Saturday, May 31, 2008

Market Logic

The WSJ reports that oil exports from top producing nations have continued to drop, even as the price of crude has shot up dramatically. Their assessment: it is "a shift that defies traditional market logic and looks set to continue."

"Traditional market logic" suggests that where prices rise and demand is constant, more of the demanded product will be produced, bringing supply and demand into equilibrium. However, the opposite is taking place: supply continues to drop. Again, the WSJ: "Fresh data from the U.S. Department of Energy show the amount of petroleum products shipped by the world's top oil exporters fell 2.5% last year, despite a 57% increase in prices, a trend that appears to be holding true this year as well."

Even if "traditional market logic" does not seem to be working, Mr. Market is indeed telling us something: the price of oil is rising because it appears that there is less of it. The logic - if not "traditional" - that IS working is that we are experiencing higher prices due to less supply. "Traditional" market logic appears to be based on the belief - or fantasy - that because something is in demand, it will appear. The actual "logic" at work is that once when supplies become constrained, prices will inexorably rise. That the traditional "logic" is not working may puzzle some, but only if one believes that the market can actually create something. It is simply not "traditional" because it's something we haven't seen before. And, it's likely that what is referred to here as "traditional" logic - rising supplies to meet any demand - only applies when there are ample supplies of energy. Going forward we're likely to see a different kind of market logic - a logic of less, not more.

This new logic suggests different sorts of behaviors than one's we're accustomed to seeing. There is growing evidence of "virtuous" behavior among Americans, cutting back and using less. Of course, this contributes to an ongoing economic downturn: the "virtue" of the citizenry is the consequence of want. Good habits may form, but at the moment choices for smaller cars and more public transportation, as well as fewer purchases of various foreign-made plastic products, are likely to be evanescent if higher energy costs don't persist.

We are seeing the rise of other behaviors as well - ones decidedly less virtuous, and more likely to increase as we become poorer. There are rising incidences of gas theft - including even used cooking grease - or even taking to the streets in Europe, giving rise to anxiety and concern in world capitals that permanently rising oil prices could lead to severe political unrest. Everyday the newspapers are revealing new ways that higher fuel prices translate into economic and ultimately political stress, and the sanguinity of our reliance upon "traditional market logic" - i.e., the belief that if we want it, it will appear - appears less a sound economic presupposition than a touching if naive and dangerous faith.


Anonymous said...

Why does stealing gas or - in particular - leftover cooking grease (which is of course an "alternative source" for cars that run on diesel fuel) not count as acting rationally? (The same goes for plowing your fields with mules, or - as in another article you posted a while ago - limiting expenses on luxury items like bottled water.) Moreover, there is evidence that people are cutting back on their fuel use: driving was down 4% in March. Obviously there is going to be political unrest as well, and not just in Europe - the recent NPR poll on political attitudes in America showed gas prices at the very top of everyone's agenda, with incredible numbers of people supporting the stupid repeal of the gas tax (now that's irrational!) - but the higher prices are bearing on people's actions in more sane and subtle ways, too.

Dad29 said...

There remains another possibility: that producers are deliberately holding back on supply.

Why not? One can arrive at a mathematical "tipping point" model which accounts for the slide in the USD value v. oil.

Why sell more and get not only less NOMINAL, but less ABSOLUTE, value?

Anonymous said...

Modernity has succeeded so well in packing the ideology of 'progress' into the basic Western ethos that common Westerners are now incapable of deliberating upon practical concerns without drawing upon the incoherence of progressive promises. The tensions and present unpredictability of the market provide the most vivid illustration of what happens when 'progress' attaches itself to logics of problem solving. Abstract worlds such as 'market' and 'progress' are bound to contribute only increased social confusion until made suitably concrete. Panic creeps into the minds of oil economists because the supply and demand ratios are directing attention to quantities of availability. This has the helpful affect of forcing the 'predictors' to incorporate figures which do not fit nicely within economic models.

One critical reason why we find market logic unsound is because the logic has made 'progress' a fixture of truth. The problem of oil shortage will begin to be resolved when the problem transcends purely economic investigations and methodologies.

8 said...

Brilliant, deep, intelligent commentary.

I tend towards the production cap hypothesis. If the world seems able to tolerate $130, why not try for $140?

Anonymous said...


Slow down a little bit. Peak oil will be true some day, and might be the right reason today. However, it is also true that production cycles for oil are like inflation and the money supply--except that the lag time is even longer. Right now a lot of old wells in this country, in places like Oklahoma, that were shut down in the mid-1980s when oil prices collapsed, are being reopened, because new technology and the current price make them profitable. But it takes months if not years to get production going again (and believe it or not there is a shortage of drilling equipment and crews in this country), and until recently, my oil friends tell me, they weren't willing to produce at a price point above $50, because they didn't believe the current high prices are sustainable, and don't want to go through 1986 again. (You think the housing collapse today is bad? Go back and check out Houston and Oklahoma in 1986-87, which was a factor in the S & L debacle.) Meanwhile, I was talking last week with a leading explorer in the natural gas industry, and he is confident that a LOT of domestic natural gas is about to come online, because of the current high prices. He walked me through places and amounts that he has in development in this country, and it is staggering.

Meanwhile, Americans are finally starting to cut back significantly on gasoline. Looks like the market works after all. Don't be surprised if this whole scene looks very different in two to three years from now.

Patrick Deneen said...

Steve -
If that's so, then would you consider that the market was working 20+ years after the oil shocks of the 1970s? If happy days are coming again, will we eschew SUVs and far-flung McMansions in the knowledge that "peak oil will be true someday"? If we (those of us who happen to be alive now) are about to get some new bonanza of energy, will we use it responsibly (not to mention, not at all!) so that we will not hand our children, or theirs, a world that can't be sustained? What I'm pointing to here in this posting is the assumption that the market will provide - when in fact, we know one thing for certain: the market (i.e., US, released from any sense of restraint) consumes extremely well and efficiently. I'm not suggesting that gummint should run our lives, but to the extent that we can act as truly rational and long-term thoughtful humans, we might want to impose certain restraints on ourselves. That's called law - something I thought conservatives supported.

Anonymous said...

First of all, I'm not a market-worshipping purist. To the contrary, I've publicly advocated a carbon tax ( But as to your question--"would you consider that the market was working 20+ years after the oil shocks of the 1970s?"--the answer is an emphatic Yes if you know what you're looking for. This is a large story with many parts, but ask why the oil price rise of the last few years has had much less of an impact on the economy than the comparable oil price rises of the 1970s. The short answer--the full data take a while to walk through-is that oil is a much less of a factor in the U.S. economy than it was in the 1970s. One stat: in the 1970s, oil accounted for 2/3rds of total energy consumption; today it is only 1/3rd, with electricity (and gas) accounting for the other 2/3rds. Between 1949 and 1973 energy efficiency in the U.S. only improved by 12 percent; between 1974 and 1999 U.S. energy efficiency improved 40 percent (usually in advance of government mandates such as auto CAFE standards); between 1949 and 1973 per capita energy consumption increased 64 percent; between 1974 and 1999, by only 2 percent. Pretty good evidence to me that markets and prices work, and that in fact we did make big changes as a result of the new energy world of post-1973. And I suspect we're going to make big changes in the years just ahead, with or without (almost surely better without) government mandates (see: ethanol debacle). In other words, the dynamic restraints of the marketplace will almost always (note: I said "almost") be superior to politically-imposed restraints.

Regarding McMansions: many of them (not the Gore/Edwards monster-size) use exactly the same amount of energy as the average new house in 1970; in other words, we traded energy efficiency gains (better insulation and appliances, etc) for more square feet in which to live. Is this really such a sin?

I could go on and on (I'm a maven for these stats, and I've practically memorized the exhaustive tables of the Energy Information Administration), but let's make this interesting: How about a Simon-Ehrlich style wager. I say that three years from now, oil will be below $75 a barrel. Let the loser of this wager buy the winner his choice of any hardbound book in the Liberty Press catalogue. Shake?

Patrick Deneen said...


We agree for the need for sound policy - meaning a place for gummint. Sorry to confuse you with the fundamentalists - I seem to be attracting a good many here these days. The effort should be on reducing use - not underwriting nutty schemes like turning our food into fuel (I opposed that one, for the record). I like Dingell's idea of tax disincentives on McMansions. I'd say extend it on large vehicles - let's kill them off all the quicker (rather than subsidizing them, as we've effectively done by declaring them exempt from auto emissions standards). We should disincentivize the destruction of good farmland for tract housing or strip malls. I hope we see more mixed zoning so it's possible to walk or bike to school, stores, work, etc. We further agree on a sound tax policy - I would go further (for once agreeing with Thomas Friedman, much as the thought pains me) that we should set a floor on the price of gasoline to encourage the continued decrease in the use of oil and confident investment in other fuel sources. There's a great deal to be worried about should demand destruction drive the cost of oil back down to $75 bbl - we'll just cease exercising good habits we've slowly and painfully been working on.

Far be it from me to debate a man with statistics at his fingertips. I am familiar with these efficiency numbers, and they do paint an impressive picture (and suggest why the economy is not at the moment even worse than it should be - bad as it is). Still, I'd ask to consider a bigger picture than efficiency percentages - for instance, some absolute numbers:

Oil imports, 1981: 2,188,420 bbl per day
Oil imports, 2007: 4,905,234 bbl per day

Oil consumption, 1981: 16,058,000
Oil consumption, 2007: 20,730,000 bbl per day

Oil as a percentage of U.S. trade deficit, 2004: 27%
As a percentage, 2006: roughly 36%

Estimated cost of Iraq war (declared, as "everyone knows," by Alan Greenspan to be about oil): $525,000,000,000

But, the biggest of the big points of the bigger picture is the most contentious, and really at the heart of my larger argument - we have become deformed as a society as a result of our utter reliance on profligate uses of external energy at the cost of all existing forms of culture and community. That's really the point of these more discrete but ultimately distracting parts of the argument. We have sold away our self-sovereignty in the broader sense of national self-destiny, as well as the no less important sense of national, communal, and personal self-governance. A combination of a libertine moral philosophy and a libertine economic philosophy has given rise to a civilization of profound unhealth. What health persists, I would argue, is an inheritance that we squander without maintaining or replenishing. So, all statistics notwithstanding, that's the real crux of what I've been arguing here for some months. I'm a broken record, I know.

To your last intriguing wager: I don't believe - all our newly discovered or enforced virtues notwithstanding - we will find it easy to transition into a world of reduced energy quantities (we're already finding it difficult). I don't think the price of will be coming down as substantially as you suggest due to even greater efficiencies, replacements or demand destruction. There are too many buyers elsewhere, and we'll just continue to burn whatever is cheap enough to buy (or borrow). I'll take your bet - and hope I'm wrong. Let's check back in on June 2, 2011 (God willing), and if I lose I'll throw in a nice dinner to boot. We'll have something to celebrate - maybe.

Anonymous said...

Well, we'll celebrate a nice dinner either way.

Dad29 said...

Prof. Deneen--two events in the last couple of days which are of interest:

1) GM closed four SUV-producing plants, leaving only one running. That was "market forces," not Gummint decree.

2) Bernanke signaled that rates will remain where they are (and possibly increase)--and the price of oil decreased on the very same day.


Anonymous said...

good post