Category Archives: Energy

… Oil

Having now written four articles on oil, its price, and the consequences that has for everyday uses of oil, such as gasoline and airfare, I have decided to turn these into a series of posts I am calling the Economics of Oil.

Fill Up at the PumpPart 1:

The Economics of Gas Prices

 

 

Oil PumpPart 2:

The Economics of International Oil Price Conspiracies

 

 

airplanePart 3:

The Economics of Airfare

 

 

Bitcoin MiningPart 4: 

The Economics of Bitcoing Mining*

 

 

As always, comments are welcome and encouraged, even if you disagree with me on any point.

*And yes, you will see just how much similarity Bitcoin mining has to oil

Advertisements

… International Oil Price Conspiracies

Last September I posted an article on gas prices (to which someone had a very thoughtful Reddit response), why prices were falling, and how to account for price discrepancies within the United States. Since then, the international price of oil has kept falling and falling. Earlier this week the price even punctured the $50 a barrel mark.

Crude Prices

This precipitous fall in the price of oil has caused conspiracy theorist to claim that the United States is secretly engineering markets to put pressure on our international enemies such as Venezuela, Russia, and Iran. Do I think that the United States is doing this? Yes, absolutely. But do I think this is a conspiracy? Hardly.

Exhibit A is the recent appointment of Department of the Treasury Under Secretary for Terrorism and Financial Intelligence, David S. Cohen, to the Number Two spot at the CIA (Deputy Director). The White House is not hiding anything about this guy. They say he administered anti-terrorism funding programs, particularly against ISIS, as well as sanctions against Iran and now Russia. Economic espionage is official government policy, and it does not seem to me that they are trying to hide that at all from anyone.

Oil producing countries, particularly the members of OPEC, have been using the price and quantity of oil as a foreign policy tool for decades. Exhibits B & C, the 1967 & 1973 Oil Embargoes, where Arab countries used their leverage in the energy market to place political pressure on the United States. The United States, too, has used oil as a political tool in the past. Many historians claim that Pearl Harbor was the result of Japan’s hand being forced by an Allied embargo on oil reaching Japan.

To return to the economic, not political, side of things, the market for oil is an oligopoly. There are a few large suppliers, and there are significant barriers to entry (primarily being that certain countries simply do not have the natural resource underneath them in the ground). More specifically, the market for oil resembles a Dominant Firm Oligopoly, with Saudi Arabia being the dominant firm. As the world’s largest producer of oil (13% of world production), it commands a great deal of pricing power – power that smaller “firms,” such as Venezuela, Ecuador, Nigeria, Iraq, Iran, Libya, and Qatar cannot match. So theoretically, Saudi Arabia could sell its oil at a lower price, and the other countries would have to lower their posted price, or else their clients would turn to Saudi Arabia, which has plenty of oil to supply if it wants to.

And that is exactly what Saudi Arabia is accused of doing, through an arrangement made with the United States (many people point to a meeting Secretary of State John Kerry had in Saudi Arabia back in September). The conspiracy theorists claim that Saudi Arabia is selling its oil at a lower-than-market rate by keeping productions levels too high relative to international demand in order to drive down the price of oil internationally, in an effort to put pressure on the governments of Iran, Syria, Russia, and Venezuela. These countries all conveniently happen to be enemies of the United States and Saudi Arabia, and they are all also conveniently highly-dependent on oil prices for government revenue and social pacification.

Saudi Arabia, from a purely economic point of view, has an incentive to cut production, which would send prices higher. Higher prices mean higher profits, which is better for their economy. Other oil producing nations feel the same way. However, the stars may have aligned this time for the US and Saudi Arabia to strike a deal and keep prices down. The US gets the assist of pressure on its enemies; and not just Russian and Iran. At the meeting between Kerry and the Saudis in September, the Saudis agreed to join the US coalition against the Islamic State. Saudi Arabia, on the other hand, may have bought itself support in its fight against the Assad regime in Syria, and the low prices will put pressure on producers in the United States and Canada, where it costs a lot more money to get the stuff out of the ground than it does in Saudi Arabia. Everyone at the table (a table set for two) gives a little and takes a little.

So do I think that the United States and Saudi Arabia are at least in part engineering the fall in oil prices for their own political motives? Yes, absolutely. But do I think that this is a conspiracy? Absolutely not. This is just business as usual for the United States, where an economist is going to be our Number Two Spy.

This is part three of a four-part series of posts on the Economics of Oil. Other posts:

The Economics of Gas Prices

The Economics of Airfare

The Economics of Bitcoin Mining

… the Inter-Oceanic Canal

Ometepe Island, in Lake Nicaragua

Ometepe Island, in Lake Nicaragua

Today marks the day that Nicaragua and her Chinese backers are breaking ground on the grand inter-oceanic canal that in five years will bisect the Central American isthmus and allow super-tankers too large for the Panama Canal to make the Pacific-Atlantic journey with ease.

Except it is never going to happen.

The history of Nicaragua is basically the history of failed canal attempts, and the foreign manipulation and betrayal, as well as the domestic anguish and languish that this brings. This is no less than the 72nd official proposal for a Nicaraguan canal. This won’t even be the first time that construction has begun. The first plans for a canal across Nicaragua were hatched by the conquistadors way back in the 1500’s, and Cornelius Vanderbilt nearly secured the financing he needed to construct the canal before the Civil War scuttled his attempts. But he did manage to incite a war and build a railroad through Nicaragua in the meantime.

Anyone who looks at a map of Central America may be puzzled by the proposal for a canal through Nicaragua. Costa Rica and Panama are far less wide. Nicaragua is the largest country, by area, in Central America. However, Nicaragua also has the largest lake in the region, Lake Nicaragua. At its closest, it is only 17 km from the Pacific Ocean. And Lake Nicaragua drains all the way to to the Caribbean Sea by way of the Rio San Juan (San Juan, or Saint John River). The vast majority of Nicaragua is an Atlantic, not a Pacific watershed. The Rio San Juan is rocky, shallow, and fraught with rapids at spots, but that has not stopped pirates from sneaking all the way up the river, as well as steam ships from being towed up the river. It is the most logical path for a successful canal through Central America.

As treacherous as the terrain of the river, the geopolitics of the river are far more rocky. The Rio San Juan is the border between Nicaragua and Costa Rica. However, it is the only riparian border in the world that is wholly owned by one country – in this case Nicaragua. And that has created endless problems and disputes with Costa Rica. So many, in fact, that the proposed route of the canal is completely bypassing the river and being cut straight through the interior of Nicaragua (and even so Costa Rica still has watershed issues that they claim Nicaragua is not responding to, in regards to the canal).

I don’t see why this time around should be any different from the 71 other attempts.

The main, insurmountable obstacle this time is the estimated price of the canal. Panama started with a good ‘ole American-made canal. Let’s say a Ford. And they have made a series of upgrades through the years. Let’s say right now they have a nice BMW model. To compete with Panama, Nicaragua is trying to acquire a Buggati. A $50 billion Bugatti, super-wide, super-deep, complete with access roads and highways, two deep-water ports, an airport, electric generation, pipelines, free-trade zones, a railroad, and a number of other necessary supply and infrastructure projects! They estimate it will take 50,000 workers and only take five years to complete.

So how is Nicaragua going to secure investors willing to provide nearly 4.5x its annual GDP ($11.26 billion, 2013 estimate, according to the World Bank)? I’ve put together a small list of possible backers and will go through my thoughts on each:

  • China
  • Nordic Sovereign Wealth Funds
  • Middle Eastern Sovereign Wealth Funds
  • Malaysian Sovereign Wealth Fund
  • Big Banks, the Backers of the Many Engineering Marvels of the Past
  • Venezuela and ALBA

China

If you ask a Nicaraguan where the money is going to come from they always say “China.” I don’t think so. Sure, the main investor at this point is a Chinese telecom mogul. And he is a multi-billionaire. But no one in the world has $50 billion to throw around, and our man in China is quick to point out that he has absolutely no backing from the Chinese government with regards to the canal. No one believes him, but it makes it very unlikely that he can muster $50 billion from his own domestic sources. Besides, between 2010 and 2012 China invested $101 billion, in total, in the entire continent of Africa (source: Business Insider). To think that they would even put half of that into one small country is irrational.

Nordic Sovereign Wealth Funds

I’ll make this one easy. Nordic countries, primarily Norway, have a lot of oil money that they are saving. But they are not going to invest it in Nicaragua. These countries have already pulled back on diplomatic channels and foreign aid to Nicaragua because of transparency concerns. They’re not going to pull a 180 and start pumping billions into a project fraught with questions and uncertainty.

Malaysian Sovereign Wealth Fund

Same story as Norway. They’re saving their oil money, and they’re not going to give it to Nicaragua. Unfortunately, this year, Malaysian Airlines, owned partially by the fund, had a rough one, losing two 777’s in their tragic entirety. The fund had to bail out the airline.  The price of oil is tumbling, which is probably helping to prop up Malaysian Airlines, on the one hand, but it is stunting the funds cash flow, on the other hand. I doubt they will be announcing a non-stop to Managua from KL anytime soon.

Middle East Sovereign Wealth Funds

And that leaves the Arabs. This is where I see the miracle coming from, if it comes from anywhere. Everyone knows that the Arabs have lots of oil wealth. And they’re known for the audacious. For one, Dubai. For seconds, it was the Arabs who bailed out some of the banks and hedge funds in the early days of the Sub-Prime Mortgage Crisis, long before Lehman Brothers became all too well known. So maybe, just maybe, a jet-setting Chinese man and Ortega’s outdated mustache can convince the right mix of petrocrats to throw in a good chunk of the $50 billion and really get the show on the road.

The Big Banks

No way Josue. Big banks in America, Europe, and elsewhere, are under immense pressure to demonstrate the viability of their investments. American regulators would pounce on any bankers working on this less-than transparent project, and European banks are already very bearish on shipping, since Northern European banks with shipping exposure were under extra scrutiny during the recently completed European banking stress tests, since global shipping has been very weak since the global recession.

Venezuela and ALBA

For years Hugo Chávez’s Venezuela was the standard-bearer for Latin-American Leftist opposition to America. When Chavez died last year his followers all started pounding their chest to become his heir. This included Correa in Ecuador, Ortega here in Nicaragua, Evo Morales in Bolivia, and of course Maduro in Venezuela. For years Venezuela, and its leftist sphere of influence, the Bolivarian Alliance of the Americas (ALBA in Spanish), have been financing cheap oil for member states as well as other social development projects. However, this all comes from Venezuelan stability and a steady stream of oil dollars into her state coffers. But with oil prices tumbling and Venezuela simmering in social unrest, it’s another no way Josue.

It is serenely ironic that the same trends, the rise of US oil and gas production, are giving rise to the need for an American super-canal, while at the same time driving the nail into the coffin of possible financing options, by driving down the price of oil.

The Sovereign Wealth Fund Institute has a nice map showing the size of sovereign wealth funds around the world. Click on the map for the link:

Red circles represent oil wealth, and blue circles represent other wealth (often mineral)

Red circles represent oil wealth, and blue circles represent other wealth (often mineral)

So it is never going to happen. But that does not mean I do not want it to happen. No one doubts that Nicaragua is starved for development. It is tied for being the second-poorest country in the Americas. Haiti takes the unfortunate crown, with Bolivia tied for second with Nicaragua.

The largest concern, after the obvious financing issues, is environmental. First and foremost, there is a 20-foot tide differential between the east and west coasts. And plans for the canal have not addressed this engineering obstacle yet. But furthermore, the canal will drive through protected wetlands, productive agricultural communities, and protected indigenous communities on the Caribbean coast. This is all not to mention that the route will go straight through and require the dredging of Lake Nicaragua, which is the largest source of freshwater in Central America. It is already an extremely fragile freshwater ecosystem due to agricultural and other pollutants streaming into the lake. Everyone from locals to parties interested in the fledgling tourism industry are in extreme opposition to the canal.

But lastly, I doubt that Nicaraguans will reap the benefits of the canal, which is how Ortega is selling the whole scheme to his people. The Chinese development corporation has a 50-year concession on profits, with another 50-year option to extend. Ortega is promising 250,000 jobs that will be born as a result of the canal, plus the need for 50,000 laborers on the construction. But of course I have my doubts. The canal will drive through some of the most sparsely populated and least developed departments of the country. Hundreds of thousands of people will have to relocate in order to realize those 250,000 jobs, which will lead to a lot of social strains on the country. Plus, given the under-education of the Nicaraguan people, the best-paying of the 50,000 construction jobs will mostly go to foreigners, not Nicaraguans. And I think it also bears mentioning that the highest HIV rates in Nicaragua are often in mobile populations, much like the worker camps will be. Has anyone put any thought into the epidemiological and public health effects of this project?

Nicaragua and the Chinese development company hired McKinsey to conduct a feasibility study. Officials refuse to release the results, but they are quick to point out the stellar economic projections. In 2013 GDP growth paced along at 4.6%. Official projections for the canal show that in the first year of construction GDP growth will skyrocket to above 14% and stay there for the foreseeable future. I just finished reading Confessions of an Economic Hitman. I hated the book. It was poorly written and not believable. But I can’t fail to mention that the author emphasized that the main tool of an economic hitman is inflated growth projections. It is guaranteed that the construction of a canal would attract a ton of foreign direct investment in Nicaragua, but sustained rates above 10% are preposterous and only part of the Chinese boondoggle to attract investment in the first place.

If the project ever truly gets off the drawing board (the groundbreaking today is ceremonial, nothing more) I will be in opposition. I fear that Nicaragua will bear many negative externalities while reaping few benefits.

… an International Climate Change Treaty

This post is apologetically months and months overdue, but I am glad that I am now completing it and posting it because I am passionate about this subject, and with all eyes on Lima now and Paris next year, it remains vitally important.

Back in October 2010 I wrote a writing sample for a job application called, “The Economics of International Climate Change.” I didn’t get the job, not even an interview, but ironically, I had to drive past the Company every day for my job at Ernst & Young in Tysons Corner that I did wind up taking. Given the attention on climate change in New York this week, I have resurrected the writing sample from the bowels of my external hard drive (an indispensable item for a Peace Corps Volunteer, I assure you) and re-tooled it here for this blog.

Western world leaders have placed great emphasis on climate change. Their contention: if the current accumulation of greenhouses gasses is not allayed then climate change is sure to wreak havoc upon vulnerable populations around the world. However, stemming the accumulation of greenhouse gasses requires a trade off with economic output that many people around the world are not willing to part with. This opposition is led by emerging nations, particularly India, Brazil, and China.

Technically, there is a rather simple solution to preventing climate change. Once environmental scientists reach consensus on what the acceptable level of greenhouse gasses like carbon in the atmosphere is (a consensus which surveys of the relevant literature reveals has been quite elusive) then governments must simply charge a price – either by taxing emitters or issuing tradable emission permits – so that the quantity of emissions is reduced to levels scientists deem appropriate. The economics of this solution is elegant in its simplicity. Sources of greenhouses gasses (electric generation, automobiles, etc.) will “pay the price” until it is cheaper for them to abate the deleterious emission than paying the tax or buying permits. They can achieve this abatement by either decreasing output or producing their products in a way that emits less greenhouse gas. These methods will increase the price of the products, so demand will re-equilibrate to a lower quantity, ensuring that the markets remain efficient while still preventing the advance of climate change.

Clearly the citizens of the world will have to pay for this protection of the environment. High gas mileage vehicles, alternative energy, and other abatement methods are costly for an economy. The institution of a comprehensive international environmental treaty would certainly decrease global output for years to come. Herein lays the heart of the opposition to such an arrangement. Low-income countries which are rapidly expanding their economies towards prosperity would have to languish in poverty for years to come, while high-income countries already enjoy relative prosperity even though they caused the overwhelming majority of greenhouse gas accumulation.

On one hand, the appeal to fairness by countries led by China seems valid [and given recent developments, no one can argue that China is not at least pretending to search for a solution]. Every person in the world has the right to economic prosperity, so countries that already enjoy high standards of living should bear the burden of global environmental stewardship while the rest of the world catches up. But there is something unsatisfying about this approach. It is arguable that knowingly damaging the environment is just morally wrong, so emerging market countries do not have any legitimate base to pollute their way to prosperity no matter the prosperity of others. It is simply unfortunate that developed countries did not know about the harms of greenhouse gas during the Industrial Revolution, because then they would have altered their behavior decades ago and prevented this crisis in the first place.

Despite these fundamental ethical dilemmas, a solution to the international deadlock on a climate change treaty is still feasible from an economic point of view. It would be prohibitively expensive for developed countries to abate all of the environmentally required greenhouse gasses on their own. It is in the economic best interest of the developed world to recruit the support of emerging nations. Therefore, developed nations should offer transfer assistance to developing nations in exchange for abating emissions. Developing nations should be willing to accept aid which exceeds their economic costs of reducing emissions, while developed nations should be willing to pay to the developing world anything less than the cost they would have to bare in order to assuage climate change all on their own. Coming to the terms of this agreement will surely take intense deliberation between nations, but there is nothing fundamentally barring its fruition.

Just to make you feel like I posted this article back when all eyes were on the UN in New York, here are some great pictures I gathered from the climate march that was held concurrently in Manhattan:

Just to take things from 2010 pseudo-academic Eric to nearly 2015 blogger Eric, I want to really quickly boil down my point here. If we want to strike an international global climate change treaty the rich countries will need to pay the poor countries. Just like water, countries take the path of least resistance to prosperity. We did back during the Industrial Revolution, not knowing the harms of the chemicals we were emitting. Now developing countries are doing it to, but they can’t afford to stop. They are poor, and their people need economic growth to achieve quality of life. So the only way to get their leaders to agree to enforce greenhouse gas emission limits is by compensating them for the economic growth that we are asking them to deliberately pare down. How is this deliberate, you may ask? If they want their prosperity to not follow the path of least resistance, they are going to have to go slower and use more expensive technologies.

 

… Gas Prices

I hope I’m not biting off more than I can chew with this post, but it is important and interesting. Gas prices are going down – 8% since the end of June, and maybe further as we continue into the fall. And that is certainly good news. American consumers will spend less on gasoline, which means more money left over to spur other sectors of the economy and to retire debt and save.

A lot of times big news outlets only focus on a few determinants of gas prices when they talk about the economics of gas and oil, but it is a vast and complicated market that is not homogeneous worldwide or within the United States.

gaspump66% of the price of a gallon of gasoline is determined by the price of oil. Big news outlets like to talk about a few themes when they talk about the price of oil: rising consumption in emerging markets, such as China, and rising production in the US, coming from North Dakota’s Bakken Shale. In addition, they cover the price of oil. The most commonly cited price of oil are West Texas Intermediate (WTI) contracts traded on the NY Mercantile Exchange (NYMEX). However, unlike stocks and bonds which can be traded and transferred digitally, ultimately, for every oil contract, someone has to take delivery of the physical commodity. And due to the realities of geography, climate, and geopolitics, it isn’t possible to charge the same amount all over the world.

When we talk about gasoline, the buyers of the crude oil that we care about are the refineries. The US has refineries on all of our coasts: the East Coast, the West Coast, and the Gulf Coast. But all of these regions are sourcing oil from different parts of the world. Increasing levels of the North Dakota oil are heading East. The Gulf is importing high quality overseas oil, so that leaves the West Coast importing more expensive oversea oil, which is more expensive to refine.

One man that is embroiled in what very well may be the world’s most important logistical system is everyone’s favorite octogenarian, Warren Buffett. A large part of his conglomerate’s business is rail shipping, which includes North Dakotan oil. However, given capacity constraints, he has to balance oil shipments with grain shipments. When he is taking on too much oil the agriculture industry and food security experts get in a fuss (Warren even had a private talking-to with the Agriculture Secretary last week), and when he is shipping grains instead of black gold, every who cares about gas prices is up in a huff.

Ever since the Arab oil embargo the United States government has banned the export of US crude oil. Therefore, despite the rising domestic US oil production, it only has a muted effect on international oil prices. So all the refineries importing foreign oil, especially those on the West Coast and the Gulf Coast (since most of the good stuff from North Dakota is heading to the East Coast), are still beholden to international geopolitics. The good news is that international prices are down 16% since the end of June (US prices are only down 11% in the same time period).

Ukraine! Gaza! ISIS! Syria! Libya! Ebola! Egypt! How is it that international prices are down? The fact of the matter is that many of these conflicts have not adversely effected oil extraction and shipping to enough extent to disrupt prices. But I personally feel like there is still a lot of possibility for a shock event to push prices higher. For instance, the capital of Yemen, Sana’a has recently resembled a battlefield. Who knows how this could affect prices if there is an unexpected outcome. Even more so, if Ebola spreads through Nigeria and other West African countries that are large oil exporters there could be widespread export disruptions, driving up prices. That’s not to mention if Russian sanctions over Ukraine spill over into the energy sector, if ISIS expands its territory and the world blacklists its oil, or the Libyan conflict turns into a more disruptive civil war.

ISIS

Right now the cheapest gasoline can be found in the South, and the most expensive in the Northwest. State gasoline taxes also play a huge role in the final price at the pump, but this is purely a political phenomenon, not an economical one. Next time you fill up or hear or read a news story on oil or gas try to remember that the economics of the issue is a lot more complicated than the story may lead you to believe, and that prices may not stay this low forever.

This is part three of a four-part series of posts on the Economics of Oil. Other posts:

The Economics of International Oil Price Conspiracies

The Economics of Airfare

The Economics of Bitcoin Mining

 

Sources:

http://www.businessweek.com/articles/2014-09-17/u-dot-s-dot-gas-price-falling-fast-time-for-the-return-of-the-3-gallon#r=rss

http://www.eia.gov/petroleum/gasdiesel/

http://www.businessweek.com/articles/2014-08-20/public-data-sheds-light-on-secret-rail-movements-of-crude-oil

http://www.nytimes.com/interactive/2014/09/16/world/middleeast/how-isis-works.html?ref=world&_r=0

 

%d bloggers like this: