In that "free market" the price of oil would be the cost of production plus a return on investment and as the price rose and fell more or less marginally profitable oil would come in and out of production. For as long as there existed sufficient reserves of oil to satisfy world demand that process would balance the supply to the price.
In a free market with zero barriers to entry the theoretical model would be that the price would soon fall to not much above the cost of production.
But we don't have zero barriers to entry. In addition to all the environmental and other government restrictions, there is the simple fact that there is a limited supply of land that contains oil, and a limited supply of oil under that land. Those who don't own the land can't easily start producing oil. They might be able to buy some of the land with the oil rights (or perhaps just the oil rights), but some of it won't be for sale, and even if they do buy the oil rights, they won't be increasing the supply, just transferring ownership of the existing supply.
If oil could be manufactured from very common and cheap materials (say air or sea water) for the cost of pumping it from the ground, sure you would get fairly cheap oil, even if the required investment was as large as the current investment in oil wells and associated equipment, plus prospecting/discovery costs. But that simply isn't the case. We can manufacture oil, but not from air or seawater, and the cost to manufacture oil from coal, or from other sources of complex hydrocarbons is much higher than the cost to pump existing oil out of the ground (typically not just higher than production costs, but higher, even much higher, than current selling prices).
Now that having been said we don't have a real free market in oil. Once the oil is pumped and available for sale its pretty much a free market, but the supply put on the market is heavily influnced by political considerations and by OPEC's desire to maximize profits (which might not effect the oil price so much when its relatively high, but which helps keep it from getting lower at times when its relatively cheap).
But I think it's also erroneous to lay the blame for the high price on speculators. It's true that speculators are influencing the price but Bob's right in suggesting that they can't set either supply or demand. I think speculators are simply attempting to project price based on the artificial constraints of supply and the greed of OPEC and big oil producers.
I agree.
What's interesting about the current price rise is how inflexible demand seems to be in response to high prices.
It shouldn't be that much of a surprise. Many things we do with oil, aren't easy to massively change in the short run. Also for many people gasoline, or more generally refined oil products, only take up a relatively small percentage of their income even with today's high prices. If I wanted to save gas I could trade in my performance car for a economy car, but the amount I'd save at the pump would be much less than the amount I would have saved in car payments from buying the economy car instead. Obviously it was worth it to me to buy the economy car even with much larger car payments, so the smaller difference for gas costs isn't likely to make me change vehicles. OTOH people are starting to change at the margin, and in your example of $20/gal gas, you would get much more change. Again using examples from my own life, many of the people in my group at work telecommute. I have a short drive, and I haven't changed yet, but at $20/gal I would even with the short drive. |
