The global economy sinks under its debts as the real cost of energy rises

Tim Morgan was global head of research at Tullett Prebon from 2009 to 2013, and is author of Life After Growth (Harriman House), published on 18 November. 

ALTHOUGH the economy is improving, this is turning out to be “a recovery, but not as we know it”. Britain may be getting better off, but people keep getting poorer, as the costs of essentials continue to grow much more rapidly than incomes. Yet far from being a uniquely British problem, this is a worldwide phenomenon.

When you consider the “richer economy, poorer people” conundrum, it might occur to you that there are in fact two parallel economies, not one. This is precisely the point made in my new book Life After Growth.

On the one hand, we have the “real” economy of energy, resources, labour, goods and services. On the other, there is the “financial” economy of money and debt. Money, of course, has no intrinsic worth, so any value that money possesses derives from its role as a claim on the output of the real economy. Together, money and debt constitute a quantity of “claims” on the real economy of today and tomorrow. That’s fine if – and only if – we do not create claims that exceed the value capabilities of the real economy.

Ultimately, the real economy is an energy equation. The economy began when the discovery of agriculture freed up a small proportion of the population for non-subsistence tasks. It took a huge step forward when the invention of the heat-engine enabled us to use fossil fuels to apply vast leverage to the very limited capabilities of human labour. Energy is vital, not just for warmth, cooking and transport, but for every other economic essential as well. Modern agriculture is hugely energy-dependent. Without abundant energy, we could not possibly extract one tonne of copper from 500 tonnes of rock. Hydrocarbons provide plastics as well as a gamut of chemical products. And so on.

But accessing energy comes at a price, and that price is the energy that is consumed in the access process. Picture, for instance, a gas well, an oil platform, a pipeline or a refinery, and you will appreciate the scale of the materials (such as steel) and the work (both mechanical and human) that the energy-delivering infrastructure embodies. What really matters to the economy is net energy – the relationship between the energy that we access and the energy consumed in the process.

In earlier times, this relationship was hugely positive. Using rudimentary wellhead equipment to access billions of barrels of energy in the sands of Arabia delivered at least 100 units of energy for each unit invested in the infrastructure. Today, those abundant, low-cost energy supplies are being replaced by resources which are ever more energy-costly to produce.

The critical measure here is EROEI (the Energy Return On Energy Invested). The days of 100:1 energy returns are long gone. The ratio for new oil projects has declined from 30:1 to barely 10:1 since the 1970s. For global energy overall, the EROEI has declined from about 37:1 in 1990 to less than 14:1 now.

The flip-side of EROEI is the real cost of energy. The cost ratio at an EROEI of 37:1 in 1990 was 2.6 per cent, but this has risen to 6.8 per cent today. The global EROEI may fall to 10:1 by 2020, increasing the energy cost “levy” on the economy to 9 per cent.

In blithe ignorance of this increasing levy, we have continued to grow the claims value of the financial system on the assumption of perpetual growth. These “excess claims” show up as unsustainable debt, undeliverable welfare commitments, and unrealisable expectations for returns on investment. My calculations suggest that the system now owes $90 trillion (£55 trillion) more than it can deliver.

For individuals, this is being manifested in the escalating real costs of fuel, power, food, water and physical infrastructure. Globally, it is visible in “energy sprawl”, as the energy-delivering infrastructure expands (both in scale and in cost) in response to the weakening in efficiency resulting from a deteriorating EROEI. As well as crimping disposable incomes and destroying returns on investment, this process is curbing our ability to invest in other things.

The essential point is that the economy is not a monetary system governed by the theoretical “laws” of economics, but an energy dynamic determined by the all-too-real laws of thermodynamics. Once we understand this, the squeeze on household prosperity becomes far less of a mystery.

Tim Morgan was global head of research at Tullett Prebon from 2009 to 2013, and is author of Life After Growth (Harriman House), published on 18 November.

City A.M.'s Opinion pages are a place for thought-provoking opinions and views. These are not necessarily shared by City A.M.

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