The Archdruid Report - Archive

The last twelve months or so of economic chaos has taught those of us in the peak oil community some useful lessons. Perhaps the most valuable of these lessons is extent to which conventional economic ideas have failed to make sense of the way that the twilight of fossil fuels is working out in practice.

Not too long ago, it bears remembering, most people on all sides of the peak oil debate – believers, skeptics, and everyone in between – assumed that the law of supply and demand would necessarily define the world’s response to the end of cheap oil. As existing reserves depleted, nearly everyone agreed, the intersection of decreasing supply and rising demand would drive prices up. Common or garden variety cornucopians insisted that this would lead to more drilling, more secondary extraction, and other measures that would produce more oil and bring the price back down; techno-cornucopians insisted that this would lead to the discovery of new energy resources, which would produce more energy and bring the price back down; green cornucopians insisted that this would finally make renewable energy cost-effective, and at least keep the price from rising further; and pessimists argued that none of these things would happen, and the price of oil would rise steadily on up into the stratosphere.

None of them were right. Instead, as the world crossed the bumpy plateau surrounding its 2005 production peak, oil prices moved up and down in waves of increasing violence, culminating in a drastic price spike driven in part by speculative greed, and followed by an equally drastic crash driven in part by speculative panic. The shockwaves from that spike and crash were not solely responsible for the economic power dive that followed – most of a decade of hopelessly misguided fiscal policy, criminal negligence in the banking and business sectors, and a popular psychology of entitlement extreme even by the standards of past speculative disasters, all had their own parts to play – but even a financial world less shaky than the house of cards that imploded last year would have had a hard time dealing with the body blow inflicted on it by the oil spike and its aftermath.

The rubble from that collapse is still bouncing, even as politicians and pundits insist that the worst is over and a recovery will follow shortly. (This is not exactly comforting; the politicians and pundits of an earlier day said exactly the same thing during the “sucker’s rally” of 1930, when stock markets and other economic indicators regained much of the ground lost in 1929 before plunging catastrophically in the years that followed.) One thing that’s already become clear amid the dust and rubble, though, is that models of the future that assumed a steady upward rise in prices don’t apply to the much more complex reality of spike and crash that is shaping our energy future.

Somewhere in the midwest, perhaps, where a half-completed ethanol plant whose parent company has gone bankrupt is being sold for scrap, and oil leases bought for high prices last June sit unused because the current price of oil won’t justify their development, the dream of a smooth market-driven transition to a different energy system is rolling across a field with the tumbleweeds. Meanwhile the price of oil is continuing its stubborn refusal to obey the laws of supply and demand. Demand has dropped, as consumers and businesses caught in the economic downdraft cut costs, and stockpiles are ample, but the price of oil has doubled since its post-spike low, following a slow, ragged, but unmistakable upward trend.

What makes this all the more fascinating is that oil has shown the same habit of standing economic rules on their heads before. Back in the 1970s, one of the great challenges facing the economics profession was the riddle of stagflation. According to one of the most widely accepted rules of macroeconomics, inflation and deflation – which can be defined precisely as expansion and contraction, respectively, of the money supply – form two ends of a continuum of economic behavior. Rising prices, rising wages, and increased economic activity leading to overproduction are all signs of inflation, while flat or declining prices and wages and diminished economic activity leading to recession are all signs of deflation. In the wake of the Seventies oil shocks, though, the industrial world found itself in the theoretically impossible situation of an inflationary recession: prices were rising, but wages struggled to keep pace, and economic activity declined sharply.

That was stagflation. For more than a decade, economists tried to make sense of the riddle it posed, before finally giving up with a certain amount of relief in the Reagan years, and deciding that it was an anomaly that had gone away and so didn’t matter any more. To many of the economists who tried to make sense of stagflation, it was clear enough that the oil crises had had something to do with it, but this in itself posed its own awkward questions. The economics of commodity prices had been studied exhaustively since the time of Adam Smith, but the behavior of the world economy in the face of rising oil prices violated everything economists thought they knew.

Only a few economists at the time, and even fewer since then, realized that these perplexities pointed to weaknesses in the most basic assumptions of economics itself. E.F. Schumacher was one of these. He pointed out that for a modern industrial society, energy resources are not simply one set of commodities among many others. They are the ur-commodities, the fundamental resources that make economic activity possible at all, and the rules that govern the behavior of other commodities cannot be applied to energy resources in a simplistic fashion. Commented Schumacher in Small is Beautiful:

“I have already alluded to the energy problem in some of the other chapters. It is impossible to get away from it. It is impossible to overemphasize its centrality. [...] As long as there is enough primary energy – at tolerable prices – there is no reason to believe that bottlenecks in any other primary materials cannot be either broken or circumvented. On the other hand, a shortage of primary energy would mean that the demand for most other primary products would be so curtailed that a question of shortage with regard to them would be unlikely to arise” (p. 123).

If Schumacher is right – and events certainly seem to be pointing that way – at least one of the basic flaws of contemporary economic thought comes into sight. The attempt to make sense of energy resources as ordinary commodities misses the crucial point that energy follows laws of its own that are distinct from the rules governing economic activities. Trying to predict the economics of energy without paying attention to the laws governing energy on its own terms – the laws of thermodynamics – yields high-grade nonsense.

Look at the way that rules governing the availability of other resources go haywire when applied to energy. When North America’s deposits of high-grade iron ore were exhausted, for example, the iron industry switched over to progressively lower grades of ore; these contain less iron per ton than the high-grade ores but are much more abundant, and improved technology for extracting the iron makes up the difference. In theory, at least, the supply of iron ore can never run out, since industry can simply keep on retooling to use ever more abundant supplies of ever lower-grade ores, right down to iron salts dissolved in the sea.

Try to do the same thing with energy, by contrast, and two awkward facts emerge. First, the only reason the iron industry can use progressively lower grades of ore is by using increasingly large amounts of energy per ton of iron produced, and the same rule applies across the board; the lower the concentration of the resource in its natural form, the more energy has to be used to extract it and turn it into useful forms. Second, when you try to apply this principle to energy, you very quickly reach the point at which the energy needed to extract and process the resource is greater than the energy you get out the other end. Once this point arrives, the resource is no longer useful in energy terms; you might as well try to support yourself by buying $1 bills for $2 each.

This difficulty can be generalized: where energy is concerned, concentration counts for much more than quantity. That’s a function of the second law of thermodynamics: energy in a whole system always moves from high concentrations to low. Within the system, you can get energy moving against the flow of entropy, but only at the cost of reducing a larger amount or higher concentration of energy to waste heat. That’s how fossil fuels came into existence in the first place; the vast majority of hundreds of millions of years of energy from sunlight falling on prehistoric plants were degraded to waste heat and radiated into outer space, and in the process a very small fraction of that sunlight was concentrated in the form of carbon compounds and buried underground.

The same rule of concentration explains a great many things that current economic ideas miss. Consider the claims made every few years that we can power the world off some relatively low-grade energy source. Latent heat stored in the waters of the world’s oceans, for example, could theoretically provide enough power for the world’s economy to keep it running for some preposterously long period of time, and any number of inventions have tried to tap that energy. They’ve all failed, because it takes more energy to concentrate that heat to a useful temperature than you get back from the process. The same is true a fortiriori of “zero point energy,” the energy potential that according to current physics exists in the fabric of spacetime itself. It doesn’t matter in the least that there’s an infinite amount of it, or something close to that; it’s at the lowest possible level of concentration, and thus utterly useless as a power source for human society.

The same limits apply, if less strictly, to many of today’s renewable energy sources. Solar energy, for example, is very abundant, but it’s also very diffuse. As with any other energy resource, you can concentrate some of it, but only by letting a larger quantity of it turn into waste heat. It’s quite common to hear the claim that because solar energy’s so abundant, our society can easily power itself by the sun, but this shows a failure to grasp thermodynamic reality. Today’s industrial societies require very highly concentrated energy sources; our transportation networks, our power grids, and most of the other ways we use energy, all work by degrading very high concentrations of energy all at once into waste heat, and without those highly concentrated resources, those things won’t work at all.

Now of course there are plenty of productive things that can be done with more diffuse energy sources. Once again, solar energy provides a good example. Passive solar heating for buildings is a mature and highly successful technology; so is solar hot water heating; so are a good many other specialized uses, such as using solar ovens for cooking, water purification, and the like. All these can contribute mightily to the satisfaction of human needs and wants, but they presuppose very different social and economic arrangements than the centralized energy economy of power plants, refineries, pipelines and power grids we have today. As concentrated energy from fossil fuels becomes scarce, in other words, and more diffuse energy from the sun and other renewable sources has to take up the slack, many of the ground rules shaping today’s economic decisions will no longer apply.

What this implies, in turn, is that economics does not exist in a vacuum. The ground rules just mentioned took shape, after all, in an age where economic processes were dominated – one might even say “distorted” – by our species’ temporary access to extravagant supplies of cheap and highly concentrated fossil fuel energy. The new ground rules of economics that will take shape in the twilight of the age of cheap energy, in turn, will be shaped by the fact that energy is once again scarce, costly, and diffuse. More generally, it’s necessary once again to pay attention to the myriad ways that human economic systems are rooted in the wider processes of the natural world – a theme that will be central to next week’s post.