Fossil Fuel Imports Are Already Constrained

Posted on August 31, 2023 by Gail Tverberg

For many years, there has been a theory that imports of oil would become a problem before there was an overall shortage of fossil fuels. In fact, when I look at the data, it seems to be clear that oil imports are already constrained.

Figure 1. Interregional trade of fossil fuels based on data of the 2023 Statistical Review of World Energy by the Energy Institute.

As I look at the data, it appears to me that coal and natural gas imports are becoming constrained, as well. There was evidence of this constrained supply in the spiking prices for these fuels in Europe in late 2021 and early 2022, starting well before the Ukraine conflict began.

Oil, coal, and natural gas are different enough from each other that we should expect somewhat different patterns. Oil is inexpensive to transport. It is especially important for the production of food and for transportation. Prices tend to be worldwide prices.

Coal and natural gas are both more expensive to transport than oil. They tend to be used in industry, in the heating and cooling of buildings, and in electricity production. Their prices tend to be local prices, rather than the worldwide price we expect for oil. Prices for importers of these fuels can jump very high if there are shortages.

In this post, I first look at the trends in the overall supply of these fuels, since a big part of the import problem is fossil fuel supply not growing quickly enough to keep pace with world population growth. I also give more background how the three fossil fuels differ.

After this introductory material, I provide charts and some analysis of fossil fuel imports and exports by region, based on data from the 2023 Statistical Review of World Energy. Theoretically, the total of regional imports should be very close to the total of regional exports. This analysis gives a little more insight into what is going wrong and where.

[1] On a worldwide basis, total supplies of both oil and coal seem to be constrained.

Figure 2. World consumption of oil, coal, and natural gas based on data of the 2023 Statistical Review of World Energy by the Energy Institute.

Figure 2 shows that world supplies of all three fossil fuels follow the same general pattern: They tend to rise in close to parallel lines, with oil supply on top, coal next, and natural gas providing the least supply.

The total supply of fossil fuels needs to be shared by the world’s population. It therefore makes sense to look at supply on a per capita basis.

Figure 3. World per capita consumption of oil, coal, and natural gas, based on data of the 2023 Statistical Review of World Energy by the Energy Institute.

On Figure 3, the top line, oil supply per capita, is almost perfectly level, suggesting that having a greater supply of oil enables having a larger world population. This relationship makes sense because oil is used to a significant extent in growing today’s food, and shipping it to market. Oil products also make herbicides, insecticides, and drugs for animals that enable the growing supply of food needed to feed today’s population. Oil products are also helpful in road making, and in providing lubrication for machinery of all kinds.

We might conclude that oil supply is essential to the growth of human population. It is only by way of a huge change in the economy, such as the one that took place in 2020, that there is a big dip in oil usage. Even now, some of the changes are “sticking.” Some people are continuing to work from home. Business travel is still low. People are still not buying fancy clothing as much as before 2020. All these things help reduce fossil fuel usage, particularly oil usage.

Figure 3 also shows that on a per capita basis, coal supply has fallen by 9% since its peak in 2011. This fact, plus the fact that coal prices have been spiking around the world in recent years, leads me to believe that coal supply is already constrained, even apart from the export issue.

[2] The share of oil traded interregionally is more than double the share of coal or natural gas traded interregionally.

The reason why oil is disproportionately high in Figure 1 compared to Figure 2 is because a little over 40% of oil is shipped between regions. In comparison, only about 18% of coal production is traded with other regions, and about 17% of natural gas production is shipped interregionally. Oil is much easier (and cheaper) to transport between regions than either coal or natural gas. Shipping costs tend to escalate rapidly, the farther either natural gas or coal is shipped.

Natural gas has a second problem over and above the high cost of shipping: It requires storage (which may be high cost) if it is not used immediately. Storage is needed for both natural gas and coal because both fuels are often used for heat in winter, either by direct burning or by creating electricity that can be used to heat buildings. Storage for coal is close to free because it can be stored in piles outside.

Besides heat in winter, coal is also used to provide electricity for air conditioning in summer, so its demand curve has peaks in both summer and winter. Natural gas is much more of a winter-heat fuel in the US, so it has a large peak corresponding to winter usage (Figure 4).

Figure 4. Coal and natural gas consumption by month based on data of the US Energy Information Administration.

Storage for natural gas needs to be available in every area where users expect to use it for winter heat. The cost of this storage will be low if there are depleted natural gas caverns that can be used for storage. It is likely to be high if above ground storage is required. Natural gas importing areas often do not have suitable caverns for storage. The easy approach is to try to get by with a bare minimum of storage, and hope that imports can somehow make up the difference.

The big question for any fuel is, “Can consumers afford to pay a high enough price to cover all the costs involved in getting the fuel from endpoint to endpoint, at the time it is needed?“

Citizens become very unhappy if the cost of winter heat becomes extremely expensive. They demand subsidies and rebates from the government, in order to keep costs down. This is a sign that prices are too high for the consumer.

Both coal and natural gas are also heavily used in manufacturing. Their prices vary greatly from location to location and from time to time. If coal or natural gas prices rise in a particular location, the cost of manufactured goods from that location will also tend to rise. These higher prices will particularly hurt a manufacturing country, such as Germany, because its manufactured goods will become less competitive in the world marketplace. GDP growth will be reduced, and the profitably of manufacturers will tend to fall.

Because of these issues, long-distance trade in both coal and natural gas tend to hit barriers that may be difficult to see simply by looking at the trend in world production.

[3] Natural gas exports may already be becoming constrained, even though the total amount extracted still seems to be rising.

A huge amount of investment is needed to make long-distance sale of natural gas possible. Such investment includes:

  • The cost of developing a natural gas field for export use, usually over many years.
  • Pipelines covering every inch traveled by the natural gas, other than any portion of the trip for which transfer as liquefied natural gas (LNG) is planned.
  • Special ships to transport the LNG.
  • Facilities to chill natural gas, so it can be shipped overseas as LNG.
  • Regasification plants, to make the natural gas ready to ship by pipeline after it has been transferred as LNG.
  • Storage facilities, so that sufficient natural gas is available for winter.

Not all of these investments are made by the same organizations. They all need to provide an adequate return. Even if “only” very long-distance pipelines are used, the cost can be high.

Pipelines work best when there is no conflict among countries. They can be blown up by another country that seeks to raise natural gas prices, or that wants to retaliate for some perceived misdeed. For this reason, most growth in natural gas exports/imports in recent years has been as LNG.

Organizations investing in high-cost infrastructure for extracting and shipping natural gas would like long-term contracts at high prices in order to cover their costs. Without a stable long-term supply contract, natural gas purchase prices can be extremely variable. Japan has tended to buy LNG under such long-term contracts, but many other countries have taken a wait-and-see attitude toward prices, hoping that “spot” prices will be lower. They don’t want to lock themselves into a long-term high-priced contract.

There are two different things that tend to go wrong:

  • Spot prices bounce up above even what the long-term contract price would have been, creating a huge high-price problem for consumers.
  • Spot prices, on average, turn out to be too low for natural gas exporters. As a result, they cut back on investment, so that the amount of future exports can be expected to fall.

I believe that there is a significant chance that natural gas exports are now reaching a situation where prices cannot please all users simultaneously. Not all investors can get an adequate return on the huge investments that they have made in advance. Some investments that should have been made will be omitted. For example, there might be enough natural gas storage for a warm winter, but not for a very cold winter in Europe.

A prime characteristic of a fossil fuel (or any resource) that is not economic to extract is that the industry has difficulty paying its workers an adequate wage. Recently, there has been news about a union strike against Chevron at an Australian natural gas extraction site used to provide gas for liquefied natural gas (LNG) export. This suggests that natural gas may already be hitting long-distance export limits. Prices can’t stay high enough for producers to pay their workers an adequate wage.

[4] Oil imports by area suggest that the rapidly growing manufacturing parts of the world are squeezing out the imports desired by high-wage, service-oriented countries.

Because oil is so important in international trade, I looked at the amounts two ways. The first is based on trade flows, as reported by the Energy Institute:

Figure 5. Oil imports by area based on the 2023 Statistical Review of World Energy by the Energy Institute.

The second is based upon a comparison of reported production and consumption for the same year, using the assumption that if consumption is higher than production, the difference must be attributable to imported oil. The problem with this later approach is that it can easily be distorted by changes in inventory levels. There may also be difficulties with my approach of netting out flows in two different directions, especially if the flows are partly of crude oil and partly of “oil products” of various types.

Figure 6. Oil imports based on production and consumption data of the 2023 Statistical Review of World Energy by the Energy Institute. Amounts adjusted to include “Refinery Gain,” as reported by the US Energy Information Administration.

In both charts, imports for China, India, and Other Asia Pacific are clearly much higher in recent years, while imports for the US, Japan, and Europe are down. The peak year for imports (in total) was about 2016 or 2017. Imports were about 3.5 million barrels a day lower in 2022, compared to peak, with both approaches.

[5] Oil imports by area indicate that nearly all oil exporters around the globe are having difficulty maintaining export levels.

Here, again I show two indications, using the same methods as for oil imports. Since trade is two sided, I would expect total import indications to more or less equal the total of all amounts exported.

Figure 7. Oil exports by area using trade flows based on data of the 2023 Statistical Review of World Energy by the Energy Institute.

On Figure 7, peak oil exports (in total) occur in 2016, with the runner up year being 2017. US oil exports are shown to be nearly zero, even in recent years, because US imports and US oil exports more or less cancel out.

Figure 8. Oil exports based on production and consumption data of the 2023 Statistical Review of World Energy by the Energy Institute. Amounts adjusted to include “Refinery Gain,” as reported by the US Energy Information Administration.

The indications of Figure 8 show that apart from Canada, the amount of oil exported for all the other export groupings shown is lower in recent years than it was a few years ago. This is also evident in Figure 7, but not as clearly.

To some extent, the lower production in recent years is related to the cutbacks announced by OPEC+ (including what I call Russia+). While these cutbacks are “voluntary,” they reflect the fact that based on current oil prices, and based on investments made in recent years, these countries have made the decision to cut back production. No oil exporter would dare mention that it is running short of oil that can be extracted without considerably more investment.

On Figures 7 and 8, “Mexico+South” refers to all the oil being produced from Mexico southward. Besides Mexico, this includes Brazil, Venezuela, Argentina, Columbia, Ecuador, and a number of other small producers. Most of them are experiencing falling production. Brazil is doing a bit better, but it does not seem to be experiencing much growth in exports.

Africa’s peak year for oil exports seems to have been in 2007 (both approaches), with recent exports at a much lower level.

With respect to Russia+, its exports seem to be down from their peak in 2017 or 2018, but not any more than for oil producers from the Middle East. The European Union oil embargo doesn’t seem to have had much of an impact.

The star performer seems to be Canada, with its rising production and exports from the Canadian Oil Sands.

In this analysis, I have “netted out” imports and exports. On this basis, the US hasn’t moved into significant oil exporter status yet. I am sure that there are some people hoping that the oil production of the US will continue to increase, but whether this will happen is unclear. The growth of US oil production in recent years has helped offset (and thus hide from view) the falling exports of many countries around the world.

[6] Coal exports appear to have peaked about 2016. Europe has reduced its imports of coal, leaving more for other importers.

Figure 9. Coal imports by area using trade flows based on data of the 2023 Statistical Review of World Energy by the Energy Institute.

The peak in coal imports seems to have occurred about 2016. In particular, Europe’s imports of coal have fallen significantly since 2006. At the same time, coal imports have risen for many Asian countries, including China, India, South Korea, and Other Asia Pacific. Even Japan seems to have been able to obtain a fairly consistent level of coal imports for the 22-year period shown on Figure 9.

Figure 10. Coal exports by area based on trade flow data from the 2023 Statistical Review of World Energy by the Energy Institute.

One thing that is striking about coal exports is that they are disproportionately from countries in the Far East. Even the coal exports of the US and Canada are from North America’s West Coast, across the Pacific. Russia’s coal exports tend to be from Siberia.

The coal exports of South Africa have declined significantly since 2018, and other African countries are eager for their imports. Today’s largest source of coal exports is Indonesia. Coal exports from Russia+, at least until 2021, have been been a source of coal export growth.

A major share of the delivered price of coal is transportation cost, which tends to be fueled by oil, particularly diesel. Overland transit is particularly expensive. The real reason for Europe’s decline in coal imports since 2006 (shown in Figure 9) may be that there are practically no affordable coal exports available to it because it is too geographically remote from major exporters. Of course, this is not a story politicians care to tell voters. They prefer to spin the story as Europe’s choice, to prevent climate change.

[7] Natural gas imports and exports have only recently started to become constrained.

Figure 11. Natural gas exports by area based primarily upon production and consumption data from the 2023 Statistical Review of World Energy by the Energy Institute.

Figure 11 shows that natural gas exports from Russia+ (really Russia, with a little extra production from other countries in the Commonwealth of Independent States) have stayed fairly level, except for a big drop-off in 2009 (probably recession related) and in 2022.

The overall level of natural gas exports has been rising because of contributions from several parts of the world. Africa was an early producer of natural gas exports, but its exports have been dropping off somewhat recently as local gas consumption rises.

More importantly, exports have increased in recent years from the Middle East, Australia, and North America. With this growing supply of exports, it has been possible for importers to increase their imports.

Figure 12. Natural gas imports by area based upon production and consumption data from the 2023 Statistical Review of World Energy by the Energy Institute.

Europe was able to maintain a fairly stable level of natural gas imports between 1990 and 2018, and even to increase them by 2021. China was able to ramp up its natural gas imports. Even Japan was able to ramp up its natural gas imports until about 2014. It has tapered them back since then. India and Other Asia Pacific both have been able to add a small layer of imports, too.

[8] What lies ahead?

The countries that have the greatest advantage in using fossil fuel imports are the countries that don’t heat or cool their homes, and that don’t have large numbers of private citizens with private passenger automobiles. Because of their sparing use of fossil fuel imports, their economies can afford to pay higher prices to import these fossil fuel imports than other countries. Thus, they are likely to be winners in the competition for fossil fuel imports.

Europe stands out to be an early loser of imports. It is already losing oil and coal imports, and it also seems to be an early loser of natural gas imports. However, for all its talk about preventing climate change, the reduction in European imports of fossil fuels hasn’t made much of a dent in global carbon dioxide emissions (Figure 13).

Figure 13. CO2 emissions for Europe and the Rest of the World, based on data of the 2023 Statistical Review of World Energy by the Energy Institute.

I am afraid that no country will really come out ahead. In some sense, the United States is better off than many countries because it is producing slightly more fossil fuels than it consumes. But it still depends on China and other countries for many imported goods, including computers. Given this situation, the United States likely cannot continue business as usual for very long, either.

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Our Oil Predicament Explained: Heavy Oil and the Diesel Fuel it Provides Are Key

Posted on August 3, 2023 by Gail Tverberg

It has recently become clear to me that heavy oil, which is needed to produce diesel and jet fuel, plays a far more significant role in the world economy than most people understand. We need heavy oil that can be extracted, processed, and transported inexpensively to be able to provide the category of fuels sometimes referred to as Middle Distillates if our modern economy is to continue. A transition to electricity doesn’t work for most heavy equipment that is powered by diesel or jet fuel.

A major concern is that the physics of our self-organizing economy plays an important role in determining what actually happens. Leaders may think that they are in charge, but their power to change the way the overall system works, in the chosen direction, is quite limited. The physics of the system tends to keep oil prices lower than heavy oil producers would prefer. It tends to cause debt bubbles to collapse. It tends to squeeze out “inefficient” uses of oil from the system in ways we wouldn’t expect. In the future, the physics of the system may keep parts of the world economy operating while other inefficient pieces get squeezed out.

In this post, I will try to explain some of the issues with oil limits as they seem to be playing out, particularly as they apply to diesel and jet fuel, the major components of Middle Distillates.

[1] The most serious issue with oil supply is that there seems to be plenty of oil in the ground, but the world economy cannot hold prices up sufficiently high, for long enough, to get this oil out.

As I frequently point out, the world economy is a physics-based system. World oil prices are set by supply and demand. Demand is quite closely tied to what people around the world can afford to pay for food and for transportation services because the use of oil is integral to today’s food production and transportation services.

Heavy oil is especially involved in this affordability issue. As oil becomes “heavier,” it becomes more viscous, and thus more difficult to ship by pipeline. If oil is very heavy, as is the oil from the Oil Sands of Canada, it needs to be mixed with an appropriate diluent to be shipped by pipeline.

Heavy oil often has sulfur and other pollutants mixed in, adding costs to the refining process. Furthermore, heavy oil, especially very heavy oil, often needs to be “cracked” in a refinery to provide a desirable mix of end products, including diesel, jet fuel, and gasoline. This, too, adds costs. Otherwise, there would be too much of the product mix that would be like asphalt. Also, as noted previously, even if the costs of production are high, the selling price of diesel cannot rise very high without raising food prices. This tends to keep the prices of heavy crude oils below those for lighter crude oils.

Many people believe that the high level of “Proved Oil Reserves” worldwide makes it certain that businesses can extract as much oil as they would like in the future. A major issue is whether these reserves mean as much as people assume they do. Oil reserves of OECD countries (an association of the US and other rich countries) are likely to be audited, but reserves of other countries may not be. Asking a relatively poor oil-exporting country the amount of its oil reserves is like asking the country how wealthy it is. We should not be surprised by fibbing on the high side. The problem is that the vast majority of reported oil reserves (85%) are held by non-OECD countries. These reserves may be significantly overstated.

Also, even if the reserves are fairly reported, will the country have the resources to extract these reserves? Venezuela reports the highest oil reserves in the world thanks to its heavy oil in the Orinoco Belt, but it extracts a relatively small amount per year. An October 2022 article says that the country is waiting for foreign investment to expand production.

Going forward, oil companies everywhere need to worry about broken supply lines for necessary items, such as steel drilling pipe. They need to worry about finding enough trained workers. They need to worry about the availability of debt and the interest rate that will be charged for this debt. If private oil companies look at the true prospects and find them too bleak, they will likely use their profits to buy back the shares of their own oil companies instead (as is happening now).

[2] While oil producers can crack heavy oil to make shorter hydrocarbons in a way that is not terribly expensive, trying to make near-gasses and light oils into diesel becomes impossibly expensive.

It is easy for people to assume that any part of the oil mix is substitutable for another part, but this is not true. Cracking long hydrocarbon chains works to make shorter chains, but the economics tend not to work in the other direction. Thus, it is not economically feasible to make gasoline into diesel (which is heavier), or natural gas liquids into diesel.

[3] If there is inadequate oil supply, the impacts on the economy are likely to include broken supply lines, empty shelves, and inflation in the price of goods that are available.

If there is not enough oil to go around, some users must be left out. The result is that some of the less profitable consumers of oil may file for bankruptcy. For example, the Wall Street Journal recently reported Trucking Giant Yellow Shuts Down Operations. This bankruptcy makes it impossible for some stores to get the merchandise that would normally be on their shelves. As a consequence, it makes it likely that some replacement parts for automobiles will not be available when needed. There is a workaround of renting another vehicle while a person’s car is waiting for repairs, but this adds to total costs.

This workaround illustrates how a lack of adequate oil can indirectly lead to higher overall costs, even if the oil itself is not higher-priced. The need to work around supply line problems tends to lead to inflation in the prices of goods that continue to be available.

[4] The fact that the quantity of oil that could be affordably extracted was likely to fall short about now has been known for a very long time, but this fact has been hidden from the public.

In 1957, Hyman Rickover of the US navy predicted that the amount of affordable fossil fuels would fall short between 2000 and 2050, with the amount of oil falling short earlier than coal and natural gas.

The book The Limits to Growth by Donella Meadows and others, published in 1972, discusses the result of early modeling efforts with respect to resource limits. These resource limits were very broadly defined, including minerals such as copper and lithium in addition to fossil fuels. A range of indications were produced, but the base model (based on business as usual) seemed to show limits hitting before 2030 (Figure 1).

Figure 1. Base scenario from the 1972 book, The Limits to Growth, printed using today’s graphics by Charles Hall and John Day in “Revisiting Limits to Growth After Peak Oil.”

Since the resource limits include minerals of all types, these limits would seem to preclude a transition to clean energy and electric cars.

Educators, advertisers, and political leaders could see that discussing the oil problem would cause economic suicide. What would be the point of buying a car, if a person couldn’t use it for very long? Educators felt that students needed to be guided in the direction of hoped-for solutions, no matter how remote they might be, if university programs were to remain open.

Politicians and government officials wanted to keep voters happy, so the self-organizing economy pushed them in the direction of keeping the story from the public. They tended to focus on climate issues instead. They added biofuels to stretch the supply of gasoline, and to a lesser extent, diesel. They also increased the share of natural gas liquids. The selling price of these liquids tends to be quite low, relative to the price of crude oil.

They started providing reports showing “all liquids” rather than “crude oil,” in the hope that people wouldn’t notice the change in mix.

Figure 2. World “total liquids” production by type, based on international data from the US EIA.

[5] The world’s number one problem today seems to be an inadequate supply of Middle Distillates. These provide diesel and jet fuel.

Diesel and jet fuel provide the big bursts of power that commercial equipment requires. Many types of equipment are dependent on Middle Distillates, including semi-trucks, agricultural equipment, ocean-going ships, jet planes, road-making equipment, school buses, and trains operating in areas with steep inclines.

Because of its concentrated store of energy, diesel is also used to operate backup generators and to provide electricity in remote areas of the world where it would be impractical to have year-round electricity without an easily stored fuel.

Figure 3. World oil consumption by product type based on “Regional Consumption” data from the 2023 Statistical Review of World Energy, published by the Energy Institute. Oil includes natural gas liquids.

In Figure 3:

  • Light Distillates are primarily gasoline (78% in 2022).
  • Middle Distillates are diesel (82%) and jet fuel/kerosene (18%).
  • Fuel Oil is a cheap, polluting, unrefined product. If environmental laws permit, it can be burned as bunker fuel (used in ships), as boiler fuel, or to provide electricity.
  • The Other category includes near-gasses such as ethane, propane, and butane (58%). It also includes some very heavy oil used as lubricants, asphalt, or feedstocks for petrochemicals.

Until recently, it has been possible to increase diesel production by refining an added share of Fuel Oil. Fuel oil is quite heavy (barely a liquid), so it is well-suited to be refined into a mix that includes a large share of Middle Distillates.

Now we are running short of Fuel Oil to refine for the purpose of producing more Middle Distillates. The Fuel Oil that is still consumed is used in what I think of as the poorer countries of the world: the non-OECD countries (Figure 4).

Figure 4. World Fuel Oil consumption split between OECD (rich countries) and Non-OECD (poor countries) from the 2023 Statistical Review of World Energy, published by the Energy Institute.

Poor countries tend to value “low price” over “prevents pollution.” It is likely to be difficult to get these countries to move away from the use of Fuel Oil.

[6] Countries around the world are now competing for Middle Distillates to maintain the food production, road building, commercial transportation, and construction portions of their economies.

Figure 5. World per capita consumption of Middle Distillates and Light Distillates based on “Regional Consumption” data from the 2023 Statistical Review of World Energy, published by the Energy Institute.

Figure 5 shows that since about 1983, consumption per capita for both Light Distillates and Middle Distillates has been generally slightly growing. Growth in usage tends to be higher for Middle Distillates than Light Distillates. The total quantity consumed is also higher for Middle Distillates.

The dip in consumption per capita in 2020 is much more pronounced for Middle Distillates than Light Distillates. For Middle Distillates, the change from 2018 to 2020 is -16%; the change from 2018 to 2022 is -7%. The corresponding changes for Light Distillates are -11% and -4%.

The difference in patterns in Light Distillates and Middle Distillates is not surprising: Gasoline, the main product of Light Distillates, has been the focus of efficiency changes. It is also possible to dilute gasoline with ethanol, made from corn. Voters in the US are particularly aware of gasoline availability and price, so politicians tend to focus on it.

Diesel and jet fuel, made using Middle Distillates, are less on the minds of voters, but they are probably more important to the economy because people’s jobs depend upon the economy in its current form holding together. Inadequate Middle Distillates leaves empty shelves in stores because of broken supply lines. It also leads to inflation of the type we have recently been experiencing. Indirectly, lack of Middle Distillates can lead to debt bubbles collapsing, and to problems of a different type than inflation.

Figure 6. Middle Distillate consumption for OECD and non-OECD countries, based on “Regional Consumption” data from the 2023 Statistical Review of World Energy, published by the Energy Institute.

Up until 2007, Middle Distillate consumption was generally increasing for both OECD countries and non-OECD countries. The Great Recession of 2008-2009 particularly affected OECD countries. European countries found their economies doing less well. For example, less diesel was used to operate tour boats carrying tourists; a larger share of available jobs were low-paid service jobs.

The year 2013 was a turning point of a different type. The consumption of non-OECD countries caught up with that of OECD countries. While non-OECD countries might like to maintain their rapid upward trajectory in the consumption of Middle Distillates, this no longer seems to be possible.

[7] Under the Maximum Power Principle, the physics of the economy pushes the economy toward optimal low-cost solutions, especially as the quantity of Middle Distillates approaches limits.

The economy, like every other ecosystem, operates under the principle of “survival of the best adapted.” In terms of the sale of goods, this means that the lowest-priced goods will tend to win out in a competitive environment, provided that they are of adequate quality and that the makers can earn an adequate profit in making them.

Furthermore, the makers of the goods must earn a high enough profit both for reinvestment and to pay adequate taxes to their governments. Payments of taxes to governments are essential; otherwise governmental collapse would occur due to the growing debt that cannot be repaid.

If inflation becomes a problem, rising interest rates would tend to push governments with large amounts of debt toward collapse because they would become unable even to make interest payments from current income.

In this self-organizing economy, buyers of goods don’t know or care much about the lives of the workers in the system. Optimal low costs of manufacturing in a world market might mean:

  • Manufacturers have access to very inexpensive energy sources and use them.
  • Pollution control is ignored to the maximum extent possible, without serious harm to the workers.
  • Governments provide very little in the way of benefits to citizens, such as health care or pensions, keeping the cost of government low.
  • Workers can get along on relatively low salaries because little heating or cooling of homes is needed.
  • Workers don’t expect private vehicles, recreational activities, or advanced medical care.

Because the economy favors the lowest cost of profitable production, a person would expect that warm countries that use oil sparingly in their energy mix (India, the Philippines, and Vietnam, for example) would have a competitive edge over other countries in manufacturing.

In general, a person would expect non-OECD countries to outcompete OECD countries, especially if cheap fuel for manufacturing is available. The lack of cheap fuel is increasingly becoming a problem in many parts of the world. Coal used to be cheap, but its price can now spike. Natural gas prices can also spike, especially if natural gas is purchased without a long-term contract. Electricity using wind and solar tends to be high-priced, too, when the cost of transmission is included.

[8] The Maximum Power Principle seems to be pushing the EU away from diesel.

The EU has a serious oil problem. It has essentially no crude oil production of its own. Furthermore, oil production in Europe outside of the EU (mainly the UK and Norway) has been falling since 1999, greatly reducing the possibility of imported oil from this area (Figure 7).

Figure 7. Total Europe and European Union oil production, including natural gas liquids, based on data from the 2023 Statistical Review of World Energy, published by the Energy Institute.

Under these circumstances, members of the EU found that they needed to import nearly all of their oil, and that most of this oil needed to come from outside Europe.

When I look at the data regarding the types of oil the EU has chosen to consume (nearly all imported), I find that it uses an oil mix that is unusually skewed toward Middle Distillates and away from Light Distillates. (Compare Figure 8 with Figure 3).

Figure 8. EU oil consumed by product type based on “Regional Consumption” data from the 2023 Statistical Review of World Energy, produced by the Energy Institute. Oil includes natural gas liquids.

Part of the reason the EU uses this skewed oil mix is because it has encouraged the use of private passenger cars using diesel through its tax structure. Underlying this tax structure was most likely an understanding that Russia, through its exports of Urals Oil, which is heavy, could provide the EU with the mix of oil products it needed, including extra diesel.

The EU has recently cut off most oil imports from Russia as a way of punishing Russia. This cutoff is being phased in, with most of the impact in 2023 and later. Thus, Figure 8 (which is through 2022) shouldn’t be much affected.

China and India are now buying most of Russia’s exported oil. These countries tend to use the oil more “efficiently” than the EU. In particular, they do more manufacturing than the EU, and they have far fewer private passenger cars per capita than the EU. Furthermore, the EU powers quite a few of its private passenger cars with diesel. If diesel is in short supply, efficiency demands that it should be saved for uses that require it, such as powering heavy equipment.

Because of the efficiency issue, I doubt that the EU will be able to continue importing as high a diesel mix in the future as it has been importing up to now. We know that Saudi Arabia cut back its oil exports by 1 million barrels per day, as of July 1, and this cutback is continuing into August. Russia is also cutting its production by 500,000 barrels a day, effective August 1. If oil prices rise again, I wonder whether the EU will be forced to cut back on its oil imports, essentially because of the Maximum Power Principle.

[9] The substitution of electricity for oil so far has been mostly in the direction of replacing gasoline usage for private passenger automobiles. Substitution of electricity for Middle Distillates would be virtually impossible.

Middle Distillates are largely used for the tough jobs–jobs that require big bursts of power. Electricity and the battery storage required for electricity are not adapted to these tough jobs. The vehicles become too heavy, especially when the big battery packs that would be required are considered. The Wall Street Journal recently reported that battery-powered commercial trucks can cost more than three times the price of diesel-powered trucks, a hurdle much smaller private passenger automobiles don’t face. The wide diversity of types of heavy commercial vehicles would be another huge hurdle in trying to substitute electricity for diesel.

Oil is a mixture of different hydrocarbon lengths. Substitution of electricity for one part of the hydrocarbon mix, namely for the Light Distillates, is not very helpful. Oil companies need to be able to sell all parts of the mix in order to make their extraction efforts worthwhile. If oil companies find themselves without buyers for most Light Distillates, they would have difficulty recouping their overall costs. There would be a possibility of oil production stopping. Without oil, farming would mostly stop. Road repair would stop. Today’s economy would come to a halt.

Of course, as a practical matter, the vast majority of the world will pay no attention to mandates that all private passenger automobiles be EVs. Buyers in most parts of the world will make decisions based on which cars are least expensive to own and operate. As a result, there is little chance of private passenger cars being completely replaced by EVs. Instead, EV mandates in some countries may somewhat reduce the selling price of gasoline worldwide because these drivers are no longer using gasoline. With lower gasoline prices, non-EV’s are likely to become cheaper to operate in countries where they are permitted, boosting their sales. This is an effect similar to Jevons Paradox.

[10] There are many related topics that could be addressed, but they will need to wait until later posts.

A few of samples of other issues:

[a] The world economy is tightly networked together. Inadequate oil supplies per capita tend to push the economy toward forced reduced activity, as was the case in 2020. Oil prices likely won’t rise a whole lot higher, for very long, if the economy is forced to shrink.

[b] Inadequate oil supplies per capita also tend to cause fighting among countries. OECD countries seem to over consume, relative to the benefits they provide to the rest of the world. Perhaps some grouping of non-OECD countries (or parts of countries) will take over in leadership roles.

[c] The self-organizing economy has different priorities than human leaders. All ecosystems in a finite world go through cycles. As conditions change, different species are favored, and new species emerge. Humans have a strong preference for recent conditions that helped humans thrive. Humans need a religion to follow, so leaders have created environmental sin to replace original sin. The catch is that ecosystems are built for change. Pollution can be viewed as a type of fertilizer for different types of species or recent mutations to thrive. Higher temperatures will have a net favorable effect for some organisms.

[d] If a local economy chooses to increase energy costs by taking steps to reduce its carbon footprint, the main impact may be to disadvantage the local economy relative to the world economy. If total energy costs are higher, the cost of finished goods and services is likely to be higher, making the economy less competitive.

[e] I expect that the members of the EU and other rich nations will be the primary countries pursuing carbon reduction technologies. Poorer economies may pay lip service to carbon reduction, but they will tend to focus primarily on increasing the welfare of their own people, whether or not this requires more carbon.

For example, in 2022, China accounted for 66% of global EV sales (5.0 million out of 7.7 million), thanks to subsidies that China made available. China no doubt had many motives, but one of them would seem to be to stimulate the economy. Another motive would be to increase the total number of vehicles in operation. The majority (61%) of electricity generation in China in 2022 was provided by electricity coming from coal-fired power plants, based on information from the Energy Institute. I would expect that more Chinese vehicles manufactured and placed into operation plus more use of electricity from coal would lead to a greater quantity of carbon emissions, rather than a smaller quantity.

Posted in Introductory Post, oil shortages | Tagged , , , | 3,527 Comments

The World Economy Is Becoming Unglued; Models Miss Real-World Behavior

Posted on June 30, 2023 by Gail Tverberg

A common belief is that if the world does not have adequate energy, the result will be high prices. These high prices will allow more fossil fuels to be extracted or will allow renewables to substitute for fossil fuels.

In my view, the real issue is quite different: Inadequate energy supply of the types the economy requires can be expected to affect the economy in a way that causes it to become “unglued.” The economy will gradually fall apart as infighting becomes more of a problem. Goods won’t necessarily be high-priced; many simply won’t be available at any price. Political parties will fragment. Conflict within countries, such as the recent Wagner conflict with the military leadership in Russia, will become more common.

It has become fashionable to use models to predict the future, but simple models do not consider real-world dynamics. They don’t consider the importance of already existing infrastructure and the types of energy products this infrastructure requires. They don’t consider the importance of continuing food production. They don’t consider the dynamics of “not enough goods and services to go around.”

In this post, I will look at some pieces of evidence that suggest we should expect the world economy to become unglued as limits are hit. A corollary is that we cannot expect a transition to a world powered by renewables to work.

[1] It is easy to show that the energy supplies of a finite world will eventually fall short.

Anyone can model the energy supplies of a finite world as a bucket of sand and a scooper. If the scooper is used to remove the sand from the bucket, it will eventually become empty. If we start with a larger bucket of sand, perhaps the process can be delayed. Or, if we use a smaller scooper, the process will be delayed. But the result will be the same.

Back in 1957, Rear Admiral Hyman Rickover of the US Navy gave a speech in which he said,

For it is an unpleasant fact that according to our best estimates, total fossil fuel reserves recoverable at not over twice today’s unit cost, are likely to run out at some time between the years 2000 and 2050, if present standards of living and population growth rates are taken into account.

In this speech, Rickover pointed out the importance of fossil fuels to maintain our standard of living and to win wars. It was clear to the military that fossil fuel energy supplies were tremendously important in preventing future problems for the economy.

[2] History shows that economies tend to grow and eventually collapse.

Economies tend to operate in cycles, as illustrated in Figure 1.

Figure 1. My chart of the findings of Peter Turchin and Surgey Nefedov in their 2009 book, Secular Cycles.

The eight economies analyzed by Turchin and Nefedov moved into a new area or acquired a new energy resource. These economies tended to grow for a long periods, well over 100 years, until the populations hit the carrying capacity of the available resources. These economies were able to work around these resource limits during a period of Stagflation, which typically lasted about 50 to 60 years. Eventually, the problems became too great to be overcome. A Crisis Period of falling population and GDP, lasting 20 to 50 years, typically ensued.

[3] The world economy today seems to be following a similar cycle based on its use of fossil fuels. In fact, we seem to be in the Crisis Period of such a cycle.

Today’s fossil fuel-based world economy started growing at varying times, in various places around the world, becoming well established by the early 1800s. It seems to have hit a Stagflation Period between 1970 and 1980. Recent patterns in oil supply per capita, interest rates, and debt levels suggest to me that the world economy has entered the Crisis Period of the current cycle.

To me, oil supply, particularly crude oil supply, is exceptionally important in keeping the economy growing because it is heavily used in producing the food supply and transporting it to market. In fact, it is heavily used in transportation of all kinds. We can see what is going wrong by looking at the trend in crude oil per capita (blue line on Figure 2).

Figure 2. World oil supply per capita based on data of the US Energy Information Administration.

On Figure 2, a line is drawn at 2005, when many people believe that peak “conventional” oil was reached. The line at 2009 points out the long-term slide in oil consumption per capita between 2005 and 2009, related at least in part to the Great Recession of 2008-2009. There was another steep drop in crude oil per capita in 2020, and this drop has not been made up. Cutbacks in drilling and low oil prices suggest that per capita consumption may never recover to the 2018 level.

US interest rates over time indicate a clear up and down pattern, with increases to 1981, and mostly decreases since then (Figure 3). Raising interest rates is like putting brakes on the economy because it makes monthly payments on loans higher. Lowering interest rates is like pressing on the accelerator.

Figure 3. Interest rates of 3-month Treasury Bills, 10-year Treasury Securities, and 30-year Fixed Rate Mortgages, based on information of the Federal Reserve of Saint Louis.

The US was in a Stagflation Period after 1980. Lower interest rates helped push the economy along, at least until they could go no lower. The first place falling interest rates stalled was in 2008, when they hit zero for the shortest-term debt. About the beginning of 2021, interest rates started to rise, to try to stop inflation.

At the same time, the US’s ability to add to debt, except US government debt, seems to have stalled about 2008 and again in 2021.

Figure 4. US ratios of debt to GDP by sector based on data from the Federal Reserve of St. Louis database. Amounts for total debt and for Households (which includes not-for-profits, such as churches), Business Non-Financial, and Federal Government are from this database. Financial+ is calculated by subtraction.

The combination of Figures 2, 3, and 4 suggests that the world economy has been on shaky ground since 2008. The US economy has been operating with incredibly low interest rates. If the world loses the ability to hide energy problems behind ever-lower interest and ever-higher debt, (particularly government debt), many parts of the economy could start coming apart.

[4] The world’s total energy supply must increase at least as fast as population to keep the economy growing and away from collapse.

A couple of years ago, I did an analysis of the growth in energy consumption compared to the growth of population over the period 1820 to 2020. I found that when energy consumption was rising faster than population, there tended to be a rise in standards of living. When energy consumption grew only as fast as population, problematic things (such as wars and governmental collapses) tended to happen (Figure 5).

Figure 5. Chart by Gail Tverberg using data from several sources, in energy data from Vaclav Smil’s estimates from Energy Transitions: History, Requirements and Prospects, together with BP Statistical Data for 1965 and subsequent.

On Figure 5, the sum of red and blue areas represents world energy consumption growth by 10-year periods. The blue areas represent population growth percentages during these 10-year periods. The red area is determined by subtraction. It represents the amount of energy consumption growth that is “left over” for growth in standards of living. When growth in energy consumption was inadequate, wars tended to take place, and the collapse of the central government of the Soviet Union took place.

We are now at a point where energy consumption may decrease dramatically in future years, especially if we attempt to convert to a system based on intermittent wind and solar. The drop in energy consumption, relative to population, would likely be far worse than any situation we have experienced in the past. Besides being inadequate in quantity, wind and solar are not adapted to handling our most basic need, which is for providing the inputs farmers require to provide us with food.

[5] A key to understanding the role of fuels of the right kinds is understanding the physics-based way that the economy operates.

The economy is very much like the human body. The operation of both is governed by the laws of physics. The human body needs to consume a variety of food products. Alternative foods can be substituted, but the overall quantity of food needs to be sufficient for the population and their level of activity.

Likewise, the world economy requires a variety of energy products to operate. Substitutions can sometimes be made, but the overall quantity must be sufficient to support the activities of the economy, including providing adequate food and water for the population and ways to transport these items to the population that needs them.

There are other similarities, as well. Humans start out as small babies. Eventually, humans grow old. In the years leading up to death, they often become frail. The cycle downward at the end of an economy’s life is somewhat similar. Economies, even the world economy, cannot last forever.

[6] To build and maintain cities, it is necessary for energy to be easily storable.

In his book, Against the Grain, the American political scientist James C. Scott points out that in order for governments to grow and to provide infrastructure for cities, it is necessary to tax farmers. Grain is ideal for this; taxing a root crop such as sweet potatoes does not work well. Root crops are hard to see when they are growing. They also are harder to transport and store.

Clearly, farmers must have a surplus of storable energy to make cities and good roads work. They must be able to produce this surplus energy in a sufficiently profitable way that governments can tax it and use the proceeds for the benefit of the overall population.

I think that excess storable energy is the true “net energy” that some authors write about. A city cannot operate only when the wind happens to be blowing or the sun happens to be shining. Everyone would clog the roads at the same time, trying to get to a job that might last only a few minutes. Even today, if a city is to have electricity when it is needed, even in winter, there needs to be a storable supply of fuel to provide this electricity. Batteries cannot provide this level of storage; we would run out of materials.

Cities are essential for the sharing of ideas and for the operation of major industries.

We can have an economy of hunter-gatherers running on intermittent energy alone. We might even be able to have cities based on stored grain, as civilizations did in the past. But the population would need to be far less than today’s 8 billion.

[7] Both energy density and storability are needed if the world’s population is to be fed.

A farmer needs machines that are not so heavy that they will sink into the soil. Soil compaction is also an issue with heavy machines. If soil is compacted, water cannot make its way through the pores properly. Rain will tend to run off, causing erosion, instead of sinking in, to provide longer-term benefit. Soil compaction is already a problem with today’s large machinery. Less dense fuels, or the use of heavy battery packs, will make the problem even worse.

Energy dense fuel is also needed for the transportation of food. In fact, energy dense fuel, such as diesel or jet fuel, is used in nearly all of today’s very large vehicles. Heavy vehicles operated in situations that require very large bursts of power especially need energy dense fuel. Examples include semi-trailer trucks, buses that drive up steep hills, airplanes that need bursts of power to take off, agricultural vehicles that might get stuck in mud, and vehicles used in construction and road making.

Trains operating on smooth tracks, with limited gradients, don’t need the same bursts of power, so they are sometimes electric. Boats don’t generally need large bursts of power, but boats generally use an energy-dense liquid fuel to propel them on long journeys. Storing enough electricity in batteries to power such long journeys would be impractical.

The recently published 2023 Statistical Review of World Energy (now produced by the Energy Institute, instead of BP) shows that the heavier, more energy-dense types of burnable oil have been falling as a share of the world’s oil supply.

Figure 6. Chart shows that more energy dense types of oil products (sum of diesel, jet fuel/kerosene, and fuel oil) have been falling relative to the world supply of diesel or total liquids oil. All amounts used in the calculation are from EI’s 2023 Statistical Review of World Energy, except for world crude oil for 1980 through 1999, which is based on EIA data.

These heavier grades are the ones best suited to essential future energy needs, and they seem to be depleting the most quickly.

[8] Added complexity is deceptive. It looks like it can save energy, but it tends to increase wage disparities and makes the overall system more fragile.

Added complexity for an economy includes changes such as more built infrastructure (roads, dams, bridges), larger businesses, more specialization of workers, more international trade, and longer supply chains. It is easy for modelers to assume that these changes have no energy cost, but in reality, they do.

Changes enabling growing complexity go hand in hand with more debt and more financialization of the economy. With greater complexity, owners and managers of businesses, as well as highly trained workers, tend to receive a disproportionate share of the wealth. This means that little is left over for non-elite workers. These wage and wealth disparities lead to the unhappiness of the lower-paid workers. This is especially the case during economic downturns.

With added complexity, the system becomes more fragile. Supply lines become longer, so missing parts are more likely to be a problem. Repair parts for wind turbines may become unavailable, for example. The US grid would need massive improvements to handle the proposed increase in wind and solar power, and the demands of EVs. All of the simultaneous commodity demands may become too much for suppliers to meet.

Even changes in financial systems could be a serious problem. With the conflict over the SWIFT money processing system, will one group of countries start using a different financial exchange program, such as Iran’s financial messaging system SEPAM? Will Western nations find themselves cut off from purchasing inputs they depend upon?

[9] Modeling underlying the analysis for the 1972 book The Limits to Growth shows that (total materials required for reinvestment each year) as a percentage of (total economic output) is an important limit.

Somehow, the economy must provide enough goods and services both for the needs of the current members of the economy and for the investment needed to keep the system operating in the future.

The economy is squeezed in three different ways:

  • The population keeps growing, and each person needs food, clothing, and a variety of services.
  • Resources of all kinds (not just fossil fuels) become more difficult to extract due to depletion. More of the output of the economy needs to go into investment, just to get the same quantity of copper, lithium, nickel, and minerals of all kinds, including fossil fuels.
  • With the rising population and increasing resource use, pollution becomes a bigger problem. Mitigation efforts lead to a need to use more resources to keep pollution away from humans.

To keep the system operating, we cannot spend very much on the combination of resource extraction and pollution control, or there will not be enough resources left to meet the needs of the growing population.

This combination limit tells me is that a rapid transition of any kind toward any new energy type, even toward the use of “green energy,” is not likely to work well. There is a reason why past transitions to new energy types have been very slow. The economy cannot invest enough without starving other parts of the economy.

Some people have interpreted this combination limit as an Energy Return on Energy Investment limit of perhaps 10:1, but it seems to me to be a far more serious limit than this. At a minimum, all types of resources, including those for backup batteries and additional long distance transmission lines, must be included in any calculation for renewables.

Also, to keep the system operating, any shift from fossil fuels to renewables cannot have a delayed payback period, relative to fossil fuels, or the huge up-front investment will become a problem. The up-front investment in renewables will be higher, but there will not be enough output to support the economy. The “real” economy does not operate on an accrual basis; people need to eat every day, and aluminum smelters expect to operate every day.

As I mentioned previously, renewables aren’t really helpful for growing food. Nor are reliable enough to power aluminum smelters, so there is a real issue as to whether they should even be considered as possible substitutes for fossil fuels. They are simply add-ons to the fossil fuel system to avoid having to talk about our fossil fuel supply problems. Reframing the issue as “wanting to move away from fossil fuels to prevent climate change” saves having to talk about the inadequate fossil fuel supply problem, and the fact that fossil fuels are what make today’s lifestyle possible.

[10] Energy prices must be both high enough for producers to make a profit and low enough for consumers to afford goods made with these energy products.

It is the conflict between the needs of consumers and producers that tends to bring fossil fuel energy production down. Consumers say, “We can’t stand oil (or natural gas or electricity) prices this high, and demand that politicians hold prices down.” In fact, this just recently happened in Australia with natural gas prices. Without an adequate profit motive, drillers cut back on drilling and production falls.

Renewables have gotten mandates and subsidies, especially the subsidy of going first on the electric grid. It is these subsidies and mandates that have made investments in wind turbines and solar panels attractive. Once governments have more financial problems and these subsidies disappear, owners are likely to stop making repairs to these systems. They will not last longer than fossil fuel-based systems, in my opinion.

[11] Conclusion: We are in uncharted territory.

I mentioned that the Great Recession of 2008-2009 seemed to mark the beginning of the downturn. More financial problems are no doubt ahead, but other kinds of strange events may also occur.

It seems possible that Covid, its vaccines, and the restrictions in 2020 may even have been part of the “ungluing.” Self-organizing physics-based systems act strangely. World oil supply started declining in 2019. Militaries around the world have been concerned about fossil fuel limits for many years. Militaries have also been deeply involved with germ warfare. Economies around the world were experiencing financial problems. The shutdowns conveniently reduced demand and prices for oil, while giving economies around the world an excuse for more debt. The problems were kicked down the road until 2022 and 2023, when they reappeared as inflation.

We can’t know what lies ahead, but it may be very strange, indeed.

Posted in Energy policy, Financial Implications | Tagged , , , | 3,059 Comments

Models Hide the Shortcomings of Wind and Solar

Posted on June 2, 2023 by Gail Tverberg

A major reason for the growth in the use of renewable energy is the fact that if a person looks at them narrowly enough–such as by using a model–wind and solar look to be useful. They don’t burn fossil fuels, so it appears that they might be helpful to the environment.

As I analyze the situation, I have reached the conclusion that energy modeling misses important points. I believe that profitability signals are much more important. In this post, I discuss some associated issues.

Overview of this Post

In Sections [1] through [4], I look at some issues that energy modelers in general, including economists, tend to miss when evaluating both fossil fuel energy and renewables, including wind and solar. The major issue in these sections is the connection between high energy prices and the need to increase government debt. To prevent the continued upward spiral of government debt, any replacement for fossil fuels must also be very inexpensive–perhaps as inexpensive as oil was prior to 1970. In fact, the real limit to fossil fuel extraction and to the building of new wind turbines and solar panels may be government debt that becomes unmanageable in an inflationary period.

In Section [5], I try to explain one reason why published Energy Return on Energy Investment (EROEI) indications give an overly favorable impression of the value of adding a huge amount of renewable energy to the electric grid. The basic issue is that the calculations were not set up for this purpose. These models were set up to evaluate the efficiency of generating a small amount of wind or solar energy, without consideration of broader issues. If these broader issues were included, EROEI indications would be much lower (less favorable).

One of the broader issues omitted is the fact that the electrical output of wind turbines and solar panels does not match up well with the timing needs of society, leading to the need for a great deal of energy storage. Another omitted issue is the huge quantity of energy products and other materials required to make a transition to a mostly electrical economy. It is easy to see that both omitted issues would add a huge amount of energy costs and other costs, if a major transition is made. Furthermore, wind and solar have gotten along so far using hidden subsidies from the fossil fuel energy system, including the subsidy of being allowed to go first on the electricity grid. EROEI calculations cannot evaluate the amount of this hidden subsidy.

In Section [6], I point out the true indicator of the feasibility of renewables. If electricity generation using wind and solar energy are truly helpful to the economy, they will generate a great deal of taxable income. They will not require the subsidy of going first, or any other subsidy. This does not describe today’s wind or solar.

In Section [7] and [8], I explain some of the reasons why EROEI calculations for wind and solar tend to be misleadingly favorable, even apart from broader issues.

Economic Issues that Energy Modelers Tend to Miss

[1] The economy is very short of oil that is inexpensive-to-extract. The economy seems to require a great deal more government debt when energy prices are high. Models for renewable energy production need to consider this issue, even if any substitution for oil is very indirect.

I think of the problem of rising energy prices for an economy as being like a citizen faced with an increase in food costs. The citizen will attempt to balance his budget by adding more debt, at least until his credit cards get maxed out. This is why we should expect to see an increase in government debt when oil prices are high; oil and other fossil fuels are as essential to the economy as food is to humans.

Figure 1. Year by year comparison of US government receipts with US government expenditures, based on data of the US Bureau of Economic Analysis, together with boxes showing when oil prices were in the range of about $20 per barrel or less, after adjusting for inflation. Series shown is from 1929 to 2022.

Figure 1 shows that most US government funding shortfalls occurred when oil prices were above $20 per barrel, in inflation-adjusted prices. For the 15-year period 2008 through 2022, US government expenditures were 26% higher than its receipts.

Figure 2 shows a reference chart of average annual oil prices, adjusted for inflation.


Figure 2. Average annual inflation-adjusted Brent oil prices based on data from BP’s 2022 Statistical Review of World Energy.

The reason why oil prices tend to be high now is because the inexpensive-to-extract oil has mostly been extracted. What is left is oil that is expensive to extract. The low prices in the years surrounding 1998 reflected a supply-demand mismatch after the Asian Economic Crisis of 1997. The crisis held down demand at the same time as production was ramping up in Iraq, Venezuela, Canada, and Mexico.

[2] Economists tend to assume that shortages of oil will lead to much higher fossil fuel prices, thereby making renewables inexpensive in comparison. One reason this doesn’t happen is related to the buildup of debt, noted in Figure 1, when oil prices are high.

Section [1] shows that high oil prices seem to be associated with government deficits. A high-priced substitute for oil would almost certainly have a similar problem. This governmental debt tends to build up, and at some point becomes almost unmanageable.

A major problem occurs when there is a round of inflation. Central banks find a need to increase interest rates, partly to keep lenders interested in lending in an inflationary economy and partly to try to slow the inflation rate. In fact, the US is currently being tested by such a debt buildup and increase in interest rates, beginning about January 2022 (Figure 3).

Figure 3. Chart by the Federal Reserve of St. Louis showing US 30-year mortgage rates, interest rates of 10-year Treasuries, and interest rates of 3-month Treasury Bills from 1935 through May 2023.

Higher interest rates tend to have the effect of slowing the economy. In part, the economy slows because the cost of borrowing money rises. As a result, businesses are less likely to expand, and would-be auto owners are likely to put off new purchases because of the higher monthly payments. Commercial real estate can also be adversely affected by rising interest rates if owners of buildings find it impossible to raise rents fast enough to keep up with higher interest rates on mortgages and higher costs of other kinds.

[3] It is uncertain in exactly which ways the economy might contract, in response to higher interest rates. Some ways the economy could contract would bring an early end to both the extraction of fossil fuels and the manufacturing of renewables. This is not reflected in models.

If the economy contracts, one possible result is a recession with lower oil prices. This clearly doesn’t fix the problem of the cost of wind and solar electricity being unacceptably high, especially when the cost of all the batteries and additional transmission lines is included. In some sense, the price needs to be equivalent to a $20 per barrel oil price, or lower, to stop the huge upward debt spiral.

Another possibility, rather than the US economy as a whole contracting, is that the US government will disproportionately contract; perhaps it will send many programs back to the states. In such a scenario, there is likely to be less, rather than more, funding for renewables. I understand that Republicans in Texas are already unhappy with the high level of wind and solar generation being used there.

A third possibility is hyperinflation, as the government tries to add more money to keep the overall system, especially banks and pension plans, from failing. Even with hyperinflation, there is no particular benefit to renewables.

A fourth possibility is disruption of trade relationships between the US and other countries. This could even be related to a new world war. Renewables depend upon worldwide supply lines, just as today’s fossil fuels do. Building and maintaining the electrical grid also requires worldwide supply lines. As these supply lines break, all parts of the system will be difficult to maintain; replacement infrastructure after storms will become problematic. Renewables may not last any longer than fossil fuels.

[4] Economists tend to miss the fact that oil prices, and energy prices in general, need to be both high enough for the producer to make a profit and low enough for consumers to afford finished goods made with the energy products. This two-way tug-of-war tends to keep oil prices lower than most economists would expect, and indirectly caps the total amount of oil that can be extracted.

Figure [2] shows that, on an annual average basis, inflation-adjusted Brent oil prices have only exceeded $120 per barrel during the years 2011, 2012 and 2013. On an annual basis, oil prices have not exceeded that level since then. For a while, forecasts of oil prices as high as $300 per barrel in 2014 US dollars were being shown as an outside possibility (Figure 4).

Figure 4. IEA’s Figure 1.4 from its World Energy Outlook 2015, showing how much oil can be produced at various price levels.

With close to another decade of experience, it has become clear that high oil prices don’t “stick” very well. The economy then slides into recession, or some other adverse event takes place, bringing oil prices back down again. The relatively low maximum to fossil fuel prices tends to lead to a much earlier end to fossil fuel extraction than most analyses of available resource amounts would suggest.

OPEC+ tends to reduce supply because they find prices too low. US drillers of oil from shale formations (tight oil in Figure 4) have been reducing the number of drilling rigs because oil prices are not high enough to justify more investment. Politicians know that voters dislike inflation, so they take actions to hold down fossil fuel prices. All these approaches tend to keep oil prices low, and indirectly put a cap on output.

Why Indications from EROEI Analyses Don’t Work for Electrification of the Economy

[5] Energy Return on Energy Invested (EROEI) analyses were not designed to analyze the situation of a massive scaling up of wind and solar, as some people are now considering. If utilized for this purpose, they provide a far too optimistic an outlook for renewables.

The EROEI calculation compares the energy output of a system to the energy input of the system. A high ratio is good; a low ratio tends to be a problem. As I noted in the introduction, published EROEIs of wind and solar are prepared as if they are to be only a very small part of electricity generation. It is assumed that other types of generation can essentially provide free balancing services for wind and solar, even though doing so will adversely affect their own profitability.

A recent review paper by Murphy et al. seems to indicate that wind and solar have favorable EROEIs compared to those of coal and natural gas, at point of use. I don’t think that these favorable EROEIs really mean very much when it comes to the feasibility of scaling up renewables, for several reasons:

[a] The pricing scheme generally used for wind and solar electricity tends to drive out other forms of electrical generation. In most places where wind and solar are utilized, the output of wind and solar is given priority on the grid, distorting the wholesale prices paid to other providers. When high amounts of wind or solar are available, wind and solar generation are paid the normal wholesale electricity price for electricity, while other electricity providers are given very low or negative wholesale prices. These low prices force other providers to reduce production, making it difficult for them to earn an adequate return on their investments.

This approach is unfair to other electricity providers. It is especially unfair to nuclear because most of its costs are fixed. Furthermore, most plants cannot easily ramp electricity production up and down. A recently opened nuclear plant in Finland (which was 14 years behind plan in opening) is already experiencing problems with negative wholesale electricity rates, and because of this, is reducing its electricity production.

Historical data shows that the combined contribution of wind, solar, and nuclear doesn’t necessarily increase the way that a person might expect if wind and solar are truly adding to electricity production. In Europe, especially, the availability of wind and solar seems to be being used as an excuse to close nuclear power plants. With the pricing scheme utilized, plants generating nuclear energy tend to lose money, encouraging the owners of plants to close them.

Figure 5. Combined wind, solar and nuclear generation, as a percentage of total energy consumption, based on data from BP’s 2022 Statistical Review of World Energy. The IEA and BP differ on the approach to counting the benefit of wind and solar; this figure uses the IEA approach. The denominator includes all energy, not just electricity.

The US has been providing subsidies to its nuclear plants to prevent their closing. When one form of electricity gets a subsidy, even the subsidy of going first, other forms of electricity seem to need a subsidy to compete.

[b] Small share of energy supply. Based on Figure 5, the total of wind, solar, and nuclear electricity only provides about 6.1% of the world’s total energy supply. An IEA graph of world energy consumption (Figure 6) doesn’t even show wind and solar electricity separately. Instead, they are part of the thin orange “Other” line at the top of the chart; nuclear is the dark green line above Natural Gas.

Figure 6. Chart prepared by the International Energy Association showing energy consumption by fuel through 2019. Chart is available through a Creative Commons license.

Given the tiny share of wind and solar today, ramping them up, or those fuels plus a few others, to replace all other energy supplies seems like it would be an amazingly large stretch. If the economy is, in fact, much like a human in that it cannot substantially reduce energy consumption without collapsing, drastically reducing the quantity of energy consumed by the world economy is not an option if we expect to have an economy remotely like today’s economy.

[c] Farming today requires the use of oil. Transforming farming to an electrical operation would be a huge undertaking. Today’s farm machinery is mostly powered by diesel. Food is transported to market in oil-powered trucks, boats, and airplanes. Herbicides and pesticides used in farming are oil-based products. There is no easy way of converting the energy system used for food production and distribution from oil to electricity.

At a minimum, the entire food production system would need to be modeled. What inventions would be needed to make such a change possible? What materials would be required for the transformation? Where would all these materials come from? How much debt would be required to fund this transformation?

The only thing that the EROEI calculation could claim is that if such a system could be put in place, the amount of fossil fuels used to operate the system might be low. The overwhelming complexity of the necessary transformation has not been modeled, so its energy cost is omitted from the EROEI calculation. This is one way that calculated EROEIs are misleadingly optimistic.

[d] EROEI calculations do not include any energy usage related to the storage of electricity until it is needed. Solar energy is most available during the summer. Thus, the most closely matched use of solar electricity is to power air conditioners during summer. Even in this application, several hours’ worth of battery storage are needed to make the system work properly because air conditioners continue to operate after the sun sets. Also, people who come home from work need to cook dinner for their families, and this takes electricity. Energy costs related to electricity storage are not reflected in the EROEIs shown in published summaries such as those of the Murphy analysis.

A much more important need than air conditioning is the need for heat energy in winter to heat homes and offices. Neither wind nor solar can be counted upon to provide electricity when it is cold outside. One workaround would be to greatly overbuild the system, so that there would be a better chance of the renewable source producing enough electricity when it is needed. Adding several days of storage through batteries would be helpful too. An alternate approach would be to store excess electricity indirectly, by using it to produce a liquid such as hydrogen or methanol. Again, all of this becomes complex. It needs to be tried on small scale, and the real cost of the full system determined.

Both the need to overbuild the system and the need to provide storage are excluded from EROEI calculations. These are yet other ways that EROEI calculations provide an overly optimistic view of the value of wind and solar.

[e] Long distance travel. We use oil products for long distance transport by ship, air, truck, and train. If changes are to be made to use electricity or some sort of “green fuels,” this is another area where the entire change would need to be mapped out for feasibility, including the inventions needed, the materials required, and the debt this change would entail. What timeframe would be required? Would there be any possibility of achieving the transformation by 2050? I doubt it.

The conversion of all transportation to green energy is very much like the needed conversion of the food system from oil to electricity, discussed in [5c], above. Huge complexity is involved, but the energy cost of this added complexity has been excluded from EROEI calculations. This further adds to the misleading nature of EROEI indications for renewables.

[f] A dual system is probably needed. Even if it makes sense to ramp up wind and solar, there still will be a need for many products that are today made with fossil fuels. Fossil fuels are used in paving roads and for making lubrication for machines. Herbicides, insecticides, and pharmaceutical products are often made from fossil fuels. Natural gas is often used to make ammonia fertilizer. Fabrics and building materials are often made using fossil fuels.

Thus, it is almost certain that a dual system would be needed, encompassing both fossil fuels and electricity. There are likely to be inefficiencies in such a dual system. If intermittent renewables such as wind and solar are to be a major part of the economy, this inefficiency needs to be part of any model and needs to be reflected in EROEI calculations.

[g] “Renewable” devices are not themselves recyclable. Instead, they present a waste disposal problem. Solar panels especially present a toxic waste problem. Without much recycling, there is a long term need for minerals of many types to be extracted and transported around the world. These issues are not considered in modeling.

Profitability of Unsubsidized Renewables Is the Best Measure

[6] If renewables are to be truly useful to the system, they need to be so profitable that their profits can be taxed at a high rate. Furthermore, sufficient funds should be left over for reinvestment. The fact that this is not happening is a sign that renewables are not truly helpful to the economy.

Some people talk about the need for “surplus energy” from energy sources to power an economy. I connect this surplus energy with the ability of any energy source to generate income that can be taxed at a fairly high rate. In fact, I gave a talk to the International Society for Biophysical Economics on September 7, 2021, called, To Be Sustainable, Green Energy Must Generate Adequate Taxable Revenue.

The need for surplus energy that can be transferred to the government is closely connected with the debt problem that occurs when oil prices are higher than about $20 per barrel that I noted in Section [1] of this post. Renewable energy must be truly inexpensive, with all storage included, to be helpful to the economy. It must be affordable to citizens, without subsidies. The cost structure must be such that the renewable energy generates so much profit that it can pay high taxes. It is unfortunately clear that today’s renewables are too expensive for the US economy.

EROEI Models Can’t Tell Us as Much as We Would Like

[7] In the real economy, the economy builds up in small pieces, as new approaches prove to be profitable and as all the necessary components prove to be available. EROEI models shortcut this process, but they can easily be misleading.

The concept of Energy Return on Energy Invested has been used for many years in the field of biology. For example, we can compare the energy a fish gets from the food it eats to the energy the fish expends swimming to procure that food. The fish needs to get sufficient energy value from the food it eats to be able to cover the energy expended on the swim, plus a margin for other bodily functions, including reproduction.

Professor Charles Hall (and perhaps others) adapted this concept for use in comparing different energy “extraction” (broadly defined) techniques. More recent researchers have tried to extend the calculation to include energy costs of delivery to the user.

The adaptation of the biological concept of EROEI to the various processes associated with energy extraction works in some respects but not in others. The adaptation clearly works as a tool for teaching diminishing returns. It gives reasonable information for comparing oil wells to each other, or solar panels to other solar panels. But I don’t think that EROEI comparisons across energy types works well at all.

One issue is that there are huge differences in the selling prices of different types of energy. These are ignored in EROEI calculations, making it look feasible to use a high-priced type of energy (such as oil) to produce a low-valued type of output (intermittent electricity from wind turbines or solar panels). If profitability calculations were made instead, without mandates or subsidies (including the subsidy of going first), the extent to which there is a favorable return would become clear.

Another issue is that intermittency of wind and solar adds huge costs to the system, but these are ignored in EROEI calculations. (The situation is somewhat like having workers drop in and leave according to their own schedules, rather than working during the schedule the employer prefers.) In EROEI calculations, the assumption usually made is that the fossil fuel system will provide free balancing services by operating their electricity generation systems in an inefficient manner. In fact, this is the assumption made in the Murphy paper cited previously.

An analysis by Graham Palmer gives some insight regarding the high energy cost of adding battery backup (Figure 7).

Figure 7. Slide based on information in the book, “Energy in Australia,” by Graham Palmer. His chart shows “Dynamic Energy Returned on Energy Invested.”

In Figure 7, Palmer shows the pattern of energy investment and energy payback for a particular off-grid home in Australia which uses solar panels and battery backup. His zig-zag chart reflects two offsetting impacts:

(a) Energy investment was required at the beginning, both for the solar panels and for the first set of batteries. The solar panels in this analysis last for 30 years, but the batteries only last for 7.5 years. As a result, it is necessary to invest in new batteries, three additional times over the period.

(b) Solar panels only gradually make their payback.

Palmer finds that the system would be in a state of energy deficit (considering only energy out versus energy in) for 20 years. At the end of 30 years, the combined system would return only 1.3 times as much energy as the energy invested in the system. This is an incredibly poor payback! EROEI enthusiasts usually look for a payback of 10 or more. The solar panels in the analysis were close to this target level, at 9.4. But the energy required for the battery backup brought the EROEI down to 1.3.

Palmer’s analysis points out another difficulty with wind and solar: The energy payback is terribly slow. If we burn fossil fuels, the economy gets a payback immediately. If we manufacture wind turbines or solar panels, there is a far longer period of something that might be called, “energy indebtedness.” EROEI calculations conveniently ignore interest charges, again making the situation look better than it really is. The buildup in debt is also ignored.

Thus, even without the issue of scaling up renewables if we are to make a transition to energy system more focused on electricity, EROEI calculations are set up in a way that make intermittent renewable energy look far more feasible than it really is. “Energy Payback Period” is another similar metric, with similar biases.

The fact that these metrics are misleading is difficult to see. Very inexpensive fossil fuels pay back their cost many times over, in terms of societal gain, virtually immediately. Wind turbines and solar panels depend upon the generosity of the fossil fuel system to get any payback at all because intermittent electricity cannot support an economy like today’s economy. Even then, the payback is only available over a period of years.

I am afraid that the only real way of analyzing the feasibility of scaling up electricity using wind and solar is by looking at whether they can be extraordinarily profitable, without subsidies. If so, they can be highly taxed and end our government debt problem. The fact that wind and solar require subsidies and mandates, year after year, should make it clear that they aren’t solutions.

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The bumpy road ahead for the world economy

Posted on May 4, 2023 by Gail Tverberg

In the post-World War II era, the US has been known for its hegemony–in other words, its leadership role in the world economy. According to one definition, hegemony is the political, economic, and military predominance of one state over other states. I believe that the US is not far from losing its hegemony. The conflict over future hegemony could lead to a major war.

Hegemony is surprisingly closely tied to leadership in energy consumption. A country with a high share of the world’s energy consumption doesn’t have to depend on imported goods and services from around the world. It can manufacture weapons of war, if it chooses, in as large quantities as it chooses, without waiting for outside suppliers.

One part of today’s problem is the fact that the world’s fossil fuel supply, particularly oil, is becoming depleted. Extraction is not rising sufficiently to keep up with population growth. In fact, total fossil fuel extraction may begin to fall in the near future. In some sense, the fossil fuel supply is no longer adequate to go around. To relieve the stress of inadequate supply, some inefficient users of energy need to have their fossil fuel consumption greatly reduced.

My analysis suggests that the US and some of its “Affiliates” tend to be inefficient users of fossil fuels. These countries are at great risk of having their consumption cut back. The result could be war, even nuclear war, as the US loses its hegemony. After such a war, the US could mostly be cut off from trade with Asian nations. In this post, I will elaborate further on these ideas.

[1] Hegemony is closely related to energy consumption because energy is what allows an economy to manufacture goods of all kinds, including armaments needed for war. The energy consumption of the US as a percentage of the world’s has been falling since 1970.

Data on energy consumption by part of the world is readily available only back to 1965, rather than 1945. Based on this data, US energy consumption as a percentage of the world’s total energy consumption has been falling since 1965.

Figure 1. US Energy consumption as a percentage of world energy consumption, based on data from BP’s 2022 Statistical Review of World Energy.

Figure 1 shows that the US’s share of world energy consumption amounted to 33.3% of world’s energy supply in 1965, but only 15.6% in 2021. In other words, in 2021, the US’s share of world energy consumption in 2021 was less than half of its 1965 level.

There are some economies that have much in common with the US. The countries in this category are advanced economies that have democratic governments. I expect these countries would tend to follow the US’s lead, regardless of whether its actions really make sense. The selected economies are the EU, Japan, Canada, the UK, and Australia. For convenience, I call these countries Affiliates.

[2] Affiliates consumed over 35% of the world’s energy supply in the 1965 -1973 period, but this has fallen in recent years.

Figure 2. Energy consumption for selected advanced economies (referred to in this post as Affiliates) as a percentage of world energy consumption, based on data from BP’s 2022 Statistical Review of World Energy. The EU is based on 2021 membership.

Figure 2 shows that Affiliates consumed 35.5% of the world’s energy supply in 1965. By 2021, their consumption fell to 17.6% of the world’s supply. This, too, is less than half of the 1965 percentage.

[3] The energy consumption of US plus Affiliates as compared to the energy consumption of Rest of the World has shifted remarkably since 1965. The consumption of the Rest of the World has been soaring, while that of US plus Affiliates has shrunk.

In Figure 3, I add together the amounts in Figures 1 and 2 and compare them to the indicated energy consumption of what is left, which I call, “Rest of the World.” It is clear that there has been a huge shift in which grouping consumes the majority of the world’s energy supply.

Figure 3. Comparison of total energy consumption as a percentage of world energy consumption for US + Affiliates and Rest of the World. Amounts based on data from BP’s 2022 Statistical Review of World Energy.

We all know that if a political party has the support of almost 70% of voters, it is likely to be dominant. There is a similar issue with energy consumption. Energy consumption is used in every aspect of the economy. It is important for manufacturing goods and transporting them to their destinations. It is also important for creating jobs that pay well.

If world energy supply is growing, it encourages growth of the world economy. Growing energy supply indirectly allows debt to be paid back with interest. In general, the faster the world’s energy supply is growing, the higher the interest rate that can be supported.

Without growth in energy supply, an individual economy is forced to become a service economy. It is forced to import almost all of the manufactured goods that it needs, even armaments needed for war. Such an economy is forced to place an emphasis on growing debt and growing complexity. Unfortunately, both of these things are subject to diminishing returns. As growth in energy supply turns to shrinkage in energy supply, we should expect debt bubbles to pop.

A country is likely to stop making advances in the sciences as it shifts to a service economy. This linked chart by Visual Capitalist analyzes patents in 2021 by the country of the individuals listed on the patent applications. On this basis, China’s patent count was more than double that of the US. China is also the major producer of many clean energy technologies because it has both the resources and the technology.

As a service economy, the US has tended to specialize in healthcare, with spending in this sector accounting for 18.3% of GDP. Yet the US’s healthcare results are dismal. US life expectancies have fallen behind those of other advanced countries. The recent covid vaccines, which were strongly advocated by US health authorities, worked far less well than had been hoped. In February 2022, the New York Times published an article, US Has Far Higher Covid Death Rate Than Other Wealthy Countries.

[4] US data shows that its energy consumption was rising rapidly in the 1949 to 1973 period. Such rapid growth in energy consumption would make other countries envious. It would tend to expand America’s hegemony.

Figure 4. US energy consumption for the period 1949 to 2022 based on EIA data with fitted exponential growth indications for periods chosen by author.

Figure 4 shows how quickly US energy consumption was growing, starting in 1949, using EIA data. Energy consumption growth averaged 3.5% per year in the 1949 to 1973 period. This rapid growth is what we would expect of a country that was an energy leader for the rest of the world. Standards of living could rise. Parents could often afford to raise several children.

An article in the Oxford University Press says that the US’s proliferation of major military bases overseas was developed in the 1950s and 1960s to contain communism and to provide global defense of US interests. Such a huge build-out of bases during this period would not have been possible without the rapid ramp-up in US energy consumption.

Between 1960 and 1969, the number of miles of high-voltage long distance electricity transmission lines tripled. This was evidence of the rapid growth in electricity production that the US was achieving; it was a pattern that other countries would want to emulate. It added to the hegemony of the US.

Statista shows that between 1951 and 1973, the number of US automobile sales per year more than doubled, from 5.16 million to 11.42 million. With this increase came a need for more paved roads and more pipelines to carry oil products. With its growing energy consumption, the US was able to accomplish all this growth. Growing energy consumption also allowed the US to manufacture nearly all the vehicles sold in the US in this period.

[5] US hegemony faced a major challenge in 1970 when US oil production hit a peak and started to fall.

Figure 5. Monthly US oil production through February 2023. Chart by EIA, with notes by Gail Tverberg.

US crude oil production rose rapidly until 1970, when it suddenly started falling. Work was quickly begun on oil extraction from the North Slope of Alaska. This oil offset most of the decline in oil production from the lower 48 states through the mid-1980s.

US hegemony depends upon the quantity of energy products US businesses and citizens consume. When oil prices become unaffordable, citizens and businesses buy less. Figure 6 shows that oil prices had been amazingly low prior to 1973, averaging only $16.31 per barrel, even after adjusting for inflation to 2021 price levels.

Figure 6. Average annual Brent spot oil prices, together with average prices for the fitted growth periods shown on Figure 4. Based data from BP’s 2022 Statistical Review of World Energy.

Comparing Figure 6 to Figure 4, we see that once oil jumped up to an average of $73.14 per barrel in the 1973 to 1983 period, US energy consumption flattened out. At this high price, efficiency became more important. Smaller imported cars, often from Japan, became popular. The US and several other parts of the world started building nuclear power plants to replace electricity created by burning oil. Within a few years, oil production was ramped up in other parts of the world, such as the North Sea and Mexico, relieving the tightness in oil supply.

Once oil prices began to rise again in the 2005 to 2008 period, US oil from shale became available in response to higher prices. The catch was that at these higher prices, oil tended to be unaffordable by the American public. Oil was still affordable in most of the Rest of the World, however.

These “Rest of the World” countries tended to use oil much more sparingly in their energy mix. They often had other advantages as well: warmer climate, lower wage levels, recently built factories, and an energy mix that emphasized coal (which tended to be inexpensive). These advantages helped bring down costs of both manufacturing and resource extraction for the Rest of the World. The shift in energy consumption shown on Figure 3 could occur.

This shift in manufacturing and resource extraction away from the US and Affiliates creates problems, however. If the US and Affiliates are increasingly at odds with countries outside this group, it becomes much harder for the US to exert hegemony over these countries. The problem is that the US depends upon the countries it is at odds with for necessities. Even in making munitions for the Ukrainian conflict, the US needs to depend on China and other Asian countries for parts of its supply lines.

[6] The world economy is now headed for a bottleneck. The world economy is similar to a Ponzi Scheme, with growth in the output of goods and services necessary to fund financial promises of many kinds. There are limits to the amounts of fossil fuels available at affordable prices, and the world is hitting those limits now.

Because the world economy follows the laws of physics, the growth in the output of goods and services depends upon the continued growth in the production of energy products.

Figure 7. World Energy Consumption by Source, based on Vaclav Smil estimates from Energy Transitions: History, Requirements and Prospects and together with data from BP’s Statistical Review of World Energy for 1965 and subsequent. Wind and solar are included in “Biofuels.”

We have known for a very long time that fossil fuel output is limited. Back in 1957, Rear Admiral Hyman Rickover of the US Navy gave a speech warning that world-wide fossil fuel energy supplies were expected to become unaffordable between 2000 and 2050. High oil prices seem to have been a major factor underlying the Great Recession of 2008-2009. This especially affected the US, with its large amount of subprime housing debt. The problems experienced since late 2021 with spiking prices of oil and high prices of imported coal and natural gas are also evidence of the limits the world is reaching.

Figure 8 shows my view of where future world energy supply is headed. While this chart was originally prepared in 2020, the forecast still seems to be reasonable, especially if regulators get their way in mandating the reduction of (unaffordable) fossil fuel use.

Figure 8. Amounts for 1820 to 2020 similar to those from Figure 7, above. Amounts after 2020 assume an average reduction of 6.6% per year to 2050.

If energy consumption falls this rapidly, the world economy will have to adapt in many ways. Economies that cannot tolerate high oil and energy prices are likely to be squeezed out. Based on what already has been happening in Figures 1, 2, and 3, the United States and Europe are especially likely to be adversely affected. The countries that are likely to fare better are ones that don’t require as much energy per capita. These countries are likely to be in warm climates and have relatively poor populations, such as those in Southeast Asia.

As energy supplies fall, business failures and debt defaults can be expected to soar. Governments will be tempted to backstop every financial promise, including failed banks and pension plans. If they do this, other countries will be unwilling to trade using their debased currency. With too much money and few imports, the result is likely to be hyperinflation. If the governments simply allow bankruptcies to take place, the result is likely to be deflation as banks and businesses fail.

[7] The US has been having increasing difficulty in its hegemony role. Some countries have come to believe that the US is now acting unfairly.

Back when the US first attained hegemony, oil and other energy supplies were inexpensive and their supply was growing rapidly. The US was experiencing great economic growth, and other countries wanted the same sort of success. The US plus Affiliates were the ones using the majority of energy products, so the interests of almost all energy users were aligned.

Things have “gone downhill” since 1970 when the US oil supply first started to shrink (Figure 5). Suddenly, the US needed help from the financial system to work around the need to import more oil. One change (in August 1971) was making the dollar a fiat currency, rather than tied to a gold standard. This enabled greater use of debt in operating the economy.

Without the gold standard, the US dollar was able to become the world’s reserve currency. Instead of gold reserves, other countries began buying US Treasuries, which they considered to be a safe store of their money. The US dollar could also play a greater role in financing international transactions. A 2021 analysis by the Federal Reserve shows the dominance of the US dollar in many areas of trade.

This dominant role for the US dollar is now being questioned after the US froze the central bank assets of Russia, as part of the sanctions imposed in response to Russia’s invasion of Ukraine. Other countries are beginning to wonder if holding Treasuries is really a good idea, if the US can impose sanctions which make them unavailable. Countries are also figuring out that it is quite possible to arrange sales of commodities and other goods in currencies other than the US dollar.

Also, the US’s ability to win wars is not very clear. The US’s first big loss was the Vietnam War. After 20 years of fighting, that war ended in 1975, with communist forces seizing control of South Vietnam. The Afghanistan War did not go well either. After 20 years, the US abruptly pulled out. While the US claims the mission was accomplished, it is hard to see that the high cost was justified.

The Russia-Ukraine conflict does not appear to be going well for Ukraine and the allies supporting Ukraine. The US and NATO are having difficulty supplying as many armaments as quickly as President Zelensky would like. Ukraine seems to be using up its conventional weapons very rapidly. Neither the US nor other NATO countries can manufacture weapons very quickly, in part because supply lines from around the world are required. How helpful is the US’s hegemony, if the US can’t even easily win a “proxy war” in Ukraine?

There are sanctions, other than freezing assets, that are of concern to other countries. A recent list from a Chinese source lists the following types of hegemony that it considers to be problematic.

  • Political hegemony – Throwing the US’s weight around
  • Military hegemony – Wanton use of force
  • Economic hegemony – Looting and exploitation
  • Technological hegemony – Monopoly and suppression
  • Cultural hegemony – Spreading false narratives

Quite a few countries in my Rest of the World grouping are clearly getting fed up with America’s hegemony. Increasingly, Middle Eastern countries that were previously at odds with each other are setting aside their differences. They are also becoming much more closely aligned with China. Countries in this group, as well as the BRICS group of countries, are already taking steps toward trading in currencies other than the US dollar.

[8] The path ahead looks very bumpy. The US is likely to be kicked out of its role as global hegemon. Rival countries may choose to attack the US with nuclear weapons, or the US may lash out with nuclear weapons as it sees its hegemony fail.

As I analyze the world economy’s future trajectory, I see the following situations falling into place:

(a) The world economy is being stressed by inadequate energy supplies. When prices rise, it tends to cause inflation. Some countries are experiencing a second kind of stress, as well. Their central banks have raised interest rates. This is a dangerous thing to do because it tends to cause falling asset prices in addition to slowing the economy.

I expect that countries that have recently raised interest rates will have many bank failures. Partly, this will come from the falling value of long-term bonds. In time, it will also come from failing real estate mortgages and other loans, since asset prices will tend to fall with higher interest rates. Governments will be tempted conduct massive bailouts. The countries that have recently raised interest rates include the US, the UK, Eurozone countries, Switzerland, Canada, Australia, and Brazil.

Countries that did not raise interest rates, which seem to include China, India, and Iran, will find their economies less affected by bank failures. Russia temporarily raised interest rates, and then lowered them again, so Russia would also seem to be less affected by bank failures.

Countries that raised rates will be tempted to do bailouts of banks and of “too big to fail businesses.” These bailouts will greatly increase the monetary supply, making countries that didn’t raise interest rates unwilling to trade with them. This dynamic will tend to increase the trend toward two separate trading areas–one including much of Eurasia and one including the US, Canada, Europe and perhaps South America.

(b) If we think about it, cutting back greatly on trans-Atlantic and trans-Pacific shipping would save a great deal of oil if there is not enough oil to go around. This will be another impetus for “Rest of the World” countries, especially those in the Asia-Pacific area, to cut back on shipping across the major oceans.

(c) With failing banks and a cutback in trade between regions, the US dollar will cease to be used as a reserve currency for a large part of the world. The US dollar might still be the reserve currency for some trades, particularly with other countries in the Americas.

(d) I expect that a block of countries will eventually coalesce, centered in Asia, that will mostly trade among themselves. China will probably be the leader of this block.

(e) The US and Europe will mostly be pushed off to the side, to trade among themselves and some geographically close neighbors. These areas may need to set up new financial systems using much less debt. These countries will not be able to produce advanced goods, such as computers, by themselves. They will not be able to build new solar electricity generation or new wind turbines because too much of the supply chain will be out of reach. While these countries have been looking at digital currencies, it is not clear that there will be a stable enough electricity supply to make such currencies possible.

(f) There will probably be war at the time of the division into the two (or perhaps more) trading areas. Nuclear weapons may be involved since there are many countries with nuclear weapons. The supply of conventional weapons available for warfare is depleted, with the ongoing war in Ukraine. According to a study done at Harvard, involving 16 cases in which a major rising power challenged an existing major power over the past 500 years, 12 cases ended in war. This analysis would suggest a 75% likelihood of war.

(g) I don’t know what the timing of all these things will be. Bank failures are just beginning. Let’s keep our fingers crossed that the world economy holds together a while longer.

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