Monday, August 13, 2007


I've thought a lot about energy use, begun some preliminary research on it, and come to the following conclusion: Energy Sustainability is not a very serious issue. There is sufficient oil resources embedded in the clays of Northern Alberta to keep our SUVs runnig for several decades at current rates of usage growth. Higher prices tend to make the profit margins on very cheaply-extracted sources of oil (like simply poking a hole in the Saudi desert) much higher than they had been, but it also pulls more expensively-extracted sources into the market. Paradoxically, the same scarcity that leads to the higher market price and discourages consumption to allocate oil more efficiently in the short run also helps resolve the scarcity issue by encouraging firms to exploit new reserves in the long run. Energy Affordability and Price Stability are much more salient to how we approch our energy policy.

Classical theories in economics, which focus on competitive markets, have found three trends for primary commodities such as oil: (1) stable prices; (2) a gradual, secular decline in the price, following the "Prebisch Thesis" (see, for example, Grilli and Yang, World Bank Economic Review, 1988), and; (3) little or no cross-sectional variation in prices. Empirically, many of these theoretical predictions described oil and energy markets quite well until about 1973, but none since. Many of these discrepancies have been explained in part by market structure (violations to the assumption of perfectly competitive markets) but more meaningful explanations of the current price volatility have focused on the lack of political stability in Middle East, where most of the most cheaply-extracted oil can be found.

The following article appeared Wednesday (Aug. 8, 2007) in the New York Times: Energy Has a Tough Act to Follow: Itself. It briefly addressess this issue of political stability, which has consequences for price levels and their stability. Remember what I mentioned before about higher prices? Well, I hate to bear bad news, but if reliance on oil from politically volatile countries is the problem, then low prices cannot be found in anywhere in the solution. When prices are low our own production of oil, as well as the diversity in the sources from which we import oil, are the also the lowest because these sources of oil cannot be profitably tapped. According to the times article: ''Over the long run, a premium will be paid for these assets (the Canadian Oil Sands Trust) because they are in a politically stable area,'' said Evan Smith, a co-manager of U.S. Global Investors Global Resources.

If we want to have reliable, stable sources of oil, we'll have to pay the price, and it appears as if we already do: "Gravity" models of international trade predict that the more homogeneous the product, the more likely it will be that countries import a particular prodcut from geographically convenient sources, and the less likely it will be that producers will bear the shipping costs of sending their supplies to geographically extended markets. An initial look at the data shows that much of the oil produced in Mexico, Venezuela, and even Alaska are going to places like South and East Asia.

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