1
Updated 06.02.04
ECON4925 Resource economics, Spring 2004
Olav Bjerkholt:
Lecture notes on the Theory of Non-renewable Resources
0. Introduction
1. Gray's problem: the discovery of resource rent
2. The Hotelling rule for prices of exhaustible resources
3. Resource markets and imperfect competition
4. Uncertainty in resource markets
5. Taxation of nonrenewable resources
6. Theories of natural gas markets
References
Appendix 1: Optimal control
0. Introduction
Crude oil and natural gas are exhaustible natural resources, in the sense that they are
available in limited quantities. The essential implication of exhaustibility is that
extraction of the resource in one period directly affects production and consumption in
ensuing periods. This implies that market behaviour for such goods has to be analysed
within a dynamic context.
The economics for exhaustible resources have been given considerable attention in the
literature, stemming back to the early works of Gray (1914) and Hotelling (1931). In
particular in the 1970s, after the first oil price shock, articles in the economic journals on
this topic were numerous. In the following, we give a brief presentation of the basic
theory of exhaustible resources, starting out from the pioneering works of Gray and
Hotelling. Some extensions of the basic theory are then outlined.
Some other characteristic features of resource markets are related to the exhaustibility
aspect:
First, it is rather intuitive that when resource scarcity prevails, the market price of the
resource will typically exceed marginal extraction costs, in order to reflect the
opportunity cost of using a resource unit today rather than conserving it for the future.
2
This gives rise to a resource rent in the extraction activity. We discuss the problem that
led L.C. Gray to the discovery of resource rent in Lecture notes 1, and the Hotelling Rule
in Lecture notes 2.
Secondly, due to aspects of property rights and limited access, oligopolistic behaviour
typically prevails in resource markets. This leads to a monopoly rent, ie. an additional
mark-up on marginal costs. It is worth noting that it is difficult to separate empirically
between the various kinds of "rents" in resource markets. In particular with reference to
the international oil market, there is little doubt that various kinds of coalitions and cartel
behaviour during "history" have had significant impacts on market development and
prices. Whether monopoly rent actually has dominated the potential resource rent in the
market for oil, is an open question. We discuss imperfect competition in Lecture notes 3.
A third feature of natural resource markets is that aspects of uncertainty become very
important. For instance, individual agents have to make assessments of remaining
reserves of the resource. In addition, the intertemporal adjustments that occur in such
markets complicate market equilibrium and induce uncertainty regarding the actual
behaviour and functioning of the market. We look at some aspects of uncertainty in
resource markets in Lecture notes 4.
We will also discuss taxation of nonrenewable resources in Lecture notes 5, mainly from
the viewpoint of whether tax rules interfere with optimal depletion. In Lecture notes 6 we
shall look at some approaches to the understanding of natural gas markets.
The objective is not to give very detailed presentation of more complicated theory, and
we avoid rigorous proofs. Rather, we intend to provide a brief overview and, hopefully,
some intuition of the basic mechanisms and conclusions, to complement Perman et al.
(2003), even briefer presentation.
For a more comprehensive exposition of the theory of exhaustible resources from the
early heydays of this theory we refer to Dasgupta and Heal (1979) and Fisher (1981).