The Theory Of Nonrenewable Resource Extraction Under Discontinuous Price Policy

Author : Joseph P. Kalt
Publisher :
ISBN 13 :
Total Pages : 21 pages
Book Rating : 4.:/5 (123 download)

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Download or read book Decontrolling Natural Gas Prices and the Theory of Nonrenewable Resource Extraction Under Discontinuous Price Policy written by Joseph P. Kalt and published by . This book was released on 1981 with total page 21 pages. Available in PDF, EPUB and Kindle. Book excerpt: Introduction: The seminal work of Harold Hotelling (1931) stressed the complexity of doing economic analysis in the context of nonrenewable, or exhaustible, resources. The nonrenewable nature of some resources does not invalidate any essential economic conclusions about, for example, the role of marginal costs in production and allocation or the optimality of perfect competition. It does, however, place an unusually high premium on consideration of dynamic, intertemporal issues; a static analysis cannot be adopted without risking a debilitating loss of realism. The emphasis on dynamic analysis arises because the marginal cost of using a nonrenewable resource at any point in time includes an intertemporal component -- so-called "Hotelling rents." These quasi-rents derive from the difference, in any period, between selling price and production cost. They represent the economic opportunity cost of foregoing future revenues when the resource is sold today. Hotelling rents serve to allocate production of a nonrenewable resource over time. If these rents rise in the future because, for example, expected future prices rise above previously anticipated levels, extraction paths are shifted toward the future by profit-maximizing producers. Moreover, the discounted present value of expected streams of Hotelling rents serves to allocate exploration and development efforts. An increase in this expected present value, for example, encourages expanded exploration and development efforts. The effects of price regulation, in the form of either a price ceiling or excise tax that follows a continuous intertemporal path, have been investigated fairly comprehensively (e.g., Burness, 1976; Sweeney, 197/). The important conclusions that emerge from these types of investigations are: (a) because price regulation can either raise or lower the value of current Hotelling rents relative to the value of future rents, the impact of regulation on the time path of extraction from existing developed reserves is a_priori ambiguous: and (b) because price regulation reduces the absolute present value of the streams of rents accruing to producers, regulation unambiguously discourages exploration and development of new reserves (see Peterson, 1975, for simultaneous treatment of both results). The ambiguity noted in (a) leaves the total output effect of policies such as natural gas price controls and the Crude Oil Windfall Profit (sic, excise) Tax uncertain -- contrary to the conclusions derived from a static analysis (Lee, 1978). The ambiguity in the output effects of nonrenewable resource price regulation is an empirical ambiguity. Determinant theoretical conditions describing the impact of smooth price regulation can be distilled and empirically applied (e.g., Kalt, 1981). The search for analogous conditions applicable to the case of abruptly changing price and tax policies, however, has yielded primarily speculation rather than definitive results. The demand for understanding the consequences of discontinuities in public policy has increased in recent years as nonrenewable oil and gas resources, in particular, have been subjected to a number of distinct price and tax regulatory regimes. In the case of oil, for example, producers have experienced no less than eight price control programs since 1971, decontrol in early 1981, and a system of substantial excise taxes starting in 1980 and scheduled to last until the early 1990s. In the case of natural gas, major changes in price control policy occurred in 1974 and 1978; and decontrol is currently scheduled for 1985. This paper offers some extensions to the theory of nonrenewable resources by investigating the analytics of resource extraction decisions in the presence of discontinuous regulatory policy. The questions of interest in the presence of regulatory discontinuities include the usual questions about the implications for allocative efficiency. In addition, considerable political concern has been directed toward the incentives producers may have to "withhold" current supply when a policy change such as decontrol is promised for the future; and the motivation of this paper is based in large part on this concern. Section II works out the determinants of extraction and withholding decisions for the case of discontinuous price controls of the type currently applicable to domestic natural gas producers. Section III presents some illustrative simulations of natural gas production paths.