Thursday, January 27, 2005

Venezuela proves my thesis: Less can be more

In a previous post on resource wars, I said that oil industries that are state-controlled, directly or indirectly, are less likely to be concerned about developing oil reserves any faster than they need to in order to fund government spending for military and social programs. They also have little incentive to find and deliver great new gobs of oil onto the international market since this would only depress the prices they receive. I also discussed this phenomenon in more detail in my post called "Faith-based economics III: Why the market price doesn't tell us the true state of oil reserves."

The International Herald Tribune reports that Venezuela wants to renegotiate the terms of some of its agreements with private oil companies that operate in the country. In some cases the government is acting unilaterally and capriciously. One chief executive of a Houston-based oil company operating in Venezuela said he couldn't understand why the country would want to restrict investment and production. But, the reporters pick up on what's happening. Higher oil prices have more than compensated for declines in production and Venezuela realizes that small decreases in production or even keeping production flat will help keep world oil supplies tight. That will mean even more money for the country's state-owned oil company and from its existing agreements with private oil companies which, of course, translates into more money for government spending.

The logic is hard to see unless you understand just how sensitive the price of oil is to small changes in supply. Since everybody has to have oil, price hikes tend to be disproportionate to declines in supply. Under the right conditions such as those that prevail in the world oil market today, a smaller amount of oil sold can actually bring a higher total price than a larger amount of oil. Venezuela's president, Hugo Chavez, is no fool. He knows this and he's using it to his and his government's advantage.

He's probably getting help from other state-owned or controlled companies in Mexico, Saudi Arabia, Russia and elsewhere who realize the same thing and are making little effort to bring more oil to market.

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