#11 Assume a tin-opener……

“Assume a tin-opener”

End-of-year thoughts

In a recent speech, former US Treasury Secretary Larry Summers posed an interesting question, which I’ll paraphrase for you.

The electricity industry accounts for 4% of GDP by value. If electricity supplies are halted, how much economic activity remains?

To the economist, the answer is 96%.

To any sane non-economist, however, the answer is 0%, because, without electricity, the entire economy would grind to an immediate halt.

This, essentially, tells you all you need to know about the real role of energy.

It probably also tells you all you need to know about economists.

My late father used to recount a story about three professors, marooned on a desert island with hundreds of tins of baked beans, but no tin-opener. How can they eat?

“My answer”, says the chemist, “is to put the tins in water. Over time, they will corrode away”.

“But”, says the physicist, “how many years is that supposed to take? My solution is to put the tins in a fire. Pressure will increase, and they will soon explode”.

“Covering the entire island with beans and peppering us with lethal shrapnel”, retorts the chemist.

Both turn to the economist for advice. It is succinct:

“Assume a tin-opener”.

A useless answer, of course. But is “assume perpetual growth” any better?

*  *  *  *  *  *  *

Unless some event provokes me into print (which is by no means impossible), this is likely to be my last article of 2013. It’s been an eventful year. In August, I left Tullett Prebon, where I’d been head of research since 2009. During the summer I completed the manuscript of my book, Life After Growth, which was published in November.

If you’ll indulge me for a few moments, I’d like to discuss my recent activities, as this leads into future plans. Let me make one thing abundantly clear, though – everything that has happened in recent months reaffirms my belief in the “surplus energy” interpretation (and it also, for that matter, reaffirms my belief that, broadly speaking, economic growth is over).

Working with Terry Smith and others at Tullett Prebon was a marvellous experience. After leaving the company, I immediately became immersed in completing the book. Life After Growth was a huge project even though I’d laid much of the groundwork with earlier research. The big challenge was to tie it all together, my aim being to articulate, in everyday language, an analysis that could be applied equally to the past, the present and the future of the economy. What you don’t really see when you read the book is the extensive statistical work that it draws on.

I got this done, but I don’t mind saying that it was exhausting. Ironically, energy (in the purely personal sense of the word) was in short supply after I’d completed the book.

As a result, I didn’t feel able to accept any of the many speaking invitations that I received, even though a lot of these were at very interesting events. As the festive season approaches, I’m recharging my batteries and thinking about what to do in 2014.

*  *  *  *  *  *  *

One big project has dominated my thinking about future directions. You could think of it as Life After Growth II – The Database. The aim is to model EROEI, and its implications in terms of energy costs and economic trends, in a comprehensive way. It’s a huge exercise, and apologies are due to anyone who has noted the dearth of written comment from me in recent months.

At time of writing, the database is nearly complete. I’ve modelled the EROEI environment by energy source and location – back-testing it for three decades, which is about as far back as is possible with the data sources that I have – and have moved on to countries and regions, starting with the US, Canada, Mexico, Germany, Britain, France, Brazil, Australia, China, India, Japan, Russia, Saudi Arabia and South Africa.

I can tell you now that most (though not all) of these countries are facing economic erosion, and most are carrying financial commitments that their future economic trajectories will not allow them to honour.

The scale of these challenges differs markedly between countries. If you were to read the database, it would cheer you up if you happened to be Norwegian or Saudi Arabian, but would depress you no end if you are British, Mexican or Japanese.   

*  *  *  *  *  *  *

The reality, you see, is that energy isn’t “only” 8% of the global economy any more than electricity is “only” 4% of US activity. Without energy, the economy would cease to exist.

This isn’t the problem, of course, because energy supplies are abundant. The real problem is that we’ve exhausted supplies of energy which are either “highly concentrated” (if you’re a scientist), “high return” (if you’re an energy economist) or, in layman’s terms, “cheap”.

As a result, much of the world is ex-growth (as, arguably, it has been for at least a decade). Human ingenuity is such that we should be able to cope with an ex-growth economy, not least by curbing wastefulness.

This would be true if we hadn’t already applied that same ingenuity in the creation of a financial system predicated on “assume a tin-opener perpetual growth”.

This means that politicians and central bankers are trying to defy economic gravity, resorting to all sorts of increasingly desperate fiddles policies in order to keep at least the semblance of growth going. It won’t work, of course.

At least my new database is already telling me where, when and how things are likely to go wrong (or, in some cases, right).

My task for 2014 is to work out how best to use this information.

Meanwhile, have a great Christmas, and please do make sure you’ve got a corkscrew, a bottle opener – and, of course, a tin-opener!

Best wishes,

Tim

18 thoughts on “#11 Assume a tin-opener……

  1. Hi Tim

    Firstly thank you for your immensely valuable contributions to the energy/growth debate – I have read widely on the subject for nearly ten years and in my view you are the leading & most articulate commentator on the complex, intertwined issues of energy & economics.

    Hopefully my Xmas stocking will contain your book and a bottle of malt whisky and I intend to spend the festive period working through both of them together.

    I think a lot of us in the energy debate were blindsided by the scale of the fracking boom and it has to some extent left us crying wolf again. I noticed the OilDrum which I followed a few years back has recently shut down – the wolves are back to the wilderness for a while. Maybe we should be grateful whilst it lasts.

    I wish you the best of luck on your projects in 2014 – any insight into the where, when & how will be of great interest.

    • Thanks – you are very kind.

      If you’ve not read the book yet, something that gets a lot of emphasis is that financial economy (which is a proxy for the real economy of energy) consists of ‘claims’ on the real economy (money and debt are examples of ‘claims’ – they have no instrinsic worth, but have ‘claim’ value).

      I mention this because a big problem is that we’ve created ‘claims’ that exceed what the real economy can conceivably deliver, hence the term ‘excess claims’. These aren’t just cash and debt, but include promises such as investment freturns, pensions, future interest on savings, and welfare commitments to a certain extent.

      Now, I estimate excess claims at end-2012 at US$90 trillion (the database is likely to refine these numbers, but they’re good enough for now). Since the banking crisis we’ve destroyed US$20-30bn of these excess claims – defaults, destroyed savings and pensions value, conversion of debt into low-grade equity, and so on. But we are reluctant to let the ongoing value of the financial economy (loosely, GDP) fall back into line with the real economy, so we’re still creating excess claims.

      Well, my database has a Predictor module which looks at each country in these ways:

      1. Where is EROEI, and where is it heading? Actually, the inverse of EROEI – which I term Energy Cost of Energy, or ‘ECOE’ – is a more manageable measure.

      2. How big are each country’s excess claims? (For some countries, like Norway, these are negative, i.e. there is a surplus – Norway has long lived below its ‘real economy’ means, hence its huge sovereign wealth fund). More critically, how big are excess claims in relation to the real economy?

      3. Obviously enough, where is the real economy trending?

      4. Is the real economy, now or in the future, sub-viable?

      5. Is the country undertaking effective amelioration strategies?

      This is already a long answer, and the database isn’t complete yet, but I already hade a lot of these indicators for the biggest economies. I might well publish these findings – but this area of work does court unpopularity!

  2. Tim,
    I would echo what has been said above :enjoy the rest !
    I have read the book and have a particular query around the assumption that there is direct link in per cent terms of EROEI as a percent of GDP ; can you elucidate?

    best Peter
    The tin opener analogy is apt….

    • Peter – thanks.
      EROEI to GDP is a tricky one conceptually – what we’re trying to do is to cross-relate different units, one measured in, say, dollars, with another in, say, BTUs of energy. Historically, though, the approach works fairly well.
      At an EROEI of 49:1 (for convenience), 2% (1/50) is energy cost and 98% is “profit” (economic output over and above energy cost).
      So ECOE (energy cost of energy) = 1/EROEI, and we can reverse this equation so ECOE gives us EROEI.
      Now, we have figures for global GDP in the money-of-the-day (GDP is a very imperfect measure, admittedly, but we have to start somewhere). We can measure historic energy cost (in money), so we can express energy cost as % of GDP (both figures are money-of-the-day, so no inflation is involved). We can take this back a reasonably long way (to, say, 1965 with accuracy, a lot further back with diminishing accuracy). The individual % cost datapoints are all over the place (hitting 15% in the 1970s oil crises, for instance). But we know that EROEI and energy costs are gradual trends, so we can take a smoothed line of energy cost as % GDP (ECOE) and convert to EROEI.
      Next, is this curve consistent with what we know about the EROEI data-points for individual fuels, when weighted into a global mix? This is the cross-check, and it works reasonably well. My database isn’t just global energy vs global GDP. It is a weighted mix, year after year, of conventional and unconventional oil and gas, coal, nuclear, hydro, wind, solar, biofuel and so on. So, do these fit? On the whole, yes.
      Remember that GDP tries to measure everything, by which I mean all activity, whether useful or not, and does not capture just “useful” activity. So the energy cost is included even though it’s a “cost” or “levy” (like a tax) on useful activity. (If EROEI is 49:1, GDP measures the whole 50, not just the 49).
      There are significant imperfections, no doubt about it. A plotted EROEI of 15 might really be 14; it might be 16. It might even be 13, or 17. But it is not 30.
      So this isn’t precise, but it’s far better than nothing (which is roughly where the political and economics establishment is!).
      There are two other things to bear in mind here, both important. First, can Britain (say) buck the trend – concentrate on low energy intensity services (banking, say, or media) and let others do the energy-intensive stuff like producing food and steel? Well, no, because Britain (in this example) still needs food (etc) so is still absorbing the energy in the food (etc) produced by others, and is paying for it via what it pays for food. So energy as % GDP works better than you might think.
      Second, what about the cost of essentials – how much does Britain (say), or the world for that matter, spend on food, steel and so on? We know this, and we know the (approx) calorific conversions. This is a useful cross check (and it’s one reason why I track cost of essentials, and not just in the UK).
      I’m guessing this is far more than you need?!

    • Tim,
      No it is is not more than I need ; but is enough to reenforce my confidence in the assumptions as expressed in the book around the topic! It is interesting that the GDP figures do tend to reflect the embodied energy of imports. So many thanks ; I look forward to any updates that you may generate based on current data or new thoughts on checking the correlation. best wishes

      Peter

  3. Tim, great contribution all round and, as you well know, I track your analyses, thoughts and ideas. Keep it up during 2014. All the best and hopefully we can stay in touch. Have a very Merry Christmas! M

    • Hi M

      Thanks, and I hope you will keep up your great work as well. The first project is the Database, and reports resulting from it. Should flutter a few dovecotes!

      Have a great Christmas, Tim

  4. Thanks for another set of excellent points. One of the reasons I see the Government failing in its handling of the economy is not that its borrowing money but it borrows and buys modern day tulip bulbs instead of basic things like loft insulation. Insulation may be not be trendy but it pays back a dividend for the lifetime of the house, pushing up the cost of housing is a one time boost to the economy with interest payments for ever more. If the Government wanted a big ticket infrastructure project it could invest in tidal power instead of estate agents, trams are much more energy efficient than cars and they could knock down the energy import bill, again for the lifetime of the infrastructure. Instead all we get is a fracking nightmare, that will completely frack the country in the long term. The country is just addicted to cheap energy the way an obese person is addicted to sugar and fat, there is nothing wrong with sugar and fat as part of a balanced diet, it will just lead to premature ageing and sickness if you have too much and the same will happen to countries economically that do not get their energy diet sorted out PDQ. Looking forward to reading the book when it arrives.

  5. Hi Russ

    You’re right that there’s a critical issue about borrowing. If, say, a sucessful restaurant borrows to expand, the extra profits will pay off the debt (this is known technically as “self-liquidating” debt). But “non-self-liquidating” debt, borrowed for consumption, is the problem, certainly in the UK.

    Government is promoting mortgage-lending for two reasons. First, higher house prices make people more confident and happier. Second, they’re more likely to take on debt for consumption, which was what happened during 2000-07, and that boosts GDP (consumption is included in GDP but, of course, debt isn’t).

    Energy policy is a shambles, and it’s interesting that two big wind projects have been cancelled in the last couple of weeks. Insulation is highly desirable and cost-effective; so is waste-to-heat conversion, and gas storage would help a bit, too.

    And, to extend your analogy, the patient may be so incapacitated by a rich diet of cheap energy that the brain has become lethargic…….

  6. Tim,
    Some more thoughts on EROEI. Say there was a source of energy which could be extracted at one unit in five out and provide a continuous source of energy . In practical terms you would build the facility with a large capital budget but thereafter the running cost would be much reduced . I suppose in GDP terms you are still spending 20% of GDP on energy but in practice are you not: you are spending the cost of the energy plus running cost; which could be significantly less in real money terms than the 20% of GDP?
    Though perhaps not well expressed but what I am trying to touch on is the volume of energy available at a given EROEI is there an offsetting factor in terms of % of GDP and some link to the business economy i.e. to invest or not ?

    best Peter

    • Peter

      Some very good points. In the final analysis, the real economy is surplus energy – the bigger the supply of surplus energy, the bigger the real economy. So, whilst plenty of high EROEI energy is best, a lower EROEI source, but at a huge scale, might be an alternative.

      In reality, though, this doesn’t work. Let’s say we had a huge source of energy available, but at a low EROEi (say 4;1). Now, for each 5 units of energy that we access, 1 unit has to be invested, or consumed, in the extraction process. If most of this cost was capital, i.e. upfront, you would have low(er) running costs. But two things need to be taken into account – capital investment, and depreciation.

      Nothing lasts forever. Let’s say our 4:1 EROEI source is high capital, with very low running costs. It still costs us 20% of GDP, remember. Say it lasts for 10 years. Annual GDP, say, $1000. GDP over ten years thus $10,000. EROEI cost is 20%, therefore $2,000. Let’s say that’s all capital, and running costs are minimal – how are we going to fund that investment? It is 2 years of GDP, up front. If the plant would last 20 years, not 10 – still with an EROEI of 4:1, remember – we need to find $4,000 before we start, or 4 years’ worth of GDP, even if running costs after that are negligible. I don’t see how we can afford that upfront investment.

      And then we have to depreciate it, i.e. provide for its eventual replacement…..

      Let me add one other thing about EROEI and investment/depreciation. We can probably run the economy at an EROEI of 10:1. Even 8:1 might work. But we cannot invest at such low levels. In a recent post, Prof. Hall said a minimum EROEI for an economy that functions AND INVESTS is 14;1.

      So let’s imagine a country with an EROEI of greater than 8, but less 14. That country is in tickover mode – functioning, but not investing. What would such a ticking-over but-not-investing economy look like? Well, it might continue (sluggishly) but it would not be capable of capital formation. That means that returns are too low to fund saving. Ultimately, it means an economy with ultra-low interest rates.

      I wonder what that describes? Britain, with an EROEI of 9.5:1 and near-zero rates? The US, EROEI of 10.2:1 and, again, ultra-low rates? Japan, at 7:1, minimal rates and printing money?

      These are figures from the new database (inelegantly named ‘SEED’, for Surplus Energy Economics Database). It portrays many Western countries as sub-investment, tickover economies…….

    • I guess this makes the case for efficiency even stronger, to put it on a simplistic level a car carrying one person might be cost effective at an EROEI of x and a car with two people x/2 etc. Buses might push it out to x/8 for example, energy policy should include recycling and energy energy efficiency on a much higher scale than they do presently. Woking apparently has done a lot of good work in this area, other councils should be mandated to follow their example.

    • Indeed so – just as we can waste energy, we can “un-waste” it by doing things more efficiently. My new SEED model incorporates an efficiency measure, though the ways in which we collect economic data in our “assume infinite growth” model are less than helpful.

      What we really need is energy budgeting – a recognition that an economy needs to use energy even more carefully than we (supposedly) budget the use of money.

      Recycling – converting waste to energy – is a critical technology for the future.

  7. Tim,
    Is there an agreed typical split in the allocation of GDP for western countries? best Peter

    • Tim,
      Yes I had seem some figures around 60% for private consumption ; so I am wondering where the slack would be to take up the extra cost of economies’ energy . Like a reduction in Government services .
      best
      Peter

  8. Hi Tim,
    Firstly, forgive me if this has been dealt with in your book which I haven’t yet read although I have been a keen reader of your work for a few years. What troubles me about the claim that the economy is a surplus energy equation is the observation that an increasingly technological and information-based society seems to me to indicate a reduction in the significance of the role of energy within the economy. I can see how the economy before the middle of the last century could be seen as an energy machine but if we can justify modelling it in times past as a heat engine why should we be able to apply the same principles to what now appears to resemble a laptop. It’s true that without a source of energy a laptop is useless but the imperative of a source of power doesn’t make the conversion of electrical energy into heat and light the most significant processes at work does it?

    Or do you see the technological progress that has transformed the economy with the tendency to increase productivity as obscuring the effects of the declining EROEI?

    • Thanks.

      Partly I think it’s about how we measure GDP, but let me take this from fundamentals.

      Our incomes divide into two categories – essentials (such as food; water; heat; physical structures like roads, bridges and hospitals; transport; and so on) – and “discretionaries”, things we like but don’t necessarily need.

      All of the essentials are energy-dependent – we can enjoy virtual reality on computers, the net, social networking and so on, but we can’t provide homes, food, water and infrastructure that way.

      Energy dictates the cost of essentials, and that currently absorbs about 7% of economic output, leaving 93% for discretionary consumption. Even the increase to 7% from about 3% over a decade has been painful, and cuts our scope for discretionary consumption. Now, what happens to discretionary consumption if the real cost of essentials doubles or trebles from here? All of the non-essentials that we enjoy come out of economic surplus, i.e. economic output less cost of essentials. Also, of course, debt servicing absorbs a significant (and rising) chunk of incomes as well.

      EROEI determines how much surplus we have – at the low EROEIs we’ve grown accustomed to, essentials have been cheap, but my point is that, as the age of cheap and easy energy ends, we’re going to be paying far more for water, food, power and light, transport and so on. No amount of technology is going to deal with that…….

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