Monday, April 9, 2012

The Price of Oil (pre-2011 gfc....)


Table of Content
1)                  Executive Summary

2)                  Introduction - 2-degrees of separation; Oil price and Technical Development.

3)                  How oil weighs down the project budget.

4)                  Recovering the oil laden budget and getting the projects back on track.

5)                  Should the Government Intervene with Policy Reform? TOC \h \z \t "Title,1,Subtitle,2"

 
The purpose of this report is to illustrate that Oil is an integrated component to any industry economics. Including the progression of Technology Development.
The paper will illustrate that there is an interesting balancing act, with technology development going with the oil markets, and going against. It will show that even though an idea costs nothing. Implementing it to a point of operation can be found not viable purely on the oil price alone. The paper will show the ironic truth that sometimes the oil price itself can limit technology development in oil production, thus keeping the costs of oil production and supply locked down.

 The first part of the report deals with the introduction of how technology development can be hampered by increasing Oil costs. It will raise question as to why we are building technologies around oil pricing and if we need to ‘re-invent the wheel’ to progress in any leaps and bounds.
The report will then question why we need oil based economic structures – and what type of structures they are. It will question if these structures are actually hindered by other aspects – and raise the question: Is Oil the problem or the solution?
The report will then conclude as to how technology development can move forward? Running parallel paths of decision making. Some embracing the use of oil pricing, others trying to adjust it.



Introduction
2-degrees of separation; Oil price and Technical Development

With knowledge walking around in peoples brains, it would be quite a surprise to see the price of that knowledge being directly affected by the price of oil.  But in today’s complicated entangled economy, a butterfly effect now occurs with the oil industry – resounding through out all other economies. Oil is now integrated into all facets of society, it is a common as water, and is traded at the same level as money itself.
Industry required oil to operate, and even if they people can survive without it – they are directly affected by changes in oil price on industry. The only way to avoid this would be a life of isolation.
So how does oil price affect Technical Development? Well apart from the obvious Logistics, Suppliers (and their associate increased costs) and product development.
The other side to this however is the not so obvious market fluctuations according to oil price. From human resource management to location.
Many new technologies being developed are based oil and its value over the years. Some technologies have been developed to try and alleviate the pressure of oil pricing on consumers, others have used the increases in oil to fund new technology ventures into the oil production industry. Then there are some technologies that have been developed to remove the human need for oil product – in a complete substitution strategy.
All of these will be discussed in the remainder of the report. 


How oil weighs down the project budget
If you were to assume the market was elastic (an inelastic market is discussed later). And we simply a simple demand supply chart for the price of oil. We can see how this price not only correlates with technology development, it is influenced by it.

Shift of supply (more expensive)
Technology could cause a shift in supply. In this situation it is the lack of Technology Development which has caused the problems. Due to a lack of technology development – oil production facilities are not able to obtain and maintain consistent oil production. This could be due to consuming all the easy to get to reserves, and having to try and drill reserves that have extra complications. Or is could be due to environment reforms forcing the oil companies to operate in cleaner ways using technology systems that may not be fully developed. Both way productions will decrease, and the costs associated with production will increase as Technology Development will require investment to progress production. These costs are then passed back down Technology Development as they will have oil based expenses (fuel, plastics, energy generation).
This leaves an increase in price due to increase in costs of technology development, but this also drags down the price due to the increased efficiency of oil production with the new technologies developed. Eventually a balance is met.
Shift of Supply – Less Expensive
The opposite can then happen. If there is an effective level of funds placed into technology development. And a breakthrough is made. Production can suddenly be completely shifted forming a new supply line. This could be improved processing development, or even something that allows for deeper exploratory drilling.
Consumers will quite willingly increase their consumption at this lower price; this includes the firms whom deal with Technology Development. They will be reaping the benefits of their past successors and will be investing more into that space. They will hire new staff and upgrade their operations. This is turn will increase their consumption for more oil. 

Shift in Demand – More expensive pricing
Who says all Technology Development would be only for the benefit of Oil Production? The fact of the matter is that Technology has always been based around improving people's lives – that includes improving their lives by consuming more. Or by making it more accessible to those whom wish to consume
This is the most common shift of recent times. As technology filters more and more down to the consumer marketplace. Phones, computers, cars……all requiring energy sources.  (Mankiw, 2009, p98)
Is Oil rare yet? Or are we still willing to pay?
Mankiw rose the point "Why the cow is not extinct" (Mankiw, 2009, p236). Questioning why cows are not extinct yet and yet elephants face this fate. The same could be applied to oil – Are we facing an oil crisis? Will we run out?
The fact that oil price is not only compared to budget, but it is measured against the concept that it is a finite resource. This makes the pricing seem inelastic, as it will only increase in price as less and less in quantity. And since it is now considered and essential energy fuel, it is now considered life essential. But the fact of the matter is that we will never run out of other energy forms such as hydro-electric generation, or solar generation. These are renewable resources, the same as the cow. Technology Development happens in these areas also. So it raises the question, if we already work in this space with technology development, why haven't we benefited of a substitution situation yet?
Well oil is not yet expensive enough to be considered inelastic yet. Technology Development has made better use of oil, with improved efficiencies. It is only demand on Technology Development which has forced the Oil price back into consideration. People want the latest technology – this costs in extra consumption of oil.



Recovering the oil laden budget and getting the projects back on track
Keeping the cost in Oil low in Technology Development is actually quite simple. We treat the Oil market as a typical elastic market.
No one (with the exception of the oil companies) actually enjoys increased oil pricing. However we tolerate certain amounts. It is this toleration that creates flexibility in the market sale price. OPEC learnt that this meant the market was quite dynamic over time in the 1970's (Mankiw, 2009, p105). When they increased the price slowly over time. Initially the market did not move. OPEC enjoyed increasing profits and steady sales. However as the price increased large amounts demand decrease, with those profits decreased even though they were selling Oil at a higher price. Technology Development was focused more on increasing efficiency in oil consumption rather than oil production. By the time the 90's had arrived, OPEC had realized that a long run strategy was required to maintain market value.
Therefore for Technology Development Projects, costs must be monitored as always – but for projects that involve a direct relationship with Oil price, caution would be aired at this point with fluctuating prices. It should be expected that the project also will fluctuate with pricing. In some situation – these price fluctuations can be dampened down with the following techniques:
            - Developing broader technologies that can be used with any energy source
            - Developing technologies that consume less energy
            - Developing technologies that generate their own energy or have their own sources
            - Integrate closer (physical distance) relationships with suppliers and workforce
            - Promote and reward innovations that eliminate wastage and decrease energy     consumption
            - Develop substitutes for Oil, or Oil base energy sources more than making them more efficient.
These simply decrease the demand (along the supply curve), and (in the case of substitution) change the supply curve.
The key thing is to either change consumer demand for Oil by developing newer Technologies, or to make them not demand Oil at all with Developed Parallel Technologies.



Should the Government Intervene with Policy Reform?
Government Intervention never really affects economies in a long run scenario. Therefore Government strategies can only be considered short run strategies.
A large section of Petrol pricing is government taxes. So by decreasing (or removing) this tax would decrease the price for the consumer. But this only really temporarily solves something as either';
a) Demand would increase, to the point where there was a shortage at which case the price would go up anyway or
b) OPEC would realize they can then add more profit to their product and the price would go up.
OPEC themselves are a monopoly. So they have to be careful they create short run supply curves that satisfy demand making them maximum profit. But long run supply curves that don't force customers onto substitute developed technology.
Another strategy that Governments tried in the 70's was Carless days. Where you could not drive on certain days of the year. While this would have worked fine in the 1930's or 40's. By the 1970's cars were not only a common place, they were a necessity. This did no curb demand, and was finally removed when technologies were developed to improve fuel efficiencies. Putting confidence in the government to allow citizens to drive, as they would save fuel whether they wanted to or not. 
Recently another government venture has been compulsory Emissions trading schemes. Once again this will not work as they have not generated the demand for the decrease in emissions. They have simply created a tax which is considered a dead administration cost and will simply shift the demand equilibrium down the supply curve.
Mankiw talks about the deadweight of taxation and how there is a benefit of welfare (Mankiw, 2009, p163). In most ETS schemes this would involve some form of payment into Technology Development to combat emissions. However this is not the case – and the money simply bounces around a "market". Likewise he talks about the drivers of Fuel tax (Mankiw, 2009, p211) and how it is in place of Congestion, Accidents and Pollution. Developing better technologies directly improves all these parameters. But often these funds never make it to firms who Develop Technology – with most government contracts going to tried and tested "old" methods. Thus the tax does not really solve anything.

So corrective taxing (Mankiw, 2009, p214) does not really assist the price of oil, as it does not make it into the hands of firms who develop new technologies to combat it. Likewise Pollution permits (such as the ETS) also don't seem to develop new technologies to decrease pollution. So government control in this space doesn't seem to change oil price in the long run.
So it could be assumed as stated earlier that government measures in this space are only short term solutions.


Reference
Mankiw, G,W,. (2009). Principles of Microeconomics.
5th
Ed. Cengage Learning, OH
www.farrst.blogspot.com