Introduction

The bias of this chapter is much more empirical and institutional than that of its predecessors. We hope to use it to provide illustrations of the practical importance of some of the phenomena referred to in previous chapters: many of our illustrations will be drawn from the oil industry because this is both an important industry and one that provides a very wide range of examples. However, we shall also discuss the validity of our observations in a wider context.

Externalities in a Dynamic Context

It was noted in Chapter 3 that the existence of external effects provides an important reason for querying whether the market mechanism would work efficiently. As we have already seen in Chapter 3, drilling for oil provides a very striking example of an externality, through what is referred to in the trade as the ‘rule of capture’. Recall that the point involved here is a very simple one. Oil companies with neighbouring concessions may all drill their wells in the same reservoir, and of course the more oil is removed by anyone, the less remains for the others. Every company therefore has an incentive to remove oil as quickly as possible, and as it is expensive to store above ground, stocks are depleted, marketed and used more quickly than is desirable on grounds of economic efficiency.