Oil Prices and the Mayflower Problem

Do oil prices really tell the market what it needs to know when it needs to know it?

In a parallel universe far, far away where neoclassical economists run everything and conditions allow for perfect markets and perfect information, finite energy resources gradually climb in price as they are depleted. This encourages the development of substitutes over time and results in a smooth transition from one energy system to another.

Back on Earth events in the energy markets are moving along a trajectory quite different from that of our doppelganger universe. This is much to the chagrin of earthbound neoclassical economists who, as it turns out, run practically everything here when it comes to government economic policy and corporate management. Until recently the real prices of oil and natural gas had been declining for more than a century, and the neoclassical economists took this as an indication that technology was expanding the resource base by making more and more of these fossil fuels extractable.


But as Douglas Reynolds explains in his paper, “The Mineral Economy: How Prices and Costs Can Falsely Signal Decreasing Scarcity,” one simply cannot know whether declining real costs for finite mineral resources are due to increasing information about where to find them, advances in the technology for extracting them, or both. Let us back up for a moment and explain why this is so. While doing this we will also discover why price signals about the depletion of finite resources such as fossil fuels are likely to come so late in the cycle of depletion as to endanger any society which relies on such resources for normal functioning.

First, we must understand the so-called “Mayflower Problem.” The name comes from the analogy of the Mayflower landing on the Massachusetts coast where the Pilgrims set up the Plymouth Colony in 1620. In those days the most valuable commodity was fertile land. Certainly, the most fertile land in America was not found in Massachusetts. It would have been best for the Pilgrims to have traveled up the Mississippi River to Iowa. But, of course, they didn’t know about the American prairie. It would take another 200 years before Europeans began to settle the Great Plains and take advantage of its rich soil. Finally, the rest of the West would be settled, but the largest find of fertile land had already occurred. True, California had rich land, but that land had already been settled long before by the Spanish.

The analogy suggests what experience demonstrates. For any finite resource the pattern of discovery is small, large, small. It takes time to discover the most productive areas for any resource when there is very little information about where to look. As knowledge about where to look expands, it becomes easier to find a resource and as a result larger discoveries occur. But at some point, all the large discoveries will have been made and therefore more information about where to look will not yield additional large discoveries. The pattern then reverts back to small discoveries.

Oil exploration appears to be in this final stage of small discoveries. We are making a lot of small discoveries, but finding very few of the huge so-called elephant fields characteristic of the Texas oil boom of the 1930s or the Mideast oil finds of the 1960s. In fact, discoveries appear to have peaked back in the mid-1960s. Currently, worldwide oil consumption is running just over 30 billion barrels a year. But, discoveries are running about 9 billion barrels. That can’t go on forever without declines in oil production.

Scitizen