﻿﻿Over the past three weeks, the second-largest economy in the world has been subject to rolling
blackouts, with more than half of all Chinese provinces now being subjected to strict power
rations. Businesses are being forced to close early, factories are being told to reduce output
and even bare essentials like traffic lights and elevators are going out with little to no warning
causing all manner of chaos in a country with a lot of traffic and a lot of high rise buildings.
The real tragedy here is that this is all simply a market failure. There haven’t been any natural
disasters or conflicts which have destroyed electrical lines or shut down power plants,
in fact, the country's capacity to produce and provide energy is the best it’s ever been.
So there is something more going on here. But regardless of root causes, this could not have
come at a worse time. China was in the process of rebuilding its economy after the pandemic,
preparing to host the winter Olympic games all while simultaneously fighting off the collapse of
some of its largest companies. Even at the best of times, power outages like this can be devastating
because well for as long as economies have existed, they have at their core been mechanisms
that value energy almost above all else. Economic prosperity, and by extension, standards of living
are highly correlated with access to energy, so much so so that some economists and scientists
have theorized that energy might actually be the de facto currency of the future,
or maybe at the very least a really good store of value. In many ways, it actually almost is
today. But there are a few things we need to understand before we get into that.
So. What is the fundamental reason behind the Chinese blackouts? What could this teach us
about our modern global economy’s relationship with energy? And, finally, What could we learn
from this issue when inevitably faced with our own energy challenges in the coming decades?
Intro Add China’s energy crisis actually started 2 years ago when the government rolled out reforms
in an attempt to liberalize the energy industry in the nation. Up until that point, the relationship
between the energy plant operators and the grid operators was almost entirely dictated by the
government. The companies that ran the plants would produce a given amount of power and sell
it to the grid operators for a set price and those grid operators would provide that energy
to businesses and households for a slightly higher price, turning themselves a profit. Now,
this might be a bit controversial but, energy generation and distribution is actually one of
those markets that does well for itself by having a few government controls put in place for a few
reasons. For starters, it’s a market prone to being monopolized. The extremely high barriers to
entry of building a power station or laying out an energy grid mean that only the largest companies
in a given country could even consider making the investment necessary to compete with an existing
provider. It’s also heavily dependent on land as a factor of production. As with all products,
producing and supplying energy requires a certain combination of land, labor, and capital. We have
already seen that the capital requirements as in the power plants and the power lines are
extremely significant, but the land is perhaps even more of a hurdle to entering this market.
Power lines take up a significant amount of space spread out all over suburbs and
industrial centers and people naturally don’t like them hanging around their homes either.
If bringing a competing energy source to market meant building out a competing energy grid,
then unsightly power lines, substations, and high voltage energy towers would be multiplied by two,
or if there are lot’s of operators in the market it would be multiplied by however many companies
have decided to build out their own infrastructure in order to compete for end-user dollars. Despite
this being very materially wasteful, it’s also comically unfeasible because with just
a dozen or so providers all of the usable land around urban areas would be taken up by a cobweb
of competing energy lines. It’s for this reason that utilities like roads, plumbing,
and electricity are subject to strict government regulations. In many instances,
they are just totally government-run, but even when they are privatized they are normally sold
to large companies with an equally large rule book about what they are allowed to do coming with it.
This is exactly what has happened in China. There are hundreds of power plants all over
the country that are primarily coal-fired. These energy plants sell their power to grid operators
who are required by law to sell their energy for a pre-set price. This pricing regulation
means that the grid operators who have an effective monopoly on energy distribution
can’t charge whatever they want for that power in order to generate massive profits, they instead
have to charge this government-mandated price which eliminates the problem of the monopolies
pricing power. But it does cause another problem. The energy grid can only reasonably
purchase energy from the providers for a price lower than what they are allowed to sell it
at. So if for example the price of coal more than quadruples within twelve months then it’s going to
cost more to produce coal-based electricity than these grid operators are allowed to sell it for,
so they just don’t buy the electricity and the power stations don’t produce it.
There are millions of homes and businesses across China right now that would be willing to pay a
higher price for access to reliable electricity, but due to regulations, that’s just not possible.
This issue has been compounded by ongoing trade tensions with Australia who has historically been
China’s largest coal provider as well as a push by certain local authorities to actually reduce
coal burning ahead of the 2022 winter Olympics in an attempt to avoid smog which could make the
country look bad on the world stage. This is a very interesting issue with so many moving parts
that it really is hard to see what will end up happening, but I am not actually bringing this up
to talk about any fundamental issues or speculate on future problems within China, I am actually too
scared to do that anymore. --- All jokes aside though there is nothing necessarily unique about
China's situation, we even saw similar issues last year in Texas with their variable pricing models
leaving millions without power and millions more with devastating energy bills. In fact,
this is all perhaps a symptom of a much larger economic factor, and that is the relationship
between Energy and prosperity When we are looking at indicators and predictors of economic well
being there are a few things that economists will turn to to paint a picture. GDP per capita, life
expectancy, educational attainment, corruption and even combinations of these factors used to
make things like the Human Development Index. But perhaps one of the strongest determinants
of prosperity is access to energy. If we look at a list of the countries that consume the most energy
per capita, it lines up almost perfectly with a list of countries ranked by GDP per capita. The
same is true if you just want to look at aggregate numbers, total energy consumption and total GDP
tell a very similar story. But this raises two important questions. Is this a case of
richer countries naturally using more energy to power more luxurious lifestyles, or is it that
countries with more power naturally become richer? And then whatever the answer to that question is,
how do we explain this, China is using 7.5 million gigawatt-hours of electricity per year,
which is almost a third of the world's total electricity usage, and more than the next seven
largest economies in the world combined. Despite this, their economy is (for now) smaller than
America’s and certainly much smaller than all of these other economies combined. So what is going
on here, is there some reason for this massive apparent inefficiency? Let’s take America as a
generic advanced economy, its electricity usage is pretty evenly split into residential, commercial,
and industrial. There is also a tiny fraction of a percent which is used for transportation,
as in electric cars, busses, and trains, but for now, we can pretty much ignore that.
Residential consumption is the largest share of this usage, and it accounts for basically
everything done within the home, it also accounts for home-based businesses. If, for example, you
are running a computer to work from home or maybe even mining bitcoin in your basement, these are
supposed to count as commercial usage, but the EPA which created this report really does not have an
effective way to track that so it kinda just gets bundled into residential. Despite these outlying
factors, we can generally assume that this is the sector that is energy usage as a result of wealth,
rather than the sector that is growing wealth. If we want to look at energy usage that
creates wealth, we need to instead look at the commercial and industrial sectors. And by the way,
if you are confused about the difference between the industrial sector and the commercial sector,
don’t worry I was too. Basically, commercial is made up of office space, shop fronts warehousing,
anything that goes into running a business that’s not actually physically building a product.
When you think of the industrial sector, just think of fair dinkum, factories, refineries,
smelting plants, and yes, ironically enough, even power stations. As of 2020, the industrial
sector accounts for less than a quarter of all electricity usage in the United States, and
it was a similar story even before the pandemic. When we compare this to China, we can see that 81%
of their energy usage goes toward industry, with just 8 and 12% going towards commercial
and residential applications respectively. Now, this might not come as a huge surprise,
most of you watching are well aware that China has a much larger industrial sector than the US,
except it doesn’t really. China’s industrial sector had a nominal output of 4.7 trillion USD
in 2017, whereas the US had a nominal industrial output of 3.6 trillion dollars in the same year.
If we reverse engineer the numbers a bit here we can find that China is using about 6 million
gigawatt-hours on industry while the US is only using 1 million gigawatt-hours on industry. The
upshot of that is that the US is almost 5 times more efficient at turning electricity into value,
so again, what’s going on here? Well, the first thing of course is that China's data may not be
super reliable. Almost every other country on this list got its energy production figures recorded by
the EIA which stands for the Energy Information Administration, an American organization tasked
with collecting information on energy production and usage all over the world. China instead elects
to publish its own figures through the state council which is fine, but they do put a bit
of a political spin on what is supposed to be boring objective data. Look there really is no
way of knowing if this is accurate or not, but the government knows energy usage is a very closely
monitored statistic amongst decision-makers around the world, so it’s not unrealistic to think they
might have massaged the numbers a bit, something, something the chocolate ration has always been
20 grams. Again you make up your own mind on this one because your guess is as good as mine.
Even if we ignore this issue the biggest reason for this apparent imbalance is something called
purchasing power parity. A dollar in China buys you a lot more than a dollar in the United States,
especially when it comes to manufactured goods and electricity. If we balance for this purchasing
power then China's industrial output goes from being about 30% higher than America's to almost
200% higher than America's. In effect they are genuinely making a lot more stuff than America is,
it’s just that, that stuff is worth a lot less in the Chinese market. This adjusted figure
means that china does still use more electricity per dollar in manufacturing output than the US,
but not by much. If we assume that the actual electrical output figures are overstated by
some degree then they might genuinely be on parity. Now what all of this means is that energy
is really unique in the sense that it is both the chicken and the egg of economic wealth,
it is both useful for creating wealth, and instrumental in determining wealth. For
that reason, it can almost be thought of as the Unrecognized Global Currency. Currencies are a way
to store and use value in an efficient manner. If you work a regular job you are trading the value
of your time and your skills for money.That money is effectively a way for you to store that value
until you use it to purchase a good or service which in theory should be equal in value to what
you contributed to your employer. I know that very broad definition might make a few people angry but
that’s the theory. Now money can take a lot of forms, gold coins, digits on a computer,
paper rectangles, seashells; it doesn't really matter so long as people agree it has value.
Now that value can be very abstract, I am sure there are some of you watching that will say
that fiat currency, which is by far the most common currency in use around the world today,
doesn’t truly have value. Those same viewers might advocate for a return to the gold standard because
gold is a little bit more tangible as a store of value, especially since it can’t just be created
out of thin air. But even gold derives a majority of it’s value from people believing it has value.
Sure it’s rare and it’s a great conductor and it looks kinda pretty, but it’s just a metal,
being stuck on a desert island with a gold brick is just the same as being stuck on an
island with a wad of cash. And actually a quick side note is that gold's scarcity is
actually a major problem when trying to use it as a currency. Most economies around the world today
try to target a low level of inflation, around 1% - 3% depending on the central bank. They do
this so people are motivated to either invest or spend their money which stimulates the economy.
If a finite resource like gold was used as a currency then a lot of people would choose
to just sit on it knowing that the economy will grow, but the supply of money won’t, making their
holdings more valuable every year. This stagnation would stifle economic growth which is why most
economists see moderate inflation as preferable to deflation. Anyway, all of this is to say that
gold is not much better than paper rectangles when it comes to being a store of true value, they both
depend almost entirely on people agreeing they have value. This is where energy is different.
It really does have value, both in the sense that it can be used to make other things of value, and
because it can be used to improve you own quality of life. Not just humans, but all life as we know
it has valued energy above almost everything else. Trees reach for the sun to conduct
photosynthesis, lions hunt zebras to feed on their calories and humans fight entire wars over access
to oil fields. An economy that just prints lots of money isn’t necessarily rich and even all the gold
in the world doesn't mean much unless it can be traded for something else. Just ask Midas. But an
economy that can produce lots of energy is simply wealthy. Not enough water? oh well, just use
desalination plants, no natural resources? That’s fine, just import them, then use your limitless
supply of energy to transform those raw materials into a value-added product, export that product at
a markup, and then import even more raw materials. This is actually basically what Iceland does today
to a less extreme degree, so if you want to learn about how this plays out in reality go and watch
that video after this one. Economics is a study of scarcity and theoretically, any economic problem
can be solved with unlimited energy. What’s more, is that sure energy can’t be created or destroyed
but it can be transformed into more usable forms almost endlessly. Someone sitting on a life
savings of kilowatt-hours is likely to see the value of those savings decrease over time as an
economy increases its capacity to generate energy in usable forms. Of course, if this energy-based
currency was to become a reality we wouldn’t be walking around with pockets full of batteries,
we would likely do what we did with gold back in the day and trade in bills denoting a set value
of energy that would be stored somewhere which is better equipped to house it. Like a battery bank.
Anyway, is this likely to be adopted? Of course not, at least not in the immediate future. But
understanding this relationship between wealth and energy can actually be a very insightful way
of viewing global economic events at almost any scale. The author and economist Vaclav Smil does
this in a number of his books and I definitely suggest checking them out if this was at all
interesting to you. He goes into much more detail and can obviously address much more nuance than
is possible in a 20-minute video. But even still thinking of energy as a true store of value can
make issues like what is happening in China at the moment much easier to break down and
understand. It can also be useful on a smaller scale, if you're looking for a business idea,
don’t think of a better way to make and save money, think of a better way to make and save
energy, in the long run, it’s going to be more valuable. Now of course to do that,
you are going to need to know something about thermodynamics, or battery technology or maybe
even workflow optimization. Fortunately, you can learn all of these things… with Skillshare.