Wednesday, June 11, 2008

Oil Price Conumdrum: Estimates vs. WAGs

I remember sitting in a diner in Manhattan in the winter of 2003, before the Iraq invasion, reading both about the impending war and about the rise in oil prices (then around $30 a barrel, up from a low of about $12 in 1999). As for the rhetoric surrounding the war, I was thinking that people could not be so gullible to simply believe the government’s wild assertions about Iraqi WMD, when every independent source (UNSCOM … or whatever the letters used at the time) failed to verify even a single claim coming from Washington hawks. As for the price of oil, well, I really didn’t know that much about it; but, like many I probably believed at the time that the “boyz in big bidness” had something to do with it.

Later that spring, while reading online sources about oil prices, I discovered a perspective that has come to be known as ‘peak oil.’ The basic idea here being that aggregate oil production in the world, after exponentially building in the first phase, would reach a peak at about the time we have consumed roughly half of the recoverable oil in the ground. Thereafter, production would decline, slowly at first and then gaining speed for a time, with an asymptotic leveling in the final stages. This process, it turns out, is a basic fact of the production of all non-renewable natural resources, not just oil. We know it is a basic fact, because we have observed the pattern over and over again in producing non-renewable natural resources around the world through time. Never has a non-renewable resource mine, once depleted, magically replenished itself.

But, as I often tell my students, basic facts are just the beginning. All facts are shrouded in uncertainties, mainly because our ability to access enough empirical information about things to gain certainty is extremely limited, and the parts we cannot see, we make up. Sometimes we make up knowledge using careful reasoning and analysis based on adequate theories that explain the data, and call those made up bits of knowing “estimates.” Sometimes, we make things up without careful reasoning or adequate theory, we should call those assertions of fact WAGs (for “wild-ass guesses”). Our habit as academics and experts is to say, “estimate,” when, by definition, we are really just giving WAGs. The point, dear reader, is that both estimates and WAG’s are often wrong, we just hope that the well-reasoned estimates are less likely to be wrong, and we stake our reputations on it.

Obviously, when Colin Powell stood before the UN in early 2003 asserting that he was giving the best “estimates” of the Iraqi capability to manufacture an deploy various nasty weapons, he was actually presenting WAGs, cooked up in the bowels of the national intelligence agencies -- well perhaps in the bowels of Dick Cheney’s basement, but that’s another story.

The same controversy has been going on in our understanding and knowledge of the reasons for rising oil prices over the last decade. The main source of the problem is that we simply do not know, and cannot know, how much recoverable oil sits underground. Like most things beyond our control, we can only estimate, using the available empirical data and the best reasoning possible given our theories that help explain the data. Or, we can offer WAG’s based on an irrational attachment to things our leaders and media pundits might tell us … yes, the very same leaders and pundits that created the human tragedy in Iraq.

So, today we are confronted with a global energy crisis. The challenge is to come to an understanding of what we can do about it, collectively and individually. The problem goes back to what we “know” about the crisis and whether what we know is built upon well-reasoned estimates or WAGs about the current global situation.

One view is that, using the available evidence for past-oil production to date, rates of the discovery of new oil fields, and the dominant theories regarding the geological formation of oil fields and oil field patterns of depletion, we are at the mid-way point of global recoverable oil RIGHT NOW! Of course, this view is only based on a well-reasoned estimate, and could be wrong by several years in either direction.

There are several competing views, all of them less estimates than WAGs. The US Geological Service (an agency of the federal government) produced the most estimate-like in a year 2000 report. That group relied on empirical evidence of past-production and rates of past oil discovery, but added an imaginary element for rates of future oil discovery, in effect adding imagined oil to their estimates to come up with tremendous growth rates into the future. This element of adding imaginary new oil to the estimates, using an arbitrary mathematical algorithm and ridiculous threshold of certainty (50%) as a justification, is what makes it more of a WAG than a true estimate. However, since this report allowed decision makers to remain optimistic about the near term availability of oil in a growing global economy, it was happily accepted by many as the gold standard for policy making.

There are many other views, all of them WAGs, built up without adequate empirical support, adequate theory, and/or adequate reasoning. Some imagine that there is a sea of oil deep in the earth’s crust, if we drill deep enough, oil will prove to be practically infinite. Note, the use of imagined oil here, once again. Others rely on their suspicions of large corporate and financial interests that use their wealth and institutional power to manipulate prices for unfair profit (meaning prices and profits that are unreasonable given the “normal” balance of supply and demand). The solution to this problem, of course, is to regulate the industrial and financial interests involved more effectively. Once again, verifiable evidence of such institutional malfeasance is never adequate. An argument based on imagination is, by definition, a WAG. Not necessarily wrong, just more likely to be so.

So, what are we to do? Given the perspectives outlined above, two very different courses of action are implied. If we take the optimists arguments, those I believe fall into the WAG category, we can (a) pressure businessmen to get off their butts and find the hidden oil! Or (b) pressure the government to enact meaningful regulations on greedy business interests. Other than that, we grin and bear higher prices until these others sort out the mess. These courses of action have some chance of working, but, since they are built upon WAGs, the likelihood of them working is low.

On the other hand, if we take the other view, one that I believe argues a case that is closest to the definition of a reasoned estimate of the current oil situation, than we need to consider much more than the lobbying efforts and patience described above. We need an immediate global discussion of how to manage ourselves and our economies as world oil production declines over the course of this century. The first place to look for solutions is in the transportation sector. Why? Because about 70% of oil consumption comes from transportation alone. Of course, that would just be the beginning of a much broader discussion of the problem and potential solutions and active renegotiation of our economies and politics.

Many Americans and many world leaders allowed the WAG to hold sway in the run up to the Iraq war. Millions are suffering and will continue suffer as a result of our collective failure to understand the limits of human knowledge and the difference between well-reasoned estimates and the WAG to fill gaps in our knowledge. To do the same in the case of rising oil prices, would likely result in needless suffering for hundreds of millions in not billions of people in the near to medium term.

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