Saturday, August 27, 2005

A fascinating and public bet on the price of oil

Two prominent people have made a very public bet on the price of oil -- whether it will go up or down in the next 5 years. Each of them has a theory on what will happen to the price of oil over time, and we will find out which theory wins.

On one side is Matthew Simmons, who believes very strongly in "peak oil". He believes that, in the near future, the oil fields in Saudi Arabia will begin to go dry and that the price of oil will explode. He believes it will hit $200 a barrel in the very near future.

On the other side is John Tierney of the NY Times. Like me, John believes that Peak oil will be a non-event. As oil becomes more expensive, other technologies will compete with oil on price and naturally replace oil in our economy

As you will see when you read Peak oil will be a non-event and the Alteng blog, I am definitely on John's side in this bet. It will be very interesting to see who wins.

John's position in the bet comes from his past experience with an economist named Julian Simon, who placed a very public bet on the price of metals in the 1980s. Here's an account of that bet from the article:If you look at Alteng blog, you will find that there are dozens of technologies that compete with oil, and those technologies will begin replacing oil in the near future.

See also the Alteng blog and Peak oil will be a non-event.

I also think the odds are greatly in Johns favor. Simmons just released his new book Twilight in the Desert. The publicity he's getting from this bet is probably worth many times what he could loose. :-)
I was watching the show "Trucks" on the channel Spike TV today and they had biodiesel worth like 77 cents per gallon!!!! They also showed how to make it yourself in the garage! It made me wish I drove a diesel so I could do that.
My brother converted his diesel truck to run on bio. His conversion ended up being just a large tank on the back with a cheese cloth filter.

He would drive around to all the fast-food and Chinese resturants in town and haul away their used cooking oil for them in plastic containers. He would pour the oil through the cheese clothe and it would filter out all of the large contaminents.

Truck ran great, and smelled like french fries. He said the Chinese resturant oil was the best, but then again he might have just been being an ass. ;-)

Unfortunately if everyone did this, there wouldn't be enough of the cooking oil to go around, but it served a purpose of giving him free fuel and the resturants didn't have to pay to have their oil taken away and recycled.
Jon- that's cool. Something you said should be emphasized here. You mentioned that "... Unfortunately if everyone did this (used cooking oil for fuel), there wouldn't be enough of the cooking oil to go around ..." Great point. This has to do with scale. Biodiesel is great stuff, but it could never replace oil because of the scale involved.

On to Marshall's post...
As much as I respect Marshall's opinions, I disagree with him on this one. I also have a lot of respect for both Tierney and Simmons - both are intelligent and knowledgable people. I'm a libertarian and a free-marketeer and generally agree with Tierney. Having said that, Simmons probably knows more about the oil industry and specifically Saudi Arabia's oil industry than just about anyone outside of the Kingdom itself.

First off, trying to compare the price fluctuations of metals in the 1980s to those of oil in the 21st century is as silly as trying to compare the year 2000 bug to peak oil (which Marshall has tried to do in his "Peak oil will be a non-event" post that he links to above). Metals are not an energy source, oil is. Oil is "the" energy source in the world today. It far surpasses all other sources and is pervasive in the global economy. Oil is not recyclable, metals are. So if Tierney is trying to use Julian Simon's bet with Ehrlich over the price of metals as the basis for his bet with Simmons, he's an idiot. I'll give him the benefit of the doubt though and assume he's got some other basis.

As far as alternative energy sources go, of course there are many out there. And eventually they will replace oil. The problem has to do with scale, infrastructure and timing. Nothing comes close to oil as far as scale goes. Oil is the lifeblood of the global economy. Are other sources of energy in use? Yes- of course. But these make a very small percentage compared to oil and none of them can compete on the same scale as oil. What about infrastructure? There is no infrastructure in place for these alternative energy sources. Timing is the crucial issue here. If oil reaches 200, 300 or more dollars a barrel in the next few years, there is no way we will be able to ramp up these new technologies fast enought to replace oil as an energy source. So if peak oil occurs 20 years from now - we're in decent shape. But if it happens next year, we're not. And there's a lot of recent evidence that peak oil is coming sooner than later - probably within the next few years.

I am a big believer in the free market. And I believe the market will get us through this crisis, just as Marshall and Tierney believe. But to say it will be a non-event is both ignorant and naive. The market is an efficient but unforgiving beast. From all the research and different points of view I've studied over the last 2 years or so since I "discovered" peak oil, I've become convinced that at the very least we will experience a severe global recession because of peak oil. That's really not that bad- we'll get through it. I don't believe the doom-and-gloomers that predict some horrible Mad Max-like apocalypse. But a "non-event"?? Why say that?

2 years ago I "discovered" peak oil by checking out Matt Savinar's site Life After the Oil Crash. Ironically, I found the site via this very blog. :) Thanks Marshall. I was extremely skeptical but also very interested. I still disagree with Savinar on the scale of the oil "apocalypse" that he believes will happen. But his site has a lot of useful information and links. I spent a lot of time researching both sides of this issue and have ended up as something of a peak-oil "moderate". The thing that really started to convince me over the past few years is watching economists and energy analysts continually say that the high energy prices we were experiencing were just "anomalies" and that the price would come back down. They said this when oil was $40, $50, $60 ... and they are still saying it. On the other hand, peak-oil advocates like Simmons have been saying the opposite- that prices would rise. I ask you- who has been right? Peter Schiff, an economist, recently discussed an issue of Barron's magazine article from Nov. of 2004 where he and 4 other "experts" predicted where oil prices would be a year from then.

"... I recently reread a Barron's article written Nov. 2, 2004, in which five Wall Strategists, myself included, where asked to predict oil prices in 2005. Of the five, I was the only one to have accurately projected higher prices (which at the time were in the upper $40 per barrel), estimating prices would reach $65-$70 per barrel. A money manager at Solomon Brothers and an energy strategist at Merrill Lynch predicted prices collapsing to $28-$35, and $31- $34, respectively. ..."

Maybe Schiff should have made a bet with these "expert" energy strategists.
> Are other sources of energy in
> use? Yes- of course. But these
> make a very small percentage
> compared to oil and none of them
> can compete on the same scale as
> oil.

Nuclear energy could easily replace oil/gas/coal for electricity generation, and China is heading that way. It is at the same scale as oil. Concentrating solar could do the same. Easily.

If we did it, we could power the United States with solar in 5 years. Electric cars replace gasoline cars. Or hydrogen cars. The price of oil would then fall, not rise. None of this is hard.
1. Simmons is immensely more qualified than Tierney on this matter. Tierney is a think tank hack whereas Simmons career has been spent in the oil industry.

2. Marshall, you're a fabulously intelligent seer on many matters, but here you place undue weight on markets. Markets will correct, but that's no solace to the millions who face starvation or those left behind in the advance of economic eras.

Economist Max Sawicky summarizes the absurdity:


We then get a textbook rehash of the principle that when scarcity grows, prices go up, people buy less of the scarce good, and substitutes come online. Investment flows to alternatives, which get less expensive in consequence.

So don't worry about the world's dependence on finite fossil fuel resources. Who needs expertise in resource economics? Markets solve all problems. The universe is a convex set whose boundary is smooth and everywhere differentiable, may God strike me dead.

The principles make perfect sense, but they are completely beside the point. They typify the incompleteness and intellectual arrogance that pollutes academic economic discourse.

Do markets really solve all problems? Most problems? Nothing ever goes wrong? I guess it depends on how you define "wrong." For instance, Amartya Sen wrote a book about poverty and famines which describes how markets solved the problems of people having no money to buy food: they die of starvation, the ultimate steady state.

If oil runs out, sure there will be substitutes. How fast will these come online, if they do? How much will they cost? What will be the costs of adjustment? Will that be fun? Who knows? Markets solve problems. Solutions do not exclude freezing in the dark, a new kind of equilbrium.

Nobody should be let loose in the wild with a Ph.D. in economics unless they've been required to take three or four courses in history, preferably taught by non-economists.


While Peak Oil may not mark TEOTWAWKI, anyone that believes there won't be significant disruption to many lives is fantasy worshipping utopian — the 70's should serve as a reminder of what the future could hold in store, and remember, we're even more tied to cheap oil, with our average commute distance increases and total distribution network primarily dependent upon gasoline power.

Resiliency and adaptability will eventually reign over. but there will definitely be impact — I don't think you understand the special and unique characteristics cheap oil provide, and how none of the alternatives to date, offer anywhere the same EROEI (energy returned on energy invested).

Perhaps if we had (or embark upon such a "moon shot" program) made provisions to be less dependent on oil (i.e., return rail industry to prominence, more nuclear plants, etc.…), then it wouldn't be such an issue. But that is not the reality that is in 2005.
What you're forgetting Marshall is that all these other technologies - nuclear, wind, hydroelectric, ethanol etc. - these are all ultimately tied to oil price. During the industrial age - and your 'bet' has only really been over a short term and during the industrial growth era - oil has been the base commodity. It has been used to mine or grow all of the others. As oil price rises, the costs of all other commodities on the marketplace will rise. Attempts at efficiency will only be subject to diminishing returns, and many 'efficiency' producing activities actually use up a lot of energy in themselves. Food is grown using oil-based pesticides, and gas based fertilisers. Whichever way, there isn't a way out - we ride the industrial bubble to the top, now we ride it back down again.
I like what Ed Stenger said " I have a lot of respect for both Tierney and Simmons - both are intelligent and knowledgable people" and later he proves his respect saying that Tierney is an idiot.
But what I want to say is this:
We hear lot of "expert" opinions about oil bouncing arount $70 per barrel:
- World oil demand at peak levels with little spare capacity
- Worries over potential supply disruption
- Closure of the US Embassy and consulates in Saudi Arabia as a precaution against possible terrorist attacks
- Iran resuming uranium conversion activities that might prompt the EU and the United States to seek UN sanctions against Iran
- Rebel attacks on oil pipelines in eastern India(no report on damage, if any)
- Fear of refinery breakdown such as a weekend fire at Sunoco's refinery in Philadelphia that interrupted operations plus about a half-dozen other unexpected outages at US refineries.
- Drawdown of US gasoline inventories(in the midst of the peak driving season, what's the surprise?)
- A growing sense of fear that something not included above will occur
- Some combination of the above.

To bring little light in this mess
we need to have a look crude transportation process and to be more precise at spot VLCC (very large crude carriers) activity.
Needless to say the fixture activity has declined from year earlier levels. Why? Oversupply?...
Maybe the responsability of high crude prices lies with hedge funds loading up on crude futures. Traders, speculators, are driving up the prices for near-term futures and this goes on and on.
In the reasons list above an item is missing: greed
Greed is good says Gordon Gecko...
the properties of money are my properties and faculties thus what I am and what I am capable of is by no means determined by my individuality.. I am ugly, but I ca buy myself the most beautiful women. Consequently, I am not ugly, for the effect of ugliness, its power of repulsion, is annulled by money...I am a wicked, dishonest man without conscience or intelect, but money is honored and so also is its possesor. Money relieves me of the trouble of being dishonest"
Skyrocketing oil and gasoline prices? Peak oil? What's next?

Werner H
Werner, actually Ed never said Tierney is an idiot he said this (my emphasis added)

"So if Tierney is trying to use Julian Simon's bet with Ehrlich over the price of metals as the basis for his bet with Simmons, he's an idiot. I'll give him the benefit of the doubt though and assume he's got some other basis."

He said that if he was using this as his basis then he's an idiot. But then he went to say that he doubted this was the case. I think he was just trying to emphasize his point about the flaws of trying to compare the price fluctuations of metals in the 80s with oil 20 years later. I tend to agree with him on this.
Can I just emphasize that Peak Oil is not about energy, it's about oil. Alternative energy doesn't have to "replace oil" for all our energy needs, because the vast majority of oil is wasted in inefficient private cars on unnecessary trips. Electricity, the most important part of a comfortable first-world lifestyle, is almost entirely made from coal, gas, nuclear and hydro. Hence, while replacing all our energy with alternative technology would be a very good idea, and help the environment, it's not actually necessary when it comes to solving Peak Oil.

This is a good thing.
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