Tag Archives: supply and demand

(Revised) The Lobster Cycle

When someone mentions lobster, this is what probably comes to your mind (as is the case for Greg Elwell of the Oklahoma Gazette): “Lobster is fancy. If you imagine a lobster talking, it probably has a British accent. Draw an animated lobster and I bet you’ll include a top hat, a monocle, and an opera cape.” This is a fantastic description. However, this may no longer be the case. The supply of lobster in the United States has shot way up. And you know what that means: falling prices (thanks, Econ 101). In fact, the supply of lobster has increased 80% over the past five years. With such a large increase in supply, it is quite obvious that prices would have to fall. Fishermen in Maine have received less than $3 per pound of lobster sold on average over the past two years compared to a high of $4.63 per pound in 2005.

With falling prices, many restaurants, including fast food chains, are finding it easier to find a place in their budget for some (or additional) lobster items on the menu. This list includes Quiznos and Golden Corral, which added lobster to its menu this year for the first time ever. That being said, would you really want to eat lobster from a fast food sandwich shop or a buffet style restaurant like Golden Corral? Let’s think about the history of the lobster and how it became such a delicacy.

Basically, lobster started out as a food served only to servants and prison inmates because it was so plentiful and cheap. The most common place it came from was Maine, on the coast. In general, people farther inland in the U.S. had never heard of lobster. Eventually, lobster was served to passengers on inland trains (still because it was cheap), but the passengers didn’t know what it was so they thought it was a rare, exotic meal. They began to love it and thus lobster became a very popular food. There were several more ups and downs for lobster’s status involving the Great Depression and World War II, but ever since then lobster has been beloved (and very expensive). This story, as an example, is very insightful within the realm of economics as a way to explore how preferences, and the changing of preferences, relate to prices.

Based on this history, are we in for another period of lobster being a food for the poor? It actually does not look this way. Nowadays, even when lobster prices fall, most restaurants unfortunately do not reduce their menu prices because they know very well that diners will pay top dollar for this delicious sea creature. However, rather than simply serving a whole cooked lobster or a lobster tail, many chefs have been adding lobster to the menu in other ways, such as in pasta dishes, salads, and in sauces, among other manners. This has become more common over the past few years with more affordable wholesale prices for lobster.

If you want to take advantage of these lower prices, look no further than Whole Foods and Wal-Mart. Both of these retailers have added frozen lobster tails and cooked whole lobster to their inventories, and actually have dropped their prices for consumers as their costs have gone down with the rise in supply.

It is crazy to think that lobster was ever “food for the poor” and served to servants and inmates. There is even a rumor that in Massachusetts during the 1600s, a contract was made up so that servants could not be served lobster more than 3 times a week. That sounds so incredibly backwards. Little did they know they were eating what would become a luxury food a couple hundred years later. I suppose the status of certain foods such as this can change over time, which has certainly been the case. And even now with falling prices, lobster is being offered in way more places and in way more dishes than any time in recent memory. I personally would not trust lobster from Quiznos or Golden Corral, but if you do, all the power to you. It will be interesting to see how the supply and price of lobster changes moving forward, and if restaurants will become even more creative with their utilization of lobster on menus around the country. In the end, until consumers stop purchasing lobster in restaurants at the current, expensive prices (and I don’t see this happening), restaurant owners will have no reason to lower prices, and lobster will never revert to being a “food for the poor” again.

Could A Sour Bean Save the World’s Cocoa Supply?

According to the Wall Street Journal, confectioners and recently broken up singles around the world may be able to breathe a sigh of relief. After fears that growing demand for chocolate in emerging markets and supply constraints in Brazil and Africa would cause a global shortage of cocoa beans, an unusual strain of beans may soon be a chocoholic’s savior.

According to Leslie Josephs of the Wall Street Journal, a high-yielding Ecuadorian variety of cocoa beans called CCN 51 may help ease the looming cocoa shortage. Josephs explains that the CCN 51 plant can produce up to four times as much cocoa as the world average. This is an important This high productivity comes at a cost, however, as the variety produces more pulp in addition to the higher yield of beans. Cocoa beans must first be fermented for around 4-6 days before its flavor fully develops, and the excess pulp typically causes the chocolate to take on a slightly sour or acidic taste. Although it may dismay many picky high-end confectioners who use only high-quality cocoa beans, the CCN 51 variety may ease supply constraints for big players in the market. For large chocolate makers, a highly productive variety is important because of the large sunk cost of planting and growing the cocoa plants, which unlike other commodities like corn or cotton takes around 4 years before the existing trees can become productive. Furthermore, the larger pods and increased bean yield of the CCN 51 variety makes it an ideal candidate to produce cocoa butter, which has nearly doubled in price over the past year.

Screen Shot 2014-03-20 at 12.03.07 AM

Supplies appear to be threatened in several key cocoa producing countries. For instance, cocoa production in West Africa has been tight due to unseasonably dry weather. Furthermore, “sap-sucking insects” called capsid bugs have threatened cocoa crops in Cameroon, infesting thousands of cocoa farms in the country and causing diseased cocoa trees to atrophy. These factors are set to dramatically reduce global cocoa production, as the West African region including Cameroon, Ghana, and the Ivory Coast supplies 70% of the world’s cocoa.

In addition, demand for cocoa has only increased in recent years, particularly in emerging markets such as in China where demand is expected to rise 5% annually through 2018. According to the International Cocoa Organization, demand for cocoa is predicted to surpass production for the next 5 years, which suggests a dramatic increase in price may follow.

While many chocolate lovers worry about getting their “cocoa-fixes” in the future, the intersection of the increase in demand and diminishing supply has some interesting implications in the cocoa market. First, as anyone who has taken Econ 101 may know, the increase in global cocoa demand will shift the demand curve out/right, while the decreasing supply will cause the supply curve to move in/left, and the combined effect would be an increase in the equilibrium price of cocoa beans and an ambiguous effect on the equilibrium quantity. Since it takes somewhere between 4 and 10 years to create a new, productive cocoa plantation, we may also expect the equilibrium quantity of cocoa beans to not change much.

Where this gets more interesting is in the market for cocoa futures contracts, which are simply contacts that state that the owner is obligated to pay a $X for Y tons of cocoa beans on a set date Z. This allows the cocoa producer to “lock in” a stable price for their product so they don’t have to worry about wide swings in the price of cocoa around the time of harvest. Futures contracts can be traded on the market and their price fluctuates just like any other financial product, meaning that you might not always pay face value for the contract. As an oversimplified example, if a one month futures contract states that you may buy 1 ton of cocoa beans for $2500/ton, but the global price of cocoa beans has risen to $3000 a ton, someone may pay $2900 for this contract and the rights to pick up 1 ton of cocoa one month from now , which would allow the buyer to make an immediate profit ($2900 for the contract, sell the cocoa for $3000 = make a profit of $100). For those who are interested, a basic pricing equation for futures is F(t,T) = S(t) * (1+r)^(T-t), where S(t) is the spot price (the price you are buying the asset for) at time t, r is the interest rate, and T is the maturity date (time at which you are obligated to make the money for asset exchange).

Screen Shot 2014-03-20 at 12.02.43 AM

Futures prices don’t only trade based on the current price, they often reflect the market’s view of what will happen to the price in the future. So if the price of an asset is relatively unchanged, while the futures price dramatically increases, it might be wise to suggest that the market anticipates that there will be a large increase in the price of the asset in the future. If we look at the cocoa futures market for the past few months, we see that there has been a dramatic increase in the price of the cocoa futures contracts, which corresponds to the anticipated shortage of cocoa that many journalists have been reporting. Since January, cocoa futures have risen in value from $2700/ton in January of this year to $3030.33 as of March 17th 2014. Therefore, despite its high-productivity, it appears that the cocoa market is not yet counting on the CCN 51 variety of cocoa to be a savior of the global cocoa supply in the near future.

The Lobster Cycle

When someone mentions lobster, this is what probably comes to your mind (as is the case for Greg Elwell of the Oklahoma Gazette): “Lobster is fancy. If you imagine a lobster talking, it probably has a British accent. Draw an animated lobster and I bet you’ll include a top hat, a monocle, and an opera cape.” This is a fantastic description. However, this may no longer be the case. The supply of lobster in the United States has shot way up. And you know what that means: falling prices (thanks, Econ 101). In fact, the supply of lobster has increased 80% over the past five years. With such a large increase in supply, it is quite obvious that prices would have to fall. Fishermen in Maine have received less than $3 per pound of lobster sold on average over the past two years compared to a high of $4.63 per pound in 2005.

With falling prices, many restaurants, including fast food chains, are finding it easier to find a place in their budget for some lobster items on the menu. This list includes Quiznos and Golden Corral, which added lobster to its menu this year for the first time ever. That being said, would you really want to eat lobster from a fast food sandwich shop or a buffet style restaurant like Golden Corral? Let’s think about the history of the lobster and how it became such a delicacy.

Basically, lobster started out as a food served only to servants and prison inmates because it was so plentiful and cheap. The most likely place it came from was Maine, on the coast. In general, people farther inland in the U.S. had never heard of lobster. Eventually, lobster was served to passengers on inland trains (still because it was cheap), but the passengers didn’t know what it was so they thought it was a rare, exotic meal. They began to love it and thus lobster became a very popular food. There were several more ups and downs for lobster’s status involving the Great Depression and World War II, but ever since then lobster has been beloved (and very expensive).

Based on this history, are we in for another period of lobster being a food for the poor? It actually does not look this way. Nowadays, even when lobster prices fall, most restaurants unfortunately do not reduce their menu prices because they know very well that diners will pay top dollar for this delicious sea creature. However, rather than simply serving a whole cooked lobster or a lobster tail, many chefs have been adding lobster to the menu in other ways, such as in pasta dishes, salads, and in sauces, among other manners. This has become more common over the past few years with reduced prices for lobster.

If you want to take advantage of these lower prices, look no further than Whole Foods and Wal-Mart. Both of these retailers have added frozen lobster tails and cooked whole lobster to their inventories, and actually have dropped their prices for consumers as their costs have gone down with the rise in supply.

It is crazy to think that lobster was ever “food for the poor” and served to servants and inmates. There is even a rumor that in Massachusetts during the 1600s, a contract was made up so that servants could not be served lobster more than 3 times a week. That sounds so incredibly backwards. Little did they know, they were eating what would become a luxury food a couple hundred years later. I suppose the status of certain foods such as this can change over time, which has certainly been the case. And even now with falling prices, lobster is being offered in way more places and in way more dishes than any time in recent memory. I personally would not trust lobster from Quiznos or Golden Corral, but if you do, all the power to you. It will be interesting to see how the supply and price of lobster changes moving forward, and if restaurants will become even more creative with their utilization of lobster on menus around the country.

Is Yuan going to raise?

Chinese Yuan raises again. Starting from mid-February, the dollar-Yuan exchange rate increased from below 6.06 to 6.10. I think that this change reflects the trends of Yuan and dollar in the future, Yuan will depreciate while dollar will appreciate. This changes in the exchange rate is backed by several reasons.

First, expected real estate market collapse in China. It is well known that China’s real estate market has a problem ever since 2008, the over investment leaded by the government and pushed by lots of big real-estate developers raised the price of Chinese houses rapidly and made them unaffordable to ordinary people. The demand for high-price houses is far lower than the supply, the bubble was already formed and kept increasing over time. At the end of 2013, LI Ka-shing, the richest tycoon in Hong Kong surprisingly withdraw from the Chinese property market, which is interpreted by some investors as the signal for the bubble to burst. The crashing down of the Chinese real estate market will bring China’s economy into big recession, which will lead to the dramatic depreciation of Chinese Yuan. So it is possible for international investors to quit Chinese market and waiting for the day.

Second, the tapering in US leads to capital withdrawal from developing countries and return to the US, which means more demand for dollar in US. And this will definitely appreciate dollar and make it relatively expensive compares to Chinese Yuan. The market is estimating that Fed will raise the rate in the foreseeable future, no matter what, the signal sent by the Fed will change the investors’ actions, which means the demand for US dollar will raise in the near future and this appreciates dollar in terms of Yuan. According to this WSJ article, tapering could lead to the stop of increasing in Hong Kong’s property prices. Once the prices of property in Hong Kong stop increasing, it will also change the price estimation in the China mainland, and then makes the investment in China not so promising. Eventually, investors will quit investment in China and depreciate Yuan.

And there is another reason why the raising in Yuan could be reasonable. China’s center bank is known to manipulate its exchange rate in order for Yuan to keep a relative advantage to increase the country’s export. In the past few years, China is required by US to appreciate its currency in order to inverse the trade decifit of US. However, China is always want to depreciate Yuan. According to this article in the WSJ, Chinese center bank catches the opportunity when the dollar is raising, it depreciated Yuan in order to increase export and improve the GDP.

Anyway, the market determined that dollar should raise and Yuan should be depreciated in the future, we can expect further news about this.

San Francisco – Almost the Perfect City

As a bay area native, I love San Francisco.  Growing up just north of SF, I fell in love with San Francisco’s diverse spectrum of people, amazing scenery, and beautiful weather (most of the time).  But as a soon-to-be college graduate starting his career in San Francisco, I now see what’s not to love about “The City” – housing.

The median home price in San Francisco is a whopping $900,000!  Consequently, most people living in SF choose to rent instead of own.  But from a tenant’s perspective, the SF rental market is progressively getting worse and worse.  In 2010, the median rental price in San Francisco was $2,968 per month.  Three years later, this median monthly price grew to $3,414, over a 10% increase.  From 2013 to 2014, median prices jumped another 16% to nearly $4,000 per month.  And this huge increase in prices will certainly effect me.  According to my future employer, the average first-year consultant pays around $1,500 a month for rent.  This is quite a bit more than the $450 I pay now in Ann Arbor!

So what could be causing this tremendous increase in rental rates?  After examining the market, this question can be answered with a basic supply and demand model.  In San Francisco, the demand for rental housing is increasing at an extremely fast pace while supply is essentially flat.

There is an obvious reason that demand is booming in the SF rental market: the job market is booming in San Francisco and the greater Bay Area.  As Silicon Valley and the tech sector continue to grow (the Bay Area is home to Google, LinkedIn, Twitter, Facebook, Zynga…the list goes on!), more and more employees are entering the SF housing market.  According to Janan New, the executive director of the San Francisco Apartment Association, San Francisco alone added 52,000 new jobs in 2012 (and this number does not even take into account the jobs added in the surrounding areas like Mountain View).

But while demand is increasing, supply is not.  While SF added 52,000 jobs in 2012, New also asserts that only 126 net rental units were added to the housing market.

Given the demand for housing in San Francisco, why isn’t supply increasing?  Does the market simply need time to adjust to a new shift in demand?  To some extent, yes.  Like any market, time is necessary for supply to catch up with demand.  But time is not the only thing standing in the way of more rental units and lower rental prices in San Francisco.  Interestingly, legislation designed to protect SF tenants is keeping landlords from investing in additional housing.

Given the liberal political environment that characterizes the bay area, it should come as no surprise that San Francisco’s housing market greatly favors tenants.  Strict anti-landlord housing laws make “habitable” conditions in San Francisco extremely expensive to maintain.  Accordingly, many “Mom & Pop” landlords (those who don’t own large swaths of apartment buildings, but are renting one or two units) can’t afford to maintain their units.  As such, these landlords choose to leave their units empty, which is allowed by a law known as the Ellis Act.

Strong rent control is further adding to the limited housing supply in San Francisco.  Given the extremely expensive real estate and the strong anti-landlord laws in The City, many landlords choose not to invest in new units because doing so is too expensive.  As  a result, rent caps, designed to protect renters, ultimately drive up prices by decreasing the supply of available units.

In a New York Times article, Scott James, a San Francisco landlord, explains the rationale and side effects of San Francisco’s legal code.  He states that:

 I’ve recently joined the ranks of San Francisco landlords who have decided that it’s better to keep an apartment empty than to lease it to tenants. Together, we have left vacant about 10,600 rental units. That’s about five percent of the city’s total — or enough space to house up to 30,000 people in a city that barely tops 800,000….after renting out a one-bedroom apartment in my home for several years, I will never do it again. San Francisco’s anti-landlord housing laws and political climate make it untenable.

James makes it obvious that something in the SF housing market needs to change.  And local government officials realize this.  The city and large real estate firms are already in the process of sponsoring and investing in huge apartment developments that should greatly increase the supply of housing in San Francisco and hopefully bring down rates for futre renters like me.  Nevertheless, the rental-housing crisis in San Francisco exemplifies that limiting the free market in order to protect consumers can backfire.  As a future SF tenant, I personally wish the government would spend more time and effort addressing other issues instead of trying to protect me from landlords.

(revised) Big-bet Strategy of Oil Companies

Gorgon is the name of the sister of Medusa – the monster with snake hair and eyes that can turn man into stone. Representing both powerful and dangerous, the name Gorgon was also used by Chevron for its all-time largest project in Australia.

By far, Chevron has invested $18 billion into this gargantuan project in terms of its 50% stake (Exxon and Shell took 25% stake for each). But this big-bet of Chevron hasn’t provided any profit for its owners yet, and it is only 75% finished up to now. Sounds like a crazy risky plan, but this project is just one among the $120 billion investment plans operated in 2013 by the team made up of Exxon, Shell and Chevron for the purpose of spurring oil production in the future.

So what are the incentives behind such risky mega scale investment actions conducted by those three big international oil companies? It isn’t news that they arrived late to the shale boom in America so they have to watch the new market divided up by small companies. United States hold more than half of the shale oil reserve in the world, so companies lost the biggest opportunity to earn the huge amount of profit.

But there is still chances left in Asia, they seek opportunities in Australia to keep control in advance of the undeveloped shale gas resource. Gorgon is one of the projects in Asia, which is the key to the promise made by Chevron to boost gas production by 20% before 2017.

The next reason is the increasing demand from Asia markets. Japan, China and South Korea are becoming hungrier for natural gas over the last decades, so big oil firms still believe that the energy market is not going to fail on the demand side.

What’s more, oil giants are facing tremendous challenges now that is they have to find the next big gusher to replace their depleted fields. The golden age for companies has passed, the truth now is that they must stake big to bet their future. And if they don’t, then they are going to shrink for sure. Chevron produce less in the past few years, Shell also declines its earning from the $27.2 billion in 2012 to the $16.8 billion in 2013. Investing in the “elephant projects” like Gorgon is their only choice.

But just like the name of Gorgon – powerful and dangerous, big investment are always risky in several aspects. First, exploration of new oil fields are difficult and expansive nowadays: labor cost soars high, competition becomes fiercer and new oil fields’ extraction is more costly. Just like it is indicated in the article Big Oil Companies Struggle to Justify Soaring Project Costs:

The easiest-to-reach oil ran dry long ago, and the most prolific fields often are controlled by state-owned companies in places like Saudi Arabia and Venezuela.

Second, the investment surge will definitely reduce the liquidity of the companies, big projects may be profitable in the long run, but it also worse the current financial statements. Third, the profitability of the investments is still doubtful, from the article Chevron Bets Big on Australian Shale Given Asian Demand, we can read this kind of uncertainty:

The deal poses some risks as the country’s shale resources are very underdeveloped, and it will take years for Chevron to finish with exploration. It is still uncertain whether the gas can be extracted at commercially viable prices.

However, I believe those oil giants are not going to quit despite of those risks above, they would definitely loss the war if they quit right now. Let’s check if they can win on their expensive bets in the future.

news about oil price

Today WSJ released a news, OPEC anticipated that the recent recovery of US and EU’s economy situation may result in oil demand raise in the future. But it also pointed that the turmoil in emerging markets could implies an opposite result on the prediction.

The main push forces of global oil demand are from developing countries like China and Brazil. According to OPEC’s report, the oil demand growth for this year will be 50,000 barrels a day, and the most increase in demand is from China, the number 2 oil consumption nation.

In my opinion, developed countries are never the main long-term push forces for the global oil demand. EU’s oil demand may contribute a lot in the raising demand as the result of the economic rebound, but US has its own strategy of replacing all oil import by domestic shale oil production. So unless some problems unexpectedly incur in the process of domestic production, the demand of oil import will decline in US for sure.

Speak of the devil, this article-U.S. Oil Prices Rise as Cushing Supplies Fall-reported some kind of emergent situation in US domestic oil supply:

Crude-oil supplies in Cushing fell by 2.7 million barrels to 37.6 million barrels, a three-month low, in the week ended Feb. 7, the U.S. Energy Information Administration said Wednesday. The drawdown was the largest weekly decline since July

However, according to the article, this temporally fall in supply was caused by nothing but “Without sufficient transportation capacity connecting the new sources of oil to existing refineries, much of that supply has been stuck in storage in Cushing.” So we can see that this is only a short period supply shortage, which will not affect the long-term trend.

Even though the potential increase in demand from China, I still think that the total demand of developing nations is weaker. From the economic point of view, demands from developing countries are expected to go downside because of the troubles in emerging markets. From the currency’s point of view, Fed’s tapering of its QE will worsen the inflation situation in emerging market countries, which means comparatively those oil import nations’ currencies are more and more worthless now. The weak currency purchase power compare to the higher oil price will result in the future decline in aggregate oil demand.

It is said that global oil price has as inverse ratio to the dollar index because the world’s staple commodities are priced in the unit of USD, so if US dollar appreciate relative to other’s countries’ currencies, the price of oil may decrease. If this is true than the price of oil will still stays high until the raise of interest rate in US, which seems to be unrealistic now.

Overall, the global oil price will experience more shocks this year. And I think that in the short term the price may rise a little, however, since the upside is blocked, the price will experience decline in the long-term.

Is raising the minimum wage a good idea?

The president proposed to increase minimum wage in the New Year, he suggested to increase it from $7.25 to $10.10. Actually this is not the first time for him to make such a call. Last year Obama also called for increasing minimum wage from $7.25 to $9. The president also pointed that lift the minimum wage can help to accelerate low-income people out from poverty.

Actually this policy will hurt those the government initially intends to protect. The minimum wage is not the poor-saving tool, any kind of over use of it may bring in the opposite effects. Some people argues that increase the minimum wage will also boost the unemployment rate, others disagree with that. So let’s check it out:

Min Wage

From this we can see that from the year 1979 to 2009, the minimum wage was kind of proportional to the unemployment rate. Whenever the real minimum wage steps up, the unemployment rate soars high, even the real minimum wage showed this patterns, too. The intuition behind is simple, whenever the minimum wage raised, the costs for employer to employ also increased, so employers tend to hire less workers. Also employers’ expectation for the new workers’ skills raised, which means they want new workers to be as skillful as the employees with higher wages. Then employers will find less people who are qualified for their requirement, so the employment rate declines as a consequence.

Obama was wrong because his original intention is to help more people from poverty, let’s forget about whether earn $3 more per hour will really help poor people a lot. However, for me the unemployment problem is much more significant and urgent. Having a job with $1 per hour is much different from jobless, and have two person both get a job with $5 per hour is better than pay one with $10 per hour and leave the other unemployed.

What’s more, raise the minimum wage will produce another serious problem; hurt the young workers. “Increasing the minimum wage is effectively creating a uniform, government workforce; one level, one pay. As we close the gap between minimum wage and a firm’s starting wage, we lessen the ability to hire younger untrained talent” Just as Richard Duncan remarked, “When the minimum wage increases, we put more demands on the outcome and performance of the new emerging workforce. This leaves youth and the entry-level workforce less opportunity to enter.” More and more young workers will have less and less opportunities as minimum wage raises.

I also think that adjust minimum wage is the kind of affairs that shouldn’t be manipulated by the government too much. We all know the story that Henry Ford’s $5-a-day revolution. Companies do have the incentive to raise wages once it is needed by the market. It is true that minimum wage is a good method for human right protecting purposes, but if it leads to higher unemployment rate then I think it’s not worthy to do it.

First price, next reserves

Do you know that you misunderstand the word “reserves”?

Let’s solve a math problem. If the world oil reserves are 639 billion barrels, and the world oil production is 59 million barrels per day, then when will we run out of all the oil? I did the calculation for you, the answer is 29 years. But actually those are the data in 1980, if my calculation was correct then there must be no oil left in 2009, so what’s wrong with it?

Capture

Captureh

If we check the graph from indexmundi.com above, we can see the world oil reserves are 1.451 trillion barrels and the daily production becomes 73 million barrels in 2011, after calculation you will find that it takes another 54 years for us to “run out” of those oil. According to BP, the world oil reserves increased to 1.67 trillion barrels in 2012. So you know now, we can never get the precise prediction due to the change of oil reserves.

Before I explain why the reserves changes so dramatically, I need to define the word “reserves” to answer the question at the beginning of this post. Reserves are the energy resources that can be produced in the future under current economic and technology condition. So, different from physical stock, “reserves” is a concept about economy and technology, not geology. For example, a new oil field is discovered, but extraction procedure will cost you $1,000 per barrel, than there is no possibility that somebody will produce those oil in the future under current oil price, because there is no revenue at all, so we can’t call the oil in this oil field as oil “reserves”. In another example, you know one place in the world may stores massive oil, but the discovery cost exceeds your minimum profit expectation, then this will never be your investment choice, the result is nobody knows if there exists oil reserves or not. The definition of reserves also suggests that the rise of price and the advance of technology will turn more unexploitable oil resources into oil reserves.

This case for oil is not the only example about energy reserves. In 1800s, people in UK worried that they would run out of coal one day. Now there are countless coal staying underground, but nobody worried about them now and no one is going to extract them, because they are not reserves anymore – oil and natural gas have out compete coal in the energy market in UK. It cost more and earn less revenue to extract those coal comparing exploit oil. That’s why I say “first price, next reserves” in the title. Relative price determined whether the energy resource can become reserves – after that, you can start worrying whether it will run out in the future. When the price is high enough, the revenue will also be sufficient for people to discover energy resources and extract that. And when you own advance enough technologies, you can turn cost relatively low, which is same as set a higher piece.

As I know, shale oil is not something that has been discovered recently in US. In late 1900s, Exxon started the colony shale oil project in US. And at the day of May 2, 1982, the so called “Black Sunday”, oil price dropped dramatically and Exxon quit that project.

The price is everything to the market, even you have resources and technology, if the price is low, then everything is done, no investment will be made.

Big-bet Strategy of Oil Companies

Gorgon is the name of the sister of Medusa – the monster with snake hair and eyes that can turn man into stone. Representing both powerful and dangerous, the name Gorgon was also used by Chevron for its all-time greatest project in Australia.

By far, Chevron has invested $18 billion into this gargantuan project for its 50% stake, Exxon and Shell took 25% stake for each. But this big-bet of Chevron hasn’t bring any profit for its owners yet, and it is only 75% finished up to now. Sounds like a crazy plan, but this project is just one among the $120 billion investments operated in 2013 by the team made up of Exxon, Shell and Chevron for the purpose of spurring oil production in the future.

So what are the incentives behind such risky mega scale investment actions conducted by Exxon, Shell and Chevron? It isn’t news that those big oil monopolists arrived late to the shale boom in America and they have to watch the new market divided up by small companies. United States hold more than half of the shale oil reserve in the world, so monopolists lost the biggest opportunity to earn the huge amount of free money. But there is still chances left in Asia, they seek opportunities in Australia to keep control in advance of the undeveloped shale gas resource. Gorgon is one of the projects in Asia, which is the key to the promise made by Chevron to boost gas production by 20% before 2017. The next reason is the increasing demand from Asia markets. Japan, China and South Korea are becoming hungrier for natural gas over the last decades, so firms still believe that the energy market is not going to fail on the demand side. What’s more, oil giants are facing big challenges now that they have to find the next big gusher to replace their depleted fields. The golden age for monopolists is passed, the truth now is that they must spend big to bet their future. And if they don’t then they are going to shrink for sure. Chevron produce less in the past few years, Shell also declines its earning from the $27.2 billion in 2012 to the $16.8 billion in 2013. Investing in the “elephant projects” like Gorgon is their only choice.

But just like the name of Gorgon – powerful and dangerous, big investment are always risky in several aspects. First, exploration of new oil fields are difficult and expansive nowadays: labor cost soars high, competition becomes fiercer and new oil fields’ extraction is more costly. Just like it is indicated in the article Big Oil Companies Struggle to Justify Soaring Project Costs:

The easiest-to-reach oil ran dry long ago, and the most prolific fields often are controlled by state-owned companies in places like Saudi Arabia and Venezuela.

Second, the investment surge will definitely reduce the liquidity of the companies, big projects are profitable in the long run, but it also worse the financial statements. Third, the profitability of the investments is still doubtful, from the article Chevron Bets Big on Australian Shale Given Asian Demand, we can read this kind of uncertainty:

The deal poses some risks as the country’s shale resources are very underdeveloped, and it will take years for Chevron to finish with exploration. It is still uncertain whether the gas can be extracted at commercially viable prices.

However, those oil giants are not going to quit despite of those risks above. Let’s check if they can win on their expensive bets in the future.