An Economist Looks at the E-Cat (Part Three): How Will the E-Cat Impact Oil Prices?

This is the third post in a series written by Paul Bennett, PhD candidate in economics at George Mason University.

What will the E-Cat’s impact be on the trajectory of the price of oil?

As discussed in previous posts, the price of oil is much higher than the extraction costs of the most easily extracted reserves. The owners of these reserves are taxing the oil and accumulating enormous wealth. It is interesting to speculate on what will happen to the price of oil over time.

Imagine that you are the king of Saudi Arabia. You own a large percentage of the world’s most easily extracted oil reserves. You have persuaded the OPEC nations that they should participate in a scheme to raise the price of oil at the rate that optimizes revenue for them and you by balancing the rate at which they allow oil to be delivered to the advanced economies with the need to avoid destroying economic growth. (In the 1970s, they got greedy and raised the price so rapidly that they caused a global recession.)

Part of the reason they can keep the price of oil high is the fear that we will run out of oil at some point in the future. To some extent, the price they can achieve is limited by the cost of extraction of reserves that are more difficult to extract. Deep sea drilling and oil shale deposits can be used as sources of oil, but the cost of extraction is much higher than for Saudi Arabian reserves. OPEC can drive prices up to maximize the net present value of their wealth, but only to the level at which oil companies can extract oil from the other sources profitably.

Now consider what happens when the E-Cat comes along. Suddenly the fear of running out of oil is gone. The fear of running out of nickel is many years, if not centuries, in the future. The king of Saudi Arabia and the rest of OPEC now have a very different maximization function. The expected market price of oil five years from now is certainly no more than the price that would make energy from oil the same price as energy from the E-Cat. I will call this the Oil-E-Cat equilibrium price for future reference. Suppose for the moment that even the most easily extracted oil cannot be extracted for this price. The king of Saudi Arabia is now faced with the reality that any oil not extracted within five years is going to be worth no more than the sands of his desert. He will certainly react by pumping a lot more oil and charging a lot less.

If he charges more than the Oil-E-Cat Equilibrium Price, he is just providing an incentive to the world to convert to E-Cats faster than they would otherwise. So I expect that he would lower the price to what he anticipates the Oil-E-Cat Equilibrium price to be. The result is that the energy price benefit expected from the E-Cat is achieved almost overnight! In short, I expect the price of oil to drop precipitously as soon as the oil market players understand the real potential of the E-Cat. Any of you gamblers out there, if you really believe that the E-Cat is as good as it looks, now is the time to sell oil futures short.

Paul Bennett

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