The above picture plots real investment in private fixed assets in the oil and gas extraction industry and the average real price per barrel of oil in the U.S. over time. The spike in oil prices in the late seventies is accompanied by a large spike in investment in the oil and gas industry.
Here are some casual explanations:
1) The change in value of the oil these firms hold in reserves gets valued as investment. This leads to a correlation between oil prices and investment, although the fact that firms held onto these reserves at a time of such high prices suggests they thought prices were going to stay that high. Basically you'd expect them to disinvest in reserves at this point.
2) The q-theory of investment says that when the ratio of the market value of assets goes above their replacement cost firms will invest.
What's strange about this is that more fashionable models of investment under uncertainty suggest that firms wouldn't react so strongly to a large move like this in oil prices because their future path is uncertain. I would have expected a more muted response, although it's possible that firms believed that oil prices had hit a new permanently high plateau.
27 comments:
I think the cartel has a lot do with the fact that you don't see disinvesting in reserves. I wonder if you could see the same graph if you plotted a different natural resource, like gold or nickel, that isn't controlled by a cartel of firms/countries.
In fact, there's an article in today's WSJ about precisely this point. "Why OPEC Idles As Gas Prices Reach New Highs".
Strike those last comments. I did not realize that the graph was of US investment...
I'd also be very interested in plots of other commodities. The cartel comment certainly makes sense. My knee-jerk intuition is that futures prices would be an informative way to distinguish between temporary and permanent shocks - although my impression is that commodity future prices aren't much different the spot rate.
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I believe there are a number of reasons for disinvestments not taking place when the prices are high. Party the disinvestments are hidden by shifting of assets from large companies to small companies. As the oil prices go up, the money starts flowing for investment in the industry. Mostly it is not cheap money. As such cash & resource poor companies are the primary target for this money. They raise the money at very high cost and buy the properties from major producers at very high prices. As the oil price goes down, a number of these small companies don't survive and the shareholders end up losing the money. At the next price spike the cycle starts all over again.
The major oil companies on the other hand are looking too far ahead and do not worry about oil price fluctuations. They can hold on to cash when prices are high or invest in the existing assets. They buy new assets only when the price fits their internal models.
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