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A recent article by Gail Tvreberg from a think tank on ‘Our Future World’ and reproduced in ‘Oil Voice’ magazine of February 4, 2014, highlights that solutions to our energy dilemma will not work if we do not understand that the problem is quite different from what it really is and developing into a long-term problem, which in fact has come to our doorstep.

The point that most energy analysts miss is that our energy problem behaves very much like a near-term financial problem that will result, is bound to cause huge job losses and our mitigation strategies need to be considered in this context. Strategies aimed at relieving energy shortages with high-priced fuels and high-tech equipment will invariably be short-lived solutions.




Our energy dilemma
Our number one energy problem is the rapidly rising need for investment capital to maintain a fixed level of resource extraction. Such investment capital will cover oil, coal and metals.

As far as the easy to extract oil, gas and coal, it is noted that the need for investment escalates rapidly. According to Mark Lewis, writing in the Financial Times, “upstream capital expenditure” for oil and gas amounted to nearly US $ 700 billion in 2012, as compared to US $ 350 billion in 2005, both in 2012 dollars. This is equal to an inflation adjusted annual increase of 10 percent per year for the seven-year period.

In theory, we expect extraction costs to rise as we approach limits of the amounts to be extracted thus giving rise to the steep rise in oil prices in recent years. However, we were able to find a solution to this problem in the 1970s, by adding more capital to oil extraction, substituting other energy products for oil and increasing efficiency.
But in the present scenario, the options for a solution are few since high-yielding reservoirs for oil and gas are exhausted and we are reaching financial limits. To prove this statement, oil prices rose from US $ 30 a barrel in 1900 dipping to less than US $ 20 on the average from 1912 to 1972 and then with the oil crisis rose to a peak of US $ 100 in 1978 dropping again to US $ 40 in 1990 and again significantly dipping to US $ 20 in 1996 and then with a steep rise to US $ 100 in 2002 but falling to about US $ 65 in 2002 and again climbing to US $ 148 in 2008.

The period 1990 to 1996 showed a significant drop in oil prices that tempted Ceylon Petroleum Corporation to the ‘hedging’ exercise which was a disaster as there was a sharp rise to US $ 148 in 2008.

The situation was exacerbated for the rapidly rising need for investment capital in other industries as well as in fossil fuels. It is noted that metals extraction followed the same pattern after extraction of high-grade ores from most accessible locations first. It is possible to extract more metals if focus is on low-grade ores, which will result in unwanted waste products using more resources including energy resources.

With the drop of ore concentration to 0.2 to 0.195, the increase in waste products was only 3 percent. However, when we move from a concentration of 0.010 to 0.005, the amount of waste products almost doubles and the total units of waste products to produce 100 units of metal will be 20,000.

When we study the inflation adjusted World Bank Base Metal Index, it was falling for a long period between 1960 and 1990 as productivity improvements were greater than falling ore quality but since 2002, the index is higher, which indicates reaching limits like peak oil.




Amount of oil extracted
It has been observed that the average amount of oil extracted if not increasing every year, there will be a conflict between the availability of oil for growing investment to maintain the status quo and for new investment to promote growth.

It was stated earlier that there is a need for increased capital investment to maintain the status quo needed in the form of oil. Further, another use of oil is to grow the economy – adding factories or planting more crops or transporting more goods. However, in theory there is a possibility of finding substitutes to oil at any point in time but  it is quite limited as most transport options require oil as well as for  farming, construction and road equipment as well as diesel powered irrigation pumps. The reason for partly slow growth of the world economy is due to lack of short-term substitutes to oil and the need for oil for reinvestment.




Countries with high costs of energy
In   countries like Sri Lanka the high percentage of oil in its energy mix has a direct impact on the slower economic growth and goods and services become less affordable and more oil is to be used. Further, it is striking when we look at countries examined by the proportion of oil in their energy mix the high oil use giving rise to high cost of energy is associated with slow economic growth. As an example Portugal, Italy, Ireland, Greece and Spain have comparatively less economic growth than the other countries of the European Union (EU) and show the same pattern of high oil consumption as a total percentage of its energy production in 2004.

In comparison, India and China have shown economic growth rates from 8 to 10 percent, respectively from 2005 to 2011 as the consumption of oil from 2004 was 30 and 20 percent of the total energy use. However, average oil consumption growth from 2004-2011 were 4.2 percent to 5.2 percent when most of the developed countries recorded negative growth in their oil consumption averaging from 0 to -3 percent.

Globalization also acted to accelerate to shift toward countries that used little oil and tended to use much more coal in their energy mix which is a cheaper fuel.



Slow-growth countries’ financial systems
It is learnt that in slow growth countries with high energy costs payment of debt becomes harder due to difficulties in repayment of interest. Governments in order to alleviate the cost of living of its citizens resort to introduce fuel subsidies due to the reduction in wages finally resulting in deficits.

Further, the governments have also attempted to fix their financial problems by lowering interest rates and by introducing quantities easing, which help to keep borrowing without having a market of ready buyers and also keeping prices of stocks and real estate, invariably helping the citizens to feel richer.

Further, the low wages due to slow economic growth, the citizens of the country will cut back on discretionary goods, as prices of oil rise because their costs of commuting and for food rises. These cut backs will result in layoffs in discretionary sectors such as hotels and centres for recreation facilities. Further, since the exported goods will be high in price due to high oil prices, buyers from other countries will tend to cut back, further leading to layoffs and low wage growth.

Further, when oil producers find that oil prices do not raise enough giving rise to increase in oil extraction costs, it becomes difficult for the demand for oil to remain high because wages are not increasing.



Globalization’s effects on fossil fuel use
Globalization added approximately four billion consumers to the world market place in the 1997 to 2001 period. These people previously had lived traditional lifestyles. Once they became aware of the goods that people in the rich counties have, they wanted to join in, buying motor bikes, cars, televisions, phones and other goods.
They would also like to eat meat more often. Population in these countries continues to grow adding to demand for goods of all kinds. These goods can only be made using fossil fuels or by technologies that are enabled by fossil fuels such as today’s hydroelectric, nuclear, wind and solar PV.



Future downward turn of economies
There are two problems that tend to merge, namely financial problems that countries are now hiding and ever rising need for resources in a wide range of areas that are reaching limits such as oil, metals, overfishing and deferred maintenance of pipelines.

On the financial side, we have countries trying to hang together despite serious mismatch between revenue and expenses using quantitative easing and ultra-low interest rates. If countries unwind the quantitative easing, interest rates are likely to rise. Because of excessive debt, the cost of everything from oil production to buying a new home to buying a new car is likely to rise. The cost of repaying the government’s own debt will also raise putting governments in worse financial predicament than they are today.

A big concern is that these problems will carry over into debt markets. Rising interest rates will lead to widespread defaults and the availability of debt including for oil drilling will be over.

Even if debts have dried up, oil companies are already being squeezed for investment funds and are considering cutting back on drilling. A freeze on credit would make certain this will happen. This may be one of the reasons why there was a poor response for the PRDS Bid Round for the 13 blocks off shore as well as those by Bangladesh for off shore blocks that were closed recently.




Future situation
With falling oil production, approved government programmes will be far in access of what governments could afford because governments are basically funded out of the surpluses in a fossil fuel economy as ours, which is the difference between the cost of extraction and the value of these fossil fuels to society.

While it is clear that oil production will drop, with all the disruption and a lack of operating financial markets, it is expected that natural gas and coal production will drop as well. Spare parts will be difficult to get because for the need for the system of international trade to support making these parts. High-tech goods such as computers and phones will be especially difficult to purchase. All these changes will result in a loss of most of the fossil fuel economy and the high-tech renewables that these fossil fuels support.



Forecast for future energy supplies
The supply of energy is basically from renewables, nuclear, gas, oil and coal with the addition of oil shale recently. In 1965, the total energy supply from these five sources was four thousand million tons of oil equivalents (thousand Mtoe) per year. It will rise to a peak in 2020 when the total energy production will reach 13 thousand Mtoe and show a very rapid decline for the next 15 years reaching two Mtoe by the year 2035.

The above issue is described as ‘Limits of Growth’ and during the period 2020 to 2035 there will be massive job layoffs as fuel use will decline. Governments will then find strained finances than today with calls for remedial measures when revenue is dropping dramatically. Debt defaulting will be a major problem and international trade will significantly drop specially in countries with the worst financial problems.

The serious emerging issue in the above circumstances will be the need to recognize governments to carry out its functions in a less expensive way. It is predicted that the situation will go back to local tribes with tribal leaders as in the past with smaller units for governance. There will also be a challenge to get the governments to act in a coordinated way with a number of changes to governance as the global energy supplies decline.

The situation will compel us to begin manufacturing goods locally, at a time when debt financing no longer is effective and governments are no longer maintaining infrastructure. New approaches will have to be figured out, without the benefit of high-tech goods like computers. It is also predicted that with these serious disruptions to the way of living, the electric grid will not last very long and then the question will arise as to what we can do with local materials for goods and services to resuscitate the economy and start from scratch.




Solutions to sustainable energy problem
It has been reported that there are a lot of solutions to the problem of sustainable energy but some will not be achievable because of the nature of the problem itself which is different from what the people have expected.

•  Substitution - Time factor is a restraint. Further, whatever substitutions we make need to be with cheap local materials if we expect them to be long lasting. And not to overuse resources such as wood, which is in limited supply.
  
  Electricity will decline in availability as fast as oil because of inability to maintain the electrical grid and disruptions such as lack of oil to lubricate machinery, bankruptcy of companies involved with the production of electricity and not a long-term solution to oil limits.
  
   

•     Solar panels - Incentive plans to help homeowners to pay for solar panels are expected to decline. Inverters and batteries will need replacement but probably will not be available. Homeowners who can rewire the solar panels for use alternately with the grid may find useful for devices that can run on direct current. As a part of the electric grid, solar power will not add to its lifetime and it will not be able to make solar panels for long years as fossil fuel economy reaches limits.
  
   
• Efficiency - For example, high-efficiency cars consuming less oil or gas or electricity are more expensive replacing one problem with another. Road maintenance will also be a problem and gains in efficiency will not be sustainable. Simple devices may provide efficiency such as solar thermal can often be a good choice for heating water but these devices should be long lasting.
  
   
•     Wind Turbines - Industrial type wind turbines are difficult to maintain and are unlikely to be long lasting. The needs for investment capital will be competitive with such capital for other investments. CO2 emissions from fossil fuels will drop dramatically with or without wind turbines in the future.
  
   
•     Shale oil - Shale oil is a product that needs high investment costs and maximum benefits are doubtful. IOCs who have tried to extract shale oil have noted that rewards are meagre. Smaller companies have compiled financial statements claiming profits with the assumption for future production and low interest rates.

Costs of extracting shale oil outside the US are likely to be even higher than in the US. The reason is that in the US, laws enable production (landowner gets a share of the profits) and there are other benefits such as pipelines in place, plenty of water and low populations in areas where fracking is done. It the countries decide to go into shale oil production they are likely to run into problems such as negative cash flows and it is difficult to predict that these operations will save the world from its financial and energy problems.

• Taxes - Taxes need to be restructured to have carbon deterrent benefits and if such taxes consumers would normally pay to the government are levied on the fuel for vehicles; the practice can encourage the use of more fuel efficient vehicles.

On the other hand, if carbon taxes are levied on businesses, the taxes tend to encourage businesses to relocate their production to lower-cost countries and such a shift will use more coal for electricity. Carbon taxes could be adjusted with a very high tax on imported goods made with coal but this has not been done. Without having a two-tier tax system for carbon it is likely to raise world CO2 emissions.

• Steady state economy - Herman Daly was the editor of a book in 1973 called ‘Towards a Steady State Economy’ suggesting that the world works towards a Steady State economy, instead of growth. Back in 1973, when resources were still fairly plentiful, such an approach would have resulted to hold off limits to growth for quite a few years, especially zero population growth was included in the approach.

Today, it is far too late for such an approach to succeed and we are already in a situation with very depleted resources and are unable to keep the currently production levels and if we are to do so, would require greatly ramping up energy production because of the rising need for energy investment to maintain current production and collapse of economies is impossible to avoid and cannot even hope for an outcome as good as a steady State Economy.

• Additional energy generation on energy return on investment (EROI) - According to Gail Tverberg, basing new energy investment on EROI calculations is uncertain and EROI calculation, which is a theoretical aspect of the whole system, “energy at the well head” and invariably miss important parts of the system, such as timing, which indicates that the investment is good when it is uneconomical for entities making the investment.

Regardless of EROI it is important to consider the financial outcome as well. If products are to be competitive in the world, electricity needs to be inexpensive irrespective what EROI calculations indicate. However, the real problem is lack of investment capital that is gobbled by energy generating devises whose costs occur mainly at the beginning of their lifetime and it is essential to use investment capital intelligently and not for expensive and  unsustainable projects.

• Demand reduction - It is realized that there is a serious need to move away from fossil fuels and even we do not have options, fossil fuels will move away from us. Accordingly, to reduce demand, it is imperative couples to have smaller families as in China would be a good choice to reduce population and avoid even in the short term the energy crisis, which is inevitable.

Conclusion
I have drawn extensively from a publication in the ‘Oil Voice’ magazine, which was a reproduction of an original paper by Gail Triverberg’s article in ‘Our Finite World’. It must be stressed that the authorities in Sri Lanka should seriously consider the facts presented and formulate a more pragmatic and cost-effective long-term policy to cushion the energy crisis, which is inevitable and is presently at our doorstep.

 (Dulip Jayawardena, a retired Economic Affairs Officer of United Nations ESCAP, can be reached at [email protected])