Speculators and peak oil 3
In my previous post on oil depletion, I claimed that markets are well-equipped to deal with the problem of peak oil. A common objection to this—typically made by those who favor a government solution to the problem—is that markets are not good at long-range thinking. Indeed, this is a common objection to markets in general. The argument with respect to oil goes like this: oil prices might rise as oil becomes scarce, but what if it doesn’t rise fast enough to cause solutions to be invented in time? Since we can see right now that it’s going to be a problem, we can use the government to institute a “Manhattan project” to come up with an appropriate alternative energy source. The central claim, in other words, is that government has better foresight than markets. The secondary claim is that government is better-equipped than markets to discover the solution. Let us examine these claims in turn.
Perhaps out of confusion with Wall Street’s reputation for focusing on short-term earnings, many people are unaware of how good markets are at long-range thinking. I’ll use oil as a concrete example, but the general idea should be clear. The mechanism is simple: if oil is running out, then it will be more valuable in the future. This means that if you buy oil now you can make a profit by holding the oil until its price rises. Of course, the future price is not the only relevant variable; it also matters how long until the price is reached, since money has time value. The higher the future price relative to the current price, the farther in advance it makes sense to buy oil and put in storage (or, more plausibly, simply leave it in the ground). Now comes the key: if many people buy oil in anticipation of its higher future price, this will increase its current price by restricting the current supply available. In other words, the current price is a reflection of its future scarcity. It’s through the price system that markets are able to anticipate the state of the world even in the far future. If there is an approaching apocalypse, it is already reflected in current prices.
The price system only functions if those who anticipate future scarcity are allowed to act on their beliefs; such people are called “speculators”. Unfortunately, those who underestimate the ability of the price system to anticipate future events are among the most likely to decry those who would buy oil in hope of future profits, maligning speculators as “hoarders”. Somehow, people’s intuition tells them that buying oil when it’s plentiful and then selling it when it’s scarce is morally suspect; after all, nobody likes a “price gouger”. And yet, as argued above, speculators perform a vital service; if you think about it, what they’re really doing is transporting oil from a place where it’s not needed to a place where it is. That these “places” are actually at different times is irrelevant. That their motive is (at least partially) profit is also irrelevant; as Adam Smith noted more than 200 years ago, as much as the baker might enjoy his work, it is not due to his better nature that we expect him to rise every morning to bake us bread.
Let’s consider now the preferred solution of many peak oil worrywarts: massive government action, sometimes called a “Manhattan project for alternative energy”. The analogy with the Manhattan project is utterly misleading, since not only did the quest for an atomic bomb require the utmost secrecy, but the drive to develop nuclear weapons was not motivated by a market need. For an energy Manhattan project, even the best possible scenario involves government-appointed “experts” allocating huge amounts of resources for alternative energy projects, with no real guide as to which sources of energy are the most promising—or, at least, no real penalty for guessing wrong.
The Manhattan project analogy is also based on the dubious expectation that the “answer” for our energy needs involves a single technology, or at most a few. And even if the experts were spectacularly lucky in identifying the right technology, the government has the wrong incentives for implementing it. With such a huge amount of money sloshing around, we could surely expect there to be massive political influence. It is depressingly likely that the most “promising” sources of energy would happen to involve large projects built in the districts of powerful congressman and in the states of powerful senators.
Markets, on the other hand, are more flexible, able to consider many different possible solutions in a massively parallel fashion. The penalty for guessing wrong is losing your investment or losing your business. If there is a single “solution”, the profits to be had from finding it would be enormous, so there is every reason to expect that the market would find it. If, as is more likely, there are many overlapping answers, involving reduced energy use and a spectrum of new energy sources, the market is well-equipped to find those as well. Indeed, saying “the market is the answer” is really simply an admission of ignorance—an admission that we don’t know the answer, or that there may not even be a single answer.
The solution to peak oil is simple: let the price system—with its heroic if greedy speculators—work its magic.
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I have to say that I think that you’re arguing against a strawman. There may be a few people arguing for massive government action to address peak oil, but those tend to be those who already have a vested interest in government. On the contrary, though, the vast majority of those I hear talking about peak oil aren’t calling for the government to do something about it. Instead they’re trying to educate individuals to be more aware of the problem and how they can ease the transition away from cheap oil to other modes of energy usage.
That said, I think it may also be fallacious to suggest that the market will automatically solve this problem when there is a huge cartel manipulating production and severely limiting the information that speculators might use to make decisions.
Kevin raises the good point that oil prices are determined in part by a cartel of oil-producing nations, which tend not to be particularly transparent about their reserves. But I would respond by saying that first, OPEC doesn’t completely control prices—obviously, the price of oil fluctuates quite a lot. Second, if the peak oil theorists are right, the days of OPEC being able to manipulate prices simply by ramping up production are numbered, and in the not-so-distant future prices will be completely determined by supply and demand. In other words, the very peak oil phenomenon that worries so many people will destroy OPEC’s ability to fix prices, thereby producing the solution to peak oil, namely, chronically high oil prices.
As for arguing against a straw man, one man’s straw man is another man’s serious argument. I’ve tried to present a simplified but not over-simplified version of the peak oil argument, and sometimes such a simplification leaves out some detail that certain people feel is important. In this case, I think what Kevin objects to specifically is my argument against massive government action. My experience is that a large fraction of people who are concerned about peak oil do explicitly advocate a government solution to the problem; the principal Caltech worrier, David Goodstein, certainly does, and I suspect that many others share his basic viewpoint.
Those who don’t explicitly favor a government solution—i.e., those who seek (ostensibly) merely to educate—make me wonder what the point is of raising awareness. I have a suspicion, which I admit it is mainly intuition, that those who worry about peak oil implicitly advocate a government solution; after all, it seems unlikely that “raising awareness” is sufficient to solve the problem, and if it isn’t, well, we have to do something, don’t we? And experience shows that people who think that “we should do something” mean “we as a society”, which nearly always means the government.
As for those who are interested in educating people about peak oil, but don’t have a particular political agenda, I would simply ask why people need to be educated about it. Just letting people know that their lifestyles may have to change in response to diminishing oil supplies does no harm, as far as I can see, but since people respond quite strongly to economic incentives it seems superfluous. I also think it probably worries people unnecessarily, and it also potentially creates a group of voters who might be worried enough about peak oil to advocate a government solution. So, my educational message would be, “World oil supplies are likely to peak sometime in the next few decades, but it’s nothing to worry about, so go back to whatever else it was you were doing.”
I think it’s a little odd that on the one hand you’re saying that people shouldn’t worry their pretty little heads about these things, but on the other hand that speculators will play a crucial role in this business.
The mistake is in assuming that speculators need to be massive investors who can buy up large quantities of oil and keep them in long-term storage. However, there’s lots of potential for small-scale speculation. Buying a hybrid, or other alternative fuel vehicle is a form of speculation. So is installing solar panels on your house, or buying energy efficient appliances. Even the choice of where to live can be partly based on energy price speculation: how big a house do you buy? Single-family or attached? In the suburb or in a dense city?
The ability to consider these sorts of issues is the type of education that the grassroots groups are interested in.