Econbrowser

World oil demand grew last year much more rapidly than anticipated, despite an increase in price at the end of the year. It appears that it is likely to do so again this year, even as prices continue to rise. I have paid over $6 a gallon for gas in the UK without demurral, since I needed a car to get where I was going. The point at which Demand Destruction kicks in, and at what level, is a matter of some interest and debate. There have been riots already in parts of the world and there are financial problems in India where the price is subsidized. Yet it is anticipated that demand will continue to rise globally through the end of the year. Both the US and China are at the point of buying more oil for their Strategic Petroleum Reserves, which will also drive the price higher, depending on how rapidly they impliment those plans. By the way demand does not depend just on price (you might want to revisit the papers describing the economic impact of a shortage of natural gas concurrent with a severe winter in the US as President Carter took office in 1977).

And, forgive me, but I still get the feeling that you don't understand the reality that in most cases, once an oilwell starts producing, the owners will keep it doing so, in many cases regardless of the price they get for the oil.

Heading Out, I did read your earlier post on keeping a producing well operating, and you're correct that I was not persuaded by the argument. I do not claim that the owner would shut the well down, only that the owner would reduce production to the point at which the spot price plus the cost of carry equals the futures price. Are you claiming that there would be an infinite cost of reducing production by one barrel, or an infinite interest rate at which the future is discounted, or that small adjustments are physically impossible? If not, then the claim that profits are maximized by choosing to operate at the point at which spot price plus cost of carry equals the futures price is simply a mathematical proposition.

In addition, the owner of the well is not the only agent in a position to profit from a violation of this arbitrage condition, given above-ground storage.

Sorry, Heading Out, I got so interested in your second point that I forgot to respond to your first point. I do not insist that price is the only thing that influences demand, or even that it is the most important thing. Rather, my claim is that the price can and most assuredly will adjust to whatever value is needed in order to equate supply with demand.

In defense of the Hirsch report, I think the issue that they are trying to raise is that a sudden rise in tne price of oil will have cause a reduction in demand that will be difficult to adjust to. This is what the Goldman Sachs report referred to as "demand destruction." Of cause, supply is always equal to demand but a sudden, large change in the supply demand balance and the resulting price spike cause problems. During the California energy crisis when prices rose from a normal $30-50/MWh to $500-600/MWh in three months, demand always equaled supply but any one who went through that experience will remember the resulting shocks to the system; businesses folding, a major utility declaring bankruptcy, blackouts, etc. Of course the critical issue is all about how much time everyone has to adjust; oil rising from $10 to $60 in 7 years is quite different from a similar six-fold increase in say a year or two. Such a dramatic increase is conceivable if panic sets in because the market suddenly becomes convinced of an impending shortage.

I therefore believe that the problem with the Hirsch report is that they decribe a real phenomenom but in language that economists will not use.

I think RayJ has 'hit the nail on the head'. Both OilDrum and JDH are talking about the same thing, but past one another. There are 2 types or levels of 'demand'- the one that will match supply at a particular price point (JDH's demand), and the one we would like to have to continue with our standard of living (OD's demand). People in Zimbabwe would love to drive their cars but have had to revert to horse and cart given the country cant pay to import enough oil at $60 per barrel, hence demand adjusts- but at what social cost?

"I therefore believe that the problem with the Hirsch report is that they decribe a real phenomenom but in language that economists will not use."

Then I think economists need to realize that the little sandbox they've created for themselves is fine and dandy, but when looking at the analysis of real world problems (e.g. peak oil), they should focus on the problems, not symantic or terminological subterfuge.

What I've found several times when interacting with economists is that they find some particular nugget of "misconception" or terminology not to their liking, then decide that the speaker is hopelessly confused. "If only they understood economics" the economist will huff and walk off.

I'd really like to know what JDH thinks of the work of folks like Daly, for example, or others in the Ecological Economics community.

It's quite obvious, for example, that demand will match supply, and that price (or Govt intervention) will force this to be the case. But in and of itself, that's a pretty trite observation, in my mind--from a physics/engineering perspective. We get it. Prices rise. Demand is destroyed.

My question: how would you model this?

"geologists and other observers believe that supply will eventually fall short of growing world demand"
Hmm just pretend that they didn't use those words to express what they thought, instead pretend they said:
"geologists and other observers believe that supply will eventually fall enough so that the cost of petrol will noticeably affect it's usage"

The problem here is that the geoglogists are using the term as:
"An urgent requirement or need: the heavy demands of her job; the emotional demands of his marriage; an increased oxygen demand."
Whereas you are thinking of demand as:
"The amount of a commodity or service that people are ready to buy for a given price: Supply should rise to meet demand."
http://www.answers.com/demand&r=67

Both are correct definitions, but one is an economic term, whereas the other is a layman's term.

One could say that the report is at fault for using non-economic jargon in an essentially economic sentence, or that JH is at fault for demanding precise economic jargon in a report that is not designed for economists.

And I think that you all are missing the fundamental point of JDH's post - every issue you've described is, by definition, knowable. It is known that winters will change demand. It is known that some fields are exhausted and others aren't. And it is known that panics can occur when supply falls dramatically, further upping the price.

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?

Secondly, you talk about the social cost of rapidly rising oil prices. There are also significant social costs involved in forcibly switching people to lower consumption systems/technologies too soon.

Remember, we're basically saying 'either you believe the large, uncontrolled mass of people who invest in the oil futures market, or you believe the small number of peak-oil pundits. Historically, pundits in any field are often wrong, because they focus on things that reinforce their message, and ignore or downplay things that don't. I'm not saying that these pundits are wrong. I am saying that if I jumped on a bandwagon every time anyone said 'X is going to be a problem in less than 5 years', I would be much, much poorer.

Much of these discussions are about semantics. The fact is that there is a finite amount of oil on the earth and one day there won't be anymore. Between today and that last day production will start to decline, and it may be that we've reached that point. But whether we have or not, the fact is the amount of oil is limited.

The process of economic development,almost by definition, involves the use of energy to become more productive. Virtually all humans want to be better off,so energy is needed.

The math,in concept,is relatively easy. The oil will run out one day so it is necessary to have other forms of energy if mankind wants to maintain or continue to improve its lifestyle.

jb wrote: "Why are 7-year oil futures still priced in the $30 - 35 range, given what you guys 'know' to be true about peak oil?"

Would a palm tree futures market have saved Easter Island from a sudden economic decline, war and cannibalism? That's not simply rhetorical; if you think a modern market could have saved the Rapa Nui, I'd like to read your explanation.

Perhaps the markets will continue to function and some clever people will prosper from energy depletion, but I fear that demand destruction will mean that many more of us will have no job, no heat and no food.

Grin - actually JDH and I agree on one thing, that those who use predictive models beynd the point where significant Demand Destruction begins to occur are venturing into the land of fiction. (From the point that the basic model conditions no longer apply). (My particular target was Cooke's "Oil - Jihad and Destiny" in my post last Sunday). And looking at overall national behavior there is some question as to whether Russia is beginning to hoard oil, working on the premise that JDH proposes that it will be worth more later. But while this can be applied on a national scale, I don't think, because of the agreement when you join a supply pipeline, that it applies to individual well owners, though I do not know for a fact. Further the high costs of generating the well, drive the owner to production as an ROI as soon as technically feasible. And once out of the ground, finding places to store it becomes expensive.

The line:

"World oil demand is expected to grow 50 percent by 2024"

is actually footnoted:

"U.S. Department of Energy, Energy Information Administration, International Energy Outlook - 2004, April 2004."

I think what Hirsch is trying to do, rather than present this number as his own, is to show how other people's projections don't match the available reserves.

Yes?

I too was struck in reading the report at the treatment of future oil demand. It wasn't a precise formulation but who doubts it? It does make the assumption that prices are held constant. I believe the point the authers were trying to make is that we would LIKE the supply to continue to increase to meet demand growth at current prices, i.e. business as usual.

The PURPOSE of the report was not to forecast future demand at some price point but to explore the technological options for convential oil substitution and their physical delivery timing. It achieved its goal albeit without economic rigor.

So how would an economist guide a small fry investor to make a profit given our view of the market ahead?

Buying futures in an increasingly volitile market is risky to one's financial health. Are there oil leaps? I've proposed elsewhere that equity in US stripper wells might be safer - I wonder if there are hedge funds or the like to pool small investments in strippers? Besides oil, one can make a case for natural gas although they usually have shorter lifetimes and the production peak is beyond oil. Simple stock purchase in E&P companies with solid reserves seems easy IF they have good management.

Some great comments on this thread.

Personally, I don't think it's just a matter of semantics, but I can understand why some posters see at as such. I too am getting very tired of economists taking laymen to task for incorrect usage of the sacred words 'demand' and 'supply'. When we hear that there was excess demand for U2 concert tickets, I think we all know what was meant.

However, I don't think Professor Hamilton is guilty of this here. My reading of his post is that he's extending the arguments he gave in the WSJ Econoblog debate with Robert Kaufmann. At the end of this he gave a powerful articulation of his views:

"We only have so much in the way of resources to cope with these great challenges -- only so much capital to invest, only so many geologists to figure out how to get at the oil that remains, only so many engineers to develop alternatives. It is precisely because I agree with Robert about the importance of this transition that I think it's critical that we put all our resources to their best use. And I honestly believe that the best way to ensure that happens is to count primarily on the same system that has generated the fantastic improvements in global living standards over the last few centuries, namely, individuals choosing to direct the resources they personally control to those activities that yield the highest personal reward."

This is the crux of the argument. Do we follow some of the recommendations of the Hirsch report, incurring potentially huge transitional costs in doing so, at the same time risking pouring resources into solutions that have no guarantee of success? Or do we allow more free market principles to enable the transition, with some assistance from government in terms of private incentives and possibly some form of energy tax?

It's a highly debatable point. I lean towards JDH's view, but with trepidation, and that's because I'm not convinced the market is going to give us price signals sufficiently in advance. I'm not sure that traders and producers are going to smoothly artbitrage future prices into the present to enable an *orderly* transition to take place.

And that's because there are too many variables for anyone -- ANYONE -- to be certain of future oil production levels.

BTW, what's the demand for whale oil? Anyone care about the price?

I think the Caleeforneea electricity crisis is the wrong example to use. In that case, the price mechanism was legally thwarted from its normal function (despite the soaring cost of production, the price to consumers was fixed at a constant rate). In fact, the California Crisis is either an example that works in JDH's favor, or at the very least demonstrates how wrong thinking about the price mechanism leads people (perhaps especially well-meaning politicians) to the wrong conclusions.

Also - for Prof Hamilton - I remember from college that it was always difficult and overly cumbersome to distinguish between "demand" (i.e. the curve) and "quantity demanded" (the amount desired or delivered at the intersection of the supply and demand curves). I think that demand for oil will not change in the short term as prices rise, but the quantity demanded will change in accordance with the price elasticity. In the longer term, demand itself will change, meaning the *quantity* demanded at all prices will change. Could someone come up with different, one- or two-syllable terms for "demand" and "quantity demanded"? Especially for the purpose of disambiguating with the lay definition of demand noted by Factory?

Although I am not an economist, I share this frustration with people who speak as in the Hirsch report. I do not think it is a semantic debate. I think that they actually think (as Jevons did in his coal report) that demand is a constant that remains at a steady state, or keeps growing at its historical pace, no matter what happens with supply or prices. If they know how much is (actually or theoretically) in the ground, they can calculate a time at which it will all be depleted. I think that there are people who really believe that you can calculate depletion with something like a ballistic equation and predict that on such and such a date, you will open the newspaper to the headline, "Last Drop of Oil Pumped; Saudi Arabia collapses 25 ft, sets off sand-nami; President (Jenna) Bush and Dale Earnhardt Jr. III refine, burn last gallon of gas in gala ceremony!" I thought it was interesting that your co-blogger in last week's WSJ discussion opened with a flat refutation of that scenario; obviously he thinks that perception is both wrong and ubiquitous. It's a conceptual problem, not a problem with word choices or meanings.

Excellent commentary. I agree with the gist of the many comments pointing out that one should (a) look to the markets, e.g. the futures market, for signals as to what will happen in the future and (b) one should be very cautious about expending large funds to incorrectly or inefficiently solve a problem that would more efficiently solve itself through market means not invisioned at present.

But ANALOGIES about whale oil and the stone age not ending for lack of stone are useless (as some, not JDH, would argue). I've yet to hear anyone point me to the predictive power of the futures market. And I've yet to hear someone tell me why demand destruction would not significantly reduce the price of oil so that $100 oil in 2010 will not happen (even after peak). I'm told that people will bet on $100 oil in 2010 (based on their collective hunches)but how many people will hold such a position if demand destruction pulls the price of oil down to $40 a barrel.

I'm not a peak oil fanatic. Nor anti-economics. But I do think we need a REALITY BASED community focusing attention on this issue. In some of the more ideological sectors of the economics community, there is no problem--markets will solve it (e.g. whale oil isn't necessary) and in the extreme peak oil community, they've already locked themselves in with military rations and weapons.

I think the most important investment right now for peak oil is good solid analysis (such as JDH is contributing to). Honest assessments of the what we might face.

I think in broad strokes the US DOE is saying that people are going to burn 50% more oil, and Hirsch is saying "Where you gonna get it?"

Maybe you have to back up to the DOE report and see that they're doing ... projecting from current demand? If it represents what the world wishes they could burn in 2025 ... the question is still "where you gonna get it?" or "if you can't get that much, who will afford it?"

Eric H,

When wholesale prices started rising in California in spring of 2000, San Diego residents felt the pain first because their local utility had already paid off their stranded costs and could therefore pass along the wholesale costs directly to their retail customers. It did not take long before some price control was put into place; the utility borrowed to purchase wholesale electricity, held down the retail price for customers, and recovered the difference over a longer period of time. While San Diego was only about 20% of the deregulated CA market, it showed what would have happened in the rest of the state if retail prices where allowed to fluctuate with wholesale prices. I agree that the crisis may not have been as severe as it ended up being (e.g. a utility would not have gone bankrupt) but it would have still been painful. It remains to be seen whether government will take a hands-off approach and let the market and the economy handle the shock if oil prices spike for an extended period of time.

Do economists have any tricks to tell us if $60/barrel oil is signal or noise? Trend or volatility?

It seems kind of like passing the buck to ask (yet again) for the geologists to go get rich and prove the trend ;-)

FTX,
You are right about the crux of the argument. From a risk management perspective, the Hirsch report is arguing that hedging by taking some action now will be cheaper than the potential cost of dislocations to the economy. They also believe that the cost of the hedge is not that large and that the economy can afford it. Of course, if the amount they recommend spending is of the order of magnitude of the cost of a peak oil induced price spike, then it will not be worth doing.

I see this as a conceptual issue, not semantic. The core message of the Hirsch report is the claim that markets will not respond to this problem. The point of my post is that this represents an assumption, with no supporting analysis or evidence, rather than a conclusion of the Hirsch report, and that the authors don't even recognize that it's an assumption in part because of the fuzziness with which they use the expression petroleum "demand".

T.R., I welcome everyone into our sandbox, and have no objection if non-economists want to use the phrase "petroleum demand" to talk about something other than what economists would mean by that expression. My only request is that, if you do so, you need to define the expression. Don't tell me, "everybody knows what it means," because I'm telling you, no, I don't know at all what you mean by "demand". I offer one definition in my post of what I think you probably mean, but if that's not it, then give me your definition.

And I won't settle for some vague references to "maintaining our standard of living." The object you're talking about is a quantitative measure with physical units. You should be able to give me a precise quantitative definition of that object if you want to use the expression "petroleum demand." If your definition is conditioned on a particular level of income and price (as I'm suggesting it should be), then tell me the income level and price that you're assuming, so that we can all be clear about what you're assuming and what you're concluding.

Using terms without defining them is an invitation to confuse yourself and everyone else.

I don't read the Hirsch report the same way as odograph. I think that what it was saying in part is that we have a huge inertia against change in the size and needs for fuel of our current transportation fleet, and that this cannot be turned around in less than about 20 years without significant impact, and that 20 years requires that R&D funds be invested now to find a new answer. Short of having that 20-years, we are in trouble. I believe that the 20-year time frame is reasonable, and I would hesitate to say that the US has a wonderful tech transfer program, since that is a world I live in, and from experience that amount of time from lab to broad use is a good first approximation.

JDH: I agree that one has to quantify and/or qualify the analysis. And to draw upon accepted terminology (or concepts). And I also highly commend your efforts to focus attention on this issue and to disambiguate where possible. Since I'm dabbling in this issue from both ends--looking at the economic issues and the geological issues--as are many--I'm operating at the intuitive level and will grasp at terms to help quantify/qualify--or confuse, as the case may be. And as a dabbler, I'm not reading something like the Hirsch report with a fine tooth comb--from either perspective, geological, or economic. I don't have the background, time, nor perhaps interest. But....I do believe what should be happening is that economists read the Hirsch report and work with those in the geological and energy fields (energy production/consumption, etc) to refine our collective understanding of the problem. My fear is that the two communities will continue to speak past one another. There are real problems to solve, or at least to quantify/qualify, hopefully in a way that both communities--or at least segments of both communities--can agree upon. Now that would be progress. The efforts you--and folks like Oil Drum--are making will hopefully lead in that direction.

There is huge boulder of inertia, and "where you gonna get it?" is the message that should be spray-painted on its side.

I think the economists here agree that we won't be burning 50% more oil in 2025 (yes?) ... so rather than goading geologists into investments, they should be telling us what happens next.

Many thanks to JDH for these continuing discussions of peak oil. The more people who know about the potential problems we face, the better.

A small comment on the economics from a non-economist: if the market is really our best hope, should not tax policy reflect this? What tax policies would best help the market find the best possible solution? It seems to me that this is where economists could make a very important contribution.

RayJ - Quite right about San Diego (and it seems to me like there were one or two other rural providers that had paid off and were likewise deregulated). It was painful, but at least SD customers had the proper motivation to back off on the quantity of power demanded. Unfortunately, the San Diego market did not dominate the state demand. Seems like I remember that buildings in LA and SF were leaving their outside architectural lights on throughout the crisis period (though peak output hours don't occur at night). But let's remember that the building of electric generation facilities on the basis of predicted future demand was not exactly guided by the price mechanism, either.

All this talk about the definition of "demand" is obscuring the more important issue: if Hirsch is right in substance (particularly in what he implies about the consensus of geologists), then why are oil futures prices so low? If Hirsch is right, you should be able to buy 7-year futures and keep rolling it over every 7 years until the price of oil skyrockets. You may have to invest some money along the way, but eventually you'll be a gazillionaire. Either (1) Hirsch is wrong; (2) oil traders are stupid; (3) there is an imperfection in the oil futures market; or (4) it is expected that substitutes for oil will become available. I wish that people would specify which of these they think is the case and why.

How much different would current demand for oil be if countries such as Nigeria, India, and others remove their pricing controls on oil?

JDH, you say

"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."

but in the ten or so years before the 1970 peak in U.S production, prices did just that. Prices stayed low after the 1970 peak, but that was because there was a substantial supply overhang.

Similarly, there was a peak in gas in the U.K section of the North Sea, but prices for most of the 90's were the equivalent of $20 or less. They are now around $100.

Is this the kind of market efficiency you are relying on?

First, another great post, Professor Hamilton...

Okay - couple of points: First, how many times have we "been close to running out of oil"? At least 3 or 4 that I can think of....absolutely YES, the PO crowd might be right - this time - but when they're talking about unilateral forced changes via the heavy hand of government, I sure as heck like to see a whoooole lot more "proof".

Second - governmental interference as a "solution". Can I just say "GAAAAHHHH"? Higher prices are what drive innovation and the market is the best mechanism for finding and promoting new innovations. Goverment sponsored/supported/subsidized innovation is not responsive to market needs/demands and funnels monies away from areas it would be productively used. How often do "bad" governmental programs die as opposed to corporate ones? Think of it this way - there's a *lot* of money potentially at stake here - esp if the PO crowd is correct. Would you rather have a single and fixed vision of the future, or a thousand companies constantly battling each other for a piece of the pie? I'll go with profit seekers every single time.

Third - the PO crowd ought to be celebrating the current "high" (And still way less than inflationary adjusted peaks) prices b/c it IS forcing conservation and innovation: There IS economic incentive to find new ways to use oil efficently and from new sources such as oil shale as well as making alternative power sources that much more viable - which in turn, attracts more money to them.

Fourth - PO is at best a moving target - if prices do double and treble from the current level, how many of the readers here will use the same amount of gas as they currently do? Obviously, demand will drop and when demand drops, the supply timeline lengthens out. Assuming a constand rate of demand is not only silly, but downright dishonest.

Look - PO people can be justifiably worried about a lot of things - and if they *are* worried about the financial impact of rising crude oil prices, then they ought using the means at their disposal to hedge their perceived risks - just buy Dec 2009 futures - which at the time of writing ar $59 poer barrel.

Me? I'm going to worry about keeping governmental interference at an absolute minimum.

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! There has been a fundamental shift in the futures market in the last 6 months 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.

Jon - do you think governmental interference is at an absolute minimum?

I think the government's project of lower oil prices has a significant effect on our preparedness for anything else.

It is kind of sad to look at their price projection (figure 11, bottom left of page 9, in the pdf):

http://www.eia.doe.gov/oiaf/ieo/index.html

They were wrong about prices falling in 2002, so they just try again in 2005 ...

Odograph wrote:

"Jon - do you think governmental interference is at an absolute minimum?"

I wish! The hand of government is everywhere - from the SPR to road subsidies for suburbia to directing alt fuel research - which rewards certain projects and punishes other on merits other than their financial viability. (The financial viability of the campaign contributions is of greater importance...)

Wow, I guess we're on the same page then!

With regard to futures markets, "jb" asked above, "Why are 7-year oil futures still priced in the $30 - 35 range?" I just wanted to point out that this is wrong, 2010-2011 futures prices are in the $55-60 range. But the basic point is still true, the market is not forecasting a big price rise between now and then.

In fact, as Prof Hamilton has explained in the past, with a commodity like oil that is relatively cheap to carry over into the future (either through storage or simply by pumping it more slowly from the ground) you will never see a major price premium going forward in the futures markets (what futures traders call "contango"). Prices six years in the future are never going to be a lot more than they are today. This is another way to see the falsity of the assumption in the Hirsch report that prices will only shoot up as we hit the peak. In fact they will increase years ahead of time.

The big question in my mind is whether the high prices we see today are actually a reflection of that phenomenon, fears of future shortages. JDH had an article on the topic last month I think showing some statistics which suggested that this is not what is happening, but I need to go look at that again.

JB also makes a good point, which Prof Hamilton mentioned in his last sentence as well. Taking regulatory steps now on the assumption that PO is a near term crisis can be very harmful if the assumption is wrong (as the markets suggest it is). For example, many Peak Oilers call for increased oil taxes in order to discourage consumption. They don't see that this will make the country poorer and leave us in worse shape to withstand the eventual consequences of an oil shortage. Taxes distort investment flows away from the economic optimum.

Just as an obvious example, increased oil taxes could reduce travel and car purchases and send airlines and car makers into bankruptcy. The shock waves would ripple through the economy and cause other businesses to cut back. Venture capitalists would have less to spend and private R&D would be reduced due to belt tightening. The result: less research into new technologies, some of which might turn out to be crucial for dealing with PO and other future problems.

Odograph - up thread you wondered "what happens next?"

I have no idea - nor does any honest person. Sure, it's fun to speculate and wonder - but a lot can and will happen over the next years - and this is precisely *why* I want the markets to determine our path, rather than the government dictated solution.

Where would you rather put your money on the best result for a liquid (!) future: The limited vision and slow movement of a government program or a thousand rapaciously innovative and greedy companies constantly morphing and changing to new monetary opportunities?

Me - I don't believe in economic Creationism - give me evolution every time.

Interesting discussion.

I would suggest that instead of blaming the Hirsch report for not properly seeing the relationship between price/supply/demand, economists should do that modeling based on geologic facts—and I do not consider the futures market a substitute for modeling.

Yes, if prices rise too high, the demand will abate until prices relax. But what are the economic consequences during that abatement? And what if prices rise again because of continuing decline? Flesh out a real world scenario for a change.

Geologists are not economists. Economists are not geologists. Nor are economists experts in alternative energies. (Greenspan blithely believes that we can easily tap the vast frozen methane deposits off the continental shelf.)

And we know that economists will not touch any global warming issues with a ten-foot pole. But the insurance industry will. Ah, yes, the market will handle it.

In short, economists have little more to say other than, “Well, we will just consume less—and the price will abate. Problem fixed.” Well, right now, it is economists who are running the show. And frankly, I am not impressed.

After the Enron debacle, I had to chuckle at Forbes protesting against any new regulations, arguing that, after all was said and done, the market forces did their work. Yup, they sure did.

“Market forces” is just as slippery a term as any other. And it seems to be an excuse for hard thinking.

I'm not an economist but could anyone explain why the price of oil should remain at very high levels after peak production is achieved? Even at $60 a barrel there are several cost effetive alternatives (e.g. ethanol, liquified coal). None will be able to displace oil in the short term, but then all that is needed is to suplement the production.

Couldn't that be the reason for the (mostly) constant 4-7 year future options prices?

Jon - I think could draft a wonderful economic strategy working from a blank sheet of paper ;-). Not really.

Given the current mess (dysfunction) though, I think the better strategy is gentle redirection. Ethanol subsidies may be damaging, but redirection toward efficient ethanol production may be the best redirection we can manage. Hydrogen fuel cell research may be misguided, but redirection toward better batteries may be all that is possible. Etc.

Most importantly, for this discussion, the DOE's rosy price predictions and demand curves may be damaging, but maybe they can be balanced with something a little more cautious.

Odo - your blank piece of paper works just fine for me!

Ethanol? Two issues there - A) still a great debate with competing studies as to whether or not it is enery inefficient wrt production and B) the subsidies received "shade" out other alt fuels by reducing the cost of production. If it was/is a viable alternative, it will do just fine on its own. Methinks the ethanol mandates in the recent energy bill have more to do with ADM and Cargill's contributions than ethanol's reality.

The DOE - I agree - they're likely offbase. But, I'm also thinking a tree falling in the woods - the DOE's projections have 0 impact on my business - the price of natural gas and crude does and that's what I watch.

Stormy

When you speak of the Enron debacle - what precisely are you referring to? The tar and feathering of Arthur Andersen during the post-collapse witch hunt? Or some sort of "market" failure?

Cerqueira,
When PO happens, the world capability to consume oil will still be there if no viable alternatives exist in sufficient quantities. One of the things that will reduce that capability to consume to the actual demand will be high prices (rationing will be another but less efficient mechanism to achieve the same reduction). The big issue is whether 1) the resulting oil price is high enough soon enough to motivate the market response that will solve the problem, or 2) governnment should take proactive action to mitigate the problem.

PS: Note that I distinguish between the actual demand at a specific price and the capability to consume at, say, zero price. This distinction is similar to that between actual production and the capacity to supply. Apologies to economists if I have not used the correct language:)

On Enron, if you ever get the chance to see "The Smartest Guys In The Room" do it:

http://www.imdb.com/title/tt0413845/

I had some business relations with SCE plant production gusy, and what I saw in that movie dovetailed with what I heard from by buddies. The partial-deregulation in California, drafted in part by industry players, allowed tremendous manipulation. They simply shut down low-cost California production, in order to import higher-margin power.

It drives home the difference between a "deregulation" bill, and a free market.

Carqueira - according to Matt Simmons, $60/barrel is still considered getting oil on the cheap. why, that's only $0.18/pint of oil!
$100/barrel = $0.30/pint.

Both deliberate disinformation and hidden bias in market information misleading people making expenditure decisions - isn't that a major component of the problem? Although predictions about the future will always have an unavoidable level of uncertainty, it seems to me that the market price signals could be considerably less biased. For example, on the science side it appears that without signficant technological innovation, the EROI on ethanol is pretty close to a wash. If that is right, aren't investment decision-makers expecting ethanol to be a major petroleum substitute being misled by the current market signals and government policy, whatever its reason? These individuals range from those deciding on a new car to those deciding on building a new gas station and to the corn farmer buying a new 150 hp tractor at about $700 per hp and so on. On the science side, coal produces considerably more CO2 per BTU than natural gas. In the opinion of far more scientists than not, human source CO2 is driving some undesirable climate change. Aren't investment decision-makers expecting coal to be a substitute for natural gas in electricity production are being misled by a WSJ op-ed author writing that global warming is theology and not disclosing that he is a board member of one of the largest coal companies?

That's pretty much my impression from the traders I know in the energy business - the partial dereg was an invitation for disaster - particularly since it prohibited any sort of vertical integration.

A free market it was not - more like a market designed by committee....

Some have written that market forces should steer technology rather than dreaded government intervention. As the US, State and Local gov'ts presently subsidize the oil industry in a myriad of ways, from handouts in the latest Energy bill to paving roads, when should we switch over to these market forces?

Donal(d)?

Now. (Assuming you're talking about getting rid of oil subsidies...) In fact, the sooner the better.

Unfortunately, most oil companies have figured out that the real gushers are located in D.C. and don't cost that much to develop.

I think of oil as a productivity enhancer. Here's some hard numbers.

I drive to work - it takes me 10 minutes each way and costs me a tank a week at $40. My alternate transport is an electric trolley/bus that takes 1 hour 15 minutes each way and costs $55 a week but my employer might buy me a transit pass giving me no out-of-pocket costs.

I save over two hours a day by driving at a cost of $40 per week plus wear and tear on the car.

So how does that affect my productivity? Rather than sit on a bus, I work overtime. At $80+ an hour, I gross $160 a day extra or $800 a week. That $40 in gasoline earns me $800 a week, a 20 to 1 win before income and sales taxes. (OK, so I don't work 10 hours everyday, just most days. Likewise, I could take public transport AND work OT but I got a life! Marginal utility of time?)

That's why I'll continue to buy gas (or whatever makes my current or future car run) - this demand won't be economically destructed for some time. That's why most economies will continue to buy liquid transportation fuels at much higher prices - it's the productivity leverage.

China and India hope to capture this productivity boost by using petroleum too. Unless they can find an equivalent booster, they are going to "demand" oil too because it is one of their best ways to spend their incomes.

Hal,

"They don't see that this will make the country poorer and leave us in worse shape to withstand the eventual consequences of an oil shortage. Taxes distort investment flows away from the economic optimum."

Taxes to assess externalities are an assistance to, rather than a distortion of, the correct operation of the market. Certainly there are a ton of subsidies today keeping the suburban motoring lifestyle cheaper than it ought to be, from restrictive zoning laws preventing urban infill to oil exploration subsidies to military adventures. At a bare minimum, a gradual tax for "global warming externalities" would help overcome some of this past structural misinvestment.

Relating to the original post by Prof. hamilton:

"...I suppose that if one did have the view that demand was something that just grew on its own without any regard to the price (as this study [Hirsch]seems to me to do), the claim by economists that supply will always satisfy demand would seem profoundly bubble-headed..."

BINGO!!! I believe that with respect to the models used by US DOE EIA and IEA (Paris), this is exactly how they work. A long-term price is assumed fairly flat for models. Long-term economic growth (consumption) is based upon the averaging of past growth rates. It is also assumed that there are sufficient reserves and that a higher price triggers the next tier of slighly more costly production. So, bubble-headed could be a good description of the modelling process. (I realize that the models are more complicated that this, and that there are plenty of cavaets regarding the assumptions, but...)

How bubbleheaded is it? In the 1998 IEA long-range forecast for world oil production, the middle east is shown as peaking around 2016ish while the rest of the world is shown peaking about about 2012ish. The gap between known supply and expected demand (for a happy, prosperous world economy) was made up with an 'unidentified non-conventional' plug. Since then, the 'non-conventional plug' has been replaced with Saudi Arabia/Middle East with no new discoveries and no technical justification. Meanwhile demand growth and matching supply continue the same trend as the past. These models do not address the implications of price shocks and demand feedback mechanisms, and essentially results in a politically ideallized forecast, not a range of realisitc scenarios.

Now keep in mind the that the 'unconventional oil' in the 1998 forecast is just a balancing item!!! It is unidentified! See Fig. 3.9 of http://www.iea.org/textbase/nppdf/free/1990/weo98.pdf

compare this to fig. 3.4 of http://www.iea.org/textbase/nppdf/free/2000/weo2002.pdf where middle east becomes the balancing item.

"Do economists have any tricks to tell us if $60/barrel oil is signal or noise? Trend or volatility?"

reading all of the reactions to the beautifully written argument that began this thread - i am starting to suspect (a) that you should never take investment advice from someone who is consumed with the rightness of a single particular idea. and (b) peak oilers seem to be strongly materialist - peak oil is the 'real' fact that cannot be denied, while investment, production, storage, manipulation, obfuscation, politics and speculation are somehow 'unreal' factors that can be disregarded.

one way to distinguish trend and volatility is simply to take the gently but steadily rising long term average of the real price (inflation adjusted) of oil. i believe it now lies at around 40 dollars / barrel. so to gamble on a price rise you must already commit yourself to pay a massive premium, even today.

looking back over 35 years of the oil price it is clear that the 'unreal' factors are the ones in the driving seat.

as with all markets - the day that everyone says without exception, 'oil has to go up', is the day that the market has to turn. meanwhile my own speculation would be that oil is going to $40 via $70, or to $30 via $80, or to under $20 via over $90.

you have heard the 'peak oilers.' they are pedestrian and literal minded materialists. this is from a 'spike oiler.'

Hey Mi3k,

Good to see you're alive

You bring up some excellent subsidy examples - am thinking it might be interesting to split them up in terms of "pure oil"/gas related v general transportation. Example - roads can be used by vehicles using pretty much any sort of "fuel" (Other than legs - bikes, highways and all that) - whereas subsidies for oil exploration and quite possibly/probably military adventures, are fuel specific.

The hirsch report is based on a simple model which gives a "wedge" to every oil alternative. The wedge is basically a supply graph that is first a flat line at zero, which is the time it takes from the information is received ("oil price is mighty high! Its going to remain high!We can go ahead and build that oil alternative") to the first drops of oil coming out from the alternative source ( he considers coal to oil, gas to oil and enhanced recovery - dismisses biodiesel (my favourite!) ). Then, it is a straight line going upwards.
------------------------------

First of all, i have to admit that he is thinking of "demand that would sustain our way of life" and not the more economically correct term. However, i don't hold that against him.

--------------------------

In essence he considers 3 scenarios - wedge begins at time of peaking, wedges begin 10 years before peaking, wedges begin 20 years before peaking. He says that in the first scenario, "we're hosed, major time." Second scenario is "struggle, but will survive, have to adjust to lower standard of living, though" Third scenario is "least cost in terms of dislocations, etc." Pls. note that items in quotes are my words. I was just thinking of catchy lines to describe an academically very detailed report.

----------------------------

Prof. Hamilton's point about future markets CAN BE INCORPORATED INTO THE HIRSCH MODEL. The existence of 7 year future markets just changes the scenarios by 7 years. And, probably 5 years is a better model because the oil price volatility may be too high for the 7 year contract.

-------------------------

A 5 year future market would give additional lead time of 5 years in every case. Effects will be mitigated likewise. Demand shortfalls (again talking about "demand that will maintain lifestyle") will be MUCH LESSER because the last 5 years of production will bring in much more oil than the 5 years before them. Sorry, can't explain it graphically in comments!

M1EK wrote: "Certainly there are a ton of subsidies today keeping the suburban motoring lifestyle cheaper than it ought to be.."

So we pay our taxes to governments to support the commonwealth - taxes are certain, the question is what do we get back?

In the specific case of my transportation, the local transit authority only takes in 10 cents in the fare box for every budgeted dollar. I'm subsidizing the public transit system that is useless to me.

I'm also "subsidizing" the gasoline delivery system to pave and police the roads, prevent piracy on the high seas, and give a tax break (perhaps) to the oil companies that make it all possible.

In so far as I can see, "subsidizing the suburban motoring lifestyle" looks like a clear winner. Might that conclusion change? Of course, but we should always remember that things are the way they are for a reason.

Taxing externalities sounds like a great idea! But who determines what is an externality and how much should we tax it? I'd be glad to see a tax on greenhouse gas emissions; one honest reason is because I would personally benefit, unless the tax were too high. It's a slippery slope.

As to proactive substitutes, Henry Kissinger argued against the Synfuel Corporation back in the 70s, saying that we could spend billions on shale oil development that the Saudis could bankrupt with a twist of a valve. Perhaps the Saudis no longer have that power but conventional oil's proposed replacements remain a huge bet. I don't remember the SAIC report offering estimates of the capital required to balance oil depletion.

Joseph, I calculate that gasoline currently costs between 4 and 16 cents a mile. At my firm, we are reimbursed 40.5 cents per mile, so I tend to use that as the actual cost of driving a car. I would assume it costs somewhat more to finance, insure, repair and drive an Escalade than an Elantra, but with the SUV subsidy, maybe not.

wild how the peak oil posts attract a different crowd. Great...uh...discussion.

Joseph,

Why am I not surprised?

In fact, the direct user fee (fare) for driving is usually zero. Zero percent. Zero dollars and zero cents. The gas tax is not a user fee, as I pay it when I'm driving on roads which don't get any funding from gasoline taxes. Tolls are the only thing that compares directly to transit fares.

Overall, the subsidies to motor vehicle use are far higher than that to transit customers. This is, like some of your more technical stuff on nuclear power, my area of expertise; so I'd advise you not to bother on this one.

"roads can be used by vehicles using pretty much any sort of "fuel""

problem with this counter-argument is that the vast majority of all spending on roadways is for the benefit of the suburban commuter. For instance, you wouldn't need the typical 6 lanes of a exurban arterial to support bike riders, transit users, truck deliveries, etc.; huge cities in Europe get by with trivial amounts of pavement per capita.

Far simpler to just account the whole lot as a road subsidy. If they want to switch to user fees, I guarantee you your local bike riders and transit users will come out way ahead, given the tons of property and sales tax spending on suburban automobile commuters.

Gillies: I agree in some ways with your “single minded” comment, e.g. beware the snake oil salesman. But you are still wrong enough. I worked at QUALCOMM, for example, a company with a single minded focus that bowled over a TDMA/GSM assumption that was considered a done deal. I think your comment lacks due consideration of what really happens in the world—single minded focus brings about change. What is the track record of economists in predicting the future? Are economists better investment advisers? Do they manage their money better? I’m not picking on economists, but I’m not going to ASSUME that they are any better at telling me what will happen. Sorry, but I really am interesting in this peak oil issue from an economics and geological perspective. And I think you are putting words in the peak oiler’s mouths. Do peak oilers not believe in “unreal” factors? That’s silly. Of course we do. But when did OPEC start colluding on oil prices? It was when the US approached/reached a geological peak. Economics and politics do exist within an environment, dictated by the laws of physics. Geology must also be considered, as must entropy. And energy efficiency. And the problem that large numbers often produce a qualitative as well as a quantitative difference. The past is not always a predictor to the future. Whale oil arguments are not necessarily a clue telling us that as oil production peaks, there will be alternatives.

For the commenter who anonymously pointed out that peak oil discussions bring out the masses for “uh discussion” I would love to know specifically what you had in mind. My own perspective is that this is a case, peak oil that is, in which a broader range of people—many of whom are of sound mind and with very honorable and deep analytical backgrounds—have taken notice of something that draws them into the dialog, whether in an economics forum or elsewhere. I think this is good. If the intent was to imply that this discussion should instead take place within the economics sandbox I referred to earlier—great, but that just means economists will continue to publish their papers within their sandbox, talk amongst themselves, and perhaps that makes them happy but I’m not sure it achieves the goal that—perhaps—JDH has considered when contributing or commenting on this discussion.

Gillies - I enjoyed your comment, even as a Peak Oil moderate. My best guess (not certainty) is that we are in for tighter supplies from here on out. I may change that opinion ... when I figure out what's wrong with the "oil depletion" argument.

oops, that "Peak Oil moderate" post was me.

Mi3k,

Perhaps my point wasn't clear enough - it was wrt to subsidy on oil v subsidies on alternative fuels - NOT transportation sectors per se.

Highways are currently primarily used by cars burning gas - but can also be used by cars using diesel and biodiesel and electrics and whatever other forms of propulsion that might arise including meth-fueled hamsters. The fuel itself doesn't matter - and a road subsidy is NOT the same thing as a direct oil subsidy: Should a viable oil/gas substitute suddenly appear, the roads will still be used.

But yes - you do make a fine point wrt to subsidies for the structure overall - much as another commentator felt that mass transit subsidies didn't work to his benefit - and both are fine examples of why and how subsidies distort.

Which leads back to splitting up subsidy talk into fuel-specific v overall transportation. Of course there is some/a significant amount of crossover - however, there is also a fair amount of separation as well.

"But yes - you do make a fine point wrt to subsidies for the structure overall - much as another commentator felt that mass transit subsidies didn't work to his benefit - and both are fine examples of why and how subsidies distort."

No, they aren't. As in past discussions with you, you're trying to equate two actions of hugely different scale because you happen to like one of those subsidies (the big, motor vehicle one) and don't like the other one (the little transit one).

They aren't like two thumbs on a scale. The transit subsidy is a thumb; the single-occupant-driver subsidy is an entire elephant.

M1EK sayeth: "so I'd advise you not to bother on this one." An appeal to authority - from you?

As usual, M1EK, you either miss the point or evade the conclusion. We use our income to create more income and a better life by supporting our government through our taxes. Subsidizing the petroleum industry and hence the road transport infrastructure has been a wonderfully productive investment. In most cases, (not all, and not for always), this has been a much better societal investment than in public transportation systems. I gave a clear, specific example.

I live within the city limits of the 10th largest city in the US in a three bedroom detached house, with a front and back yard, 7 fruit trees, and a two car garage. My kids can play in the streets and walk to school. Yes, my wife drives them to soccer practice and piano lessions. I prefer this to an apartment with no car and taking a subway to work, perhaps like Europeans with half the per capita income. Petroleum supports my preferences so I support government policies that supports petroleum.

I will further support prudent government policies that intend to continue that productivity advantage and my preferred way of life in the face of petroleum supply depletion.

In spite of Mr. Elliott's hard-on about my whale oil jest, he has a good point - there are limits to understanding the world using an economist's paradigm. Economics is just one way of looking at the complexity of how humans survive on this planet. Useful, yes; omniscient, no.

Thanks again to Prof. Hamilton for encouraging and facilitating these exchanges.

Oh, and I forgot the key relevance: the entire road network subsidy issue is important because without it, the US economy wouldn't be so irrevocably tied to cheap oil. $100/barrel will hurt us a lot more than it hurts the French or the Germans, and it's NOT because of nuclear power.

Looking at expensive oil and continuing to subsidize suburban sprawl like we do is difficult to characterize as anything but moronic.

Just for fun - why is the word "ridiculous" so common in customer reaction to gas prcies?

http://news.google.com/news?hl=en&ned=us&ie=UTF-8&q=ridiculous+gas+prices&btnG=Search+News

Not sure how much more clearly I can state this - but I'll try again.

I don't like subsidies. Period.

I don't like little ones. I don't like big ones. I don't like them for trains and not for planes. I don't like them, Mi3k I am. I don't like them for green eggs or ham.

But then again, from our prior discussions, you already knew that.

Just asking, but does anyone remember how just six short years ago everyone in the oil indsutry was bewailing how prices were out of control on the *down* side -- with oil at single digits/b in the USA?

"To better understand the producers dilemma let's look at a year end snapshot. On December 29th IPE February Brent closed at $10.61 and NYMEX February light crude closed at $11.70. On the same date one of the major crude oil marketers was offering to purchase crude for as little as half that amount. The table shows some ranges for posted prices...."

http://www.wtrg.com/opec.html

And remember how the oil companies were slashing, budgets, production, people, human capital in response?

Is it really more credible that the price shift from then until today is due to "peak oil" suddenly making itself felt for the first time in 100+ years -- or that this is yet another example of the price of oil being *volatile*, as can easily be seen by eyeball...

http://inflationdata.com/inflation/Inflation_Rate/Historical_Oil_Prices_Chart.asp

... due to the standard, long-known process of supply responding to demand with a delay. "Volatile" of course meaning that price goes down too.

That happening when the second half of the lag cycle kicks in as sharp price increases produce the standard result of restraining demand while bringing forth increased production...

http://www.washingtonpost.com/wp-dyn/content/article/2005/07/29/AR2005072901672.html

Here's something else I'm just wondering about: People are seeing "bubbles" everywhere these days -- has anyone at all speculated about one in oil prices? It seems to fit the bill for a bubble by both economic and psychological standards.

Economically a bubble supposedly occurs when money is loose but the CPI doesn't rise so price rises have to push through in some kind of asset: stocks, Japanese bonds, land, houses ... why not oil?

And psychologically a bubble is supposed to be supported, when the price of an asset suddenly shoots way up from the long-term trend, by a lot of people believing that from now on price can *only* go up ... sure the price has always been volatile in the past and fallen after similar rises by normal economic rules, but from just now on, from this moment, things will be *different*, there's a special new reason that applies only now, as it never did before, so prices will only go up!

Sounds like oil is as good a candidate as any other for bubbledom to me.

"Would a palm tree futures market have saved Easter Island from a sudden economic decline war and cannibalism? That's not simply rhetorical;"

Well, a functioning market for trees sure would have kept Easter Island from running out of trees, assuming they had value to the natives. For if trees grew scarce the tree owners would have had the powerful incentive to increase their wealth greatly by preserving their appreciating tree stocks and growing more as fast as they could.

Of course if there was no market, but only a commons, and the chief warlords simply gave the orders to cut all the trees down to help build their religious statutes, or to pursue their cannibalistic wars or whatever, well then the trees would be gone.

But to attribute that to some kind of market failure would be, frankly, a rather stretched bit of rhetoric.

If one equates the chief warlords with the political forces and governmental powers that be, it would seem rather more like the political-governmental powers running over the market, stopping the market from what it was trying to do, with them acting on the tragically costly conceit that they knew best.

Here is a question: is it realistic to assume only supply responses to increasing petroleum demands--i.e. demand is increasing so let's increase supply, but not price?

If it is realistic, then the IEA and EIA models previously referrenced for 1998 and 2002 world energy outlook are infact not 'bubble-brained'.

Otherwise, the official EIA and IEA forecasts for world petroleum demand are just political garbage, as they fail to account for demand-price responses.

I think that depending how one answers the question, it might help shed some light.

Odo

Good question about "ridiculous". I'll start the guessing with "It makes for a good quote".

Or they're cribbing their stories off each other ;-O

Well, the press is rather oily at times, even if that is a crude statement. Writing stories is probably not all it's cracked up to be - they'll just have to drill a bit deeper, otherwise they're just carbon copies.

Jon,

Regarding your request for clarification re Enron: Market transparency, the separation between analysts and sellers. Forbes comment stunned me. Free markets work best with real transparency. And yes, regulation is required.

The rest:

I, for one, think that some services should not be privatized: Water, roads, electricity, sewerage, and the military for starters. Some parts of the world should not be up for sale…or privatized.

All this talk of subsidies seems a bit loose. I am not quite sure how we identify subsidies. But be that as it may. Using the rather loose definition of “subsidy,” I would suggest that business’s misuse of the environment is an enormous subsidy. So has been our unwillingness to insist on pollution controls regarding the car. This list could be quite extensive.

Joseph:

Regarding Kissinger’s remark that the Saudi’s could easily have stopped Synfuel with a twist of valve: Hogwash. Tax systems are there to make choices. Blame our own choices, not a Saudi valve. Kissinger’s remarks were political; they remain political to this day. He now has the Saudis for clients.

As a matter of record, according to Simmons, by being reasonably good world citizens, the Saudis have accommodated the world’s desire for cheap energy. Perhaps they should not have done so.

The abundance and timing of oil onto the world stage have made it remarkably cheap, as it has remained to this day. This will not be true for the next generation. Like lazy couch potatoes, we will have to decide what is worth the energy and what is not.

Stormy

Might I ask whether or not you believe Enron broke existing financial laws?

As for analysts - yes - there ought to be more separation between the analysts and the sell side - but might I also point out that it was an analyst whose name I'm forgetting, that first threw up a red flag wrt Enron's financial statements? In addition, how exactly should we enforce separation between analysts and the sell side? If nothing else, Enron demonstrates the exquisite need for one to do one's own homework wrt to price.....

Yes - "subsidy" is a rather loose term and you provide some fine examples of indirect subsidies. I'll clarify "direct payments".

Such as those to farmers in Central California who receive massive discounts on government supplied water and have little economic incentive to use efficiently.

Stormy,

"Hogwash"? In the event, Henry K. spoke the truth! (Hard to believe, I know.) Synfuel Corporation would have been overpriced and unmarketable before it reached full production! A waste of billions. Please prove otherwise.

I do agree with your opinion about infrastructure. Taxes are eternal - wisdom is putting them to use in productive ways, like roads and sewage treatment.

Muhandis,

If you think the EIA and IEA models are rosy, check check the USGS estimates of oil and gas resources. What are these guys smoking?

Elliott,

You who scoffed (repeatedly) at the whale oil analogy, check out this article tracking whale oil production and prices - peaked at $1500 a bbl in 2003 dollars. A Hubbert Curve for a biological non-renewable resources, here:
http://www.energybulletin.net/3338.html

My purpose wasn't to be an Optimist - I don't see anything comparable to kerosene in our horizon (and I'm looking hard). Neither am I a Pessimist, building an energy efficient fallout shelter stocked with guns.

Count me in the "Buckle Down" school - there are ways to make a transition to a post-Peak world, albeit at considerable expense.

Jon,

Apparently, the laws to which I am referring were loosened some years earlier--Lieberman, I think, was one of those instrumental there. Not sure, though. My memory here is not the best.

As far as market manipulation in California, I do think so, but I am not a lawyer in this field. I am, however, enough of a citizen to be quite outraged. Perhaps you should ask a Californian. :)

I do think that major power grids and suppliers of power should be government owned; they would then be immune from foolish cost-cutting in the effort to increase profits and would also be immune to market manipulation such as happened in California. In addition, the grid is very interdependent on all its parts. The failure of one private supplier because of negligence can affect all.

England is a bit ahead of us in deregulation. I suggest the following report based on their experience as of 2003. Deregulation is a mixed bag and often not quite what its proponents say.

http://www.consumersunion.org/pub/UK%20dereg.pdf

The following site references a number of interesting articles, including ones concerning California.

http://64.224.99.117/i/Telecom___Utilities/Electricity_Deregulation/

In short, I am not convinced that market forces work best in all areas.

Joseph,

If you wish to protect an fledgling industry because in the long run it will protect the nation, then

Tax the product of the mature industry (oil) so that it cannot crush the newcomer.

You can't have your cake and eat it too. And we are talking here about the future of a nation.

Face it: We are addicted to cheap energy and complain about OPEC whenever they raise prices. (And sometimes it is just a couple of refineries going off line for a bit.)

OPEC is faced with a curious "market" problem. If they raise prices, then they encourage alternate energy sources. If they continue to turn on the taps, then they hasten the day when their golden goose will be out of eggs.

I would suggest to you that oil, in this respect, has been a curious problem in terms of market forces: Supply can be made abundant quickly, but that supply has a real life span. In this respect, it has not been a good competitor for other sources of energy.

Or maybe I should say, it has too good a competitor for other sources of energy. A wise government would have realized this problem and acted.

"Well, a functioning market for trees sure would have kept Easter Island from running out of trees, assuming they had value to the natives."

Is there a current example where the market system rewards conservation of critical resources in the face of high demand?

Somsel: I'm familiar with the whale oil curve (as discussed by ASPO). I'm simply pointing out that many of the arguments I hear are analogies. The Ehrlich/Simon bet. The whale oil/kerosene argument. And the "running out of stones" argument. That's all.

Donal, fine wines are often stored for years in hopes of appreciation. Top race horses get better health care than you do.

Donal,

Have you read a "A Short History of Progress" by Ronald Wright? Napa Nui writ large--looking at precisely that issue through the lens of all the great, past civilizations. It's a short and interesting read. But that discussion is outside the range of this blog, I think.

FTX,

Regarding alternatives...a number of countries are already pursuing them. It is the wise thing to do. The U.S. has no energy policy but to argue over the Alaskan Wildlife Preserve.

Major oil companies are now running ads regarding the coming problems with oil.

http://www.energybulletin.net/7388.html

Now, the cynical will look at this as a self-serving way to raise prices. I think not. Exxon is positioning itself for nuclear.

Change is in the air. Too bad it can't find its way to a certain Texas ranch.

At least everyone is talking. But then we talked in the 70's too.

Dr. Hamilton: thank you for your response to my last post regarding the article on energybulletin. You pointed out:

Albert, statements such as the following in the report you cite,

"to support this doctrine of material consumption, economists must assume that the natural world offers a limitless source of the raw materials necessary for the finished goods that are to be consumed,"

suggest to me a rather profound lack of economic training on the part of the authors of this report.

Here, however, is the main problem that has been stated in one way or another: the lack of multidisciplinary approach with regards to the economic effects of Peak Oil.

I believe a one-dimensional approach/analysis often falls short of giving an accurate picture because often you can have a completely conflicting if not contradictory analysis in another.

Take, for example, the nature-vs-nuture debate. In one instance, from the scientific camp you have the argument that we are created to have certain traits and it is otherwise impossible to change them (as applied to the issue of homosexuality), vs. the psychologists' camp that say that certain areas can be influenced at certain times, etc.

So, my suggestion to you, Dr. Hamilton, is to pick a discipline - any discipline (some suggestions: ontology, history, geology, physics) and allow that to be factored into your overall analysis.

To the rest of the economics crowd: I'm not asking any of you here to become experts in such fields, but my suggestion is that it would give you a more accurate picture of "reality" as it pertains to the future of our species.

Even a man of wealth and taste still might not be able to power his car with a fine wine or a racehorse (only 1 hp, or about 1000 watts), and so perhaps JDH's analogy with oil is not perfect (despite how much I like to make analogies).

You may say, well, we are not so stupid as the Easter Islanders because we have better markets, and we're not so stupidly enamored of large stone statues on an obviously limited island. I say, the world has a lot more parts than it did on Easter Island, and very few individual people understand even a small subset of them, as is quite apparent from the threads in this discussion. But like Easter Island, many far flung parts of our much larger island are intimately interrelated.

Find me a person who is an excellent mathematician, a good computer scientist, an economist, an oil geologist, an oil investor, a physicist, a nuclear engineer, a solar cell engineer, a sociologist, a brain scientist, a cognitive scientist, a mayor, and a congressman. Looking back on Easter Island, *we* can easily see what their problem was -- from the vantage point of a fossil-fueled jet plane visit, a fossil-fueled airplane or satellite photo, radioactive dates, pollen deposits, and oral histories. Clearly, they had no one who could step back, take in the current picture at the time, together with a few hundred years of their previous history, and then convince their people to do a more sensible thing.

Many people such as myself think we may have gotten ourselves into much the same situation as the Easter Islanders, but just that we are on a much bigger, much more complex island. Sometimes it can appear that economists are merely priests who are praying that the market will get scientists and engineers to find a solution to our upcoming tight spot. Those of us looking at the science of energy and of evolutionary biology are aware that there is a distinct possibility that our much more complex system could very well run up against similarly unforgiving limits to those that decimated the Easter Islanders -- who eventually descended into cannibalism -- or to the limits that 'right-sized' countless earlier animal and plant populations that unknowingly and unthinkingly overshot their resources. We have gotten to where we are only after many harsh prunings visible in the geological record of the Paleozoic, Mesozoic, Cenozoic, the Pleistocene, and the Renaissance -- when perhaps 70 million people perished in the Americas in the century after the Europeans arrived in the Americas.

When Captain Cook arrived on Easter Island, the few "small, lean, timid, and miserable" residents could only excitedly mutter the word "miru" (timber) to the uncomprehending English speakers on the ships (J. Diamond). If *we* screw up, there will be no Martian cargo ship to visit us, and even if one did, it is likely the Martians would not comprehend our requests for "oil", which is made from several hundred million year old plankton (Ghawar). Many of us are worried that the market is going to screw up. The genius of the market decided to disinvest in renewables up until 2004. Many of us trying to stand on higher ground think this may turn out to have been a strategic mistake at a crucial turning point in human history.

I don't claim to know the best route forward through the forest that includes things like the genius of the market as well as an American public, half of which somehow simultaneously manage to believe in their cell phones (and hence the Maxwell equations), internet browsers, but not evolution. My only heuristics are, try to keep and open mind, don't ignore history, and don't rely on someone else to figure things out -- all the main points have to be present together, inside single brains.

Certainly, the oil peakers are missing the 'economic' perspective, and a good lesson here.
After reading the Oil Peak advocate Campbell's description of oil being like beer in a glass, I conclude that Campbell is wrong. Oil is like toothpaste in the toothpaste tube. We will never run out of oil - it will just get harder and harder to squeeze it out.
He thinks the economic view is wrong and the view of natural scientist is right. but how much oil is there *is* an economic question: It's a different answer if oil is $10/barrel vs $100/barrel.

So I have one question for them, or you, since you'll actually understand the question:

What is the price elasticity of the supply of oil?

Sure we know that in a rational world, oil wouldnt just shoot up in a short period of time ... but wait, it did recently. Will it fall because we are in a bubble or due to new supply/demand changes? or is this plataeu permanent?

The differences between short and long-term elasticity is what makes for the volatile market. It's possible that excessively high prices can cause a crash later (viz. DRAM price/demand cycle history).

Patrick:

I like the toothpaste analogy, but beer and pubs makes more sense from the point of view of sources and field depletion as analogies go...

I also wonder whether we err by somehow rationalizing costs as absolutes. Is $100 today really the same as $100 twenty years ago? What would $200 oil really mean if we had a period of intense inflation? I would be curious to know what a barrel of oil has cost with respect to loaves of bread and bottles of milk.

Economists must do much better than architects, because fine wine and racehorses are not on my list of critical resources.:-( Somewhere there must be a commodity that applies. I know it isn't timber, because the government has to regulate logging. I know it isn't fish, because many fisheries have been depleted. Has the futures market offered any warning signs to the fishing industry?

I dind't have time to read everything hear but from what I did I never saw the most important word regarding oil prices come up - inelasticity. Demand for oil is very inelastic - that is demand tends to change very little even with fluctuations in price so the price is largely determined by supply - a slight under supply of oil and prices increase dramatically and a slight oversupply and prices really crash.

The statement in the original post that if oil was selling for $1 then lots and lots of oil would be consumed is false. Does the person think people are going to spend all day driving around in circles just to consume more gas because its cheap. No. Demand just doesn't change that much with respect to price - it is inelastic. And you can see this by just looking back a few years to when oil was at $10 and consumption wasn't very different.

So I keep coming back to it but if you want to discuss oil prices the first thing you have to recognize is the inelasticity of demand for oil.

BTW, it is also this inelasticity that makes OPEC such a good idea for its member states. By cutting back on production a little you can increase prices a lot and significantly enhance your overall revenues.

Stormy: Thanks, I'm always looking for another book. Amazon loves me, but the wife just rolls her eyes when the packages show up.

"Not sure how much more clearly I can state this - but I'll try again.

I don't like subsidies. Period.

I don't like little ones. I don't like big ones. I don't like them for trains and not for planes. I don't like them, Mi3k I am. I don't like them for green eggs or ham.

But then again, from our prior discussions, you already knew that."

Yes. I knew that you're equating a thumb on one side of the scale to an elephant on the other side because you don't want to give up the elephant.

Patrick,

Not even Simmons claims we are "running out of oil," and he certainly qualifies as a "peak oiler." There are great quantities of oil still in the ground. Even the Saudi's can pump for decades yet.

Yet, Simmons claims that the Age of Oil is coming to a close.

The following--still in draft form--is an interesting report on Saudi issues. Much of what is said here may be new.

http://www.csis.org/features/050420_SaudiOilCapacity.pdf

As an aside, I often thought that the world's limited refinery capacity was simply a way of making some people very rich. Now, I am not so sure. The issue may be more complicated than that.

M1EK,

Life in the West is full of subsidies--small and large--that have made life very comfy at the expense of others. Dream on. Those subsidies will disappear one by one...like teeth being pulled.

Peak oil is real--you just have to get a handle on how to define it.

As an important aside, reports are just in that the vast Siberia peat bog--an area greater than the size of France and Germany combined--has begun to melt rapidly. Within the space of three years, thousands of lakes are appearing where none had been before. This is fast.

The resulting release of billions of tons of methane could be an ecological landslide. For those of you who have access to the New Scientist link:

http://www.newscientist.com/home.ns

At some point, economists are going to have to sit up and smell...whatever. And yes, the melting of that peat bog is a subsidy...the bill collector is at the door.

In terms of comparable models of shortages, one may be developing as we speak...
There seems to be a shortage of treasury bonds, and it will be interesting to see how it plays out.
http://money.cnn.com/2005/08/11/markets/bondcenter/bond_shortage/index.htm

Giles -

Thanks for insulting me. I didn't know "spike oilers" were so good at stereotyping. I could add that conservatives want to regulate the heck out of everyone's personal and social life. I bit of a digression from our topic, I'm sure.

The larger issue -

Alot of you guys are missing the point. I know the Economist magazine missed the point in their feature expose' about Oil. The issue has nothing to do with a belief in materialism or our single party system and mega media in America.

Start what what we agree on. The Sky is Blue. We agree that the oil resource is finite. The question then becomes what will happen to both the local (U.S.) and global economy when the price must rise to lower demand sufficiently enough to meet ever lowering quantities of supply?

That's what I want to know. I figure price goes up, but after that I'm not so sure. I see the price of WTI broke $66 today. The media sure doesn't have a clue about oil prices since they blame "refinery" outages for increases (if a refinery goes DOWN, the demand goes DOWN, not UP). I figure the answer is pretty simple: demand is outstripping supply at the old price points of $20-$40 a barrel. Finding an economist to say that's the answer is a whole different ballgame.

Petronius: You've expressed my opinions exactly. I understand the economists who say that oil is “unlimited” (all a matter of price) but that argument, to me, is trite at best and subterfuge at worst. The world consumes approximately 80 mbd of oil. Odds are that the world is going to struggle to jack this production up too much higher than this, and will then struggle to keep it from falling. Shocks based on natural disasters and political disasters will exacerbate this.

So let’s model this. One can then determine the implications. What is the futures market telling us? I don’t think anyone really knows. Because nobody knows how peak oil will affect the economy. Hence talking about what the futures market is telling us is like telling me that the experts don’t understand what impact peak oil will have, but a million people who also don’t understand what impact peak oil will have somehow collectively understand. Ok, fine. Prove that one to me. Or give me evidence that the futures market in fact has a predictive power that we should rely on. I’m just not sure. I think the futures market is great. It’s an insurance scheme. Insurance is a good thing. But insurance companies don’t predict hurricanes—I believe they rely on science to do that—and then the insurance companies use historical precedent and other tools to come up with the appropriate pricing. And then the govt steps in to clean up the mess when the insurance companies get it wrong.

That’s what the futures market is to me. A large insurance scheme. That’s good. But given that humans will only use the available fossil fuels once, there is little historical precedence to tell us how this will play out. Anecdotes and analogies are the best we have.

In summary, I’m not sure how progress is to be made, but I’m pretty sure we’re not advancing much here. Unfortunately, I suspect it’s the same everywhere. No progress. Except the price of oil this morning.

So, let's see if I'm getting this right. The price of oil rises because of ...whatever. It could be peak oil(PO) or inoperative refineries, or something else altogether. Demand is decreased in the face of this (presumably because that consumption was inessential or perhaps the consumer just could't afford it or was able to find an alternative to oil). There will be a (relative) excess of oil. Some will not sell at that price and a lower price will eventually work itself out through the usual market mechanisms.Supply and demand are in synch. Demand then rises, for whatever reason; some oil is sold at the old price but the (relative) scarcity of the oil brings on higher prices. In turn a new equilibrium is reached between the new demand and the existing supply.Supply and demand are in synch. And so on, successively. In the words of Prof.Hamilton, "Supply equals demand today, supply will equal demand in 2025, and supply will equal demand in 2050."
There is a principle in informal logic called the "principle of charity"; in a few words: construe your opponent's argument in the strongest way possible. The reason for doing this is both side's agreement that we are after the truth and not trying to score points.

Using the principle of charity I think it is reasonably clear that the concept of demand as used by peak oil people generally is not that used by economists. The question is, from the economists' perspective: what does it mean? Does it mean anything? I think it is fair to say that PO proponents are trying to address a certain technologically irreducible limit below which, if the availability of petroleum falls, much of our industrial, agricultural, transportation, and even financial economic structure will falter. It is, for purposes of this particular conversation on that limit, irrelevant whether supply and demand are in equilibrium. What matters at that point is more a question of social utility or standard of living. Given a reduced availability of gasoline with its price bid up, Chicagoan John Smith will forego his RECV vacation in Florida. He'll go to Devil's Lake in Wisconsin instead.John will pump some money into the economy but, being a rational actor, will spend less than he would have in Florida. The campground owner in Ft. Lauderdale will lose out on John's rental. The familiar ripple effect will go out. If enough of this happens,and given that oil undergirds our entire economy, you can have a recession or even a depression some time in the future.

Prof. Hamilton construes Hirsch's argument, in generous mode, this way: "The price stays stupidly frozen for ten or so years, and then all of a sudden starts shooting violently upward." I can think of better and more reasonable ways to construe this argument than setting up a straw man. For example, an erosional model in which, in the face of increasing scarcity, supply and demand
do their equilibrium dance but at lower and lower points on the scale of social utility or standard of living. In this model we would not jump off the edge of a precipice but slide by degrees into that dark night. And that, in fact, appears to more closely mirror the idea that most PO advocates have of the future development of this crisis.

One further point regarding Hirschs' formulation of the argument. On p. 64 of his report, Hirsch states,"Under business-as-usual conditions, world oil demand will continue to grow, increasingly approximately two percent per year for the next few decades." Under business-as-usual conditions! I believe a fair reading of this is that Hirsch is aware that there is interplay between supply and demand but that he is here, as elsewhere in his report, showing that the trendlines for future petroleum supply and for present consumption trends are in conflict. This is a somewhat rough approach but, given the uncertainties of the data, it's about as good as we can get. Hirsch's main focus, which is the possibilities of mitigation given different scenarios for the development of the crisis, is well served by the development of the argument.

Oil wars -

If oil is inelastic, why wouldn't OPEC increase the price to $10,000 a barrel? Oil is relatively inelastic in the short term, but experiences increasing elasticity in the long term. I won't sell my SUV the day gas spikes 20 cents, but if it stays there for a year or two I'm certainly going to re-evaluate its' necessity. If prices remain high for extended periods I'll probably re-evaluate my living conditions as well.

I did a little calculation relating number of barrels of oil to number of shares of stock outstanding. For example, when buying one share Exxon you have reserve of 3.41 barrels per share; one share of BP gives you 5.6 barrels per share. Canadian Oil Sands gives you 10.9 barrels per 1-unit holder (it is a Canadian energy trust). I am curious as to why more is not written or discussed about huge reserves in oil sands in Canada, some have said it is close to amount in Saudia Arabia. Can you enlighten me?

Off subject - but a hat tip to JDH and Econbrowser for being mentioned in today's WSJ.

Regarding price elasticity of oil--I recall numbers I've seen from the late 1970s:
10% in short run (e.g. drive less), 50% in long run (e.g. buy more efficient car)

I have not seen any more recent estimates. Wonder if anyone has newer estimates.

Regarding efficiency of markets: politics and economics are much different views of reality. Real world much more like Easter island. Look at production on a country by country basis. Much of production is determined at the state level. In some cases such as Mexico the decision is by default based on funds allocated for production/exploration.

From an economist's point of view, efficient production decisions are based on the price of selling oil today vs. the present value of the future price is production is deferred. From real world politics(applying to dictatorships as well as democracies), the decision is based on keeping the public happy with the current government RIGHT NOW or, in a democracy, in the time frame to the next election. No successful politician will sacrifice current well being in exchange for well being after his term of office. If you look at the production of countries such as Indonesia or Nigeria, they produce flat out because they could really use the money right now. The fact that the oil would be more valuable in the future is irrelevant. Social stability and satisfaction with the government demands maximum current production regardless of future benefit lost. In this environment, with few producers concerned about the long run, it is quite conceivable to have a high rate of production followed by a dramatic drop off as supplies run out. Historical evidence is showing just such a pattern. A variety of producers have passed their peak production, but continue to produce flat out rather than save some for the future, when prices may be higher. This has been true regardless of whether oil prices are at historic highs or lows. Economic theory suggests that profit maximizing producers should cut back when prices are low. This rarely happens.

Economists have difficulty thinking about this stuff because they deal with tautologies and balance sheets. They simply tell us when the balance is out of wack and tell us how to move money around so that it goes back into wack. (Consume more, China. I don’t care if you are getting slave wages.)

Ev Verquizas,

The trite examples you give regarding vacation time are a wee bit below the mark here.

Nonetheless, you present the argument nicely. Is it not time for an economist to reply? Or are they going to insist on consulting their balance sheets and call us all idiots?

Or is this blog topic just a sandbox for bozos while the real economists are off doing real-economist work, debating the future’s market in China, or the latest Fed rate hike?

Let’s put it this way: If transportation energy becomes more expensive, then there will be an inflationary effect on everything transportation affects: not only food but the cost of all those wonderful things our companies put together in underdeveloped countries and turn around and sell to us. (Brazil now sends cashews to India for peeling—it’s cheaper. The cashew you eat has been around the world.)

All those multinational firms sending parts hither and yon because of cheap labor are going to find their margins cut…and cut…and cut. Cheap labor has been deflationary. The recent rise in oil, which is inflationary, is offsetting that deflationary trend. In the end, inflation will win.

In addition, we will see some new thinking regarding globalization. Factories will be nearer the consumer. So will food sources. Offshoring in some areas will have to be brought home. Now, while some of this is good news, extrapolate out a bit. Keep upping the price of oil to see what has to give or be re-arranged.

Peak oil is hitting just before global warming will really dig its unwieldy toes into the planet. There is not much I can say to those who insist that its effects are the result of left-wing ravings. But even now, the ice roads into Alaska--very very important roads--have less and less of a window each year. And that monstrous peat bog in Siberia is not just for mosquitoes. Nor is the fact that hurricanes are now increasing in intensity.

Party on.

FishEpid understands both geology and economics, yet his post was ignored. David Pimentel writing in Natural Resources Research (Vol. 14:1, 65-76)proved that methanol production (and all other fuel biomass schemes) uses more energy then is available in the resulting liquid. Right now that production is subsidized with cheap petroleum.

According to FishEpid, misinformation is skewing futures. He said, "If that is right, aren't investment decision-makers expecting ethanol to be a major petroleum substitute being misled by the current market signals and government policy, whatever its reason?"

http://www.news.cornell.edu/stories/July05/ethanol.toocostly.ssl.html

Peter,

You are absolutely right.

That's funny. I was grumpy yesterday and Stormy is grumpy today. :-) While I think I understand my own impatience (with the similarity of the last five articles?), I think I should have found a better way to express it. If I could write lik