A higher oil price would increase incentives to develop new oil resource extraction, but it also increases the competitiveness of sustainable energy sources.

Conversely, a low oil price might mean less development of new resource extraction, putting projects such as hydraulic fracturing or offshore Arctic drilling on hold.

What I wonder is: what oil price will lead to the lowest level of new resource extraction? Or, in other words: suppose that I strongly oppose the development of new resource extraction with potentially very high environmental costs (such as hydraulic fracturing or Arctic offshore drilling), should I be glad when oil prices or low... or when they are high?

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    $\begingroup$ (I know economists sometimes use the word production. As a physicist, I find the word production in this context completely incorrect. Oil is not produced — it is destroyed, which is the exact opposite of destruction.) $\endgroup$ – gerrit Feb 2 '15 at 19:02
  • $\begingroup$ You should consider higher fossil fuel taxes for making you happy: providing more profit opportunites for alternative energy industry and less demand for oil. $\endgroup$ – snoram May 12 '15 at 23:38
  • $\begingroup$ @snoram Right, but prices fluctuate with or without taxes. $\endgroup$ – gerrit May 13 '15 at 10:47
  • $\begingroup$ Of course, just pointing out another means to your end. However, in the short run at least, a higher tax (in say US) would lower world demand and therefore price. $\endgroup$ – snoram May 13 '15 at 14:12

Let us just assume, without any loss of generality, that it is OPEC nations who can produce oil most cheaply. That is, the cost per barrel for all OPEC nations is homogeneous and is lower than the cost per barrel for any other oil producing nation or entity.

Then OPEC can continue to allow the price of oil per barrel to fall until other oil producing nations and entities are not gaining enough revenue to cover variable costs. This is because, in general, a firm will shutdown whenever marginal revenue is lower than average variable cost at the profit maximizing output.

For example, If US oil companies have total costs of 20 US dollars per barrel of oil and half of those are variable but they can only sell a barrel of oil for 9 dollars, then the US firm will stop producing oil. This is because continuing to extract oil causes larger loss than not extracting oil. If, however, the company could sell a barrel of oil for 12 dollars, they would continue extracting oil since doing so would 'eat away' some of the fixed costs.

The techniques you mentioned do cause oil producing entities to incur significantly higher costs than most OPEC nations. And most economists interpret OPEC's decision to not cut production as a predatory strategy meant to drive out marginal producers.

If you are seeking a concrete numbers, you could probably find some company reports and do a bit of math to calculate these things and develop a rough estimate of what price-per-barrel might cause these firms to make the shutdown decision.

So to actually answer your final question:

You should probably be happy that oil prices are falling. Those techniques are expensive. If oil continues its downward plunge most of those marginal producers will have to exit the market.

Something to consider is what this might mean over a longer time horizon. If many of these firms leave infrastructure in place (meaning there are relatively low barriers to re-entering the market), they could do a bit of hit-and-run until oil prices once again fall. This is assuming this situation arises while they are still incurring some fixed costs and are therefore seeking to minimize losses. Or perhaps it rises enough for them to even eek out a bit of profit etc. Perhaps not.

  • $\begingroup$ Citation or revision needed: "And most economists interpret OPEC's decision to not cut production as a predatory strategy meant to drive out marginal producers" $\endgroup$ – snoram May 12 '15 at 23:32

An oil price of 0 will make any extraction of oil unprofitable and hence imply no further oil extraction.

You should think about how prices carry signals. A low oil price (even if not 0) carries the signal that we, as society, do not value that oil as much. The conclusion is imminent.


What would be economically most efficient is that for the price of oil to reflect all its costs, including all the pollution costs. A price that high would destroy a lot of demand, and incentivise all the cleaner alternatives with less need to subsidise them.

Professor Jeff Sachs has spoken emphatically of the advantage of a low oil price, for the COP21 negotiations. Firstly, it makes a lot of the existing resource uneconomic. And secondly, it cuts oil companies profits; they are a very powerful, very vocal lobby, and deep cuts to their revenue weakens them.

So, low prices received by producers is good, because it will minimise new resource extraction (and exploration); and high prices paid by consumers is good (because it reduces oil consumption). And the gap between the two is optimally filled by a carbon tax across all greenhouse-gas emitters.


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