What is the Peak Oil theory of value?

published 28 September 2006

"NONE OF US can go a little way with a theory," wrote John Henry Cardinal Newman (1801-1890) in his book Essays Critical & Historical. "When it once possesses us, we are no longer our own masters. It makes us speak its words, and do violence to our nature."

What is theory?

What an interesting quotation about theory from the good cardinal. But before we go too far along, here is the next question: What is theory? The word itself derives from the Greek word "theoria," meaning examination, contemplation, or speculation. A theory is a doctrine, or scheme of things, which terminates in speculation or contemplation. Or you can say that it is an exposition of the general principles of a given field of study. A simple way to understand the concept of a theory is that it is the premise or set of premises upon which an argument rests, although the focus of theory is on the "science" of something, more so than the "art" thereof.

Cardinal Newman was writing in his essays, of course, about theory in the context of the consuming power of religious faith. After all, the great Roman Catholic Newman had the word "Cardinal" in his name and was one of the leading theologians of the 19th century. But Newman's description of the power and impact of a theory is not just a statement about religion. Had he been writing only to describe religion, perhaps he would not have used a word of such scope as "theory." He was speaking in a broad sense.

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Exxon's Mr. Nolan did not amplify this last comment. He simply threw out the bald assertion that "there is no Peak Oil theory of value." In later comments, Mr. Nolan explained the Exxon "view" that "the world has abundant energy resources." He stated, "According to the U.S. Geological Survey (USGS), the Earth currently has more than 3 trillion barrels of conventional recoverable resources and so far we've produced 1 trillion of that. Conservative estimates of heavy oil and shale oil push the total recoverable resource to over 4 trillion barrels."

I will refrain from dissecting the infamously optimistic USGS estimate of there being "more than 3 trillion barrels of conventional recoverable resources." A lot of very good petroleum geologists and engineers have taken the USGS to task on this point, and even the USGS has backed off from its rosy view of the Earth's "conventional" oil resources. My focus in this article is to review the Exxon man's comment about there being "no Peak Oil theory of value."

We have to get back to basics again. What is a theory of value? OK, we discussed theory above, but what is "value"? At a fundamental level, value relates to the worth of something, or its utility to satisfy the needs of people. So a theory of value must be the premise or set of premises upon which an argument rests, relating to the worth of something, or its utility to satisfy the needs of people. Let's discuss this just a bit more.

The encyclopedia definition of the expression "theory of value" is that it is a generic term that encompasses all the theories within economics that explain the worth of goods and services. That is, a key question in economic theory is how the value of goods and services comes about, and how to calculate the correct value of goods and services if such a value exists. The following paragraphs are summaries of several related articles posted on Wikipedia, which contains a useful set of online links to different theories of value and describes several main categories of these theories.

The first category is called the "intrinsic theory of value." An intrinsic theory, as the name implies, holds that the value of goods and services is a property built into the item itself. This implies that every item has a certain worth that does not depend on what people think of it. Most intrinsic valuations look at the process of producing an item and the costs involved in that process as a measure of the item's intrinsic value. For instance, the "labor theory of value" - the most influential of the intrinsic theories - holds that the value of an item comes from the amount of labor spent producing the item. For a simple example, if it takes two workers six hours each to produce some product, then that product is worth 2 x 6 = 12 man-hours.

The second category is called the "subjective theory of value." Subjective theories hold that for an object to have economic value, meaning a price, the object must be useful in satisfying human wants and must be not be in unlimited supply. That is, it must be scarce. This is the foundation of the "marginalist" theory of value, as seen commonly in neoclassical economics. That is, the value of something is set by the marginal purchaser, which is another way of saying that the theory recognizes that one thing may be more useful in satisfying the wants of one person than another, or of no use to one person and of immense use to another. Goods that are in unlimited supply, or in a greater supply than that demanded, would have lower value.

The third category is called the "cost-of-production theory of value." In economics, the cost-of-production theory of value is the theory that the price of an object is determined by the sum of the cost of the resources that went into making it. The cost can be composed of the cost of any of the factors of production, including labor, capital, land, or technology. This theory makes the most sense under assumptions of constant returns to scale and the existence of just one so-called "nonproduced" factor of production. These are the assumptions of the so-called "nonsubstitution theorem." Under these assumptions, the long-run price of a commodity is equal to the sum of the cost of the inputs into that commodity, including the cost of money (or "interest"). Historically, the most well-known proponent of a cost-of-production theory of value was probably Adam Smith.

Now that we have examined several versions of the theory of value, let's think about them in terms of Peak Oil. The central argument of Peak Oil is a serious, scientifically valid concept that relies on both historical "discovery" numbers and extraction figures for conventional petroleum. That is, you cannot extract what you have not discovered. Peak Oil is a shorthand way of saying that mankind's ability to extract conventional oil from the Earth is "peaking" because mankind has found most of the world's oil deposits. And it also appears that mankind has extracted about half of all of the conventional oil that will ever be extracted. This is the basic premise. Keep your eye on that ball.

By conventional petroleum, I mean the rock oil that can be made to flow from pores in a rock formation and into a bore hole in the ground, and from there be lifted to the surface of the Earth. This is the substance for which most of the world's liquid-fuel plumbing has been installed - and through this plumbing, the world's extraction and use is currently close to 85 million barrels per day. Conventional petroleum is the substance for which most of the world's exploration, production, transportation, refining, marketing, delivery, and end use is geared. And conventional petroleum is the substance that "Peak Oil" predicts will be available in lower and lower quantities, starting at some time in the future, sooner or later, depending on whom you care to believe.

Conventional petroleum is a different substance entirely than so-called tar sands or oil shale. Tar sands and oil shale require quite different methodologies, certainly to extract or produce, but also to transport, refine, and deliver. The world has very little in the way of plumbing for these types of substances. Aside from the lack of infrastructure, nonconventional hydrocarbon sources have quite different, and far more negative, economies than do conventional hydrocarbons, of both energy use (energy return on investment - EROI) and monetary metrics (return on investment - ROI).

So is it fair to say, as did Exxon's Mr. Nolan, that "there is no Peak Oil theory of value"? Is he saying that Peak Oil brings nothing of substance to the table? What is the value of Peak Oil? Is it intrinsic? Is it subjective? Does it have a cost-of-production attached to it? Is there some useful way to fit the Peak Oil concept into all of these value systems? At the end of the day, what is it worth to be able to predict, or at least to know and understand, that the world's capacity to extract conventional petroleum is about to go into irreversible decline? What is it worth to be forewarned?

Certainly, some adherents to the Peak Oil concept see in it, and read into it, their own hopes or biases. Is Peak Oil somehow the "end of civilization," and are we all headed for a cold, bleak future such as James Kunstler describes in his book The Long Emergency ? Well, the "long emergency" sort of future is one option, of course. If things do not transition from the current state to some future adaptive state, then The Long Emergency may well be prophecy. But it is not the only option.

Is the future bleak, or is it happy and hopeful? Who knows? No one can forecast the future like some modern Oracle of Delphi. But this mortal, human inability to forecast the future does not mean that you should not take Peak Oil for what it is, which is a signal of caution toward the future trends of mankind's energy use in general, and oil use in particular. Once cautioned, you must then move ahead as if crossing a minefield: Any one wrong step could be your last. But then again, if you plan for things, even for crossing minefields, you tend to turn the odds of success in your own favor. You might not be able to predict the future. But you can work to invent the future that you desire.

And Peak Oil is just getting started. Peak Oil is not well known outside of its own inner circles. The circles, however, are expanding. Other fields of study are picking up on the Peak Oil theme. So Peak Oil is gaining intellectual traction and respectability. What does Peak Oil mean to those on the outside of the concept? We are just now in the process of finding out as the word and understanding of Peak Oil begins to spread.

As I discussed in a recent article, "It's a Dogma-Eat-Dogma World," Peak Oil now is a lot like the then-developing concept of plate tectonics back in the 1960s. What was it good for? At first, the concept of plate tectonics was a curiosity, if not a scientific heresy. But when it came to be better understood, it explained a lot. Eventually, people figured out that they could even make money off of it.

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