Wolf, Becker, and Posner on Oil (With a Shocker From Posner)

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There are some interesting cross currents in the day’s offerings on oil.

What a difference a year makes. Not so long ago, the peak oil crowd was seen in much the same light as the discredited Club of Rome: worrywarts about a bad future that would probably take a long time to arrive. Now everyone is on the resource scarcity bandwagon.

Martin Wolf offers a workmanlike treatment of the “this time it’s real” thesis; what is intriguing are some divergent observations from Gary Becker and in particular Richard Posner (hat tip reader Steve), who advocates aggressive taxing of energy. Mirable dictu, I never would have expected that from his end of the political spectrum (although Posner isn’t as easily pigeonholed as some other thinkers). I hope his stature encourages others to warm up to the idea.

First from Wolf in the Financial Times:

Here are three facts about oil: it is a finite resource; it drives the global transport system; and if emerging economies consumed oil as Europeans do, world consumption would jump by 150 per cent. What is happening today is an early warning of this stark reality. It is tempting to blame the prices on speculators and big bad oil companies. The reality is different….

It looks increasingly hard to expand supply by the annual amount of about 1.4m barrels a day needed to meet demand. This means an extra Saudi Arabia every seven years. According to the International Energy Agency, almost two-thirds of additional capacity needed over the next eight years is required to replace declining output from existing fields. This makes the task even harder than it seems. As the latest World Economic Outlook from the International Monetary Fund adds, the fact that peak production is reached sooner, because of today’s efficient technologies, also means that subsequent declines are steeper.

This is not to argue that speculation has played no role in recent rises in prices. But it is hard to believe it has been a really big one…. As I have argued before, if speculation were raising prices above the warranted level, one would expect to see inventories piling up rapidly, as supply exceeds the rate at which oil is burned.

Note that Wolf’s views on oil are in part based on the assumption of continued strong growth ex the US. This is contradicted by IMF forecasts that anticipate global growth of 3.7% (that may sound like a good number for the US, but is considered sluggish for the world as a whole). Over the last two quarters, the IMF has slashed its forecasts from 4.9% and sounded this cautionary note in its end of April release:

Citing the unfolding financial market turmoil as the biggest downside risk to the global economy, the April 2008 report said the IMF expects world growth to slow to 3.7 percent in 2008—0.5 percentage point lower than what was forecast in the January 2008 World Economic Outlook Update.

Further, world growth would achieve little pickup in 2009, and there is a 25 percent chance that the global economy will record 3 percent or less growth in 2008 and 2009, equivalent to a global recession.

Contrast this with Wolf:

The price spikes of the 1970s were followed by big absolute falls in demand and output (see chart). This was partly because of the recessions and partly because of rising efficiency. Both forces should work again this time, but to a much smaller extent. The slowdown in the US economy is indeed likely to be significant. Slowdowns will also occur in western Europe and Japan and even in the emerging world. But the latter will still grow rapidly. Overall, the world economy – and so world oil demand – is likely to continue to grow reasonably briskly. Similarly, the improved efficiency of use of petroleum, as people switch to more efficient vehicles, notably in north America (where the room for doing so is so large), will be offset by the rising tide of demand for motorised transport in the world’s fast-growing emerging countries.

This is admittedly a difference of degree rather than kind. His evidence:

The areas of difference with the Becker/Posner tag team are instructive. First from Becker, who claims that conservation and new technology will tame oil price hikes:

The run-up in the world price of oil during the past several years, and especially the rapid climb during the last few weeks to over $120 per barrel, has fueled predictions that the price will reach $200 a barrel in the rather near future. Such predictions are not based on much analysis, and mainly just extrapolate this sharp upward trend in oil prices into the future. The price of oil in “real” terms (i.e., relative to general prices) will not reach $200 in this time frame without either terrorist or other attacks that destroy major oil-producing facilities, or huge taxes on oil consumption….

The present boom in oil prices has been mainly driven by increases in demand from the rapidly growing developing nations….To be sure, supply problems…. have contributed…

[A]ny rise in oil prices to over $200 a barrel in the next few years would have serious disruptive effects on the world economy. To many persons who have commented on this prospect, such a high oil price seems plausible…For the evidence is rather strong that the short run response of both the supply of and the demand for oil to price increases is rather small….

However, the long run response to price increases of both the demand and supply for oil and other energy inputs is considerable. For example, given enough time to adjust, families react to much higher gasoline prices by purchasing cars, such as hybrids and compacts, that use less gasoline per mile driven. They also substitute trains and other public transportation for driving to work and for leisure purposes. High energy prices, and hence the opportunity for large profits, induce entrepreneurs to work more aggressively to find fuel-efficient technologies, including the use of batteries as a replacement for the internal combustion engine.

Clearly, given high enough oil prices, many ways are available to increase the supply of petroleum….Rising prices of oil and other energy inputs will eventually be controlled by new technologies that greatly economize on the use of these inputs. Increased supplies of oil and other energy sources that become profitable to exploit only with prolonged high prices will also push these prices back.

Now from Posner, who argues that high taxes on oil, or preferably CO2 emissions, will produce a benefits on a variety of fronts (including reducing wealth transfer to the Middle East):

I would like to see the price of oil rise to $200, despite the worldwide recession that would probably result, provided that it rises as a result of heavy taxes on oil or (better) carbon emissions. The taxes would jump start the development of clean fuels, and the financial impact on consumers could be buffered by returning a portion of the tax revenues in the form of income tax credits. That would not reduce the effect of the taxes on the demand for oil or the incentives to develop alternative fuels, because the marginal cost (the production and distribution cost plus the tax) of oil to consumers would not be affected. Higher oil prices are necessary to check global warming, reduce traffic congestion, and reduce dependence on foreign oil, so much of which is produced by countries that are either unstable or hostile to the United States. Heavy taxes on oil would reduce not only the amount of oil we import but also the revenue per barrel of the oil exporting nations, so there would be a double negative effect on those countries’ oil revenues: they would sell less oil and earn less per unit sold. The reason for the latter effect is the upward-sloping supply curve for oil. Suppose the first million barrels of oil can be produced at a cost of $1 per barrel and the second million at $2 per barrel. If total demand is one million barrels, the suppliers break even: they have revenues of $1 million and costs of $1 million. If total demand is two million barrels, the suppliers have revenues of $4 million (because the price of all barrels is determined by the price that the marginal purchaser is willing to pay) but costs of only $3 million ($1 million for the first million barrels, $2 million of the second). The lower the price of oil received by the oil producers (that is, the price net of tax), the lower their net income.

Unfortunately I cannot see a confluence of political forces that would make heavy taxes on oil feasible. We seem to be experiencing a democratic failure, in which long-term problems simply cannot be addressed.

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  1. badanov

    If you can use legislation to stop exploring and drilling for oil, hell yes you will get “peak oil.”

    Why don’t these three wise men make these assumptions using a model that includes what would happen to the global oil supply were it not for all the restrictions on an otherwise legitimate economic activity?

    This is a government inspired shortage, created as a sop to environmentalists, the only long term consequence of which we are seeing now.

    I also can add that we wouldn’t even be talking about “peak oil” were it not for these legalized restrictions were in place.

  2. Av

    In this context, this testimony i read yesterday was fascinating and quite relevant.

    It was made in December, 2007 to a Senate subcommittee on energy. The testimony says it is quite likely that oil would go to $120. But the reasons for the run up in oil prices are quite interesting and quite different from the ones which are usually put forward.


    “…First, the rise in light sweet crude prices to almost $100 per barrel in November came
    about because the U.S. Department of Energy has been removing a significant share of
    the daily volume of this type of crude from the market for storage in the Strategic Petroleum

    Second, prices have been pushed higher because private firms have been reducing inventories.
    Over the last six months, U.S. refiners liquidated as much as 50 million barrels of
    crude oil stocks….

    Third, light sweet crude demand has been boosted by new environmental regulations requiring
    the removal of almost all sulfur from diesel fuel sold in the United States, Canada, and Europe.”

  3. Independent Accountant

    I read Becker/Posner and link to it. I read the article cited here and was astounded with Posner’s comment.

  4. macndub

    My criticism with Peak Oilers is not the assertion that demand is outpacing supply; rather, Peak Oil seems to be a catchall for all sorts of intellectually fuzzy arguments about the pace of supply growth and the impact on the economy.

    So I react very emotionally to the term Peak Oil, because I firmly believe that the world’s supply of oil has not yet peaked, defining “oil” as hydrocarbon (including natural gas).

    However, I do believe that the current growth in demand is outpacing supply. This cannot stand, long-term. It never has. People change their behavior in the face of higher prices. The low-hanging fruit in North America is gone (power generation and home heating), but technology has continued to improve in the generation since the last spike. Oil intensity of GDP in the US is one-third what it was in 1980. So it implies (round numbers) an oil price of $240/bbl to have the same economic impact.

    Think about that. And think about how close our democracy came to the brink in the late seventies and early eighties. We don’t face nearly that same level of energy costs now as we did then, with consequently less potential for a grinding energy-price-driven recession. (Note that a recession led by housing is a different matter).

    Europe is 10, maybe 20 years behind North America in the use of natural gas, so there is likely some demand destruction possible there, tempered by the fact that the largest nat gas supplier is a very unreliable Russia. The rest of the world could clearly use more nat gas with little economic consequence. India is already moving in that direction: all three-wheeled taxis in Mumbai are nat gas now, as are all mass transit vehicles in Delhi.

    The big issue, I believe, with oil supply is Krugman’s inverted supply curve… at very high prices, keeping oil in the ground is actually a form of investment. So he is correct that above-ground inventories are still relatively consistent with their level in the 90s, but below-ground inventories are sky high. So much more oil in the world can be economically extracted, but the Saudis (say) prefer to keep it in the ground rather than extract it and fuel domestic inflation or further bad bets on Citi.

    So you get a situation where 50% of the world’s drilling rigs are chasing 3% of the world’s oil and gas (the lower 48 US).

    Anyway, the term “Peak Oil” is irrelevant. This I believe: we will run out of demand before we run out of supply. Carbon taxes will further reduce the pretax price of oil at any given demand level (the tax shifts the supply & demand curves to the left, correct?), arguing further against a catastrophic collapse in oil supply. And there will be carbon taxes; otherwise, our civilization collapses and nothing matters.

  5. Anonymous

    Just a note: Wolf’s graph on non-OPEC supply growth forecasts vs. outturns is misleading.

    In particular, it appears to have failed to take into account Angola and Ecuador joining OPEC, as well as the IEA’s methodology change in mid-2007. The result is that the graph artificially mis-states the difference between the forecasts and outturns.

    The IEA’s Jan08 OMR discusses this in substantial detail on p.24.

  6. Anonymous

    About 90% of the dialogue over oil prices is cacophony.

    It seems counter intuitive to dedicate so much time and energy trying to predict certain market determinants–effect of recession on oil demand, effect of high oil prices on oil demand and effect of high oil prices on oil supply–while at the same time completely ignoring geopolitical determinants of at least equal, if not greater, importance.

    So what if global recession and/or high oil prices drive down oil demand? It is incredibly naive to fail to see that OPEC and other major producers could (and most likely would) cut back on production (supply) to compensate.

    Likewise, what if for some reason the ruling family of Saudi Arabia were persuaded that it is in its best interest to increase oil production? Could it not open the valves and flood the world oil markets tomorrow? (This is of course assuming that Saudi Arabia’s claim that it has 2 to 3 million BOPD of excess production capacity is true).

    If I were weighing it up, I would say the price of oil is about 80% dependent on geopolitics (especially in short run) and 20% on these other factors. It’s been that way since 1931 when Governor Sterling sent the national guard in to shut down the East Texas Field.

  7. chegewara

    i can’t believe how little attention is given to the fact that the only sizeable countries in which oil consumption is growing are China, India, Saudi Arabia, Iran and Russia. and the only reason is that oil prices are subsidized. in fact, if you are a petrochem connected to sinopec in china and get your oil at $60-70bbl (which is the current subsidezed level) your insentive is to consume as much as you can and sell your output outside of china at prices implying $120bbl. this is money tranfer from the govts of these countries to people in the local oil industries. think about another example: emirates is now the cheapest airline to fly from europe to asia with a stop over in dubai. the reason is simple – no fuel surcharge. how come? they get all the oil from abu-dhabi at subsidized level. so everybody starts to fly emirates, their demand for oil goes through the roof. the game can’t continue forever and subsidies NEVER work. the day these governments can’t afford subsidies peak oil will be over.
    and then think about it this way, as oil prices fall back to $60s, all the funny guys like chavez and maybe even saud royal family would be gone. then perhaps they would invest more into oil development in the countries where extracting oil is cheap, instead of investing in all these unsustainable projects like tar sands and super deep drilling.

  8. Anonymous

    Posner’s view is not so surprising when you see it is driven by foreign policy more than economics. He throws economics out the window when he asserts that lower prices would cause oil exporters to sell less oil–Saudi Arabia is the low cost producer. High taxes would crush Canadian oil sand development, the major growth area in North America.

    It’s the same as reading Thomas Friedman on energy (and environmental) issues; it’s all about the Middle East and hurting our “enemies” there.

  9. Anonymous

    badanov is correct that the gov’t prevents exploitation of some reserves–for example, the reserves in ANWR and the continental shelf. But even if we could begin production in ANWR and the continental shelf today (which we couldn’t, because we don’t have the rigs), the new production would have only a very short-term, modest effect on prices. We just won’t see that much oil flow from those places relative to world demand, and the decline rate in other production is getting so high, largely because we’ve already applied high tech to tap the world’s reserves so efficiently.

    The filling of the Strategic Petroleum Reserve raises the price of a barrel of oil roughly $1-$1.50. They’re filling the SPR at the rate of 70,000 barrels per day. That’s 0.08% of worldwide daily production. As a general rule of thumb, the price rises 10-15% for every 1% of supply taken off the market, or every 1% of demand added to the market, all other things being equal. So 70,000 barrels per day would move the price about 1.2%. That comes to about $1.50 when the price of a barrel of oil is $125, or a few cents of the price of gasoline. This is the one single thing Bush has done right in his entire presidency–he’s right to get that reserve filled now while oil is still cheap.

    Chegewara points out correctly that gov’ts in China and the Gulf subsidize gasoline prices for their people, and that this drives up world demand. But the U.S. subsidizes oil consumption for its people too, through hefty ethanol subsidies, and that’s keeping U.S. demand higher than it would otherwise be, while also raising food prices. Like Yves, I don’t expect any change in policy in any of these subsidizing countries–China has the savings to be able to afford it, the Gulf has the oil earnings to be able to afford it, and U.S. politicians could never face the public outcry.

    Becker is wrong when he says that predictions of $200 a barrel are mere extrapolations rather than based on analysis. Predictions of $200 a barrel are based on a number of academic studies of price and short-term demand elasticity, combined with a realistic view of the production decline rate over the rest of this year and next year. We will definitely see increasing demand destruction, but it won’t be sufficient to keep up with this decline rate, because we are nowhere near achieving the rates of energy efficiency we need for the coming decline rate.

    Posner is right–we should inaugurate high taxes on both oil and emissions, and for all the reasons he says, which are not single-mindedly geared toward “hurting our ‘enemies'”. We need to stop this transfer of wealth so that we have the wealth to invest in energy efficiency and alternative energy, or we will be in real trouble.

    Moe Gamble

  10. Anonymous

    “Unfortunately I cannot see a confluence of political forces that would make heavy taxes on oil feasible. We seem to be experiencing a democratic failure, in which long-term problems simply cannot be addressed.”

    The conservative ascendancy, of which Posner is a part, bear some responsibility for just this situation. They have downgraded democratic government, for by and of the people, for the government of money, lobbyists, and the (always short term) interests of corporations.

  11. Anonymous

    This is Moe Gamble again–one more thing. Macndub is correct that “oil intensity of GDP in the US is one-third what it was in 1980.” But this also means the easy gains in energy efficiency have already been exploited.

    And a lot of the reason our GDP oil intensity is lower now is because so much of our economy has been riding on the back of China (with our energy use transferred to them, while we kept most of the profits) and a financial industry with very iffy prospects.

    And I just don’t see any evidence that large amounts of reserves are being deliberately held in the ground as a form of investment. ANWR and the U.S. continental shelf are being held in the ground–true. But there’s no way that this is some kind of investment strategy to gain higher prices later. Since I’m certain that Bush and Cheney understand the oil situation, we may be holding back those reserves to have some supply later, but that would be for dealing with a serious energy crunch, not for higher profits!

    Meanwhile, the rest of the world has been positively stupid about its extraction policies. Saudi Arabia, for example, has actually damaged some of its most important reservoirs in an attempt to maintain it’s role of swing producer and image of endless supply. Within the biz, the dominant view until the past year or so has been that OPEC would be able to crank it up and high prices were temporary, so everyone has been pumping like crazy to cash in on the high prices.

  12. Petey Wheatstraw


    Spoken like a true crack whore. There’s nothing wrong here that more of the same wouldn’t fix.


  13. Dan

    While we’re in the process of placing higher taxes on oil to “prevent the collapse our civilzation” and “to promote the develpolment of alternative fuels” a la Friedman and Posner, let’s also place a big, fat tax on AIDS, and maybe heart disease and cancer.

    It’ll work like this: If you’re HIV positive,for example, then you need to start forking an AIDS tax so that a real cure can finally be established. The disincentive, coupled with a windfall tax will finally put these insidious diseases to rest.

    Then…and this is the best part!!….we can teach countries in Africa to do the same. They can apply this simple disincentive-inventive taxation plan to end poverty, war and AIDS.

    “Malaria got you down? The government of The Congo hereby annouces the imposition of $1.00 tax on all mosquito bites. An Inspector with a Skeeter Meter will be visiting each village weekly. Anyone who claims that a bite is just acne or a rash prosecuted for tax evasion.”.

    Then, with money in hand, watch the government work its magic!

    Do you really think a tax will help solve our energy woes? If so, do you think it’ll take $1.00 a gallon or $10.00? Or $20?

    Why would you trust our government (or any government) with a solution…to anything?

  14. macndub

    Moe at 12:16, there is considerable debate over the ability of the Saudis to pump more and their reservoir management. People who I trust tell me that the Saudis are the best reservoir managers in the world, period, and extremely conservative to boot. This argues for keeping oil in the ground as a form of investment. I think the Saudis drill fewer than 100 wells a year, compared to well over 10,000 in Alberta alone.

    Furthermore, higher royalties shares, especially via production sharing agreements, create the impression of declining reserves because of SEC reporting. (Exxon reports only the post-royalty share of oil, for example, which in high price environments creates the impression that reserve replacement is negative. In fact, oil reserves that were physically added belong to the royalty owner’s account, so the reported reserves reflect only Exxon’s economic interest, not the amount of oil found).

    Bottom line: private companies will certainly pump more in high priced environments, but royalty owners (governments) have different incentives. And when governments own some 70% of the world’s oil, they’re the deciders.

  15. Anonymous

    I’m inclined to agree with Posner. $200 oil is going to get us farther in research and development on new technologies than any government subsidy ever has.

    As for the Becker-Posner blog, its one of the best on the web. The two are dueling geniuses… each reaching to outsmart the other.

    For the record, I’m an alum of the University of Chicago Graduate School of Business and Law School (JD/MBA)… so I’m biased.

  16. Anonymous

    These arguments were being made in 1980, the end of oil was in sight then as it is now. People will change their behavior when it is cost efficient/ necessary to do so. We don’t live in a static economy. There is and will be no shortage of oil at the right price.

  17. chegewara

    >>I don’t expect any change in policy in any of these subsidizing countries–China has the savings to be able to afford it, the Gulf has the oil earnings to be able to afford it, and U.S. politicians could never face the public outcry.<< i disagree completely. at least one of the countries (India) is gradually falling out of equation, as there is only so much of oil bonds that indians can raise. chinese savings is a different story, but think about it in terms of having $1.5K per capita in a country without any wealthfare safety net. IMO China can only pay for all of the price fixing only as long as foreigners hype persists and they can get all the $ they want. Middle East is a disaster in the making. Public sector salaries and food handouts are up on a permanent basis. People don’t remember that as recently as 2003 Saudi Arabia was on precipice of fiscal disaster. i am missing the point of the comment on US subsidies of ethanol as i don’t think that has any global impact on >>oil<< prices. finally, think about it in common sense terms – if you are given oil at half the global price, you will max out your consumption (petrochem, smuggling, absence of fuel surcharges etc) and you will continue increasing it until there is smth in the pipe. subsidies NEVER work. ultimately they lead to physical shortages (of which you have in spades in both China and India) and development of black markets. and if you think price controls work in US, ask Nixon.

  18. Independent Accountant

    I too am a Chicagoan, MBA, 1974. I remember Becker had been awarded the John Bates Clark Medal and I was awestruck with his intellect. I don’t say that often. I agree, Becker-Posner is a fine blog.
    Posner is my favorite sitting judge and I believe the second best ever to sit on the bench after Oliver Wendell Holmes.

  19. john c. halasz

    Arguably, at these high oil prices, a tax on barrels of oil, without discrimination as to foreign or domestic sourcing, since it’s basically one global market, would end up as a tax on the rents of virtually all conventional oil producers. The logic is fairly straight forward. An additional $10 added to the price of oil in the U.S. would initially raise the price and reduce demand. Other countries. especially those that subsidize the oil price might take up some of the slack and bid up the price, but such subsidies are costly to them, and the size of the U.S. demand is so large that it’s doubtful that the remaining global demand could take up the slack. SO the Saudis, the lowest cost/highest rent producer might decide to swallow $5 of the tax to maintain its market share and relative revenues. Russia, a higher cost producer, but still enjoying large rents, would be forced to slash its price accordingly to avoid losing relative market share, and so on through further price cuts down to the level of most of the tax. The large revenue windfall at the expense of oil producer rents could be used to cushion dislocations to the lower income strata of the population, but most of all could be used to finance development of alternative energy sources.

  20. juan

    A quick reading of the three authors and it seems apparent that, to slightly different degrees, they are not particularly aware of changes in oil price regimes but are moreless working backwards from high price to supply/demand considerations, i.e. ‘since the price is so high, sufficient S/D imbalance must exist, therefore…’.

    In effect, they are demanding that reality conform to types of efficient market theory, no matter that the pricing of oils, first nationally then internationally, has had little to do with such theories but forms of price management for nearly a century and that the current price regime is centered in both on and off-exchange financial markets, so open to pressures that would not have applied during the days of the “seven sisters” or the relatively short period of OPEC price setting.

    Certainly it can be argued that financial markets are, if only at the ‘weak’ level, efficient but behavioral finance and the history of manias/bubbles with their inclusion of socio-psychological channels, seem much more applicable than strictly physical supply/demand arguments.

    From mid-1960s considerations of a “social industrial complex” through Forrester and Club of Rome into the modern environmental movement and late 1970s formation of the German Green Party to the rise of peak oil explanations on one hand and AGW on the other, the required social psychology has been under formation.

    Equally, the post-1970 decline of ‘Fordism’ as a viable regime of accumulation and attempts to discover/implement a replacement able to resurrect capitalism’s 1950-70 “golden age”.

    Consciously and not, what we have been seeing for some time now has been an integrating of the preceeding two paragraphs, an integrating standing with and generating hopes for a ‘green’ solution and/or bubble able to overcome the insufficiencies of its contents.

    Very high priced oils/distillates improve the likelyhood of a new regime of accumulation but, to the extent these prices diminish global performance, also detract from such possibility other than, perhaps, on the terrain of finance and its struggle to save itself.

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