For those interested in Weijia's posts regarding Oil prices, please see below.
Oil prices tend to follow the Hotelling Model, described as:
pt – c = (p0 – c)(1+r)^t t=1,…,T-1, T
Notation:
qt = quantity depleted (used, consumed)
in time t
B(qt) = benefit function
c = marginal extraction cost
cqt = total extraction cost at time t
pt = resource price in time t
r = interest rate
S0 = stock available at time 0
T = exhaustion date
Where two conditions hold:
(1) price rises to the “choke price”
pT = pc [QD(pc) = 0]
(2) entire stock is just exhausted
∑T-1 qt + qT = S0
Additionally, Michael Moore brings up the "Arbitrage notion": rate of return in all physical asset markets equals rate of return on all financial instruments. Think about it...
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4 comments:
Interesting post, though admittedly I cannot follow that model (there also seems to be some notation missing), I'd be interested in hearing what the takeaway from it is supposed to be given the current oil market conditions.
Regarding the "arbitrage notion", this is a huge theoretical extrapolation given perfect capital markets (ECN 442 is a good class about stuff like this if anyone is interested). Obviously we do not live in a world in which capital markets are anywhere near perfect. There are clearly different transaction costs for physical and financial assets that stem from storage and transportation alone. More interestingly, different tax regimes across assets are also a huge detriment to the enforcement of this parity. This is all before taking account for certain risks, that are notoriously difficult to price in, most notably with counter-parties.
I was curious to know if you or anyone had any ideas about the role cartels (read: OPEC) are playing in the current price of oil. Obviously they have an incentive towards higher prices, but if they learned anything from the '70s in the US, prices that are too high result in diminishing returns in the form of reduced reliance on oil, as well as crippled economies that inherently use less oil. I haven't been following news on them too much, anyone know about any speculation as to their future actions?
Today in my Energy class the professor gave some simple intuition behind OPEC's decision to keep production constant even with high prices. Because oil is very scarce they know that as time goes on the price will have to go higher. While this says nothing about the short term impact on price it does make sense when looking at the long term perspective. According to current estimates the current oil reserves are going to run out some time in our lifetime and this is basically a huge bargaining chip that OPEC has.
Who provides those estimates? THE OIL COMPANIES!
We will never run out of crude oil.
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