Inflation-Adjusted-Energy Prices Will Not Rise!

Inflation-Adjusted-Energy Prices Will Not Rise!
Sept. 3, 2005

Well, that’s the word of John Tierney’s in an op-ed of the NY Times (reprinted in N&O) last week. It caught my interest because of my energy career and his $5,000 bet with Matthew Simmons that fuel prices within the next five years will not rise above the current prices when adjusted for inflation. This statement might seem ludicrous in light of the current volatile supply/price situation. He based his prediction on the economic views of his late mentor, Julian Simon. (Not to be confused with William Simon, President Nixon’s Treasury Secretary in 1974, later becoming head of Federal Energy Administration -- the "energy" czar.)

• Article (in full print below) excerpts: “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." http://www.simmonsco-intl.com/default.asp “Julian (Simon) took up gambling during the last end-of-oil crisis, in 1980, when experts were predicting a new age of scarcity as the planet's resources were depleted by the growing population. Julian had debunked these fears in "The Ultimate Resource," the bible of Cornucopian economics, which showed how human ingenuity had kept driving down the price of energy and other natural resources for centuries.” http://www.juliansimon.com/

In what direction does the future energy barometer point?
In my 41-years of the energy business, gasoline, fuel oil, and propane there were some very troubling operational times. It was literally the times of uncertainties in not knowing if and when the next supply would be available to serve our company’s customers.
The company I began working for in November 1959, Smithfield Oil Company owned by J. Marvin Johnson, at that time sold kerosene and fuel oil for about 10 to 12 cents per gallon and gasoline for about 22 cents during the early sixties. Those prices remained fairly consistent through the early part of 1970s. By this time prices for oil were about 15 cents, propane about 18 cents and gasoline about 25 to 30 cents per gallon. Enter 1972: There was some speculation that supply was tightening. In the winter of 1972-73 evidence began to seep out that some energy shortages were on the horizon. After all, a price freeze had been implemented by the Nixon administrations in 1971, and now the major oil companies were not making profits commensurate with investments and stockholder expectations. Consequently, the energy shortage became reality for some people. The arrogance that some major oil companies began to demonstrate was an unbridled power to bring about a shortage. (Yes, that’s what I believe; at least in part they were responsible.) That’s never been proven to my knowledge, but it was the talk in those years. In my opinion it was their way of dealing with the Nixon administration’s price controls. They may have seen an embargo coming, but they exploited the situation, either for greed or otherwise.
Maybe in a sense the major’s instigation had some justification, but their discriminately (or indiscriminately) canceling of dealer supply contracts like Smithfield Oil and Gas Company proved to be an astonishing narcissism of the majors. By the Spring of 1973, CITGO (a different entity now), one of our fuel oil, gasoline, and propane suppliers, and Shell Oil Company, one of our propane suppliers, refused to sell even a gallon of fuel to our company and many more throughout the nation. Other majors also participated in this diabolism.
With the ensuing tobacco curing season, in May 1973 I attended the national propane convention in Chicago, where normally all the suppliers congregate to sell their product. My visit proved futile. The Shell and CITGO supplier’s representatives made themselves inaccessible, even to meet to discuss the situation with me. No other majors would even entertain the idea of taking a new dealer. This was a major crisis for our petroleum dealership. We did have some gasoline and fuel oil supply from ONCO, another major we had purchased from. But, as probably the largest county distributor of tobacco curing fuels, we had not one gallon of propane commitment by a supplier.
Thanks be to the workings of politics: By mysterious events a relief (some might call black-market opportunity), we obtained propane through an out of the county friendly competitor and his Mobil major supplier --- of course at a premium of additional .04 cents per gallon. (4 cents decimated profit margins for those years.) But we gladly paid. This life experience taught me some things about big business – of which I have since reflected on the arrogance, moral decay and downfall of companies in recent years.
Suffering through that summer and the uncertainty of the coming heating season, we came to realize the US Congress was getting plenty of complaints and inquiries. Hence, enactment by the US Congress, even as Watergate was brewing, on Nov. 27, 1973 President Nixon signed the Emergency Petroleum Allocation Act, embracing government regulations. This act enforced the equitable distribution of all supplies based on record of their purchases before the major companies had cancelled so many dealers’ contracts. I assembled our records, took flight to the Regional Energy Office in Atlanta and applied for our fair portion. As a result we had an abundance of fuel; we served gasoline lines with vehicles backed up three blocks from our adjacent Truck Lane Service Station. Smithfield Oil and Gas Company’s supply was free sailing throughout the ongoing so-called embargo that lasted through March 18th, 1974.
My experiences tell me that continuing disruptions in supplies and emotional speculations will drive market forces in radical price swings. But will energy prices not go higher when adjusted to inflation? When gasoline prices were only 30 cents per gallons here in 1970, England, France, and Germany pump prices were approaching $2 to $3 per gallons, as I remember reported by Time Magazine. Until 1973 U. S. prices had not kept up with inflation. (Actually crude oil prices from 1957 until 1972 were in a gradual decline. See graft link below.) Since 1973, on an average, I believe, price increases have exceeded inflation. The current dramatic upturn in gasoline prices hardly could be seen as a result of inflation adjustment -- but moreover it is driven by national demand (which includes petroleum for manufacture of plastics and many other products), demand of developing countries such as China, Iraqi uncertainties, OPEC’s attitude, speculative projections, and now the Gulf Coast crisis.
I predict gasoline prices will decline again; however, probably not much below $2.50 pump prices anytime soon. No bets! OPEC will expect us to think that’s reasonable after the $3.00 plus experiences. Poor folks will take the brunt of burden.
Considering that inflation is driven in large part by energy price escalation, of which many factors affect the volatility, Mr. Tierney’s bet might be a safe one. Although, with all the new technologies for alternate-energy sources and satisfactory conservation measures -- should this country’s energy cost have to continue on an inflation-float? Will government and new-energy-business cooperate to fully develop and bring these needed new-energy sources to market – with sustainability? If gasoline prices stabilize around a $3.00 level, I suspect there will be substantial development of these new-energy sources. If that’s the case, the dreams of alternate-energy sources that originated during the first energy crunch of 1973 might become a reality.
To learn more about various alternate energy sources go to: http://www.personal.psu.edu/users/s/a/sam5000/citations.html
Best wishes for a safe and restful Labor Day. And let’s not forget the Gulf Coast victims’ critical needs. However small our help, collectively, we can alleviate much of the suffering.
Cornell Cox
Click this link to get grafts of oil history from 1947: http://www.wtrg.com/prices.htm
August 23, 2005
The $10,000 Question
By JOHN TIERNEY
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. http://www.simmonsco-intl.com/default.asp
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.
Julian took up gambling during the last end-of-oil crisis, in 1980, when experts were predicting a new age of scarcity as the planet's resources were depleted by the growing population. Julian had debunked these fears in "The Ultimate Resource," the bible of Cornucopian economics, which showed how human ingenuity had kept driving down the price of energy and other natural resources for centuries.
He offered to bet the pessimists that oil or any other resource they chose would be cheaper, in real terms, at any date they picked in the future. The ecologist Paul Ehrlich, author of "The Population Bomb" and "The End of Affluence," took up his offer and chose copper, tin and three other metals worth $1,000 in 1980.
When the famous bet was settled 10 years later, the value of the metals had declined by more than half. As usual, people had found new ways to get the metals as well as cheaper substitutes, like the fiber optic cables that replaced copper telephone wires.
After collecting his winnings, Julian expanded his challenge, offering to bet anyone on any other resource price or measure of human welfare. Julian, who died in 1998, never managed to persuade Mr. Ehrlich or other prominent doomsayers to take his bets again. But now we have a braver prophet in Mr. Simmons.
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.
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.
The first person I told was Julian's widow, Rita Simon, a public affairs professor at American University. She was delighted to see Julian's tradition carried on and thought the bet sounded so good she wanted a piece of the action herself.
With Mr. Simmons's approval, we arranged for Rita and me to split the wager, with each of us putting up $2,500 against Mr. Simmons's $5,000. (Note to accounting department: I'm aware that my expense account doesn't cover gambling. I'm using my own money.) All the money is being put into escrow in a joint account; the winning side will collect the $10,000 plus any accrued interest on Jan. 1, 2011.
I realize this isn't a sure thing, because the price of oil has risen before - it quintupled in the 1970's. But then it dropped, thanks to new discoveries and technologies, validating the Cornucopians' optimism.
So I figure the long-term odds are with me. And while I'm at it, I'll extend Julian's challenge and consider bets from anyone else convinced that our way of life is "unsustainable." If you think the price of oil or some other natural resource is going to soar, show me the money.
Email: tierney@nytimes.com
For Further Reading
"The Breaking Point" by Peter Maass. New York Times Magazine, August 21, 2005.
Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy by Matthew R. Simmons. Wiley, 448 pp., May 2005.
The Ultimate Resource 2 by Julian L. Simon. Princeton University Press, 778 pp., revised edition, July 1998.
"Betting on the Planet" by John Tierney. New York Times Magazine, December 2, 1990