With the recent Opec meeting we have once again been bombarded by a lot of analysis, often misguided and incorrect, both in the lead-up to the actual meeting and then after it is over. The main culprit is the phrase “cost of oil [production]”.

Let us try to understand this so we can sift through the hype and see if there are any nuggets of wisdom to be found. Our first tool is understanding the difference between average cost and marginal cost.

Let us consider as an example a company like Microsoft that develops and sells software. Whenever Microsoft develops a new version of its Windows operating system, it costs money to pay for the software developers, the buildings they work in, the computers they use and all the support staff, such as finance and HR.

Let us assume it takes US$100 million to develop the new OS. This is usually called the fixed cost or capital expenditure.

If Microsoft ends up selling 1 million copies of this software, then one might think, as a first calculation, that the average cost of the software is $100 per copy and that it should not bother selling if the price is lower.

The problem here is that the actual cost of producing a copy of the new OS for sale, which is usually delivered online, is negligible once it has been developed.

This is called the marginal, or variable, cost.

It simply is not that expensive to copy an existing piece of software. As long as the cost of producing an extra unit of goods is less than the sale price then it makes sense to sell.

This well-studied idea permeates the oil industry. When analysts talk about the break-even cost of ­production they usually only, or mostly, include the marginal cost.

The capital expenditure, such as exploration and drilling, is ignored. Historically this is not a bad assumption as a standard oilfield will produce for decades. Shale oil wells, on the other hand, have a useful life of about three years.

This means that the capital expenditure rolls over far more quickly and the actual break-even is well above the marginal cost.

There are other issues, of course: the cost of human capital, insurance, debt, transportation and so on. But then we have issues such as what percentage of revenue is shared with technical partners and how much crude is actually used locally rather than sold for revenue.

What this means is that any analysis of the break-even costs of different oilfields basically requires a supercomputer and an advance mathematics degree to truly understand.

This, however, is only the revenue side of the equation.

As I have repeatedly pointed out, the expense side of the equation, the government budgets of oil-exporting companies, simply do not exist in some static reality, unchanging and making it easy for analysts to compute a so-called government budget break-even price.

Let us consider a simple example of how useless this is. Just like a company, a government can optimise its funding structure to meet its needs.

Saudi Arabia did just that by issuing the largest emerging-market debt offering in history, and this was oversubscribed several times. There is also Saudi Vision 2030 that many of these oil analysts are underestimating. They are too blind to see the possibilities, perhaps because they are still wiping the egg off their faces from their miscalculation of the success of the Saudi bond issuance.

If you are an investor you know how hard it is for an analyst to get it right on a company, let alone a sector.
If you are a businessman then you know it is even harder to get it right about an economy.

Can you imagine the complexity of successfully analysing the impact of oil on the global economies?

A simple review of articles over the past year about oil and a comparison to what actually happened to the oil price, let alone various economies around the globe will quickly show that analysis, articles and speeches create no value to an actual investor or businessman.

The recent Opec announcements are creating quite a stir.

For the serious investor and businessman there is zero actionable information. If the price of oil is going to have a big impact on you, then hedge your position in the derivatives markets.

Stop wasting your time trying to understand oil. Invest in more productive endeavours. I hear there’s an interesting Emirati writing for The National.

PS: Hey, Britain, say hello to Italy. And keep an eye out for France. I hear they’re just around the corner.

The follow up to this article is: Oil, Opec and the Revenge of Rosneft’s Sechin. You may also enjoy: Saudi Oil Price, the Global Economy and Correcting Media Economists, Saudi Oil Price Redux, Saudi Oil: Through the Looking Glass & Other Adventures in Investing, Second Order Questions and Sterilising the Oil Price Effect and Shale Oil Producers: Swing Producers or Price Takers?

This article was originally published in The National.