Ed Dolan's Econ Blog

The Myth of Affordable Energy — Interview with Ed Dolan

Posted by James Stafford: We were fortunate enough to speak with the well known economist Ed Dolan on various energy and economic issues.

In the interview Ed talks about the following:

• Why cheap energy is not vital to economic growth
• Why high oil prices aren’t necessarily a bad thing
• Why the U.S. oil and gas boom is hurting Russia’s global influence
• Why Obama’s desire to cut oil industry tax breaks could be a great idea
• Why energy policy needs to be completely reformed
• Why Russia’s Arctic Exploration could cause the worst environmental disaster to date
• Why renewable energy investors should be very worried about the Natural gas boom
• Why the EU was flawed from the start
• Why subsidies for renewables are just plain wrong.
• Why we should give QE3 a chance
• Why abundant natural resources can bring a curse of riches Access to cheap energy is vital to economic growth. What do you see happening with the economy over the coming years as the time of cheap oil comes to an end?

Ed Dolan: In my view it is a myth that cheap energy – “affordable energy” as many people like to say is vital to growth. The idea that there is a lockstep relationship between growth of GDP and use of energy is widespread, but the data simply does not bear it out. Instead, what they show is that the world’s best-performing economies have become dramatically more energy efficient over time.

The World Bank uses constant-dollar GDP per kg of oil equivalent as an energy efficiency metric. From 1980 to 2010, the high-income countries in the OECD have increased their average energy efficiency by 55 percent. The United States has done a little better than that, increasing its energy efficiency by 81 percent over that period. That’s pretty remarkable, considering that we haven’t really had a policy environment that is supportive of efficiency.

Think what we could do if we did.

Even after the efficiency gains in efficiency we have made, we still have a long way to go. The US economy is still 15 percent less energy efficient than the average for high-income OECD countries, giving it plenty of room to improve. Switzerland is almost twice as energy-efficient as the US, and the UK is 68 percent more efficient.

Some people say that the only reason the United States has been able to grow while using less energy is the deindustrialization of its economy, outsourcing heavy industry to China. However, compare the US with Germany. Germany is an export powerhouse and Europe’s best-performing economy, yet its energy efficiency has increased at almost the same rate over the last 30 years as the United States, an 80 percent gain in efficiency compared to 81 percent. Furthermore, despite being proportionately more industrialized than the US and a major exporter, Germany squeezes out 41 percent more GDP from each kg of oil equivalent.

In short, we don’t have to hypothesize about the possibility of someday breaking the lockstep relationship of growth and energy use—we and most of the rest of the advanced world are already doing it. What effect can you see America’s Oil & Gas boom having on foreign policy?

Ed Dolan: On the whole, I see it as beneficial. Energy dependence has led us to buy a lot of oil from countries that are unstable and/or unfriendly to us. Anything we can do to reduce that dependence gives our foreign policy more room to maneuver. The beneficial effects reach beyond our actual imports and exports. The US gas revolution is having repercussions all the way to Russia, where Gazprom is seeing its market power undermined, and Russia, as a result, is losing some of the geopolitical leverage its pipeline network has given it. From Siberia and Poland to China and Qatar – the shale revolution has politicians salivating at the thought of a cheap and abundant source of energy. But can the results seen in the U.S. be easily replicated in other parts of the world?

Ed Dolan: I think you’re going to have to ask someone with more engineering background for the technical details, but from what I read, the answer is that it won’t always be easy. It is my understanding that some countries where shale seemed just recently to have great promise have already encountered disappointments in practical exploratory work. Poland I think is an example. Furthermore, the environmentalist opposition to fracking seems even stronger in many European countries than in the United States.

Still, I am hoping that the shale revolution will pan out in at least some countries. Think how much difference it would make, say, to Ukraine’s foreign policy if they were able to break their dependence on Russian gas. Gail Tverberg has written a recent article suggesting the world is suffering from high-priced fuel syndrome, which has the following symptoms:

• Slow economic growth, or contraction
• People in discretionary industries laid off from work
• High unemployment rates
• Debt defaults (or huge government intervention to prevent debt defaults)
• Governments in increasingly poor financial condition
• Declining home and business property values
• Rising food prices
• Lower tolerance for immigrants
• Huge difficulty in funding retirement programs, programs for disabled, and regular pension plans
• Rising international tensions related to energy supply

Do you think this is too convenient and an oversimplification of the problems facing world economies at the moment? What would you blame for the plethora of economic woes being experienced at the moment?

Ed Dolan: I don’t buy the argument at all. Yes, when countries are hit by unexpected upward shocks in fuel prices, we do see short-run results like slower growth and layoffs, but those are short-term problems. When the proper structural adjustments are made, countries with high fuel prices manage to achieve strong growth and full employment.

Where are fuel prices lowest? If you look up the data and rank countries by retail fuel prices, you find the low-price end of the rankings crowded with countries like Egypt, Cambodia, Iran, Pakistan—not exactly economies we would like to emulate.

We’ve got big economic problems, but a lot of them don’t have much to do with energy.

What about a healthcare system that delivers mediocre results at the world’s highest cost?

Health care isn’t all that much energy driven. What about our steady move down the international rankings in education—are you going to blame that on the high cost of heating classrooms? Hardly. Oil prices have been near to the $100 a barrel mark for some time now, and don’t look likely to drop back to previous low levels. What effect could this increased price have on oil importing economies compared to oil exporting economies?

Ed Dolan: Clearly, any oil price increase has the short-term effect of transferring wealth from using countries to producing countries. However, the long-run effects are what matter.

In the long run, high prices just accelerate the trend for using countries to become more efficient and less dependent. Meanwhile, the producing countries often don’t manage their oil riches well. They fall victim to the “curse of riches.” The curse takes the form partly of a loss of competitiveness in their non-energy sectors (the so-called “Dutch disease”). Partly it takes the form of corruption of their political systems. Russia is a poster child for both aspects of the curse of riches. Renewable energy is more expensive than fossil fuels, so how can people be persuaded to choose the less economical option of renewables over the likes of coal and natural gas?

Ed Dolan: There is only one right way to promote renewables, and that is to introduce full-cost pricing of all forms of energy. Full-cost pricing is a two-part program.

First, it means pricing that covers the full production costs for every form of fuel. No subsidies for anyone—not for oil, not for ethanol, not for wind or solar.

The second half of full-cost pricing is to include all of the nonmarket costs, what economists call the “external costs” or “externalities.” The most publicized of these are pollution costs, whether those take the form of local smog, oil spills, climate change, or bird kills. Some people, I am one of them, would like to count in something for the national security costs of dependence on unfriendly and unstable foreign sources of energy supply.

Full-cost pricing accomplishes two things. First, it levels the playing field so that each form of energy competes on its economic merits, not whether corn-growing states have early primaries or oil companies have big SuperPacs. Second, by raising prices to consumers to a realistic level, it accelerates the trend toward energy efficiency that is already underway.

Subsidies for renewables are just plain wrong, even if you look at them from a hard-core environmentalist point of view. With a subsidy, on the one hand, you say, “produce more green energy” and other the other hand, you turn around and tell the consumer, “waste more green energy.” We don’t want to waste energy from wind or solar any more than we want to waste oil and gas. We shouldn’t forget that even the greenest renewables can have significant environmental impacts.

The whole “affordable energy” idea is based on the myth that if we don’t include those external costs in the price—the pollution costs, the national security costs—they just go away. They don’t. Keeping prices artificially low just transfers those costs to someone else, someone unlucky enough to live downwind, someone who owns beachfront property that gets eroded away as the sea level rises, someone who has to go off to fight a war to keep the shipping routes open. There are two things wrong that. First, it’s immoral. If we believe in the market economy, the rule of law, and all that, we have to respect people’s property rights and their human rights. Second, it’s inefficient. It doesn’t strengthen our economy, it weakens it. If there’s one thing we can’t afford, it’s “affordable energy.” Obama has made clear his desires to cut the $4 billion a year tax breaks given to oil companies. What affect do you believe this would this have on the US economy and the US oil industry?

Ed Dolan: If it is done as part of a comprehensive move toward full-cost pricing, it could only strengthen the US economy. The oil industry would whine, but if we cut subsidies and tax breaks for competing energy sources at the same time, oil will remain a competitive part of the energy mix for many years to come. The oil industry has enjoyed decades of subsidies and grants, so do you think it is unreasonable to already start cutting the subsidies to renewable energies and expect them to survive on their own?

Ed Dolan: As I explained above, the answer is yes, provided it is done as part of a package that reforms our energy policy as a whole in the direction of full-cost pricing. Economic growth is generally dependent on the access to energy. As the supply of energy grows, so too does the economy (more or less). Global oil supplies are pretty much stagnant, so do you predict that only nations that successfully convert to a renewable energy mix with an abundant supply of cheap energy will be able to experience continued economic growth at a similar level experienced by the developed countries of recent years?

Ed Dolan: Again, I just don’t buy the doctrine that growth is dependent on ever-increasing energy use. For sure, those countries that pursue sound policies, like full-cost pricing to rationalize their energy mix and promote efficiency, are the ones that are going to keep growing. As the arctic ice melts at a rapid pace the world’s superpowers are jockeying for position to exploit the region’s vast oil & gas & mineral deposits. Environmental groups are rightly concerned, but is this a resource that we cannot afford to ignore?

Ed Dolan: Arctic oil, like any other source of energy, should pay full freight for any environmental impacts it has. If it can bear those costs and still be competitive, I think it should be in the mix. I am worried about Russia, though. It has a dangerous combination of an environment-be-damned attitude and low technical competence that could lead to headline-grabbing disaster worse than the Gulf blowout or Exxon Valdez. What effect do you see the shale revolution having on investments in renewable energy?

Ed Dolan: If I were trying to make money by generating electricity with wind or solar, I’d be worried about gas. I don’t have all the relevant numbers at my disposal, but my gut feeling is that even if you price in full environmental costs for wind, solar, and gas—including environmental costs associated with fracking—gas is still going to be pretty competitive. What are your views on Ben Bernanke’s QE3?

Ed Dolan: I’ve written repeatedly about QE over at Economonitor, so I am on record as saying we should try it. The trouble is, QE is not a magic bullet. Properly executed and properly communicated, it can help support the recovery, but it can’t do it alone.

That is one point where I agree 110 percent with Ben Bernanke Here is what he said in a speech at the Fed’s Jackson Hole conference at the end of the summer:

“It is critical that fiscal policymakers put in place a credible plan that sets the federal budget on a sustainable trajectory in the medium and longer runs. . . Monetary policy cannot achieve by itself what a broader and more balanced set of economic policies might achieve.” How do you see the EU solving its debt crisis?

Ed Dolan: I’m afraid I’m a euro pessimist. The US debt situation is hard enough to resolve, but Europe’s is worse. At the same time, whatever you say about gridlock in Washington, our political decision making is a model of streamlined efficiency compared with the EU. Do you think the EU was doomed to fail from the start with the format that it has? Could more success be seen in a split EU, with the northern/richer nations using one currency, and the southern/poorer nations using a different currency?

Ed Dolan: Doomed, I don’t know, but flawed, certainly. Just recently, I was looking back at what economists were writing about the prospects for the euro back in the early 1990s, when it was still just a project. They were telling us, for one thing, that Europe is too diverse to be ideal for a currency union—and that was when there were only 15 EU countries. Second, they said that you can’t run a monetary union without a central government, a fiscal union, and a banking union. You still don’t have any of those.

I am not sold on the idea of a northern euro and a southern euro. If the currency union doesn’t work, it doesn’t work. Break it up. Sure, some countries will find it works for their special circumstances to tie their currencies to a large, stable neighbour. I could see the Danes or the Latvians keeping a link to the German currency, for example, and I’m sure the Vatican will continue to use whatever currency Italy uses. But a formal, north-south divide doesn’t make much sense to me. In terms of tackling the current economic situation in the US, of the two main presidential candidates, who do you suggest is the best man, and why?

Ed Dolan: I do not think we can tackle the current economic situation without a thorough-going fiscal policy reform that includes three key elements: Spending cuts, revenue increases, and a rewrite of the whole tax system to eliminate loopholes and cut marginal rates. Furthermore, the package can’t be heavily front-loaded like George Osborne’s austerity program in the UK, which has sent their economy back into recession. Ours should be back-loaded, with an element of stimulus now and an ironclad commitment to move the budget toward surplus as the economy improves. It’s a lot to ask for.

We are not going to get good budget policy out of the GOP unless members of that party make a clean break with mantra that they will not accept a dime of new revenue, not even if it comes from eliminating the most loathsome tax loopholes. Personally, I am never going to vote for a candidate for President, the Senate, the House, or any office who has signed that nonsensical Grover Norquist tax pledge.

At the same time, I have been very disappointed at the lukewarm support Obama has given to the kind of program I would like to see. During the first debate, Romney said that when Obama didn’t “grab” Simpson-Bowles—that was his word, and a good one—it was a failure of leadership. That was one point where I agreed with Mitt.

Then, you also have to take into account the vote for Congress. I’m afraid there is going to be continued gridlock as long as the GOP controls the House. In the Senate, there are at least a few people in both parties who are willing to meet behind the scenes and talk compromise, but not in the House, not right now, anyway. Maybe what we need in the White House is someone who is a real politician, a negotiator and dealmaker in the mould of a Clinton or an LBJ. Instead, we have the choice between a manager and a law professor. I’m not optimistic that either of them will be able to do what needs to be done.

This post was originally published at and is reproduced here with permission.

9 Responses to “The Myth of Affordable Energy — Interview with Ed Dolan”

dwbOctober 17th, 2012 at 3:55 pm

this is a great interview. another reason to be skeptical that affordable energy is vital to growth is that fundamentally, most of the cost of energy production is, ahem, labor income. That's true from nuclear (where the bulk of the cost is upfront in the design and construction of the plant) to natural gas or coal (where again, engineering and extraction costs are the bulk of the cash production costs). If I am paying 10 cents/kwh for electricity, probably 70% of that passes through to someone else income. What is vital to growth, as you say, is productivity (i.e. energy efficiency) not the price level itself.

Overall i am deeply skeptical that renewable energy like wind farms on the whole are really less carbon (energy) intensive if we did a full cost accounting. Maybe it appears cheaper because we are building them in China where there are no environmental regs. Then there is the whole supply-demand mismatch problem generation and load, and batteries are carbon intensive to manufacture. The whole tenor of the environmental debate has the flavor of a free lunch. But there is no such thing – either we make a mess one way (mercury and greenhouse gases), or make a mess another way (radioactive waste).

ThomasGrennesOctober 17th, 2012 at 10:03 pm

The announced bankruptcy filing of the subsidized battery producer, A123 Systems, illustrates the point that government support for renewable energy is not a wise idea. Picking winners based on political influence conflicts with sound economic decisions.
Continued attempts to try to use the environment to justify the wildest schemes is one
of the most dangerous "renewables".

William TOctober 23rd, 2012 at 4:21 am

If you expect the price of renewables (specifically solar PV) to continue decreasing over time, then a well designed subsidy can help to bring forward those lower prices by accelerating market learning effects. The subsidy to early adopters is effectively a loan from the future when we expect the prices to be much lower and even cheaper than alternatives. Or a mechanism to bring about that expected future more quickly.

Indeed some of these bankruptcies may have been victims of the market success as prices declined faster than their business/technology could adapt.

Look at the German experience – a steadily decreasing FIT has helped push down solar costs to where they are now half of the US (install costs). This trend looks likely to continue.

The effect is that early adopters are subsidized by late adopters – in the end, when "everyone" wants it because the cost becomes so low, everyone benefits.

GuestOctober 25th, 2012 at 10:55 pm

As an engineer, your assessment is wrong.  Efficiency is potential source of energy, no different than renewables, nuclear, or solar.  Using any single source of energy, creates the most expensive and least desirable system from an economic and environmental evaluation.  

Your proposal that efficiency is the common thread versus something else is too simplistic.  

Did abundant and low cost natural gas have any thing to do with the return of jobs in north east?  As reported in WSJ week of Oct 22,  states competed to win jobs from a new $1.4 B build out that will add 800 jobs after the build out.  The jobs came because the area was the most attractive location globally.  Therefore, these jobs came to this location because of cheap abundant natural gas……..not because the area put in LED lights, wind mills, solar panels, or coal fired power plants.

Which begs the question:  can a nation that is composed of 20% of the world GDP create a successful society with high cost energy?  Never in the history of the world has this been done for an economy the size of the USa relative to global GDP.  

Possibly in a future post, you can share your vision of a world of higher and higher efficiency…to the point everyone in this nation of "hope"  is so efficient that the nation's machines use zero energy as they do their work to replace the work of man.  

To grasp the absurdity of your energy efficiency economic proposal, this professional engineer-retired, ask you to explain how the work of your machines is achieved without violating the second law of thermodynamics.  Sir, your economic theory of energy has met physical reality……and reality won.

I am for getting rid of subsidies….but let's also get rid of externalities the elected use to drive politics into energy decisions.  For instance, why is a bird killed from a wind mill worth less than a bird killed oil production.  Why does wind or any energy source get a time of day versus need preference?  Create a level playing field for externalities.

Ed Dolan EdDolanOctober 26th, 2012 at 12:09 am

1. With regard to "cheap gas"–full-cost pricing does not mean all sources of energy cost the same. It means each source bears its own costs. Under full-cost pricing, if gas becomes more abundant, it becomes less expensive because the price base onto which external costs are added becomes lower. Furthermore, it is widely thought that even when externalities associated with fracking are included, the total externalities from natural gas are less than from oil or coal, so the associated full-cost surcharge would be less. In short, nothing in full-cost pricing would limit effects like jobs and growth for a region or country where natural gas became more abundant.

2. It is hard to see what the size of an economy has to do with it. Suppose we made California an independent country–why would that suddenly make it easier (or harder) to implement full-cost pricing or achieve efficiency? It makes no sense. BTW notice that two of the largest 5 world economies are "high energy cost" countries (Germany, Japan). The remarkable thing is not that US, China, and India are larger in total GDP. The remarkable thing is that Germany and Japan make the top-5 list at all despite having far smaller populations.

3. Several commenters have accused me of wanting to abolish the second law of thermodynamics. The reasoning seems to be that there is a lower limit to the energy needed to, say, light a room even if bulbs were 100 percent efficient. The criticism is silly. No one proposes an economy that runs without energy. The proposal is just to move up the engineering-efficiency curve to a point that is economically efficient, that is, where marginal costs (including external costs) balance marginal benefits. I have never met an engineer who grasps the concept of economic efficiency.

4. Ah, finally! Something I agree with. "Create a level playing field for externalities." Why did you think I place a higher value on a bird killed by oil production than one killed by a windmill? Or, for that matter, by flying into a window, which, I am told, kills a lot more birds.

GuestOctober 26th, 2012 at 11:07 am

A Point of Clarification
I am not sure what your “full cost pricing model” means because I have not taken the time to study the model. I am an engineer who loves economics, and I love energy. I do understand energy and how humans interact with energy. I have spent my life observing, pondering, and pontificating on this subject. Please excuse me for not answering your full pricing model questions….and just addressing the engineering side of your proposal.

(3) The Second Law of Thermodynamics
You are being accused of violating the second law of thermo because perpetual motion machines are impossible.

First a couple of definition: Energy efficiency is equal to useful work per quantity of energy. Therefore, before a system can have efficiency, one must have useful work and one must have energy. The equation demonstrates that to have efficiency, one needs a machine/operating system, useful work and energy. Once one has an operating system, if either the numerator or denominator is zero, then there is no efficiency. Energy in this case is potential energy. Potential energy is derived from one of three physical sources (Newtonian: F=MA, Chemical – Oxidation or movement of a valence electron to outer ring;, and Einstein: E=MC2).

By proposing a system that is using only efficiency as an energy source, one is proposing to gain more and more work from the same quantity of energy. To achieve such a goal, one must eventually have no losses, or put another way, one must be using 100 per cent of the available potential energy…..which is a violation of the second law of thermodynamics.

In conclusion, your proposed solution is a perpetual motion machine and ultimately will violate the second law of thermodynamics. Sir, I am not accusing of violating the second law of thermodynamics. Sir, I promise you; your proposed system violates the second law of thermodynamics. If you can find a professional engineer that agrees with you and can physically prove it, please have them contact me because we will all become stinking filthy rich!

(Please continue in next comment)

GuestOctober 26th, 2012 at 11:07 am

(2a) Economy Size

I suggest you study big systems to gain an understanding of the issues around efficiency and why it becomes more and more difficult to manage energy in larger and larger systems. To put one efficiency standard on the USA (with efficiency as the energy source), will drive economic inefficiency throughout the system. We call this the law of unintended consequences.

One finds in some large engineered systems, one can be much less energy efficient early in a process and gain lower cost and greater economic efficiency for the total process. In the olden days when I went to university, we thought higher and higher quality cost more and more money. Deming proved through Toyota this was not true. Deming proved that doing things right the first time or correcting the error early in the process results in lower cost. Likewise, the same is true with work by machines. One may choose to be energy inefficient early in the process to gain “free efficiencies” later in the process….with the intent of gaining a lower total cost of output.

The larger and more complex the system, the more difficult it is to identify these gains. By placing one common mandated rule on complex systems, one generally introduces greater inefficiencies. I suspect the pricing scheme you are proposing MAY suffer from this problem and make the nation less efficient in many areas versus more efficient…but as previously stated, I have not studied your model.

(2b) Germany, Japan, and California

How are Germany and Japan, high cost energy nations, competitive? Sir, may I suggest that you are not looking at their economies correctly. One must look at the entire economic system of production, and not at individual components. These nations economic production are highly interconnected with other nations in their goal to produce goods nations wish to purchase. The high energy intense production is outsourced to nations with an energy competitive advantage, while the tasks with low energy intensity are retained in the nation. This is true for California, Germany, and Japan.
My guess is as follows: If a nation adopted a pricing scheme for energy that forced efficiency as the sole source of energy, the nation would find all the high intense energy jobs outsourced to lower cost locations. If I was running a company with high energy intensity, I would quickly outsource these jobs and production to lower cost locations.

(4) Why did you think I place higher value on a bird kill by oil versus wind?

Because that is the USA law that currently exist. Does your proposal have a mechanism to over ride the Environmental Protection Agency? If not, then why not? For if your proposal does not create an even playing field among energy sources, then you never achieve a level playing field for energy sources.

(1) “Surcharge” to achieve Full Cost Pricing

Who sets these charges and how are they calculated? I know of no one with the capability to set these charges in such a manner that would be fair, non-political, and create a more efficient economy. All I can see if another layer of government this legislation to win votes and favors.

My view of efficiency

Let each energy consumer, and in turn, each business decide how they want to spend their money. I assure you, I drive the maximum efficiency from each dollar I make for both my personal life and my business. There is no regulation nor premium pricing model that would increase my efficiency. And when one aggregates all these efficiencies, the nation is more energy efficient….even though, I can demonstrate case upon case of individuals making decisions that were less energy efficient than before.

In closing, I like the idea of eliminating all subsidies for all energy sources. I am passionately against ANY surcharge to achieve the goal of some bureaucrats’ idea of full cost pricing.

mary rose dayocNovember 26th, 2012 at 10:54 pm

the topic's in the interview were all true. Many of us use the natural resources to have good wealth, they did not bother to think hundred tmes what will happen for the next past few years. Oil pricing is one of the reason of some of the countries,oilprice is simultaneously increasing rather than decreasing. In these case it can affect the lives of those who has limited source of income especially those who has not