Thursday, June 26, 2008

The Political Economics of Oil

Economics teaches us that as the price increase, supply increases, and as the price decreases, supply falls. This is true in the long term for the oil market, I suppose, but in the short term because so many oil companies are nationalized, things can get a bit skrewy.

Twenty years ago, John Londregan, then at Carnegie Mellon, noticed something odd about how Iran, Iraq and some other countries responded to declining oil prices in the mid 1980s. Instead of pumping less oil, they pumped more. This contradicted economic theory. His answer was that the domestic political situations and financial demands faced by these countries meant that a decline in oil income was not politically acceptable. To compensate for lower prices, leaders pumped more oil.

Reverse the situation. Over the last few years the price of oil has been going up. But... as noted by Howard a few weeks ago on Trade-Wars, the amount of oil many countries are pumping has been dropping. Perhaps this is because the countries cannot produce more, as 'peak oil' theorists surmise. On the other hand, with the price so high, state owned exporters probably feel much less pressure to pump. Better to keep the extra oil in the ground to smooth out the budget cycle.

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