Wednesday, October 26, 2011

Goods vs. Commodities: Why Shell & Exxon are not Walmart

Today in my natural resources & environmental issues course, I brought in a guest speaker, an economics professor.  He visited with my class in order to discuss some of the relationships between ore deposits and economics.  Though I'm certainly no economist, even some of the basic stuff is misunderstood by a large number of people (kind of like geology...).  The relationship between ore deposits & economics is obvious if you know that an ore deposit, by definition, is a mineral deposit that is economically viable.  The issues we are facing related to energy resources, economic growth, environmental preservation & protection, and climate change are complex, and we don't do ourselves any favors by continuing to misunderstand some fundamental concepts.  Our society won't solve these massive, complex problems until we better understand them and rid ourselves of many common misunderstandings.

One of the more common misconceptions that I hear from people about energy resources is the idea that oil companies set the price of oil.  When we hear that these companies are making record profits and at the same time the price of gasoline is breaking our bank accounts, people are quick to get angry and many ask why those companies can't simply lower the price to something that American's could more easily handle.  Large corporations are easy targets in our society - partly for good reason - but falsehoods are falsehoods no matter who believes them or what purpose they might serve.  And so here's a fact: Shell and Exxon/Mobile do not set the price of oil.  They don't decide what they are going to sell it for.  And neither does any other single entity on earth - not even OPEC, or the single most influential member, Saudi Arabia, gets to set the price of oil.  A major producer like Saudi Arabia certainly has some impact, but they don't get too choose.  The misconception boils down to this: people think that oil companies are like Walmart - that the company itself decides what price it will mark on the product when it puts it up for sale.  This problem is that people don't understand the difference in economics between goods and commodities.

In economics, commodities are basically extracted materials - just about any kind of raw material that is extracted from the Earth.  This includes energy resources such as coal, uranium, & oil, metals such as gold, silver, copper, chromium, aluminum, & iron, and other non-metal mineral resources such as road salts, fertilizers, & building stone.  Outside of geology, economic commodities also include timber, corn, soybeans, & other agricultural materials.  Goods, on the other hand, are finished products.  A computer, a desk, a chair, and a kitchen sink are all goods.  The difference between goods and commodities is that commodities have no real difference between one sample of the product and another.  A bushel of wheat is a bushel of wheat.  And a barrel of oil is a barrel of oil.  One company can't claim their bucket of copper is any better than someone else's bucket of copper, so all buckets of copper sell for the same price.  The prices of commodities are determined by the buying & selling of the commodity on international markets.  With a finished good, however, different sellers can try to convince buyers that their version is better.  So computers & lawnmowers don't all sell for the same price, because one lawnmower can be significantly better than another.

I'm not posting this to in any way defend "big oil" companies.  I don't have any intention to either attack them or support them in this post.  My goal is to simply point out that understanding a few simple principles of economics can help us understand what is true, and what just ain't so.  Walmart certainly sets the prices for the products in their store, but Exxon/Mobile doesn't set the price of oil any more than a farmer sets the price of corn.