1. Economics of abiotic resources

2. Non-renewables
Fossil Fuels
Minerals
Land

3. The Hubbert curve-discovery

4. The Hubbert curve-production

5. The Hubbert curve (cont.)
Production requires discovery
Peak discovery year was 1969
Operating at net deficit since 1980s
Depends to some extent on how you measure reserves

6. Price trends of oil

7. Why aren’t oil prices increasing?
Scarcity effect and information effect
Traditional theory
A dose of reality

8. Scarcity effect vs. information effect
Discovery is followed by production
Production increases scarcity
Discovery provides information, increases known reserves
Information can counterbalance use=depletion for a time

9. Marginal extraction costs
Easiest to extract deposits extracted first, therefore should become increasingly expensive to extract. Why then do resources get cheaper?
Are easiest to extract deposits discovered first?
What has happened to the size of discoveries over time?
Technology can reduce costs
Energy costs of extraction increase, more limiting than financial costs.
What does this tell us about Exhaustibility?

10. Efficient extraction- Static efficiency
Maximize profits in current time period
Increasing marginal extraction cost

11. What about scarcity?
Marginal extraction cost increases over time

12. Efficient extraction Dynamic efficiency
What happens when the resource starts to run out?
Does it make sense to produce for zero profit in this time period?
Profit maximizing extraction in this time period while accounting for profits in future time periods
Maximization of Net Present Value

13. Intertemporal valuation and discounting
What is discounting?
Compounded interest in reverse.
What would you rather have, $1000 now or $1000 in five years? Why?
How economists value future benefits now
Discount rate
Many justifications for discounting, therefore many possible rates
Discount factor: (1/(1+r))t

14. Example

15. How is discounting used?
Cost-Benefit Analysis: NPV=(Bt-Ct)/(1+r)t

16. Justifications for discounting
opportunity cost
Returns on investments
Time preference for consumption
Impatience
Eat drink and be merry, for tomorrow we die
Consumer sovereignty
Theoretically equivalent to opportunity cost

17. User cost
If oil supplies are finite, then if we extract and use oil now, that reduces the amount left to extract and sell in the future.
Assumptions:
Use = depletion = growing scarcity
price reflects scarcity
Prices are increasing over time
If we extract the resource now, we lose the opportunity to extract it in the future, at which time it will have a higher price. The value of this lost opportunity for future profits is User Cost. It is a real cost of production.
User Cost= opportunity cost of producing now instead of in the future

18. Marginal user cost
Marginal User Cost = opportunity cost of producing one more barrel
The more we extract now, the lower the price is in the current period (greater current supply=lower current price)
The more we extract now, the less we have next year, and the higher next year’s price will be (lower future supply= higher future price)
This means that each additional unit of production has a higher user cost than than the previous unit, so MUC is increasing with total production.

19. MUC and production by firm
The individual producer takes prices as fixed, and produces
until marginal benefit (price) = marginal private cost

20. Other definitions (meanings) of Marginal user cost
Marginal user cost = user cost from additional unit
User cost is value of resource in the ground
Resource has value because it is scarce. Remember diamond water paradox
User cost is unearned economic profit
No one created resource in ground, therefore profit unearned
User cost = royalty (how much resource owner can charge producer)

21. How fast should MUC increase?
$$ in future worth less than $$ in present
NCE: In profit maximizing equilibrium, MUC increases at same rate as discount rate
Pt = MECt + MUC0(1+r)t
Treat resource as an investment
If MUC increases slower than interest rate in bank (discount rate), then extract resource now and invest profit in the bank
If MUC increases faster than interest rate in bank, then leave the resource in the ground as a more profitable investment

22. Can we measure marginal user cost?
Theoretically, MUC = price - extraction cost
For this to be true, each individual producer would have to know how much of the resource exists.
Price is intersection of supply and demand, but we do not know the supply.

23. Price in future determined by Supply and Demand: What is future demand?
Substitutes reduce demand
Technological progress
Scarcity --> price increase --> innovation
Backstop resource/technology.
Justification for discounting
Complements increase demand
Are technology and natural resources substitutes or complements?
Increasing size of economy or number of people increase demand

24. Why do Prices fail to increase in Spite of Increasing Scarcity?
Producers are ignorant of in ground supply
Price determined by above-ground scarcity
Money in the bank grows, resource prices do not
If prices do not grow, there is no reason for producer to leave resource in ground.
Producer should produce until increasing marginal extraction cost = price (i.e. static optimization)

25. Scarcity effect vs. Information effect
Scarcity effect: as we use up the resource, we have less
Drives price up
Information effect: the more we explore and extract, the more we learn
We can find more
It becomes cheaper to extract
Drives price down
As scarcity effect comes to dominate information effect, producer will reduce production, price will rise, and producer will reduce production even more.

26. Marginal External Costs
Negative externalities
Extraction
Waste disposal
Socially efficient price should include marginal external cost

27. Non-renewables and sustainability
Binding constraints: source or sink?
Impact of non-renewable extraction and use
Can non-renewables increase optimal scale?
Is the current population level dependent on non-renewables?
Solutions?
Invest MUC (rent) from non-renewables into renewable substitutes (and technology).

28. Discount rates revisited
Opportunity cost
Why does money in the bank grow?
economic growth
Ignoring environmental cost
Treating natural resources as free good
Discounting goods and services which can’t be invested
Time preference for consumption
Interpersonal comparisons

29. Ethical question of how much we have the right to consume
Rights of future generations
Technology and the ethics of resource depletion
WHAT IS AN ALTERNATIVE?- maybe making sure that our use of exhaustible resources doesn’t leave future generations worse off, and not leaving future generations dependent on resources in imminent danger of exhaustion.

30. Land Supply curve for land Who creates the value in land?
How can society capture the value it creates?