Still Lovin' That Simon Guy.

Even with oil prices shooting towards the heavens faster than a Saturn V, I still think that Julian Simon is essentially correct. From Tyler Cowen's list of hypotheses I'll take #4 - Markets don't allow bets on Simon's claim. At least not reasonable bets for those of us with limited funds. I won't be laughing my way to the bank as the common shorting instruments have limited upside and unlimited downside (err...why does that seem backwards?). IOW, current conditions will hold longer than I can remain solvent.

If reasonable terms can be had, I'll wager that the lowest per gallon price for gasoline that I will buy in my life is in the future.

However, I want to hedge my bet. If energy markets are insufficiently free then prices will continue to rise indefinitely. There is a lot of ruin in an economy, are the energy markets free enough or are we about to find the limits?

  • Significant oil reserves are off limits at any price.
  • Alternative energy subsidies are concentrating entrepreneurs and investors on what may very well be the poorest energy substitutes.
  • Many oil producers are state owned and being siphoned for short term political gains.
  • The most promising substitute for fossil fuels is for all intents only possible as a state run enterprise.
  • The nation that is soon to be the world's biggest oil consumer is subsidizing consumption.
  • Continuing war in one major oil producing nation and threatening another major producer can not be helping.

The two scenarios for 2028:
#1 - The market is free enough and our dominate energy sources are increasingly non-fossil fuel and some were unknown in 2008. Oil exploration and production continues to increase, and consumption either decreases or at least increases at a much lower rate than production.

#2 - Prices continue to rise, though possibly at a slower rate. Political tensions between major consumers and suppliers increase, possibly to open hostility between nations that have other stresses between them. I am not sure whether it will be consumer vs consumer or consumers vs producers, possibly both. Politicians enact even more counter-productive legislation. In the U.S., price controls and nationalizing energy companies becomes increasingly likely.

I'll bet on #1, but only with a hedge for #2.

[Update: cleared up possible confusion in scenario #1]

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I don't buy this "Markets

I don't buy this "Markets don't allow bets on Simon's claim" at all. Maybe organized electronic market don't, but over the counter you can structure almost anything.

If anything, oil could be underpriced, since above a certain price, your reserve most likely gets looted by the government.

Got something in mind?

I spent much of my free time today thinking about what an OTC contract would have to look like to be beneficial to myself, and to a counter-party. I have come up short.

My requirements:

1. I have a set amount of money I am willing to risk - any deal or series of deals must not put any additional money at risk. (It is allowable to set aside some portion in other investments with both principle and yield used at a later point to maintain or increase my position.)

2. That amount of money must keep me in the game for 20 years, and the contract(s) should be 20 years or rolled over periodically for 20 years. I expect to begin cashing out (win or lose) in year 20. Depending on the details of the contracts I would be willing to go to year 25 before I was completely out.

3. The contract(s) does not appear to be a sucker bet to a sophisticated trader.

4. Expected upside (factoring in risk) must be greater than the expected upside of index funds.

I am more than willing to believe that my imagination is lacking, and I might even be convinced to admit it.

David Masten

What are you betting on

What are you betting on exactly?

What about a 20 year European put on gold denominated crude oil ?

Price of oil drops long term.

What are you betting on exactly?

That the price of oil, say some combination of light sweet crude and other grades commonly used for fuel, is much lower in twenty years than now.

What about a 20 year European put on gold denominated crude oil ?

What purpose do you see for denominating in gold?

As for a 20 year European style contract, I don't think I'll get a counter party at a premium and strike price that will result in sufficient gains.

David Masten

I wonder if it'd be more appropriate to use the benchmark of...

...something broader - say the price of a "quantum" of energy, i.e., the cost of the energy needed to travel 1 mile or something like that, or even a basket of commodities.

It seems that the foundation of this multi-blog discussion rests on oil being the key resource upon which the validity of Simon's prediction rests. But wasn't Simon's prediction really about humanity's ability to escape the Malthusian trap? (Maybe I'm missing something; there are professional economists at the center of the conversation after all.)

Whatever may happen to oil, I'm confident most of humanity has long ago escaped the Malthusian trap and resources in general will continue to get cheaper over the long term even if there are intermittent periods in which they rise in price. Oil is just one variable subject to various whims, geopolitical forces, and governmental regulations.

Also, I agree with the commenter who said that money supply changes screw up prices too much in such a contest. It might make more sense to use labor as the divider: the cost of energy needed to travel 1 mile/ the cost of 1 hour's labor from a construction worker (or something similar). The assumption here would be that money supply inflation would similarly effect both labor and the price of the resource.

I think the relevant

I think the relevant resource here is energy, not oil, as Jonathan alluded to. Oil will probably stay this expensive, though perhaps more for political reasons than because of actual scarcity. However, I think the Simonian outcome is that energy gets continually cheaper in the long run with or without expensive oil. We may well run out of cheap oil, but there are plenty of potential substitutes and expensive oil means big incentives to develop them. However, Caplan still made a bet on oil.

It turns out that...

If another energy source becomes a significant cheaper substitute for oil, then oil prices will also drop.

David Masten

assuming that political

assuming that political issues don't artificially increase the price of oil relative to other energy sources, yes.

I think Dave's right

If nobody wants oil, politics won't matter. The price will be low.

Or the market might just dry

Or the market might just dry up for it. If there is a significantly cheaper substitute for oil, there may be no one left drilling for oil. What is the inflation adjusted price of whale blubber now relative to what it was before oil was discovered as a substitute?

Quantum of energy

...something broader - say the price of a "quantum" of energy, i.e., the cost of the energy needed to travel 1 mile or something like that, or even a basket of commodities.

Do you mean a unit of energy? Like calorie? There are lots of existing units (joules, watt-hours) - let's not add yet another.