The market is broken because demand is way down, but production isn't being lowered to match. Saudi Arabia intends to keep their production high. The other producers are losing money but haven't reduced output, because changing output levels is more expensive than taking the loss.
This does indicate market inefficiencies, but such tactics -- flooding the market with cheap products to kill competition, then raising prices back -- is pretty common. I have seen it everywhere from cell phone marketing to grocery stores. I have personally seen, twice, Stop and Shop moving in, dropping prices, driving a less-well-funded competitor out, then going back to business as usual.
I do not see that the current tussle of oil producers indicates that the market is broken. Suboptimal, sure, but not broken. My 2c.
This is exactly why "fair trade" products like coffee and chocolate exist. There is an agreement to have an absolute minimum purchase price to prevent a big corporation from clobbering the competition by taking a loss, then jacking up the price.
See also: rideshare. VC pumps in billions so that Lyft & Uber can be cheaper than taxis at a HUGE loss -> taxis go out of business -> Lyft & Uber jack up their prices because they own the market.
> See also: rideshare. VC pumps in billions so that Lyft & Uber can be cheaper than taxis at a HUGE loss -> taxis go out of business -> Lyft & Uber jack up their prices because they own the market.
Did the rideshare companies actually jack up their prices at any point? How would they do that when they're still in competition with each other and the barrier to entry to the market remains low? Any attempt to raise prices would immediately result in more competitors.
That was the whole thing with the taxi medallions. It was a cartel, because that market has very low barriers to entry and the taxi companies didn't want the competition.
Uber didn't make prices artificially low, they just provided competition which stopped them from being artificially high. They're not losing money on rides, they're "losing money" on self-driving car R&D and things like that.
And "fair trade" is a marketing device. People want to feel good about not exploiting people, so companies not exploiting people get to charge a premium for that. That doesn't mean companies who are paying suppliers less don't still exist or offer similar products for lower prices purchased by customers who don't care as much about that.
Neither of these are examples of what you're describing.
Uber rides are subsidized. Uber loses money on each ride. The self-driving R&D is what will presumably save Uber. Their biggest expense (the drivers) will go away.
That's not unit cost. Companies spend money on advertising when they're new because it pays dividends for decades. It's not inherently loss-making, it's just investment that hasn't returned its full yield yet.
It's an investment that the company can't afford to make at the moment. An existing, efficient, and self-sustaining player can be drowned out by a few VCs subsidizing costs and making it impossible to compete for a few years.
The American VC system is disgusting. It allows a few wealthy individuals to choose winners not because they are the best solution, but just because through nefarious tactics they are the last ones standing.
> It's an investment that the company can't afford to make at the moment.
This is nonsense logic and the very reason not to use cash-based accounting for anything serious.
They raised capital, therefore they have the money. Basically all companies start off "losing money" because most investments don't instantaneously produce their full return. How would anybody ever open a factory or a restaurant if they had to be profitable before spending any money on anything that generates profit? You can't use the profit from making widgets to build your first widget factory because you need a widget factory to make widgets.
> They raised capital, therefore they have the money.
Right, and as a result of this, the companies that have capital can always beat out the ones that don't. Who gets to decide which companies get capital? VCs. So that means that it's not the market that decides who wins and loses, it's VCs. Does that sound like the intention of capitalism to you?
Having a better or more efficient idea is meaningless in today's economy. All that matters is how big your warchest is, and how many rich investors you have in your pocket.
> Right, and as a result of this, the companies that have capital can always beat out the ones that don't.
If your idea requires capital to execute and you don't have any then you can't execute it. How do you propose to change that?
> Who gets to decide which companies get capital? VCs. So that means that it's not the market that decides who wins and loses, it's VCs.
Who gets to decide which companies get capital? Venture capitalists. In other words, people with capital are the ones who decide which companies get capital. This is almost tautologically true.
But that is the market. The VCs fund the companies they think have the most promise. If you have a good idea but not capital then you convince some people with capital to fund you so you can execute it. That's what VC is.
What are you proposing as an alternative? One where raising capital is impossible and so you were either born with it or you're stuck working hand to mouth at a McJob forever because your idea takes more funding to execute that you can save in a lifetime as a wage slave?
Please take at least one second to google next time?
Fair Trade absolutely has an impact, by your own admission! You are applying the "if you can't fix everything don't bother fixing anything" fallacy. I don't know why certain personality types have to hide behind this when someone is trying to do something good. Do you just hate yourself?
So you have no evidence that they'll raise prices and the claim that they would is pure speculation. Which still doesn't explain how they would be able to when they still have to compete with each other and when the barrier to entry is very low such that if they ever did they would quickly get new competitors.
> Profitabilty: Here, I did your research for you, not too hard
Websites explaining why they currently spend more than they take in (answer: long-term investments like R&D and advertising), not how they would lose money on the average ride.
> Fair Trade absolutely has an impact, by your own admission! You are applying the "if you can't fix everything don't bother fixing anything" fallacy.
I never claimed it doesn't do anything. It's just not an example of dumping or anti-competitive behavior. Non-fair trade coffee isn't excluded from the market in any way. The higher price for fair trade coffee doesn't come from market power, it comes from marketing and selling a different product (a specific brand of morality) which is worth more money to some customers.
There is no cartel there. There is nobody stopping anybody new from paying higher wages and marketing their coffee as such, nor from paying lower wages and charging lower prices.
It's also called product differentiation. Oil is a commodity, but there are grades of oil and the amount of sulfur varies, so there is "sour" oil, "light" oil, etc. similar to "fair trade" chocolate.
That depends on what you define as a market that isn't broken. In a perfect free market the oil producers make zero profits and this is a move towards fixing the market
In a perfect free market for a commodity price is the marginal cost: in other words if there is demand for N barrels of oil per day at the market price, that market price is the cost of production for the Nth most cheapest production cost. Anybody whose cost of production is cheaper makes money.
For a long time that marginal cost was Canadian oil sands oil, which cost about $40 a bbl to extract and $10 to ship. The Saudis who can produce at $10 a bbl were making money hand over fist.
Most definitions of perfect free markets include some element of perfect competition. The math essentially assumes there are an infinite number of saudis producing at $10 a barrel that compete with eachother down to marginal cost. Obviously these aren't realistic assumptions and pretty much everyone has some form of monopoly power, such as the saudis in your case which have monopoly power coming from lower cost of goods.
> Obviously these aren't realistic assumptions and pretty much everyone has some form of monopoly power, such as the saudis in your case which have monopoly power coming from lower cost of goods.
That's not what "monopoly" means. Monopoly power isn't just a fancier word for market power. Monopoly power is power derived from the fact that nobody else is selling what you're selling.
Note that in this example, the Saudis can't raise the price of oil above $50 / barrel. Setting a price of $60 would send their sales to 0 rather than to whatever the level of demand is at $60. They can't do it because they don't have monopoly power.
(If you expand the example a little, saying that world oil demand exceeds the amount Canada can produce, then you can claim that Saudi Arabia has monopoly power by virtue of being able to sell oil that Canada can't sell. But in the model where Canada can produce any amount of oil at $50 / barrel and Arabia can produce any amount at $20 / barrel, there is no monopoly power anywhere.)
Pricing power is a better word that monopoly power in this case then, should have been more precise in wording. They arent price takers is the point. They have price making power and a downward sloping demand curve until 50 bucks a barrel
no, economists and policymakers agree with your usage of monopoly power. monopolies aren't simply a function of number of market participants. semantic digressions like these are non-sequiturs and should be ignored.
> economists and policymakers agree with your usage of monopoly power
Policymakers may; they'll agree with most definitions of a Bad Thing.
Economists have to be more careful. Saying Saudi Arabia has monopoly power in the oil market because it produces oil at a lower cost than other suppliers is crazy. What power they have to manipulate the market doesn't come from what they're already doing -- it comes from what they could do. They have a marginal cost of production which is below the current market price. The fact that their average cost of production is below the current market price is not relevant.
Consider a world where Arabia, Canada, Russia, and Venezuela all produce oil and sell it at the world price of $50 / barrel. In this world, Arabia's strategy is "pump all the oil we can sell at a profit". They have a marginal cost of production of $70 / barrel, above the market price, and an average cost of production of $20 / barrel, well below the market price. They're making money hand over fist.
No one considers them to have monopoly power here. What would it mean? How would they exercise it?
See e.g. The Concept of Monopoly and the Measurement of Monopoly Power ( https://sci-hub.tw/https://link.springer.com/chapter/10.1007... ), which would define Arabia's monopoly power in the hypothetical I've described as, on a scale from 0 to 1, negative 0.4.
But again, profits are determined by average cost, not marginal cost. There is no reason to expect average cost to equal marginal cost.
I agree, and I'm basically trying to appease the hn crowd with the semantics. I didn't think my statement was controversial or incorrect enough to be hit with that many downvotes (I am an econ major - trying to balance layperson definitions with hyper technical ones) but clearly that ended up not being the case.
Marginal cost isn't a useful term if you assume infinites. If you have infinite number producing at the same price you can just say "cost" instead of "marginal cost". Marginal cost is only a useful term if each product has a different cost.
Marginal cost is the amount it costs to produce additional unit of a good, cost overall would include fixed costs. Price is different from cost as well, since that's what people pay, not how much it costs (though in perfect competition price will equal marginal cost - but not the case in monopolies). These are nitpicky technical things but they do give you different answers when you do out the math.
Even in the real world the idea that "companies exist to make profit" sounds wrong. Companies exist to ideally output goods or services, and profit is a tool to ensure they can continue making those goods or services. It can be hard for a company to exist without making a profit, but not the reason they exist.
Perfect here refers to the mathematical model of a perfect market and perfect competition, not an external normative sense of the word as some societal ideal.
Don't quote me, it is ages since I had my economics book open last time, but if I recall correctly, there is a confusing terminology here. Zero profit means in the context of economice profits that exceed risk adjusted return. That is, even in a perfect market, in the models you are allowed to pay a decent return to your capital, but not more. These extra profits are called almost as confusingly "rents" in economics. That's why "rent-seeking" is considered bad even if it is fine that your landlord collects rents from you. Two different things and one word.
Your answer and the others reinforce why I allways avoided everything with economics in university. The definitions and models are (mostly) just weird.
I would intuitively define a free market, as a (virtual) place, where people can trade freely (goods or labour) without restrictions. And they profit, if they are better off with the trade, than without. The more free the market, the less restrictions.
It's actually too oversimplified to be a great model for most things. Extend your intuition to imagine that you have perfect competition where there are infinitely many identical goods all competing to the lowest price either no differentiation, and people will price at zero profit. To extend that to the real world requires more and more complications like the time value of money etc
"Extend your intuition to imagine that you have perfect competition where there are infinitely many identical goods all competing to the lowest price either no differentiation, and people will price at zero profit. "
But this is not reality.
I doubt doing abstractions like these are helpful in understanding anything, when the base is so far off.
Right, never said that was attainable or good. The point is that some people view perfect free markets as the ideal, and this is a move towards that, so people might view the market as getting g fixed rather than being broken.
Basic economics. The problem with basic economics is that all models are wrong and there are not in fact infinitely many perfectly fungible producers of identical commodities in perfect competition with eachother, but under perfect competition, nobody makes economic profits.
Profit is market inefficiency, whether due to missing information or inadequate competition. Perfect efficiency drives prices down to the marginal cost of a good or service. Micro 101 stuff.
Zero profits in economic models are usually in the context of economic profits, not accounting profits. So yeah, kind of (though there's risk adjustment needed, but when you start bringing in real world stuff like that your econ 101 supply curve/demand curve abstraction really starts breaking down, there are far more sophisticated economic tools for that). Perfect competition doesn't also really exist so we're just being guided by the math.
"Profit is market inefficiency" Profit is motive to do something.
No profit = no motive.
"perfect efficiency" means "no market" in this definition. It's a make believe process that will literally never happen. Companies that work with perfect efficiency close their doors.
Well, sorta but um no. If no profit includes a situation where everyone involved is paid at least enough that they are willing to do the work, then there is by definition motive to do the work.
These economic models are simplistic to the point of stupidity. But motivation to do the work can be totally priced in to the equations as a cost of doing business. Profit beyond that is what must, in the models, end up at zero to be efficient.
Not necessarily the stock market, but yes of course all models are wrong. Some are useful though, including these models. You can see that a pharma company with a government granted monopoly with patent power has high gross margins, while a more undifferentiated retail firm like walmart has far lower gross margins. That understanding can be drawn from using these models to understand how businesses will behave under a set of given assumptions (they want to maximize profit etc)
Yep. Perfect markets dont actually exist in any realistic way, and the US constitution itself deliberately breaks perfect markets by providing for patents.
I don't know much economics, but one thing I learned is that markets tend to not work as such when the players are few and motivated by other reasons than pricing. Airlines are one such example, depending on the time period, because being so few and dependent on entry barriers such as airport slots and flying licenses, they can easily collude. Oil producers are even more so, being driven by government decisions and geopolitics more than just profit alone.
So I wouldn't say that the oil market is broken, as much as it has never really worked as a close-to-ideal market.
> The market is broken because demand is way down, but production isn't being lowered to match.
Given these prices, shale oil and tar sands production is going to shut down at some point. This is good news in a way, because these are among the dirtiest sources of oil in terms of environmental impact. Saudi Arabia extracts "light" oil and it's a frickin' desert, so the environmental impact of that extraction is quite a bit lower all things considered.
I think the strategic advantage is to drill, baby, drill, and profit from those natural resources as much as possible while we're still in the Oil Age. If the Middle East runs dry it will be a strategic victory for all those countries and a loss for the other countries where high production costs kept the remaining oil in the ground, just sitting there never having generated a penny in profits, with renewables and electrification of transportation an even more imminent threat to the oil market.
Beaver fur doesn't have much economic relevance today--indeed, even the Hudson's Bay Company ceased fur trading decades ago--but the United States and what is now Canada are much better off having exploited that resource for profit while they could.
Bit of a win/win though. Either the oil age ends before the ME runs out and we potentially avoid an environmental disaster, or it doesn't, in which case our reserves might prevent a strategic disaster.
> Saudi Arabia extracts "light" oil and it's a frickin' desert, so the environmental impact of that extraction is quite a bit lower all things considered.
Wait, what? A desert is just as much an ecosystem as a rainforest or a city.
Are you seriously claiming that, say, the sand of the Sahara (or the ice at the south pole) is as rich as, say, the Amazonian rainforest?
Sure I guess technically anything is an ecosystem, but some clearly support far more life (and variety of life, and sometimes exclusive life) than others. They obviously have different ecological "value".
Also pumping oil in the desert doesn't lead to the local residents being able to set their tap water on fire, you know, the way fracking can.
I think I read they were doing this in part to hurt Russian producers who would not cooperate with OPEC (KSA wanted to reduce production in a coordinated way). As a side effect this hurts American producers too and could drive them out of business.
Which would be bad for energy independence and in the end give more price control back to OPEC.
I'm unclear how that's supposed to work. Oil goes below $30 for an extended period of time. So long that all the shale producers go bust. So long that no one buys up all those assets but instead just lets them go fallow.
After all that time Saudia Arabia now lets the price rise. How much time will it be over $30 before the shale producers start up again? Will it really pay off compared to the amount of time they had to spend with it under $30? And say they keep it _just_ over $30 - just how much over $30 can they go and for how long?
It seems like in the long run you'd better be prepared to keep it not much over $30 if you want to keep the shale producers out for good. That the idea of "put them out of business and then double the price" won't really work in a practical manner.
I'm failing to think of an example where this did work. Diamonds? I thought that the producers either bought or colluded to create an effective monopoly. That would be like S.A. just buying producers. That doesn't seem practical but who knows -maybe it is.
“ How much time will it be over $30 before the shale producers start up again?” I work in this field, and the answer to your question is “instantaneously.” The largest operators will not go out of business because they have sufficient exposure to non-shale assets; they will simply immediately drill the wells they had planned to drill when the crisis hit. Capital will rapidly find its way into the hands of the people with the expertise to drill and complete money-making wells.
The oil industry is like one of those organisms that evolved to thrive in an intertidal zone, or in a region with random lengthy droughts. The industry knows how to shed or calcify all the parts of itself it doesn’t need in lean times and then rapidly redeploy those parts as soon as the environment changes, because this sort of thing happens over and over and over. Sometimes the thing the industry doesn’t need it and therefor sheds is “workers” and that’s a shame, but so it goes.
To add to that, the wells they already have drilled are perfectly happy to sit around until someone goes out to frack them, and the wells they've already fracked are almost perfectly happy to sit around until someone produces them. The only investment that can't survive a year of unfavorable prices is the effort the business development guy put in to making phone calls.
This guy understands the energy business where oil is concerned.
I'd only add that the above is also the reason that the Saudi gambit to put competitors out of business is highly unlikely to work. These competitors will just sit it out until favorable environments come back around. I'm not sure what the Saudis aim to achieve? But to achieve what people are speculating that they want to achieve, they need to have something else up their sleeves. Because a temporary low price barrage alone is not gonna do it.
Maybe they are thinking about low prices forever? Not really sure. But they must have some kind of additional plans since they should definitely know everything everyone else in the industry knows.
They want Russia to come back in line with OPEC. Russian economy depends on oil exports, and the low oil prices might force it back to table. See what happened to Russian currency when price went down.
But they aren't going to achieve that on low prices alone. That's just reality. Coronavirus has placed Russia squarely in the driver's seat here. Saudi production surplus or no surplus is meaningless as Covid is depressing prices in any case. (And will continue to do so for the foreseeable future.)
So what is the Saudi endgame? Keep prices low for an additional year after the global economy recovers from covid-19? (Which covid-19 recovery, in and of itself, could take a year?)
It just doesn't make sense unless they have some other weapon in their arsenal here. Which they might? I just don't know what it is. (But if anyone does they could make a billion right now trading.)
>That the idea of "put them out of business and then double the price" won't really work in a practical manner.
Well, then you haven't paid any attention because that isn't the strategy. The strategy is to force them to become members of the cartel or you risk taking losses every decade. Those losses aren't high enough to drive out competition but they are high enough to make cooperation appealing.
> How much time will it be over $30 before the shale producers start up again?
I think that depends on how expensive it is to "start up again." If it costs $10mil to turn the taps on, then it won't be economic to do so unless the operators expect oil prices to stay above the $30 level long enough to make up the startup cost in operating profit.
From that perspective, an oil cartel could keep unconventional oil out of the market by holding out a credible threat that they'll crash the prices if ever unconventional oil becomes too big.
I think it’s more a side-effect of the Russia pricing fight than the goal itself.
If the price drops and shale producers don’t have the capital to whether the storm then they don’t have much of a choice. Sure later they could come back when prices are high again, but in practice that’s probably hard and takes time.
It's not that changing output levels is too expensive, it's that shutting down/starting up is too expensive. The fixed costs are so high that it's far cheaper to produce at a loss (and stockpile if needed) than to shut down.
That’s not a broken market. That’s just standard behavior when a supply cartel falls apart. Eventually those producing at a loss will be forced to stop.
