Oil at $1,000 per barrel?

Great Debates
21

His point is a good one, though. He’s asking what would happen if there were a bubble in the price of some absolutely critical commodity, like oil or grain or meat. Sure, the market would sort it out, but on what timescale? You might still have a week where gas costs $40 a gallon and bread costs $50 a loaf, and many people would simply not be able afford to drive anywhere or eat anything. It would be a disaster.

I am a die-hard believer in the power of free markets - in the long run, free markets will always work things out. But in the short term, while the markets are in the process of doing so, people get screwed. And I think it’s perfectly valid for government to step in and try to minimize the negative short term effects.

22

In the real world, the government will step in with some price control if gasoline prices suddenly swing out of control over a short time. If gasoline prices suddenly spiked, and it was $5.00, then $6.00 the next week, then $10 the next week, Congress would declare an emergency and pass some ad-hoc price control. If it came to that.

And since the likelihood of that happening is pretty slim, there doesn’t seem to be much reason to set up a complex regulatory scheme to prevent it. Whether it would be a good idea or not to interfere in the market this way, if such a speculative price swing really did happen then ad hoc emergency government action is guaranteed.

I suppose even the OP would conceed that if the “real” cost of oil is something like $1000/barrel, then government regulation to lower the price is counterproductive. But if the price of gasoline rises by a factor of ten then all sorts of alternative fuels become cheaper than gas. The Germans were making synthetic gasoline via the Fischer-Tropff process 65 years ago during WWII. Gasoline from petroleum can’t get much more expensive than synthetic gasoline except in the short run.

23

Crude oil is a commodity. That means there are multiple sources of crude oil but for all intents and purposes, a barrel of crude is a barrel of crude. Theoretically, no one supplier of crude oil should control enough of the market that they could influence prices. Traders would just purchase crude from one of the other suppliers. Also, as the price rises, it encourages producers to produce more to increase profits, which tends to drive the price down as the supply increases.

So IOW the price of oil is closely tied to the actual physical amount of oil in the market vs the demand at any given time. If the price keeps going up, the demand decreases until the price comes down.
A stock (say…Exxon NYSE:XOM) is an equity. It represents a piece of ownership in a company. The value of that stock represents what people believe the value of that company to be worth. It can keep going up and up because companies constantly try to grow and diferentiate and expand into new markets with new products.

24

I’m surprised that no one has mentioned the Bunker Hunts and their attempt to corner the market in silver. It didn’t end well for them.
I doubt it would be possible to speculate the price of oil to $1,000/barrel today.
Next year, maybe.

25

Yes, people can. They don’t want to, and it would have serious consequences, but yes, at that price, lots and lots and lots of people would stop using gas. If you live, say, 20 miles from work, are you going to pay $80 a day to go to your job?

I doubt many people would. People would start carpooling, jamming as many neighbors in their car as possible, using public transportation where available, some people would start biking, and God knows how many would just stop going to work because it was too expensive.

The idea that consumption would be anywhere near current levels if gas suddenly spiked to $10, $18, or $40 a gallon is completely unrealistic. And for each person who stops consuming, there would be downward pressure on prices. But there’s no doubt expensive gas would have a tremendous effect on our economy: unemployment would go up, consumer consumption would go way down, our transportation system would slow to a crawl, international trade would end, and the war in Iraq would probably come to a halt since it’d be too expensive to drive Humvees around Baghdad.

And monkeys could theoretically fly out of my butt if I ingest them and they are Martian supermonkeys that are impervious to digestive acids. Investors know that demand for $1000 oil would be next to nil, so no investor in his right mind would pay that much for oil. And as the price rises, the incentive to increase production gets exponentially greater, so additional supply would provide downward pressure on prices, as would government release of stockpiles.

The market does a fantastic job of preventing such radical swings in prices, so long as there is not interference (eg, severe fuel rationing) the theory is closer to fantasy.

These radical shifts over short time periods you’re talking about happen all the time with stock scams. Amazon never hit $400. It went from like $5 to about $100 over a two year period, then went down to $25 two years later. This stuff doesn’t happen overnight unless something is rigged.

26

“circuit breakers” on exchanges are mainly in place to make sure that no “funny business” is going on. If a price went crazy for a real event in the market, trading might be halted for a while, but would be allowed to run soon enough.

27

You should get your economics theory straight.

If the demand for $1,000 oil will be next to nil, why would there be incentive to increase production? Increase production to sell to whom?

And if this theory works so well, why hasn’t it worked out so far with the price of oil in the past few years?

The price of oil went from $25 to $120, so according to your theory, there should be “incentive to increase production, so additional supply will provide downward pressure on prices”.

I don’t see any indication of increased production or downward pressure on prices.

How is that theory working now?

Yes, that’s why the price of wheat has tripled in the past year.

28

In many cases, there are two or more price points that maximize profits.

Depending on the demand curve of a product, a company could maximize profits on a gadget that costs $10 to produce, by selling 1,000,000 gadgets at $100 each, or roughly 9,000 gadgets at $10,000 each.

The company is indifferent to which of these two price points prevails in the market, since it makes the same profit from both of them.
But to the consumer, the latter price point is much worse. Much fewer people will be able to afford them, and they will cost more.

This is not common, but I don’t think all products have a single price that maximizes profits for the company.

If oil is one the commodities that has multiple price points that maximize profits for the oil companies, then they don’t care if they sell a lot of oil for $25 per barrel or less oil for $200 per barrel*. But for consumers, the latter option is devastating.
*In fact, they may prefer the latter option, since it means that oil will run out later.

29

As I mentioned to Ravenman, why hasn’t this mechanism worked for oil prices? They went from $25 to $120, but I don’t see producers producing more to increase profits, or see the price driven down “as the supply increases”.

I think these are all ECON101 theories that fail miserably when applied to the more complex nature of the real world.

30

You are wrong.
*
If non-OPEC production rises as expected and some OPEC members add production capacity as planned, surplus crude oil production capacity should increase and ease upward price pressures by early next year. The expected surplus capacity, however, is less than projected in last month’s Outlook*.

Cite

31

One thing you have to consider is that drilling an oil well is an expensive, risky, and time-consuming process. We are just now starting to see increased production resulting from the price rises of the last 2 years. First off, the price has to rise enough to make the newer, more difficult wells profitable, then the oil producer must be convinced that the oil price will stay high long enough for the venture to return a profit, then construction will begin, which can take 2 years or more.

Furthermore, unless you’re denying that consumption has risen dramatically, you must conceed that production has indeed risen.

32

Seriously…you shouldn’t be so snarky when it’s clear you don’t know what you are talking about.

Because the only way you will ever get that price is to pretty much halt production by making the oil an extremely scarce commodity (how you would manage this trick is of course fantasy…but that’s what your OP is all about). No consummers are going to be willing to buy it at the price you set so either you are going to have to increase production to sell it to someone take a loss. Even if YOU (the magic man who cornered the worlds production of oil somehow) don’t want to increase production (gods know why you wouldn’t), I can promise you that someone will. Maybe the Canadians getting their tar sands on line, or perhaps friend Hugo decides to actually produce oil instead of attempting to destroy his own oil industry. Perhaps America decides to more fully exploit our own reserves, or maybe nations in the ME start peeling off from OPEC and going their own way. Regardless, someone is going to start upping production and undercutting your price…which would implode like a balloon with a needle in it. No government intervention needed.

Look, your entire OP is ridiculous and you are nit picking the details…simply put it won’t happen. Oil isn’t going to ever be $1000/barrel. Even if we assume that we are running out of oil someday all it will mean is that oil reaches some peak price at which point it becomes economical to switch to some alternative. The lack of demand will drive the price of even scarce oil back down because no one will buy it if they have a viable alternative.

Wrong. The price went from $25-$120 over the course of several years (looks like 1999-2008, though oil was over $20 a barrel in 1997 for a time). WHY did it go up over that time? Was it because of speculators driving the price up? War? Increased demand world wide (like, oh, say the fact that China has been putting millions of cars on the road in recent years, followed closely by India??)?

So…lets do a rough extraoplation, ehe? Lets assume that this increase from $25/barrel to $120/barrel is a natural progression (personally I think it’s a bubble…and one that is bound to pop when people realize that demand is dropping in the US at least). How long would it take at that rate to get oil to $1000/barrel (lets assume for a moment that it actually WOULD go that high since we are already in fantasy land)? Assuming your answer is the same as mine, what effect do you think this progression would have on consumption? What effect has the CURRENT price increase had on US consumption? How about if oil is $200/barrel? $300/barrel? And if demand goes down and supply stays the same? Or increases? What effect will that have?

Now…what effect would there be if the government stepped in and said ‘Oil will now be set at no more than $90/barrel from here on out’? What do you suppose the effect of this action would be? Is that what you are looking for?

Then you haven’t been looking very hard if you haven’t seen any indications of increased production. The reason there hasn’t been downward pressure on the prices is because DEMAND has increased. You are right about one thing though…this IS economics 101 stuff.

It’s working exactly as it should.

I won’t touch your next post except to say that you really don’t seem to grasp the basic concepts of how the commodities market works or functions.

-XT

33

xtisme nailed what I was going to say, but let me add this. You’re failing to understand the difference between economics and business – not the “greedy corporate baron” type business, but what it takes to produce things. Oil companies simply can’t turn on a spigot and produce more oil overnight, nor can wheat farmers. It takes time to do so, and businesses will tend to hedge against price spikes: if oil from tar sands is profitable when oil rises over, say, $85 a barrel, that doesn’t mean that Canadians are going to spend billions to invest in new extraction technologies when oil hits $86.

You’re seriously misunderstanding the trade in oil (and other commodities) as being an issue of corporate barons manipulating prices, instead of price being a function of supply and demand.

And lastly, downward pressure on prices doesn’t mean that prices will necessarily be reduced. It also means that price increases will be limited due to demand/consumption. As you’ll see, consumption of gas in the US has more or less leveled off in the last couple of years. If you don’t think this has an effect on prices (as opposed to consumption continuing to grow at a good pace as it did in the 90s and up to about 2004 or so) then I quite simply don’t know what to say.

I am very curious how you’d answer xtisme’s question: what do you think would happen if the government put a price gap on gas? The answer should be crystal clear to anyone who has taken a semester of economics.

34

I was going to mention this. To the OP, I would give you the cash equivalent of all of Berkshire-Hathaway money, Bill Gate’s money, Wal-Mart’s money, and all the oil sheiks in the top 20, on two conditions: 1) you must use every single penny exclusively to corner the market on oil; and, (because I don’t feel like waiting) 2) you must announce 1) to the world. I will not only guarantee that you won’t even come close to $1000/barrel, you will also be broke.

Getting oil to $1k/barrel isn’t going to happen overnight even with that kind of cash. As soon as gas gets to $6/gal, (I’m speculating) my company as well as a host of others will start introducing alternative/renewable energies to the market. People will start buying coal and making gasoline out of that (as mentioned above). Producers will borrow money and people will quit jobs to get into the oil industry because these oil producers are going to need bodies for all the drilling and capacity building that they need to do. Hell, such an experiment might even be a good thing in the long run.

35

Doesn’t the USA have 3 options?

  1. tap the 2 billion-barrel startegic reserve-stored in salt dome traps in Louisiana
  2. Open up the Naval reserve (“Teapot Dome” to new drilling
  3. Tell the texas railway Commission to authorize those well pumps 9the “nodding Ducks”) to pump 24-7 (ISO the 8 hours/day they presently pump at
    We can increase crude production-but waht about refinery capacity?
36

No, it’s because most of the people who come into these threads to discuss these matters have never taken Econ 101.

In reality, the oil market is not perfectly competetive as defined by most Econ 101 books:

Atomicity - An atomic market is one in which there are a large number of small producers and consumers on a given market, each so small that its actions have no significant impact on others. Firms are price takers, meaning that the market sets the price that they must choose.

Homogeneity - Goods and services are perfect substitutes; that is, there is no product differentiation. (All firms sell an identical product)

Perfect and complete information - All firms and consumers know the prices set by all firms (see perfect information and complete information).

Equal access - All firms have access to production technologies, and resources are perfectly mobile.

Free entry - Any firm may enter or exit the market as it wishes (see barriers to entry).

Individual buyers and sellers act independently - The market is such that there is no scope for groups of buyers and/or sellers to come together with a view to changing the market price (collusion and cartels are not possible under this market structure)
Obviously oil drilling and refining requires a significant amount investment in capital to create wells, refineries, etc.

The very simple answer is that increase in demand from China and India and the US is increasing faster than the increase in supply. And because the price of oil is increasing relatively slowly and is relatively inelastic, companies aren’t particularly interested in making massive investments required to increase productivity. For now, they can just take the profits instead.

If oil suddenly rose to $1000 a barrel, you would find that very few people could even afford to buy it and companies would not make much money.

37

Let me parse that sentence:

  • If non-OPEC production rises as expected and
  • If some OPEC members add production capacity as planned,

surplus crude oil production capacity

  • might increase and
  • **might ** ease upward price pressures by early next year.

I’ll believe it when it happens, without all these qualifiers.

38

I may be mistaken about this, but I assume a country like Saudi Arabia can increase production relatively easy, without having to find “difficult wells”.

They just have to make the strategic decision to do so.

However, it may not be in the best strategic advantage of the country to do so, for various reasons.

That’s why I’m finding all these predictions naive: “If the price of oil goes up, production will increase and prices will come down”.

It’s not as simple as that.

Countries may have reasons not to increase production to keep the price down.
(IIRC, didn’t Saudi Arabia recently reject Bush’s request to increase oil production to ease oil prices?)

Also, even if production is increased, the prices may not come down, due to, for example, increased demand.

So, stating confidently that “If the price of oil goes up, production will increase and prices will come down” ignores the realities of how the world works.

39

So you do think bubbles are possible in the oil market.

What caused the bubble, in your opinion? Was it speculation?

Let’s not focus too much on the $1,000 figure. All I meant was that speculation can increase the price of oil (or other critical commodity) to high levels. And this can be done without anyone “cornering the market” and without any nefarious companies or countries trying to increase the price of oil artificially.

The question is, how high can the actions of speculators push the price of oil? I agree that $1,000 is untenable at this moment, but what about $200, $400?

I never said that price controls were the solution, as most people agree that they do not work.

(In this case especially, they are not even feasible, since other countries own the oil. So even if price controls worked, they could not be implemented in this case)

Except ECON101 did not address speculation or other real-world issues

Here is an AP article

Also, the same article, addresses the issue of increasing supply

So, it seems the US government, at least, believes that production could be increased relatively easily, without the need to spend billions of dollars to find “difficult wells” or “alternative sources”.

But OPEC is refusing to increase production. They have their reasons of course, but that is my point. Just echoing ECON101 stuff “if price increases, production will increase” is naive.

40

Look, it’s not guaranteed that just because the price rose, that production will rise. There’s only so much oil in the ground that is recoverable at a certain price, and if the price of oil isn’t high enough that oil can’t be recovered economically. So with a limited amount of oil, and increasing demand for that oil, then you can have a situation where the price increases and not much additional production can be brought online.

And note that your articles that say that the current runup in oil prices are part of a speculative bubble means that oil companies probably don’t want to invest a lot in additional production, because the current prices are not sustainable.

I guess I’m not sure what your question is, then. Yes, speculative bubbles can run up the price of oil. And since it takes billions of dollars and several years to add new production, adding new production is always risky for the producers. Remember the oil glut of the 90s? If we have a bubble then investing in new production means you’re going to go bankrupt when the bubble bursts.

So let’s say that we’re paying a premium for oil today because of speculation, and a more reasonable long term price would be $2.50/gallon (say), instead of $3.50. So, given that, what should the US government do about it? Remember, this price increase isn’t just an American phenomenon, it is a global phenomenon. Oil is a global commodity.

Sure, speculation can push up the price even higher…more people buy oil futures because they expect the price to increase, and that causes the price to increase, which means more people figure the price will increase, which means more buying, and pretty soon it’s obvious that the price is unsustainable, yet the price keeps increasing on the “greater fool” theory. But eventually we have a correction. What the price will be at the peak is unknown, if it were known we wouldn’t have a peak.

And your cite below says that we might be paying a 10% speculative premium. How high can that go? 20%? 30%? The trouble is, it can’t go too high, because the facts of oil production and consumption are too well known. It’s going to be too hard to find that greater fool. It’s not like the dotcom bubble in that sense, because during the dotcom bubble no one knew what the future of the interweb would be. People were willing to make very risky bets on companies because of the possibility that a small investment now could mean unlimited profit later. And you had to get in NOW before the risks were well understood, because that was the only way to make that killing. If you waited until there was a clear picture of exactly how much money Kozmo.com was going to make, it would already be too late, like the old joke about the two economists walking along the sidewalk. One says, “Look, a $20 bill!” The other says, “No, there can’t be a $20 bill there, because if there were, someone would already have picked it up.”

So the dotcom bubble was caused by radical uncertainty about the future of the internet, and the potential for getting in on the ground floor of the next Microsoft. But that’s not going to happen in crude oil speculation. You can’t get in on the ground floor in an industry that’s been in operation for over a century. It’s easy to speculate that the price of oil is going to be higher in the long term future, with decreased production and increased demand, but how high is that price going to get in the short term? Demand for oil isn’t going to double next year, the supply isn’t going to halve. So any speculator who thinks that the global price of oil will be 4 times higher on May 7th 2009 is an idiot, because the market is fairly well known. The speculators who thought Pets.com stock would quadruple in a year were idiots too, but a different sort of idiot.