Monday, July 28, 2008

Why More Offshore Drilling Won’t Bring Down Gas Prices

Critics, and even supporters, of John McCain’s proposal to open up more coastal waters to offshore drilling have rightly noted that it would take ten years or longer for any oil to reach consumers. But there’s a more fundamental reason why opening up more of our coastal waters won’t bring down gas prices, as any student of corporate strategy will tell you.
Consider an imaginary strategy session in an imaginary oil company. An executive proposes that the company increase its capital investment in order to bring down the price of its products. It doesn’t take much imagination to realize that it would be irrational for the executives around the table make the extra investment.
This is basic business school stuff. The oil business is an example of a mature industry; there is little chance that any technological breakthrough or change in the market would alter the fundamental economics of the industry.
A company in a mature industry should treat its productive assets as a cash cow, “milking it for all its worth” and using the profits elsewhere. Why? Simply put, more capital investment won’t generate more revenue.
This is why oil companies have not drilled on 41 million acres of offshore leases they already control, as Joe Biden pointed out two weeks ago. It’s also why oil companies are returning more cash to their shareholders rather than increasing investment in production:
HOUSTON (AP) — As giant oil companies like Exxon Mobil and ConocoPhillips get set to report what will probably be another round of eye-popping quarterly profits, just where is all that money going?
The companies insist they're trying to find new oil that might help bring down gas prices, but the money they spend on exploration is nothing compared with what they spend on stock buybacks and dividends.
It's good news for shareholders, including mutual funds and retirement plans for millions of Americans, but no help to drivers already making drastic cutbacks to offset the high cost of fuel.
You don’t have to view oil executives as morally deficient to understand why they won’t pour more capital into production—you just have to see them as acting to maximize return to their shareholders.
The standard strategy for companies in mature industries is to use their profits from cash cows to fund investments in new industries—which is just what Joe Biden and T. Boone Pickens are proposing to do by investing in renewable energy.


Blogger Suspended License said...

This is an excellent economic and almost psychological (although it seems the two disciplines are often tied) argument to make for the futility of more drilling. It is distressing that so many of the arguments come from the environmental side of the debate (which is, of course, very valid) when this other important side of the equation also exists. Awesome post.

6:04 PM, July 28, 2008  
Anonymous Anonymous said...

The real futility of drilling, economics aside, is that it delays the inevitable. This debate distracts from the conversation that should be going on - that no matter what is done, world oil production will soon begin its inexorable decline.
The question is: If you have a billion dollars to throw at the problem, should you spend that money on adding a little cushioning to the catastrophic downside of peak oil, or should you spend it on promoting and disseminating technologies and policies that will (eventually) make modern life without oil possible. I think the answer is clear.
The same goes for natural gas, which isn't far behind its liquid sibling.

Unfortunately, I don't think politicians and the media wil subscribe to peak oil until we are well over the peak - or recognize that the economic havoc associated with peak oil should onset slightly before the peak, as suppplies start to level off in the face of growing demand

9:30 PM, July 28, 2008  
Anonymous Anonymous said...

you know I'm battling over here to make you some money! the least you could do is weigh in on this entire thing!

just sayin....

9:39 PM, July 28, 2008  
Anonymous Anonymous said...

Therefore the only way to decrease gas prices is to provide an alternative that is cheaper so that to compete, gas prices have to fall.

Or, by increasing corporate taxes on capital gains, so that a corporation registers making less money investing its money in itself, which it keeps. The less profit, the less it pays out in taxes. An oil company by increasing its investment, could write off all its taxes if it pumped all its profits back into its own infrastructure....

That would be a big shot in the arm for the economy. One could argue that profit taking is extreme this year because of the reduced burden of capital gains tax. This is the year you want to This year the Bush tax cuts make it stupid to build anything as you well point out.

2:36 AM, July 29, 2008  

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