That enormous ball of flying trouble has just got bigger and a tad bit closer to hit that proverbial fan in slow-motion. Actually a large portion of it is already in the process of shredding, sending pieces flying across the room. Last week energy prices continued their march upwards — and winter hasn’t arrived yet. Enter Evergrande, the giant Chinese real estate company on the brink of bankruptcy, and it looks like we indeed live in interesting times.
Putting energy into perspective
In my previous post I’ve made an attempt at filling the narrative gap between what traditional economics tells us and what is really going on in the real world of goods and services. I’ve highlighted the importance of energy in our economy — stating that in fact energy is the economy. There is no mining, manufacturing, agriculture or services without spending a tremendous amount of energy. In 2019 alone, before the pandemic hit, we have consumed a mind boggling 173,340 Terawatt-hours (that is 173 thousand trillion Watt-hours), yet moneywise spent only an estimated 8% of the world GDP on it.
Global primary energy consumption by source
Primary energy is calculated based on the 'substitution method' which takes account of the inefficiencies in fossil…
If all this energy would be taken away on an instant, and you would have to replace it with human labor, paying the average hourly wage of a worker to perform this unimaginable amount of work, the cost of energy would be 2,593 trillion USD. For comparison the entire world GDP amounted to 87 trillion USD “only” in 2019. This means that the real value of energy (the work it performs) is actually 30 times higher than that of the whole economy. (See my calculation at the bottom of this article for more details.) Even if you calculate with a $1/hour wage you get a number which is almost 300% of the world GDP. Compare this to the actual 8% of the gross domestic product we spend on it today... This is in no way get accounted for and often gets forgotten.
Why does this matter?
There are multiple reasons:
- In order to make this huge amount energy available to the economy we still need to burn fossil fuels (more than 80% of our energy comes from these sources — see the chart above).
- Burning fossil fuels causes climate change — no questions. We need to stop using them within a couple of decades to avoid reaching a catastrophic level of global heating.
- It is impossible to replace these fuels with human labor, neither from a physical, nor from an economical standpoint… Unless you can melt steel with your gaze, carry three hundred metric tons of rock on your back, or plough ten acres (four hectares) a day on your feet. “Renewables” simply cannot make up this vast difference either.
- Fossil fuels are finite, non-renewable resources. Due to geological reasons their depletion starts soon after we have eaten up roughly half of the total reserves ever discovered. This means, production (ahem, extraction) cannot be expanded further after this point, unless an unreasonable amount of energy is spent during the process; making the whole undertaking unprofitable in the end. It looks like we have already reached this point — meaning that extraction will first slowly, then ever more drastically decrease in the coming decades. And not because of the lack of demand.
- When a resource becomes scarce its price starts to increase. This is what we see today with all fossil fuels, and as a result with the price of electricity — and everything else. Yes, there is a spill over at the money printing machine too — but consider this: if energy supplies could be readily expanded this should not be a problem. If traditional economic theory were true, supply would magically appear shortly and all would be fine — except for the carbon pulse caused by this sudden burst of growth. Thing is, this money printing gimmickry never worked on the large scale. It only worked in the last decade, when enough investors could be fooled to believe in the shale oil miracle — a business which was never really cash flow positive and which failed to replicate in places other than the US. Result: sluggish growth do to the lack of exponential expansion of the underlying energy-base to support it. In the real world there is no way to print cheap and easy to access energy. Once you burn the good stuff, laid down several hundred million years ago, it’s gone forever… It is now back in the atmosphere where it is now doing it’s job restoring the tropical conditions which made it’s deposition possible in the first place.
- Rising energy prices will first stop, then eventually kill businesses. Usually the most energy intensive ones will go first (e.g.: fertilizer production) which then causes a range of other businesses (the entire agriculture and food sector) to struggle. This plays out in many fields (e.g.: mining and metallurgy) similarly, until finally the chain breaks at the weakest link — then off we go with another Merry-go-around of recession and slow recovery… with industrial output never reaching previous levels again.
- Since fossil fuels still account for more than 80% of our energy consumption, their decline will inevitably force us to give up 80% of the economy, including critical industries like steel, concrete, mining, or large scale agriculture… feeding 8 billion of us. Then, without heavy machinery and high heat processes to support it, the remaining 20% will go as well — leaving us nothing with, but wood and hay to burn. The industrial age has used up its cheap fuels and now it must face its own demise. It will be a long, slow — and very much necessary — goodby to this planet-wrecking lifestyle of ours.
The end of Growth
Evergrande’s growth was financed from debt, because the underlying economic growth (i.e.: growth in consumption and thus the growth in energy usage) was not there to support such high increases in the housing stock. People and companies had to rely more and more on debt to buy that bigger house, that new plot of land, but their incomes could not grow fast enough to cover their needs. Of course, with near zero interest rates mortgage was cheap. On the flip side more debt meant higher monthly installments… Since the real economy itself could not grow fast enough due to the lack of cheap enough energy, higher monthly payments could not be supported… This is what we start to see now around the world. There are limits to growth everywhere — even when it comes to financing.
How does this affect the energy markets? As it is usual with complex systems, the answer is far from being straightforward. Here is what I managed to put together as a coherent story behind skyrocketing energy prices, starting with natural gas. This summer (especially August) was characterized by low wind speeds in North-Western Europe. Since 20% of the regions electricity production comes from “renewables” (mainly wind turbines) this meant, that spare electricity generation capacities had to be turned on: chiefly gas turbines in large power plants. Thanks to the colder than usual spring though, gas storage levels were already low and this backup solution just made an already bad inventory situation worse. To avoid totally draining gas supplies before the winter, many coal power plants had to be fired up as well.
This shouldn’t be a problem in a perfect world, where fossil fuels are cheap and readily available. Of course this is no longer the case. Russia could not send more gas to Europe: some say because they are trying to pressure the German government to approve the newly built Nord Stream II pipeline. While this is plausible to some extent, there is another side of the story — which is much more gloomy to think about. China is slowly running out of coal. The black magic substance, making the country the factory of the world, is no longer cheap and as readily available for them as it used to be. Thus it’s price hit record highs already in the summer (explaining China’s attempt to wean itself off of it as a matter of economical “choice” rather than an aspiration coming from their newfound environmental concerns). As a backup solution gas power plants had to be fired up in the East as well… using Russian gas. Hence the sluggish deliveries to Europe. LNG (liquid natural gas) was not a solution either: the existing fleet of LNG tankers is not enough to fill in the gap. The net result: soaring electricity and gas prices across Europe. When the wind doesn’t blow, China burns it’s coal to oblivion and you have only one Russia then you get a shortage.
The recent rally in energy prices didn’t went unnoticed among economic pundits either: by now at least some of them get it, how important energy is:
“I expect energy to be the proximate cause. Watch it closely. Demand is still recovering from Covid, yet energy prices are already at multi-year highs.”
Let me correct the above sentence: energy is not the proximate cause. It is the cause. No energy = no business. It was realized however that high energy prices lead to high inflation:
“Consider what happens if it is a cold winter. Could natural gas go crazy? Propane. Ethane. Heating Oil. They’re all waking up. These are the feedstocks for everything in our lives. The whole periodic table is going mental. There’s even food inflation — the sort of inflation that gets very political. The inflation is everywhere that the government gets in the way of supply while increasing demand.”
Is it really governments standing in the way of increased energy supply? Why can’t we see an increased supply at will?
In search for answers
Traditional economic theory holds, that this energy supply issue is due to chronic under-investment in the energy sector. This begs the question however: why is that so? And why now? There are a number of official reasons according these industry experts cited above:
- Capital restraint. Capital somehow managed to refrain from being invested into dirty energy sources. Investors were afraid buying into assets which might go stranded (i.e.: forced to stand idle before paying back the investment). OK, but why is that so?
- Green energy. “If the greening of energy production goes according to plan, who will then buy oil?” — goes their argument, but this is magical thinking in many ways. First electricity generation is only a mere 20% of total energy use in itself. Western countries started to utilize more and more “renewable” sources, that is true, but the process is still decades away from completion… Presuming, that we have the resources (which we don’t) and are able to solve the intermittency problem without fossil fuels on a hundred thousand trillion watt-hour scale (which we can’t). Second, we would still need oil, gas and coal for “hard-to-electrify” businesses (the remaining 80% of our energy use). Like high heat applications requiring 1000°C or higher temperatures (e.g.: steel and cement production) and transportation of goods around the globe (using aircraft, container ships, large trucks etc.), not to mention mining equipment (dumpers, excavators)… OK, let’s assume that investors were misled on the quick and easy advent of green-energy. Most of them — unfortunately — does not give a rat’s hind leg about our green future however, and would be eager to invest in anything provided there is a profit to be realized. Why are fossil fuel investments drying up still?
- Carbon-tax. “Because of bad policy!” — true, governments around the western world are trying to use the “free-market” to “encourage” the use of “renewables” by taxing emissions from fossil fuels. Note, however how this is a last attempt to prop up failing government revenues and tax something which is no longer taxable.
- Regulations. Methane is a potent greenhouse gas — regulating it’s emission is of utmost importance to slow climate change. Obeying these tighter regulations however costs money, equipment — and you guessed: energy… making fossil fuel extraction even more expensive and less profitable.
Sure, all of the factors above play a significant role in diminishing investments for fossil fuels and a resulting “supply-crunch” (as if it were a temporary situation). Take note though, how the forbidden word (depletion) is avoided at all costs even in articles written by professionals, who have spent their entire career in the oil and gas industry and should know it better (just hit ctrl+F and type ‘depletion’ in any of the linked articles).
Back in the real world, money spent on exploring new fields has dropped dramatically from 2015 onward: this is not a recent phenomenon at all. The reason was simple enough: exploration companies were unable to find enough oil to justify their spending since 2010 (!) already… Of course the official narrative is bit more cautious, but look at the resource discoveries chart and decide it for yourself. Actually, we are finding less and less oil annually compared to what we extract in a given year since the early 1980’s…
There were only two big additions since then: Venezuela (extra heavy oil) and Canada (tar sands). Both of these sources are extra energy intensive (ahem, carbon-intensive according to the new narrative) to extract. No matter how you mince words though: they are both very unprofitable (both economically and energetically) and only heavy subsidizing from the government can “save” them from being left in the ground…. You know how that ended for Venezuela — and it looks like Canada will be next to cut back on it’s oil industry. Commentators call it “consolidation” and try to paint a rosy-picture of how this is a chance “to ramp up their operations and make them more economical.” This, however reminds me of internal corporate communications wizardry used in failing companies trying to sell the idea of “consolidation” to the soon-to-be-former employees of theirs. Fortunately, at least the conclusion was not lost on experts: “capital spending is falling. Soon, production will follow.” How does this sound during a “supply crunch”? Where is the magic theory of increased prices making increased production a reality now? Shale oil, despite being “profitable” is of sluggish growth… I have a feeling that they are in a debt-repayment phase — before closure.
Is it possible — maybe — that this whole underinvestment story in an era of not so bad (and increasing!) oil prices is due to the depletion of cheap resources, leaving us with more and more unprofitable stuff to extract? What has happened to OPEC? Is it possible that even their resources are finite too and started depleting? Look at Algeria, Angola, Nigeria (no small players): their production is falling like a rock — no matter how high or low the price of oil is. How long can Iraq or the UAE compensate their falling extraction rates? When will Saudi Arabia start its long descent? I believe we don’t have to wait for long to find it out. Investing in capital intensive (read: energy intensive) sources will make matters worse for oil companies: if the price of oil were to drop they would find themselves on a highway to bankruptcy.
The rest of the economy
Needless to say, the world economy already struggles under high energy prices. It is already a great headache for China, and it is no wonder that they are stopping all coal power plant project outside their boarders — to reduce future international coal demand and thus ease the burden on their economy. (Russia, in the meantime, prepares for the end of the oil era… maybe, they know something.)
Sure, there is every chance that governments will intervene. Who knows, after this little “crunch” of the season governments will allow drilling in the arctic and we might see another peak in fossil fuel extraction. But for how long? Drilling way up there is not only uneconomic and yields a terrible energy return, but extremely dangerous as well. Any mishap or carelessness could release megatons of methane into the atmosphere (by accidentally disrupting methane hydrates or releasing carbon from the once frozen soil). I would not bet the farm on seeing such high oil “production” numbers by the end of this decade... On the contrary: I expect oil extraction to fall 5–30% by 2030 (compared to 2019 levels) — and this lost energy supply will not be compensated by “renewables”.
As it was demonstrated recently “renewables” are not up to the task of replacing fossil fuels. Should we increase their adoption — the way we do today — and we would see even more severe crunches in the future. “Renewables” were never meant to be used as primary power — only as auxiliary sources to the existing grid. The whole concept of a “renewable” economy is false: different power sources require different infrastructures. Stable, dense, concentrated sources (fossils plus nuclear) require centralized grids and favor economies of scale. They support mining, manufacturing and international logistics 24/7. “Renewables” on the other hand are seasonal, intermittent and diffuse by nature, thus favor localized use with as little transformation or transmission as possible (to minimize losses). They are much more useful in a rural, small farm setup as auxiliary power to do work when conditions are met, than powering our urban lifestyles with food, products and services brought in from around the world.
Humanity is now stuck between a rock and a hard place. The rock has Climate Change printed on it with red capital letters, while the hard place has Resource Depletion on its nameplate. Should we continue extracting fossil fuels against all odds and start drilling the arctic, no matter how energy-inefficient or dangerous it is, and climate change will kill us all — sooner than expected. Should we stop / limit extraction, or rather: succumb to oil’s natural depletion curve, and the world economy will slowly slip into an eternal coma, then ceases to exist. Either way, this civilization is lost forever… and human life will be transformed into something utterly different.
Neither options are nice, in fact both of them will be very painful. Still, I would rather opt for the later, giving us and the rest of the biosphere a chance to recover from this madness of attempting infinite growth on a finite planet.
Until next time,
An average human can sustain a power output of 75 Watts/hour, which translates to 600 Watt-hours for an 8-hour work shift. Compare this to the 173 thousand trillion Watt-hours generated mostly from (or with the aid of) fossil fuels. Don’t let Watts confuse use you: this huge amount is not coming from electricity only, but includes all forms of power combined, like mechanical work in your car’s engine added to heat produced by your gas cooker. Let’s also factor in our civilizations efficiency of turning this wast amount of energy into useful work, which currently stands at around 10% — the other 90% of it is wasted in extraction, conversion, transmission and transformation. This wast amount of energy still equals to the useful work of 79 billion people working 8 hours a day 365 days a year, in addition to nearly 7.9 billion of us doing our own part. That is to say, each and every one of us has 10 energy slaves (a term coined by Buckminster Fuller) on average. Of course overdeveloped nations use much more energy per capita, thus have more “slaves” working for them than people living in Africa. If you would had to pay the average hourly wage of a worker in the US ($11.22) to your energy slaves (paying for the useful part of the work only), the total amount would be 2,593.166 trillion USD. For comparison the world GDP was 87.345 trillion USD in 2019.