Sounds Like Pistachios

by Elaine Schwartz    •    Dec 25, 2010    •    624 Views

“Remember the pistachios,” is a memorable line from a novel by economist Russ Roberts. In the first several pages of The Invisible Heart: An Economic Romance, a teacher says you have been given a room filled 5 feet high with pistachio nuts. The nuts are free, you are a nut lover, and you have only one rule to follow. The empty shells have to remain in the room. At first, you dive in. Eventually though, you are searching for uneaten nuts through mounds of empty shells. Finally, you stop looking. Why? It costs you too much time, energy, effort. It is “cheaper” to buy them.

Reading “New Interest in Turning Gas to Diesel” reminded me of the pistachio nut story. With the price of oil climbing and natural gas still cheap, suppliers are developing the technology to turn natural gas into liquid fuel. As one commentator said, if oil climbs to $100 a barrel, “the conversion technology could be a ‘money- maker for whoever is a first mover in that space.'”

Similarly, this Bloomberg article suggests that OPEC countries are concerned about $100 oil. Instead, they prefer a price that is closer to $80. Why? Sounds like pistachios.

The Economic Lesson

The price of a barrel of (light sweet) crude (for future delivery) varies on the supply side primarily because of production decisions from the Organization of the Petroleum Exporting Countries (OPEC). On the demand side, we have the world’s hunger for oil. In addition, some suggest that speculators investing in oil futures can have a significant impact on price.

Responding to demand and supply determinants, the price of oil has changed considerably. On July 4, 2008, at $145.29, a barrel of light sweet crude futures touched a recent high. And yet, only 6 1/2 months later, on January 16, 2009, the price was down to $36.51.

If the pistachio story is accurate, we will neither run out of oil nor have to worry about its price remaining high for too long. If supply is too low or demand is too high, price soars. Then, with so high an opportunity cost, we develop and use alternative fuels.

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