Sunday, November 15, 2015

When, and Why, did the Economy Start to go Downhill

When, and Why, did the Economy Start to go Downhill

This post is in response to a question to a comment I made over at:
It is also posted as a series of comments at that site.  asked the question:

“So, greg, please, exactly when out of all that mess was "the turning point"?” referring to the point at which I said “when the increasing energy cost of energy and other resource production started to be a significant problem.”  The word “mess” refers to the entire price history of oil production.

So:  The short answer might be that point when it became (nominally) more profitable to exploit society, to plunder it, rather than provision it and invest in it.  When it became more profitable to be a pirate, than a builder.  (Understanding this clarifies the motives and actions of the Right, and the modern capitalist. “Greed is good” is the motto of a pirate, not a builder.)   But this transition itself is a consequence of the increased difficulty in extracting resources from the environment.  In particular, non-renewable energy resources. 

So if you want a date, sometime around the Reagan presidency, in perverse reaction to the oil crises of the1970’s.

In the beginning, (Well, once the ball got rolling, about 1880.)
the real cost of energy extraction was low, lower than the cost of  developing the infrastructure needed to distribute and consume the oil.  So the cost of extraction was the benchmark for the price. Only as the infrastructure for demand was emplaced did demand on occasion drive the price.  In the first half of the 20th Century, because of the- inconsistent nature of the supply and its irregular rate of increase, sometimes demand, sometimes supply drove the price. 

With the opening of the Middle Eastern fields, supply smoothed out.  Supply and demand both expanded apace, the price relatively stable and low.     Until the Arab oil embargo of 1973, and the later panic in 1979 due to the Iranian crisis. The result was an effective and dramatic increase in the *real* cost of oil to the US, since it now had to hand over an increased quantity of goods and services to pay to import foreign production.  Domestic fields were becoming exhausted.  New ones (Prudhoe Bay, etc.)  more expensive to develop.

In an energy based society such as ours, (almost) all inputs can be traced back to the energy needed to support them. Thus the size of the economy can be measured in terms of energy consumption, and this is measured in terms of energy input. This instead of dollars.  With this understanding, the inverse of the EROI, the energy return on (energy) investment, is the portion of the real economy which must be devoted to the extraction of energy.  Only the remainder of the economy is available not only to providing services to society, but also to investment and maintenance.

For EROI, see: "Energy, EROI and quality of life"
Check out: Fig. 1  The Net Energy Cliff

Now:  From about 2004, supply has been constant, but until the 2008 crisis, demand increased, driving up the price.  Demand and price then crashed with the recession, increased with the recovery, and recently spiked again, and is now again depressed. 
The question is why is the price, and demand, now (relatively) depressed. 

We return to the short answer, considering the gradually decreasing EROI, that is, a gradually increasing average real cost of extraction.   

So:  We have two different measures of accounting in an economy:  Energy accounting, and money.  Is the price in money necessarily a faithful measure of the real cost, in energy, of energy production?

Why should it be?  Instances where monetary price does not reflect cost, real or even merely monetary, are common occurrences.  Is the current energy market one of them?  In particular, we ask: “How can we subsidize energy production? 

Well, we can’t.  When we subsidize something, we divert real resources from elsewhere in the economy to promote the production of the subsidized good.  We decrease the nominal cost, and therefore the nominal price at which the good may be offered for profit.  However, the real cost must be greater than if the good were produced without the subsidy. So when we subsidize the real cost of energy, we are merely increasing the real cost of production. (Note:  Subsidizing production is not to be confused with subsidizing the capitalization of production.)   That is, because of the cost of our churning resources through the mechanism of subsidy, we are worse off than if we let the price reflect the real cost of production. 

However, we can still manage to increase quantity produced, and depress price. Especially if we also depress demand.  Remember, those resources transferred to subsidize production can only come from one place:  The remainder of the economy, where a portion of those resources would have gone to maintain and capitalize the infrastructure which supports the economy, the infrastructure which also enables the consumption of oil.  

the world formally spends about $400 billion per year, one way or another subsidizing fossil fuel production.  (The US, formally, a mere $25 billion.)  Given an inelastic demand curve, this can result in a dramatic reduction in price. 

But there are other mechanisms of subsidy.  For instance, consider the US trade deficit in goods.  All those goods, if made in the USA, would require energy inputs, and concomitant infrastructure, for their production.  Just as agricultural imports can be regarded as water imports, the importation of goods can be regarded as energy imports. So energy supply is increased, while demand is contracted. 

Further, the production cost of fracking, while recently improved, is still above the current market price of oil. (Externalization of costs also represents a form of subsidy.)  This production has been financed in large part by massive quantities of debt. This debt represents an enormous effective subsidy, much, much larger than the formal subsidies provided the fossil fuel industry, especially those debts, (and they represent a substantial fraction,) which will never be repaid.  Considerations of the relative discount rates of oil and money, also suggest the actual effective subsidy is much greater.  (The discount rate of a non-renewable resource should probably be considered at most zero, and more likely negative, since all current consumption necessarily implies less ultimately available in the future, likely coupled with an increase in demand.)  And as above, these debts represent demand transferred from the larger real economy to support the production of energy.
Infrastructure neglect is also an effective subsidy. 

My guesstimate of a price that reflects the real cost, everything I can think of considered, of oil is somewhere well over $100 per barrel.  The difference between that and what we actually pay we are passing to the future, our own and that of our descendants.  It is a price we will begin to pay when the delusion live under (and which requires an input of real resources to maindain,) can no longer be sustained.

So, sometime around or, actually before1980, the leaders of society decided to pursue their own narrow and what may ultimately prove to be ephemeral gains, rather than look after the enduring interests of their society. The actual process of their choosing the consolidation of power has been noted elsewhere.  (Consider also eg the Exxon climate data suppression scandal.)  They propounded an ethos to justify their actions, and geared up their media to convince society of the rightness of those actions.  And the people, for their part, got to live beyond their means, splurging on underpriced energy,  their political acquiescence purchased with their own futures, and that of their descendants.  Most of them.  So now society is in a hole, 30 years and many trillions of dollars of squandered resources and mal-investment, with an economy ill-adapted for a future of costly energy.  

Now some might argue that the economy has not been going down hill for the past 30 or so years.  That we have instead made remarkable progress during that time.  We will address that issue in the next post.