Reference no: EM131373000

You own a small pipeline that transports crude oil from Canada to the US. Yours is one of manysuch pipelines (which we'll label "S", for small) operating in this competitive market, each ofwhose cost is $3/bbl (barrel). There are two other ways to export crude oil from Canada's tarsands as well. The cheapest way is via a large pipeline ("XL"), whose cost is $1/barrel, andthe most expensive way is by rail ("R"), with a cost of $4/barrel. Total capacity of XL, S, andR are 10, 40, and 30 MMbbl/day (millions of barrels per day), respectively. Assume that themarket is perfectly competitive, and that there is no entry or exit.US demand for Canadian oil is perfectly inelastic at 35 MMbbl/day in the winter, and 55MMbbl/day in the summer.

1: On an annual basis, do you expect your pipeline to be profitable? Explain.

2: Suppose the marginal cost of all S-type pipelines (including yours) increases to $3.25/bbl,and the cost of R increases to $4.50. In the short-run, are these changes likely to raise your annual profits, lower your profits, or have no effect on your profits?

3: The XL pipeline encounters political resistance, and is forced to shut down for one month.Would this affect your profits more if the outage occurred in the winter, when demand tends to be fairly low, or in the summer when demand is higher?

4: Now suppose that you run an oil refinery in the US, and your only option is to buy oil from one of these Canadian exporters. Your refinery demands the same amount of oil on all days of the year, but the overall market is the same as in parts 1-3 above. If the marginal cost of the XL pipeline increases (if, say, environmentalists successfully lobby for a tax on XL oil), would that harm you more if it occurred in the winter or during the summer?