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Economists not connecting the dots on new energy economy

In the continuing discussion of what will facilitate an economic economy in the United States, people are generally not connecting the dots that point to what kind of economic growth is even possible in the future. The very large dot that most politicians and economists are not connecting is the role of energy, and more specifically the services that technologies provide when consuming energy resources. Sometimes green energy or the production of energy resources is mentioned as a sound bite, but little to no substantial insight exists.

Economic growth models (i.e. production functions) are commonly written assuming that growth results from investments in three areas: labour (hours worked), capital (intellectual knowledge and physical infrastructure), and energy (consumption or services from consuming energy). Research from the last several years, with particularly keen contributions by Robert Ayres of INSEAD, shows that for developed economies to grow in modern times, investments in labor are relatively insignificant. However, investments in capital and energy enable almost all economic growth with each category contributing roughly the same impact. Therefore, with the current economic discussions focusing on how to decrease the unemployment rate, we shouldn’t expect robust economic growth if employment increases soon, and vice versa. This is exactly what is behind the “jobless recovery” that economist and politicians spoke of earlier this decade and that we are discovering may be happening again. The recovery is jobless in the United States and other developed economies, but not in developing economies where labour is cheaper. See the video from Meet the Press at www.msnbc.msn.com/id/34386643/ns/meet_the_press/

So how do we envision what will happen with a transition to a “green economy”? Some of the US stimulus money is meant to facilitate this transition. During Meet the Press this Sunday, Jennifer Granholm, the governor of Michigan (home of the US auto industry) held up an article from the Detroit Free Press (www.freep.com/article/20091213/SPECIAL04/312130004/1318/Auto-supplier-turns-trouble-to-triumph-by-venturing-into-turbines from minute 7:30) indicating that at least one automotive supply company has changed focus to adjust to a changing economy. Instead of waiting for a rebirth of the auto industry, the company changed to manufacturing parts for wind turbines using the same basic set of tools and skills from the existing workforce.

The question we can ask ourselves is: “Does making wind turbines instead of automobiles facilitate more jobs and/or more economic growth?” I certainly do not know that answer, but it seems the path to understanding should focus upon what service is being provided. The auto industry provides transportation and facilitates trade of goods via shipping. The wind turbines provide electricity as a service to homes, businesses, and factories. If electric vehicles become prominent, then electricity will begin to provide transportation services as well.

Businesses and governments are striving to create new ways to provide the same services, and it is not clear if these are fundamentally transformational or if they simply represent a diminishing return of investment of time, labour, money, and energy. Increasing efficiency in energy usage induced from the Arab oil embargoes of the 1970s showed that there was much to gain from using less energy to provide and expand the same services. Certainly there is less room for improvement now, but many claim that there is still so much room for efficiency improvements that economic growth can reoccur easily. However, to me it is not clear if investments in using more information in a smart utility grid will be sufficiently offset by increased energy efficiency. Putting insulation in your home is simple and straightforward and easily measureable. Installing a smart meter that communicates with your mobile phone so you can communicate with household and commercial appliances, heaters, and air-conditioners is significantly more investment in complexity. Measuring if that investment produces returns that outweigh that complexity will be more difficult to determine, but that is now on the agenda of many companies after the recent awards of US stimulus money for smart grid projects throughout the US.

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Energy return on investment and economic stimulus spending

There is much discussion today in the US regarding how much the government should spend, and go further into debt, to help get the economy growing and increase employment such that we can later pay back this debt when economic growth is good (i.e. positive) again. For those who do not believe in the general capitalism arrangement that assumes economic growth (as we define it today) can and must continue indefinitely, the logic of spending more so we can pay it back later can seem like putting off the inevitable final economic bust.

Persons such as Robert Reich, former Labor Secretary under the President Bill Clinton, are calling for more stimulus spending (see http://robertreich.blogspot.com, and for an entry on his normal calling for more stimulus spending, visit http://robertreich.blogspot.com/2009/11/great-disconnect-between-stocks-and.html). Reich correctly says that the latest increase in US GDP growth, of a reported 3.6% in the 3rd quarter of this year, is mostly related to a shift in capital assets at the expense of labor. This is supported by research by Robert Ayres and Benjamin Warr indicating that investments in providing “useful work” and capital are responsible for roughly 50% of US economic growth whereas additional labor investments are only responsible for some amount of less than a few percent. Useful work is roughly equivalent to primary energy consumption divided by efficiency of conversion into mechanical motion – but think of essentially as how energy impacts our economy. In 1900 their research shows that investments in labor were the most influential factor (55%) in US economic growth with useful work responsible for nearly 40%.

What all of this means is that over the last 100 years our industrialized economy has replaced physical labor (working in factories and farms) with machinery run on fossil fuels. Therefore as long as cheap energy is available to operate this machinery and make more of it, human labor is simply not necessary. We pay people to think of ways to not need as may people to make a product, and then we act surprised when we succeed. We now pay people to think, not use their muscles, and we translate this to a need for better education. We also translate this to other areas of life, such as health care, where investments in capital (knowledge and machinery) have enabled incredible tools and techniques to cure disease and injuries.

What all of these advancements depend upon is excess energy such that people CAN be paid to spend time and think of new inventions. This excess energy is a function of the resource (renewable or fossil) and our ability to exploit it. This ability can be measured as energy return on investment (EROI). If US oil had an approximate EROI of 100 in the first decade of the century and today has an EROI of 10–20, then each barrel of oil in 1900 had approximately six times more capability of growing the economy than today. This estimate is calculated as follows:

˜ ((EROI-1)“useful work” productivity factor in 1900) / ((EROI-1)“useful work” productivity factor in 2000)

˜ ((100-1)40%) / ((15-1)50%)

˜ 40/7 = 5.6

So when we look to the past and assume we can invest in various economic stimulus packages with the thought that we have always had the ability to repay the debt in the future, I believe understanding this tie energy (EROI, useful work) and economic growth is important. So we can say:

1. The US has a large national debt load (the highest ever) and now the annual budget deficit is reaching the highest levels ever reached. Thus, we seem not to be paying back the debt over time, except interestingly the US did that during the time Robert Reich was serving in the 1990s under the Clinton administration; and

2. The total system-wide conversion of energy resources into useful work is becoming less productive over time yet more influential on the economy.

The conclusion is that we are increasing our debt load at the same time we are having less ability to pay it back. This basic conundrum will define this current century.

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Commercial viability of CO2 capture and storage – of course not (under the historical paradigm)

A recent article titled “Government impose ‘carbon capture levy’ to fund coal-fired power plants”, discusses the UK government imposing a tax on electricity to potentially fund carbon capture and storage (CCS) development on up to four coal plants over the course of 10–15 years. A quote from the article sums up the discussion:

“The Department for Energy and Climate Change said yesterday that uncertainty over the commercial viability of CCS meant that public support might have to continue beyond 2030.”

Of course CCS is not commercially viable. The only way to make it commercially viable is to internalize the cost of CO2 emissions to such a degree that the cost of investing in the infrastructure for capturing the CO2 justifies the investment. The price of CO2 is not there yet for the UK, and is nonexistent within the United States. So the commerical viability question is not even applicable except for potentially using captured CO2 to extract more oil out of mature reservoirs. Still, given that there are natural sources of CO2 that only require major investments in pipelines while avoiding interacting with the electricity indudstry, a sufficient CO2 price may not exist for a couple of decades that induces investment in CO2 capture on coal plants.

But the real “commercial viability” conundrum rests on the fact that a large portion of society believes that we (well, the industrialized world) should place a value on reducing CO2 emissions. Capturing CO2 from coal plants will lower their net electricity output by 20–35%. In terms of the normal venacular of economics, this is going to something less efficient. In this case, the efficiency is less electricity output per unit of fuel input. This is a fundamentally different concept than has occured since the dawn of the industrial revolution.

Sure, we have imposed certain types of pollution mitigation technologies on power plants before (e.g. SO2 and NOx scrubbing, mercury capture), but these have for the most part not prevented coal plants, and the power plant industry in general, to increase their efficiency over time by increasing the pressure and temperature of operation. But everyone knows that the thermodynamics of the power plant with CO2 capture will be less efficient. This goes directly against the purpose of investments and technological advancement since the founding of modern civiliazations.

People have historically invested in ways to extract more productivity and wealth from the Earth per unit of effort (human effort) until some ecological feedback prevents that from being a desireable option any longer. These feedbacks to date have mostly been associated with direct air-, soil- and water-quality problems. And the past mitigation methods have been of a small order of cost such that the human population has continued to grow since the Industrial Revolution. But this feedback fo global warming appears to cost several orders of magnitude more to deal with. The question is: “Is coal power so valuable to us that we will continue to use it even at lower efficiency?” In other words: “Are other viable technologies so inferior that coal power must continue to exist by providing less direct services than it has since we first put it in a steam cycle connected to a dynamo?”

So far, the answer seems “yes” to these two questions. Widespread use of CCS will mean that we value environmental/ecosystem services more than energy services on a larger scale than any time before in history of human civilization.

—–

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Net energy, bank reserve ratio, and jobs

As we have reached the one-year anniversary of Lehman Brothers bank collapsing, many are still wondering what happened to the US and world financial system. Many in the government are calling for better regulation of the financial and banking industry, but perhaps there is one regulation that towers above all others: banking reserve ratio.

The reserve ratio, or reserve requirement, identifies the amount of customer bank deposits that must be held within the bank. The bank is allowed to lend out the rest of the money. Currently the US reserve requirement is 10%. Thus, for every 100 dollars deposited, 90 dollars can be lent to borrowers.

The reason that the reserve ratio is important, is that it parallels conceptually to another ratio of concern in the area of energy: energy return on energy invested (EROI). To some, the question remains whether or not this parallel is also a correlation caused by the physics and thermodynamics describing energy, rather than “laws” of economics and financial practice. But to me, there is no debate. To think that we can have an industrialized society without much excess energy, or high EROI, is not feasible. Also, because net energy and economic growth are so highly coupled, there likely cannot be a continuing industrialized society without a relatively low banking reserve ratio.

Economists model the macroeconomic output (GDP) as a function of three basic factors (that are not necessarily independent): labor, energy (energy services), and capital. Research since the 1970s by a group of dedicated ecological economists has unequivocally shown that the modern US economy grows significantly with more energy (energy services) and capital. Over the last 100 years in the US the labor factor has become insignificant. That is to say, and increase in the labor force will cause practically no economic growth (see Robert Ayres (2008) Ecological Economics). The reason is that in the US, labor has been almost 100% replaced by primary energy sources including fossil fuels, nuclear energy, and renewables. Consider that economic capital includes the intellectual capital and education of the workforce, and we see that physical human labor is valued quite poorly.

Before you say this doesn’t make any sense, then keep in mind that people expect a “jobless recovery” yet again after we apparently had such an economic recovery (in the US) after the dot-com bust. I say apparently because it is probable that the US fiscal policies fighting off recession during the early 2000s just kicked the can down the road until the current economic recession.

While there are no systematic analyses of how EROI should relate to banking reserve ratio, I think this is a fruitful area for study. Lending money and expecting a return on investment is analogous and reliant on lending energy to invest for future energy return. It is likely that the inverse of the reserve ratio (that is amount of money lent out to that held in deposit in the bank) cannot be larger than EROI. As the EROI of fossil fuels to energy services seems to be only slightly above 10 (where the inverse of US reserve ratio is 9), or in the 10–20 range at the “mine mouth”, and even less for finished products such as gasoline and electricity, we might very well already be operating society on an energy services EROI <10. Can our society operate as it exists if we lend more money than we our lending ourselves energy? I hope we can learn the answer to this soon.

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Austin Energy (leading green power program in US) struggles with costs of more renewables

Austin Energy is the municipal utility of Austin, Texas that sells the most renewable energy in the United States, and it has done so for the last several years. They sell the renewable power via their voluntary GreenChoice® program, and have done so since about 2000. However, as they strive to increase the percentage of renewable energy in their total mix, the latest batch of green power is not selling as it is almost 80% higher cost than the last.

To get residential and commercial customers to sign up for the renewable power that was more expensive than the normal rate, Austin Energy sold the GreenChoice® power using a fixed charge for ten years. This was the selling point that caused the program to sell out for the last 8 years. The customer gets 100% renewable power at a fixed price that can hedge against rising natural gas prices that dictate the marginal cost of electricity in Texas. And since 2000, the natural gas price at the wellhead have risen from approximately $2/MMBtu to the range of $6/MMBtu, even though as of this writing the price is below $4/MMBtu.

Austin Energy sells electricity based upon two different charges based on a $/kWh basis. One charge is applied to all customers, but different for residential, commercial, and industrial customers and covers many of the costs of distributing electricity. For residential customers during the Summer, this base charge is 3.55 cents/kWh for the first 500 kWh consumed in a month and 7.82 cents/kWh for each kWh over 500. The second charge is the fuel charge that fluctuates as necessary to cover the costs of fuel, and the GreenChoice® charge replaces this fuel charge for those who sign up. Listed here are the charges for the GreenChoice® “fuel charge” for all of the batches of renewable power sold by Austin Energy:

GreenChoice® “Fuel Charge”
Batch-1 Green Power Charge:       $ 0.0170 per kWh
Batch-2 Green Power Charge:       $ 0.0285 per kWh
Batch-3 Green Power Charge:       $ 0.0330 per kWh
Batch-4 Green Power Charge:       $ 0.0350 per kWh
Batch-5 Green Power Charge:       $ 0.0550 per kWh
Batch-6 Green Power Charge:       $ 0.0950 per kWh

and for comparative purposes, the fuel charge since 2000 that is replaced by the GreenChoice® charge:

Austin Energy “Fuel Charge”
Jan 1999 – Jul 2000        1.372 cents/kWh
Aug 2000 – Oct 2000        1.635 cents/kWh
Nov 2000 – Jan 2001        2.211 cents/kWh
Feb 2001 – Dec 2001        2.682 cents/kWh
Jan 2002 – Jun 2003        1.774 cents/kWh
Jul 2003 – Oct 2003        2.004 cents/kWh
Nov 1, 2003 – Dec 31, 2003        2.265 cents/kWh
Jan 1, 2004 – Dec 31, 2005        2.796 cents/kWh
Jan 1, 2006 – Dec 31, 2006        3.634 cents/kWh
Jan 1, 2007 – May 31, 2007        3.343 cents/kWh
Jun 1, 2007 – Dec 31, 2007        3.044 cents/kWh
For electric bills received beginning Jan 1, 2008 3.653 cents/kWh

Batch-5 of GreenChoice® power was sold out during 2008. Batch-6 is now open for voluntary subscription, but is not selling. Recall that this charge substitutes for the normal fuel charge that is currently 0.03653 $/kWh, so the GreenChoice® charge is 2.6 times larger than the comparable fuel charge. Therefore, considering the base charge plus the fuel charge, a residential customer signing up for the latest batch of GreenChoice® power will pay 13.05 cents/kWh for the first 500 kWh, and 17.32 cents/kWh for each additional kWh – all at a fixed price for 10 years. Comparatively, a non-GreenChoice® residential customer power will pay 7.2 cents/kWh for the first 500 kWh, and 11.5 cents/kWh for electricity after the first 500 kWh in the month.

This difficulty in selling the #1 renewable power program in America provides useful data on how people perceive the value of renewables. Before Batch-6 of GreenChoice®, the only renewable energy that Austin Energy was purchasing was wind power generated in West Texas. As of this year, Austin Energy has made power purchase agreements to buy power from 100 MW of biomass generation and 30 MW of photovoltaic solar power from land just to the east of Austin. Due to the increase in wind turbine prices leading up to the middle of 2008, most of the new wind farms constructed in 2008 were built at significantly higher cost than those just a few years ago – when usually everyone expects costs to decrease due to better technology. In fact, data from the Energy Efficiency and Renewable Energy office of the US Department of Energy clearly show that wind turbine prices bottomed out in 2001 at approximately $1,400/kW and were over $1,900/kW in 2008. However, the price of power ($/MWh) is still decreasing.

All of this means that renewable energy may be becoming more expensive and some of the easy options that people thought were expensive in the past were not. This also brings to the forefront the need for conservation of electricity as using half of the electricity at twice the price is still the same expenditure. The model of decoupling electricity sales from utility profits is a good start that many utilities and regulatory bodies have made. Let’s see what other good ideas we can come up with. “Cash and prizes” seem to work for gameshows, maybe it could work for “energy conservation games!”

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The Meaning of “Government Motors” in Energy and Economic Policy – Example of a larger tale

As of last week, the United States government will own just nearly 72% of General Motors (GM) after going through a bankruptcy procedure. Additionally, new Corporate Average Fuel Economy (CAFE) standards will be targeting nearly 35.5 miles per gallon (MPG) of gasoline, or approximately 15 kilometers per liter. The 35.5 MPG by 2016 is broken down as 39 MPG for cars and 30 MPG for trucks. Taken together, free market capitalists are appalled at these actions early in President Obama’s tenure. People discuss how political motives, mostly those pushing environmental agendas, are unduly forcing consumers to “buy cars that they don’t want”. They say the profit motive of a car company will best guide the decisions. Environmentalists say we are simply incorporating external costs, such as greenhouse gas emissions (global scale) or emissions of particulate matter and smog-forming gases (local scale).

First of all, GM had been losing money and market share for the last couple of years. The typical capitalist will tell you that private industry will make better decisions about making cars than the government, and I agree. Unfortunately in this case, GM made enough incorrect decisions over the last decade that they are now a failed company. GM was out-marketed and out-designed by Japanese and German automakers that focused broadly on the overall world market and were not over-committed to the US consumer who wanted to buy light trucks and sport utility vehicles. This is not to say that Toyota does not have top-selling full size pickups and SUVs that supported the sales of their flagship hybrid Prius.

Secondly, GM suffered from general short-sidedness of mainstream economics. There is a major disconnect between the time frames of interest in economics and the time frame of energy resource development. The lure of making large margins when selling more light trucks and SUVs in the short term (think of quarters to years) was just too great. When global forces significantly increased the operating cost of these vehicles – interpret that as high oil and gasoline prices – people “wanted” more fuel efficient cars. Then when US gasoline prices dropped from over $4/gallon in the summer of 2008 to near $2/gallon by the end of 2008 (a tremendously quick change) people were again considering relatively low fuel-efficient cars, and now one can buy a hybrid vehicle off a car lot instead of needing to pre-order a Prius months in advance.

I believe we are crossing into a new era of less prosperity governed by increasingly expensive energy resources, and most politicians and economists do not comprehend the situation. The prerequisite of available energy for economic growth is simply not universally understood well enough. For instance, the usual reason cited for the tremendously quick increase and drop of oil prices in 2008 was that “speculators” were pushing up the price. Well, speculators are part of the market system, so you can’t say that the system was being “gamed” by part of the system itself. For the first time in the history of oil, the world market found out what price of oil was so high that consumers would legitimately begin to alter their lifestyles … and that means a lower lifestyle in the form of lower purchasing power. Because this oil price increase (and subsequent crash) was not politically driven, as during the 1973 OPEC oil embargo, it is a much more important data point. What most people neglect to discuss is that world oil production was essentially level from 2005 to 2008 hovering in the range of 85 million barrels per day. This is after world oil production experienced an annual increase of 1-1.5 million barrels per day from 1990 to 2005. This literally means that the demand continued to increase, as evidenced by increases in consumption in China and the US, as oil production did not. The price of oil had to go up.

So we have a market system that can cause the price of oil to rise and fall over 300% within the span of 1 year. The oil resource and the technologies for extracting oil cannot possibly change that quickly and at that magnitude. It takes up to a decade for investments in the oil and most other energy industries to come to fruition. In making investments, or incentives for investments, in energy production and generation infrastructure or energy consumption infrastructure – such as automobiles and buildings – governments and businesses cannot judge success or failure based upon time frames of only a few years. It takes approximately a decade to see the benefits of changes in energy investment. This time frame is much longer than quarterly financial reports and election time scales. There is much evidence that suggests US presidents lost reelection (e.g. Carter) or lost much popularity (Nixon) made good energy policies for the long term, but that caused pain in the short term.

Elected officials in the United States, the European Union, and around the world, must focus energy policy on time scales longer than fiscal and election cycles because the market is not set up to perform this necessary function. Putting a price on greenhouse gas emissions, or carbon, is the major option to connect long time scales (centuries) of energy and the environment with short time scales (years) of economic markets. A price on carbon will be the most influential change to the economic system since banking began. It combines externalities of energy resources and environmental impacts to economics in a way that has never been done. Some detractors say it will destroy the economy to have such a “tax” on carbon, but what it really does is redefine what the economy is.

The economic influence of a price on carbon will be more of an artifact of the abundance and quality of current and future energy resources. In other words, the abundance of energy resources will dictate economic prosperity many times more than a tax/price on carbon. After all, if there were limitless fossil fuel supplies, we could (1) capture 90% of the CO2 emissions from all fossil fuel combustion at centralized power plants and (2) use the electricity to power industrial machinery and run homes and businesses as well as electrolyze water to create hydrogen as a stored fuel for transportation. In this case, the price on carbon wouldn’t matter because we could use our limitless energy supply to take prevent the carbon from being emitted. Unfortunately, we know that do not have easily accessible and limitless supplies of fossil fuels.

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