From my analysis, it doesn't make sense that the price of oil should depend on Hotelling's rule instead of the traditional supply and demand models. It's on average, and in any particular month, or even year, the stock market swings wildly because of unexpcted supply and demand changes. This basic rule forms the theoretical core of the economics of nonrenewable resources, is present in one form or another in every modern paper on nonrenewable r… To explain these facts, we reformulate Hotelling’s (1931) classic model of exhaustible resource extraction as a drilling problem: firms choose when to drill, but production from existing wells is constrained by reservoir pressure, which decays as oil is extracted. The Hotelling rule may not be a good guide to the actual behavior of mineral prices over time for several reasons. To explain these facts, we reformulate Hotelling’s classic model of exhaustible resource extraction as a drilling problem: firms choose when to drill, but production from existing wells is constrained by reservoir pressure, which decays as oil is extracted. Hotelling’s rule is based on the assumption of no uncertainty and perfect competition. Participants on this site seemed to be evenly split on the issue. oil and mineral development and cutting timber on certain gov- ernment lands have this justification, as have also closed seasons for fish and game and statutes forbidding certain highly efficient means of catching fish. How much of that is royalty, and how much is extraction cost? Hotelling’s drafts, as well as his correspondence, with oil engineers for example, point to a reinterpretation of the 1931 article. )�8�}td���R Hotelling's rule and all economic models derived from its perspective deal with the issue of how much of a non-renewable resource must be extracted today and how much must be saved for the future, depending on present and expected economic conditions. That's nothing at all to do with how things happen in reality: it's just how things behave in textbooks for beginners. Oil is a nonrenewable (exhaustible) resource—that is, a resource that does not regenerate over time. A general conclusion Hotelling's Rule only applies to the royalty for the oil, not the produced oil price. Uncertainty in demand and reserves may affect the expected change in the oil price. 281 0 obj <>stream How helpful is Hotelling's Rule in determining the price of oil? 254 0 obj <> endobj If the natural resource market is perfectly competitive, then the Hotelling rule implies that the market price minus marginal costs must grow at the rate of interest, and therefore that the natural resource price should be increasing over time if marginal costs are constant. Given the discount rate, the actual price path still depends on the initial price Po , as can be seen from the diagram. The Hotelling rule states that the nominal price of oil will increase at the nominal rate of interest. Hotelling’s theory proposes that the only time holders of nonrenewable resources should produce their commodities is when the revenue generated from them can exceed that from other financial instruments. The emphasis is put on how those factors can potentially help bridge the gap between the basic Hotelling's rule of natural resource exploitation and the historical behaviour of the flow price of a number of resources. In that case, it is the \$10 part that should rise at the discount rate, which means the \$60 price will rise at a much lower rate. :�X\D����v�|��0���f�&pJ���K`��s��@���&���m�. III. First, that markets are efficient. Energy transition and environmental regulation. Hotelling's theory is used by economists to attempt to predict the price of oil and other nonrenewable resources, based on prevailing interest rates. Figure 2.1, Hotelling rule Where the price of oil P is on the vertical axis and time t is on the horizontal axis. Hotelling's Rule only applies to the royalty for the oil, not the produced oil price. The Hotelling rule states that the nominal price of oil will increase at the nominal rate of interest. By using our site, you acknowledge that you have read and understand our Cookie Policy, Privacy Policy, and our Terms of Service. It turns out that the ‘rule’, which he had devised as early as 1924 for abstract assets, was in no way intended to be applied to the concrete case of mineral and energy resources. 2. Using a state-level panel data set on US oil exploitation, this paper reexamines the relationship between the extraction rent and the depletion of crude oil reserves. Both paths in fact satisfy the Hotelling rule. Because the amount of oil produced was small, supply (for the most part) remained constant; businesses would also be incentivized to raise prices to market levels, increasing their profit margins. The price of oil is about \$60/barrel now. Areas of Focus: Energy Markets The origins of the field of nonrenewable resource economics can be traced to Harold Hotelling's (1931) “The Economics of Exhaustible Resources”. ��Y�p[0��#䂦Di�)�'��i��@A�y����x��V��ތKt!�{����v��?B���:������ܱߛ%�u���GJr��䣽��Mq���T. Hotelling rule, economic responses and oil prices Gideon Fishelson The traditional Hotelling model is applied to explain the stability of oil prices in the 1960s and in the second half of the 1970s. Moreover, oil as well as other minerals come in different grades. This prediction is now known as the ”Hotelling rule” (Krautkraemer, 1998). The model implies a modified Hotelling rule for drilling revenues net of costs, explains why the production constraint typically binds, … After posting this question, I realized that there was quite a bit of controversy surrounding the use of Hotelling's Rule to estimate the price of oil. Oil production from existing wells within an oil field is isolated from the drilling of new wells. 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