Monday, May 12, 2008

Peak Oil now? Does Krugman really think so?

In March of this year I wondered if the rise in oil prices were rational speculation or speculative bubble. I decided that six months would be reasonable time to watch for bubble signs ...
Gordon's Notes: Oil price speculation: is it rational investment or a bubble?

... here's my proposal for deciding if Peak Oil is on the way.

If the price of oil craters ($65) in the next 6 months then we're living in an energy bubble today and Peak Oil is more than 10-15 years away.

If the price of oil is above $105 a barrel in August of 2008 then Peak Oil is on the sooner rather than later, and the world I grew up in is shuffling away -- sooner than I'd expected....
I've been thinking that the first onset of true "peak oil" would be due around 2013 to 2018. Since markets think about 5-10 years ahead, peak oil before 2018 would lead to rational speculation. On the other hand, irrational speculation can happen at any time.

What do I mean by rational speculation? I mean not investing in refining capability, since demand constraints might limit return on investment. I mean leaving oil in the ground, since its value will appreciate faster than other forms of investment. I mean looking for new oil, but not drilling new wells. Why drill now, when oil may appreciate in value by 10-14% a year? Oil in the ground, by this reasoning, is worth far more than money in the bank.

Heck, anyone with oil in the ground can just take out low interest loans against the oil, and make money on leveraged investing. No need to drill the messy stuff.

So I figured if Peak Oil is really 5-10 years away we'd see price signals now -- due to rational speculation. If prices stayed up from March to August 2008, that would be a sign that we were seeing rational speculation, thus $300/gallon oil would be on the 5-10 year horizon, and I should make sure my next car gets 50 miles to the gallon.

Incidentally, I assume this is obvious, but I'll mention it anyway. If Peak Oil is really 5-10 years away, then rational speculation and today's price rises are extremely positive developments. We will be far better off with a gradual and prolonged rise, accompanied by relatively gradual behavioral and lifestyle changes, than with a sudden crash.

Rational speculation is the IQ of the market place. Now if rational speculation would only price the externalities of coal appropriately ...

So that's where I stood in March of 2008. I didn't speculate that we might be already seeing a true demand/supply constraint -- the first Peak of the Peak Oil Range.

Paul Krugman, however, seems to be saying exactly that today:
The Oil Nonbubble - Paul Krugman - New York Times

...all through the period of the alleged bubble, inventories have remained at more or less normal levels. This tells us that the rise in oil prices isn’t the result of runaway speculation; it’s the result of fundamental factors, mainly the growing difficulty of finding oil and the rapid growth of emerging economies like China. The rise in oil prices these past few years had to happen to keep demand growth from exceeding supply growth....

...I wouldn’t be shocked if oil prices dip in the near future — although I also take seriously Goldman’s recent warning that the price could go to $200. But let’s drop all the talk about an oil bubble...
I think Krugman has gone too far -- he seems not to consider the possibility that holders of oil and refining capacity might be rationally constraining supply in appropriate anticipation of prolonged 10-20% annual returns on oil reserves.

Even so, it's unsettling to consider that we might be already seeing true demand/supply peaks -- even if they are likely to be wax and wane as we head for Oil-Everest.

I'll stick with my original plan for now. I'll make my own Peak Oil call in August. I will, however, add a third possibility to my original two - rational speculation, speculative bubble, and Peak Oil Now.

Update 5/13/2008: Paul K features a Sydney Herald graphic suggesting other adaptations to consider. I recall hearing (NPR) of one real estate speculator who felt the final straw in his collapse came from rising gas prices reducing interest in a his distant suburban development. Seven years ago I thought terrorism would drive home owners to the suburbs, but that hasn't happened (yet). I guess there's hope for the (now depressed) value of our ideally located St Paul home.

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