Energy Leveraging: An Explanation for China's Success and the World's Unemployment
If an employer wants to maximize profits, it will want to leverage its use of high-priced energy sources. From an employer’s point of view, there are basically three kinds of energy, from most to least expensive:
- Human energy
- Petroleum energy
- Everything else
If an employer wants to keep its costs low, it needs to minimize its use of expensive energy sources. The primary way it does this is by leveraging expensive energy sources with cheaper energy sources that help keep overall energy costs in line with what competitors (including overseas competitors) are paying. Thus, employers will want to use as little human and petroleum energy as possible, instead using cheap energy to substitute.
Human energy is the most expensive form of energy. It is very expensive because an employer needs to pay the employee enough to live on. This amount includes the cost of energy to fulfill the human’s needs, plus enough extra to cover taxes to cover the cost of energy for those who for some reason cannot work, plus taxes for maintenance of public infrastructure. An employer can keep his cost of human energy low by
- Substituting mechanical or electrical energy, which is usually cheaper.
- Hiring humans whose wage costs are low. Usually this means is humans who use little energy in their personal lives, and what energy is used, is cheap energy.
- Hiring in areas where taxes are low, usually reflecting a lack of benefits to employees.
Petroleum is a second form of energy. It is the second most expensive form of energy, after human energy. Its supply on a world basis is constrained (Figure 1, below). Crude oil supply is only growing at a rate of about 0.3% per year on a worldwide basis. While the growth in extraction in the US temporarily higher than the world average, it is not of sufficient in quantity to offset big declines elsewhere, such as in Europe.
America’s recent oil-drilling success relates primarily to shale oil (sometimes called tight oil). There is no guarantee that America’s success with shale oil will continue. The Bakken is today’s biggest source of shale oil, with some claims that Bakken will be able to provide over 1 million barrels a day of oil for many years. It seems strange then that recently ONEOK Partners was not able to find subscribers for a 200,000 barrel a day crude pipeline for Bakken oil. The number of drilling rigs active in North Dakota is now down about 13% from its high in June, according to Baker Hughes–something else a person wouldn’t expect in an area where future production is expect to grow rapidly.
Because world oil supply is growing less rapidly than either population or GDP, businesses and consumers find that they need to use less of it, each year. In addition, the rising cost of oil is a problem. This occurs because we extracted the cheapest to extract oil first, and now the “easy to extract” oil is gone. We see many news items supporting the need for higher oil prices. For example, Brazil’s offshore oil is supposed to be one of the sources of rising future oil production, but reports now say:
The company [Petrobas] hopes to sell $14.8 billion of assets this year as soaring costs, falling production and rising fuel imports have crimped Petrobras’s ability to pay for a $237 billion five-year expansion plan, the world’s largest corporate investment program, Reuters reported.
As another example, Credit Suisse estimates that BP needs a Brent price of $121 barrel in 2013 in order to have sufficient cash flow to cover both investment expenses and dividends.
Oil has many very specific uses, and when used in these ways, substitution is very difficult. Oil is used to power the vast majority of automobiles, trucks, and ships in operation today, and all of the world’s airplanes. It is used for pumping water and generating electricity in areas where electricity is unavailable, either temporarily or long-term. It is used as the feedstock for pharmaceuticals, herbicides, and pesticides. It is used for lubricating machinery of all types.
There are literally trillions of dollars of built infrastructure that depend on oil, supporting all of the above uses, plus others. We don’t have a non-oil replacement for most of our oil-dependent infrastructure. Even if we did, we couldn’t afford a full replacement until current infrastructure wears out. Because of the cost issue, a transition away from oil will likely require very long time, up to 50 years.
Other Kinds of Energy, Besides Human and Petroleum
There are many kinds of energy besides human and petroleum. Biomass has been a source of energy for over 1 million years. Animal energy, such as dogs for hunting or animals for riding or plowing is another source of energy. Other types of energy include coal, natural gas, nuclear, wind power, water power, heat from the sun, solar PV, geothermal, peat moss, and man-made substitutes such as ethanol.
From the point of view of a business wanting to produce some type of goods or service, the most important characteristic of the energy product used is cheap relative to the services performed, assuming the business wants to be competitive with other businesses. At this point, coal seems to be the winner in the “cheap” category, especially if a country has local supply and is willing to overlook the need for good scrubbers.
In the US recently, natural gas has been selling very cheaply as well. The low price of natural gas seems to be a temporary, local situation, however, because very little of the natural gas can actually be produced for the price it is currently being sold for. Many shale gas companies have had to write off reserves. Either the sales price of natural gas will need to increase significantly from the current U. S. level, or many players will have to drop out. If the price rises by several dollars per Mcf, we can expect considerable electrical-generation switching from natural gas back to coal.
Some companies may prefer higher-priced fuels for environmental reasons, but unless there is a tax on imports of goods and services produced with coal, goods produced with higher priced fuels are at a competitive disadvantage. The competitive disadvantage runs to labor costs as well, since using cheap coal (especially without proper environmental protection), helps keep the cost of living down through cheap prices on home heating and local transport.
Looking at Energy Services from a Citizen’s Point of View
The naive view would be that humans don’t need external energy. In order for this belief to be true, we would need to live like other animals. Humans could live without external energy if we could live without clothing or shelter, and if we could eat all of our food raw, without chewing for literally half the day.
Humans discovered how to control fire over 1 million years ago. We have now adapted to the availability of external energy sources in many ways. As we learned to cook part of our food, the size of our teeth, jaws, and digestive system shrank, leaving more energy for brain development. With better brains and clothing (made using embedded energy) we were able to move to less hospitable areas of the world, increasing our total numbers.
The amount of external energy each person needs today varies. In particularly hospitable areas, a few people can live as hunter gatherers, burning twigs or dung for fuel. But in general, the vast majority of people will need some additional external energy. They will also need some means of either buying food (which is a form of energy) or growing it on a plot of land that has been provided. They will also need other essentials, including clean water and protection from the elements. If humans do not have a job in today’s economy, they will need financial support to purchase the goods and services they require to live.
The more cheaply the necessary services can be provided to citizens (generally meaning the lower the energy costs), the lower the salary employees need to earn to provide a comfortable way of life. An employee who lives in a tropical area where he can walk to work will probably not need a very high salary to be comfortable; an employee in a very cold area may need heat for a home, besides needing clothing and a warm vehicle. If the employee uses expensive oil products for his vehicle, he will require a higher salary than if similar services are provided with, say, an electric bicycle, or walking.
How China Beats the United States at Energy Leveraging
If we look at China’s energy leveraging, we see that it uses very little oil and much coal. China joined the World Trade Organization in December 2001, and ramped up its coal usage shortly thereafter.
The percentage of people in the US with jobs started decreasing at about the same time that China ramped up its coal usage.
While we can’t prove there is a connection, we know that several other Asian countries, including India and Bangladesh, also ramped up international trade about the same time. The combination of lower salaries in Asian countries and low energy costs made Chinese costs of production much cheaper than that of developed countries. The cost of services, such as computer technical support in India, also became very inexpensive, and with greater trade, more available to companies seeking to reduce coasts.
Toward the beginning of the period shown on Figure 3 (above), there were more US farmers, and more women staying at home with children (on the farm and otherwise) than there are today As the birthrate in the US dropped in the 1960s and 1970s, more women joined the work force. Many households were able to add a second wage-earner. So prior to 2000, there was a long-term rise in the percentage of the US population with jobs–a trend then many economists seem to have overlooked in analyzing long-term economic growth. Now the trend has reversed, during a time when the US is having increased financial problems.
Higher oil prices are also tied to the reduction in the proportion of US citizens with jobs, because high oil prices tend to cause a reduction in discretionary expenditures, and a loss of jobs in discretionary sectors. The combination leads to government financial problems, as I explained in my recent post about the Fiscal Cliff. Countries like China and India which leverage their oil use to a greater extent with more coal use are less affected by a rise in oil prices. This is another reason why jobs are moving to China and India, and away from the US.
In China, demographics seem to be keeping the cost of maintaining a household low. At this point, Chinese households have relatively few children and elderly to take care of. In some instances, multiple generations live in one household, further lowering required per-person income needed to maintain a household.
Lack of pension programs in China can also be a boon for Chinese businesses because without such a program, there is likely to be increased private savings and thus more funds for investment. This is especially the case with one-child families, because citizens realize that with small families, they cannot depend on offspring for support, leading to a greater need to save for retirement.
The Path Ahead - Fewer and Fewer Fossil Fuel Supported Jobs
What is concerning is where the current path leads us. With the miracles of computers and mechanization in general, fewer and fewer employes are needed to produce goods and services. The employees that companies choose to hire often live in parts of the world where labor is cheap because the standard of living is low. With expensive petroleum expected to stretch farther and farther, more potential users (who might start a new company or sell a new service) are priced out of the market.
In a competitive world economy, there is little role for people who need high wages because they live petroleum dependent lifestyles. The major exceptions are (a) a few management employees and (b) employees in sheltered areas of the economy, such as health care and higher education. It is not clear that these sheltered areas can continue very long because it is increasingly difficult for other workers to afford their high cost.
It is possible to leverage human labor using non-fossil fuel energy, but generally the leveraging isn’t very good. For example, a person can raise a horse, if he or she has an extra ten acres to graze the horse on, and reasonable rainfall. The horse can then be used for transportation and perhaps pulling a plow. A windmill made from local materials can perhaps be used to pump water for the horse, and a water wheel can be used to grind grain.
In 1800, with little fossil fuel use, the world supported about 1 billion people. It is not clear how many people the world could support now if fossil fuel use were discontinued. Fossil fuels are needed to make concrete and to make metals in the quantity used today. Because of this, without fossil fuels we would likely lose our ability to make new “renewable” energy products, such as hydroelectric dams and wind turbines, as well as supporting products such as new electrical transmission line.
Should There Be More Taxes on Businesses?
There are a couple of kinds of taxes that are needed in our current situation. One type of tax is to pay for transfer payments to all of the unemployed individuals, as our current system requires fewer workers. These taxes are now being paid mostly by employees, either through federal taxes or through local taxes. If the cause of this unemployment is actions by employers, perhaps these taxes should be paid by employers. The ones particularly at fault are those who choose to hire workers from lower wage areas and those who subcontract with companies from low-wage areas.
Another kind of tax that is needed is a tax to support the increasingly high cost of maintaining infrastructure, because upkeep of infrastructure is usually oil-dependent. (I suppose this could be called an “entropy tax.”) Even if individuals are priced out of having their own vehicles, businesses are still likely to expect to use roads for shipment. These roads need to be maintained, because freezing and thawing will cause the roads to deteriorate, even if few use them. Similarly, hurricanes and windstorms will bring down power lines, regardless of how little electricity is used. We will also need to maintain oil and natural gas pipelines and water and sewer pipelines, if we expect to use these services at all.
At the present time, the cost of maintaining this infrastructure is either paid by the companies selling the product or by taxes on individual citizens. As fewer people are employed, it will be difficult for US utilities to continue to collect as much revenue from individual subscribers. If businesses want to continue to receive these services, perhaps a change in funding is needed, with businesses bearing a disproportionate share of these costs. Of course, this will further increase costs in countries with lots of built-infrastructure, compared with low-income countries, adding to the competitive disadvantage of developed countries.
Does it really make sense to continue on the path to increasing globalization? We will need to quit a some point, either because of a choice to move away from fossil fuels, or because oil supply becomes even more constrained, and the ensuing financial problems cause us to cut back.
Policymakers and economists assume that the only path forward is increased globalization, and have not really examined any other path. In a world with limited resources, the path away from globalization is more sustainable one. The big concern is how much population it can support.
A Note on The Role of Biofuels
Biofuels can act as a partial substitute for oil, in some cases, and thus extend supply. If their cost is no higher than that of oil, they can make it possible to produce more goods and services, especially if the use of biofuels leads to more petroleum availability in the industrial/commercial sector.
Adding biofuels to the personal sector is of questionable benefit. Increasing biofuel production leads to burning coal and gas more quickly, since it adds to oil supply, rather than substituting for it. Increasing personal biofuel use tends to keep citizens’ use of oil products higher than they otherwise would be, leading to a need for higher wages, and thus a less competitive position in the world economy.
I think anyone who reads this far will feel like screaming, “This is not a system that works!” It isn’t, and it is frustrating. But it is hard to see a way to change the system in a way that makes the system work better for all 7 billion humans alive today. Perhaps the best we can do is work toward a less globalized system, even if not everyone can be helped by it.
Gail Tverberg is a casualty actuary whose prior work involved forecasting and modeling in the insurance industry. Starting in 2005-2006, she decided to apply her skills to the question of how oil and other limits would affect the world. Besides writing on her own blog, Our Finite World, she is also an editor at The Oil Drum.
Other Posts by Gail Tverberg
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