Last month I posted a list of predictions from the simple economics models of depletable oil stocks. Those predictions were:
INCREASING OIL PRICES create the incentive to invest in transitional technologies. PRICES OF ALTERNATIVES FALL with investment. CONSERVATION OF EXISTING STOCKS will ease the transition.
Well, I forgot one. Higher oil prices create the incentive for existing producer to INVEST IN EXPLORATION.
With higher oil prices, the oil that used to be too expensive to extract become economically attractive. Let's use the fruit tree example to illustrate. At low fruit prices, it might be profitable to stand on the ground and pick the fruit you can reach (low cost). But, the fruit you can't reach by hand requires more equipment--ladders, mechanical lifts, more labor--to pick (higher cost). When will producers invest in picking the 'high hanging fruit'? When the price of fruit rises to the point that it is profitable.
Same goes for oil. It's relatively cheap to poke a hole in the ground and extract the big pools of oil. But as stocks deplete it requires more and more investment to extract the deeper, harder to find stocks. What creates the incentive to extract these tough to extract oil stocks? Higher prices of course.
From today's Financial Times...
The Organisation of the Petroleum Exporting Countries, the cartel controlling 75 per cent of the world's oil reserves, on Monday revealed its most important members had drilled 7.5 per cent more wells last year than in 2003 in response to the oil price boom. Opec's annual statistical bulletin also showed that the number of rigs in operation within the 11-member cartel rose 18.8 per cent last year after dropping by almost 6 per cent a year earlier.
Rising prices create incentives for conservation by consumers AND exploration by producers.
UPDATE: Conumers demanding smaller cars in response to rising gas prices.
