Feldstein on Oil

Martin Feldstein explains a theory of rising oil prices that I am quite partial to:

Unlike perishable agricultural products, oil can be stored in the ground. So when will an owner of oil reduce production or increase inventories instead of selling his oil and converting the proceeds into investible cash? A simplified answer is that he will keep the oil in the ground if its price is expected to rise faster than the interest rate that could be earned on the money obtained from selling the oil. The actual price of oil may rise faster or slower than is expected, but the decision to sell (or hold) the oil depends on the expected price rise.

3 responses to “Feldstein on Oil

  1. This is just Hotelling’s theory on the pricing of nonrenewable resources. There’s a very good writeup on this topic:

    http://www.overcomingbias.com/2008/06/the-future-of-o.html

  2. Nick

    Interesting, but I would question whether oil is — or behaves as — a classic non-renewable resource. New extraction and discovery mechanisms have produced multiples of the capacity expected in Hotelling’s day.

  3. Truly interesting on the actual interest of the product. Never considered that possible angle.

    However lately, my question relates to increasing supply to a point where the major speculative investors might something to worry about.

    I wonder if Goldman Sachs might fight the current call to drill anywhere we can, a “threat” to their bottom line, assuming they are as heavily invested in futures as reported?

    Would they perhaps move to prevent it from coming out of the ground?

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