Publications: Notes at the Margin

Live by the Delta, Die by the Delta (October 30, 2023)

 

This Notes at the Margin delves into the complicated subject of options theory and real options. It is a topic seemingly beyond the intellectual capability of most economists, analysts, policymakers, and company executives, whose knowledge of economics apparently remains frozen around 1980. Options theory, not Middle Eastern events, explains the oil price collapse during the last week of October. Real options theory also explains ExxonMobil’s acquisition of Pioneer Natural Resources but not Chevron’s acquisition of Hess. Exxon’s planners, whose knowledge is current with modern economic theory, understand that by purchasing Pioneer they have the option of boosting output in the future if demand warrants but also know they are not committed to expansion should demand falter. Chevron, on the other hand, has bet the company on the belief that demand will continue to rise.

 

As mentioned, options theory explains the dramatic oil price drop during the week of October 23, 2023. The companies that had written options sold thousands of Brent futures contracts as the options’ expiry approached, propelling prices down. The data suggest that the options purchasers were primarily those in the merchant category, probably refiners and traders. Their use of options rather than futures contributes to an increase in price volatility that has prompted imprudent firms to commit to long-term investments in exploration and development. Chevron’s executives must have skipped the options lecture in graduate school.

 

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