEC was supposed to be set on “cutting” production, the 14-nation group produced a whopping 33.39 million b/d crude in Sept., up 220k b/d from August.

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Moving the PPF Out

March 11, 2016 Leave a comment

I mentioned in class yesterday that I thought the U.S. had become the world’s largest hydrocarbon producer, surpassing Saudi Arabia. But I didn’t have the actual figures at hand; here they are for interested students:

The United States remained the world’s top producer of petroleum and natural gas hydrocarbons in 2014, according to U.S. Energy Information Administration estimates. U.S. hydrocarbon production continues to exceed that of both Russia and Saudi Arabia, the second- and third-largest producers, respectively. For the United States and Russia, total petroleum and natural gas hydrocarbon production, in energy content terms, is almost evenly split between petroleum and natural gas. Saudi Arabia’s production, on the other hand, heavily favors petroleum.

Categories: Energy

Abnormally Normal, or Just Normal?

November 13, 2015 Leave a comment

I usually find articles in the Economist about the energy industry informative, but this one leaves me scratching my head:

Only rarely, says Jason Bordoff, director of Columbia University’s Centre on Global Energy Policy, has the oil market behaved like a normal market, more subject to the laws of supply and demand than to the whims of a cartel. Now is one of them.

Take supply. A year ago Saudi Arabia refused to allow OPEC to try to raise prices by pumping less crude, in the hope that a low price would drive competitors, especially America’s shale-oil producers, out of business. Since then it has used its low cost of production to carve out a bigger slice of the pie.

Question 1: Does the author mean “competitive” or “efficient” when using “normal”? It seems to me the oil market has always behaved as a typical (i.e. normal) monopolistically competitive market.

Question 2: How is a cartel’s decision to greatly increase production for the purpose of driving down prices more like a competitive market? If a single supplier (or multiple suppliers acting as a single supplier) can shift supply out, how is that different from a single supplier shifting the supply curve in?

It’s true that lower prices and higher quantities are what one would expect when a particular market transitions to a more competitive market structure. Some of what we are seeing must be attributed to more suppliers and better extraction technology. But if OPEC can still move the supply curve so effectively, in either direction, the drop in equilibrium price and increase in equilibrium quantity isn’t an indication of anything more “normal” than a normal, monopolistically competitive market structure.

Remember, Many Business Journalists Majored in Journalism, Not Business

November 2, 2015 Leave a comment

Students, for an example of business journalism you should read critically, see CNN Money’s Matt Egan’s article Saudi Arabia to run out of cash in less than five years:

If oil stays around $50 a barrel, most countries in the region will run out of cash in five years or less, warned a dire report from the International Monetary Fund this week.

That’s poor reporting.

Here are some clues that the reporter doesn’t understand the IMF report he’s covering:

(1) No link to the original source. When you attribute something to a published online report…why wouldn’t you link to it?

(2) Even if oil falls below $50 a barrel, all Middle Eastern countries will have cash in five years.

Maybe Mr. Egan has an unusual definition of “cash.” Surely he can’t mean that Saudi Arabia will run out of currency and coins. Does he really think the IMF is saying Saudi Arabia will have no currency or currency-equivalents in five years if oil prices don’t go up?

If Mr. Egan really thinks any one of these countries will “run out of cash” I’d like to make a sizable bet with him!

Saudi Arabia’s war chest of cash is still humungous [sic] at nearly $700 billion, but it’s shrinking fast.

(3) Can’t spell humongous. 🙂

(4) Sovereign wealth funds don’t exist to simply store up hordes of cash. Resource-exporting economies are supposed to draw on reserves of wealth built up in better years when resource prices fall. Saudi Arabia would be foolish to not use these funds in years of low oil prices.

The kingdom barely has enough fiscal buffers to survive five years of $50 oil, the IMF said.

(5) Mr. Egan must not understand the concept of ”fiscal buffer” as used in the report. The report actually says:

A good starting point is the size of governments’ financial assets—commonly referred to as “fiscal buffers.” In general, countries with larger buffers can afford to maintain fiscal deficits further into the future, so as to reduce the impact of lower oil prices on growth. On current trends however, all non-GCC MENA oil exporters are already projected to run out of liquid financial assets in the next three years [emp. mine] (see Chapter 1). In, contrast, …GCC countries are split evenly between countries with relatively large buffers (Kuwait, Qatar, and the United Arab Emirates—more than 20 years remaining) and countries with relatively smaller buffers (Bahrain, Oman, and Saudi Arabia—less than five years).

An asset is liquid if it can be converted into cash quickly and with little impact on the asset price. Saudi Arabia is smarter than to stuff cash from oil revenues into a gigantic (humungous?) mattress. Its investments are both in liquid assets like bonds and illiquid assets like real estate. If, in a year or two, oil prices are still low, and it needs more cash, it will simply begin to liquidate assets–that is, turn them into cash.

I will assume Mr. Egan isn’t responsible for the [mis]-“infographic” that is titled “Break-even Oil Prices in the Middle East.” The IMF says that Saudi Arabia needs a price of $106/barrel to balance its budget. Hopefully even my first-year students know that this is not the same as “break-even” when discussing oil production. Saudi Arabia has one of the world’s lowest crude production costs, and could continue to profitably generate positive cash flows even if oil prices drop further. It won’t be able to maintain its current level of government spending without borrowing or drawing down on reserves of wealth, but that’s not the same as not “breaking even.”

This is CNN. I wouldn’t depend on it for reliable business analysis.

The Economics of Recycling

October 5, 2015 Leave a comment
The largest aluminum/copper AC core I ever baled!

The largest aluminum/copper AC core I ever baled!

John Tierney has an interesting op-ed piece in the New York Times on recycling:

Despite decades of exhortations and mandates, it’s still typically more expensive for municipalities to recycle household waste than to send it to a landfill.

Much of what Mr. Tierney says is spot on. It makes far more sense–both for the environment and economically–to recycle metals and paper than yard trimmings, plastic bottles and food waste.

Take glass bottles, for example. They are, essentially, sand that is rock-hard and in the shape of a container. To bury a glass bottle in a landfill isn’t much different than burying a rock in the earth. But recycling glass is costly. Just hauling the heavy material to recycling plants burns lots of fuel, as does crushing it to make it easier to transport. So, two cheers to Mr. Tierney for pointing out that recycling isn’t always a matter of “more is better for the environment.”

However, I take issue with two points, one from the perspective of an economics teacher, and one from the perspective of someone who worked in the recycling industry.

First:

The environmental benefits of recycling come chiefly from reducing the need to manufacture new products — less mining, drilling and logging. But that’s not so appealing to the workers in those industries and to the communities that have accepted the environmental trade-offs that come with those jobs. (emphasis mine)

Economically, this shouldn’t matter. Recycling aluminum cans, for example, is economically viable–it will happen in a free market economy without government mandates or subsidies. That being true, it’s better for some jobs of bauxite miners to go away. Those miners can be put to more productive use in other industries. “More mining jobs” is a terrible economic justification for less recycling.*

Second:

As a business, recycling is on the wrong side of two long-term global economic trends….Recyclers have tried to improve the economics by automating the sorting process, but they’ve been frustrated by politicians eager to increase recycling rates by adding new materials of little value.

As a business, recyclers know very well how to substitute capital for labor to maximize profits. They don’t take low value materials because they are foisted on them by politicians. Rather, local governments, knowing some materials are much less valuable than others, give financial incentives to recycling companies to accept these low value materials. Recycling companies that only want to accept metal or paper are free to do so–and in the absence of government subsidy–will usually do just that.

So, blame the politicians, but plenty of recyclers are happy to take government subsidies to accept the less valuable stuff.

Lastly, if you want to know more about this fascinating industry, check out Adam Minter’s always interesting Shanghai Scrap. (I just saw that he also posted in response to Tierney’s article. Haven’t read it yet.)

*That said, it’s true that if government mandates and subsidies are causing people to recycle despite it being economically more efficient to make new products or extract additional raw materials, then job losses in those industries are part of the hidden costs of government interference in recycling markets.

Reading Doesn’t Always Make You Smarter

October 1, 2015 Leave a comment

Remember, journalists (and many influential people in media) often don’t have in-depth knowledge of the fields they write about:

nooil

That’s from September 29, 1975. Today, proven world reserves stand at about 230 billion metric tons.

Efficiency and Environmentalism

April 11, 2014 Leave a comment

UPStruck

Improving business efficiency is often good for the environment:

As of 2012, the right turn rule combined with other improvements — for the wow factor, UPS doesn’t separate them out — saved around 10 million gallons of gas and reduced emissions by the equivalent of taking 5,300 cars of the road for a year.

Sometimes governments can improve on the market. Pollution is a huge negative externality and the market often doesn’t produce the socially optimal quantity of it.

But often overlooked are the ways the market does work in favor of the environment.