When to Rob a Bank: ...And 131 More Warped Suggestions and Well-Intended Rants by Steven D. Levitt, Stephen J. Dubner Page A
Authors: Steven D. Levitt, Stephen J. Dubner
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from natural gas or coal, become economically viable as the going rate for a barrel rises past, say, $40 or more, especially if consuming governments choose to offer their own incentives or subsidies. So even if high prices don’t cause a recession, the Saudis risk losing market share to rivals into whose nonfundamentalist hands Americans would much prefer to channel their energy dollars.
As he notes, high prices lead people to develop substitutes. Which is exactly why we don’t need to panic over peak oil in the first place.
So why do I compare peak oil to shark attacks? It is because shark attacks mostly stay about constant, but fear of them goes up sharply when the media decides to report on them. The same thing, I bet, will now happen with peak oil. I expect tons of copycat journalism stoking the fears of consumers about oil-induced catastrophe, even though nothing fundamental has changed in the oil outlook in the last decade.
Betting on Peak Oil
(SDL)
John Tierney wrote a great New York Times column in response to Peter Maass’s Times article about peak oil that I criticized. Tierney and the energy banker Matthew Simmons, who is the point man for the peak-oil team, made a $5,000 bet as to whether the price of oil in 2010 would be above or below $200 a barrel (adjusted for inflation to be in 2005 dollars).
The bet was designed in the spirit of the famous bet between Julian Simon and Paul Ehrlich , which the economist Simon won when the five commodities that Ehrlich said would rise in price actually fell substantially.
I am a betting man. And when I see that the NYMEX December 2011 crude oil future is priced under $60 a barrel, under $200 looks like a pretty good price to me! So I asked Simmons if he wanted any more action.
He was kind enough to write me back. As it turns out, I wasn’t the first economist to offer him some more action. He declined to take my bet but he stuck to his guns in his belief that oil is priced way too cheaply, and that “real economic pricing will soon end almost a century of fantasy prices.”
One thing that Simmons is definitely right about is that oil and gas are mighty cheap by volume compared to other things we consume. Imagine that a brilliant inventor came along and said he had invented a pill you could drop into a gallon of distilled water to turn it into gasoline. How muchwould you be willing to pay per pill? For most of the last fifty years, the answer is next to nothing, because a gallon of gas usually costs about the same as a gallon of distilled water.
But one place where I think Simmons’s logic goes awry is that he seems to be arguing that because a gallon of gas is so valuable relative to say, a rickshaw driver, it should be as expensive as a rickshaw driver. In reasonably competitive markets, like the ones for gas and oil and presumably rickshaws, the determinant of price is how much it costs to supply the good, not how much consumers are willing to pay. That is because the supply of the good is close to perfectly elastic over some reasonable time horizon. If there were huge profits to be made at some price, firms will compete away the profit by lowering price. How much consumers like the good just determines the quantity consumed when supply is perfectly elastic. That is why water, oxygen, and sunshine—all incredibly valuable products—are virtually free to consumers: it is cheap or free to supply to them. And that is why we use a lot of gas and oil, but not many rickshaws at current prices.
If the cost of supplying oil suddenly jumped, then prices would certainly rise, more in the short run than the long run, as people figured out how to substitute away from using gas and oil. (Rickshaws, most likely, won’t be the primary form of substitution, at least not in the U.S.) Whether we should care about “peak oil” boils down to: 1) Will the cost of supplying oil jump; 2) If it does jump, by how much; and 3) How elastic is the demand?
John Tierney won his bet:
As he notes, high prices lead people to develop substitutes. Which is exactly why we don’t need to panic over peak oil in the first place.
So why do I compare peak oil to shark attacks? It is because shark attacks mostly stay about constant, but fear of them goes up sharply when the media decides to report on them. The same thing, I bet, will now happen with peak oil. I expect tons of copycat journalism stoking the fears of consumers about oil-induced catastrophe, even though nothing fundamental has changed in the oil outlook in the last decade.
Betting on Peak Oil
(SDL)
John Tierney wrote a great New York Times column in response to Peter Maass’s Times article about peak oil that I criticized. Tierney and the energy banker Matthew Simmons, who is the point man for the peak-oil team, made a $5,000 bet as to whether the price of oil in 2010 would be above or below $200 a barrel (adjusted for inflation to be in 2005 dollars).
The bet was designed in the spirit of the famous bet between Julian Simon and Paul Ehrlich , which the economist Simon won when the five commodities that Ehrlich said would rise in price actually fell substantially.
I am a betting man. And when I see that the NYMEX December 2011 crude oil future is priced under $60 a barrel, under $200 looks like a pretty good price to me! So I asked Simmons if he wanted any more action.
He was kind enough to write me back. As it turns out, I wasn’t the first economist to offer him some more action. He declined to take my bet but he stuck to his guns in his belief that oil is priced way too cheaply, and that “real economic pricing will soon end almost a century of fantasy prices.”
One thing that Simmons is definitely right about is that oil and gas are mighty cheap by volume compared to other things we consume. Imagine that a brilliant inventor came along and said he had invented a pill you could drop into a gallon of distilled water to turn it into gasoline. How muchwould you be willing to pay per pill? For most of the last fifty years, the answer is next to nothing, because a gallon of gas usually costs about the same as a gallon of distilled water.
But one place where I think Simmons’s logic goes awry is that he seems to be arguing that because a gallon of gas is so valuable relative to say, a rickshaw driver, it should be as expensive as a rickshaw driver. In reasonably competitive markets, like the ones for gas and oil and presumably rickshaws, the determinant of price is how much it costs to supply the good, not how much consumers are willing to pay. That is because the supply of the good is close to perfectly elastic over some reasonable time horizon. If there were huge profits to be made at some price, firms will compete away the profit by lowering price. How much consumers like the good just determines the quantity consumed when supply is perfectly elastic. That is why water, oxygen, and sunshine—all incredibly valuable products—are virtually free to consumers: it is cheap or free to supply to them. And that is why we use a lot of gas and oil, but not many rickshaws at current prices.
If the cost of supplying oil suddenly jumped, then prices would certainly rise, more in the short run than the long run, as people figured out how to substitute away from using gas and oil. (Rickshaws, most likely, won’t be the primary form of substitution, at least not in the U.S.) Whether we should care about “peak oil” boils down to: 1) Will the cost of supplying oil jump; 2) If it does jump, by how much; and 3) How elastic is the demand?
John Tierney won his bet:
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