The Corner

Oil Prices and Market Failure

Here’s the always-interesting (but not always right) Anatole Kaletsky on the oil price. I don’t agree with everything he suggests (I’d be considerably less gung ho about boosting oil taxes (already very high in many nations) than he is, and the thrust of any government regulation should, for the most part, be to encourage rather than to prohibit) but some of the points he makes are at least worth pondering:

But the market is not always right. It is usually right, but sometimes it is spectacularly wrong – as in the recent sub-prime saga. To acknowledge that governments must sometimes correct market failures is not to reject the economic lessons of the 1980s but rather to apply a proper understanding of economics. There are three main reasons why the market cannot be trusted in the case of oil. First, there is the enormous gap between the cost of producing oil in areas where it is abundant and the cost of producing any close substitutes for this oil. Easily accessible oil in places such as Saudi Arabia, Venezuela and Nigeria costs only a few dollars a barrel to pump once an oilfield is producing. Even including exploration expenses, the total cost of production of Opec oil is well below $10 a barrel. However, the cost of any substitute runs to $50 or $60 a barrel, whether the Opec oil is replaced by oil from more hostile environments, such as deep-sea drilling in the Arctic, or by some other energy source such as nuclear or wind power. The gap between cheap Opec oil and any other energy source creates an enormous “rent”, beyond any normal return on capital and costs of production, which either accrues to Opec as profits or to consumers as the benefit they enjoy from an energy source cheaper than any alternative in their own economies. This rent, currently running at around $2 trillion annually, is at the heart of the perennial struggle between oil-producing and consuming governments.

Read the whole thing.


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