Tuesday, 2 February 2016

On That So-Called "Ghastly" Substance


I wonder what Gordon "Let's nationalise our oil fields" Brown and Ed "The nefarious multinational oil companies monopolise to the tune of inflated prices" Miliband are thinking today with the news that crashing oil prices have engendered a market slump. Are they finally ready to understand how supply and demand work in the oil industry?
 
The problem is, the left, being prone to conspiracy theories, were quite willing to go along with the confused narrative. In the run-up to the last election Ed Miliband had convinced swathes of people that energy providers were a monstrous cartel that were ripping everyone off (an imputation I was happy to call out as rubbish at the time).
 
A little bit of common sense ought to tell anyone that the oil industry is quite different to the picture the left paints. Except in extreme cases (see below), oil companies are not making unconscionable profits, and therefore the calls to tax the bejeebus out of them and impose price controls are fraught. When there is a spike in prices, most people ask how the so-called monopolising companies can get away with ripping us off. I'm guessing it never occurred to them to ask why, if they really are monopolising the industry, the prices weren't higher much sooner? That is, if providers suddenly became greedy when prices were high, why weren't they greedy when prices were low?
 
The answer, of course, is that what changed wasn't a sudden bout of greediness from the suppliers, it was a change in supply and demand. As more countries become prosperous their demand for oil increases, which affects prices. As the world is chaotic and prone to lots of interruptions in the supply of oil (both present interruptions and future instability), there are inevitable spikes in oil prices in times of stress and unrest. Governmental tax increases on oil or price controls won't redress turmoil in the Middle East or severe weather conditions or instability between Russia and the West - hence they won't make the situation better. In fact they would have the opposite effect as oil companies would be more insecure about repairing their supply chains and about making future investment if politicians are just going to over-tax them or restrict the natural price mechanisms from which their initial investments bear fruit.
 
Oil companies invest in the industry by playing the long game to the tune of tens, often hundreds, of millions of pounds - investments that require years, often decades, to reach fruition, and part of that investment is based on derivatives concerning future supply, future demand and future prices.
 
Ironically, the major problem with oil as a resource gets mentioned far too infrequently - and that is the problem of over-reliance on it by some countries, and an over-abundance of oil reserves concentrated in a handful of countries with highly unstable populations and dictatorship governments.
 
On the first part, the over-reliance is known in economics as Dutch disease (a term that was coined to describe the decline of the manufacturing sector in the Netherlands after the discovery of the large Groningen natural gas field about 50 years ago), whereby relying too much on the revenue from one type of good leads to under-investment in the country's other goods and resources.
 
On the second part, slow growth and economic hardship have often been correlated with oil wealth in the hands of dictatorships, where the resources are controlled by the government and not very beneficial to the population. Naturally, nations that rely on these dictatorships for oil often have a cosy relationship with them, when really they should be standing up and condemning many of their barbarian practices.
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