Sunday, January 31, 2016

The rent was too damn high


Ok oil is about $30/bbl these days having been as high as probably $150 or so over the last years.  The oil market is a monopoly with OPEC out there and this cartel organization works to fix the price of oil and when they are successful, they are able to extract monopoly rent in the marketplace.

Tom has been banging the table on this concept of rent for years here and I have to admit I never really understood it. I thought it was some sort of lefty/Marxist BS or whatever and put it on the back burner.

But in the last month or two I think I am finally coming around to understand what this concept is or means as the oil price has collapsed and yet the marketplace is still being supplied as if nothing real happened due to this collapsing of the price.

Can the magnitude of the rents previously extracted by the oil people be estimated in numismatic terms? Here is a quick shot:

Global use of oil is 85Mbpd.  Let's say $100 of monopoly rent has been removed down here at $30/bbl.  Ok that is 85M x $100 x 365 days = $3,102,500,000 or $3.1T USD per year (flow) of payments made for essentially no productive contribution to the global economy as manifestly the oil is still flowing down here at $30.

For perspective that is equivalent to 75% of ALL leading USD flow withdrawn from the US Treasury's account.  Or in labor terms lets say a global wage of $25/hr that would be 124 billion man-hours at 2,000 man-hours per year that would represent 62 million people working full time 40 hours per week for a year.

So somewhere, 62 million people have literally been getting a free ride for like the last 8 years or so.  I think I know where most of these perhaps irreparably damaged people are and are leaving now that the free ride is over.



22 comments:

Michael Norman said...

Great article, Matt. Great analysis. You don't see this anywhere. Only here, like pretty much everything.

Bob said...

Enjoy the cheap oil while you can. It seems to escape you guys that energy is heavily subsidized.

Ignacio said...
This comment has been removed by the author.
Tom Hickey said...

For the global "rent," figure the average global productioncost wrt to the average price.

But the monopoly rent to the swing producer is far higher. It's estimated that the Saudi cost is only about $3 bbl.

http://knoema.com/vyronoe/cost-of-oil-production-by-country

Some producers are doing nicely at $30 oil while others are booking losses.

I am also given to understand that there is considerable lag in both shutting down production and investment for various reasons, such as contracts in force. This maybe as long as a year or two.

But changes in oil price and anticipated future prices do have an effect on both production and investment over time. The low price will likely knock out some marginal players and curtail investment somewhat. The major effect of this is on countries suffering from Dutch disease. Venezuela is a case in point, but it will hurt some African producers, too. Russia has a large and deep enough economy to weather it, and they are already taking serious steps to address Dutch disease.

But oil price may be low at $30. Russia figures that the actual market price wrt to world supply and demand and various producers costs should fluctuate between $50-80. Higher cost producers could survive and the lower cost producers would be doing great. Total rent extraction would likely still be substantial since the lower cost producers would be producing the bulk of global supply.

There are two other major issues with cost ad price. First, as Bob says, oil is subsidized. Secondly, negative externality is not figured as a cost but rather gets socialized.

Ignacio said...

Fair average global value is currently around 75 USD, but production costs for certain places is way lower (although hardly lower than 40 USD), so for those places are like rent.

bob, the problem is cash flow, they have to keep pumping. FMI already saying Sa should implement 'austerity', ME gonna explode in pieces lol. But as oil rigs close down and the glut gets absorbed prices will swing up towards 60USD. The problem then is that the global economy will be under deep recession (it's already at recession in several countries), and higher prices + recession is just a sign of how screwed up the economy is, CB's don't know what to do anymore.

MRW said...

Tom, what is Dutch disease and explain negative externality? Thx.

MRW said...

Matt,

Can you explain these figures some more? Stuck on the 75% bit.

"For perspective that is equivalent to 75% of ALL leading USD flow withdrawn from the US Treasury's account. Or in labor terms lets say a global wage of $25/hr that would be 124 billion man-hours at 2,000 man-hours per year that would represent 62 million people working full time 40 hours per week for a year."

Thx. Appreciate it.

MRW said...

Tom, never mind about Dutch disease. I realize it was the economic definition, not the tree. ;-).

Tom Hickey said...


(Economics) the deindustrialization of an economy as a result of the discovery of a natural resource, as that which occurred in Holland with the exploitation of North Sea Oil, which raised the value of the Dutch currency, making its exports uncompetitive and causing its industry to decline


The Free Dictionary

A negative externality occurs when an individual or firm making a decision does not have to pay the full cost of the decision. If a good has a negative externality, then the cost to society is greater than the cost consumer is paying for it. Since consumers make a decision based on where their marginal cost equals their marginal benefit, and since they don't take into account the cost of the negative externality, negative externalities result in market inefficiencies unless proper action is taken.

heconomics.fundamentalfinance.com/negative-externality

Matt Franko said...

This is from Warren's blog the other day:

"Three major U.S. shale oil companies have slashed their 2016 capital spending plans more than expected in a bid to survive $30 a barrel oil prices, with one of them saying prices would need to rise more than 20 percent just to turn a profit."

OK 20% onto $30 is $36 to "just turn a profit" well what is so bad about that? No monopoly rent only profits? (if we assume reasonable profits are not part of monopoly rent...)

Much of the current expenses being reported are probably non-cash charges which are collapsing the current earnings... iow "cash basis" they are still making munnie and once the non-cash charges are over they will report earnings even at the lower prices...

Matt Franko said...

MRW the 75% is just the comparison of two flows... trying to understand the magnitude...

Total leading flow of USDs from the US Treasury directly is about $4T/year and if we value the previous rent at $100/bbl equivalent (oil is probably also purchased in EUR and GBP etc...) and globally the oil flow is 85M bpd then the previous amount of rent being achieved by the oil producers was about $3T/year so 3 out of 4 is 75% of leading USD flow equivalent so all of that is being like "removed" from those economies by pursuing these monopolist public policies... chaos ensues there...

Matt Franko said...

Tom points out that Russia is somewhat avoiding the chaos (no Russian refugees...) but we have to remember that Russia never joined OPEC either... so they had other public policies other than seeking monopoly rents...

China has been victimized by this as well as the US and EU... Russia has perhaps benefited from it as they had more forex to purchase goods from EU or US before sanctions and the price being reduced...

Bob said...

OK 20% onto $30 is $36 to "just turn a profit" well what is so bad about that?

Might want to ask shareholders what is so good about it.

Not saying that fossil fuels are a free market, but there should be an incentive for producers to find the maximum price that a market can bear. Speculators like to try their hand at that game too.

Bob said...

From wikipedia:
OPEC countries account for 40% of global oil production and 73% of the world's "proven" oil reserves, making OPEC a major influence on global oil prices.

Not a monopoly.

Matt Franko said...

Bob look into what Warren calls the "swing producer" in a cartel marketplace... they dont have to have near a majority of the market in order to control the price... they had that capability for a while now they dont...

Bob said...

The low cost producers can wag the dog, but them dogs will not give up their ability to hunt. Domestic production of oil is like agricultural production - to be protected at all costs.

Btw, when the price of oil is high, do we see non-OPEC producers bemoaning the situation?

Matt Franko said...

Bob they had growth plans and made investments that were booked at an asset value... now they have to mark down the value of the assets as they are not worth what they said they were... its a non-cash charge it has to come out on the income statement and then it is recorded on the balance sheet..

Steel is down over 50% and so is diesel fuel... take a step back and look at those operations assets... they are simply made out of steel and diesel that's it.... and both of those are waaaaay down by law they have to mark them down otherwise it is fraudulent representation...

They will take the marks and then get back to making plenty of munnie at $36/bbl

Bob said...

Saudi Oil Minister Ali Al-Naimi blocked appeals from poorer OPEC members for production cuts to support prices. Naimi argued that the oil market should be left to rebalance itself at lower price levels, strategically rebuilding OPEC's long-term market share by ending the profitability of high-cost U.S. shale oil production.[90] As he explained in an interview:[91]

Is it reasonable for a highly efficient producer to reduce output, while the producer of poor efficiency continues to produce? That is crooked logic. If I reduce, what happens to my market share? The price will go up and the Russians, the Brazilians, U.S. shale oil producers will take my share... We want to tell the world that high-efficiency producing countries are the ones that deserve market share. That is the operative principle in all capitalist countries... One thing is for sure: Current prices [roughly US$60/bbl] do not support all producers.

Bob said...

Sorry, who is "they"?
The shale leases were the source of some of the profits. Those have already been taken and those folks have since exited the market.

Ignacio said...

36 USD to be barely profitable (ie. not having to default on their bonds lol) on origin translates to around 75 USD average global price. Realize that in S.A. the origin price is way lower even.

Much of the costs of things, including oil, is logistics. Moving stuff around the world is not cost free.

Matt Franko said...

those leases were where the rent went...

All the people who work there are making productive contribution and they get paid... the rent is non-productive contribution...

And no they dont complain that is how you get the "Texas miracle" (alleged) so they are down there extracting monopoly rents from the rest of us and you get that $1.3B Taj Mahal Jerry Jones was GIVEN for the Cowboys to play 8 games in, etc...

That's over.

So we have the same $4T leading USD flow into the US economy happening only #YUGE amounts of non-productive contribution has been removed so we should see a pretty quick increase in productive contribution (ie an increase in REAL output and employment) occur in 2016 here as long as oil stays very low... earnings are already starting to reflect this process from the Q4...

Matt Franko said...

"logistics. Moving stuff around the world is not cost free."

But the price of the oil itself is included in those costs so it is Neil's feedback (negative in this case) coming in here...