Surplus Energy Economics
Shortly after the publication of Life After Growth, I undertook to produce a Brief Guide to surplus energy economics – and here it is, available for free download. In this article, I discuss some of the findings of the data system that I’ve built to track and predict energy returns, energy costs and economic performance on a worldwide basis.
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Compiling the guide has taken quite a while, because I decided to complete my EROEI database first.
Called “SEEDS” (which stands for ‘Surplus Energy Economics Data System’), this has been a big undertaking.
The first imperative was to track, so far as available information allowed, the course of EROEI in the past, and to project this forward into the future. I found that I was able to go back as far as the 1960s, and the projections go out to 2030. EROEI is tracked by fuel, covering oil, natural gas, coal, nuclear, hydroelectric, wind, solar, biofuels and other forms of renewable energy, with oil and gas further divided between conventional and unconventional sources such as tar sands and shales.
Next, I needed to compile data for consumption, production and net exports, by fuel type, for each of the 43 selected countries – more will be added – together with aggregations for five regions and the overall global picture. This gave me, for each country, data from which two other time series could be plotted – the EROEI of consumption in each country or region, and the overall EROEI for each, after adjustment for net trade in energy.
The inverse of EROEI, of course, is the Energy Cost of Energy, or “ECOE”. Put together with various economic data series, this enabled me to track the “financial” and “real” economies of each country and region. It also enabled me to calculate each country’s legacy of “excess claims” – essentially, the extent to which the financial economy of money and debt economy has entered into commitments that the real economy is not able to meet.
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Here are some of the findings of the SEEDS model.
First, overall EROEI has been declining since the 1960s, and has fallen from 55.7:1 in 1980, and 37.2:1 in 1990, to 24.3:1 in 2000 and 13.6:1 in 2013. Reflecting this, the trend in the Energy Cost Of Energy (ECOE) has risen to 6.8% in 2013, from 1.8% in 1980, 2.6% in 1990 and 3.9% in 2000.
Looking ahead, the model projects EROEIs of 10:1 in 2020 and 7.9:1 in 2025, equivalent, respectively, to ECOEs of 9.1% and 11.2%.
Globally, and expressed in constant (2012) dollars, this means that the real economy will decline pretty gradually, falling by 2.9% between 2013 and 2020, and by a further 5.9% between 2020 and 2025, leaving the real economy some 8.5% smaller in 2025 than it was in 2013.
Unfortunately, it’s going to feel rather worse than that, for two main reasons. First, of course, we’ve long become accustomed to growth. Second, the financial economy already exceeds the real one, because we are continuing to create “excess claims” at the rate of close to US$5 trillion annually. The global real economy of 2020 is projected to be almost 9% smaller than last year’s financial economy – and that’s going to hurt.
How much it will hurt, of course, depends on where you are. On a ranking of 1 to 43, the best-placed countries (in rank order) are Norway, Saudi Arabia, Russia, Indonesia, Australia and Switzerland. At the other end of the scale, the worst-affected countries are Greece (#43), Portugal (#42), Spain (#41), Italy (#40), Hungary (#39), Turkey (#38), Britain (#37), Japan (#36), Slovakia (#35) and India (#34).
Globally, there is huge scope for value destruction, because aggregate excess claims – monetary commitments, that is, which the real economy will be unable to satisfy – total US$63 trillion. This, I should stress, is a net number, with negative scores offset by the positive claims of countries which are net creditors of the system. These include Norway (US$1.8 trillion), Russia (US$2.7 trillion), Saudi Arabia (US$3.5 trillion) and other Middle East countries (in aggregate, US$4.3 trillion).
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The system identifies two critical thresholds. The lower of the two is the “viability threshold”, at an EROEI of about 6:1. At this point, energy costs absorb over 14% of economic output, making the economy barely viable at all.
Well before that point is reached, however, there is the “investment threshold”, set at an EROEI of 14:1. At this point, the cost of energy is 6.7%. Whilst the remaining 93% of output may suffice to keep the economy going, it is insufficient to fund net investment in new capital assets.
What would an economy look like at levels of EROEI below the 14:1 “investment threshold”?
Well, first and foremost, it would not be able to afford net capital investment. What this really means is that the economy’s consumption needs would not leave any scope for capital formation, which, in everyday parlance, means the economy could not afford to save.
So an economy in sub-threshold condition would have to have negative real interest rates, offering a negative return on savings, and deterring any rational person from saving – every available cent would be needed for day-to-day consumption, and it is probable that the sub-threshold economy would be borrowing extensively as well. At the same time, negative real interest rates would be imperative simply to keep the economy going, and to put off the evil day when “value destruction” – the destruction of “excess claims” – kicks in.
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Does this seem familiar? It should, because it describes a swathe of Western economies right now.
Plenty for us to ponder there, I think…..
Surplus Energy Economics 
Do you plan to provide access to the underlying data and calculations? The theory behind what you are doing is interesting but I would feel more comfortable with your conclusions if I could review the underlying analysis more closely.
Thanks. I understand your point. The database is huge, and I’m not sure as yet how much of it to publish, and in what format. The basic techniques are as described in the book, but each country and region is now examined fuel-by-fuel, and adjusted for net exports/imports. I might release selected reports, based on SEEDS data output, on individual countries (I’ve just completed drafts of Australia, South Africa, Singapore and the UK, for example).
Might I suggest that there some people (perhaps, many) who would be happy to assist in the data-mining & report generation work if you could find some way to open the data without ceding control of it….I know a few people who would be happy to support/contribute, myself included.
I’m not sure how this would work, but wouldn’t rule it out.
It seems to me, though, that what people really need is the output – “the ECOE of the US is xx% and will by yy% in 2020” – and so on?
2 things
1) The figures imply a story that the majority do not want to hear, so the more transparency and the more collaborators the more weight the story will carry. Your figures and story are of more relevance than most because you are one of very few people working on tying the thermodynamics to the financial/fiscal consequences.
2) I will be in London on Fri and on Thurs & Fri of next week….I’d be happy to buy you lunch or coffee to discuss matters further….email me directly if it suits.
an excellent article
I think the scariest thinking on economics (now that Julian Simon is no longer with us) is that of Paul Krugman, (Nobel prizewinner for economics)
I quote: My neighbour’s spending pays my wages, My spending pays his wages. Genius!!!
Keynes was of similar ilk. His economic genius was founded entirely on ever increasing volumes of oil being produced and burned. His lifetime exactly spanned the era of maximum oil production in the USA, 1886-1946. No economic forecast can go wrong if oil output rises at 7% a year. The 30s depression was blip in the upward trend. It was Adolf Hitler who brought the solution to unemployment, not Keynes or Roosevelt’s new deal. Yet everyone points to the ‘Keynesian model’ as and example of economic brilliance.
It was nothing of the sort. Surplus oil guarantees success in war and peace.
Thanks.
I’d like to take one step back here. Basically, economics isn’t a science. Its basic unit is money, which is an artificial construction. As you’ll know, my preferred approach is to use the real, scientific unit of energy, and look at things using real laws, i.e. thermodynamics. I’ve said before that those who look only at money, and ignore fundamentals such as energy, are practising a flat earth “science”.
A key measure in economics is GDP. But it is very flawed. For a start, it’s a measure of flow, not stock, so it disregards changes in assets, debts, nartural resources etc.. GDP measures all activity, but does not attach relative values (if the government employed people to dig holes, and more people to fill them in, that would increase GDP, without increasing real prosperity at all). And so on.
So Keynes (and others) are observers, not scientists. Increasing state spending does increase economic activity, as measured using GDP. It also increases debt, but GDP ignores that, because it’s a stock measure. Whether higher state spending (like digging holes!) really adds value is a different question – and one that conventional, GDP-based economics cannot answer.
Given these fundamental limitiations of economics, I don’t blame its practioners when things don’t work, or don’t seem logical. But what ‘conventional’ economists really need to do is to admit the limitations of their discipline.
Your surplus oil point is totally right. In the 19th Century, coal was supreme, so Britain dominated. The 20th Century was the century of oil, and the USA. The 21st Century? – we don’t know yet, but it won’t de dominated by oil.
I agree. Much of the mess we’re in has come about because economists have had a century or more of ‘progress’ which confirms their forecasts. which ‘proves’ that economics is the reason for that success and constant growth, There is the weird certainty that technology delivers energy, not the other way round.
I think the 21st century will be dominated by the politics of denial, the fixation on technology as the means to keep the wheels on our society. The politics of denial must inevitably mean fighting over what’s left as the century rolls on and technology ultimately fails to deliver and humankind looks for other reasons for collapse. Those reasons are readily available, usually through worshipping the wrong god or being the wrong colour or whatever. Humankind seems to have an ability to cling to certainties of our own making, no matter how unreal they are.
I like the term ECOE. While it’s recursiveness may turn some off (“Energy Cost of Energy? What the heck does that mean?) it plainly reflects what hardly anyone seems to understand, it takes (“costs”) energy to make energy. The EIA and IEA should be speaking in terms of “Net Energy” i.e. the energy available to society after the energy required to extract/produce the energy is backed out.
Thanks, good points. Hitherto, the difference between gross and net energy has been pretty small, but now this difference is widening sharply – so now the IEA, EIA and so on really do need to emphasise net energy – but will they? Well, I won’t be holding my breath on this…..
PS I’ve just added a downloadable chart of gross and net energy consumption to the blog.
Unfortunately very few people ‘get it’ that energy isn’t made. Certainly not those we elect to govern us.
It is impossible to put across, that energy can only be converted from one form to another
Nice work. You are first person I have come across that really gets it and you managed to have enough time to work on it. Way to go. They could get all this into modern economics if they just modified the definition of money by adding that it is also has the added property of being able to enable or endorse an expenditure of energy. I would love to see a comparison of GDP to an economies energy consumption (useful work plus food). I suspect they would line right up with the divergence being the inflation rate. An economy is nothing more than an energy conversion machine. That’s just obvious. Slaving the money supply to the energy conversion capacity might actually enable sensible management of a market economy. I wonder if Alan Greenspan could get his head around that?
I am surprise you have not stated the energy return ratios for the various conversion technologies in play. My estimates are that many are in the range of 6 – oil sands, solar, wind, and new nuclear. Fracturing I have not got feel for. Admittedly I don’t get paid for this stuff so the calcs could be off but it would seem that sensible policy direction could be demonstrated on where to put current resources in terms of energy infrastructure with your calcs and energy return ratios for various conversion technologies. . If it need to be 14 to keep some semblance of what we have (I need to read your stuff a bit closer – just sort of scanned through it). ………someone needs to pull the proverbial energy rabbit out of the proverbial hat. And, they need to do it soon.
Thanks, many good points. I do have a database which contains estimates of EROEIs for oil (conventional and unconventional), gas (ditto), coal, nuclear, solar, wind, geothermal, biofuels and so on. It then meshes these into two EROEIs per country – average EROEI of consumption, and average EROEI of supply, adjusted for net exports or imports of energy.
It’s interesting how things are trending – downwards, basically. Japan, for example, has driven down the value of the yen, in order to boost trade – but this has resulted in the worst ever trade deficit, because export gains have been far more than cancelled out by the higher cost of imported energy.
As a layman who is not trained in any of this science i still found it very readable and well explained. One wonders when this sort of stuff will ever be discussed at main stream media/political debates and so on. About time. A great read thanks
Thanks, glad you like it. My guess is that the mainstream will not move on this until it has to!
You may have to modify your EROI investment threshold somewhat. I am thinking about tar sands in particular which appear to be viable despite low EROI estimates ranging from 3:1 to 5:1. I believe tar sands may work because the cost of natural gas, a major component of the energy invested is so low. Even $5 per million BTU’s comes out to an energy equivalent of about $30 oil. Perhaps tar sands are a way to arbitrage energy costs which won’t last? I also wonder about the utility of competing fuels to provide transportation even at much reduced levels without a thorough and unaffordable infrastructure change.
Point taken, but what you are describing is actually “energy cannibalism”.
This term describes what is happening if you take an energy source with an EROEI of, say, 5:1, and use it to extract another energy source with a lower EROEI of, say, 3:1.
Likewise, if you take oil (or gas, or coal) and convert it into electricity, you lose at least 65% of your initial energy (BTU) input (which, incidentally, is one reason why electric vehicles are such a dumb idea).
Gas in the US is only cheap at the moment because of enormous investment in shale wells. But output from these wells declines very rapidly, say an 80% fall in production by year 3. So long as investors keep funding new wells, output will continue to increase. But when well saturation is reached (in 2017 or 2018), shale gas output will slump. Gas will then cease to be cheap. Investors don’t seem to grasp this point (yet), though the US military does grasp it, apparently.
Ultimately, EROEI is a physics equation, even though we attach financial numbers to it.
When you graphically display and write about the real vs financial economy “gap” in Portugal vs “non-gap” in the Netherlands, does this involve inflation? Asked differently, is the difference/gap between Portugal’s real economy vs its financial economy reflective of the inflatedness of the currency unit? If it is, then why is there a gap since both lines are using the same currency unit, i.e., the USD, and commonly cited GDP real are real (inflation adjusted) anyway? Or, is the difference simply a calculation of the amount of debt-based claims that reasonable projections show to be not repayable? I’m a non-economist and am very interested in your work, and hoping to understand it better.
On another note, the most shocking shale news to me was the notion that it will likely be all drilled up by 2018? I live in the heart of the Barnett Shale and have been laboring under the apparently mistaken impression that the drilling activity, frenetic as its been for nigh on a decade now, was first wave only. And further that any subsidence we’ve seen was primarily because of relatively depressed gas prices and therefore incentive to hold off punching new holes till demand catches up with supply. Can you please clarify your source(s) on this notion of the U.S. shales being ‘all drilled up by 2018’?
Thanks for your very interesting work.
Thanks. On the shale point, I recommend the web-site of Deborah Rodgers, who is extremely knowledgable on this; a book by David Hughes, likewise; and “Snake Oil”, a book by Richard Heinberg which explains this well to a non-specialist readership. I also have (somewhere) a paper published by a senior officer (retired, I think) from the US military.
Essentially, enough data now exists to plot well productivity on a comprehensive basis. Though there are some “sweet spots”, the overall picture is clear – sharp declines in production within a year of start-up. From this, you can calculate the number of new wells required each year just to maintain output (the “drilling treadmill”). The number of potential well locations is known, too. So a future profile isn’t hard to calculate.
The price issue is volume-related, sure. But you need to consider the truly vast sums invested, because Wall Street loves shale and investors have rushed to invest. A lot of wells means a lot of INITIAL production, hence oversupply and low prices. I know there are some daft ideas and rumours around – for instance, I refuse to believe that anyone has or would frack a formation using an A-bomb! – but the facts, especially the decline rates and the number of potential locations, are pretty well known.
I’ll get back to you on the other point. But here’s a suggestion. For the pre-crunch years, do two sums:
– From the Fed, get total credit market debt for end-2000 and end-2008, to calculate the overall increase in debt.
– From the BEA (or many other sources), get US GDP data and calculate the increase in GDP in $bn over the same period.
Then, divide the debt increase by the GDP increase. You’ll find that way more than $1 is being borrowed for each $1 increase in GDP.
GDP, as you’ll know, is a measure of flow, like an income statement. There is no included measure of stock, like a balance sheet. So, if GDP rises by $100m, that’s an “increase” – the fact that, say, $400m of net new borrowing was needed to generate that $100m of “growth” is ignored.
I am a big fan of yours and enjoy reading your work. Thank you!
Now my question: as you rightly point out GDP is measure of flow over a period of time. To properly compare indebtedness of, say, the US with any other country shouldn’t we compare the debt/asset ratio of each country? Of course we need some way of estimating the total value of an economy (any suggestions?). That would give us a more real measure of how indebted is a country and allow appropriate comparison.
GDP could still be used for calculating the debt service coverage ratio.
Another unrelated question: have you read any of the Jeremy Rifkin’s books and if yes what is your opinion?
Thanks. It’s ironic that you should raise the question of assets because I am writing about it at this very moment!
Countries often comfort themselves by calculating their assets – the total “value” of the housing stock, for example, plus the “value” of infrastructure and so on. But this is delusional, because it does not express an understanding of what an asset really is – or what it is worth. So I am happy to explain this here.
Let’s start with what an “asset” really is, and what it is worth. An asset is something that can earn an income. The REAL economic value of a factory or a business, for example, is the future stream of earnings that you can get from it. The real value of your house is the saving in future rent (though of course you might put an extra, personal value on it as well because it is your home, and you like it). The value of a road or a bridge is its contribution to the economy (broadly considered).
Let’s consider a factory. It will cost you, say, $10m to build it. You know what its stream of earnings will be in the future. After adjusting for inflation, adding up the stream of future earnings totals $20m. So you build the factory.
Obviously its value is $20m (its future earnings), not $10m (which is the figure in your accounts, because that is what it cost you). Now, say Mr B offers you $15m for it. That’s less than the $20m value, but you might accept, if you have a better use for the money. It now goes in Mr B’s accounts at $15m (what he paid for it), but its real worth is still $20m. Next, Mr C offers Mr B $25m for it, and he accepts. It goes in Mr Cs accounts at $25m (what he paid for it). Mr C then sells it to Mr D, for $10m (a big loss). It goes in his books at $10m.
So, what is it really worth? Is it:
$10m, which it cost you?
$15m, which Mr B paid for it?
$25m, which Mr C paid for it?
$10m, which Mr D paid for it?
Answer: none of the above. It remains worth $20m, which is what it can earn.
What this tells us is that the book value of an asset is not its real value. It is just the accounting value.
If you take the average price of a house in Britain, and multiply this by the number of houses, you will come to a big number which people sometimes say is the value of the British housing stock. That is wrong, because in practice you cannot sell all the houses in a country – the buyers and the sellers are the same people. The value of houses is really decided by how much mortgage finance is available.
Next, imagine that house prices in Britain collapse. Is the country really worse off? No. The houses still exist, they haven’t gone anywhere. Their value as places to live – saving on future rent, if you like – hasn’t changed. Young people can buy houses more cheaply. Labour flexibility is improved. More money is available (in future) to be invested in more productive uses. (There is a huge problem, of course, but that problem is caused by debt, not by the actual economic worth of the houses).
So, to cut to the chase, national asset values are notional, and hugely misleading. A house is something you live in, not invest in.
But, whilst asset values are notional – and variable – debt is fixed, and real. It is real numbers, and is contractual.
So measuring debt against GDP is probably best. Though it could be better still if we measured DEBT SERVICE (interest plus annual repayments) against GDP.
A bit of a long answer, but I hope it helps?
another pitch on asset delusion might be gold too
True – but its advocates might say that gold is simply a better store of value than fiat money?
I think that farm land is probably a better hedge than gold, and also earns an income……..
my meaning was that there is an ongoing delusion that gold itself carries a useful and convertible ‘value’ within itself, when in fact it can produce nothing.
Obviously land is the ultimate store of value in that it is the prime producer of energy
Thanks. The only function of gold is an alternative to fiat money. As you say, it doesn’t produce anything. We dig it up, refine it, bury it again, and pay people to stand around guarding it. Seen that way, it’s bonkers.
But the enduring popularity of gold reflects the shortcomings of fiat money, so it has become more popular than ever since the USD was cut adrift from gold in 1971. Fiat money, perhaps the ultimate expression of government interference in the economy, illustrates that governments cannot be trusted. Effectively, having issued money, they steal back its value through inflation – look at the purchasing power of the USD or the GBP over, say, four decades and you’ll see how extensive that confiscation of value has been.
So it’s understandable that people want an alternative, hence the interest in Bitcoin etc.. Governments cannot afford to let that happen, BTW, because much of their power rests on money issuance.
We’re in an odd situation. On the one hand, governments are in cahoots with the wealthy, and preside over policies that have worsened inequality. On the other, governments seek to grab an ever larger share of national income now that the economy has become (in my analysis) ex-growth. The public seems broadly disillusioned with governments, and it will be interesting to see where that leads……