Wednesday, March 19, 2008

Chain Letters and Saudi Oil

I always find it amusing when I get a chain letter proposing a wonderful solution to a social or political problem. The current fad seems to be getting off of Middle East and Venezuelan oil supplies. The typical solution basically says "boycott these companies who use middle eastern oil, and you will solve the problem." Unfortunately, boycotting specific companies on an inelastic good like oil won't work, even if we assume that the boycott works to start with. Here's why...

Basic economic logic says that if we all start buying from the companies suggested, they will see a sudden surge in demand leading to skyrocketing prices as they run up against supply constraints. One of two things then happen - either (a) boycotters notice that other companies (Mobil, Shell, etc) have much lower prices because they have seen less demand and switch back to them, or (b) Hess, BP, et al. purchase excess supply of oil from middle eastern sources to maintain enough supply to meet the increased demand. In either scenario, aggregate demand remains the same for oil, and given that the vast majority of oil reserves reside in OPEC countries, we will still be required to purchase from them in similar amounts (particularly since they underproduce to maintain high prices).

Always remember that firms respond to profit-incentives. Just because current suppliers are not from the middle east, doesn't mean that they won't shift to those suppliers if they need to. Investors will continue to demand profits, and corporate directors will continue to strive to provide those profits - even if it means buying Saudi oil. Profit incentives are hard to shake off in a liberal market economy.