There’s a short-but-great exchange today in the Wall Street Journal on the subject of peak oil. You have to subscribe to read it there, but PeakOil has reprinted it in full.

It’s a conversation between James Hamilton, an economist at UC San Diego (blog here), and Robert Kaufmann of Boston U’s Center for Energy & Environmental Studies (what, no blog?!). Generally speaking, Kaufmann favors government intervention in markets to prepare for peak oil, and Hamilton favors letting the free market sort it out. But neither is dogmatic or shrill, and the exchange is quite enlightening, ending in a surprising degree of agreement.

Below the fold is a play-by-play.

One of Kaufmann’s points — and I think it’s a crucial one — is that the market might not be a very good predictor of peak oil.

Statistical studies of futures markets indicate that the price of oil in the "outer months" (six months or a year ahead) is not a very good "predictor." … Large fields can maintain a steady rate of production for many years and then decline steeply. The markets’ ability to anticipate the timing and rate of decline is limited by the lack of transparency. Without SEC rules that define proven oil reserves, OPEC’s estimates are mix of geology and politics. This uncertainty is critical because much of the oil produced between now and the peak (and beyond) will come from a few geological provinces inside OPEC nations.

If the market doesn’t anticipate the peak, the price signals needed to stimulate research and development may not arrive until after the peak. By then, it will be too late to avoid major disruptions. Think about the changes needed to replace motor gasoline. Society will have to retool the auto industry, alter every gas station and retrain every auto mechanic. These changes need to start before the peak. If they start after, they will add to the disruptions caused by the peak.

So, score one for intervention.

But Hamilton makes an equally good point: If markets are limited in their ability to anticipate sudden energy price and supply changes, governments may be even worse.

How much should we be surrendering right now in the way of current resources, researching and developing alternatives for energy supply and utilization, and forcing consumers to pay more now in order to make sure that we save enough oil for the future? These costs in the here-and-now are most real and tangible, and yet we somehow have to weigh them against something we only see through a veil, darkly. If you ask people today to make huge sacrifices that later turn out to be unnecessary or to be following a dead-end technological alternative, you’ve created poverty as a deliberate object of policy. I don’t see uncertainty about the world as something that would give us a good reason to prefer government intervention over market solutions; if the market is uncertain, then so should you be about what the best government policy would be.

In fact, the more uncertainty we have about these matters, the more I am inclined to turn to markets to assimilate that information for us. After watching the sausage8-creation9 of the current energy bill before Congress, I have relatively little faith that Washington is going to figure out for us exactly which technologies are most promising. But the entrepreneur who brings a workable hybrid vehicle to the market will make himself or herself quite rich.

The lure of earning such profits is, in my mind, a much more powerful and effective incentive than anything that the world’s leaders are likely to dream up and try to lead us to on their own.

Ah, so score one for staying out of the market.

But, Kaufmann counters, not all government interventions are equal. Not all "pick winners and losers."

Sound policy should establish an economic environment that increases the economic returns and reduces the risk to long-term research and development on alternative energies. Specifically, policy should impose a large energy tax that is phased in over a long period, perhaps 20 years. Furthermore, increases in the energy tax should be "offset" by reducing other taxes, such as payroll or corporate taxes. Economic studies show that such an approach can generate a "win-win" solution — reduce energy use (and the environmental damages not paid by users), stimulate research and development on alternative energies, and speed economic growth. Phasing in an energy tax would send a signal to entrepreneurs that there will be a market for alternative energies. The tax does not pick technologies — that will be left to the market, which is smarter than any Democrat, Republican, or even myself!

Sounds reasonable, right? It’s a form of intervention, but one that leaves specific strategies and solutions for private actors to determine.

So what say you, Hamilton? Mr. Market? Huh?

I am also very sympathetic to the idea of using taxes in this way.


Hamilton acknowledges externalities — namely the location of remaining oil reserves and underfunding of basic research — that argue for some public policy response.

Kaufmann concludes:

The totality of impacts may force policy makers to rely heavily on the precautionary principle, which compares the costs of being correct to those of being incorrect. We know that oil production will peak within our lifetime, we think market prices may not anticipate this peak and we know that not having alternatives in place at the time of the peak will have tremendous economic and social consequences. So, if society does too much now, as opposed to later, there will be some loss of efficiency. But if society does too little now, as opposed to later, the effects could be disastrous. Under these conditions, doing too little now in the name of efficiency will appear in hindsight as rearranging deck chairs on the Titanic.

Hamilton concludes:

We only have so much in the way of resources to cope with these great challenges — only so much capital to invest, only so many geologists to figure out how to get at the oil that remains, only so many engineers to develop alternatives. It is precisely because I agree with Robert about the importance of this transition that I think it’s critical that we put all our resources to their best use. And I honestly believe that the best way to ensure that happens is to count primarily on the same system that has generated the fantastic improvements in global living standards over the last few centuries, namely, individuals choosing to direct the resources they personally control to those activities that yield the highest personal reward.

So, let me conclude:

Here we have two smart, reasonable guys who agree on the basic shape of the problem and the basic shape of a good policy response.

The problem is that oil supply will soon begin declining, but we don’t know when and we don’t know how fast. The market will adjust sooner or later, but if it’s later, disruption could be enormous and long-lasting — possibly even, if you believe the loudest alarms, irreparable. So the thing to do is preemptively curb demand and increase the efficiency of supply via an energy tax (and — this is not stated by either guy, but I doubt either would argue — remove the panoply of targeted subsidies and tax breaks currently distorting the market).

This accords with most of what I’ve read about the issue, give or take a few degrees of alarmism

What’s striking is twofold: 1) how robust the consensus is, and 2) how far, far, far away our current policy is from what’s needed.