Seeker Blog

James Hamilton examines the scarcity rent concept:

Does the market price of oil reflect a recognition that the resource is fundamentally limited?

Dave Cohen, writing at the Oil Drum, has been doggedly wading through the writings of economists on resource scarcity, going the extra mile (and then some) trying to understand how those on the other side of the river from him have thought about the issue of resource scarcity.

As Dave nicely explains, the traditional Hotelling model reasons that market forces will cause there to be a “scarcity rent” incorporated in the price of an exhaustible resource. The observation is that someone who sells a disappearing resource today is thereby surrendering the opportunity to sell that commodity in a future market in which it might be more highly valued. As a consequence of owners bringing more or less of the product to the market at each date on the basis of such calculations, the theory predicts that the scarcity rent should rise over time at the rate of interest.

Dave then runs into the same stumbling block as anyone else who has tried to apply this elegant theory to reality– if you look at the inflation-adjusted price of what should be exhaustible commodities over the last century, there’s no hint at all of an upward trend:



Dave concludes that sellers have been regarding the day of exhaustion as so far off in the future, that, given also advances in the technology of extraction, a scarcity rent has made essentially no contribution to the price. But Dave’s geological assessment is that in the case of oil at least, declining annual production rates in fact are going to come relatively soon. He concludes that perhaps the scarcity rent is not making the contribution that it should for oil due to possible factors such as investors too heavily discounting even relatively near-term events, or deliberately misleading data provided by oil producers such as Saudi Arabia in a strategic game to prevent investments in alternatives to conventional oil reserves.

James does not believe speculation is a big part of the recent price trends. In his earlier post “Oil Bubble” he wrote:

Let me repeat here that I do not believe that speculation is the reason oil went from $60 to $120 a barrel. The biggest part of that longer term trend is due to fundamentals, not speculation. Notwithstanding, it does appear that speculation has gotten ahead of those fundamentals in the most recent developments.

For the bubble to continue, we would need to see ever-increasing volumes of investment money pouring into the futures markets, and continuing stagnation in global production to ratify them. Even if the former occurs, my best guess is that the latter will not.