The smiles on our faces while pumping gasoline comes from a historic 50 percent fall in oil prices. Most news commentators point to an oil over-supply as the reason. But that begs the question: Why? Since 1974, the Organization of Petroleum Exporting Countries (OPEC) has curtailed oil supplies to raise prices and profits. What changed that is causing oil producers to keep on pumping oil in the face of lower prices?
Steve Hanke, professor of applied economics at John Hopkins University, uses Net Present Value analysis to suggest why oil producers are selling so much oil at today’s low prices. In layman's terms, he believes oil producers are harvesting the proverbial bird in hand because they know that the two in the tree are taking flight. If so, what does that mean to us, our environment and the future for low pump prices?
Is the Net Present Value of oil changing?
Net Present Value is a tool for answering the question of whether you make more money selling a barrel of oil today for $40 or holding it for five years before selling. You would sell today if you think that $40, plus your future earnings on the $40, will be higher than a future price of oil. You would curtail supply and sell later if you are confident that the price of oil will rise higher than what you can earn on selling the oil today.
OPEC was formed to ensure future high oil prices or an escalating Net Present Value. OPEC pursued a strategy of curtailing supply to drive prices higher based on two key assumptions:
- The consumer thirst for oil will continue to increase
- The future will always allow individual oil producers to sell all the oil they want.
But what if today's oil producers see a disruptive future that negates these key cartel assumptions? Could we be on the threshold of a new era for oil, oil prices and oil emissions?
Disruptive changes devaluing oil and oil producers
There are three disruptive 21st century mega-trends that hold the potential of completely upending the role of oil in our economy and how oil emissions (plus coal emissions) are creating global warming. These three mega-trends are:
- Global warming is creating a Middle Eastern catastrophe. The Middle East is heading toward a climate catastrophe created by global-warming-enhanced heat waves. It is projected that the Middle East will become uninhabitable due to heat for months during the year. If the Syrian Civil War is actually a war over water scarcity acerbated by global warming, then consider the ramifications if the entire Middle East were too hot for humans. Assume you are Saudi Arabia, Iran and Iraq. Using Net Present Value analysis, it is better to sell all the oil you can at today’s low prices than bet on surviving the cooking of the Middle East.
- Electric cars win. Today’s electric cars are a niche market. The hybrid plug-in Chevy Volt just achieved an industry leading 100,000 unit sales since its 2011 launch. That success represents one half of one percent of 2015 U.S. car and truck sales. But electric cars are just now entering a period of declining prices driven by technology innovations and manufacturing economics of scale. In 2017 both Chevy and Tesla will be launching electric cars with a 200 miles range that sell for less than the average price of a new car (after incentives). 75 cents is the price per gallon equivalent for refueling an electric car from the grid. Many solar homeowners are refueling for “free.” Plus electric cars have faster straight-line acceleration than most V-8s. How soon will America, and the world, shift to electric cars if they cost less to buy, cost less to run, can be refueled at home or work, accelerate faster and social influencers pronounce them as “cool?” Even more so, if autonomous electric cars become a mainstream technology then ground transportation, and oil consumption, will forever be radically changed.
- World’s voters demand climate change solutions. How many more floods, droughts and wind storms will it take before voters demand that their government address manmade climate change? How will a swing state like Florida vote if its precious coastal cities are overwhelmed with costs tied to pushing back rising sea levels? Will voters in the United States, Japan and Europe continue to accept losing jobs to countries that win competitive advantage through pollution? If voters do swing on these issue then how much oil can be sold in a future where governments enact regulations, trade policies and taxes to curb emissions?
Not if but when
Oil producers are numbers driven, rational people. They are selling so much oil today because their future looks disruptive.
As consumers, we are not acting rationally. We are loving low gas prices to the max by buying record numbers of SUVs and full size pick up trucks.
Who do you think is right? Are the oil producers wrong to see a future where oil demand (and prices) fall because electric and autonomous vehicle technologies displace gasoline powered vehicles? Is Saudi Arabia, Iran and Iraq wrong to pump out all the oil they can because they see a coming climate catastrophe? Or are Americans right to live for today by buying gasoline powered vehicles that can take up to seven years to pay off? One of these two groups is really wrong. I am betting it is not the oil producers.
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