Microeconomics

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.

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 loss of $10 for every oil barrel, one of the key advantages for both the government and the citizens is that the oil will generate revenue. This will facilitate the sustenance of social benefits, low rates of taxation for the citizens and at the same time guaranteeing full employment.

Secondly, some of the oil fields could be old and about to reach the culmination of their lifespan. Therefore, this implies that stopping oil production could lead to slowing down completely. This procedure of decommissioning can be significantly costly, and therefore, it might be sensible to continue pumping the oil and operate at a negligible loss instead spending a lot of funds to close down the oil business operation (Schoen, 2015).

Another implication for sustaining the process of oil pumping is the decline in revenues generated and the negative profit that is sustained. The inference of this is that both the government and citizens of Petrolo would have to sustain the loss incurred. In accordance to Schoen (2015), the costs of production for the oil encompass government taxes and royalties, which could be diminished or suspended if the government of Petrolo wishes to sustain the production process.

For instance, if the taxation rate stands at 20 percent, the government can choose to reduce the rate to perhaps 15 percent or even 10 percent. This will decrease the cost incurred in pumping the oil. In regard to the employees, the implication of keeping the oil pumping process is that there would be a need to take pay cuts in order to be able to sustain the operation. This would also reduce the cost of production.

Furthermore, the citizens would have to experience a decline in the social amenities provided by the government. For instance, if the tax revenues are used for constructing roads, then the government would commission a lesser number of public roads for construction. Most of all, this implies that there will be continues losses generated by producing the oil barrels at a rate of $50 yet the market selling price for every barrel is $40. Such losses will hamper the oil exploration and drilling process.

Option 3: Sell offshore licenses to private international companies, which would pay a royalty of $15 per barrel with all extraction costs borne by the licensees. There are different economic impacts that for this particular option. From a positive perspective, the government of Petrolo will not have to risk their own financial resources whilst conducting the oil exploration and pumping process. Therefore, there is less fiscal or monetary risk borne by the government. Secondly, there will be mutual interests between the private internal companies and the government of Petrolo.

That is, both of these parties have hope that the exploration and oil pumping will result in substantial amounts of oil. In this regard, the government will be able to offer licensing terms to the international companies that are attractive enough to take up the risk but at the same time maximize government revenue (Oxfam, 2017). There are negative implications for this particular option.

To begin with, the terms of the oil licensing can attract the international companies but at the same time might end up leaving the government of Petrolo with solely a small percentage of the proceeds generated. In addition, there is the negative impact of decreased employment prospects. Notably, when international companies are given the oil licensing contracts, they are free and open to bring in their own employees. This implies that the local employees might end up losing their jobs (Oxfam, 2017).

Option 4: Prepare a bond to finance entry into the leisure market with high-end hotels, casinos and entertainment venues. Although this would restrict drilling operations to southern half of the island, the northern end of Petrolo could become a magnificent tourism venue for the world’s wealthy. Tax-free operations for the first ten years of operations for major hotel/casino operations would entice investment.

The inclusion of tax-free operations for a period of ten years will have a negative implication on public finances that are utilized for carrying out social amenities. It is imperative to note that taxes are essential for the state of Petrolo to undertake its functions. On the one hand, the tax relief will promote the businesses and will lure in companies into developing the major hotel or casino operations. This is largely for the reason that there will be a decline in the tax payers’ liabilities.

In addition, it will aid the residents in generating greater income and also diminish social exclusion. At the same time, the downside to this approach is that the tax relief will also increase the cost of tax, which will adversely impact public finances. This will give rise to a loss of income for the government for a period of ten years, an amount that could be utilized for social and public amenities and improve the standard of living for the people of Petrolo (Bikas and Jureviciute, 2016).

A second negative implication is linked to the fact that the inclusion of high-end hotels, casinos as well as entertainment venues means that the area set out for drilling and oil exploration becomes minimal. Therefore, this would imply that the oil reserves for the government would be reduced. On the other hand, this particular option would be an economically positive path for the government and the citizens. Delving into the leisure market with high-end hotels,.