Tuesday, 3 June 2008

What do the Economists say?

A scary illustration thrown in to catch your attention

A comment often voiced about oil depletion is that surely the economists modeling the markets know about this and have something to say.

Unfortunately, barring a few physically minded economists (e.g. Ayres, Georgescu-Roegen) the number of economists trying to understand the issue has been relatively small. Most have been merely studying price elasticities, market substitution price levels and world economic growth impacts as black boxes with no input from the physical reality. That is, they have tacitly assumed without proof that markets will fix the issue and find a new equilibrium without a single hiccup.

However, the exceptions to the rule are coming to the surface now more frequently. A couple of noteworthy examples are:

Fueling Growth when Oil Peaks, Garcia, Smulders (2008)
"We also arrived at the conclusion that some important economic trends in
energy use and prices, which we observe in reality, are likely to be reversed in the
future. First, the model predicts that per capita energy use will start declining at some point in the future, and will keep declining in the long run."
Strategic Oil Dependency, Reyer Gerlagh, Matti Liski (2007)
"When moving to renewables and unconventional oil, the market becomes more capacity constrained when facing short run shocks, potentially increasing market power of those holding the remaining conventional oil stocks."

While the findings are not necessarily anything new to people following the oil depletion discussion, it is noteworthy that these are post-doc economists talking oil depletion and noting at least three interesting points that the mainstream economy watchers and the media seem to completely miss:

  1. We are likely to move into an energy constrained future (less energy/capita)
  2. Supply shocks become more likely (whatever the transition type)
  3. Most importantly: it is probably within the interest of OAPEC to keep the markets supplied and deny the peak, until it cannot be avoided anymore. At that point, the rapidly rising prices due to shrinking supply, and lack of alternative fuels due to lateness of new energy technology adoption ensure continued profit for AOPEC nations, even in the face of decreasing net exports. Or to put it in other words, the last remaining oil exporters will try to delay the rest of the world moving off oil to any other energy technology, because doing so will maximize the cumulative profits for such oil exporters (possibly at the expense of the security/price paid/stability of the oil users).
The last point is a worthy one. If a couple of European economists are able to model that, then surely the few dozen thousand investment bankers and economists working in Riyadh can manage the same. Oil producers are not stupid. They have their own people and future to think of.

Yes, it is just a model and model is not reality.

However, if in this case the model roughly approximates reality, then we're in for a ride of our life, when the last remaining giant reserve countries finally announce they've hit the peak. However, we are likely to get the same information via the markets, long before the countries admit it publicly.