Monday, December 27, 2010

Julian Simon via John Tierney Wins Another Bet

In the summer of 2005, when oil was trading at $60 per barrel (see chart above), there was a bet between Malthusian Matthew R. Simmons (member of the Council on Foreign Relations, head of a Houston investment bank specializing  in the energy industry, and author of “Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy”), and New York Times science writer John Tierney, proponent of the Julian Simon school of economics.  

"Peak oil" advocate Simmons predicted in 2005 that the inflation-adjusted price of oil would more than triple over the next five years, and he made a $5,000 bet with Tierney that the average price of oil in 2010 would be at least $200 per barrel in 2005 dollars.  Tierney agreed to share his bet with Julian Simon's widow, who enthusiastically participated in a bet on the real price of a natural resource in the tradition of her late husband, who won the famous bet in 1990 against Malthusian Paul Ehrlich about resource scarcity based on real prices of five commodities selected by Ehrlich and his doomsayer colleagues (see details here)

Although Mr. Simmons died in August of this year, the representatives of his estate will deliver $5,000 on January 1 to John Tierney and Rita Simon, because the price of oil this year has averaged about $80, or about $70 in inflation-adjusted 2005 dollars (see chart above), which is about 1/3 of the $200 per barrel price predicted by Simmons.   

John Tierney summarizes his economic optimism a la Julian Simon here:

"Giant new oil fields have been discovered off the coasts of Africa and Brazil. The new oil sands projects in Canada now supply more oil to the United States than Saudi Arabia does. Oil production in the United States increased last year, and the Department of Energy projects further increases over the next two decades. The really good news is the discovery of vast quantities of natural gas. It’s now selling for less than half of what it was five years ago. There’s so much available that the Energy Department is predicting low prices for gas and electricity for the next quarter-century.

Maybe something unexpected will change these happy trends, but for now I’d say that Julian Simon’s advice remains as good as ever. You can always make news with doomsday predictions, but you can usually make money betting against them."

26 Comments:

At 12/28/2010 8:55 AM, Blogger PeakTrader said...

"The average price of oil in 2010 would be at least $200 per barrel in 2005 dollars."

The odds are in your favor betting against that prediction, because it has to meet two simultaneous conditions: Price and timing.

 
At 12/28/2010 8:59 AM, Blogger Shawn said...

yeah, betting on an average, trending cost in real terms would be a better bet for peakers.

 
At 12/28/2010 10:10 AM, Blogger VangelV said...

I guess that Matt never counted on demand collapsing. He was an optimist like Mark and assumed that the economy would continue to expand. Had he bet on production peaking he would have won his bet. We now have even the IEA admitting that the production of light sweet peaked in 2006 and admitting that its previous forecasts were totally wrong as it has downgraded projected maximum production levels by more than 20%.

Julian Simon was an optimist. When he won his bet it was in an environment of a growing economy and an increasing standard of living. That has not been the case with this current bet. For Simmons to lose it took the greatest economic collapses in the post war period.

 
At 12/28/2010 10:56 AM, Blogger Jason said...

Peak oil is always a sore point of discussions in my circle of friends. I take a smart-ass approach and say we haven't been at peak oil since the Romans started pulling oil out of the Caspian region for Greek Fire. Others say peak oil refers to the so-called peak in oil production.

However, a compelling peak oil arguement is that peak oil is a concept where the amount of energy to produce a barrel of oil has passed a point where it will only increase going forward. IE: Tar sand oil, shale oil, deep-water drilling require far more energy to produce a barrel of oil than a barrel of oil does in Saudi Arabia. Therefore, effective oil production, that is the amount made available for non-energy production consumption, will only stay flat or decrease going forward.

I believe that overall energy consumption will decrease faster than production will stagnate - the "Necessity is the mother of invention" argument. My evidence is the innovation I've seen in electronics where power consumed has dropped to fractions of what was once consumed to do far less even a few years earlier.

 
At 12/28/2010 1:14 PM, Blogger Bloggin' Brewskie said...

Well, I said for years that Mr. "Nuke the Gulf" was a crackpot, but many didn't buy it because, afterall, he was Matthew Simmons! Of course the illustrious illusion disintegrated earlier in the year when, during the Macondo Oil Spill, he made a complete ass of himself - declaring things like, "We don't have the technology to plug the well," or "The spill may last twenty-five years" - and some of his most committed admirers distanced themselves from him.

It’s actually sad because Matt was a brilliant man who built a colossal investment banking enterprise, he carried a lot of foresight, and nobody does that by being stupid. But based on some of the very, very weird assertions made the past few years, some cognitive function in his head that wasn’t working the way it used to.

(BTW, VangeIV: Yes, I know you'll want to refute me, so by all means, take the last word as far as you want. Call me a fool or whatever, I'll take everything as a silent strong man.)

 
At 12/28/2010 4:17 PM, Blogger Benjamin said...

Bloggin' Brewski-

I still miss the best blog ever, "Ghawar Guzzler."

Peak Oil doomsters never understand the price mechanism, and man's ability to innovate.

Now we have gas coming out of rear ends for the next 100 years, and CNG cars/trucks for sale (see cngvehicles.net) for $6k in Oklahoma City.

The future just gets better abnd better. I wish I could live for 1000 years (in a 30-year-old body).

 
At 12/28/2010 5:06 PM, Blogger juandos said...

The problem I see here is the continued insistence of looking at crude oil instead of the overall 'carbon based energy sources'...

Relatively speaking it isn't a massive leap chemistry-wise to make the change over from crude oil to consumer to 'carbon based energy source' to consumer...

I'm not sure how that will play out in the industrial sector when it comes to investing in new equipment...

 
At 12/28/2010 6:12 PM, Blogger Taleb's Drudge said...

On the issue of NA production, there is a pretty strong argument to be found against fixing "problems" using a top down approach.

Since the announcement of the Pickens Plan in July '08, US imports from the Persian Gulf as a % of total consumption declined from 11.7% to 8.9%. As a % of total imports, the Persian Gulf declined from 17.9% to 14.5%. (Source: EIA website)

Yet Pickens persists. Hopefully, when oil tops $100 in the new year, people will be better informed than in 2008.

 
At 12/28/2010 7:31 PM, Blogger VangelV said...

However, a compelling peak oil arguement is that peak oil is a concept where the amount of energy to produce a barrel of oil has passed a point where it will only increase going forward. IE: Tar sand oil, shale oil, deep-water drilling require far more energy to produce a barrel of oil than a barrel of oil does in Saudi Arabia. Therefore, effective oil production, that is the amount made available for non-energy production consumption, will only stay flat or decrease going forward.

There is no need to over-complicate the subject. The production of light sweet crude peaked in 2005. (The IEA claims 2006.) Hundreds of billions of new investment were unable to get production to rise above the 2005 level even though new heavy oil projects, biofuels, and a reclassification of NGLs added barrels that were never counted before.

Because demand collapsed the producers were able to save some of their vulnerable fields by turning down the pressures. This will allow them to get more oil out of the fields as less of it is trapped behind the water flood but it will also mean that the previous peaks cannot be reached without significant new developments. The problem is that given the low prices and high costs such developments cannot be justified at this time.

I believe that overall energy consumption will decrease faster than production will stagnate - the "Necessity is the mother of invention" argument. My evidence is the innovation I've seen in electronics where power consumed has dropped to fractions of what was once consumed to do far less even a few years earlier.

Why would consumption fall faster than production? If you look at the dynamics it makes sense for producers to conserve their older fields by turning down the taps every time the price fell below a certain level. By being prudent they can actually make their own marginal fields increase in value relative to those of producers who are pushing their own fields to get out as much as they could as fast as they could and take advantage as the high prices made their undeveloped reserves worth more each year even as cash was extracted through modest production. By cutting capital investments these producers could increase profitability even as they drew down less oil each year and still see a huge increase in the value of their in-ground reserves.

You are assuming that the incentives at the back end of Hubbert's Peak are the same as they were while production was rising. That is not a case and is very dangerous for those making the assumption.

 
At 12/28/2010 7:45 PM, Blogger VangelV said...

Well, I said for years that Mr. "Nuke the Gulf" was a crackpot, but many didn't buy it because, afterall, he was Matthew Simmons! Of course the illustrious illusion disintegrated earlier in the year when, during the Macondo Oil Spill, he made a complete ass of himself - declaring things like, "We don't have the technology to plug the well," or "The spill may last twenty-five years" - and some of his most committed admirers distanced themselves from him.

You need perspective. World crude production peaked five years ago. That made Simmons right about the problem facing us. Where he went wrong was his optimism that the economy could hold up in the face of $100+ oil. Obviously it is not strong enough for that so what is needed is a mechanism to squeeze out some of the users from the market. The best candidate is the US, which uses a disproportionate amount of oil which it pays for by printing money. Europe is in a similar position. Some time in the next few years the USD will be taken down and Americans will have to use far less oil than they use today. That would permit other countries to use more.

 
At 12/28/2010 7:54 PM, Blogger VangelV said...

It’s actually sad because Matt was a brilliant man who built a colossal investment banking enterprise, he carried a lot of foresight, and nobody does that by being stupid. But based on some of the very, very weird assertions made the past few years, some cognitive function in his head that wasn’t working the way it used to.

My problem with Matt was his statist sentiment and his misread on the damage that the BP spill could do. Anyone familiar with the Gulf of Mexico seepage would know that nature could handle several such spills without much trouble. I had no problem with his suggestion to close the well using a nuke because it would have done the job easily without doing any damage to the Gulf. But as I said, it was totally unnecessary because the spill was quite small and could not do much damage even if BP and the US government did nothing about it.

BTW, VangeIV: Yes, I know you'll want to refute me, so by all means, take the last word as far as you want. Call me a fool or whatever, I'll take everything as a silent strong man.

The problem that I have with you is the denial of the Peak Oil problem even when presented with the evidence. You kept using the IEA as a source for quite some time but the IEA has since changed its predictions and has reduced its maximum production estimate even as it has upped its depletion estimate from producing fields and has reduced its predicted maximum production level by more than 20 mbpd to under 100 mbpd. It has said that production peaked in 2006 and needs a lot more new oil to be found and developed in order for its predicted maximum production level to come true. Given the trend it is only a matter of time until the IEA finally admits what people like Matt Simmons, Colin Campbell, and Kenneth Deffeyes pointed out several years ago.

 
At 12/28/2010 8:07 PM, Blogger VangelV said...

Peak Oil doomsters never understand the price mechanism, and man's ability to innovate.

Of course they do. As prices explode we will come up with substitutes and develop some of the marginal fields that make no sense today. But that does nothing to change the fact that production will peak. The problem is not the inability to innovate and come up with solutions eventually but with surviving the transition with the minimum amount of pain.

And labeling the Peak Oil proponents as 'doomsters' is unwarranted because these are the people who are looking for solutions today. In my case, I am interested in ocean energy and methane hydrates. Simmons had a scheme to use wind power to develop liquid ammonia production that would allow internal combustion engines to use it as fuel. Others are looking at using LNG as a fuel for automobiles.

The problem comes from the optimists who argue that there is no problem and that we don't have to take any steps now because someone else will come up with something to solve all of our problems. They are the ones who are relying on the people they call 'doomsters' to come up with the solutions because as optimists they are certainly not doing anything to solve the problem.

 
At 12/28/2010 8:11 PM, Blogger VangelV said...

Relatively speaking it isn't a massive leap chemistry-wise to make the change over from crude oil to consumer to 'carbon based energy source' to consumer...

The issue is capital and thermodynamics. You will need trillions to make the transition and a source close to the conversion facilities that would make the liquid fuel that will be needed to keep the economy going until the transition is complete.

 
At 12/28/2010 8:16 PM, Blogger VangelV said...

Yet Pickens persists.

No. Pickens has given up on his wind power scheme because it does not do anything to solve any of our problems. He is now pushing natural gas but I suspect that in 2011 we will have bankruptcies of some of the shale players that illustrate the problems with that sector.

http://www.sustainablebusiness.com/index.cfm/go/news.display/id/21598

 
At 12/28/2010 10:13 PM, Blogger Bloggin' Brewskie said...

Ben,

Good to hear from you. Yes, I know it's been a while since I've posted but while I have been busy, the truth is I've become quite bored with the subject, and have demonstrated little interest in debating it; I check the Oil Drum very sporadically now days.

That having been said, I do intend to do an update pretty soon. Look for the update in January.

 
At 12/28/2010 11:27 PM, Blogger Bloggin' Brewskie said...

VangeIV,

I was looking forward to your lengthy replies, and since I'm in a good mood, I think I'll hit some points:

"You need perspective. World crude production peaked five years ago."

The record for yearly production was two years ago. We had a very lengthy argument about this, remember?

"That made Simmons right about the problem facing us. Where he went wrong was his optimism that the economy could hold up in the face of $100+ oil."

Actually, much of what drove Simmons to believe oil would average $200 a barrel in 2010 was his assertion - something that was the thesis behind his book: Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy - that Saudi Arabia would experience a near-term collapse in oil production - something he carried in 2003, a year before he released his book.

"My problem with Matt was his statist sentiment and his misread on the damage that the BP spill could do"

Okay, I guess I can go with this.

"The problem that I have with you is the denial of the Peak Oil problem even when presented with the evidence. You kept using the IEA as a source for quite some time but the IEA has since changed its predictions..."

You still seem to misinterpret my argument, but that's easily understood since many perceived "optimists" of this debate believe production can climb to the moon. That was never my argument. Rather, it was that peak oil wouldn't be as bad as many believed: meaning, it would result in a prolonged plateau, or a slow decline in production. Considering the ongoing plateau in non-OPEC crude production, despite the IEA's damning report (which placed an estimated double-digit depletion rate for non-OPEC production) I don't think I've done half bad.

Anyway, I'll shut up and put up now. The truthfulness is that if I had known then what I know now - that you're a successful, self-made man who's not the dumbass "comment section troll" (like so many in the debate) I mistakenly assumed you were - I would have defiantly treated you with more civility. If we ever debate this subject again, I guarantee you, you will gain a more cordial discussion.

 
At 12/29/2010 11:24 AM, Blogger Eric said...

Maybe Tierney should double down against former Shell Oil chief John Hofmeister.

 
At 12/29/2010 4:33 PM, Blogger HFT said...

In the last 60 days ,

PBR ( Petrobas ) discovered 8 billion bbl. of oil off their shores in the "lula" field,
and

NBL (Noble Energy ) finds 16 trillion cubic feet in Leviathon field ( Israel's largest energy discovery ever --enough to meet gas needs for 100 years )

 
At 12/29/2010 6:25 PM, Blogger VangelV said...

The record for yearly production was two years ago. ..remember?

I do remember. Since then the IEA has come around and said that production peaked early in 2006. It has also admitted that the depletion rates were much higher than its estimates. I

Actually, much of what drove Simmons to believe oil would average $200 a barrel in 2010 was his assertion...that Saudi Arabia would experience a near-term collapse in oil production - something he carried in 2003, a year before he released his book.


When I heard him speak he said that Saudi production increases were a thing of the past because the claims of 15 mmbpd production could not come about and that even 12 mmbpd were unlikely. Simmons' problem was that he never thought that the high oil price could trigger an economic collapse and panic in the commodity pits. It did. That said, he was right about the supply side problems.

...Rather, it was that peak oil wouldn't be as bad as many believed: meaning, it would result in a prolonged plateau, or a slow decline in production. Considering the ongoing plateau in non-OPEC crude production, despite the IEA's damning report (which placed an estimated double-digit depletion rate for non-OPEC production) I don't think I've done half bad.

People like Deffeyes have argued that governments and the majors could pull out all the stops to create a plateau for a short time. But that is not sustainable because the incentives on the back end of Hubbert's Curve are to turn down the taps and let prices explode. Producers can return more value to shareholders if the value of their in-ground reserves grows faster than what they take out each year. Some players may be best off by cutting their capital investment entirely and let their reserves act as a perpetual call option on petroleum.

Anyway, I'll shut up and put up now....

All ideas need to be attacked as much as possible because that is what is required to discover the truth about reality. Too many people on this blog are afraid of contradicting themselves because if they learn something new they would have to admit that they were wrong. As such, their opinions are far harder to change no matter what objective evidence is provided to them.

I think that it is foolish to look at a complex system like the economy (or the energy industry) and think that there is something universal that can be pulled out of it that could be manipulated to get an outcome that is desired. The real world does not work that way.

In the real world incentives matter, which is why I believe that it is important to look at how the financial thinking changes at the back end of Hubbert's curve. Think of yourself as a producer with decent reserves that are being depleted and require massive amounts of new investment to maintain. Would you deplete those reserves faster because the price went up or would you reduce production to increase profits (higher prices and lower capital expenditures) and to increase the value of the reserves in the ground? In my opinion the management of your oil company will apply the warehouse model. Your reserves are the inventory and you make your money by selling that inventory. I suggest that to maximize value you will quickly figure out that pushing production and spending large amounts on capital will not work. The prudent players will do what some of the old Texas fields have done. Ignore water drives and enhanced methods and get out the crude slowly but steadily because that would allow you to own the assets far longer and give you far more wealth over the long run. The problem with that for users is that the declines will be far worse than projected and exports will be lower than projected. And that gives us an entirely new ball game.

 
At 12/29/2010 6:34 PM, Blogger VangelV said...

Maybe Tierney should double down against former Shell Oil chief John Hofmeister.

You can't bet on a price over the short term because you can be right about the issue and still lose. The trick is to break it down to what is essential and that is the supply side response to depletion. The fact is that no matter how many deep water fields we find, there is no way to bring them on line fast enough to offset depletion or to make them economic at sub $100 oil.

But we could still see price collapses in the short term because over a period of a year or less the big factor is not long term fundamentals but buying and selling pressure in the commodity pits.

If the economy collapses we could see supply go down sharply and still see a price decline for crude. This is why the producers need to look at their business models and adapt. The trick is to sell some of their production forward at a price that is considered acceptable and use pullbacks to increase shareholder value by buying more reserves cheaply or to buy back their own shares during price collapses. Cash can be conserved easily by managing capital expenditures and per share reserves should be grown if the management uses the correct strategy and is patient enough to execute.

 
At 12/29/2010 7:14 PM, Blogger VangelV said...

In the last 60 days ,

PBR ( Petrobas ) discovered 8 billion bbl. of oil off their shores in the "lula" field,..


Statoil and PBR need to do a lot of work to figure out what they have and the amount of oil that is likely to be produced. They will need more exploration wells to be drilled, will need to do flow tests, and will have to plan out how they will need to develop the field including the number of injector wells, infrastructure investment, etc.

As a comparison, the 2006 Tupi discovery, which is supposed to be around the same size, will take at least 15 years to reach 500,000 bpd of gross production. After accounting for the energy that will be needed to power the injector wells and to extract and distribute the oil, net production will be significantly lower. The cost will be somewhere in the neighbourhood of $100 billion, which comes out to be around 5% of Brazil's GDP. If Brazil's companies plan and invest properly and if they are lucky, the total production by 2025 will not be enough to offset the decline from Ghawar. Where will the other oil needed to offset production from current fields come from? And what will be source of the additional oil needed to grow production?

NBL (Noble Energy ) finds 16 trillion cubic feet in Leviathon field ( Israel's largest energy discovery ever --enough to meet gas needs for 100 years )

NBL (Noble Energy ) finds 16 trillion cubic feet in Leviathon field ( Israel's largest energy discovery ever --enough to meet gas needs for 100 years )

I may be wrong but isn't that a fraction of 1% of global reserves? While great for Israel, that is not exactly a massive find.

 
At 12/30/2010 10:09 AM, Blogger Eric said...

VangelV,

So, what do you think of Hofmeister's proposal of a federal energy reserve and using $5/GALLON GAS! as the appeal to fear?

 
At 12/30/2010 11:43 AM, Blogger VangelV said...

So, what do you think of Hofmeister's proposal of a federal energy reserve and using $5/GALLON GAS! as the appeal to fear?

There are far too many federal agencies. Most if not all of them should be abolished because they limit individual liberty and interfere with voluntary exchanges in society. The price of gas should be set by the market. If it goes to $5 a gallon you will see a much faster development of substitutes by people looking to get rich by solving the high price problem.

 
At 1/01/2011 1:05 AM, Blogger Gale Pooley said...

Will Steve Andrews bet on the price in 2015?

 
At 1/03/2011 4:19 AM, Blogger rjs said...

Stupidest Man Alive Nominations for Don Boudreaux, Mark Perry, and John Tierney » Brad DeLong

http://delong.typepad.com/sdj/2011/01/stupidest-man-alive-nominations-for-don-boudreaux-mark-perry-and-john-tierney.html

 
At 1/03/2011 9:16 AM, Blogger VangelV said...

Stupidest Man Alive Nominations for Don Boudreaux, Mark Perry, and John Tierney » Brad DeLong

http://delong.typepad.com/sdj/2011/01/stupidest-man-alive-nominations-for-don-boudreaux-mark-perry-and-john-tierney.html


No chance. When it comes to stupidity Brad Delong is so far ahead that Mark or Don can't even see him. I have no problem with Mark and Don most of the time or with their argument that the market will come up with some solution. Where they fail is their understanding of the nature of the oil business, particularly the issue of energy returns on energy invested. John is a different story. He knows better and understands that he won his bet not because of any supply side response but because of a collapse in demand that was partially triggered by the problem that Simmons was pointing to. He is like the bettor who sees his horse come in first after the two who were ahead crash due to a collision. Even though he picked the weaker horse and was a bad judge of talent he won. All he is doing is playing up the win. There is nothing really wrong with that.

 

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