Sunday, November 30, 2014

Economics, limits to growth, and the falling price of oil and coal

The price of oil and coal is falling, despite both resources clearly being finite.
In a nutshell, the price of both is falling because of temporary over-supply. I believe this has several reasons. In Australia some coal mines produce coal at a cost higher than they can now sell it for. It seems irrational to do this, but there are some cases where temporarily stopping production is even more expensive. There is a momentum which propels employment and investment. In some cases mines may have to pay penalties if they temporarily halt production. There must be articles on this, if I can find time I will investigate and link. 

Consider there are n (say 100) coal producers in this position (producing coal - or oil - at a loss). If n/2 (50) cease production then the supply falls, the prices rise and suppose the other 50 then become profitable. But many of the 100 gamble that they will survive the unprofitable "window" .. and if they do pull out then they definitely "lose" - they cannot (quickly) become profitable again .. i.e. join the 50 who in theory are profitable if 50 pull out .. so a kind of tragedy of the commons applies, inhibiting all 100 from behaving rationally.

Now, of those 100, some have much higher production costs and -- if they all know their production costs, in comparison to others then the most expensive would pull out first. Let's assume a few outliers (say 10) will, so we have 90 left. But of these, the production cost for many is similar. So they all see it as in their long term self-interest to hang on.

I think the duration of irrationally persisting with the loss-making exercise also depends on the patience (or desperation?) of the banks investing in the mine. I bet few if any of the coal company (or bank) executives making the decision to continue to produce at a loss are risking their own money, though some probably have shares in the company and bank.

In fact, the longer these executives delay ceasing production, the longer they draw their income, and the longer they delay the hassle of looking for another job. Maybe some of them take a paycut but hang on in their position (Alan Joyce comes to mind) .. thus many executives have a conflict of interest .. their own financial well-being is enhanced by decisions against the financial well-being of their company.

And I reckon something similar happens at the bank level .. and beyond that at the politician level. .. So, it is a house of cards.

If resources were not limited, it would not really matter (apart from the financial loss to small investors who, for example, see their investment in Whitehaven etc fall).. but physical and ecological resources are limited .. the embedded energy in the stranded assets has an opportunity cost and also a pollution cost.