August 22, 2005

"Peak Oil" Idea Demolished

Economics' newest celebrity Steven Levitt demolishes a NY Times Sunday Magazine story about "peak oil" and how it means oncoming economic catastrophe. It's obvious to Levitt that writer Peter Maass didn't pay much attention in his economics classes (if he took any). Levitt offers a Cliff Notes version of one very important economic insight:

What most of these doomsday scenarios have gotten wrong is the fundamental idea of economics: people respond to incentives. If the price of a good goes up, people demand less of it, the companies that make it figure out how to make more of it, and everyone tries to figure out how to produce substitutes for it. Add to that the march of technological innovation (like the green revolution, birth control, etc.). The end result: markets figure out how to deal with problems of supply and demand.

Thomas Barnett, a book-generated celebrity like Levitt, is skeptical about story because of the low quality of information it's based on:

Here's my problem with this analysis: Maas admits that the studies cover only a portion of the known Saudi fields and "date back, in some cases, several decades"! Despite these huge faults, these studies are presented "as perhaps the best public data about the condition and prospects of Saudi reservoirs."

Oh, and did I mention that the great expert, Matthew Simmons, is a banker and not a geologist?

This is the guts of a major NYT mag cover story?

How about a real expert?

Being a student of economics I'm very sympathetic to Levitt. Incentives matter, the price system conveys scarcities and a lack thereof, and the profit motive drives people to develop new technology and methods to deal with changing prices. If oil continues to go up alternative energy will become cost-effective. We might be reaching the point where nuclear power will be worthwhile even with all the regulatory, security, and insurance burdens placed on them. One thing we can be sure of is a growing global economy will need more energy. Satisfying more wants and needs requires more energy. We're seeing that already in the increased energy needs of developing India and China. Wait until Africa and the Middle East finally get their economic houses in order. We can't conserve our way to growth. In The Bottomless Well Peter Huber and Mark Mills argue that energy conservation ends up leading for more energy use. (Conservation lowers energy's price which increases demand.)

Prices change incentives which in turn change behavior. We may well be reaching the peak of oil production. That doesn't mean economic disaster is at hand, nor does it mean us using less energy. What it does mean is change. That's the one thing that's always constant.

"The Breaking Point"

[Added to OTB's Beltway Traffic Jam.]