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Wednesday, March 15, 2006

Prices Will Increase Because Producers Want More Profits?

A caller to Rush wanted to talk about the likely price increase of gasoline even if oilwells are drilled in ANWAR or the coast of California. The caller opined that the oil companies will incur massive capital expenses in drilling and will have to recoup that cost plus charge a profit.

Thus, gas prices would increase despite the increased supply. Rush responded by merely stating he supports the additional drilling to reduce our dependence on foreign crude oil. Rush rhetorically asked whether there were capital expenses for oil companies if they merely continued to drill where they are currently drilling. Naturally, capital expenses, while not as great as perhaps the cost of locating new oil wells and buying and transporting the equipment, are likely to be greater. oil companies still try to recoup those costs (and all other costs as well). But, said Rush, no doubt over time prices inevitably go up.

That is not necessarily true. The price will react to the gas market and the supply and demand at the time it is refined and reaches the gas pumps. That price may be higher or lower but is not automatically raised due to the increased capital costs. In a free market, parties invest money, time and effort for profit. The amount of that profit will be as high as the market will bear. Suppose that after drilling in these US locations, the world oil markets increases supply four-fold (Okay. That is impossible, I know). Say, the sheiks see this competitive supply about to hit and decide they want to try to kill that newcomer right out of the box. So they pre-emptively incerase their supply four-fold. That increased world supply will create a glut and gas prices may go down to $.75 per gallon. The new US oil drillers will then lose money or more slowly recoup their money, if ever. And who will be shedding tears for those investors when gas costs under a dollar a gallon?

BTW, the caller said he was "all for capitalism, but...". It is capitalism that will advise us how much of the whatever is available. If we still do not need it, its price will drop. Profits are certainly never a sure thing.

Vicente Fox of Mexico just announced a new deep-water oil discovery he said could eventually yield 10 billion barrels of crude oil. Will that added supply increase or decrease prices worldwide?

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