Drum on Peak Oil
I liked Kevin's series on Peak Oil, but it seemed a little bit lite compared to what I have been reading on the subject lately (see books below, plus a few on Photovoltaics and Biodiesel). I had comments here, here, here, here, and here.
Two disturbing trends that I saw in the comments and elsewhere in the world: the first is the idea that there is a "true" price of oil, and the second is the idea that people don't respond to market signals until their is some sort of panic-inducing, earth-shaking discontinuity.
A market is not a place or a thing, it is a process. A price is a description of the state of that process at one place and time. The process is the discovery of the cost of:
I have a co-worker who is bothered to the point of distraction that everyone on a plane is probably paying a different price. He believes that this is inefficient, and I believe that he believes that because he believes that there is a One True Price. All of the other prices fluctuate around the OTP because of "unnatural" discounts and "unnatural" markups.
I dare you to find any product for which everyone pays the same price. Gas? Drive around town and note the differences, then consider the fact that people don't all fill up on the same day and contemplate the daily variation in gas prices. Milk? There are different prices in the same cooler in a single store, prices are different from store to store within the same chain, and prices vary from one chain to another. Cars? Except for possibly Saturn 8~) , nobody pays the same price at the same dealer, much less in different dealers and different cities. So why should airplane seats be any different?
It has been a while since I've seen the claim, but it used to be common to find people on the internet going on about how markets can't be efficient because one day Enron is worth billions and the next day it's in the tank. They ask, "Was it worth billions one day and then that changed the next?" The answer is obvious that it was not, but the market constantly adjusts to new information. The market saw to it that they did "collapse in a wave of accounting scandals" long before regulators and prosecutors got in on the act. Efficient doesn't mean omniscient.
The second disturbing problem is that there seems to be widespread belief that people don't respond to market signals, especially with regard to oil and energy. The geologist's approach, as Julian Simon thoroughly explains, is ignorant of human nature and the ability to act on the price signals coming from the market. That approach, shared by the Ehrlichs, Browns, and Meadows of the world, takes past demand trends to make future forecasts. Then they make a claim about production falling off, and then wildly exaggerated claims about shocks and price spikes. Ironically, that is exactly what they accuse Simon of doing, reversing production and demand (that he shows production going up forever and demand falling off). Unfortunately, the Club of Doom just can't seem to understand the logic of the situation.
My guess is that the short-run demand curve for gasoline is nearly vertical near the current price at any given time, with perhaps a slight knee at higher prices. That is, gas prices can fluctuate up and down on a daily basis a few cents, and people will not change their behavior one bit. However, if gas prices spike way up above some psychological point (e.g. 20 cents above current price, or above the next higher quarter-dollar), people will become a little more thoughtful about their use of their vehicle. My other guess is that the long-run demand curve is more elastic; this guess is born out by recent news about flat sales for heavily discounted SUVs, and long lines for ... ah, ... Prii? What is the proper plural for Prius? The rate and persistance of price rise are therefore additional factor in people's decision-making processes.
Prices can rise for a variety of reasons (see above), not just because supply starts to dwindle. If demand outstrips supply even as supplies increase, prices may rise. It looks like the reason for the current high price of oil is due to rising Asian demand (though Venezuelan politics may not be helping the situation). Therefore, we need not hit a peak in production in order to start seeing the sustained higher prices that will lead people to buy conservation.
When (indeed, if) we ever see a peak in production, it is likely to come about slowly. Shell, ExxonMobile, and BP aren't all going to wake up one morning and say, gee, we don't have any new projects on the horizon and just within the last 24 hours the production of individual wells started to decline. Instead, what we are likely to see is that new production comes online slower, with longer gaps in between new finds, and those findings are smaller than previous fields. It won't be sudden, but rather will play out over a period of years (because that's how exploration and extraction work). During that time, prices will drift higher gradually. As they do, fields that are already online but not economically viable to pump will be brought online.
Furthermore, existing technologies that are in the lab or in the startup stage will be brought online as prices rise. If an existing technology is feasible at $3/gal, we won't see much of it until gas gets to $3/gal. That's no surprise and makes perfect sense. If the existing technology was feasible at current prices, it would be available now. Once gas is permanently over that point, we will see the market share of the new technology begin to accelerate. Claiming that X is not and will never be a viable alternative for gasoline on the basis that X costs $3 while at the same time claiming that gasoline prices will easily climb to $5 or more is obviously faulty logic. Who would pay $5/gal when a technology is available that will cost $3/gal?
So I believe that as we near peak oil (and I believe that what we will see is peak demand, not Hubbert-style peak geologically viable production), demand will have more of an effect on prices than production, that the price rises will be as gradual as or even gentler than what we have seen so far, that the sustained higher prices will drive conservation efforts, and that 10 years hence, inflation-adjusted oil prices will be lower than current prices even after oil sales have declined (again, due to demand reduction, not supploy disruption).
I am willing to wager $1000 on it.
BTW, if you think oil prices will spike, invest heavily in oil companies. Investing in Shell or BP has the added attraction of being a bet on hydrogen and photovoltaics.
Two disturbing trends that I saw in the comments and elsewhere in the world: the first is the idea that there is a "true" price of oil, and the second is the idea that people don't respond to market signals until their is some sort of panic-inducing, earth-shaking discontinuity.
A market is not a place or a thing, it is a process. A price is a description of the state of that process at one place and time. The process is the discovery of the cost of:
- production of a product at a place,
- transport from that place,
- risk factors including weather and political strife,
- the productivity of production and transit workers,
- the productivity of production and transport capital,
- rent of manufacturing, warehousing, wholesale, and retail space,
- taxes in each place and in transit,
- regulatory conditions at the production location and in transit,
- the same product at a different location and transport from that place,
- production of competing products,
- the opportunity cost to each producer (what could they have invested in or manufactured instead of this product? How many could they have manufactured with different pricing and feature points? How many could they sell to people in a different location?),
- the opportunity cost to each transporter and warehouser (how much are they losing by dedicating assets to this rather than another producer?),
- the opportunity cost to each retailer (how much are they losing by dedicating floor space and sales staff time to this instead of other products?),
- the cost of deferring the purchase decision,
- the opportunity cost to the consumer (the foregone value of things not bought because of the proximate purchase),
- the cost of a substitute product or manufacturer
I have a co-worker who is bothered to the point of distraction that everyone on a plane is probably paying a different price. He believes that this is inefficient, and I believe that he believes that because he believes that there is a One True Price. All of the other prices fluctuate around the OTP because of "unnatural" discounts and "unnatural" markups.
I dare you to find any product for which everyone pays the same price. Gas? Drive around town and note the differences, then consider the fact that people don't all fill up on the same day and contemplate the daily variation in gas prices. Milk? There are different prices in the same cooler in a single store, prices are different from store to store within the same chain, and prices vary from one chain to another. Cars? Except for possibly Saturn 8~) , nobody pays the same price at the same dealer, much less in different dealers and different cities. So why should airplane seats be any different?
It has been a while since I've seen the claim, but it used to be common to find people on the internet going on about how markets can't be efficient because one day Enron is worth billions and the next day it's in the tank. They ask, "Was it worth billions one day and then that changed the next?" The answer is obvious that it was not, but the market constantly adjusts to new information. The market saw to it that they did "collapse in a wave of accounting scandals" long before regulators and prosecutors got in on the act. Efficient doesn't mean omniscient.
The second disturbing problem is that there seems to be widespread belief that people don't respond to market signals, especially with regard to oil and energy. The geologist's approach, as Julian Simon thoroughly explains, is ignorant of human nature and the ability to act on the price signals coming from the market. That approach, shared by the Ehrlichs, Browns, and Meadows of the world, takes past demand trends to make future forecasts. Then they make a claim about production falling off, and then wildly exaggerated claims about shocks and price spikes. Ironically, that is exactly what they accuse Simon of doing, reversing production and demand (that he shows production going up forever and demand falling off). Unfortunately, the Club of Doom just can't seem to understand the logic of the situation.
My guess is that the short-run demand curve for gasoline is nearly vertical near the current price at any given time, with perhaps a slight knee at higher prices. That is, gas prices can fluctuate up and down on a daily basis a few cents, and people will not change their behavior one bit. However, if gas prices spike way up above some psychological point (e.g. 20 cents above current price, or above the next higher quarter-dollar), people will become a little more thoughtful about their use of their vehicle. My other guess is that the long-run demand curve is more elastic; this guess is born out by recent news about flat sales for heavily discounted SUVs, and long lines for ... ah, ... Prii? What is the proper plural for Prius? The rate and persistance of price rise are therefore additional factor in people's decision-making processes.
Prices can rise for a variety of reasons (see above), not just because supply starts to dwindle. If demand outstrips supply even as supplies increase, prices may rise. It looks like the reason for the current high price of oil is due to rising Asian demand (though Venezuelan politics may not be helping the situation). Therefore, we need not hit a peak in production in order to start seeing the sustained higher prices that will lead people to buy conservation.
When (indeed, if) we ever see a peak in production, it is likely to come about slowly. Shell, ExxonMobile, and BP aren't all going to wake up one morning and say, gee, we don't have any new projects on the horizon and just within the last 24 hours the production of individual wells started to decline. Instead, what we are likely to see is that new production comes online slower, with longer gaps in between new finds, and those findings are smaller than previous fields. It won't be sudden, but rather will play out over a period of years (because that's how exploration and extraction work). During that time, prices will drift higher gradually. As they do, fields that are already online but not economically viable to pump will be brought online.
Furthermore, existing technologies that are in the lab or in the startup stage will be brought online as prices rise. If an existing technology is feasible at $3/gal, we won't see much of it until gas gets to $3/gal. That's no surprise and makes perfect sense. If the existing technology was feasible at current prices, it would be available now. Once gas is permanently over that point, we will see the market share of the new technology begin to accelerate. Claiming that X is not and will never be a viable alternative for gasoline on the basis that X costs $3 while at the same time claiming that gasoline prices will easily climb to $5 or more is obviously faulty logic. Who would pay $5/gal when a technology is available that will cost $3/gal?
So I believe that as we near peak oil (and I believe that what we will see is peak demand, not Hubbert-style peak geologically viable production), demand will have more of an effect on prices than production, that the price rises will be as gradual as or even gentler than what we have seen so far, that the sustained higher prices will drive conservation efforts, and that 10 years hence, inflation-adjusted oil prices will be lower than current prices even after oil sales have declined (again, due to demand reduction, not supploy disruption).
I am willing to wager $1000 on it.
BTW, if you think oil prices will spike, invest heavily in oil companies. Investing in Shell or BP has the added attraction of being a bet on hydrogen and photovoltaics.
Labels: energy
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