Our finite world exploring how oil limits affect the economy gas efficient cars 2010

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Why have long-term interest rates generally fallen since 1981? Why have asset prices risen? Can these trends be expected to continue? The standard evaluation approach by actuaries and economists seems to be to look at past patterns and assume that they will be repeated.

The catch is that energy consumption growth plays a hugely important role in GDP growth. It also plays an important role in interest rates that businesses and governments can afford to pay. Energy consumption growth has been slowing; it is hard to see how growth in energy consumption can ramp back up materially in the future.

Slowing growth in energy consumption puts the world on track for a future like the 1930s, or even worse. It is hard to see how GDP growth, interest rates, and inflation rates can ramp up in the future. More likely, asset price bubbles will pop, leading to significant financial distress. Derivatives may be affected by rapid changes in prices and currency relativities, as asset bubbles pop.

The article that follows is a partial write-up of a long talk I gave to a group of life and annuity actuaries. (I am a casualty actuary myself, which is a slightly different specialty.) A PDF of my presentation can be found at this link: Reaching Limits of a Finite World

In my most recent post, Why the Standard Model of Future Energy Supply Doesn’t Work, I made some comments about the calculation of Energy Returned on Energy Invested. Professor Charles Hall sent me the following response to what I said, which he wanted to have published. I have a few follow-up comments, but I will save them for the comments section.

The Energy Return on Energy Invested (EROEI) Model of Prof. Charles Hall depended on the thinking of the day: it was the energy consumption that was easy to count that mattered. If a person could discover which energy products had the smallest amount of easily counted energy products as inputs, this would provide an estimate of the efficiency of an energy type, in some sense. Perhaps a transition could be made to more efficient types of energy, so that fossil fuels, which seemed to be in short supply, could be conserved.

The catch is that it is total energy consumption, that matters, not easily counted energy consumption. In a networked economy, there is a huge amount of energy consumption that cannot easily be counted: the energy consumption to build and operate schools, roads, health care systems, and governments; the energy consumption required to maintain a system that repays debt with interest; the energy consumption that allows governments to collect significant taxes on exported oil and other goods. The standard EROEI method assumes the energy cost of each of these is zero. Typically, wages of workers are not considered either.

There is also a problem in counting different types of energy inputs and outputs. Our economic system assigns different dollar values to different qualities of energy; the EROEI method basically assigns only ones and zeros. In the EROEI method, certain categories that are hard to count are zeroed out completely. The ones that can be counted are counted as equal, regardless of quality. For example, intermittent electricity is treated as equivalent to high quality, dispatchable electricity.

The EROEI model looked like it would be helpful at the time it was created. Clearly, if one oil well uses considerably more energy inputs than a nearby oil well, it would be a higher-cost well. So, the model seemed to distinguish energy types that were higher cost, because of resource usage, especially for very similar energy types.

Another benefit of the EROEI method was that if the problem were running out of fossil fuels, the model would allow the system to optimize the use of the limited fossil fuels that seemed to be available, based on the energy types with highest EROEIs. This would seem to make best use of the fossil fuel supply available.

I have always been, remain and will probably always continue to be a huge fan of Gail Tverberg, her analyses and her blogs. I am also committed to try and make sure science, such as I understand it, remains committed to truth, such as that is possible, which includes an accurate representation of the scientific work of others. In that spirit I wish to correct a short piece (referenced above) that is attempting to represent my own work on Energy Return on Investment (EROI or EROEI) but does not do so in a way that is fully consistent with the published work of myself and my colleagues. Continue reading →

The most prevalent view regarding future oil supply, as well as total energy supply, seems to be fairly closely related to that expressed by Peak Oilers. Future fossil fuel supply is assumed to be determined by the resources in the ground and the technology available for extraction. Prices are assumed to rise as fossil fuels are depleted, allowing more expensive technology for extraction. Substitutes are assumed to become possible, as costs rise.

Those with the most optimistic views about the amount of resources in the ground become especially concerned about climate change. The view seems to be that it is up to humans to decide how much energy resources we will use. We can easily cut back, if we want to.

The problem with this approach is the world economy is much more interconnected than most analysts have ever understood. It is also much more dependent on growing energy supply than most have understood. Surprisingly, we humans aren’t really in charge; the laws of physics ultimately determine what happens.

In my view, Peak Oilers were correct about energy supplies eventually becoming a problem. What they were wrong about is the way the problem can be expected to play out. Major differences between my view and the standard view are summarized on Figure 1.