Is the world still running out of oil?

Can Kazakhstan count on the blessing of rising oil prices?


When people forecast continued growth of the Central Asian economy, they usually assume that the prices of natural resources – such as oil, natural gas, and gold – will keep growing, too. How likely is this?

Those who foresee price hikes point out that as population and income keep growing, so will the demand for natural resources. Some resources, like oil, are finite; others, like whales, grow slowly. When demand for a resource grows faster than supply, its price will increase.

How can we tell when we may reach the point of scarcity for resources in general?

This is an old problem. In 1980, the late economist Julian Simon challenged biologist Paul Ehrlich (author of The population bomb) to a $1,000 bet over whether resources were becoming more scarce. Ehrlich invested $200 in each of five metals on the commodities market: Copper, chrome, nickel, tin and tungsten. In 1990, the bettors would assess the new prices of the metals.

Exploration may mitigate oncoming scarcity. The oil firm will spend more money to discover deposits until the additional bit of revenue from another discovery equals the additional cost. Up to that point, exploration tends to be profitable because the firm begins with its best prospects – fields that promise to yield a lot of oil at a relatively low cost.

New technology also delays exhaustion. For example, pelletization lowered the cost of producing steel, noted economist Tom Tietenberg. The producer extracts iron ore from taconite ore of a low grade and processes it at the mine. This cuts labor and energy costs.

Finally, when one resource becomes too costly to extract, we can often substitute a cheaper resource for it. To produce electricity, Kazakhstan has plans to substitute nuclear energy for coal-burning that incurs such environmental costs as air pollution that aggravates lung disease and carbon gases that strengthen global warming. Looking at the big picture, H. Goeller and Alvin Weinberg foresaw that, over the centuries, an “age of substitutability” would dawn in which virtually inexhaustible elements would replace the fossil fuels. “To reach this state without immense social disruption will, however, require unprecedented foresight and planning.”


The good ol’ days of copper


Indeed, the price increase of the exhaustible resource may induce firms to develop its substitute, in order to earn profits. Copper telephone wires today are valuable only to nostalgia buffs.

How can we gauge imminent scarcity? The most popular measure is the ratio of reserves to current consumption. If oil reserves are 40 times annual consumption, then we supposedly would run out of oil in 40 years.

Since the reserve-to-use ratio is a physical measure, it would make sense to count as reserves the entire endowment of the resource. In 1976, Goeller and Weinberg did just that, defining the endowment as the atmosphere, the oceans, and a one-mile-deep layer of earth. They computed reserve-to-use ratios for every element in the periodic table and for some compounds. The common element that would run out first, phosphorous, would last 1,300 years. For most elements, supply was practically unlimited. Exceptions included trace elements used in farming (cobalt, copper and zinc) -- and the fossil fuels (oil, coal and natural gas), “by far the most important scarce natural resource[s].” Some assumptions underlying the study may have been strong: Lower grades contained more of the resource; the economic and environmental costs of extraction were not prohibitive.

The reserve-to-use ratio is easy to interpret -- but inaccurate, because it treats scarcity as a physical concept. In truth, the market determines scarcity if we define it as unsatisfied demand at the given price. Such scarcity raises the price, which discourages consumption and encourages production, obviating the scarcity, be it physical or economic. In this cornucopian perspective, Goeller and Weinberg overstate the need for planning. A drop in the reserve-to-use ratio may predict impending abundance about as well as it does an impending shortage. In 1960, use-to-reserve ratios for gold, lead, mercury, silver, tin and zinc were less than 30 years. But we still have all of these resources.

So why not use movements in the market price to gauge whether scarcity in the near term is rising or falling? Well, markets are not well defined for all resources. The unregulated market for coal takes no account of the illnesses and storms that arise from coal burning, since a particular illness cannot be traced back to a particular power plant. The market price for coal is too low. The “market” for the fishery is a misleading concept, since no fisher owns a migratory school of fish. Since no fisher gains from conserving the school that he happens to be harvesting today, he will overfish. The result is that the price of fish is too low, because it does not represent the loss of fish to future consumers that occurs through overfishing.


Simon says…


Another possibility is to look at the profit rate for extracting, say, oil. The oil producer can choose between drilling and selling the oil today or doing so next year. If oil is becoming more scarce over time, then next year’s price ordinarily would be higher than this year’s, even though we adjust for inflation. To prevent a loss of profits, the oil producer would raise his price this year. The greater the expected scarcity, the greater the boost in the current price. This boost, called “scarcity rent,” thus measures expected scarcity. An example is the stumpage fee that timbermen pay for the right to cut.

Being a price increase, the scarcity rent is subject to the same weaknesses as a measure of scarcity as is the market price. In an unregulated market, an increase in pollution costs over time will not show up in the scarcity rent. And even when the rent accurately measures expected scarcity, it will not indicate whether this arises from an expected increase in demand or an expected decrease in supply.

Despite their flaws, economic measures of scarcity, such as the market price and the scarcity rent, at least account for a dimension that physical measures, like the reserve-to-use index, ignore – human behavior. Which brings us back to Simon’s bet.

In 1990, the market prices for all five metals in the bet had fallen, reported John Tierney. Ehrlich paid Simon $576. Simon then challenged Ehrlich to a $10,000 bet, based on any resources that Ehrlich wished to choose. Ehrlich took a pass. – Leon Taylor, tayloralmaty@gmail.com


Good reading

Harold Barnett and Chandler Morse. Scarcity and growth: The economics of natural resource availability. Baltimore: Resources for the Future. 1963.

H. E. Goeller and Alvin M. Weinberg. The age of substitutability. American Economic Review 68. December 1978. Pages 1-11. Reprinted from Science, February 20, 1976.

J. A. Krautkramer. Nonrenewable resource scarcity. Journal of Economic Literature 36(4). 1998. Pages 2065-2017.

Bjorn Lomborg. Environmental alarmism, then and now. Foreign Affairs. July/August 2012.

John Tierney. Betting on the planet. The New York Times Magazine. December 2, 1990.

Tom Tietenberg. Environmental and natural resource economics. Boston: Addison Wesley. Seventh edition. 2006. Chapter 14 discusses generalized resource scarcity.