Nations are Made Wealthy by the Efficient Extraction of Energy, Not by Newly Printed Money

by Andrew Alexander The views represented in this article are solely those of the author and may not be construed as in any way representative of the views or policies of Oxford Royale Summer Schools.

Image shows an oil refinery near Bangkok.

What is wealth?

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Leaving aside the answers that draw, correctly, on the concept of a spiritual treasury, and confining ourselves to the material world, most of us would answer that it is possession of a large amount of money. This is certainly the view of the world’s central banks. In reacting to a financial crisis which had enjoined, as they always do, a large amount of wealth destruction, the central banks of the world decided that they would react by increasing the money supply. Creating money from nothing, using it to buy government debt, and hoping that the reinvestment of the windfall made on government bonds would be reinvested elsewhere by banks, pushing up asset prices, is the process known as quantitative easing. QE has made many people paper profits, but it is hard to argue that it has made nations richer – as the volume of money in circulation has increased, the price of assets has increased also – but the number of assets in a society has not been increased by such a move, they are simply less easily obtained.
[pullquote]Technological innovation and modern equipment have reduced the cost of transport over a mile by 31x, freeing up economic resources to be used elsewhere.[/pullquote]Printing money does not create wealth. In this essay, I will argue that the wealth of nations is, in fact, a wealth in energy, rather than the existence of large amounts of money. It is energy that enables production, and production that drives all economic processes. Money serves a role as a measure of the energy needed to complete a process – it does not create wealth as a result of its existence. While such an approach is a useful conceptual tool when it comes to understanding the rise and fall of great powers – particularly with reference to the United Kingdom and the United States – it also presents a contemporary conundrum: does the greatest threat to our contemporary economic order come not from financial chaos, but from a failure to generate an energy supply sufficient to match the existing and anticipated needs of our nation? In other words, has the fact that we have lost sight of what money does (measure the energy input into processes) mean that we are conceptualising the problems that we face in the decades to come in completely the wrong way? While my essay last week took in the strategic problems presented by the dithering of the British government over the past decades, this week’s analysis will concentrate on the global implications of the boom in global energy consumption given that the low-hanging fruit is now nearly all gone.

The Energy Equation

Image is 'A Rococo Scene' by G. Borgelli, showing a woman getting out of an elaborate sedan chair.
The cost of travelling luxuriously for a mile has fallen dramatically.

One of the most original pieces of research undertaken in this area was by Dr Tim Morgan, Global Head of Research at Tullett Prebon, whose work The Perfect Storm: energy, finance and the end of growth conceptualises the economy as an energy equation. In this view, economics amounts to the process of transforming tangible resources into a form necessary to meet human needs. The skill with which humans have been able to extract and harness energy sources (not just conventional energy such as oil and coal, but also nutrition for labourers, for instance) is tied, in this view, to economic development – economic growth is a representation of the increasingly efficient use of energy. As an example, the medieval monarch carried in a litter over one mile would entail say four men carrying a heavy load and walking for an hour. A modern car can cover the same distance for less than a litre of fuel burnt. Converted into a common energy measurement (such as Watts), we can see that the former mode of transport is far more energy intensive than the latter. This can be shown in price terms (with money acting as a measure of energy effort in this view) too – employing four men to commit to hard labour for one hour would cost around £10 per person, per hour, so £40. The price of the same trip in a car would be £1.30, the price of a litre of petrol. In other words, technological innovation and modern equipment have reduced the cost of transport over a mile by 31x, freeing up economic (read energy) resources to be used elsewhere.
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This view has a number of intuitive strengths. For a start, the great advances in human development have all been tied to developments in the extraction or use of energy. The harnessing of agriculture in the Fertile Crescent provided the nutrition to fuel larger organised societies which did not live purely hand-to-mouth but instead gathered in cities and centres of learning. The industrial revolution harnessed the energy potential of natural resources through the invention of the steam engine and began the mechanisation process which would greatly reduce the human work requirement per unit of production. Arguably the computer revolution is the third part of this history. The advent of micro-processing capabilities enhanced again the amount of work which could be done, in one sense, using the same unit of energy.

Efficient energy extraction allows the extraordinary level of specialisation that characterises modern economies

Image shows a coloured lithograph of the engine Northumbrian (mis-labelled as the Rocket) on the Liverpool and Manchester Railway line.
Stevenson’s 1830 steam engine, the Northumbrian, being used on the Liverpool and Manchester railway.

There is a marked overlap in between the efficiency and ease with which humans have harvested energy and the growth in GDP which has occurred over that period – as can be seen from the relative flat lining of GDP between the Norman Conquest and the age of steam. The advent of energy efficiency also helps us on another level, however. We are able to organise our societies to a degree of complexity and specialisation which would have astonished our forbears. In large part, we attribute this to the modern science of economics which teaches that men and nations should perform a narrow range of production functions well and trade between one another to satisfy their other desires. This science, however, is again dependent on sufficient energy resources being harnessed to manage extreme specialisation in production – in an agrarian society, the only power source available is labour, and the majority of energy is devoted to growing sufficient nutrition to fuel labour, making each man a farmer and specialisation impossible. It is worth adding that it is instinctively correct that, as Dr Morgan notes, “all goods and services on which money can be spent are the products of energy inputs either past, present or future.” This analysis has a necessary implication: where the fecundity of our energy resources decreases, and where this is not offset by a universal and equivalent improvement in energy efficiency, the result is a diminished productive capacity and a diminished quality of life. To draw this out, let’s imagine a coal mine with three layers of coal – anthracite, bituminous and sub-bituminous. Burning coal from the first layer will produce twice the energy as burning coal from the second, and this in turn produces double the energy of the bottom layer. Let us also say that the energy cost of digging out one tonne of coal is fixed. The amount of surplus energy – as in, energy that is left over once the energy used in the production process is replaced – halves when each layer is fully mined. To produce the same energy from a layer of sub-bituminous coal as you could from a layer of anthracite you need four times as many tonnes extracted, and four times the energy input.
This means that, all other things being equal, once the most fertile layer is used up there must be a production sacrifice elsewhere because the energy output of that layer is generating a smaller surplus. This ratio, between energy surplus and energy used in unit production, is known as the Energy Return on Energy Invested [EROEI]. The EROEI ratio has been in decline since the oil rushes in the deserts of Texas and Arabia. In the 1930s, the rich pools of oil deposited close to the surface allowed an EROEI of 100:1; by the 1970s this had fallen to 30:1. Today, new technologies such as biofuels and the tar sands have an EROEI of around 4:1. Andrew Lees of UBS believes the current global ratio to sit at around 20:1, falling to 5:1 over the next decade. The implication is very serious – the degree to which humanity is able to leverage muscle power through energy harvesting enables modern urban civilisations. With this ratio in decline, either we will need to divert an increasing amount of energy and capital into energy production itself, leaving less for non-essentials and causing a decline in the standard of living, or we witness an even sharper decline in energy production as conventional power sources are extinguished. As the Economist noted; “if the world were a giant company, its return on capital would be falling.”

Declining EROEI will destroy our standard of living if we don’t address the issue aggressively

Image shows rows of rotating solar panels at an air force base in Nevada, USA.
Solar panels at Nellis Air Force Base, Nevada, USA.

The apparent relentless movement downwards in terms the EROEI is deeply alarming, but it is not necessarily terminal. Tim Worstall makes the argument that, in fact, the ratio is irrelevant given that the energy deployed on energy extraction can be sourced from renewables, effectively making all energy extraction inputs free and effectively offering a much greater real return on the ration. Certainly, this is a plausible case. Energy invested in terms of that from the sun is cost free, the only extraction cost is in the machinery required to harness it. Even allowing for the purchase and maintenance costs of the machinery required, there is a prima facie case to be made that renewables render the energy equation less potent, and potentially redundant as a predictor of the progression in complexity which societies are able to make.
There are three reasons for which in reality this is not likely to be the case for some time. The first two reasons are practical and outside of our control. Firstly, given the current renewable models available, the energy lost in transmission relative to that generated, and the fact that they are very seldom “always on” represent significant constraints on their ability to dominate the energy mix. Even with energy prices in the retail market at near record highs, these are un-economic forms of energy provision. As matters stand they are completely unsuited to singlehandedly sustaining a modern industrial economy – their local reach and the low EROEI return when construction is factored in render these, for now, best suited as toys of rich men and rich governments. The second reason for which renewables are unlikely to rescue us from the maths of EROEI decline is the volume of land required to house them. It is wrong to present any energy source as free from opportunity cost – carpeting farm land in solar panels, or damming great rivers presents a cost in terms of land usage, which will rebound in terms of energy needs elsewhere – for instance, converting a quarter of farm land for solar would require a significant improvement in the intensity of farming elsewhere, a process which will inevitably require a higher energy burn.
Image shows the preamplifier at a nuclear fusion reactor.
Nuclear fusion could solve all of our energy problems, but it requires expensive research.

Ultimately, though, the fundamental problem with imagining that new or improved technology will defeat the declining EROEI lies within our corporate system. Capital allocation in the present model is an incredibly myopic business. The focus on driving up corporate profit margins and on trading based on data releases which can be conducted by algorithm has encouraged a paring back on cost areas as firms seek to stay ahead of target estimates. One important casualty is real wage growth which has stagnated seriously in the non-financial sector since the turn of the millennium. The second important casualty is research work. Cutting research budgets is an easy way to increase paper profits for firms. In the same way, cutting research grants is an easy way for governments to cut costs without provoking howls of outrage from the private recipients of state funds through the welfare system, and without cutting any of the interesting alternative uses governments find for public money such as deciding to enter the Ethiopian pop music market. Nor have stock market valuations helped.
The amusing consequence of the transition from the economy of things to the ideas economy is that the ideas it has provoked – social networking technology for instance – are almost completely functionally useless, luxury by-products of affluence which are diverting the best and brightest minds from those fields of inquiry which might themselves help sustain that affluence long into the future. We are a long way from either the corporate or government sponsored research that will help us break through the energy barrier. EROEI does matter. The decline in the ratio presents a serious problem which will start to have a much more pronounced impact on lifestyle over the next decade. It does not present an inevitability – these difficulties can be overcome through innovation — but until such time as we allocate our capital, energy and talent better, we find ourselves drifting towards the point of no return.


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Image credits: banner; litter; Northumbrian; solar panels; nuclear fusion