I can see how cutting oil production increases prices, but I don’t see how the profit makes its way back to the exporter.
If I sell 5,000 widgets per day at $1 per widget, I make $5,000. If I decide that price is too low and cut back production to 2,500 widgets per day so as to increase the price to $2 per widget, I still make $5,000.
You’re talking about sales, it’s profit that matters.
If the cost of production of one widget is 50c (and is fixed), then in your first example you’ll make $2,500 profit. But in the second example, you’ll make $3,750.
Also, in the case of oil among other things, there is a non-linear relationship between supply and demand.
FWIW,
Rob
It is not generally true that if you cut the supply by half the price doubles. You could say cut production back to 2,500 and find that you can sell them form $3. Or find people will still only pay $1 for them.
The price of a barrel of oil has dropped from a peak of around $120 to around $40 now. The amount of oil used fell only slightly.
And, if you’re talking about the recent surges in oil prices following Katrina, there was, overall, not much in the way of a fuel shortage in most of the US. Certainly not enough to balance out the increase in price.
Also, bear in mind that it is a finite resource. The situation is more analogous to a warehouse full of widgets than a widget factory. So, unlike widgets, selling less per day at a higher price will make you more money in the long run.
Oil is obviously finite, but the warehouse analogy is seriously oversimplified. It appears (for example) that Canada has a vast amount of oil whose cost of production is something like $70/bbl. So there’s a big difference in what can be had when the world price is around $50 vs. $120.
If you’re the only source for widgets, this might work. If other sources exist they may be happy to step up their output, and you may not get much more than a dollar apiece for your smaller production run.
Also note that you almost certainly have fixed costs, so your cost per widget may be substantially higher when you sell only 2500 per day.
Yes, the warehouse analogy is, like any analogy, simplistic. However, it is, as I said, a better analogy than a factory. With a factory, your production costs may go up or down, but (barring a supply chain disruption) there is nearly always a supply of raw materials with which to make products.
An even better analogy would be an ancient burial site full of gold coins, the exact number of which is unknown. It costs money to survey an area of the ground for coins (or check for overlooked ones) and even then, the count is likely to be off by at least a little.
Furthermore, the cost to retrieve any given coin is variable-some coins can be picked right off the ground whereas others require expensive digging (as you pointed out with the Canadian oil). Sometimes, digging turns up more or less coins than anticipated, resulting in a reassessment of the number of the as yet un-dug coins in a section of the site, or the whole thing.
Assuming that reducing the amount produced will cause the price to rise, resulting in the same total profit, (which is not necessarily the case, as has been pointed out by others) it would be a wash if oil production worked like a widget factory. However, since it is more like (although not exactly the same as) a bizzarro treasure trove, it sometimes makes sense to reduce the amount you extract and sell today and live with the reduced near term cash flow while waiting for prices to improve, in order to get more value out of your finite resource over time. It is not necessarily an attempt to manipulate prices (especially if the decrease in production is small) or a decision to not produce at a loss.
The warehouse model is the correct one. To use the OP’s example, you can sell 5,000 widgets a day at a four dollar profit apiece or 10,000 widgits a day at two dollars profit apiece. Either way you’re making $20,000 a day now.
But if your supply is based on having a warehouse full of 1,000,000 widgits what you’re really doing is making the long term choice of making $20,000 a day for 200 days or making $20,000 a day for 100 days.
When you’re selling a finite asset like a warehouse of widgits or a field of oil, the plan is to maximize your income by selling each individual portion for as high a price as possible.
At 35 bucks a barrel they don’t have much oil in Canada. Digging it out costs too much.
There can surely be few real-world examples of this: constant profit that’s independent of volume. One that could work is if you’re more or less a monopoly supplier - say, a popular rock band - and you arbitrarily set your price low.
Well, pretty much everyone sells what they produce for the best price they can get.
But despite having a finite supply, you can’t always hold out for a big price. Suppose you have an oil field with 100,000 bbl. The price has dropped from $140 to $40, so you’re inclined to stop pumping it and wait for an increase. But you recently borrowed $1m to drill and develop the field, and the bank takes it kinda hard if you don’t send them a check each month, as you promised. So you’d better pump some product if you hope to stay in business.
As I wrote, it only works like this when there is a finite supply of the product. Your rock band example isn’t like that - in theory they could put out a new album every week and maximize their profit by increasing their output.
But otherwise, it’s pretty fundamental economics - supply and demand set prices. If the demand is constant and you lower the supply, the price will go up. If you’re selling a fixed amount of the product, it benefits you to keep the price high and sell your product for the most amount of money.
Fundamentally, it doesn’t matter if Canada were to discover a vast supply of oil. There’s still only a finite fixed amount of oil and the Saudis would still be better off lowering their output even if Canadian oil flooded the market. Eventually the Canadian oil will run out and the Saudi oil will go back up in price. The only thing they would change the equation would be if somebody discovered a way to cheaply manufacture oil or invented a cheap alternative to oil.
The reason you rarely see this logic applied in the real world is because most people aren’t really logical. Even if they concede the economics, they can’t defer their desire for whatever money is available now rather even when they know they could get more money by waiting.
But if there are widgit factories, you have to worry about the competition. If you decrease the rate you manufacture widgits at, somebody else with another widgit factory will just increase their rate. The same amount will be made, the price will remain the same, and you’ll just have a smaller share of the market. This is the difference between the factory model and the warehouse model.
But - as I note in post #13 - waiting often has costs. It’s not illogical to take steps to meet these.
I think that’s what I said in post #8.
But that’s a whole different subject. We’re talking about prices and income. How much you need the money has no effect on either.
I know. And we’ve been pointing out to you why your model doesn’t apply to the subject here.
We’re talking about oil. Nobody can make oil; they’re just digging up natural reserves of it. So if you’ve got a supply of oil and somebody else is trying to compete with you by increasing their oil production, let them go ahead. They’ll inevitably run out and your oil will now be more valuable because the total supply has been reduced.
You have to grasp the concept that every country has so much oil under its ground. And there’s nothing they can do to increase that amount. So if they only have so much oil, they can’t increase their profits by selling more oil. There’s no such thing as more oil - you have the amount of oil you have. The only way they can increase their profits is by selling whatever oil they have at a higher price. And reducing the rate they produce it at raises the price.
This is incorrect on two counts. First, there’s quite a lot of conventional oil in Canada. Second, $35/bbl is right around the break even point for the oilsands. We have lots and lots of oil at $35.
I’ve stipulated this - though in meaningful ways it isn’t really true: You can discover oil that wasn’t previously known. You can figure out more efficient ways of recovering oil that previously was known but would have been too expensive. You can figure out how to make other sources of energy and other raw materials serve for needs previously being met by oil.
But (as I’ve noted) if you’ve been producing oil (and at over $100/bbl, most everyone who could has been) there may be real problems and costs involved with shutting down production, creating significant incentive not to do so. Countries that have been raking in the dough tend to get comfortable with that, and to make commitments based on the expectation it will continue. So there can be heavy political costs to saying “Let’s take a couple of years’ break from oil production.”
I’m a little uncertain of your position here - are you trying to say that there’s only just so much oil? That’s it? No more?