Increasing future production effects current prices for gas

Don Chance:

One of the most contentious issues of late has been the question of whether increased drilling for oil would reduce the price of oil today.

Certainly increased drilling will not bring an immediate increase in the supply of oil. But many people, even so-called experts, believe that the effect on the pump price would not be felt until the oil is actually at the pump, possibly years later.

In fact, the price will fall well before the first hole is drilled. Even the possibility of increased drilling will bring down the price of oil. It already has.

Almost everyone knows that supply and demand determine price in a market. But that knowledge seldom goes beyond understanding how supply and demand themselves are determined.

The belief that the current quantities demanded and supplied are the sole determinants of price misses an important point. Both current and expected future demand and supply interact to determine the quantity demanded and supplied in the current marketplace.

That is true because oil, and indeed almost everything else, is storable.

When a quantity is storable, the amount a producer will supply and a consumer will demand is not independent of future expectations.

Take the case of Robinson Crusoe, an example used in some economic texts. Crusoe is a simple case because he is both the supplier and the demander.

Stranded on an island with some corn, he might consume all of it in the first year if he expects to be saved in the second. If he does not expect to be saved in the second year, he will consume some of the corn and use the rest as seed corn.

His consumption might also be affected by other factors. If he feels weak, he might consume more today; if he feels strong, he might consume less. Crusoe will hardly ignore his expectations when deciding how much to plant and eat.

Thus, the current price of any storable commodity will be affected by expectations of future supply because producers use those expectations to determine when to bring their product to market.

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There is much more.

You can see this effect when new finds are announced even though they want be in production for years. When Chevron announced its new find in the deep waters of Gulf of Mexico a couple of years ago the price immediately dropped. It will drop when the restrictions the Democrats have put on exploration are removed.