Steve Kopits recently gave a presentation [link to presentation at resilience.org] explaining our current predicament: the cost of oil extraction has been rising rapidly (10.9% per year) but oil prices have been flat. Major oil companies are finding their profits squeezed, and have recently announced plans to sell off part of their assets in order to have funds to pay their dividends. Such an approach is likely to lead to an eventual drop in oil production. I have talked about similar points previously (here and here), but Kopits adds some additional perspectives which he has given me permission to share with my readers.
I encourage readers to watch the original hour-long presentation at Columbia University, if they have the time.
- “Capex” – “Capital expenditures” – How much companies are spending on things like exploration, drilling, and making of new offshore oil platforms
- “Crude oil production” –
People in the industry thought, “Capex has been going up and up. It will continue to do very well. We have been on this trajectory forever, and we are just going to get more and more money out of this.”Now why is that? The reason is that in a Demand constrained model for those of you who took economics–price equals marginal cost. Right? So if my costs are going up, the price will also go up. Right? That is a Demand constrained model. So if it costs me more to get oil, it is no big deal, the market will recognize that at some point, in a Demand constrained model.Not in a Supply constrained model! In a Supply constrained model, the price goes up to a price that is very similar to the monopoly price, after which you really can’t raise it, because that marginal consumer would rather do with less than pay more. They will not recognize [pay] your marginal cost. In that model, you get to a price, and after that price, there is significant resistance from the consumer to moving up off of that price. That is the “Supply Constrained Price.” If your costs continue to come up underneath you, the consumer won’t recognize it.The rapidly growing Capex forecast is implicitly a Demand constrained forecast. It says, sure Capex can go up to a trillion dollars a year. We can spend a trillion dollars a year looking for oil and gas. The global economy will accept that.
Mr Hockey said reaching the goal would require increasing investment but that it could create “tens of millions of new jobs”.