Global oil risks in the early 21st Century

(with M. Höök and A. Angelantoni)

Energy Policy , forthcoming (2011)

Abstract: The Deepwater Horizon incident demonstrated that most of the oil left is deep offshore or in other difficult to reach locations. Moreover, obtaining the oil remaining in currently producing reservoirs requires additional equipment and technology that comes at a higher price in both capital and energy. In this regard, the physical limitations on producing ever-increasing quantities of oil are highlighted as well as the possibility of the peak of production occurring this decade. The economics of oil supply and demand are also briefly discussed showing why the available supply is basically fixed in the short to medium term. Also, an alarm bell for economic recessions is shown to be when energy takes a disproportionate amount of total consumer expenditures. In this context, risk mitigation practices in government and business are called for. As for the former, early education of the citizenry of the risk of economic contraction is a prudent policy to minimize potential future social discord. As for the latter, all business operations should be examined with the aim of building in resilience and preparing for a scenario in which capital and energy are much more expensive than in the business-as-usual one.

 

    (back to the main page)
 

       I present below the presentation slides as well as additional materials and discussions that were not included in the paper due to space limits and/or article coherence.

 

 

 

 Energy consumption and GDP: Why mixed (and inconclusive) evidence so far?

The study of the relationship between energy and GDP has involved a very large number of research studies, often multi-disciplinary, starting mainly from the end of the ‘70s after the first oil shock. To get an idea of work done so far, the five large surveys by Beaudreau (2010), Belke et al. (2011), Payne (2010 a), Payne (2010b) and Ozturk (2010) are definitively a must. It may come as a surprise for some, but the literature studying the causal relationship between energy consumption (EC) and GDP has not yet reached a consensus, and the empirical results have yielded mixed results in terms of the four crucial hypotheses:  

a) growth,  if an increase in EC causes an increase in real gross domestic product (GDP), so that energy conservation-oriented policies can have negative effects on economic growth;

b) conservation, if an increase in real GDP Granger-causes an increase in EC, so that energy conservation policies and demand management policies do not have negative effects on economic growth;

c)  neutrality, in case of absence of Granger-causality between EC and real GDP, so that energy consumption does not have a significant impact on economic growth and energy conservation policies (as for the “conservation” hypothesis) should not adversely affect the real GDP;

d) feedback, if there is evidence of bi-directional Granger-causality between energy consumption and real GDP, so that energy consumption and real GDP are interdependent and complements to one another, and energy policy which aims at improving energy efficiency may or may not have negative effects on economic growth, depending on the specific feedback relationship.

When considering country-specific studies, the causality seems to be running from EC to economic growth for most of the past empirical studies, so that “we may conclude that electricity is a limiting factor to economic growth and, hence, shocks to energy supply will have a negative impact on economic growth”, Ozturk (2010). However, the more conflicting results come from high income and middle income developed countries, for which recent works show a  causality running from  GDP to  EC.

 

Why this mixed evidence, then? Well, at least three causes may be behind this outcome:
 

1) The countries’ characteristics, the different data sets examined,  the different variables used and the different econometric methodologies employed in the this (large) field of the literature may be one of the reasons of these conflicting results, as recently suggested by Ozturk (2010).


However, recent works by Beaudreau (2010) , Wagner (2010) and Warr and Ayres (2010) give new insights about the possible causes of these mixed results:

2) Beaudreau (2010) clearly states that "...given the very nature of energy and energy consumption, any model that linked past energy consumption with current output would violate the laws of physics (classical or thermodynamics). Force applied at time t cannot affect work in time t + i for all i > 0. Put differently, Granger causality cannot and should not violate classical mechanics nor thermodynamics". This is why Beaudreau (2010)  introduced the concept of Energy Availability (EA), defined as the product of unknown supply of energy (E), the fraction of energy that is known (δ) and energy efficiency (ξ), that is E * δ * ξ. However the development of a quantitative operational measure of EA is left as avenue for future research.

In this regard, the importance of the specific aggregation of energy flows and its effects on the results of the empirical analysis were highlighted by Cleveland et al. (2000) and Warr and Ayres (2010), who highlight that energy flows are usually aggregated in units of thermal equivalents, but such a method is unable to reflect the qualitative differences among energy inputs. However, there are two possible alternatives:

a) One is the economic approach which considers price-based aggregation, the so-called Divisia Index, which assumes that energy quality can be measured by using the price of fuels, expressed as expenditure shares, to weight their heat equivalents (Warr and Ayres, 2010): Stern (1993, 2000) found that when using energy measured in thermal equivalents, there was statistically significant evidence for unidirectional causality running from GDP to energy, while the reverse was true when using a quality-adjusted energy index.

b) Recently, Warr and Ayres (2010) used a second alternative approach based on thermodynamic principles: they used the concept of available energy defined as ”exergy” and the ability of exergy to provide “useful work”. Exergy provides “...a science based and time-invariant measure of the potential of energy inputs to generate useful work that can be delivered to the point of use”, while the “...aggregate measure of useful work provides an index describing changes in the structure of energy supply (quantity and quality of energy inputs), technological progress (precisely the efficiency of energy conversion technologies) and the structure of energy service demand (the type of useful work or energy services – heat, light, mechanical drive) - Warr and Ayres (2010).
Warr and Ayres (2010) found evidence of unidirectional causality running from exergy to GDP, while useful work has no short-run effect on GDP but it does have a long-run influence on GDP. Instead,  they found no evidence of any causality flowing from GDP to exergy. They showed that  reductions of  exergy consumption may result in negative effect on future GDP growth rates. However, they also showed that output growth can be potentially maintained if  the available work (exergy) is used more efficiently, so that efficiency gains can generate sufficient increases in useful work supplied in the face of constant exergy inputs.


3) Besides the previous two issues, a third major problem was recently highlighted by Wagner (2010), who discussed the problem of energy embedded in imported goods and energy consumed in a country. He shows that rich countries use less energy in their industrial production, whereas they still consume relatively large amounts of energy indirectly by importing energy-intensive goods from poor countries where energy and pollution-intensive production have migrated. This allows rich nations to consume less energy while not changing their consumption habits. Clearly, an energy measure that would discard the energy embedded in imported goods would easily bring to biased results in any causality analysis, and this may well explain why recent works provided support for the conservation hypothesis (i.e. causality running from  GDP to  EC) in case of  high income and middle income developed countries: in this case a rich country would be able to sustain economic growth and decrease energy consumption insofar as it can outsource the “dirty job” of energy and pollution-intensive production to developing and/or poor countries. No surprise that 16 out of the 20 most polluted cities are Chinese.