Dec

18

 A recent Financial Times headline focuses on a threat: "Oil price fall threatens $1tn of projects."

A bigger threat though would be to invest $1 trillion on oil development projects when oil is available from less exotic and expensive sources.

Frederick Bastiat's essay "What is Seen and What is Not Seen" explains why it is misleading to look only at the scene under the media spotlight.

Oil firms putting on hold $1 trillion in oil projects leaves that capital available for other uses. We can't know what investors and firms worldwide will do with that saved trillion dollars. But falling oil prices signal then that it's time to widen the search. A extra $1 trillion spent on roads and railways in the U.S., Asia, and Africa, for example, might bring higher returns.

In could be the oil drop is temporary and prices will soon bounce back. And investors are reasonably concerned the unexpectedly steep fall reflects global demand driving off a cliff. Still, it's good every so often to look on the bright side of life. Apart from the savings to consumers now with more to save or spend on other goods and services, investors now have more to invest in other sectors with other profit opportunities and human well-being potentials.

Newspapers and pundits complain that lower oil prices hurt Nigeria, Russia, Venezuela, and Middle East countries. That's misleading. Maybe Swiss banks will take a hit, with billions of dollars less flowing in from siphoned oil-revenues. But the people of Nigeria, Venezuela and Russia suffer BECAUSE long years of high oil prices enabled their governments to get drunk on oil money and further distort and disrupt their economies.

Lower oil prices also pulls the rug out from under hundreds of green energy projects. Expensive wind and solar projects in the U.S. and Europe have diverted research, engineering, and manufacturing talent away from higher-valued uses and have raised energy costs for companies and customers, especially in Spain, Germany, and the U.K. Maybe far lower oil prices will help Europeans and Americans see the light on weaknesses with today's subsidized and regulated alternative energy sectors.

Another Financial Times story "The Big Drop: Cheap oil burns green" takes a glass half-empty look at these issues.

Again though, today's "green energy" projects are what is seen. What is unseen, and unseeable, are what the world would have developed had those same research and development man-hours and dollars been market-directed rather than politician and green special-interest directed.

Solar, wind, and other alternative energy sources offer a bright, clean, and wonderful future. But market forces will bring these technologies on-stream when inventors, innovators, and entrepreneurs have solved the various cost and development puzzles in their own unexpected ways.

For today, consumers are the majority winners from lower energy prices. Concentrated groups of energy producers, investors, and green-energy projectors benefit from higher energy prices. Media naturally focuses on the concentrated producers hurt by falling energy prices.

Bad news sells newspapers and draws page-views. Stories hinting at it-might-get-much-worse scenarios sell even more papers and page views.

Unseen though are the billions of stories worldwide of everyday people saving at the gas pump, and thereby gaining a little more control of their earnings and lives.


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3 Comments so far

  1. Tommy on December 18, 2014 3:18 pm

    Excellent analysis on the change of current oil prices!

  2. Bill Posters on December 18, 2014 6:29 pm

    From http://moslereconomics.com/ this guy seems to know what he is talking about

    Crude pricing

    The Saudis are the ‘supplier of last resort’/swing producer. Every day the world buys all the crude the other producers sell to the highest bidder and then go to the Saudis for the last 9-10 million barrels that are getting consumed. They either pay the Saudis price or shut the lights off, rendering the Saudis price setter/swing producer.

    Specifically, the Saudis don’t sell at spot price in the market place, but instead simply post prices for their customers/refiners and let them buy all they want at those prices.

    And most recently the prices they have posted have been fixed spreads from various benchmarks, like Brent.

    Saudi spread pricing works like this:
    Assume, for purposes of illustration, Saudi crude would sell at a discount of $1 vs Brent (due to higher refining costs etc.) if they let ‘the market’ decide the spread by selling a specific quantity at ‘market prices’/to the highest bidder. Instead, however, they announce they will sell at a $2 discount to Brent and let the refiners buy all they want.

    So what happens?
    The answer first- this sets a downward price spiral in motion. Refiners see the lower price available from the Saudis and lower the price they are willing to pay everyone else. And everyone else is a ‘price taker’ selling to the highest bidder, which is now $1 lower than ‘indifference levels’. When the other suppliers sell $1 lower than before the Saudi price cut/larger discount of $1, the Brent price drops by $1. Saudi crude is then available for $1 less than before, as the $2 discount remains in place. Etc. etc. with no end until either:
    1) The Saudis change the discount/raise their price
    2) Physical demand goes up beyond the Saudis capacity to increase production

    And setting the spread north of ‘neutral’ causes prices to rise, etc.

    Bottom line is the Saudis set price, and have engineered the latest decline. There was no shift in net global supply/demand as evidenced by Saudi output remaining relatively stable throughout.

  3. Gregory Rehmke on December 19, 2014 3:07 pm

    The Mosler Economics discussion is interesting. The Saudi stable output is the key to the price decline, given the increased production from U.S. shale, Libya, and Iraq. In recent years the Saudis as the swing supplier have lowered sales to maintain prices. But not so many years ago it was Saudi policy to keep oil prices below $25 (or maybe $40 in current dollars). Higher prices attract new suppliers for oil and alternative energy.

    The NY Post article (”Saudi Arabia’s oil war against Iran and Russia”) is interesting too. The Saudis get to help the U.S. whack Iran and Russia, troublemakers in their regions. Plus boost economic growth everywhere else.

    http://nypost.com/2014/12/14/saudi-arabias-oil-war-against-iran-and-russia-2/

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