Comments on: Energy Update Nov 21 http://www.investorgeeks.com/articles/2006/11/21/energy-update-nov-21/ Learning and sharing investment knowledge. Fri, 21 Nov 2008 23:59:16 +0000 http://wordpress.org/?v=2.0.4 by: Doug http://www.investorgeeks.com/articles/2006/11/21/energy-update-nov-21/#comment-13430 Wed, 22 Nov 2006 23:05:54 +0000 http://www.investorgeeks.com/articles/2006/11/21/energy-update-nov-21/#comment-13430 Good point about Chavez and all of the OPEC regimes, because how OPEC responds to falling prices is the big unknown. OPEC as a cartel, does not have to respond in ways that classical economics suggests. So, when prices rise, which should lead to more supply, OPEC might chose to push prices higher by maintaining or even cutting output. Likewise, classical economics suggests that if prices fall that OPEC will cut production and reduce supply, supporting prices. Expectations that this will happen are a major part of the price equation in oil markets. But will they respond this way? History suggests that they will not. After the great run up in the 1970s, OPEC started INCREASING supply as prices fell. What drove this behavior? Another economic axiom - the desire for even consumption over time. Having grown accustomed to the huge revenues that high prices gave them, most OPEC countries were unwilling to stick to their quotas, they wanted to be able to continue to have the same income they had had when prices were high, so they actually INCREASED their volumes in an attempt to realize higher income. Now, if only one member of the cartel cheated, supplies would have remained tight enough for them to enjoy that higher income, but since all of them were playing the same game, huge supplies drive the price of oil downwards for two decades, finally hitting a low of under $11 in 1998. Chavez, the Mullahs of Iran and other regimes rely on being able to dole out the oil money liberallly in order to keep key elements of their societies happy. Like all rackets, those who are paid off under the scheme are not likely to take kindly to the idea that business is a bit tight, we will have to scale back your cut. When the restaurant has a bad month, Tony Soprano had still better get a fat envelope. Problem is, who do you short when every one you have to pay is a Tony Soprano? Faced with the consequences of a light envelope, you cheat on your production quota - break a different law. You pump a few more barrels to make up the difference. So do all of your other fellow OPEC members, and we are on the way to an oil glut. Good point about Chavez and all of the OPEC regimes, because how OPEC responds to falling prices is the big unknown. OPEC as a cartel, does not have to respond in ways that classical economics suggests. So, when prices rise, which should lead to more supply, OPEC might chose to push prices higher by maintaining or even cutting output. Likewise, classical economics suggests that if prices fall that OPEC will cut production and reduce supply, supporting prices. Expectations that this will happen are a major part of the price equation in oil markets. But will they respond this way?

History suggests that they will not. After the great run up in the 1970s, OPEC started INCREASING supply as prices fell. What drove this behavior? Another economic axiom - the desire for even consumption over time. Having grown accustomed to the huge revenues that high prices gave them, most OPEC countries were unwilling to stick to their quotas, they wanted to be able to continue to have the same income they had had when prices were high, so they actually INCREASED their volumes in an attempt to realize higher income. Now, if only one member of the cartel cheated, supplies would have remained tight enough for them to enjoy that higher income, but since all of them were playing the same game, huge supplies drive the price of oil downwards for two decades, finally hitting a low of under $11 in 1998.

Chavez, the Mullahs of Iran and other regimes rely on being able to dole out the oil money liberallly in order to keep key elements of their societies happy. Like all rackets, those who are paid off under the scheme are not likely to take kindly to the idea that business is a bit tight, we will have to scale back your cut. When the restaurant has a bad month, Tony Soprano had still better get a fat envelope. Problem is, who do you short when every one you have to pay is a Tony Soprano? Faced with the consequences of a light envelope, you cheat on your production quota - break a different law. You pump a few more barrels to make up the difference. So do all of your other fellow OPEC members, and we are on the way to an oil glut.

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