Thursday, January 31, 2008

The Oilman’s Dilemma (2/27/07)

People in Anthropology and Economics departments at universities like to use thought experiments and goal based games to explore human interactions and perhaps explain, or at least model, why people behave the way they do. Some of them are quite clever, such as the object of this discussion: The Prisoners’ Dilemma. Without going into detail about the origin of this thought experiment, let me just explain how it is used today.

Two people enter into some kind of cooperative arrangement. This has to be a single interaction. In its simplest form, there are two options for each of the participants, and therefore four possible outcomes to the entire interaction. The options are: You can live up to your end of the bargain (cooperate) or shirk your responsibilities (cheat.) When two people enter into an exchange like this, they can both cooperate, they can both cheat or some combination giving a total of four outcomes.

The reward structure is based on points gained. The amount of points that a player can earn depends upon how much cooperation occurs according to certain rules. Suppose both parties cooperate. In this case, each party gains three points. If both cheat, they each gain only one point. So far, cooperation seems to make the most sense. However, it gets more interesting when one cooperates and one cheats. In this case, the one who cooperates gets nothing (called the Suckers prize) while the one who cheats gets five points (called the Temptation).

So, if you enter into a Prisoners' Dilemma game with one other person, this is how you will reason: If I live up to my end of the bargain (cooperate) and so does the other person, I will get three points. However, if I cooperate and he doesn’t, I will get nothing, which is the worst case for me. If he cheats then the best strategy is for me to cheat, too, as a defensive strategy. In this case I will get only one point, which is better than nothing. Furthermore, suppose that he cooperates. If I cooperate also, I will gain three points, but if I cheat, I will get five points, which is obviously better for me.

In both cases, the safest strategy is to cheat. Cheating in the first case is defensive whereas cheating in the second case is opportunistic. Unfortunately, your opponent is thinking the same way. Ironically, when viewed in total, the greatest outcome only comes when both parties cooperate. In this case, the total gross number of points is amassed: Six points. If one cheats and one cooperates, that total is five. The worst case, where both parties cheat, results in only two points. Even though the best strategy for both parties taken together is for both to cooperate, the most likely outcome seems to be for both to cheat, which results in the worst outcome for all involved.

The Prisoners' Dilemma has been applied to many cooperative ventures, such as OPEC pumping quotas, cooperative farming and contributing to Public Radio. The reward structure reflects the difference between how much you put in and how much you take out (EROI.) Cheating gives you a greater reward since your investment is less. There may be less to go around because you haven’t put in your fair share of the work, but you personally get more out of it. Your own personal energy returned on energy invested is greater. Of course, if nobody contributes then there is even less left over to share. This model works great with an enterprise that requires investment of labor, such as a shared garden. It also works with other shared resources.

Let’s look at the OPEC example.

If two countries agree to production limits and honor those agreements, they will collectively produce the most profit on a per barrel basis. The reward, instead of being points won in a game, is actual money. Now, let’s suppose that I decide to cheat and pump more oil than is allowed by my quota. Since there is more oil mysteriously on the market, the price goes down. I get more money in total because I am pumping more oil at a reduced price, but the profit per barrel goes down. My partner, assuming that he is adhering to the quotas, suffers the reduction in revenue due to the inexplicably lower price of the oil but does not gain any extra revenue. Indeed, his revenue goes down since he is selling fewer barrels of oil at a reduced price. I get the Temptation while he is stuck with the Suckers prize.

If we both violate our pumping quotas, there is even more oil in circulation. The price goes down even more and the total profit for both of us, on a per barrel basis, goes down even further. We may get more money by pumping more oil, but at a lower profit margin. We both loose equally.

The temptation comes from the fact that two people can both share some common resource or one can benefit spectacularly at the expense of the other person as well as the degradation of the total system output. The cheater is milking the system which depletes the total while maximizing his own little portion.

Now let us take this game and apply it to the Peak Oil problem. As the availability of oil goes down and the price goes up, forces will dictate that we use less. Using less is a form of cooperation in the PD game. If everyone conserves, the supply will rise and the price will go down, such as we saw last fall going into winter (2006-2007.) Everyone wins. However, as soon as the price drops and supplies rise, the temptation will be to grab some more and hope that someone else keeps up the good work of conservation. I cancel that Prius order, schedule my winter vacation in the Bahamas and gleefully say, “Whew. Thank God that’s over!" What I in effect am doing is cheating while hoping that the other guy cooperates. However, if I conserve, turn down the thermostat and stuff newspaper under the doors of my modest house while my next door neighbor rolls into the driveway of his McMansion with his new Jeep Grand Cherokee towing a barge, then I’m the one stuck with the Suckers prize. My conservation has made it possible for someone else’s excesses.

So whatever the price of oil is, the safest and most opportunistic strategy is to use as much as I possibly can, whether that is great or small, and hope that someone else is conservative. Conservation is great, only not in my gas tank. From the reward structure of the Prisoners' Dilemma, conservation makes no sense whatsoever.

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