More evidence that firms operate when average total cost > price > average variable cost and shut down when price < average variable cost

More Cuts Loom as Oil Nears $25
by: Erin Ailworth and Bradley Olson
Feb 12, 2016
Click here to view the full article on WSJ.com

TOPICS: Oil Markets, Production

SUMMARY: As crude prices slide toward $25 a barrel, many oil companies have little choice but to start making the steep cost cuts they have avoided up until now, jettisoning every well that can't break even or isn't needed to keep the lights on.

CLASSROOM APPLICATION: In the context of this oil case, students can evaluate two economic principles: the shut-down point and a firm's optimal level of employment. Students can evaluate the reason why oil producers are operating despite losses and the reason why the producers are laying off workers.

QUESTIONS: 
1. (Introductory) U.S. and Canadian producers are losing at least $350 million a day at current prices, according to an AlixPartners analysis. Should all producers that are losing money be shutting down operations? Characterize the oil price at which a producer should shut down.

2. (Advanced) Why are oil companies laying off workers? Use the wage rate and the concept of the marginal revenue product of labor for a given type of job in answering the question.

3. (Advanced) John England, vice chairman of energy for Deloitte LLP, is advising energy clients trying to stave off bankruptcy to go ahead and make the steep cost cuts they would have to if forced to declare. How does the potential prospect of bankruptcy affect a firm's decision to make steep cuts in costs?

Reviewed By: James Dearden, Lehigh University

Why haven't the supermines shut down?

Supermines Add to Glut of Metals

by: John W. Miller
Jan 05, 2015
Click here to view the full article on WSJ.com

TOPICS: Production, Supply and Demand

SUMMARY: Giant mines, begun when prices were high, are adding to the oversupply of copper, iron ore and other metals, compounding the woes of the depressed mining sector.

CLASSROOM APPLICATION: With an increase in the supply of copper due to the startup of new supermines, prices of metals and iron ore have declined. As a result, mining companies have not shut down mines, but rather have kept them operating and reduced labor inputs. The article notes that while profit margins are declining, prices continue to be above shut-down prices. "The mine's huge scale keeps its operating costs down, at under $1.50 per pound. That means even with copper prices now just above $2 a pound, a six-year low, it will continue to make money on an operational basis."

QUESTIONS: 
1. (Introductory) What is the effect of the opening of supermines on the prices of metals and iron ore?

2. (Advanced) What is the effect of depressed metals and iron ore prices on the profit margins of mining companies? Are the companies currently losing money? If so, then why are the mining companies continuing to operate?

3. (Advanced) The article states: "The big mines cost so much to build and extract minerals so efficiently that mothballing them is unthinkable-running them generates cash to pay down debts, and huge mines are expensive to simply maintain while idle." Is "the big mines cost so much to build" a good rationale for not shutting them down in the short run? Discuss the effect of fixed costs on operating decisions.

Reviewed By: James Dearden, Lehigh University

Two videos on MR=MC and Perfect Competition

Mr. Clifford on MR=MC for perfect competition
Kahn on MR=MC for perfect comp

http://www.wsj.com/articles/in-west-texas-oil-drillers-keep-pumping-1446254165

When are the variable costs lower:  when "drillers can use one rig to bore vertically down through as many as four layers of oil-and-gas-rich rock and then horizontally through each layer in succession to stretch out the productive life of a well" or when they need a rig for each layer?

Why does the Permian continue to show strength even though the number of oil rigs drilling in the Permian has plunged by about 60% so far this year. What does this imply about marginal costs, average variable cost, and average total cost?

Two recent articles paint different pictures of the oil market.

No End in Sight for Oil Glut
by: Russell Gold
Aug 21, 2015
Click here to view the full article on WSJ.com

TOPICS: Oil Markets

SUMMARY: When oil prices started to edge down a year ago, most energy mavens thought the drop would be small and short-lived. Instead, the price of crude has plunged by almost 60% from its 2014 peak.

CLASSROOM APPLICATION: Students can evaluate the factors that have caused declining oil prices and examine whether a firm, or in this case oil producer, would optimally maintain output while facing declining prices.

QUESTIONS: 
1. (Introductory) What factors have caused the increasing supply of oil?

2. (Introductory) Why are oil companies suspending deep-water projects?

3. (Advanced) What are possible reasons for an oil producer to increase oil production while facing declining oil prices?

4. (Advanced) What is the effect declining oil prices on the demand for gas guzzlers?

Reviewed By: James Dearden, Lehigh University

Here is a graph from the article.

Here are some questions.

1. Does the graph depict demand and supply or the quantity traded and quantity produced?
2. What would you expect to happen to the price of oil between 2013Q1 and 2015Q2? Click here to see what happened.
3. If revenues for a county increase when it increases production and prices are low, would would happen to revenues when a country increases production and prices are high? If the answer is the revenues would increase, why didn't the countries increase production BEFORE the price of oil fell?
4. When is the quantity supplied greater, when producers expect the price of oil to increase or when producers expect the price of oil to decrease? What do you think expectations were in 2013Q1? 2015Q2?
5. What is the impact on the future quantity supplied when producers suspend work on deep-water projects and push back oil-sands projects?

Oil Prices Soar Amid Lower U.S. Output Estimates, OPEC Article
by: Nicole Friedman
Sep 01, 2015
Click here to view the full article on WSJ.com

TOPICS: Oil Markets, Supply and Demand

SUMMARY: Oil prices soared Monday, marking their strongest three-day rally since Iraq's 1990 invasion of Kuwait, on doubts the global glut of crude would be as long-lasting as many investors and traders had earlier believed.

CLASSROOM APPLICATION: Students can evaluate the cause of Monday's increase in oil prices. They can also evaluate whether a response in oil production to oil price increases would be a movement along a supply curve or a shift in a supply curve. Furthermore, they can evaluate the length of a decline in oil prices required for oil producers to decide to shut down production.

QUESTIONS: 
1. (Introductory) "The newly released federal data confirmed that U.S. oil output has taken a hit from falling oil prices, as new investments have proven unprofitable and some companies have struggled to stay afloat. The number of rigs drilling for oil in the U.S. has dropped by 58% since October...." Does the above report imply that the drop in U.S. drilling is a shift in supply? Alternatively, is it a movement along the supply function?

2. (Advanced) "Many analysts argue that oil prices still need to stay low for an extended period to force more production cutbacks in the U.S. and elsewhere." Why would an extended period : as opposed to a short period : of low oil prices be required for oil production cutbacks?

3. (Advanced) What investment strategy prompted the three-day rally in oil? Why did investors adopt the strategy?

Reviewed By: James Dearden, Lehigh University