Comments (19)

• Ron

  Excellent article, Bob. Thank you.

  It's very obvious that a prediction of lower future oil production causes current prices to rise. Few dispute that talk about military action in the Middle East by the US government, or threats by OPEC to curb production have a near instantaneous effect on oil prices. It stands to reason, then, that the promise of higher future production would cause prices to fall.

  Of course, that's the last thing the anti-oil crowd wants to see happen. They would prefer that the price of oil stay high to better support the alternative energy movement.

  Published: July 28, 2008 8:54 AM

• Jaime Raul Molina

  This article is good and puts forward a good argument why drilling now would influence present prices, and we Austrians know that the expectation of things to come in the future definitely influence our actions in the present. If I expect that the world will come to an end within one year, I will not save and work as I would if I think otherwise.

  However, even if prices today were to be unaffected by the start of drilling in ANWR, we still should go for such drilling. As one commentator put it: Should we stop sending our children to school because results will take 12 years to manifest?

  Published: July 28, 2008 9:41 AM

• Person

  That's a great article, Bob. A truly great one. We see markets now working perfectly, given the constraints of an imperfect world. If men with guns keep folk from drilling for oil in a specific region, that represents a restriction on the ability to bring oil to market. So it's only right and proper that the market price should reflect this restriction via price signals that say, "Hey -- oil's being kept off the market: only use a oil if it is worth *this* much to you."

  Great stuff.

  But in contrast, when people buy up oil futures in a frenzy, based purely on the herdlike belief that other idiots will join in, that new price of oil doesn't reflect any scarcity. It's just an arbitrary decision of bubble-buyers. It makes no more sense than paying more for oil because it's a holiday.

  Right?

  Published: July 28, 2008 10:21 AM

• P Johnston

  Robert Murphy, your article here exhibits the logic of a lunatic. However, let me quickly add, that what you lack in the way of logic you make up for by a vast ignorance of the oil biz.
  
  “The mere possibility of an extra million or more competing barrels per day may have been enough to reverse the Saudis' stance.”

  Who are you kidding? In a system that uses 85 or so million barrels a day, (i.e. a million every 16 or 17 minutes), an additional million barrels would be hardly more than a rounding error.
  You really should bother to learn a bit about the industry before running you mouth, like, for example, how much oil is used each day. Might save a little embarrassment.

  But I have to say this, too: there is a kind of madman quality to your piece that I like.

  Grant to a lunatic that, yes, he is Napoleon, and everything he says follows with perfect sense, and is utterly logical.

  Ah, but is he Napoleon?

  Same with you article. You go off on this satisfying riff about all sorts of good things that are going to happen by even saying that we are going to look for oil in ANWR. But can oil be found there? Is it there? Who the hell knows? One constant of the biz is this: you don’t know if there is oil until you start drilling holes in the ground. (Google “Mukluk and Sohio” and see if you can’t find a little info about one of the most expensive dry holes in history ---- in Alaska, by the way.)

  One reason lots of places exist where oil people have not looked for oil is because there is probably no oil to be found. You see, if you are in the biz, and have spent a lifetime looking for oil, plus know a thing or two about how oil is formed, plus also know a thing or two about geology, and so forth and so on, you know that there are a lot of places where you don’t need to look.

  But don’t let me wake you up.......fantasy is so much more satisfying.

  Now, what was it you were saying about the Egyptian campaign......
  

  Published: July 28, 2008 10:37 AM

• Ed

  Another way of explaining this is to give the Fin101 explanation of how futures markets work. At first there appeared to be the blunder of

  "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."

  which is quickly seen as a strawman used for illustrative purposes only. The price can go up or down. Security is an issue (and priced into the price of oil) as is the time value.

  The question is whats a barrel of oil worth today and what's it worth next year (or any future time period). The simplistic answer is that the market sets the price today - check your newspaper and the future price is based on the spot priced plus the market rate of interest (based on treasuries and not including the interest rate for storage)

  But what about the idea that oil will rise in value or even fall in value by well more than the 1 yr treasury which is at 2%?

  I can simply borrow $125 (today's spot) and pay interest on that money and then hold the oil for one year. Voila, a one year future barrel of oil for ~$128.75. (Aside: assume storage costs and interest costs for holding are minimal which they typically are)

  Add any time figure you want and it still basically works. This is the entirety of the futures market which, for oil and most commodities, is highly liquid and priced efficiently. The beauty of it in relation to ANWR is it works in reverse.

  Lets say that everything changes and ANWR is opened. The owner of those resevoirs sell those 10 year future barrels for $185 per barrel at the time of delivery. How did the owner come up with that figure? He looked at spot and used the discount rate. $125 at 4% for 10 years is $185. But selling this new excess of oil, even in the future, causes prices to drop at all time periods. Does anyone here think they can sell all futures at $185? No .So, they lowers price to $175. This discounts to present value of $118 on today's prices. Put another way, Anyone buying oil today to extract in 10 years is not willing to pay $125 with the new knowledge of ANWR opening.

  Therefore prices fall today. And this has nothing to do with a change in Middle East policy. That newfound change in policy is a completely different set of inputs for traders pricing oil.

  Another interesting aspect is the length of time all these different inputs take to occur. And the difficulty it is to exactly show how much any one input affected price. This is especially true when, as the aucthor mentioned, one input like Bush pushing the opening the Gulf affects a second one of Middle East opening the spigot.

  Published: July 28, 2008 11:03 AM

• billwald

  Doesn't compute. There are at least two, maybe three reasons for a disconnect between the commodity price and the retail price of gasoline.

  First, gas is traditionally priced to low. The price jumps 25% and sales drop 4%. price is to low. Yes, gas sales are inelastic in the short run. The retailer wants to maximize his profits in the short run. "In the long run, we are all dead."

  Second, most retail gas stations make their profits on beer and ciggy butts. The gas is a loss leader and if they make a profit from gas, icing on the cake.

  Third, in most small communities there is only one gas wholesaler. All the brands come out of the same tank. The local dealer might dump in some special additive when the gas is delivered. The brands that can charge an extra dime because of advertising and customer loyalty charge the extra dime. I pay the extra dime for Chevron because of the claimed additive and the bathrooms are most always clean.

  In a small town, the station owners know each other and probably set the price over coffee once a week. That's why I don't gas up in Williams, Cal. or Leavenworth, WA. They are always two bits higher than the stations 20 miles down the road.

  Published: July 28, 2008 11:07 AM

• Robin Anderson

  Murphy,

  Thank you for the excellent article.

  I look forward to your next article. May I suggest you examine the T Boon Pickens plan? I find it to be a joke but the mainstream media and politicians (both parties) are gushing over it.

  (P Johnston, if you don't think a million barrels per day is significant then YOU sir don't understand the petroleum market.)

  Published: July 28, 2008 12:15 PM

• LanceH

  This article contradicts Bob Murphy's earlier claim that speculation on oil futures does not affect spot oil prices, in:
  http://blog.mises.org/archives/008217.asp

  In today's article he argues that an expectation of lower future prices might encourage oil producers to pump more now and hence depress spot prices.

  In his earlier article he considered the possibility that higher futures prices might raise spot prices due to "oil hoarding" by oil producers. But he ruled that out on the grounds that "spare production capacity is well below its ten-year average. Non-OPEC production in 2007 was at a record high, and is forecasted to set another record by the end of 2008, meaning that market signals are almost certainly not leading producers to scale back current output for speculative reasons."

  In today's article he argues that because there is still SOME spare capacity, there could indeed be an element of oil-hoarding. He refers to a Reuters article which quotes Saudi's Oil Minister as saying in January that Saudi Arabia maintains spare production capacity of about 2 million barrels per day use when there is "an unexpected need".
  

  Published: July 28, 2008 8:52 PM

• TokyoTom

  P Johnston: "But can oil be found there? Is it there? Who the hell knows? One constant of the biz is this: you don’t know if there is oil until you start drilling holes in the ground."

  Great points, but ... in fact, peole have drilled holes in ANWR. Maybe THAT'S why there's been constant pressure to reopen it for exploration and development.

  TT

  Published: July 29, 2008 6:51 AM

• TokyoTom

  Bob, I agree generally with your analysis, but you really fail to address or answer the question of WHY the government should open up ANWR or the OCS - you state that the best reason to do so is because opening up more federal lands for drilling will "alter current behavior, leading to rapid relief at the pump."

  Interesting, but unexamined. Is it the government's job to open up lands that political decisions, on the basis of competing values, have kept off the market, simply to provide relief to the complaining parts of the market (fuel users)? If so, should the government also open up the SPR whenever markets climb and users complain? Are there other markets that the government should also try to manage for the benefit of consumers? And how do we choose between what markets and marlet segments to listen to - what happens if, say, environmental demands rise suddenly after an oil spill - should the government then rapidly move producing areas off lease and into reserves?

  You also conclusorily state that it is an "absurd situation where 94 percent of federal land, and 97 percent of federal offshore waters, are not being leased by energy companies." How is it that you have the wisdom to know how much and where the unidentified oil and gas resources lie, so you know what percentage of federal lands SHOULD be under an energy company lease? And what about the small consideration of other values for the land in question - have you decided that energy trumps all?

  Finally you conclude 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." As my initial questions to you may indicate, I actually agree with you on this, but the reason is NOT to provide relief to consumers and other users at the pump, but in order to end incompetent and politicized and sometimes logjammed federal managment, while improving management of both environmental and other resource values.

  Not only have I done a more thorough job of explaining WHY the feds and our Congresscritters ought to open up ANWR and the OCS, I've also explained HOW we can move past the existing deadlock - in a proposal I laid out last week in my blog here: "Breaking the senseless impasse on ANWR and OCS exploration and development - a tax and rebate proposal",
  http://mises.org/Community/blogs/tokyotom/archive/2008/07/16/breaking-the-senseless-impasse-on-anwr-and-ocs-exploration-and-development-a-tax-and-rebate-proposal.aspx.

  A deal on OCS seems easier to do than ANWR, because all that is needed to get the coastal states to agree is greater revenue-sharing with the states.

  An ANWR deal should happen just out of fairness to the Inuit who own land that is now bottled up in ANWR. If they get fee simple, then they could start drilling immediately.

  By the way, has it ever occurred to you to wonder how much COAL leasing would occur if private parties and not the federal (and state) government owned the Western lands on which production is occurring? With all of the royalties flowing into the coffers of federal and state governments?

  Or to wonder how much extremely destructive coal production would occur in West Virgina and the rest of the Appalachians, if the governments were not being paid tremendous sums to turn a blind eye and to deny justice to those who are suffering all of the costs of the ongoing violation of private health and property rights and the transfer of costs and risks? http://mises.org/Community/blogs/tokyotom/archive/2008/03/03/are-those-who-homes-and-health-are-injured-by-mountain-top-removal-in-w-va-and-e-tennessee-snivelling-evil-enviros.aspx

  Regards,

  Tom

  Published: July 29, 2008 7:27 AM

• TokyoTom

  My second post was held up, so I've copied it to my blog, here: http://mises.org/Community/blogs/tokyotom/archive/2008/07/29/breaking-the-impasse-on-anwr-and-ocs-exploration-and-development-part-ii-a-response-to-bob-murphy.aspx.

  Bob, I'd be grateful if you could see that the full post is let through.

  Regards,

  Tom

  Published: July 29, 2008 7:48 AM

• Daniel M. Ryan

  A quibble on a point in Dr. Murphy's argument, to wit:

  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.

  There's one reason why full production would be undertook even if oil prices are expected to rise: variable costs are expected to rise also, to the point where margins would be thinned out. The gold juniors have been facing precisely this block through most of the current gold bull market.

  Published: July 30, 2008 11:07 AM

• kt

  Other factors:

  1) If the price of oil is rising, the price of everything is rising -- so, the value of the oil in the ground is not increasing in a trivial manner, and could be decreasing.

  2) Petrochemical enrichment of society is in severe doubt and no matter what the price of oil is, we continue to pay for an increasing _cost_ of oil use that will just be ever greater -- that's a cost for everyone, not just the anonymous and much abused "consumer," but the owner of oil interests, the investor in oil interests, and the politician who regulates those interests.

  3) There are already alternatives that are suppressed not by legitimate economic interests, but by fiat (in government and industry).

  4) Any argument based on sound economic principles is suspect, because no one with money or large financial interests uses sound economic principles -- they attempt to engineer data and understanding to augment their investment. Sometimes that may happen to correspond with "sound economic principle," but that is not the operative consideration.

  Published: July 30, 2008 12:40 PM

• Mike D.

  Paul Johnson wrote
  
  One constant of the biz is this: you don’t know if there is oil until you start drilling holes in the ground. (Google “Mukluk and Sohio” and see if you can’t find a little info about one of the most expensive dry holes in history ---- in Alaska, by the way.)
  
  Geophysical seismic methods can identify domes and "bright spots" - gas trapped in the structure, without drilling. However, you can not see "bright spots" through permafrost. This is why Mukluk was a bust - the dome structure had been identified, but the top of the reservoir was perforated and the oil had escaped into the Kuparak oilfield. Unless technology has improved, Paul is right - nobody will know for sure whether there is any oil in ANWR until someone drills a hole.

  Published: July 30, 2008 1:30 PM

• Mike D.

  Tokyo Tom wrote
  
  Great points, but ... in fact, people have drilled holes in ANWR. Maybe THAT'S why there's been constant pressure to reopen it for exploration and development.
  
  Given the cost, this seems highly unlikely - it takes 2 winter seasons of drilling to reach the required depth. Also, the well-log information would be in the public domain with the State of Alaska - I can't find any online reference.

  Published: July 30, 2008 1:46 PM

• Mike D.

  Here is the justification for the 10 year timeline
  
  At the present time, there has been no crude oil production in the ANWR coastal plain region. This analysis assumes that enactment of the legislation in 2008 would result in first production from the ANWR area in 10 years, i.e., 2018.
  
  The primary constraints to a rapid development of ANWR oil resources are the limited weather “windows” for collecting seismic data and drilling wells (a 3-to-4 month winter window) and for ocean barging of heavy infrastructure equipment to the well site (a 2-to-3 month summer window).
  
  The assumption that ANWR oil production would begin 10 years after legislation approves the Federal oil and natural gas leasing in the 1002 Area is based on the following 8-to-12 year timeline:
  

  * 2 to 3 years to obtain leases, including the development of a U.S. Bureau of Land Management (BLM) leasing program, which includes approval of an Environmental Impact Statement, the collection and analysis of seismic data, and the auction and award of leases.
  
  * 2 to 3 years to drill a single exploratory well. Exploratory wells are slower to drill because geophysical data are collected during drilling, e.g., rock cores and well logs. Typically, Alaska North Slope exploration wells take two full winter seasons to reach the desired depth.
  
  * 1 to 2 years to develop a production development plan and obtain BLM approval for that plan, if a commercial oil reservoir is discovered. Considerably more time could be required if the discovered oil reservoir is very deep, is filled with heavy oil, or is highly faulted. The petroleum company might have to collect more seismic data or drill delineation wells to confirm that the deposit is commercial.
  
  * 3 to 4 years to construct the feeder pipelines; to fabricate oil separation and treatment plants, and transport them up from the lower-48 States to the North Slope by ocean barge; construct drilling pads; drill to depth; and complete the wells.
  
  The 10-year timeline for developing ANWR petroleum resources assumes that there is no protracted legal battle in approving the BLM’s draft Environmental Impact Statement, the BLM’s approval to collect seismic data, or the BLM’s approval of a specific lease-development proposal.
  

  Published: July 30, 2008 2:13 PM

• TokyoTom

  Mike D:

  Please see p. 30 (CRS-27)of the following CRS report, which states:

  "It will be recalled that an exploratory well was already drilled on KIC lands and some oil companies could be ready to move forward immediately on the Native lands."

  http://lieberman.senate.gov/documents/crs/anwrlegalissues.pdf

  Published: July 31, 2008 10:56 PM

• newson

  to ed:
  'agree with everything you said, except the bit about storage costs, which i believe are fairly costly for a bulk product, and i think there may also be storage-facility constraints, too.

  Published: August 1, 2008 11:14 AM

• Simon

  If eventually ANWR is not drilled expect a gap up in prices.

  Gaps are always filled. Additional oil will be used allowing more growth more waste more people more destruction. I think we need less oil, less growth (except cerebral) less waste and less people.

  Published: August 12, 2008 2:34 AM