Russell Roberts of Cafe Hayek gives several reasons why oil prices are falling over time (in real terms), countering the seemingly common-sense argument that they should rise at the rate of interest (if prices rise less, then sell your oil and by bonds). He points out that the transaction costs for selling oil – extracting it from the ground – are much higher than the transaction costs of selling bonds.
I think, however, he misses the most important aspect of this – that the cost of extracting oil is relatively low until you reach capacity – and then it goes way up, because it requires adding capacity. The economics of the situation strongly encourages pumping oil at capacity, making production relatively impervious to interest rates.
UPDATE – Russell Roberts writes: I actually think the capacity part is only a small part of it. There are search costs of finding new sources, extra costs of pumping oil from difficult spots and so on.
Believe it or not, I was actually thinking of these sorts of things when I said "adding capacity".
Posted by David Boxenhorn at May 20, 2004 11:16 AM