Keeping Tabs on Economic Bets

Thirty years ago, Julian Simon and Paul Erlich made a famous bet on the direction of commodity prices. Erlich was one of those “gloom and doom” writers who said that we’re living in an age of scarcity.

Simon asked Erlich to choose any five commodities and averred that the prices would decrease over the next decade. Erlich avowed that they would increase. Erlich chose copper, chromium, nickel, tin, and tungsten. All five went down and in 1990, Erlich paid up.

Now John Tierney and Matthew R. Simmons have just settled a five-year-old $5,000 bet over whether or not oil would average $200 in 2010.

The bet was occasioned by a cover article in August 2005 in The New York Times Magazine titled “The Breaking Point.” It featured predictions of soaring oil prices from Mr. Simmons, who was a member of the Council on Foreign Relations, the head of a Houston investment bank specializing in the energy industry, and the author of “Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy.”

I called Mr. Simmons to discuss a bet. To his credit — and unlike some other Malthusians — he was eager to back his predictions with cash. He expected the price of oil, then about $65 a barrel, to more than triple in the next five years, even after adjusting for inflation. He offered to bet $5,000 that the average price of oil over the course of 2010 would be at least $200 a barrel in 2005 dollars.

I took him up on it, not because I knew much about Saudi oil production or the other “peak oil” arguments that global production was headed downward. I was just following a rule learned from a mentor and a friend, the economist Julian L. Simon.

As the leader of the Cornucopians, the optimists who believed there would always be abundant supplies of energy and other resources, Julian figured that betting was the best way to make his argument. Optimism, he found, didn’t make for cover stories and front-page headlines.

So how did oil prices do? At first, things were going in Mr. Simmons’ direction. Oil hit $145 per barrel by 2008. Then the recession came and oil dropped to $50. For 2010, oil has averaged $80. Adjusted for inflation that’s about $71 per barrel which isn’t too far from the $65 when the bet was made in 2005.

It’s true that the real price of oil is slightly higher now than it was in 2005, and it’s always possible that oil prices will spike again in the future. But the overall energy situation today looks a lot like a Cornucopian feast, as my colleagues Matt Wald and Cliff Krauss have recently reported. Giant new oil fields have been discovered off the coasts of Africa and Brazil. The new oil sands projects in Canada now supply more oil to the United States than Saudi Arabia does. Oil production in the United States increased last year, and the Department of Energy projects further increases over the next two decades.

The really good news is the discovery of vast quantities of natural gas. It’s now selling for less than half of what it was five years ago. There’s so much available that the Energy Department is predicting low prices for gas and electricity for the next quarter-century. Lobbyists for wind farms, once again, have been telling Washington that the “sustainable energy” industry can’t sustain itself without further subsidies.

As gas replaces dirtier fossil fuels, the rise in greenhouse gas emissions will be tempered, according to the Department of Energy. It projects that no new coal power plants will be built, and that the level of carbon dioxide emissions in the United States will remain below the rate of 2005 for the next 15 years even if no new restrictions are imposed.

Maybe something unexpected will change these happy trends, but for now I’d say that Julian Simon’s advice remains as good as ever. You can always make news with doomsday predictions, but you can usually make money betting against them.

In April 2008, Prieur du Plessis and Barry Ritholtz highlighted a $1 million bet from Jim Sinclair that gold would hit $1,650 per ounce by the second week of January 2011.

I don’t know if anyone took him up on his offer. There are only a few days left and unless gold stages a big rally, it looks like Sinclair will have lost.

Posted by on December 29th, 2010 at 9:48 am


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