The Economics and Geo-Politics of Energy

by George Hatjoullis

The earth is just a single solar cell. It absorbs energy from the sun in various ways and stores it. Human beings forget that they too are stored energy. The history of mankind could be recast as the struggle to access the energy for humans and promote the growth of individuals, groups and the species I do not recognise history in the conventional sense. I do recognise this struggle and it does not take much thought to see energy as the root of much of today’s conflict. The conflict arises not because there is insufficient energy but rather because human technology has been limited in the ways it can effectively access energy. How wonderful would it be if the sun’s energy was freely accessible by all. There would be a massive surplus. The good news is that we are heading towards this point at speed. The bad news is that it requires technological transition and such phases carry risks, as there are always losers.

The conventional store of energy used by mankind has been carbon based. The energy released also releases carbon compounds, most notably CO2, and these are now recognised as harmful to the solar cell we call earth. The technology to move away from carbon based energy stores is now substantially in place. There is scope for improving efficiencies but this will follow from greater investment in these so-called alternative energy sources. They are of course no longer alternatives. They are essential if mankind is to stop damaging the fuel cell on which it lives. Nevertheless the vested interests will resist the change. There is a huge complex of vested interest in carbon based energies. The transition will destroy jobs and capital and shift the balance of political power. Those that have power do not normally give it up easily.

Accessing stored energy is capital intensive. The fixed costs are very high. However, the marginal costs are not necessarily very high. If you have invested heavily in fracking you do not stop producing just because the price per barrel is now below your average cost. You will not get this back by not producing. Any A-level economics textbook will tell you that it pays to continue as long as the marginal revenue exceeds the marginal cost. Hence as long as the last barrel of oil you pump can be sold for more than the extra cost of pumping it, you may as well keep pumping. It helps pay the debts that your ill-considered investment has accumulated.

The same is true for many other ways of capturing and releasing energy. Once purchased and installed a solar panel produces electricity at a very low marginal cost. Similarly with wind and wave farms. The problem with these technologies is storage. Carbon based fuels come in their own stable storage container (the carbon compound). Solar, wind and wave must be consumed directly or stored in some way. One should not ignore potential environmental damage from chosen storage methods. Hydro-electric, for example, often requires flooding good land and batteries use toxic chemicals. Nevertheless the non-carbon based fuel sources seem to offer compelling advantages over carbon based. One huge advantage is the wide distribution of non-carbon based energy.

The sun shines everywhere. The wind blows everywhere. Many countries have coastlines. Even these sources are not equally distributed but there is so much energy beaming down and surging around all countries that the distribution is largely irrelevant. There is enough for all, everywhere. The problem is access and storage which requires investment and capital. Fortunately not all non-carbon based technologies are as capital intensive as carbon based and the cost of such technologies is falling rapidly. The following chart that I have lifted from the internet is illustrative. The cost decline is unlikely to be over.

Price of solar panel per watt

 

 

The problem is to sustain the investment in non-carbon based technologies. New investment is very much concerned with average cost. Low energy prices will discourage investment in all energy types. There is thus a strong case to be made for taxing carbon based energies and using the proceeds to subsidise non-carbon based investment. At a time of falling oil and gas prices this would be politically feasible because it would manifest as petrol prices etc falling more slowly than oil, rather than not falling at all. Oddly, the opposite appears to be happening. This reflects the power of vested interest.

There is much economic and political capital vested in the carbon based energy sector. If the transition occurs too quickly it will be economically and politically disruptive. Pensioners in drawdown relying on income funds will suffer a drop in income. People employed in the carbon based fuel producing industries will suffer. Countries that are over-reliant on carbon based fuel production for income will suffer. Countries that sell weapons and luxury goods to them will suffer. The connection between oil sales and weapon sales is particularly strong. It would be safe to say that current conflicts are disproportionately associated with the carbon based fuel and weapon link. Both interest groups are very powerful, economically and politically. The world will be a safer place if carbon based fuels become less important.The problem is to get to this stage.

The immediate outlook for energy is grim. Over-investment has created excess supply. OPEC is a failed cartel. Some suggest the failure to try to constrain supply is deliberate action led by Saudi Arabia to discourage new investment. This strategy has been tried before and evidently failed. The financial situation for Saudi Arabia is quite poor so the inclination to keep on pumping may be a sign of desperation and recognition that the economics of oil is changing structurally. The long run equilibrium real oil price is much lower than was once thought. It may be best to keep pumping, especially if one is embroiled in regional conflict and dependent on generous social payments to keep a disparate population peaceful.

Bad news for oil producers is good news for everyone else. In the 70s and 80s when OPEC successfully hiked oil prices, western economies suffered big drops in GDP. There is no reason to think the reverse is not also valid. The balance of economic power is shifting away from carbon energy producers to those possessing sophisticated technology and capital. Technology and capital are very mobile. The long run outlook of cheap energy and highly productive economies is becoming a reality. The trick is not to destroy ourselves in another world war first and to find social innovations to match our technology. What is needed is a social innovation to widen the distribution of the benefits of this brave new world without demotivating its creation. It is time for economics to place income distribution at its centre and not relegate it to an add-on. It is time to return to political economy.

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