What could explain why a Trump is even possible?

While it’s tempting to spend this entire issue on The Current Unpleasantness, with its weird mixture of low comedy and awful dread, the mission of OregonPEN is to provide insight rather than just add to the volume of the chorus already operating at fever pitch.

Although the frightening spectacle of the FBI deciding to leave the confines of probity and embracing an audition as members of a political secret police organization — a KGB for America — is not to be ignored totally. Thinking about FBI-head James Comey’s cowardly refusal to stand up to the blackshirts in the ranks who want to install Herr Trump makes one recall another little man whose zealotry, 102 years ago, lit a fuse that sparked a global conflagration that produced destruction on a scale the world had never before then known, Gavrilo Princip.

 If lightning strikes and the Electoral College again hands the White House keys to an ill- educated man-child of the elites whose total lack of empathy for others is his trademark feature, the odds seem good that America will at last expire from the deep wound suffered during the Scalia-led Constitutional Coup of 2000. And even if the tireless GOP vote-suppression efforts — blessed, energized, and enthusiastically supported by Chief Justice John Roberts — fail, the odds are that the US cannot survive another four years of determined Congressional effort to repeal the 20th Century, with its concomitant refusal to observe the norms of small-d democratic governance, again led by the former slave states who have never forgotten and never forgiven the rest of the country for taking away their property rights in enslaved human beings.

But, whether America survives the test Tuesday by electing a politician within the normal parameters instead of a frighteningly megalomaniac sociopath, the real forces that worked to make such a wildly unqualified candidate possible — the same forces that decide how life proceeds in Oregon and the rest of America — will still be present and hard at work.

Those forces, which operate in plain view but, as a result, are so often unnoticed, are the subject of today’s OregonPEN, the last issue before the 2016 Presidential Election, which may as well be called “The Election to Decide if We Ever Get to Have Elections Again.”

Our tourguide through the connections is the perceptive and thoughtful Gail Tverberg, who has again kindly given OregonPEN to republish a lengthy and important article from her blog, OurFiniteWorld.com. It is one of the best summaries we have for explaining why a con man like Donald Trump is able to make such headway with working people in America, people who experience the effects of the forces Tverberg identifies, even if they are not aware of the source.

What really causes falling productivity growth — an energy-based explanation

What really causes falling productivity growth?

The answer seems to be very much energy-related. Human labor by itself does not cause productivity growth. It is human labor, leveraged by various tools, that leads to productivity growth. These tools are made using energy, and they often use energy to operate.

A decrease in energy consumption by the business sector can be expected to lead to falling productivity growth. In this post, I will explain why such a pattern can be expected, and show that, in fact, such a pattern is happening in the United States.

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Total quantity of per capita energy used by the US Commercial and Industrial Sectors (excluding transportation). Computed by dividing EIA Energy Consumption by Sector by Total Non-Farm Employment from the Bureau of Labor Statistics.

Background

The problem of falling productivity growth seems to be a concern to many economists. An August Wall Street Journal article is titled, Productivity Slump Threatens Economy’s Long-Term Growth. The article says, “Productivity is a key ingredient in determining future growth in wages, prices and overall economic output.”

The general trend in falling productivity growth does not seem to be particularly recent.  OECD data shows a long-term pattern of slowing productivity growth, dating back to the 1970s for many developed economies.

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Five-year average growth in productivity per hour worked based on OECD data. By Tverberg.


Falling productivity can be expected to affect wages. Figure 2 shows that in the United States, wages for both low and high paid workers increased much faster than inflation between 1948 and 1968. Between 1968 and 1981, wages for both sets of workers stopped rising. After 1981, wages for high paid workers (“Top 10 percent”) have risen much faster than for the bottom 90%.  This reflects the way this lower productivity has been distributed to the work force. Low-wage workers have been affected to a much greater extent than high-wage workers.

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Chart comparing income gains by the top 10% to income gains by the bottom 90% by economist Emmanuel Saez. Based on an analysis of IRS data, published in Forbes.


A Major Culprit in Falling Productivity Seems to Be Diminishing Returns with Respect to Oil Extraction

Many people believe that the only oil problem we need to worry about is the possibility that supply will “run out” at some point in the future. In my opinion, the real problem is different. What we are experiencing is diminishing marginal returns with respect to oil supply.

In other words, it is becoming increasingly expensive to extract and process oil.

Total costs, including wages for human labor, the cost of capital, the cost of energy to extract the oil, and required tax payments, are rising ever higher. Businesses are finding it nearly impossible to earn a reasonable profit extracting oil. If oil producers want to cover all of their costs, they need to borrow an increasing amount of money simply to cover normal business expenses, including the development of new fields (to replace currently depleting fields) and the payment of dividends.

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Bloomberg exhibit showing that returns for three large oil companies on a “cash” basis fell after 2008, and are now at 50-year lows. CROCI means “Cash Return On Capital Invested.” Bloomberg source.


The problem of diminishing marginal returns extends to other commodity types as well, such as coal, natural gas, fresh water, and metals. Oil is especially important, because it is energy-dense and easy to transport, making it the world’s most-used fossil fuel. At the same time, we are experiencing rising costs for pollution control of various kinds, including attempts to prevent climate change.

The combination of diminishing returns for commodity production together with rising pollution control costs tends to make the world economy increasingly inefficient.

This increased inefficiency affects the cost of producing many things that consumers value, including food, fresh water, housing, and transportation. Indirectly, the ability of businesses to create jobs that pay well is affected, also. I believe that this growing inefficiency in producing goods and services is the basis for the falling growth in productivity that appears in Figure 1.

Why Diminishing Returns with Respect to Energy Supplies Are Likely to be the Culprit in Falling Productivity


There are several basic issues that make our economy vulnerable to the impacts of diminishing returns:

  1. Energy plays a critical role in creating goods and services, and thus in economic growth.
  2. Energy that is very inexpensive to produce is important in setting up a benevolent cycle of greater productivity and more economic growth.
  3. Diminishing returns for oil and other energy products lead to higher costs of production. If these higher costs of production are passed through to the consumer as higher prices, this leads to what we think of as a recession, and a slow-down in economic growth.
  4. The timing of falling productivity “matches up” with falling energy consumption on the part of employers, and also with high oil prices.

Energy plays a critical role in economic growth because energy is necessary for all kinds of economic activity.

Energy allows transportation to take place; it allows heating to take place, so metals can be smelted and chemical reactions of many kinds can take place; it allows the use of computers and the internet.

When workarounds for problems are needed –– for example, increased pollution control, or deeper wells, or desalination plants -–- all of these workarounds also require the use of energy products. So, the problem is not simply that it takes more fossil fuel energy to create energy products. Many other parts of the economy, including pollution control and extraction of fresh water and minerals, become more demanding of energy supplies as well.

Cheap-to-produce oil and other types of energy are important in setting up a cycle of economic growth
. We think of productivity growth as being something that an employee is able to do. In fact, productivity growth is enabled by the use of “tools” that the employer (or the government) gives workers, allowing these workers to create more goods and services per hour worked.

These tools can be either physical tools, such as machinery, computers, vehicles, and roads, or they can be tools provided through more specialization and training. In the case of physical tools, it is clear that energy is used both to create and operate the tools. In the case of specialization, energy is needed in a more indirect way; extra energy allows the economy to have sufficient surpluses to permit training of specialized workers, and also to allow them to have higher wages later.

Thus, we can think of human labor as being increasingly leveraged by energy-related tools. In fact, if we divide energy consumption of businesses (commercial and industrial) by the total number of non-farm employees in the United States, we find that energy consumption per employee falls very much according to the pattern we might expect, based on the rise and then fall in productivity growth shown in Figures 1 and 2. A slowdown in energy leveraging seems to correlate with the decline in the rate of productivity growth.

Figure 4 shows that energy consumption per employee reached a peak in 1973. Energy consumption per employee started falling in 1974. This date corresponds to the first major run-up in oil prices (Figure 5). Oil prices, on an inflation-adjusted basis, have never returned to the very low level experienced prior to 1973.

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Historical annual average price of oil, for a grade of crude similar to “Brent,” based on data of 2016 BP Statistical Review of World Energy.


The period between the end of World War II and the early 1970s was generally a period in which inflation-adjusted oil prices were under $20 per barrel.

At this very low price level, it made sense to add a new interstate highway system and to greatly upgrade the electric grid and the oil pipeline distribution systems. Once oil became high-priced, the US greatly backed away from leveraging worker productivity with such big projects. Other changes began as well, including gradually shifting manufacturing to other countries. These countries typically had lower labor costs and a cheaper energy mix (more coal and hydroelectric, and less oil).

The first run-up in prices occurred after US oil supply reached a peak in 1970 (Figure 5). According to a presentation by Steve Kopits, the second run-up in prices started occurring about 1999 (Figure 6). By then, we reached a point where a disproportionate share of the cheap-to-extract oil had already been removed. Oil producers needed to start work on new oil fields in areas where extraction costs were higher.

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Figure by Steve Kopits of Westwood Douglas showing trends in world oil exploration and production costs per barrel. CAGR is “Compound Annual Growth Rate.”


Oil’s diminishing returns affect the economy
.

As we reach diminishing returns with respect to oil production, the cost of producing additional barrels of oil tends to increase. If this higher cost is passed on to goods made directly and indirectly with oil products, we find that the prices of many products rise. Food costs are particularly affected, because oil is used extensively in agriculture and in transporting goods to market. Higher oil prices affect the cost of other types of goods, because many goods–even coal–are transported using oil. The higher cost of oil tends to ripple throughout the entire economy.

The problem, however, is that higher oil costs lead to lower productivity, because employers and governments tend to purchase fewer energy products for the benefit of their workers when oil prices are high. We end up with a mismatch:

The cost of oil products, and many other products, tends to rise.

  • The productivity of workers tends to grow more slowly. Wages rise very slowly, if at all. They certainly do not keep up with soaring oil prices.

The result of this mismatch is recession, as occurred in the 2007-2009 period. 

Economist James Hamilton has shown that 10 out of 11 post-World War II recessions were associated with oil price spikes. 

2004 IEA report states, “.  .  . a sustained $10 per barrel increase in oil prices from $25 to $35 would result in the OECD as a whole losing 0.4% of GDP in the first and second years of higher prices. Inflation would rise by half a percentage point and unemployment would also increase.”

A Second Way Diminishing Returns Can Work Out Badly: Prices that Are Too Low and Oversupply

In the preceding section, I explained how oil prices, if passed on to the consumer via higher prices of other goods, could lead to recession. 

Because our economy is a networked system, the situation doesn’t need to work this way to come out badly. There is an alternative scenario in which oil prices stay too low for businesses extracting oil to make an adequate profit.

In this scenario, it is businesses, rather than consumers, who find that they have a huge financial problem. This is the problem we are encountering now. In fact, it is not just oil-producers who have a profitability problem; the profitability problem extends to businesses producing coal, natural gas, metals, and many kinds of agricultural commodities.

The reason why this kind of low-price scenario can take place (despite rising costs) is because workers are also consumers. We saw in Figure 2 that the wages of the lower 90% of workers tend to lag behind when energy consumption per worker is falling. There are a very many workers in the bottom 90%.

If the wages of these workers lag behind, homes, cars, vacations, and many other kinds of discretionary goods become less affordable. The reduced demand for these finished products leads to lower demand for a wide range of commodities. This lower demand tends to push commodity prices of many kinds lower, even though the cost of production is rising. As a result, profits for a wide range of commodity producers tend to fall in a way similar to that shown in Figure 3.
It may be that we can expect a recessionary impact, a short time after profits fall. According to Deutsche Bank:

Profit margins always peak in advance of recession. Indeed, there has not been one business cycle in the post-WWII era where this has not been the case. The reason margins are a leading indicator is simple: When corporate profitability declines, a pullback in spending and hiring eventually ensues.


The article goes on to show that there is a lag of about two years between the time of profit compression and the time when recession hits. The amount of variability is quite high, with one recession coming as soon as 4 quarters after a fall in profitability, and two coming as late as 15 or 16 quarters after a fall in profits. The median lag was 8 quarters, and the average lag was 9 quarters.

This Deutsche Bank description of the cause of recessions gives an explanation why Hamilton encountered recessions after oil price spikes. These rising oil prices affected one of the costs of production for most companies. These rising costs compressed profits, and eventually led to recession.

This description of the cause of recession shows how recession can also ensue if commodity prices remain too low for an extended period.

We know that oil prices began falling in the third quarter of 2014. It is now two years later. Profit margins of many commodity producers have been squeezed. We have already seen layoffs in the oil and coal industries. In this low-priced situation, companies are affected unevenly: some benefit from low prices, while others are hurt by low prices.

Commodities are often essential to economies, especially for countries that export commodities. These exporters are especially likely to be affected by low prices. Impacts are likely to include civil disorder and falling production, similar to what we are now seeing in Venezuela.

Oil importers are dependent on oil exporters, so eventually oil imports must drop. Low oil prices are likely to lead to a drop in locally produced oil products as well. As a result, we can expect that less oil and fewer other energy products will be available for leveraging the labor of human workers. If past patterns hold, we can expect a further decline in productivity growth. Rising oil prices are not really a solution either, because, as we have seen, they tend to lead to recession.

Diminishing Marginal Returns Don’t Just Go Away by Themselves

Economists claim that the law of diminishing marginal returns operates only in the short run, because in the long run, all factors of production are variable. This statement might be true, if we lived in a world without limits.

In fact, the amount of arable land is very  close to fixed.

We have not found a way to stop population growth, either. As a result, the amount of arable land per person is falling. We need to keep finding ways to produce increasing amounts of food per arable acre of land. Doing so typically requires energy products, including oil.

We are having similar problems with fresh water supply. We can solve our falling fresh water per capita problem with deeper wells, long-distance transport, or desalination. Any of these workarounds requires energy products.

Of course, we have had diminishing returns with respect to oil supply since the 1970s.

We have not yet found a reasonable workaround. Intermittent electricity is not a reasonable substitute; it does not power existing airplanes, trucks and most cars. When all costs are considered, intermittent electricity tends to be very expensive. Experience shows that if subsidies are given for intermittent electricity, they are needed for other types of electricity generation as well.

The belief that diminishing marginal returns are temporary is probably related to the belief that there are substitutes for everything, including energy supplies. Unfortunately, this is not the case; the laws of thermodynamics dictate otherwise.

As a result, when businesses use falling amounts of energy per capita, we should not be surprised if productivity lags, and if wages for many workers barely rise with inflation.

It is possible to get some productivity gains through education, but it is very unlikely that these gains are as large as when more capital goods are used, as well as more direct use of energy.  There are also clearly diminishing returns with respect to education and training; for example, if we need 10,000 additional dentists per year, training 50,000 additional dentists per year would not be helpful.

Can We Solve Our Productivity Problem with Lower Interest Rates, or with Increased Deficit Spending?


I wouldn’t count on it. Our problem is an energy problem.


Increased deficit spending could perhaps raise commodity prices a bit, and thus help the profitability of companies producing commodities. The reason commodity prices might rise is because increased spending by governments would act to supplement the low spending by workers who are suffering from low growth in wages. The sale of goods might rise for a while, but productivity of workers would still lag. Economic growth would, at best, remain very slow. If the economy were headed for recession or the collapse of commodity exporters, that situation would continue to be the case.

Lower interest rates would likely be even less helpful than deficit spending. There is no guarantee that these low interest rates would lead to increased spending on capital goods that would benefit workers. Banks in Europe and Japan would likely have even more problem with adequate profitability than they do now. Bank failure would become even more of a concern than it is now.

Our problem is really a lack of very cheap-to-produce energy that can be used to inexpensively leverage the labor of human workers. This energy needs to be of the correct kind to match the requirements of existing equipment. Without this leveraging, it is likely to be impossible to fix our productivity problem.

Selection of related Tverberg links for further reading

All of Tverberg’s articles are fruitful jumping-off points for deeper study. Below are a sampling of the links to other examples of her work, which is becoming a substantial body of essential reading for those who really want to understand the deep signal that is driving events instead of being confused by the superficial noise that fixates most media channels.

How Researchers Could Miss the Real Energy Story

I have been telling a fairly different energy story from most energy researchers. How could I possibly be correct? What have other researchers been missing?

The “standard” approach is to start from the amount of resources that we have of a particular type, for example, oil in the ground, and see how far these resources will go. Growing development of technology seems to allow increasing amounts of these resources to be extracted. Thus, limits seem to be farther and farther in the distance, especially if a person starts out with an optimistic bias. It is easy to get this optimistic bias, with all research funds going in the direction of, “What can we do to solve our energy problems?”
Approaches for forecasting future supply problems that start from the amount of resources in the ground suffer from the problem that it is hard to draw a sharp line regarding when we will run into difficulties. It is clear that at some point, there will be a problem–EROEI (Energy Return on Energy Investment) will be too low–but exactly when is hard to pinpoint. If a person starts from an optimistic viewpoint, it is easy to assume that as long as Energy Output is greater than Energy Input for a given process, that process must be helpful for solving our energy problem.

In fact, in my opinion, the story is very different. The very thing that should be saving us–technology–has side effects that bring the whole system down. 

The only way we can keep adding technology is by adding more capital goods, more specialization, and more advanced education for selected members of society. The problem, as we should know from research regarding historical economies that have collapsed, is that more complexity ultimately leads to collapse because it leads to huge wage disparity. (See TainterTurchin and Nefedov.) Ultimately, the people at the bottom of the hierarchy cannot afford the output of the economy. Added debt at lower interest rates can only partially offset this problem. Governments cannot collect enough taxes from the large number of people at the bottom of the hierarchy, even though the top 1% may flourish. The economy tends to collapse because of the side effects of greater complexity.

Our economy is a networked system, so it should not be surprising that there is more than one way for the system to reach its end.

I have described the problem that really brings down the economy as “too low return on human labor,” at least for those at the bottom of the hierarchy. The wages of the non-elite are too low to provide an adequate standard of living. In a sense, this is a situation of too low EROEI: too low return on human energy. Most energy researchers have been looking at a very different kind of EROEI: a calculation based on the investment of fossil fuel energy. The two kinds of EROEI are related, but not very closely. Many economies have collapsed, without ever using fossil fuel energy,

While what I call “fossil fuel EROEI” was a reasonable starting place for an analysis of our energy problems back in the 1970s, the calculation now gets more emphasis than it truly deserves. The limit we are reaching is a different one: falling return on human labor EROEI, at least for those who are not among the elite. Increasing wage disparity is becoming a severe problem now; it is the reason we have very divisive candidates running for political office, and many people in favor of reduced globalization.

Overly Simple Models Give Misleading Answers

People who don’t work with models very much can easily assume that a model is telling them more than it really is. I discussed this issue in my recent article Overly Simple Energy-Economy Models Give Misleading Answers. It is quite possible to make a model that works some of the time, but not always. A researcher who is unaware of this problem is likely to overuse the model. As the saying goes, “If a person’s only tool is a hammer, every problem is a nail.”

If a system has multiple parts to it, as is the case with the system that controls energy extraction and energy prices, it is likely that a fairly complex model is needed to make a model that really represents the situation. The earliest models were in a sense one dimensional, when they needed to be multi-dimensional. With these additional dimensions, the model would include such characteristics as the fact that demand is controlled by a financial system, and the fact that the level of demand (and thus prices) depends on the ability of even the lowest-paid workers to afford the output of the system.

The model could also include what is essentially a physics problem–if there is not enough energy to go around, the usual solution is “more technology” or “more complexity.” What more technology and more complexity add is more concentrations of energy in various ways: in capital goods such as machinery and vehicles, in larger businesses to own these devices, in high-paid management officials, and in workers with specialized training.

These concentrations of energy are what lead to wealth disparity–some people “own” businesses and capital goods, and some people (but not others) receive advanced education or other specialized training. All of these things allow a relatively small number of privileged people to receive a greater share of the output of the economy. This leaves less for the rest.

As the result of this wage disparity, the economy ends up with too many people either dropping out of the work force, or earning low wages. It is lack of the ability of these people to afford the output of the economy that brings the economy down. Demand is closely related to affordability of goods made using fossil fuels, such as homes and cars. Many people miss the connection between demand and affordability.

Of course, if we didn’t have this falling demand problem (or low price problem) caused by increased concentrations of wealth leaving too large a share of the population too poor, we would eventually get to something similar to the problem that many have been concerned about: fossil fuel EROEI would eventually fall too low.

Intermittent Renewables Seem to Give Funding to the 1% and Raise Costs for the 99%, Unlike Fossil Fuels

Something that we don’t often think about is that individual types of energy production can be evaluated from the point of view of the extent to which they provide funding for the 99%, versus funding for the elite 1%. EROEI, of course, cannot consider this at all.


Fossil fuels would seem to favor the 99% because the fossil fuel industry has traditionally has been heavy payers of taxes. These taxes go to help the vast majority. It is rare to find reports showing taxes paid by fossil fuel producers, however. Instead, reports tend to show subsidies, which are offsets to the high tax payments. These offsets are frequently payments for such purposes as helping low income people pay their winter heating bills. While these payments are called “subsidies,” in a true sense they are often ways of helping the 99%.


Wind and solar tend to be financed in the US with tax credits. These tax credits help concentrate wealth among the already wealthy. In Europe, the high cost of intermittent renewables tends to be paid by individual households. This leads to a situation where businesses, and the owners and operators of these businesses, benefit at the expense of those who are financially less well off.


The debt level with wind and solar (and all of their related paraphernalia that often gets left out of EROEI calculations) also tends to be high. Interest on this debt transfers money from the 99% to the 1%. The grid likely will need upgrading to handle intermittent renewables. This cost, too, will be borne by the 99% through higher electricity rates or higher taxes.


What Should the Role of EROEI Be?


EROEI is now well established as a tool to try to see how much energy is being consumed in making an energy product. I think that many people have expectations for EROEI beyond what it really can do. For example, I don’t think that EROEI calculations can predict when the economy will collapse, because the mechanics for reaching collapse come from a different direction–namely, increasing wage disparity and low commodity prices.


EROEI doesn’t consider whether a high-valued product is being used to produce a low-valued product, or vice versa. The solution here is to look at the actual cost involved in producing the energy product, as a supplement to EROEI calculations. This is important if our real energy problem is high cost and lack of affordability, rather than “running out” of fossil fuels.


EROEI calculations also are not designed to look at the required growth in debt, and the required transfer of wealth from the 99% to the 1%. Clearly, it would be helpful to add some new tools to the tool set, to look at these problems.

As a check on whether EROEI calculations are really producing reasonable results, any energy product that is producing net energy should be able to support the government with taxes, rather than being dependent on subsidies. If an energy product is dependent upon continued subsidies, this should be considered as likely evidence that it is, in fact, a net energy sink.

EROEI studies do have a continued role, but they need to be used with care.

The final Tverberg piece below is the text (without charts) of an essay she wrote earlier this year about problems integrating wind and solar-generated electricity into the existing electric system.

Many OregonPEN readers will not necessarily realize how difficult it is to couple sources like wind turbines and small, distributed solar power arrays into a system designed and built up over a century for increasingly larger, central station power plants, often topping 1,000 megaWatts in size.

As you read the article below, recall what one of OregonPEN’s heroes, Chuck Marohn of StrongTowns.org notes about people who demand “Solutions!” from those who point out problems in our existing approaches. What Marohn (and OregonPEN) have found is that the actual intent of most people demanding “Solutions!” is that they want to be told “How other people can change what they’re doing so that I don’t have to change what I’m doing.”

Americans who have no experience or background in energy typically have no idea how dramatic a change an “all-renewable energy future” will be, and it is not at all clear that people think very realistically about it. In Oregon, we have countless “environmentalists” who operate under the delusion that we can unplug fossil fuels and swap-in renewable, carbon-free energy sources in their stead “one for one,” which would allow us to have the magical “free lunch.” This is a serious error, and repeats the error US policy has made with attempting to integrate agrofuels into the liquid-fuels energy system (gasoline and diesel). All we have accomplished with agrofuels is the destruction of even vaster acreage of precious topsoil accompanied by the conversion of enormous quantities of fossil fuels into “ethanol” and “biodiesel” with essentially no net energy production — despite the production of prodigious quantities of greenhouse gases.

Environmentalists were “all in” for agrofuels (which they call “biofuels” in a mistaken attempt to distinguish the products from oil, ignoring that oil is itself a biofuel, one made over aeons by nature). Today, those same corporate-friendly environmentalists mostly don’t talk about agrofuels at all because the subject is so embarrassing as the CO2 levels reach ever higher peaks.

Instead, they have moved on and are “all in” for a 100% renewable electric future. However, since the electric budget available for individual households if we are to attain the “100% renewable grid” is probably not more than a few percent of current consumption, be very suspicious of anyone who is driving an electric car while claiming that we can attain an all-renewable future. The reality is that an all-renewables future has very few powered vehicles capable of moving faster than a bicycle.

Intermittent Renewables Can’t Favorably Transform Grid Electricity

Many people are hoping for wind and solar PV to transform grid electricity in a favorable way. Is this really possible?

Is it really feasible for intermittent renewables to generate a large share of grid electricity? The answer increasingly looks as if it is, “No, the costs are too great, and the return on investment would be way too low.”

We are already encountering major grid problems, even with low penetrations of intermittent renewable electricity: US, 5.4% of 2015 electricity consumption; China, 3.9%; Germany, 19.5%; Australia, 6.6%.

In fact, I have come to the rather astounding conclusion that

Even if wind turbines and solar PV could be built at zero cost, it would not make sense to continue to add them to the electric grid in the absence of very much better and cheaper electricity storage than we have today.

There are too many costs outside building the devices themselves. It is these secondary costs that are problematic. Also, the presence of intermittent electricity disrupts competitive prices, leading to electricity prices that are far too low for other electricity providers, including those providing electricity using nuclear or natural gas. The tiny contribution of wind and solar to grid electricity cannot make up for the loss of more traditional electricity sources due to low prices.

Leaders around the world have demanded that their countries switch to renewable energy, without ever taking a very close look at what the costs and benefits were likely to be. A few simple calculations were made, such as “Life Cycle Assessment” and “Energy Returned on Energy Invested.”

These calculations miss the fact that the intermittent energy being returned is of very much lower quality than is needed to operate the electric grid. They also miss the point that timing and the cost of capital are very important, as is the impact on the pricing of other energy products.

This is basically another example of a problem I wrote about earlier, Overly Simple Energy-Economy Models Give Misleading Answers.

Let’s look at some of the issues that we are encountering, as we attempt to add intermittent renewable energy to the electric grid.

Issue 1. Grid issues become a problem at low levels of intermittent electricity penetration.

In 2015, wind and solar PV amounted to only 12.2% of total electricity consumed in Hawaii, based on EIA data. Even at this low level, Hawaii is encountering sufficiently serious grid problems that it has needed to stop net metering (giving homeowners credit for the retail cost of electricity, when electricity is sold to the grid) and phase out subsidies.

Hawaii consists of a chain of islands, so it cannot import electricity from elsewhere. This is what I mean by “Generation = Consumption.” There is, of course, some transmission line loss with all electrical generation, so generation and consumption are, in fact, slightly different.

The situation is not too different in California. The main difference is that California can import non-intermittent (also called “dispatchable”) electricity from elsewhere. It is really the ratio of intermittent electricity to total electricity that is important, when it comes to balancing. California is running into grid issues at a similar level of intermittent electricity penetration (wind + solar PV) as Hawaii–about 12.3% of electricity consumed in 2015, compared to 12.2% for Hawaii.

Even with growing wind and solar production, California is increasingly dependent on non-intermittent electricity imported from other states.

Issue 2. The apparent “lid” on intermittent electricity at 10% to 15% of total electricity consumption is caused by limits on operating reserves.

Electric grids are set up with “operating reserves” that allow the electric grid to maintain stability, even if a large unit, such as a nuclear power plant, goes offline. These operating reserves typically handle fluctuations of 10% to 15% in the electricity supply.

If additional adjustment is needed, it is possible to take some commercial facilities offline, based on agreements offering lower rates for interruptible supply. It is also possible for certain kinds of power plants, particularly hydroelectric and natural gas “peaker plants,” to ramp production up or down quickly. Combined cycle natural gas plants also provide reasonably fast response.

In theory, changes can be made to the system to allow the system to be more flexible. One such change is adding more long distance transmission, so that the variable electricity can be distributed over a wider area. This way the 10% to 15% operational reserve “cap” applies more broadly. Another approach is adding energy storage, so that excess electricity can be stored until needed later.

A third approach is using a “smart grid” to make changes, such as turning off all air conditioners and hot water heaters when electricity supply is inadequate. All of these changes tend to be slow to implement and high in cost, relative to the amount of intermittent electricity that can be added because of their implementation.

Issue 3. When there is no other workaround for excess intermittent electricity, it must be curtailed–that is, dumped rather than added to the grid.

Overproduction without grid capacity was a significant problem in Texas in 2009, causing about 17% of wind energy to be curtailed in 2009. At that time, wind energy amounted to about 5.0% of Texas’s total electricity consumption. The problem has mostly been fixed, thanks to a series of grid upgrades allowing wind energy to flow better from western Texas to eastern Texas.

In 2015, total intermittent electricity from wind and solar amounted to only 10.1% of Texas electricity. Solar has never been large enough to be visible on the chart–only 0.1% of consumption in 2015. The total amount of intermittent electricity consumed in Texas is only now beginning to reach the likely 10% to 15% limit of operational reserves. Thus, it is “behind” Hawaii and California in reaching intermittent electricity limits.

Based on the modeling of the company that oversees the California electric grid, electricity curtailment in California is expected to be significant by 2024, if the 40% California Renewable Portfolio Standard (RPS) is followed, and changes are not made to fix the problem.

Issue 4. When all costs are included, including grid costs and indirect costs, such as the need for additional storage, the cost of intermittent renewables tends to be very high.

In Europe, there is at least a reasonable attempt to charge electricity costs back to consumers. In the United States, renewable energy costs are mostly hidden, rather than charged back to consumers. This is easy to do, because their usage is still low.
Euan Mearns finds that in Europe, the greater the proportion of wind and solar electricity included in total generation, the higher electricity prices are for consumers.

Issue 5. The amount that electrical utilities are willing to pay for intermittent electricity is very low. 

The big question is, “How much value does adding intermittent electricity add to the electrical grid?

Clearly, adding intermittent electricity allows a utility to reduce the amount of fossil fuel energy that it might otherwise purchase. In some cases, the addition of solar electricity slightly reduces the amount of new generation needed. This reduction occurs because of the tendency of solar to offer supply when the usage of air conditioners is high on summer afternoons.

Of course, in advanced countries, the general tendency of electricity usage is down, thanks to more efficient light bulbs and less usage by computer screens and TV monitors.

At the same time, the addition of intermittent electricity adds a series of other costs:

  • Many more hook-ups to generation devices are needed. Homes now need two-way connections, instead of one-way connections. Someone needs to service these connections and check for problems.
  • Besides intermittency problems, the mix of active and reactive power may be wrong. The generation sources may cause frequency deviations larger than permitted by regulations.
  • More long-distance electricity transmission lines are needed, so that the new electricity can be distributed over a wide enough area that it doesn’t cause oversupply problems when little electricity is needed (such as weekends in the spring and fall).
  • As electricity is transported over longer distances, there is more loss in transport.
  • To mitigate some of these problems, there is a need for electricity storage. This adds two kinds of costs: (1) Cost for the storage device, and (2) Loss of electricity in the process.
  • As I will discuss later, intermittent energy tends to lead to very low wholesale electricity prices. Other electricity providers need to be compensated for the effects these low prices cause; otherwise they will leave the market.

To sum up, when intermittent electricity is added to the electric grid, the primary savings are fuel savings. At the same time, significant costs of many different types are added, acting to offset these savings. In fact, it is not even clear that when a comparison is made, the benefits of adding intermittent electricity are greater than the costs involved.

According to the EIA’s 2015 Wind Technologies Market Report, the major way intermittent electricity is sold to electric utilities is as part of long term Power Purchase Agreements (PPAs), typically lasting for 20 years. Utilities buy PPAs as a way of hedging against the possibility that natural gas prices will rise in the future.

The report indicates that the recent selling price for PPAs is about $25 to $28 per MWh (Figure 6). This is equivalent to 2.5  to 2.8 cents per kWh, which is very inexpensive.

In effect, what utilities are trying to do is hedge against rising fuel prices of whatever kind they choose to purchase. They may even be able to afford to make other costly changes, such as more transmission lines and energy storage, so that more intermittent electricity can be accommodated.

Issue 6. When intermittent electricity is sold in competitive electricity markets (as it is in California, Texas, and Europe), it frequently leads to negative wholesale electricity prices. It also shaves the peaks off high prices at times of high demand.

In states and countries that use competitive pricing (rather than utility pricing, used in some states), the wholesale price of electricity price varies from minute to minute, depending on the balance between supply and demand. When there is an excess of intermittent electricity, wholesale prices often become negative.

When solar energy is included in the mix of intermittent fuels, it also tends to reduce peak afternoon prices. Of course, these minute-by-minute prices don’t really flow back to the ultimate consumers, so it doesn’t affect their demand. Instead, these low prices simply lead to lower funds available to other electricity producers, most of whom cannot quickly modify electricity generation.

To illustrate the problem that arises, [consider] Germany’s average wholesale electricity prices [for] residential electricity prices for a number of European countries. Clearly, wholesale electricity prices have been trending downward, while residential electricity prices have been rising. In fact, if prices for nuclear, natural gas, and coal-fired electricity had been fair prices for these other providers, residential electricity prices would have trended upward even more quickly than shown in the graph!

Note that the recent average wholesale electricity price is about 30 euros per MWh, which is equivalent to 3.0 cents per kWh. In US dollars this would equate to $36 per MWh, or 3.6 cents per kWh. These prices are higher than prices paid by PPAs for intermittent electricity ($25 to $28 per MWh), but not a whole lot higher.

The problem we encounter is that prices in the $36 MWh range are too low for almost every kind of energy generation.

A price of $36 per MWh is way down at the bottom. Pretty much no energy source can be profitable at such a level. Too much investment is required, relative to the amount of energy produced. We reach a situation where nearly every kind of electricity provider needs subsidies. If they cannot receive subsidies, many of them will close, leaving the market with only a small amount of unreliable intermittent electricity, and little back-up capability.

This same problem with falling wholesale prices, and a need for subsidies for other energy producers, has been noted in California and Texas. The Wall Street Journal ran an article earlier this week about low electricity prices in Texas, without realizing that this was a problem caused by wind energy, not a desirable result!

Issue 7. Other parts of the world are also having problems with intermittent electricity.

Germany is known as a world leader in intermittent electricity generation. Its intermittent generation hit 12.2% of total generation in 2012. As you will recall, this is the level where California and Hawaii started to reach grid problems. By 2015, its intermittent electricity amounted to 19.5% of total electricity generated.

Needless to say, such high intermittent electricity generation leads to frequent spikes in generation. Germany chose to solve this problem by dumping its excess electricity supply on the European Union electric grid. Poland, Czech Republic, and Netherlands complained to the European Union.

As a result, the European Union mandated that from 2017 onward, all European Union countries (not just Germany) can no longer use feed-in tariffs. Doing so provides too much of an advantage to intermittent electricity providers. Instead, EU members must use market-responsive auctioning, known as “feed-in premiums.” 

Germany legislated changes that went even beyond the minimum changes required by the European Union. Dörte Fouquet, Director of the European Renewable Energy Federation, says that the German adjustments will “decimate the industry.”

In Australia, one recent headline was Australia Considers Banning Wind Power Because It’s Causing Blackouts. The problem seems to be in South Australia, where the last coal-fired power plants are closing because subsidized wind is leading to low wholesale electricity prices. Australia, as a whole, does not have a high intermittent electricity penetration ratio (6.6% of 2015 electricity consumption), but grid limitations mean that South Australia is disproportionately affected.

China has halted the approval of new wind turbine installations in North China because it does not have grid capacity to transport intermittent electricity to more populated areas. Also, most of China’s electricity production is from coal, and it is difficult to use coal to balance with wind and solar because coal-fired plants can only be ramped up slowly. China’s total use of wind and solar is not very high (3.9% of consumption in 2015), but it is already encountering major difficulties in grid integration.

Issue 8. The amount of subsidies provided to intermittent electricity is very high.

The renewable energy program in the United States consists of overlapping local, state, and federal programs. It includes mandates, feed-in tariffs, exemption from taxes, production tax credits, and other devices. This combination of approaches makes it virtually impossible to figure out the amount of the subsidy by adding up the pieces. We are pretty certain, however, that the amount is high. According to the National Wind Watch Organization,

At the federal level, the production or investment tax credit and double-declining accelerated depreciation can pay for two-thirds of a wind power project. Additional state incentives, such as guaranteed markets and exemption from property taxes, can pay for another 10%.

If we believe this statement, the developer only pays about 23% of the cost of a wind energy project.

The US Energy Information Administration prepared an estimate of certain types of subsidies (those provided by the federal government and targeted particularly at energy) for the year 2013. These amounted to a total of $11.3 billion for wind and solar combined. About 183.3 terawatts of wind and solar energy was sold during 2013, at a wholesale price of about 2.8 cents per kWh, leading to a total selling price of $5.1 billion dollars. If we add the wholesale price of $5.1 billion to the subsidy of $11.3 billion, we get a total of $16.4 billion paid to developers or used in special grid expansion programs. This subsidy amounts to 69% of the estimated total cost. Any subsidy from states, or from other government programs, would be in addition to the amount from this calculation.

Paul-Frederik Bach shows a calculation of wind energy subsidies in Denmark, comparing the prices paid under the Public Service Obligation (PSO) system to the market price for wind. His calculations show that both the percentage and dollar amount of subsidies have been rising. In 2015, subsidies amounted to 66% of the total PSO cost.

In a sense, these calculations do not show the full amount of subsidy. If renewables are to replace fossil fuels, they must pay taxes to governments, just as fossil fuel providers do now. Energy providers are supposed to provide “net energy” to the system. The way that they share this net energy with governments is by paying taxes of various kinds–income taxes, property taxes, and special taxes associated with extraction. If intermittent renewables are to replace fossil fuels, they need to provide tax revenue as well. Current subsidy calculations don’t consider the high taxes paid by fossil fuel providers, and the need to replace these taxes, if governments are to have adequate revenue.

Also, the amount and percentage of required subsidy for intermittent renewables can be expected to rise over time, as more areas exceed the limits of their operating reserves, and need to build long distance transmission to spread intermittent electricity over a larger area. This seems to be happening in Europe now. In 2015, the revenue generated by the wholesale price of intermittent electricity amounted to about 13.1 billion euros, according to my calculations.

In order to expand further, policy advisor Daniel Genz with Vattenfall indicates that grids across Europe will need to be upgraded, at a cost of between 100 and 400 billion euros. In other words, grid expenditures will be needed that amount to between 7.6 and 30.5 times wholesale revenues received from intermittent electricity in 2015. Most of this will likely need to come from additional subsidies, because there is no possibility that the return on this investment can be very high.

There is also the problem of the low profit levels for all of the other electricity providers, when intermittent renewables are allowed to sell their electricity whenever it becomes available. One potential solution is huge subsidies for other providers. Another is buying a lot of energy storage, so that energy from peaks can be saved and used when supply is low. A third solution is requiring that renewable energy providers curtail their production when it is not needed. Any of these solutions is likely to require subsidies.

Conclusion

We already seem to be reaching limits with respect to intermittent electricity supply.
Few people have stopped to realize that intermittent electricity isn’t worth very much. It may even have negative value, when the cost of all of the adjustments needed to make it useful are considered.

Energy products are very different in “quality.” Intermittent electricity is of exceptionally low quality. The costs that intermittent electricity impose on the system need to be paid by someone else. This is a huge problem, especially as penetration levels start exceeding the 10% to 15% level that can be handled by operating reserves, and much more costly adjustments must be made to accommodate this energy. Even if wind turbines and solar panels could be produced for $0, it seems likely that the costs of working around the problems caused by intermittent electricity would be greater than the compensation that can be obtained to fix those problems.

The situation is a little like adding a large number of drunk drivers, or of self-driving cars that don’t really work as planned, to a highway system. In theory, other drivers can learn to accommodate them, if enough extra lanes are added, and the concentration of the poorly operating vehicles is kept low enough. But a person needs to understand exactly what the situation is, and understand the cost of all of the adjustments that need to be made, before agreeing to allow the highway system to add more poorly behaving vehicles.

In An Updated Version of the Peak Oil Story, I talked about the fact that instead of oil “running out,” it is becoming too expensive for our economy to accommodate. The economy does not perform well when the cost of energy products is very high. The situation with new electricity generation is similar. We need electricity products to be well-behaved (not act like drunk drivers) and low in cost, if they are to be successful in growing the economy. If we continue to add large amounts of intermittent electricity to the electric grid without paying attention to these problems, we run the risk of bringing the whole system down.