The Jevons Paradox
Comment of the Day

March 07 2011

Commentary by Eoin Treacy

The Jevons Paradox

Over the weekend I was browsing the web for a history of shale gas and came across this highly informative blog posting by Kathy Shirley dated August 2008. I recommend it to anyone interested in an account of when and how various shale gas resources have been exploited in the USA. Two things stuck in my mind on reading this account. The first was that shale gas is by no means a new phenomenon. The technology used in extracting it today was developed more than 20 years ago. The second was a discussion of the Jevons Paradox. Here is a section from Wikipedia which has more information:
In economics, the Jevons paradox, sometimes called the Jevons effect, is the proposition that technological progress that increases the efficiency with which a resource is used tends to increase (rather than decrease) the rate of consumption of that resource.[1] In 1865, the English economist William Stanley Jevons observed that technological improvements that increased the efficiency of coal-use led to the increased consumption of coal in a wide range of industries. He argued that, contrary to common intuition, technological improvements could not be relied upon to reduce fuel consumption.

The issue has more recently been reexamined by modern economists studying consumption rebound effects from improved energy efficiency. In addition to reducing the amount needed for a given use, improved efficiency lowers the relative cost of using a resource, which increases demand for the resource, potentially counteracting any savings from increased efficiency. Additionally, increased efficiency accelerates economic growth, further increasing the demand for resources. The Jevons paradox occurs when the effect from increased demand predominates, causing overall resource use to increase.

Eoin Treacy's view Energy efficiency gains have always been reinvested in consumption. A simple example of this is that even though cars are considerably more fuel efficient today, energy savings have been used to bring down the cost of production and increase the number of added extras such as electric windows, heated seats and air conditioning. The result is that people can live farther from their places of work, afford larger cars and pay less for them. Car ownership has increased and gasoline consumption is well above where it was 20 years ago.

I'd like to examine the Jevons Paradox in the context of how it affects energy supply and demand. When energy prices are low, those who consume energy are under less pressure to innovate because they don't need to. They have access to ample supply for their needs and will tend to focus on other areas of interest. During the lengthy energy bear market that persisted from the 1980 peak near $35 to when oil completed its base in 2004, demand for energy alternatives such as wind, solar and nuclear was at a low ebb because there was no perceived need for them.

On the other hand, when energy prices are low suppliers are under the most pressure to innovate. Only the lowest cost producers have a chance at survival. At the margin, innovators have to figure out how to minimise costs in order to remain competitive. Technological innovations such as horizontal drilling and various forms of hydraulic fracturing were developed at a time when the pricing environment for energy was challenging to say the least. Necessity is the mother of invention and low prices helped to drive the need to create production efficiencies. This does not mean that necessity is the only component necessary for discovery but it does often have a considerable bearing on which ideas get funding.

The energy production efficiencies gained in the 1980s and 1990s were reinvested in consumption and helped to raise standards of living. The pass through of these efficiencies has also contributed to the increase in per capita consumption in Asia and Latin America. From the early 2000s demand began to outstrip supply and prices began to rise. When energy prices are high, there is less need for suppliers to innovate. Previously uneconomic production areas become viable and existing technology, with some tweaking, can be used to exploit them.

When prices are high, the demand component has no choice but to either cut consumption or to innovate so that the same level of service can be sustained at a cheaper cost. CFL light bulbs have only really gained prominence since energy prices began to rise. Government subsidies for solar and wind power are now more generous than ever because high energy prices improve their competitiveness. The number of nuclear power plants under construction has multiplied in the last decade as the need for a reliable source of energy at a competitive price has been made more compelling. Recycling is now more important than ever because of the energy conservation implicit in the process. Massive investments in battery technology are being made because of the sense of urgency sparked by high energy costs.

High energy costs contribute to demand destruction for as long as prices remain high, until new consumption efficiencies are created or a new low cost of production is found.

At today's level of $105, crude oil prices are beginning to get to a stage where demand destruction could set in. Some consumers will simply no longer be able to use as much energy. At some point (last seen in 2008) energy prices get to a point where they inhibit economic growth and cause recession. This is a temporary solution to energy supply and demand because once energy prices fall, the demand component kicks back in and the cycle begins once more.

Investments in energy efficiency either through high cost alternatives to fossil fuel such as wind and solar are primarily aimed at cutting consumption and bringing down prices. However, they have so far been unsuccessful in mitigating the rise in the marginal cost of energy despite massive investment.

Battery technology holds out great hope to lower energy consumption by evening out variability in supply however, the necessary technological advances have not yet been made. (Also see Comment of the Day on January 27th).

Natural gas prices are low today because technology developed in the energy bear market can profitably be applied to previously inaccessible reserves. A surfeit of supply is helping to depress prices. The higher oil and other energy prices rise, the more competitive natural gas becomes. If the Jevons paradox tells us anything, it is that demand will invariably rise for an energy source which is cheap and abundant relative to other sources.

The building of LNG terminals is helping to create a global market for natural gas and consumption is expected to rise more than 50% in the next 20 years. This comparatively clean fuel should also help it to gain credence among the green lobby and it is reasonable to expect that the number of uses for the fuel will increase over time.

Cost to the end consumer should be the central aim of all energy policy. Greater efficiency as well as new cheap sources of supply will be required to help improve global economic growth and raise standards of living.

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