Friday, January 07, 2011

Update on the "Stupidest Man Alive" Kerfuffle; We'll Never Run Out of the Ultimate Resource

Here are the latest posts from Brad DeLong and Don Boudreaux on the "Stupidest Man Alive" kerfuffle.  While Brad and Don work out the terms of their possible upcoming bet on the future trends in the inflation-adjusted prices of natural resources or petroleum products, let's do a quick review of the historical record of real gas prices over the last 92 years (this series goes back to 1919, which is the longest historical price record I could find for oil or gas). 

The chart above shows the inflation-adjusted retail price of regular gasoline on an annual basis back to 1919, using data from the EIA. Here's what we know for sure:

1. The real price of gas is cheaper today in the U.S. than in the early 1920s, even though:
a. The U.S. population has increased by about three times from 104 million to 308 million.
b. We produce about 17 times more output today (real GDP) than in the early 1920s.
c. There are more than 30 times as many automobiles today (250 million) in the U.S. compared to 1920 (7.5 million).  

2. Despite the OPEC-induced artificial shortages around 1980, the 2008 spike, and the recent upturn, the long-term trend in real gas prices going back to 1919 has been significantly downward (see trend line in graph). 

Bottom Line: The significant downward trend in real gas prices over the last century seems to generally support Julian Simon's cornucopian view that the human resources of innovation, discovery, and substitution will always be strong enough to overcome and offset increases in population and the accompanying rising demand for natural resources like oil and gas, which will be reflected in stable or falling real prices of natural resources over time, e.g. gasoline since 1919.  

And even if the downward trend has now reversed, and real oil and gas prices are headed upward in the near future, that will certainly lead to: a) increased exploration and discovery to find more oil (e.g. North Dakota) , b) increased substitution to alternative fuels like natural gas and nuclear, and c) reduced demand.  In other words, supply will increase and/or demand will decrease, which will moderate price increases, or lead eventually to falling prices.  This is just basic ECON 101, and is why "peak oil" is "peak idiocy."

If we look beyond the Ehrlich-Simon, Tierney-Simmons and DeLong-Boudreaux bets on resource prices, the bigger Simonesque lesson is clear: the "ultimate resource," i.e. the human mind, human capital, human ingenuity, and human innovation, are infinitely abundant, and will meet, address and overcome any scarcity in natural resources.  The bottom line as I understand Julian Simon is this: we'll never run out of the ultimate resource.  And that is why limited or finite supplies of natural resources have never, and will never, result in any significant binding constraints or limits on human progress, economic growth, or the continual increases in our standard of living, wealth and abundance.  

15 Comments:

At 1/07/2011 4:25 PM, Blogger Buddy R Pacifico said...

Does the retail price of gasoline statistics include ever increasing state and fed taxes? If so, then the argument by professors Perry and Boudreaux is even stronger.

 
At 1/07/2011 5:34 PM, Blogger Mark J. Perry said...

Thanks Klockarman, it's a great point.

 
At 1/07/2011 5:36 PM, Blogger Klockarman said...

I think Simon's ideas would gain greater acceptance if more people understood (and many don't) that short-term high price swings play an integral role in achieving lower real prices in the long term.

Julian Simon:

"More people, and increased income, cause resources to become more scarce in the short run. Heightened scarcity causes prices to rise. The higher prices present opportunity, and prompt inventors and entrepreneurs to search for solutions. Many fail in the search, at cost to themselves. But in a free society, solutions are eventually found. And in the long run the new developments leave us better off than if the problems had not arisen. That is, prices eventually become lower than before the increased scarcity occurred.

(Sorry for the two deletions, but I noticed typos)

 
At 1/07/2011 6:32 PM, Blogger rjs said...

that chart at the top of this post could be the inverse of this one:

http://static.seekingalpha.com/uploads/2010/2/10/saupload_olduvai.png

 
At 1/07/2011 6:38 PM, Blogger Gale L. Pooley said...

You might want to also adjust price against average wage rates. This would account for the increasing productivity of human beings.

For example: What is cheaper?
$3.00 a gallon gas if I am earning $10 an hour, or $4.00 a gallon if I am making $15 an hour?

The time-price (Cox and Nordhaus) is the more precise measurement of cost.

 
At 1/07/2011 7:05 PM, Blogger PeakTrader said...

U.S. real per capita GDP (output = income) 2005 dollars. MeasuringWorth.com:

1950 $13,225
1960 $15,661
1970 $20,820
1980 $25,640
1990 $32,112
2000 $39,750

2007 $43,842 (peak year)

2009 $41,890

 
At 1/07/2011 7:27 PM, Blogger PeakTrader said...

Inflation Adjusted Gasoline Prices

Year Price

1958 $2.26
1968 $2.13
1978 $2.17
1988 $1.77
1998 $1.36
2008 $3.26
2010 $2.73

 
At 1/07/2011 8:35 PM, Blogger Rufus II said...

Of Course. What could be more "idiotic" than imagining that we would ever reach "peak extraction" of a Finite Resource.

You'd hafta be a Maroon to consider such a thing, eh?

 
At 1/07/2011 9:05 PM, OpenID Sprewell said...

Rufus, I assume you're arguing that since oil is a "finite resource," the peak oil crowd is onto something. Let me illustrate why that's a silly argument by comparison to another "finite resource:" the Sun. It's estimated that the Sun will run out of Hydrogen in 5 billion years. Since that's halfway through its cycle, you could argue that we're at peak Sun now. ;) However, it hardly matters because that is such a long time frame that what happens in 5 billion years is almost certainly not going to matter to us, either because we're all dead or on spaceships to Alpha Centauri by then. :) Now, admittedly oil is on a shorter time frame than the Sun, ;) but some of the same arguments apply. Oil is not going to matter because we will figure out where to get more of it or how to replace it completely. It is the oil dictators and regimes who should worry much more about our finally figuring out how to genetically engineer algae that makes for a great biofuel, as opposed to us worrying about future energy shortages.

 
At 1/07/2011 9:17 PM, Blogger Gale L. Pooley said...

This comment has been removed by the author.

 
At 1/07/2011 9:57 PM, Blogger Gale L. Pooley said...

PeakTrader's analysis suggests that the cost of gas today is less than half of what it was in 1960.

Dividing the price by the GDP per Capita gives a better indication of the time-price.

Another method for the wager with DeLong would be to use the average hourly rate and the price of oil.

The current price of oil is around $88 and the current average hourly wage is $22.36. This would indicated that oil requires 3.94 hours.

I would use this index for a wager. As an economist DeLong should agree.

Bet $10,000.

At the term date of the bet, if the time price to buy a barrel of oil is more than 3.94 hours, DeLong wins. If it is less Boudreaux wins.

 
At 1/07/2011 10:59 PM, Blogger VangelV said...

Does the retail price of gasoline statistics include ever increasing state and fed taxes? If so, then the argument by professors Perry and Boudreaux is even stronger.

The limited knowledge by Perry and Boudreaux is a problem for them. Up until the early 2000s there was always a huge surplus capacity ready to bring more oil to market when prices rose. Now that capacity is created by demand collapses, which is a different mechanism than what we are used to. And now that we are on the back end of Hubbert's Curve the incentives for producers are very different than what they used to be. It is easy to survive downturns if you have decent conventional reserves. All you have to do is to cut capital spending to the bone and let depletion take production lower until it catches up with demand. That way, real returns will be maximized even as high priced competitors that produce unprofitable unconventional fuels are driven into bankruptcy.

 
At 1/07/2011 11:05 PM, Blogger VangelV said...

If we look beyond the Ehrlich-Simon, Tierney-Simmons and DeLong-Boudreaux bets on resource prices, the bigger Simonesque lesson is clear: the "ultimate resource," i.e. the human mind, human capital, human ingenuity, and human innovation, are infinitely abundant, and will meet, address and overcome any scarcity in natural resources.

As an investor I agree with this statement. But what you are missing is the transition path. From here to there is a long way and the journey may take a lot longer than imagined. While we will find cheap natural gas in Mexico, the Middle East, Russia, and many other places the development times and the building of the gas to liquids facilities will take more time than you believe and will drive many existing operations out of business. Our biggest problem was a two decade period of underinvestment. To catch up we will need massive amounts of capital to be invested in new projects but even after we spend a huge amount there is no way to offset depletion in the petroleum sector. That requires a new supply of fuel and a lot of time.

If you are an optimist than you should be willing to predict that in a decade we should see 100 mbpd of production. I would argue that we would be lucky to see a decline that only takes us down to 70 mbpd.

 
At 1/08/2011 11:27 AM, Blogger Junkyard_hawg1985 said...

Prior to 1971, the dollar was essentially fixed to the price of gold. Since then, there has been a lot of variability in the value of the dollar. If you plot the value of oil in gold terms, there has been a lot less variability in the price of oil and it is still on a downward trend. In 1969, you could buy 10 barrels of oil. Today, that same ounce of gold will buy 15 barrels of oil.

 
At 1/08/2011 9:34 PM, OpenID hanmeng said...

If you taught at the kind of state university I do, you wouldn't be so sure that "the human mind, human capital, human ingenuity, and human innovation, are infinitely abundant".

;-/

 

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