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?
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:
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 Saudis have not been able to increase output in meaningful amount to put a lid on crude price hikes.
- Demand from US and China is far more robust than anyone thought possible under $50+ crude price.
- OPEC understand point 2)and has moved their long run upper price band target from $30 to $40 or may be $50/bbl.
- Instability in ME, VZ, and RU means the risk of supply disruption is far greater than over supply.
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,
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.