I've just returned from a meeting at the State University of New York (SUNY) Environmental Science and Forestry in Syracuse, New York. The purpose of the meeting was to discuss a new kind of economics, a real science of economics. Truthfully, it isn't the first attempt to reconcile economics with a more scientific methodology. Nor is it the first to try to start from a scientific (natural sciences, that is) basis in theory. In fact it appears to be derived from, or expanded from ecological economics, the approach you might have read my enthusiasm for in prior posts. Indeed the main proponent of biophysical econ was a student of Howard T. Odum and has worked with the most prominent ecological economists (e.g. Herman Daly and Robert Costanza).
Charlie Hall is one of the most active researchers pursuing the concept of energy return on energy investment (EROI). He has had a major series of posts on the Oil Drum (thanks to Nate Hagen) in which he demonstrated the concept and then applied the analysis to a number of energy production systems. You should read his series to learn about this important concept. Start with the last link.
Briefly, EROI attempts to produce a net energy calculation; after you account for all of the energy inputs required to produce an energy flow to society you have to subtract the inputs from the output to determine the return on the energy invested. EROI is actually a ratio of energy out for energy in. So, for example, if we were to add up all of the energy used to manufacture solar PV collectors and associated installation equipment, including the energy used to mine the raw materials, labor, transportation, and so on, it needs to be considerably less than the energy produced (measured in common units like Joules). Or otherwise we are not ahead in energy for the whole world. The energy output is measured over the effective life of the collector, so in principle we should have a large positive EROI. An EROI of 10:1 is probably needed for any energy system to have an effective return.
This analysis can be applied to any energy supply system. Most famously Charlie has done a lot of work on oil. Since there are a huge number of factors involved in oil as an energy source, like oil quality, it has been a daunting task and still needs refinements. You can estimate how much energy it takes to manufacture and install an off-shore platform reasonably well. But then what about the energy that went into producing the manufacturing facilities to build off-shore platforms? To be technically correct you have to look at energy inputs all the way down to that used to grow the food used by every worker who had a role in producing the final product. This means exploration (amortized, of course), drilling, pumping, shipping, refining... Well you get the picture. Our energy infrastructure is unbelievably complex! Yet everything feeding into the production of oil and its products takes physical and chemical work and requires energy. Thus there is a net left over for use in our cars and homes and factories.
The problem is that the net has been getting less and less over the last 100 years. It has especially been declining since the 70's when we really got into off-shore and unconventional sources. An oil rig on land requires much less support equipment, and hence less energy. But today we are chasing oil in all quarters, some very difficult areas with associated high energy costs to retrieve the oil. Whereas oil EROI was estimated to be around 100:1 (one hundred barrels out for each barrel of oil used to retrieve it) in the early 1900s, it is now estimated to be closer to 15-20:1 today for imported oil and around 30:1 as an average world-wide (see Charlie's 'Balloon diagram').
The reason we haven't noticed this decline is because until the 80's we were always bringing more oil resources on-line, enough so that the final result, more oil to meet demand, masked it. Then gradually we brought less and less until 2005 when it now appears the world production of oil reached an effective plateau. The EROI decline is actually reflected in monetary costs and monetary returns on investment. The oil companies and nation began to feel the decline as an apparent decline in return on money invested — first in exploration then on punching new wells in old fields. Oil is a finite resource and as anyone with high school algebra will know, if you use up a finite resource there comes a time when it pays diminishing returns. We have hit peak oil, not because we have run out of the stuff underground, but because we've run out of incentive!
That brings us back to economics. Neo-classical economics is a theory looking for support and it is basically a bad one. It doesn't take physical reality into account, like when you used up finite resources (its theory of substitutability says so what!) there will always be a substitute. But this is proving to be wrong. Ecological economics does a better job. It embeds the human economy within the ecological systems of Earth. You have to pay nature a price for its services like raw energy supply and absorbing our wastes. Then the market will play its role in allocating resources appropriately. But by Charlie's reckoning this isn't yet enough. Energy is a far more compelling consideration than even the ecological economists have taken into account. Hence biophysical economics.
I'm not really wild about the name. The biophysical part is OK. But I'm concerned that by calling this new science a kind of economics it will do two things that we wouldn't want. First it will irritate the neo-classical guys (maybe even some of the ecological guys) and they might do to biophysical what they did to ecological and evolutionary economics (yes there is a school of that too), namely ignore them and brush them off as fringe nuts. The second thing it would do is scare the very people whose support is needed to push a change in perspective on the politicians; everyone else. It would do so because if they even got a glimpse of the results (like EROI and peak oil) they would not like the implications for our fossil fuel-based consumption party. The party would be over. I would like to see a wholly new nomenclature that puts emphasis on the systemic nature of the study, but that is just me. We'll see who salutes it after running it up the flag pole.
My own contribution to this meeting was to present a talk on my Money = Energy thesis. The Powerpoint presentation slides are here for anyone interested.
I think the talk went well. It is hard to visualize how standardizing monetary value on energy can be done, by people used to thinking about fiat money and regular economics. But as some of you know from reading my prior blogs, it has a ring of truth to it. Most of the folks at the meeting were nodding their heads on most of my points about why we should have an energy standard for money. A lady from the hedge fund industry preceded me and gave a talk devastating to the whole notion of fractional reserve banking and higher orders of phoney money (M3, M4,... etc.). It was a great entre for my talk because I pointed out that not only is this debt crisis due to no one knowing what anything was worth anymore, but that what we've been borrowing (against the future) for is to produce toys and big houses. It wasn't even like we were investing in real wealth generating capital. Then I argued why it would have been impossible to have made such stupid decisions if we had had a firm, and physically realistic, standard for money. The economic signals of cost and price would have really performed their informational role. In the final series of slides there is a series of arguments that were meant to counter those of one of the world's foremost energy and its social meaning experts, Vaclav Smil. He has argued in his book, "Energy in Nature and Society," that it is nearly impossible to have an energy basis for money. But I just don't think his arguments are very strong. It's probably a fool's game to go up head to head with the world expert, but I thought I would give it a shot. You never know.
An energy standard for money (and you can read back in some of the blogs to see this argument) would have done something that gold did for money in days gone by. You couldn't create it out of nothing. A stock of energy (ready to do useful work - after EROI was taken into account) is definitely measurable. Even with measurement error it is still relatively easy to account for. Bankers and greedy people cannot create money out of thin air when the money is tied to real value. This current crisis would not exist had we been on a standard basis for our currency.
I'm not sure where this new science/perspective of how the economy really works is going to go, but I will be working on my own contributions to it, regardless of what it is called. Charlie and his comrades are on to a lot more truth than the fellows from Chicago ever imagined in their philosophies.
George I think this is a good idea.
Yes, it will get mangled by all those who adapt poorly.
I figure your about 2 decades ahead of the curve ;)
Posted by: RBM | October 22, 2008 at 01:43 PM
RBM,
As I might have written in an earlier posting, I'm thinking about what to do when the dust settles!
George
Posted by: George Mobus | October 22, 2008 at 03:51 PM
Thank you for the Money=Energy slides. Your explanation of the work-energy principle with respect to money has been very helpful in illustrating the problems we face. Any scientist will appreciate learning about the relationship between physics and economics.
I wish I had the energy to go to school for four more years and get a degree in Energy Systems!
Posted by: Sukhbir Dadwal | October 24, 2008 at 11:45 AM
I haven't been reading you long enough, here, so went to Google:
Homo eusapiens - first
Homo caladus - second
'to think about what could be'
Yes, I have come to name it - Room for Improvement.
RBM
SEE'Ya
Posted by: RBM | November 02, 2008 at 06:37 AM
Delete previous reply- wrong post.
Posted by: RBM | November 02, 2008 at 06:41 AM