Energy & The Financial System: Introductory Chapter

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This is the introductory chapter to my book on Energy & The Financial System, which can be purchased from Amazon.

The Nature of The Problem

Over the next decade or so, the most basic assumptions you have about how the economy and the financial system work will, almost certainly, be turned upside down. The perpetual economic growth you’ve always known will become less and less possible as the cheap energy powering it steadily diminishes. As more energy is required to extract fossil fuels or to provide alternative energy sources there will be less energy for everything else. That ‘everything else’ includes both your favourite company’s earnings and the ability for individuals, companies, and governments to keep paying their debts. The financial system that you assume will multiply your savings and provide for your retirement is completely dependent upon continued growth; and without that growth, it will cease to function. Societies may be able to mitigate these impacts through increased energy efficiency and other measures, but these will only slow down the impacts rather than being a cure for the underlying scarcity of cheap energy.

Rapid economic growth and the modern financial system really took off about 200 years ago with the exploitation of fossil fuels. Many new institutions were required to support and fund this growth, such as shareholder owned joint-stock companies (the predecessors of the modern corporation), corporate bonds, and stock markets(1). Without these innovative ways of concentrating and directing investment capital, the financial system could not have supported such rapid growth. As that growth started to produce a middle class, and then even a working class, who could afford more than mere subsistence, the consumer finance industry came into being and grew rapidly. From the 1970’s onwards, extensive financial deregulation and the delinking of money from gold accelerated the pace of growth. The post-war industrialization of Japan, then South Korea and Taiwan, followed later by the behemoths of Brazil, China and India provided still more growth opportunities for finance. The opening up of the USSR and Eastern Europe to capitalism further added to these opportunities. After 200 years of this fossil-fuelled growth, the financial system has become completely dependent upon its continuance. However, without continued access to cheap sources of energy, that growth is impossible as the tight correlation between global energy use and economic growth shows.

Figure 1.1 Relationship between global energy usage and global GDP







Source: Is it really possible to decouple GDP growth and Energy Growth? Gail Tverberg, Our Finite World website article, November 15th, 2011

There are those who say that growth has been decoupled from energy use; but they are wrong. The rich countries have moved their most energy-intensive production offshore to places like China and India. The result is an apparent decoupling of energy and growth. However, if the energy used to produce the goods and services actually consumed in the rich countries – including imports – is analyzed, the tight linkage is again apparent. Over the past 200 years, much of humanity has had a wonderful party underwritten by exploiting huge deposits of fossil fuel. Unfortunately, we have managed to burn through these deposits at an astonishing rate with those easiest (and thus cheapest) to extract being used up first. While we are not going to run out of fossil fuels any time soon, we are running out of the cheap stuff which funded our modern societies, economies, and financial systems.

The cost of extracting fossil fuels can be treated as we would any other investment; there is an amount that has to be invested and an amount that will be returned by that investment. If the return is not high enough then the investment will not be made. In the case of energy, the best insight is gained by looking at the amount of energy invested and the amount of energy returned; so instead of dollars invested and dollars returned we will use energy invested and energy returned, to produce an Energy Return on Investment (EROI). When the first commercial oil and gas wells were drilled, the EROI was incredible; in the region of 30 to 1, and for coal mining about 60:1(2). That is like investing $1 and getting $30-60 in return. These incredible returns are what fuelled the creation and growth of our complex modern economies.

As time passed, our energy demands grew, and some of the easy and cheap oil and gas wells showed the beginnings of depletion. With that ‘low hanging fruit’ drying up, more difficult, more expensive conventional wells had to be utilized. The EROI of the ever newer conventional oil and gas wells had already fallen to about 18:1 a few years ago, and is at about 10:1 presently(2). In practical terms, this means that for a given amount of oil or gas produced, the net amount of energy available to society becomes less, as more energy has to be used for exploration and extraction. On average, for the unconventional oil obtained from tar sands, or oil and gas produced from deep sea wells and by hydraulic fracturing (fracking), the EROI is less than 10:12. For now, because oil is a globally traded ‘fungible’ commodity, the amount of oil flowing from old, established high EROI fields keeps the average EROI reasonably high. Natural gas supply is more locally traded, which shows up in large regional price differences, but its global EROI is also kept reasonably high by the older, cheaper, wells. The use of unconventional resources may maintain production levels, but is a sign that the days of cheap energy are numbered as the global EROI continues to decline. Each ‘down tick’ of the average EROI for oil and gas will siphon a greater share of the available energy into the extraction process.

As for the non-fossil energy alternatives, solar PV, bio-fuels, and nuclear power also have the same low, or even lower, EROIs than the new or unconventional oil and gas. The widespread attempts at replacing depleting low-cost oil and gas with them only add to the decreasing net energy problem. Currently, only hydro-power and wind provide net energy levels equal to conventional oil and gas. Hydro-power is severely constrained by availability of usable sites, and wind power currently provides only 1% of global energy supplies so even with very rapid growth it will remain a small contributor for a decade or more. That leaves the oldest and dirtiest of the fossil fuels, coal, which still has a high EROI2. Society is currently living off coal plus the high EROI oil and gas wells, the vast majority of which are decades old and rapidly depleting. Those old wells, together with coal, and a recession-driven reduction in oil usage by Europe and the USA, are keeping modern society going. In recent years, the continued growth of the world economy has depended on China’s utilization of its massive coal reserves (its coal production is now three times that of the USA(3)). If the Western economies recover, oil shortages and rising energy prices are sure to follow.

The relationship between EROI and net energy is very much like that between interest rates and the price of a fixed rate bond. At high interest rates a 1% move, let’s say from 20% to 19%, has a relatively small impact on the bond price. At low interest rates the effect is much greater; a move from 4% to 3% will have a very significant impact on the bond price. As EROI falls below 10, the fall in net energy becomes much more significant; at 10:1 the net energy is 90%, at 5:1 its 80%, at 3:1 its 66%. This has been referred to as the “Net Energy Cliff”. Our modern societies have become so hooked on nearly-free energy that even a decline in the net energy below 90% will cause severe issues, with an EROI of at least 8:1 being required to maintain the high living standards and complex society that we have become accustomed to.

Figure 1.2 Relationship between EROI and Net Energy

Figure 1.2

Source: “The Net Energy Cliff” chart first developed by Dr Euan Mearns based on concept from Dr Nate Hagens.

As more and more of the energy produced is required to provide new supplies, less and less is available for everything else, even if overall energy production remains stable. We are now close to the point where the economy will be directly impacted, if in fact it has not already been so. Charles Hall and colleagues have produced a model of the impacts (below) which shows the difference between 1970 and his projections for 2030. Notice how a greater production of energy still results in a smaller level of consumption, as more of that energy has to be redirected towards its extraction and production. The biggest hit will be to discretionary consumption, with shrinking consumer and consumer-finance sectors – no more Gucci in the shopping mall or bargains at Wal-Mart; perhaps no Wal-Mart or shopping mall at all. Also affected will be public investments including the maintenance of current infrastructure such as roads and bridges. According to the Association of Civil Engineers, $3 trillion of investment is needed to return US bridges and roads to safe functioning levels(4).

Figure 1.3 Global Energy Usage and Production in 1970

Figure 1.3 Global Energy Use and Production in 1970

Source: Energy & the Wealth of Nations: Understanding the Biophysical Economy. Hall & Klitgaard, Springer 2011.

Figure 1.4 Global Energy Usage and Production in 2030Figure 1.4 Global Energy Use and Production in 2030

Source: Energy & the Wealth of Nations: Understanding the Biophysical Economy. Hall & Klitgaard, Springer 2011.

Unfortunately, the newer oil and gas sources tend to have much lower rates of production, as well as lower EROIs. So, we get fewer barrels of oil while more of each barrel is used up in the extraction process. A telling comparison is that of the world’s biggest oil field, Ghawar, with the Alberta tar (it really is tar, not oil) sands. The former has produced 5 million barrels of oil a day for many decades, using relatively straight-forward drilling techniques. It has taken decades to get the tar sands to a production level of 2 million barrels per day (bpd) and even optimists see it growing to only 3.5 million bpd by 2025. Meanwhile, the Ghawar field is being flooded with vast amounts of sea water to maintain its output. This can only go on for so long before the inevitable drop in production arrives.

Since 2005, global oil production has been on a bumpy plateau, with the newer smaller flow and lower EROI fields struggling to offset the depletion of the much larger flow of the older, higher EROI fields. Tar sands, fracking, deep sea oil and now even attempts at finding Arctic oil are acts of increasing desperation to keep replacing the depleting older fields. If there were easier ways to get the oil, energy companies would not be bothering with these difficult operations. The new renewables, such as solar, PV and wind are even poorer choices as they require much up-front investment and deliver their output in small incremental amounts over long periods of time, so for the first few years at the least they use more energy than they provide. When I put gas in my car, I get all its energy immediately, but solar panels and wind turbines deliver their energy output in small increments over decades.

Figure 1.5 Crude Oil Production 2002 to 2013

Figure 1.5

Source: Global Average Annual Crude Oil Production mbpd 2002-2013. Peak Fish website article, September 25th, 2013.

What all of this means for investors is that, at best, growth may cease at the global level in the relatively near future. Once you accept that growth will cease, all of the current “common sense” assumptions about investing, such as the assumption of making money from money, cease to be true. Completely different assumptions will be required, including an understanding that the future will be a less wealthy place than the present. The modern financial system acts as a time machine, transferring our perceptions about the future into the present. Thus, rather than the actual arrival of non-growth, the simple failure of our general belief in continued growth, could destabilize and crash the financial system. Even if an end to economic growth were still 10 years in the future the impact upon financial assets could start to be felt in the present as more and more people begin to accept its inevitability.

In this book, I first explain the concepts of Energy Return on Investment (EROI) and Energy Flow from the different energy sources in more detail. These two chapters are structured so that you can just read the introduction and the summary if you don’t need to delve into the details of each energy source. Then I move on to explain the impact that growth constraints will have on financial wealth and the financial system. The final chapter covers what this means for individuals and their personal wealth. Whether you are a financial professional, or are simply concerned about your own wealth, this book will change the way you see the future, and hopefully allow you to keep some of the wealth you currently think that you have.


1. Grossman, Richard (2011), Unsettled Account: The Evolution of Banking in the Industrialized World since 1800, Princeton University Press

2. Hall, Charles and Kent Klitgaard, (2012), Energy and Wealth of Nations: Understanding the Biophysical Economy, Springer

3. n/a (2012), Coal Facts, World Coal Association. Accessed at

4. n/a, (2013), 2013 Report Card for America’s Infrastructure, Association of Civil Engineers. Accessed at

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