Arnold Kling  

The Future of Oil

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Lynne Kiesling and Don Boudreaux have already pointed to an article by Morris Adelman, who was at MIT back when Krugman and I were in grad school there.

There is not, and never has been, an oil crisis or gap. Oil reserves are not dwindling. The Middle East does not have and has never had any “oil weapon.” How fast Russian oil output grows is of minor but real interest. How much goes to the United States or Europe or Japan — or anywhere else, for that matter — is of no interest because it has no effect on prices we pay nor on the security of supply.

...Think of it this way: Anyone could make a bet on rising inground values — borrow money to buy and hold a barrel of oil for later sale. With ultimate reserves decreasing every year, the value of oil still in the ground should grow yearly. The investor’s gain on holding the oil should be at least enough to
offset the borrowing cost plus risk. In fact, we find that holding the oil would draw a negative return even before allowingfor risk.

To sum up: There is no indication that non-opec oil is getting more expensive to find and develop. Statements about nonopec nations’ “dwindling reserves” are meaningless or wrong.

Read the whole piece.

For Discussion. In whose interest is it to have us believe that the world is running out of oil?

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TRACKBACKS (6 to date)
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The author at Foolippic in a related article titled Oil's Well writes:
    Arnold Kling, in EconLog, The Future of Oil: Library of Economics and Liberty, points to an article by M. A. Adelman of MIT explaining why we're not running out of oil, and why it just doesn't matter where oil comes... [Tracked on May 13, 2004 8:37 AM]
The author at Houston's Clear Thinkers in a related article titled The myth of declining energy reserves writes:
    Morris A. Adelman is a professor emeritus of economics at Massachutsetts Institute of Techonology and long has been one of America's leading energy economists. In this article, Professor Adelman eviscerates the myth that humanity’s need for oil cannot ... [Tracked on May 13, 2004 8:55 AM]
COMMENTS (23 to date)
Paul Cox writes:

Oil and gas are finite resources. There are no reasonable alternatives or replacements. Try operating your vehicle or house on timber. Energy resources are not renewable. And the U.S. economy is rendered useless without the use of energy. Energy is as important as the air we breath.

The ability of producers to meet demand is diminishing and therefore prices are the mechanism to allocate the resource to the most efficient areas. Is this China or the United States?

Costs do not have any affect in todays pricing of oil and gas. Prices are purely based on supply and demand. The surplus of supply expired. Prices now reflect the increasing demand.

You can read more of my rough and annoying opinions at my blog.

M. Stephen Zitrin writes:

"When Willy Sutton was asked why he robbed banks he said, 'That's where the money is.' Why do you go into the Persian Gulf? Because that’s where the oil is. Any way you slice it, two-thirds of the world’s oil reserves are in the Persian Gulf. There is no way to get around it. If you are an oil company, and Saudi Arabia and Kuwait are opening up to foreign investment such that you can get oil out of the ground at $2 per barrel, or offshore West Africa at $4 a barrel, why are you going to go to Kazakhstan or Azerbaijan--where you need $13 or $14 per barrel to make money--and put up with all the corruption and other problems?”

“I think that what you have seen is that the oil companies, certainly in Central Asia, have poked around and have somewhat soured on it....I may be totally wrong--we might find another giant, double-Tengiz somewhere--but I do not think that there are a lot of choices.”

--Robert Manning, in Global Markets and National Interests: the New Geopolitics of Energy, Capital, and Information (Bloomfield, ed.:2002, CSIS Press)

Barry Posner writes:

It appears Mr. Cox did not read Adelman's article. The finite mass of oil in the earth's crust mey be declining, but we will never run out.

There are currently plenty of alternatives that will be viable when the price of oil is credibly above $45-$50 per barrel (coal gasification being the most obvious one). When it gets higher, we'll find more.

Producers do have the ability to meet demand today, and will have for as long as we can reasonably forecast. Some producers are *choosing* to not produce at their maximum output. At a given restricted output, the price will rise until demand drops to the amount supplied. Demand is not some fixed point we are falling short of. It is a curve that intersects the supply curve at some price. If there is an intersection, demand is being met. This is Econ 101.

The surplus has not expired. If there was no surplus, then the world price would be the marginal cost of oil, and Hotelling's theory would kick in, with us seeing annual increases in the rent at the rate of inflation. This isn't happening. There is no oil being produced today with a marginal production cost of $40 per barrel. Prices exceed marginal cost because a dominant group of sellers is choosing to restict supply.

If Mr. Cos reads Dr. Adelman's article, he will find that the real cost of purchasing existing fields in the US has not changed significantly in the last 20 years. This invalidates the notion that scarcity rents are starting to kick in.

Side note to Arnold: Dr. Adelman was the thesis supervisor of one of my thesis advisors, Dr. Richard Gordon, who is now a professor emeritus. Which tells you something about how long Adelman has been at MIT.

Donald Lacombe writes:

I think it would be in the interest of those who produce alternatives to oil (e.g. solar, etc...) to convince everyone that we are running out of oil so that their alternative can be heavily subsidized, regardless of the cost benefit ratio.

Lawrance George Lux writes:

Years ago I made a Cost speculation that a synthetic fuel of liquid plastic could be made of surface Carbon waste, and suggested but did not publish, that it could be made for less than $50 a barrel. The overall Cost structure of production has altered today, but the idea that Oil must be pulled from the ground must be challenged.

The real trouble with alternative energy development lies almost completely with the lack of participation by Business organizations. Whenever Companies have thought to invest time and management to developing alternative energy technologies, they did not find spectacular gains, but they did find increases in Profitability. lgl

Walker writes:

Environmentalists are the strongest interest group who would be likely to push this thesis.

The problem is that there is a lot of fundamental uncertainty surrounding the question of how much oil is recoverable. The controversy over this question reflects this uncertainty -- if there was a clear answer there would be no need to discuss the debate in terms of competition between interest groups. From personal experience talking to people in the oil industry, there exists no consensus opinion even from the people on the ground.

In the medium term, the answer depends on the pace at which new reserves can be found, the extent to which new technologies continue to lower the cost of retrieval, and the level of future consumption. Beware anyone who says he has answers to these questions.

Paul Cox writes:

I thank Mr. Posner for the economics lesson. I would ask him to consider why it is that Starbucks charges $33 per gallon for his morning ritual, or $2.00 for the quart of Perrier?

What the true costs of energy is might be an interesting debate, however, if he belives that the energy industry is withholding production I beg to think of what he thinks that Juan Valdez, the Columbian coffee picker is doing. And since were on the topic, what have the French being putting into their water?

Paul Cox writes:

This morning CNBC stated that 1980's adjusted price of oil is $78.

Thinking back to that time frame, I can recall the saying that fame would get you $0.25 to by a cup of coffee.

If coffee was $0.25 in 1980, Juan Valdez, the Columbian coffee picker has really exploited his resource, and the oil companies should have been elevated to Saint hood.

I would also like to assert the point that there are no alternatives to energy. That it is finite and the american economies life blood is energy, and there is now global competition for the energy resources of the world.

Bernard Yomtov writes:

It's hard to sort out what we're arguing about here. Surely the supply of oil depends on the price, but that hardly means that it's no worry. A big price rise would certainly be harmful.

Similarly, technological advances in extraction methods might help keep the price down, but Walker is correct that this is hard to predict.

Unfortunately, purely economic analyses leave out the political aspects of oil. It is easy to say that producers will act in their economic self-interest, and to derive conclusions from this assumption. But they don't have to, and they might not. Might an extreme Islamist regime in Saudi Arabia decide that the harm to western economies from severe production cuts was worth the cost? That doesn't seem like a wild speculation to me.

And such analyses also assume that the money paid for oil is spent in ways that need not concern us. But we know that Saudi and Iranian money has gone to fund terrorism, and probably still does. Those political consequencces need to be considered as well.

It's all very well to produce nice arguments, with equations and talk of marginal costs and so on. But to analyze oil markets without regard for political aspects (not to mention environmental issues) is an obvious case of defining the problem as a nail simply because one owns a hammer.

Paul Cox writes:

Mr. Yomtov's comments about the political side of the commodity needs to be considered and better understood by the American oil consumer.

The reason that Bush doesn't tell the Saudi's et al to keep the price low is that no one is listening.

Are the Chinese so inefficient in their use of oil that they are using 5 times the volume of oil that Canadians consume to generate $1 of GNP, or are they building a strategic petroleum reserve of their own.

If the Chinese are building their own SPR, they would not be building it for the same purposes as the americans. And, would they want to be able to cripple the American economy with both high labor and high energy costs. Two strategic competitive advantages that their economy does not share with any other country?

Eric Krieg writes:

The whole concept of "reserves" is actually not economically sound. Do the Candain Oil Sands count towards the world's reserves of oil? Those oil sands are marhinally recoverable at current prices (moreso every day as technology advances). But every dollar increase in the cost of oil just makes them more and more viable.

There is more oil locked up in the sands up in Canada than in Saudi. If oil were to go higher, at some point they would be viable.

Synthetic fuels could be made from coal, again if the price goes high enough.

Scott Gustafson writes:

There's an awful lot of oil in the oil shale in Colorado. With sufficient technology it may become economic. Then again we've been trying to do that since the 1890's.

Bernard Yomtov writes:

Oil shale? That one's been around forever. Try reading The Money game by Adam Smith.

Barry Posner writes:

As of now, there is no viable technology for extracting oil from oil shale.

Oil sands are a different story. It costs less than US$10 to produce a barrel of oil from oilsands, which compares favorably to many conventional and offshore fields in North America.

I'm surprised to find that many Americans still think that oil sands are a sub-marginal experimental technology. They're not: they've been producing hundreds of thousands of barrels per day for years. Very soon, it will be a million barrels per day.

Mats writes:

Arnold, in whose interest is it to have people thinking that oil supplies from the mid east have little impact on western economies? Arnold?

JJ writes:

I'm surprised no one mentioned the possibility of using gas hydrates for energy. The supplies of this potential energy source are far more abundant than oil and coal.

David Cass writes:

I don't understand Paul Cox's assertion that energy is finite. I think it is only finite when you think in terms of the total mass of the universe. Oil is finite and the use of it will go down as the price goes up eventually leaving a lot of it in the ground never to be used.

A viable alternative fuel is electricity produced by fission. There is lots of uranium but we don't use it. (Politics per Yomtov).

I think we are cowards in the bluff game with Opec.

Paul Cox writes:

When I state the quantity of oil and gas is finite, I mean that it does not grow on trees. How much of the resource is available is continuoulsy decreasing due to the daily production. When used the energy is irretrievably lost and unrecoverable, leaving less and less of the resource each day.

Scott Gustafson writes:

We’ve been mining gold for about 5000 years. Every year there is less and less of it in the ground. Yet we continue to mine it with no indication that it will ever run out. Also, over the long run, the real cost of extracting gold from the ground has been falling.

Why should oil be any different?

Paul Cox writes:

The difference between gold and oil is that oil can not be reused. In addition to the mined gold, there is the inventory of all previously mined gold.

Dez Akin writes:

But if we think long term, oil can be reused... Its just carbon and hydrogen arranged in different ways. With energy, we can certainly turn CO2 and water into oil, and it is even economic to do so above a certain price range. Theres enough fissile fuel in the ground to last hundreds of millions of years, the sun will last billions, and I imagine we'll get fusion working sometime before a million years are up.

Scott Gustafson writes:

While there is a gold stock that can continue to be recycled, primary production continues unabated. Since we’ve been mining it for 5000 years, it should give us a rather good indication of what happens over time to non-renewable natural resources.

Other minerals show similar trends over the long run – a continuing reduction in production cost. The real price of coal in the US (and the world) is at or close to an all time low. We’ve been producing it twice as long as we have oil.

Jim Hardt writes:

A comment from my brother: ..but the article by M. Adelman is a piece of rubbish. The man is a professor emeritus of economics, not a geologist. It seems that he must have an axe to grind, I surmise of a political nature.

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