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The effect of opening up ANWR to drilling on the current price of oil

Coats, R. Morris and Pecquet, Gary M. (2008): The effect of opening up ANWR to drilling on the current price of oil.

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Abstract

The Effect of Opening up ANWR to Drilling on the Current Price of Oil

R. Morris Coats and Gary M. Pecquet

Abstract:

Everyone knows that oil discovered today, perhaps in the Alaskan National Wildlife Refuge (ANWR), has no effect on prices until that oil hits the market. For instance, on its website, the Democratic Policy Committee, (http://democrats.senate.gov/~dpc/pubs/107-1-72.html) states that “it will require seven to twelve years from approval before there is any oil production from the ANWR area. Therefore, production in ANWR will have no impact on current or short-term gasoline and oil supplies and prices.” While this is something that everyone seems to know, it is a case that the theory held by everyone just happens to be wrong. Since future prices are expected to be lower, future profits are also lower, so the value of oil not produced now, but held for future sales, is lower, making it more profitable to go ahead and produce and sell now instead of waiting for future profits. Using oil now reduces the amount of oil available for the future, which involves the opportunity cost of forgone future profits, which are sometime called the marginal user costs or scarcity rents. In this paper, we use simple two-period models to show that if an amount of newly discovered oil is significant enough to reduce prices in the future, any drop in future prices reduces the future profitability of oil, reducing the marginal user costs of oil now. That reduction in the marginal user costs reduces the current price of oil just as if there were a reduction in the marginal costs of extracting oil now. We explore the effects of the reduction in marginal user costs in the competitive or price-taker case as well as the price-searcher case, where a monopolist or dominant supplier responds to a substantial discovery by another seller, but where the discovery will not contribute to production for some years to come. In both cases, we find that oil that is expected to reach the market at some time in the future has an immediate impact on oil prices.

Topic Area: Q4 Energy

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