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I was asked to give a talk to a committee of actuaries who are concerned about modeling the financial future of programs, such as pension plans, given the energy problems that are often discussed. They (and the consultants that they hire) have been using an approach that puts problems far off into the future. I was trying to explain why the approach that they were using didn’t really make sense.

Below are the slides I used, and a little explanation. A PDF of my presentation can be downloaded at this link: The Mirror Image Problem.

Slide 1

FCAS stands for “Fellow of the Casualty Actuarial Society”; MAAA stands for “Member of the American Academy of Actuaries.” Actuaries tend not to be interested in academic degrees.

Slide 2

I try to explain how a more complex situation can be hidden in plain sight.

Slide 3

It is not obvious that both the needs of energy producers and energy consumers should be considered.

Slide 4

If we look back at what the discussions of the time were, we can see when remarks were that prices were too high for consumers, and when they were too low for producers. See for example my article, Oil Supply Limits and the Continuing Financial Crisis and my post, Beginning of the End? Oil Companies Cut Back on Spending. This latter article shows that companies were already cutting back on spending in 2013, when prices appeared to be high, because even at a $100+ per barrel level, they still were not high enough for producers.

Slide 5

Oil companies tend to extract the cheapest and easiest to extract oil first. Eventually, they find that they need to move on to more expensive to extract fields–even with technology enhancements, costs are rising.

…click on the above link to read the rest of the article…

Raising Interest Rates Can’t End Well!

March 13, 2017

Raising Interest Rates Can’t End Well!

The Federal Reserve would like to raise target interest rates because of inflation concerns and concern that asset bubbles are forming. Part of their concern seems to arise indirectly from the rise in oil prices, relative to their low level in early 2016.

Figure 1. WSJ figure indicating likely reasons for rate hike.

A finite world does not behave the way most modelers expect. Interest rates that worked perfectly well in the past, don’t necessarily work well now. Oil prices that worked perfectly well in the past don’t necessarily work well now. It seems to me that raising interest rates at this time is very ill advised. These are a few of the issues I see:

[1] The economy is now incredibly dependent upon rising debt to prop up its spending. The pattern of total debt to GDP for the United States is shown in Figure 2.

Figure 2. United States’ debt to GDP ratios based on Federal Reserve Z1 data and BEA GDP data. The red line represents the increase over the latest three years.

There was a huge increase in debt in the period leading up to the 2008 crash. Every year between 2001 and 2008, the increase in debt was greater than four times the increase in GDP. In fact, for some years in that period, more than $8 of debt were added for every dollar of GDP added.

We now seem to be starting a new run up in debt. In 2015, the amount of debt added was $2.5 trillion ($66.1 trillion minus $63.6 trillion), while the amount of GDP added was only $529 million. This indicates a ratio of over 4.7 for the single year of 2016. (Figure 2 shows only three-year averages, because of the volatility of amounts.)

…click on the above link to read the rest of the article…

Oops! The economy is like a self-driving car

February 20, 2017

Oops! The economy is like a self-driving car

Back in 1776, Adam Smith talked about the “invisible hand” of the economy. Investopediaexplains how the invisible hand works as, “In a free market economy, self-interested individuals operate through a system of mutual interdependence to promote the general benefit of society at large.”

We talk and act today as if governments and economic policy are what make the economy behave as it does. Unfortunately, Adam Smith was right; there is an invisible hand guiding the economy. Today we know that there is a physics reason for why the economy acts as it does: the economy is a dissipative structure–something we will talk more about later. First, let’s talk about how the economy really operates.

Our Economy Is Like a Self-Driving Car: Wages of Non-Elite Workers Are the Engine

Workers make goods and provide services. Non-elite workers–that is, workers without advanced education or supervisory responsibilities–play a special role, because there are so many of them. The economy can grow (just like a self-driving car can move forward) (1) if workers can make an increasing quantity of goods and services each year, and (2) if non-elite workers can afford to buy the goods that are being produced. If these workers find fewer jobs available, or if they don’t pay sufficiently well, it is as if the engine of the self-driving car is no longer working. The car could just as well fall apart into 1,000 pieces in the driveway.

If the wages of non-elite workers are too low, they cannot afford to pay very much in taxes, so governments are adversely affected. They also cannot afford to buy capital goods such as vehicles and homes. Thus, depressed wages of non-elite workers adversely affect both businesses and governments. If these non-elite workers are getting paid well, the “make/buy loop” is closed: the people whose labor creates fairly ordinary goods and services can also afford to buy those goods and services.

…click on the above link to read the rest of the article…

The “Wind and Solar Will Save Us” Delusion

February 19, 2017

The “Wind and Solar Will Save Us” Delusion

The “Wind and Solar Will Save Us” story is based on a long list of misunderstandings and apples to oranges comparisons. Somehow, people seem to believe that our economy of 7.5 billion people can get along with a very short list of energy supplies. This short list will not include fossil fuels. Some would exclude nuclear, as well. Without these energy types, we find ourselves with a short list of types of energy — what BP calls Hydroelectric, Geobiomass (geothermal, wood, wood waste, and other miscellaneous types; also liquid fuels from plants), Wind, and Solar.

Unfortunately, a transition to such a short list of fuels can’t really work. These are a few of the problems we encounter:

[1] Wind and solar are making extremely slow progress in helping the world move away from fossil fuel dependence.

In 2015, fossil fuels accounted for 86% of the world’s energy consumption, and nuclear added another 4%, based on data from BP Statistical Review of World Energy. Thus, the world’s “preferred fuels” made up only 10% of the total. Wind and solar together accounted for a little less than 2% of world energy consumption.

Figure 1. World energy consumption based on data from BP 2016 Statistical Review of World Energy.

Our progress in getting away from fossil fuels has not been very fast, either. Going back to 1985, fossil fuels made up 89% of the total, and wind and solar were both insignificant. As indicated above, fossil fuels today comprise 86% of total energy consumption. Thus, in 30 years, we have managed to reduce fossil fuel consumption by 3% (=89% – 86%). Growth in wind and solar contributed 2% of this 3% reduction. At the rate of a 3% reduction every 30 years (or 1% reduction every ten years), it will take 860 years, or until the year 2877 to completely eliminate the use of fossil fuels. And the “improvement” made to date was made with huge subsidies for wind and solar.

…click on the above link to read the rest of the article…

2017: The Year When the World Economy Starts Coming Apart

January 11, 2017

2017: The Year When the World Economy Starts Coming Apart

Some people would argue that 2016 was the year that the world economy started to come apart, with the passage of Brexit and the election of Donald Trump. Whether or not the “coming apart” process started in 2016, in my opinion we are going to see many more steps in this direction in 2017. Let me explain a few of the things I see.

[1] Many economies have collapsed in the past. The world economy is very close to the turning point where collapse starts in earnest.

Figure 1

The history of previous civilizations rising and eventually collapsing is well documented.(See, for example, Secular Cycles.)

To start a new cycle, a group of people would find a new way of doing things that allowed more food and energy production (for instance, they might add irrigation, or cut down trees for more land for agriculture). For a while, the economy would expand, but eventually a mismatch would arise between resources and population. Either resources would fall too low (perhaps because of erosion or salt deposits in the soil), or population would rise too high relative to resources, or both.

Even as resources per capita began falling, economies would continue to have overhead expenses, such as the need to pay high-level officials and to fund armies. These overhead costs could not easily be reduced, and might, in fact, grow as the government attempted to work around problems. Collapse occurred because, as resources per capita fell (for example, farms shrank in size), the earnings of workers tended to fall. At the same time, the need for taxes to cover what I am calling overhead expenses tended to grow. Tax rates became too high for workers to earn an adequate living, net of taxes. In some cases, workers succumbed to epidemics because of poor diets. Or governments would collapse, from lack of adequate tax revenue to support them.

…click on the above link to read the rest of the article…

EROEI Calculations for Solar PV Are Misleading

December 21, 2016

EROEI Calculations for Solar PV Are Misleading

The Energy Returned on Energy Invested (EROEI) concept is very frequently used in energy studies. In fact, many readers seem to think, “Of course, EROEI is what we should be looking at when comparing different types of energy. What else is important?” Unfortunately, the closer to the discussions of researchers a person gets, the more problems a person discovers. People who work with EROEI regularly say, “EROEI is a tool, but it is a blunt tool. An EROEI of 100 is good compared to an EROEI of 10. For small differences, it is not so clear.”

Because of the idiosyncrasies of how EROEI works, different researchers using EROEI analyses come to very different conclusions. This issue has recently come up in two different solar PV analyses. One author used EROEI analysis to justify scaling up of solar PV. Another author published an article in Nature Communications that claims, “A break-even between the cumulative disadvantages and benefits of photovoltaics, for both energy use and greenhouse gas emissions, occurs between 1997 and 2018, depending on photovoltaic performance and model uncertainties.”

Other EROEI researchers with whom I correspond don’t agree with these conclusions. They recognize that in complex situations, EROEI analyses cannot cover everything. Somehow, the user needs to be informed enough to realize that these omissions result in biases. Researchers need to work around these biases when coming to conclusions. They themselves do it (or try to); why can’t everyone else?

The underlying problem with EROEI calculations is that EROEI is based on a very simple model. The model works passably well in simple situations, but it was not designed to handle the complexities of intermittent renewables, such as wind and solar PV. Indirect costs, and costs that are hard to measure, tend to get left out.

…click on the above link to read the rest of the article…

What has gone wrong with oil prices, debt, and GDP growth?

December 7, 2016

What has gone wrong with oil prices, debt, and GDP growth?

Our economy is a mystery to almost everyone, including economists. Let me explain the way I see the situation:

(1) The big thing that pulls the economy forward is the time-shifting nature of debt and debt-like instruments.

If we want any kind of specialization, we need some sort of long-term obligation that will make that specialization worthwhile. If one hunter-gatherer specializes in finding flints that will start fires, that hunter-gatherer needs some sort of guarantee that others, who are finding food, will share some of their food with him, so that the group, as a whole, can prosper. Others, who specialize in gathering firewood, or in childcare, also need some kind of guarantee that their efforts will be rewarded.

At first, these obligations were enforced by social norms such as, “If you don’t follow the rules of the group, we will throw you out.” Gradually, reciprocal obligations became more formalized, and included more time shifting, “If you will work for me, I will pay you at the end of the month.” Or, “If you will pay my transportation costs to a land of more opportunity, I will repay you with 10% of my wages for the first five years.” Or, “I will sell you this piece of land, if you will pay me x amount per month for y years.”

In some cases, the loan (or loan-like agreements) takes the form of stock ownership of an enterprise. In this case, the promise is for future dividends, and the possibility of growth in the value of the stock, in return for the use of funds. Even though we generally refer to one type of loan-like agreement as “equity ownership” and the other as “debt,” they have a great deal of similarity. Funds are being provided to the enterprise, with the expectation of greater return in the future.

…click on the above link to read the rest of the article…

How Researchers Could Miss the Real Energy Story

October 27, 2016

How Researchers Could Miss the Real Energy Story

I have been telling a fairly different energy story from most energy researchers. How could I possibly be correct? What have other researchers been missing?

The “standard” approach is to start from the amount of resources that we have of a particular type, for example, oil in the ground, and see how far these resources will go. Growing development of technology seems to allow increasing amounts of these resources to be extracted. Thus, limits seem to be farther and farther in the distance, especially if a person starts out with an optimistic bias. It is easy to get this optimistic bias, with all research funds going in the direction of, “What can we do to solve our energy problems?”

Approaches for forecasting future supply problems that start from the amount of resources in the ground suffer from the problem that it is hard to draw a sharp line regarding when we will run into difficulties. It is clear that at some point, there will be a problem–EROEI (Energy Return on Energy Investment) will be too low–but exactly whenis hard to pinpoint. If a person starts from an optimistic viewpoint, it is easy to assume that as long as Energy Output is greater than Energy Input for a given process, that process must be helpful for solving our energy problem.

In fact, in my opinion, the story is very different. The very thing that should be saving us–technology–has side effects that bring the whole system down.

The only way we can keep adding technology is by adding more capital goods, more specialization, and more advanced education for selected members of society. The problem, as we should know from research regarding historical economies that have collapsed, is that more complexity ultimately leads to collapse because it leads to huge wage disparity. (See Tainter; Turchin and Nefedov.)

…click on the above link to read the rest of the article…

Why energy prices are ultimately headed lower; what the IMF missed

October 16, 2016

Why energy prices are ultimately headed lower; what the IMF missed

We have been hearing a great deal about IMF concerns recently, after the release of its October 2016 World Economic Outlook and its Annual Meeting October 7-9. The concerns mentioned include the following:

Too much growth in debt, with China particularly mentioned as a problem
World economic growth seems to have slowed on a long-term basis
Central bank intervention required to produce artificially low interest rates, to produce even this low growth
Global international trade is no longer growing rapidly
Economic stagnation could lead to protectionist calls

These issues are very much related to issues that I have been writing about:

It takes energy to make goods and services.
It takes an increasing amount of energy consumption to create a growing amount of goods and services–in other words, growing GDP.
This energy must be inexpensive, if it is to operate in the historical way: the economy produces good productivity growth; this productivity growth translates to wage growth; and debt levels can stay within reasonable bounds as growth occurs.
We can’t keep producing cheap energy because what “runs out” is cheap-to-extract energy. We extract this cheap-to-extract energy first, forcing us to move on to expensive-to-extract energy.
Eventually, we run into the problem of energy prices falling below the cost of production because of affordability issues. The wages of non-elite workers don’t keep up with the rising cost of extraction.
Governments can try to cover up the problem with more debt at ever-lower interest rates, but eventually this doesn’t work either.
Instead of producing higher commodity prices, the system tends to produce asset bubbles.
Eventually, the system must collapse due to growing inefficiencies of the system. The result is likely to look much like a “Minsky Moment,” with a collapse in asset prices.

…click on the above link to read the rest of the article…

Intermittent Renewables Can’t Favorably Transform Grid Electricity

September 10, 2016

Intermittent Renewables Can’t Favorably Transform Grid Electricity

Many people are hoping for wind and solar PV to transform grid electricity in a favorable way. Is this really possible? Is it really feasible for intermittent renewables to generate a large share of grid electricity? The answer increasingly looks as if it is, “No, the costs are too great, and the return on investment would be way too low.” We are already encountering major grid problems, even with low penetrations of intermittent renewable electricity: US, 5.4% of 2015 electricity consumption; China, 3.9%; Germany, 19.5%; Australia, 6.6%.

In fact, I have come to the rather astounding conclusion that even if wind turbines and solar PV could be built at zero cost, it would not make sense to continue to add them to the electric grid in the absence of very much better and cheaper electricity storage than we have today. There are too many costs outside building the devices themselves. It is these secondary costs that are problematic. Also, the presence of intermittent electricity disrupts competitive prices, leading to electricity prices that are far too low for other electricity providers, including those providing electricity using nuclear or natural gas. The tiny contribution of wind and solar to grid electricity cannot make up for the loss of more traditional electricity sources due to low prices.

Leaders around the world have demanded that their countries switch to renewable energy, without ever taking a very close look at what the costs and benefits were likely to be. A few simple calculations were made, such as “Life Cycle Assessment” and “Energy Returned on Energy Invested.” These calculations miss the fact that the intermittent energy being returned is of very much lower quality than is needed to operate the electric grid. They also miss the point that timing and the cost of capital are very important, as is the impact on the pricing of other energy products.

…click on the above link to read the rest of the article…

An Updated Version of the “Peak Oil” Story

August 16, 2016

An Updated Version of the “Peak Oil” Story

The Peak Oil story got some things right. Back in 1998, Colin Campbell and Jean Laherrère wrote an article published in Scientific American called, “The End of Cheap Oil.” In it they said:

Our analysis of the discovery and production of oil fields around the world suggests that within the next decade, the supply of conventional oil will be unable to keep up with demand.

There is no single definition for conventional oil. According to one view, conventional oil is oil that can be extracted by conventional methods. Another holds it to be oil that can be extracted inexpensively. Other authors list specific types of oil that require specialized techniques, such as very heavy oil and oil from shale formations, that are considered unconventional.

Figure 1 shows the growth in unconventional oil supply for three parts of the world:

Oil from shale formations in the US.
Oil from the Oil Sands in Canada.
Oil characterized as unconventional in China, in a recent academic paper of which I was a co-author. (Temporarily available for free here.)

Figure 1. Approximate unconventional oil production in the United States, Canada, and China. US amounts estimated from EIA data; Canadian amounts from CAPP. Oil prices are yearly average Brent oil prices in $2015, from BP 2016 Statistical Review of World Energy.

Oil prices in 1998, which is when the above quote was written, were very low, averaging $12.72 per barrel in money of the day–equivalent to $18.49 per barrel in 2015 dollars. From the view of the authors, even today’s oil prices in the low $40s per barrel would be quite high. Since the above chart shows only yearly average prices, it doesn’t really show how high prices rose in 2008, or how low they fell that same year. But even when oil prices fell very low in December 2008, they remained well above $18.49 per barrel.

…click on the above link to read the rest of the article…

Energy limits: Why we see rising wealth disparity and low prices

July 10, 2016

Energy limits: Why we see rising wealth disparity and low prices

Last week, I gave a fairly wide-ranging presentation at the 2016 Biophysical Economics Conference called Complexity: The Connection Between Fossil Fuel EROI, Human Energy EROI, and Debt (pdf). In this post, I discuss the portion of the talk that explains several key issues:

Why we are right now seeing so many problems with respect to wealth disparity and low commodity prices (Answer: World per capita energy consumption is already falling, and the energy/economy system needs to reflect this problem somehow.)
Why the quest for growing technology leads to growing wealth disparity (Answer: The economy must be configured in more of a hierarchical pattern to support growing “complexity.” Growing complexity is the precursor to growing technology.)
Why rising debt is an integral part of the energy/economy system (Answer: We could not pay workers for making long-lasting goods and services without using debt to “pull forward” the hoped-for benefit of these goods and services to the present, using debt and other equivalent approaches.)
Why commodity prices can suddenly fall below the cost of production for a wide range of products (Answer: Prices of commodities depend to a significant extent on debt levels. A major problem is that when commodity prices rise, wages do not rise in a corresponding manner. Rising debt levels can mask the growing lack of affordability for a while, but eventually, debt levels cannot be raised sufficiently, and commodity prices fall too low.)
The Brexit vote may be related to falling energy per capita in the UK. Given that this problem occurs in many countries, it may be increasingly difficult to keep the Eurozone and other similar international organizations together.
My talk also touches on the topic of why a steady state economy is not possible, unless we can live like chimpanzees.

…click on the above link to read the rest of the article…

China: Is peak coal part of its problem?

June 21, 2016

China: Is peak coal part of its problem?

The world’s coal resources are clearly huge. How could China, or the world in total, reach peak coal in a timeframe that makes a difference?

If we look at China’s coal production and consumption in BP’s 2016 Statistical Review of World Energy (SRWE), this is what we see:

Figure 1. China’s production and consumption of coal based on BP 2016 SRWE.

Figure 2 shows that the quantities of other fuels are increasing in a pattern similar to past patterns. None of them is large enough to make a real difference in offsetting the loss of coal consumption. Renewables (really “other renewables”) include wind, solar, geothermal, and wood burned to produce electricity. This category is still tiny in comparison to coal.

Figure 2. China’s energy consumption by fuel, based on BP 2016 SRWE.

Why would a country selectively decide to slow down the growth of the fuel that has made its current “boom” possible? Coal is generally cheaper than other fuels. The fact that China has a lot of low-cost coal, and can use it together with its cheap labor, has allowed China to manufacture goods very inexpensively, and thus be very competitive in world markets.

In my view, China really had no choice regarding the cutback in coal production–market forces were pushing for less production of goods, and this was playing out as lower commodity prices of many types, including coal, oil, and natural gas, plus many types of metals.

China is mostly self-sufficient in coal production, but it is a major importer of natural gas and oil. Lower oil and natural gas prices made imported fuels of these types more affordable, and thus encouraged more importing of these products.

…click on the above link to read the rest of the article…

$50 Oil Doesn’t Work

June 4, 2016

$50 Oil Doesn’t Work

$50 per barrel oil is clearly less impossible to live with than $30 per barrel oil, because most businesses cannot make a profit with $30 per barrel oil. But is $50 per barrel oil helpful?

I would argue that it really is not.

When oil was over $100 per barrel, human beings in many countries were getting the benefit of most of that high oil price:

Some of the $100 per barrel goes as wages to the employees of the oil company who extracted the oil.
Often, the oil company contracts with another company to do part of the oil extraction. Part of the $100 per barrel is paid as wages to employees of the subcontracting companies.
An oil company buys many goods, such as steel pipe, which are made by others. Part of the $100 per barrel goes to employees of the companies making the goods that the oil company buys.
An oil company pays taxes. These taxes are used to fund many programs, including new roads, schools, and transfer payments to the elderly and unemployed. Again, these funds go to actual people, as wages, or as transfer payments to people who cannot work.
An oil company pays dividends to stockholders. Some of the stockholders are individuals; others are pension funds, insurance companies, and other companies. Pension funds use the dividends to make pension payments to individuals. Insurance companies use the dividends to make insurance premiums affordable. One way or another, these dividends act to create benefits for individuals.
Interest payments on debt go to bondholders or to the bank making the loan. Pension plans and insurance companies often own the bonds. These interest payments go to pay pension payments of individuals or to help make insurance premiums more affordable.

…click on the above link to read the rest of the article…

The real oil limits story; what other researchers missed

May 14, 2016

The real oil limits story; what other researchers missed

For a long time, a common assumption has been that the world will eventually “run out” of oil and other non-renewable resources. Instead, we seem to be running into surpluses and low prices. What is going on that was missed by M. King Hubbert, Harold Hotelling, and by the popular understanding of supply and demand?

The underlying assumption in these models is that scarcity would appear before the final cutoff of consumption. Hubbert looked at the situation from a geologist’s point of view in the 1950s to 1980s, without an understanding of the extent to which geological availability could change with higher price and improved technology. Harold Hotelling’s work came out of the conservationist movement of 1890 to 1920, which was concerned about running out of non-renewable resources. Those using supply and demand models have equivalent concerns–too little fossil fuel supply relative to demand, especially when environmental considerations are included.

Virtually no one realizes that the economy is a self-organized networked system. There are many interconnections within the system. The real situation is that as prices rise, supply tends to rise as well, because new sources of production become available at the higher price. At the same time, demand tends to fall for a variety of reasons:

Lower affordability
Lower productivity growth
Falling relative wages of non-elite workers

The potential mismatch between amount of supply and demand is exacerbated by the oversized role that debt plays in determining the level of commodity prices. Because the oil problem is one of diminishing returns, adding debt becomes less and less profitable over time. There is a potential for a sharp decrease in debt from a combination of defaults and planned debt reductions, leading to very much lower oil prices, and severe problems for oil producers.

…click on the above link to read the rest of the article…

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