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.

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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.

Posted in Alternatives to Oil, Financial Implications | Tagged , , , | 3,344 Comments

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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The Fed Cannot Fix Today’s Energy Inflation Problem

Posted on April 5, 2023 by Gail Tverberg

There is a reason for raising interest rates to try to fight inflation. This approach tends to squeeze out the most marginal players in the economy. Such businesses and governments tend to collapse, as interest rates rise, leaving less “demand” for oil and other energy products. The institutions that are squeezed out range from small businesses to financial institutions to governmental organizations. The lower demand tends to reduce inflationary pressure.

The amount of goods and services that the world’s economy can produce is largely determined by fossil fuel supplies, plus our ability to use “complexity” in many forms to produce the items that the world’s growing population requires. Adding debt helps add complexity of various types, such as more international trade, more advanced education, and more specialized tools. For a while, the combination of growing energy supplies and growing complexity have helped pull economies along.

Unfortunately, the world’s oil supply is no longer growing. Without an adequate oil supply, it becomes difficult to maintain complexity because complex solutions, such as international trade, require adequate oil supplies. Inasmuch as we seem to be reaching energy and complexity limits, nothing the regulators try to do to change the debt and money supplies–even reeling them back in–can fix the underlying oil (and total energy) problem.

I expect that the rich parts of the world, including the US, Europe, and Japan, are in line to be adversely affected by high interest rates this time. With their high levels of complexity, they are among the most vulnerable to disruption when there is not enough oil to go around.

Figure 1. World oil consumption divided into consuming areas, based on data of BP’s 2022 Statistical Review of World Energy. Europe excludes Estonia, Latvia, Lithuania, and Ukraine.

The problem I see is that rich countries expect to maintain service economies that are fed by huge streams of manufactured goods and raw materials from poorer countries. This pattern appears unsustainable to me, in a world with falling exports because of energy problems.

I expect a significant change in the trading of goods and services, starting as soon as the next few months. Major financial changes may be ahead, fairly soon, as well. In this post, I will try to explain these and related ideas.

[1] Growing debt is a temporary substitute for growing energy supply of the right kinds.

Economists seem to believe that the economy grows because of an invisible hand. I believe that the economy grows because of a growing supply of energy products of the right kinds, together with a growing supply of other raw materials, and a growing supply of human labor. The economy grows in keeping with the laws of physics.

Debt does help provide an extra pull, however, because it enables growing “complexity.” Even in the days of hunters and gathers, it was helpful for people to work together and share the benefit of their labor. A type of short-term debt results from the delayed benefit of working together, even if the delay is only a few hours.

In modern times, debt can help build a factory. The factory can provide more/better output than individual people working by themselves using available resources. There needs to be a way of paying for the delayed benefit of the human labor involved in the whole chain of events that leads to the finished output. Growing debt can help pay workers, long before the benefit of the factory becomes available.

Debt can also make high-priced goods more affordable. A car, or a home, or a college education is more affordable if it can be paid for in installments, as income becomes available to pay for it.

[2] Diminishing returns on added complexity is one issue that puts an end to the ability to grow debt.

As an example, we are slowly discovering that it doesn’t make sense to provide everyone with a university education. Yes, advanced education is of benefit to a percentage of the population, but, in general, there are not enough jobs that pay sufficiently well for it to make economic sense to provide advanced education for everyone who would like to attend college. If debt is provided to finance everyone who applies for advanced education, there are likely to be many loans that can’t be repaid.

As another example, long supply lines can provide cost savings for a manufacturer, but if there is a disruption in any necessary raw material, the whole manufacturing operation may need to be temporarily suspended. The high cost of such a suspension may encourage shorter supply lines or the provision of more stored inventory.

[3] US total debt as a percentage of GDP already seems to be hitting a limit, quite possibly related to diminishing returns on added complexity.

Figure 2. Ratio of US total debt for all sectors to GDP in a chart by the Federal Reserve of St. Louis. Amounts are on a quarterly basis, through 2022.

Figure 2 shows that the US ratio of debt to GDP started increasing shortly after 1980. This was about the time that Ronald Reagan became President in the United States, and Margaret Thatcher became Prime Minister in the UK. There was a need to get energy costs down, and growing debt was one of the tools used to accomplish this. With added debt, new types of hopefully less expensive electricity generation could be added, using debt. Electricity producers were encouraged to compete with each other. The new approach led to less concern about providing adequate upkeep for transmission lines. California is one state where this approach is starting to catch up with the electricity system. Costs are rising, and reliability is falling.

Figure 2 shows that the ratio of US debt to GDP hit a maximum in 2008. An even loftier level was reached in 2020 because of the debt added at the time of Covid-related shutdowns. Now, however, the system doesn’t seem to be able to maintain the high debt level. The quarterly analysis used in Figure 2 highlights how quickly the added debt rolled off.

Analyzing US debt to GDP ratios by sector provides some insight regarding the reason for the fall in the ratio of debt to GDP since 2008 in Figure 2. (The amounts used in Figure 3 are on an annual basis, rather than a quarterly basis, so the shape of the graph is a little different from that in Figure 2.)

Figure 3. Annual data showing US ratios of debt to GDP by sector. Amounts for debt from Households (which includes not-for-profits, such as churches), Business Non-Financial, and Federal Government are from the Federal Reserve of St. Louis database. Financial+ is calculated by subtraction. Financial+ will also include other small categories, such as the debt of state and local governments.

Figure 3 shows that the category I call Financial+ Debt has played an amazingly large role in the growth of total debt. One of the issues bringing about the 2008-2009 Great Recession was defaults related to Collateralized Debt Obligations (CDOs) and Collateralized Debt Swaps (CDSs), involving debt that had been cut into layers and resold. Various tranches of this debt would then default, as the economy slowed. It became clear that this approach to adding debt is very risky. The elimination of some of this type of debt is likely one of the reasons for the drop-off in Financial+ debt after 2008.

It also becomes clear that there are interactions among the different types of debt. Back in 1947, Federal Debt related to World War II had begun dropping off. To provide civilian jobs for all the people who had served in the war effort, it was helpful to add other debt. More recently, the big run-up in debt of the Federal Government seems to have taken place partly to try to offset the huge loss of debt in the Financial+ category.

Figure 4 shows the gross debt of the Federal Government, relative to GDP, on an annual basis.

Figure 4. Gross Federal Debt as a Percentage of GDP, on an annual basis, in a chart prepared by the Federal Reserve of St. Louis. Amounts are through 2022.

The gross debt of the Federal Government is now at a higher level than it was when the Federal Government borrowed money to fight World War II! Part of the rise may very well be the need to keep total indebtedness high, to prop up the economic system in general, and energy prices in particular.

[4] In previous posts, I have shown that oil prices seem to be very sensitive to manipulations of the Federal Reserve.

In Figure 5, below, I also make the point that the popping of a debt bubble can cause oil prices to fall precipitously. With the high level of debt that the world economy has today, major defaults are a worry. Because of this concern, central banks today seem willing to bend over backwards to prop up failing banks. If a substantial number of banks are propped up, this will add to inflationary pressure.

Figure 5. Figure I prepared in early 2021, based on EIA monthly Brent Crude Oil spot oil prices, together with notes added at that time.

Another point that Figure 5 makes is the importance of high oil prices for producers, and the importance of low oil prices for customers. A big part of today’s conflict with respect to oil supply has to do with the affordability of the oil supply, and the fact that such affordable prices for consumers tend to be too low for producers. For example, the European union has attempted to pay Russia for oil at $60 per barrel, partly to hurt Russia, but also to try to bring costs down to a more affordable level. Oil producers tend to cut back supply, as OPEC has recently agreed to do, when prices fall too low.

[5] One thing that people forget in trying to find substitutes for oil is that any substitute must be inexpensive if it is to be affordable. They also forget that they need to consider the cost of required changes to the entire system in any cost estimate.

We often see cost estimates for wind energy and solar energy that consider only the cost of the generation of intermittent electricity. Unfortunately, an economy cannot operate on intermittent electricity. At this point, there isn’t even a single island that can operate its electricity system solely on renewables (including hydroelectric energy, in addition to wind and solar).

In theory, a very high-cost electricity system could be put together using some combination of long-distance transmission lines, batteries, and overbuilding, to try to have enough electricity available for periods of long periods of low electricity generation. But even this would not fix the problem that arises because the world’s agricultural system is mostly powered by oil, not electricity. We cannot get along without food.

If electricity were to be used for the agricultural system, at a minimum, we would need to figure out how to transition all the machines used in fields to use electricity, rather than oil. We would also need to figure out what to do about products that are manufactured using the chemical products that we get from oil, such as herbicides and pesticides. Natural gas or coal is often used to produce ammonia fertilizer. If all fossil fuels are eliminated, a new approach to ammonia production would be needed, as well.

[6] Natural gas cannot be counted on as an inexpensive fuel for a transition to renewables.

Some people hope that a ramp up in natural gas production can be used to help substitute for oil, and thus aid in any transition. A problem that many people are not aware of is the fact that shipping natural gas over long distances as liquified natural gas (LNG) is very expensive. A calculation I saw a few years ago indicated that when LNG was shipped from the US to Europe, adding shipping costs roughly tripled the cost of the natural gas.

Part of the high-cost problem is the need for a huge amount of infrastructure. Natural gas sold as LNG must be compressed, transported at very low temperatures in specially made ships, and then brought back to a gaseous state at the other end. Pipelines are needed at both ends. There is also a need for inter-seasonal natural gas storage because natural gas is often used for heating in winter.

With this huge amount of infrastructure, there is a need for debt to finance all the pieces. When interest rates increase, the result is particularly expensive for those planning to produce LNG for overseas shipment. Such high overhead costs are likely to discourage the building of new LNG export facilities unless long-term contracts at high prices can be obtained in advance.

[7] A huge amount of today’s debt relates to plans to transition to renewables. If these plans cannot work, many debt defaults are certain.

Almost certainly, massive amounts of debt obligations are destined for default if the transition to renewable energy is not successful. The very existence of such liabilities can be expected to lead to widespread problems. Some of this debt will be held by banks; other debt has been issued as bonds or by derivative financial instruments. Pension funds would be badly affected by bond defaults. Derivative financial instruments are likely of many types. Some seem to back exchange traded funds (ETFs).

Young people who have spent thousands of dollars to pursue specialized degrees in fields directly or indirectly related to renewable energy will find that their investment has mostly been wasted. They will not be able to repay their student loans, a large proportion of which is owed to the US Federal Government.

[8] In fact, student loans in general are likely to be a problem for repayment.

The problem with student debt extends beyond students who obtained their training planning to go into the field of renewable energy. In fact, many former students in fields other than renewable energy are already finding that they cannot repay their student loans because there are not enough jobs available that pay sufficiently high compensation. Also, some individuals who took out the loans were not able to finish their courses of study, so they did not gain the skills needed to secure higher-paying jobs. These individuals, in particular, have problems with repayment.

Figure 6. Comparison of the amount of student loans owed to the Federal Government, with the amount of motor vehicle loans, owned and securitized, by financial institutions. Chart by Federal Reserve of St. Louis.

Figure 6 shows that, in total, the amount of student loans debts owed to the Federal Government is about equal to the debt outstanding on motor vehicle loans. Since Covid began, there has been forbearance in debt repayment, but this is likely to end later in 2023. There seems to be a significant chance of defaults starting when this forbearance ends.

It might be noted that there are more student loans outstanding than shown on Figure 6. Besides loans made by the Federal Government, there are also bank loans, amounting to a smaller total.

[9] Falling interest rates since 1980 seem to have played a major role in allowing the US economy to stay on the growth track it has been on.

Up until about 1979, the US economy grew about as quickly as oil consumption, and, in fact, as growth in total energy consumption. Since 1979, the US economy seems to have grown a little more quickly than consumption of oil or of energy of all types combined.

Figure 7. Three-year average growth in real (inflation-adjusted) GDP, based on US BEA data, compared to three-year average growth in oil consumption and total energy consumption, based on US EIA data.

The strange thing that happened around 1979-1981 was a peaking of interest rates on US Treasuries. As I will explain, it was these falling interest rates that indirectly allowed inflation-adjusted GDP to grow faster than oil or total energy consumption.

Figure 8. Ten-year and three-month interest rates on US Treasuries through March 27, 2023, in a chart by the Federal Reserve of St. Louis.

Figure 7 shows that during the period 1952 to 1979, consumption of both oil and total energy were (with short interruptions) growing rapidly. The extra oil and other energy could be used to leverage human labor. Thus, productivity could be expected to grow. In fact, the Fed chose to raise interest rates to slow the economy during this period, based on Figure 8.

Higher interest rates on debt would be expected to make monthly payments for buying a home or car more expensive. They would also tend to hold down prices of assets, such as homes or shares of stock, discouraging speculators from trying to make money by investing in homes or shares of stock.

Most of the time since 1980, interest rates have tended to fall. Falling interest rates can be expected to have the opposite effect: They reduce monthly payments for items bought on credit. Because they make homes and factories more affordable, they tend to raise asset values. Also, the existence of more debt encourages more complexity, such as in cases where a large company purchases a smaller one, using debt. Also, as asset prices rise (for example, a rising home price), leaving more equity, there is the temptation to borrow against the newly available equity to buy something else (for example, home furnishings or a boat). Thus, falling interest rates tend to pull the economy forward.

I believe that the indirect impacts of falling interest rates are behind the huge growth in debt, especially in the Financial+ category, seen in Figure 3. This debt looks likely to hit even worse default problems than happened in the 2008 era, if interest rates remain high, or rise to even higher levels.

Furthermore, without the support of growing debt, GDP growth is likely to fall back to being equal to the growth in energy or oil supply. If a loss of complexity starts occurring, GDP growth could even start to be smaller than growth in energy or oil supply. Of course, if shrinkage of energy consumption occurs, economies can be expected to contract.

[10] Poorer nations will be able to consume much more oil for themselves if they can push down the consumption in areas that use oil heavily, such as the US, Europe, and Japan.

Figure 9. Oil consumption per capita for the areas shown, based on data of BP’s 2022 Statistical Review of World Energy. Europe excludes Estonia, Latvia, Lithuania, and Ukraine.

With their high per capita oil consumption, the combined oil consumption of Europe, Japan, and the United States amounted to almost 38% of total oil consumption in 2021. This can be seen on Figure 1. If this consumption could be brought to zero, the rest of the world could consume about 60% more than they would otherwise.

Of course, the US currently produces most of its own oil, so its oil cannot be obtained unless the US economy collapses to such an extent that it cannot access the oil that it now extracts and refines. As indicated in the introduction to this post, the US is very dependent upon imported goods. Even goods used in the extraction of oil, such as steel pipe used to drill wells, and computers, are imported. Furthermore, whether or not problems with imported goods occur, financial problems seem likely in the near future, either caused by collapsing debt, or by the issuance of excessive new governmental debt to try to offset the problem of collapsing debt. Such financial problems are likely to make imports of required foreign goods difficult. Problems such as these might be one way the US loses access to its own oil.

A loss in a “hot” war could also reduce the ability of the US to access its own oil. Poor countries most likely covet the US’s oil resources. In my opinion, the more oil the US leaves in the ground related to climate concerns, the more vulnerable the US becomes to other countries’ trying to access its resources. For most of the world, adequate food supply has priority over climate concerns.

If total world oil supply is shrinking, as seems likely with OPEC cutting its output, poorer countries around the world are now becoming concerned about finding workarounds for this expected oil supply shortfall. One workaround would be for oil exporting countries to reduce their exports to countries that are not their close allies. Another approach would be for the poorer nations of the world to reduce the quantity of oil now used for international transport by cutting back on exports of all types of goods to richer counties.

Changes to the international financial system may be very near. There are now stories about greater cooperation among countries of the Middle East and China. There are also stories about moving away from the US dollar for trade.

[11] I have written in the past about the world self-organizing economy being built up in layers and being hollow inside. We can imagine the loss of Europe, and perhaps the United States and Japan, as being rather like an avalanche, removing some unsustainable parts of the system.

Our economy is a physics-based self-organizing system that looks as if it could keep growing forever.

Figure 12. Figure by Gail Tverberg demonstrating how the world economy grows.

As the economy grows, new businesses are added. We can envision them as new layers, added on top of existing businesses. The growing consumer (and worker) base helps push this growth along. At the same time, unneeded products and businesses tend to fall away, making the center of the structure hollow. For example, the world economy no longer makes many buggy whips, since horses and buggies are no longer the primary means of transportation.

Built into this system are financial and regulatory structures, operated by banks and governments. When the rate of growth of the energy supply is constrained, the system starts encountering more debt defaults and banking crises. I think that this is where we are today.

In a way, the economy with all its debt is like a Ponzi Scheme. It depends on a growing supply of energy and other resources to continue to be able to pay back its debt with interest. The higher the interest rate, the more difficult it is to keep the whole arrangement operating.

Something will have to “give,” as the growth in oil supply turns to shrinkage. In theory, what is lost could be the operation of the whole world economy, but the system does seem to hold together, to the extent that it can, if adequate energy supply exists for even part of the global economy. That is why I think that the near-term result may be more of an avalanche than a complete collapse.

We don’t know exactly what lies ahead, but the situation does look worrying.

Posted in Financial Implications, News Related Post, oil shortages | Tagged , , , , | 4,007 Comments

When the Economy Gets Squeezed by Too Little Energy

Posted on March 5, 2023 by Gail Tverberg

Most people have a simple, but wrong, idea about how the world economy will respond to “not enough energy to go around.” They expect that oil prices will rise. With these higher prices, producers will be able to extract more fossil fuels so the system can go on as before. They also believe that wind turbines, solar panels and other so-called renewables can be made with these fossil fuels, perhaps extending the life of the system further.

The insight people tend to miss is the fact that the world’s economy is a physics-based, self-organizing system. Such economies grow for many years, but ultimately, they collapse. The underlying problem is that the population tends to grow too rapidly relative to the energy supplies necessary to support that population. History shows that such collapses take place over a period of years. The question becomes: What happens to an economy beginning its path toward full collapse?

One of the major uses for fossil fuel energy is to add complexity to the system. For example, roads, electricity transmission lines, and long-distance trade are forms of complexity that can be added to the economy using fossil fuels.

Figure 1. Chart by author pointing out that energy consumption and complexity are complementary. They operate in different directions. Complexity, itself, requires energy consumption, but its energy consumption is difficult to measure.

When energy per capita falls, it becomes increasingly difficult to maintain the complexity that has been put in place. It becomes too expensive to properly maintain roads, electrical services become increasingly intermittent, and trade is reduced. Long waits for replacement parts become common. These little problems build on one another to become bigger problems. Eventually, major parts of the world’s economy start failing completely.

When people forecast ever-rising energy prices, they miss the fact that market fossil fuel prices consider both oil producers and consumers. From the producer’s point of view, the price for oil needs to be high enough that new oil fields can be profitably developed. From the consumer’s point of view, the price of oil needs to be sufficiently low that food and other goods manufactured using oil products are affordable. In practice, oil prices tend to rise and fall, and rise again. On average, they don’t satisfy either the oil producers or the consumers. This dynamic tends to push the economy downward.

There are many other changes, as well, as fossil fuel energy per capita falls. Without enough energy products to go around, conflict tends to rise. Economic growth slows and turns to economic contraction, creating huge strains for the financial system. In this post, I will try to explain a few of the issues involved.

[1] What is complexity?

Complexity is anything that gives structure or organization to the overall economic system. It includes any form of government or laws. The educational system is part of complexity. International trade is part of complexity. The financial system, with its money and debt, is part of complexity. The electrical system, with all its transmission needs, is part of complexity. Roads, railroads, and pipelines are part of complexity. The internet system and cloud storage are part of complexity.

Wind turbines and solar panels are only possible because of complexity and the availability of fossil fuels. Storage systems for electricity, food, and fossil fuels are all part of complexity.

With all this complexity, plus the energy needed to support the complexity, the economy is structured in a very different way than it would be without fossil fuels. For example, without fossil fuels, a high percentage of workers would make a living by performing subsistence agriculture. Complexity, together with fossil fuels, allows the wide range of occupations that are available today.

[2] The big danger, as energy consumption per capita falls, is that the economy will start losing complexity. In fact, there is some evidence that loss of complexity has already begun.

In my most recent post, I mentioned that Professor Joseph Tainter, author of the book, The Collapse of Complex Societies, says that when energy supplies are inadequate, the resulting economic system will need to simplify–in other words, lose some of its complexity. In fact, we can see that such loss of complexity started happening as early as the Great Recession in 2008-2009.

The world was on a fossil fuel energy consumption per capita plateau between 2007 and 2019. It now seems to be in danger of falling below this level. It fell in 2020, and only partially rebounded in 2021. When it tried to rebound further in 2022, it hit high price limits, reducing demand.

Figure 2. Fossil fuel energy consumption per capita based on data of BP’s 2022 Statistical Review of World Energy.

There was a big dip in energy consumption per capita in 2008-2009 when the economy encountered the Great Recession. If we compare Figure 2 and Figure 3, we see that the big drop in energy consumption is matched by a big drop in trade as a percentage of GDP. In fact, the drop in trade after the 2008-2009 recession never rebounded to the former level.

Figure 3. Trade as a percentage of world GDP, based on data of the World Bank.

Another type of loss of complexity involves the drop in the recent number of college students. The number of students was rising rapidly between 1950 and 2010, so the downward trend represents a significant shift.

Figure 4. Total number of US full-time and part-time undergraduate college and university students, according to the National Center for Education Statistics.

The shutdowns of 2020 added further shifts toward less complexity. Broken supply lines became more of a problem. Empty shelves in stores became common, as did long waits for newly ordered appliances and replacement parts for cars. People stopped buying as many fancy clothes. Brick and mortar stores did less well financially. In person conferences became less popular.

We know that, in the past, economies that collapsed lost complexity. In some cases, tax revenue fell too low for governments to maintain their programs. Citizens became terribly unhappy with the poor level of government services being provided, and they overthrew the governmental system.

The US Department of Energy states that it will be necessary to double or triple the size of the US electric grid to accommodate the proposed level of clean energy, including EVs, by 2050. This is, of course, a kind of complexity. If we are already having difficulty with maintaining complexity, how do we expect to double or triple the size of the US electric grid? The rest of the world would likely need such an upgrade, as well. A huge increase in fossil fuel energy, as well as complexity, would be required.

[3] The world’s economy is a physics-based system, called a dissipative structure.

Energy products of the right kinds are needed to make goods and services. With shrinking per capita energy, there will likely not be enough goods and services produced to maintain consumption at the level citizens are used to. Without enough goods and services to go around, conflict tends to grow.

Instead of growing and experiencing economies of scale, businesses will find that they need to shrink back. This makes it difficult to repay debt with interest, among other things. Governments will likely need to cut back on programs. Some governmental organizations may fail completely.

To a significant extent, how these changes happen is related to the maximum power principle, postulated by ecologist Howard T. Odum. Even when some inputs are inadequate, self-organizing ecosystems try to maintain themselves, as best possible, with the reduced supplies. Odum said, “During self-organization, system designs develop and prevail that maximize power intake, energy transformation, and those uses that reinforce production and efficiency.” As I see the situation, the self-organizing economy tends to favor the parts of the economy that can best handle the energy shortfall that will be taking place.

In Sections [4], [5], and [6], we will see that this methodology seems to lead to a situation in which competition leads to different parts of the economy (energy producers and energy consumers) being alternately disadvantaged. This approach leads to a situation in which the human population declines more slowly than in either of the other possible outcomes:

  • Energy producers win, and high energy prices prevail – The real outcome would be that high prices for food and heat for homes would quickly kill off much of the world’s population because of lack of affordability.
  • Energy consumers always win, and low energy prices prevail – The real outcome would be that energy supplies would fall very rapidly because of inadequate prices. Population would fall quickly because of a lack of energy supplies (particularly diesel fuel) needed to maintain food supplies.

[4] Prices: Competition between producers and customers will lead to fossil fuel energy prices that alternately rise and fall as extraction limits are hit. In time, this pattern can be expected to lead to falling fossil fuel energy production.

Energy prices are set through competition between:

[a] The prices that consumers can afford to pay for end products whose costs are indirectly determined by fossil fuel prices. Food, transportation, and home heating costs are especially fossil fuel price sensitive. Poor people are the most quickly affected by rising fossil fuel prices.

[b] The prices that producers require to profitably produce these fuels. These prices have been rising rapidly because the easy-to-extract portions were removed earlier. For example, the Wall Street Journal is reporting, “Frackers Increase Spending but See Limited Gains.”

If fossil fuel prices rise, the indirect result is inflation in the cost of many goods and services. Consumers become unhappy when inflation affects their lifestyles. They may demand that politicians put price caps in place to somehow stop this inflation. They may encourage politicians to find ways to subsidize costs, so that the higher costs are transferred to a different part of the economy. At the same time, the producers need the high prices, to be able to fund the greater reinvestment necessary to maintain, and even raise, future fossil fuel energy production.

The conflict between the high price producers need and the low prices that many consumers can afford is what leads to temporarily spiking energy prices. In fact, food prices tend to spike, too, since food is a kind of energy product for humans, and fossil fuel energy products (oil, especially) are used in growing and transporting the food products. In their book, Secular Cycles, researchers Peter Turchin and Sergey Nefedov report a pattern of spiking prices in their analysis of historical economies that eventually collapsed.

With oil prices spiking only temporarily, energy prices are, on average, too low for fossil fuel producers to afford adequate funds for reinvestment. Without adequate funds for reinvestment, production begins to fall. This is especially a problem as fields deplete, and funds needed for reinvestment rise to very high levels.

[5] Demand for Discretionary Goods and Services: Indirectly, demand for goods and services, especially in discretionary sectors of the economy, will also tend to get squeezed back by the rounds of inflation caused by spiking energy prices described in Item [4].

When customers are faced with higher prices because of spiking inflation rates, they will tend to reduce spending on discretionary items. For example, they will go out to eat less and spend less money at hair salons. They may travel less on vacation. Multiple generation families may move in together to save money. People will continue to buy food and beverages since these are essential.

Businesses in discretionary areas of the economy will be affected by this lower demand. They will buy fewer raw materials, including energy products, reducing the overall demand for energy products, and tending to pull energy prices down. These businesses may need to lay off workers and/or default on their debt. Laying off workers may further reduce demand for goods and services, pushing the economy toward recession, debt defaults, and thus lower energy prices.

We find that in some historical accounts of collapses, demand ultimately falls to close to zero. For example, see Revelation 18:11-13 regarding the fall of Babylon, and the lack of demand for goods, including the energy product of the day: slaves.

[6] Higher Interest Rates: Banks will respond to rounds of inflation described in Item [4] by demanding higher interest rates to offset the loss of buying power and the greater likelihood of default. These higher interest rates will have adverse impacts of their own on the economy.

If inflation becomes a problem, banks will want higher interest rates to try to offset the adverse impact of inflation on buying power. These higher interest rates will tend to reduce demand for goods that are often bought with debt, such as homes, cars, and new factories. As a result, the sale prices of these assets are likely to fall. Higher interest rates will tend to produce the same effect for many types of assets, including stocks and bonds. To make matters worse, defaults on loans may also rise, leading to write-offs for the organizations carrying these loans on their balance sheets. For example, the used car dealer Caravan is reported to be near bankruptcy because of issues related to falling used car prices, higher interest rates, and higher default rates on debt.

An even more serious problem with higher interest rates is the harm they do to the balance sheets of banks, insurance companies, and pension funds. If bonds were previously purchased at a lower interest rate, the value of the bonds is less at a higher interest rate. Accounting for these organizations can temporarily hide the problem if interest rates quickly revert to the lower level at which they were purchased. The real problem occurs if inflation is persistent, as it seems to be now, or if interest rates keep rising.

[7] A second major conflict (after the buyer/producer conflict in Item [4], [5], and [6]) is the conflict in how the output of goods and services should be split between returns to complexity and returns to basic production of necessary goods including food, water, and mineral resources such as fossil fuels, iron, nickel, copper, and lithium.

Growing complexity in many forms is something that we have come to value. For example, physicians now earn high wages in the US. People in top management positions in companies often earn very high wages. The top people in large companies that buy food from farmers earn high wages, but farmers producing cattle or growing crops don’t fare nearly as well.

As energy supply becomes more constrained, the huge chunks of output taken by those with advanced degrees and high positions within the large companies gets to be increasingly problematic. The high incomes of citizens in major cities contrasts with the low incomes in rural areas. Resentment among people living in rural areas grows when they compare themselves to how well people in urbanized areas are doing. People in rural areas talk about wanting to secede from the US and wanting to form their own country.

There are also differences among countries in how well their economies get rewarded for the goods and services they produce. The United States, the EU, and Japan have been able to get better rewards for the complex goods that they produce (such as banking services, high-tech medicine, and high-tech agricultural products) compared to Russia and the oil exporting countries of the Middle East. This is another source of conflict.

Comparing countries in terms of per capita GDP on a Purchasing Power Parity (PPP) basis, we find that the countries that focus on complexity have significantly higher PPP GDP per capita than the other areas listed. This creates resentment among countries with lower per-capita PPP GDP.

Figure 5. Average Purchasing Power Parity GDP Per Capita in 2021, in current US dollars, based on data from the World Bank.

Russia and the Arab World, with all their energy supplies, come out behind. Ukraine does particularly poorly.

The conflict between Russia and Ukraine is between two countries that are doing poorly on this metric. Ukraine is also much smaller than Russia. It appears that Russia is in a conflict with a competitor that it is likely to be able to defeat, unless NATO members, including the US, can give immense support to Ukraine. As I discuss in the next section, the industrial ability of the US and the EU is waning, making it difficult for such support to be available.

[8] As conflict becomes a major issue, which economy is largest and is best able to defend itself becomes more important.

Figure 6. Total (not per capita) PPP GDP for the US, EU, and China, based on data of the World Bank.

Back in 1990, the EU had a greater PPP GDP than did either the US or China. Now, the US is a little ahead of the EU. More importantly, China has come from way behind both the US and EU, and now is clearly ahead of both in PPP GDP.

We often hear that the US is the largest economy, but this is only true if GDP is measured in current US dollars. If differences in actual purchasing power are reflected, China is significantly ahead. China is also far ahead in total electricity production and in many types of industrial output, including cement, steel, and rare earth minerals.

The conflict in Ukraine is now leading countries to take sides, with Russia and China on the same side, and the United States together with the EU on Ukraine’s side. While the US has many military bases around the world, its military capabilities have increasingly been stretched thin. The US is a major oil producer, but the mix of oil it produces is of lower and lower average quality, especially if obtaining diesel and jet fuel from it are top priorities.

Figure 7. Chart by OPEC, showing the mix of liquids that now make up US production. Even the “Tight crude” tends to be quite “light,” making it less suitable for producing diesel and jet fuel than conventional crude oil. Chart from OPEC’s February 2023 Monthly Oil Market Report.

Huge pressure is building now for China and Russia to trade in their own currencies, rather than the US dollar, putting pressure on the US financial system and its status as the reserve currency. It is also not clear whether the US would be able to fight on more than one front in a conventional war. A conflict with Iran has been mentioned as a possibility, as has a conflict with China over Taiwan. It is not at all clear that a conflict between NATO and China-Russia is winnable by the NATO forces, including the US.

It appears to me that, to save fuel, more regionalization of trade is necessary with the Asian countries being primary trading partners of each other, rather than the rest of the world. If such a regionalization takes place, the US will be at a disadvantage. It currently depends on supply lines stretching around the world for computers, cell phones, and other high-tech devices. Without these supply lines, the standards of living in the US and the EU would likely decline quickly.

[9] Clearly, the narratives that politicians and the news media tell citizens are under pressure. Even if they understand the true situation, politicians need a different narrative to tell voters and young people wondering about what career to pursue.

Every politician would like a “happily ever after” story to tell citizens. Fortunately, from the point of view of politicians, there are lots of economists and scientists who put together what I call “overly simple” models of the economy. With these overly simple models of the economy, there is no problem ahead. They believe the standard narrative about oil and other energy prices rising indefinitely, so there is no energy problem. Instead, our only problem is climate change and the need to transition to green energy.

The catch is that our ability to scale up green energy is just an illusion, built on the belief that complexity can scale up indefinitely without the use of fossil fuels.

We are left with a major problem: Our current complex economy is in danger of degrading remarkably in the next few years, but we have no replacement available. Even before then, we may need to do battle, in new ways, with other countries for the limited resources that are available.

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