U.C. Berkeley economist Brad DeLong has a recurring series on his popular blog where he nominates people for being the “stupidest person alive.” DeLong’s fans think this is quite amusing, whereas his critics might disagree. Recently DeLong nominated a trio of people who thought the world was in store for an “energy cornucopia.”
For his part, DeLong is resigned to a bleak future of scarce energy. It will be interesting to contrast the two views, and explain the possible role of the Fed’s loose monetary policy.
Betting on Optimism
Last month John Tierney wrote a NYT article called “Economic Optimism? Yes, I’ll Take that Bet.” He opens with a discussion of his successful $5,000 wager against a (now-deceased) leading “peak oil” theorist:
Five years ago, Matthew R. Simmons and I bet $5,000. It was a wager about the future of energy supplies — a Malthusian pessimist versus a Cornucopian optimist — and now the day of reckoning is nigh: Jan. 1, 2011.
The bet was occasioned by a cover article in August 2005 in The New York Times Magazine titled “The Breaking Point.” It featured predictions of soaring oil prices from Mr. Simmons, who was…the author of “Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy.”
I called Mr. Simmons to discuss a bet. To his credit…he was eager to back his predictions with cash. He expected the price of oil, then about $65 a barrel, to more than triple in the next five years, even after adjusting for inflation. He offered to bet $5,000 that the average price of oil over the course of 2010 would be at least $200 a barrel in 2005 dollars.
I took him up on it, not because I knew much about Saudi oil production or the other “peak oil” arguments that global production was headed downward. I was just following a rule learned from a mentor and a friend, the economist Julian L. Simon.
For those unfamiliar with the famous wager between free-market economist Julian Simon, and Population Bomb doomsayer Paul Ehrlich, Tierney’s account is important reading. (John Holdren, President Obama’s current science advisor, was also on the losing Malthusian side of the bet.) After recounting the famous Simon-Ehrlich wager, Tierney goes on to discuss the case for continued optimism about global energy supplies:
It’s true that the real price of oil is slightly higher now than it was in 2005, and it’s always possible that oil prices will spike again in the future. But the overall energy situation today looks a lot like a Cornucopian feast, as my colleagues Matt Wald and Cliff Krauss have recently reported. Giant new oil fields have been discovered off the coasts of Africa and Brazil. The new oil sands projects in Canada now supply more oil to the United States than Saudi Arabia does. Oil production in the United States increased last year, and the Department of Energy projects further increases over the next two decades.
The really good news is the discovery of vast quantities of natural gas. It’s now selling for less than half of what it was five years ago. There’s so much available that the Energy Department is predicting low prices for gas and electricity for the next quarter-century. Lobbyists for wind farms, once again, have been telling Washington that the “sustainable energy” industry can’t sustain itself without further subsidies.
The Case for Pessimism
After two free-market economists lauded Tierney’s case, DeLong made his charming nomination for them (and Tierney) being the “Stupidest Man Alive.” An economist himself, DeLong in a subsequent post argued that the market itself put the lie to Tierney’s sunny outlook:
The professionals, of course, do not think that the overall energy situation looks like a “cornucopian feast.” If they did, then they would be selling their oil in the ground right now at an “energy cornucopia” price. What [would] an “energy cornucopia” price be? Well we had an energy cornucopia in the first post-World War II generation–and, adjusted for inflation, the price then corresponds right now to a price of $20/barrel. If the professionals saw an energy cornucopia coming, they would be pumping more oil out of the ground right now and selling it for a lot less than $80/barrel in order to make money before the price of oil falls to its cornucopia price.
Instead, the professionals think that keeping oil in the ground rather than selling it at $80/barrel is a reasonable bet.
Refereeing the Dispute
No one knows the future for certain, so it’s possible either side will eventually be vindicated by the facts. However, DeLong and Tierney might not actually be disagreeing so much on the facts as on their interpretation of them.
For one thing, DeLong is certainly correct that professional speculators do not seem to anticipate $20 oil in the near future. (If they did, they would be massively shorting oil futures and other derivatives—just as DeLong says.) But where did Tierney say that he was predicting $20 oil? Reading his article, it is clear that Tierney is trying to debunk the doomsayers’ projections that oil will rise sharply in price because of limited resources and growing human appetites.
So when Tierney talks of an “energy cornucopia,” he primarily had in mind the physical availability of energy to supply the demands of industry and households. As David R. Henderson pointed out, DeLong should be sympathetic to this usage of the term, since DeLong himself employed it (in a different context) when writing an encyclopedia article on the material prosperity of the 20th century.
A second important factor in this debate is the role of the Federal Reserve’s aggressive monetary policies of the last two years. As we have previously argued, the tripling of crude prices in two years (from their trough in December 2008) could be at least partially attributable to investor fears of inflation. Therefore, oil producers (such as the Saudis) could be hoarding their supplies in the ground right now, not because they anticipate a global oil crunch in the next few years, but rather because they think the dollar itself may sink sharply in value.
In other words, DeLong is correct to say that oil producers (and speculators) don’t forecast $20 crude oil, but that’s possibly because they predict that prices quoted in dollars in general will rise. When Tierney and Simmons made their bet, they adjusted crude prices for the general level of prices, i.e. they bet on the “inflation-adjusted” price of crude.
In summary, it’s possible Tierney and DeLong are both right, but for different reasons: Market professionals don’t buy into the doomsday predictions of an energy crunch, but they also don’t expect the absolute dollar-price of oil to sink to previous levels, when the dollar was a much stronger currency.
Especially over the long run, innovative entrepreneurs tend to solve problems and create a better world, as gauged by material indicators of economic output. In the area of energy supplies, we see this in the fact that global petroleum liquids output continues to set new records, year after year (.xls), even as the world stockpile of “proven reserves” steadily grows (.xls).
Planet Earth has more than enough conventional energy stockpiles to satisfy human needs for the foreseeable future. So long as government policies don’t cripple entrepreneurs’ ability to turn those resources into usable products, we have nothing to fear. We can indeed bet on an energy cornucopia.