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By James Hamilton on Feb 21, 2012 with 4 responses

Wealth Creation: Playing the Crude Oil Spreads

Here’s my suggestion for how to become rich: buy low and sell high.

It’s a strategy that works for individuals, and can work for the entire nation as well. If you can figure out a way to find resources whose value in their current use is not very great– in other words, if you buy low– and redeploy them somewhere else where their value is much greater– in other words, sell high– then you will not only add to your personal wealth, you will be creating new wealth for society as a whole. The process of allocating resources to their most efficient use is the heart of what drives economic growth. The fact that individuals have a strong personal incentive always to be looking for better ways to do that is the primary factor responsible for the standard of living that we enjoy today.

Let me give a concrete example of what I’m talking about. On Friday, you could buy a barrel of light, sweet crude oil produced in North Dakota for less than $81. On that same day, oil refiners in Port Arthur on the coast of Texas were paying around $110 to import a similar grade of oil produced in Nigeria. That’s $30 worth of incentive to you to try to figure out a way to transport oil from North Dakota to Port Arthur in order to replace a barrel of imported Nigerian oil with Williston sweet. As a nation, if we could divert some of the resources we are currently devoting to pay for oil imported from Nigeria, and use them instead to enable the Port Arthur refinery to get its oil from North Dakota, we will become richer.

Buy low, sell high.

So there’s a very concrete mission. How can you go about implementing it?


You could try to ship the oil from North Dakota to Port Arthur by truck, but that would eat up most of your profits in transportation alone– the combined resources we’d use to produce the oil and then truck it to Texas are not much less than the resources we’re currently surrendering to get the oil from Nigeria. Rail is a much better way to get the oil from North Dakota to Texas, and rail is being used more and more, but it’s still pretty expensive. And America doesn’t have enough of the specialized rail infrastructure to handle the volumes that are needed.

Source: Association of American Railroads.

A far better idea is to transport the oil by pipeline. We could get the product where it needs to go with a fraction of the resources currently used up trying to move the product by rail, permitting us as a nation to produce more of everything else.

Wealth creation.

Of course, this is not a new idea, but has been the obvious solution from the industry’s beginning. The first pipeline for transporting oil was built in 1865, only 6 years after the start of the industry. In the years since, America has laid a half million miles of oil and natural gas transmission pipelines, and millions more in gas distribution lines.

Major U.S. oil, gas, and product pipelines. Source: World Factbook.

But now we need some more, to make best use of the growth in new oil production from places like Canada and North Dakota. What we need, for example, is the proposed BakkenLink system to connect North Dakota to the bigger proposed Keystone pipeline expansion.

Proposed BakkenLink Pipeline in North Dakota and Montana.
BakkenLink and the Keystone Gulf Coast Expansion.

That obvious solution was proposed some time ago by TransCanada, a private company that’s offered to build and pay for the pipeline, and has been waiting now for more than 3 years for the U.S. State Department to do nothing more than say, “OK.”

On Wednesday, President Obama announced that he needed more time to study the proposal.

For 150 years, Americans understood perfectly well that pipelines are the rational way to transport oil. We’ve reached a new and very troubling paralysis if we can’t even agree on such an obvious fact at this point.

In addition to the question of how to make the best use of productive resources, another issue that has been raised in the debate is whether projects like the Keystone Expansion Project might also be helpful in terms of putting unemployed Americans back to work. Certainly laying more than a thousand miles of new pipe ought to cover a few paychecks. Critics say that these would only be temporary jobs, lasting only as long as it takes to build the pipeline. That’s a valid point. But many of those same critics seem to think that America would be well served by other government-funded, temporary stimulus spending, as a good plan for getting people to work.

But here’s the problem– how shall we choose the projects worthy of this government funding? One of the key drawbacks to having elected officials choose which projects get funded is that they are likely to favor the projects that reward their political allies and consolidate their power. For example, U.S. taxpayers might find themselves committed to pay a half-billion dollars to a solar company that ceased operations shortly after receiving the money.

Which is the better strategy for creating new wealth, Keystone or Solyndra? Maybe we need a few more years to study that question.

This article originally appeared on Econbrowser.

  1. By Risk_Transfer on February 21, 2012 at 7:23 pm

    Until the government changes its appetite for risk and approach to creating debt, it will continue to have a skewed perspective on projects in need of funding.  If I were an investor, I would approach any project with a certain level of skepticism and require a certain amount of due diligence because it is my money at risk.  However, if I was comfortable taking a loss because I could borrow additional money without negative repercussions, I would certainly throw my money around more liberally and be subject to the self-interests of others.  
    One may go so far as to say that government funding will fail to be the most efficient allocation of resources for wealth creation and that private funding will be a better strategy.  Unfortunately, even privately/commercially funded projects can be subject to government scrutiny and/or regulation, so all are not immune. 
    In the end, privately funded projects may be more efficient at wealth creation, but in order to have the massive impact that is every politician’s holy grail, the government will have to step up and properly evaluate/fund these projects.  Sadly, until budgets are fixed, these departments and oversight committees will remain inadequately funded and continue to inefficiently (and sometimes irresponsibly) create or redistribute wealth.

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  2. By James Hamilton on February 22, 2012 at 12:21 pm

    Risk_Transfer:

         These pipelines are all privately funded.  All that is sought is government permission to build, not government funding.

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    • By Risk_Transfer on February 23, 2012 at 11:18 am

      James,
      I should have phrased my response differently, as you are correct about pipeline funding.  Since your original question asked for the better solution (Keystone vs. Solyndra) to wealth creation, I should have said that privately funded projects, such as Keystone, will do a better job creating wealth than those projects (like Solyndra, various wind farm projects and biofuel companies) that cannot survive with out Production Tax Credits, Renewable Energy Credits, Blending Credits, etc. from the government. 

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  3. By Optimist on February 22, 2012 at 5:47 pm

    Nice article, James!
    We are indeed at “a new and very troubling paralysis”. Problem, IMHO, boils down to this: both major political parties are comfortable with the status quo, and regularly punt when a tough decision needs to be made. I blame the fact that most politicians are lawyers. A lawyer is basically a mercenary for any argument that pays his fee. It never pays him to consider if he is doing the right thing: what pays is to pretend you are always right, and never backdown. Watch that dynamic play out in Washington. Is it any wonder we’re paralyzed?

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