Figure 1. Base scenario from 1972 Limits to Growth, printed using today's graphics by Charles Hall and John Day in "Revisiting Limits to Growth After Peak Oil" http://www.esf.edu/efb/hall/2009-05Hall0327.pdf

In my earlier post, I talked about how rising oil prices are associated with rising food prices, and how these high prices can make it harder for borrowers to repay their loans, as is now happening in Europe. These same problems can lead to a contraction of credit availability. A contraction in credit availability can be doubly problematic: it can lead to a cutback in demand because buyers cannot afford goods using oil, such as new cars, and it can lead to a drop in financing for industrial uses, including expanded oil drilling. All of these issues may lead to contraction of the type expected in Limits to Growth. US governmental debt limit problems and European debt defaults are also outcomes of the type expected with rising oil prices.

In this post, I would like to discuss some other basic issues that seem to be associated with Limits to Growth, and that may eventually lead to an abrupt downturn or collapse.

Limits to Growth: More Basic Issues

1. The over-use of resources by humans seems to be of very-long standing origin, dating to the time-period 100,000 BC when there were fewer than 100,000 people on earth. Capitalism today is an extension of this long-term pattern.

2. World systems often seem to work as a gradual build-up of forces followed by a cataclysmic release. Examples include earthquakes and hurricanes. Even getting hungry, and then eating, follows this pattern. A similar pattern may happen with the Limits to Growth that we seem to be reaching.

3. The extent to which humans can gather resources for their own use depends on their geographical reach. As hunter-gatherers, our reach was quite limited. This reach has gradually grown through inventions such as ships, through the settling of new lands and colonialism, and most recently through international globalization. Globalization is necessarily the end of this growth.

4. Globalization sows the seeds of its own demise because factory workers are effectively forced to compete for wages with workers from around the world. Workers in the Global South can get along with lower wages for a number of reasons, including the fact that they tend to live in warmer areas, so do not need to build as sturdy homes and have less need to heat them. With fewer jobs and less investment in the Global North, demand falls and debt defaults become more of a problem.

5. In the normal scheme of things, world systems would rest and regroup once resources reach some sort of crisis point, defined by Liebig’s Law of the Minimum. Soils would build up again; aquifers would refresh; climate would reach a new equilibrium; and a different group of plants and animals would become dominant. Oil and gas supplies might even be rebuilt, over millions of years. It is not clear that humans will be part of the new world order, however.

Long-Term Overuse of Resources

Over the past 100,000 years, man’s record of sustainably using natural resources has been poor. Humans differ from other primates because of their relatively larger brain size, but humans have not used this intelligence to preserve the environment. Colin McEvedy and Richard Jones in Atlas of World Population History report that the final increase in Homo sapiens’ brain size to the current average of 1450 cc took  place about 100,000 years ago.

There have been five periods in the history of the world in which large numbers of species have died off. These are sometimes called “mass extinctions“. (See my post European Debt Crisis and Sustainability.) According to Niles Eldridge, the Sixth Extinction is occurring now:

• Phase One began when the first modern humans began to disperse to different parts of the world about 100,000 years ago.
• Phase Two began about 10,000 years ago when humans turned to agriculture.

According to Eldridge, humans have been like bulls in a China shop. They disrupted ecosystems by overhunting game species and perhaps also by spreading disease organisms. Regarding the development of agriculture, he says:

Homo sapiens became the first species to stop living inside local ecosystems. . . . Indeed, to develop agriculture is essentially to declare war on ecosystems – converting land to produce one or two food crops, with all other native plant species all now classified as unwanted “weeds” — and all but a few domesticated species of animals now considered as pests.

The development of fossil fuels ramped up the attack on natural systems further. Fossil fuel could be used for irrigation, and to produce herbicides, pesticides, and fertilizer, allowing farmers to choose the crops they preferred to grow. Fossil fuels also enabled large fishing boats to deplete the oceans of large fish.

Capitalism furthered this attack on the natural order by giving those who extracted resources from the earth profits based on this extraction. While governments may have taxed these profits, these taxes, too, were used for developing infrastructure so that man could continue his attack on the natural order, and this extraction of resources would become more efficient.

The final tool man found in his attach on natural ecosystems was debt based financing. While debt had been used for many years, it took on a new role when economists started realizing that greater debt could be used to increase demand for goods. This happens because debt financing gives people money to spend in advance of when it is earned (for example, a car loan allows a person to buy a car that he could not otherwise afford).

Because debt allows people to buy thing that they would not otherwise be able to afford, it has a tendency to raise commodity prices. These higher commodity prices make it economic to extract more marginal resources, such as oil in difficult locations.

Natural systems often operate through a build up of forces, followed by a cataclysmic release

There are no doubt some natural forces operate at a pretty steady level indefinitely–gravity, for example. But many of the processes we experience are “batch processes”. We remain awake during the day; by evening we become tired, and fall asleep until the next morning. We eat, digest the food, and become hungry again. Movement of earth’s plates gradually builds up forces which are released by an earthquake. When force is released, the change can be quick and dramatic.

Right now, one stress is that of  limited oil supply. This is leading to rising oil prices and stress on economies of oil importing countries.

Figure 2. Two views of future growth

The problem is that when limited oil supply is rationed by high oil prices, economic growth slows down, and eventually decreases (Figure 2). When this happens, it becomes much less advantageous to borrow from the future, because the future is no longer better than today. If an economic contraction occurs for very long, the whole debt system can be expected to undergo a major “unwind”.

Logic says the result would be fairly cataclysmic. We recently started seeing the beginning of this unwind with the financial crisis of 2008-2009. We are seeing more of the potential unwind with the problems in Greece and the rest of Europe, and with the US government reaching limits on borrowed debt. Exactly how this will play out is uncertain, but debt defaults in Europe could spread to banks worldwide, in one scenario.

With much less credit available, demand for extracted energy products would fall, because with less debt, people can afford to purchase fewer products that use energy, such as new cars. Prices of oil and oil substitutes will fall, making oil extraction unprofitable in locations where extraction costs are high. The result is not likely to be a slow decline, of the type attributed to M. King Hubbert. Instead, a much more precipitous decline can be expected (Figure 3).

Figure 3. Historical crude, condensate, and NGL production based on BP and EIA data, plus a Guesstimate of Future Oil Supply.

Human Geographical Reach

The amount of food and other goods we have access to and the steadiness of supply depend very much on our geographical reach. In the earliest days, humans were nomadic, so that they could gather food from a wide area. It was not until about 10,000 years ago that humans began to settle down with agricultural existence. When a change to local agriculture took place,  this change led to shorter stature and earlier deaths. Part of this was due to poorer nutrition from a less varied diet; part of this was due to an increase in the incidence of infectious diseases, because of closer proximity to other humans and domesticated animals.

Now, with globalization, we have reached the logical maximum in our geographical reach. Those who are rich enough can buy foods from around the world. We also have access to computers and other high-tech devices that can only be made with inputs from around the world. Most people’s expectation is that somehow we will keep up this wide reach, even if our world financial system fails due to debt defaults, but we have no guarantee that this really will be possible.

If we start re-localizing, we will likely run into problems that people have had since the dawn of agriculture. It is hard to grow a wide range of crops in one area. Weather conditions are often bad in one year, necessitating either multiple-year storage of crops, or trade with other areas. If we cannot maintain our use of antibiotics and of water and sewer treatment, deaths from infections may soar.

Globalization Sows the Seeds of Its Own Demise

From the point of view of profit-making businesses, globalization is wonderful. Workers can be found in “less developed” areas of the world who will work for lower wages. As a result, wages of workers in the Global North are put in direct competition with wages for workers in the Global South. Wages in the Global South can be lower for several reasons:

• Workers may expect to work more hours per week to earn the funds needed to support themselves and their families.
• Payments to workers do not need to include as much for healthcare benefits, or as much for retirement payments to the elderly, because of the younger workforce, and differences in the healthcare systems.
• Energy costs of workers are likely to be lower because of greater use of coal, smaller homes, less needed for heating in warm climates, and use of bicycles instead of cars.

But there are adverse effects of sending manufacturing oversees:

• The unemployed need to be taken care of by government programs, even if they don’t have jobs.
• Demand for goods produced may fall. Neither the low-wage workers producing the goods in the Global South nor the workers without jobs in the Global North are likely to be able to afford the products that are being produced.
• Economic growth is likely to decline in countries of the Global North that outsource manufacturing and other processes.
• Debt is likely to become more of a problem in countries of the Global North, because of low economic growth or actual contraction. Laid-off workers are likely to find themselves less able to repay their loans. Governments are likely to find themselves in difficulty because of low tax revenues, high benefits to laid-off workers, and high debt levels.

Thus, globalization sows the seed of its own demise.

Regrouping is Likely to be Needed

At some point, the system can be expected to fail, and regrouping will be needed. The path to failure seems to be through debt defaults, leading to falling demand for the products that capitalism provides.

Once this decline starts, it is hard to see a natural “stopping point” for the decline. On the “way up,” businesses, governments, traditions, and even religious beliefs are built that reinforce the processes that are in place. For example, if a certain amount of oil, gas, and coal is being extracted from the ground, businesses will be formed that use these fossil fuels, and traditions will be started (for example, expensive healthcare for many, and college education for most) that will use these fossil fuels. Economics becomes the new religion, touting the benefits of more consumption.

If the decline is to stop, we need a whole different set of businesses and traditions to support a much lower level consumption of fossil fuels and other inputs. It is not at all clear that we can adapt quickly enough for a change of this type.

When we look back a few thousand years, societies had a surprisingly rich tapestry of businesses and traditions to support them. For example, David Graber, in Debt: The First 5,000 Years talks about the ancient (2700 BC) Mesopotamian city-states being dominated by vast temples where trading was done. It wasn’t until about a century later that Abraham left “Ur of the Chaldeans” (Genesis 11:31), a major port at that time.

Part of our problem in going back is that we can’t even imagine what web of businesses and traditions would be needed to support a lower fuel use than we have now.  We can build a garden in our backyard, and we can print some “local currency” for local citizens to trade, but these types of activities do not really fill the major void that would be left if our current approach to civilization fails.

Sustainability: What Would Work

If we think about it, it is pretty obvious how humans could fit into the natural world better. We could behave like other animals. We could stop wearing clothes. We could stop living in houses. We could eat food in its raw form. This food would be only that which we can pick or catch with our bare hands. We could co-evolve with our fellow creatures. If a virus or bacteria comes along and kills off a significant share of mankind, or if a woman dies in child-birth, we could simply accept that as the natural order of things.

I don’t think any of us would accept such a solution, though. It is just too harsh an outcome. Such a solution would not work except in very warm climates, and even there, we would need fire to cook meals and tools for killing animals. Under one theory, cooking of food is necessary for our current level of intelligence, so we could not give that up.

We can’t know how our current predicament will turn out. Logic says that the natural system needs to rest and regroup after Limits to Growth are reached, in one way or another. Perhaps there is a “happily ever after” solution that will include a large number of humans. Unfortunately, it is hard to see what that solution might be.

Figure 1. Structure built with blocks. (Barkless tree blocks from www.childmode.com) Our economy is also built piece by piece, based on the rules and prices that are in effect when individual decisions are made.

Clearly there are many possible ways forward. Using Figure 1 as an analogy, there is the theoretical possibility of continuing to build our economy to ever-higher heights, as we are told by economists and politicians, despite the obstacle of high oil prices. There is the possibility of taking down parts of the economy, and rebuilding in a more fuel-efficient manner. There is also the theoretical possibility of eliminating unneeded parts of the economic structure we have built to date, so that the structure is more compact. And, unfortunately, there is also the possibility that a major portion of what we have built to date will inadvertently be knocked down, as constricted oil supply makes its effects known.

Before discussing what paths may lie ahead, I would like to talk about how contraction of an economy differs from continued expansion.

Economic Expansion vs. Economic Contraction

It is easy to assume that economic contraction is similar to economic expansion, just with the sign reversed, but anyone who has lived through the last few years knows that this is not the case.

For example, on the way up, it appears that the size of the current economic system easily “scales” upward, as the economy grows. The number of available workers gradually rises, as does the number of job openings, and the amount of goods and services produced. Everything rises together, and the system “works”.

On the way down, there is a good deal more “stickiness” to the system. There are now seven billion people on the planet, and they all would like to eat on a regular basis. There are perhaps two-thirds as many potential workers, and most of them would like to have jobs, even if the economy is contracting, and their particular job is disappearing.

Another issue is that we have built millions of miles of electrical transmission, oil and gas pipelines, water and sewer pipelines, and roads. It becomes difficult to abandon parts of these systems, even if total resources for maintaining the system are constricted. If we think of the situation in terms of tax dollars (or charges by utility companies), it becomes increasingly difficult to collect enough tax dollars (or utility charges) to pay for the inflated cost of replacing worn out roads, pipelines, and electrical transmission, as the rising price of oil makes these costs rise much more rapidly than salaries.

Figure 2. Repaying loans is easy in a growing economy, but much more difficult in a shrinking economy.

Another issue is debt repayment (Figure 2). We are used to an ever-expanding economy, where future goods and services produced will always be greater than those produced this year. As long as this growth pattern persists, our system of long-term financing of major expenditures, even if the expenditures are not really income producing, can continue. For example, we are able to buy homes with 20 or 30 year loans, and governments are able to continue borrowing, claiming that they will have more funds to repay loans (with interest) in the future. Once the situation changes to a shrinking economy, it becomes much more difficult to repay loans, and the financial system quickly reaches the risk of collapsing, due to multiple debt defaults.

A related issue is that of financing a new or expanding company. If the economy continues to grow, investment in a new company is likely to make sense because the value of the company can be expected to grow as the demand for products of the type it sells continues to grow. But if it becomes clear that the economy is on a path of long-term contraction, the possibility of failure within a few years rises, so new investment makes much less sense.

Where may continued high oil prices lead?

1. Widespread loan defaults, leading to far less international trade and the manufacture of fewer high-tech goods.

This is my personal view as to a likely outcome of continued high oil prices, unless some approach is developed that will somehow allow economic growth to continue, despite limited oil supply and high oil prices. Renewables at this point are higher priced, and not helpful in this regard.

In this situation, widespread loan defaults would lead to impaired credit availability and difficulty in arranging international trade. Individual countries would presumably continue to issue their own currency, so local trade would continue. In the new environment, countries with debt default problems, such as Greece, would likely have difficulty buying oil (and other scarce goods) without something (besides Drachma) to trade in return.

With limited international trade, there would likely be disruptions to oil and gas extraction, since workers and equipment are traded internationally today. At some point, it may be difficult to make high-tech goods like computers, because of the difficulty in assembling the many inputs from sources around the world.

Political disruptions would seem to be likely as well. Some countries may even see civil war. Some countries may even break into smaller units, similar to the way the Soviet Union did in 1991.

The timing is not clear, but disruption could come as soon as the next few months. The current problems with debt defaults in Europe would seem to have the possibility of spreading to banks and other financial institutions around the world.

We don’t know how much of the system such a contraction would pull down. It seems to me that in the analogy of Figure 1, some vulnerable sections (like Greece) could be pulled down first, with others falling later. Bailouts may help temporarily, but at some point, the bailouts are likely to fail as well, because the underlying problem of restricted oil supply has not been fixed.

2. Planned contraction, with certain parts of the economy left behind.

In this approach, particular unneeded segments of the economy would be discarded. For example, President Obama is planning military cuts. President Obama is also talking about merging agencies and eliminating the Commerce Department.

In a shrinking economy, changes of these types are certainly needed. The problem is that the amount of shrinkage that is being proposed is far too small to have much impact.

Another type of contraction that has been suggested relates to expenditures which seem unnecessary. For example, the US medical care system could be scaled back, because healthcare expenditures in the US accounted for 17.6% of GDP in 2009, far more than for other developed nations. Another area which might be scaled back is animal production on industrialized farms, since corn-fed animals are not good for health, and since the huge amount of meat we eat contributes to global warming. These are just two examples; each of us could name favorite boondoggles to eliminate.

The problem is trying to get agreement on any kind of contraction, such as these. Our current system is the only one most of us have ever known. Most people are not aware of our need for change, and would resist changing what appears to be working at least somewhat well. Employees in the current systems would certainly be unhappy, because they would stand a chance of losing their jobs.

If changes such as these could be made, it would be one way of contracting the current system, hopefully without crashing it.

3. Contraction away from the poles and other areas with bad climactic conditions.

This appears to be a natural approach to contraction.

It takes more fuel to heat homes near the poles. Homes also have to be built more substantially. If we look back at the historical record, populations have tended to be highest in warm climates–India, fairly warm areas in China, and the Middle East. According to scholar Angus Maddison, about 75% of the world’s population lived in these areas in the year 0 AD, and even in 2008, 68% of the world’s population lived in Asia. Northern countries of Europe and America have tended to have lower populations, but higher average real GDP (fueled by fossil fuels).

This past week, newspapers discussed Nome, Alaska’s fuel shortage. They reported that a Russian fuel tanker was being used to deliver additional oil. If oil prices stay high, we will have an increasingly difficult time supporting populations that disproportionately need oil, such as those in very cold areas.

High oil prices may also limit the amount of infrastructure repairs that can be done. If this happens, decisions will need to be made regarding which roads not to repave and which electric transmission lines not to maintain. I would expect that infrastructure that serves the fewest people would be most likely to be subject to cutbacks.  These areas are likely to be in areas that are unattractive for settlement because they are very cold or very dry.

4. A transition back to “old” renewables

In my view, there are two kinds of renewables:

(1) Old renewables, like wood, and small wind and water power that can be replenished with local materials. This category would probably also include draft animals. It would also include solar thermal water heaters, similar to hot water bottles that can be left out in the sun to heat water, since they can be made simply with recycled materials.

(2) New renewables, like electricity from large industrially produced wind turbines, solar electric, and large hydro-electric dams, that require modern technology for building and repairs. Electric cars might also be in this category.

In this section, I am discussing the first of these categories, Old Renewables. One concern is that at some point, perhaps many years from now, today’s whole economic structure will collapse (Figure 1). How this would play out is unknown. Perhaps we could continue to reuse parts of our current system. If not (for example, if difficulties with international trade greatly reduce access to fossil fuels), we may be faced with creating a new economy, based primarily on “old renewables”.

The problem with this outcome is that old renewables are quite limited in their quantity. The world could not possibly support seven billion people. McEvedy and Jones, in Atlas of World Population History, estimate that if human population followed the population patterns of similar animals (gorillas and chimpanzees), world human population would be somewhere in the range of 70,000 and 1,000,000. This was the approximate probable initial human population, about 200,000 years ago.

Human population gradually grew, reflecting mankind’s ability to appropriate resources for its use beyond what its normal role in the ecosystem would allow.  McEvedy and Jones estimate that human populations grew to 1.7 million by 100,000 BC and to 4.0 million by 10,000 BC. Over time, humans gradually increased their ability to operate outside ecosystem boundaries, killing off other species, domesticating animals, and using resources such as water power, wind power, and burning wood and peat. Total world population grew as follows, according to Angus Maddison:

1 AD – 225,820,000

1000 AD – 267,000,000

1500 AD – 438,428,000

1820 AD – 1,041,708,000

How far back population would fall in the case of collapse is not at all certain. As long as humans keep their ability to appropriate resources that might theoretically be shared by other species, their numbers will remain high. This propensity, however, is what leads to the tendency toward renewed growth, and new pressure on resource availability.

5. A transition to “new” renewables

Some people are hoping for a transition to new renewables–”unbuilding” the fossil fuel structure that we have, and trying to build a new one based on renewables instead. This approach may be appropriate for some wealthy individuals, but it is not clear that it has significant feasibility for society as a whole, because the cost of most new renewables is higher than that of the fuels they replace, making the high oil price problem worse, not better. If new renewables drop in price, this situation may change.

The extent of today’s new renewables is less than many people understand. In the United States, renewable energy (including hydroelectric, biofuels, wood burned as fuel, geothermal, wind, and solar) amounted to 5.4% of total energy consumed in 2010, according to BP energy statistics. If we lived on today’s renewables alone, our per capita energy consumption would be roughly equivalent to that of India. India generally does not need fuel for heating, while we in the United States do. Taking into account the differing fuel needs, the average US citizen living on renewables alone would be somewhat worse off than today’s citizen of India.

The other issue that people tend not to be aware of is that new renewables, as they are built and used today, are very much part of the fossil fuel system. They are built using fossil fuels, and they are maintained using fossil fuels. Except for biofuels, they depend on electric transmission lines, and these need to maintained with fossil fuels as well. Furthermore, if we are to maintain electric transmission lines, we need oil to maintain the roads that lead to the lines.

We probably also need international trade to maintain new renewables, because replacement parts use minerals from many parts of the world, and depend on the availability of computerized systems to support production. If financial problems disrupt international trade, we may find that our “renewable” systems degrade quite quickly, because we are not able to maintain them properly.

Nevertheless, there is a possibility that new renewables will soften the economic fall for those who have access to them, especially if issues of repairs can be kept at a minimum. Because of this, new renewables such as solar PV remain a popular choice among people who are concerned about continued economic contraction.

6. The “Just Use Less” approach

If oil prices remain high, this view suggests that finding ways to use less should be our primary response oil limits. For example, responses might include planting gardens near home, getting people to change their light bulbs for more energy-efficient models, and building more fuel-efficient cars.

While this approach has merit, it is not clear that this approach, in and of itself, is more than a small part of the solution, because of the bigger picture issues that are causing major strains on the system. Saving fuel in one place puts financial strains on other parts of the system. For example, a utility that fails because of bankruptcy could reduce electricity availability. What appear to be frivolous uses of our current systems (for example, game playing and downloading movies over the Internet), help to keep costs down for more serious users. Because of the complexity of our current system, savings in one area could cause problems in another section of our economic structure.

Thus, this approach would shrink some parts of Figure 1. While this may somewhat work, there is also the possibility that this shrinkage will by itself cause strains or actual breaks in other parts of the economic system.

—–

All in all, we do not have firm answers. Instead, we have a number of views of how the downturn due to high oil prices may proceed, and appropriate responses to it.

Historically people have shifted their belief systems in various ways. The Greeks and Romans believed in numerous gods and goddesses and attributed all kinds of powers to them. Then the great monotheistic religions came along and people began to believe in just one god, though they honored him under different names.

Recently, beliefs have shifted again, with people worshipping just one part of a god, the invisible hand. Thanks to Adam Smith and those who followed him, especially the current neoclassical economic theologians, we have seen such an increase in the world’s wealth and sheer numbers that it is hard to imagine life before the industrial revolution, with its shift from mostly human and animal muscle power to the energy dense fossil fuels—coal, oil, and natural gas. It is also hard to imagine that humanity could someday slide back into another age of scarcer and more expensive energy, but that is a possibility that cannot be excluded from our thinking.

The Faustian Bargain

What about the Faustian bargain? It remains deeply hidden from view because its exposure by the high priests of modern economics would force us to rethink how we live and why we live this way, as well as what we’re planning to leave for future generations. The Faustian bargain goes something like this: Thanks to the discovery and exploitation of fossil fuels, humans (really just a small minority of them) are able to live richer lives today than even the queens and kings of yore could have dreamed of.

Furthermore, we’ve used some of those finite resources to increase food supplies and to expand the human population, which provides the economic system with both more workers and more consumers, a necessity to keep the economy growing under our current economic model. The world’s population increased from 1.6 billion in 1900 to 7 billion today, and we add about 80 million more each year. Humans have quickly become the most numerous megafauna on the planet.

The other side of the bargain, the side hidden from view and never mentioned in economics texts is this: At some undetermined time in the future, one that creeps ever closer, this economic system, fed by energy and other resources at ever increasing rates at one end and spewing out waste products at rates that cannot be absorbed by Earth’s ecosystems at the other, is unsustainable. What that means is simple enough: Industrial society as we know it cannot go on as it has forever—not even close.

Our economic system must exist within Earth’s finite limits, so recent and current generations have sold their soul to the devil for temporary riches, leaving the Devil to collect his due when the system falls apart under its own weight and the four horsemen of the apocalypse ride again across the world’s landscapes. None of this will happen tomorrow or this week or this year, but our economic system is faltering at both ends.

For many, if not most, of the world’s population life may become more difficult, incomes lower, and uncertainty greater. It does not mean the end of the world, as some predict for 2012, but it will mean that future generations probably will not live like current ones. Rather than admit that the current system cannot be sustained, the affluent and powerful will do everything possible to maintain the status quo.

The Fallacy of Long-Term Economic Growth

Economic growth remains a mantra for politicians and corporate leaders, including the banksters who brought us the Great Recession. Even President Obama, like presidents before him, speaks regularly about “growing the economy.” But nothing in the real world suggests that economic growth can continue forever. Nor does much evidence support the notion that economic growth has been a good thing for either the planet or billions of its human residents. It looks more like a colossal Ponzi scheme.

One of the most optimistic supporters of modern economics and its marvels is Tim Harford, who wrote, in his book The Logic of Life, “The more of us there are in the world, living our logical lives, the better our chances of seeing out the next million years.” This may be the dumbest thing an economist has ever written and he shows not even the slightest understanding of the planet on which we live. Homo sapiens has only been around for about 200,000 years, so another 800,000 years at the rate we’re going seems absurd. If our population were to continue to grow at an annual rate of only 1.0 percent, slightly less than our current growth rate, then our numbers would increase to over 115 trillion in just the next thousand years. You can play with the growth rate if you wish, but you cannot escape the cold hard fact that human population growth must stop. Only economists seem to miss the fact that economic growth must stop.

Among the high priests of modern economic theology, Paul Krugman came closer than anyone to admitting that growth could not go on forever on our planet. In an Op-Ed piece in the New York Times (12-26-10) he wrote, “What the commodity markets are telling us is that we’re living in a finite world [my italics] ….” He went on to mention the possibility of peak oil production and even climate change, both of which threaten the modern economic system, but then, returning to the faithful fold, he wrote, “This won’t bring an end to economic growth….” He admitted that our lifestyles might have to change but gave no clue about where and how that might come about or where it might lead.

Economic reality and economic theology don’t fit together very well. In 1988 Edward Abbey wrote, in his book One Life at a Time, Please:

It should be clear to everyone by now that crude numerical growth does not solve our problems of unemployment, welfare, crime, traffic, filth, noise, squalor, the pollution of air, the corruption of our politics, the debasement of the school system (hardly worthy of the name ‘education’), and the general loss of popular control over the political process—where money, not people, is now the determining factor.

Today, 24 years later, virtually every word of Abbey’s statement is truer than ever, yet politicians and economic theologians continue to preach that if we can just grow the economy (local, state, national, and world) then all will be well again. You need not look far or deeply to see how wrong they are and what price we’ll pay when the Devil comes looking for our collective souls.

Among economists, Herman Daly is one of the few who has tried to reveal the Faustian bargain for what it really is, as is apparent in this statement from a Dec. 26 article, Rio+20 Needs to Address the Downsides of Growth:

Even though economies are still growing, and still put growth in first place, it is no longer economic growth, at least in wealthy countries, but has become uneconomic growth. In other words, the environmental and social costs of increased production are growing faster than the benefits, increasing “illth” faster than wealth, thereby making us poorer, not richer. We hide the uneconomic nature of growth from ourselves by faulty national accounting because growth is our panacea, indeed our idol, and we are very afraid of the idea of a steady-state economy. The increasing illth is evident in exploding financial debt, in biodiversity loss, and in destruction of natural services, most notably climate regulation.

As a geographer, I look for signs in my local cultural landscape that look ominous, from potholes in streets to for sale and/or for lease signs strewn around our city like leaves after a storm. Ours is a small city, with about 30,000 residents, yet our city manager, in an end-of-the-year report, pointed out that we would need some $80,000,000 to repair our current infrastructure, a figure out of all proportion to our physical and residential size. That amounts to nearly $2,700 for each man, woman, and child. He also pointed out that our city is operating with below necessary numbers of police, fire, and emergency responders. The potholes will get larger in 2012 and beyond.

Though these and other problems are widely distributed across the nation, I think the infrastructure issue alone is symbolic. The U.S. is becoming a “pothole culture,” one in which the pothole is a symbol of our inability to accomplish all kinds of things any more. (See recent New York Times article.) Other nations are on their way as well.

Despite the continued whirring of the world economy, most people here and elsewhere are not getting anywhere and are feeling jilted by the system they’ve depended on for decades because they thought it could be sustained forever. It cannot, but that doesn’t mean life cannot go on, it means, instead, that we need to move in new directions, but we won’t do that until we understand what is making so many people so unhappy. We need to realize that instead of believing bigger is better we need to decide to favor better over bigger, quality over quantity, less over more.

Two examples illustrate the point that the world economy has exceeded both Earth’s ability to provide ever more inputs and its ability to absorb and purify excessive wastes. Crude oil is a good example of the first; carbon emissions and global warming good examples of the second. Both were mentioned by Krugman, but he provided no details about how we might deal with either issue, nor did he say how economic growth would continue without confronting these and numerous other raw material and waste issues.

First Example of Limits to Economic Growth: Crude Oil

Given that most Americans have a knowledge of history that doesn’t go back much over a month or two, it is no surprise that they cannot conceive of a time without cars, gasoline (preferably cheap), and a pattern of settlement that requires the use of both—our modern suburban landscape. For many years the U.S. was the world’s largest producer of crude oil and the largest exporter of it as well. In 1970, however, our oil extraction reached a peak and then started down hill. We became an importer of oil and today import more oil than any other nation, even though we still produce lots of oil and our extraction has been increasing in recent years.

Since about 2005 the world’s extraction of crude oil has been almost flat, despite prices that rose at one point to around $147 per barrel. Though we may not know for a while whether the world has reached its peak oil production or not, we do know that it will. In the meantime we know that traditional oil fields are getting more and more difficult to find, are harder to get to, and will be more expensive to develop. Alternative sources of oil, such as the Athabascan tar sands, are abundant but also expensive to develop and environmentally undesirable. Substitutes for gasoline, such as corn ethanol, are not only nonsensical from either an environmental or an economic viewpoint, they are also diverting food from humans (mostly via animals) to SUVs, driving food prices upward.

Figure 1 below, by mathematician Tom Murphy on his Do the Math blog, in  post called, The Future Needs and Attitude Adjustment, provides a deeper historical perspective on oil production and industrial societies.

Figure 1: Image by Tom Murphy. Original caption: "On the long view, the fossil fuel age is a blip, with a down side mirroring the (more fun) up side."

You don’t need any knowledge of either deep history or the unpredictable future to get the point of this graph (unless, of course, you are an economist). Like Earth itself, the supply of crude oil is finite, even if we don’t know exactly how much is there, where it all is, or how much of it we can ultimately recover. Though we can tweak this curve, argue about its shape, and nibble along its edges, the basic fact remains: World oil extraction will reach a peak, probably sooner rather than later. After that, extraction will decline, though along what kind of curve we don’t know for sure. Just as the Stone Age did not end because of a lack of stones, the oil age will not end because of a lack of oil. Rather, it will end because what is left of the oil supply will at some point cost far more than it is worth; it will take more energy to extract it than we would get from it.

Knowing this, the prudent course would be to wean ourselves from this energy source as soon as possible, in order to treat our addiction before it is too late. However, we live in one of the most competitive periods in world history. Not only do Americans not want to be parted from their cars but millions of Chinese, Indians, and others are lining up to get their first taste of “the freedom of the road.” That is one of the reasons why, despite a sagging world economy and lower crude oil consumption in the U.S. in recent years, the price of crude oil has hovered around $100 per barrel through most of 2011 ($98.83 on Dec. 31).

Second Example of Limits to Economic Growth: Carbon Emissions and Global Warming

Burning fossil fuels to provide energy at the input end of our economic system results in a combination of outputs or waste products that cannot be removed or neutralized quickly enough by our ocean and atmosphere. That leads to an increasing amount of gases and particulates gathering in both, changing the chemistry of both the ocean and our atmosphere. Among the gases is carbon dioxide, a greenhouse gas that we know plays a role in how Earth’s atmosphere is warmed. Adding more carbon dioxide to our atmosphere is analogous to turning our heater up a little—we get more heat.

We know that the carbon dioxide content of the atmosphere has gone from about 280 parts per million around 1850 to 390 parts per million in 2011, an increase of just over 39 percent. Though we did not discover how to measure the atmospheric content of carbon dioxide directly before the mid-1950s, we do have a careful record of what it has been doing since then, as shown in Figure 2 below (from Wikipedia):

Figure 2. The Keeling Curve of atmospheric CO2 concentrations measured at the Mauna Loa Observatory. (From Wikipedia)

It is hard to miss the upward trend in the carbon dioxide content of the atmosphere since 1958. Few scientists would identify a source for this trend outside of humans and our burning of fossil fuels. Figure 3 below  shows how much more carbon dioxide humans are adding each year through the burning of fossil fuels, setting a new record for emissions in 2010 (source):

Figure 3. Greenhouse Gas image from Yahoo News

It also shows the major contributors, China and the U.S. The failure of the U.S. to lead the world toward an economic system less dependent on fossil fuels is monumental. Modeling shows that rising carbon dioxide emissions can be expected to lead to global warming.

Conclusions

Though causes and effects may be difficult to connect, the outbreak of protests around the world in 2011 doesn’t seem coincidental. From the Arab Spring, to Greece and other European countries, to the Occupy Wall Street movement in the U.S., and even to demonstrations in Russia, people have taken to the streets to protest governments, corporations, and policies that are affecting their lives in negative ways. TIME magazine in 2011 chose “The Protestor” as its person of the year.

The are several reasons for people to be angry and upset. High oil prices and more extreme weather conditions have been driving food prices upward and high gas prices act as a tax on consumers, slowing modern economies. In addition, in the U.S. awareness has grown that most of the gains of economic growth are going to the top one percent (or less) of the population. Figure 4 below from Mother Jones (“It’s the Inequality, Stupid,” by Dave Gilson and Carolyn Perot, March/April 2011) says all one needs to know about inequality in the U.S. today.

Figure 4. Average Income Per Family Distributed by Income Group. (From Mother Jones)

Figure 5 below from the Congressional Budget Office shows how things have changed for different income groups in recent decades in the U.S. Citizens who are not in the top 1% are coming out very much worse than those at the top, whether they realize it or not.

Figure 5.

Even as nations continue to prop up banks and the Fed plays games with trillions of dollars, the general feeling seems to be that the “pothole culture” or its equivalent is spreading, that the benefits of what economic growth there is are not being shared equitably, and that many places cannot even maintain what they have in terms of infrastructure. Frustration is widespread, and much of it seems connected to what may be first signs that our modern industrial economy is breaking down. An analogy might be those first tiny pools of oil that you start to see under your car, warning you softly that things may be going wrong.

Unless humanity recognizes the bargain we’ve made with the Devil, and soon, we’ll saddle ourselves or posterity with paying the Devil his due. We cannot treat our current addiction to fossil fuels and economic growth until we admit we have them. Perhaps the best advice I’ve seen lately came from John Greer, who wrote:

Right now, as the limits to growth tighten around us like a noose and an economy geared to perpetual expansion shudders and cracks in the throes of decline, one of the things that’s needed most is the willingness, in a time of gathering darkness, to locate what lamps can still be found, and light them.

Is anyone out there listening? You can bet the Devil is!

Figure 1. Wind energy (dark green) is barely visible in a graph of US energy consumption by source. Based on EIA data.

Such slow progress seems strange for a product that seems to have such great promise. It can reduce CO2 emissions. It doesn’t require fuel. It is at least partly US made. It seems to have promise for protecting against rising fossil fuel prices.

In this post, I discuss a few of the obstacles facing wind energy in the United States and their implications for the expansion of wind energy. 

Obstacle 1: Wind energy is dependent on large subsidies.

According to the EIA’s report, Direct Federal Financial Interventions and Subsidies in Energy in Fiscal Year 2010, wind energy received subsidies of $4.986 billion from the federal government for Fiscal Year 2010. This amount is equal to approximately half the cost of new wind power installed during that period. State and local subsidies would be in addition. (The US Wind Energy Association shows that 6034 megawatts of new capacity was installed between October 1, 2009 and September 30, 2010, so the subsidy per megawatt was $826,318. This compares to an average cost per megawatt of about $1.4 million, excluding construction and connection costs.)

Wind energy’s largest subsidy, the Production Tax Credit, is set to expire on December 31, 2012, unless Congress acts to extend it, so there is now a big rush to get orders filled before that date. A study by Navigant Consulting forecasts a large drop in wind investment, if the Production Tax Credit is not extended (Figure 2).

Figure 2. Annual Investment in Wind Energy in $ Billion, according to Navigant Consulting.

Needless to say, the US Federal Government is not flush with money for subsidies, so there is the possibility that subsidies will not be renewed or will be cut back.

Obstacle 2: Wind energy is more variable than electricity produced by fossil fuels and by nuclear energy.

Wind blows when it chooses, which is often not when it is needed most. In theory, this problem could be resolved with robust long-distance transmission of electricity and with adequate electrical storage, but in the US, these are not available. Bill Richardson, energy secretary under Bill Clinton has said, “We’re a superpower with a Third World grid.”  This means that even in locations where wind energy makes up a relatively large share of the fuel mix, other types of generations must be available to supply almost the full level of demand, if the wind is not blowing.

As a result, the role of wind energy is fairly limited.  What wind energy does is permit electricity generating plants, particularly those fueled by natural gas, to use less fuel. Consequently, the price of wind energy tends to compete with the price of fuel, rather than with the wholesale price of electricity.

Chis Namoviz, who is in charge of renewable energy forecasting at the EIA, explained this to me in an e-mail in 2009:

Because of its relatively low “capacity value” (a result of usually not blowing very regularly during peak load hours), wind largely competes as a “fuel saver” resource, and can generally be compared against the fuel cost of what ever mix of fuel it is displacing (whether from existing capacity or from alternative investments in future capacity). In the U.S., this is typically some mix of relatively inexpensive coal and somewhat expensive natural gas, depending on the location of the wind plant, and the resulting seasonal/daily wind and load profiles . . .[Note from Gail: Natural gas is now cheaper than when this statement was made.]

We can see the result of this situation in Figure 3, from Annual Report on U. S. Wind Power Installation, Cost, and Performance Trends: 2007. The price of wind generation tends to trade a below the wholesale band for other types of wind generation, more at the price of the fuel that is saved (frequently natural gas) than at the usual wholesale price.

Figure 3. Comparison of prices of wind generated electricity with electricity generated by other means, from US Department of Energy report, "Annual Report on U. S. Wind Power Installation, Cost, and Performance Trends: 2007."

This lower price for wind-generated electricity helps explain some of the need for subsidies.

A related issue is the confusion caused by a comparison of the “levelized cost of wind” with the levelized cost of other types of generation, such as is shown in Figure 4 by the US Energy Information Administration.

Figure 4. EIA's exhibit showing Estimated Levelized Cost of New Electricity Generation Resources, from Annual Energy Outlook 2011.

Because wind acts as a fuel-saver, Figure 4 represents an “apples to oranges” comparison, if one makes the standard comparison of amounts in the last column. Instead, since wind energy only replaces fuel, what needs to be compared is

• “Total System Levelized Cost” for wind relative to
• “Variable O&M (including fuel)” for other sources of production

In Figure 4,  the Total System Levelized Cost of Wind is 97.0, and of Wind-Offshore is 243.2. These might be compared with the Variable O&M (including fuel) of coal (Advanced coal is 25.7) or of natural gas (Conventional Combined Cycle is 45.6), for example. On this basis, wind energy comes out badly, and is one reason it requires such high subsides.

Another related issue is that a person would normally want to substitute a less-scarce fuel for a more scarce fuel, but to some extent this works in reverse for wind power. At least some petroleum is used in manufacturing, transporting, installing, and maintaining wind turbines, but the energy that is provided as an output is mostly replacing natural gas, and perhaps some coal. Coal and natural gas are much cheaper (and more abundant) than oil, so even a small input/output substitution in this direction can quickly hurt the economics of the process.

While one intent of wind energy was to protect against rising fossil fuel prices, in the US  those prices are not rising evenly. Oil is particularly high priced, but it is not oil that is being saved, it is other fuels.

Obstacle 3: Natural gas is now very cheap in the US, and there is a huge amount of natural gas generating capacity already built.

Since wind energy tends to compete with the cost of fossil fuels used to produce electricity (mostly natural gas and coal in the US), a low price for natural gas is a problem because even greater subsidies will be required for wind energy to be competitive.

Furthermore, natural gas generating capacity is no issue, because a great deal of natural gas generating capacity has been added in recent years.

Figure 5: US Generation Capacity by Year and Source, based on EIA Data. (The amount of electricity generated is not proportional to capacity, however. Nuclear is used at over 90% of capacity, coal a little below 70%, and wind at a little under 30% of capacity.)

Obstacle 4: In the US, we do not have an electrical grid that can provide very much long distance transport of electricity, and there are several reasons why changing this situation is very difficult.

Growth in wind energy requires very good long distance transmission capability, partly because wind resources are often located a long way from prospective users, and partly because the variable nature of wind can be “evened out” if wind energy is shared over a large area. Unfortunately, the US electrical system has grown up under a system where each locality has been expected to generate its own electricity. Under such a system, electrical transmission from city to city was originally designed to handle only occasional emergencies, and thus is very limited. I have written more about US electrical grid issues in The US Electrical Grid: Will it Be Our Undoing? and Upgrading the Grid – Many Pluses but Some Minuses Too.

The way the US electric transmission system was set up produces many anomalies. Electrical rates vary greatly from state to state. We needlessly burn large amounts of oil transporting coal to where it will be burned for electricity, rather than burning it near where the coal is mined, and then transporting the electric power over transmission lines.  Nuclear-fueled power plants are sometimes located near large cities.

The problem is very difficult to fix for many reasons. Any improvement in electric transmission would tend to even out electricity rates, but this would be to the detriment of customers who currently have low electric rates. To the extent that new transmission costs more, and these higher costs are charged back in electric rates, such a change could result in higher electricity costs for more than half of the population–something most politicians would find unacceptable.

If better transmission were readily available and free, no one would want to build a power plant in their back yard, making it even harder to site new power plants than it is now.

Another issue is that a good mechanism for paying for the installation and maintenance of new long distance transmission lines has not been established. Under current procedures, a determination must be made as to which electric generating companies will benefit from new transmission lines, and the costs allocated among the beneficiaries. The government in the past has not funded long distance electrical transmission. No one really “owns” the long distance lines.

The only partial fix I can see would be to create a separate organization to build and maintain a few new long-distance transmission lines. Wind energy and other users seeking to use these lines would be charged for the use of these lines, similar to a toll road. It might be possible that more coal fired-power plants would be built near these lines, because wind usage by itself could not support these lines. Even this arrangement would likely require a change to current laws. The net effect might be more CO2, rather than less.

The cost of long distance electric transmission is likely to be fairly high–at least several cents per kWh, for wind energy transported over long distances. Over time, the price can be expected to rise as the price of oil rises. Some maintenance may become very difficult, such as that currently done by helicopters in remote locations.

Obstacle 5: A high proportion of funding for wind energy is up front.

Oil, coal, and gas all started out as fairly high EROEI investments, and much of the investment took place as the fuel was extracted. In such a situation, the investments threw off a high level of profit which could be used to fund further investment.

Fossil fuels are gradually shifting away from this model, with higher up front investment, and lower profit available to fund further investment. Wind turbines represent the extreme end of this continuum with most of the investment up front, and the return trailing many years behind.

As a result of this shift in timing, it is becoming more difficult to fund projects with huge up-front investment. In the “good old days,” we had the low price of fossil fuels which made other investments easier to afford. We also could count on a being always able to add more debt, but we are reaching limits on sustainable debt. I wrote two posts on The Link Between Peak Oil and Peak Debt (Part 1 and Part 2). More recently, I talked about how Net Savings is dropping dramatically in the US, so that non-debt sources of funding are also disappearing.

Figure 6. US Savings and Investment Ratios, based on US Bureau of Economic Analysis Data.

The net of all of this is that if we are reaching limits with respect to finite resources, it is going to be increasingly difficult to fund projects that require large up-front investment and provide a return later. We will likely have to give up some investments we really need (such as replacing worn out roads, pipelines, and school buildings) in order to ramp up investments in projects that require large front-end funding, like wind turbines.

Obstacle 6: Adding wind energy to the electric grid adds complexity which may be difficult to manage with declining resources.

The job of balancing supply with electrical demand and keeping all sources of electricity “in synch” becomes more difficult, as more variable sources of supply come on line. While it is theoretically possible to find technical solutions to these issues, it is not clear that we will in practice.

Furthermore, one approach that is being tried in order to avoid the cost of adding new electricity generating capacity and new electric transmission is to use the Smart Grid to help limit demand when at times when demand would normally be high, such as when temperatures are high or low.  In the words of Smart Grid R & D: 2010-2014 Draft 2, “Smart grid can improve asset utilization and thereby avoid the need for new capacity.“

The expected effect of avoiding new capacity is that components are operated at closer to maximum capacity. Since adding new capacity is avoided, assets will over time tend to be older as well.  While theoretically everything should go well, operating older units at closer to their theoretical capacity adds stresses to the system. Because of these factors, Smart Grid enhancements add efficiency to the system, but may reduce resilience.

According to the same report, the Smart Grid is being built as it is being planned. The amount of funding is not clear; costs must be recovered from customers based on cost recovery laws which vary by state. There are a huge number of details that need to worked out, such as necessary cyber security measures. It would be easier to rest easy if the Smart Grid had all been planned out in advance, tested on a small scale and pre-funded.

The grid with the new enhancements will work until at some point it doesn’t work–for example, an unplanned event causes a major failure within the system, or a needed system upgrade is too expensive to afford, or a replacement part from overseas is unavailable. Hopefully, failures of this type will be temporary and local, but if resources are limited, the time may come when the high cost of maintaining the system becomes unsustainable.

Further Thoughts about Wind Energy

I have not been able to touch on more than a few issues in this post.

One of the big issues with wind is that hopes have been raised for its widespread use, without really working through feasibility issues. If we are already having trouble with the electrical grid not being able to accept more wind energy in popular wind-generating areas when wind energy constitutes only 2.3% of total electricity supply, then wind energy is going to be difficult to scale up quickly. The issues I point out in this article suggest that the cost problem is still large, and the fixes needed to add long-distance transmission are likely to make the cost problem even worse.

The government needs to be able to show it is “doing something” about our energy problem, so it makes statements such as “Wind generation added 30% of all US generating capacity in 2007.” (See Figure 5 above.) Few people are energy literate enough to realize that even this progress is very slow, because relatively little new capacity is added in a year, and because wind, with its low-capacity factor, requires a disproportionate share of total new generation capacity, to make much progress. If wind turbines have an average life of 20-30 years, and other types of generation last for 40+ years, this will also affect the amount of new generation needed for wind, compared to other units.

It is easy for readers to become confused, when confronted with the many technology possibilities available, when they don’t understand the time, cost, and scale involved. Dr. Robert Hirsch, in the January 9, 2012, issue of the ASPO-USA Peak Oil Review writes:

The foregoing are realities that many people fail to understand, which means that they can be trapped into advocating energy changes that are not practical in the short term. Examples of some of the current common traps: 1) Assuming that wind and solar systems – electricity producers – can be a near-term solution to high gasoline prices; 2) Assuming that natural gas from shale is a near-term solution to our dependence on foreign oil; 3) Assuming that wind and solar can be a near-term means to lower the emissions from vehicles now powered by oil products; etc.

If transitions to new energy sources and new technologies could be made cheaply and quickly, then many options that appear to be feasible in fact would have a reasonable chance of working out. But there is another issue as well. Based on technology today, we need fossil fuels to make wind energy, and we need fossil fuels to transport wind turbines to the locations where they are to be installed. We also need fossil fuels to repair wind turbines and to maintain transmission lines. So wind energy and other proposed replacements for fossil fuels are deeply imbedded in the fossil fuel system, and dependent on it.

I expect that at some point grid problems will become overwhelming, so at least the long-distance portion of the grid will be lost. It is possible that adding more wind energy to the grid will make that date come sooner, rather than later, because of the complexity issues I mentioned. Unless the limiting factor on the life of the electric grid is the amount of coal and natural gas available, and wind energy somehow delays running out of these, I have a hard time seeing how wind energy will make the electric grid last longer.

There are so many obstacles for wind to overcome in the US that I am not sure that we should even try to push for higher wind penetration levels. The only exception might be in areas where wind energy is cheap to produce and the grid can readily accept the electricity.

Since the world is finite, there is a good chance that at some point we are going to have to get along with less electricity as well as less oil. Instead of focusing on delaying the inevitable, perhaps we should start thinking about preparing people for simpler lives that use less energy of all types. Such an approach might solve multiple problems at once–too much CO2, too little oil, and too little capital to tackle all the problems that need to be tackled at once.

• Drill for more oil and gas;
• Develop alternative energy sources;
• Build more efficient gas-powered cars or electric cars;
• Fix homes and offices so they are more energy efficient.

I thought I would check through government data to see if we really have a chance of being able to invest enough money to solve our problems.

What I found was more than a little disturbing. United States’ “Net Savings,” as a percentage of Gross National Income has dropped greatly and is now below zero. This is a situation one website described as implying an “unsustainable path”.

Figure 1. US Net Savings as a Percentage of Gross National Income, based on Bureau of Economic Analysis Data (Table 5.1)

Back in the 1950s and 1960s, when the Interstate Expressway System was built and the electric grid that we are still using today was built, Net Savings averaged close to 10% of Gross National Income. It has dropped since then, and is now negative.

Let me explain “Net Savings” by showing a second graph.

Figure 2. US Savings and Investment Ratios, based on US Bureau of Economic Analysis Data.

In the United States, investment is made in many kinds of long-lasting goods, including everything from buildings, to roads, to oil and gas drilling, to pipelines, to wind turbines, to equipment for factories. Gross Domestic Investment (blue) is the total of such investment made in a given year, shown as a percentage of Gross National Income.

Some of this Gross Domestic Investment comes from an increase in debt; some of it comes from savings. Gross Savings (red) is the portion that comes from savings (foregone consumption), rather than an increase in debt.

Each year, some long-term assets wear out or are destroyed. Net Savings (green) is what is left, after subtracting the portion that relates to these assets which are lost (“Consumption of Fixed Assets”). So basically Net Savings is the amount of investment during a given year in long-lasting goods that was not financed by an increase in debt, and is not simply a replacement for something that has worn out. If Net Savings is negative (as it is today), we are not even replacing things that wear out, except through the use of more borrowed money.

Quarterly data shows that Net Savings is still negative in 2011.

Figure 3. US Net Savings as a Percentage of Gross National Income on a Quarterly Basis, based on BEA Data.

When Does High Net Savings Occur?

High Net Savings occurs when companies in general are quite profitable–in other words, when invested capital can be expected to yield a high rate of return. In such an environment, most companies will be earning enough profit that they can invest in additional plant and equipment, if desired. In such an environment, real wages are likely to rise. Governments will have little difficulty obtaining enough taxes for schools and roads, and other governmental investment.

The term “bankable project” is sometimes used to describe a project with an expected high rate of return, since this is something that a bank might be willing to lend money on, if  asked. An economy with high Net Savings will have many bankable projects.

Why would Net Savings Decline?

I can think of four reasons for the decline:

1. Declining EROI. Much of the infrastructure of the United States was built in the day when oil was cheap because the Energy Return on Energy Invested (EROI) was very high. Over time, EROI has dropped, and as a result, the price of oil has risen. When the price of oil was inexpensive, new infrastructure could be added cheaply. Oil and gas companies made good returns, even with low oil prices. Now oil costs have risen but wages have not risen correspondingly, creating a mis-match. With the relatively lower wages now, it is harder for workers to afford oil-based products and goods manufacturers make.

2. Human Labor Has Been Mostly Replaced. At one point, it was possible to create substantial efficiency gains simply by replacing human labor by fossil fuel labor. For example, a ditch digger could be replaced by a machine that dug ditches, and the cost of digging ditches would go down quickly, creating a profit for the entrepreneur buying the machines and the company making the ditch digging machines. The biggest opportunities for efficiency gains have already been taken.

3. Decline in Protectionism / Rise of World Market. In the early days, domestic industries were protected with tariffs. As tariffs were lifted and world trade increased, there was increased competition from areas with lower wages.  Capital was attracted to parts of the world where returns on capital appeared to be better, leading to a loss of investment in the US.

4. Limits to Growth. As we reach Limits to Growth (of the type described in the 1972 book by that name), completing claims for limited resources can be expected to raise costs for basic materials relative to wages. As a result, bankable investment projects can be expected to become less numerous. Herman Daly talks about a lack of bankable projects, not only in the US, but around the world,  in this recent post. In his view, the low returns on projects today may be related to ecological limits to growth.

Will There be Enough Funds for the Investments that will be Required to Solve our Energy Shortfall?

It is difficult to see that there will be enough funds available for such investment.

At this point, we need increasing debt just to stay even in terms of replacing infrastructure. We cannot expect ever rising debt to continue, however.  Instead, we should expect reduced debt, as I described in my post The Link Between Peak Oil and Peak Debt – Part 1. Private debt is already declining and is under further pressure, because of  European banking problems and Basel III rules reducing the amounts European banks are able to lend. The US Government keeps increasing its debt level, but this continued growth in debt is unsustainable, and is the reason behind threatened governmental shut-downs.

With reduced debt levels in the future, Gross Domestic Investment will drop below Gross Savings in Figure 2, above, leaving even a smaller amount of funds available for investment than we have today. We may very well, in the aggregate, reach the point where we are not able to maintain current infrastructure with the funds that are available for investment. This means that will need to make choices on which things we maintain–schools or roads or oil distribution pipelines or electric grid or our housing stock. If we suddenly want to spend a lot more on new oil and gas drilling, or on an upgraded electrical grid and more wind turbines, this would seem to reduce funds available for investment in other things, which are also quite necessary.

If we think of investment as requiring the use of resources such as oil, steel,  copper, and fresh water, it would stand to reason that there is an upper limit on how much we can invest each year. If we are in fact reaching “Limits to Growth,” or even “Peak Oil,” the total amount of these resources available in world markets will be declining. Even if the amount of resources extracted each year does not decline, but stays close to flat, the share of these resources that the US is able to obtain and use for infrastructure building is likely to decline, because of more-rapid growth of emerging market nations.

The Way Forward

The only way around this difficulty that I can see is adding high EROI, quick payback, energy projects such as oil wells from the 1930s. Unfortunately, there aren’t any of these left (and of course, they have environmental issues as well).

We have deluded ourselves into thinking that projects that require government subsidies and that theoretically will produce an adequate return over a long period (20 to 60 years) are an acceptable way of replacing high EROI, fast payback projects. This might be true, if we still lived in a world in which fossil fuels would provide enough of a  subsidy to the system that we could live without favorable cash flow returns from other investments.

The problem is that now, even fossil fuel investments require a lot of up front funding (think oil sands extraction in Canada, and fracking of oil and gas wells in the US), and don’t necessarily have all that good a long-term return, regardless. This is especially the case if the government needs to take an increasingly large share of this return, in order to fund its infrastructure requirements.

And increased debt is less and less of a solution.

Somehow, we need to be looking at the overall picture. How can we get enough profitable cash flow to get the cash we need to buy the resources needed to maintain essential parts of infrastructure? If we are looking at energy-related investments, what do they really provide in terms of cash flow? They may supposedly have a high EROI, if viewed over a long enough period, but this in itself is not all that helpful, if cash flow is not positive in a fairly short time-period–probably seven years or less.

My expectation is that the majority of energy investments will be terrible in terms of cash flow, and thus make our “Net Savings” (and Gross Domestic Investment) even lower over time. Installation of wind turbines and solar panels is likely to fail in terms of providing quick cash returns.

In fact, anything that requires a subsidy is likely to have serious cash flow issues. But even new nuclear power plants and new coal-fired power plants will have such issues. Adding scrubbers to coal-fired power plants without them is a great idea from an environmental point of view, but further adds to the need for additional infrastructure investment, without ever generating additional cash.

Perhaps we need to be figuring out which infrastructure investments we can eliminate, that won’t bring down the whole system. Which roads do we turn from asphalt to gravel? Can we eliminate purchase of military jets? Do we stop building and upgrading schools and universities? Do we stop building new homes and office parks?

I will admit I do not fully understand this whole issue. If we could suddenly convince the world that US has more opportunities for profitable investments than anywhere else in the world, theoretically our problem could be solved. But I don’t see this happening. Some have claimed that the recent improvements in oil and gas drilling make the US a more attractive place for investment, but I am doubtful that this is a true solution. Many of the assessments seem to be based on very optimistic estimates of future oil and gas production from “fracked” wells. And the amount of the effect is likely small.

I am afraid that the lack of cash flow funding for investment in infrastructure is what will eventually bring the system down. This is not an issue that researchers have looked at much, to my knowledge. This connection has the potential to pull the whole system down quite quickly–I would guess in 20 years or less.

Perhaps we need to be thinking more about what infrastructure investments can truly last beyond the system itself. The names “Renewables” were given to our current high-tech wind turbines and solar PV to give us the impression that they can last beyond the system themselves, but I  am doubtful that this is really the case, since they depend on the availability of the electric grid and other support systems. Perhaps we need to be focusing more on lower tech applications that can be repaired with local materials and will truly provide lasting benefit.

A recent history of oil production from the November Oil Market Report, both for OPEC and in total, is shown in Figure 1.

Figure 1. Recent oil production for World and for OPEC, according to OPEC November Oil Market Report.

According to a Platts report of the meeting, Venezuelan Oil Minister Rafael Ramirez told reporters, “We are going to reduce the level of production of each country to make space for Libya.” That is not what people want to hear–Brent oil price is still over $100 barrel, even with what seems to be record production for both the world and OPEC, based on Figure 1.

The same Platts report also says, “OPEC on Tuesday said it expected demand for OPEC crude next year to average 30.09 million b/d.” Thus, the new production cap is slightly less than what OPEC sees as demand going forward.

It should be noted that the new limit includes Iraq in addition to the “regular” OPEC countries. Thus, the agreement says that if Iraq increases its production, other OPEC countries will reduce their production to keep total production to 30 million barrels a day. 

All of this comes shortly after Saudi Arabia announced that it has halted plans to increase capacity to 15 million barrels a day by 2020. I wrote about this in a recent post. Saudi Arabia claims to have 12 million barrels a day in capacity now, but there is little evidence that it can actually produce this amount of oil. Saudi Arabia recently boasted that it would increase oil production above 10 million barrels a day, to help offset the drop in Libyan oil production, but amounts reported by the OPEC Oil Market Report and the EIA report of monthly oil production are still under this amount. The highest Saudi oil production reported by the EIA is 9.94 million barrels a day in August 2011.

There would seem to be several reasons for applying an overall cap to OPEC production:

1. OPEC needs/wants high oil prices. They certainly don’t want the price of oil to fall by very much, if they are to have enough funds to pay for all their social programs. So holding production down is in their best interests. An overall cap provides as direct a way as possible of keeping overall production down.

2. It is not clear that most OPEC members have any spare capacity. Saudi Arabia may, in fact, need to “rest” its wells after pushing production to its recent high of 9.94 million barrels a day in oil production. Writing the agreement as an overall cap gives Saudi Arabia “cover” for resting its wells, as needed.

3. This approach is at least theoretically easier to administer. One or two or three countries can make a change in production, if desired, to bring total oil production down to the desired level, if others raise their production.

4. This approach gives a framework for future agreements that can be helpful if Iraq’s oil production should actually increase by very much. Iraq’s production is in effect pulled back in under the agreement.

5. This approach provides great “cover” if one or more OPEC countries experiences a decline in oil production. There is no need for embarrassment if an individual country should experience declining production, since a country can simply blame the result on a need to keep overall production within the selected limit, and thus “save face”. A country with very high stated reserves might be especially embarrassed by an unexplained decline in production, since this might also suggest that the stated reserves were inaccurate.

Why the Market Discounts the New Cap

I am aware that the price of oil dropped after the announcement of the new 30 million barrel a day cap. The view underlying this decline is that the new cap is similar to the individual country caps, and likely to be exceeded if circumstances are right. Furthermore, the 30 million barrel a day cap is similar to what OPEC has recently been producing, so there is no expectation of a cut in production at this time.

It seems to me, though, that OPEC is gradually changing from an association whose primary purpose is to hold down production, to an association of mostly aging oil countries who need to cover up the fact that their oil production may not be able to keep up much longer. The new methodology works much better, if part of the purpose is to cover up the reason for declining production of a few countries.

Figure 2 is a graph I showed in a recent post. It shows Middle Eastern and North African (MENA) oil production as a percentage of world oil production.

Figure 2. Middle East and North Africa oil production as percentage of world total, plus oil price in 2010 dollars. Amounts from BP Statistical Report. Oil includes NGL. Oil price comparable to Brent.

The countries included in MENA are not the same as OPEC, but there is a large overlap with the older OPEC members. Figure 2 shows that this group has not raised production relative to world production by very much, even when oil prices were high, suggesting that they have little capacity to do so.

As the very old wells in MENA countries age further, declining production can be expected to be an increasing problem, adding to the need for countries to “save face” as production declines, as mentioned in Point 5 above.

Conclusion

It will take a while to see how the new cap works out in practice. The important effect may not be in the next three months, but over the longer term, especially if Iraq’s production increases.

Both EIA and IEA are expecting that OPEC will provide the majority of future increases in world oil production. If my interpretation is right, OPEC is suggesting that they will decide how much, if any, increase in production will be allowed through to the rest of the world–that is, assuming that the increase in OPEC production is really there in the first place, and not offset by other OPEC declines.

My expectation is that oil price will really depend on how well the world economy is doing. The world economy is threatening to slip into recession now. If it does, prices may go down. If it does not, and OPEC indeed keeps its production capped at 30 million barrels a day, we should expect higher oil prices ahead.

In any new agreement, the real question is how the agreement is administered in practice. I have suggested one way the new agreement may be used. It will be interesting to see what actually happens.

Figure 1. Saudi Arabian oil production and exports, from Energy Export Data Browser. Note that oil production is in grey, oil exports are in green, and the black line represents consumption.

The figure shows that Saudi Arabia has not been increasing its production for many years. At the same time, the country’s own oil consumption has been rising rapidly. The combination means that oil exports have already started declining.

Saudi Arabia tells us that its crude oil capacity is 12 million barrels a day. In fact, its crude oil production has not exceeded 10 million barrels a day in recent years, according to EIA data. Perhaps it can produce a bit over the 9.9 million barrels a day it produced in August 2011, but this has not yet been proven.

If we look at recent additions to crude oil capacity, we find this list, according to Jadwa Investments.

While Saudi Arabia claims that these additions have added to total capacity, I think we should question whether this is really true. The amount of the additions on this list would seem to more or less offset a decline rate of 5% or 6% per year, and such a decline should be at least considered as an alternate explanation. It is possible, too, that the explanation is somewhere in between–a small capacity increase, but some of the new production is offsetting decline.

Between now and 2020, we know of relatively little additional crude oil capacity to be brought on line. The only big project that has been announced relates to the Manifa heavy oil field. It is planned to reach a capacity of 900,000 barrels a day in 2014.

In addition, there is a substantial amount of natural gas capacity planned in the 2012 – 2013 timeframe. Jadwa Investments estimates that the new capacity will increase natural gas production by over 70%, relative to 2010 levels. This increase in natural gas production should help hold down the growth in domestic oil consumption.

But the question becomes: What will happen to oil production between now and 2020?  Production from most wells declines with age. Wells that have been producing for a long time, including Ghawar, will at some point start producing less. (In fact, we don’t know if Ghawar is already producing less, and the new production that has been brought on line is covering up the decline.) It seems as though we should start seeing a decline in production in the next few years, if no more production than this is brought on line.

Given these considerations, there would seem to be a fairly high probability that Saudi oil exports will decline more rapidly in the next few years. If this happens, Saudi Arabia will encounter financial problems unless the price of the oil rises very substantially, because of the need to fund its social programs.

Deutche Bank analyst Paul Sankey estimates that Saudi Arabia now needs $92 a barrel to break even fiscally because of greater social spending, up from $60 barrel in 2008. If exports decline in future years as production falls and consumption rises, further escalation in the break-even price can be expected. Once new programs are put in place, it is difficult for a government to remove them.

News releases from Saudi Arabia emphasize the supposedly rosy world oil situation: Saudi production can still rise to 12 million barrels a day, and  there will be plenty of oil from other sources, such as Iraq or a shale oil revolution. Furthermore, the world economy may need less, because of recession.

All of these statements are far from proven. They appear to be crafted to make peak oil look like it is not a problem, and to keep people from asking, “Why would a country whose entire economy revolves around oil, and that supposedly has the world’s largest oil reserves, announce that it is cutting back its plans for expansion? How can it possibly maintain its programs, if it doesn’t keep expanding?”

One thing that strikes me about Saudi Arabia is how extremely oil (or oil and natural gas) dependent it is. According to the CIA World Factbook:

The petroleum sector accounts for roughly 80% of budget revenues, 45% of GDP, and 90% of export earnings. Saudi Arabia is encouraging the growth of the private sector in order to diversify its economy and to employ more Saudi nationals. Diversification efforts are focusing on power generation, telecommunications, natural gas exploration, and petrochemical sectors.

Even the diversification efforts don’t sound all that diversified, with the mention of power generation, natural gas exploration and petrochemicals. Saudi Arabia is the world’s largest producer of desalinated water (24 million cubic meters per day), and until recently 90% of the desalination plants ran on oil or natural gas. Saudi Arabia has subsidized agriculture in the past, but plans to rely entirely on food imports by 2016. Whether a desert country like Saudi Arabia attempts to grow its own food, or depends in imports, it takes a lot of oil to provide food for 26 million people.

The very high level of oil consumption in Saudi Arabia can be seen from this chart comparing Saudi per capita oil production with that of the United States, France, and the World in total. (France is shown as being typical of the European countries.)

Figure 3. Per capita oil consumption for selected countries. Oil consumption is by BP, and includes biofuels and natural gas liquids. Population data used in calculation is from EIA.

As oil production reaches its limits, countries everywhere will have to scale back on consumption, and Saudi Arabia is no exception. It is not clear how soon this drop in consumption will come for Saudi Arabia–at some point there will be a clash between falling oil exports and the revenue available to keep up current government programs,  and oil consumption will have to fall. Saudi Arabia is better set than most countries in terms of reserve funds, but at some point these too will run short, and Saudi Arabia will have to economize.

I expect that the downward transition will be more difficult for Saudi Arabia than for many other countries. There aren’t easy options for backyard gardens or transitioning to a “service economy”. Solar PV and natural gas can help somewhat, but the transportation portion of the economy is still very oil dependent. Interesting times are ahead, unless the Saudi Arabian government can somehow figure out ways around these issues.

This is a post I wrote for the ASPO-USA Newsletter, issued December 5, 2011.

I decided to sift through individual country results, to see if I could see a pattern emerging behind these changing results. When I did this, I found three major groupings of countries:

1. Southeast Asia, excluding Japan, Australia, and New Zealand. This group has been rapidly industrializing. In total, the group’s energy consumption has grown as rapidly as GDP in the last decade, and CO2 emissions have grown faster than GDP. This group includes China, India, Korea, Viet Nam, and a long list of other countries in Southeast Asia, including nearby islands.

2. Middle Eastern Countries. This group showed energy use growing more rapidly than GDP,  suggesting that it was taking more energy to extract oil and to pacify its population, over time. I included all countries in this group that BP includes in its Middle Eastern grouping, even though Israel (and perhaps some other countries) do not fit the pattern well.

3. Rest of the World. This group is the only group showing a favorable trend in energy growth relative to GDP growth, even in the last decade, although the pace of improvement has slowed. Two reasons for this favorable trend seem to be (a) continued growth of services, such as financial service, healthcare, and education, which use relatively little energy and (b) outsourcing of a major portion of heavy industry to Southeast Asia.

When we look at CO2 emissions broken out into these three categories, the shift over time is quite surprising:

Figure 1. Carbon dioxide emissions emitted in year shown by the three major areas described (Southeast Asia, Middle East, Remainder), based on BP Statistical Data

The vast majority of the CO2 increase since 1980 has taken place in the Southeast Asia and the Middle Eastern areas!

The energy intensity of GDP (that is, the amount of energy consumed per trillion dollars of real GDP) has shown very different patterns for the three groups of countries:

Figure 2. Energy Intensity of GDP by Area, based on BP Statistical Data regarding Energy Consumption in Barrels of Oil Equivalent, and USDA Economic Research Data regarding real GDP.

The World energy intensity of GDP has flattened in the last decade, reflecting a combination of the impacts of the three areas. The only area that has an improving energy intensity of GDP is the Remainder group. The Southeast Asia group is roughly flat. The Middle Eastern group is shows increasing energy use, relative to GDP growth.

Based on data in this post, I come to the following tentative conclusions:

1. The industrialization of Southeast Asia has allowed importers from around the world to reduce their energy intensity of GDP, but much of the savings has been offset by greater energy use (largely coal) in Southeast Asia. On a CO2 basis, we are likely  worse off, because of this transfer.

2. There is no evidence that the Kyoto Protocol reduced worldwide CO2 emissions. In fact, to the extent that it encouraged outsourcing of industrial production to the Far East and made goods from the Far East more competitive, it may have contributed to rising world CO2 emissions. It would appear that a different approach is needed that recognizes the fact that fuels are part of a world market. Fuel savings in one part of the world are not necessarily helpful for the world as a whole.

3. In my view, world industrial production has self-organized in a way that assigns different roles to companies operating in the three country groups I described above, as a way to minimize manufacturing costs. Over the long term, this particular version of self-organization cannot continue. The Middle East will reach a point where its oil exports drop rapidly. Southeast Asia will reach maximums on coal production/imports and on pollution levels. The “Remainder” is already reaching limits in competing with Southeast Asia. Unemployment rates are high, manufacturing wages are low, and many workers lack the  income needed to purchase additional services which might “grow” GDP.

Before leaving the breakdown into the three areas, I might mention that when one views energy consumption by area (Figure 3), changes in energy consumption for the three groups do not appear as extreme as changes in CO2 production (Figure 1).

Figure 3. Energy consumption by area, based on BP Statistical Data.

The results look even more like business as usual, when viewed on a real GDP basis (Figure 4), because GDP in the “Remainder” group is buoyed up by a large amount of GDP relating to services.

Figure 4. World real GDP by area, based on USDA Economic Research data.

Differences in Energy Use by Area

A person cannot help but be struck by the very different pattern in energy consumption by area. Southeast Asia’s energy use has grown by about 7% per year in the last decade, with coal being the primary source (Figure 5).

Figure 5. Southeast Asia's energy consumption by fuel, based on BP Statistical Data.

Figure 5 indicates that coal use in Southeast Asia has especially grown since 2003.

The Middle East’s energy use has grown by a little more than 5% per year in the last decade. Its energy use is almost exclusively oil and natural gas (Figure 6).

Figure 6. Middle Eastern energy consumption by fuel type, based on BP statistical data.

The Remainder grouping shows energy growth of less than 1% per year in the past decade, and a very different mix of fuels, including nuclear (Figure 7).

Figure 7. Consumption of energy by type for remainder of world, based on BP Statistical Data.

How the Fuel Consumption Market “Works”

This is my view of how the market works, in practice:

Middle East. Figure 8 shows recent oil production, consumption and exports.

Figure 8. Middle Eastern oil production, consumption and exports, from Energy Export Data Browser, based on BP Statistical data. Note that total production is in grey; exports are green. Consumption is the heavy black line.

Because the Middle East has ready access to oil, it uses it freely–to provide social programs for large populations without jobs, and to aid in increasingly energy-intensive oil extraction. At the same time, Figure 8 shows that the total amount of oil extracted has been flat to declining, so oil exports have been declining. Since GDP is based mainly on oil exports, the result is that energy consumption is rising faster than GDP, unless oil prices happen to rise very rapidly.

Southeast Asia and Remainder. These two groups have taken two very different strategies:

1. The Remainder group has sought to minimize its oil use, and the use of  fossil fuels in general, for a variety of reasons–to reduce the financial cost of imports, to minimize CO2 emissions, and to ensure “energy security” if the fuels should decline in availability. Coal is especially not favored, because of its high CO2 emissions.

2. The Southeast Asia group has chosen to try to produce economic growth through the export of manufactured goods, making use of its inexpensive labor force and the availability of cheap coal. Southeast Asia’s cost advantage is especially great in energy-intensive manufacturing, because coal is relatively cheap, and new factories often use the latest technology, limiting fuel use.

When other countries buy exports from Southeast Asia, it starts a whole chain of other economic activity as well–new roads, more concrete buildings, and more workers with a high enough salary to afford cars. So the impact of outsourcing is much greater than the energy directly used in producing the goods for export.

The Kyoto Protocol may have aided Southeast Asia in developing its export-oriented economy. Once CO2 goals were announced, it was clear that signatory countries would want to limit energy intensive manufacturing in their own countries. An easy way of doing this was to substitute the purchase of goods made in countries such as in Southeast Asia. The limits on carbon emissions also made it clear that Southeast Asia would experience relatively little competition for coal in the world marketplace, because countries that signed the Protocol would be limiting coal imports.

Furthermore, if Kyoto Protocol signators enacted carbon taxes, the taxes would tend to make Southeast Asian products (and services such as oil refining), even more cost-competitive than they otherwise would be, since similar manufacturing and services would face no taxes in Southeast Asia. And any oil that was saved by the Kyoto Protocol would be available on the world market at a slightly lower price, further helping Southeast Asia.

If there weren’t a world market in fossil fuels, and in goods made from fossil fuels (with no tariffs on them), the principles of the Kyoto Protocol would work very nicely. The problem is that the Kyoto Protocol doesn’t really address world market issues.

Why None of the Three Groupings Can Continue Its Current Strategy Indefinitely

Middle East. We know that because oil is a finite resource, eventually decline must occur. In fact, Figure 8 shows that oil exports may already have begun to decline in the  Middle East, and this may be contributing to the unrest in the region. If exports are decreasing, it is difficult to maintain welfare programs unless oil prices rise to cover the funding gap.

It is not clear whether exports can be ramped up in the future. Saudi Arabia recently put plans on hold for a $100 billion expansion to 15 million barrels a day capacity by 2020. It also has delayed until 2014 its only other big expansion plan–a  900,000 barrel per day refinery that would allow it to use oil from the Manifa field. Given this situation, Saudi Arabia may see falling exports in the not-too-distant future.

Many have hopes for expansion of oil production by Iraq, but such expansion depends on maintaining peace in the country, which may be difficult. Furthermore, even if one country (namely Iraq) has adequate oil exports, other Middle Eastern countries may face unrest if their exports are declining, and oil prices do not rise enough to offset the impact of the decline.

Southeastern Asia. This part of the world is already encountering serious pollution problems. Air quality is notoriously bad, because of all the coal burned. A recent Science article reported that fully 90% of China’s shallow groundwater is polluted, and 37% of it is so foul it cannot be treated for use as drinking water.

While coal supplies are believed to be larger than oil supplies, they are not unlimited, and costs are already rising. Higher coal costs cause dislocations in the system. For example, costs of producing goods for export are higher, making them less competitive. Higher coal prices may also mean that domestic buyers have to cut back on other purchases, if they are to continue to purchase electricity and food that uses coal inputs.

Furthermore, Southeast Asia’s production is also dependent on the continued availability of oil exports, which cannot continue indefinitely.

So the current model of continued export growth cannot continue forever, and perhaps not for very long at all–a few years at most.

“Remainder” Countries. These countries have planned to outsource a significant share of their industrial production and purchase the products as imports. This approach only works if the population has jobs, and are rich enough to afford the imports. Increasingly, this seems not to be the case.

Another part of the strategy in “Remainder” countries is continued growth of services. This growth of services works only as long as citizens have jobs that pay enough that they can afford ever-increasing amounts of services. A recent article in the Wall Street Journal called Holding Off on Haircut to Buy a New Car points out that increasingly that is not the case. Figure 9 was attached to illustrate the issue:

Figure 9. Illustration from the Wall Street Journal, November 25, 2011. Note that the red and green bars at the bottom of the graph are percentage changes since the beginning of the recovery. Percentage changes are also shown (but not graphed) relative to the beginning of the recession.

This shrinkage in growth of services would seem to explain the convergence of US GDP  growth and energy use growth in the last few years as shown in Figure 10.

Figure 10. USA growth in real GDP and growth in energy consumption

A New Model

Our current system of creating and trading goods is not the creation of any single government. Instead, there is a huge network of rules set forth by governments and organizations around the world, that has evolved over time. There is an even larger number of businesses and individuals making decisions based on these rules. The system is in many respects self-organized, because businesses try to make a profit within this system, and organize themselves in the best way they can, given  the rules they have been given to work with.

Our problem now is that we need a new system, but it is not easy to co-ordinate all of the changes in rules that would be needed around the world to create such a system. In fact, it would be virtually impossible to put together the right set of rules, because it is impossible to foresee all of the indirect impacts and feedbacks that would occur within the new system as the new rules take effect. A system almost of necessity needs to be designed piecemeal, and to evolve slowly over time.

The system we have now takes many things for granted, such as the long-term availability of fossil fuels, and that we will always be able to have enough jobs for workers. These assumptions are proving not to be true. Furthermore, it wasn’t until fairly recently that we recognized CO2 emissions might be a problem.  What we need now is a new model, with a complex set of new rules, but it is hard to see how we can get to that point. We can’t rely on any single rule–even the Kyoto Protocol–to get us to where we need to be.

When the price of WTI dropped, the prices of quite a few other grades of oil (especially in the Midwest, but perhaps elsewhere) were affected as well. To get an idea of how much the overall impact was, I compared the price refiners pay for oil to that of Brent and WTI (Figure 1).

Figure 1. Average refiners acquisition cost, Brent oil price, and WTI oil price, based on EIA data.

I found that the drop in the prices refiners pay for crude oil prices is much more akin to the drop a person would expect if 40% of crude were affected, than the small drop one would expect if only WTI itself were affected. The price change during 2011 did not seem to be due to changes in average viscosity or in sulfur content either.

Some of the types of crude that have been hit by lower prices are those from the Alberta. Recently, there have been proposals by Canadian companies to try to fix the problem. Enbridge announced that it is buying a 50% stake in the Seaway pipeline, and will reverse its direction, so that it will carry crude oil southward, from Cushing to the Gulf, instead of northward, as soon as the second quarter of 2012. In addition, TransCanada has announced the it wants to build the segment of the Keystone XL pipeline from Cushing to the Gulf, possibly starting as soon as January 2012.

The question now is what impact the proposed pipelines will have. Will they even out the Brent/WTI price disparity, and, at the same time, cause the prices of other crudes, such as Canadian and Bakken crudes, to rise as well? Or will the pipeline adjustments fix only part of the problem, and add new problems at the same time? In my view, the latter seems more likely, for reasons I discuss in this post.

For those who are interested, I wrote a post in February giving more background, which can be found here.

The problem isn’t Brent prices, it is WTI prices (and the prices that follow WTI)

Neither Brent nor WTI itself represents more than a tiny fraction of the world’s oil supply. One question that has been raised is, “Is the Brent price high, or is WTI price low, or is it a combination?” To look at this, I compared both prices to the world average oil price, as calculated by the US Energy Information Administration, found here or here.

Figure 2. Comparison of WTI, Brent, and world average oil prices, based on EIA data.

The answer seems to be primarily that WTI has fallen relative to world oil prices. Figure 2 shows that during 2010, both WTI and Brent prices tended to be a little higher than the world average oil price. Starting shortly after the beginning of 2011, Brent rose about 1.5% relative to world oil price–while WTI dropped below the world average oil price. The amount by which WTI declined varies by month relative to the world average oil price. For the period graphed, WTI has averaged 14.3% (or $15.75) lower than would be expected during 2011, based on the average world old prices during 2011, and the 2010 relativity to average world oil price.

Refiners Costs are Much Lower than a Drop in WTI Prices by Itself would Suggest

To see if the lower WTI prices were actually translating to lower prices for refiners, I compared “refiners acquisition cost” to Brent and WTI oil prices, as shown in Figure 3.

Figure 3. Average refiners acquisition cost, Brent oil price, and WTI oil price, based on EIA data. (Repeat of Figure 1)

My conclusion was that refiners acquisition costs in 2011 have been significantly lower than expected based on 2010 relationships–far lower than if the price adjustment related only to the 3% or so of oil that is actually WTI.

The amount of the difference between the actual average refiners cost and the expected average costs varies by month, averaging about $6 lower for the 9 month period, meaning that the average refiners cost of $100 during January to September, might have been $6 higher (or 14 cents a gallon higher), without the recent pricing shift. I checked to see if average viscosity or sulfur content was changing in a way that might explain this change, and it was not (even though we are importing somewhat more crude from Canada).

Gasoline prices seem to be following the lower US crude oil prices

I next reviewed the relationship between refiners’ acquisition cost and retail gasoline prices, to see whether the relatively lower prices refiners are paying is being translated into lower gasoline prices (Figure 4):

Figure 4. Relationship between average retail gasoline price and refiners acquisition costs, based on EIA data.

Another way of looking at this is in terms of relativities to January 2010 prices, as  shown in Figure 5.

Figure 5. Gasoline and Oil Prices Relative to January 2010, based on EIA data.

My conclusion from Figures 4 and 5 is that savings in refiners acquisition cost have (more or less) been passed through to customers. This is too rough a comparison to say anything very precise, but suggests that high refining margins that have been reported in the Midwest are being balanced out by lower margins elsewhere.

Refiners are selling about 510 million barrels a month of finished products in the US, so the savings of $6 barrel would amount to savings of $3 billion a month or $36 billion a year.  The savings to consumers would be about 14 cents a gallon, if these cost-savings are passed on to consumers. This difference may not be enough to keep the US out of recession, but it provides at least a small benefit, relative to paying full world oil prices.

The United States’ refiners’ relatively low-cost structure in 2011 may also help explain why the US has become a net exporter of petroleum products this year, as shown in Figure 6.

Figure 6. Net imports of petroleum products. (Graph created by EIA.)

I was surprised to discover that the United States now even exports gasoline. In recent years, we have imported gasoline from Europe and elsewhere. Our recent shift from importing to exporting oil products tends to help our balance of trade problem.

One reason that we export petroleum products is because the amount of petroleum products the US makes (including blended-in ethanol) continues to rise each year, as shown in Figure 7, while our own consumption has leveled off or is declining.

Figure 7. Products made by US refineries, including biofuels blended in afterwards. (Graph by EIA.)

Will reversing a pipeline from Cushing to the Gulf fix the WTI/Brent differential?

It is not clear to me that either or both of the proposed pipeline changes (Seaway reversal and new Keystone XL segment to the Gulf) will fix the refining problems currently being encountered.  One issue is that the Gulf Coast refineries are almost as full right now as the Midwest refineries. For the year 2010, the average refinery utilization percentage for the Gulf Coast (PADD 3) was 88.6%, compared to that of  Midwest (PADD 2), at 88.7%.  For 2011 through August, the Gulf Coast is averaging 88.3%, while the Midwest is averaging 90.4%.

I can think of a couple of reasons why Midwest and Gulf Coast refinery utilization rates are already be quite high:

(1) Demand for oil products is relatively high in the Midwest and South, compared to the East and West Coasts, and oil is being refined as close to its desired end location as possible, and

(2)  The Midwest and Gulf Coasts seem to have a disproportionate share of  ”complex” refineries that can handle heavy, sour crude, and these types of refineries seem to be more in demand.

Since Gulf Coast refineries are already close to maximum capacity, it is not clear that bringing oil from the North will add much to the quantity of oil being refined by the US. It would seem as thought the new southbound pipeline capacity may lead to a new pricing conflict–between the oil coming from the North, and the oil that was previously being refined on the Gulf Coast. Oil from the North, including oil from Canada, will need to compete head to head for refinery space along the Gulf.

In such a case, it seems to me that the world will have closer to a level playing field with respect to refineries competing for crude oil. Some oil will be diverted elsewhere with more capacity, such as the East Coast or the Far East. Oil prices will tend to even out, so American refiners will pay more, and will likely raise their prices of refined products, because of this. These higher prices will reduce the quantity of oil Americans will buy, and may even cause recessionary influences. These higher prices may also cause our refined products to be less competitive in the world market, reducing quantities sold and putting pressure on “crack” margins.

Figure 8. ENI refinery complexity chart

At this point, we don’t really know if there is adequate world capacity for rising production of heavy-sour oil, because lack of southbound pipeline capacity from Cushing  has kept the increased amount of non-upgraded crude oil from Canada from the world refinery market. (See Figure 8 for recent “complex” capacity by ENI.) If there is inadequate complex refinery capacity worldwide, it will become apparent through a rising world-wide differential between heavy-sour and light-sweet crude price. If this differential should widen, the Canadian producers may not get the benefit they are hoping from the southbound pipelines, even though the WTI/Brent spread may drop to near zero.

Over time, one might expect additional Canadian crude to flow south, with the benefit of the new southbound pipeline capacity. The one benefit of additional Canadian oil, even if it only displaces crude from other sources, is that it is likely to be a longer-term stable source of supply than some other sources of imported oil, such as Mexico, whose oil is rapidly declining, and Venezuela, which is forming ties with China. Of course, Canada is itself an oil importer on its East Coast. If it loses those imports, it may have more need for oil from Alberta itself.

Would a pipeline change help or hurt diesel fuel supply?

When we look at recent EIA graphs, we see rapidly dropping stocks of distillate fuel (which is used for diesel and home heating), shown in Figure 9, below.

Figure 9. EIA graph showing Total Distillate Fuel Stocks (Diesel + Heating Oil), as of November 16, 2011.

The problem is especially severe in PADD 2 (Midwest), shown in Figure 10.

Figure 10. PADD 2 (Midwest) Distillate Fuel Stocks

We also read stories about diesel shortages in North Dakota (in the Midwest), such as: Diesel fuel shortage is one of worst.

Somehow, it seems a little ironic that we are talking about turning around pipelines to send more oil south to the Gulf Coast, when oil product shortages are occurring in the Midwest. When we turn around pipelines, we may, for a time, end up operating Midwest oil refineries at a lower percentage of capacity, adding to our lack of distillate in the Midwest, unless more refined oil products are sent back to the Midwest after they are created elsewhere.

The issue here would seem to be at least partly price. What the US is doing is making a lot of distillate fuel, and exporting a growing share of it. What we really need is higher US distillate fuel prices, if we are to compete in the world distillate market. If US refined product prices are higher as a result of the pipeline change, it should help this problem, but as noted above, higher prices for the consumer are not without difficulty–they can lead to declining purchases and even push the economy toward recession.

Figure 1. Growth in world energy consumption (based on BP data) and growth in world real GDP

Prior to 2000, world real GDP (based on USDA Economic Research Institute data) was indeed growing faster than energy use, as measured by BP Statistical Data. Between 1980 and 2000, world real GDP growth averaged a little under 3% per year, and world energy growth averaged a little under 2% per year,  so GDP growth increased about 1% more per year than energy use. Since 2000, energy use has grown approximately as fast as world real GDP–increases for both have averaged about 2.5% per year growth. This is not what we have been told to expect.

Why should this “efficiency gain” go away after 2000? Many economists are concerned about energy intensity of GDP and like to publicize the fact that for their country, GDP is rising faster than energy consumption. These indications can be deceiving, however. It is easy to reduce the energy intensity of GDP for an individual country by moving the more energy-intensive manufacturing to a country with higher energy intensity of GDP.

What happens when this shell game is over? In total, is the growth in world GDP any less energy intense? The answer since 2000 seems to be “No”.

It seems to me that at least part of the issue is declining energy return on energy invested (EROI)–we are using an increasing share of energy consumption just to extract and process the energy we use–for example, in “fracking” and in deep water drilling. This higher energy cost is acting to offset efficiency gains. But there are other issues as well, which I will discuss in this post.

If GDP growth and energy use are closely tied, it will be even more difficult to meet CO2 emission goals than most have expected. Without huge efficiency savings, a reduction in emissions (say, 80% by 2050) is likely to require a similar percentage reduction in world GDP. Because of the huge disparity in real GDP between the developed nations and the developing nations, the majority of this GDP reduction would likely need to come from developed nations. It is difficult to see this happening without economic collapse.

Real GDP Growth and Energy Growth for Several Countries

I started this analysis by looking at trends (1) in real GDP and (2) in total energy consumption for a number of countries, and was struck by how different the patterns appeared.

Figure 2. USA's real GDP and total energy consumption

Up until 2005, the USA was able to increase real GDP by 3% per year, while increasing energy use by only 1% per year. The 2% savings would seem to come from some combination of offshoring and energy efficiency. Since 2005, the relationship between GDP growth and energy growth has been closer.

Figure 3 - Germany's total energy consumption and real GDP.

Germany is another example with much higher GDP growth than growth in energy use. Between 1980 and 2005, energy use was close to flat, while GDP rose by an average of 1.7% per year.

Figure 4. Italy's energy consumption and real GDP

Italy’s real GDP grew by about 1.7% a year between 1980 and 2005, while its oil use grew about 1.0% per year, so it too shows energy efficiency/offshoring gains, amounting to about 0.7% per year. This gain is less than that of the USA and Germany, but Italy was also less industrial to start with, so offshoring was less of an option.

Figure 5. Japan's energy consumption and real GDP

The tie between energy consumption and GDP growth has been much tighter for Japan, especially since about 1987. Since 1987, the two have grown at about the same rate.

Figure 6. Spain's energy consumption and real GDP

Spain has also showed a very close tie between growth in energy consumption and growth in real GDP, with both growing by close to 3% per year between 1980 and 2005.

Figure 7. Greece's energy consumption and real GDP

Greece managed to grow its energy use faster than real GDP during most of the 1980 to 2005 period. This may contribute to its current economic problems.

Figure 8. China's energy consumption and real GDP.

China shows more rapid growth in real GDP than in energy consumption. Its real GDP grew by about 10% a year between 1980 and 2005, while energy use grew by a little less than 6% per year. Between 2005 and 2010, real GDP continued to grow by about 10% per year, while energy use grew by about 7.5% per year.  The country has been changing so rapidly that a person wonders how accurate the early GDP numbers are.

Figure 9. Energy consumption and real GDP for the Former Soviet Union

Figure 9 shows that the pattern for the Former Soviet Union (FSU) has been very unusual. Both energy use and real GDP collapsed after the collapse of the Soviet Union, but the drop in GDP was greater than the drop in energy use. Recently, real GDP has been soaring while energy use remains flat, suggesting that outsourcing of high energy manufacturing is occurring, or that new sources of GDP that do not require much energy use are being created.

Changes in Energy Intensity

The usual way of measuring energy intensity is as the ratio of energy consumed to real GDP (the red line divided by the blue line in the above graphs), and these ratios vary greatly. In fact, it is hard to even put energy intensities for different countries on the same graph, because the amounts are so different.

Figure 10a. Energy intensities for the world, the Former Soviet Union, and China

Figure 10b. Energy intensities for the world minus the Former Soviet Union, the USA, Japan, and the EU-15 countries

It seems to me that what we are really interested in is the energy intensity of the world, (or perhaps of the world less the Former Soviet Union, if Former Soviet Union data is totally bizarre, reflecting very high energy usage in the past that is now disappearing, and cannot be replicated elsewhere). We show these in Figure 11:

Figure 11. Historical energy intensities for the world, and for the world excluding Former Soviet Union

Figure 11 shows that energy intensity on a world basis has been flat since 2000. This is also the case when FSU data is excluded. We expected recent world energy intensity to be flat, based on Figure 1 at the top of the page.

Why does world energy intensity remain flat, while energy intensity for many individual countries has been decreasing?

We are dealing with a large number of countries with very different energy intensities. The big issue would seem to be outsourcing of heavy manufacturing. This makes the energy intensity of the country losing the manufacturing look better. Outsourcing transfers manufacturing to a country with a much higher energy intensity, so even with the new manufacturing, its ratio can still look better (lower). It is hard to measure the overall impact of outsourcing, except by looking at world total energy intensities rather than individual country amounts.

Looking at world energy intensities, it appears that the huge amount of outsourcing is resulting in pretty much comparable energy use to the original energy that was outsourced. It is hard to make a direct calculation of the difference in energy use, because much of the new energy use is indirect. For example, the government of the developing nation may build huge amounts of new paved roads and concrete homes with tax revenues, and individual workers may buy new cars with their salaries. These amounts are not captured in a simple comparison of the energy used in making a widget in the USA relative to the energy used in making a widget in China, for example.

Another issue is that the energy use of interest is per dollar of real GDP, and a savings in energy that results in a cost savings may not be very helpful in lowering energy intensity of GDP. For example, suppose that a manufacturer creates a new, smaller car, that is 20% cheaper and uses 20% less gasoline on an ongoing basis. More workers will be able to afford this car. Furthermore, a well-off worker who can afford this new cheaper car (and who could also have afforded a more expensive car) will have left-over money. With this left-over money, the well-off worker can purchase something else, such as an airline trip, food flown in from overseas, or a new iPod. All of these extra purchases take energy as well. So when the overall picture is viewed, the fact that more energy-efficient cars are being manufactured does not necessarily translate to lower energy intensity of GDP.

One issue mentioned in the introduction to this post is the fact that EROI for fossil fuels is declining because the easy-to-extract fossil fuels have mostly been extracted. As a result, we are now extracting the more difficult to extract fossil fuels, requiring more energy.

A similar situation occurs in many other endeavors, because we live in a finite world, and we are reaching limits. In mining, the quality of ores is getting poorer, meaning than more energy needs to be used in extraction. In farming, we are stretching our resources tighter, requiring more fertilizer, pesticides, and more irrigation, all requiring energy. We are running short of fresh water in some places, so water is pumped from greater distances or desalination is used, adding to energy usage. Pollution is an issue, so we require utilities to add scrubbers to old coal plants. All of these efforts require energy, and likely contribute to an upward trend in energy usage, offsetting efficiency savings elsewhere.

Another issue that tends to raise energy intensity of GDP is the long-term trend toward using machines and additional energy to do jobs, rather than simple human labor. For example, if a person chops down a few trees and builds his own house, most calculations would say that there is neither GDP nor (outside) energy used. If a person hires a builder to build a house, and the builder uses hand tools to chop down trees and human labor to build the house, the result is an increase in GDP, but little fossil fuel energy use. If the builder becomes more “modern” and uses earth movers and concrete to build homes, then energy use rises relative to GDP created.

Carbon Dioxide Emissions

As might be expected, carbon dioxide emissions per unit of GDP are closely related to energy intensity. In fact,

(Co2 Emissions/GDP ) = (CO2 Emissions / Energy Used) x (Energy Used / GDP)

The ratio (Energy Used /GDP) is simply energy intensity, which was graphed in Figures 10a, 10b, and 11. The other ratio is (CO2 Emissions / Energy Used) graphed below in Figure 12. It shows a similar pattern: declining prior to 2000, and then leveling.

Figure 12 - Carbon dioxide emissions per barrel of oil equivalent energy, based on BP Statistical Data.

The ratios in Figure 12 reflect changes in energy mix over time, and their relative propensity to generate CO2. Since 2000 these emission per unit of energy use have, in fact, started to rise a little, because of the greater use of coal in the energy mix. The CO2 measurements used in this analysis are BP’s calculations, based on the types of energy used each year (including renewables*). They do not reflect actual measured CO2 in the atmosphere.

The ratio of new CO2 emissions to Real GDP reflects a combination of these ratios (C02/Energy and Energy/Real GDP) and is shown in Figure 13.

Figure 13: Ratio of New Energy Carbon Dioxide Emissions to Real GDP

Figure 13 indicates what we would expect from Figures 11 and 12: A declining ratio of CO2 emissions to real GDP until about 2000, then fairly flat thereafter. In fact, there is a distinct upturn in 2010. Thus new CO2 emissions from energy sources have been rising about as fast as real GDP since about 2000, and a little faster than real GDP in 2010. This is no doubt discouraging news to those who adopted the Kyoto Protocol in 1997, thinking it would reduce CO2 emissions.

A Few Thoughts on Energy Policies

Carbon taxes and cap and trade policies seem to encourage outsourcing of manufacturing. The primary benefits of outsourcing would seem to be (1) a reduction in imported fossil fuels, (2) lower cost of manufactured goods to the consumer, because of lower labor costs, and (3) possibly higher profits to the company selling the new cheaper product. Offsetting these benefits are a loss of jobs for the country doing the outsourcing and a loss of control over what types of energy are used in the manufacturing process. It seems to me that we would be better off not encouraging this outsourcing, especially when essential goods are being created.

One misconception that seems to guide much energy policy is the view the biofuels will substitute for oil, and that use of additional electricity use will substitute for oil. Oil use is pretty much maxed out. Oil supply is very close of inelastic, regardless of price. Someone, somewhere, will use any oil pulled out of the ground, perhaps at a slightly lower price, even if a particular country can reduce its oil consumption through the use of biofuels, or if a car can run on electricity.

This means that any biofuel that is created will add to world energy supply, by using natural gas and coal supplies more quickly, since their use is still somewhat elastic. Similarly, by moving energy demand from oil to electricity, we what we are really doing is expanding total energy usage, by burning more coal and natural gas to make more electricity.

Thus, from a world CO2 perspective, biofuels and increased electrical usage are not helpful. Individual countries may still find biofuels and expanded electrical use helpful, because they can reduce oil imports, if oil use can be shifted to another country. There is also the hope that we can continue our motoring  lifestyle longer, using electric cars.

If our intent is really to reduce CO2 emissions, it seems to me that we need to look much more broadly at the issue. Maybe the issue should be viewed in terms of (1) fossil fuel resources that we are willing to use in each future year, and (2) how much real GDP can be created from those resources, given the issues we are facing. The quantity of fossil fuels to be used each future year might consider CO2 goals as well as limits on the amount of oil that can be extracted each year because the “easy oil is gone”. The amount of real GDP that can be created from these fuels would depend on a number of factors, including declining EROI and increasing efficiency.

If the plan is to reduce fossil fuel consumption, then we may very well be expecting real GDP to also decrease, perhaps by a similar percentage. In fact, looking at the experience of FSU in Figure 9, the GDP decline may even be greater than the energy decline.

Conclusion

We are facing a challenging time. This post seems to suggest that there is yet another story that we are being told, that isn’t quite true. It seems to me that we need to examine the issues ourselves, come to our own conclusions, and start telling the real story.

*I have not attempted to discuss the impact of renewables, since to date their impact has been small. The front-ending of energy use of renewable makes their impact on energy intensity of GDP less beneficial than standard comparisons would suggest.