Thursday, September 3, 2009

Test your understanding of economics in the news: Is this a change in supply or a change in demand?

In the September 1, 2009 article "BP Makes `Giant´ Oil Find in Gulf of Mexico," Tom Bergin explains that the discovery of new oil reserves in the Gulf of Mexico may affect the future price of oil. Using the ceteris paribus assumption that ignores other potential changes, what is the likely effect of this discovery on the market for oil?

Is this change in the oil market (a) an increase in the supply of oil, (b) a decrease in the supply of oil, (c) an increase in the demand for oil, or (d) a decrease in the demand for oil? Will the equilibrium price of oil increase or decrease as a result of these newly found oil reserves?

Read the article below and then illustrate this price change with a graph that shows the initial positions of the supply and demand for oil and the new positions of the supply and demand curves. (Hint: Only one of the curves shifts.) There is a link at the bottom that provides the answer.
LONDON (Reuters) - Oil major BP Plc said it has made an oil discovery in the Gulf of Mexico, which analysts believe could contain over 1 billion barrels of recoverable reserves, reaffirming the Gulf's strategic importance to the industry.

BP said in a statement on Wednesday that it had made the "giant" find at its Tiber Prospect in the Keathley Canyon block 102, by drilling one of the deepest wells ever sunk by the industry.

Further appraisal will be required to ascertain the size of volumes of oil present, but a spokesman said the find should be bigger than its Kaskida discovery which has over 3 billion barrels of oil in place.

Estimates of recoverable reserves range from around 20 percent of oil in place.

"Assuming reserves in place of 4 billion barrels and a 35 percent recovery rate, BP's proven reserves .. would rise by 868 million barrels -- equivalent to 4.8 percent of the group's 18.14 billion barrels of proven reserves," Aymeric De-Villaret, oil analyst at Societe Generale said in a research note.

BP, the biggest oil producer in the U.S. and biggest leaseholder in the Gulf of Mexico, has a 62 percent working interest in the block, while Brazilian state-controlled Petrobras owns 20 percent and U.S. oil major ConocoPhillips owns 18 percent.

Iain Armstrong, analyst at Brewin Dolphin, said the discovery may have implications for long-term oil prices.

"It will ease concerns about peak oil because it shows there is life left in these mature areas," he said, adding that it could be the second half of the next decade before the find is producing.

The discovery also bodes well for other exploration in that part of the Gulf of Mexico, including at Royal Dutch Shell's nearby Great White field, Jason Kenny, oil analyst at ING in Edinburgh, said.

BP shares, which had been trading slightly down ahead of the statement, closed up 4.3 percent at 541 pence, outperforming a 1.75 percent rise in the DJ Stoxx European oil and gas sector index.

The Gulf of Mexico has become increasingly important to Western oil majors as oil rich-countries such as Saudi Arabia, Venezuela and Russia reserve their richest fields to be developed by their state-owned oil companies.

The Gulf is especially attractive because it offers high profit margins, due to relatively low taxation compared to countries such as Russia and Nigeria, and because of the low political risk.

As nearer-shore discoveries dry up, companies have pushed further out to sea, which has forced them to develop new technologies to detect and extract the oil.

The prospects for massive discoveries in the deep water of the Gulf of Mexico is also good news for U.S. politicians' ambitions to reduce the country's reliance on imported oil, although oil executives doubt the U.S. is capable of becoming self sufficient in oil.

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