Sunday, November 30, 2008

The Economics of a Cartel

Nice little look into the mouth of the beast this morning. Crude oil is currently selling at around $55 a barrel, and we've heard some noise out of OPEC lately that they believe a "fair price" is around $80. What does this mean? Well, it means a price in which they can continue to extort undue influence over the world economy by cooperatively fixing prices.

I'm of a mixed mind on this subject, though. Reading that Canadian industry is slowing their oil shale extraction method because of the cheap price of crude reinforces for me the value of high prices in changing consumptive behavior. The only way we'll put these petro-thug terrorists out of business is to consume less and to find other ways to power our economy. I doubt whether the free market alone can deal adequately with a pricing and supply situation in which an entire world is dependent upon a diminishing single source of power.


b bauer said...

It's interesting that we are all for a market economy until we don't have any goods to sell.

The Conservative Wahoo said...

Who is "we are all"? I think if you read the post, it expresses doubt that the free market can deal with this.

Ace said...
This comment has been removed by the author.
Ace said...

I offer that cartel behavior is, by definition, anti-competitive and not conducive to the benefits of a free market. If the cartel was really interested in "fair price" discovery, they would disband and allow the market to set the price. It seems pretty clear their interest is in sustaining prices that promote the longest-term revenue generation for the current cartel membership.

To CW's point, the free market actually will take care of your concerns over the long-term. The "invisible hand" will move commodity allocation efforts as the supply line shifts "to the left" of the notional demand/supply chart. Imagine a chart that expresses the demand/supply "X" for sweet crude superimposed on a chart with the "X" for any other energy commodity. Right now, the center of the "X" for sweet crude is at a lower point on the Y axis than most others... the market price is much lower than the others. As supply decreases or demand rises, the center of the "X" rises on the Y axis... eventually the center of the crude X will rise above one or more of the others, and that is when the market responds and most likely the supply line of those alternatives will increase, i.e. shift to the right, and lower the price even further.

It is almost as though Adam Smith got it right, isn't it? :)

The Conservative Wahoo said...

Ace--gotta deviate from AS and the hidden hand here....the plain truth of the matter is that we have no idea WHAT the supply is, so any pricing mechanism is from the get-go specious. That said, because the entire world is so dependent on this one commodity of unknown supply, when it does become obvious that we've reached a crisis and demand may indeed prevail. But for now, if we increase demand back to pre-summer levels just because the price has dipped, we're continuing to screw ourselves and not changing necessary behaviors that can ultimately free us from our outright dependency on oil. I just don't see the free market solving this one.

Ace said...

CW, I love you like a brotha from anotha mutha, but those are some dangerous notions to entertain. The question of resource supply in this case is a question not of commodity quantity extant, but production quantity from proven reserves. Your point is true of the former, but not the latter. Applied more broadly across energy sectors, there is a virtually limitless quantity of energy supply from the various forms, but a constrained supply from industrial production methods.

This is why AS was, is and will continue to be right. The production capacity is a product of investment, risk and market reward. The supply will be dictated by the level of capital investment, the demand will be based on lowest market price, and the reward will be based on which investment produces a satisfactory level of supply to meet market demand.

If we overwhelm our concern with one form of energy simply because it is the current primary form, we miss the point of the larger market dynamic in investment and reward. If it turns out the Earth does not feature a soft center of tasty petro-nougat and natural reserves go dry, the investment curve will shift profits to those who take risks on other forms of production.

The time to be concerned is the day you see "Exxon Ice Cream" products at the convenience store.

In the meantime, the principe I observe is that old saw about innovation: "The Stone Age did not end for a lack of stones."

The same can be said of our energy concerns, and cartels only complicate the natural ebb and flow of market dynamics.

b bauer said...

article from WSJ over the weekend:

Anonymous said...

Coming soon to a UFC cage near you...CW vs Ace. In the red corner - CW fighting from the command heights. And in the blue corner, wearing invisible boxing gloves...Ace.

Gents, love the sparring. Props. the CW blog has arrived.

The Conservative Wahoo said...

Ace--I remain unconvinced. It is exactly BECAUSE there is no way to know what the supply is (proven or otherwise) that BEHAVIOR is so important here. Because of the relatively low state of technological advancement in the production of other kinds of energy and its transmission, there exists a very real potential for a "gap" as it were, in the time when western civilization comes to the realization that supply has become a problem and the maturation of the technologies necessary to mitigate the shortage. The market works perfectly fine now in energy, as long as everyone beleives that production from proven reserves is equal to supply, largely because there is a lot of whistling past the graveyard going on about how much "unproven" supply is out there. At some level of abstraction, AS and the hidden hand will handle this--but at what price? A completely decimated global system of trade and finance? A thoroughly contracted world economy? War and conflict over diminishing supplies of oil that would make a great Mad Max movie?

Ace said...

Well, CW, you certainly grasp the argument in favor of a command economy. The problem with command economies historically has been they tend to produce the opposite effect they intend over the long run by stifling innovation as they impede upon the risk and reward features of a free market economy. Sure the Soviet Union produced lots of high-tech hardware, but so much of it was mimicry... copying and stealing innovation invented in the west. That's part of the danger I see in your proposed solution. We might achieve short-term benefits from interrupting the market by fiat, but over the long run we'll suffer for it... either through loss of innovation across the board or to a marketplace competitor yet unseen who does not forsake the market forces of nature.

So, if we find ourselves at a classic command/market economy impasse, then we'd probably be better off seeking compromise rather than trying to persuade each other. After all, De gustibus non est disputandum, right?

So I'd suggest a compromise based on demonstrated historical success. Perhaps we could benefit from some sort of energy "Manhaatan Project" that attempts to leverage the best elements of a market economy with a momentary command method. If it couldn't provide us with a petroleum postmortem, then you could back down and let the market resume control.

Of course, in a way, we've attempted this by extension through federal subsidies of meager energy alternatives that yielded virtually nothing. However, if the government assumed control of the process it might help progress.

Of course, the cynic would point out just how much government control has recently "helped out" in programs like Social Security, Fannie and Freddie Mac, and the DMV, but I'd be willing to argue your side in this based on the successes we reached in the New Mexico desert in 1945.... notably the most recent revolution in energy production.

The Conservative Wahoo said...

Ace--you are a gentleman and a scholar. I definitely did not mean to imply that I wished to see a command economy instituted in energy (or anywhere else for that matter)--I did mean to imply "the hidden hand" wouldn't cut it. As you indicated, we hardly have a "free market" with a "hidden hand" in energy today. Tax credits for fuel efficient vehicles? Tax penalties for gas guzzlers? Tax incentives for exploration? When I say that I don't think we can "free market" our way out of the energy crunch, I mean generally to respond to those who would like to do NOTHING...claiming that to do more would interfere in a free market. These are of course, people who do not recognize the extent to which that market has deviated from "free".

No--I don't want to see soviet style commmand economics in energy. A Manhattan Project would be wonderful. Real tax incentives would help. Serious direct investment in promising technologies (like the CIA's In-Q-Tel I think it is called) is an idea. Lots of things well short of a command economy and neither the nose nor the camel--can be done to prod this market along.

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