Wednesday, December 29, 2010

Cornucopia or Malthusia - a reply to John Tierney

Five years ago John Tierney agreed on a bet with Matt Simmons that by this year the average price of crude oil would average $200 a barrel. The bet is now due, although, sadly, in the interim Matt has passed away. And Mr Tierney has just posted (h/t Leanan) his comment upon winning the bet. While recognizing the impact of the recession on oil prices, after their rise to $147 in the intervening years, he points out that this year crude averaged $80. This he feels justifies the position of the Cornucopian approach to life, rather than the Malthusian.

Would that he were right! In his article he cites oil from new fields coming ashore from fields off Africa and Brazil, and increased production from the oil sands of Canada and the United States, as promising a maintenance of this Cornucopian era into the future. And he uses a historic parallel to show how in an earlier time Julian Simon won a similar bet against Paul Ehrlich, John Holdren and John Harte over the price of a basket of 5 metals.

Admittedly he is currently in good company, since the EIA is not looking for the price of crude to rise above $100 a barrel for another six years, and the IEA recently posted in their December Oil Market Report that global production increased from both OPEC (up 45 kbd) and non-OPEC (up 355 kbd) sources in November. It sees that production will continue to increase through 2011, meeting an increase in demand to 88.8 mbd. 0.5 mbd of that will come from an increase in NGL from OPEC, rising to 5.8 mbd.

Art Berman has just explained some of his concerns with the optimistic projections of the EIA Annual Energy Outlook and I agree with his line of argument. But let me take a slightly different tack in disagreeing with the Cornucopian position.

And it is true that oil companies are now gearing up for a much greater level of investment in this next year than in the recent past. The WSJ quotes a Barclay’s Capital report that levels will reach $490 billion, up 11% on last year. It also notes that the price rises of 2008 led to a boom in deepwater rig construction, and the 25 built in 2010 will be joined by 35 next year. All of which allows the Journal to end with a quote that “Higher investment now will mean lower prices than they would otherwise be in the future.” (Well yes, but . . . . ) But the reality is that the levels of investment that will be required to sustain current levels of production are likely to exceed these numbers, and we are in a time when greater prospecting will likely only lead to a diminished return. Not that we don’t need that investment.

So how does one address this issue. Well Let’s just go back to that original bet by Simon against Ehrlich et al on the price of metals. The original bet was as follows:
Ehrlich and his colleagues picked five metals that they thought would undergo big price rises: chromium, copper, nickel, tin, and tungsten. Then, on paper, they bought $200 worth of each, for a total bet of $1,000, using the prices on September 29, 1980, as an index. They designated September 29, 1990, 10 years hence, as the payoff date. If the inflation-adjusted prices of the various metals rose in the interim, Simon would pay Ehrlich the combined difference; if the prices fell, Ehrlich et alia would pay Simon.

Then they sat back and waited.

Between 1980 and 1990, the world's population grew by more than 800 million, the largest increase in one decade in all of history. But by September 1990, without a single exception, the price of each of Ehrlich's selected metals had fallen, and in some cases had dropped through the floor. Chrome, which had sold for $3.90 a pound in 1980, was down to $3.70 in 1990. Tin, which was $8.72 a pound in 1980, was down to $3.88 a decade later.
Which is how it came to pass that in October 1990, Paul Ehrlich mailed Julian Simon a check for $576.07.
Just out of curiosity I went to Infomine and looked at the price of those metals over the past 10 years (though they only plot chromium and tungsten prices for five). The plots for the 5 metals follow, and to make the calculations simple I have rounded the metal values a little.

Chromium:

$200 in 2000 would have bought 66.7 lbs (it was $3), and in 2005 would have bought 160 lbs of chrome, which would now be worth $425 roughly. Over the 10-year interval however, buying $200 of chromium would have cost you $23, not counting inflation.

Copper:

However, when we look at copper, that $200 would have bought 250 lb of copper in 2000, and over the decade that purchase has gained $862, roughly.

Nickel:

A similar situation applies to nickel, where $200 would have bought about 66.7 lbs of nickel in 2000, and that investment would have gained $533 over the 10 years.

Tin:

The same is also true for tin, where $200 would have bought 91 lb of tin in 2000, and that would sell today for about $1,090; the investment thus making $890 over the decade.

Tungsten:

$200 would have bought 6.25 lb of tungsten in 2005, which would now be worth $265 roughly. It has been difficult to find the price of tungsten in 2000, although the price is reported to have trebled from that pre-2004, suggesting that it was around $14 back then. That would give a purchase of some 14 lb, which would now be worth around $600.

So the $1,000 investment from 2000 would now be worth (in 2010 dollars) $177+$1,062+$733+$1090+$600 = $3,663

Using the Inflation Calculator there has been 27% inflation since 2000, so that the $1,000 would now be worth $1,270. The price of the metals has thus roughly trebled over the time period.

I have not been able to find an accurate value for tungsten in 2000, though I know that the price went up significantly in 2003 when the only mine in the North Americas (the Cantung mine in Canada) closed. It is now re-opening. Most of the world’s tungsten now comes from China.

This reality suggests the underlying longer-term truth to the supply situation for materials that are extracted from the earth. There is only a finite amount there, and while it is possible, due to changing economic circumstance, that a Cornucopian viewpoint might for a while appear true, the growing demand for product, as countries, particularly those in Asia, aspire to Western levels of consumption, will rapidly emphasize the Malthusian long-term condition. (Although cherry-picking specific dates may allow one to transiently make the alternate case).

One has only to consider what is happening to gold and silver, not to mention the rare earth minerals.

Matt may have been a little early in his prediction on $200 oil, but I would be very surprised if we did not see a bit more than $100 within the year. The impact that a price rise above this level will have on the global economy makes it difficult to predict what will happen after that, but we could easily see $150 a barrel by 2015, if the economy can sustain it.

36 comments:

  1. Do these kinds of "bets" miss the point? The resources which are important, and their price, depend on decisions which human beings make.

    The original form of renewable energy was slavery, and was used in various forms in most cultures over a period of thousands of years. What has happened to the price of a slave today?

    We all know that question is irrelevant. Renewable slave energy was replaced by fossil fuels -- to the great benefit of us all. Technological progress has the potential to render issues such as "Peak Slave" irrelevant; provided that we continuously encourage technological progress.

    If the West had not been mislead by a small band of activists in the 1970s, nuclear energy would by now have made signficant inroads into the market for fossil fuels, with consequent impact on fossil fuel prices.

    The obvious path forward was to replace coal with nuclear for electric generation, and then to use nuclear power to "mine" liquid hydrocarbon fuels from that coal and various other carbon sources. Those "mined" liquid hydrocarbons would have set the ceiling price for conventional oil production.

    But the activists succeeded. The West turned its back on technological progress. And now the future belongs to those who are embracing technology, most notably China & Russia.

    ReplyDelete
  2. Great post! Not that it would satisfy Michael Lynch and pals over at masterresource.org.

    Easy enough to find charts of the missing metals, here's chromium, courtesy Seeking Alpha, and tungsten courtesy of a dedicated blog - this chart goes back to 1900. Looks like both started out the 21st century flattish but chromium took off on a steady linear rise in 2002, tungsten doing the same in 2004 - suggesting a different shape than the infomine graph, perhaps. USGS page on tungsten has .xls with some price data.

    ReplyDelete
  3. If I look at the plot of price for tungsten in the first ref, it is around $6,000 a ton, which would give a price of around $3 a lb, allowing for the thickness of the graph line and seeking only a rough estimate. If that is indeed the case, then the gain would be from $3 to $19, which for some 66 lb purchased would give a gain of $2,600. This would raise the size of the check to close to $5,000. Wow!

    ReplyDelete
  4. Look again at that tungsten plot.

    Presumably, the reported price is inflation-adjusted -- if not, the real price of tungsten has dropped dramatically over the last 100 years. But how do we meaningfully adjust for inflation when comparing the very different horse-drawn world of 1900 with today?

    Leaving that philosophical issue aside, the reported price of tungsten in 2004 was about the same as in 1900. Wow!!

    The graph shows reported price spikes during World War I, following World War II, and in the 1980s -- and today. It would be a bold man who predicted that today's higher price was a permanent increase rather than just another temporary spike.

    ReplyDelete
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