Few consumers like high oil prices. Do-it-yourselfers like me wish copper pipe and fittings had not gotten so expensive. But such high prices do illustrate how markets work.
Prices in an economy function to transmit information and motivate actions. High prices tell producers to produce more and consumers to use less. They also tell people to discover better ways to produce the high-priced product or to find acceptable substitutes.
In towns like Minot, N.D., Campos, Brazil, and Butte, Mont., high prices for crude oil and copper are spurring production, bringing an economic boom to areas that had been in the doldrums for years.
Moreover, high commodity prices increase the “reserves” of such raw materials even if no new physical discoveries are made, since they increase the proportion that can be extracted profitably.
Reports of large, previously unexploited oil fields in North Dakota and Brazil are good news, at least for energy prices. (If we really want to cut fossil fuel use in coming decades, large new oil discoveries are of lesser value.)
As reported in the Sunday Pioneer Press, the Bakken geologic formation in North Dakota may contain some 400 billion barrels of oil. It is a “tight” formation of rocks with low porosity. Only 1 percent to 3 percent of the oil may be extractable under current conditions. But even those low percentages put the recoverable amount in the ballpark of the much-ballyhooed Alaska National Wildlife Refuge.
Coincidentally, the recoverable oil in the Bakken is very close to the 8 billion barrels that Petrobras, Brazil’s national oil company, reported in a deep offshore field in November. That oil and gas, lying under more than a mile of ocean water, another 1.5 miles of rock and a final mile of salt, will be extremely costly to extract. A well 180 miles off the Brazilian coast costs at least 50 times as much as a typical North Dakota well, yet both may be profitable with $80 a barrel oil.
Wells in neither oil field would have been technically feasible 20 years ago. Wells into the Bakken formation depend on sophisticated 3-D seismic imaging and horizontal drilling. Brazil’s Tupi field depends on the same imaging and sophisticated offshore drilling technology.
Drilling in either field would not be profitable if oil prices were less than $30 a barrel, as they were for most of the 1990s. Nor would oil extraction technology have advanced as rapidly if prices had remained stagnant.
When the price of some raw material goes up, producers can spend more money getting it out of the ground and still turn a profit. So production from known oil fields and mines increases.
High prices also motivate the search for new deposits. This is evident in North Dakota. That state has produced oil for half a century. But the amount of exploration and drilling has varied widely over the years. As a regional economist at the Minneapolis Federal Reserve Bank in the 1990s, I had to follow the “rig count,” or number of drilling rigs actively working in the state each week. When oil prices dropped near $10 per barrel, the rig count might only be seven or eight. When prices got above $25, more than 20 rigs often were drilling. Now, with prices for North Dakota oil in the high $80 range, more than 50 rigs are operating.
Some are adding wells to oil formations that have been pumped for years. Others, like those tapping the Bakken Formation, are venturing into previously unexploited deposits.
High prices can rejuvenate mining areas that long were dormant. Butte, Mont., was a major copper mining center from the late 1800s into the 1970s, but production waned as the easiest deposits were mined out and cheaper copper from countries like Chile and Zambia filled the market. There still is a great deal of copper near Butte, but it was not profitable to mine when copper was worth less than 90 cents per pound. But with prices above $3 per pound, mining these long-abandoned deposits can be worthwhile.
High prices motivate research into new technology. The $20-a-barrel oil we had a decade ago did not smother oil industry research. But it focused the industry on finding lower-cost ways to pump from existing fields. Developing new technology to tap challenging formations like Brazil’s had less importance. Now, four years of high prices have dramatically increased work on new ways of reaching deep undersea deposits as well as thin ones in tight rock as in North Dakota. Effective new technologies in turn increase reserves, the quantities of oil or minerals that can be extracted profitably with existing technology at prevailing prices.
All this does not mean we will soon see gas at $1 a gallon. But it does show how price signals motivate actions in natural-resource development.
© 2007 Edward Lotterman
Chanarambie Consulting, Inc.