Authored by Gail Tverberg via Our Finite World blog,

There are a huge number of people doing energy modeling. In my opinion, nearly all of them are going astray in their modeling because they don’t understand how the economy really operates.

The modeling that comes closest to being correct is that which underlies the 1972 book, The Limits to Growth by Donella Meadows and others. This modeling was based on physical quantities of resources, with no financial system whatsoever. The base model, shown here, indicates that limits would be reached a few years later than we actually seem to be reaching them. The dotted black line in Figure 1 indicates where I saw the world economy to be in January 2019, based on the limits we already seemed to be reaching at that time.

Figure 1. Base scenario from 1972 Limits to Growth, printed using today’s graphics by Charles Hall and John Day in “Revisiting Limits to Growth After Peak Oil,” with dotted line added corresponding to where I saw the world economy to be in January 2019, based on how the economy was operating at that time.

The authors of The Limits to Growth have said that their model cannot be expected to be correct after limits hit (which is about now), so even this model is less than perfect. Thus, this model cannot be relied upon to show that population will continue to rise until after 2050.

Many readers are familiar with Energy Return on Energy Invested (EROEI) calculations. These are favorites of many people following the Peak Oil problem. A high ratio of Energy Returned to Energy Invested is considered favorable, while a low ratio is considered unfavorable. Energy sources with similar EROEIs are supposedly equivalent. Even these similarities can be misleading. They make intermittent wind and solar appear far more helpful than they really are.

Other modeling, such as that by oil companies, is equally wrong. Their modeling tends to make future fossil fuel supplies look far more available than they really are.

This is all related to a talk I plan to give to energy researchers later in February. So far, all that is pinned down is the Summary, which I reproduce here as Section [1], below.

[1] Summary: The economy is approaching near-term collapse, not peak oil. The result is quite different.

The way a person views the world economy makes a huge difference in how one models it. A big issue is how connected the various parts of the economy are. Early researchers assumed that oil was the key energy product; if it were possible to find suitable substitutes for oil, the danger of exhaustion of oil resources could be delayed almost indefinitely.

In fact, the operation of the world economy is controlled by the laws of physics. All parts are tightly linked. The problem of diminishing returns affects far more than oil supply; it affects coal, natural gas, mineral extraction in general, fresh water production and food production. Based on the work of Joseph Tainter, we also know that added complexity is also subject to diminishing returns.

When a person models how the system works, it becomes apparent that as increasing complexity is added to the system, the portion of the economic output that can be returned to non-elite workers as goods and services drops dramatically. This leads to rising wage disparity as increasing complexity is added to the economy. As the economy approaches limits, rising wage disparity indirectly leads to a tendency toward low prices for oil and other commodities because a growing number of non-elite workers are unable to afford homes, cars and even proper nutrition. 

A second effect of added complexity is growing use of long-lasting goods available through technology. Many of these long-lasting goods are only affordable with financial time-shifting devices such as loans or the sale of shares of stock. As non-elite workers become increasingly unable to afford the output of the economy, these time-shifting devices provide a way to raise demand (and thus prices) for commodities of all types, including oil. These time-shifting devices are subject to manipulation by central banks, within limits.

Standard calculations of Energy Returned on Energy Invested (EROEI) ignore the fact that added complexity tends to have a very detrimental impact on the economy because of the diminishing returns it produces. To correct for this, today’s EROEI calculations should only be used to compare energy systems with similar complexity. The least complex energy systems are based on burned biomass and power from animals. Fossil fuels represent a step upward in complexity, but they still can be stored until their use is required. Intermittent renewables are far ahead of fossil fuels in terms complexity: they require sophisticated systems of storage and distribution and therefore cannot be considered equivalent to oil or dispatchable electricity.

The lack of understanding of how the economy really works has led to the failure to understand several important points:

(i) Low oil prices rather than high are to be expected as the economy reaches limits,

(ii) Most fossil fuel reserves will be left in the ground because of low prices,

(iii) The economy is experiencing the historical phenomenon of collapse, rather than peak oil, and 

(iv) If the economy is not to collapse, we need energy sources providing a larger quantity of net energy per capita to offset diminishing returns.   

[2] The world’s energy problem, as commonly understood by researchers today

It is my observation that many researchers believe that we humans are in charge of what happens with future fossil fuel extraction, or with choosing to substitute intermittent renewables for fossil fuels. They generally do not see any problem with “running out” in the near future. If running out were imminent, the problem would likely be announced by spiking prices.

In the predominant view, the amount of future fossil fuels available depends upon the quantity of energy resources that can be extracted with available technology. Thus, a proper estimate of the resources that can be extracted is needed. Oil seems to be in shortest supply based on its reserve estimates and the vast benefits it provides to society. Thus, it is commonly believed that oil production will “peak” and begin to decline first, before coal and natural gas.

In this view, demand is something that we never need to worry about because energy, and especially oil, is a necessity. People will choose energy over other products because they will pay whatever is necessary to have adequate energy supplies. As a result, oil and other energy prices will rise almost endlessly, allowing much more to be extracted. These higher prices will also enable higher cost intermittent electricity to be substituted for today’s fossil fuels.

A huge amount of additional fossil fuels can be extracted, according to those who are primarily concerned about loss of biodiversity and climate change. Those who analyze EROEI tend to believe that falling EROEI will limit the quantity of future fossil fuels extracted to a smaller total extracted amount. Because of this, energy from additional sources, such as intermittent wind and solar, will be required to meet the total energy demand of society.

The focus of EROEI studies is on whether the EROEI of a given proposed substitution is, in some sense, high enough to add energy to the economy. The calculation of EROEI makes no distinction made between energy available only through highly complex systems and energy available from less complex systems.

EROEI researchers, or perhaps those who rely on the indications of EROEI researchers, seem to believe that the energy needs of economies are flexible within a very wide range. Thus, an economy can shrink its energy consumption without a particularly dire impact.

[3] The real story seems to be that the adverse outcome we are reaching is collapse, not peak oil. The economy is a self-organizing system powered by energy. This makes it behave in very unexpected ways.

[3a] The economy is tightly connected by the laws of physics.

Energy consumption (dissipation) is necessary for every aspect of the economy. People often understand that making goods and services requires energy dissipation. What they don’t realize is that almost all of today’s jobs require energy dissipation, as well. Without supplemental energy, humans could only gather wild fruits and vegetables and hunt using the simplest of tools. Or, they could attempt simple horticulture by using a stick to dig a place in the ground to plant a seed.

In physics terms, the economy is a dissipative structure, which is a self-organizing structure that grows over time. Other examples of dissipative structures include hurricanes, plants and animals of all types, ecosystems, and star systems. Without a supply of energy to dissipate (that is, food to eat, in the case of humans), these dissipative structures would collapse.

We know that the human body has many different systems, such as a cardiovascular system, digestive system and nervous system. The economy has many different systems, too, and is just as tightly connected. For example, the economy cannot get along without a transportation system any more than a human can get along without a cardiovascular system.

This self-organizing system acts without our direction, just as our brain or circulatory system acts without our direction. In fact, we have very little control over these systems.

The self-organizing economy allows common belief systems to arise that seem to be right but are really based on models with many incorrect assumptions. People desperately need and want a “happily ever after” solution. The strong need for a desirable outcome favors the selection of models that lead to the conclusion that if there is a problem, it is many years away. Conflicting political views seem to be based on different, equally wrong, models of how world leaders can solve the energy predicament that the world is facing.

The real story is that the world’s self-organizing economy will determine for us what is ahead, and there is virtually nothing we can do to change the result. Strangely enough, if we look at the long term pattern, there almost seems to be a guiding hand behind the result. According to Peter Ward and Donald Brownlee in Rare Earth, there have been a huge number of seeming coincidences that have allowed life on earth to take hold and flourish for four billion years. Perhaps this “luck” will continue.

[3b] As the economy reaches limits, commodities of many types reach diminishing returns simultaneously.

It is indeed true that the economy reaches diminishing returns in oil supply as it reaches limits. Oil is very valuable because it is energy dense and easily transported. The oil that can be extracted, refined, and delivered to needed markets using the least amount of resources (including human labor) tends to be extracted first. It is later that deeper wells are built that are farther from markets. Because of these issues, oil extraction does tend to reach diminishing returns, as more is extracted.

If this were the only aspect of the economy that was experiencing diminishing returns, then the models coming from a peak oil perspective would make sense. We could move away from oil, simply by transferring oil use to appropriately chosen substitutes.

It becomes clear when a person looks at the situation that commodities of all kinds reach diminishing returns. Fresh water reaches diminishing returns. We can add more by using desalination and pumping water to where it is required, but this approach is hugely expensive. As population and industrialization grows, the need for fresh water grows, making diminishing returns for fresh water a real issue.

Minerals of all kinds reach diminishing returns, including uranium, lithium, copper and phosphate rock (used for fertilizer). The reason this occurs is because we tend to extract these minerals faster than they are replaced by the weathering of rocks, including bedrock. In fact, useable topsoil tends to reach diminishing returns because of erosion. Also, with increasing population, the amount of food required keeps increasing, putting further pressure on farmland and making it harder to retain an acceptable level of topsoil.

[3c] Increased complexity leads to diminishing returns as well.

In his book, The Collapse of Complex Societies, Joseph Tainter points out that complexity reaches diminishing returns, just as commodities do.

As an example, it is easy to see that added spending on healthcare reaches diminishing returns. The discovery of antibiotics clearly had a huge impact on healthcare, at relatively little cost. Now, a recent article is entitled, The hunt for antibiotics grows harder as resistance builds. The dollar payback on other drugs tends to fall as well, as solutions to the most common diseases are found, and researchers must turn their attention to diseases affecting only, perhaps, 500 people globally.

Similarly, spending on advanced education reaches diminishing returns. Continuing the medical example above, educating an increasing number of researchers, all looking for new antibiotics, may eventually lead to success in discovering more antibiotics. But the payback with respect to the education of these researchers will not be nearly as great as the payback for educating the early researchers who found the first antibiotics.

[3d] Wages do not rise sufficiently so that all of the higher costs associated with the many types of diminishing returns can be recouped simultaneously.

The health care system (at least in the United States) tends to let its higher costs flow through to consumers. We can see this by looking at how much higher the Medical Care Consumer Price Index (CPI) rises compared to the All Items CPI in Figure 2.

Figure 2. Consumer price index for Medical Care versus for All Items, in chart made by the Federal Reserve of St. Louis.

The high (and rapidly rising) cost of advanced education is another cost that is being passed on to consumers–the students and their parents. In this case, loans are used to make the high cost look less problematic.

Of course, if consumers are burdened with higher medical and educational costs, it makes it difficult to afford the higher cost of energy products, as well. With these higher costs, young people tend to live with their parents longer, saving on the energy products needed to have their own homes and vehicles. Needless to say, the lower net income for many people, after health care costs and student loan repayments are deducted, acts to reduce the demand for oil and energy products, and thus contributes to the problem of continued low oil prices.

[3e] Added complexity tends to increase wage disparities. The reduced spending by lower income workers tends to hold down fossil fuel prices, similar to the impact identified in Section [3d].

As the economy becomes more complex, companies tend to become larger and more hierarchical. Elite workers (ones with more training or with more supervisory responsibility) earn more than non-elite workers. Globalization adds to this effect, as workers in high wage countries increasingly compete with workers in lower wage countries. Even computer programmers can encounter this difficulty, as programming is increasingly moved to China and India.

Figure 3. Figure by Pew Research Center in Trends in Income and Wealth Inequality, published January 9, 2020. https://www.pewsocialtrends.org/2020/01/09/trends-in-income-and-wealth-inequality/

Individuals with low incomes spend a disproportionately large share of their incomes on commodities because everyone needs to eat approximately 2,000 calories of food per day. In addition, everyone needs some kind of shelter, clothing and basic transportation. All of these types of consumption are commodity intensive. People with very high incomes tend to buy disproportionately more goods and services that are not very resource intensive, such as education for their children at elite universities. They may also use part of their income to buy shares of stock, hoping their value will rise.

With a shift in the distribution of incomes toward those with high earnings, the demand for commodities of all types tends to stagnate or even fall. Fewer people are able to buy new cars, and fewer people can afford vacations involving travel. Thus, as more complexity is added, there tends to be downward pressure on the price of oil and other energy products.

[4] Oil prices have been falling behind those needed by oil producers since 2012.

Figure 4. Figure created by Gail Tverberg using EIA average monthly Brent oil price data, adjusted for inflation using the CPI Index for All Items for Urban Consumers.

Back in February 2014, Steven Kopits gave a presentation at Columbia University explaining the state of the oil industry. I wrote a post describing this presentation called, Beginning of the End? Oil Companies Cut Back on Spending. Oil companies were reporting that prices had been too low for them to make an adequate profit for reinvestment, back as early as 2012. In inflation-adjusted terms, this was when oil prices were about $120 per barrel.

Even Middle Eastern oil exporting countries need surprisingly high oil prices because their economies depend on the profits of oil companies to provide the vast majority of their tax revenue. If oil prices are too low, adequate taxes cannot be collected. Without funds for jobs programs and food subsidies, there are likely to be uprisings by unhappy citizens who cannot maintain an adequate standard of living.

Looking at Figure 4, we see that there has been very little time that Brent oil prices have been above $120 per barrel. Even with all of the recent central bank stimulus and deficit spending by economies around the world, Brent oil prices remain below $60 per barrel.

[5] Interest rates and the amount of debt make a huge difference in oil prices, too.

Based on Figure 4, oil prices are highly irregular. Much of this irregularity seems to be associated with interest rate and debt level changes. In fact, in July 2008, what I would call the debt bubble associated with the subprime housing and credit cards collapsed, bringing oil prices down from their peak abruptly. In late 2008, Quantitative Easing (QE), (aimed at bringing interest rates down) was added just prior to an upturn on prices in 2009 and 2010. Prices fell again, when the United States discontinued QE in late 2014.

If we think about it, increased debt makes purchases such as cars, homes and new factories more affordable. In fact, the lower the interest rate, the more affordable these items become. The number of purchases of any of these items can be expected to rise with more debt and lower interest rates. Thus, we would expect oil prices to rise as debt is added and fall as it is taken away. Now, there are many questions: Why haven’t oil prices risen more, with all of the stimulus that has been added? Are we reaching the limits of stimulus? Are interest rates as low as they can go, and the amount of debt outstanding as high as it can go?

[6] The growing complexity of the economy is contributing to the huge amount of debt outstanding.

In a very complex economy, a huge number of durable goods and services are produced. Examples of durable goods would include machines used in factories and pipelines of all kinds. Durable goods would also include vehicles of all types, including both vehicles used for businesses and vehicles used by consumers for their own benefit. As broadly defined here, durable goods would include buildings of all types, including factories, schools, offices and homes. It would also include wind turbines and solar panels.

There would also be durable services produced. For example, a college degree would have lasting benefit, it is hoped. A computer program would have value after it is completed. Thus, a consulting service is able to sell its programs to prospective buyers.

Somehow, there is a need to pay for all of these durable goods. We can see this most easily for the consumer. A loan that allows durable goods to be paid for over their expected life will make these goods more affordable.

Similarly, a manufacturer needs to pay the many workers making all of the durable goods. Their labor is adding value to the finished products, but this value will not be realized until the finished products are put into operation.

Other financing approaches can also be used, including the sale of bonds or shares of stock. The underlying intent is to provide financial time-shifting services. Interest rates associated with these financial time-shifting services are now being manipulated downward by central banks to make these services more affordable. This is part of what keeps stock prices high and commodity prices from falling lower than their current levels.

These loans, bonds and shares of stock are providing a promise of future value. This value will exist only if there are enough fossil fuels and other resources to create physical goods and services to fulfill these promises. Central banks can print money, but they cannot print actual goods and services. If I am right about collapse being ahead, the whole debt system seems certain to collapse. Shares of stock seem certain to lose their value. This is concerning. The end point of all of the added complexity seems to be financial collapse, unless the system can truly add the promised goods and services.

[7] Intermittent electricity fits very poorly into just-in-time supply lines.

A complex economy requires long supply lines. Usually, these supply lines are operated on a just-in-time basis. If one part of a supply line encounters problems, then manufacturing needs to stop. For example, automobile manufacturers in many parts of the world are finding that they need to suspend production because it is impossible to source the necessary semiconductor chips. If electricity is temporarily unavailable, this is another way of disrupting the supply chain.

The standard way to work around temporary breaks in supply chains is to build greater inventory, but this is expensive. Additional inventory needs to be stored and watched over. It likely needs financing, as well.

[8] The world economy today seems to be near collapse.

The self-organizing economy is now pushing the economy in many strange ways that indirectly lead to less energy consumption and eventually collapse. Even prior to COVID-19, the world economy appeared to be reaching growth limits, as indicated in Figure 1, which was published in January 2019. For example, recycling of many renewables was no longer profitable at lower oil prices after 2014. This led China to discontinue most of its recycling efforts, effective January 1, 2018, even though this change resulted in the loss of jobs. China’s car sales fell in 2018, 2019, and 2020, a strange pattern for a supposedly rapidly growing country.

The response of world leaders to COVID-19 has pushed the world economy further in the direction of contraction. Businesses that were already weak are the ones having the most difficulty in being able to operate profitably.

Furthermore, debt problems are growing around the world. For example, it is unclear whether the world will require as many shopping malls or office buildings in the future. A person would logically expect the value of the unneeded buildings to drop, reducing the value of many of these properties below their outstanding debt level.

When these issues are combined, it looks likely that the world economy may not be far from collapse, which is one of my contentions from Section [1]. It also looks like my other contentions from Section [1] are true:

(i) Low oil prices rather than high are to be expected as the economy reaches limits,

(ii) Most fossil fuel reserves will be left in the ground because of low prices, and

(iv) If the economy is not to collapse, we need energy sources providing a larger quantity of net energy per capita to offset diminishing returns. 

Regarding (iv), the available energy supply from wind and solar (net or otherwise) is tiny relative to the total energy required to operate the world economy. This issue, alone, would disqualify a Great Reset using wind and solar from truly being a solution for today’s problems. Instead, plans for a Great Reset tend to act as a temporary cover-up for collapse.