Brad DeLong's Semi-Daily Journal (2004)

This may be the first signs that we are reaching Hubbert's Peak (if indeed we have not passed it). Ken Deffeyes wrote an excellent book _Hubbert's Peak_, in which he marshalled quite a few convincing arguments from various data that we should be reaching Hubbert's Peak right about now. And the decline in available oil, with China and the rest of the world needing increasing amounts, will probably be swift. (I just ordered a Prius, BTW.) see also www.hubbertpeak.com

Question: Do oil producers really have any incentive to produce more? As far as I can see it costs no more to produce a barrel of oil during a shortage than it does a glut, and they make much more money during times of shortage.

So why is it assumed that producers will produce more when prices go up? I can see why NEW producers would enter the market, but the data seems to suggest there aren't any to come in.

Also, isn't there a formula for calculating the price to optimize profits in a monopoly situation? If I recall the answer isn't the highest or lowest possible price. Why wouldn't the producers just get together and use that formula?

$40 is the new floor. As soon as we figure out that Saudi has peaked the sky is the limit.

We were told that the Saudis were advocating an increase that would save us. Well. The increase that the Saudis are talking about would simply rescind the cut that they announced last month. The purpose of last months cut was to take them below their capacity so they could make a big show out of increasing their production now.

We is screwed.

The simple answer, Alan, is that producers have an incentive to produce more when prices go up because they make more money from each barrel of oil they produce. To the extent that the marginal cost of producing an extra barrel of oil increases as production increases, a higher market price for oil will support greater production by individual oil producers.

The more complex answer relies on an aspect of game theory called "The Prisoner's Dilemma". As you note, oil producers could reap greater and greater profits by collectively limiting production and creating an artificial shortage. (This is exactly what OPEC attempts to do.) But as the price increases, individual producers have greater and greater incentives to cheat on this collective bargain, particularly if cheating is hard to detect or hard to effectively punish. As a result, it's hard for a collective of producers to effectively maintain such an agreement, despite it being in their collective best interests to do so.

so you think that the oil market would be better if we had say a very flate supply and demand curve so that say a 1 dollar increase in price ,meant we increased oil ouptut by 10mbpd - i.e. good bye Alaska and oil stocks in 10 years.

This assertion about flat curve is just a standard piece of DIY economics. The slope of the curves represent real production functions and real preferences. There is no such thing as good or bad curves any more than there are good or bad consumers. They're people they just are and a good market is simply one that clears.

Demand and supply curves for world crude petroleum market? Isn't that a little quaint? Isn't it an oligopolistic extractive resource industry? Overlaid with short term game theory issues because of the ability of the big swing producer to make changes in production with very little costs. And there there are dynamic inconsistency issues with Saudi Arabia's long run production schedule. And we are going to find a suppy curve? Help me with this.

I think finding Hubbard's peak would be easier. And I don't have much confidence in that. Hasn't there been several estimates of when we arrive at Hubbard's peak, that have shifted over time? Both geologists and economists agree that "mineral reserve" is an economic concept. So shouldn't Hubbard'd peak be a function of the long run demand curve for crude petroleum? But I will check out the Hubbard's peak website.

I think that the supply curve itself in this case is a crude metaphor and the equilibrium at the supply curve intersects the demand curve stuff is a crude metaphor that oversimplifies the positive and normative questions involved.

Hubbert's peak. Sorry. I guess I should check out the website asap. It has been a long time since I read about this.

By all means, let's wait for oil production to peak and then let's take serious action on alternative fuels and on alternative forms of transportation. Given our lack of alternatives,here in the United States, other countries will be in a better position to compete against us with respect to energy intensive production. No doubt we will see this as unfair.

In the mean time, my decision to buy a hybrid just seems to be looking better and better.

We have just about the cheapest gasoline in the world because of our relatively low taxes. Whining to follow. I'd like to see some of those higher prices skimmed off as taxes rather than in increased trade deficits and more dollars flowing to the Middle East.

One of the things that contributes to the inelasticity of demand for oil is the lack of alternatives to using fossil fuels, especially gasoline.

I live on the SF Peninsula, and even with a fuel-inefficient car, it's still usually cheaper to drive to SF (and always cheaper to drive to Berkeley) than it is to take transit. Frankly, I'd rather use BART, but if I'm going into the city with two friends, it costs $7.50 each plus a dollar for parking to use BART, versus $4 for gas and about $6 for parking (on a weekend).

And the Bay Area is fortunate. Here, transit exists, but it's expensive. Just try using transit anyplace in Florida. Or Texas. Even the poorest have to keep a car, usually a cheap, fuel inefficient car (because the initial cost is more important than incremental costs) with bad emissions and poorly maintained safety systems. So, we get increased social costs thrown in to the problem just for kicks.

Of course, we could be using all of our amazing deficit spending to change this, but that would be bad for the oil companies, wouldn't it?

We should all be grateful for the higher oil and particularly gasoline prices. They're what Americans will feel most directly feel when they come to evaluate the policies of the Bush administration in November.

Most Bush supporters are too uninformed or "faith"-full to the "war on terror" and seem to accept most of the atrocity and ineptitude in Iraq and here at home as part of the price to be paid to "make us safe". We here on this forum all know that none of what Bush is doing is making us safe in any way, but most Americans who support him don't understand that, and these issues are too vague and distant from their everyday lives to make a difference.

They do understand, however, that it pisses them off to pay $50 to gas up their SUV. Doing that enough times, with no end in sight, gets anyone -even the Bush faithful- thinking that somebody in power is doing something dramatically wrong.

It may end up amusingly ironic that Bush be forgiven at the voting booth for all his actual heinous sins against humanity, but defeated because of something not really his fault.

So high oil prices? Bring it on!! :)

Just to add to James' correct comment:

One other factor that prevents oil companies from keeping supplies low to reap maximum profit from each barrel is the structure of CEO compensation. In the long run, given a finite set of oil reserves, it is better for the oil company to limit production now so that the same oil will generate higher profits later, even when the time value of money is factored in. For, while short term oil prices do fluxuate wildly, over the long term they are inevitably going to outpace inflation by a large percentage. (This is due to the realities of peak production and increasing consumption mentioned elsewhere.)

However, most CEOs hold their positions for only a short number of years, and their compensation is structured to reward short-term profits. The result is that they make decisions to maximize short-term profits at the expense of greater profits over the long term.

To wrap your head around this issue, you should really look at the doe numbers.

http://www.eia.doe.gov/emeu/aer/pdf/pages/sec5_21.pdf

Input (closely related to demand) increases until 1978 then starts to level off and drop like a rock. Remember that the CAFE standards were passed in 75 and starting to take effect. By 1983, input had dropped by over 20%. This was all driven by conservation efforts. Since 83, CAFE standards have been abused, but it still took until 1998 to reach 1978 input levels. This explains why few new refineries have been built in the US between 1980 and 1998. CAFE standards and conservation REALLY WORK. President Clueless obviously does not get it.

For an informative article:

http://www.washingtonpost.com/wp-dyn/articles/A47945-2004Apr27.html

The importance and impact of conservation should not be underestimated.

Larry B: You are correct, but I'd like to note that the biggest factor on whether mass transit is used is convenience.

For example, I used to commute from the South Bay to SF. 1 hour, if lucky, by car, one way. 2.5 hours by mass transit (shuttle to cal train to two busses). Being an environmentalist I decided to tough it out and to work on my laptop during the train ride to compensate for the time lost. But the poor ride quality caused my laptop to quickly develope screen problems from the bouncing. Others reported the same problem. I finally gave up.

Mass transit works when it is more convenient than car transit. Period. (At least until gas hits $10/gallon.)

Part of the effect of CAFE can be seen in the petroleum usage category. There are users of petroleum other than automobiles and that is not broken out. Again notice the consumption drop from 1978-1983.

http://www.eia.doe.gov/emeu/aer/pdf/pages/sec2_8.pdf

I used to have a graph of gasoline consumption over the same period. It shows more or less the same picture. The CAFE standards had a huge impact.

Larry B wrote, "Frankly, I'd rather use BART, but if I'm going into the city with two friends, it costs $7.50 each plus a dollar for parking to use BART, versus $4 for gas and about $6 for parking (on a weekend)."

Yes, but that doesn't include fixed costs of owning a car (purchase and auto insurance).

Of course, in most of the US it's almost impossible to live without a car.

I am with PaulO. I wish the pump price hit $3 -- in addition to hopefully making Bush supporters angry, people who choose to drive those big SUVs on paved highways, should pay more taxes becaue they increase risk for every car driver behind them or hit by them.

> Of course, in most of the US it's almost impossible to live without a car.

Yes, but there are ways of cutting back on the automobile expenses that most Americans never consider. I live in San Francisco. My wife and I share a single economy car. We rent a car in the two or three occasions per year that we have a temporary need for a second vehicle or a larger cargo space. We take MUNI around town when we're not in a rush. We take a taxi when the extra expense for the expediency seems worth it.

When the costs of producing petroleum fuel begins to approach the costs of producing synthetic petroleum alternatives from completely renewable sources, then Americans will find out about these simple ways to live with fewer gas-guzzling dinosaurs clogging up their driveways. They'll also probably rediscover the joys and risks of firewood poaching, but that's another issue for later down the road. So, why should they care now?

Especially since the silly fools in power are likely to respond to high gasoline retail prices by shifting the Federal gasoline tax over to a Federal commodity sales tax.

Does anyone know what the "right" Pigouvian tax on a gallon o' gas is? I've that there are estimates from $0.60 a gallon to $3.00 a gallon, or something. Anyone here know what the "consensus" estimate is, or what you think the right estimate is?

And why wouldn't oligopolistic markets have supply curves? I thought they did: they were just... kinkier, or something.

Maybe what I'm proposing already exists: I don't know enough economics to say, but what if there were some sort of measure of markets to measure how "smoothly" they operated based on how orthogonal the supply and demand curves are? It seems to me that how flat one or the other curve is isn't so important as how orthogonal they are. If the curves are parallel, whether vertically or horizontally, then watch out!

Say... the dot product of unit vectors alligned with the derivatives of the supply curve and the demand curve WRT price at the current price? Zero good, one bad?

Or is the orthogonality of supply and demand curves just not all that important?

By the way, I've been having a thought on supporting federal highways in the proportion to wear-and-tear inflicted upon them, but I'm not sure about it, because my physics is shaky.

Namely, the idea would be to place a tax on tires. The tire tax would be in proportion to the tire's durability. The idea here is that, for any given surface and a tire, abrasion inflicted on the tire will be abrasion inflicted on the surface. Is that true, from a physical/engineering standpoint? Thanks. If we support roads based on gasoline taxes, then a fuel efficient car that inflicts a lot of wear and tear (unlikely, but possible) gets off easy, so to speak, and a gas guzzler that doesn't harm the roads get unfairly penalized. (I still support far higher-than-current gas taxes, but because of environmental reasons, not to support highways)

The demand curve would actually be jaggy if there were substitutions for alternative fuels available. The problem is that alternative fuel production is capital intensive, so facilities will only get built if entrepreneurs are convinced that oil prices not only are high enough now so that customers will substitute, but will remain high enough for long enough while the cost of the plant gets amortized.

A blip to $40/barrel won't convince anyone.

"CAFE standards and conservation REALLY WORK. President Clueless obviously does not get it... The importance and impact of conservation should not be underestimated."
--Bakho--

Not to take anything away from President Clueless and his oil centric, alternative phobic administration, but the American public is also clueless, buying up the biggest gas guzzling SUV's they can afford, and many of them purchased since 9/11, which makes them doubly clueless.

Julian Elson:

"Does anyone know what the "right" Pigouvian tax on a gallon o' gas is? I've that there are estimates from $0.60 a gallon to $3.00 a gallon, or something. Anyone here know what the "consensus" estimate is, or what you think the right estimate is?"

I did a stint at the California Energy Commission
as a summer intern (a seperate story). In the
process I read a whole bunch of literature on
what the Pigouvian tax should be on gas. The
actual range is something like the .60 to 3.00,
but with most estimates towards the lower end
(anything above 1.50 is an outlier). It always
depends on how you asses the external cost
associated with automobile usage which leaves
a lot of room for interpretation. The standard
analysis usually includes the costs of pollution,
increased traffic accidents, and time wasted commuting.
You can see how you can get a wide range of
estimates. For example, when evaluating the
cost of increased traffic deaths you've got
to put a price on the life lost. If nothing
else this means you've got to choose a discount
rate (to calculate the lost earnings - again,
at minimum) - really iffy. Time wasted commuting
needs to be measured against some alternative -
like public transport or value of leisure - again
lots of room for interpretation. Then you can
throw in other things like cost of "noise
pollution" for folks who live near highways,
expenditure on keeping up the roads etc. and
up the estimate.

I think there was some consensus that a figure
around a 1$ was sensible but I wouldn't call
that "scientific". The general feeling was
however "US slightly not enough", "Europe way
too much"

Oh yeah, there is no supply curve for monopolies
or duopolies because it assumes price taking
behavior. A supply curve tells
you GIVEN A PRICE how much a firm (market)
wants to supply. But for a monopoly it makes no
sense to say "given a price" since a monopoly
doesn't take prices as given. It sets them.
(Cournot's a bit weirder - since here the price
is still determined by the market not set by
the firms - but essentially still no supply
curve in the traditional sense -
instead you've got reaction functions)

Anyway I think what both Brad and Krugman are
really talking about is inelastic demand, not
supply. The more inelastic demand the bigger
the markup over cost that the monopolist can
charge - (in fact a monopolist facing a perfectly
elastic demand curve acts as a competitive firm).
The problem with the "supply" comes in the
fact that there is some capacity constraint on
the output of oil so the producer's marginal
cost curve ("supply") is vertical - perfectly inelastic at that capacity.

Or in other words, the long run demand for
gasoline is more elastic than the short run
demand (so "better" in the sense that the monopolist, OPEC, has less market power) - but
for reasons pointed out in the column - more or
less fixed demand for travel in SR, time it takes
to replace old gas guzzling cars, etc. - here the
long run can be very long.

Assumption of a Model

Consider a China-OPEC-connection....

What do you mean when you say "markets work best?" Work best relative to what? If you mean that price adjustments are smaller than in markets where both curves are inelastic, then you've made an uninteresting point. Yes, it would be nice if supply or demand of petrol were more elastic. If you mean that market solutions are best relative to non-market solutions when one of the curves is elastic but that non-market solutions are better when both curves are inelastic, then you've said something interesting but the assertion requires more proof.

What do you mean when you say "markets work best?" Work best relative to what? If you mean that price adjustments are smaller than in markets where both curves are inelastic, then you've made an uninteresting point. Yes, it would be nice if supply or demand of petrol were more elastic. If you mean that market solutions are best relative to non-market solutions when one of the curves is elastic but that non-market solutions are better when both curves are inelastic, then you've said something interesting but the assertion requires more proof.

I have a friend who deals Chevvies and the big gas hogs are not moving. They will end up discounting them and they will end up on the road.

Aaron, he has made an "uninteresting point". Very large changes in the equilibrium price tend to be unstable. The change in supply does relatively little to change demand. If the supply continually creeps downward, then it sets off skyrocketing price inflation.

The way to make supply more elastic is through conservation, a reduction in demand so that it is significantly lower than supply capacity. In the case of oil, supply is not linear. It has is an asymptote with a maximum supply that is very inelastic. Gas prices are a terrible way to regulate demand. The far cheaper route (for the consumer) is to have conservation gas mileage standards. This allows for economy of scale in adoption of energy efficient technology. It also means that conservation conscious consumers do not end up subsidizing gas hogs. Fuel conservation has diminishing returns. Doubling the gas mileage from 20 to 40 mpg reduces the fuel consumption by 10 gallons on a 400-mile trip. Doubling gas mileage from 40 to 80 mpg on reduces fuel consumption by 5 mpg on a 400-mile trip. It makes more economic sense to get one 20-mpg gas-guzzler off the road then to go from 40 to 80 mpg if the technology cost is about the same.

But bakho, doesn't the fact that it's better to go from 20 mpg to 40 mpg than from 40 to 80 apply to the gas-tax as much as CAFE standards? (plus, of course, it puts a bit of cash in our public coffers, while CAFE doesn't, which we need.)

In the mid 90's, Krugman had a short piece about the possibility of multiple equilibrium prices for crude oil and the reason why a higher price might obtain, inspite of a considerable excess in reserve capacity. The reasoning was roughly thus: most oil producing countries have few other resources and poorly developed or relatively undifferentiated economies. Therefore, they do not have much incentive to maximize gross earnings from oil in the short-run, since they can not recycle those revenues through the domestic economy to produce further domestic growth. Rather such earnings would only be invested for interest abroad. On the other hand, the reserves of oil are finite and will not last forever. Hence, a higher rather than a lower equilibrium price may be in the interests of most such producers, independent of any collusion, since the oil that remains in the ground amounts to an equivalent of interest-bearing investments held for the future: the price of oil will keep pace with inflation and perhaps more, at a high equilibrium price, while the value of the reserves will only increase as the global demand increases and excess reserves decline. Of course, the equilibrium price can not be so high as to stimulate efforts at conservation and the economic viability of substitutes. I read the piece at the "Unofficial Krugman" website; it may still be there.

In addition, John, there was a diversification factor - if money from oil sales is invested in the world markets, it is useable in case of exile (see Kuwait, 1990). However, it is very vulnerable in case of political upeaval (see Iran, ~1979). Nationalization of holdings is always a weapon in the hands of the (richer) oil consuming countries.

Leaving some oil in the ground provides a nice back-up in the event that things get to that point.

Of course this won't go down well on an economist's web site. But the primary reason we are all totally fucked when it comes to the oil supply situation is that we have allowed economists to be the last word on an issue that is determined by geology. The dismal "science" has screwed the pooch on this one and allowed us to live in a state of denial long past the time when any solutions could be envisioned.

I think a gas tax that would stabilize gas prices in the $2-3 range would be a good idea. $2-3 would be an affordable range for gasoline and having the price be consistent in that range would provide support for the CAFE standards. To drive a car 100000 miles takes 5000 gallons at 20 mpg and 2500 gallons at 40 mpg. At $2 per gallon, that is a cost savings of only $5000. That means that if the additional gas mileage costs more than $5000, it is not worth it (assuming you drive the car for 100,000). To really affect consumer purchases, gas prices probably have to get up to the $4-5 range.

Gasoline taxes are very regressive. A lot of low to middle income people accept long commutes because they cannot afford more expensive urban and suburban properties. Changing this dynamic means significant restructuring of the residential and urban landscape, a 20-40 year project.

BTW- Have you looked at the availability of high mileage cars in the US? Very few US models are above the European average for gas mileage. A CAFE standard sends a clear signal to the auto industry. A gas tax is a mixed signal. What is to say many won't just adjust to higher prices. If you pay over $30,000 for a vehicle, is $5000 a year for gasoline that exhorbitant? A CAFE standard plus a gas tax would be reinforcing and send a very clear message to the auto industry.

Gas tax is not politically popular. Clinton raised taxes by about 4 pennies per gallon and got beat up by the GOP. After gas prices dropped under $1, the complaints ended. Gas prices have a huge effect on people's pocketbooks. The more sensible and politically salable way is new CAFE standards. The case can easily be made that several years after CAFE was passed in the 70s gasoline prices went down. People would support legislation they thought would lower gas prices, benefit the environment, etc.

There seems to be an utter lack of appreciation for the magnitude of the problem we are facing. It is WAY too late for CAFE standards and gas taxes to do much regarding the dislocations that are right around the corner.

But, SW, if CAFE standards were to be set low enough, with a realistic window for achieving them, that the automotive industry had no choice but to actively pursue alternatives to the gasoline combustion engine (with hybrid cars a feasible first start) we would have precisely the development we so badly need. Industry always whines when the government puts pressure on it but is has performed well nonetheless.

Julian,

I remember to have seen that damage to roads is proportional to the third power of the weight of the vehicle. So a 10 tons truck does a thousand times the damage of a one ton car. The erosion of tires is more dependent of other aspects (the kind of materials to which the tire is in contact, temperature, humidity, ...)

DSW

We could get an instant 10-15% improvement in mpg in all cars by making the engines a bit less powerful (very inexpensive to do engineering wise, minor changes in design) and tuned to produce more low end torque. So you can drive responsively while using less throttle. You lose a little highway power, such as 70-90 mph acceleration.

But the car companies have become addicted to advertising horsepower, and consumers have become addicted to cars more powerful that are much faster than they need. There is no need to go from 0-60 in 6.5 seconds. 8 seconds will do just fine -- and that's already way faster than the turtle-paced cars that were sold from the mid 70s until around 1990 and are understandably unattractive.

SW is correct. CAFE standards would not do anything about short term dislocations. Neither would a gas tax. The best a gas tax would do is tax the oil company profits. Short term dislocations have already begun.

I think if we enact CAFE now, we could keep gas below $5 in 8 years. If we don't enact a CAFE, then we get market regulation. As PK suggests, the curves are dangerously steep.

SW says we aren't reading this with due seriousness. "It is WAY too late for CAFE standards and gas taxes to do much regarding the dislocations that are right around the corner."
Should we be laying up a cache of a dozen or so 45 Gallon drums to tie us over the 'dislocation'?
Should we sell one of the cars and start pedalling?
OK, a little sweaty for me too --how about buying the hybrid at any price. Atleast it'll Go when there's no gas to be had.
Go where? Hard to imagine that every other piece of the picture will remain if the fuel is missing.
Even a short term 'dislocation'.
So is this regional ( some areas without gasoline) and is it possible to cover (this summer) with the emergency reserves?
Hard to believe Mr. Bush won't allow us to get out on the road this summer,no?

Calmo, You have to ask whether refinery capacity is enough if the reserves were released today. As for buying a hybrid at any price, Ford has announced that they will produce around 20,000 hybrid SUVs next year. 30,000 potential buyers showed up in an online survey. Even the hybrids get less than 30 mpg. Less driving will be the answer. The question is how high gasoline prices will have to rise to have a big enough impact.

Here's the link to the archived Krugman article on multiple equilibria:

http://www.pkarchive.org/crises/opec.html

The major disincentive to increasing oil production is the U.S. deficit in addition to the potential for dramatically higher prices as we approach the end of all oil supplies. How ironic that the U.S. occupies Iraq -- which in turn decreases the supply of oil instead of increasing it.

Dem writes, "For, while short term oil prices do fluxuate wildly, over the long term they are inevitably going to outpace inflation by a large percentage."

Would you like to place some money on that?

I will bet you up to $10 that the price of crude oil on May 18, 2005 will be lower than today, adjusted for inflation (as measured by the Consumer Price Index).

Further, if you lose, I will happily renew the bet for May 18, 2006, again adjusting for inflation. I will be happy to renew the bet for the next 30 years, if you are "behind" overall. (For example, if you lose this year and next year, and win the following year, I'll still renew the bet, because you'll be "behind" overall.)

The only thing I require is that you also can't refuse to renew the bet if *I'M* behind. That is, only the person who is behind can cancel the bet.

Mark Bahner (who thinks Julian Simon was right, and Kenneth S. Deffeyes and others who hold a similar opinion are not)

http://pup.princeton.edu/titles/7121.html

A clarification on my last post (just to make sure we agree on the terms of the bet before we make it):

My bet is that the price of oil on May 18, 2005 will be less than the current price, adjusted for inflation.

For example, a barrel of NYMex crude today is $40.27.

http://www.bloomberg.com/energy/

Let's assume inflation as measured by the CPI in the coming year is 3%. Then my bet is that the price will be less than 40.27 x 1.03 = $41.48 per barrel.

And let's say inflation continues at 3% for the following year...then my bet is that the price on May 18, 2006 will be less than 41.48 x 1.03 = $42.72 per barrel.

Online Casino Directory

O! Plus! Perge! Aio! Hui! Hem! - Oh! More! Go on! Yes! Ooh! Ummm!

Ratio et consilium propriae ducis artes - Reason and deliberation are the proper skills of a general

Summa cum laude - With highest honor

Nihil est ab omni parte beatum - Nothing is good in every part. (Horace)

Propino fibi salutem! - Cheers!