« Interest rate swaps | Main | A Supply Side Approach to the Crisis »
Questions that are rarely asked
Was September 2008 the month of greatest increase in United States Wealth in History?
Doesn't the long term economic impact of 5-10 trillion dollars of offshore oil overwhelm the trillion dollars from the bailout?
That's from Andrew, a loyal MR reader. He sends along this link. I have not myself done any calculations of the fiscal benefits from such oil (which are distinct from the price effect, which is likely small). Does anyone know a number?
At first I thought he was going to mention the recent decline in the price of oil, which on average you can expect to be permanent. The real lesson, I would say, is how much coordination (or lack thereof) matters and how badly representative agent models perform in explaining the most important economic changes.
Posted by Tyler Cowen on September 25, 2008 at 07:29 AM in Sports | Permalink
Comments
Unfortunately there are lots of hurdles that energy companies still need to jump through in order to actually start producing. See this summary. And there are environmental groups hoping to reinstate (large portions of) the moratorium after the election; the Democrats didn't want to go into November having opposed offshore drilling when a sizable majority of the voters favor it.
Anyway the point is that you need to discount the potential wealth of that oil because it's not guaranteed it will be legal to develop. Also, does Andrew's figure take into account the time value of money? E.g. if the stock market drops $x billion in September, while dropping the drilling ban allows the development of $10 trillion over the next 50 years...
Posted by: Bob Murphy at Sep 25, 2008 9:02:46 AM
The oil was already there and already owned by us. "Drain America First" legislation does not have a first order effect on our wealth, although there may be second order effects (positive and negative).
Posted by: a student of economics at Sep 25, 2008 9:06:29 AM
There are two sides to the value of oil. Yes, a drop in the price of oil increases the real income of oil consumers. But it also creates an equal and offsetting drop in the income of oil producers. It is a wash.
I had to double check, as I was making my comment I though this has to be written by Ale, not Tyler. You are better than this. Take some time to think.
Posted by: spencer at Sep 25, 2008 9:42:51 AM
Spencer -- many will point out that it's "our" oil and thus "we" get the revenue (instead of a new discovery in Brazil giving "them" money). OTOH, "our" oil companies will be making the money (so you'd have to be a worker/shareholder to benefit), with some coming to "us" via the nicely-corrupted royalty division of Dept. Interior. You should start feeling richer soon :)
I wonder how much it will cost us (lost efficiency or royalties) if exploration/production contracts are limited to US companies...
Posted by: David Zetland at Sep 25, 2008 9:55:48 AM
Spencer, it is the sum of consumer and producer surplus, resulting from the increase in quantity, which matters. Furthermore I am suggesting that I don't know how large that sum is. MR readers, beware the confident and insulting commentators: don't be taken in by their bluster.
Posted by: Tyler Cowen at Sep 25, 2008 10:23:21 AM
Even if we drill, drill, drill, the best we can hope for is that the rate of decline in US oil production will moderate. Estimates that new sources of domestic oil can more than offset the continued drop in output from existing wells have no basis in reality.
Posted by: spencer at Sep 25, 2008 10:26:24 AM
You only become marginally wealthier (because of time value purposes) when a zero coupon, non-transferable bond matures, when you hit 65 and can pull out your 401k and you don' become wealthier when you start receiving pension payments that were due to you. All of these things were part of your net worth before the even when you could access them as well as after them.
Posted by: Mo at Sep 25, 2008 11:37:24 AM
Ok, we will play the game your way. A drop in price causes an increase in consumer surplus and a drop in the producer surplus. Unless you have exact data on the slope of the relevant curves there is no way to estimate the size of the increase in the consumer surplus and the drop in the producer surplus. So you have no idea what the change in the total surplus is.
Second, wealth is ownership of an asset. It has no relationship to consumer and/or producer surplus and a change in consumer/producer surplus has no impact on wealth. Owning oil in the ground is wealth and a drop in the price of oil causes a drop in this wealth. What gain in wealth more than offset the loss of wealth by the owners of oil in the ground?
I stick with my original point that the drop in the price of oil did not generate a big gain in wealth.
Posted by: spencer at Sep 25, 2008 11:42:54 AM
There are two posts on the Environmental Economics blog that reference a paper measuring the net benefits of ANWR drilling:
http://www.env-econ.net/2008/09/drill-baby-dril.html
http://www.env-econ.net/2008/09/an-end-to-the-o.html
These papers measure large net benefits. However, they make an important assumption: they explicitly ignore the effects of new American oil on climate change. A quote from one of the papers: "if demand is not met with ANWR oil, it will be met with oil from somewhere else. For this reason we do not consider increased emissions from the oil in ANWR to be an environmental impact of opening the area to development." Thus, it is saying that it can ignore certain costs of oil because total quantity of oil produced will not change whether or not we drill in America. Of course, this also implies that there is no efficiency loss from not drilling. So take the estimates with a grain of salt.
Posted by: brian at Sep 25, 2008 12:11:59 PM
10 billion barrels of oil
At $100/bl, that is *gross* revenues of $1 trillion.
30 billion barrels of oil that is $3 trillion. 30 billion is the absolute high side of any calculation of theextracitlbe reserves from US offshore and ANWR. It's as large a discovery as has been made in the world since the 1970s-- similar size to the new Brasilian discovery, if that plays out. (it's also about 3.5 years of US consumption or 15 months of world consumption).
Now that assumes your margin is $100/bl ie gross revenue. I think a lifting cost deep offshore of at least $30 is justified (probably higher)-- that would be consistent with the North Sea.
So $700bn-$2.1trn. Of course that is undiscounted, whereas a financial loss now is fully discounted. Over 50 years or production say, the Present Value will be lower *if* your realised price grows at a lower speed than your discount rate.
Note that the oil industry uses a range of $45-65/bl for long term planning.
Your lifting cost is likely to grow at least in line with the oil price: that has been the experience of the olil industry to date.
IN addition, your net gain of Present Value is the PV of extracting the oil now MINUS the PV of extracting the oil in the future. So if you think the price of oil will rise faster than your discount rate, you are justified in waiting to extract.
And we haven't included anything for the shadow cost of extracting oil arising from the pollution emitted during the burning of that oil.
Nor have we included anything for environmental costs of habitats destroyed in perpetuity (which would be the case in ANWE even if we assume marine ecosystems in southern waters do recover.
$5-10 trillion? I doubt the actual value is more than $1 trillion.
Where are we getting 5-10 trillion?
Posted by: Valuethinker at Sep 25, 2008 1:21:18 PM
30 bn barrels would be just over 4 years of current US consumption (mea culpa).
Posted by: Valuethinker at Sep 25, 2008 1:26:04 PM
I like that McCain has made it a priority to embrace more offshore drilling.
At the risk of sounding obnoxiously pedestrian, our government is full of some very very stupid people.
Can you tell me how to get- how to get to....
Posted by: Big Bird at Sep 25, 2008 1:56:37 PM
OK, I seem to remember a bunch of posts on this blog indicating that the price run-up in oil from January to July was based on fundamentals, while a few of the commentors like myself insisted that speculation and a price "bubble" was largely to blame.
I think the bubble crowd won this argument in commanding fashion when prices crashed from just shy of 150 down to 90 in a little more than a month. . .
Posted by: Matthew C. at Sep 25, 2008 2:04:20 PM
I was the one who asked the original question.
For the 5-10 trillion dollar number I was (incorrectly, I suppose now) using a figure that I had read of 90 billion barrels offshore. That number is probably highly politicized. If the latest estimates are really 20-30 billion barrels, then of course the number goes way down.
Of course, since we haven't actually *explored* the local offshore areas much for the last few decades, the number of recoverable barrels may be significantly higher.
What I didn't realize is that it looks like bans on oil shale exploration and development are also going to expire. That's very hard to recover oil--recovery at all is speculative--but it's supposedly 800 billion to 2 trillion barrels. That's a lot of potential wealth.
Posted by: Andrew Berman at Sep 25, 2008 2:33:20 PM
In real rather than nominal terms? Surely the purchase of Alaska or the Louisiana Purchase would trump this. Or perhaps when California and other territories were wrested from Mexico.
Posted by: Mr. Market at Sep 26, 2008 7:53:37 AM
Andrew Berman
Re oil shale: or not.
Revenue NOT EQUAL to Profits
Profits = Revenues MINUS costs
You have to make a (heroic) assumption re extraction costs.
Note that Alberta Tar Sands (which are oil) have an extraction cost for new projects of north of $60/bl (as low as $15 for old projects)-- shortages of both water and natural gas loom, besides soaring capital costs (and less attractive deposits).
By contrast 'oil shale' is neither shale nor it is oil. It is a kerogen in rock. We don't even know how to extract it economically, yet.
Posted by: Valuethinker at Sep 26, 2008 4:36:42 PM
Andrew Berman
By a sleight of rhetorical hand you convert '30 billion' into 'maybe 90 billion'.
How about '30 billion, uncertain' could be '10 billion'?
There is no particular reason to think that there is 90 bn barrels of oil, undiscovered, off the US coasts. You've just thrown that number in, because it *might* (depending on your assumptions of lift cost per barrel)justify a dubious $5-10 trillion assumption?
And if there is, the world is saved... NOT. less than 4 years of global consumption.
Posted by: Valuethinker at Sep 26, 2008 4:39:08 PM
Well, Valuethinker, at least you didn't call me a Chucklehead. I really hate when people do that.
I'd appreciate it if you re-read my last post-- the one with the '(incorrrectly, I suppose now)' and the 'if the latest estimates are really 20-30 billion,' you'll see I was trying to be honest and not engaging in 'sleight of hand.'
And thank you for letting me know that revenues != profits. Now if I can only find the place where I claimed all of the money was 'profit,' I will fix it.
Posted by: Andrew Berman at Sep 26, 2008 5:19:59 PM
Pardon a layman here, but a couple of statements poked me in the eye>
" . . .the recent decline in the price of oil, *which on average you can expect to be permanent*."
So should I expect, any day now and ongoing: a decline in in demand for energy, increases in oil production (at a fixed present cost), and an increased presence in the marketplace of cost-superior energy alternatives (don't forget infrastructure establishment costs)?
Those, or a Die-Off, are the only possible routes to a "permanent" decline in the price of oil.
"...the bubble crowd won this argument in commanding fashion when prices crashed from just shy of 150 down to 90 in a little more than a month. . ."
So the future is known? Maybe the 'speculators' were saying something, and our penchant for ascribing a truly scary event to 'speculation' just means we didn't hear it.
I don't think I'm crazy for thinking the following: An inability to return to a "cheap energy" paradigm, or rapidly adapting to a new "2-3X prior cost" energy paradigm means we wmay soon be spectators to the four horsemen.
Posted by: Pete Guder at Sep 30, 2008 12:08:07 AM
