August 23, 2005

EASY MONEY:

The $10,000 Question (JOHN TIERNEY, 8/23/05, NY Times)

I don't share Matthew Simmons's angst, but I admire his style. He is that rare doomsayer who puts his money where his doom is.

After reading his prediction, quoted Sunday in the cover story of The New York Times Magazine, that oil prices will soar into the triple digits, I called to ask if he'd back his prophecy with cash. Without a second's hesitation, he agreed to bet me $5,000.

His only concern seemed to be that he was fleecing me. Mr. Simmons, the head of a Houston investment bank specializing in the energy industry, patiently explained to me why Saudi Arabia's oil production would falter much sooner than expected. That's the thesis of his new book, "Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy."

I didn't try to argue with him about Saudi Arabia, because I know next to nothing about oil production there or anywhere else. I'm just following the advice of a mentor and friend, the economist Julian Simon: if you find anyone willing to bet that natural resource prices are going up, take him for all you can.


The initial bet that Mr. Tierney proposed is even safer:
I proposed to him a bet using what Julian considered the best measure of a resource's value: how it compares with the average worker's wage. I offered to bet that the price of oil would not rise faster than the average wage, meaning that future workers would be able to afford oil more easily than they could today.

There's a reason none of us work harder than our ancestors did.

MORE:
Betting on the Planet (JOHN TIERNEY, December 2, 1990, NY Times Magazine)

In 1980 an ecologist and an economist chose a refreshingly unacademic way to resolve their differences. They bet $1,000. Specifically, the bet was over the future price of five metals, but at stake was much more -- a view of the planet's ultimate limits, a vision of humanity's destiny. It was a bet between the Cassandra and the Dr. Pangloss of our era.

They lead two intellectual schools -- sometimes called the Malthusians and the Cornucopians, sometimes simply the doomsters and the boomsters -- that use the latest in computer-generated graphs and foundation-generated funds to debate whether the world is getting better or going to the dogs. The argument has generally been as fruitless as it is old, since the two sides never seem to be looking at the same part of the world at the same time. Dr. Pangloss sees farm silos brimming with record harvests; Cassandra sees topsoil eroding and pesticide seeping into ground water. Dr. Pangloss sees people living longer; Cassandra sees rain forests being decimated. But in 1980 these opponents managed to agree on one way to chart and test the global future. They promised to abide by the results exactly 10 years later -- in October 1990 -- and to pay up out of their own pockets.

The bettors, who have never met in all the years they have been excoriating each other, are both 58-year-old professors who grew up in the Newark suburbs. The ecologist, Paul R. Ehrlich, has been one of the world's better-known scientists since publishing "The Population Bomb" in 1968. More than three million copies were sold, and he became perhaps the only author ever interviewed for an hour on "The Tonight Show." When he is not teaching at Stanford University or studying butterflies in the Rockies, Ehrlich can generally be found on a plane on his way to give a lecture, collect an award or appear in an occasional spot on the "Today" show. This summer he won a five-year MacArthur Foundation grant for $345,000, and in September he went to Stockholm to share half of the $240,000 Crafoord Prize, the ecologist's version of the Nobel. His many personal successes haven't changed his position in the debate over humanity's fate. He is the pessimist.

The economist, Julian L. Simon of the University of Maryland, often speaks of himself as an outcast, which isn't quite true. His books carry jacket blurbs from Nobel laureate economists, and his views have helped shape policy in Washington for the past decade. But Simon has certainly never enjoyed Ehrlich's academic success or popular appeal. On the first Earth Day in 1970, while Ehrlich was in the national news helping to launch the environmental movement, Simon sat in a college auditorium listening as a zoologist, to great applause, denounced him as a reactionary whose work "lacks scholarship or substance." Simon took revenge, first by throwing a drink in his critic's face at a faculty party and then by becoming the scourge of the environmental movement. When he unveiled his happy vision of beneficent technology and human progress in Science magazine in 1980, it attracted one of the largest batches of angry letters in the journal's history.

In some ways, Simon goes beyond Dr. Pangloss, the tutor in "Candide" who insists that "All is for the best in this best of possible worlds." Simon believes that today's world is merely the best so far. Tomorrow's will be better still, because it will have more people producing more bright ideas. He argues that population growth constitutes not a crisis but, in the long run, a boon that will ultimately mean a cleaner environment, a healthier humanity and more abundant supplies of food and raw materials for everyone. And this progress can go on indefinitely because -- "incredible as it may seem at first," he wrote in his 1980 article -- the planet's resources are actually not finite. Simon also found room in the article to criticize, among others, Ehrlich, Barry Commoner, Newsweek, the National Wildlife Federation and the secretary general of the United Nations. It was titled "Resources, Population, Environment: An Oversupply of False Bad News."

An irate Ehrlich wondered how the article had passed peer review at America's leading scientific journal. "Could the editors have found someone to review Simon's manuscript who had to take off his shoes to count to 20?" Ehrlich asked in a rebuttal written with his wife, Anne, also an ecologist at Stanford. They provided the simple arithmetic: the planet's resources had to be divided among a population that was then growing at the unprecedented rate of 75 million people a year. The Ehrlichs called Simon the leader of a "space-age cargo cult" of economists convinced that new resources would miraculously fall from the heavens. For years the Ehrlichs had been trying to explain the ecological concept of "carrying capacity" to these economists. They had been warning that population growth was outstripping the earth's supplies of food, fresh water and minerals. But they couldn't get the economists to listen.

"To explain to one of them the inevitability of no growth in the material sector, or . . . that commodities must become expensive," the Ehrlichs wrote, "would be like attempting to explain odd-day-even-day gas distribution to a cranberry."

Ehrlich decided to put his money where his mouth was by responding to an open challenge issued by Simon to all Malthusians. Simon offered to let anyone pick any natural resource -- grain, oil, coal, timber, metals -- and any future date. If the resource really were to become scarcer as the world's population grew, then its price should rise. Simon wanted to bet that the price would instead decline by the appointed date. Ehrlich derisively announced that he would "accept Simon's astonishing offer before other greedy people jump in." He then formed a consortium with John Harte and John P. Holdren, colleagues at the University of California at Berkeley specializing in energy and resource questions.

In October 1980 the Ehrlich group bet $1,000 on five metals -- chrome, copper, nickel, tin and tungsten -- in quantities that each cost $200 in the current market. A futures contract was drawn up obligating Simon to sell Ehrlich, Harte and Holdren these same quantities of the metals 10 years later, but at 1980 prices. If the 1990 combined prices turned out to be higher than $1,000, Simon would pay them the difference in cash. If prices fell, they would pay him. The contract was signed, and Ehrlich and Simon went on attacking each other throughout the 1980's. During that decade the world's population grew by more than 800 million, the greatest increase in history, and the store of metals buried in the earth's crust did not get any larger.


It's no coincidence that Darwin's eureka moment came when he read Malthus.

Posted by Orrin Judd at August 23, 2005 8:53 AM
Comments

Well, you lost a bet with me last year that oil would never see $50. Oil will see triple digits before the end of next year. I'll bet you a book.

Posted by: Robert Duquette at August 23, 2005 9:14 AM

I was right about both supply and the real cost--just couldn't account for temporary speculation.

I'll bet you ten that the price of oil won't rise faster than the average wage as measured ten years from now.

Posted by: oj at August 23, 2005 9:33 AM

I'm out here in the western end of the Permian Basin in West Texas, where for the past 20 years or so virtually nobody was doing any serious exploration, because the depths of the wells in this area regularly are in the 15,000 to 20,000 foot range. There had been geological and sisemographic surveys, and they knew the oil and/or natural gas was out there, but the cost to drill a four-mile deep well and extract it was greater than the cost the drillers could get to sell it, so the deposits sat untouched.

Now the main problem is a shortage of both workers and drilling equipment, since so many of the rigs that used to operate in the U.S. were either sold/transferred to overseas interests or left to rust during the post-1985 oil bust. But there are sections of state land going towards El Paso that were never considered for drilling before that have sold out on three-year "Use it or lose it" leases, and there are efforts to find rigs that can meet Gov. Bill Richardson's environmental demands on the Otero Plateau in New Mexico, east of the White Sands Missile Range, that was never seriously considered as an exploration site when oil was at $18 a barrel.

That's just the activity in one small area of the country. Search around and you can find similar projects all over the place that were non-viable just a few years ago but which are very much workable now, and would be even if oil slipped back $20 a barrel or so. If Tierney bet Simmons on a short-term basis, there's an outside chance he could lose due to price spikes and the amount of time it will take to get all these new sources on-line, but like Simon, if he took a 10-year bet, he's in really good shape (and even if he didn't I'm sure Tierney could cover his losses by putting down a 10-year wager with the bulk of the rest of the Times' op-ed staff, whiich I'm sure would be happy to go along with Simmons' theory).

Posted by: John at August 23, 2005 9:55 AM

The NY Times link is subscriber only. Did Tierney and Simmons actually make the bet? Or did they only hypothetically talk about it?

Posted by: Bret at August 23, 2005 11:14 AM

All you have to do is register.

Posted by: oj at August 23, 2005 11:21 AM

These should work.

$10,000 Question

Betting on the Planet

Posted by: erp at August 23, 2005 12:04 PM

Erlich lost. The price for the basket of metals declined by $576. Prices of the metals chosen by Ehrlich fell so much that Simon would have won the bet even if the prices hadn't been adjusted for inflation.

Posted by: Old Grouch at August 23, 2005 12:16 PM

Does it make a difference that Oil is a commodity that is totally different in Nature that that of precious metals; namely that oil 1) can't be recycled after consumption (except for some plastics) 2) the demand for it cannot be met by the current supply, and that trend is expected to continue 3) is a requisite cost for almost every consumer product.

Posted by: Jeff at August 23, 2005 12:28 PM

Julian Simon is absolutely correct, and Mr. Ehrlich and like-minded thinkers are being foolish.

The Earth's resources, (and by extension the entire solar system's), are NOT finite, by human standards.

"Carrying capacity" is a valid concept, but misapplied. We can only compute the ultimate carrying capacity of the planet if we know the sum total of all resources that are available, and how they react when exploited by humans, and WE DO NOT.
For instance, humans have been exploring for oil for 152 years, and we still don't know how much is really out there.

In earlier eras, much alarm was caused by the dwindling availability of firewood, and of whale oil. In each case, alternative methods were found - coal and petroleum.

Most of the resources that humans currently consume aren't NECESSARY, they're just the CHEAPEST way to do what we wish to do.
If the resources that we're currently using become too expensive, then we'll just change how we reach our goals.

We make high performance airplanes out of glue and sand - why anyone thinks that we could deplete our ability to produce food, fresh water (!*), or essential minerals is beyond me.

If anyone wants to give me an example of anything that they feel is being rapidly depleted, with no alternative available, I'll gladly respond with how humanity is going to finesse it.

The price of crude oil might well spike into triple digits next year, although I very much doubt it.

If it did do so, it wouldn't stay there for long, a couple of months at most. Demand for $ 100 oil would drop very quickly, since the Chinese can't afford to match bids with Americans, and Americans themselves would decrease their demand by perhaps 10%.

Further, any sustained price levels above $ 80/bbl would cause a vast increase in supply, even if the Arabian oil fields are as played out as Matthew Simmons thinks that they are - and it is true that the House of Saud is vastly overstating their known reserves and potential for expansion.

In addition to the projects that John mentioned, these additional sources can be tapped:

* ANWR
* The Gulf Coast of Florida, where drilling is currently prohibited, to protect the tourists' views
* There are huge oil and gas deposits in Utah and Nevada. Exploratory drilling is currently being conducted.
* Canada has oil reserves second only to Arabia, and they know exactly where they're at - no exploration needed. They are currently expanding production.
* Russia has huge oil fields that haven't yet been tapped.
* The 'stans of Asia, whose oil production could be expanded.
* The production of biodiesel in the U.S. could be expanded.
* Thermal depolymerization plants can produce crude oil at a cost of $ 80/bbl - or less.
* A petroleum replacement could be profitably made from coal, of which America has a superabundant supply, if prices of crude oil were to somehow stay above $ 100/bbl.

Robert Duquette:

I'll gladly take a piece of that action, and I'll even give you 3:2 odds.

oj:

I was right about both supply and the real cost--just couldn't account for temporary speculation.

You can see that in energy markets, but cannot recognize the same dynamic in the housing market ?


* Only the most common material on the Earth's crust; the "fresh" part takes some work, but not much.

Posted by: Michael Herdegen at August 23, 2005 1:22 PM

Michael:

Yes, it's identical. Oil is a bubble because we have more supply than we need and demand is going to decline. Housing is not a bubble because we have less supply than we need and demand is going to increase.

Posted by: oj at August 23, 2005 1:26 PM

Flux Capacitors, man. I'm tellin' you that's the future.

Posted by: John Resnick at August 23, 2005 1:31 PM

oj:

Fundamental demand will increase, but slowly.

There are maybe three U.S. housing markets where supply truly isn't matching the fundamental demand.
In all other locales, the supply is simply lower than the demand for second or third homes.

The American housing market isn't monolithic, it's an aggregate of local markets, dozens of which are having their prices set by speculators, a situation which CANNOT LAST.

You acknowledge that speculators will get burnt; you refuse to acknowledge that plenty of shelter-seeking families are going to get hurt, as well.

Posted by: Michael Herdegen at August 23, 2005 1:51 PM

There is currently insufficient housing stock in the United States for all the people who wish to buy homes and we're falling further behind, not building excess. Local markets will adjust and people will move.

Posted by: oj at August 23, 2005 1:59 PM

Yes, it's the "adjustment" that is going to be so painful.

Posted by: Michael Herdegen at August 23, 2005 2:07 PM

Life isn't without pain. Mere adjustments aren't bubbles bursting.

Posted by: oj at August 23, 2005 2:11 PM

You're hung up on the "bubble" label.

There is not a national American housing bubble.

How does that change the reality that there are regional pricing discontinuities, which will ultimately negatively affect millions of U.S. households ?

Home prices will not fall to zero.

Who is saying that they will ?

Posted by: Michael Herdegen at August 23, 2005 3:09 PM

Michael:

You win. There's no housing bubble.

Posted by: oj at August 23, 2005 3:12 PM

Michael: OK, say you are a young professional in LA, and will likely be in the area for at least 5 years, but not necessarily any longer. Assuming you could afford a house for ~500-600K, would you buy it? Keep in mind that during those 5 years you'll spend ~100K in rent.

Posted by: b at August 23, 2005 3:25 PM

b:

Given those conditions, I would not buy.

You'd also be spending ~ $ 250K on your home over the same time period, assuming a standard fixed mortgage.

If I believed that I would be in LA for at least TEN years, then I WOULD buy.

Or, I'd buy a repo fixer-upper for the five year period, as I'm fairly sure that you could break even during the next five years if you bought at a discount now.

However, timing the real estate market is difficult, and for people simply seeking shelter, the primary consideration should be what kind of lifestyle one is willing to pay for.

Posted by: Michael Herdegen at August 23, 2005 3:42 PM

Yeah, timing the market always works so well.

Posted by: oj at August 23, 2005 3:51 PM

John,

In the Piceane Basin on CO's Western Slope, there is renewed drilling. The Houston-based energy firm doing the drilling hired a Chinese rig outfit with a Chinese crew. Another firm is hiring a rig and crew from Pakistan.

Posted by: Brad S at August 23, 2005 8:05 PM

If memory serves, I believe that Paul Ehrlich refused to pay up when he lost.

Posted by: Brooks at August 24, 2005 2:12 AM

If memory serves, I believe that Paul Ehrlich refused to pay up when he lost the bet.

Posted by: Brooks at August 24, 2005 2:12 AM

> If memory serves, I believe that Paul Ehrlich refused to pay up when he lost the bet.

The article says he did pay up.

Posted by: Guy T. at August 24, 2005 7:00 AM

I'll take OJ's bet and Michael's.

I don't know where you guys see demand for oil dropping, it is going higher and higher. Oil demand is growing faster than oil supply, and as of yet there is no large scale effort to move to alternative sources. Has a single, new nuclear power plant been commisioned in the US in the last 30 years?

China will continue to grow and so will India. They can't cook the tar sands fast enough to make up the difference. And $60 oil has yet to put a crimp in demand in the US, so it looks like it will take $100 oil to make any meaningful dent in demand.

Posted by: Robert Duquette at August 24, 2005 9:27 AM

Robert:

$100 oil may not make a difference in the US, but in China...

Posted by: Mike Earl at August 24, 2005 11:06 AM

The taxi driver will just pass on the cost to his riders. But yes, at some point the price will slow down the economies of the world to the point where supply and demand are in balance. I don't know where that price will be, but it is greater than $60, you can be sure of that.

Another factor in China is the fact that the state has been subsidizing gas to keep it affordable and to ward off any negative impact on their re-industrialization. They'll have to phase those subsidies out at some point.

Posted by: Robert Duquette at August 24, 2005 1:54 PM

OJ, speculation is a normal component of market pricing, you can't eliminate it, indeed it is necessary to ensure liquidity. Successful speculation builds upon the existing trend.

It is interesting that you pooh-pooh speculation in the oil markets but see it as a normal response to the real estate boom.

Posted by: Robert Duquette at August 24, 2005 1:58 PM

Robert:

Yes, speculation in oil makes sense as long as the price is rising.

Posted by: oj at August 24, 2005 2:55 PM

Robert Duquette:

I don't see demand decreasing, over the long term, but I do see supply increasing, for the reasons that I listed above.
Canada's tar sands are only part of the picture.

The point of a market price is to show where the balance point between supply and demand is.

Since crude oil is currently being priced in the mid-$ 60 range, and the link that Mike Earl provided shows that China's demand is unsustainable, and we further know that speculation makes up perhaps 20% of the current price, we can conclude that even without slowing, the "true" balance point between world supply and world demand for crude oil is perhaps $ 48/bbl.

I'm buying oil puts with the idea that prices in the spring of '06 will be lower than $ 70/bbl.

Posted by: Michael Herdegen at August 24, 2005 3:34 PM

OJ,
The speculators would get creamed if the price was falling. It isn't.

Posted by: Robert Duquette at August 24, 2005 4:44 PM

Robert:

Right.

Posted by: oj at August 24, 2005 4:46 PM
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