The effect of opening up ANWR to drilling on the current price of oil
Coats, R. Morris and Pecquet, Gary M. (2008): The effect of opening up ANWR to drilling on the current price of oil. Unpublished.
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Abstract
The Effect of Opening up ANWR to Drilling on the Current Price of Oil
R. Morris Coats and Gary M. Pecquet
Abstract:
Everyone knows that oil discovered today, perhaps in the Alaskan National Wildlife Refuge (ANWR), has no effect on prices until that oil hits the market. For instance, on its website, the Democratic Policy Committee, (http://democrats.senate.gov/~dpc/pubs/107-1-72.html) states that “it will require seven to twelve years from approval before there is any oil production from the ANWR area. Therefore, production in ANWR will have no impact on current or short-term gasoline and oil supplies and prices.” While this is something that everyone seems to know, it is a case that the theory held by everyone just happens to be wrong. Since future prices are expected to be lower, future profits are also lower, so the value of oil not produced now, but held for future sales, is lower, making it more profitable to go ahead and produce and sell now instead of waiting for future profits. Using oil now reduces the amount of oil available for the future, which involves the opportunity cost of forgone future profits, which are sometime called the marginal user costs or scarcity rents. In this paper, we use simple two-period models to show that if an amount of newly discovered oil is significant enough to reduce prices in the future, any drop in future prices reduces the future profitability of oil, reducing the marginal user costs of oil now. That reduction in the marginal user costs reduces the current price of oil just as if there were a reduction in the marginal costs of extracting oil now. We explore the effects of the reduction in marginal user costs in the competitive or price-taker case as well as the price-searcher case, where a monopolist or dominant supplier responds to a substantial discovery by another seller, but where the discovery will not contribute to production for some years to come. In both cases, we find that oil that is expected to reach the market at some time in the future has an immediate impact on oil prices.
Topic Area: Q4 Energy
Item Type: MPRA Paper
Language: English
Keywords: ANWR; resource discovery; timing of price impact; speculation
Subjects: Q - Agricultural and Natural Resource Economics; Environmental and Ecological Economics > Q4 - Energy > Q41 - Demand and Supply
ID Code: 9543
Deposited By: Professor R. Morris Coats
Deposited On: 12. Jul 2008 15:44
Last Modified: 12. Jul 2008 15:44
References: 4. References Conrad, Jon M. and Koji Kotani (2005). When to drill? Trigger prices for the Arctic National Wildlife Refuge, Resource and Energy Economics 27:273-86.
Dasgupta, Partha and Geoffrey Heal (1974). The Optimal Depletion of Exhaustible Resources, “Symposium on the Economics of Exhaustible Resources,” Review of Economic Studies, 41:3-28.
Democratic Policy Committee (2006). Drilling in ANWR: An Empty Promise for U.S. Energy Policy, downloaded (October 29, 2006) from URL: democrats.senate.gov.
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3. Conclusions
Whether the market is monopolized by a single producer, dominated by one producer
with another producer who acts as a price taker, or is competitive, increases in future output
capabilities because of current discoveries will lead to lower prices in the future and so, a lower
opportunity cost of using those resources in the present. ANWR production is likely to be small
relative to world production, and we doubt that ANWR production, by itself, would do much to
reduce current prices. On the other hand, if oil firms were allowed to drill in ANWR and many
of the other areas that are currently off limits to oil production, it is possible that these areas
together might have a significant impact on world oil prices.1 We must also recognize that
because of the extreme inelasticity of oil demand, small percentage increases in output lead to
much larger percentage decreases in prices. While we are not advocating the current use of
ANWR or off-shore areas currently off limits, neither are we advocating keeping ANWR and
1 To the extent that opening ANWR to development signals a shift in U.S. energy policy, making it appear more
likely that other off-limit areas would also be developed, the impact of opening ANWR might then be enough to
have an impact on future and current prices.
other areas untouched and unused forever. Instead, we only hope to make clear the implications
of opening such areas to energy development.
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