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Do you share my worries?

by FransGroenendijk Tue Aug 23rd, 2005 at 12:32:10 PM EST

This is a moderated version of a post on my own blog called Peak oil? No really, what is the problem?. It starts with a reaction on professor Hamilton of the blog Econbrowser who strongly criticized a report by Hirsch on Peak Oil. Eventually Hamiltons point of view boils down to "the market knows better".
Generally I do not appreciate the phenomenon of polls on blogs as such.  Here at  Eurotribune however I expect that a poll can help to somehow organize the comments.  An experiment.


At first I just wanted to react on Econbrowsers post on the Hirsh report on Peak oil with the math puzzle I described before:

...how to share a pie with an unknown or even an infinite number of people, giving everybody the same and never run out of pie? Answer: you simply give everyone the same piece of the pie (that is left).
Nobody is interested in the question whether we shall ever run out of oil completely. The question is what will happen if the price is rising very sharp. One thing is for sure: the effects on the world economy are huge.

So the argument that it is nonsense to suggest that we can run out of oil is just semantics.
In the very first sentences of the executive summary of the Hirsch-report it says:
As peaking is approached, liquid fuel prices and price volatility will increase dramatically, and, without timely mitigation, the economic, social, and political costs will be unprecedented."(my emphasis, fg)

The point James D. Hamilton is making is not just semantics really. Rereading it carefully I think his main topic is trying to prove that approaching (the moment of) peak oil is not going to give rise to a sudden increase in price because:
So now I think I've got the picture. The price stays stupidly frozen for ten or so years, and then all of a sudden starts shooting violently upward. Readers of my earlier remarks or related points made by Steve Verdon will know my opinion about this idea. Basically, if Hirsch is right, he would be able to turn himself a handsome millionaire by buying oil, or oil futures, or oil options, before that rapid price increase. That opportunity would be available not just to Hirsch and his two co-authors, but also to all their cousins, and my nephews, and all the people in China, to take a few examples. For Hirsch's vision to be accurate, none of those people, not one of us, is going to be clever enough to take our profits. Because if we did, that of course would cause the price of oil to rise well before we get to the peak, and people would begin making all the adjustments that Hirsch wants to discuss, on their own, <u>without needing any good instructions or advice from him</u>."(my emphasis, fg)

I have several problems with this line of reasoning.
Of course there is some truth in his theory (like in every theory) but it also reminds me of the line If children needed to eat, the Free Market would have made them a cake. Basically he is proclaiming that the superiority of the "Free Market" (above every individual study, government proposals etc) is going to take care of everything. The truth in it is that indeed markets somehow organize the good (and bad) ideas of many, many people and organizations giving it a enormous potential to give the right indications on what society is heading to. What he seems to (want to) forget is that the clever people hired by companies and investors base their ideas and predictions on all kinds of information; the Hirsh report being one of them. This is not semantics: what I am saying is that you cannot argue against any study in itself by saying that the market tells you something else. That is lazy if not stupid. If the study is very good the markets will adapt to the new insights brought to them by the study. You have to argue against the arguments in the study itself!
A tendency in "the market" can be wrong. We have this phenomenon called "bubble" have we not?
In the Oil market there are huge extra problems. The predictive power of markets is stronger the more free and transparent the markets are I assume. You can have your doubts on the strength of the cartel (OPEC) but one can not deny that negotiations and even war have tremendous effects on the oil-market.  Both the unpredictability and the risks are very high. (did Hamilton btw check if Hirsh bought futures in oil?)
What makes Econbrowser a very interesting site is the number and quality of the  comments. There is a good debate on the issue of semantics-or-not too. I read most of the hundreds of comments but I have to read them again to learn more.
I repeat some of the most remarkable comments here.
In support of Hamiltons arguments JB wrote:
"Having said that, there is a futures market in oil, with 7(!) year futures options available. Why are 7-year oil futures still priced in the $30 - 35 range, given what you guys 'know' to be true about peak oil?

RoyYoung answered:
When I checked the Nymex screen today, Nymex WTI contract for 2011 is over $58/bbl! <u>There has been a fundamental shift in the futures market in the last 6 months</u> that is different from the (now outdated) heavy backwardation shape some people are referring to.
Energy market Profs have recognized the following facts:
  1. The Saudis have not been able to increase output in meaningful amount to put a lid on crude price hikes.
  2. Demand from US and China is far more robust than anyone thought possible under $50+ crude price.
  3. OPEC understand point 2)and has moved their long run upper price band target from $30 to $40 or may be $50/bbl.
  4. Instability in ME, VZ, and RU means the risk of supply disruption is far greater than over supply.
Take away the semantics, I think the bottom line is that marginal cost to increase world oil production capacity is much higher than in years past (infinity if we have truly reach peak oil), so it will be difficult if not impossible to maintain reasonable rate of economic growth while maintaining current rate of energy consumption (Energy Consumed/GDP). So the choice is either lower future econ growth rate, or lower rate of energy consumption per unit of output.
The idea behind my reference to Marie Antoinettes cake is repeated by commenter Z:
Imagine a shop that sells food, but there's only enough for 50 people. Now there's a hundred hungry people waiting outside to buy some. Let's look at the consequences :
1 Economic theory : The shop owner raises prices so that only 50 people can eat. The 50 other die of starvation ( demand destruction ) but that's no big deal. Everything is dandy.
2/ Human theory : There's a riot, deads everywhere (including the shop owner ) and the shop is looted.
Homo sapiens sapiens is not the same as Homo economicus

So yes, I have very serious problems with Hamiltons line of reasoning but I think he is right in one very important point.

Politicians should not aim for wealth and happiness for everyone. Instead they should focus on preventing the most negative developments that can appear if we do not act the right way:
Hamilton is right that Peak Oil in itself is not a clearly defined problem.
Peaking of Oil is a complicating factor in the approach of real problems.
For example: the negative effects of the Chinese and Indian economic growth. From a cosmopolitical point of view the economic growth of China and India is really great progress. In the long run not just for the inhabitants of these countries but to the world at large. To important groups it can and does have very negative effects however. There is a chance that demagogues will use the negative effects to enhance instability to fuel anti-Chinese sentiments in the USA and the southern EU-members with possibly horrible effects on the political climate as such and on the potential positive effects of Chinese and Indian economic growth.
Another example is that peak oil complicates the geopolitical problems (US-Middle-East relations..) related to oil and terrorism.
Or yet another example could be the climate change through greenhouse effect. Actually this is not a clear problem too. Climate change has positive effects too.
So indeed it is extremely important to be very clear on what problems exactly you are addressing.

This finally brings me to my biggest worry nowadays.
The next decades, maybe years even, due to
strong economic growth in China and other countries,
the possible hard-landing of the US-deficit-led-economy,
demographic developments,
inescable necessity to cope with the environmental challenges
(deliberately leaving out disruptive effect of islamism-related conflicts and terrorism)
the chances in my opinion are high that the western countries will go through a period of zero or even negative growth.
Responsible politicians should prepare the people (and themselves) for this challenge.  
Sufficient support for policies coping with this challenge can only be achieved with an inversion of the trend of rising (income)inequality as a central part of the program.

Poll
What do you think about my worry?
. Your ideas are to much based on fear (a little bit like the people focusing on peak oil) 11%
. You should not present this highly differing problems as aspects of one big problem 0%
. I share (most of) your worries 44%
. Glad finally somebody makes the link between income-inequality on one hand and the great political and economical challenges we face on the other 44%
. By not including the "war on terror" you ignore the most important issue: economical and ecological problems (unfortunately) come second now. 0%

Votes: 9
Results | Other Polls
Display:
I think the important point is the risk of increasing volatility in the energy market, which will cause short-term price jumps that in turn cause short-term economic dislocation.

The peak oil concept is fine, and we may have already passed it, depending on exactly how it's defined. But the important point is not the passing of a supply peak, but the results of doing so.

The demand for oil is very elastic, although arguably not as elastic as it was in 1970. I don't know about Europeans, but in America there is hardly anyone--I claim, without statistical support--who "must" drive long distances in an SUV to get to work. There are plenty of options: Carpool, bus, bike, train; even bay foot. There are plenty of inexpensive, efficient cars available new and used, so people can park their SUVs. Many in the engineering and information fields can work from home part of the time. Working hours can be re-adjusted; even school schedules can be changed from five to four days a week to reduce travel expenses.
http://www.educationworld.com/a_admin/admin/admin279.shtml
Approaches like this, and others, were implemented in the 1970s and will be used again as short term price peaking takes place.

And while these are only short term "solutions," they lead to long term solutions, including not only changes in lifestyle, home ownership patterns, and work habits, but improved energy consumption efficiency like that touted by the Rocky Mountain Institute. (Not that I support Lovin's ideas completely; some of them are beyond practicality and/or simply misguided.)
http://www.rmi.org/

The market will indeed solve the problem in the long run. The only question is about how we handle the short term irregularity in the price and supply.

by asdf on Tue Aug 23rd, 2005 at 03:49:30 PM EST
The market will indeed solve the problem in the long run.

Can not disagree with that but in the long run we are all dead too (as Jerome rightly keeps reminding us of the great John Maynard Keynes with this). Not to discredit your remark, really, but to me it is not the most important question if or when markets solve problems but how.

Still I disagree with this:
The only question is about how we handle the short term irregularity in the price and supply. because "we" are not the market in the first place but beside that in my opinion it tends to avoid the need to make it clear that the western societies will have to give up some of our lead.
One of the reasons to come up with this post here is that I found out that among Dutch Green it is argued that the message of decreasing consumption is not attracting enough voters and so (!) they should better suggest that technology will solve environmental problems.
Overestimating the possibilities of biomass and wind-energy for example.

    ...Save democracy from direct elections
by FransGroenendijk on Wed Aug 24th, 2005 at 05:41:38 AM EST
[ Parent ]
Thank you for this post...lots to think about here...and welcome to European Tribune (unless I'm mistaken, your first post here...and a good one!). Hope to see you around more...

"Once in awhile we get shown the light, in the strangest of places, if we look at it right" - Hunter/Garcia
by whataboutbob on Tue Aug 23rd, 2005 at 04:17:06 PM EST
..and the recommendation. Yes this is my first post here. Nice to get some comments the very same day I posted it.

    ...Save democracy from direct elections
by FransGroenendijk on Tue Aug 23rd, 2005 at 04:50:03 PM EST
[ Parent ]
is a pool of wrong decisions and failed enterprises. Market in principle does not predict catastrophes, it tries them out, often many times.

With the global economy, within unique environment and with physically limited resourses, a failure to foresee limits of the most convenient resourses may mean a huge setback for the civilization. The free market does not guarantee that we won't fail to manage global resourses responsibly.

After all, it is not a crime at all to play safe. For example, if (for the sake of argument) we would have adopted restrictive policies toward oil and other resourses in 1970's, we might have been a decade late with commercial internet and cell phones, but we might have saved natural resourses for two generations.

by das monde on Tue Aug 23rd, 2005 at 08:17:37 PM EST
First, people that believe in "market solutions" have rarely worked around a real market.  They just have a belief structure that allows them to rationalize selfish behavior. Markets work to satisfy the needs of the strongest participants.  Hence an infinite amount of work for the Eliot Spitzers of the world. I've worked in the European oil market where rules were laughed at.  The slimy people you have to interact with in that world have zero scruples and little honor. They aren't the majority but they have a big chunk of the business. Some pretty disgusting crap was going on.

That said, the analogy of the bakery where suddenly 50/100 have to die due to lack of bread is silly.  The world produces about 84.5 MMBD of crude at the moment and is using a little less (world stocks are building for 4th quarter).  Saudi/Kuwait/UAE "slack" that held prices down for a generation is gone. What is the likely scenario from here?

Even at current high prices we are likely to see modest growth in world demand.  Let's guess 2% or 1.7 MMBD.  If OPEC or other producers cannot meet the increased demand and we begin to see an imbalance, prices will rise very quickly.  The weakest buyers will have to do with less.  As will anyone who chooses to conserve to minimize their energy expense.  Balance comes back by necessity.  We can all cut 2% if there is a societal pressure to do so, especially if it is backed up by a 30% rise in price.

People like me that were driving 15 yr old rolling wrecks getting 15 MPG will pay for a new vehicle getting 25+.  In the last year, I put 170 gallons of gas back into the system or 40% of my prior demand.  Others will ditch Ford Excursions for Prius'.  Chinese taxi occupants will consider going back to the bike if the choice is gas or food.  

Each year the screw will likely turn a little tighter, but there isn't going to be some magic date when a switch is flipped and no one can buy any gas (barring a nuke on Ras Tanura).  Some may really suffer in energy hog societies like the US until they move or make other accomodations, but  Africans  making $200/yr will barely notice.  They already pay obscene prices for the little bit of fuel they use.  Ditto 900 million of the 1 billion in India and 1.1 billion of the 1.3 billion Chinese.

Over time, our economies will shift to value energy more.  We will have to make changes in our lives.  But is it really all that awful to have to give up on some of that cheap plastic crap from Walmart?  Energy use for fertilizer is not that enormous (and mostly nat gas based anyway).  We already pay farmers to grow less and most of our grain production goes to produce meat.  Could we all eat meat only 3-5 times a week like my parents did in the 1930-40's?  Sure.  Probably do us all a world of good.  Will food be priced beyond reach?  Bah.  and the cost of transport to market is a tiny percentage of US transportation energy use.

I just don't see the world meltdown scenario the wild eyed fringe among the peak oilers do.

by HiD on Wed Aug 24th, 2005 at 01:18:23 AM EST
I also knew some real princes in the european energy biz and many of the sleazeballs in the Euro market were Americans.  And the American market is only cleaner (and not by a lot witness the Enron mess) because there isn't all the juridictional boundary problems.
by HiD on Wed Aug 24th, 2005 at 01:21:42 AM EST
[ Parent ]
.

A water buffalo costs $500 and lives for decades. A tractor for plowing the rice paddies costs $1,500 plus you need to purchase diesel. Easy calculation for the small Thai rice paddy farmer!

That means much oil saved for the Western SUV's now being marketed.

I recently posted this after reading a news item!

~~~

by Oui on Wed Aug 24th, 2005 at 03:08:46 AM EST
[ Parent ]
The link to the post about SUV's is very much to the point!
Doing some googling on it I can find several pieces of information on the amounts of SUV's but no reliable statistics yet. What is clear however is that the driving of SUV's is all about mach-oism.
This source  http://www.jsonline.com/wheels/peak/mar05/306235.asp
shows that it is not just about SUV's but pickup-trucks as well. Some over 3000 kg...
The macho-ism is part of my worries. I remember that the Bushists campaigning against Kerry came up with a distortion of his ideas on taxing gas. The Kerryists defence focused on the distorting part, not on the gas-guzzling.

Part of the campaign must be ideological. In Dutch conversation I prefer to refer to the SUV's with the word "PC-Hooft-tractor". The word comes from comedian Yoep van 't Hek. The wording refers to the fact that SUV's can be seen most of the times on the Amsterdam street with the most expensive shops: the PCHooft-straat where they preposterously brake for speed humps!
Any English equivalents for this ridiculing description?

    ...Save democracy from direct elections
by FransGroenendijk on Wed Aug 24th, 2005 at 05:16:08 AM EST
[ Parent ]
First, people that believe in "market solutions" have rarely worked around a real market.  They just have a belief structure that allows them to rationalize selfish behavior. Markets work to satisfy the needs of the strongest participants.  (...) I've worked in the European oil market where rules were laughed at.
I have that strong impression too. I like this confirmation from inside.

The comparison with people dying for shortage of bread is a bit exaggerated (it was not my own btw) but it makes very clear what you are actually talking about when claiming (correctly!) that the price mechanism will take care of shortages.

(I worked for a multinational for a while, for a small enterprise and in education. By incident I drive a car that is rather big and because of its age not very efficient in my view. It takes a litre for a little over 13 km, so that is about 30 miles a gallon )

    ...Save democracy from direct elections
by FransGroenendijk on Wed Aug 24th, 2005 at 04:35:27 AM EST
[ Parent ]
Trimming 1%/year of oil use for 2 decades will be more like putting a 150 Kg man on a diet.  Most of our oil use is in Western societies where we waste a big percentage.  Cutting back won't kill us.

If you are an Xurban idiot commuting 75 miles one way to town for your job, you will be screwed.  That it, until you move back to town or get the job moved to Xurbia. Or ride the bus.....

by HiD on Wed Aug 24th, 2005 at 04:14:18 PM EST
[ Parent ]


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