I don't go a great bundle on the Economist these days but it does have some
good articles occasionally -- such as the one shown below. The subject
matter of energy is one which the Bernankes of this world ought to consider
very carefully while they try to find ways of stimulating the economy. Most
economists know very little about thermodynamics so they tend to put energy
resources in the same box as all other resources. But energy is actually
very special -- the essential underpinning of everything we make and every
consumer service.
Keith
ENGINE TROUBLE
A rise in the cost of extracting energy will hit productivity
Oct 21st 2010
Many factors were responsible for the industrial revolution. But the use of
fossil fuels was clearly vital in driving a step change in rates of
economic and population growth. So the current rise in the cost of
extracting such fuels should be the subject of considerable concern.
Until the 18th century mankind's output had been restricted by the amount
of physical force that humans (and domesticated animals) could exert and by
the amount of wood that people could chop down. Fossil fuels delivered a
massive productivity boost.
In a recent article for the Cato Institute, Matt Ridley, a former
journalist at The Economist, argues for the importance of coal in allowing
the industrial revolution to be sustained. Fossil fuels were the only power
source that did not show diminishing returns, he writes. In sharp contrast
to wood, water and wind, the more you mined them the cheaper they became. A
further advantage was that coal supplies were so large. By 1830, Mr Ridley
estimates, Britain was consuming coal with an annual energy output
equivalent to 15m acres of forest, about three times the size of Wales.
In the 20th century oil replaced coal as the cheap fuel of choice. It has
had an enormous impact, most noticeably in transport. Think about how much
of your daily activity depends on energy -- the commute to work, the
heating and lighting for home and office, the steel and bricks needed to
construct both properties, the transport costs involved in delivering your
food to supermarkets (and the energy used to cook it), and so on.
It was only natural for mankind to exploit the cheapest energy sources
first, such as easy-to extract oil reserves under Saudi Arabia. The problem
now is not that the world is running out of energy but that the new sources
of energy are more expensive to exploit.
The key ratio is energy return on energy invested. Analysis by Tim Morgan
at Tullett Prebon, a broker, estimates that oil discovered in the 1970s
delivered around 30 units of energy for every unit invested. By itself this
was well down on the returns from oil discovered in the 1930s, which were
nearer 100-to-1. Current oil and gas finds, such as undersea reserves, may
offer a return between 16-to-1 and 20-to-1. The return on sources such as
tar sands and biofuels like ethanol are in the single digits.
Tar sands and biofuels represent only a small part of global energy use.
Nevertheless, to the
extent that conventional sources of energy production are declining, the
high marginal cost of new sources of energy will slowly drive up the
average cost. Andrew Lees of UBS, writing in The Gathering Storm, a new
book, argues that the global ratio of energy return on energy invested is
around 20, corresponding to energy's 4-5% share of global GDP. Mr Lees
thinks the ratio might fall to five over the next decade, implying that
energy's share of GDP could quadruple. That is probably too extreme a
forecast. Nevertheless, the direction of change seems clear. If the world
were a giant company, its return on capital would be falling.
The first big oil crisis was in the 1970s when the OPEC export embargo was
followed by
stagflation. By the 1990s, with oil down at $10 a barrel, the economic
impact of fuel costs tended to be downplayed. Developed economies had moved
from being manufacturing-based to being service-based, it was argued: the
volume of GDP produced for a given unit of energy had accordingly
increased. Yet the surge in the crude price to $147 a barrel in July 2008
undoubtedly played its part in exacerbating the recent recession, acting as
a tax on Western consumers at a time when confidence was already low.
That rise in energy prices was driven by demand, however. A surge propelled
by the costs of
extraction would be a negative productivity shock for the global economy.
That would be a
particular problem for Europe, which is also facing significant demographic
pressures. There will be a decline in the number of people of working age
(15-64) in France, Italy and Germany over the next decade. If there are
fewer workers, GDP growth will depend on productivity improvements.
It is possible that some new source of cheap and abundant energy might be
developed -- the cost of solar panels could be reduced substantially, for
instance. The same high energy prices that might crimp economic activity
would have the effect of stimulating investment in alternative energy
sources. But there could still be an uncomfortably long period in which the
world has to cope with higher energy costs. That is a headwind the global
economy could do without.
Keith Hudson, Saltford, England
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