Energy and Wealth Creation

benjamin.warr@gmail.comhttps://sites.google.com/site/rexsgate/

Dr Benjamin Warr, Senior Research Fellow

INSEAD Social Innovation Centre Sustainability Group

Alumni Reunion Energy Network Presentation

22ndOctober 2011

Topic and Objectives

• Reconsider some assumptions of the role of energy

• Provide alternative assumptions: energy as a driver of growth

• Supply and efficiency are critical for growth

• Supply challenges lay ahead

• Efficiency promises are blocked, ignored and unfulfilled

Standard Paradigm

• Closed system in equilibrium with no wastes

• Growth occurs through accumulations of capital and labour

• Both increase in productivity at an exogenous rate (TFP)

Production of Goods and Services

Consumption of Goods and Services

Purchases

Wages, Rents

Invested(Energy Generating)

Capital

GDP Index (1900=1)

1900 1920 1940 1960 1980 2000year

5

10

15

20

25

US GDP

Cobb-Douglas

SOLOW RESIDUAL(TFP)

US GDP actual vs. modeled using a 3-factor Cobb-Douglas

Unexplained Solow residual

TFP (~1.6% per annum)

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

year

1

1.5

2

2.5

3

3.5

4

4.5

5

5.5

Index (1900=1)

The Solow residual, US 1900-2010

Something is missing ?

• Unable to explain historic growth rates.

• Exogenous unexplained technological progress is assumed, hence growth is assumed to continue.

• No link to the physical economy, only capital and labour are productive.

• Energy, materials and wastes are ignored.

• Energy availability is overcome by investments in capital.

Capital and useful work substitute for labour: the rise of the energy slaves

Our approach

0%

10%

20%

30%

40%

50%

60%

1900 1925 1950 1975 2000

Heat (Hight Temperature)Heat (Low Temperature)Mechanical DriveElectricityLightMuscle Work

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

1900 1925 1950 1975 2000

Coal

Crude Oil and PetroleumProductsNatural Gas

Non-conventional

Biomass (Food and Feed)

0%

5%

10%

15%

20%

25%

30%

35%

40%

2000199019801970196019501940193019201910year

effic

ienc

y

Low Temperature Space Heating

Mechanical Work

Medium Temperature Industrial Heat

High Temperature Industrial Heat

Electric Power Generation &Distribution

SUPPLY USES EFFICIENCY

USEFUL

WORK

0

5000000

10000000

15000000

20000000

25000000

30000000

35000000

40000000

45000000

1900 1925 1950 1975 2000

Heat (Hight Temperature)Heat (Mid Temperature)Heat (Low Temperature)Mechanical Drive

ElectricityLightMuscle Work

Wastes

Exergy (or maximum available work)

The exergy flow from the sun, and the exergy stocks on earth create the resource base for human societies on earth.

Exergy Quality Index

0

10

20

30

40

50

60

70

80

90

100

Poten

tial

Kineti

c Elec

trica

lChe

mical

Nucle

arSun

light

Hot Ste

amDist

rict H

eatin

gW

aste

Hea

tAm

bient

Hea

t

Exergy reflects energy quality in terms of distinguishability and availability

Efficiency

Each transformation involves a loss of available energy (exergy)

Exergy is consumed to provide energy services

A system expressed in energy units looks as though

the room for efficiency improvements is small.

Accounted for in exergy units reveals the loss of available work due to inefficiencies.

Exergy input share by source (US 1900-2000)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1900 1925 1950 1975 2000

Year

Biomass (Food andFeed)

Non-conventional

Natural Gas

Crude Oil andPetroleum Products

Coal

Source: Ayres & Warr, 2009

Useful work by type(US 1900-2000)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1900 1925 1950 1975 2000

Year

Muscle Work

Non-Fuel

Light

Electricity

Mechanical Drive

Heat (LowTemperature)

Heat (HightTemperature)

Source: Ayres & Warr, 2009

0%

5%

10%

15%

20%

25%

200519851965194519251905

year

effic

ienc

y (%

)

US

Japan

UK

High Population Density Industrialised Socio-ecological Regimes

Resource limited

Low Population Density Industrialised New World Socio-ecological Regime

Resource abundant

Evidence of stagnation•Pollution controls •Technological barriers•Ageing capital stock•Wealth effects

Efficiency

Empirical and Estimated GDP US 1900-2000

0

5

10

15

20

25

30

1900 1925 1950 1975 2000

Empirical GDP

Estimated GDP

Source: Ayres and Warr, 2009

Using a LINEX production function with useful work (exergy*efficiency) as a factor

of production.

Corresponds to Cobb-Douglas with Capital share 0.57, Labour share 0.01and Useful

Work share 0.41.

Our growth dynamic

Concerns

• Availability and supply of energy (and specifically oil)• low price elasticity – people need it• increasing costs of production – harder to find and obtain• weak substitutability – alternatives unavailable for various reasons• increasing demand growth rate, global energy equity and poverty

alleviation

• The rate of efficiency improvements• imperfect markets (externalities, subsidies)• wealth effects, the energy-poverty nexus imperative• lock-in and current technology asymptotes• climate, health & safety (real and unreal concerns)• (lack of access to finance)

Oil Supply

0

20

40

60

80

100

-4 -1 2 5 8 11 14 17 20 23 26 29 32 35 38 41Years

Ann

ual D

isco

very

& P

rodu

ctio

n(a

rbitr

ary

units

)

Conv. oil peak is counter-intuitive. It occurs when production is rising, reserves are large, new fields are being discovered, & technology is increasing recovery factors.

From discovery to production takes~ 5 years, starting with the big and easy fields.

0

10

20

30

40

50

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41

Years

Ann

ual P

rodu

ctio

n(a

rbitr

ary

units

)

Produced Reserves

Yet-to-Find

Discovery

Production

Source: Roger Bentley, University of Reading

Peak oil - fluctuating plateau - declineconsumption exceeds discoveries since circa. 1980

Net Energy and EROEI

Impacts on oil price

Long-run costs increasing due to low elasticity of substitution and price

0

20

40

60

80

100

120

1950 1975 2000 2025 2050

year

GD

P (

1900

=1)

1.2% per annum1.3% per annum1.4% per annum1.5% per annumempirical

What effects efforts to increase energy productivity?

0

5

10

15

20

25

30

2000199019801970196019501940193019201910

year

inde

x

r/gdp

e/gdp

Historical rate of decline in exergy intensity of GDP is 1.2% per annum

For Business-as-Usual, (1.2% decay rate) – by 2025 GDP doubles and exergy inputs increase by half.

With a 1.4% decay rate output doubles ~10 years later, but requires ~50EJ less than 2010 levels

Possible trajectories for efficiency improvements

For efficiency growth smaller than 1% p.a. we obser ve a future decline in GDP. The historical rate of improvement is 1.1% per annum.

0

10

20

30

40

50

60

70

1950 1975 2000 2025 2050

year

GD

P (

1900

=1)

lowmidhighempirical

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

1950 1975 2000 2025 2050

year

tech

nica

l effi

cien

cy (

f)

lowmidhighempirical

Efficiency ScenariosLow 0.4% yr -1

Mid 0.72% yr -1.High 1.2% yr -1

Scenario GDP growth (2030)Low 0.4% yr -1 -2.0%High 1.2% yr -1 2.2%

Oil scarcity, growth, global imbalancesIMF , World Economic Outlook April 2011

2000 05 10 15 20-5

-4

-3

-2

-1

0

1

2000 05 10 15 20-4

-3

-2

-1

0

1

2000 05 10 15 20-4

-3

-2

-1

0

1

2000 05 10 15 20-4

-3

-2

-1

0

1

2000 05 10 15 20-8

-6

-4

-2

0

2

Real GDP (percent difference)

World

Figure 3.10. Alternative Scenario 1: Greater Subst itution away from Oil

Oil Exporter United States Emerging Asia

2000

Euro Area

Benchmark scenario Upside scenario

Real GDP(percent difference)

This scenario considers a higher value for the price elasticity of demand (0.29, compared with 0.08 in the baseline scenario), consistent with greater substitution away from oil.

This scenario considers a higher value for the pric e elasticity of demand (0.29, compared with 0.08 in the baseline). This is consistent with greater s ubstitution away from oil.

2000 05 10 15 20-15

-10

-5

0

5

2000 05 10 15 20-15

-10

-5

0

5

2000 05 10 15 20-15

-10

-5

0

5

2000 05 10 15 20-15

-10

-5

0

5

2000 05 10 15 20-20

-15

-10

-5

0

5

Real GDP (percent difference)

World

Figure 3.11. Alternative Scenario 2: Greater Decli ne in Oil Production

Oil Exporter United States Emerging Asia

2000

Euro Area

Benchmark scenario Downside scenario

Real GDP(percent difference)

This scenario considers the implications of a more pessimistic assumption for the decline rate of oil production (3.8 percentage points annually, compared with 1 percentage point in the baseline scenario).

Oil scarcity, growth, global imbalancesIMF , World Economic Outlook April 2011

This scenario considers a more pessimistic assumpti on for the decline rate of oil production

3.8 percentage points annually compared with 1 p.p. in the baseline.

2000 05 10 15 20-8

-6

-4

-2

0

2

2000 05 10 15 20-5

-4

-3

-2

-1

0

1

2000 05 10 15 20-8

-6

-4

-2

0

2

2000 05 10 15 20-8

-6

-4

-2

0

2

2000 05 10 15 20-10

-8

-6

-4

-2

0

2Real GDP (percent difference)

World

Figure 3.12. Alternative Scenario 3: A Greater Eco nomic Role for Oil

Oil Exporter United States Emerging Asia

2000

Euro Area

Benchmark scenario Downside scenario

Real GDP(percent difference)

This scenario considers a higher contribution of oil to output: 25 percent for the tradables sector (compared with 5 percent in the baseline scenario) and 20 percent in the nontradables sector (compared with 2 percent in the baseline scenario).

Oil scarcity, growth, global imbalancesIMF , World Economic Outlook April 2011

This scenario considers a higher contribution of oi l to output growth.

25% compared to 5% in baseline scenario – consistent with Ayres-Warr model.

Summary

• Neoclassical growth theory does not describe the natural resource dependency of growth.

• We model economic growth with useful work as a factor of production. This explains past growth well.

• Economic growth need not be a constant percentage of GDP. It can be negative.

• Future sustainable growth in the face of peak oil depends on accelerating energy (exergy) efficiency gains and alternative supplies.

• Future efficiency gains may be inexpensive if existing double dividend possibilities are exploited.

A path forward – a neo-liberal solution

• These results provide the evidence to justify macro-economic (risk-management) policies:

• energy security through appropriate long-run renewable energy policy

• energy productivity through short-term energy efficiency drive• economic stimulus through ‘green’ jobs creation

• Large but avoidable inefficiencies exist corresponding to significant departures from the optimal equilibrium growth path that is commonly assumed.

• Eliminating inefficiencies can create “double divid ends”

Sources

Ayres, R.A. and Benjamin S. Warr, 2010. The Economic Growth Engine: How energy and work drive material prosperity, Edward Elgar.

Smil, V. 2007. Light behind the fall: Japan’s electricity consumption, the environment, and economic growth. Japan Focus, April 2.

Cleveland, C. J. 1991. Natural resource scarcity and economic growth revisited: Economic and biophysical perspectives. In Ecological Economics: The Science and Management of Sustainability. Edited by R. Costanza. New York: Columbia University Press.

Hall C.A.S. and John W. Day, 2009. Revisiting the Limits to Growth After Peak Oil. American Scientist, Volume 97, Number 3, Page: 230.

IMF, 2011. Oil Scarcity, Growth and Global Imbalances. World Economic Outlook 2011.