Oil Company X is a large oil refinery which has been expanding and taking on new investment projects. Recently, they have considered building a pipeline that stretches across the United States, from Canada to New Orleans.
As a cost analyst at Oil Company X, submit a proposal to the board of the company critiquing the costs and benefits of building a new oil pipeline that stands to generate copious amounts of revenue. Include in your report the following: expected changes to supply and demand, a cost analysis of the project, the cross-price elasticity of an alternative energy source, cost curves, the new expected profit-maximizing quantity and price of oil after completion, a risk assessment evaluating liabilities from potential environmental damage, and a final recommendation.
Instructions
Use the Excel document below to complete the assignment, and submit it to the Drop Box when finished.
Student Excel Spreadsheet
As an economic analyst at your firm, you are being asked to evaluate this investment opportunity and submit a 5-page proposal as a Word document.
You must include an explanation of expected changes to supply and/or demand from economic shocks such as natural disasters and recessions, as well as the anticipated effect of substitute goods (alternative energy sources) flooding the oil market. Be sure to include the expected impact on equilibrium quantity and price in your regional market from these potential changes.
Another team member in the Cost Analysis Department has compiled the necessary data in the attached spreadsheet below.The total upfront cost of this project is $1.72 million in fixed costs. Be sure to include in your proposal any relevant curves graphed from the data in the spreadsheet. Your Excel spreadsheet needs to include the following columns in addition to what has been given to you:
- TFC
- TVC
- ATC
- AVC
MC
Assume that your firm will hold market power as a supplier of oil in your region, due to extensive trade restrictions the government has agreed to put in place after completion of the pipeline. Define the new market structure, and give new pricing strategies the firm can use to maximize profits for this particular market structure.
You will also include graphs to show new expected profit-maximizing quantity and price of oil after completion. After determining the profit-maximizing price and quantity, as well as the corresponding average variable cost, determine the expected total profit for the 15-year duration the pipeline will be in operation.
Be sure to also include a calculation of the cross-price elasticity of the alternative energy source and oil. Assume the current price of oil is $50/gallon of crude oil. If the price increases to the profit-maximizing price, the quantity demanded of the alternative energy source increases by 20%. Explain if these goods are complementary goods, substitute goods, or non-related goods. If there is a relationship, indicate whether the relationship is weak or strong. Justify your answer with an explanation based on the elasticity figure.
Assume there is a 10% probability of the pipeline leaking, with an expected liability of $3.2 billion which will be deducted from total profit. There is a 90% probability the pipeline will not leak. Determine the expected return on this investment, as well as the variance.
The firm also has an alternative investment which will yield $1.6 billion over the course of the same 15-year period, with a probability of 80%, or $1.15 billion with a probability of 20%. Calculate the expected return, as well as the variance. The risk should be expressed as the standard deviation.
Perform a marginal analysis to determine if the firm should build the pipeline, considering currently available investments and opportunity costs.
Format your proposal to include a title page, introduction, conclusion, and references. Include all relevant graphs, equations, and calculations. Show your work on calculations to ensure you receive partial credit for incorrect answers. No credit will be given if your work is not shown. Remember to cite your sources using correct APA format, and also use correct grammar, spelling, and formatting.
All of the assignment is completed except for one portion. It should not take long to complete. The word file has a grading scale which states what needs to be completed.
Running Head: PROPOSAL TO BUILD A PIPELINE
8
HelloDavid –
Below you will find comments for your Deliverable 7 submission.
Please note that the following calculations need to be included in the spreadsheet provided for the assignment.
Please be sure to include the following:
Expected Profit for Pipeline
Variance for Pipeline
Quantified Risk for Pipeline
You can find a rubric below that highlights your grade.
Everything else looks good.
Proposal to Build a Pipeline
David Pursell
Econ3250
03/02/20
Proposal to Build a Pipeline
As a cost analyst for Oil Company X, I have been assigned the duty to come up with a plan to submit to the board where am se to have a look at the cost as well as the benefits of building a new oil pipeline which is set to generate set of revenues. In this proposal, I am set to have a look at the cost which is going to be incurred during the construction of the pipeline, make a classification of the alternative sources of energy, look at the aspect of price elasticity, examine the cost curves, make a review of the expected changes and finally make a discussion of the new expected profit-maximizing quantity and price of the oil. I will also perform a risk assessment evaluation on the liabilities from the environmental disaster and make a final recommendation on the matter (Perl off, Brander2017).
Natural disasters are observed to be a significant concern more so because they can disrupt the operation of a pipeline and cause a lasting effect on the market equilibrium. For instance, a natural disaster near the inlet of a pipe is expected to harm the Oil Company X which means that it is set to reduce the supply of oil in the market and it would drive up the price. Some of the potential natural disasters such as hurricanes, floods, or earthquakes are more likely to cause possible damage. Events such as magnitudes are set to ensure that they increase the risk of leakage or explosion. Some of these forms of disruption are more likely to cause a disruption both in terms of the market and also in terms of production. Scarcity events such as these disruptions are more likely to lead to a hike in the price levels, and it will call for a market response which is going to act as a manifestation of an increased level of production to those organizations which are not affected by such disasters.
A recession is usually defined as a decline in the level of economic activities which is set to be accompanied by a fall in the GDP. Recessions might result in a drop in trade and also loss in the manufacturing sectors and jobs. Decrease of production and industrial activities is coupled up with a diminish in the workforce, and it will result in a surplus or glut in the market. Declining demand for the product is going to dictate a lower price for oil production, and in the short run, there is going to be the creation of a new equilibrium price. A small price level is more likely to bring a slow demand of the products up to the point where it meets the supply (equilibrium) until to the time where there will be external stimuli such as government interventions which are aimed at increasing economic activities.
An increase in the availability of alternative energy sources is more likely to pose a significant threat to the oil market. Some of the alternative sources of energy which might have a harmful effect oil include things such as natural gas and home heating oil. For instance, reports from the market show that the gas market is facing uncertainty as there is a rapid shift in the society view on the environment and how fossil fuel contributes to its decline. The market has also enjoyed new products in the market such as an electric car which does not in any way use oil, and they are considered to be much easier to use as compared to fuel-powered counterparts(Perl off, Brander2017). The general increase in these alternative cost energy sources has caused a glut in the market, and as a result, it is driving the market prices of oil products down and also raise their demand in an attempt to compete with these upcoming products.
I have been in a place to calculate the cross-price elasticity of the elasticity of alternative sources of energy and classified it as a substitute. I have performed an intensive analysis of the production to determine the profit maximization point. The assessment is inclined towards assessing the correlation between an increase in the price level of crude oil and the increase in the demand level of the alternative sources of energy.
After calculation of the price elasticity at starting price of $50 a barrel, and after calculation of profit maximization, I was able to arrive at a new equilibrium price to be $57.50 a barrel. A keen look at this shows that the amount of by 15% and 20% increase in the quantity demand of the alternative sources of energy. Alternative energy is substitute good, and the relationship between crude oil and substitute good is secure as we can observe from the equation. Therefore, the cross-price elasticity of the quantity demanded alternative energy sources is 1.33.
Oil Company X is observed to be competing in a market which has got both domestic and imported crude oil. The company is currently competing in an oligopolistic market where there is the competition of a few competitions from dominant producers. The price structure in this market allows the price to be set free more so due to the use of market forces in the market.
The other thing to note about an oligopolistic market is that the producer’s behavior is observed to be closely related to each other in terms of output as well as pricing. Extensive trade restriction is set to ensure that the suppliers hold market power the government has agreed to put in place upon completion of the pipeline. The limitation of the crude oil imports will drastically reduce the impact of foreign end on the supply as well as the market price. In an n oligopoly marker, firms are in a place to control the market mainly because other firms are less likely to enter this market.
The increase in the level of product and efficiency in the transport sector has been observed to play a pivotal role in Oil Company more so to ensure that it has controlled the market. Though there are other similar firms in the market which are selling related products, by putting more efforts, I have a belief that the company is set to control the entire market. This means that the company has to offer product differentiation to raise their shares in the market. The current market structure is also observed to be of great advantage for the company since there is a less likelihood of entry of a new firm in this market since this market calls for a huge capital outlay.
I have also been in a place to perform a profit-maximizing assessment to determine what are the new expected profit-maximizing quantity as well as the price of the oil upon the completion of the new pipeline project (Boyes, 2011). Data tables derived from the excel table shows that the new profit maximization quantity is set to be 5 million barrels of the crude oil and the equilibrium price is set to be $57.50 which in this case is considered to be the profit-maximizing price. An intense analysis shows that Oil Company is established to enjoy highest profits which are going to be 134.23 million dollars annually. In the case there is no going to be a recess or trade restriction of the oil products in the market, the company is set to enjoy a revenue of $287.75 million with a total cost of $153.28 million annually.
This market is observed to be faced with limited resources and high start-up costs for those organizations or individuals who have intentions of joining this market. The projections from the new estimates show that it is set to generate high profits. The main objective for all these motives is to ensure that there is profit maximization which is the difference which exists between revenues and the cost — for instance, taking the opportunity cost to be $1,510.00 which is used when it comes to building of the pipeline and not putting the funds to an alternative investment as well as the identified marginal costs. The minimal price would include things such as the destruction of the wildlife habitats, which are situated along the path where this pipeline is set to pass through the wildlife habitats (MAHESHWARI, 2012). The other thing is that it is set to lead to collateral damages which are associated with leakage and natural disasters, EPA regulations as well as legal fees. The analysis is set to include an evaluation of the marginal benefits which are identified with job creation, tax revues as well as economic boom within the surrounding area of the pipeline. We are also set to have a look at the increase in the increase in the production levels, revenues, lower transport cost, and the tax revenues which are going to be earned by the government. When we take into consideration of the projected revenue, pending trade regulations as well as the marginal benefits identified, I would be in a place to make a recommendation that the pipeline project should go on (Perl off, Brander2017). When I made an intensive analysis of the expected profit for the 15 years, it amounted to $1533.38 which amounts to $1510 when profit variance is factored in for each identified risk (Boyes, 2011). This investment is considered as a low-risk investment when we make a comparison of the expected profits along with the expected revenues which are going to be generated when the project is complete.
In conclusion, we have been in a place to identify that the cross-price elasticity of the demand calculated is 1.33 which is a clear indicator that the alternative energy sources are a substitute product which has a strong elasticity on the crude oil. The new equilibrium price is identified as five along with $57.50 per the barrel of the crude oil. The new level of production is observed to total to revenue of $287.5 Million, and the total cost is projected to be 153.28 million.
References
Perloff, J. M., Brander, J. A. (2017). Managerial Economics and Strategy, 2nd Edition. [Bookshelf Ambassadored]. Retrieved from https://ambassadored.vitalsource.com/#/books/9781323467916/
Boyes, W. (2011). Managerial Economics: Markets and the Firm. Cengage Learning.
MAHESHWARI, Y. (2012). MANAGERIAL ECONOMICS. PHI Learning Pvt.
>Sheet RICE
YEARS)
. 0
0 2
1 $82.70 $1.72 7
$29.19 $1.72 $27.47 .51
.40
2 2.80
$1.72 $1.72 $29.92 .54
4 $1.72 $1.72 $30.66 6 $1.72 $1.72 $31.39 8 $1.72 $1.72 $32.12 10 $1.72 $32.49 P 15 20 &”Helvetica,Regular”&12&K000000&P1
Values in Millions
imperfect market structure
P
QUANTITY
TOTAL REVENUE
MARGINAL REVENUE
TOTAL COST
TOTAL FIXED COST
TOTAL VARIABLE COST
AVERAGE TOTAL COST
AVERAGE FIXED COST
AVERAGE VARIABLE COST
MARGINAL COST
MARGINAL PROFIT
TOTAL PROFIT
TOTAL PROFIT (1
5
8
9
0
$1.
7
$1.72
$0.00
82.70
$82.70
$29.19
$27.
4
$29.92
$52.78
5
3
Ksh 802.70
7
6
$
15
$
70.
10
$59.11
$57.39
$29.55
$0.86
$28.69
$30.66
$39.45
93.69
Ksh 1,405.38
70.10 3
$210.30
$
57.50
$89.76
$88.04
$0.57
$29.35
$31.39
$26.11
1
20
Ksh 1,808.06
63.80
$255.20
$
44.90
$121.15
$119.43
$30.29
$0.43
$29.86
$32.12
$12.78
134.05
Ksh 2,010.72
57.50 5
$287.50
$
32.30
$153.28
$151.56
$0.34
$30.31
$32.86
-$0.56
134.23
Ksh 2,013.38
51.20
$307.20
$19.70
$186.13
$184.41
$31.02
$0.29
$30.74
$33.59
-$13.89
121.07
Ksh 1,816.02
44.90 7
$314.30
$7.10
$219.72
$218.00
$0.25
$31.14
$34.33
-$27.23
94.58
Ksh 1,418.66
38.60
$308.80
-$5.50
$254.05
$252.33
$31.76
$0.22
$31.54
$35.06
-$40.56
54.75
Ksh 821.28
32.30 9
$290.70
-$18.10
$289.11
$287.39
$0.19
$31.93
$35.79
-$53.89
1.59
Ksh 23.90
26.00
$260.00
-$30.70
$324.90
$323.18
$32.49
$0.17
$32.32
-$63.19
-64.90
-Ksh 973.50
Expected Profit
Expected Profit for Alternative Investment
CROSS-PRICE ELASTICITY
$ 1,533.38
$1,510.00
SUBSTITUTE GOOD
Profit Variance
Variance for Alternative Investment
% Increase
A 15% increase in price of oil triggered a 20% increase in the alternate energy source. The alternate energys source is a substitute good. The relationship between crude oil and the substitute good is strong as we can see by the equation; The relationship is represented by a postive number over 1 which indicates strong elasticity is present.
$ 1,305,600.00
$32,400.00
Ksh 50.00
Quantified Risk
Quantified Risk of Alternative Investment
Ksh 57.50
1.33
$1,142.63
$180.00