You will never wake to the headline, “Today, the world ran out of oil.” Rather, global oil
production will rise, reach one or more “peaks,” and decline. Forecasts for the peak vary between
Thanksgiving, 2005 and 2050. Personally, I think global oil production will peak between 2015 and
2025 and be a greater challenge than the “looming crisis” in social security.
The peak marks a fundamental change in oil supply. Prior to the peak, production can increase
with little or no increase in oil prices…. After the peak, production declines, regardless of
Declining oil supplies will be a watershed in economic history of the twenty-first century.
Because oil readily comes from the ground and is easily refined, oil generates a large energy
surplus that powers the non-energy sectors of the economy, such as the transportation networks that
support international trade, living patterns, and modern agriculture….With twenty years till the
peak, no fuel now being researched generates a greater surplus or can be used more efficiently than
I agree strongly with most of what Robert said…. The one aspect of Robert’s analysis to which I
might add a qualification is the suggestion that oil prices need not rise much until after we’re
past the peak. While that might be true from an engineering cost point of view, it ignores the
opportunity cost. As I
noted here, it makes no sense to sell oil for $60 today if you could get $200 by holding that
barrel back in order to sell it a few years later. What I instead expect to see is for oil prices
to rise gradually as we get closer to the peak, and start rising pretty quickly once it’s less than
five or ten years out. Those price rises are in fact critical for making this economic
I am less sanguine than James in the market’s ability to anticipate the peak and price oil
accordingly. Statistical studies of future markets indicate that price of oil in the “outer months
(six months or a year ahead)” is not a very good “predictor”….
Large fields can maintain a steady rate of production for many years and then decline steeply.
The markets’ ability to anticipate the timing and rate of decline is limited by the lack of
transparency. Without SEC rules that define proven oil reserves, OPEC’s estimates are mix of
geology and politics.
Again, that’s all very much true. I would perhaps express it not so much as “markets are not a
very good predictor” as “nobody’s a very good predictor.” It’s very hard to know for sure exactly
when the peak is coming, for precisely the reasons that Robert gives.
But any such statement invites us to look at the underlying policy question…. I don’t see
uncertainty about the world as something that would give us a good reason to prefer government
intervention over market solutions; if the market is uncertain, then so should you be about what
the best government policy would be.
In fact, the more uncertainty we have about these matters, the more I am inclined to turn to
markets to assimilate that information for us. After watching the href="http://www.knowledgeproblem.com/archives/001350.html">sausage- href="http://www.env-econ.net/2005/07/3_of_energy_bil.html">creation of the current energy bill
before Congress, I have relatively little faith that Washington is going to figure out for us
exactly which technologies are most promising. But the entrepreneur who brings a workable hybrid
vehicle to the market will make himself or herself quite rich. The lure of earning such profits
is, in my mind, a much more powerful and effective incentive than anything that the world’s leaders
are likely to dream up and try to lead us to on their own.
Sound policy should establish an economic environment that increases the economic returns and
reduces the risk to long-term research and development on alternative energies. Specifically,
policy should impose a large energy tax that is phased in over a long period, perhaps twenty years.
… Phasing in an energy tax would send a signal to entrepreneurs that there will be a market for
alternative energies. The tax does not pick technologies– that will be left to the market, which
is smarter than any Democrat, Republican, or even myself!
Why is such an approach needed? If the market does not anticipate the peak, the price signals
needed to stimulate research and development may not arrive until after the peak. By then, it
will be too late to avoid major disruptions. Think about the changes needed to replace motor
gasoline. Society will have to retool the auto industry, alter every gas station, and retrain
every auto mechanic. These changes need to start before the peak. If they start after, they will
add to the disruptions caused by the peak.
I am also very sympathetic to the idea of using taxes in this way. Usually economists look for a
justification for such a policy in terms of externalities, some reason why the true cost to society
of using another barrel of oil today is greater than the production plus opportunity cost perceived
by the owners who sell the oil.
I think one such externality is related to the geographic location of the remaining world’s
reserves. As the U.S. and North Sea reserves get depleted, the world is increasingly reliant on
places like Saudi Arabia, Iran, and Venezuela, whose governments are actively using the oil
revenues they receive from us in ways that are very fundamentally contrary to the interests of most
There also is a classic economic externality that may lead to underfunding of basic research.
For something like fusion, it is clearly unreasonable to expect the private market to invest
adequate resources, because the benefits to society from a successful program exceed the private
returns to individual investors. On the other hand, as you get into more specific and near-term
technologies, the justification for government involvement becomes less clear.
Government policy aimed at the next energy transition must strive for efficiency, which is a good
thing, but too much of a good thing is not good. Efficiency cannot and should not be the sole
criterion. One can think of important and successful policies that were not guided only by
principles of economic efficiency.
The totality of impacts may force policy makers to rely heavily on the precautionary principle,
which compares the costs of being correct against those of being incorrect. We know that oil
production will peak within our lifetime, we think market prices may not anticipate this peak, and
we know that not having alternatives in place at the time of the peak will have tremendous economic
and social consequences. So, if society does too much now, as opposed to later, there will be some
loss of efficiency. But if society does too little now, as opposed to later, the effects could be
disastrous. Under these conditions, doing too little now in the name of efficiency will appear in
hindsight as rearranging deck chairs on the Titanic.
To me, “economic inefficiency” refers not to paying a little more at the gas pump, but rather to
taking valuable resources and throwing them into the ocean to no one’s benefit. We only have so
much in the way of resources to cope with these great challenges– only so much capital to invest,
only so many geologists to figure out how to get at the oil that remains, only so many engineers to
develop alternatives. It is precisely because I agree with Robert about the importance of this
transition that I think it’s critical that we put all our resources to their best use.
And I honestly believe that the best way to ensure that happens is to count primarily on the
same system that has generated the fantastic improvements in global living standards over the last
few centuries, namely, individuals choosing to direct the resources they personally control to
those activities that yield the highest personal reward. Yes, the risks are great here, but so are
the private rewards to those who best figure out how to navigate our way through them.
In so saying, let me be clear that I distance myself from those who might claim that there is
nothing to worry about and markets will solve everything. I think there is plenty to worry about,
and markets may or may not solve the problems. But what I am saying is that I see private
incentives as our best hope.
There’s quite a bit more that each of us had to say. You can check out the complete discussion
at href="http://online.wsj.com/public/resources/documents/econoblog08032005.htm">Wall Street Journal Online. You’re also welcome to express your thoughts and comments on
these issues both at the href="http://discussions.wsj.com/n/mb/message.asp?webtag=wsjvoices&msg=3591.1&ctx=0 ">Wall Street
Journal site and right here.