Sometimes I like to base exam questions for my students on recent news. Here’s an exam question to see how thoroughly students understand the economic issues associated with today’s allegations about oil companies and the Cheney energy task force.
EXAM ESSAY QUESTION (answer on separate paper)
Senator Frank Lautenberg (D-NJ) today issued the following press release:
In the four years since the secret Cheney task force met, we have seen gas prices double and oil company profits skyrocket. What went on at these secret White House meetings that may be motivating oil company executives to deny their participation? Now it appears that some Big Oil CEOs might have lied to Congress to cover up their involvement with the White House task force. What are they trying to hide from the American people?
Your assignment is to describe in detail the possible economic mechanisms whereby the actions of this task force might have contributed to a doubling in the world price of oil. Be sure to address in your essay the following issues.
1.) The Cheney task force resulted in the Bush energy plan released in May 2001. Discuss in detail three elements of this plan that led to an increase in oil prices. Be sure to explain how this happened despite the fact that the legislation proposed in that plan was not passed by the Senate and, if passed, would have increased energy supplies.
2.) Even if one ignores the Bush energy plan itself, explain how secret consultations by the task force could have resulted in higher oil prices. Recall that the five executives who were
called before the Senate last week represented BP, Exxon-Mobil, Shell, Chevron, and ConocoPhillips. Including all their global operations, these five companies between them produced 10.1 million barrels of oil per day in 2004 (data from Petroleum Review with a tip of the hat to The Oil Drum), which would represent 12% of global production of 83 mbd. Describe the precise actions these companies could have taken that could have led to a doubling of oil prices. If possible, bolster your argument with a numerical example using plausible elasticities and actual production figures.
3.) Develop further Lautenberg’s theme that the statements made by those called before the Senate were knowingly false. In particular, refute the claim by
ConocoPhillips CEO James Mulva that in 2001 he had been the chief executive of Phillips and that Cheney met with someone from Conoco, which at that time had been a separate company.
4.) Perhaps the most important accusation made by Senator Lautenberg is that the statements by the oil company executives before the Senate committee were misleading. Describe some of the economic harm that can result when someone in a position of power makes statements that could result in a misunderstanding of the facts by the American public.
“Describe some of the economic harm that can result when someone in a position of power makes statements that could result in a misunderstanding of the facts by the American public.”
The country could go to war under false pretenses. The war could cost many hundreds of billions of dollars and cost many lives and make the country less secure and lower the country’s stature in the world.
1. 3 Items that would increase prices if the legislation had been adopted:
A. increased production costs created by additional government regulations (“mandatory reduction targets for pollutants”, “efforts to improve pipeline safety”.
B. Increased domestic demand resulting from strengthening the “Low Income Household Energy Assistance Program.”
C. Increased internation demand resulting from increased stockpiling by oil consuming countries.
Even if not adopted, these could influence market prices through expectations: firms would rationally postpone some production until the high demand kicked in; firms might voluntarily adopt higher cost production methods to avoid having to retrofit after new regulations are adopted.
If the legislation passed and resulted in higher energy supplies, the long term impact on prices would depend on the size of the higher energy supplies, compared to the other effects.
2. If the oil market is truly a world market, then it is a remarkably competitive one, with the top five firms controlling only 12% of production among them. This would lead to a Herfindahl Index in the 100-200 range. According to Department of Justice guidelines, ” The Agency regards markets [Herfindahls of less than 1000] to be unconcentrated. Mergers resulting in unconcentrated markets are unlikely to have adverse competitive effects and ordinarily require no further analysis.” In other words, even if the top 5 oil firms were to merge into a single firm, this would not create any adverse competitive effect.
Are questions 3 and 4 appropriate economics questions?
JDH: How much time do your students have on this exam?
Pop quiz
From James Hamilton, oil economist extraordinaire: EXAM ESSAY QUESTION (answer on separate paper) Senator Frank Lautenberg (D-NJ) today issued the following press release: In the four years since the secret Cheney task force met, we have seen gas price…
Howard– now there’s an A+ answer!
Mesmer– it’s a take-home exam that’s due on Monday.
I think my answer would be that the professor has selectively mined the public discourse in order to demonstrate (a) scandal-mongering (b) his own ideological predilections. Lautenberg’s statement is political. He ascribes no cause and effect. It is therefore completely accurate, particularly within the political domain. I would admit that Lautenberg’s statement can propagate unnecessarily economic falsehoods and conspiracies, in particular the idea that oil companies are controlling the price of gas and oil. But the statement itself does not say that the two are related. Though he’s juxtaposed them for political gain. I would wonder why the professor did not select an example of Cheney and Bush juxtaposing high energy prices, American energy independence, and drilling in Alaska.
I would fail the test. But I’m not trying to jump through the hoops of the economic curriculum. Economics has some very fundamental lessons. Once those are learned, it’s seems more a closed system, not so different from postmodernist neo-historicist cultural theory (pick your “ist” on the prior list).
True, economics makes predictions. Lots of them. Most of them wrong. A few of them right. “Fooled by Randomness” by Taleb goes a long way in describing those accurate predictions.
The most interesting task force question is “did anyone mention Iraq back in 2001?”
… and aside from “price doublings” it would be interesting to know what expectations the government shared with the oil industry, and not us citizens.
another thing to consider is the stock market
the stock market had a pretty good week during the recent congressional grilling
so while we can not say for certain that the congressional hearings helped teh stock market, we may be able to say they did not hurt the stock market in the short-run.
P.S. – Given that 2001 was still “peacetime” I wonder if the Prof would share his philosophy on “secret negotiations” between government and commercial players in those circumstances.
Surely those future-buyers, the ones we expected to know the reality of “peak oil” a few months ago, would have appreciated a place at the table.
Can a principled stand be made for including some in such a high-level confab, and not others?
P.P.S. – My idea would be that both markets and decmocracies require a degree on transparency.
This reminds me of an old story about the economic opportunities and problems of arson. Punch line is “Yeah, but how do you start a huricane?.”
Bill
For Every Drop Of Rain…
Glenn quotes Hitch asking “What do you have to believe in order to keep alive your conviction that the Bush administration conspired to launch a lie-based war?” You’ll find the perfect answer in the second comment here, in response to…
I think you have asked the questions backwards. It should be something like:
1.) Please explain in which bizarro world oil company execs would be so eager to participate in a government task force in order to lobby for programs that would lower prices and profits in contravention of their fiduciary duties.
2.) Given the oil execs devotion to the public welfare explain their fanatical insistence on keeping their good deeds secret.
I think one could at least begin to make an argument that torpedoing CAFE standards and making trivial symbolic investments in alternative energy sources certainly does nothing to improve matters in the long run.
And who is to say they haven’t colluded to reduce their investment in new refining capacity, the real cause of the recent short term price spike in gasoline. We already know they have the propensity to lie and before you dismiss the thought, there is proven precedent in the electrical energy industry.
well, just off the top of my head…
seems like bombing the crap out of the infrastructure, control, and human knowledge assets sitting on top of the second largest reservoir of oil left on the planet might be a good way to squeeze the supply and drive up the prices across the board and into the future.
It is now apparent that this did not require passing the energy bill at all, just the abdication of war powers to the president to let him take care of the details.
Let me see if I’ve got this right. The White House intentionally planned, at the urging of the oil executives, to have the current level of insecurity in Iraq in order to curtail the flow of oil in order to raise the price? In contrast to earlier claims that the purpose of the war was to obtain oil, the true purpose of the war was to destroy oil?
JDH – I see it as two issues:
First, if industry is going to testify for the purpose of making public policy, should that be in an open or closed venue? I think the long history of open congressional hearings has worked pretty well. And certainly plays fewer favorites than a closed meeting.
Second, some people have suggested that oil execs were given a preview, before 9/11, of future conflict in Iraq. Independent of oil and energy policy, that might shed some light on “true workings” of the run-up to the second Iraq war.
P.S. – would the transcripts to those meetings answer your questions more definitively than I can, JDH?
You have asked the wrong question. Lautenberg said nothing about the price of oil. He mentioned the price of gasoline. These few oil companies control over 90% of the gasoline in the US and are quite capable of manipulating its price. After all, we have seen the cost of feedstock oil go up at the same time that gasoline profits go to record highs. That seems contradictory. In most industries when the cost of production (meaning gasoline) goes up, profits go down. Their profits come primarily not from oil production, but from buying oil and producing gasoline.
Joseph, I believe that the doubling in the price of gasoline should have something to do with the doubling in the price of oil.
I think a more relevent question would be:
If you are the manager or owner of a business and one of your employees refused to tell you how he spends his time, or if he was working to achieve results contrary to the interest of your firm would you justified in firing him.
As a tax payer and voter the Vice President is working for me. So why can I not insist that he tell me what he is doing?
“Joseph, I believe that the doubling in the price of gasoline should have something to do with the doubling in the price of oil.”
But does doubling the price of oil imply the doubling in profits in gasoline? I would think just the opposite.
In other words, oil companies don’t just produce oil, they buy oil — lots of it.
For example, looking at Exxon’s quarterly report total revenues were about $100 billion but they spent $52 billion buying oil. Their cost of purchasing oil went up 40% compared to a year ago yet their net income went up 75%. How many industries are capable not only of instantly passing on 100% of increased costs but at the same time increasing profits by 75%? This just doesn’t seem to be a very competitive industry — more like a cartel.
While many of you are aware of the scientific advances we have made, for the uninformed I would point out that there is credible evidence that the oil companies have developed the ability to utilize their oil platforms in the Gulf of Mexico to generate hurricanes.
I would also note that none of these hurricanes did any damage in Wyoming which appears to be proof positive that Cheney is in on the conspiracy.
There is also evidence that the oil companies agreed not to drill in the Artic Wildlife Refuge if the government wouldn’t permit it. Another sure sign of a secret conspiracy.
Bill
and baby panda bears with frikin’ laser beams …
Has any one told David Horowitz about this take-home exam? Looks like this here prof is going to fail anyone who doesn’t agree with his political views!!! To the barricades!!!
Let’s see – much of this represents subsidies to either the consumers or producers of energy, so much of this would have lowered the price paid by consumers as it gave more revenues to the suppliers. Let’s assume that the elasticity of supply is very modest. Then much of the incidence of the subsidies would have gone to the suppliers. And of course, we would have to pay more in taxes but only years later since Bush & Cheney pretended to give us tax cuts. And lest we forget – Dr. Cheney says deficits don’t matter.
Fred C.,
Seriously, does suggesting that claims that ‘inside baseball means doubled gas prices’ is an economic stretch really equate with a belief that there is nothing wrong with energy policy being strongly influenced by energy producers?
If you back out your normative views of these events, there is some really good economic analysis that can take place. In the real world, of course you cannot do that, but in the hypothetical world of an econ exam, it’s fully appropriate. Put it another way, either a prof. uses real world examples like this, or their students are subjected to questions about his/her kids lemonade stand. I know which I preferred…
Also note that question 4 covers misleading statements by either Lautenberg or the oil execs, there’s something there for everyone.
The “secret” meetings probably contained nothing more than information that would be politically damaging but blindingly obvious. Remember Sen. Kerry’s gas tax vote ? Hooooo, got some mileage (ha!) outta that one !
And who cares what was in the meetings ? With an all-republican-everything there is no energy policy aimed at improving the economic impact on consumers over any length of time. No plan save giving our natural resources away as fast as possible.
I know that as an american I have to have an immediate and complete deference to the laws of capital (here in our perfectly free markets). But wasn’t this the “corporate presidency?”. Maybe it’s time to revisit lemonade stand economics for some folks.
You need the final exam after that lame ass post on investment by oil companies. Ron Braetigan or Pekka Heital need to give you a little interrogation…
(sorry…I’m drinking…let the post up anyhow…)
Biker, the amusing thing about this discussion is that people can base an argument on what the meetings were “probably” about.
The question is whether in a democracy we should have to guess.
Earlier, JDH asked:
In contrast to earlier claims that the purpose of the war was to obtain oil, the true purpose of the war was to destroy oil?
It’s possible that the war reflected the attitude of “if I can’t have it, no-one can.” Perhaps Bush believed that the war would go smoothly, and by this time all the oil would be in the hands of American companies, allowing them to raise profits from selling higher quantities, even as prices come down and everyone else is happy.
I don’t think that any good capitalist government would want energy prices to go up, since that would hurt every business in the country (except the energy companies). If a capitalist wants to funnel money to the energy companies, it’s best to do that with subsidies so that market prices come down and everyone’s profits go up along side the profits of the energy companies.
Adam: It’s been a while since I was in college, but last I looked, “it’s possible that” isn’t considered evidenciary.
Joseph: “But does doubling the price of oil imply the doubling in profits in gasoline? I would think just the opposite.”
Then you’d be mistaken. A doubling of the price in oil, with the same margin (remember that oil companies still have to make a profit for the widows and orphans getting the dividends) would result exactly in doubling the profits.
My only point was that “war to get oil” and “war to disrupt oil” are not mutually exclusive, because both of them fit into the paradigm of “if I can’t have it, nobody can”
you need to take into account that the people who went to war were not all of one mind – there is a pentagon view of the world and there is a big oil view of the world.
as i understand it, the pentagon expected a sell off of iraqi oil to private companies. but this would have increased production through the competition obetween the new owners of the oil. instead, big oil put on intense pressure to keep iraqi oil unified under state control. and it was big oil who got the ear of the president, and won. if this is true – it shows big oil more interested in high prices than in increased production.
thus it does make sense to stop building refineries. oil is a finite resource. better to restrict refining capacity – thus slightly reducing demand for crude oil, and slightly weakening the price. but at the same time, by restricting the supply of gasoline and oil derived products, boosting the price of these. lower costs plus sharply higher selling price = record margins.
the meetings had to be secret because higher gas prices are politically unpopular. the politicians have to respond to big oil – their paymasters – but also to the voters. all participants understand this . . .
My two cents on the “energy policy meetings under Executive Privilege” is that the environmentalists were screaming because they hadn’t been invited.
My response to that complaint is “Who doesn’t know ahead of time what they would have said?”
Cheney would have gotten the same old useless rhetoric about conservation, renewables, more regulations, etc etc etc.
The public behavior of the energy companies has clearly indicated a desire and a willingness to increase production of energy. The environmentalists have advocated policies that would constrain production directly and divert resources into non-productive programs (solar as one example.)
Yet, now we hear the Orwellian accusation that producers are scheming to produce less.
The Democrats have made excessive and cynical use of inversion in their politcal arguments of late. It is very unbecoming.
Links and Minifeatures 11 22 Tuesday
Carnival of the Capitalists is up! Recommended Posts: View From a Height,
Then you’d be mistaken. A doubling of the price in oil, with the same margin (remember that oil companies still have to make a profit for the widows and orphans getting the dividends) would result exactly in doubling the profits.
Posted by: Charlie (Colorado) at Nov
Uhm shouldnt profits rise faster because the sunken cost, like refineries, would stay the same
sell off of iraqi oil to private companies was a politcal impossibility in Iraq. Any Iraqi goverment would renationalize it. This would depress prices for the oilfield and so would make it even more likely that they would be renationalised as you cant really claim that you bought something legally when you pay cents on the dollar for it. Add the feeling from the Iraqis and their guns that your a thief and it would be better to leave the opportunity to less morally upstanding elements
the sell off of oil to private companies now seems underway, if this is to be believed –
http://www.CrudeDesigns.org