DON'T CALL ME STUPID!
Craig A. Bond
Associate Professor
Department of Agricultural and Resource Economics
Colorado State University
English Tags: nonrenewable resources, finance, oil, rent-seeking
So what determines the price of oil? In class this week, we learned that the physical constraint on the extraction of non-renewable resources causes a divergence between the marginal benefit and marginal cost of extraction, known as marginal rent, which must rise at the rate of discount in order to be intertemporally efficient. Even if marginal costs were constant, the slope of the demand curve would determine how quickly prices would ultimately rise But in any case, so long as there is real economic scarcity, the price of oil will be greater than marginal costs.
Of course, since we don’t know future prices with certainty, any individual or firm looking to extract must forecast the future and behave accordingly. How might these agents forecast future prices? Any number of ways: Flip a coin, draw random numbers, assume last period’s price, etc. But of course, better decisions can be made with better information.
Where might we get that information? Well what we really need is an unbiased expectation of the future price of the actual asset. Wherefrom might this be found? Why, a futures market of course!
Not all futures markets function perfectly, but in many cases, they provide excellent, market-disciplined information on future prices, especially in global commodity markets with many players. So, in essence, the former Congressman seems to want to restrict information and at the very least distort, and at most ban, the futures market in order to regulate the oil market. Perhaps he really is that ignorant of the role of price signals in the economy. Or perhaps he thinks the voters are?
*Professor Craig Bond is an up-and-coming resource economist from the United States, currently visiting the University of Stavanger Business School for the main purpose of teaching natural resource economics to the master students in the course MØA350: Environmental and Resource Economics. His academic webpage can be accessed here.
Here (https://www.gtap.agecon.purdue.edu/resources/download/5675.pdf) is a paper that does a great job at attempting to disentangle the effects of so-called macroeconomic shocks versus financial shocks on oil prices. Loosely speaking, what is referred to as macroeconomic shocks are related to real economic phenomena (demand and supply factors), whereas financial shocks are related to demand and supply for financial instruments, hereunder speculation in oil futures. The paper finds evidence of both types of influences on oil prices, as well as interaction effects. Over the analysis horizon, the macroeconomic fundamentals are found to be most important in explaining price movements, with financial shocks playing a larger role in recent years.
SvarSlettBe that as it may, the detection of presence of the latter effects does NOT in and by itself constitute a rationale for a government intervention in (oil) financial markets as suggested by Kennedy in the NYT op-ed. First, an argument must be presented that this undermines the overall efficiency of market outcomes. Second, anytime the government seeks to intervene in markets, to correct what economists classify as market failure (externality, public goods, information asymmetry), one should be aware of the high changes of unintended consequences. In other words, it is not in society’s interest to replace a market failure with a, potentially, worse government failure (associated with greater efficiency/welfare loss). In any public policy action, this is always a real possibility.