Review: In my first article regarding price gouging I discussed how fuel markets are characterized by a Nash Equilibrium strategy that prevents long term 'price gouging.' In the second article I discussed how the Clean Air Act has increased capital expenditures by nearly 400% and reduced ROI by 42% between 1996 and 2001. This I explained has reduced investment and production capacity.
What happens when we take both of these effects into account? The decreased profitability acts as a barrier to entry preventing competitors from entering the market or increasing capacity. In fact there hasn't been a new refinery built since 1972. When demand exceeds supply, prices rise but there is very little supply response. As a result prices remain high for longer periods of time.
With barriers to entry, there are fewer 'players' in the price gouging game. With fewer players, it takes longer for the market to converge to the lower priced Nash Equilibrium.
Although environmental regulations have reduced return on investment, the resulting barriers to entry have increased the market power of existing firms. In essence, it is environmental regulations that make it possible for firms to ‘price gouge’ because of the increased market power that these laws create for oil companies.
Monday, April 24, 2006
Wednesday, April 12, 2006
PRICE GOUGING II
Are oil companies really that profitable? Not when it comes to refining. Between 1977 and 2002 net margins per barrel have averaged about 2.00. In 2001 they reached 2.78, then fell back to .19. From 1988-1992 environmental compliance costs went from an annual 560 million to 2.69 billion (400%).
As result return on investment dropped 42% per year between 1996 and 2001. With reduced ROI, refining capacity is severely limited, and the profitability of expansion is greatly reduced.
The recently hailed 'record profits' that oil companies have posted since last summer are in effect an anomaly. Instead of being an indication of future profitability and expansion, they simply are a reflection of scarcity produced by increased usage, instability from hurricane Katrina and the Middle East, and environmental policy.
In essence, what policy makers should focus on are policies that will allow refining to become a more profitable venture. Profits help direct resources to where they are needed most, and we are in desperate need for refining capacity.
As result return on investment dropped 42% per year between 1996 and 2001. With reduced ROI, refining capacity is severely limited, and the profitability of expansion is greatly reduced.
The recently hailed 'record profits' that oil companies have posted since last summer are in effect an anomaly. Instead of being an indication of future profitability and expansion, they simply are a reflection of scarcity produced by increased usage, instability from hurricane Katrina and the Middle East, and environmental policy.
In essence, what policy makers should focus on are policies that will allow refining to become a more profitable venture. Profits help direct resources to where they are needed most, and we are in desperate need for refining capacity.
PRICE GOUGING
Are oil companies price gouging? If you can define price gouging as charging a price greater than what competitive market fundamentals would support, then I wish I could say YES!
Ologopolistic markets (like fuel markets) are characterized by a non-cooperative Nash Equilibrium for defection. This means that if all of the oil companies are 'price gouging' now then there is a revenue increasing incentive for discounting.
The previous analysis indicates that with price gouging, the high prices at the pump are unsustainable, and cannot be maintained for long.
However, if the high prices we are now experiencing are related to fundamentals, like increased demand from China and India, Middle Eastern instability, reduced refining capacity due to EPA standards, and hurricane setbacks, then it is likely that we will see gas prices remaining near 3.00/gallon and oil at 70.00/barrel.
Of course, much of the 3.00/gallon is still artificially inflated. (the real price of gas since 1950 not adjusting for tax differences across time has ranged 1.90-2.00) While our gas prices are not artifially inflated nearly to the extent as in Europe, we still pay a significant portion of taxes at the pump.
In addition, provisions of the Clean Air Act make it impossible to reduce shortages in one market with surpluses from others. As a result supply fluctuations lead to price spikes.
While technological progress will lead to alternative fuels in the future, a more immediate solution can be found via changes in tax and regulatory policy.
Ologopolistic markets (like fuel markets) are characterized by a non-cooperative Nash Equilibrium for defection. This means that if all of the oil companies are 'price gouging' now then there is a revenue increasing incentive for discounting.
The previous analysis indicates that with price gouging, the high prices at the pump are unsustainable, and cannot be maintained for long.
However, if the high prices we are now experiencing are related to fundamentals, like increased demand from China and India, Middle Eastern instability, reduced refining capacity due to EPA standards, and hurricane setbacks, then it is likely that we will see gas prices remaining near 3.00/gallon and oil at 70.00/barrel.
Of course, much of the 3.00/gallon is still artificially inflated. (the real price of gas since 1950 not adjusting for tax differences across time has ranged 1.90-2.00) While our gas prices are not artifially inflated nearly to the extent as in Europe, we still pay a significant portion of taxes at the pump.
In addition, provisions of the Clean Air Act make it impossible to reduce shortages in one market with surpluses from others. As a result supply fluctuations lead to price spikes.
While technological progress will lead to alternative fuels in the future, a more immediate solution can be found via changes in tax and regulatory policy.
Tuesday, April 11, 2006
BIOTECH A BOON TO 3RD WORLD
MYTH: Biotechnology only benefits wealthy western economies.
Currently there are over 21 countries with major biotech production. For the last 10 years we have seen the percentage of biotech crops planted double each year.
In fact >90% of farmers that plant biotech crops are in developing countries-many of which would be considered at the subsistence level.
Biotechnology is actually a size neutral technological advancement. Unlike advances in mechanization, GPS, or inputs that may require a large scale of production, biotechnology can be adopted by the smallest of producers.
Drought resistance, disease resistance , and insect resistance are all examples of traits that are size neutral. Advancements in genomics, quantitative genetics, and molecular biology will only perpetuate this trend.
Currently there are over 21 countries with major biotech production. For the last 10 years we have seen the percentage of biotech crops planted double each year.
In fact >90% of farmers that plant biotech crops are in developing countries-many of which would be considered at the subsistence level.
Biotechnology is actually a size neutral technological advancement. Unlike advances in mechanization, GPS, or inputs that may require a large scale of production, biotechnology can be adopted by the smallest of producers.
Drought resistance, disease resistance , and insect resistance are all examples of traits that are size neutral. Advancements in genomics, quantitative genetics, and molecular biology will only perpetuate this trend.
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