What role does energy, and specifically oil play in the economy? What impact on growth can we expect a decline in oil production to have? When is the decline in production likely to happen? What can we do to mitigate the worst impacts?

1. Dr Benjamin Warr, Senior Research Fellow
INSEAD Social Innovation Centre Sustainability Group
Alumni Reunion Energy Network Presentation
22nd October 2011
Energy and Wealth Creation
benjamin.warr@gmail.com
https://sites.google.com/site/rexsgate/

2. 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

3. 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)
Purchases
Production of Consumption of
Goods and Goods and
Services Wages, Rents Services
Invested
(Energy Generating)
Capital

4. US GDP actual vs. modeled using a 3-
factor Cobb-Douglas
GDP Index (1900=1)
25
20
US GDP
15
10
SOLOW RESIDUAL
(TFP)
5
Cobb-Douglas
1900 1920 1940 year 1960 1980 2000

5. The Solow residual, US 1900-2010
Index (1900=1)
5.5
TFP (~1.6% per annum)
5
Unexplained Solow residual
4.5
4
3.5
3
2.5
2
1.5
1
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
year

6. 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.

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

8. Our approach
SUPPLY USES EFFICIENCY
45000 60% 40%
Coal Heat (Hight Temperature)
Electric Power
40000 Heat (Low Temperature)
Generation &
Crude Oil and Petroleum 50% Mechanical Drive 35% Distribution
Products
35000 Electricity
Natural Gas
Light
30000 40% Muscle Work 30%
Non-conventional
25000 Biomass (Food and Feed)
30% High Temperature
25% Industrial Heat
20000
efficiency
15000 20%
20%
10000
Medium Temperature
10% Industrial Heat
15%
5000
0 0%
10% Mechanical Work
1900 1925 1950 1975 2000 1900 1925 1950 1975 2000
5%
45000000 Low Temperature Space Heating
40000000 Heat (Hight Temperature) 0%
Heat (Mid Temperature) 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000
Heat (Low Temperature) year
35000000 Mechanical Drive
Electricity
30000000 Light
Muscle Work
25000000
USEFUL
20000000
15000000 WORK
10000000 Wastes
5000000
0
1900 1925 1950 1975 2000

9. Exergy (or maximum available work)
The exergy flow from the Exergy Quality Index
sun, and the exergy stocks 100
on earth create the resource 90
base for human societies on 80
earth. 70
60
50
40
30
20
10
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Exergy reflects energy quality in terms of distinguishability and availability

10. Efficiency
Each transformation involves a loss of available energy (exergy)

11. 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.

12. Exergy input share by source
(US 1900-2000)
100%
90% Biomass (Food and
Feed)
80%
Non-conventional
70%
Natural Gas
60%
Crude Oil and
50% Petroleum Products
40% Coal
30%
20%
10%
0%
1900 1925 1950 1975 2000
Year Source: Ayres & Warr, 2009

13. Useful work by type
(US 1900-2000)
100%
90%
Muscle Work
80%
Non-Fuel
70%
Light
60%
50% Electricity
40% Mechanical Drive
30%
Heat (Low
Temperature)
20%
Heat (Hight
10% Temperature)
0%
1900 1925 1950 1975 2000
Year Source: Ayres & Warr, 2009

14. Efficiency
Evidence of stagnation
•Pollution controls
25% •Technological barriers
High Population Density •Ageing capital stock
Industrialised •Wealth effects
20% Socio-ecological Regimes
Japan
Resource limited
efficiency (%)
15%
US
10%
UK
Low Population Density
5% Industrialised New World
Socio-ecological Regime
Resource abundant
0%
1905 1925 1945 1965 1985 2005
year

15. Empirical and Estimated GDP
US 1900-2000
30
Empirical GDP
25
Estimated GDP
20
Using a LINEX production function with
15
useful work (exergy*efficiency) as a factor
of production.
10
Corresponds to Cobb-Douglas with Capital
share 0.57, Labour share 0.01and Useful
5
Work share 0.41.
0 Source: Ayres and Warr, 2009
1900 1925 1950 1975 2000

16. Our growth dynamic

17. 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)

18. Oil Supply
100 50
Annual Discovery & Production
80 40
Annual Production
(arbitrary units)
(arbitrary units)
Discovery
60 30
40 20
Production
Yet-to-Find
20 10
Produced Reserves
0 0
-4 -1 2 5 8 11 14 17 20 23 26 29 32 35 38 41 1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41
Years Years
From discovery to production Conv. oil peak is counter-
takes~ 5 years, starting with intuitive. It occurs when
the big and easy fields. production is rising, reserves
are large, new fields are being
discovered, & technology is
increasing recovery factors.
Source: Roger Bentley, University of Reading

19. Peak oil - fluctuating plateau - decline
consumption exceeds discoveries since circa. 1980

20. Net Energy and EROEI

21. Impacts on oil price
Long-run costs increasing due to low elasticity of substitution and
price

22. What effects efforts to increase
energy productivity?
For Business-as-Usual,
(1.2% decay rate) – by 2025
Historical rate of decline in GDP doubles and exergy inputs
30 exergy intensity of GDP is 120 increase by half.
1.2% per annum 1.2% per annum
r/gdp 1.3% per annum
25 100 1.4% per annum
e/gdp
1.5% per annum
20 empirical
80
GDP (1900=1)
With a 1.4% decay rate output
doubles ~10 years later, but
index
15 60
requires ~50EJ less than 2010
levels
10 40
5 20
0 0
1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 1950 1975 2000 2025 2050
year year

23. Possible trajectories for efficiency
improvements
0.35 70
0.3 low 60 low
mid mid
high high
0.25 50
technical efficiency (f)
empirical empirical
GDP (1900=1)
40
Scenario GDP growth (2030)
0.2
Low 0.4% yr-1 -2.0%
0.15 30 High 1.2% yr-1 2.2%
Efficiency Scenarios
0.1 Low 0.4% yr-1 20
Mid 0.72% yr-1.
0.05 10
High 1.2% yr-1
0 0
1950 1975 2000 2025 2050 1950 1975 2000 2025 2050
year year
For efficiency growth smaller than 1% p.a. we observe a future decline
in GDP. The historical rate of improvement is 1.1% per annum.

24. Oil scarcity, growth, global imbalances
IMF , World Economic Outlook April 2011
Figure 3.10. Alternative Scenario 1: Greater Substitution away from Oil
This scenario considers a higher value forof demand (0.29, compared withdemand baseline scenario), consistent with greater sub
This scenario considers a higher value for the price elasticity the price elasticity of 0.08 in the (0.29, compared with 0.08
from oil. in the baseline). This is consistent with greater substitution away from oil.
Benchmark scenario Upside scenario
World Oil Exporter United States Emerging Asia Euro Area
Real GDP Real GDP (percent difference)
(percent difference)
1 1 1 2 1
0 0 0 0 0
-1
-1 -1 -2 -1
-2
-2 -2 -4 -2
-3
-3 -3 -4 -6 -3
-4 -4 -5 -8 -4
2000 05 10 15 20 2000 05 10 15 20 2000 05 10 15 20 2000 05 10 15 20 2000 05 10 15 20 2000

25. Oil scarcity, growth, global imbalances
IMF , World Economic Outlook April 2011
Figure 3.11. Alternative Scenario 2: Greater Decline in Oil Production
This scenario considers the implicationsa more pessimistic assumption for the decline rate of oil production (3.8of oil production
This scenario considers of a more pessimistic assumption for the decline rate percentage points annually, compare
percentage point in the baseline scenario).
3.8 percentage points annually compared with 1 p.p. in the baseline.
Benchmark scenario Downside scenario
World Oil Exporter United States Emerging Asia Euro Area
Real GDP
Real GDP (percent difference)
(percent difference)
5 5 5 5 5
0
0 0 0 0
-5
-5 -5 -5 -5
-10
-10 -10 -10 -10
-15
-15 -15 -15 -20 -15
2000 05 10 15 20 2000 05 10 15 20 2000 05 10 15 20 2000 05 10 15 20 2000 05 10 15 20 2000

26. Oil scarcity, growth, global imbalances
IMF , World Economic Outlook April 2011
Figure 3.12. Alternative Scenario 3: A Greater Economic Role for Oil
This scenario considers a higher contribution of oil to output: 25 percent for the tradables sectorto output growth. in the baseline scenario) and
This scenario considers a higher contribution of oil (compared with 5 percent
nontradables sector (compared with 2 percent in the baseline scenario).
25% compared to 5% in baseline scenario – consistent with Ayres-Warr model.
Benchmark scenario Downside scenario
World Oil Exporter United States Emerging Asia Euro Area
Real GDP Real GDP (percent difference)
(percent difference)
2 1 2 2 2
0 0 0 0 0
-1 -2
-2 -2 -2
-2 -4
-4 -4 -4
-3 -6
-6 -4 -6 -8 -6
-8 -5 -8 -10 -8
2000 05 10 15 20 2000 05 10 15 20 2000 05 10 15 20 2000 05 10 15 20 2000 05 10 15 20 2000

27. 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.

28. 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 dividends”

30. 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.