Monday, May 01, 2006

Talking about Oil

Jon and McQ are dealing with misunderstandings about oil economics. Jon takes Tim Russert to task for not understanding basic laws of supply and demand.
MR. RUSSERT: Mr. Secretary, if, if demand is up but supply is down, why are the profits so high?

MR. BODMAN: For that reason.
Yes if supply drops while demand remains high, then prices go up. Duh. See every economics textbook ever for graphs.

As McQ points out, this supply shortage isn't going to just disappear.
Supply is so tight - because we are at max capacity - that any hint of trouble or problems in production will cause pricing to rise in the futures markets and thus at the pump...

But the main point to take away from all of this is this is the present pricing is here to stay and may go higher ... much higher. All the whining, crying, complaining... in the world aren't going to change that.
Maybe. I don't see this problem disappearing in the next year or two. But I think it is exceedingly unlikely that we will be dealing with this supply problem and accompanying price volatility for the next decade. I believe this to be the case for a few reasons.

First, price volatility can be a good thing for investing and day trading, but oil is a feedstock for most of our economy. Economies run on stability. Sudden unexpected bursts of nationwide inflation are not a good thing. The outcry for more stability from big oil's customers across the board will be loud and industries like to listen to their customers. Market forces or if necessary government action will com into play.

Two, the oil companies are current maximizing their profits by making more money per barrel. However profit is derived from the price multiplied by the amount sold. If the price gets too high (or supply too low), industry profits will drop and they don't want that. So I expect oil industry exploration to increase because shortages are bad for everyone, not just the consumer.

Three, the whole reason we went abroad for oil production is that the US capacity peaked. Now foreign capacity is peaking and we are having to look not at new countries but at new sources and supplements for oil. That means agricultural production of bio-diesel or ethanol. That hopefully means processing the heck out of our waste products for similar bio-fuels. It will also mean exploring new forms of soil for oil. Colorado is full of oil shales that are now becoming profitable to process. Canada is full of similar oil sands. I'm expecting US oil production to increase a lot by the end of the decade because these new domestic sources for oil are going to be under a lot economic and political pressure.

So yes in the short order we're a little screwed. Maybe you can buy a motorcycle. But I don't expect the current problems to continue forever.

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