Arnold Kling  

Oil Econ 101 Revisited

Your Planners at Work... Climate Change Discussion...

Robert Higgs writes,

If we were talking about bananas, everybody would see immediately the foolishness of seeking “banana independence.” Nobody would fall for half-baked arguments about our addiction to foreign bananas or our love affair with banana bread. It’s obviously uneconomic to grow millions of bananas in this country; it could be done, but doing it would entail much greater costs than buying them from producers in places better suited to their production (that is, places where they can be produced at lower opportunity cost).

Thanks to Don Boudreaux for the pointer.

In Oil Econ 101, I wrote,

The problem with sponsoring terrorism is not that oil revenues are the source of funds. The problem with sponsoring terrorism is that it is grossly immoral.

Whether you are an anti-war liberterian like Higgs or a xenophobe about Islamic radicals like me, the economics always comes out the same: choosing the high-cost energy path is not in the interest of American citizens.

It would be interesting to list all of the causes that sound good to politicians (and presumably to voters) but which frighten me, based on past policy proposals: the family farmer, affordable housing, energy independence...

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The author at Trade Diversion in a related article titled Banana independence! writes:
    Robert Higgs: If we were talking about bananas, everybody would see immediately the foolishness of seeking “banana independence.” Nobody would fall for half-baked arguments about our addiction to foreign bananas or our love affair with banana bread... [Tracked on August 13, 2008 5:19 PM]
COMMENTS (14 to date)
Les writes:

There is an enormous difference between bananas and oil. Bananas are not produced by a monopoly. Oil largely is.

OPEC nations are mainly Middle East Islamic states, which own almost 80% of world proven reserves of crude, but supply only about 40% of world demand. Clearly they restrict supply to keep prices very high. Middle East oil costs about $2-$3 per barrel at the well-head, while selling for > $100 per barrel.

Large integrated oil companies own only about 3% of world proven reserves of crude, and their cost of production is about $15 per barrel at the well-head. They gladly shelter under the high price umbrella provided by OPEC.

So high oil prices received by Middle East states do finance terrorism, meaning that we pay our costs of fighting terrorism, plus the costs of defending Middle East oil producing states from terrorists, plus the high oil prices we pay which are used to subsidize the terrorists.

The free riders are (a) Middle East oil producing states, and (b)large oil importers like Europe, Japan and China, who pay us nothing for protecting Middle East oil from being seized by terrorists.

manuelg writes:


> ...own almost 80% of world proven reserves of crude...

Reserves of _sweet_ crude. Canada has much more petroleum, but in oil shale. Considerably more expensive to extract and refine, but still a sound petroleum source.

OPEC cannot raise the price of a barrel of oil past the point where it becomes economic to extract petroleum from shale.

The world has probably hit peak sweet crude, but is nowhere near hitting peak oil, when we include oil shale sources.

Another difference between oil and bananas is the size of the impact that the good's price fluctuations has upon our economy. I would imagine that bananas are largely a final good, and one with a higher elasticity of demand compared to that of oil. It is much easier to find substitutes for bananas and banana products than oil and oil products.

In contrast, oil is an intermediate good that impacts the costs (and thus prices) of a great number of other goods. This includes all goods that need to be transported (or whose inputs need to be transported), or any good or service whose labor force commutes (companies may not pay for this oil directly, but increases in the cost of living of laborers will increase the equilibrium wage).

Not to mention national defense.

This is why our country has chosen to allocate/deploy much more military resources to defending oil producing countries than banana producers. You can argue that this policy is wise or foolish, but comparing oil to bananas doesn't seem apt.

Lord writes:

If we would starve without bananas would that change your mind?

John Thacker writes:

Les and perfectlyGoodInk:

I have to say that you both seem to be missing the point. Nothing that you say disagrees with the basic point that Professor Kling was alluding to: it would be even more expensive than our current behavior to attempt to achieve "oil independence." Yes, the fact that certain countries have a great deal of a valuable commodity makes them rich. That's still no argument for wasting even more money on getting energy from other sources than we waste on buying it from them.

Les writes:


I did not miss the point. Energy independence is simply out of reach. We import over 60% of our crude oil. It is ludicrous to think we could more cheaply derive oil from domestic sources. If that were the case, it would already be done, or at least well under way.

Even with offshore and ANWAR drilling, our oil production costs are far above the Middle East $2 per barrel.

Of course there are options available, such as demanding payment from Middle East countries for providing protection, or even following the suggestion to simply seize the Middle East oilfields by force if our demand for payment is denied.

Bob Knaus writes:

It wasn't so long ago that we did, in fact, demand payment from Middle Eastern countries for protection. This took the form of selling them expensive sophisticated weapons systems that they were incapable of using without significant help from American contractors.

Acceeding to Bin Laden's demand that we withdraw from Saudi Arabia ended one of the more profitable versions of that particular rent extraction. Perhaps others will appear in the future.

Matt writes:

Well, actually, our domination of banana republics started with the banana business, and banana independence was a big left wing issue for a while.

Ray Gardner writes:

I was wondering if the banana wars subject would come up, and it did; bully for that guy.

As for a better understanding of what the point really is, maybe lester & co should forget about bananas and think about the bygone farm life wherein the farmer relied mostly upon himself for his goods.

Is it better for the farmer to maintain 100 acres, make all of his own goods, trade with no one or very few people since he is so independent he has no need for trade, or should he farm 500 acres, and be very dependent on trade?

Even addicted to trade?! Gasp. . .

John Thacker: you...seem to be missing the point...that Professor Kling was alluding to: it would be even more expensive than our current behavior to attempt to achieve "oil independence."

I was not addressing that point, which I alluded to with my, "You can argue that this policy is wise or foolish," remark. I was just complaining about the comparison not being a very good one as well as reminding folks that our current behavior includes subsidizing the price stability of oil with our military -- behavior which began post-WWII.

Lord: If we would starve without bananas would that change your mind?

Yes, if bananas had no substitutes, the demand would be infinitely inelastic, and it would be a better comparison in that sense, but a worse comparison in the sense that you're now talking about a hypothetical good.

Jesper writes:

Actually, Les, the US is the reason Middle East produces terrorists nowadays. The Middle East arguably needs US force to make the regional powers refrain from waging wars against each other, such as Iraq did with Kuwait. However, US force obviously and greatly increases terrorism in the region, and Bush policies towards Iraq and Iran has also, just as obviously, resulted in much more expensive oil ever since he announced the intent to invade Iraq. I guess at least $20 is a Bush-premium.

Sure, Europe free-rides to some extent, but also suffers to some extent, from US policies.

Jody writes:

While there are substitutions for everything, the substitution costs for banannas are orders of magnitudes less than the substitution costs for oil.

Niccolo writes:

Les and others, take into consideration an alternative reality.

I wonder, if the Japanese were involved in holding up despotic regimes that controlled larger and smaller pieces of the United States, using their governments to create agricultural cartels at the expense of the residents within the countries and for the profit of the despots, what could I call you? Because you're white, probably freedom fighters, correct?

cached writes:

How much is "peace dependence" costing the US for energy? Would the world be better off if we were "peace independant" like the isolationist days. Doubtful....ask Europeans circa 1944. Maybe we're funding terrorism to a degree. We didn't fund Hilter and he did just fine without us.

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