I wrote a short piece for Hillsdale’s student paper in response to a physics professor’s warnings about an impending oil shortage. (He’s a nice guy so please don’t insult him…) I thought some people might be interested in my fanciful arguments.Last week’s Collegian contained a letter from physics professor Kenneth Hayes, who challenged the CCA assertion of Stephen Moore that, “Today we have more known reserves of oil than any time before…And tomorrow we will have more than we did today…because we are actually always finding oil at a faster pace than we are using it up…” Thus, although it is obviously the case that the total supply of oil decreases with every barrel we consume, Moore was claiming that the amount of known reserves could, paradoxically, increase over time, as entrepreneurs are led to discover more reserves in response to oil prices.
Dr. Hayes understood the subtlety of Moore’s claim, and simply disputed his facts. Specifically, Hayes presented a chart that indicated that known reserves have been declining since about 1984. Now I am not in a position to say which of these two men is correct; to do so would involve researching their respective data and deciding which set I trusted more. (One of the benefits of being in economics, rather than a hard science, is that you can actually make a career out of non-falsifiable tautologies. A downside is that there is a greater expectation that you’ll wear a tie to work.) Statistics aside, I would like to offer some general remarks on the economics of non-renewable resources that may cast Dr. Hayes’ warnings in a different light.
First, note that it would be absurd for the present generation to refrain from all consumption of oil; our children would be faced with the same ethical imperative, and in turn would abstain in order to provide for their children and so on—the oil would sit in the ground forever, serving no one. So the proper amount of oil to use in the present is greater than zero, even though every barrel consumed now means one fewer barrel available for all future humans.
Next we should consider that the market economy rations goods over time just as effectively as it does over space. Right now oil flows to all corners of the globe, because consumers all over the planet are willing to pay for it. Similarly, it would never be profitable for an oil tycoon to drain his oil fields as quickly as technologically possible, because he would be ignoring the demand of consumers in future years.
It would be difficult to come up with a rational policy for the “socially optimal” rate of oil extraction that wasn’t equivalent to the principle that owners of oil should sell it at a rate that maximizes the present discounted value of their fields. Consider this fanciful example: Suppose aliens abduct Bill Gates to understand how terrestrial computer systems operate. While they are probing him, Gates overhears their plans to siphon off half of the world’s oil reserves in exactly one year. After he is returned to Earth, Gates tries to warn everyone of the impending crisis. Alas, his pleas fall on deaf ears, and only provide fodder for late-night comedians.
Realizing he can’t prevent catastrophe, Gates decides to make the best of it and personally profit from the impending oil shortage, based on his extraordinary insider information. He checks CNBC and discovers that the futures price for oil is $50 per barrel, but Gates knows that once the aliens carry out their devious plan, the spot price for a barrel of oil will soar to well over $200. Thus Gates uses his vast fortune to purchase oil futures until his massive buying has pushed their price up to $200 per barrel. So long as his prediction of the future price of oil turns out to be correct, Gates stands to make billions of dollars from his speculation.
Notice that Gates’ selfish behavior will have the same effect that he desired with his initial (unheeded) warnings. Because of the huge price hike in the oil futures market, current producers will reduce the amount of oil they sell in the present. (If someone sells a futures contract, he or she needs to actually deliver the product on the due date.) This reduction in the current amount of oil on the market will cause the current price of oil to rise, almost to $200 per barrel. Gasoline will become outrageously expensive, forcing consumers to increase carpooling, ride bicycles to work, look into electric cars, and all the other “responsible” behaviors advocated by environmentalists.
There is one point where I directly disagree with Hayes, and that is his recommendation to the Opinions Editor (and presumably all other Hillsdale students) to “educate yourself” on this topic. On the contrary, I would say that this is a waste of time; you would do much better to go study for midterms. The market penalizes mistakes, and rewards success, when it comes to speculation on the future supply and demand for oil, and I highly doubt that any undergraduate will bring an important increment in expertise to this realm. And lest you think my “blind faith” in the market is wholly unwarranted, consider this: I plan on buying a turkey and a real tree next Thanksgiving and Christmas, respectively. In order to fulfill these plans, entrepreneurs right now need to exercise foresight (in feeding a turkey and caring for a tree). Yet I have no doubt that these goods will be available for purchase when the holidays roll around.
{ 13 comments }
I agree, with the caveat that State-created distortions in the financial and oil markets (and others) have artificially kept the price of oil far from a free market clearing price.
Assuming these distortions end now, then yes, the market will come to reflect the proper scarcity of oil.
The best thing we could do about possible oil scarcity is stop interfering in oil markets, and stop inflating.
The funny thing is that people who often moan about how we’re spending all of our oil and should conserve our resources (and in doing so outlaw SUV’s among one thing) also complain when the price of gasoline goes up – a natural market indicator (though I’m sure it’s been warped by taxes and whatnot) of lower supply.
Again, the economically uninformed do a good job of wearing two heads.
Chances are, oil will never run out because it is not a fixed resource. In fact, it’s probably not even a fossil fuel. I recommend reading up on the abiogenic theory of oil.
Adem Kupi writes: “…State-created distortions in the financial and oil markets (and others) have artificially kept the price of oil far from a free market clearing price.”
Correct. Adjusted for inflation, gasoline is still nowhere near its historic high, its nominal (pump) price being less than half the true price — http://washingtontimes.com/commentary/20030722-093718-6082r.htm.
Which is to say that if oil were not so heavily subsidized by the government, the untold billions of dollars that would have been invested in alternative fuels, power sources, and modes of development would have long ago freed us from oil bondage and its attendant evils.
Hubbert’s peak is at least scientific and the predictions have worked so far.
It is not whether more reserves are discovered – but whether they are economic to get. How many barrels are available at $30/bbl is very different than that available at $100 or $200.
There can be a shift to ethanol, biodiesel, and other sources, and the market will take care of that once the price rises – these technologies have a cost per barrel currently higher than the expected and likely cost of oil. If ethanol is cheaper than oil (as it was in Brazil for a long time) there will be a shift.
About motor oil…
my car just had an untimely leak of oil and the concrete garage floor is covered with an ugly stain. Has the free-market got a solution for me to get rid of the unseemly sight ? I m renting the garage and I do want to repair this mishap since my landlord is bound to ask this of me anyway ? Should I spread sand on the stain or is there some available product I could acquire to solve and dissolve my problem ? What is the “solution” ?
Unhappy with my car
Messy, try to put a bunch of cat litter on it. It will absorb the oil remaining.
Scrubbing w/ Reg. dish detergents and hot water are good at getting the remaining stain out. There may be a small residual stain, but concrete appears to be a rather porous nature, and it may be impossible to get every last bit of the stain out. My spouse and I plan to paint our garage floor to cover up all the old stains.
Paul D,
“abiogenetic oil is the theory that oil is made by processes deep within the earth’s mantle/core. Basically, inorganic carbon is chemically reacted in conditions in the mantle that form hydrocarbons.
The Russians tried a few drills out and the results were inconclusive. 99% or so of the oil we get is from sedimentary layers of rock and are most likely of biological origin. The abiogenetic theory holds that we can find oil/petroleum in igneous and metamorphic rocks.
As for the renewing of field, as so far no fields have been documented (outside of Eugene Island, but that was an isolated case) refilling, the abiogenetic theory holds practically no real use/solution. If the mantle creates oil at a rate similar to that of biogenic origin, then no real solution is found. About the only thing else that the abiogenetic theory offers is finding oil in lower rock formations, areas normally considered unsuitable as a trap for petroleum.”
thanks to 0mar Jawaid for his insight on the subject.
i guess! that the market will take care of that once the price rises – these technologies have a cost per barrel currently higher than the expected and likely cost of oil. If ethanol is cheaper than oil (as it was in Brazil for a long time) there will be a shift.
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I do love the way you have presented this issue and it does indeed supply me personally some fodder for thought. However, coming from just what I have observed, I really wish as other feedback pile on that people today keep on point and not get started upon a tirade involving the news du jour. All the same, thank you for this excellent point and whilst I do not necessarily concur with the idea in totality, I value the perspective.
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