March 24, 2010

Fuel Efficiency Paradox (aka Jevons Paradox)

If you become more efficient at your job, do you go home early? No. You produce more output using the same amount of time.

The same goes for energy.

Here’s something to consider when we’re being bombarded with PSAs on energy efficiency. The following shows why better efficiency may not reduce consumption of energy.

Increased energy efficiency can have two outcomes within an economy:

1. The economy uses the same amount of energy, but at a lower cost.
2. The economy uses more energy, but at the same cost.
In a system with competing economies, businesses and individuals, outcome 2 is more likely.


Since energy usage drives economic growth, which is tied to corporate, political and military power, economic participants that are able to use more energy at the same cost will grow and become rich and powerful. On the other hand, economic participants that choose to use the same amount of energy at a lower cost will fall behind.

One can view oil as a form of capital, and energy efficiency as a return on capital. Greater energy efficiency is equivalent to a greater return on capital. As the return on capital increases, so too does the demand for capital.

Alternatively, one can also view energy efficiency as an energy subsidy. When something is subsidized, people tend to consume more of it. [In fact, energy subsidies are a growing problem in many OPEC countries where oil revenues are used to subsidize the cost of fuel. This has resulted in rampant energy use in these countries, and domestic OPEC consumption is increasingly competing with oil exports to America, Europe, China, etc.]

Greater energy efficiency leads to greater energy consumption…evidence?

Look at the US since the 1970s. Automobile fuel efficiency has increased dramatically, but this has not resulted in less fuel consumption. Instead, it has enabled greater consumption through economic growth and ‘innovation’:

- There are 130 million more drivers on the road in the United States today vs 1970
- 2 and 3 car families have increased
- Annual miles driven per person is now about 12,000 vs 9,500 in 1970
- There are more energy-consuming features in cars (e.g. air conditioning, on-board computers)

So, improvements in fuel efficiency resulted in more cars and greater car usage. This contributes to greenhouse gasses and speeds up the depletion of scarce resources.

So how do we reduce energy consumption, assuming that is the goal?

We make oil and gas more expensive and develop cheap, efficient alternatives that don’t simply make it easier to consume traditional fossil fuels. That means solar, wind, hydro and geothermal are the answer.

Bottom Line for Investors:
1. Solar, geothermal, hydro, wind have huge potential over the next several years.
2. High oil prices will be the ‘cure’ that weans people off depleting oil resources.
3. As long as ‘efficiency’ (e.g. hybrid vehicles) is sought as a goal, rare earth metals provide a opportunity to to invest, as they are scarce and required to produce batteries.