Show Me The Money: Peak Oil and Hope vs. Belief

In the still ongoing peak oil thread, I wrote the following:

It seems to me if the Peak Oilers were as confident in their predicitions as they claim to be, they would put their money where their mouths are and invest in the equivalent of selling oil short and make gobs and gobs of cash. [Edit: as Jim Lippard pointed out, I suck at finance. This should be selling oil long, not short] If enough of them did this, they would be sending a market signal - a real, believable signal (ala Patri’s Hope vs. Belief paradigm) - that oil is destined to rise in price, and it would rise accordingly before any shortage occurs. The fact that they don’t put their money where their mouths are leads me to trust those who do - and those who do don’t think we have much to worry about any time soon.

Well, as it turns out, John Tierney, channelling the late Julian Simon, makes precisely the same argument in the hallowed pages of the New York Times:

I don't share Matthew Simmons's angst, but I admire his style. He is that rare doomsayer who puts his money where his doom is.

After reading his prediction, quoted Sunday in the cover story of The New York Times Magazine, that oil prices will soar into the triple digits, I called to ask if he'd back his prophecy with cash. Without a second's hesitation, he agreed to bet me $5,000.

His only concern seemed to be that he was fleecing me. Mr. Simmons, the head of a Houston investment bank specializing in the energy industry, patiently explained to me why Saudi Arabia's oil production would falter much sooner than expected. That's the thesis of his new book, "Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy."

I didn't try to argue with him about Saudi Arabia, because I know next to nothing about oil production there or anywhere else. I'm just following the advice of a mentor and friend, the economist Julian Simon: if you find anyone willing to bet that natural resource prices are going up, take him for all you can. ...

I realize this isn't a sure thing, because the price of oil has risen before - it quintupled in the 1970's. But then it dropped, thanks to new discoveries and technologies, validating the Cornucopians' optimism.

So I figure the long-term odds are with me. And while I'm at it, I'll extend Julian's challenge and consider bets from anyone else convinced that our way of life is "unsustainable." If you think the price of oil or some other natural resource is going to soar, show me the money.

The Peak Oilers want us to believe that they have access to information that the rest of us do not: credible evidence that we will run out of oil shortly, without notice, and inevitably. Yet we observe that those who have the most to gain from this information - that is, investors - are not buying oil futures hand over fist. Though prices may be relatively high, they are not that high. And Peak Oil theories are not hidden or anything new; they are all over the Internet and have been around for decades (and in their other Malthusian forms, centuries). So why should we lend any credence whatsoever to Peak Oilers when they have no explanation for why they have access to privileged, incredibly valuable information - information that, if true, investors would pay dearly for? Either: (a) investors just never heard of these Peak Oil theories, or (b) they've heard of them and rejected them as the nonsense that they are. My money is on (b).

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I'd like some more specifics

I'd like some more specifics on what a "Peak Oil theory" says, and what is being disputed.

If it's that there is a finite amount of oil on earth, and that we'll reach at least a halfway point in total quantity used, and a peak amount of production per year, I'd say that's pretty undisputable.

If it's that the price of oil will go inevitably and inexorably upward from that point, that doesn't follow unless the demand for oil will never go down, that we will never find a substitute. That seems quite likely to be false. (BTW, as Mills and Huber argue in _The Bottomless Well_, improvements in efficiency of use of oil won't help--demand increases faster than improvements in efficiency.)

Likewise, if it's that we will never develop methods to obtain oil that was previously thought unobtainable or inefficient to obtain, that's likely false (though this will no doubt become more difficult and require more energy to achieve).

My view is that (a) we will reach a point of Peak Oil production, and that may be quite soon, (b) we will see the price of oil continue to increase, which will (c) lead to a shift to substitutes (most likely more coal use and more nuclear for electricity generation, along with smaller but growing quantities of electricity generated with solar, natural gas, wind, cow manure, etc., and use of electrical cars, probably using hydrogen fuel cells for storage) and may (d) make it profitable to obtain formerly unavailable oil using more expensive methods. The Bush energy bill's oil company subsidies will provide some disincentive for (c), but will provide incentive for (d).

I think betting on the price of oil increasing over the next several years is a pretty safe bet, and I'd guess that a triple digit number of dollars is a real possibility (especially since I'd also be willing to bet on continued declines in the value of the U.S. dollar). I don't see a time frame on Tierney's bet--if he didn't place a time limit on it, he can't win. I note that Simon's bet had a one-decade time frame and was also inflation-adjusted, which is pretty important.

BTW, Simon and Ehrlich bet over the prices of $200 each of chromium, copper, nickel, tin, and tungsten from September 29, 1980 to September 29, 1990. All of those metals declined in price during that period, adjusted for inflation.

Copper hit a record high price in 1995 and is higher than 1980; tungsten has been pretty flat (and is cheaper than 1980), chromium is more expensive than in 1980; tin is much cheaper than in 1980; nickel went up in late 1988/early 1989 but is now slightly cheaper than in 1980. (See http://minerals.usgs.gov/minerals/pubs/metal_prices/ .) It looks like had Simon and Ehrlich repeated the same bet for another ten years, Simon would have won again.

"The Peak Oilers want us to

"The Peak Oilers want us to believe that they have access to information that the rest of us do not: credible evidence that we will run out of oil shortly, without notice, and inevitably. Yet we observe that those who have the most to gain from this information - that is, investors - are not buying oil futures hand over fist. Though prices may be relatively high, they are not that high."

Peak Oilers have anticipated this criticism and offered reasons as to why this may be the case. I would, of course, strongly prefer the Holy Market to be correct seeing as this is all we have left to rely on.

But the thing that scares me most is that the Peak Oilers have a nontrivial chance of being right about depletion curves. In which case *we are not prepared* in a way that would make drastic Peak Oil give us a soft landing.

I'm not certain where I see

I'm not certain where I see that the market would inform us ahead of time about peak oil. It seems like something, that by its very nature, could easily be very disputable till the event itself. It might even be possible that peak oil will pass and we won't know till a year or so of data comes in to confirm it. If that's the case and hence we don't really know how much remains in reserves, then the bet described above is probably a good model of investor rationale: resource doomsayers were wrong in the past, probability tells us they are wrong now. If that's the only information, I wouldn't expect any sort of hand-over-fist speculation but at the same time, I wouldn't expect prices to reflect the likelihood of peak oil in the near future.

Thank you Steven Schreiber.

Thank you Steven Schreiber. You are clearly more concise than I. That's been a point I've been trying to get across after many many posts.

Just to argue against

Just to argue against myself: The Economist (Aug. 13-19, p. 62) points out a factor that could lead to a near-term decline in oil prices: a recession. The yield curve is already quite flat; if it inverts that's a fairly reliable indicator of an imminent recession.

...a shift to substitutes

...a shift to substitutes (most likely more coal use and more nuclear for electricity generation, along with smaller but growing quantities of electricity generated with solar, natural gas, wind, cow manure, etc., and use of electrical cars, probably using hydrogen fuel cells for storage)

I suspect we will see a shift from moving around in 1-ton metal boxes for two hours a day to high-speed communications. The biggest reason against this is that employers prefer to see their employees working. But this could be replaced with a shift from payment-for-hours to payment-on-deliverable. The biggest reason against payment-on-deliverable is that there is a high overhead on an employment contracts that favor locking in an employee full-time to make health care and other benefits manageable by employers. Governments want employers to manage employees' benefits so they can have a third-party pays tax system (that is, employers pay taxes to the government on behalf of employees).

It would be fun to calculate the increase in productivity if we were to shift to a workforce of flexible employment contracts.