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Wednesday, July 13, 2005

Economists and Peakniks

I read a discussion today on the gulf that exists between economists and peak oil scientists. The thrust of the poster’s argument was; if we can be reasonably sure that oil is going to decline in supply, why isn’t this being priced in now? It isn’t yet, it was argued, so the theory must be flawed.

Putting aside the details of the rate of decline and the current and future price expectations used in the article, we are dealing with an issue of how do we explain any price in a market. This is, after all, what economics is trying to do.

The lengthy thread that followed the article illustrated very nicely the issues involved. No two posts were identical in their import: None of the many posters, be they engineers, businessmen, economists, peak oil sympathisers or anonymous cowards, used the same methodology for analysing the problem.

Some talked of the rational economic actor, hoarding oil now for when it will be scarce in the future. Some talked of meta-stable bands, and discontinuous pricing functions. Yet others talked of the opacity of information. Reading the thread could make you feel, as one poster admitted, “dense”.

I don’t think anyone should feel uninformed for having not understood the arguments put forward. It would make sense that something as complicated as a commodity market would require a complicated explanation. The core issue is: are the movements of markets strictly explicable by economic theory?

Mathematicians will tell anybody who is interested that there are relatively simple formulations that can produce insolubly complex outcomes (the basis of chaos theory) and physicists will cheerfully admit that there are limits to our understanding of both microscopic and macroscopic systems. Yet an economist will have an explanation for systems that are every bit as complicated as fluid motion or strange attractors.

Despite economics having a nobel prize to award every year, there is a qualitative difference between the analysis it uses and the methods of science. Economic predictions are ethereal things, not to be absolutely relied upon, certainly open to debate. They make interesting newspaper articles and they make for good small talk: They say that growth is going to…” But they are not infallible, rigorous or sometimes even very testable. Economists are not able to perform true control experiments, or view their test subjects in splendid isolation.

And there’s the rub – economists are an integral part of the system they are studying. A physicist’s announcement to the world that he thinks a particle will follow a certain path has no earthly bearing on the outcome of the experiment. But the Chairman of the Federal Reserve is often credited with moving markets simply by his economic prognostications. Economics is quite simply not a science. Its predictive power is weak and its assumptions often unrealistic.

So clearly there is a gulf between the scientists working on peak oil and economists who are suspicious of the veracity of their claims. Economists say: “Your evidence doesn’t fit with what my model says should happen.” Peak oilers say: “The problem ain’t with my evidence buddy!” There are two competing ideologies at work, and no mean feat to reconcile them. Economics is guilty of masquerading as a predictive science, but peakniks must also admit that the uncertainty that surrounds peak oil bedevils their cause.

There is no accuracy attached to the arrval date of peak oil, but it is certain that oil production will peak at some point. That much only those most distantly connected to reality can deny (and yet they do). It remains to be seen whether it is in fact possible to successfully transition away from oil (and fossil fuels in general) in a manner that is orderly and equitable. This is what both sides of the debate should be focussing on, and this is the area that both can actually contribute most to.