In the last video we explored when you pay a
certain amount of money on a per gallon basis
at the pump, how does that break down who get what?
How much of that goes to the gas station,
verses the transportation network, verses the
refineries, verses the actual oil producers?
The one thing I do want to emphasis is I just
use that as kind of indicative numbers.
They can change widely based on what's going
on in the market, and where we are in the world.
They are fairly indicative. The other thing
I want you to realize is that they aren't
always proportional. It's not like that if oil
prices were to double that this 15 cents that
the retailer got would turn into 30 cents.
In general, regardless of the price of oil,
at least in the United States, the retailer
tends to get between 5 cents per gallon and
20 cents per gallon. It's normally in that
10 to 15 cent range. Some of that has to be
netted against the 5 cents or so that goes
for credit card processing. Taxes can be
relatively fixed. It's often on a per gallon basis.
The spread that the refineries gets, it's
also not necessary proportional to the price
of oil. There are times where the oil prices very
high because their might be a lot of excess
capacities at the refineries.
Their not able to charge a huge premium,
or maybe their not able to get a lot of the
other stuff. The refineries might not be able
to make much if anything on each barrel of oil
that they actual refine. Sometimes it goes
the other way around. A low price of oil,
if the refining capacity is really tight,
the refineries can raise the price of the actual refined
oil products. They can raise more and more money.
The players in this whole supply chain that do,
whose profits are a function of the price of
oil are the oil producers. Just to be clear,
sometimes all of these are owned by the same
company. That's what they call these kind of vertically
integrated oil producers. Sometimes they are
different players, and when they are different
players, the ones that makes the most when oil
prices are high are the producers.
These producers, they invest huge amounts of
money in exploration and then in drilling.
They make some assumptions. They say, "Hey, this
oil rig that I'm going to spend a hundred or
two hundred million dollars on, this is going
to be break even if oil prices are say $30 a barrel."
Obviously, if oil prices end up being at $100 a
barrel, they're going to make a killing.
They're going to make $70 per barrel of profit.
This thing is going to produce millions and
millions of barrels. On the other hand, if oil
prices go down to $15 per barrel, they're going
to be killed. They're going to take a huge loss
on this huge investment they made.
The one question I want to at least attempt to
address, and it's not a simple question.
Many people devote their careers to this.
What is actually dictating the price of oil?
We see it can't be just the traditional supply
and demand, or at least in the short term it can't.
If we look here at 2008. In mid 2008 oil prices
were pushing $150, and then only a few months
later they had collapsed to $32 a barrel.
They had gone down by a factor of 5.
There is something that happened here.
The financial crisis hit, obviously, peoples
expectations of global growth would have been
gone down. The economy wouldn't grow.
People might use a little less energy, a little
less fossil fuels, whatever. That wouldn't
be enough to justify a 5 fold decrease in the
price of oil. Something else is at play.
As you can imagine, a lot of it is just going to be
the psychology of the crowd right over here or the
psychology of market.
People were driving up the price of oil,
and over here people freaked up, and they
started driving down the price of oil.
To think about that in a little bit more concrete terms.
I mean think about the price, or I'm going to
think about the oil markets in particular in the long term
and short term, or the long run and the short run.
In the long run, let me draw the long run
right over here. In the long run we can think of
the oil markets like you would think of any
traditional microeconomic market.
Oil is entrusting because it's a microeconomic.
It's one good or service that has huge
implementations on the macroeconomy on the
growth of nations, how they act, and whatever else.
We can think of it in kind of classical
microeconomic terms. That's the price of oil.
That's the quantity of oil. You can imagine
that those first few millions of barrels are
fairly cheap to produce, and then every
incremental millions of barrels.
If you think about this, this is the quantity
the millions of barrels per day.
They have to go explore finding it harder
and harder places, using more and more
technology to find it, so the marginal cost
of producing incremental barrels goes up.
Another way of thinking about this, at a low
price, oil producers say, "Hey, I'm going to
leave that oil in the ground. Why should I pump
it out and produce it now? So there won't be a
lot of quantity produce."
At a higher price they're like hey, we're going
to pump as much as we can. We're going to find
that oil wherever it is. We are going to pump
it and get it to the market.
Two ways to interpret the long run supply curve.
Long run supply.
The demand, also, we can kind of view it in
kind of a classical way. Those first few millions
of gallons, a huge benefit to the consumers.
There are some people that maybe oil is the only
thing they can use. They can't go to any source
of energy. They get huge benefits, but then
the marginal benefit goes down for every
incremental barrel of oil.
Another way of thinking about it, at high prices
there aren't a lot of people who are interested
in doing it. They say,"Thank you. I'll just
go use something else. I'll use solar power,
I'll walk to work, or whatever else."
Then at low prices they say, "Hey. I'm going
to use all the oil I can use. I'm going to drive
my gas guzzler 100 miles to work. I'm just
going to drive it around the block for fun.
I'm going to leave it running, because I don't
like to start my engine, and all the rest."
This kind of gives you a classical model
downwards-sloping demand curve, and an
upward-sloping supply curve. Then you would end up
with some equilibrium price in the long run, and
some equilibrium quantity.
This right over here does not describe this
all too well. Between here and here you did
not have dramatic changes in how people ... the amount of
oil that supplied into the market.
You did not have dramatic changes in peoples
behavior in terms of how they consumed,
or where they consumed a lot or a little of it.
One way to think about it is this is the long run.
Think about dynamics in the long run, if there
is new technology to find new oil to supply
curve could shift to the right like this.
If for whatever reason people start driving
electric cars, then the demand curve could shift
to the left like that. If for whatever reason
it became fashionable again for people to
drive SUVs, the demand curve could shift to the right.
If countries economic growth accelerates, if
people in India and China end up becoming wealthier
and want to buy more combustion automobiles,
it could shift to the right.
In the long term you can think about it in that way.
If there's more drilling, if there's eases
regulation on drilling, you could shift the supply
curve to the right. If you increase environmental
regulations, supply curve could shift to the left.
You could figure out the implications.
That's not what's really at play in the short run.
When I think about the short run, I'm not thinking
about on a second-by-second basis, the short
run is really we're thinking on over a period
of months or even a small number of years.
That's because people aren't changing their behavior
dramatically on a month-to-month basis.
They already bought their cars.
They already bought their gas-guzzling SUVs.
Also, it not easy for suppliers to turn capacity
on or off in the very short run.
In the short run our model might look something
like this. Obviously, these are gross over
simplifications, but they help us think about
it a little bit. This is the quantity.
This is price, so in the short run, the quantity
supplied is really not going to be too sensitive
to price. It might look something like this.
I'll just do it as a vertical line just to really state
how in the short offering, over a of months,
people are just going to pump out the oil that they were
planning on pumping on. Their not going to shut wells.
Their not going not use their tankers or whatever
else to transport their oil.
Their going to produce, and it's going to be
transported to the market.
This is the short run supply curve, regardless
of the price. In the long run, if the prices go
down they might decided to turn off capacity. If prices go
up they might do more expiration, open up more wells,
but that takes time. Often years to do that,
especially if you start from the expiration phase.
This is supply not too sensitive to price.
Demand might look something like this.
Once again this is one way of thinking about it.
A very simple model. Demand might look something ...
I'll do it in orange. Might look something
like this. Where is goes ... looks something
like that. The reason I drew demand that like,
is it kind of fits at least people short term
behavior. If our price right now is right over
here, if it were to pop-up right over there,
in the short run, people don't change their
behavior that dramatically. Their house and
their work is the same distance.
It's takes them a while to start thinking about
moving a little bit closer, changing jobs,
maybe getting a pass for public transportation,
or trading in their gas-guzzling car for another
car, or car pooling, or whatever else.
If prices go down, the other way around.
They might still have their Prius.
They won't trade it in for a more gas-guzzling
car, et cetera, et cetera. What this describes
is in the short run the prices aren't being
dictated by these classical mircoeconomic inputs
or factors in terms of supply and demand.
What's really effecting them in the short term
is market psychology, and this is why I put a
little picture of Chicago Board of Trade.
Which is where they trade futures contracts.
Futures contracts and I've done video where I
go into detail on what futures contracts are.
They are a way of trading commodities.
Instead of people walking around with vials
or barrels of oil and exchanging them, they say,
"Here's a contract to purchase oil from me in
a month, or at a specific date, or two months
at a specific date." People trade those.
In the near term, what's really driving the price
of oil? What's really causing these fluctuations
right over here? That can't really be described
by all of these things, is peoples psychology, and
peoples information. They look at things like
the Middle East. They say, "Will Israel,
Benjamin Netanyahu, Israels Prime Minister,
decide to preemptively bomb Iran in an attempt
to get rid of their nuclear program. Will Iran
do something crazy? How would they retaliate?
Would they try to close off the straight of our moves?"
Even if no one really believes that is happening,
some of them might say, Well someone else
might believe it." They might buy the futures contracts
and then try to trade it up, and other people,
eventually, that oil has to be delivered,
they might take deliver of that oil but not
bring it to market. They might hoard it in some
way, because they believe that somethings going to
happen and oil is going to be scarce at some
point in the future.
The big take away is all of these things, the
production of oil, other sources of energy,
peoples behavior, they do matter in the long
run on the price of oil. In the short run,
we're talking about the order of 6 months to
over a year. It really is market psychology.
Some of these geopolitical events that might
effect market psychology that's causing these
wild swings in the price of oil.