Economic Wagers and the ‘Ultimate Resource’

A recent article in the New York Times by John Tierney about a current ‘energy cornucopia’ and his winning of a bet on energy resources has brought back to light the famous Simon-Ehrlich wager of 1980 – and sparked a mini-furore in the economic blogosphere and a possible third bet of a similar vein.

Bet 1

Convinced claims made by environmental doom-monger Paul Ehrlich that population growth would quickly outrun the supply of food and natural resources were false, Julian Simon had Ehrlich choose five commodity metals: Simon bet that their prices would go down in real terms, Ehrlich bet they would go up.

The chosen commodities, collectively costing $1,000 in 1980, fell in price by over 57% over the following decade. In October 1990 Ehrlich mailed Simon a cheque for $576.07.

Bet 2

Then in 2005, following in the footsteps of his friend and mentor Julian Simon, John Tierney accepted a bet for $5000 with Matthew Simmons (a former member of the US Council of Foreign Relations and author of Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy) that the average price of oil for the year 2010 would be less than $200 per barrel.

Tierney and Julian Simon’s widow Rita (who was so happy to see her husband’s tradition carried on that she shared half the bet) were sent their winnings on January 1 this year.

Bet 3?

Since Tierney’s article was published, economist Donald Boudreaux has been trying to organise terms for a third bet in a similar vein with Brad DeLong after DeLong foolishly nominated Tierney, Boudreaux and Mark Perry for the ‘stupidest man alive’ following Boudreaux and Perry’s support of the Tierney article.

No bet

In a comment on a blog I wrote titled Has the ‘Peak Oil’ Drama Peaked?, Steve W wrote that he had challenged Jeannette Fitzsimons to a bet along the Simon-Ehrlich lines during a debate… and that she refused.

The ‘ultimate resource’

Amusing and instructive as it may be, if you put all the gambling to one side it is the ‘ultimate resource’ principle that Julian Simon himself developed in his 1981 book of the same name that is the key to these arguments.

It is a principle that I subscribe to – that humans’ capacity to invent and adapt will overcome scarcity of natural resources.

One way of looking at the basic economics behind the principle is that as a resource becomes scarce, its price will rise. This creates an incentive for people to exercise intelligence and creativity to discover more of the resource, economise on its use and develop substitutes.

In a broader context, it is the ultimate resource because it is limitless – we are constantly discovering solutions to problems once thought insurmountable – and it will never run out.

Mark Perry puts it well:

…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.

It is also a positive way to think. We live in an age (or perhaps it has always been this way) where people lurch from one fearful impending doomsday scenario to another. If it’s not the ‘silent spring’ or the Y2K catastrophe, it’s ‘peak oil’, ‘acid rain’ or ‘global warming’.

It is reassuring that the historical record shows that humans can and do overcome the obstacles we face.

And of course the ‘ultimate resource’ has countless applications beyond oil and metals.

Consider the amazing work of the American genetic scientist and Nobel Laureate Dr Norman Borlaug who created a high-yield dwarf variety of disease-resistant wheat which, when coupled with modern agricultural techniques, solved the India-Pakistan food crisis of the mid-1960s; turned Mexico into a major wheat exporter; dramatically improved the lot of many other developing nations; and was eventually credited with saving over 1 billion people from dying of starvation.

This was a triumph of the ‘ultimate resource’.

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Has the ‘Peak Oil’ drama peaked?

Remember Peak Oil?  Just a few years ago Green Party leaders Jeanette Fitzsimons and Russell Norman routinely issued warnings about ‘the world running out of oil’ and told us that we needed to move freight off roads and on to shipping and rail, and commuters out of cars and on to trains, buses and bicycles.

They weren’t alone of course.  An April 2006 article in The Economist reported that:

For years a small group of geologists has been claiming that the world has started to grow short of oil, that alternatives cannot possible replace it and that an imminent peak in production will lead to economic disaster.  In recent months this view has gained wider acceptance on Wall Street and in the media.  Recent books on oil have bewailed the threat.  Every few weeks, its seems, “Out of Gas”, “The Empty Tank” and “The Coming Economic Collapse: How You Can Thrive When Oil Costs $200 a Barrel”, are joined by yet more gloomy titles.

How times change!  Just this month the following items have appeared in the international media (hat tip:  Global Warming Policy Foundation).

In the last few years, we’ve discovered the equivalent of two Saudi Arabias of oil in the form of natural gas in the United States. Not one, but two. –Aubrey McClendon, CBS, 14 November 2010

Just as it seemed that the world was running on fumes, giant oil fields were discovered off the coasts of Brazil and Africa, and Canadian oil sands projects expanded so fast, they now provide North America with more oil than Saudi Arabia. In addition, the United States has increased domestic oil production for the first time in a generation. Meanwhile, another wave of natural gas drilling has taken off in shale rock fields across the United States, and more shale gas drilling is just beginning in Europe and Asia. Energy experts now predict decades of residential and commercial power at reasonable prices. Simply put, the world of energy has once again been turned upside down. –The New York Times, 17 November 2010

The word “revolution” is overused, but it’s truly appropriate when applied to these technological breakthroughs. Literally trillions of dollars’ worth of shale oil and gas can now be economically extracted. The implications are staggering. Oil production, too, in the U.S. will increase far beyond what experts thought possible a few short years ago. The Earth is awash in energy. –Steve Forbes, November 2010

Oil and gas will continue to be pillars for global energy supply for decades to come. The competitiveness of oil and gas and the scale at which they are produced mean that there are no readily available substitutes in either one year or 20 years. — James Burkhard, The New York Times, 17 November 2010

“When wind guys talk to each other,” said Michael Skelly, president of Clean Line Energy Partners, a developer of transmission lines for renewable energy, “they say, ‘Damn, what are we going to do about the price of natural gas?’” Without a government policy fixing a price on carbon emissions through a tax or cap and trade, the hydrocarbon bridge could go on and on without end. –The New York Times, 17 November 2010

In order to avoid higher electricity prices, Prague is slowing the solar power boom and is slapping a new tax on it. It will be the death knell for smaller operators – up to 1450 companies are seriously effected by the new tax. In the neighbouring country of Slovakia, an amendment to the Energy Law was adopted in May which has severely curtailed the potential for solar energy investment.  –Christoph Thanei, Die Presse, 17 November 2010

The Spanish government has launched a new regulatory framework that will result in subsidized tariffs for ground-mounted solar energy projects drop 45% this year, killing future investment in the trade, which industry leaders expect will be frozen in the next few years. In addition, approximately 75,000 jobs have been lost with countless firms moving abroad to find new growth opportunities. -–Renewable Energy World, 15 November 2010

Danish environmentalist Bjorn Lomborg suggested in his 2003 Sir Ronald Trotter Lecture for the Business  Roundtable that oil and substitutes like shale oil could cover current energy consumption levels for 5000 years.

He also noted that “Sheik Yamani, founder of the Organisation of Petroleum Exporting Countries (OPEC), has often pointed out that the oil age will come to an end but not for a lack of oil, just as the stone age came to an end but not for a lack of stones.  Humans search constantly for better alternatives.”

Provided markets are allowed to adjust to supply and demand trends, and are not distorted by government interventions based on false ‘peak oil’ premises, there is every likelihood of an eventual smooth transition to other energy sources.