Art Carden  

We-e-ee Are NEVER EVER EVER--Running Out of Oil!

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Here's an extra credit assignment I gave my principles of macro students last week when we were talking about supply and demand. Fans of Russell Roberts might recognize that this is inspired in part by chapter 1 of The Invisible Heart.

A friend of mine once posted on Facebook that "life is too short to mess around with the last 2% of the toothpaste in the tube" (I paraphrase from memory). How does this help us understand why supply curves are generally upward-sloping? Please report on the following:

1. When you last brushed your teeth, was the tube mostly full, mostly empty, or somewhere in between?

2. How easy was it to get a squeeze of toothpaste?

3. As the tube nears empty, do you expect it to get easier or harder to get a squeeze of toothpaste?

4. How will you ultimately respond?

5. What does your answer to #4 suggest about the following claim: "we will run out of oil in our lifetimes"?

And here are my answers:

1. When you last brushed your teeth, was the tube mostly full, mostly empty, or somewhere in between?

Luxuriously full.

2. How easy was it to get a squeeze of toothpaste?

So easy a baby could do it. And if our baby got ahold of it, I'm' sure he would.

3. As the tube nears empty, do you expect it to get easier or harder to get a squeeze of toothpaste?

As the tube empties, it will get harder and harder to squeeze toothpaste out of the tube. The marginal cost of each extra squeeze of toothpaste is rising. Getting squeeze #1 is really easy, like getting oil out of the ground in the Middle East. Getting squeeze #100 is much harder, like getting oil out of the tar sands in Alberta, Canada.
4. How will you ultimately respond?

I will buy a new tube of toothpaste.

5. What does your answer to #4 suggest about the following claim: "we will run out of oil in our lifetimes"?

I am confident that we will never, ever, ever run out of oil (note that not all of you answered this way). #4 suggests that as it gets harder and harder to acquire toothpaste, we seek substitutes. The same holds for oil. If we expect demand to rise faster than supply in the future, the price will increase. If we expect a higher price next year (or in ten years), we have an incentive to take oil today off the market and sell it in the future for the higher price.

This is one of the really awesome things prices do: prices aggregate and transmit information about everyone's best guesses as to current and future supplies of and demand for resources. If you know better than everyone else what the market for oil will look like in ten years, then you can profit handsomely from this information. There are a lot of people who make confident predictions about how we will run out of this or that and yet refuse to put their money where their mouths are by purchasing financial assets that would allow them to profit handsomely from their superior insight. The fact that they don't do so and use their profits to address the problems they foresee reduces my faith in their predictions.

You might recall that Harold Camping predicted the end of the world on May 21, 2011. It didn't come to pass. We have a pretty bad track record when it comes to predicting the end of the world--and this goes not only for preachers and self-styled religious prophets, but also for self-styled environmental prophets. I discuss this in greater detail here.


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COMMENTS (12 to date)
Nathan writes:

I don't necessarily disagree with (5) but it doesn't follow from (4). Buying a new tube of full but otherwise identical toothpaste from a store which has an unlimited supply at that price is qualitatively different from substituting away from a commodity that has become scarce.

If we expect demand to rise faster than supply in the future, the price will increase. If we expect a higher price next year (or in ten years), we have an incentive to take oil today off the market and sell it in the future for the higher price.

Well, yes, but suppose you have a cost of capital of 8% and storage costs are 7%. The price of oil would have to rise by more than 1,600% over 20 years and by 6,600% over 30 years for this trade to break even.

I don't think it is likely, but it is certainly possible that the price of oil will rise by so much that we will have to drastically cut back on consumption within our lifetime. We wouldn't run out of oil if you define running out to mean there is absolutely no oil left but if the price increased 66-fold in 30 years that would satisfy a colloquial definition.

A claim that we will not run out of oil I think has to rely on price signals stimulating technological changes that make more oil available or provide cost-efficient substitutes for oil.

Tom West writes:

Indeed, we'll never run out of oil, but I've seen an awful lot of transitions from "everything's fine" to "Oh my God" take place very quickly indeed, even when there's a lot of money on the line.

Running out of oil and having it quickly transition to insane price levels are essentially equivalent. With luck, it'll be a slow price transition upward allowing for orderly substitution, but history and human behavior doesn't seem to make this likely.

Tom E. Snyder writes:

Art,

I hope you didn't stockpile natural gas 5 years ago waiting for the price to go up.

Arthur_500 writes:
You might recall that Harold Camping predicted the end of the world on May 21, 2011. It didn't come to pass. We have a pretty bad track record when it comes to predicting the end of the world--and this goes not only for preachers and self-styled religious prophets, but also for self-styled environmental prophets.

Damn, I thought this was nirvana! Now you tell me I am not living in an alternate universe. There goes my day.

Supply and Demand seem to work pretty well. Taxes and Regulations try to shift or change the demand curve. Regretfully, we are woefully inadequate in predicting the unintended consequences.

EPA Regulations requiring clean truck/ equipment engines are way ahead of the technology. As a result we have cleaner burning engines that fail, are expensive to operate and utilize more fuel than that which they are replacing. [Remember when we switched to unleaded? It utilized 1 1/5 times the raw material per gallon of finished product]

Compound this with the reality that companies must spend scarce resources to develop 'fixes' and stay in business and they are unable to commit the resources necessary to come up with real useful technology that actually works.

The current Administration would like to see us find substitutions for the current truck/ equipment engines but there is inadequate incentive or resources to come up with entirely new technology. Oil is "cheap" and will remain powering vehicles into the foreseeable future.

Matt H writes:

What if the transition isn't so smooth. What if really suddenly prices spike to a level that causes farmers not to be able to afford to run their machines, or to get fuel in time to harvest their crops this followed by food shortages and famine, and die offs. The correct term for your way of thinking is Utopian.

Kevin writes:

Oil is continually produced by the same processes that produced the oil humans have been extracting. Even if "we" ran out of oil, more would be made.

Rob writes:

I think Tom West and Matt H both make good points, which is actually supported by the toothpaste analogy.

It doesn't get that much harder to remove toothpaste until the last or next to last dosage of toothpaste. For me, it normally takes me by surprise that I am out (because its been really easy until the last dosage that I really need to coax out), such that if I don't already own a backup tube, I'm scrambling to buy one (my strategy now is to always buy a new tube as soon as I open a tube).

We do not have a good replacement for oil yet. It is possible oil will be relatively easy to extract until we reach a real shortage, in which case prices will spike. Without a ready substitute at hand, it could be painful.


Taras writes:

Matt H wrote:

What if the transition isn't so smooth. What if really suddenly prices spike to a level that causes farmers not to be able to afford to run their machines, or to get fuel in time to harvest their crops this followed by food shortages and famine, and die offs. The correct term for your way of thinking is Utopian.

What if aggressive aliens come to earth tomorrow bearing advanced weaponry which our state military is completely incapable of defending against? Wouldn't our entire military budget be a waste then? Surely all statists are Utopian if they believe that the military can protect us.

You are trying to reduce his point of view to absurdity by putting forth an extremely low probability hypothetical "what-if" scenario. I'll call it a "what-if" fallacy.

Matt H writes:

Taras,

Art's point isn't about oil at all its about all resources. At some point one them will be depleted and we will have a very rough transition. Low probabilities for this transition on anyone of them isn't a bug in my argument its a feature.

Long tail events happen, its just probability. Because a substitute may exist, doesn't mean it will found quickly, or that the tech to scale it will be timely. That it will always be a smooth painless transition is wishful thinking techno-utopianism.

But even back to oil, what probability would you give to a non-smooth transition to a substitute product. I think that probability is pretty low, but non-trivial. Lets say 5%. Once you admit this can happen, its really obvious that there will be famines in poor countries, the sharper the transition, the more likely this could hit rich countries too.

There were some really good examples of technologies reaching their limits and causing havoc in history of farming in china, the US, and other places.

Jeff writes:
Matt H writes: Taras,

Art's point isn't about oil at all its about all resources. At some point one them will be depleted and we will have a very rough transition. Low probabilities for this transition on anyone of them isn't a bug in my argument its a feature.

Long tail events happen, its just probability. Because a substitute may exist, doesn't mean it will found quickly, or that the tech to scale it will be timely. That it will always be a smooth painless transition is wishful thinking techno-utopianism.

But even back to oil, what probability would you give to a non-smooth transition to a substitute product. I think that probability is pretty low, but non-trivial. Lets say 5%. Once you admit this can happen, its really obvious that there will be famines in poor countries, the sharper the transition, the more likely this could hit rich countries too.

There were some really good examples of technologies reaching their limits and causing havoc in history of farming in china, the US, and other places.

What about Art's argument implies that the transition is always or necessarily smooth and a substitute necessarily exists and can be scaled sufficiently to avert disaster under any scenario?

(Hint: the ambiguous hyperbole "We are NEVER running out of oil" isn't part of the actual argument.)

ryan p writes:

#5 seems like an informal corrollary to the Hotelling Price Path**. And yeah, if you take Hotelling seriously, not only should we expect producers to save for the future if they expect future shortages, but the general transition should be smooth -- prices should rise with nominal interest rates, plus some noise and maybe uncertainty premiums. The trouble is, if you're taking Hotelling seriously, it's hard to see why the prices of all non-renewable resources haven't tended over time to rise at some steady-ish exponential rate. Julian Simon famously argued real costs should fall over time, but I have never quite wrapped my brain around how that could be possible in a rational market.


**Harold Hotelling famously pointed out that the alternative to pulling an exhaustible resource out of the ground and selling it today is pulling it out of the ground and selling it in a year. [Contra Nathan above, no need for storage -- just leave it in the ground.] So, yadda yadda yadda, prices (or really, prices less extraction costs) should eventually rise at the rate of interest. You can complicate this with uncertainty about future demand and future technological progress, but that's the gist.

Tom West writes:

Jeff:

What about Art's argument implies that the transition is always or necessarily smooth and a substitute necessarily exists and can be scaled sufficiently to avert disaster under any scenario?

Perhaps I'm getting wound up for little reason, but I will say that 98% of the "we're never going to run out of oil" arguments I'm exposed to are arguments against government efforts to find make the transition smoother (which inevitably means more pain now 4). Using toothpaste as an example re-enforces the "transition is painless, so no need for government intervention" thesis.

Now, it's quite possible that this isn't the argument he's trying to make, but it should be no surprise that given the tropes he's chosen to use, it's interpreted that way.

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