#77. The picture refined


After a long concentration on financial issues, the focus of this discussion is on energy.

The issues of energy and the economy are, of course, intimately connected. As a stagnant global economy goes on piling up debt to no useful purpose, it is reasonable to ask, not just why economic policy is turning into such a grotesque failure, but whether energy trends are contributing to that process. One conclusion of this discussion is that they are.

In this context, the explanation for policy failure seems breathtakingly simply. Ultimately, the economy isn’t a monetary system, but an energy equation – so trying to fix the real economy using monetary manipulation is like trying to fix an ailing pot-plant with a spanner.

It is not surprising, then, that the economy simply has not performed as the authorities have expected. Ever since 2000, debt has grown much more rapidly than economic output, giving rise to a strong presumption that reported “growth” has, in reality, been nothing more than the simple spending of borrowed money. Experimental, “unconventional” monetary policy has failed to deliver the expected stimulus. We face a world that is awash with debt, whilst pension and other provisions for the future are being destroyed before our eyes.

Where does energy fit into this picture?

Critical connections

In a bizarre economic situation, it is imperative to point out two things, both illustrated in fig. 1.

First, there is a remarkably close correlation between energy supply and economic output.

Second the rising energy cost of energy – the proportion of accessed energy that is consumed in the access process – correlates very closely indeed with the explosion in borrowing. In other words, the rising trend in the real cost of energy is pushing us ever deeper into debt. Recognition of this linkage enables us to distinguish between debt taken on out of choice before 2008, and borrowing now being undertaken out of necessity.

Fig. 1: energy, growth and debt77-1

These issues will be addressed later – but we should note, from the outset, that policy failure will continue for as long as the authorities persist in seeking monetary rather than energy-based explanations for what is happening to the economy.


A review of energy requires a lot of myth-busting. A widely-accepted narrative today is that there is nothing to worry about, because the world will make a seamless transition from fossil fuels to renewables. Some even argue that the oil, gas and coal industries are already all but dead-and-buried.

The facts simply do not square with this facile interpretation. Renewables, despite very welcome progress, still account for just under 3% of global primary energy consumption, whilst fossil fuels supply 86%. A transition to renewables will happen, and must – but it is going to take a lot longer than the glib popular narrative tends to assume. Looking ahead to 2030, the renewables component will, of course, be very much larger – but the workhorses of the economy will remain oil, gas and coal.

Within the overall energy slate, the cost of energy (measured as the proportion of accessed energy consumed in the access process) remains on a strong uptrend. This means that, even if gross energy supply can be maintained, the net amount of energy available for us to use is poised to decline, presenting major economic challenges.

Energy prices – extended cyclicality and the myth of “seamless transition”

The slump in oil and other energy prices since 2014 is widely misunderstood. The price crash is cyclical, and followed directly from a lengthy period of enormous investment, which necessarily created a big supply surplus as soon as the economy faltered.

Now, though, investment has collapsed, such that depletion of supply will in due course restore equilibrium, even if the economy does not improve.

An improvement in the economy actually looks pretty unlikely. The economy remains in “secular stagnation” despite the use of truly extraordinary monetary gymnastics in order to produce a semblance of “business as usual”. Surplus energy – that is, the difference between energy accessed and the energy consumed in the access process – continues to deteriorate, yet few recognise the connection between this erosion and the deterioration in economic growth, the weakening in productivity and the ever-growing reliance on the spending of borrowed money.

Perhaps because we live in an age of sound-bites, so-called “social media” and diminished attention-spans, there is a tendency to leap to glib conclusions that do not stack up under proper analysis. Nowhere is this more striking than in the widespread assumption that a quick and painless transition to renewables beckons. Renewables are indeed the future – but it is not a future to which we can transition quickly, let alone painlessly.

Some cautions against exuberance and complacency are needed. First, replacing today’s fossil fuel consumption with solar power would require carpeting an area the size of Austria with solar panels. Second, electric vehicles do not eliminate the dependency on primary energy, but simply displace it, at significant cost in terms of system losses. Petroleum, in particular, offers a concentration of energy-to-weight and energy-to-volume that will, for the foreseeable future, remain unrivalled. Producing a 747-sized aircraft powered by electricity remains a pipe-dream.

Price dynamics

The impression that a quick transition is taking place has been fostered by the slump in oil prices which, at around $47/b, are more than 50% below their 2013 average of $109/b.

The reality, as fig. 2 shows, is that this slump fits into an extended cyclical pattern spanning decades. The crisis-induced oil price excesses of the 1970s (1) prompted both demand reduction and huge investment in exploration and development, resulting in oversupply and a lengthy period of low prices (2). Debt-fuelled economic expansion, together with rapid growth in China and the Far East, then brought about a new era of high prices (3). This era has been ended decisively by a combination of massive energy investment (most obviously in shales) and economic weakness (4).

Fig. 2: real crude oil prices since 1965


Today, investment in exploration and development has collapsed, with well over $400bn of previously-planned investment now either deferred, or cancelled altogether. The outlook for shale investment is particularly significant, because the ultra-fast depletion rates characteristic of shales dictate a continuing need for investment capital. This has already become difficult to obtain, and could become even more so if there is a major correction away from inflated values and minimal yields in debt and equity markets.

At current prices, neither shales, nor hydrocarbons more generally, can earn the kind of returns normally required by capital markets.

Though economic weakness may make this period of low prices a prolonged one, it is a pretty safe assumption that under-investment will in due course create the conditions for a sharp rise in prices. Until profitability is restored by higher prices, capital investment will continue to languish – and, until investment can be increased, the erosion of supply capacity will continue.

Energy prices and costs – underlying trends

Fig. 3 imposes a trend-line onto the cyclical pattern of oil prices, a trend calibrated in terms of the rising Energy Cost of Energy (ECoE) of the global oil production slate.

The concept of ECoE recognises the fact that energy is never free, but comes at a cost. Though this cost can be expressed in money, it makes far more sense to examine, within any given quantity of energy accessed, how much of that energy is consumed in the access process. This, expressed as a percentage of the gross amount, is the Energy Cost of Energy.

Fig. 3: actual and trend oil prices since 1965

77-3 The secular trend in ECoE is upwards, as it has been for decades. The reason for this is that, as huge, ultra-low-cost sources of fossil fuels are exhausted, costlier and often unconventional supplies account for an ever-growing proportion of total energy consumption.

Technology can blunt this progression, but cannot stop the underlying rise in costs, let alone reverse it. Shale development typifies this equation. Innovation has made shale oil much cheaper to extract today than shale oil would have been ten or even five years ago. What technology cannot – ever – do is make shales cheaper than the super-giant conventional fields of the past.

Much the same can be said of renewables. Prior to the collapse in crude prices, the best renewables were capable of producing energy at costs lower than oil and gas being brought on stream today.  Commercially, that is all they need to do. But what they will not do is bring back an age of super-abundance.

Fig. 4 completes the price cyclicality picture by showing estimated aggregates for all primary energy, calibrated in constant dollars per barrel of oil-equivalent in order to facilitate comparisons with earlier charts. Again, a trend has been superimposed, based on estimated ECoE

Fig. 4: actual and trend energy prices since 1965


If this trend is correct, energy prices are now drastically below underlying replacement cost, a situation explicable in terms of two factors – a long (roughly 2000-14) investment boom, resulting in excess capacity; and the weakness of the economy.

This suggests that a sharp upward move in energy prices – to or beyond the trend – is inevitable. What it does not tell us, given the weakness of the economy, is how long this might take.

Energy cost – gross and net supply

Since energy is never “free”, there has always been a cost of energy, and this is expressed here as ECoE.

In times past, a super-abundance of cheap-to-produce energy made this cost small enough to ignore. More recently, however, the upwards progression of trend ECoEs has become the true “elephant in the room”, the missing factor which explains the supposed “mystery” of decelerating growth. Moreover, the trend rise in ECoEs is an exponential progression, as depicted in figs. 3 and 4.

ECoE can be factored in to the supply equation by expressing energy volumes in two forms – the gross amount of energy accessed, and the net amount which is available for us to use once ECoE has been deducted.

This equation is pictured in fig. 5, which shows estimates of gross and net energy supply since 1965, including projections out to 2030.

Fig. 5: gross and net energy supply since 1965 (I)

77-5As you can see, the difference between gross and net supply has only started to become meaningful in comparatively recent years. In 2000, for instance, gross supply of 9.4 billion tonnes of oil equivalent (bn toe) equated to a net amount of 9.2 bn toe, the difference (ECoE) being pretty modest at 0.2 bn toe. By 2015, this gap had widened to the point where a gross quantity of 13.4 bn toe yielded net supplies of 12.6 bn toe, with ECoE now equivalent to 0.8 bn toe.

This divergence between gross and net is hugely important going forward. As fig. 6 shows, it is likely that gross supplies of energy can be maintained out to 2030, with growth in renewables matching, and perhaps exceeding, a decline in the gross availability of fossil fuels, a decline which – courtesy in part of an investment slump – looks likely to commence pretty soon.

By 2030, gross energy output may be about 13.7 bn toe, up from 13.4 bn toe last year. Over that period, the renewables contribution is likely to rise briskly, accounting for 7.1% of total supply in 2030 up from 3% last year.

On a net basis, however, the trend in overall energy supply is downwards – even if gross supply can be pushed up, the rising trend in ECoEs is set to more than cancel out any such growth at the net level.

Fig. 6: gross and net energy supply since 1965 (II)


Within the gross energy “mix”, these forecasts equate to a compound annual rate of growth of 5.5% in renewables output over the coming fifteen years. This may seem low – and is an easy-to-beat number now (when growth rates are appreciably higher, but from a very low base) – but will become progressively more demanding as the denominator gets ever larger. Renewables output might grow faster than this, of course, but by the same token the rate of decline in fossil fuels output might be more pronounced than is assumed here.

This is put into context in fig. 7, which divides gross and net supply into separate components.

Fig. 7: composition of gross and net energy supply 77-7

Between today and 2015, aggregate gross energy supply is projected broadly flat (B), despite an assumed gradual erosion in the fossil fuels component (B). Growth in renewables output looks pretty spectacular (C) – until it is rebased (D) onto the same vertical (quantity) axis as the aggregate and fossil fuels charts.

The outlook, then, is for stable or slightly higher gross energy supply, with renewables gradually displacing fossil fuels. On a net basis, however, the outlook is very challenging – and, where the economy is in concerned, it is net supply that matters.

Economic implications

The main focus of this discussion has been energy, so that comments on economic issues must necessarily be kept brief, at least pending a planned comprehensive review of this issue. The key points to note, however, are as follows:

  1. There is a close relationship between economic output and the consumption of primary energy, as set out in fig. 8. The curve in real GDP has seemed to move ahead of the aggregate supply of energy over the last decade or so, but this reflects, at least in part, the impulse temporarily imparted to GDP by the spending of borrowed money.
  2. Looking ahead, the likelihood that the gross availability of primary energy will be flat makes a return to brisk economic growth look difficult.

Fig. 8: energy and economic output since 1980 (I)


  1. This difficulty is reinforced if we shift our assessment from gross to net energy availability, which is what really matters. This is set out in fig. 9.

Fig. 9: energy and economic output since 1980 (II)


  1. The rise in the trend cost of energy correlates pretty closely with annual borrowing, as illustrated in fig. 10. This chart portrays both the trend cost of energy and estimated annual net borrowing in constant dollars. The clear implication is that, whilst debt growth before 2008 was a discretionary choice, borrowing since then has been forced on the system by the need to accommodate the drag effect of rising trend ECoEs.

Fig. 10: Borrowing and the trend cost of energy


Some technical points need to be made before concluding this article. First, global GDP expressed in US dollars is surprisingly tricky to calculate, as data is reported on two bases of currency conversion – market and PPP (purchasing power parity) – which produce extremely divergent results. The basis used here is Standard Constant GDP, a methodology designed to overcome these difficulties.

Second, GDP calculation includes the cash cost of energy access – not least because one company’s cost is someone else’s revenue – but fails to incorporate the economic rent imposed by rising ECoEs. Another way to look at this is to observe that GDP does not capture what else money could have been spent on if it were not required for investment in energy access.

In conclusion, we can state that economic stagnation and rising trend ECoEs are by no means coincidental events.

We can also conclude that rising ECoEs are, by cramping the scope for non-energy expenditures, forcing us to increase debt. The best metric for examining this relationship is probably that between average incomes and the cost of essentials, since these essentials are the prime means of whereby changes trend energy costs impact prosperity.

Finally, rising ECoEs, and the likely erosion of net energy availability in the future, indicate that there can be no easy or pain-free way of escaping from the combination of stagnating output and rising debt.