villageindian

I think it is interesting that Gregor MacDonald thinks that the Hotelling Rule is going to be applicable to Brazil quite simply because President Lula realizes the overall value of these reserves with respect to the overall oil market and the need to ensure reliable and consistent supplies.

I am not an economist but I see the problem in applying the Hotelling Rule to Brazil just so quickly. While it may be that Brazil sees no need to flood the market to counter OPEC oil, I think Brazil is quite content to let the “cheaper” grades be mined to exhaustion before touching their own resource. Simply because the cost of extraction is likely to increase as the cheaper grades are exhausted from the market and that different grades of oil have different extraction costs.

As of now, I have never seen a paper that has studied the technological progress in the oil industry (such as deep-water drilling platforms, horizontal drilling methods, enhanced recovery techniques) and its relation to the reduction in extraction costs to pump out the oil. Technology is so vital to the oil industry that I have never seen it properly accounted for at all in papers that I have read. It is either included as an implicit variable (extraction costs although it is part of finding costs) or is not accounted for as a separate variable. Therefore, reading Matt Simmons’s “Twilight in the Desert” as well as help complete a study on subsea production that talks about the latest drilling technologies is helpful for me to offer the following perspective.

Technological progresses, no doubt, change the extraction cost over time resulting in a variable price trajectory for the (now higher) extraction cost and resource price. This “inefficiency” due to distortion should also be compounded with the inefficiency “perpretrated” by OPEC where traditional oil prices are now well above marginal costs and that extraction in deep water and oil sands resources are happening only when cheaper oil runs out. The Hotelling Rule fails to account for these “inefficiencies” and so it will be seen as if Brazil is ok with letting the oil remain in the ground as long as it knows that returns in the following year (when it is time to harvest it) will be higher than currently now.

As of date, there have been few studies that indicate that countries possessing an abundance of natural resources display low economic growth. The reasons attributed to this low growth is the need of resource-rich countries to acquire maximum profits with an extreme rent-seeking behaviour. This leads to an inefficient use and depletion of resources. And those countries that have established funds (for future generations) to manage the money from the returns of exporting the oil, have failed to establish programs that have a tighter integration with their government budget and this coupled with the combination of concentrated power within select special interest groups, the need to lag behind innovatively (once a certain economic wealthiness has been achieved) and the extreme volatility of the profit from changing oil prices results in a total failure (although this presentation seems to go in greater depth giving examples of successes and failures of resource-rich countries).

I would like to see, however, if Brazil would conform to Hartwick’s rule (which states that a country which produces exhaustible resources can maintain a constant level of consumption indefinitely if it invests all profits from these resources in reproducible capital) by remaining indifferent to keeping its oil underground and receiving a market rate of return on its sale. While I certainly understand and agree that the optimal production path taken by Brazil should be towards equalizing the present value of tomorrow’s price of oil to today’s price given all other things being equal, I just think it is the harbinger of things that oil will be finally treated (and given the respect) as the non-renewable resource that it is. Whether this leads to a more efficient market is something that real and experienced people working in the market can answer. In the meantime, Brazil can read and develop a plan on how to optimize its performance in the future.