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August 30, 2022

Energy & EnvironmentClimateGeopoliticsTechnology / Infrastructure

EXECUTIVE SUMMARY

Global economies are facing a potential energy shock—the third such shock of the past half century. Energy costs and security have returned to center stage, as has the realization that the world remains deeply dependent on reliable supplies of petroleum, natural gas, and coal. And all this has arrived during an inflation itself partially the result of higher energy prices that are raising production and transportation costs across industries.

In these circumstances, policymakers are beginning to grasp the enormous difficulty of replacing even a mere 10% share of global hydrocarbons—the share supplied by Russia—never mind the impossibility of trying to replace all of society’s use of hydrocarbons with solar, wind, and battery (SWB) technologies. Two decades of aspirational policies and trillions of dollars in spending, most of it on SWB tech, have not yielded an “energy transition” that eliminates hydrocarbons. Regardless of climate-inspired motivations, it is a dangerous delusion to believe that spending yet more, and more quickly, will do so. The lessons of the recent decade make it clear that SWB technologies cannot be surged in times of need, are neither inherently “clean” nor even independent of hydrocarbons, and are not cheap.

The only path to significantly lower energy prices while maintaining vibrant economies—and unlinking them from Russian oil and natural gas—is to radically increase the production of hydrocarbons. The U.S. holds the greatest potential for achieving this outcome, and without government subsidies. On the contrary: increasing the production of these energy sources would generate government revenues, increase U.S. geopolitical soft power, and, in due course, save the world trillions of dollars.

America’s hydrocarbon-centric industries could, if unleashed, replicate the unprecedented growth in oil and natural gas production over the past 15 years. That growth resulted in the U.S. becoming the world’s biggest producer and a major exporter of both. The crucial question now is whether America has the political will to forge an energy path based on the lessons learned and the urgencies of the new geopolitical landscape.

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Introduction

Despite ever-escalating rhetoric, an “energy transition” away from society’s dependence on hydrocarbons is not feasible in any meaningful time frame, and it is a dangerous delusion to base policies on the idea that such a transition is possible. Data, not aspirations, show just how critical hydrocarbons are and, in the wake of the Ukraine invasion, the consequences of failing to realize what reality permits. A different understanding of “transition” is required, one that recognizes that new energy sources should be considered additives, not outright replacements, for oil, natural gas, and coal.

Demands that hydrocarbons no longer be used—to generate electricity, heat homes, power factories, or transport people and goods from one place to another—emerge from climate-focused objectives. Observations that they aren’t being replaced and can’t be in any meaningful time frame evoke specious claims of “climate denialism” or the equivalent. But the realities of the physics, engineering, and economics of energy systems are not dependent on any facts or beliefs about climate change.

Meanwhile, current policies and two decades of mandates and spending on a transition have led to escalating energy prices that help fuel the destructive effects of inflation. The price of oil, which powers nearly 97% of all transportation, is on track to reach or exceed half-century highs, and gasoline prices have climbed. The price of natural gas, accounting for 40% of all industrial energy use and one-fourth of global electricity, has soared past a decadal high.[1] Coal prices are also at a decadal high. Coal fuels 40% of global electricity; it is also used to make 70% of all steel and accounts for half its cost of production.[2]

It bears noting that energy prices started soaring, and oil breached $100 a barrel, well before Russia invaded Ukraine in late February.[3] The fallout from that invasion has hardened, not resolved, the battle lines between those advocating for and those skeptical of government policies directed at accelerating an energy transition.

Epitomizing that divide, a tweet from Elon Musk in the immediate weeks following the invasion acknowledged that “we need to increase oil & gas output immediately.”[4] By contrast, the president of the European Commission had announced: “We are doubling down on renewables. This will increase Europe’s strategic independence on energy.”[5] The International Energy Agency (IEA) and the Biden administration are on board with this approach. Indeed, Congress has recently enacted legislation to expand subsidies and spend hundreds of billions of dollars more in that pursuit.

Yet as the Ukraine war dragged on, a policy bifurcation emerged. On one hand, Europe is expanding commitments to SWB technologies, even including bans on conventional car sales within the next decade or so.[6] On the other hand, the European Union (EU) simultaneously reanimated access to conventional energy supplies from Saudi Arabia to Egypt; Germany built its first ever liquefied natural gas (LNG) import terminals; France and Germany refired coal power plants.[7] Behind these contradictory responses is the fact that Russia is one of the world’s three largest producers and exporters of petroleum and natural gas. EU nations depend on Russia for about 25% of their oil and 40% of their natural gas.

The loss of a major share, never mind all, of Russia’s energy supplies would trigger the third and greatest global energy shock since the invention of the computer. Given that hydrocarbons are essential for contemporary society, the consequences of shortfalls or bans would be severe. The first two global energy shocks in the modern world—the 1973 Arab oil embargo and the 1979 Iranian revolution—triggered oil price increases of 200% and 400%, respectively, and touched off global recessions.[8] Each one had long-lasting impacts on policies, government spending, and geopolitics.

This time, there’s potential for even greater harm because, unlike the previous two oil-centric shocks, the Russia-Ukraine crisis also involves natural gas at a scale comparable to the oil at risk. While oil keeps everything moving, natural gas keeps the lights on and is an irreplaceable chemical feedstock that keeps manufacturing supply chains humming. Russian gas provides both the heat and feedstock for one of the world’s largest chemical hubs, Germany. Loss of more than half the supply there would lead to shutdowns and thus shortages and price spikes in key global materials, not to mention massive layoffs.[9]

While oil and gasoline prices continue to rise, we have yet to experience (as of this writing) a loss of supply or rise in prices comparable to the two previous energy shocks. In such a case, JPMorgan analysts recently noted, oil could hit $380 a barrel.[10] The real possibility of an outcome such as that is what motivates political scrambling, publicly and behind the scenes, for alternative supplies of hydrocarbons.

Against this backdrop, consider that years of hypertrophied rhetoric and trillions of dollars of spending and subsidies on a transition have not significantly changed the energy landscape, nor have they altered the long-standing geopolitical tensions inherent in supplying fuels critical for survival. Civilization still depends on hydrocarbons for 84% of all energy, a mere two percentage points lower than two decades ago. Solar and wind technologies today supply barely 5% of global energy. Electric vehicles still offset less than 0.5% of world oil demand.

Naiveté about energy realities has robbed the U.S. and Europe of important soft power options to counter Russian ambitions, i.e., the kind of geopolitical leverage that Russia is currently wielding against Europe and the U.S. regarding fears of the economic and social consequences of shortfalls in critical energy supplies. In the near term, options to Russia’s exports are limited. But doubling down on the energy policies of the past couple of decades won’t significantly impact the need for hydrocarbons. Instead, it’s a formula for more problems in the future, both geopolitical and economic. One of those problems is inflation.

The main trigger for inflation is a rising supply of money sloshing through the economy, typically caused by a government’s massive deficit spending—“printing money.” In the present circumstances, this spending was motivated by the economic destruction of the pandemic lockdown policies combined with the current U.S. administration’s ambitious expansion of social programs. Federal spending in both absolute and relative terms hasn’t been this high since World War II.

But the amount of money circulating through the economy is not the whole story. In normal times, energy typically accounts for just under 10% of the cost of most products and services.[11] Doubling the cost of energy will have an inflationary impact on the average final price tag for all products and services.[12] Impacts are obviously more severe for the most energy-intensive activities such as farming, flying aircraft, or fabricating polysilicon for solar cells.

The U.S. inflation rate surpassed a 40-year high this past October.[13] The last time the Federal Reserve, under Paul Volcker, pushed an aggressive increase in interest rates was in reaction to more than a decade of inflation-inducing federal policies that, combined with the 1979 oil price crisis, triggered a severe recession.[14]

Today’s episode of rising energy costs emerged from a combination of self-inflicted wounds and unanticipated forces damaging global fuel infrastructures. It started with government policies and political pressure that have been, for decades, hostile to expanding the production of conventional energy. From the North Sea to America’s offshore domains—and across most European nations and U.S. states—policymakers actively opposed and even banned the expansion of hydrocarbon infrastructures. Then pandemic lockdowns wreaked havoc on the global economy and energy supply chains. The year 2020 saw the biggest annual decline in global energy demand in nearly a century.[15] The combination of the decline in demand and uncertainty about how long this would last disrupted operations, exploration and expansion plans, and the livelihoods of the energy sector’s skilled workforce. Finally, when the world was already well on the way to $100 oil, the invasion of Ukraine rattled energy markets about possible supply interruptions from Russia, one of the world’s three biggest producers.

Economists ignore the current trends by assuming rising energy prices are necessarily only a short-term episodic influence on broader inflation.[16] As far as supplies of commodities including energy are concerned, the belief is that history has shown that generally, the cure for high prices is, high prices. But will the current price escalation be a brief episode, or will we face a policy-driven era of persistently high prices? If the latter occurs, then the world will enter another period similar to what Federal Reserve historians call the Great Inflation that lasted from 1965 to 1982, when “the inflation being caused by the rising price of oil was largely beyond the control of monetary policy.”[17]

Policymakers ignore at their political peril the importance of energy costs. Gallup’s long-running tracking poll about what people volunteer as the “most important problem” finds that the economy and inflation top the list by a huge margin. The number two issue was “government/poor leadership.” The Russia “situation” was halfway down the top 10. Climate change didn’t make the top 10.[18] (That doesn’t mean citizens “deny” the idea of climate change. Indeed, most citizens say “yes” if prompted with a specific question about whether they believe anthropogenic climate change is happening.[19])

Given the destructive reminders about the importance of low-cost energy—and the brutal lessons, now visible again, about the geopolitics of energy supplies—it is past time to reset energy policies based on reality, not wishful thinking.

Immutable Energy Realities

One can begin with a reality that cannot be blinked away: energy is needed for everything that is fabricated, grown, operated, or moved. It’s easy to ignore the benefits of cheap energy when it’s cheap, but not so much when it isn’t. Consider, to take one example, that more than half the recent rise in wheat prices arose directly from far higher costs for the natural gas used to make fertilizer.[20] Consider as well that digital devices and hardware—the most complex products ever produced at scale—require, on average, about 1,000 times more energy to fabricate, pound for pound, than the products that dominated the 20th century.

Historically, the energy costs of manufacturing a product roughly tracked the weight of the thing produced. A refrigerator weighs about 200 times more than a hair dryer and takes nearly 100 times more energy to fabricate. But it takes nearly as much energy to make one smartphone as it does one refrigerator, even though the latter weighs 1,000 times more.[21] The world produces nearly 10 times more smartphones a year than refrigerators. Thus, the global fabrication of smartphones now uses 15% as much energy as does the entire automotive industry, even though a car weighs 10,000 times more than a smartphone.[22] The global Cloud, society’s newest and biggest infrastructure, uses twice as much electricity as the entire nation of Japan.[23] And then, of course, there are all the other common, vital needs for energy, from heating and cooling homes to producing food and delivering freight.

Advocates of a carbon-free world underestimate not only how much energy the world already uses, but how much more energy the world will yet demand. There are more people, more wealth, and more kinds of technologies and services than existed when President John F. Kennedy faced the Cuban Missile Crisis in 1962, and 60 years later, global energy consumption has risen more than 300%. In the future, there will be yet more innovations and more people, many of whom will be more prosperous and want what others already have, from better medical care to cars and vacations. In America, there are nearly as many vehicles as people, while in most of the world, fewer than 1 in 20 people have a car.[24] More than 80% of the world population has yet to take a single flight.[25] Drug manufacturing is far more energy-intensive than fabricating cars or aircraft, and hospitals use 250% more energy per square foot than commercial buildings.[26]

In terms of energy supply, my earlier reports detailed the challenges, indeed the impossibility, of an energy transition directed at eliminating the use of hydrocarbons for what society needs today, never mind in the foreseeable future.[27] And as I and others have also pointed out, this is not to question whether electric vehicles (EVs) and solar/wind technologies are now dramatically better than in years past. Of course, they are—and that will stimulate, even without mandates and subsidies, greater use of those technologies. But policies to decarbonize energy have demoted the primacy of the three key metrics that have long dominated mankind’s access to energy: low costs, high reliability, and geopolitical security. While numerous new means to deliver energy to civilization have emerged throughout history, they have not led to transitions eliminating the use of previous means. Instead, new means have served as additions to society’s options, shifting the relative importance of each while expanding prosperity.

The core challenge for energy transition goals today arises not from policies or political philosophy but from the physics of energy and technology. Put simply: policy aspirations and soaring language cannot change the existence or nature of, for example, the laws of thermodynamics. The consequences of the underlying physics of energy are visible in five key realities, summarized below: real-world costs, the velocities of big systems, the use of materials for building all machines, the locus of key materials suppliers, and the inflationary impact of forcing markets to adopt minerals-int