Crude oil prices and rig counts

Each week Baker Hughes releases a count of the number of active drilling rigs in the international oil and gas industry. Their data has been available for over sixty years and is regarded as a barometer for the oil services industry in particular as a lead indicator of demand for the capital equipment used in drilling, producing and processing hydrocarbons.

Why look at rig counts?

Partly because the number of active rigs might reflect a market-driven response to changes in oil and gas prices and also expectations of future price movements. When crude oil carries a high price in world markets, the profitability of drilling for oil from known reservoirs ought to improve and we might expect to see an expansion in the number of active rigs.

That said there are many factors that affect how many rigs are in operation – it is not simply a question of rigs changing in response to market demand for oil.

Technological change affects the number or rigs needed to develop a reservoir and also allows new known reserves to be exploited – for example the deepwater areas off the west coast of Africa.

Climatic conditions can affect the logistics of drilling schedules including the ability of oil producers to move rigs and establish new drilling sites.

Some reservoirs are only available for exploitation on time-limited leases – and as these leases come to an end, so more rigs might be brought into use.

Our chart shows that in recent years there has been a substantial rise in the world total of active oil rigs – indeed since 2002 the number has grown from around 2,000 to over 3,500 with the number of US-based rigs more than doubling although this figure is still less than half of the peak at the end of 1981.

I have added to the chart an index of global crude oil prices using the Goldman Sachs Commodity Index data series. To what extent do you think that the oil rig count reflects movements in global crude oil prices? Is the volume of active rigs a useful measure of the supply-side response to the recent boom in prices? And what impact might the sudden and dramatic fall in prices have on the number of rigs in operation as we head into 2009? The Times reports today that world crude oil demand will fall in 2009 for the first time since 1983.

Economics of fishing

The BBC today has two stories on the economics of fishing. Firstly the government has announced a £5m plan to fund the de-commissioning of some of the UK’s in-shore fishing fleet in a bid t oreduce what the government regards as fundamental excess capacity in the industry.

£5m fund to scrap fishing boats

This BBC video looks at the background

Secondly the rising stocks of cod in the north sea has led in part oa rise in the size of the annual cod quota given to scottish fishermen by the European Union as part of their common fisheries policy. But the thorny issue of discarding excess fish remains unsettled. The quotas refer to landed cod which encourages fishing vessels to dump much of the fish they have caught before they reach home in order to avoid fines for over-fishing. The result is a deadweight loss of scarce resources in an industry already suffering from the long term decline in fish stocks.

Fishermen land cod deal at talks

See also “Scots anger over discarded fish”

 

Economies of Scale - Giant Wind Farms

This BBC article on the granting of permission for a giant wind farm off the coast of North Wales might be a good example of the importance of economies of scale in making renewable sources of energy more cost efficient. And heading to the web site of the Gwynt y Môr Offshore Wind Farm accesses some resources on the potential costs and benefits of a scheme that might provide electricity for up to 500,000 homes. If construction goes to plan, the wind farm will start to produce power from 2012.

Frozen Pizzas and Theory of the Firm

A big hat tip to my colleague David Fox who alerted me to this superb three-minute BBC video which takes us inside the Goodfella’s pizza site in Naas, Republic of Ireland - a fully-integrated plant that produces over two million frozen pizzas every week! There is so much in this video. I suggest showing it a couple of times and then gathering together the contributions from students and turning it into a mind map or a word cloud - perhaps using wordle

I tried with one group and they came up with

Capital intensity
Automation
Bulk purchase of ingredients
Economies of linked processes.
High labour productivity (very small workforce)
Standardised products - important for branding
Quality control
Bulky capital
Economies of increased dimensions
Minimising wastage
Perfectly elastic supply
Constant cost

A great short video resource!

Barriers to Entry

In business there are often important barriers to entry which act to limit the ability of businesses to break into new markets. The Bottom Line on Radio 4 this week considered the existence of these barriers. Leading the discussion was Will King, the founder and CEO of KMI King of Shaves, the innovative UK-based personal grooming business that has successfully broken into the shaving product markets and whose new four bladed razor is now number three in handle sales to Gillette. King mentioned that there were over 20,000 patents in the razor and personal grooming industry including mechanical hinges on the construction of razors which requires new entrants to design their way around the patents.

The panelists on the programme discussed a number of other entry barriers - among them:

  1. Intellectual patents and ownership of technology - but patents are needed to provide an incentive to invest
  2. Expertise and reputation of the incumbent - intangibles
  3. Licences are important such as professional qualifications
  4. Inherent suspicion among consumers about new ideas - behavioural economics tells us that many people are quite happy with their default choices - it may take a while for any change in preferences to occur.
  5. Regulations and legislation involving employing people - a major barrier for fast-growing smaller businesses many of whom are highly innovative

The Bottom Line is always worth a listen - the podcast is available for free from iTunes. And this weeks programme also considered which kinds of sectors will weather the storm and do well in a recession? The different nature of a recession this time around may well give us a clue to the likely winners from the downturn especially with credit so hard to find.

It was thought that successful businesses during the current downturn would tend to be:

  1. Agile and entrepreneurial, customer centric
  2. Businesses with low debts and those who are cash rich - cash flow management is becoming critical - cash flow forecasts will come under increasing scrutiny.
  3. High energy businesses that swim against the tide
  4. Knowledge building companies

The Bottom Line

Markets in Action: Steel Industry is Hurting

Leander McCormick-Goodhart writes about an industry under pressure

The steel industry is the new victim of the financial crisis. Arcelor (the world’s largest steel producer) is planning to cut its output for the fourth quarter by over 30%. The crippling of the steel industry is explained simply through the consideration of supply and demand in the complex interconnected markets.

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Markets in Action: Economics of Opium Production

Ed Maris writes on the incentives to supply opium in the turbulent country of Afghanistan

The Opium trade has existed for hundreds of years; it was the cause of the Anglo-Chinese wars of the nineteenth century and has been a resilient market despite increasing pressure from law enforcement agencies and governments worldwide. It is a part of most country’s shadow economy - it is an illegal good and a factor of the world narcotic trade. Opium is an example of a good exhibiting derived demand; whilst it may be consumed in its raw state, it is usually processed into Heroin, a powerful and damaging drug. Afghanistan’s opium production is estimated to account for 52% of the country’s legal GDP and 87% of the world’s total supply.

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Why are the car companies cutting production?

This week Nissan became the latest car manufacturer to announce a scaling back of production in the face of falling demand for new vehicles. Nissan, which is 44%-owned by Renault SA, of France plans to halt production at its huge plant in Sunderland for a fortnight and shorten production runs on its main assembly lines for a further three weeks in the lead up to Christmas.

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Maintaining profitability in the airline industry

My students have been tackling this assignment this week as part of their microeconomics course.

(a) Many airlines have reported heavy losses and several have already gone into administration or filed for bankruptcy. Using cost and revenue diagrams, explain why airlines have been experiencing such losses (15)

(b) Discuss the ways in which airlines can control their losses and continue to operate profitably in an industry where costs and revenues are unpredictable (15 marks)

Answers to part (b) sort the wheat out from the chaff!

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Something to chew over

It was a surprise at breakfast today to read the following in the births, deaths and marriages column of my newspaper

Mars Bar
Twix
Snickers
Aero

Then on closer inspection I realised I was reading the A-Bit_Chewy column

This pun reminds me of the cost pressures that confectionery manufacturers are under. Mars is the latest chocolate monalinth to report that the rising cost of ingredients is having a negative effect on their profit margins and that they will be looking to push through higher prices to wholesalers - this will feed through pretty much direct to chocolate-lovers in the days and weeks ahead.

This BBC report looks inside the Bournville chocolate factory in Birmingham

Beet farmers look for better price to sweeten the pill

Here is a story that highlights the monospony power of a business when set against the determination of farmers to get a better price for their product. For some time sugar beet producers in the UK have been battling with British Sugar to reach an agreement for the contracted price for their beet harvest in 2009.

 

 

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Will the sunshine on this solar subsidy?

I spotted this article in the Guardian from a little while back - “The largest rooftop solar power station in the world is being built in Spain. With a capacity of 12 megawatts of power, the station is made up of 85,000 lightweight panels covering an area of two million square feet” It brings into play three important economic concepts - renewable energy as a factor resource, economies of scale in production and also the costs and benefits of government subsidy - Spain has introduced subsidies of €0.42 per kilowatt per hour for investment in solar power - though the level of subsidy may be lowered in the months ahead.

 

Fares fair?

For occasional taxi journeys from my home to and from Heathrow and to my local station at Slough I am almost completely price insensitive. But in central London I do weigh up the costs and benefits of jumping in a taxi for shorter forays. This is a terrific article on the cost pressures facing London’s metered cabs whose prices are capped by Transport for London. Earlier on this year, the price of metered can journeys was raised by 2.7% - below the CPI and RPI rate of inflation and nowhere near the increase in the cost of fuel at the forecourts.

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Demand and Supply Revision Challenge

Draw a demand and supply diagram and show a shift in one of the curves (e.g. demand shifting outwards).

Give the students 5 minutes to think of as many causes of this shift.

1 point awarded for each correct cause; 3 points for one no one else has thought of.

12.1 came up with these 15 causes of demand shifting outwards:

1. increase in income – particularly luxury goods
2. increase in wealth (housing market or stock market boom)
3. increase in price of substitute
4. decrease in price of complement
5. increase in population
6. successful advertising campaign
7. anticipation/speculative demand – e.g. anticipation of scarcity
8. increase in popularity/fashion
9. Veblen effect – ‘snob’ effect, ‘must have’ good
10. change in legislation (e.g. compulsory safety equipment or emissions technology)
11. falling interest rates
12. easier credit availability
13. increase in quality of good
14. anticipation of inflation – consumers bring forward purchases
15. appreciation in exchange rate in market for imported goods which are a substitute for domestic goods

After the break we are doing the same for supply shifting inwards….. lots of good revision points already on linking the correct curve to the correct determinant!

Here are the answers for supply shifting inwards:

1. higher costs (wages, rent, raw materials, land, machinery/physical capital)
2. labour strike
3. natural disasters – particularly agriculatural-based/LEDCs
4. war
5. higher indirect taxes
6. lower or removal of susbidy
7. supply restrictions
8. cap on emissions
9. change in incentives away from producing this good
10. resources moved into other industries
11. increased scarcity of resource, e.g. oil – linked to higher costs
12. greater monopoly power/less competition
13. decrease in factor mobility
14. changing goal of seller – e.g. withdraw from particular market
15. appreciation in exchange rate increasing prices of imported raw materials and finished goods – ‘imported inflation’

Many thanks to Alex, Atin, Will, Clive, Arvin, Liam, Keval, Neal, Matt H, Matt S, Thomas…...