Bryan Caplan  

Two Interesting Things James Hamilton Told Me

PRINT
What do Financial Intermediari... Thoughts on Short-Selling...

Noted energy economist James Hamilton just spoke at GMU. The two most interesting things he said:

1. OPEC has almost no effect on world oil prices; most countries produce less than their quota, and when countries want to produce more, their quota goes up.

2. The price of oil follows a random walk. But the oil industry isn't trying very hard to develop new sources because oil execs believe that the price of oil is mean-reverting (i.e., what goes up must come down). Why are the oil execs so wrong? Hamilton's guess: They're putting too much weight on their last big experience with high oil prices in the 70s and 80s.

Where is he right? Where is he wrong?


Comments and Sharing





COMMENTS (12 to date)
Arnold Kling writes:

I believe both of these. But, as I've written before, the oil executives' attitude burns me up. They should be selling oil futures contracts and exploring for oil. If they're right about future oil prices, they can make huge profits on the futures contracts. If the market is right, they will make money on the oil exploration. By choosing the right hedge ratio, they can make a profit either way.

My point is that there is no excuse for not doing more exploration. As the saying goes, drill here, drill now.

kebko writes:

Wouldn't they have risk on your hedging strategy if carbon tax policies or windfall taxes were enacted that simultaneously increased oil prices & decreased the potential profits from selling that oil?

ChrisA writes:

Oil companies are not constrained by the oil price, i.e. they aren't deciding to not do projects because they don't meet their economic returns at their chosen forecast prices, instead the constraint is resources; people and capital spending. I realised this when I saw oil companies raising their oil price forecast when they realised they have spare capacity in these areas. Basically the low oil price forecast acts more of a filter, and covers the oil companies for cost overruns etc or when projects don't go to plan. The capital spending is set at a level that they think they stock market will allow, and what's left over when dividends are paid. That's why it goes down in low oil price years and up in good years.

Gary Rogers writes:

This is one of the few times I disagree with Bryan and Arnold. What gives any of us the right to care what the attitude of an oil executive is? As far as putting too much weight on the results of the 70's and 80's, we will know who is correct by who makes the best decisions. That is how the market works and why competition is so important. In any case, I will take the judgment of someone in the business over an economist any day. They have a better track record.

Les writes:

I question the statement that "OPEC has almost no effect on world oil prices; most countries produce less than their quota, and when countries want to produce more, their quota goes up."

The OPEC website states that OPEC has 78% of World Proven Reserves of crude oil, but OPEC supplies only 55% of World supply of crude. This strongly suggests that OPEC restricts output, in order to keep the price of crude oil high.

dearieme writes:

Exploration will prove pointless if some sovereign state then steals the oilfield from you. When "nationalisation" of oilfields first began is when the USA should have used its armies.

Andrew writes:

"When "nationalisation" of oilfields first began is when the USA should have used its armies."

After all it is our oil.

MSK writes:

A brief observation on oil companies, OPEC, and the price at the pump. OPEC and current events have as much to do with the price at the pump as does the Easter Bunny. Example - This weekend in the Atlanta metro area as Hurricane Ike was prepairing to make landfall, 3 out of 4 gas stations were "bagging" their pumps. National and regional chains alike - signs were posted blaming shortages - the storm hadn't made landfall yet, and we were half a continent away. I find it hard to believe that pipelines were preemptively drained all the way from Houston to Atlanta in anticipation of landfall. While 20% of the nation's refining capacity may well have eventually been directly affected by the storm, it was not lost - merely halted. Louisiana's production capacity - arguably equal to that of Texas was not impacted and there was not the catastrophic destruction of the drilling platforms in the Gulf of Mexico that accompanied Hurricane Katrina. Meanwhile back in Atlanta - by 7:30 Sunday morning the gas stations in the Marietta area were all magically back in business - starting with those closest to I-75 and I-85 - and the average spike in price, 30 cents per gallon ($4.09 to $4.39 in 6 hours). Tuesday here in North Carolina we saw a drop from $4.08 to $3.79 - has the price per barrel dropped 20%? Are all the refineries back to full production? Did OPEC open the spigot? No - it's what the oil companies can get away with, plain and simple. It can not be explained away or excused with economic theories - Price gouging laws have been introduced in many coastal states, maybe it's time for federal legislation to follow. Let's start at the pump.

Rolo Tomasi writes:

MSK,

I have three points:

1)According to the Minerals Management Service, by Fri. Sept 12th, 1.2 million barrels per day of production was shut-in to protect personnel and equipment from the coming storm--about one fifth of U.S. daily production. I'm also pretty sure some refineries were shut-in as well.

2)People knew Ike was coming and filled up their tanks in anticipation of the storms arrival. Prices were not allowed to rise because of existing anti-gouging laws, causing local shortages. See Don Boudreaux http://cafehayek.typepad.com/hayek/2008/09/markets-anticip.html

3)I don't think that oil companies like to "get away with" not selling their product and not making as much money as they could.

Dan Weber writes:
The OPEC website states that OPEC has 78% of World Proven Reserves of crude oil, but OPEC supplies only 55% of World supply of crude. This strongly suggests that OPEC restricts output, in order to keep the price of crude oil high.

There's no reason for those figures to be the same. If I suddenly find out my oil well is twice as big, my % of world reserves has doubled, but that doesn't mean I can pump it out twice as fast.

diz writes:

1. Is probably true in recent months while supply has been tight. There's has just not been much need to restrict supply of late. It has certainly not always been the case. Lately the bigger effect of the National Oil Companies (NOCs) has been their stumbling incompetence and general tendency to bleed capital from the oil business for other purposes. This has obviated the need for greater cartel discipline. The main way OPEC restricts supply is simply leaving the oil undeveloped. Or at least developing reaserves far slower than a profit motivated company that saw itself as a price taker would. If you think about it, how much sense does it really make for OPEC to invest in excess capacity anyway? No sane producer would spend billions to develop 2 million barrels per day of capacity and just to let it sit there.

2. It's probably fair to say that oil execs have seen price go up and come down and this affects the speed at which they react to prices fluctuations. Most of the current crop of execs also went through the Boone Pickens raider era, where companies that frittered away capital (and most were) became takeover targets. Capital discipline was a key to survival for a while back in the 1980's. It was drilled into all of us. But probably more important than all of that is personnel. There is a limited capacity to develop a prospect from initial concept through drilling. When oil price doubles, you still only have 15 engineers and geologists that understand the Gulf of Mexico. You can become more aggressive at the margin, but the quality of your prospects will deteriorate rapidly if you try to force more projects through your relatively constant ability to process projects. And, there just aren't that many people you can just go out and hire. And, don't forget, the geographical area you can access doesn't get any bigger.

As of now, at least with repsect to oil, the big effect is that places like the Bakken shale slide from uneconomic to very economic. You also see redevelopment of existing fields, and maybe secondary or tertiary recovery projects in old fields that become economic. An enormous amount of talent and resources if flowing into these sorts of projects as we speak, but they just don't move the needle all that much. Remember, existing wells decline. You gotta run pretty hard just to stay even. We are runing much harder domestically (you can get an active rig count chart that will illustrate this nicely at Baker Hughes' website), and in fact are doing better than staying even on natural gas.

dearieme writes:

"After all it is our oil." It is if you've signed a contract.

Comments for this entry have been closed
Return to top