A comment on Peak Oil

Here's a comment I posted on this M1EK's BSOB thread.  I'm reposting it here because (i) it's what I think about Peak Oil; and (ii) it took me a long time to write.   

The crux of the issue is this: Should we reallocate our resources today in anticipation of a potential future scarcity? The peak oilers say yes, although they differ in how much reallocation is necessary.

The anti-peak oilers say no. Here's the argument, at least as I see it:

(1) Reallocating resources today will cause certain and quite genuine economic loss. (E.g., reserving valuable urban land as marginally productive farmland, a common peak-oiler policy recommendation.)

(2) The peak oilers assume that we should reallocate resources today because it will be easier now than when scarcity sets in. But that's got to be wrong. What matters is the price of energy relative to other goods. We can't possibly know what that relative price will be in 10 or 20 or 30 years. For example, it "costs" an average worker X minutes of labor to drive one mile. How much will it cost an average worker, measured in minutes of labor, to drive one mile 20 years from now? That depends not only on how much oil's left, but on increases in average productivity, technological innovation (substitutes for oil or the combustion engine), and the amount of demand for driving one mile. No one know what that relative price will be in 20 years. Anyone who says he does know is practicing religion, not science or economics.

(3) Because we do not know what the relative price will be in 20 years, it is foolish to reallocate resources today based on a wild-assed guess. Rather, it is better to let rising prices encourage efficient conservation and reallocation of resources, as well as technological innovation. (We should diversify our energy base, but not because of peak oil. Diversity will cushion us against sudden shocks to our oil supply.)

The "cornucopian" part of this argument is (2), where people like me say that energy may be cheap in the future because of technological innovation. No, technological innovation is not guaranteed. But technological innovation is a possibility, and a real one based on past results. The constant technological innovation that's going on around us -- innovation unmatched by any society, past or present -- is relevant to our capacity to innovate in the future.

Peak oilers generally refuse to recognize the possibility of technological innovation; that's where they fall into the malthusian trap. Once we recognize that innovation is a genuine possibility, then it's hard to say that we should incur a certain loss today to avoid a speculative loss tomorrow, particularly when we don't know how to reorganize things to avoid that loss.

Note that I do not dispute that the world's oil production has peaked.  I'm agnostic on that particular issue.

Comments

[Dave Austin]

Don't forget ... we were supposed to be driving around in flying cars by now. I want my flying car!

In 20 years I'll want that zippy little 80 mpg car too because I won't be able to afford to drive anything else. Will it also be nothing more than a "possibility"?

Me thinks it will. But over the next 20 years "energy conservation" measures will have little impact, and conserving oil reserves will never happen anyway (so don't you worry). That like telling a 5 year old to not lick an icecream melting in their hand. If we have it, we'll burn it.

Renewable energy is our only hope.

[TechnoJabber]

I agree that technological breakthroughs could feasibly avert the global impact of peak oil, but it all comes down to risk - can you risk there NOT being a technological breakthrough? Can you risk that the governments of the world won't get their act together until things get really uncomfortable?
If you want to take that gamble, I wish you luck. I really do hope it comes through, for all our sakes. If it doesn't, wouldn't it be prudent to at least have some basic idea of how you're going to feed your family when food is scarce and hideously expensive?
I’m proud to be labelled a "peakist". I’m not a gambler and I have a backup plan.

[dan]

If it really worries you, hedge your risk with oil futures. What's the problem?

[M1EK]

The kind of risk presented by peak oil is definitely NOT one you can hedge by just buying futures. Macroeconomics matters - another Great Depression, for instance, might make your future contracts nothing more than toilet paper.

[dan]

What model are you using and what's the mechanism?

Using the AS/AD model, there’s a supply shock; AS goes up, so price goes up, of course. But, last time I checked, long term oil futures were actually in backwardation, so it would be essentially impossible for the price increase to cancel out your profit, if it were cause by an oil price shock.

Or, using the IS/LM model: the IS curve shifts left. Now what?

I don’t really see the connection between a macro scale change and futures becoming worthless. Unless your currency became worthless, but currency risk can be hedged too, and more developed economies are less oil dependant than developing economies, so I’d actually reduce my usual currency risk hedging if I were worried about peak oil.

[M1EK]

dan,

I'm referring to at a FIRST level the possibility of a political 'solution' to vastly higher oil prices, like massive direct subsidies for gasoline (already done in some countries); nationalization of industry; imposition of price rationining; etc.

Then you can start going into scarier stuff like Great Depression Deux. And, no, I'm sorry, but you can't glibly assert that one can successfully hedge against the collapse of the US dollar.

[M1EK]

Should have read "imposition of price controls and/or rationing". Am sleepy after redeye (sleepless) from Honolululuulu...

[LeOgAhEr]

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