Friday, February 09, 2007

Peak Oil-ers Do Not Understand Markets

The ‘Peak Oil’ debate is one of the regular use of alarm-and-despondency, added to popular ignorance, to frighten the chattering classes into desperate measures to combat whatever the pressure group considers the world’s number one priority.

So far, on an environmental front allied to global warming, the ‘alarm and despondency’ tendency has caught the eyes of governments, lobby groups, politicians in and out of office, the media (which loves nothing so much as a headline-grabbing story for its news cycles), and the impressionable minds of children and some parents, that ‘something must be done’.

Well, that’s not for me to get involved in. After aids, Mad Cow Disease, lead-in-petrol panics, terrorist bombings, radiation poisoning, ID cards and Big Brother in the guise of the Nanny State ('everything we eat is poisoning us'), I am quite relaxed about the latest end-of-the-world-is-nigh hysteria, especially when exponents parade their ignorance of basic economics; a far easier challenge than understanding the natural sciences. I am not sure the global warmers are sound in their claims to scientific certitude, but I am absolutely sure that Peal Oil-ers do not understand the economics of markets.

A Mr de Sousa, apparently a Peak Oil-er, writes:

A regular economist will tell you a fable like this:
If a shortage of potatoes occurs either by lack of supply or by growth on demand the market price will rise. This new higher price will signal to the farmers a need to produce more. Supply will rise, meeting demand, lowering the price and bringing the market back into balance.”

And Tim Haab on of the impressive “Environmental Economics” Blog takes him up on the fabulous nonsense of the above quotation. I shall not try to improve on Tim Haab’s demolition of Mr de Sousa’s presentation of how a market adjusts to an excess demand at the going price.

Tim Haab writes:

If there is a lack of supply--presumably due to some unexpected conditions like a drought--or growth in demand, the market price will rise. I agree. But, the reason the price will rise is to remove the shortage. A shortage occurs when the quantity demanded exceeds the quantity supplied at a given price. This creates upward pressure on the price causing consumption to fall and quantity supplied to rise. This is what Adam Smith referred to as the invisible hand and TODEE refers to as the magic hand. When the price rises high enough, quantity supplied will equal quantity demanded and the shortage is gone. So far I agree with the potato fable--although I might have worded it a little different.

Whether the physical quantity supplied rises depends on many factors and the time-lags involved (supplies do not adjust at infinite velocity); but what is certain (barring government intervention) to happen is that price will rise and this reduces effective demand, often quite quickly at the margin, and increasingly so, as customers are disappointed when sellers refuse to sell at the previous going prices.

Mr de Sousa’s potato example itself should have told him about the growing season (a lack of knowledge of botany and biology?) and it will take time to increase the physical supply, should that be a response from suppliers on this occasion. The increase the physical supply of oil depends on geology and the costs of extraction, and the availability of the products of substitute technologies, and suitable politics.

Where I do have a reservation about Tim Haab’s rebuttal of the luckless Mr de Sousa’s efforts is in his statement that: “This is what Adam Smith referred to as the invisible hand and TODEE refers to as the magic hand.”

Regular readers know that Adam Smith said no such thing about price adjustments in markets linked in any way to ‘an invisible hand’. New readers may scroll down the archives and see many examples of what he used the metaphor of ‘an invisible hand’ for and they do not include price theory.

I have no idea what ‘TODEE’ stands for, or what they mean by the ‘magic hand’. It has nothing whatsoever to do with Adam Smith’s political economy, or with economics. ‘Magic’ belongs to nonsense like astrology, contacting the dead in séances, Tarot cards and superstition.

There is nothing ‘magic’ in markets; their processes are well known and commonly understood by Economics 101 (though apparently not by Peak Oil-ers). Like rainbows, markets may be admired but not wondered at, and understood but not worshipped.

[Read Tim Haab’s measured demolition of the latest economics from the Peak Oil-ers at:]


Blogger obewan said...

The blogger does not understand statistics 101 or the bell curve. Oil is not a renewable resource like potatoes that can be "grown" to replace a supply shortage. When world demand EXCEEDS ALL available SUPPLY, economic DELCINE will be inevitable. That is the basis of the peak oil theory and econmnics 101. Quote the real statistics if you want to substantiate your weak position.

7:55 pm  
Blogger Saildog said...

I agree with Obewan. The blogger hasn't a clue. Economics 101 is all very well as an explanation for the bleeding obvious, but why bother us with the pseudo-science clap-trap?

The problem is that people listen to economists. They are dotted around in government and big corporations with far too significant an impact on key strategic decisions. They have been demonstrably wrong on oil for several years now, yet (some) people still listen to them.

I understand they do not understand the laws of thermodynamics (that is a BIG gap in economics), however Peak Oil is very easy to understand. It goes like this:

Current global oil production is 85m barrels per day (approx.).

Existing oil fields are suffering declining production of 4m barrels per day every year.

New oil (or suitable substitutes) production must grow by at least as much as the decline rate in order to maintain production.

The latter is happening, but only just. Production is "stuck" (including substitutes) at around 85m barrels per day. There is a lot of evidence that production cannot or will not increase. It doesn't matter which, production is still stuck.

With supply inelastic, price can only go up, so long as the demand is there.

That is why the price is $124. It isn't rocket science, its an Economics 101 explanation for Peak Oil.

The laws of thermodynamics are important because unlike the laws of economics the laws of thermodynamics are real laws. You cannot fool around with them and make up intelligent sounding put downs. The point is that oil/substitutes production may be steady at 85m barrels, but the energy contribution to society steady is declining, because oil is coming from more difficult places and substitutes include boondoggles like ethanol. That is another reason for the price: the same volume includes significantly less net energy (gross energy less energy consumed in procurement)

Then there is the thorny problem of net exports; and these are also in decline. Russia, Norway and Saudi, the three biggest oil exporters all exported less oil in the last two years. With flat and declining production, booming economies and rampant domestic oil consumption growth, their net exports are doubly suffering. Add to that 20% growth from China and it is clear that other importing countries have a significant problem.

Adam Smith, his invisible hand and economics in general are arrogant, irrelevant and do not understand the problem. They have no use in the discussion.

4:16 am  
Blogger lynton said...

I would have thought that how acute the problem of the economics of supply and demand might be not only depends on how renewable a commodity might be but also how essential it is and the availability of suitable alternatives.
There are many alternatives to potatoes (except if you lived in Ireland in the 1840's) there are not so many suitable alternatives to oil at the moment.

The idea of peak oil is all well and good this goes for any non-renewable resource. The nub of the problem lies in planning for the proportional use of different energy sources including nuclear power for different uses.

The future of our world is not dependent on economics only thermodynamics

7:04 am  

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