Update on the Simmons-Tierney Bet
Posted by Stuart Staniford on March 17, 2008 - 10:00am
Topic: Economics/Finance
Tags: oil prices, peak oil, plateau [list all tags]
Greeen (left scale) monthly spot price of West Texas Intermediate crude oil, expressed in $2005 (CPI deflated) per barrel. Plum (right scale), number of barrels of WTI crude purchasable by forty average hours of private industry wages, pre-tax. Source: EIA for crude prices, BLS for CPI index, and BLS via Alfred for average hourly wages. Dashed lines are extrapolations of exponential fit from Jan 2002 on for illustration of trends only. These are not predictions, and the basis for assuming future trends will be similar to past ones is weak.
I don't share Matthew Simmons's angst, but I admire his style. He is that rare doomsayer who puts his money where his doom is.After reprising the history of the famous bet between Paul Ehrlich and Julian Simon, the actual terms of this new Simmons-Tierney bet were detailed further down the column:After reading his prediction, quoted Sunday in the cover story of The New York Times Magazine, that oil prices will soar into the triple digits, I called to ask if he'd back his prophecy with cash. Without a second's hesitation, he agreed to bet me $5,000.
His only concern seemed to be that he was fleecing me. Mr. Simmons, the head of a Houston investment bank specializing in the energy industry, patiently explained to me why Saudi Arabia's oil production would falter much sooner than expected. That's the thesis of his new book, "Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy."
I didn't try to argue with him about Saudi Arabia, because I know next to nothing about oil production there or anywhere else. I'm just following the advice of a mentor and friend, the economist Julian Simon: if you find anyone willing to bet that natural resource prices are going up, take him for all you can.
I proposed to him a bet using what Julian considered the best measure of a resource's value: how it compares with the average worker's wage. I offered to bet that the price of oil would not rise faster than the average wage, meaning that future workers would be able to afford oil more easily than they could today.We are now close to the half way point on this bet, so how is it looking?Mr. Simmons said he favored a simpler wager, based on his expectation that the price of oil, now about $65 per barrel, would more than triple during the next five years. He said he'd bet that the price in 2010, when adjusted for inflation so it's stated in 2005 dollars, would be at least $200 per barrel.
Remembering a tip from Julian, I suggested that we use the average price for the whole year of 2010 instead of the price on any particular date - that way, neither of us would be vulnerable to a sudden short-term swing as the market reacted to some unexpected news. Mr. Simmons agreed, and we sealed the deal by e-mail.
To assess this, I constructed two measures - one is the measure on which the bet will actually be decided - oil prices in 2005 dollars. Tierney's column doesn't define exactly which oil price, or how to deflate it, but simple choices are to use West Texas Intermediate (WTI) oil prices (from the EIA) and correct for inflation with the BLS's CPI-U index.
In addition to this, I also looked at a metric to measure what Tierney was originally trying to propose - how much oil can be bought with a given unit of wages, which he said should increase over time (people should become worth more and more, relative to oil). My implementation of that was to take average hourly wages in private industry, multiply by forty, and then see how many barrels of oil that would buy (ie how many barrels of oil does a week's worth of gross pay buy).
Furthermore, I noted in June 2006 that the run up in oil prices since the beginning of 2002 was exponential in form, and this is still roughly true. So I fit an exponential to both metrics and projected it out for a few years. The average doubling time in price is a shade over three years at present for nominal prices, and about 3 1/2 years for real prices. Obviously, an exponential increase in oil prices cannot continue forever (too many doublings and people would be spending all their income on oil), and I have no real idea when it will stop. Thus these extrapolations are just to be taken as what happens if current trends continue, not an unconditional assertion that they will continue.
With those caveats out of the way, here's the data:
Greeen (left scale) monthly spot price of West Texas Intermediate crude oil, expressed in $2005 (CPI deflated) per barrel. Plum (right scale), number of barrels of WTI crude purchasable by forty average hours of private industry wages, pre-tax. Source: EIA for crude prices, BLS for CPI index, and BLS via Alfred for average hourly wages. Dashed lines are extrapolations of exponential fit from Jan 2002 on for illustration of trends only. These are not predictions, and the basis for assuming future trends will be similar to past ones is weak.
However, it seems to me important to look a little deeper. In a sense both men look wrong in light of the data of the last few years. Simmons looks too pessimistic - at least so far, oil prices are not increasing as fast as he presumably expected them to. On the other hand, if we look not at the final terms of the bet, but rather at what Tierney initially proposed, then Tierney looks much too optimistic. The oil value of a week's work has not gone up, but instead has continued to fall rather sharply (real wages having been roughly flat, while oil is increasing rapidly). And while Simmons is quantitatively wrong, Tierney's original proposal would seem to be qualitatively wrong - things are moving in the opposite direction from what he predicted.
Of course, there are still two years, nine months, and a couple of weeks to go before the end of 2010 when the bet will be settled for sure. Who knows what will happen in the intervening time. But the trends right now point to Simmons losing the bet by being right on the big picture, but overstating his case somewhat.
Added in Press
After I had written the piece to this point, on Saturday, I sent it to Matt Simmons and John Tierney to see if they had any comment. Only Simmons responded:
Good piece. This is also first time I re-read John's column in a long time. Here are a few observations I would add. At the time when Tierney called, I obviously had no certain idea where crude prices would be in 2010, but thought the likelihood they would rise a great deal was very high. To make the story simple, I picked $200.Simmons in essence is arguing that there's still hope for him to win along the kind of trajectory I've marked in orange here:If you take your same chart and ignore the slow rise until mid 2005, and then take the times it shot up, or start trend line in 2007, the trajectory gets you there in fine shape.
We obviously talking about far more than a fun $5,000 bet. If oil has peaked, and the world stays in denial, there could be such social chaos that it might be hard to even define what the price of crude even is.
More important is the question "Is $110 oil now priced right?" Answer is also easy. No since this is still only $.17 a cup!
Greeen (left scale) monthly spot price of West Texas Intermediate crude oil, expressed in $2005 (CPI deflated) per barrel. Plum (right scale), number of barrels of WTI crude purchasable by forty average hours of private industry wages, pre-tax. Source: EIA for crude prices, BLS for CPI index, and BLS via Alfred for average hourly wages. Dashed lines are extrapolations of exponential fit from Jan 2002 on for illustration of trends only. These are not predictions, and the basis for assuming future trends will be similar to past ones is weak.
Now, however, we are in a somewhat different world. It looks like there is at least a small bump in supply at the end of 2007, and the prospect of more in 2008 - maybe as much as a couple of million barrels/day, though it's hard to be sure, still less precise. Given similar to recent trend GDP growth, this wouldn't require as large a growth in oil price. And given a global recession, it might be expected to lead to much lower price growth, maybe even price falls.
However, what is happening instead is, as the credit bubble deflates rapidly, we have sharp falls in the dollar and negative real interest rates, sparking a rush to commodities. How long this trend will continue is probably anyone's guess. The best hope for Simmons was perhaps raised by Paul Kasriel in a very important analysis last week, concerning the possibility of the failure of the currency pegs of the Saudi riyal and Chinese yuan
But, in our opinion, what could turn a walk on the dollar into a sprint would be a decision by the Chinese and/or Saudi central banks to eliminate the pegs of their currencies to the greenback. Now, what would motivate these central banks to sever the peg? The desire to rein in their domestic inflation. In an environment in which the dollar is under downward pressure, the by-product of pegging one’s currency is higher inflation in the economy whose central bank is pegging.The inflation mechanics are as follows. The pegging central bank has to buy U.S. dollars in the foreign exchange market in order to prevent the dollar from falling against its currency. The dollar-buying central bank purchases dollar with its own currency. The dollar-buying central bank gets its own currency the same way all central banks get their own currency – it figuratively “prints” it. The dollar-purchasing central bank therefore floods its economy with its own base money, resulting in inflation – inflation in the prices of goods/services and inflation in the prices of assets.
Recent trends in Saudi Arabian and Chinese consumer inflation. Source: Northern Trust
And if the Saudi and Chinese pegs come undone, then maybe oil could get expensive enough in dollars for Simmons to win his bet after all.
You think smooth curves. Some of us think in terms of curves with discontinuities. If there is an upcoming discontinuity, the nice smooth curve doesn't really tell us anything. Simmons may be thinking in terms of discontinuities also.
With enough stresses, there are likely to be fractures in the system.
Discontinuities was the thing that I was thinking too - essentially, the system is running flat out, and America seems to be wobbling from its position at the top. E.g. - the price in dollars may continue to rise beyond any reasonable expectation, as the dollar loses its value to those selling oil to America.
Well Simmons is a smart guy... who's to say (except him?) that he didn't peg this bet to the dollar value as opposed to Euros or a currency basket because of his assessment of the likely future value of the dollar?
If I were a betting man, I'd have taken that into account.
(Although he might then have put the bet itself in Euros or a currency basket if he believed that ... although it would perhaps have been more clever not to do that so as not to alert his betting partner to the reason he took his position in dollars...)
Well, as I said:
I agree that there could be geopolitical discontinuities, though with the release of the Iraq NIE (and consequent drop in Bush-Administration Sabre Rattling Index (BASRI), the world looks a little safer. We are also in the middle of financial market discontinuities, though at the moment, they are not as discontinuous as all that. They would have looked a lot more discontinuous this morning if the Fed hadn't operated so swiftly over the weekend.
Even the great depression took four years, peak to trough!
I beg to differ. With the recent stepping down (firing) of Adm. Fallon, and the continuous ramping up of anti-Iran rhetoric, the chances for more American military action in the Middle East looks to have increased, not decreased. All-out war in that region would certainly make a very strong case for discontinuities, perhaps for extended periods of time.
Indeed
http://www.jpost.com/servlet/Satellite?cid=1205420704459&pagename=JPost%...
Peak Oil is now a reality that we must adapt to or ????
Simmons has upped his Cup-o-Crude to 17 cents. Corn is still at about 5 cents per cup. The dollar is breaking down big time. How long before foreign holders of dollars decide to spend some more on American agriculture commodities? When they do ethanol will get the blame if the recent past is any indication.
Why wasn't Bear shopped to China?
What can China use it's $$$'s for?
The US has actual cash of $400 Billion with 15% in the vaults.
That will have to spread over 300 million Americans.
What will millions of Americans use for cash?
I can't confirm this, but I believe Bear Sterns was shopping around China for investors, and they got turned down flat.
Chinese have been burned by Blackstone, etc. and they are not about to do so again.
China brokerage rethinking Bear Stearns stake (March 16, 2008)
I think it was more of a "Hell no!".
So far, it looks like Tierny will win his bet the same way that Robert Rapier won his no $100 oil before 2008 bet - by the skin of his nose!
But, fundamentally, so far, it looks like Simmons was "right". A little more time will tell (as always)...
Simmons is obviously betting on the oil situation to accelerate. We are seeing this now with high prices. Ace's project show a demand gap as you will beginning to widen now. We have three factors at play that make Simmons bet reasonable and BAU or business as usual a bad bet.
1.) Bidding wars develop between wealthier nations.
2.) Export Land.
3.) Production begins to drop at some unknown but probably accelerating rate.
On the geopolitical side tensions will increase dramatically under these conditions.
The financial gyrations around peak oil are just that by most measures a good bit of the wealth supposedly created over the last ten years is rapidly evaporating. Outside of China and India our economies have probably been stagnant since 2000 in terms of real wealth. This has been hidden buy extreme financial policies that are now blowing up.
A good argument for this is simply that wages have been stagnant or even dropping despite inflation thus any growth since 2000 has been based primarily on debt not spending wages earned.
So Simmons will probably win.
This is the dumbest structure for a bet I've ever seen. It is essentially two bets. One bet is the price of oil and the other is how many barrels a week's pay will buy. Come Jan 1, 2011 both parties could claim victory. The price of oil fails to reach $200 and Tierney claims victory while the amount that a week's paycheck can buy drops and Simmons claims victory.
;}
Absolutely right.
The actual bet was on the price of oil. Tierney just revealed something about what he would have been prepared to bet on, and I chose to illustrate that. Had Matt taken him up on those terms, that (hypothetical) bet would have been looking pretty bad to date.
Your idea of the amount of price rise for percent of increase in demand given flat production is wrong by a huge amount.
Part of the reason you're wrong is you're considering 2006 to be a normal year.
2006 was heavily skewed by a short-term successful manipulation of the price of gasoline and oil through the GSCI reweighting. Since this price fix then caused changes in production plans, we have been paying heavily for that manipulation since September 2007, and we're not even close to being finished with the adjustment.
You might want to check out this 2006 U of C study of price elasticity of gasoline demand: http://repositories.cdlib.org/cgi/viewcontent.cgi?article=1062&context=u...
It looks to me as if price will be rising 25% per 1% increase in demand, given constant production, up from a norm of 10-15% per 1% of increased demand given flat production.
It's also incorrect to assume that flat production is really flat production. It is taking more rigs and more energy to produce the same amount of production. So flat production is really falling production.
Having said all that, I don't know whether Simmons will win his bet. In my opinion as a professional gambler for more than 20 years, it was stupid of Simmons to base his price target on inflation-adjusted dollars. A rise in the real oil price inevitably triggers price inflation. That doesn't mean the rise in the price of oil isn't "real." The inflation we're seeing right now is primarily due to the rise in the price of oil, not from any Fed money-printing spree. M1 and M2 are basically flat, and the Fed has been systematically neutralizing recent liquidity injections. What Bernanke gives via TAF, for example, he takes away from SOMA.
So, Simmons, though right on the direction of oil prices and the reason for that direction, may lose because he didn't think through how rising oil prices would raise other prices.
Let me say in closing that the people around here are terrible in general at constructing bets, even though you're very smart about peak oil. You should all stay away from gambling.
Moe Simmons bet was a political statement I'm pretty sure he was not worried about losing money.
The fact that he believes he is certain to win despite it being a poor bet should be cause for concern.
You're exactly right and eloquent is the way you said it.
8D
And I'd enjoy playing Blackjack all evening long with you.
> A rise in the real oil price inevitably triggers price inflation.
Plus the shift away from petro-dollars pulls the rug out from under the dollar, as predicted.
Your wage data is horribly skewed. You simply cannot use a wage mean to describe household purchasing power in the United States. I'd recommend that you drop the top and bottom 20% of households (or 10% of each if you want to be picky), then run your numbers. Over 60% of households in the US have been below the mean household income level for many years (roughly 35). If you need that data, feel free to email me.
Either way you do it, to say that neither Simmons nor Tierney are right is another exercise in skewed logic. It's like saying: "Person A bets that the world will end when the sun burns out in 9 billion years. Person B bets we will be rescued by sky fairies in 8 billion years." Well, since neither one has happened, they are both wrong....
Whoever stated that quantitatively, both are wrong, but qualitatively Tierney is wrong and Simmons right--is more correct than Stuart.
If one preferred median to mean, it would change the picture a whole bunch - either way, the point is that it's going entirely in the wrong direction.
It's not a matter of means or medians, it's a matter of inequality. I criticized your wage operationalization because it is the standard "pick a statistic" approach that goes unquestioned today--it fails to adequately consider the underlying structure of wage distribution in the US. It is similar to the assumption that phenomenon are linear. By choosing an easy to use tool, you lose most of the meaningful information, and actually reduce the usefulness of your "results".
Feel free to graph your preferred metric of average wages. I claim no reasonable choice of metric is going to change the picture a whole lot.
Oh also, when you say, "Whoever stated that quantitatively, both are wrong, but qualitatively Tierney is wrong and Simmons right--is more correct than Stuart", it was actually me that said that:
Ha! I guess that's pretty funny then--nice job.
The inflation adjustment of the dollar price seems odd, as oil price is one of the main inflation drivers in the CPI (currently more then 25% of the US CPI) and other price increases are also corelated with price of oil. Therefore the more oil price rises the higher inflation and therefore the lower "real price" of oil after the CPI adjustment. I.e. an extreme would be, if the oil was the only comodity in the inflation basket ==> the "real=CPI adjusted" price of oil would then be always stable, because in the "oil only world" 1 barrel of oil has always the value of 1 barrel of oil.
In other words, you have to use some oil independent inflation basket otherwise you are double counting and decreasing the effect of rising oil prices.
Probably the suggested "average purchasing power", i.e. average wage divided by price per barrel is the best indicator of some real price changes, compared to some simplistic CPI or GDP adjusments.
I was under the impression that BLS had removed energy and food prices from their CPI calculations (and it was done in 2003?).
The "Bureau of Labor Statistics" definitely includes price of oil (or gas etc) in their published CPI index, e.g. see the following link (transportation and energy has highest contribution to CPI): http://www.bls.gov/news.release/cpi.nr0.htm
BLS probably started to publish some "core inflation" index, i.e. without the impact of energy price changes, but I cannot find it right now (I remember reading about it in the past...). Anyway, the published CPI adjusted prices of oil are definitely using the standard US CPI with oil price increases included, e.g. see/click the chart at EIA: http://www.eia.doe.gov/cabs/AOMC/Overview.html
You are correct--it was the creation of a "core inflation" CPI measure that I was thinking of. To find BLS' core inflation figure, take a look at the first link you posted; at the bottom of their first CPI-U figures, they pull out energy and food ("special indexes")--subtract that from the "all items" CPI-U figures and you arrive at "core inflation," which is the figure they advertise.
You're technically correct - ideally I should deflate with cpi ex-oil. I'm not sure that series exists, however (though cpi-ex energy exists). However, this was easy to do and gives us a good enough idea given that the uncertainties here are dominated by what will happen in the remaining period of the bet. Even nominal prices are not on track for $200 by 2010 - so a discontinuity will be required for Simmons to win.
I find the bet interesting and distressing because it indicates how strong a hold Simonesque (aka cornucopian) thinking has on the mainstream punditry. The stronger and more pervasive this type of thinking is, the worse things will get (let's see Stuart plot that statement out graphically :)
An attack to Iran before November, as leap2020dotcom now suggests at 70% likely, and Simmons would win easily.
It would be the last heroic action of GWB (the 10 trillion debt man)!
Stuart Staniford wrote:
People on this site may interested to know that Stuart Staniford has recently argued in the comments on an economics blog (before Bear fell) that nationalization is on the way.
See on Feb 29 here and on March 11 here .
Turns out they didn't have months (or even weeks!).
But good call. Since nationalization has indeed begun to happen. Judging by US stock market's reaction by the end of today, it will have a stabilizing effect. Of course, the American public is now on the hook for part of the risk associated with Bear Stearns's more questionable assets. Stability has its costs. In this case, bearing those costs is very worthwhile.
I was pleased to see Krugman say this very clearly this morning also:
It's either the Dollar or the Fed.
Pick one.
Now that's a bet!
And the BLS has as much credibility as S&P/Moody's/ and Fitch right now.
Early Friday, the CPI came out flat and defied any sense of logic for 95 percent of the population.
I can only assume Krugman is being sarcastic. Current situation: taxpayer money funnelled to Wall Street insiders so the entire Ponzi scheme can be held together. No interest from ANY government representatives, elected or otherwise, in enforcing current laws in this area. The one public figure raising a stink thrown to the wolves-probably half the sheeple feel that who Spitzer is banging is far more important than the outright theft of their money. Yes, of course, taxpayers' money will be directed toward the people who caused the problem- it is the (Latin) American way.
On a somewhat related topic as far as oil price and speculation goes it bounced pretty hard of 104 and was close to 112 so about 7% speculation in the price.
Considering peak oil is not yet obvious I don't consider this a large speculative position. Assuming peak was back in 2005 then by 2010 it should be obvious and at that point a 25% speculative addition seems reasonable. I'd not call it speculative by a reasonable pricing in of the real value of oil during a transition away from oil.
So
140*.25 = 35 == 175 dollar including just peak oil based repricing of oil.
Add in and additional 10% for geopolitics gets you to 189.
Next to continue a bit more assume that a bidding war between wealthy nations to avoid shortages leads to and additional 50% premium gets you to about 260 a barrel.
Add in Export land and your pushing 300 by 2010 this would imply with a bit of backtracking that we should end 2008 at around 140 adjusted somewhat for inflation gives about 160.
So if we end the year around 150-160 then it makes sense to assume that Simmons is probably right if its closer to 200 then we are probably heading toward 300 by 2010 and Simmons was conservative.
However if we end the year around 90 which implies that economic slowdown had a big effect and that new oil sources where found then we are probably going to be going into 2011-2012 before we see serious problems.