ANWR Drilling Would Provide Quick Relief

Discussion in 'Economy' started by BaronVonBigmeat, Jul 28, 2008.

  1. BaronVonBigmeat
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    BaronVonBigmeat Senior Member

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    With record oil prices, many on the Right (as defined with today's labels) have understandably called for the federal government to remove its restrictions on oil exploration and drilling in ANWR (located in Alaska) as well as other federal lands and offshore water areas.[1] They point out that these federal restrictions, in conjunction with local environmental activism, have resulted in the absurd situation where 94 percent of federal land, and 97 percent of federal offshore waters, are not being leased by energy companies. The US government itself estimates that its own prohibitions currently render 18 billion barrels in the outer continental shelf (OCS) and 19 billion barrels located under federal lands off limits. Note that these are very conservative estimates, because nobody has gone out and extensively explored the areas where it is illegal to extract oil!

    Of course, calls to open up domestic areas for drilling horrify environmentalists and others on the Left, who liken the move to giving a junkie one more fix rather than dealing with his addiction. One of their strongest arguments is that ANWR drilling isn't a real solution for today's crisis, since

    Faced with this response, the people on the Right have typically come back with a few zingers. First, they point out that the critics of drilling have provided alternative proposals (development of renewable energy, conservation measures such as raising CAFE standards, etc.) that would also take years to kick in. They also frequently mention that this ten-year lag would have been over by now, if President Clinton hadn't vetoed the attempt to open up ANWR back in 1995.

    Yet there is an even stronger argument for opening up ANWR: because of its impact on oil prices in the future, relaxing federal prohibitions would cause current oil producers to change their pumping decisions right now. Even though the additional barrels from ANWR wouldn't physically hit the market for years, current knowledge of this fact will alter current behavior, leading to rapid relief at the pump.

    Though compelling, this argument is subtle and has only recently gained attention. I myself didn't bat an eye when experts in the industry told me (last year at a briefing) that opening ANWR wasn't a near-term solution. It wasn't until a colleague passed along an unpublished paper by Coats and Pecquet that I considered the impact of future supply increases on current production decisions.

    Once I heard the argument, it was obvious and I couldn't believe I had missed it. I began using it wherever I could, and was very glad to see that the respected Martin Feldstein made the case in the Wall Street Journal. Hopefully, proponents of ANWR drilling will now feel confident to repeat the claim. In the remaining space, I'll spell out the argument as simply as possible, because, admittedly, at first it sounds too good to be true.

    Imagine that you are sitting on a huge oil deposit, which has (let us suppose) one billion barrels that can be brought to the surface for $20 each, so long as you don't pump more than one million barrels per day. (If you want to pump at a higher rate, you have to spend more money per barrel, and you might reduce the total number of barrels you can extract from the deposit.) So the question is, how fast should you pump?

    You might at first think that you should pump at the maximum extraction rate, without raising your marginal costs — i.e., that you should pump at one million bbls/day. But this clearly is wrong, if you expect oil prices to keep rising. Why sell 365 million barrels in 2008 at an average of $150 each, when you could postpone production for a year and then sell those same million barrels for, say, $200 each?

    In light of this consideration, maybe you think you should just hold your barrels off the market forever. By letting them sit in the ground, the market value of your asset rises over time, as the market price of oil rises.

    But that isn't necessarily the right thing to do, either. What if oil prices rise an average of only 10 percent per year over the next two decades? Do you really want to put all your eggs (oil) in one basket, by leaving them sitting underground? Especially if your deposit is located in the Middle East, you might feel more comfortable selling off some of the oil now, and then using the revenue to buy stocks and bonds, not to mention a few surface-to-air missile silos. (And of course, you could be wrong in your forecasts; maybe oil prices will tank in two years.)

    My point here isn't to come up with the "optimal" extraction plan for an oil producer; since I'm not in the business, there are undoubtedly considerations I would overlook. But what I will say is that the expected price of oil in the future plays a very important role in these decisions. As always, a liquid futures market allows oil producers (and consumers) to make much more confident plans, because they can lock in prices for future transactions. For example, the oil producer doesn't have to simply guess that he can postpone production today, in order to sell next year at $150 per barrel; he can sell futures contracts to make sure of it (assuming he can find a buyer at that price).

    Now what happens if we are at an initial equilibrium, and then all of a sudden the US government relaxes the prohibitions on ANWR drilling? If oil traders really believe the policy shift is permanent, and that up to a million extra barrels will be hitting the market in a decade, then this will obviously reduce the expected world price of oil starting at that time. Consequently, any oil producers who had previously settled on a production rate with "excess capacity" — i.e., where they could have produced and sold more barrels today, but decided not to for reasons of profit — will re-evaluate their decision.

    Without specifics we have no idea how much the new information will change their output plans, but surely they will pump more in the present than they had previously decided.

    If we step back and survey the big picture, what would happen is that the market in a sense would be transferring some of those future ANWR barrels to the present. It's true, the market doesn't have recourse to time machines. But physical barrels of oil that would have otherwise sat underground in 2008, 2009, and so on, will now be brought to the surface and sold, because they have been displaced by the barrels currently buried in Alaska that will be brought to the surface and sold in 2018, 2019, and so on.

    If this seems too theoretical and farfetched, consider this: In May, the Saudis officially rebuffed President Bush's request for them to increase their output. Yet one month later, they reversed their position. What changed in the interim?

    Obviously I don't know for sure what motivates oil barons, but the political mood in the United States shifted in between those two announcements. All of a sudden, opening up ANWR and offshore areas for drilling was "on the table." The mere possibility of an extra million or more competing barrels per day may have been enough to reverse the Saudis' stance.

    Market prices help coordinate actions over space and time. To the extent that it is physically possible, the market will exploit the availability of new future supplies in order to provide immediate relief. The time lag involved should be no deterrent to opening up ANWR (and other prohibited areas) for oil development.

    Beyond that, the ideal solution would be to completely privatize federal lands, so that the decision of whether or not to drill would no longer be a political one.

    ANWR Drilling Would Provide Quick Relief - Robert P. Murphy - Mises Institute
     
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  2. jreeves
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    jreeves Senior Member

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    Do what, the promise of future supply could effect the price today? OMG...who would have thought?(sarcasm)
     
  3. Shogun
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    Shogun Free: Mudholes Stomped

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    In other words, don't mind the speculators who run up the prices... let's facilitate their place in the food chain and squander away what we have so that some chicken necked capitalist can have yacht money.
     
  4. Zoomie1980
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    Zoomie1980 Senior Member

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    The economy is driven more by psychology than anything else. Nothing reflects this more than the recent market in oil, but overall the economy is really a psychological phenomena more than it is anything else. Than "Consumer Confidence" is now the single most important economic indicator we have kind of tells the whole story.

    So any moves today that have significant PSYCHOLOGICAL impact are the moves that make the biggest immediate impact even if their physical impact is years off or even negligible direct impact on supply and demand. The price of oil today nowhere near reflects the supply and demand situation TODAY but generally reflects the fear of what it MIGHT be like five to ten years from now. No other market works like that, but oil has been working like that for some time now. So to counter it we have to make moves that also effect the perceived situation five to ten years down the line, as well. Openning up drilling does EXACTLY that. It will have impact on actual supply five to ten years from now but an IMMEDIATE impact on the PSYCHOLOGY of the market TODAY.
     
  5. dilloduck
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    dilloduck Diamond Member

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    Odd thought huh? Great article. hmmmm people who are buying FUTURES today would have to consider that supply in the future might balloon enough to make the price of their current futures look pretty stupid.
     
  6. jreeves
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    jreeves Senior Member

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    No it's the free market and the supply and demand economic models at work.
     
  7. Zoomie1980
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    Zoomie1980 Senior Member

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    The oil market has had nothing to do with supply and demand for some time. Oil continues to be in significant surplus not shortage yet the market acts as if we are in a critical current shortage, or at least was before the recent crash. If oil gets back into the 50's it will again be back to reacting to real and current supply demand issues.
     
  8. jreeves
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    jreeves Senior Member

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    I have to disagree with you, with a slim global surplus of what 2 million barrels, the market reacts drastically to anticipated supply interruptions. Prime example, Americans driving less coupled with the executive ban on offshore drilling being lifted has caused over a 20% drop in the price of oil. That is supply and demand 101 if you ask me.
     
    Last edited: Jul 29, 2008
  9. Zoomie1980
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    Zoomie1980 Senior Member

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    There has NEVER been a supply disruption to the point that a contracted delivery was not made due to a supply shortage, not even during the Arab Oil Embargo of the early 1970's. Oil production has fluctuated between and one and two million barrels a day surplus since the 1960's. And there will not be a missed delivery due to lack of supply for MANY years to come even with a whole series of major hurricanes AND a military attack on Iran. You forget, not one delivery was missed to our refineries during Katrina or Rita and for eight years of full warfare between Iraq and Iran in the 1980's and six wars with Israel since WWII not one singe barrel of oil went missing on a contract shipment. Nigeria has been in open civil war for much of the past 50 years and yet not one single consumer has been denied a shipment in that 50 years due to lack of supply. Not ONE.

    There IS NO OIL SHORTAGE and there will NOT BE ONE for MANY years to come, no matter who is at war or what the weather does. We eventually will have a REAL shortage but not any time in the several years. And it costs about $30 +- $5 to produce a barrel of oil today and get it to a refinery

    And the recent move is a reflection of a change in the psychology of supply HYSTERIA that has infected the market the past four years. That hysteria is pure psychological, not REAL.
     
    Last edited: Jul 29, 2008
  10. Paulie
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    Paulie Platinum Member

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    You've continually pointed out in here that it would probably be about 5 years before production started to decline. How then, are you not able to understand the "psychological" effect this could be having on the market NOW? 5 years is NOTHING. That's soon enough to be worried about, and to me it makes perfect sense why investors would want to position themselves for it NOW, rather than wait until 5 years from now when the supply starts to really lag the demand, like you yourself have pointed out that it will, causing higher prices again.

    I also think you're crazy if you think oil is ever going to be $50 again.
     
    Last edited: Jul 30, 2008

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