Flow to Stability

Tuesday, May 6, 2014

Sustainable Energy Transitions: the energy trap and the currency option 

By Sgouris Sgouridis

Energy is a sine qua non for any self-organizing system and yet it features surprisingly in the margins of what passes for mainstream, long-term planning of our societies. We have grown critically dependent on cheap, energy-dense fossil fuels but their price and climate externalities have been rising as we are nearing peak production. This necessitates a transition to renewable energy sources. This post addresses the implicit physical and financial requirements if this Sustainable Energy Transition (SET) is to happen as a result of a planned, and seamless transformation, and not forced upon our societies. More specifically, we propose five principles (three limiting and two normative) that can be used as a guide for the transition. On the physical side, based on a quantified application of the fourth principle, we demonstrate the need to increase the amount of investment in renewable energy resources by one order of magnitude to achieve a SET within the IPCC carbon budget. Similarly, starting from the fifth principle, we present a concept of an energy currency that could mobilize resources to achieve this target while better aligning the monetary system with the biosphere limits.

First hand accounts from the situation in war zones (more recently Syria) refer to the seeming ease of acceptance of very drastic changes in the energy situation -people continue to live their lives moving from a 24/7 grid-access to 3-hour, diesel generator-based households without expressing a sense of severe deprivation. Nevertheless, this acceptance comes in the context of a much larger crisis and the risks of war. It is possible that this situation could be a preview for how the vast majority of humanity might deal with a forced depowering as fossil fuels become increasingly expensive and the infrastructure for alternatives (renewables, higher efficiency equipment) becomes impossible to obtain as the available energy resources would be prioritized for primary needs (food & shelter) – a situation which could be described as a an energy trap. The question is not whether this would be the future under BAU but rather when - as we show that even allowing for full use of fossil resource reserves (and frying the planet in the process) it would still require a fourfold increase in the investment rate for renewables to achieve an energy transition of shorts.

The first two sections provide an introduction for the energy view of the economy and a basic model of it to set the stage for the discussion of the SET principles and their corollaries. Perhaps readers of this blog may want to skip the introductory section as it may seem trivial to them.

Introduction: From Flows to Stocks and Back Again

One of the main problems in discussing the potential for a future energy transition is that in fact, on a global scale, we never really completed one since moving from being hunter gatherers to farmers. And yet one of the great civilizational challenges that we are currently facing without explicitly recognizing, is exactly how to pull such a transition off. The challenge sounds simple: transition completely from a fossil fuel based society to one based on renewable energy. Nevertheless it requires a shift of the economic paradigm because the energy metabolism that it relies on is shifting. It needs to revert back from an economy of stocks to an economy of flows. 

Up until three centuries ago, societal energy metabolism was overwhelmingly based on the capacity of the land (stock) to capture solar energy (flow) through agricultural photosynthesis. As a result a maximum power (flow) was limiting what society could use -determined primarily by the stock of land under production/exploitation. The amount of primary energy society used in a given year was on average* proportional to the flow of energy it received on its land for that period hence the name economy of flows. (*granaries allowed for a small reserve to adjust for crop fluctuations).  

With fossil fuels, suddenly a stock of solar energy cumulated over millenia became available. This stock being several orders of magnitude greater than the annual energy requirement of society, effectively permitted energy to become something free for the taking basically at the marginal cost of extraction. This cost of extraction (determined in energy terms by the inverse of the energy return on energy invested - EROEI) was very much lower than for agriculture. Same as oxygen in the air we breathe, if an economic process needed additional energy, those huge reserves were there to provide it. We are able to afford levels of energy per capita that were unheard of for kings of the past to about half of humanity, exponentially raise population levels, and wage massively destructive wars and then recover in a few years. Given that humans could not metabolize fossil resources directly, we found ways to massively boost our agriculture productivity using them. 

This resulted in exponential growth taking over from linear. In the early stages the two are very difficult to distinguish but as time progresses the differences become staggering as the king who decided to pay the inventor of chess in the apocryphal story realized. In many ways we acted as a species that won the cosmic energy lottery. But the prize is finite: stocks in the form of oil, gas, and coal reserves. The fossil-fuel economy is an economy based on the existence of an abundant stock - the limits to available energy is not the supply but the rate at which we can use the resource - the demand. This economy of stocks is only possible as long as the rate at which energy extraction can expand is higher than the rate at which the economy itself expands. Once the two rates swithc, the paradigm fails. And the arduous road back to an economy at equilibrium with its ecosystem natural flows needs to commence.

In understanding these dynamics, it is critical to realize that the energy system that is underpinning our society is its lifeline. All economists realize that value is dependent on scarcity - when oxygen or water are abundant markets put a price of zero on them, yet when scarce all wealth on earth would be gladly exchanged for a breath or a drop. The same is explaining the seeming paradox of why energy is only a small percentage of the GDP, yet without energy our GDP would have been exactly zero. Conditioned by three centuries of increasing abundance, neither our mainstream economic theory, nor our intuition, is prepared to accept the longer-term implications of this fact for a society dependent on a depleting resource. This unwillingness to value the depleting resource that seems to be the current limiting factor in our economies may have multiple causes which are further discussed in the last section. 

Modeling the Energy Metabolism of the Economy as a System of Systems

Before proceeding further though, we need to provide a context to help visualize/conceptualize the complex interactions present in the energy metabolism of our economy. It is a useful abstraction to consider the energy system as consisting of four subsystems or views: fossil fuel extraction, renewable energy installation, energy-utilizing capital, and demographics. We provide a brief, stylized, description of each of the first three as a model for understanding the approach we are taking on mapping the society’s energy metabolism. We leave demographics aside because of their significant inertia and strong dependence on social norms and political priorities that can be developed outside the energy system dynamics.

Fundamentally, the fossil fuel extraction subsystem is comprised of two types of stocks: the fossil resource reserves and the stock of machinery that is used for its exploitation. Fossil fuel EROEI is, for the most part, operational - i.e. the energy we invest in their extraction is recovered in the EROEI multiple very shortly - in a generational timeframe instantaneously. As a result, fossil resource extraction is governed by three main dynamics at play. While reserves are plenty and EROEI high, fossil resources are perceived as abundant, and with the equivalent of an energy bonanza the demand for them grows exponentially. This is a reinforcing behavior that any self-organizing system (see yeast) that has access to an abundant energy source will inevitably take as long as it is not limited in any other way. On the other hand, fossil fuel resources are becoming progressively harder to extract as the reserves are being depleted increasing their -energy and monetary - cost (delayed balancing feedback). In response to this, technology development provides a counterbalance increasing the efficiency of the extraction process (e.g. horizontal drilling and enhanced oil recovery techniques). While this interplay would be rather difficult to model and calibrate for each resource, it turns out that in aggregate it has exhibited, pretty consistently, a pattern known as the Hubbert curve.

Most forms of renewable energy (with the exception of biomass) are, unlike fossil resources, capital intensive. They require an upfront investment (in energy and financial terms) to which they provide returns over a long lifetime (around 30 years for most projects). In back of the envelope math, if we invest X amount of energy in developing a renewable energy resource, we will be receiving annually X * EROEI / Lifetime. This creates a very different dynamic - if we need a certain amount of energy a decade from now, we need to be investing today so that the cumulative investment allows us to reach the desired level in the future - renewables cannot provide instant gratification. The amount of energy investment that goes into the RE generation infrastructure can be presented as a ratio of the investment in renewables in a given year over the total amount of energy available on that same year - the renewable energy investment ratio (epsilon).

On the consuming side, energy demand is dependent to a first degree on the availability of the energy utilizing capital - the infrastructure and equipment (roads, cars, buildings, boilers etc.) that transform primary energy into useful services. This energy-utilizing capital is characterized by two main attributes: utilization rate and efficiency. The infrastructure’s rated power is much higher than average consumption - as an example, the power of cars produced in just one year is ~10TW while the global average power consumption is ~16TW which gives a sense of the very low utilization rates but also of the scale of the productive capacity of the current economic system. The utilization rate is, as basic economics suggest, dependent on the price of energy - at lower prices utilization increases and spurs the demand for expanding infrastructure and increase the stock of energy-consuming capital. The price of energy should have been, in theory, reflecting the opportunity cost of depletion but, given the timeframes and institutional structures involved, in reality prices reflect only the marginal cost of extraction (global in the fungible oil market) or regional (in the cases of natural gas or coal). So from an energy metabolism perspective, the price of energy to society is the amount of energy that is reserved for producing it (i.e. it would directly correlate to the inverse EROEI for fossil and the epsilon for RE). One therefore would expect that as the “cost” of energy increases, its demand should be reduced (a balancing loop). But this is counteracted by other balancing effects: as energy costs rise, there is a strong push to increase the efficiency of the energy utilizing capital (with significant delays usually) through technology improvement. Another alternative is to mask the effect of costs through debt - a factor we examine again in the next section.  

So far this picture is familiar to any students of ecological economics that have followed the ideas of Daly, Georgescou-Rogen, Hall and others. This article though presents two novel perspectives: first how should we define the shape and form of the sustainable energy transition (SET) - i.e. the dynamics of this transition and second how can we modify our financial system and the way we create money in order to conform with the realities of a finite planet (a closed economy in an open thermodynamic system).

Five Propositions for Sustainable Energy Transitions (based on Sgouridis & Csala 2014  )

It is always good to start with a definition to create the common basis for understanding and judging an idea. In this case, I will define SET as: 

a controlled process that leads an advanced, technical society to replace all major fossil fuel primary energy inputs with sustainably renewable resources while maintaining a sufficient final energy service level per capita.

As definitions are wont to be, it tries to capture a lot of concepts laconically. But the key words are “controlled”, “technical”, “all” and “sufficient”. The ideas conveyed indicate that the transition should be smooth and not associated with dramatic social dislocation (controlled). It should allow for society to at least maintain its technological capabilities (technical), and at the level of the individual meet a certain threshold of final energy availability (sufficient).

Knowing that the transition will be complete when practically all fossil fuels are replaced, we can try to backcast the evolution of the transition to the current energy situation. In this exercise, it is instructive to take an energy metabolism perspective. This approach has several advantages: first it focuses on the net energy availability for society   

In order for this transition to be indeed “sustainable" we would need to concern ourselves with each of the three sustainability pillars (environmental, social, economic). Extending Daly’s ideas, we propose five principles that need to be met - de minimis - for a SET to be successful. 

The five SET principles can be stated as follows: 

I.The rate of pollution emissions is less than the ecosystem assimilative capacity.

II.Renewable energy generation does not exceed the long-run ecosystem carrying capacity nor irreparably compromises it.

III.Per capita available energy remains above the minimum level required to satisfy societal needs at any point during SET and without disruptive discontinuity in its rate of change.

IV.The investment rate for the installation of renewable generation and consumption capital stock is sufficient to create a sustainable long-term renewable energy supply basis before the non-renewable safely recoverable resource is exhausted.

V. Future consumption commitment (i.e. debt issuance) is coupled to and limited by future energy availability.

The first two principles address the environmental aspect (neither fossil nor renewables should impact the environment irreparably within a human generation). The third addresses the social aspect ensuring that (i) a minimum level of available energy is available, and (ii) the rate of change in energy availability is not so drastic that it creates breakdown of social support systems. A direct corollary of this is that a more equal society faces an easier SET task than an unequal one. Finally, the last two principles address economic sustainability (physical and financial). P.IV, a variant of the Hartwick rule in economic literature, ensures that the rate of investment in renewable energy is sufficient to compensate for the drawdown of the fossil fuel supply while, P.V makes the connection between debt issuance and the availability of energy to service that debt in the future.

Viewed from a normative angle, the first three principles act as constraints of the transition function - the first gives an upper limit in the amount of fossil energy available, the second puts a limit in the amount of renewables that can be installed, the third provides a lower bound on the per capita energy availability (and of its first derivative during the transition). The latter two though are prescriptive and actionable - they offer a quantifiable approach to estimate the minimum energy investment in renewable energy and the maximum debt that can be extended for that level of investment. 

Focusing on the physical side, we can essentially create an equation that ties the renewable energy investment ratio (epsilon) to net societal energy availability which can be seen below (derivation in the paper and supplement):

This recursive equation can be solved numerically (through simulation) or analytically (harder). Below we provide, as a starting point of the discussion, a comparison of the evolution of future energy availability under the following scenarios. As typical of energy transitions (and to meet the discontinuity constraints of Principle III), we assume that it takes thirty years to change epsilon from its current value of around 0.25% (we actually assume 0.375% for this model) to the “target” value and simply compare energy availability with population dynamics in the next two graphs.

Carbon Uncapped Emissions Dynamics (planet fries) – Requires 4x acceleration of RE investment ratio to maintain energy availability at 2100

Carbon capped Emissions Dynamics (planet 50% chances of staying with 2C) – Requires 8x acceleration of RE investment ratio to maintain energy availability at 2100

The results are starkly clear: if we allow fossil fuels to run their course, we will need to increase our rate of investment in renewables fourfold. If we decide to save the climate and adhere to the IPCC recommendations of no more than 3010 anthropogenic Gt CO2 in the atmosphere by 2100 for having a 50% chance of remaining below 2C by the end of the century (which, apropos, is still the moral equivalent of loading a revolver with three bullets and playing Russian roulette with your grandchildren) we need an eight-fold increase of the epsilon rate. Of course, there are key sensitive assumptions involved like the EROEI of renewables which in the scenarios shown starts at 20 and increases with the installations - readers are welcome to enter their own assumptions in our model (http://www.runthemodel.com/models/1418/) - yet we believe that our choices are neither conservative nor aggressive and we intend to enhance the simulation’s resolution by disaggregating specific renewable energy technologies as we did for fossil fuels.

Bringing the Financial System Back to (physical) Reality: The Case for an Energy Currency
(based on Sgouridis 2014)

Internalizing the civilizational nature of SET is necessary but will not be sufficient to overcome the significant coordination problems involved - either on a regional or a global scale.  As was alluded earlier, there are multiple factors at play.  Cognitive psychology has repeatedly shown the severe discounting of the future that most (western-ized) humans exhibit. Olsonian capture of key regulatory processes through lobby groups and election influence by moneyed interests through media control are also shown to be widespread. There is significant inertia in the habitual and systemic components of everyday behavior - even if we wanted to change our behavior, it requires a rebel spirit to go against ingrained norms and without the right infrastructure some choices may be impossible (e.g. walkability and public transport in US suburbs). But all these factors, are in the end reflection of the fundamental economic reality - the root obstacle lies in the disconnect between financial and physical economics.

The current financialized economy is the result of a reinforcing process in which wealth seems to become increasingly abstract and with nominal values exceeding the productive capacity of the planet. To a large extent this is another artifact of the ability to harness energy at will. Before the industrial revolution, societies tended to grow at much slower pace and when they did enter periods of “irrational exuberance” and debt overextension, jubilees, revolutions, migration, or wars managed the debt write-offs. This past three-hundred years though have probably seen the only time in history where continuous economic growth has allowed most of the debt issued to be repaid. It should be clear by now, that the ability to expand the economy at a rate sufficient to repay debt (collectively) is only made possible by the ability to expand the energy source to fuel the expansion. As fossil fuels peak, we reenter the dynamics of an economy of flows and an alternative path to financialization will be needed.

If we revisit Principle V, we can see that in a post-peak economy, the ability to extend debt (that in aggregate could reasonably be expected to be repaid)  would depend on the future energy availability and the rate at which energy use becomes more efficient. It is possible therefore to write this equation for our closed earthship economy for post-peak fossil as we did for P-IV. It would be written as:

This equation ties the amount that new debt a society can be expected to issue to the same renewable energy investment ratio - if the debt to GWP ratio remains below this bound, it would reduce the chances for a financial crisis in the future to wipe off unpayable debt. 

Combining the implications of the two SET principles and their resulting equations, it becomes clear that in order to set in motion an adequate SET we need to control both the financial system and rapidly increase the renewable energy investment ratio. An ideal option would harness the two in a positively reinforcing dynamic. Realizing that debt is, by far, the predominant mechanism for increasing the monetary supply, then exploring the idea of an energy currency system becomes a logical inference.

There are many flavors an energy currency system could take. I distinguish two basic types: a system of energy credits, and one where debt issuance (and hence monetary supply) is in part or in its entirety adjusted based on the energy/debt equation above.

The first type (and the one more likely to be implemented earlier) can start from the bottom-up. Local and regional complementary currencies based on energy can be fairly easily introduced to support local economies that have specific energy limits. As described also in Sgouridisand Kennedy 2009, energy credits are issued in advance (similar to prepaid phone credits) in a way that they represent the available (or targeted) energy supply for the issuance period. As citizens and companies consume energy services they withdraw from their allotment. In order to avoid either hoarding or imbalanced front-heavy consumption, the credits should be issued at fairly short intervals (daily/weekly) and expire thereafter. An asymmetric market for those credits can support both of these goals and adjust demand to the actual energy supply. This market operates by allowing users to sell their credits to the market if they find the spot price attractive and are willing to adjust their consumption. The spot price is generated algorithmically by comparing the actual cumulative energy curve to the anticipated cumulative curve and increasing (reducing) the price if the actual demand exceeds (is lower than) the anticipated one in an attempt to correct the divergence. A key part of the system is the existence of energy futures (which could act as yield bearing, maturing investments) when an investor decides to invest in future renewable energy generation. Energy futures would eventually mature and provide as yield a certain amount of normal energy credits.

It is possible that if a number of such energy credit systems emerge, then the futures could act as a substitute (better alternative) to fiat currencies presenting a bottom-up path to an energy currency system.  

Alternatively, a top-down path of energy currency institutionalization is also possible if the political will to effectively control monetary supply materializes - perhaps as a result of an ongoing crisis. In theory, there are several ways to control debt issuance by governments but none that is consistently effective (even in a controlled economy like China’s) as bank-issued debt tends to be either more (fueling bubbles) or less (strangling the productive economy) than desired. This problem was noticed in the Great Depression, and a proposal known as the Chicago Plan was put forward by a group of economists spearheaded by Irving Fisher. The idea that bank-issued debt should be centrally controlled and fully regulated if it does not utilize investment savings (i.e. deferred consumption) is regaining ground led by IMF economist Michael Kumhoff.

The question though of how much debt to extend remains unclear - what should be the desired level of debt that would allow an economy the right growth? My thesis is that in a post-peak fossil fuel society, it should be governed exactly by the energy/debt equation. If that becomes the case, financial capital suddenly has a clear case to invest in renewable energy generation so that the amount of extendable credit available increases (the only way of exercising leverage of capital in the financial markets under the Chicago Plan). It should be fairly trivial to tie some preferential terms and prioritize the investors active in the physical energy markets for access to debt to make this a reinforcing loop. Of course, it might be possible that the energy market could overheat and exceed the desired levels of investment but this is still controllable by the central bank authority that could preset maximum limits.

Concluding Thoughts on Defusing the Energy Trap 

While the targets of a carbon budget and the perils of a peak in fossil fuels have been repeatedly discussed, a coherent, systematic look at the energy economy system allowed us to relate the rate at which we need to invest energy in building the renewable energy infrastructure with social, environmental and economic requirements and constraints. It is clear that the carbon constraints are more binding than the depletion rates but in either case, a significant acceleration in the RE infrastructure buildout is necessary if we are to avoid the energy trap. Our debt-based financial system still acts as an additional mask of the depletion of easily accessible fossil fuels and if we maintain it intact in the future, it will act as a break in the efforts to reversing the decline in energy availability. A preview of how this operates can be seen today in the countries of the European South - especially Greece. The essence is that once the decline in energy availability cannot be masked by debt, infrastructure investment will freeze further and the focus will be addressing more pressing needs of day to day survival.

Our estimate for the appropriate rate of epsilon (the renewable energy investment ratio) in a carbon-capped scenario (we should accelerate from the current 0.3% to 3% of all available energy being used for such investment) - this is dependent on the assumptions: that the current average RE EROEI is 20 and will increase in the future, that energy efficiency will increase the available final per capita energy by almost 50% and that the energy needs of the global citizen will be stable to 2000W. 

Any estimate done using the SET principles is a conservative estimate. The SET principles assume that RE is perfect substitute for fossil - basically we assume that all energy-utilizing capital investment is done in ways that will allow the use of renewables. If this investment is delayed or requires higher investment than the replacement of the existing infrastructure would have, then additional energy would be needed to be able to build these rail lines, and electric vehicle batteries and insulated buildings. Another direct implication is that since RE is mostly variable, there is possibility for perfect storage (i.e. no waste in curtailment of energy supply). Since, even with extensive storage and very flexible demand side management it would be likely that some energy will be wasted or at best used at much lower efficiencies than average. Thirdly, if we desire to meet the social development goal of providing 2000W per person, then the energy supply estimate is for an equal society - our unequal one, would therefore require a much larger primary energy supply to be able to provide 2000W as a minimum basic. Finally, there is less discretionary energy than we assume here as the food production system is a significant user of energy that will need to increase to support population increases. 

Even if the dream for a viable fusion reactor becomes real (which I personally think is rather unlikely in the critical timeframes ahead - i.e. 5 decades), ramping up such extremely complex energy system in a society with declining energy resources would be very difficult if not impossible. Even when it comes down to simpler distributed renewable energy systems, harnessing the financial system to prevent excessive debt and incentivize the right type of investment can be done using the concept of the energy currency.