Discussing prices and demand

Over on Econbrowser there is a discussion going on relating to the Hirsch report, which we last discussed here. It is very much an economist's discussion, but contains within it the continued question as to why, if the supply of oil in the world is drying up, haven't we seen higher prices than we currently are. This applies both to current, and, more particularly, futures prices.

Well the times they are a changin'. As was pointed out in the comments section of that post, future prices for oil are now heading steadily up there. And as the season moves on the price of oil is moving with it. My own belief is that Hirsch was really more interested in proving that if we did not do something to enhance supply, starting fairly soon, we would be in deep trouble. And he anticipated that we had to be working on a solution for 20 years, in order to have enough oil to go around, when supply stopped meeting the demand for oil that would allow us to continue to maintain, worldwide, our current standard of living. The reason that we are here at this site, of course, is that to a large extent we don't think that Hirsch got it right, and in fact we have a darn sight less than 20 years before there is a serious problem. But by putting up the evidence, we do try to let you make up your own minds as to when the problem will arise, but don't expect a long warning. While not deliberate, it does seem that more economists than anyone else are running around telling us that we don't need to worry, and predicting that soon oil prices will be down to $30, $35, $20 - pick a number. (see here).

After all, as I commented in that earlier post, the public was caught short by the energy crisis of 1977, even though geologists and others in the know had been warning of the problem for some time. The only difference this time around, perhaps, is that the advent of the internet makes it easier to get the word out than it did back then.

The other issue that crops up over there in the discussion that bothers me is this idea that, when demand begins to get destroyed by price increases, that all of a sudden there will be a surplus again, and the price will drop.

Bluntly I think that is hokum! The impact of higher prices will reduce demand at the edges, with prices rising to continually trim demand to what is available. But there will not, initially, be that much difference between supply and the level of demand that is going forward. So that price rises should not, in the immediate short term, go to the heights that Matt Simmons is now predicting.

The problem is that we tend to make judgements more and more based on theory, rather than going out and looking at the reality. There is much talk, in England and over here in the mantra that "technology will solve everything", that "the Stone Age didn't end because we ran out of stones."

Unfortunately to have an alternative we have to have engineers. And in this country that is not a priority as Robert Samuelson commented in today's Washington Post.
All advanced societies now depend so completely on technology that their economic might is often measured by their number of scientists and engineers. By that indicator, America's economic power is waning. We're producing a shrinking share of the world's technological talent.....Among engineers with bachelor's degrees, the gaps are already huge. In 2001 China graduated 220,000 engineers, against about 60,000 for the United States, the National Science Foundation reports.

Freeman also documents a second worrisome reality: U.S. scientists and engineers aren't well paid, considering their skills and -- especially for PhDs -- the required time for a degree. This means, Freeman says, that "the job market . . . is too weak to attract increasing numbers of U.S. students. . . . . From 1990 to 2000, average incomes for engineering PhDs increased from $65,000 to $91,000, up 41 percent;...the 891 MBA recipients of the Harvard Business School's class of 2005. At an average age of 27, they command a median starting salary of $100,000....these new Harvard MBAs also got huge one-time bonuses; the median was $43,000.
Note that it is an average over-a-life salary for engineers, but a starting salary for MBA's. However he takes comfort in the fact that
In 2002 universities earned $915 million from (patent)licensing fees, almost four times the 1993 level,
The actual truth being, unfortunately, that most of those fees were for medical items, rather than engineering.

We have got into a world of hurt with depleting expertise in many fields because it has been less economic for Universities to teach the more costly disciplines. This ranges from the mining and petroleum schools to such things as nursing . But then, of course, market forces "must prevail," and we should, perhaps, forget the ancient virtues such as leadership and vision, and planning for the future.

The only problem I have with that is that if it leaves us terribly uncompetitive and unhealthy at a time when the rest of the world is going to be competing for the same resources that we are.

It also means that those who do go into these disciplines (especially the extractive ones) are finding more lucrative starting salaries, and while not yet up to MBA standards, J has mentioned that a couple of new hires (BS Petroleum) he recently talked with, started in the mid $70's, about $10k up on the last number I had reported.

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Just noted this fascinating story at Nasdaq.com.

Iran's chief delegate to the International Atomic Energy Agency has made a thinly veiled warning that Western nations would see even higher crude oil prices if they pursue their threat to refer Iran to the U.N. Security Council over its uranium conversion program, CNN reported Wednesday from Vienna.

At 4mbpd, they could have a pretty big effect by holding back.

The problem isn't merely know-how. The problem is growing deman! Continuous growth in energy consumption that has been fundamental to the ENTIRE industrial revolution. Where is the equivalent energy going to come from not to just meet current demand. But endlessly growing demand ad-infinitum.

Check out the curve in In Figure 1 of this artilce in Physics today:

If technology is going to save the day, it must do so by finding energy source that keep the curve goin' up! (Before anyone goes on about "efficiency" as our saviour - go back and read about Jevon's paradox at:

There has NEVER been an organic system that has maintained a growth curve like the one in Figure 1 of the Physics today piece forever. Ours is no different. This is something that seems to be entirely absent from economic theory which seems predicated on the idea (wish?) that growth can and will be infinite (with the right policy mix).

I meant to write growing demand, not growing deman. But, with America's wasteline growing annually, maybe we are growing deman, and dewomen, and, of course, dechildren too ;-)

Those who are predicting $35 per barrel oil (EIA) are delusional. But if the world economy nose-dives the price of oil will dip. And these bobble heads will automatically assume that this movement validates their model of how the world works. That is what I see as potentially dangerous about the period we are about to enter into. It seems to me that the areas that we are interested in regarding peak oil, that is the geology and the extraction technology, the production and depletion fundamentals are a somewhat different issue than demand and price. Yes they are related. But economists are focused on the later exclusively. To me, these things are only dimly understood. It seems pretty clear where we are regarding depletion and our future production potential to within a year or so. But precisely how that will play out in this complex web, ln this interconnected, non-linear, global feedback system that is in many ways still in the process of being created beats the hell out of me.

sorry again, here is the Wikipedia link:


I agree that the problem with the supply will always match demand circular thinking is that its too much of an instantaneous and circular assesment. Its trivia to say that they will always balance at any given moment. The question is will supply meet the demand's desire to grow!



So, we have dueling nuclear options (production cut from Iran and "strategic nukes" from Cheney's kitchen cabinet crew).

This is going to be an interesting next few months, to say the least. Wonder what product Bush et al. have planned for a Fall roll out this time...

Face it, America abandoned the future when they elected Reagan and started down the road of Social Darwinism. We have been defunding education, and America in general, for 20 plus years as we were shifting our economy from an industrial giant to a pathetic service economy and an over bloated Wall Street gambling casino.

Americans copulated with the capitalistic devil instead of making it their sex slave. Now we all are paying the price as a declining joke on the world scene. Only going to get a lot worse before anybody figures out what happened--especially our ruling elites!

R. Nemo

Consider the Irish potato famine. No shortage of food; just shortage of "demand". The food was shipped to England where people could pay for it.

Look, in most corporations engineering is at best considered a necessary evil. Your promotability in most organizations depends on you getting out of pure engineering work as quickly as possible. Most executives are perfectly comfortable with the Chinese or Indians eventually doing all their engineering work; marketing is their thing. The U.S. is not generating the jobs for the engineers we do graduate as it is.

You might as well face it, for good or evil, the MBAs have won. Outsourcing your engineering talent to other nations is probably extremely stupid long-term but the U.S. is going to try it anyway.

Economics is more akin to a religion than a science They have there beliefs rather than theory's and they don't change when their 'beliefs' fail a test.

Economic's, religion, Maths, geology, physics chemistry.

guess the 2 odd ones.

I wouldent pay to much attention to economists


The current glut of 'unemployable' graduates has been picked up on other blogs. Seems employers have it in for anyone who's taken time out to look at how the world really works (or could work). Skirting past the question of 'why?', the result is an entire subculture of the over-educated and under-paid. The thing is, cos they've seen how the world really is (or could be), they don't necessarily mind, deep down inside. Is this then the future of the middle classes? - to become a load of educated people used to shortages, and happy and able to innovate to survive? Hmmm... isn't that just what we need when the cliff comes?

Something odd is going on, certainly. I've been seeing all sorts of things and people in a different light recently. My advice is: keep your eyes open.

Neither would I, but the problem is that everyone else does -- from regular people to governments. Even the very fundamentals of neoclassical economics aren't sound but that doesn't stop them.

Gtj - why do you think that is?

Don't get me started on forcing universities to adopt a "business model" that makes profitability of programs the only data point worth examining. You'd think the example of Warren Buffet would inspire some sort of business-school counterculture that worshipped the long-term outlook.

I can't remember who said it or the exact quotation, but it goes something like this: first rate people hire other first rate people. Second rate people hire third rate people. I think the applicability here is that marketing types don't like having people around who have a stronger world view, so they send that type of job overseas or keep them out of the loop.

I've seen some mention that this administration has very little need for expert advice on policy--they know the policy they want without bothering to consult, and simply want their staff experts to validate it for them.

willpax -

I think it is even more base and subtle than that.

No CEO wants to hear bad news. And that single item trickles down to corrupt entire corporations and government bodies. For years, it was the engineers and scientists (witness Hubbert, for example) who were raining on economic parades and harbingers of change, which no CEO wants to face. Now, we are not producing engineers and scientists.

Want to know exactly what we ARE producing?

Spend one evening watching MTV, VH1 or any of the MSM networks.

That, my friend, is what America exports....

Quite clearly demand destruction will occur on the edges. But it's also possible for economic growth to stall, deep recession to set in, and consumption to drop by upwards of 10 million bpd. Not so much from the edges in that case. Why not? That doesn't mean that consumption won't increase afterwards, but without time frames these discussions are largely meaningless. True, oil will be $100/barrel, $200/barrel or whatever (in real 2005 dollars) one of these days. And hold those values. But I don't know when. And that's the problem with the rebuttal of Econbrowser discussions in your post. The comment that "there will not, initially, be that much difference between supply and the level of demand that is going forward" all depends on that word "initially."

I'm betting that prices will continue to edge up, and with a crisis will spike, but serious demand destruction will put an upper limit on that. Anyone betting that oil will be $200, for example, in 2008, is betting that the economy can hum along just fine between now and then with escalating prices. At some point, I think growth will seriously stall.

I still think it will be $5 a gallon gas that forces change in consumption. George Ure apparently is of similar mind:


It will need to impact the day-to-day soccer Mom for it to hit home. When it becomes a real question of affordability to drive for soccer practice, dance lessons, etc., then prices are finally impacting with a vengeance on the middle class. And we will react the only way possible - reduce consumption.

With all our jobs migrating elsewhere, it is not going to work to ask for a raise...hybrids are on huge backorder, and most of the economical cars are already sold, with Detroit building NONE WHATSOEVER (what dumb bastards!)... Then the finger pointing and government misdirection will begin.

I think we'll see oil at $35-$40 a barrel again. Unfortunately, by then that will be two or three days wages for the average American worker.

I guess I sure hope that all this isn't a way to the PTB cooked up to equalize wages across the planet...downward...

Reposted from comments track of next higher disscusion at Oil Drum

Price of Fuel is "Fool's Gold" and can easily backfire on the Peak Oil community.

Yes the public understands the hard kick between their bulging pockets, but that is the wrong message to send.

"Price" is not a "scientific" measure of anything. It is fool's gold because underlying our reliance on price as a fair measure of anyhting, is our "assumption" (wrong wrong wrong) that human beings act "rationally" when they negotiate prices. Human beings are not rational. The evidence is blowing up all around you and yet you deny it even as it explodes in your face. Take suicide bombers. They are "human". They are not rational. Take the voting public in democracies (us us). They vote for the sugar daddy politician that promises them candy. The voters are "human". They are simply not rational. So how can you rationally conclude that "price" --it being a fantasy number created out of thin air by negotiating humans, irrational humans-- is a measure of anything real?

It very well could be that the hedge hogs in the futures markets are currently cooking up the price irrationally as each digs his way to personal prosperity in our "Wealth of Tunnel Visions" society. I for one, sure hope so. I'd hate to realize that current prices accurately and scientifically reflect our current condition.
step back | Homepage | 08.11.05 - 10:15 am | #

Tedman -

This quote is from your Wikipedia link:

"...since Jevons paradox is really just an anecdotal observation (as opposed to a logical paradox), it is insufficient by itself to support such an argument."

Well, this article points out something I have known because my neighbor works for Continental, but most people aren't hearing about:


My neighbor (pilot) told me last week that they had been making up all kinds of BS about flight delays to avoid telling people that jet fuel wasn't available for an hour or two....


Great article, and funny that when I pulled it up there is an ad right in the middle for "the best V8 for the planet"

Makes me feel all tingly that I get by with a mere 4 cylinder...

As far as futures prices, the theory that the upward trend is due to anticipation of Peak Oil has one problem.

Look at the crude oil futures prices at http://quotes.tradingcharts.com/futures/quotes/CL.html.
If you examine the farther-out crude oil futures, say 2007-2011, you see a phenomon called "backwardization". That just means that the later prices are LOWER than the earlier ones.

The market is predicting that oil prices will begin to fall a few years from now!

If the market were really worried about PO and this were what is driving prices up, we would see a price trend which futures traders call "contango", where prices each year are higher than the year before. We'd see 2011 oil being predicted to sell for MORE than today's price, not less.

But in fact, oil for delivery in 2011 can still be bought for under $60/bbl compared to $65 for delivery next month. This clearly indicates that the markets still do not believe the Peak Oil story. They are worried about more short term concerns, like terrorism in Saudi Arabia, hurricane threats to the Gulf, or heating oil demand this winter. That is what seems to be driving the prices at this point.

Halfin: Can you point to studies indicating the we can rely on the futures market to predict accurately?

Another question...looking at the NG futures vs. the CL futures. The NG futures have the same bump, but have higher prices out a little longer, with the same "return to normalcy." (look at NGG7 for example v. late 06).

See, this is my problem with saying "the market understands" because that just really isn't the case with either CL or NG...there's way too much uncertainty with regard to reserves and/or other supply capacity for the market to judge with any certainty whatsoever with regard to the long term. So, no one is willing to take the risk of going that long with the options...isn't that the case?

The market behaves rationally only when it has information. I don't think we can say that the market has reserve or other important information in this calculus, can we?

Where's that Oil Trader guy on this??

If that is what he does, surely he will know what he bases his decisions on and how far ahead people are willing to look....

TR Elliot,

I don't think the claim is that the futures market can predict anything accurately. Asset prices move on a stochastic (ie. random) basis and are inherently unpredictable. The theory in fact claims that it is impossible to predict, but that futures prices give a more accurate pointer than any other available data.

Futures markets, just like stock markets, are a way to see what the people who have actually made bets on the price think. By definition, half of people buying futures contracts believe that the price will be higher and half think it will be lower.

So when you see the term futures price, forget about the economics and theory and read it as "the average price that people are willing to commit to in advance at a given date".

I will also try to look up academic studies on this, there are many. I can probably more easily find studies on currency markets. There have been detailed studies that have compared a group of forecasters to the futures prices and found that no one was more accurate.

So think of it this way:
1) Theory says that futures markets will be wrong. Prices are random and no one can predict them. The track record of ALL forecasting is miserable.
2) All other ways of trying to get a feel for a future price or direction are more wrong.

When any oil company, finance firm, etc. buys oil, money or any commodity in advance, the price is set at the future rate. That is because this is the best available predictor of where the price will go, it doesn't mean anyone thinks it is right.

So if you looked back you would find two things:
1) Nobody has ever predicted future prices of any asset accurately over a significant period of time.
2) The futures price, however, has been the single best forecaster.

Dear Anonymous: (I am sure people have moved on, but I will post this for posterity)

Look at the Physics Today article. We have been increasing efficiency on the consumption side for well over 150 years (at an exponential rate that has intensified since the end of WW II). See any sign of energy consumption leveling off to a sustainable maximum? How about just an inflection point suggesting a slowing of growth in total energy consumption?

The empirical evidence is in: Jevons paradox (well, "rule" actually) is the reality for industrial society. Start with empirical evidence and then build your argument. Otherwise you are just a fantasist.

Jack: Agreed. I just wonder about the accuracy. I 100% agree that, provided 100% accurate information about the price of some object in the future, the futures market would be 100% accurate (well, except for noise for idiots, but a sucker is born...). Anyway, someone else (here or elsewhere) posted that the futures market is only as good as the information available. So I wonder how accurate the futures market has been for different classes of commodity, currency, and other speculative items.

The spread between the front month contracts and the back months dec10,11 is tightening, Most of my contracts are near the back of the board. A few years ago the spread was over $10 now its about $5. My feeling on the back months is if the front spikes to high enough price and kills of enough demand the longer term delivery contracts maywell fall.

I also dont think the market gets P.O yet but some of its participents are starting to.

Note i think the markets are stuipid and slow to get 'it'. Note the price of wheat way to cheap when you consider how much energy is required to grow the stuff.

We have been increasing efficiency on the consumption side for well over 150 years (at an exponential rate that has intensified since the end of WW II). See any sign of energy consumption leveling off to a sustainable maximum?

Perhaps. But in the last 25 years we've also pissed away a lot of energy on transportation which could have been conserved had we applied the available technoloogy. That goes to timing more than anyone's general theories but, clearly, we could have consumed much less of the world's reamaining supply of oil and we could still apply 25 additional years of efficiency technology (hybrid, anyone?), if we chose to do so.

And, as long as I'm in a flight of fancy, let me also put in a plug for telecommuting. If we were able to mandate just a 10% reduction in urban commuting via telecommuting (anyone here think people are more productive in the office - you haven't been watching) how much congestion/pollution/energy consumption could we save? How about 25%?

As I think has been made clear on this very important blog, we can't engineer our way out of the problem (unless Exxon/Mobil or Ford already have a cold fusion formula locked in a safe somehere, waiting for the most profitable time to use it). We need to treat this as a social/political problem and start thinking outside the box. That is, if we can get people to start thinking about it at all.

OK, so I may be way off base here (wouldn’t be the first time) but I’d like to do the math. Is anyone who knows this stuff able to help me?

First rough calculation (let me know if I have any bad data points; I already know about the bad math):

114 million commuters by car or light truck (2003) (x) average commute of approx. 10 miles (x) 240 days (/) 17mpg average mileage (/) 20 gallons per barrel = 804 million barrels per year (this seems small if cars and light trucks are responsible for 2.8 (40%) of 7 billion barrels of annual consumption). But, assuming that commuting is only about a third of car and light truck energy use and we could telecommute only 15-25% of car commuters, if we could pull 120-200 million barrels (about 1.5-3%) from annual consumption through telecommuting, would it matter?