Charles A. S. Hall . March 2010. Peak oil, declining EROI and the probability of degrowth.
Second Conference on Economic Degrowth for Ecological Sustainability and Social Equity March 26-29th 2010, Barcelona
Peak oil is not some fuzzy academic concern but a reality: for the US in 1970, for some 60 of 80 oil-producing countries and, at least for the moment, for the world since about 2005. In addition the net energy delivered to society (as opposed to the total) is declining in recent decades from 30 or more to one to ten or less to one as we have exhausted our largest, shallowest, closest to shore and highest quality oil and gas fields. While technological improvements have slowed the effects of depletion the net effects are that there is a declining EROI (Energy Return on Energy [and money] Invested). Most alternatives to oil and gas except hydroelectric or coal have a small or very small EROI, and even for these the highest EROI sites in the US are already dammed and coal has obvious environmental issues. All of these factors are affecting our economy.
In systems thinking we normally divide our problem into two controlling factors, those endogenous to the system under consideration and those exogenous. The latter are also called forcing functions . In recent decades most of our consideration of the economy has been dominated by those who focus on the endogenous factors and that believe that economies are most appropriately controlled by manipulating interest rates, the money supply and so on. The usual economic training emphasizes that fuels and other natural resources are commodities, and hence fungible, substitutable and of limited importance except for their market value. In fact the work of Reiner Kummel and others has shown energy to be THE most important input to economic production, far more important than the economists’ traditional labor and capital.
Probably most people at this conference are in the endogenous camp – i.e. believing that degrowth can and should be a consequence of deliberate decisions made for that purpose. But in fact degrowth, or at least a cessation of growth, has already occurred for the US and European economies without our slightest help, apparently due to the forcing of declining energy availability (and its increasing cost) and its impact on discretionary income. The latest available GDP estimates for the US economy give the GDP for the fourth quarter of 2009 as 13.1 trillion 2005 dollars, the same value as the first quarter of 2007. So for three years the US economy, according to these official numbers, has not grown at all, and since population has been growing per capita GDP has decreased by some 3 percent, as is painfully obvious to the unemployed.
While endogenous business cycles may generate economic constriction, in fact most recessions in the US are preceded by increases in energy price (Murphy and Hall 2010). During this same period the world has reached “peak oil” after many decades of steady growth, despite sharply rising prices during much of this period, as had been predicted by many geologists and others for decades (Figure 1). While it is not yet clear whether there will be a later, higher peak, it is clear that the production of oil, our most important energy source, is no longer growing (Figure 1). The US has also peaked, more or less, in the energy gained from coal (but not for tonnage used). Total US energy use has declined by about 5 percent starting even before the recession. Thus we might want to ask to what degree the two cessations in growth (energy and economic) are linked and whether future predicted restrictions in energy supplies (Figure 2) will continue to bring about degrowth independent of what this forum or anyone else may or may not choose to do for policy. In other words our future economy may be determined far more by external forcing rather than policy of this or any other group. Those who wish for degrowth might be able to capitalize upon this.
Growth has been, of course, the mantra of conventional (neoclassical) economics. However readers should be aware that conventional economics is under attack as never before, although in most cases working economists who routinely apply conventional economics are unaware of the attacks. But a near majority of the recent Nobel Laureates in economics have received their honors for, essentially, undermining the legitimacy of various aspects of the conventional neoclassical model. This includes Ostrum, Krugman, Kanahan, Ackerlof, Smith, Sen, Stiglitz and others. At a less lofty level economics is under even stronger attacks by Ecological Economics President John Gowdy (and many within that subdiscipline) as well as by myself and colleagues. Our main arguments are not that conventional neoclassical economics makes some errors by undervaluing nature, encouraging maldistribution, ignoring larger social needs (all of which are true) and so on. Rather it is that neoclassical economics is logically corrupt at its core and the mathematics, although often elegant, are inappropriately specified. This corruption begins with the basic system of firms and households that is familiar from every beginning text book in economics. This simplified model has incorrect boundaries, violates the laws of thermodynamics and has not been put forth as testable hypotheses (e.g. Hall 2001). The original Walrasian model was constructed by borrowing a model from physics but in fact not only was the model seriously incomplete it also violated the laws of thermodynamics that was the point of the original model in physics (e.g. Mirowski 1989). Of course many economic models can be parameterized from empirical data to “work”. For example the brilliant Egyptian mathematician Ptolemy could make a model of the solar system that “worked” (i.e. was a good predictor of the location of e.g. planets, the moon and so on) but that had the wrong essential structure (e.g. Ptolemy’s system had the Earth at the center of the Solar system, with epicycles for Venus and Mercury to explain their “erratic” behavior). It is easy to draw parallel critiques to economic models.
Economics is usually considered a social science, but why should that be since economics is mostly about stuff, and stuff must obey the laws of physics and many other constraints? We wish instead to generate a biophysical, instead of simply social, basis for economics (http://web.mac.com/biophysicalecon). Money is not wealth, goods and services are, and they require energy to obtain them. Money is a medium of exchange (and a financial instrument). Some people think gold is wealth, but it is not either. When the Spaniards brought back gold from the new world to Europe they doubled the supply and halved its value. That is because the real wealth production (from farms, forests, fisheries, mines of useful metals, work of housewives and artisans) had not changed. The wealth was generated by the energy of the sun as captured by land and by the energy of labor, both of which transformed the materials of nature into what we want and call wealth. Energy is necessary to make wealth. There is no other way with a few minor exceptions in e.g. some art. Classical Political Economists, beginning with the Earl of Lauderdale, wrote extensively that the use values provided by nature were the source of wealth. That discussion was lost with the emergence and dominance of neoclassical economics, and needs to be reclaimed.
Energy and many materials will in all probability be unable to expand production for much longer (Heinberg 2007). Figure 2 shows some guesses of what the curves for oil, gas and coal might look like for the world. Some important materials (copper, gold, zinc) might look quite similar. Figure 3 shows that for US oil and gas drilling, market mechanisms do not work, i.e. that when prices and hence drilling rates increased in response to the “energy crises” of the 1970s production did not increase, and the converse. Figure 4 shows how the inflation corrected Dow Jones (as a sample financial indicator) tends to “snake around” the total US energy use. The ups and downs appear to be the psychological lemming actions of investors but that the general trend for 100 years is constrained by US energy use — which generates the real wealth but has plateaued and declined recently. Efficiency increases has some potential but I believe far less than generally believed.
All of these figures show the importance of energy and its potential restrictions for growth. The point is that energy use is what generates wealth (capital equipment is the means of using energy, but it is the energy that generates the wealth — wish Solow had got that right). Energy is a far better predictor of real economic activity over time than capital or labor or policy. Money is (or at least was once) how we keep track of wealth. Inflation is the ratio of money supply (times velocity) divided by energy use (times a nearly constant efficiency). On the upside (first 45%) of the Hubbert Curve we were generating more wealth every year so the government had to “create” more money via the Federal Reserve to lubricate the increased volume of transactions necessitated by growth or we would have enormous deflation. Thus when energy supply increased, the activities of the Central Bank and the Federal Reserve in “making” money makes sense. As long as energy use and hence production was expanding more money was needed to avoid deflation. However we may have, or may soon have, reached the point where energy use and hence real wealth production no longer increases. Then more money generated by the Federal Reserve just generates inflation, although this is buffered by the global demand for dollars as other countries have even more difficult economic problems. The problem is that we derived all our economic/financial principles on the left hand side of the Hubbert curve, when growth-based theory usually worked (recessions were a usually temporary exception) because the economy was growing through more energy use anyway. So then theories of the right, left, North, South, capitalists, communists, whatever ALL had a decent chance of success because the real economic potential tended to increase year after year regardless of policy because energy use increased at 2-3 percent per year. One could be fiscally conservative, prime pumps or whatever. Many financial institutions could make a great deal of money. Franklin Roosevelt’s debt became trivial as the economy grew and grew. But now if we paid off just Ronald Reagan’s debt to Japan and they used it to buy fish, rice, beef or fords it would take most of our remaining oil in US to make that stuff. Retiring today’s debt will be much tougher than FDRs as we will almost certainly not have an expanding energy supply and hence economy.
This is why we need a new economics for the second half of the age of oil. The “science” of economics can no longer even appear to “break” the laws of thermodynamics. Although it never did it thought it could, and few economists paid attention.
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Gowdy, J., C.A.S. Hall, K. Klitgaard and L. Krall. The end of faith-based economics. The Corporate Examiner. (New York) In press.
Hall, Charles, D. Lindenberger, Reiner Kummel, T. Kroeger, and W. Eichhorn. 2001. The need to reintegrate the natural sciences with economics. BioScience 51 (6): 663-673.
Hall, Charles A.S, Gowdy, John. 2007. Does the Emperor Have Any Clothes? Chapter 1. In Making Development Work: A New Role for Science. University of New Mexico Press, Albuquerque.
Hall, C.A.S., R. Powers and W. Schoenberg. 2008. Peak oil, EROI, investments and the economy in an uncertain future. Pp. 113-136 in Pimentel, David. (ed). Renewable Energy Systems:
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Murphy, David J., Hall, Charles A. S. 2010. Year in review—EROI or energy return on (energy) invested. Annals of the New York Academy of Sciences. 1185, Special Issue: Ecological Economics Reviews:102-118