Saturday, July 26, 2008


About Oil

A news item on NPR this morning dealt with a dispute in the Senate about drilling for oil off-shore. Some politicians assert that such drilling and possible extraction of oil will drive down the high price of petroleum on the world market. Other politicians assert that the high price is due to speculators who have cornered the supply (through buying oil futures) and are maintaining the current price to guarantee their profits.

Politicians understand instinctively how to appeal to mass opinion to gain votes. They don't understand (or care about) a very fundamental axiom of economics. The axiom is that no one will willingly start or engage in a business enterprise that is certain to lose money. American oil companies don't need government permission to drill for oil off-shore. They have leases on large tracts that have proven oil reserves. They can start drilling for oil in their existing oil leases whenever the price of crude oil is greater than the cost of getting the oil out of the ground.

It's the cost of "new" oil that is driving the world market price of petroleum. We are gradually running out of "old" oil, oil that has been exploited for years and is still inexpensive to extract. The price of "old" oil is limited; supply and demand is forcing the price. The "new" oil will not be available until the world market price reaches the extraction cost.

No amount of posturing, demagoguing, talking about off-shore drilling, punishing speculators, or opening the nation's strategic oil reserve can change the world market price of petroleum. The price of petroleum is set by the cost of pumping oil from least efficient oil well in the world.


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