Usually I don't like to respond point by point to a readers comments--especially in a new post, but one of the comments on yesterday's post on Peak Oil clearly illustrates the differences in opinion between economists and natural scientists as to how oil markets will play out. I thought seeing the debate in a post would be informative. This should in no way be viewed as a personal attack. We truly value all of our readers comments--except maybe Joshua and Dano--and hope that debates like this help to inform both sides. So here goes:
In response to my claim that peak oil is a non-issue, reader Michael P. writes (my responses are in italics).
Guys, a few key questions for you before you write off peak oil as a non-issue.
* Why do they call unconventional petro resources "unconventional"? Could it be because they are a worse deal, economically than the light sweet crude oil we've already burned through? Any thoughts on the fact that we've peaked on production of light sweet crude, and now have to make that up with these other sources?
Exactly--if by worse deal you mean more expensive and less efficient. That's the whole point. We pick the low hanging fruit first then the high hanging fruit. Light sweet crude is/was cheap. Now we're moving towards more expensive sources. In response, prices will rise. And that's a good thing. High oil prices are not a problem. Low oil prices are.
* What's different about deep-water oil production compared with extraction from the 1930's? Are the economics comparable?
Ummm...I'm not sure.
* Are tar sands just another unexploited resource? Or is this a raw deal costing Canada their natural gas supplies, their fresh water, and their environment, all adding up to a very costly liquid fuel? Hmmm, maybe NAFTA is about more than just "free trade", since it also secures US access to natural resources from other countries? Wonder if those Canadians and Mexicans are getting pissed off for a good reason after all.
Two things here. 1) If the U.S. is willing to pay enough, Canada may be willing to accept payment for their oil sources. That's how markets work. If a trade is mutually beneficial, both parties will agree. If one party feels a trade is not in their interest, the trade doesn't take place. Is that unfair to some people? Absolutely. But what's the alternative? 2) You bring up the environmental costs of extracting new sources. This is obviously an important issue, but one I intentionally left out of the post yesterday. I wanted to focus attention on the price adjustments to a depleting pool of a fixed resource rather than the external costs. Once we abstract from the external costs, the simple model hypothesizes--can model hypothesize?--that market forces (that is, prices) will efficiently allocate the remaining pool of oil. Once we understand that, we can then focus on how those prices respond--or fail to respond--to external policies and costs, like those you mention.
* What do you think about the statistics on the number of countries already past their production peak? Think an ever fewer number of producers will always be able to make up for the mounting production declines of everyone else?
At the risk of coming across as cavalier, I don't think it matters. The fact that production is declining simply implies that prices have to rise. If they are allowed to rise--that is if prices aren't impeded by policy or externalities--then the incentive will be there to look for new sources. If new sources aren't there, then the rising prices create the incentive to invest in alternative fuel technologies. The incentive is also there to conserve. Will it be a smooth transition? Maybe not perfectly smooth. Sure there will be some price fluctuations, and any technological transition is pleasant for some and unpleasant for others. Do you think that everyone was happy about the transition from horse and steam to internal combustion transportation? Nope, I'm sure there were a lot of people displaced. But is anyone willing to argue we're worse off as a result--never mind, I probably shouldn't ask a question for which I'm afraid of the answer.
* How does EROEI play into the economics of the energy extraction business? Could some energy sources be more profitable than others? Might the profitability of a single natural source decline over time?
EROEI--Energy Return on Energy Invested--had to look that one up. My simple understanding--When EROEI is less than 1, the production of the energy source eats up more energy than it produces. In such a case, it would be unprofitable and no reasonable firm would invest in such technologies. That means one of two things. First if it is an existing energy source, it is likely that source will be abandoned in favor of a newer more profitable one. Second, if it is a new energy source where the EROEI is low because technology isn't well developed yet (maybe corn-based ethanol?) then there may need to be public investment in R&D to produce innovation--read subsidy. Yes profitability declines over time, and that's a good thing! If it didn't it would mean the market is not signaling scarcity.
* What do you think about oil discovery rates declining over the past few decades? Concerned that for some time now we've been buring more than we find each year?
No concern. I would only be concerned if prices weren't responding. But they are. Again, prices need to rise to create the necessary incentives. Market based high oil prices are not a problem. Artificially low oil prices are.
* How does the "scalability" of alternative resources stack up to our current levels of petro consumption? Does your analysis show that we can replace the energy we're consuming through ramping up renewable sources to the same levels?
No, I think the world will be a much different place with renewables. Economic models can't predict what the new technologies will look like, or where they will be located on anticipate new inventions or discoveries. But they can investigate the inherent incentives to look.
* Check out the "stabilization wedges" that try to help us minimize global climate change. Replacing our petro consumption with other sources is a very similar problem. The numbers don't really add up.
Not sure what a stabilization wedge is--I think I used one when I replaced a window one time. Anyway, you seem to be assuming that we need to replace energy one-for-one. There is no such requirement. Change happens, and change is good. It may be uncomfortable for some during a transitions, but in the long run, it's called progress.
* For historical situations where we overcame some natural resource limit, what percentage of those were overcome by using vast inputs of cheap energy? E.g. wood supplies, the green revolution, ocean fishing, ground water irrigation, global trade routes, top soil depletion, vertical cities, etc.
I think I'm running out of steam, because I'm not sure how to interpret the question.
The arguments *against* peak oil are simply not holding up to close scrutiny. That's why this topic has been taking off over the past couple of years. Not because its a fad where people simply misunderstand economics, but because people are beginning to educate themselves on the geology, the mathematics, and the science behind our actual and potential energy sources.
Again, peak oil is not the issue. Oil depletion is the issue. Focusing on the peak causes panic where panic is unnecessary. Prices will not peak at peak oil. Prices will continue to rise in response to increased scarcity. Getting those prices right should be the focus.
John and Tim, keep it up with those econ undergrads. You tell 'em: economic markets will not be constrained by natural resource limits. You might want to also mention fish stocks, lumber supplies, grain production, fresh water availability, and top soil. Adam Smith to the rescue! Way to go, boys.
Gee--I detect sarcasm, without an emoticon even. Each of the problems you mention are examples of market failures. That is, something going wrong with the market allocation. Economists have been studying them for years and have developed ways to correct market failures. Economic analysis of markets is not about leaving the market alone. It's about getting the market based allocation right. Many of the problems you mention are due to bad policy. Not bad economics.