Coyote Blog

Kevin Drum titles a post on providing government incentives for high MPG cars "Ending the Addiction,"  by which I presume he means addiction to gasoline.   I really struggle with the point of view on life that describes consumer affinity for enormously value-producing technologies to be an "addiction."  One could equally well refer to our preference for good health or prosperity to be an "addiction," particularly when fossil fuels have played such a central role in fueling the industrial revolution and the prosperity which it has brought.  With the current jump in oil prices tied so closely to growing wealth in China, never has the tie between fossil fuel use and prosperity been more obvious.

Drum advocates for what he calls a "progressive" proposal:

For cars, the most effective thing would be a "feebate": In the
showroom, less-efficient models would have a corresponding fee, while
the more-efficient ones would get a rebate paid for by the fees. That
way when choosing what model you want you would pay attention to fuel
savings over its whole life, not just the first year or two. It turns
out that the automakers can actually make more money this way because
they will want to get their cars from the fee zone into the rebate zone
by putting in more technology. The technology has a higher profit
margin than the rest of the vehicle.

I will say that this is probably less bad than other "progressive" proposals I have heard, but the logic here is based on consumer ineptness.  Higher gas prices, which drive higher lifecycle costs, are presumably providing exactly this incentive without any government program.  The problem, it seems, is that progressives don't think very much of the common people they wish to defend.  Just as the justification for Social Security is that the average person can't be trusted to make good decisions about their retirement savings so we elites will do it for them, this seems to be the logic here, but even more patronizing.   Here is the best bit which really demonstrates the point I am making:

Here's a further suggestion: require stickers to list the estimated cost of fuel consumption over a five year period.

Basically this calculation is total estimated miles per year divided by mpg times estimated gas prices times five. A simple piece of math with four numbers that can be completed on a calculator in 10 seconds or by hand in less than 30 seconds.  Mr. Drum, a big supporter of our current monopoly government school system, apparently does not think that people educated in this system can do this math for themselves.  Could it be clearer that "progressivism" is really about disdain for the common man and a belief that elites should make even the smallest decisions for them?

Yesterday we saw the people who have done the most to keep oil prices high (e.g. Congress) trying to blame shift their policy failures onto oil company executives.  Hilariously, Maxine Waters thinks she would do a better job for consumers if she were in charge of the US oil companies. 

Beyond the realities of supply and demand, which I guess we all despair of teaching Congress, there were these remarks by Shell's John Hofmeister (via Powerline):

While all oil-importing nations buy oil at global prices, some, notably
India and China, subsidize the cost of oil products to their nation's
consumers, feeding the demand for more oil despite record prices. They
do this to speed economic growth and to ensure a competitive advantage
relative to other nations.

Meanwhile, in the United States, access to our own oil and gas
resources has been limited for the last 30 years, prohibiting companies
such as Shell from exploring and developing resources for the benefit
of the American people.

Senator Sessions, I agree, it is not a free market.

According to the Department of the Interior, 62 percent of all
on-shore federal lands are off limits to oil and gas developments, with
restrictions applying to 92 percent of all federal lands. We have an
outer continental shelf moratorium on the Atlantic Ocean, an outer
continental shelf moratorium on the Pacific Ocean, an outer continental
shelf moratorium on the eastern Gulf of Mexico, congressional bans on
on-shore oil and gas activities in specific areas of the Rockies and
Alaska, and even a congressional ban on doing an analysis of the
resource potential for oil and gas in the Atlantic, Pacific and eastern
Gulf of Mexico.

The Argonne National Laboratory did a report in 2004 that identified
40 specific federal policy areas that halt, limit, delay or restrict
natural gas projects. I urge you to review it. It is a long list. If I
may, I offer it today if you would like to include it in the record.

When many of these policies were implemented, oil was selling in the
single digits, not the triple digits we see now. The cumulative effect
of these policies has been to discourage U.S. investment and send U.S.
companies outside the United States to produce new supplies.

As a result, U.S. production has declined so much that nearly 60 percent of daily consumption comes from foreign sources.

The problem of access can be solved in this country by the same
government that has prohibited it. Congress could have chosen to lift
some or all of the current restrictions on exportation and production
of oil and gas. Congress could provide national policy to reverse the
persistent decline of domestically secure natural resource development.

This is a point I have made for a while:

Exxon Mobil is the largest U.S. oil and gas company, but we account for
only 2 percent of global energy production, only 3 percent of global
oil production, only 6 percent of global refining capacity, and only 1
percent of global petroleum reserves. With respect to petroleum
reserves, we rank 14th.
Government-owned national oil companies dominate the top spots. For an
American company to succeed in this competitive landscape and go head
to head with huge government-backed national oil companies, it needs
financial strength and scale to execute massive complex energy projects
requiring enormous long-term investments.

Lots more good stuff, check it out.

This is almost beyond parody:

The House of Representatives overwhelmingly approved legislation on
Tuesday allowing the Justice Department to sue OPEC members for
limiting oil supplies and working together to set crude prices, but the
White House threatened to veto the measure.

The bill would
subject OPEC oil producers, including Saudi Arabia, Iran and Venezuela,
to the same antitrust laws that U.S. companies must follow.

The measure passed in a 324-84 vote, a big enough margin to override a presidential veto.

The
legislation also creates a Justice Department task force to
aggressively investigate gasoline price gouging and energy market
manipulation.

"This bill guarantees that oil prices will reflect
supply and demand economic rules, instead of wildly speculative and
perhaps illegal activities," said Democratic Rep. Steve Kagen of
Wisconsin, who sponsored the legislation.

I am sure, either through scheming or more likely incompetance, that OPEC countries are under-supplying their potential capacity for oil production.  But if we want to deem this a crime, who is the biggest criminal?   The US is the only country I know of that has, by statute, made illegal the development of enormous domestic reserves.  Just last week, Democracts in Congress, in fact the exact same folks sponsoring this bill, voted to continue an effective moratorium on US oil shale development.  No country in the world is doing less to develop the most promising oil reserves than is the US.  Congress, sue thyself.  I mocked this idea weeks ago when Hillary first suggested it.  If this passes, I would love to see the US counter-sued for not developing ANWR.  Or large areas of the Gulf.  Or most of the Pacific coast.  Or all of the Atlantic coast.  Or our largest-in-the-world oil shale deposits. 

This post from TJIC, which is really about something entirely different, mentions that the price of cocaine has been dropping sharply over the last 10 years.  This is something I have heard police officials lament as well.

Does the profit motive rock or what?  The largest and most powerful government in the world stations armed men and ships around the country.  It has a legal system in place with huge penalties that has of late been nearly entirely dedicated to drug enforcement.  The US has even subverted 200 year old Constitutional restrictions on searches and property seizures (the Patriot Act is mostly used for drug, not terrorism, actions).  All to stop the importation of certain valuable substances.  And even so, the human mind is powerful enough to subvert all of these restrictions and bring in so much supply that the price continues to drop.

Al Gore believes that alternative energy efforts in the US are being subverted by the oil companies:

Apparently, according to Gore, the oil companies drive up prices
reducing supply and then depress them in a telling pattern. As soon as
the political will swells to a light boil, the companies reduce
prices/increase supply.

Really?  Independent drug traders are able to subvert a million government officials with guns to keep cocaine prices low, but Exxon, with a 5% market share (at most) in oil, is able to hold the line on oil supply?

Sure.  In 1972 and 1978 there were a series of oil price shocks (to real levels about where they are today) that convinced everyone that oil prices would keep going up and up and that oil would run out within a few decades.  Of course, in about 1984 oil prices crashed, and stayed down for almost 20 years.  Depending on how you date it, it took oil supply development between 6 and 12 years after the price signal to flood the world with oil, and that was in an environment with price controls and windfall profit taxes that reduced development incentives. 

Right now, we are about 5 years in to the current oil price spike.  Go long at your own risk.

More on supply and demand vs. price manipulation in oil here.  More on Al Gore, including a fisking of his solar plan, here.

Update: Of course, the Democrats in Congress are doing everything possible to keep oil prices up.  If I wanted to ensure high oil prices, I would 1.  Kill incentives to increase supply, perhaps with a "windfall" profits tax and 2.  Put the most promising potential new exploration areas off-limits to new development.  Congressional scorecard:  #2 is in place, and both Obama and Hillary and Pelosi are proposing #1.

Update #2:   Another thought on Gore's statement:  The boom-bust
patterns in oil are characteristic of nearly every other commodity out
there, which therefore presupposes that if oil prices are the result of
manipulation, then every other commodity must be as well since their
prices demonstrate the same patterns.  We see these patterns in
commodities that politicians have never even heard of and in which they
have never thought to exercise their "political will."  (political will
in this context defined as use of government force against a segment of
the populace).

A reasonable person might
suppose that the surge in prices followed by a drop a number of years
later is better explained by the time delay in increasing oil
production after oil prices spike. In many ways, Al's theory is simply
delusional.  If your friend started trying to tell you, in all
seriousness, that every action Microsoft takes is actually aimed at
thwarting him personally, you would think him insane.  But this is
effectively Gore's argument, showing the immensity of the politician's
ego.  Oil prices move not because of supply and demand, but because of
us politicians.  Every tick up and down is carefully managed to thwart
us brave Congressmen!

When a politician describes price signals as mainly influencing political actions, rather than the actions of free producers and consumers, they are probably a socialist.

Neo-Erlichism from Paul Krugman:

Much of what I did back then was look for estimates of the cost of
alternative energy sources, which played a big role in Nordhaus's big paper that
year. (Readers with access to JSTOR might want to look at the
acknowledgments on the first page.) And the estimates "” mainly from
Bureau of Mines publications "” were optimistic. Shale oil, coal
gasification, and eventually the breeder reactor would satisfy our
energy needs at not-too-high prices when the conventional oil ran out.

None of it happened. OK, Athabasca tar sands have finally become a
significant oil source, but even there it's much more expensive "” and
environmentally destructive "” than anyone seemed to envision in the
early 70s.

You might say that this is my answer to those who cheerfully assert
that human ingenuity and technological progress will solve all our
problems. For the last 35 years, progress on energy technologies has
consistently fallen below expectations.

I'd actually suggest that this is true not just for energy but for
our ability to manipulate the physical world in general: 2001 didn't
look much like 2001,
and in general material life has been relatively static. (How do the
changes in the way we live between 1958 and 2008 compare with the
changes between 1908 and 1958? I think the answer is obvious.)

My goodness, its hard to know where to start.  Forgive me if I do not remain well-organized in this post, but there is so much wrong here it is hard to know where to start.

A forecast is not reality

First and foremost, the fact that forecasters, whether they be economists or science fiction writers, are wrong on their forecasts does not say anything about the world they are trying to model -- it merely says that the forecasters were wrong.  The fact that the the Canadian will be wrong in its prediction that 4.5 billion people will die by 2012 due to global warming does not mean that the physical world will somehow have changed, it means that the people at the Canadian are idiots.  The fact that an ice shelf in Antarctica collapsed earlier than one forecaster expected does not mean global warming is accelerating, it means the forecaster was wrong.

In fact, I can play this kind of game in exactly the opposite way in the energy field.  I can point out that economists like Krugman predicted that we were going to be out of oil (and food, etc) by 1980, then by 1985, and later by 1990, and by 2000, and by... now.  Does the fact of their continuing forecast errors on oil supply and demand tell us anything meaningful about oil markets, or does it tell us something about economists?  He practically begs for this counter-example by titling his article "limits to growth..." which hearkens back to the horribly wrong sky-is-falling forecasts in the 1970s by the likes of the Club of Rome and Paul Ehrlich. 

Advances in Energy

But his key statement is that progress on alternative energy technologies has consistently fallen below expectations?  Whose expectations?  Certainly not mine, or those of the knowledgeable energy industry insiders, who have been consistently pessimistic about most of these alternatives over the last decade or two.   Perhaps they have fallen below Krugman's or Greenpeace's expectations, but so what?

At this point, though it is embarrassing to have to point this out to a man who once was a real economist rather than a political hack, I must remind Mr. Krugman that since we are talking about substitutes for oil, then perhaps oil prices might have something to do with this "lack of progress."  Because, while we may tend to forget the fact over the last few years, for 20 of the last 25 years oil prices have been, on a real basis, near all-time lows.  They languished for decades at $20 or less, a price level that made the economics of substitutes impossible.  Nobody is going to put real money into substitutes when oil is at $16 or so.  Exxon, for example, had huge money invested in LaBarge, WY oil shale in the late 70's until decades of middling oil prices in the eighties and nineties forced them to pull the plug.  Ditto everyone and everything else, from shale oil to coal gasification.  And I can't even believe any sentient adult who lived through this period actually needs it pointed out to him that maybe there are non-technical reasons breeder nuclear reactors have not advanced much, like say the virtual shutdown of the nuclear business by environmentalists and local governments.

I will myself confess to being a bit surprised that solar efficiencies have not advanced very much, but again I remind myself that until the last few years, there was virtually no economic justification for working much with the technology. 

But all this masks another fact:  One of the reasons that these technologies have not advanced much is due to the absolutely staggering advances in oil exploration and production technology.  The last 35 years has seen a revolution, from computer reservoir modeling to horizontal drilling to ultra deep sea oil production to CO2 floods, it is in many ways a totally new industry.

Here is the way to decode what Mr. Krugman is saying:  It is not that the energy industry is not making huge technology gains, but that it is making gains in areas that Mr. Krugman did not expect, and, even more likely, it is not making its gains in the areas that Mr. Krugman wanted them to be.

Other technological advances

But Mr. Krugman did not stop there.  He could not resist throwing out a bit more red meat when he posits that all of our advances over the last 50 years in manipulating the material world have been disappointing.  Really?  Again, by what metric?  The revolution in computing alone has been staggering, and I feel like I could just say "Moore's Law" and leave my rebuttal at that.  Kevin Drum, oddly, suggests that Krugman means to say "besides computers" by using the "manipulate the physical world" wording.  If so, that is pretty hilarious.  Saying that "when you leave out computing and semiconductors, we haven't done much with technology over the last 50 years" is roughly equivalent to saying "leaving out the energy revolution and the application of steam power, there was not much progress in the early industrial revolution."   It's a stupid, meaningless distinction.  I am sure he would include a "car" in his definition of manipulating the physical world, but then how would you explain all those semiconductors under the hood?

But, that being said, I will take up the challenge.  Here are a number of technological revolutions besides computing and semiconductors over the last 50 years that clearly outstrip the previous 50:

• Cost / Affordability Revolution.  One can argue that many of the technologies we enjoy today existed, at least in primitive form, in 1958.  But the vast majority of these items, from television to automobiles to air conditioning to long distance travel were playthings for the rich.  Over the last 50 years, we have found a way to revolutionize the cost and availability of all these items, such that most are available to everyone  (more on this below)
• Reliability revolution.  In 1958, and even in 1968 and to a lesser extent in 1978, it was critical to have an address book full of good repair people.  Cars, televisions, home appliances, radios, air conditioners -- all were horrendously unreliable.  They could fail on you at any time, leaving you in an awkward or even dangerous spot, and repairs were common and expensive.  When I was a kid, we used to have a guy in our house at least twice a year fixing the TV -- when was the last time you saw a TV repair man?  I would argue that reliability (and this applies to industrial products as well) barely budged from 1908 to 1958, but has improved exponentially in the last 30-40 years.
• Environmental and efficiency Revolution.  This one is no contest.  The environmental improvement -- in air quality, in water quality, in litter, in just about every category -- has shown substantially more improvement since 1958 than it did in the first half of the century.  This one is no contest
• Safety revolution.  While there are ways in which this has gone too far, there is no denying that a huge amount of engineering over the last 50 years has gone into making products and services safer to use and operate.  And by the way, on the topic of flying cars (everyone likes to lament, "where is my flying car") could one not imagine that one reason we don't have flying cars is that anyone who is smart enough to design one is smart enough to know the government is never going to let people fly around willy-nilly, so maybe there is no mass market for them worth the investment and time?
• Bio-medical revolution.  In less than 20 years from the time the world really recognized and understood the AIDS virus, science had a fairly good treatment for it.  And people complained it took too long!  Think of it -- a new, totally foreign virus that is extremely deadly appears nearly out of nowhere, and science cracks it in 2 decades.  No such ability existed before 1958.
• Communications and Entertainment revolution.  1958:  Three US TV networks.  2008: 300 million people with the ability to broadcast their thoughts, their movies, their works of art to the world.  'nuff said.

In many ways, all of these thoughts come together if we look at a car.  Its easy to say that cars have not changed much - no wings yet!  But in fact, a car mechanic from 1909 would have a fighting chance to work on a 1958 engine.   No way a 1958 mechanic could make much progress with a 2008 internal combustion engine, much less a hybrid.  A car in 1958 was nearly as unsafe, and unreliable, and inefficient, and polluting, as a car in 1908.  Today, all of these have improved by orders of magnitude.  In addition, our cars have air conditioning and leather seats and hard-top convertible roofs and satellite radios and DVD players for the kids.  And mostly, the don't rattle like they used to after 6000 miles.

Material Life

But Krugman is still not done throwing out red meat, as he concludes that material life has not improved much over the last 50 years, and the answer is "obvious", to him at least, as to whether it has improved more in the last 50 years or the previous 50 years. 

Well, first I would observe that one should probably not trust people in data-based professions like economics who say that the answers to complicated questions are obvious without feeling the need to put any facts on the table.  By so positing, he looks extraordinarily lazy compared to folks like Steven Levitt who are out there trying to quantify the seemingly unquantifiable.

But the question is not at all obvious to me.  I suppose one could argue that the very rich have not seen much change in their material condition.  In 1958 they could jet around the world and had televisions and air conditioning and could afford the costs of unreliable products  (it does not matter so much if your car breaks down a lot if you can afford to have five or six cars).

But is strikes me that the material condition of the poor and middle class have improved markedly over the last 50 years.  As I mentioned before, there has been a revolution in the price and availability of what used to be luxury items:

The following are facts about persons defined as "poor" by the Census Bureau, taken from various gov­ernment reports:

• Forty-three
  percent of all poor households actu­ally own their own homes. The
  average home owned by persons classified as poor by the Census Bureau
  is a three-bedroom house with one-and-a-half baths, a garage, and a
  porch or patio.

• Eighty percent of poor households
  have air conditioning. By contrast, in 1970, only 36 percent of the
  entire U.S. population enjoyed air conditioning.

• Only 6 percent of poor households are over­crowded. More than two-thirds have more than two rooms per person.
• The
  average poor American has more living space than the average individual
  living in Paris, London, Vienna, Athens, and other cities throughout
  Europe. (These comparisons are to the average citizens in foreign countries, not to those classified as poor.)

• Nearly three-quarters of poor households own a car; 31 percent own two or more cars.
• Ninety-seven percent of poor households have a color television; over half own two or more color televisions.
• Seventy-eight percent have a VCR or DVD player; 62 percent have cable or satellite TV reception.
• Eighty-nine percent own microwave ovens, more than half have a stereo, and more than a third have an automatic dishwasher.

What has not improved

To bring us back full circle, the one thing I would argue that definitely has not improved much is forecasting and modeling.  It appears from Krugman in this article (and form global warming modelers)  that orders of magnitude increases in computing power have improved neither the hubris of the modelers nor the quality of their forecasts.  I am sure I could as easily find someone in 1958, or even 1908, out there crying "My forecast is fine - its reality that's broken!"

OK, I am spent.  I am sure there is more that could be said on this, but I will leave the rest to you guys.

I agree with Kevin Drum, this is the dumbest thing I have read today:

There is a solution to the rising cost of oil, but it is a painful
one. Let's say there is a lot of $20-a-barrel oil in the world "”
deep-sea oil, Canadian tar sands. But who would look for $20-a-barrel
oil if someone else (Saudi Arabia) has lots of $5-a-barrel oil? The
answer is: no one.

Basically, American taxpayers have to guarantee potential producers
that the price in the future will not fall below $20 a barrel and that
they will not lose their investments.

This is easy to do. The U.S. needs to guarantee that it will buy all
of its oil at $20 a barrel before buying anything from OPEC. This
forces the price of oil down to $20 a barrel, but it eliminates the
possibility that it will ever go back to $5 a barrel.

The implication that no one will add capacity if there is anyone at all to the left of them on the supply curve is just silly, and defies history in any number of industries, including oil.  By this argument, no one would be building super-deep water oil platforms today.  The reason there is not more oil exploration today in certain areas of North America is that there are formal and informal government restrictions that make it hard and/or impossible.  And to the extent that oil companies are treating current oil prices as a bubble that will inevitably fall, all I can say is, bring it on. 

... because that may make it easier for the Democrats to summon the political will to kill ethanol subsidies, though don't hold your breath.  Certainly, though, the NYT, after years of cheerleading ethanol, may finally be coming around:

Congress must take a hard look at the effect of corn ethanol on food
supplies in the same way the new energy bill requires it to review the
environmental effects. It must move toward ending subsidies that will
become even more difficult to justify as oil prices rise and the costs
of producing corn ethanol decline. And it must press other wealthy
countries to do the same before hunger turns to mass starvation.

Via Tom Nelson

By the way, these problems with ethanol we are experiencing today were are inevitable as night follows day, yet we still had to blunder into it before we started questioning the economics.  The power of political correctness to trump science and logic is amazing.

It is always amazing how big round numbers hold the media in thrall.  Last week we saw the inevitable spate of articles about oil crossing the $100 mark, if only for a few minutes of trading  (actually, the more interesting milestone was somewhere back in the low $90 range when we exceeded the highest past price for oil in inflation-adjusted dollars).

I don't get hugely worked up about gradual commodity price changes.  Oil price increases are signals, signaling marginal consumers to use less and suppliers with historically marginal sources and substitutes to consider their development.  Also, our economic dependence on oil per dollar of GDP has declined, meaning that $100 oil has less impact on the economy than, say, it would have 20 years ago:

I would certainly prefer lower oil prices, and my business suffers to some extent when gas prices rise, but it is not a disaster  (it is interesting that higher oil prices are considered bad in the media, while lower home prices are considered bad in the media).  I know from past experience in the oil patch that oil price bubbles are often followed by oil price drops.  The high oil prices of the seventies were followed by rock-bottom oil prices in the eighties, and subsequent recession in the oil patch (causing the housing bust I discussed here). 

Also, given how we got to these higher oil prices, I tend to take them as good news.  Oil prices are not rising due to some drop off in supply.  Instead, they are rising because of a strong global economy, in particular with millions of people entering the middle class in Asia.  This is GOOD news. 

I have written on peak oil a bunch, so I won't get into it again.  Oil production at worst is going to flatten out for a long time, meaning we will have a steady rise in oil prices over time as the economy grows.  If you want a third party evaluation of peak oil theory, go ask climate catastrophists who believe that CO2 production is an impending disaster for the economy.  These guys know that there are lots of unproduced hydrocarbons out there, and it terrifies them.   Al Gore and James Hansen were running around last week trying to close off Canadian tar sands from development.

Finally, after this series of random thoughts, one more interesting take on this via Megan McArdle:  $100 oil was a stunt

Some observers questioned the validity of the price mark when it
emerged that the peak was the result of a trader "“ one of the "locals"
who trade on their own money "“ buying from a colleague just 1,000
barrels of crude, the minimum allowed, industry insiders said. The deal
on the floor of the New York Mercantile Exchange was at a hefty premium
to prevailing prices.

Insiders named the trader as Richard Arens, who runs a brokerage
called ABS. He was not available for comment. Analysts said he may have
been testing the ceiling of the crude price, but the premium he paid
surprised the market.

Before the $100-a-barrel trade, oil prices on Globex were at $99.53
a barrel. Immediately after the trade, prices went down to about
$99.40, suggesting a trading loss of $600 for Mr Arens.

Stephen Schork, a former Nymex floor trader and editor of the
oil-market Schork Report, commented: "A local trader just spent about
$600 in a trading loss to buy the right to tell his grandchildren he
was the one who did it. Probably he is framing right now the print
reflecting the trade."

A while back, I talked about a conversation I had with a friend of mine that prices for oil were set $20 dollars or more above the natural clearing price because a few oil traders controlled the market.  I argued in a long post that this was absurd, and might be possible for a few minutes in the trading day, but over multiple years it would be just impossible either to store the extra oil supply or hide the efforts to suppress supply from thousands of sources.

Well, another argument I made is that buyers in the oil markets are big boys too, and would not tolerate paying $20 a barrel too much for years or even hours.  After all, it was silver buyers and the exchange owners who stopped the Hunt's famous attempt to corner the silver market.

Anyway, one proof of this latter proposition is this:

The alleged manipulation occured during the so-called "Platts window,"
a 30 minute interval at the end of the trading day when the energy
publishing firm Platts pulls data used to set prices for other foreign
and domestic crudes. CFTC said Marathon tried to sell oil below market
prices during the window in order to get a lower price set for oil it
intended to purchase.

Again note the timing -- trying to influence the market for minutes, not years.  If companies like Marathon are willing to risk criminal prosecution to get lower oil prices for purchase, they certainly are not going to sit back and tolerate a multi-year manipulation that raises prices $20.

A while back, I wrote of my conversation with a friend who was convinced that oil prices are set by a small cabal of traders, and that while they have been at $60-70 over the last several years, they would have been at $40 or less without the traders manipulating the price.  I won't go into my arguments again here, but I wrote that it would be virtually impossible to maintain a price artificially above the market clearing price for so long without 1) massive product gluts or 2) almost-impossible-to-hide widespread suppression of production involving thousands of parties.

Michael Giberson at the Knowledge Problem writes about a price-fixing case by natural gas traders.  Amaranth is accused of manipulating gas prices, and I won't judge their guilt or innocence.  But, apropos of my statement above, it is interesting to note that the key question is whether it was possible for the company to manipulate commodity prices for eight minutes.  It looks as if they tried it, but it also looks as if they were not successful (since the government is charging they attempted to manipulate the market, but is not trying to prove they succeeded in doing so).  Making it hugely absurd to think that anyone could do it for three or four years.

I understand the environmental logic to tax petroleum -- I don't particularly agree with it, but some sort of carbon-based tax is probably the least-bad way to achieve various environmental goals (I will leave for other posts whether these goals make any sense).

However, the Senate's proposal to tax oil companies directly, rather than the oil or petroleum products themselves, is a gutless chickenshit maneuver that is just so typical of politicians.  A tax on oil companies is less efficient than a direct carbon tax on the fuel (because it is operating less directly on price signals), but it makes sense to our political masters for several reasons:

• Populist Congressman can argue to their constituencies that "we didn't tax you consumers, we taxed those evil bloated oil companies."  Of course, in the end, the money comes from consumers anyway.  That's just basic economics.
• Oil companies, not politicians, get blamed for collecting the tax from consumers.  This is an tried-and-true approach, that has worked well with gasoline taxes embedded in pump prices.
• When oil prices inevitably rise due to the tax, the Congress will use this oil price rise as a rallying cry to...increase taxes more.  It is the classic government win-win of proposing increased regulations to solve problems caused by government regulations.

This part is even worse:

Another measure, pushed by Sen. Jeff Bingaman, D-N.M., was aimed at
collected $10.7 billion in royalties the government has been unable to
collect because of flawed oil leasing contracts issued by the Interior
Department in 1998-99. The government would collect an excise tax on
any oil taken from the Gulf of Mexico, subject to royalties not being
paid.

Here is what happened:  The government wrote offshore lease/royalty contracts in a certain way.  Oil companies read the contract language, and entered into the contract as written, and subsequently invested billions of dollars to develop the leases.  More recently, as oil prices rose, the government thinks it made a bad deal, and should have written the contracts differently.  The solution for private companies who make a bad deal: live with it.  The solution for the government, though, it apparently to use the coercive power of the government to extract the royalties you failed to put in the contract 18 years ago via special excise taxes.

And don't even get me started on this farm subsidy program masquerading as energy policy:

The bill would funnel about $11 billion over 10 years into the
development of renewable fuels such as ethanol, biodiesel and power
from wind turbines in a combination of extensions of existing tax
breaks and new tax benefits. An additional $18 billion in tax breaks "”
from tax credits to clean and renewable energy bonds "” also were
approved.

We are making a mistake of epic proportions pouring money and regulatory breaks into ethanol.  Ethanol, in the form we ar investing in it in this country, does NOTHING to reduce our oil use or improve the environment or reduce CO2 emissions.  Nada.  All it does is increase taxes, increase fuel prices, increase food prices, and, soon, cause environmental problems as marginal lands are brought into corn production.  I made a plea to stop this before it is too late, ie before the industry becomes so entrenched it will be politically impossible to cut it off.  I fear we are rapidly approaching this point of no return.

I had an odd and slightly depressing conversation with a friend the other night.  He is quite intelligent and well-educated, and in business is probably substantially more successful, at least financially, than I.

Somehow we got in a discussion of oil markets, and he seemed to find my position suggesting that oil prices are generally set by supply and demand laughable, so much so he eventually gave up with me as one might give up and change the subject on someone who insists the Apollo moon landings were faked. I found the conversation odd, like having a discussion with a fellow
chemistry PHD and suddenly having them start defending the phlogiston
theory of combustion. His core position, as best I could follow, was this:

1. Limitations on supply in the US, specifically limitations on new oil field development and refinery construction, are engineered by oil companies attempting to keep prices high.
2. Oil prices are set at the whim of oil traders in London and New York, who are controlled by US oil companies.  The natural price of oil today should be $30 or $40, but oil traders keep it up at $60.  While players upstream and downstream may have limited market shares, these traders act as a choke point that controls the whole market.  All commodity markets are manipulated, or at least manipulatable, in this manner
3. Oil supply and demand is nearly perfectly inelastic. 
4. If there really was a supply and demand reason for oil prices to shoot up to $60, then why aren't we seeing any shortages?
5. Oil prices only rise when Texas Republicans are in office.  They will fall back to $30 as soon as there is a Democratic president.  On the day oil executives were called to testify in front of the Democratic Congress recently, oil prices fell from $60 to $45 on that day, and then went right back up.

Ignoring the Laws of Economics (Price caps and floors)

While everyone (mostly) knows that we are suspending disbelief when the James Bond villain seems to be violating the laws of physics, there is a large cadre of folks that do believe that our economic overlords can suspend the laws of supply and demand.   As it turns out, these laws cannot be suspended, but they can certainly be ignored.  Individuals who ignore supply and demand in their investment and economic decision making are generally called "bankrupt," at least eventually, so we don't always hear their stories (the Hunt brothers attempt to corner the silver market is probably the best example I can think of).  However, the US government has provided us with countless examples of actions that ignore economic reality.

The most typical example is in placing price caps.  The most visible example was probably the 1970's era caps on oil, gasoline, and natural gas prices and later "windfall profit" taxes.  The result was gasoline lines and outright shortages.  With prices suppressed below the market clearing price, demand was higher and supply was lower than they would be in balance. 

The my friend raised is different, one where price floors are imposed by industry participants or the government or more likely both working in concert.   The crux of my argument was not that government would shy away from protecting an industry by limiting supply, because they do this all the time. The real problem with the example at hand is that, by the laws of supply and demand, a price floor above the market clearing price should yield a supply glut.  As it turns out, supply guts associated with cartel actions to keep prices high tend to require significant, very visible, and often expensive actions to mitigate.  Consider two examples:

Realtors and their trade group have worked for years to maintain a tight cartel, demanding a 6% or higher agency fee that appears to be increasingly above the market clearing price.  The result of maintaining this price floor has been a huge glut of real estate agents.  The US is swimming in agents.  In an attempt to manage this supply down, realtors have convinced most state governments to institute onerous licensing requirements, with arcane tests written and administered by... the realtor's trade group.  The tests are hard not because realtors really need to know this stuff, but because they are trying to keep the supply down.   And still the supply is in glut.  Outsiders who try to discount or sell their own home without a realtor (ie, bring even more cheap capacity into the system) are punished ruthlessly with blackballs.  I have moved many times and have had realtors show me over 300 houses -- and you know how many For Sale By Owner homes I have been shown?  Zero.  A HUGE amount of effort is expended by the real estate industry to try to keep supply in check, a supply glut caused by holding rates artificially high. 

A second example of price floors is in agriculture.  The US Government, for whatever political reasons, maintains price floors in a number of crops.  The result, of course, has been a supply glut in these commodities.  Sopping up this supply glut costs the US taxpayer billions.  In some cases the government pays to keep fields fallow, in others the government buys up extra commodities and either stores them (cheese) or gives them away overseas.  In cases like sugar, the government puts up huge tarriff barriers to imports, otherwise the market would be glutted with overseas suppliers attracted by the artificially high prices.  In fact, most of the current subsidy programs for ethanol, which makes almost zero environmental or energy policy sense, can be thought of as another government program to sop up excess farm commodity supply so the price floor can be maintained.

I guess my point from these examples is not that producers haven't tried to impose price floors above the market clearing price, because they have.  And it is not even that these floors are not sustainable, because they can be if the government steps in to help with their coercive power and our tax money to back them.  My point is, though, that the laws of supply and demand are not suspended in these cases.  Price floors above the market clearing price lead to supply gluts, which require very extensive, highly visible, and often expensive efforts to manage.  As we turn now to oil markets, we'll try to see if there is evidence of such actions taking place.

The reasons behind US oil production and refining capacity constraints

As to his first point, that oil companies are conspiring with the government to artificially limit oil production and refining capacity, this certainly would not be unprecedented in industry, as discussed above.  However, any historical study of these issues in the oil industry would make it really hard to reach this conclusion here.  There is a pretty clear documented record of oil companies pushing to explore more areas (ANWR, offshore) that are kept off-limits due to environmental pressures.  While we have trouble imagining the last 30 years without Alaskan oil, the US oil companies had to beg Congress to let them build the pipeline, and the issue was touch and go for a number of years.  The same story holds in refining, where environmental pressure and NIMBY concerns have prevented any new refinery construction since the 1970's (though after years and years, we may be close in Arizona).  I know people are willing to credit oil companies with just about unlimited levels of Machiavellianism, but it would truly be a PR coup of unprecedented proportions to have maintained such a strong public stance to allow more capacity in the US while at the same time working in the back room for just the opposite.

The real reason this assertion is not credible is that capacity limitations in the US have very clearly worked against the interests of US oil companies.  In production, US companies produce on much better terms from domestic fields than they do when negotiating with totalitarian regimes overseas, and they don't have to deal with instability issues (e.g. kidnapping in Nigeria) and expropriation concerns.  In refining, US companies have seen their market shares in refined products fall since the 1970s.  This is because when we stopped allowing refinery construction in this country, producing countries like Saudi Arabia went on a building boom.  Today, instead of importing our gasoline as crude to be refined in US refineries, we import gas directly from foreign refineries.  If the government is secretly helping oil companies maintain a refining capacity shortage in this country, someone forgot to tell them they need to raise import duties to keep foreign suppliers from taking their place. 

What Oil Traders can and cannot do

As to the power of traders, I certainly believe that if the traders could move oil prices for sustained periods as much as 50% above or below the market clearing price, they would do so if it profited them.  I also think that speculative actions, and even speculative bubbles, can push commodity prices to short-term extremes that are difficult to explain by market fundamentals.  Futures contracts and options, with their built in leverage, allow even smaller players to take market-moving positions.  The question on the table, though, is whether oil traders can maintain oil prices 50% over the market clearing prices for years at a time.  I think not.

What is often forgotten is that companies like Exxon and Shell control something like 4-5% each of world production (and that number is over-stated, since much of their production is as operator for state-owned oil companies who have the real control over production rates).  As a point of comparison, this is roughly the same market Toshiba has in the US computer market and well below Acer's.  As a result, there is not one player, or even several working in tandem, who hold any real power in crude markets.  Unless one posits, as my friend does, that NY and London traders somehow sit astride a choke point in the world markets.

But here is the real problem with saying that these traders have kept oil prices 50% above the market clearing price for the last 2-3 years:  What do they do with the supply glut?  We know from economics, as well as the historic examples reviewed above, that price floors above the clearing price should result in a supply glut.  Where is all the oil?

Return to the example of when the Hunt's tried to corner the silver market.  Over six months, they managed to drive the price from the single digits to almost $50 an ounce.  Leverage in futures markets allowed them to control a huge chunk of the available world supply.  But to profit from it (beyond a paper profit) the Hunts either had to take delivery (which they were financially unable to do, as they were already operating form leveraged positions) or find a buyer who accepted $50 as the new "right" price for silver, which they could not.  No one wanted to buy at $50, particularly from the Hunts, since they knew the moment the Hunt's started selling, the price would crash.  As new supplies poured onto the market at the higher prices, the only way the Hunt's could keep the price up was to pour hundreds of millions of dollars in to buy up this excess supply.  Eventually, of course, they went bankrupt.  But remember the takeaway:  They only could maintain the artificially higher commodity price as long as they kept buying excess capacity, a leveraged Ponzi game that eventually collapsed.

So how do oil traders' supposedly pull off this feat of keeping oil prices elevated about the market clearing price?  Well, there is only one way:  It has to be stored, either in tanks or in the ground.  The option of storing the extra supplies in tanks is absurd, especially over a period of years - after all, at its peak, $60 of silver would sit on the tip of my finger, but $60 of oil won't fit in the trunk of my car.  The world oil storage capacity is orders of magnitude too low.  So the only real option is to store it in the ground, ie don't allow it to get produced. 

How do traders pull this off?  I have no idea.  Despite people's image, the oil producer's market is incredibly fragmented.  The biggest companies in the world have less than 5%, and it rapidly steps down from there. It is actually even more fragmented than that, because most oil production is co-owned by royalty holders who get a percentage of the production.  These royalty holders are a very fragmented and independent group, and will complain at the first sign of their operator not producing fast and hard enough when prices are high.  To keep the extra oil off the market, you would have to send signals to a LOT of people.  And it has to be a strong and clear signal, because price is already sending the opposite signal.  The main purpose of price is in its communication value -- a $60 price tells producers a lot about what and how much oil should be produced (and by the way tells consumers how careful to be with its use).  To override this signal, with thousands of producers, to achieve exactly the opposite effect being signaled with price, without a single person breaking the pack, is impossible.  Remember our examples and the economics - a sustained effort to keep prices substantially above market clearing prices has to result in visible and extensive efforts to manage excess supply.

Also, the other point that is often forgotten is that private exchanges can only survive when both Sellers AND buyers perceive them to be fair.  Buyers are quickly going to find alternatives to exchanges that are perceived to allow sellers to manipulate oil prices 50% above the market price for years at a time.  Remember, we think of oil sellers as Machiavellian, but oil buyers are big boys too, and are not unsophisticated dupes.  In fact, it was the private silver exchanges, in response to just such pressure, that changed their exchange rules to stop the Hunt family from continuing to try to corner the market.  They knew they needed to maintain the perception of fairness for both sellers and buyers.

Supply and Demand Elasticity

From here, the discussion started becoming, if possible, less grounded in economic reality.  In response to the supply/demand matching issues I raised, he asserted that oil demand and supply are nearly perfectly inelastic.  Well, if both supply and demand are unaffected by price, then I would certainly accept that oil is a very, very different kind of commodity.  But in fact, neither assertion is true, as shown by example here and here.  In particular, supply is quite elastic.  As I have written before, there is a very wide range of investments one can make even in an old existing field to stimulate production as prices rise.  And many, many operators are doing so, as evidenced by rig counts, sales at oil field services companies, and even by spam investment pitches arriving in my in box.

I found the statement "if oil prices really belong this high, why have we not seen any shortages" to be particularly depressing.  Can anyone who sat in at least one lecture in economics 101 answer this query?  Of course, the answer is, that we have not seen shortages precisely because prices have risen, fulfilling their supply-demand matching utility, and in the process demonstrating that both supply and demand curves for oil do indeed have a slope.  In fact, shortages (e.g. gas lines or gas stations without gas at all) are typically a result of government-induced breakdowns of the pricing mechanism.  In the 1970's, oil price controls combined with silly government interventions (such as gas distribution rules**) resulted in awful shortages and long gas lines.  More recently, fear of "price-gouging" legislation in the Katrina aftermath prevented prices from rising as much as they needed to, leading to shortages and inefficient distribution.

Manipulating Oil Prices for Political Benefit

As to manipulating oil or gas prices timed with political events (say an election or Congressional hearings), well, that is a challenge that comes up all the time.  It is possible nearly always to make this claim because there is nearly always a political event going on, so natural volatility in oil markets can always be tied to some concurrent "event."  In this specific case, the drop from $60 to $35 just for a Congressional hearing is not even coincidence, it is urban legend.  No such drop has occurred since prices hit 60, though prices did drop briefly to 50.  (I am no expert, but in this case the pricing pattern seen is fairly common for a commodity that has seen a runup, and then experiences some see-sawing as prices find their level.)

This does not mean that Congressional hearings did not have a hand in helping to drive oil price futures.  Futures traders are constantly checking a variety of tarot cards, and indications of government regulatory activity or legislation is certainly part of it.  While I guess traders purposely driving down oil prices ahead of the hearing to make oil companies look better is one possible explanation;  a more plausible one (short of coincidence, since Congress has hearings on oil and energy about every other month) is that traders might have been anticipating some regulatory outcome in advance of the hearing, that became more less likely once the hearings actually occurred.  *Shrug*  Readers are welcome to make large short bets in advance of future Congressional energy hearings if they really think the former is what is occurring. 

As to a relationship between oil prices and the occupant of the White House, that is just political hubris.  As we can see, real oil prices rose during Nixon, fell during Ford, rose during Carter, fell precipitously during Reagan, were flat end to end for Bush 1 (though with a rise in the middle) and flat end to end for Clinton.  I can't see a pattern.

If Oil Companies Arbitrarily Set Prices, Why Aren't They Making More Money?

A couple of final thoughts.  First, in these heady days of "windfall" profits, Exxon-Mobil is making a profit margin of about 9% - 10% of sales, which is a pretty average to low industrial profit margin.  So if they really have the power to manipulate oil prices at whim, why aren't they making more money?  In fact, for the two decades from 1983 to 2002, real oil prices languished at levels that put many smaller oil operators out of business and led to years of layoffs and down sizings at oil companies.  Profit margins even for the larges players was 6-8% of sales, below the average for industrial companies.  In fact, here is the profitability, as a percent of sales, for Exxon-Mobil over the last 5 years:

2006:  10.5%

2005:  9.7%

2004:  8.5%

2003:  8.5%

2002:  5.4%

2001:  7.1%

Before 2001, going back to the early 80's, Exxon's profits were a dog.  Over the last five years, the best five years they have had in decades, their return on average assets has been 14.58%, which is probably less than most public utility commissions allow their regulated utilities.  So who had their hand on the pricing throttle through those years, because they sure weren't doing a very good job!  But if you really want to take these profits away (and in the process nuke all the investment incentives in the industry) you could get yourself a 15 to 20 cent decrease in gas prices.  Don't spend it all in one place.

** One of the odder and forgotten pieces of legislation during and after the 1972 oil embargo was the law that divided the country into zones (I don't remember how, by counties perhaps).  It then said that an oil company had to deliver the same proportion of gas to each zone as it did in the prior year  (yes, someone clearly took this right out of directive 10-289).  It seemed that every Representative somehow suspected that oil companies in some other district would mysteriously be hoarding gas to their district's detriment.  Whatever the reason, the law ignored the fact that use patterns were always changing, but were particularly different during this shortage.  Everyone canceled plans for that long-distance drive to Yellowstone.  The rural interstate gas stations saw demand fall way off.  However, the law forced oil companies to send just as much gas to these stations (proportionally) as they had the prior year.  The result was that rural interstates were awash in gas, while cities had run dry.  Thanks again Congress.

A few days ago, I was astounded to find that oil prices had a here-to-for unsuspected (at least by Congress) utility - that they can actually manage demand to help match supply.  But this strange phenomenon is even more amazing, because it now appears that higher oil prices also have the ability to stimulate investments in increasing production of this scarce commodity:

The American oil patch, once left to languish during an extended
period of low oil prices, is on the rebound. Wildcatters like Mr.
Bryant are ready to pounce. With oil prices now hovering around $60 a
barrel "” three times higher than they were throughout the 1990s "” the
industry is expanding at a pace last seen decades ago.

"The oil
industry has changed dramatically in the last 20 years," Mr. Bryant
says. "Barriers to entry have dropped significantly. It doesn't matter
if you've been in the business 100 years or 100 days."

Easily
available capital and technology, once the preserve of traditional oil
companies, are reordering the business. Investors are lining up to
finance energy projects while leaps in computing power, imaging
technology and collaborative online networks now allow the smallest
entities to compete on an equal footing with the biggest players.

"There's
a lot of money out there looking for opportunities," said John
Schaeffer, the head of the oil and gas unit at GE Energy Financial
Services. "It seems like everyone wants to own an oil well now."

Advice to Nancy Pelosi and Maria Cantwell:  You may need to study this phenomenon.

In my earlier post, I commented that one reason a number of foreign oil fields may be "peaking" is not necesarily because they are hitting their production limits, ala "peak oil theory," but because state run companies tend to be terrible at making the intelligent long-term investments that are needed to maintain oil production in aging fields.  I observed:

There are a lot of things you can do to an aging oil field,
particularly with $60 prices to justify the effort, to increase or
maintain production.  In accordance with the laws of diminishing
returns, all of them require increasing amounts of capital and
intelligent management.

Unfortunately, state owned oil companies like Pemex (whose assets,
by the way, were stolen years ago from US owners) are run terribly,
like every other state-owned company in the world.  And, when
politicians in Mexico are faced with a choice between making capital
available for long-term investment in the fields or dropping it into
yet another silly government program or transfer payment scheme, they
do the latter.  And when politicians have a choice between running an
employment meritocracy or creating a huge bureaucracy of jobs for life
for their cronies they choose the latter. 

So today, via Hit and Run, we see this exact same effect in Venezuela:

No one sees an immediate crisis at Petróleos de Venezuela. But its
windfall from high oil prices masks the devilish complexity and rising
costs of producing heavy oil. Meanwhile, the company acknowledged last
month that spending on "social development" almost doubled in 2006, to
$13.3 billion, while its spending on exploration badly trailed its
global peers. And Petróleos de Venezuela's work force has ballooned to
89,450, up 29 percent since 2001 even as production declined
...
Petróleos
de Venezuela's cash is said to be running short as Mr. Chávez uses its
revenue to cement political alliances with Bolivia, Cuba and Nicaragua.
The company has borrowed more than $11 billion since the start of the
year, a rapid debt buildup that reflects a wager by Mr. Chávez that oil
prices will remain high indefinitely.

One of the issues that is giving Democrats an entre to wack on oil companies is the issue of "subsidies" for deep offshore drilling.  These subsidies appear to take the form (though nothing in the world of oil field royalty payments is very simple or clear) of reduced royalty payments:

With oil prices still above $60 a barrel, do oil companies need
inducements to find and produce more oil? That's the underlying
question of today's NYT front-page article about an Interior Department report questioning the value of royalty rebates and tax breaks for gas and oil production.

The rebates are targeted at expensive and difficult exploration,
usually in deep water or that requires deep drilling. The intention is
to incentivize that exploration, allowing the United States to increase
its domestic reserves using "unconventional oil."

This is the kind of "incentivizing" that always goes wrong for the government, and turns even the best of intentions into massive rent-seeking opportunities.  My solution is similar to Cato's Tom Firey's:  Just make the royalty payment amounts and percentages subject to a bid as part of the offshore leasing process.  The government can include minimum reserve prices and such to protect itself (as they already do for offshore leases).  He suggests rolling all the value into a single up front number.  I would instead suggest a bid upfront number plus a bid royalty that is either a fixed amount per barrel, or more likely, a fixed percentage of oil revenues at some benchmark oil price.

What I am NOT sympathetic to is one party in a lease agreement trying to use its legislative party to void the terms of a previous agreement because it no longer likes the terms:

The article notes that royalties and corporate taxes deliver into
federal coffers about 40 percent of the revenue produced from oil and
gas extracted from federal property. The worldwide average government
take is about 60"“65 percent. A 40 percent federal take may have been
fair at a time when oil prices and profits were lower, the article
suggests, but the government should be getting a much higher cut from
today's prices.

Trying to just void previous deals in order to get better terms is just thuggery, and is the worst possible disincentive for long-term investment.

Recently, the so-called "reality-based community" on the left has developed the theory that US oil companies have purposefully dropped gasoline prices from over $3.00 to $2.00 a gallon solely to help Republican re-election prospects in November.  This notion is so insane as to be, well, insane, and I am not even going to bother fisking it any more than I would bother refuting a flat-earth hypothesis.  OK, I can't resist, here are two quick arguments, by no means comprehensive.

• US oil companies control a minority of world oil supplies, and those folks who do dominate the market (Hugo Chavez, Iran, the Saudis, the Russians) are highly unlikely to be cutting Bush much slack.
• The implication is that either the old, high price or the current low price is somehow an unnatural contrivance.  If the higher price was a contrivance, ie above the normal market clearing price due to some collusion, then we would have been swimming in oil as supplies outstripped demand, and inventories would be overflowing.  If the current lower prices are a contrivance, then demand should outstrip supply and we should have lines at every gas station.  Of course, neither situation has been observed.

So here is this week's message for the Left:  Economics is a science.  Willful ignorance or emotional rejection of the well-known precepts of this science is at least as bad as a fundamentalist Christian's willful ignorance of evolution science (for which the Left so often criticizes their opposition).  In fact, economic ignorance is much worse, since most people can come to perfectly valid conclusions about most public policy issues with a flawed knowledge of the origin of the species but no one can with a flawed understanding of economics.

Postscript: In fact, the more I think about it, the more economics and evolution are very similar.  Both are sciences that are trying to describe the operation of very complex, bottom-up, self-organizing systems.  And, in both cases, there exist many people who refuse to believe such complex and beautiful systems can really operate without top-down control.

For example, certain people refuse to accept that homo sapiens could have been created through unguided evolutionary systems, and insist that some controlling authority must guide the process;  we call these folks advocates of Intelligent Design.  Similarly, there are folks who refuse to believe that unguided bottom-up processes can create something so complex as our industrial economy or even a clearing price for gasoline, and insist that a top-down authority is needed to run the process;  we call these folks socialists.

It is interesting, then, given their similarity, that socialists and intelligent design advocates tend to be on opposite sides of the political spectrum.  Their rejection of bottom-up order in favor of top-down control is nearly identical.

Update:  From Cafe Hayek, letter to the Washington Post

Dear Editor:

Alleging
that today's falling gasoline prices result from a fiendish plot to
keep the GOP in power, Kenneth Jones is certain that "gasoline prices
will go right back up to $2.75-plus after the [November] election"
(Letters, October 2).

If Mr. Jones is correct, he can make a
financial killing.  All he need do is to invest all of his assets going
long in gasoline futures (which are today about 30 percent lower than
they were in late July).  Indeed, he ought even to cash out all the
equity in his house, max out on his credit cards, and borrow heavily
from his brother-in-law so that he can invest as much as possible in
these futures.

He can then contribute his post-election financial bounty to the Democratic National Committee.

Sincerely,
Donald J. Boudreaux

After reading this article on the earth running out of resources,  I discovered another article from the archives of the Coyote Broadsheet, a predecessor of this blog written by one of my distant relatives, dated April 17, 1870:

As the US Population reaches toward the astronomical total of 40 million persons, we are reaching the limits of the number of people this earth can support.    If one were to extrapolate current population growth rates, this country in a hundred years could have over 250 million people in it!  Now of course, that figure is impossible - the farmland of this country couldn't possibly support even half this number.  But it is interesting to consider the environmental consequences.

Take the issue of transportation.  Currently there are over 11 million horses in this country, the feeding and care of which constitute a significant part of our economy.  A population of 250 million would imply the need for nearly 70 million horses in this country, and this is even before one considers the fact that "horse intensity", or the average number of horses per family, has been increasing steadily over the last several decades.  It is not unreasonable, therefore, to assume that so many people might need 100 million horses to fulfill all their transportation needs.  There is just no way this admittedly bountiful nation could support 100 million horses.  The disposal of their manure alone would create an environmental problem of unprecedented magnitude.

Or, take the case of illuminant.  As the population grows, the demand for illuminant should grow at least as quickly.  However, whale catches and therefore whale oil supply has leveled off of late, such that many are talking about the "peak whale" phenomena, which refers to the theory that whale oil production may have already passed its peak.  250 million people would use up the entire supply of the world's whales four or five times over, leaving none for poorer nations of the world.

Too bad Julian Simon wasn't around to make a bet on whale oil prices.

Its probably time for another once-every-six-months update on global warming.  In this post I will address the current leading climate intervention position, which is:  Even if we don't understand global warming fully, the time to take massive action is now, before the process builds momentum (similar to the notion that it is easier to deflect a meteor away from earth when it is millions of miles away, rather than right on top of us).  The potential downside of global warming, it is argued, is too high to justify waiting until we are sure.   

While I find arguments that attempt to challenge the current global warming orthodoxy in any way tends to get one labeled a Luddite not worth listening to, giving one the feeling of being a southern Baptist advocating creationism in a room full of Massachusetts Democrats, I will once again try to refute this need to immediate and massive intervention.

The shorthand I use for my argument against intervention is "creating a cooler but poorer world".  In a nutshell, given current technology and likely government intervention approaches, slowing global warming almost certainly entails slowing world growth.  And while the true cost of warming is poorly understood, the true cost of reduced world economic growth is very well understood and is very high.  The real question, then, is do we understand global warming and its potential downsides enough to believe that curbing them outweighs the almost certain negative impact from a poorer world.

I will begin by conceding some warming

Typically when making this argument, I will concede some man-made global warming.  It is hard to refute the fact from various CO2 concentration estimates that man has increased the amount of CO2 in the atmosphere over the last 50 years, and that this CO2 likely has had and will have some impact on global temperatures.  As a result, I am willing to concede a degree or two of warming from man-made effects over the next century.  This is lower than most of the warming estimates that you see in the press, but scientists will have to nail down a lot more issues before they can convince me these higher numbers are correct.  Some of these issues include:

• World temperatures rose by a half degree in the first half of the 20th century through mostly natural phenomena.  No one knows why (though solar activity may help explain it), but even global warming's strongest supporters agree that it was probably not due to man.  No one can therefore with any accuracy separate warming in the late 20th century due to this natural effect and warming due to man's impact.  Check out Mann's now-famous hockey stick below:

Global warming advocates love this chart - I mean this is their chart, not the skeptics' - and it probably plays well with non-scientific editors who are believers themselves, but I sure wouldn't want to defend this in a board room.  What if this were a sales chart, and I wanted to claim that the sales increase after I started work in 1950 was all due to my effort.  I can just see my old boss Chuck Knight at Emerson, or maybe Larry Bossidy at AlliedSignal, saying - "well Warren, it sure looks like things changed in 1900, not 1950.  And whatever was driving things up from 1900 to 1950, why do you think that that effect, which you can't explain, suddenly stopped and your influence took over.  And by the way, why did you end your chart with 1998 - I seem to remember 1998 was the peak.  Isn't it kind of disingenuous to leave off the last 6 years when the numbers came back down some?" (update:  Even in the arctic, where the media writes with so much confidence that global warming is having a measurable impact, the difference between cyclical variations and man-made effects is hard to unravel.)

• No one really understands the cyclical variations in world temperatures and climate.  I think it is large, and certainly there are historical records of the last 800 years that seem to point to climactic extremes.  Mann, et. al. claim to have shown that man's effects dwarf these natural variations with their 1000-year hockey stick, but there are a lot of problems with Mann, not the least of which is his unbelievably suspicious refusal to release his data and methodology to the scientific community, behavior that would not be tolerated of any other scientist except one who supported the global warming consensus view.
• It is still not clear that the urban heat island effect has been fixed in the ground data, so satellite data tends to show less warming (but some none-the-less).
• The climate models are absurd in ways even a non-climatologist can figure out.  For example, economies in energy inefficient undeveloped nations are assumed to grow like crazy in the IPCC scenarios, such that "then the average income of South Africans will have overtaken that of
  Americans by a very wide margin by the end of the century. Because of
  this economic error, the IPCC scenarios of the future also suggest that
  relatively poor developing countries such as Algeria, Argentina, Libya,
  Turkey, and North Korea will all surpass the United States."
• I no longer trust the scientific community on global warming.  This quote from National Center for Atmospheric Research (NOAA) researcher and global warming action promoter, Steven Schneidersays it all:

We have to offer up scary scenarios, make simplified, dramatic
statements, and make little mention of any doubts we have. Each of us
has to decide what the right balance is between being effective and
being honest.

While many serious scientists are working on the issue, 100% of the anti-growth, anti-technology, anti-America, and anti-man folks have jumped strongly on the global warming bandwagon, and many of these folks have in fact grabbed the reins, leading major efforts and groups.  It is important to note that these folks do not care about scientific accuracy or facts.  Their agenda is completely and absolutely to use global warming as their lead issue to push their anti-growth agenda.  As such, none of these folks are going to tolerate any fact, study, or scientific voice that in any way questions the global warming orthodoxy.  And can any scientist be considered serious who uttered the following statement (from the UN's IPCC Conference Summary, page 2):

"It is
likely that, in the Northern Hemisphere, ... 1998 [was] the warmest year during the past thousand years."

My physics instructors in college used to criticize us students constantly for not understanding the error range in our lab work.  I wonder what they would think of a group of scientists that stated with confidence that 1998 was the warmest year in the last one thousand, when they only have direct measurement for the last 100 years or so and even then over only a small percentage of the planet and the other 900 years are estimated from tree rings and ice cores.  I am tired of being criticized as a Luddite for challenging "scientists" who think they know with confidence the exact world temperature since Charlemagne. 

Anyway, to avoid getting bogged down in this mess, I am willing to posit some man-made warming, say 1-2 degrees over the next 100 years.  For most who argue the subject, this is the end of the discussion.  For me, it is just the beginning.

What impact, warming?

Beyond bad cinema and Sunday supplement hyperbole, its difficult to find the good science aimed at quantifying the impacts, positive and negative, from global warming.  In fact, it is impossible in any venue at any level of quality to find any mention of the positive impacts of warming, though anyone with half a brain can imagine any number of positive impacts (e.g. longer growing seasons in cold climates) that will at least partially offset warming negatives.

Now, I am sure many scientists would respond that climate is complicated, and its hard to judge what will happen.  Which I believe is true.  But surely the same scientists that can cay that the world will warm by x degrees with enough certainty to demand that billions or even trillions of dollars be spent to change energy use should be able to come to some conclusions about the net effects, both positive and negative, from warming.

Certainly sea levels will probably rise, as some ice caps melt, by maybe a foot in the consensus view.  And storms and hurricanes may get worse, though its hard to separate the warming effect from the natural cyclical variation in hurricane strength, at least in the Atlantic.  What does seem to be clear is that the warming disproportionately will occur in colder, drier climates.  For example, a large part of the world's warming will occur in Siberia. 

When I hear this, I immediately think longer growing seasons in cold climates plus less impact in already warm climates = more food worldwide.  It strikes me that since the climate models tend to spit out warming not only world wide but by area of the world, it would be fairly easy to translate this into an estimate of net impact on food production.  This seems to be such an obvious area of study that I can only assume it has been done, and, since we have not heard about it, that the answer from global warming was "increased food production".  Since this conclusion neither supports scary headlines, increased grant money, or the anti-growth agenda, no one really talks about it or studies it much.  I would bet that if I took all the studies and grants today aimed at quantifying the impact of global warming, more than 95% of the work, maybe 100% of the work, would be aimed solely at negative impacts, studiously ignoring any positive counter-veiling effects.

I often get looks from global warming advocates like I am from Mars when I suggest work needs to be done to figure out how bad warming is, or even if it is really that bad at all.  I have learned that there are typically two reasons for this reaction:

1. I am talking to one of the anti-growth types, for whom the global warming issue is but a means to the end of growth limitation.  These folks need global warming to be BAD as a fundamental premise, not as something that can be fact-checked.  They cannot have people questioning that global warming is the ultimate bad thing that trumps everything else anymore than the Catholic Church can have folks start to question the fallibility of the Pope.
2. I am talking to an environmentalists who considers man's impact impact on earth as bad, period.  It is almost an aesthetic point of view, that it is fundamentally upsetting to see man changing the earth in such a measurable way, irregardless of whether the change affects man negatively.  These are the same folks with whom you cannot argue about caribou in ANWR.  They don't oppose ANWR drilling because they honestly think the caribou will be hurt, but because they like the notion that there is a bunch of land somewhere that man is not touching

By the way, though I know this will really mark me as an environmental Luddite, does anyone really believe that in 100 years, if we've really screwed ourselves by making things too hot, that we couldn't find a drastic way to cool the place off?  Krakatoa's eruption put enough dust in the air to cool the world for a decade.  The world, unfortunately, has a lot of devices that go bang laying around that I bet we could employ to good effect if we needed to put some dust in the stratosphere to cool ourselves off.  Yeah, I am sure that there are hidden problems here but isn't it interesting that NO ONE in global warming, inc. ever discusses any option for solving warming except shutting down the world's economies?

What impact, Intervention?

While the Kyoto treaty was a massively-flawed document, with current technologies a Kyoto type cap and trade approach is about the only way we have available to slow or halt CO2 emissions.  And, unlike the impact of warming on the world, the impact of such a intervention is very well understood by the world's economists and seldom in fact disputed by global warming advocates.  Capping world CO2 production would by definition cap world economic growth at the rate of energy efficiency growth, a number at least two points below projected real economic growth.  In addition, investment would shift from microprocessors and consumer products and new drug research and even other types of pollution control to energy. The effects of two points or more lower economic growth over 50-100 years can be devastating:

• Currently, there are perhaps a billion people, mostly in Asia, poised to exit millenia of subsistence poverty and reach the middle class.  Global warming intervention will likely consign these folks to continued poverty.  Does anyone remember that old ethics problem, the one about having a button that every time you pushed it, you got a thousand dollars but someone in China died.  Global warming intervention strikes me as a similar issue - intellectuals in the west feel better about man being in harmony with the earth but a billion Asians get locked into poverty.
• Lower world economic growth will in turn considerably shorten the lives of billions of the world's poor
• A poorer world is more vulnerable to natural disasters
• The unprecedented progress the world is experiencing in slowing birth rates, due entirely to rising wealth, will likely be reversed.  A cooler world will not only be poorer, but likely more populous as well.  It will also be a hungrier world, particularly if a cooler world does indeed result in lower food production than a warmer world
• A transformation to a prosperous middle class in Asia will make the world a much safer and more stable place, particularly vs. a cooler world with a billion Asian poor people who know that their march to progress was halted by western meddling.
• A cooler world would ironically likely be an environmentally messier world.  While anti-growth folks blame all environmental messes on progress, the fact is that environmental impact is a sort of inverted parabola when plotted against growth.  Early industrial growth tends to pollute things up, but further growth and wealth provides the resources and technology to clean things up.  The US was a cleaner place in 1970 than in 1900, and a cleaner place today than in 1970.  Stopping or drastically slowing worldwide growth would lock much of the developing world, countries like Brazil and China and Indonesia, into the top end of the parabola.  Is Brazil, for example, more likely to burn up its rain forest if it is poor or rich?

The Commons Blog links to this study by Indur Goklany on just this topic:

If global warming is real and its effects will one day be as devastating as
some believe is likely, then greater economic growth would, by increasing
greenhouse gas (GHG) emissions, sooner or later lead to greater damages from
climate change. On the other hand, by increasing wealth, technological
development and human capital, economic growth would broadly increase human
well-being, and society's capacity to reduce climate change damages via
adaptation or mitigation. Hence, the conundrum: at what point in the future
would the benefits of a richer and more technologically advanced world be
canceled out by the costs of a warmer world?

Indur Goklany attempted to shed light on this conundrum in a recent paper
presented at the 25th Annual North American Conference of the US Association for
Energy Economics, in Denver (Sept. 21, 2005). His paper "” "Is a
richer-but-warmer world better than poorer-but-cooler worlds?" "” which can
be found here, draws
upon the results of a series of UK Government-sponsored studies which employed
the IPCC's emissions scenarios to project future climate change between 1990 and
2100 and its global impacts on various climate-sensitive determinants of human
and environmental well-being (such as malaria, hunger, water shortage, coastal
flooding, and habitat loss). The results indicate that notwithstanding climate
change, through much of this century, human well-being is likely to be highest
in the richest-but-warmest world and lower in poorer-but-cooler worlds. With
respect to environmental well-being, matters may be best under the former world
for some critical environmental indicators through 2085-2100, but not
necessarily for others.

This conclusion casts doubt on a key premise implicit in all calls to take
actions now that would go beyond "no-regret" policies in order to reduce GHG
emissions in the near term, namely, a richer-but-warmer world will, before too
long, necessarily be worse for the globe than a poorer-but-cooler world. But the
above analysis suggests this is unlikely to happen, at least until after the
2085-2100 period.

Policy Alternatives

Above, we looked at the effect of a cap and trade scheme, which would have about the same effect as some type of carbon tax.  This is the best possible approach, if an interventionist approach is taken.  Any other is worse.

The primary other alternative bandied about by scientists is some type of alternative energy Manhattan project.  This can only be a disaster.   Many scientists are technocratic fascists at heart, and are convinced that if only they could run the economy or some part of it, instead of relying on this messy bottom-up spontaneous order we call the marketplace, things, well, would be better.  The problem is that scientists, no matter how smart they are, miss with their bets because the economy, and thus the lowest cost approach to less CO2 production, is too complicated for anyone to understand or manage.  And even if the scientists stumbled on the right approaches, the political process would just screw the solution up.  Probably the number one alternative energy program in the US is ethanol subsidies, which are scientifically insane since ethanol actually increases rather than reduces fossil fuel consumption.  Political subsidies almost always lead to investments tailored just to capture the subsidy, that do little to solve the underlying problem.  In Arizona, we have thousands of cars with subsidized conversions to engines that burn multiple fuels but never burn anything but gasoline.  In California, there are hundreds of massive windmills that never turn, having already served their purpose to capture a subsidy.  In California, the state bent over backwards to encourage electric cars, but in fact a different technology, the hybrid, has taken off.

Besides, when has this government led technology revolution approach ever worked?  I would say twice - once for the Atomic bomb and the second time to get to the moon.  And what did either get us?  The first got us something I am not sure we even should want, with very little carryover into the civilian world.  The second got us a big scientific dead end, and probably set back our space efforts by getting us to the moon 30 years or so before we were really ready to do something about it or follow up the efforts.

If we must intervene to limit CO2, we should jack up the price of fossil fuels with taxes, or institute a cap and trade scheme which will result in about the same price increase, and the market through millions of individual efforts will find the lowest cost net way to reach whatever energy consumption level you want with the least possible cost.  (The only real current alternative that is rapidly deploy-able to reduce CO2 emissions anyway is nuclear power, which could be a solution but was killed by...the very people now wailing about global warming.)

Conclusion

I would like to see some real quality discussion as to the relative merits of the path the world is on today vs. an interventionist world that is cooler but poorer, more populous, hungrier, and less politically stable.  If anyone knows of some thoughtful work in this area, please leave a link in the comment area or in my email.

By the way, I got through this whole post without mentioning or quoting Bjorn Lomborg, which really is not fair since he has been very eloquent about just this cooler but poorer argument, but since he is treated like the anti-Christ by global warming believers, it generally only causes people to stop listening when you mention him.

Note finally that other past articles in this series can be found here and here and here.

Disclosure:   I am not funded in any way by the automobile or electric power industry. In fact, my personal business
actually benefits from higher oil prices, since our recreation sites
tend to be near-to-home alternatives for those who can't afford to
drive across country, so global warming intervention would probably help me in the near term.  However, I do own a fair amount of Exxon-Mobil stock, so you may assume that all my opinions are tainted, following the tried and true Global Warming formula that any money from the energy industry is automatically tainting, but incentives that tie grant money, recognition, or press exposure to the magnitude of warming a scientist predicts never carry a taint.  My opinions carry with them an honest concern for the well-being of non-Americans, like the Chinese, which I'm told used to be considered a liberal value until liberals and progressives decided more recently that they actually fear and oppose economic growth in places like China.

Well, our most socialist state is attempting to repeal the laws of supply and demand:

Hawaii issued a list of wholesale price caps for gasoline, the
state Public Utilities Commission said, amid this month's
record-breaking run up in retail gas that saw island residents paying
some of the highest prices in the nation.

This marks the first state cap on gasoline prices since the 1970s
energy crisis, when the average inflation-adjusted price of a gallon of
regular unleaded hit $3.

Hawaii's recently enacted gas cap law goes into effect on September 1, with the pre-tax wholesale cap in Honolulu set at $2.1578

Gee, I bet this will work out really well.  Either the price cap will be set high, such that it is meaningless, or it will be set low, such that Hawaii will likely get this:

update:  given the structure of the price caps, the result could actually be higher rather than lower prices at the pump -- see update #2 below.

It's good to know that Hawaii is looking to China for economics ideas.

The Chinese government and its state-owned oil companies are locked
in battle over artificially low gasoline prices at the pump that has
caused a massive shortage in the southern manufacturing province of
Guangdong....

The crisis
highlights the persistent problems Beijing faces as the economy is
transformed to a more market-based system but that is often retarded by
authorities who fear loosing political control in the face of
full-fledged capitalist rules.

Beyond the obvious run-up in world-wide oil prices and Hawaii's logistical isolation that raises all of the prices on the island, the article on CNN identified one other possible culprit for high prices: the state government

Higher-than-average taxes on gasoline in Hawaii contribute to those
high prices. The state levies a 16 cent per gallon tax, and various
local authorities add on other taxes.

In Honolulu, for example, total state, federal and local gas taxes
amount to about 53 cents per gallon, one of the highest rates in the
United States. The national average, according to the American
Petroleum Institute, is about 42 cents per gallon

It seems like only a few days ago I was pointing how governments have a hard time resisting meddling in oil markets, and that this meddling never works out well.

Even in the US, which is typically more comfortable with the operation
of the laws of supply and demand than other nations, the government has
been loathe to actually allow these laws to operate on oil.  During the
70's, the government maintained price controls that limited demand side
incentives to conserve, thus creating gas lines like the ones we are
seeing in China today for the same reason.  When these controls were
finally removed, a "windfall profits tax" was put in place to make sure
that producers would get none of the benefit of the price increases,
and therefore would have no financial incentive to seek out new oil
supplies or substitutes.  Within a few years of the repeal of these
dumb laws, oil prices fell back to historical levels and stayed there
for 20 years.

Like the gas rationing and price controls in the 1970's, this occurs in a Republican administration (Hawaiian Governor Lingle).  It continue to be difficult to take the Republican Party's professed support for free markets seriously.

Hawaii's Star Bulletin reported that Governor Linda
Lingle (R) is an opponent of the caps. The newspaper said Lingle
believes it would be better to force oil companies to open their books
and show consumers how much money they make at each stage of business.

If she is so opposed to it, why didn't she veto the bill?  And is having government officials marching into private offices to confiscate accounting data really her preferred "free market" alternative?

Update:  Apparently the cap in Hawaii was passed pre-Lingle, and she fought to reverse it, so I will cut her some slack. Lynne Kiesling has more details on the plan, which includes how the cap will be calculated week to week.  Politicians there are calling it a "market-based price cap".  LOL.  Next we will see freedom-based speech limitations and privacy-based telephone taps.  Note that how the cap is calculated does not change the statement I made before:  Either the price cap will be set high, such that it is meaningless, or
it will be set low, such that Hawaii gets gas lines.

PS- Lynn is the economic goddess of energy markets, so if energy and power markets and regulation interest you, I recommend her blog.

Update #2:  Jane Galt makes the good point that the Hawaiian price caps are on wholesale gasoline prices, so while there may be gas shortages at the wholesale level, retail prices may be able to float higher to close the supply gap.  This would ironically lead to higher, not lower prices at the pump, and large profits for gasoline retailers.  Since wholesale sources of gas tend to be out-of-state corporations, and gasoline retailers tend to be smaller, locally owned businesses, I wonder if this is a case of rent-seeking by gas station owners.

I can't check the guy's methodology, but Robert Shiller claims in the NY Times to have built a better, more accurate measure of housing prices.  You might ask, don't we already have that - I always see things like "median home sales price" in the paper?  The problem with existing metrics is that they don't correct for mix.  If a lot of large houses in the pricey part of town sell, median home prices will rise just given the mix shift of the sample.  What you really want is a price index for equivalent home sales, something that corrects for things like square feet, inflation, and perhaps zip code.  This is what Shiller claims to have done, and the results are dramatic.  He shows that real housing prices have been flat for most of the century, right up until the last decade, where they have increased dramatically.

I can't think of any structural change that would explain this (except maybe a change in relationship between mortgage rates and inflation) so it certainly creates a flashing red light saying "bubble". 

By the way, isn't it interesting that people can see the graph above and immediately think "prices are due to crash" but when they see this very similar chart:

...and think that prices will keep going up and up and up.

Hat tip to Marginal Revolution.  Other posts on housing prices here, here and here.  More on oil prices here.

Everything old is new again.  Back in the late 70's, all the talk was about the world running out of oil.  Everywhere you looked, "experts" were predicting that we would run out of oil.  Many had us running out of oil in 1985, while the most optimistic didn't have us running out of oil until the turn of the century.  Prices at the time had spiked to about $65 a barrel (in 2004 dollars), about where they are today.  Of course, it turned out that the laws of supply and demand had not been repealed, and after Reagan removed oil price controls and goofy laws like the windfall profits tax, demand and supply came back in balance, and prices actually returned to their historical norms.

Today, as evidenced by the long article on "peak oil" in the NY Times Magazine this weekend, we are apparently once again headed for imminent disaster.  The Freakonomics blog has already chimed in with a partial rebuttal, but I wanted to share some of my own thoughts.

Are the Saudis hiding a reserve shortfall?  Much of the peak oil phenomena consists of Paul Ehrlich type doom-saying that takes pains to ignore the laws of supply and demand.  However, the question of Saudi behavior is an interesting one.  Lets for a moment hypothesize that the Saudis were indeed somehow running out of oil.  One thing the article misses is how bad a thing this would be for the Saudi leadership.  The author notes that the ruling family shouldn't care, since it is already rich, so declining oil revenues won't hurt it.  But that misses the point.  With a large percentage of the world's oil, the Saudis are a country that must be treated with respect and deference.  Without oil, Saudi Arabia becomes that Arab nation that virtually enslaves half its population (ie the females) and that funds much of the world's terrorism, including the 9/11 attacks.  Suddenly, without oil reserves, the Saudi's might find themselves moving up the Bush-Rumsfeld priority list for a little visit from the US military.  I have no way of knowing if the Saudis are hiding anything -- the fact that some Saudi fields are using secondary and tertiary recovery methods (as noted in the article) really does not mean much.  But if they were losing reserves, they sure would have the incentive to hide it.

Reserve accounting is a tricky thing.  The vagaries of reserve accounting are very difficult for outsiders to understand.  I am not an expert, but one thing I have come to understand is that reserve numbers are not like measuring the water level in a tank.  There is a lot more oil in the ground than can ever be recovered, and just what percentage can be recovered depends on how much you are willing to do (and spend) to get it out.  Some oil will come out under its own pressure.  The next bit has to be pumped out.  The next bit has to be forced out with water injection.  The next bit may come out with steam or CO2 flooding.  In other words, how much oil you think will be recoverable from a field, ie the reserves, depends on how much you are willing to invest, which in turn depends on prices.  Over time, you will find that certain fields will have very different reserves numbers at $70 barrel oil than at $25.

Trust supply and demand.  Supply and demand work to close resource gaps.  In fact, it has never not worked.  The Cassandras of the world have predicted over the centuries that we would run out of thousands of different things.  Everything from farmland to wood to tungsten have at one time or another been close to exhaustion.  And you know what, these soothsayers of doom are 0-for-4153 in their predictions.  Heck, they are about 0-for-five on oil alone:

Most experts do not share Simmons's concerns about the imminence of peak oil. One of the industry's most prominent consultants, Daniel Yergin, author of a Pulitzer Prize-winning book about petroleum, dismisses the doomsday visions. ''This is not the first time that the world has 'run out of oil,''' he wrote in a recent Washington Post opinion essay. ''It's more like the fifth. Cycles of shortage and surplus characterize the entire history of the oil industry.'' Yergin says that a number of oil projects that are under construction will increase the supply by 20 percent in five years and that technological advances will increase the amount of oil that can be recovered from existing reservoirs. (Typically, with today's technology, only about 40 percent of a reservoir's oil can be pumped to the surface.)

One of the problems with oil is that governments have a real problem with allowing supply and demand to operate.  I have wondered for a while why Chinese demand has kept growing so fast in the face of rising prices.  The reason is that the Chinese government still is selling gasoline way below market rates, shielding consumers from incentives to reduce consumption.  On the supply side, I also wondered when I was in Paris why gasoline prices as high as $6 per gallon were not creating incentives for new sources of supply.  It turns out that nearly $4 of the $6 are government taxes, so none of this higher price goes to producers or creates any supply-side incentives.  Instead, it goes to paying unemployment benefits, or whatever they do with taxes in France.

Even in the US, which is typically more comfortable with the operation of the laws of supply and demand than other nations, the government has been loathe to actually allow these laws to operate on oil.  During the 70's, the government maintained price controls that limited demand side incentives to conserve, thus creating gas lines like the ones we are seeing in China today for the same reason.  When these controls were finally removed, a "windfall profits tax" was put in place to make sure that producers would get none of the benefit of the price increases, and therefore would have no financial incentive to seek out new oil supplies or substitutes.  Within a few years of the repeal of these dumb laws, oil prices fell back to historical levels and stayed there for 20 years.

But meddling with prices is not the only way the government screws up the oil market.  I laugh when I see people with a straight face say that we have not opened up any big new fields in this country since Prudhoe Bay.  This is in large part because the three most promising oil field possibilities in this country -- ANWR, California coast, and the Florida coast -- have all been closed to exploration by the government.

In addition, the government has, through a series of energy bills that are each stupider than the last, managed to divert valuable energy investment capital into a range of politically correct black holes.  All we seem to get are unsightly windmills in Palm Springs that always seem to be broken and massive ethanol subsidies that actually increase oil consumption rather than decrease it.  It should come as no surprise that  despite government subsidies for a range of automotive technologies like fuel cells and all-electric cars, the winning technology to date has been hybrids, which weren't on the government subsidy plan at all.

Don't Ignore Substitutes.  All the oil doomsayers tend to define the problem as follows:  Oil production from current fields using current methods and technologies will peak soon.  Well, OK, but that sure defines the problem kind of narrowly.  The last time oil prices were at this level ($65 in 2004 dollars), most of the oil companies and any number of startups were gearing up to start production in a variety of new technologies.  I know that when I was working for Exxon in the early 80's, they had a huge project in the works for recovering oil from oil shales and sands.  Once prices when back in the tank, these projects were mothballed, but there is no reason why they won't get restarted if oil prices stay high.  At $65 a barrel, even nuclear starts looking good again, though we would have to come up with a more sane regulatory environment.  Look for venture capital to steer away from funding the next shoelace.com and start looking for energy investments.

Dueling Catastrophes.  As a final note, its funny seeing the New York Times crying "disaster" over the peak oil scenario.  Those who read this blog know that I am skeptical that the harm from man-made global warming is bad enough to justify large, immediate Kyoto-like reductions in hydrocarbon consumption.  However, the New York Times is on record as a big believer in and cheerleader for immediate cuts in hydrocarbon consumption to head off global warming.  So why is peak oil so bad?  Shouldn't they be celebrating an ongoing drop in oil availability, which would force the world to produce less CO2?  Along the same vain, it is funny seeing a publication that has decried over and over again our dependence on Saudi Arabian and other foreign oil at the same time lamenting the fact that Saudi Arabia is running out.  If that's true, won't Saudi reserve declines solve the whole dependence problem, one way or another?

Postscript:  The other day, I found one of Paul Ehrlich's doomsday books from the 70's in a used book store.  When I have a chance, I am going to post some of its predictions, which were treated with breathless respect by most of the media, including the NY Times.

A couple of years ago, California suffered through a summer of electricity blackouts while the state and  state-protected power monopolies nearly bankrupted themselves.  While California politicians have tried to cover their behinds by blaming Enron for the problems, the real mistake that led to the debacle was allowing the wholesale price of electricity to float higher, while the retail price remained low and fixed.  As a result, as wholesale prices skyrocketed, the State and the power monopolies had to buy high and sell low, causing massive financial losses.  At the same time, consumers saw no change in prices, so they had no incentive to change their behavior and cut back on usage, which they would have done if retail electricity prices had been allowed to rise with the market.

Via Instapundit and Gateway Pundit, comes this article about gas shortages in China and the ensuing lines at retail gas stations, that look worse than anything we suffered through in this country.  The article makes fairly clear what is going on:

The Chinese government and its state-owned oil companies are locked
in battle over artificially low gasoline prices at the pump that has
caused a massive shortage in the southern manufacturing province of
Guangdong.

For weeks skyrocketing global oil prices and rising
demand has led to a fuel-supply crunch as domestic refineries have been
caught short in Guangdong.

Some fear it is only a matter of time before gas-guzzling cities such as Shanghai are hit too.

The
government has blamed recent stormy weather for the shortfall, which is
feasible but not enough to result in the kilometre long queues at
filling stations that drivers in Guangdong have endured for nearly a
month.

As oil prices climbed, a standoff erupted between China's
National Development Reform Commission (NDRC) -- a key economic policy
planning body -- and the country's two largest state oil groups
PetroChina and Sinopec, analysts said Wednesday.

The crisis
highlights the persistent problems Beijing faces as the economy is
transformed to a more market-based system but that is often retarded by
authorities who fear loosing political control in the face of
full-fledged capitalist rules.

I blame Enron.  Anyway, I wrote about gas line and what caused them in the US here.  Some genius also attempted the same policy as China is pursuing in post-war Iraq, with similar results.

When I read this article on waste disposal, via Instapundit, all I could think of was Julian Simon.  For those who may be too young to remember, back in the 80's, after the panic that we were running out of oil was over, but before the current panic that we are producing too much carbon dioxide, there was a panic that we were running out of garbage dump space.  Uh, never mind:

Simply put, operators of garbage dumps are stuffing more waste than
anyone expected into the giant plastic-lined holes, keeping disposal
prices down and making the construction of new landfills largely
unnecessary....

The
productivity leap is the second major economic surprise from the trash
business in the last 20 years. First, it became clear in the early
1990's that there was a glut of disposal space, not the widely believed
shortage that had drawn headlines in the 1980's. Although many town
dumps had closed, they were replaced by fewer, but huge, regional ones.
That sent dumping prices plunging in many areas in the early 1990's and
led to a long slump in the waste industry.

Since then, the
industry and its followers have been relying on time - about 330
million tons of trash went into landfills in the United States last
year alone, according to Solid Waste Digest, a trade publication - to
fill up some of those holes, erase the glut and send disposal prices
skyward again. Instead, dump capacity has kept growing, and rapidly,
even as only a few new dumps were built.

Shortages seldom persist where the human mind is left free to attack the problem, and economic incentives are allowed to operate freely.  I wrote my own post attacking the zero-sum mentality that causes certain people to jump from one shortage-panic to the next. 

My prediction:  Five years from now, we will be seeing the same article on oil and natural gas.  "This oil field in west Texas is over 80 years old, and was thought to be depleted, until $60 oil prices and some new technology...."   You get the idea.

Note:  I have posted a more recent article with updated data here.

Mises Blog has a good article on the "Peak Oil" meme.  You may have gotten investment solicitations urging you to invest in oil because production is supposedly going to peak in 2006.

Oil production will peak some day.  I do not know when.  I do know that when I was in high school debate in the late 1970's, the topic one year was on resource policies.  I read everything there was at the time on oil supply as well as other critical mineral supplies.  Most "experts" at the time were predicting that oil would "run out" in about 1985 or 1990.  As you can see below, folks who invested in oil in 1980, after a price run-up similar to the one we have seen lately, got slaughtered.

Think twice or maybe three times about this graph before you invest.  Notice that there is no long term trend in real oil prices, even over one hundred years!  To make money buying oil, you have to do it on timing, buying ahead of sharp temporary increases.  And given that we are at the top of one of those sharp increases, can now really be the time to buy?

You can never get all the oil out of a field, and the exact amount of oil you can recover is dependent on how much you want to spend to do it, which in turn is related to oil prices (or expectations of oil prices).  The first 20% of the oil in a field might just squirt out under its own pressure.  The next 20% might have to be pumped.  The next 20% might need high pressure water injection to help it.  The next 20% might need expensive CO2 injection to help it.  If you ask the field manager how much oil was left, he would give you different answers at $20 and $45 a barrel, because he would make different assumptions about how far along this investment curve he would go.

If you are still thinking about investing, do one more thing: Study the famous bet between Paul Ehrlich and Julian Simon:

In 1980, economist |Julian Simon| and biologist Paul Ehrlich decided to put their money where their predictions were. Ehrlich had been predicting massive shortages in various natural resources for decades, while Simon claimed natural resources were infinite.

Simon offered Ehrlich a bet centered on the market price of metals. Ehrlich would pick a quantity of any five metals he liked worth $1,000 in 1980. If the 1990 price of the metals, after adjusting for inflation, was more than $1,000 (i.e. the metals became more scarce), Ehrlich would win. If, however, the value of the metals after inflation was less than $1,000 (i.e. the metals became less scare), Simon would win. The loser would mail the winner a check for the change in price.

Ehrlich agreed to the bet, and chose copper, chrome, nickel, tin and tungsten.

By 1990, all five metal were below their inflation-adjusted price level in 1980. Ehrlich lost the bet and sent Simon a check for $576.07. Prices of the metals chosen by Ehrlich fell so much that Simon would have won the bet even if the prices hadn't been adjusted for inflation. (1) Here's how each of the metals performed from 1980-1990.