Beautiful and Not so Beautiful Minds: An Introductory Essay on Economic Theory and the Supply of Oil

Abstract

Both the teaching and the studying of energy economics have been severely disadvantaged by the emphasis placed on the Hotelling theory of resource exhaustion. For example, in the study of oil and gas economics, this unrealistic construction is fundamentally irrelevant, because it does not consider fixed investment, nor the (real) options associated with such things as starting or interrupting production. In addition, both economics students and teachers have failed to recognize the crucial importance of the reserves-to production ratio, as well as the research of M. King Hubbert. Among other things, this oversight has led to an irrational optimism, where expectations of the future availability of oil are concerned. To be more specific, the probability that the oil pessimists are correct is large enough to justify the attachment of a sizable discount factor to any claim of future oil abundance.