Saturday, August 27, 2005

Oil: The Optimist vs. Pessimist Debate

Oil Drum and other blogs are drawing wide attention debating whether we are near an end of the oil age. The Oil Drum pointed me to a 8/13/2005 letter by Matt Simmons in the Washington Post that argued that Daniel Yergin is too optimistic about the future of oil. I have a few questions for Mr. Simmons.

He highlights that he has recently conducted an intensive study of oil production capabilities in Saudi Arabia and has concluded that “obscure Saudi technical papers create serious doubts about Saudi claims of adequate supplies of oil for decades to come. The Saudis and OPEC have been quietly admitting that they will not be able to meet world oil demand in 10 to 15 years which is at odds with Yergin’s Cambridge Energy Research Associates and other optimists.”

Taking Matt Simmons’ findings to be true, he has performed an important task. The 2001 Nobel Prize in economics was awarded to Akerlof, Spence and Stiglitz for their work on asymmetric information. Capitalist markets function better when buyers and sellers are equally informed. Famous examples of the problems of asymmetric information include the market for used cars; sellers sell only “lemons” and potential buyers cannot cheaply certify product quality and the market for health insurance; only sick people want to buy it.

Returning to Simmons, his findings help level the information “playing field”. If oil consumers, auto makers, and rival oil producers thought that Saudi Arabia has been telling the truth by claiming that it has ample reserves then this retards the incentive to invest in green cars, conservation and new exploration. By “getting the information out”, utility maximizing consumers and profit maximizing firms will now have an incentive to respond. If General Motors had thought that Saudi Arabia has ample oil, it may have invested little in green car development and ex-post greatly regretted this decision once the “truth” is revealed.

I would like to ask Simmons; “If every person on the planet read your report on the Saudi’s oil overstatement of reserves, would you still think that we’re heading into a “crisis”?” Does Simmons believe that “educated” economic agents can adjust to the now anticipated decline in Saudi oil production? A vast majority of economists would say yes.

A second issue here is whether Simmons’ evaluation of Saudi Arabia’s reserves is kosher. Turning to game theory, if Saudi Arabia will not allow in an independent team of auditors to measure their reserves, does this signal that Simmons is right?

If a capitalist firm such as General Motors knows that “it does not know” the truth about an important future event, such as Saudi oil supplies, how does it plan for this event? Does it take a risk averse strategy and invest more in fuel efficient vehicles?