Microeconomics Case Study

Tags: public finance cash flow oil government tax operations employees risk island taxation economics culture

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Introduction

The small island nation of Petrolo has massive oil reserves that are ranked number five globally in terms of high grade petroleum. On the downside, the global industrial economies have significantly slowed down in petroleum consumption. In fact, the global demand for oil is presently at a 25-year low. The prices of oil are approximately 30 percent of what they were 1 year ago. In the present day, the price of a barrel is $40 whereas Petrolo’s current average cost of pumping oil is $50 per barrel. This is a major concern for Petrolo owing to the losses being incurred for every oil barrel. As a special consultant to the President, my task is to undertake an evaluation of the economic impact of four different options and provide a specific recommendation for what Petrolo as a nation should do.

Option 1: Stop pumping until the market price reaches at least the extraction cost of $50 a barrel.

Taking into consideration that the price of a barrel is retailing at $40 and the average cost of production is $50 per barrel, one of the options that Petrolo is considering is stopping to pump the oil until the market price reaches the least cost of extraction of $50 per barrel. First of all, stopping the production of oil because of the drop in the prices, means that there will be losses incurred by the government. This is because an investment made by the government usually brings revenues and therefore ceasing to use the investment means that there will be losses incurred. It is imperative to note that it takes numerous years to position new oil extraction projects in place. The inference of this is that if a project has been worked on, then the low prices should not deter this course. One of the key reasons why stopping to pump the oil should not be done and the projects ought to be continued is the existence of debt that has to be repaid with interest, regardless of whether or not the process of oil pumping continues (Tverberg, 2016).

Another downside is on the government and citizens, specifically the issue regarding employee retention. To some extent, the greatest assets for the oil companies are the employees. Therefore, ceasing to pump the oil implies that the employees will lose their jobs. This increases the unemployment rate in the nation. In addition, once these employees are lost, it will be significantly challenging to employ and retail new employees. The oil wells can be stopped and restarted. However, the costs involved are substantially high and therefore hamper the government (Tverberg, 2016). According to Schoen (2015), turning off the flow of pumping oil and restarting it again is an intricate process, which takes into account the injection of steam into the ground, and this practice makes it costly to restart the whole process yet again.

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In addition, stopping to the pump the oil implies that the government will not be generating revenue, and therefore, the funds obtained through taxes will decline. Furthermore, once the oil stops being pumped, it means that the citizens of Petrolo will experience a shortage in the supply of oil. This implies that they will face difficulty in attaining sufficient oil for various purposes such as driving cars and also the by-products that are achieved from oil refining, usually employed in the production of chemicals and plastics (Schoen, 2015).

Option 2: Keep pumping to provide some cash flow.

A second option for Petrolo would be continuing to pump the oil in order to provide some cash flow. In spite of generating a…

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…entertainment venues implies that there will be more job opportunities for the citizens of Petrolo. With this being in the service industry, there is expected to be a greater employment rate in the nation. Furthermore, areas such as hotels, casinos and the entertainment services prompts increased consumer spending. The inference of this is that there would be increased revenues for the government after the 10 year period (Bikas and Jureviciute, 2016).

Conclusion and Recommendation

The world demand level for oil is presently at a 25 year low with the prices for every barrel being approximately 30 percent of what they used to be a year ago. Presently, the government of Petrolo is facing a predicament in the sense that the selling price for an oil barrel is $40 yet they produce one barrel at $50. The first recommendation is to prepare a bond to finance entry into the leisure market with high-end hotels, casinos and entertainment venues. From an economic perspective, this is a sensible option owing to the reason that the nation will continue to explore and pump oil. Secondly, owing to the increasing decline in the demand and oil prices, Petrolo will be able to generate income in different ways in another business sector. Employment opportunities will be created in this regard and this is a prospect for the nation’s economy to grow. In addition, this will being in numerous tourists, increase consumer spending and attract more international companies to bring in their operations. The second recommendation is for Petrolo to sell offshore licenses to private international companies. The key advantage of this approach is that the government will not be the one to bear the losses. Secondly, there is decreased financial risk incurred and the oil pumping will continue in the foreseeable future. Furthermore, once the contract period culminates,….....

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References

Bikas, E., & Jurevi?i?t?, L. (2016). Impact of Tax Relief on Public Finance. Economics and Culture, 13(2), 14-22.

Oxfam. (2017). Malawi’s Troubled Oil Sector: Licenses, Contracts and Their Implications. Retrieved from: https://mininginmalawi.files.wordpress.com/2017/02/oxfam-2017-malawis-troubled-oil-sector-licenses-contracts-and-their-implications.pdf

Schoen, J. W. (2015). When, and where, oil is too cheap to be profitable. CNBC. Retrieved from: https://www.cnbc.com/2015/01/12/oil-production-costs-when-and-where-the-price-of-crude-is-making-it-unprofitable.html

Tverberg, G. (2016). Why oil under $30 per barrel is a major problem. Our Finite World. Retrieved from: https://ourfiniteworld.com/2016/01/19/why-oil-under-30-per-barrel-is-a-major-problem/
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