Industry and Business, Energy as a Factor of Production in

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The production of goods and services requires energy as an input, which is called a factor of production. Energy sources vary in their effectiveness as a factor of production, depending on their energy characteristics. The energy characteristics are measured in energy grades, which indicate the levels of usefulness of any given energy input. Low-grade energy resources are less useful to an economy than high-grade resources, because any given process will be able to produce more economic value from a high-grade energy resource than from a low-grade energy resource. For example, it is easier to fly a passenger jet aircraft using jet fuel rather than coal because jet fuel has more suitable energy characteristics.


There are four energy grades used to measure energy characteristics: weight, volume, area, and state. The weight grade is British thermal units (Btus) per pound of the energy resource. For example, coal has 10,000 Btus per pound, while oil has 20,000 Btus per pound, making oil the higher-grade resource. The volume grade is Btus per cubic foot of the energy resource. Oil has 1 million Btus per cubic foot while compressed natural gas, at 3,000 pounds per square inch, has 177,000 Btus per cubic foot, which makes oil the higher-grade resource. The weight and volume grades are important determinants for how easy energy is to transport. Light, compact energy sources are much easier to store and use than heavy, voluminous energy sources. The area grade is Btus per acre where the energy resource is found in its original state. Wood has 1 billion to 5 billion Btus per acre as a forest, whereas coal has 10 billion to 1 trillion Btus per acre in a mine. The area grade generally determines how costly it is to extract or produce energy. Energy that is diffuse over an area, such as trees in a forest, tends to require more capital and labor to extract each Btu of energy than concentrated sources. The state grade is the original physical state of the energy resource, such as a liquid, gas, or solid as measured at standard atmospheric temperature and pressure. The highest state grade is the liquid state, followed by the gas state, the solid state, and the field state. The liquid state is the highest state grade because liquids are easier to use than gases and solids. The field state is the lowest state grade, since energy from energy fields such as solar energy is difficult to store. The field state is any kind of energy field such as a magnetic field, an electric field, or a radiation field. Nuclear energy is a field state grade, since it derives its energy from a radiation field. The state grades are fundamental in determining how well various energy resources can produce economically valuable outputs.

High-grade energy resources can create higher-valued, lower-cost outputs. For example, oil is one of the highest-grade energy resources there is. It is a liquid that is a very high state grade. It has a high weight and volume grade, better than any other energy resource except nuclear fuels, making it cost-effective to carry with a mobile machine. For example, chain saws and automobiles work better with a light-weight fuel than with a heavy fuel, because there is less fuel weight to carry. Oil also has a high area grade—100 billion to 1 trillion Btus per acre in oil fields—which makes it easier and cheaper to produce. Because oil is a liquid, it is easy to extract with no mining, and it is easy to convert into a refined liquid fuel. Finally, liquid fuels are the easiest of all energy resources to store and transport. Liquid fuels can be used in internal-combustion engines, which are lighter in weight and have more power per pound than external-combustion engines (steam engines) that operate on solid fuel (coal). And although internal-combustion engines can operate more cleanly on natural gas, the infrastructure needed to compress and store gas is much more complex and expensive.


For any energy to produce goods and services, it goes through a sequence of usage called an energy utilization chain (EUC). The EUC determines how energy will be used to produce goods and services. Link 1 of the EUC is simply obtaining the energy source. This includes exploration and extraction of the energy or in some way producing it. Link 2 is energy conversion. More often than not, energy must be refined or converted into a more useful form of energy for consumption to occur. Link 3 is energy transportation and storage. All energy must be brought to the consumer or firm for use and if necessary be stored for later use. Link 4 is energy consumption. This is where energy is burned or used up. Conservation of energy resources is also a part of link 4—that is, consuming less energy resources in link 4 is conservation of energy. Link 5 is the energy service. The ultimate end of using and consuming any energy resource is to provide some sort of service to society. The service can be used directly by consumers or be an input into the production of other goods and services.

The use of oil for transportation, such as in automobiles and in aircraft, for example, is generally called the oil EUC. The chain of EUC links are the following: the exploration and production of oil; the transportation of the oil by pipeline or tanker; the refining of the oil in a refinery; the transportation of the gasoline to filling stations; the consumption of the gasoline in automobiles, which is sometimes conserved by the use of high-mileage cars; and finally the transportation service from driving the automobile. The EUC then explains the system for using energy. If an alternative energy resource is used to replace oil, then some or all of the EUC links must change. For example, replacing the oil EUC with coal converted into oil, requires only changing the first two links of the oil EUC. Using solar energy to replace the oil EUC may require all of the links to change. For example, gasoline-driven automobiles would be replaced with electric vehicles, which give different services than normal automobiles. Electric vehicles based on solar energy may have less range of operation, carry less cargo, and take longer to refuel than ordinary automobiles.

The oil EUC is one of the highest-value EUCs in the economy. Alternative EUCs for transportation are the natural gas EUC, the solar/electric EUC, the synthetic fuels EUC, and so on. The reason it is so costly to use these alternative EUCs to replace the oil EUC is because of the low energy grades of the energy sources for the alternative EUCs. For example, to replace the oil EUC with an ethanol alcohol fuel, the alcohol EUC would have to use industrial distilleries to convert grain into alcohol. However, grain has a low area grade of about 40 million Btus per acre, as compared to oil's 1 trillion Btus per acre. Oil has about five magnitudes greater energy per acre in its original state, making it much cheaper to produce. It takes about 100,000 acres of farmland planted in grain to equal one acre of an oil field. In terms of supply, it takes about three times as much capital and 10 times as much labor to extract a Btu of ethanol from farmland as to extract a Btu of gasoline from an oil field. If all U.S. farmland were used to make ethanol, it could replace only 35 percent of U.S. oil needs. In addition, the grain needs to be converted from a solid-state grade energy resource into a liquid. Because oil is already a liquid, this transition is much easier and cheaper.


In the future, as oil and other energy resources begin to deplete, the economy will need to use alternative EUCs. One alternative EUC is the solar EUC. Solar energy is a field grade—that is, it is and energy radiated in light waves similar to an electric field. Because it is a field, it cannot be stored easily. An acre of solar collectors can catch about 65 million Btus per hour. One hour of an oil field operation on one acre of land can produce 2 billion Btus. The oil requires much less capital to extract its energy than does solar energy. This is why it is cheaper to obtain energy from oil than from solar energy; in addition, it is easier to convert, store, and transport the oil energy, allowing it to produce cheaper and more useful energy services than solar energy can. Once oil supplies decline substantially, the economy may be forced to use the solar EUC, but at a substantially higher cost than for the oil EUC.

Alternative EUCs provide the economy with energy services such as transportation at a certain cost. Usually, low-cost, high-value EUCs are used wherever possible and are used before higher-cost, lower-value EUCs. However, as a high-grade energy resource declines, lower-grade energy resources must be used, meaning the economy must begin to use higher-cost, lower-valued EUCs—that is, the cost of energy as a factor of production may rise, at least in the short run. In the longer run, breakthroughs in advanced energy sources, such as from hydrogen, may actually lower energy costs. The cost structure of alternative EUCs, though, depends on the cost of inputs. Ironically, one of the inputs that goes into every EUC is energy itself. It takes energy to produce energy. For example in the case of the synthetic fuels EUC, oil shale is used as an energy source to replace crude oil. To produce oil from oil shale, the oil shale must be converted from a solid-state energy grade into a liquid energy grade, which requires much more capital and labor inputs than does converting crude oil into fuels. However, the capital and labor require energy to produce oil from oil shale. When the price of oil goes up, the costs of the labor and capital inputs also rise causing the price of the shale oil to go up. In 1970, before the first oil shock, oil from oil shale cost about $3 per barrel to produce, while oil cost $1.50 per barrel. However, by 1982, when oil was $30 per barrel, shale oil cost $60 per barrel to produce. The high cost of oil made other inputs into the synthetic fuels EUC cost more, creating a higher price for the synthetic fuel, which in turn resulted in an inflation cost spiral. The nature of energy grades and the inflation cost spirals of inputs into the EUCs tend to make it difficult to pin down the cost of energy.

In general and in the short run, alternative EUCs have higher costs and lower-valued services than currently used EUCs. As the economy begins to use alternative EUCs, they tend to cost more, possibly creating an inflationary cost spiral. Technology can help to make alternative EUCs cost less and create more value, but is not likely to change the physical characteristics of alternative energy resources in the short run, making alternative EUCs overall less valuable than currently used high-grade-energy EUCs. One way to deal with higher-cost, lower-value alternative EUCs is for society to change its lifestyle. The value of alternative lifestyles must be evaluated in comparison to the cost of alternative EUCs. Higher-cost EUCs may force society into changing lifestyles to be able to afford energy services.

In the longer run, perhaps new alternative EUCs, even superior to the current high-grade-energy EUCs, can be developed. This possibility offers the opportunity of defeating any energy-induced inflationary cost spiral that might have developed, and opening up new possibilities of economic expansion driven by inexpensive energy as a factor of production. Given the critical role of energy to the production process, our economic output in the future is dependent on further advances in energy technology.

Douglas B. Reynolds

See also: Auditing of Energy Use; Capital Investment Decisions; Economically Efficient Energy Choices; Energy Economics; Industry and Business, Productivity and Energy Efficiency in.


Cuff, D. J., and Young, W. J. (1986). The United States Energy Atlas, 2nd ed. New York: Macmillian.

Graham, S. (1983). "U.S. Pumps $2 Billion into States Oil Shale." Rocky Mountain News, July 31, pp. 1, 22, 25.

Katell, S., and Wellman, P. (1971). Mining and Conversion of Oil Shale in a Gas Combustion Retort, Bureau of Mines Oil Shale Program Technical Progress Report 44. Washington, DC: U.S. Department of the Interior.

Reynolds, D. B. (1994). "Energy Grades and Economic Growth." Journal of Energy and Development 19(2):245–264

Reynolds, D. B. (1998). "Entropy Subsidies." Energy Policy 26(2):113–118.

Ricci, L. (1982). Synfuels Engineering. New York: McGraw-Hill.

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