"Will we run out of oil?" is the wrong question.
By: Robert Patrick Murphy
11.8.2007
Over the past few months I’ve participated on panels that apply free market principles to the oil industry. We often get the question, “Will we run out of oil?” The answer is “no,” but that’s neither comforting nor alarming because the person asked the wrong question. Really what the person wants to know is, “Will energy become more or less scarce as we continue to use nonrenewable resources such as oil?” To understand the contrast, it’s easiest to take a simplified scenario. Suppose all the oil in the world were concentrated in one big pool, and that experts could measure exactly how many barrels were there and how fast it was being depleted. If, say, there were a trillion barrels in the pool, and humans were consuming 80 million barrels of oil per day, then we would have about 34 years’ worth of oil left, from a purely engineering point of view. Concerned citizens might lobby for “controls” on the consumption of oil, lest people wake up 33 years in the future and realize they were about to run out. But this entirely misconstrues the function of market prices. So long as the oil pool were owned and the price of oil were set in a free market, the oil pool would never run out completely. To understand why, consider the incentives facing the owner of the oil. When he decides how many barrels to pump today versus holding off the market for the future, he would take into account the spot and future price of oil. It would be foolish to dump the entire trillion barrels on the market today (even if that were feasible physically), because the spot price would get pushed very low; the owner could make more money by holding some back and selling it in the future. As economist Harold Hotelling worked out in 1931, this simple model yields the result that in equilibrium, the spot price of oil has to steadily rise over time, in order that the seller is indifferent to selling a marginal barrel today (for the current spot price) versus holding it off the market and selling it in the future (for a slightly higher price which covers the lost interest from the delayed sale). So what’s my point? Even in this highly simplified tale, humans wouldn’t run out of oil. As the pool grew smaller and smaller, the spot price of oil would rise more and more, causing consumers to switch to other resources for their energy needs. The rate of consumption would slow, with oil being devoted to fewer and fewer uses. The initial 34-year window would constantly move back. None of this means that the situation would be rosy. If people didn’t discover new energy sources, or find ways to economize on the use of oil, then the dwindling pool would indeed cramp their lifestyles. On the other hand, in practice humanity during the 20th century did a good job staying ahead of the curve, with new sources and new technologies being discovered quickly enough to postpone the day of reckoning. My point with the present post, though, isn’t to argue for optimism or pessimism. All I’m saying is this: Whether humanity is in trouble or not regarding energy, we’re not going to “run out of oil.” Even in the doom-and-gloom scenario, what would happen is that energy prices would continually skyrocket, rationing the dwindling supplies of oil (and coal, etc.) to fewer and fewer uses.
oil, energy, sustainability, price system
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