Demand and Economics, or are we mushrooms?

Just as I was sharpening my pencil to begin the post on drilling that will follow, I glanced over at Reuters, to see how oil was doing today. Given the discussion over at Econbrowser, and his apparent demand (as in command) that you can't use the word demand (as in need) without defining that in terms of price(and the post has 203 comments attached in an interesting discussion) my eye was caught by the following quote from the Reuters article
Oil prices raced to record highs above $67 a barrel on Friday as investors fretted over the world's strained capacity to refine and pump crude oil.

U.S. oil rose more than 7 percent this week and has climbed 51 percent since the start of the year. The stage could be set for further gains, with no let-up seen in global demand growth and no signs that $60-plus oil is harming the economy of the world's largest consumer, the United States.
Now what this says to me is that at current prices demand is not being controlled by price. Which would contradict Econbrowser's point, and perhaps suggest that the Hirsch Report was correct in writing the document the way it did?

At the same time the story does not mention a global peak on supply, but rather:
"We're going to have a very strong price environment until the steam is taken out of demand or until investment catches up and restores a spare capacity cushion to production and refining."
The News Hour's expert last night had bought into the CERA prediction of 15 mb of new oil being on its way, and I guess that the Reuter's staff have too. No mention of depletion, or that it may be too late now to make the investments that will raise supply much above its current level. We're mushrooms, that's all, just plain mushrooms.

Herumph! So where's that pencil sharpener?

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"at current prices demand is not being controlled by price. Which would contradict Econbrowser's point"

No, technically not. Demand, viewed as a curve, doesn't have to be smooth. IE, the immediate demand for oil at 65 can be nearly the same as the immediate demand for oil at 70.

Do you notice that once you enter the realm of "mainstream" economics, you spend most of your time bumping against its framing and assumptions?

Instead of dealing with geological or biological reality, or with historical experience, one stumbles about in a fantasy world of abstraction. Granted that the abstractions can be useful in describing market behavior, the problem is that most practitioners do not admit the limitations of their discipline.

As it is, Econbrowser's brand of economics functions more as ideology, a rooting squad for capitalism. To me, the jaw-dropping arrogance comes when they claim to be Science or Real Economics, when in fact several alternative schools exist (Keynsian economics, Marxian economics, eco-economics).

The tragedy is that Econbrowse'sr analysis and prescriptions will lead to disaster as we move away from the political and economic stability of the last few decades. His model just cannot deal with abrupt shifts in the system, with resource wars, revolutions and famines.

No, Econbrowser is correct with respect to economic theory. I posted something similar in an weekend open thread a few weeks ago--remember my "pet peeve" post?. No one here seemed very happy about it either.

The reason that quantity demanded hasn't changed much is that demand is inelastic in the short run. There are only so many changes that most people are willing to make in the short run. For example, not many individuals will trade in their Hummer for a Prius the instant fuel prices rise a few cents. But over time, as prices remain high, people (i.e., "consumers" in econ speak) can make lifestyle choices such as where they live, how they commute, what they drive, etc.

Picture a steeply downward sloping demand curve with price on the vertical axis and quantity on the horizontal axis. With a steep downward slope, a large price increase will only result in a small change in the quantity demanded--with perhaps no change at all in the short run as too few individuals have changed their behavior for the changes to be discernible in national figures. This is probably why Simmons predicted that a few mbd shortfall this winter could result in a massive, disproportionate price change.

Not being an economist, I find a lot of these discussions almost insanely academic.

Is supply and demand in balance all the time - yes, sort of. But oil is not an ordinary commodity. It is the drug that runs the world economy, and the US is an especially heavy addict of it. As demand increases world wide, we US consumers are willing to pay more and more, to a point, and so I fully agree with JLA's point that:

"not many individuals will trade in their Hummer for a Prius the instant fuel prices rise a few cents. But over time, as prices remain high, people (i.e., "consumers" in econ speak) can make lifestyle choices such as where they live, how they commute, what they drive, etc."

But the current condition is a big change from the recent past. A couple years ago, available supply exceeded demand, so that as demand increased, the price did not have to increase to meet the increased demand. Now that is not the case, and the price is shooting up exponentially.

We now are in a situation with a commodity, and I would argue THE COMMODITY, that has both inelastic demand and inelastic supply. And it is the supply side that I worry about.

What most economists don't get is how little effect that the increasing cost of oil will have on the supply side of the equation. I am an engineer/geologist who works for a major oil company. My job is to technically review upstream exploration and development projects worldwide. We (and most other major oil co.'s) are still ranking projects at $25/bbl and testing them to make sure that they are greater than 0 NPV at much lower prices. These peak oil discussions are not even whispered in the hall where I work. The people running the major oil companies are all prepared to fight the "last war" - that being the war of price collapse that happened in the mid '80's.

The other thing that most economists don't get is that, despite what Daniel Yergin says, there just ain't 15 million barrels per day of new production (net above normal decline rates) ready to come bursting on the market. If that really is so, it sure is hidden to me. What I generally see is very risky, very technically challenging projects in 1 to 2 miles water depth 100 miles from shore in places like West Africa, Brazil, the Gulf of Mexico, and SE Asia, that might net a company 100 to 300 million barrels of oil - starting in about 2012.

Bubba, I understand your post, it makes sense,
the enconomist posts are just blowing smoke.

What happens to the quantity demanded when the price of oil goes up? If your answer is, "relatively little," then I certainly agree with you, at least in the short run. If your answer is, "nothing at all, no matter how high the price goes," then I should have a very easy time proving to you that you are wrong.

What difference does it make whether the answer is "very little" or "not at all"? Depends on what question you're asking. If you want to know what happens when the supply decreases, if the correct answer is "very little," then that means that the response to a supply decrease will be a very big increase in the price. And that big increase in price will have big effects further down the road, because users will make much more significant adjustments once you give them a little more time. In addition, big price increases today will also generate supply responses with respect to both oil and its alternatives.

If you claim that, as a physical proposition, there are no significant responses that either consumers or producers of this energy source or any other can ever make, well then, I agree with you, the whole game is hopeless for any strategy either one of us may come up with. But if there is some physical way to reduce consumption or develop alternative supplies, price increases are a guaranteed way to accomplish those changes, and indeed will prove far more successful in doing so than any government program you might dream up.

I don't consider myself a professional economist. I'm an urban planner with a strong economics background. I occasionally dip into the economist bag of analytical tricks for my clients, but I don't wear a Greenspan decoder ring to work every day.

Economic models, like all models, are abstractions of reality. "The map is not the territory" as the saying goes. However economic models can be very useful for understanding certain things--namely, how markets for SCARCE resources function. The importance of oil, and its geological limitations, should not escape any resource economist worth his or her salt. The only economists who have a problem with these basic concepts are apparently the straw men/caricature economists that some peak oilers have built up so they can delight in tearing them down. I don't see the utility in this.

The point that econbrowser was making, I believe, is that if you are going to use economics (e.g., "supply exceeding demand"), do everyone a favor and be conceptually/analytically clear. It's one thing to talk about "supply exceeding demand" in everyday conversation, but Hirsch should have been more careful in his technical report. Had the paper gone through a peer review, this probably would have been picked up. A simple qualification, such as "producers will not be able to meet projected demand at $25/bbl" probably would have sufficed.

James (Hamilton):
I think that one of the things that concerns me most is the lack of recognition of the time problem in this debate. Bubba touches on it when he talks about corporate planning still being based on $25 oil. Even when the accepted base price goes up it still takes years to change supply much. Witness when first President Bush and then the President of the European Union (or someone at around that level) talked to then Prince Abdullah about raising oil production in Saudi Arabia. There was nothing the Prince could do. He has to have more wells, and the current well production from existing rigs is planned to give some increase, but nowhere near what is now expected. Getting more rigs takes time and this is where there is a relative inelasticity in the supply situation, short term, and almost regardless of price increase.

I think everyone is concentrating on the person of Hirsch, and treating those ever-rising demand curves as his. I don't get that. He and his co-workers were perparing a report for the US government, based on the exisiting US DOE projections:

I mean, look at those graphs! I think Hirsch was answering those numbers by using them ...

Maybe you think, as a strategy, he should have objected to those numbers and mounted an attack on them. I think I can see how an independant team might try a little more indirect response.

In either case they were hardly "Hirsch's demand."

Bubba: "We now are in a situation with a commodity, and I would argue THE COMMODITY, that has both inelastic demand and inelastic supply."

This is *exactly* the point that must be emphasized.

Ask an economist what happens when inelastic supply meets inelastic demand. It's not pretty. And that's exactly the short-term issue with peak oil. Over the long term, the economists are right, but it's the substatiantial risk of severe short-term economic shocks that is the issue.

Me: "It's not pretty."

To understand how "not pretty" it gets you have to understand this quote: "The intersection of the supply curve and the demand curve, shown by (P*, Q*), is the market clearing condition."

(from this page: )

In the case of perfectly inelastic supply (say at 85mmbpd) and perfectly inelastic demand (say at 90mmpbd) the supply curve and demand curve don't intersect. There is no market clearing price. It's the economics equivalent of dividing by zero.

Of course there's no such thing as perfectly inelastic supply and demand, but in the case of petroleum, there's a hard upper limit on the quantity value of the supply curve, and, in the short term, a very steeply convex demand curve with an elbow at a quantity which is uncomfortably close to the quantity limit on the supply curve.

So, when an economist says something like "supply equals demand by definition", the proper response is, "yes, but what's the upper bound on the market clearing price if you start shifting the supply curve to the left?".

Odograph: Good point. Many people seem to be assuming that Hirsch developed an econometric model without understanding demand. As you point out, the data Hirsch uses as his starting point is the output of the DOE EIA model. He could have very well used data from the USGS model or the OPEC Review model.

Note that all of the above models are very sophisticated econometric/simulation models developed with significant input from economists. These models require massive amounts of input data and compute a number of scenarios for future supply, demand and prices based on a set of assumptions. The results of these models depend critically on the quality of the input data and the assumptions. Currently most of the major models use input data and assumptions that point to a peak 20+ years from now. This is probably why policymakers are "complacent" and the market is not pricing in a peak in the near future; the "best" models say there is no imminent problem. If the peak oilers are right, eventually the modelers will realise their error and change the key input data and assumptions to their models. Don't expect any significant policy changes until that happens.

The tricky thing about demand modeling is that it is basically behavior modelling. On long run, high prices does mean lower demand but as always the devil is in the details.
- in France people buy more heating fuel since the prices have gone up (they anticipate for still higher prices in winter)
- there are physical limits to what people can do to lower their comsumption. They can and do cut unnecesserary travel but still need to work and shop. So they make budget choices and buy, not less oil, but less pizzas, books or potted plants.
- higher oil price can temperoraily boost growth because it means a lot more cash for producers who will, in turn, buy more (mostly from Asia), which will boost oil demand.
- In France, diesel is common place yet, despite greater efficiency and cheaper fuel, diesel car are far from being majoritary. Why? Because they are more expensive and most people don't drive enough for cheaper fuel to make up the difference. This should cool down the enthusiasm about Prius and cie.

About the policy-makers, don't forget they don't live in a vacuum. There are ideological and societal constraints to their action; That's wy the aristocracy of easter island continued building statuess as crop yields plummeted because of deforestation. The society couldn't afford it but the individual chieftain could not afford not to do it.
Some policy-makers, at the higher level, may be aware of peak oil but the needed change to cope with it are so costly that implementing them is likely to get them out of power. So the usual solutions are.
- denial of the problem (Algeria is France and those guys in the mountain are mere bandits)
- half-measure under various guises (energy economy campains nowadays in France)
- buying time by telling the people everything will be fine (not stupid in itself, the last thing we want is panic)
- scape-goating
- last-man standing strategies

When you look at history. Political courage and lucidity is the exception rather than the norm

MR said:
But if there is some physical way to reduce consumption or develop alternative supplies, price increases are a guaranteed way to accomplish those changes

That's it! there are no alternatives available at the scale oil is being used. scalability is the issue here, oil alternatives are local solutions on a small scale. Prices will curve demand only in two situations:
1) demand destuction: some people cannot afford oil anymore
2) some alternatives become economically attractive on a large scale

Another thing to consider is the potential ramifications of the relative elasticity (or more to the point, inelasticity) of demand on a per country basis. In the US, the current sole super power of the world, the inelasticity is far higher than anywhere else. Heck, maybe at $150 a barrel the US will still be fine for a couple of years.

However developing nations which are not as heavily strung out will have to quit. Cuba was able to feed itself without petro fertilizers, and the US has some dim memory of victory gardens. The rest of the world might be able to wean itself, and show the US the way. However while there might not be a mass die-off from starvation, I'm not sure how the US (or Canadian (as I'm emmigrating to Canada, they're more important in my mind)) economy moves on is quite another question.

There are a lot of issues, and one meme I liked (I think it was from the econbrowser discussion) is that under the existing fiat money system and the economy built the way that it is, one might as well call our money system the Oil Standard. Well what happens when oil eventually runs out? It will be the atomic/whatever Standard, but that amount of energy will be much lower than oil, which at the very least will cause a big recession. I think a depression is much more likely.

Getting back on point, the developing countries are all going to have to face this first, and in the meantime, unless a miracle occurs (politics change, or some great energy-related innovation (I think a political change is more likely, but would be surprised to see anything before 2012)), the US will continue unabated with business as usual, with the increased price of oil continuing the rumblings indicating oncoming recession (from events irrelavent to the aforementioned possible collapse of the Oil Standard). But again, those rumblings will not be listened to.

While I'm unsure what the future will actually be, without a great energy innovation, I think it is safe to say that economies will begin to localize, and globalization will be forgotten. If there aren't food shortages, if you're not on a personal sustainable farm, the cities will be best. If there are food shortages, why aren't you on a personal sustainable farm?

However, just as the world might finally starting to get comfortable without cheap oil, we might start facing some larger after-effects of our oil binge than "just" a few peat bogs dethawing in siberia and antarctica. Remember when I said that if there isn't a food shortage, the cities would be the place to be. Well, scratch that, and replace that with the cities significantly above sea level will be the place to be. Ever more annoyingly, areas of fresh water might move, and climates could shift enough to require one to swtich to different crops. Perhaps there could be some food shortages.

I'm unsure what the potential for any "information age" jobs will be in the future. Electricity to power computers might be possible, but there won't be a lot of new ones coming out, and I'm unsure of the utility of a computer to most people without the tweaking economy. Not to mention that electricity won't be cheap. Well, it might depend on the area; looking at my electric bill, 50% comes from nuclear, and over 25% comes from hydro. But we'll sell energy to the states at a premium, and that will haunt Canadian consumers (three cheers for deregulation, ... ... ... maybe I have wax in my ears).

So, to make a long story short (too late) if you're in the US/Canada/Western Europe/Japan, I'd say stock up on vermicompost and rabbits, and watch what happens in the other countries. Be ready to sell that house in the suburbs and get an efficient apartment in the city, or start looking for the farm. We'll feel the effects later. However how much later is unknown. I'd like to say that there'd be a year or two, perhaps as much as 5. But it could be as little as a couple of months. After all, if all of South America, Africa, Eastern Europe and much of Asia are all in turmoil and hyper inflation, that could actually startle wall street. And then we get to see the understatement known as a "correction."

Perhaps another manhatten project type effort oriented at energy could save the system. However, due to the scale (it's one thing to make three atomic bombs, it's quite another to retrofit an entire country with a merel 1 billion barrels of oil and a collapseing monetary system), I don't have faith that it isn't already too great to prevent relief.

HO's "Getting more rigs takes time and this is where there is a relative inelasticity in the supply situation, short term, and almost regardless of price increase". Right. Near term, we're about to hit the ceiling at 85/86 mbd and "That's All Folks!". Depletion is about geology, not economy. Discoveries peaked a long time ago. There is new supply out there, most of it small (e.g. Sakhalin I estimated recoverable reserves = 2.3 bbo) or in under-developed (or undeveloped) unconventional sources. Will depletion outrun new production? That is the question because that is the peak.

On the elasticity of demand. From here:

Elasticity is a measure of responsiveness. Two words are important here. The word "measure" means that elasticity results are reported as numbers, or elasticity coefficients. The word "responsiveness" means that there is a stimulus-reaction involved. Some change or stimulus causes people to react by changing their behavior, and elasticity measures the extent to which people react.

The most common elasticity measurement is that of price elasticity of demand. It measures how much consumers respond in their buying decisions to a change in price. The basic formula used to determine price elasticity is

e= (percentage change in quantity) / (percentage change in price).
(Read that as elasticity is the percentage change in quantity divided by the percentage change in price.)

If price increases by 10% and consumers respond by decreasing purchases by 20%, the equation computes the elasticity coefficient as -2. The result is negative because an increase in price (a positive number) leads to a decrease in purchases (a negative number). Because the law of demand says it will always be negative, many economists ignore the negative sign, as we will in the following discussion.

An elasticity coefficient of 2 shows that consumers respond a great deal to a change in price. If, on the other hand, a 10% change in price causes only a 5% change in sales, the elasticity coefficient will be only 1/2. Economists would say in this case that demand is inelastic. Demand is inelastic whenever the elasticity coefficient is less than one. When it is greater than one, economists say that demand is elastic.

What does common sense tell us here? Or, in other words:

What is the ability of [so-called] consumers to change their behavour in the face of rising prices for oil and its by-products? ie. how much elasticity is there in the system?

The obvious answer, now that we have framed the question in a simple, understandable way, is that most people have virtually no ability to respond to price hikes. Which is why they have not. I say this because of stuff like this:

1) they can not do much about their gas mileage
2) they can not change their commute to work
3) they can not change their non-work commutes to buy food and necessities
4) they can not stop eating
5) they can not stop buying many plastics
6) they can not easily change where they live
7) they can not change the size of their current house
8) they can not turn off the heat in the winter
9) they can not afford solar panels (or even get them, at this point)

Given this inelasticity, which has now been made concrete -- this is no longer an abstract discussion -- we see that demand can not decrease (much) and can only grow if only because humans are making more babies all the time. There will be shortages in the future, not merely highly priced supply.

So, some of us believe that demand never actually decreases when you're talking about oil (or energy in general) given an ever-burgeoning population. But usage decreases merely because people can not afford to live their lives anymore or businesses must stop operating, etc. This goes by the newly invented euphemism demand destruction.

Dave writes: "The obvious answer, now that we have framed the question in a simple, understandable way, is that most people have virtually no ability to respond to price hikes. "

Demand is not as inelastic as Dave implies. For example here are some short-term changes people can make:

1) they can not do much about their gas mileage - but they can limit their maximum freeway driving speed to under 55MPH
2) they can not change their commute to work - but they can carpool more
3) they can not change their non-work commutes to buy food and necessities - but they can reduce some discretionary travel
4) they can not stop eating - but they can eat out less, limit the amount they eat and lose weight too!
5) they can not stop buying many plastics - but they can limit purchase of some discretionary items made of plastic
6) they can not easily change where they live
7) they can not change the size of their current house
8) they can not turn off the heat in the winter - but they can set the thermostat to a lower temperature and wear a sweater
9) they can not afford solar panels (or even get them, at this point)

Note that everyone does not have to do everything listed above for there to be a measurable change in the consumption of oil.

There are even more conservation actions one can take to reduce demand even further given more time (e.g. Items 6, 7 and 9 require a response in the longer-term.).

The above may seem callous but remember that Europeans seem to do OK with about half the amount of oil per capita as us.


RayJ, I like your modifications to my list. But I am not convinced that the conservation methods you point out will make a big difference even if they can be implemented. One obvious example is carpooling. Can you take four people from some suburban neighborhood, put them all in the same car/SUV and then get them all to the places where they work each weekday according to each person's flexible schedule? And then coordinate all this to get them home every night? I doubt it....

Or "they can eat out less, limit the amount they eat and lose weight too!". Fast food nation.

I respect your response and applaud your (misguided, to my mind) optimisim. Bear in mind that I said that people have not responded much to price increases precisely because their options are limited and therefore they can not do so. So, it is not surprising that current price increases have not modified behavour or demand.... Nor is it likely to do so until prices are indeed high enough to make normal behavour in our (American) culture unaffordable or impossible.

Keep in mind that quantity demanded dropped significantly in the early 80s following the 81 price shock. Part of this was due to recession, but we also made great strides in conservation.

Americans haven't paid attention to the amount of energy they consume since the price collapse in 86. All of our engineering improvements for automobiles have gone towards performance rather than fuel economy, and very few people think to look for the EnegyStar label when buying a new appliance for the home. Once manufacturers, homebuilders, planners, etc. start focusing on energy efficiency, I suspect that we could make dramatic improvements in 5-10 years. Short term options for reducing demand are somewhate limited but, as RayJ points out, we do have options.

Dave and Ray,

I have considered this demand side as well. With respect to most conventional vehicles, changing speed has very little effect on gas consumption. By percentage it may be a 10% improvement but 10% of 20 mpg is only 2 mpg and insignificant for most peoples driving habits. See Walter McManus's columns at on how time is worth more to people than improved gas milage. Commuting in the city or suburbs these vehicles actually get worse gas milage below 40 mph. (check sites like or to research this.)

Now hybrids, like the Toyota Prius and honda insight, benefit greatly by reduced speed and modified driving habits with increases of 10-15 mpg, getting into the mid 50's mpg (check same sites as above). In my opinion this is where government policy can have a huge effect by favoring one technology over another for the sole point of using less oil.

I agree in concept with Ray on car pooling, but side with Dave on practice. People are moving in too many diverse directions every day and can't coordinate trips. Even when you find people going the same place, you can't coordinate TIME because most people no longer work fixed 8-5 schedules. This is a great concern to me on bringing back mass transit. How do you set up routes?

I agree that individuals can cut consumption but only through very significant changes in lifestyle which I don't see them doing until scarcity, not price forces them to.

As NC pointed out reducing highway speeds is not a big gainer. This is mostly because gasoline engines develop a vacuum behind the throttle plate, which costs energy. The slower it goes, the less flow past the throtle and thus a higher vacuum. The fuel consumption curve is remarkably flat across the load range. The losses that would respond to lower speed, air drag and tire heating, won't be that big a factor on many vehicles. Diesels, which are unthrottled, would show a decent fuel reduction, but we don't have many diesel cars in the US.

Diesel trucks might burn less fuel, or not depending on gearing. But, in our JIT-inventory economy where trucks need to arrive on a tight schedule they would probably deploy more trucks to maintain the intervals.

Some gas engine cars actually get worse MPG at lower speeds. It seems some designers actually work toward maximum efficiency at expected operating speed. Back in the late '50s-early '60s there was a trans-continental fuel economy competition called The Mobilgas Fuel Economy Run. During those years, certain Chrysler Corporation models usually won their classes while making substantially higher average speeds than their competitors. Slower highway speeds might reduce consumption, but probably by way less than 10%. There is at least some chance that consumption might increase a little. It absolutely won't do anything good with regard to the "sheeples" tempers.

"Drive 55" was the conception of politicians, not engineers.
After all, they needed to be seen to be doing something!

Our big gains in motor fuel economy in the 80s was mostly due to the "sheeple", finally having had all they could take of Detroit's absolutely abysmal build quality and powertrain engineering, buying huge numbers of Japanese cars that just happened to only offer small engines in small cars.

When it comes to conservation, every little counts. Also one should not think of what the individual does but what the average effect over the whole population. According to the DOT (see DOE graph at you could save up to 25% by driving at 65 rather than 75 MPH. A 55MPH freeway speed limit does not mean no one drives above 55. It means that some people who drive at 75 in the 70MPH limit zone may slow down to say 60MPH. The net effect will be to reduce average freeway speed and improve fuel efficiency.

Current growth of oil consumption in the US is about 2% per year. So when scorned says "Slower highway speeds might reduce consumption, but probably by way less than 10%", he is right but even a more realistic 0.5% reduction reduces the growth in oil imports by 25%. Granted, for most people, a 2% reduction may not seem to be worth the trouble (who cares whether they pay $20 instead of $19.60 at the gas station) but it all adds up.

Similar comments apply to encouraging people to commute. If 2 million more people out (of a workforce of 80 million) share commutes and reduce their driving by 150 miles a week each, the amount of gas used goes down by 1 billion gallons each year.

Finally, I agree with Dave that the short-run solutions are not going to be enough (only 2-5% savings total maybe). You need long-run solutions such as better mileage cars, hybrids, a shift to public transport, etc. to have a big impact (25-50% savings). However, when prices spike during a scarcity, a 2-5% reduction in demand can have a dramatic impact on prices.

The challenge for policymakers is striking the right balance among:
a - mandatory action (55MPH speed limit, longer daylight savings time),
b - exhortation for voluntary action (commute more, appeals to buy more efficient cars) and
c - market based solutions (let high prices force people to reduce consumption.


I posted this on Econbrowser also... the first point is exactly the problem "Bubba" above identified - with price volatility (we already have experience of this) oil companies have no guarantee that prices will remain high, so they're investing only in things they know will be profitable if prices drop again.

Two things wrong with James Hamilton's points:

1. The argument about getting rich by hoarding and buying futures assumes the peak oil people believe prices will inevitably keep rising. In fact, that's incorrect - as Ken Deffeyes explains in "Beyond Oil", a commodity peak is characterized not by continuing price increases, but by greatly increased price volatility. That's an observational fact, not a theoretical economic point, but it certainly ought to make anybody cautious who is thinking of betting on oil (or oil companies) right now. The same sort of volatility comes out in other models, such as of ecological systems, when a critical point is reached.

Volatility causes (without government intervention at least) strong fluctuations in investment in expensive sources and alternatives and in the R&D to make them cheaper, making both supply and demand even less reliable. The time delays make the problem somewhat more difficult than classical micro-economic analysis suggests.

2. Just because supply is equal to demand doesn't mean all is well and good with the world. In particular, watching prices rise or fall with market forces does nothing to avoid "render[ing] those who are forced to follow them unambiguously poorer." Economics can model decline just as well as growth; what Hirsch and his colleagues are talking about are ways to mitigate the human suffering they see as inevitable consequences of the end of the oil age.

There are many paths for our collective action here (including inaction), but only one which would, if successful, make those who follow "unambiguously richer": finding an alternative to fossil fuels that can provide the same supply at a lower price. Investment in energy R&D should be in the $300 billion/year range, $75 billion/yr in the US, not the paltry $2-3 billion we have now, most of it wasted on stupidies like hydrogen cars.

Peak oilers and economists may not be all that far apart. Part of the problem is terminology, and there are subtypes of "demand." If we clarify the language, the issues get clearer. (I'll ignore elasticities for the moment.)

When economists state that "demand" will equal supply at a given price, they are referring to "aggregate demand" or "effective demand." In general terms, effective demand is the sum of all oil purchased by people who both a) want the oil and b) can afford to pay for it. There is lots of effective demand in the developed world at current prices.

The idea of "latent demand" is the concept that there are people who a) want oil but b) can't afford to buy it. It is desire that's not fulfilled by a purchase. There is lots of latent demand in the third world at current prices.

So, aggregate or effective demand is an easy-to-measure behaviour (I buy oil). This is what economists usually refer to simply as "demand."

Latent demand is a harder-to-measure attitude or a wish (I'd like to buy oil). When peak oilers refer to "demand," I think we are often using the term to mean a total: (effective demand + latent demand). If you define demand this way, then it can easily exceed supply.

"Demand destruction" is a process where we change aggregate or effective demand (a behaviour: I buy oil) into latent demand (wishful thinking: I want oil, but I'm not buying at this price, or with this level of inconvenience). Effective demand drops, but latent demand increases. An economist will see this situation as demand dropping; peak oilers might see this as demand exceeding supply. If you define the terms clearly, both arguments are valid.

Good post, Rick Starr. When I said usage will drop but demand will still be there, you use the term latent demand.

"An economist will see this situation as demand dropping; peak oilers might see this as demand exceeding supply. If you define the terms clearly, both arguments are valid".


Yep Dave, Rick Starr gets a gold star.

Anyone up for an economist/geologist/ecologist/conspiracy theorist/doomsdayer/veridian optimist rendition of Kumbahya?