Petrocapita : EROEI has peaked

Haven’t heard of EROEI? You can be forgiven if its not a
topic that is on the tip of your tongue with issues of sovereign
insolvency, QE3 and the like dominating the airwaves.
I feel confident that EROEI is an acronym that will receive much
wider recognition over the next decade. What is EROEI you
ask? It requires energy to produce energy and that relationship is
expressed as “Energy Return On Energy Invested” or EROEI for
short. Why is EROEI important? Because we are in the process
of transitioning from high EROEI sources of hydrocarbon energy
to low EROEI sources – think Saudi Arabia versus the Alberta oil
sands.
Even if you don’t believe that peak oil is an issue, I would
argue that EROEI decay is most certainly one. Discoveries of
conventional oil total around 2 trillion barrels, of which around 1
trillion barrels have been extracted, leaving approximately 1 trillion
barrels remaining. However the first trillion barrels was found on
shore or nearby, shallow and concentrated in large reservoirs
and generally in politically stable regions – the “easy” oil. The
remaining oil is far offshore or deep underground, in smaller,
harder-to-find reservoirs and mostly in politically unstable locations
– the “difficult” oil.
I believe an increasing dependence on “difficult” oil has some
serious consequences for the global economy.
– The amount capable of being produced from a given quantity
of reserves – the delivery capacity – will be reduced. This
will make it harder to increase overall production even where
reserves remain theoretically abundant.
– The cost of extracting remaining reserves will escalate in
terms of the energy inputs required which in turn will drive real
energy prices upwards.
Current production is around 86 million barrels of oil per day
(“BOPD”). However an 86 million BOPD oil production profile of
high EROEI sources is very different from 86 million BOPD of low EROEI sources. Effectively the net energy left over
to drive economic growth is significantly lower in the
latter scenario. Here are some highly approximate
EROEI ratios for various energy sources:
– 1970s oil & gas discoveries – 30 to 1
– Current conventional oil & gas discoveries – 20 to 1
– 1980 coal – 20 to 1
– Oil Sands – 5 to 1
– Nuclear – 4 to 1
– Photovoltaics – 4 to 1
– Biofuels – 2 to 1
To engage in a simplistic piece of analysis, assuming
86 million BOPD composed of 1970s oil & gas
reserves – there is around 83 million BOPD net to fuel
growth. Assuming 100% biofuels then this drops
to 43 million BOPD. The farther down the list we
must go to maintain supply the worse the net energy
situation becomes.
Why do we care about this?
Economic growth is in large part a surplus energy
function as well summarized by Chris Martenson
in his book “Crash Course”. A reduction in surplus
energy will increase energy prices at the same time
it is putting pressure on growth. If the real cost of
hydrocarbon energy is going to increase then the
real cost of other commodities will also increase as
most have significant energy inputs. On balance, I
believe the net result will be a transfer of wealth from
commodity consumers to commodity producers.
In less vague terms, the prospect of deteriorating
EROEI will certainly increase food prices, as modern
agriculture depends heavily on the use of fossil fuels –
for machinery, irrigation, fertilizers, herbicides, storage
and transportation. Here are just a few examples:
– The US and Canada export million of tons of grain
every year – grain that contains large quantities
of nitrogen, phosphorus, and potassium. The
ongoing export of grain would slowly drain the
inherent fertility from cropland if the nutrients were
not replaced with man-made fertilizers.
– Irrigation accounts for approximately 20% of US
farm energy use and in water constrained locales
such as India over half of all electricity is used to
drive irrigation pumps.
A rhetorical question – if declining EROEI drives up
the real cost of agricultural commodities will it confer
a competitive advantage on land with lower energy
intensity – e.g. no need for irrigation and low fertilizer
use – such as Canadian prairie farmland?
I believe the twentieth century trend of low real
commodities prices is in large part a reflection of the
abundant, high EROEI supplies of energy that were
available during that period. Without new sources of
high EROEI energy I would argue that this favorable
trend will reverse.
If this is the case then significant amounts of wealth
will be transferred from commodity consumers to
commodity producers – particularly to producers
of commodities with the most inelastic demand
curves. Declining EROEI is in part why I believe in 1)
direct investments in western Canadian commodity
production assets and 2) in investments that serve as
proxies for the increasing real cost of commodities –
e.g. businesses linked to commodity production.

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