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Prisoners of Math: Falling into the Resource Fixity/Depletion Imbroglio

[Editor note: the current debate over climate policy has obscured another important energy-policy controversy: the notion that the production of hydrocarbons (even coal) has, or will soon, reach a physical peak. This post, like the author's previous ones on this subject, shed light on the fallacious concept (from a business/economic viewpoint) that mineral supply is fixed and thus depleting.]

The recent death of Patrick McGoohan brings to mind one of the best lessons offered by television, and one ignored by all too many analysts (including academic economists). In an episode of his cult-classic series The Prisoner, McGoohan is confronted with a unique teaching system, wherein “The General” pumps information into villagers while they sleep. The General proves to be a ‘supercomputer’ (presumably less capable than desktops now available) containing all known information. McGoohan causes it to breakdown by asking the simple question “Why?”

It has become common amongst many academics to do research that consists primarily of examining streams of data, using sophisticated mathematical tests. For example, Maslyuk and Smyth (2009) test to see if oil production data show unit roots. Slade (1982) and Pindyck (1999) examine price series to determine the appropriate path of mineral and/or energy prices, and particularly whether linear or quadratic equations better fit historical data. But none of them include any explanatory variables, that is, none ask why production or prices behave the way they do, and they typically ignore the effects of price controls, tax changes, and so forth.

Others at least have the excuse that they are not economists and/or not trained in mathematical modeling. Peak oilers like Colin Campbell, Jean Laherrere, Jim Rodgers, and others note declining production and extrapolate that into the future. In part, this reflects the faux debate between geologists and economists. The former object to the latters’ assertion that higher prices bring on more supply, misinterpreting this to mean that higher prices somehow add to oil resources rather than to investment, discovery, and production.

Still others are performing simple extrapolation (perhaps without realizing it) or assuming physical models rather than economic ones to explain the behavior of oil production. Rodgers, for example, assumes that once production decline has occurred, it will continue, despite abundant evidence to the contrary. This is quite common now amongst those believing that non-OPEC production—and possibly global production—has peaked. For example, Raymond James Associates notes the recent decline in certain areas and extrapolate it further.

Mineral and energy prices do not follow a particular physical law, especially in the United States where a variety of factors, such as wellhead price controls for oil and gas, intertemporally shift production. Indeed, both Slade and Pindyck note a trough in prices during the early 1930s, but think this reflects the shift from improving production methods to growing scarcity as opposed to the onset of the Depression.

Similarly, peak oil advocates point to declining Mexican production as a sign of an imminent global peak, ignoring the clear indications that it came in response to the government’s lengthy policy of starving the national oil company of capital. Russian oil production likewise demonstrated weakness over the last year as falling oil prices met high oil export taxes. The last few months have seen exports holding up, although presumably weak domestic demand is a factor.

References:

Maslyuk, Svetlana and Russell Smyth, “Non-linear root properties of crude oil production,” Energy Economics, 2009.

Pindyck, Robert S., “The Long-Run Evolution of Energy Prices,” The Energy Journal, 1999.

Slade, Margaret, “Trends in Natural-Resource Commodity Prices: An Analysis of the Time Domain”, Journal of Environmental Economics and Management, Vol. 9, No. 2, June 1982, pp. 122-137.

5 comments

1 ZK { 05.19.09 at 8:13 am }

Merely two years ago these same people were forecasting the U.S. to soon proceed off a cliff in natural gas production. None of them took into account the vast quantities of shale gas that have become available as techniques have advanced. The innovation and creativity of free markets is nowhere in their models, so their predictions will invariably be left in the dust everywhere that creativity is allowed to florish.

2 Andrew { 05.19.09 at 1:01 pm }
3 Peak Oil Nonsense, and Clean Energy Hooey. « American Elephants { 05.20.09 at 11:30 pm }

[...] transportation.  Wind and solar produce some electricity, but do not power automobiles. Peak oil advocates point to declining oil production in Mexico as a sign of an imminent global peak, but ignore [...]

4 Christopher { 06.09.09 at 11:04 am }

The last time I checked, the peak oilers weren’t denying that structural effects have all kinds of consequences for oil prices. The question I think you and they differ on, and which you failed to address in this post, is whether or not these are fluctuations about a long-term trend dictated by physical realities. Is there a finite extractable amount of oil in the ground? Yes. Does the amount we can extract go up when the price of oil goes up? Of course. At what point does that price go high enough that it becomes dangerous to an oil-dependent economy, and when will we reach it, and will it be a new floor on energy prices, and what effects will it have on our economy? And, ultimately: will we switch to renewables fast enough? These are the questions worth asking and answering.

5 rbradley { 06.14.09 at 9:46 pm }

My 2004 essay for PERC Reports might be of interest:
http://www.perc.org/pdf/sept04.pdf

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