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Page added on March 5, 2014
EROEI: Economics Without the Money
“For some years now,” Tim Morgan writes in Life After Growth, “global average EROEIs have been falling, as energy resources have become both smaller and more difficult (meaning energy-costly) to extract.”
You may have heard of this concept called energy return on energy invested (EROEI). It looks at how much energy we expend in relation to how much energy we extract. Some, like Morgan, think this is very important.
Consequently, falling EROEIs have become the basis of a variety of dire forecasts…
Be skeptical of anything that seeks to analyze our economy by taking money out.
In these scenarios, we spend more and more energy just getting energy, and we have less and less for other discretionary items. As Morgan writes, “If EROEI falls materially, our consumerist way of life is over.”
I’m writing to you today to slay this flawed EROEI concept.
I have to say I used to be taken in by this argument. I wrote an issue of my Capital & Crisis newsletter a couple of years back with the headline “Crack This Code: EROEI — Why It Matters Now and What to Do About It.” I included a list of approximate EROEI ratios for various energy sources:
- 1970s oil and gas discoveries: 30-to-1
- Current conventional oil and gas discoveries: 20-to-1
- Oil sands: 5-to-1
- Nuclear: 4-to-1
- Photovoltaic: 4-to-1
- Biofuel: 2-to-1
I noted that such ratios were falling and concluded that a lower mix of EROEI sources means higher prices for many commodities, because “it will take more energy to produce them.”
It means nothing of the kind.
I would like to right my old error and convince you why EROEI is fatally flawed, so you don’t fall for it. I’ll use Morgan as the foil, because he is an articulate and strong proponent of the idea in his new book.
Morgan’s crucial assumption appears on page 5: “The economy is not primarily a matter of money at all. Rather, our economic system is fundamentally a function of surplus energy.”
This is the key to the whole EROEI argument. Morgan repeats it often. And it is completely wrong.
You can’t take money out of the equation! Money is what it’s all about. It is the essence of the economic life. It’s at the center of decision making. As economist Hyman Minsky said, “Money isn’t everything. It is the only thing.”
Be skeptical of anything that seeks to analyze our economy by taking money out. Households and firms make decisions based on money. They certainly don’t use EROEI, nor should they.
When a firm decides to drill a well or not, it does so on the basis of estimated costs and profits. It makes a decision based on some expected return — as measured in money. They are not the same. High-EROEI projects can be losers. Low-EROEI projects can be winners — as measured in profits and return on investment in money terms.
According to Morgan’s logic, you wouldn’t bother generating electricity…
Here is Robin Mills, currently with Manaar Energy (and once a petroleum manager for the Emirates national oil company in Dubai):
“Generating electricity, usually at a thermal conversion efficiency of less than 50% plus transmission losses, has an EROEI of much less than 1, but is still rational and economic because electricity is such a useful form of energy.”
Put another way, the money costs of the inputs are less than the money prices of the outputs. It works because… it’s profitable! People value electricity more than they value the inputs. Looked at through an EROEI lens, though, it doesn’t make sense.
You can build any scary resource scenario you want if you exclude money prices. If, say, falling ore grades were predictive of prices, then we would see continually rising prices for copper and other resources. Clearly, this isn’t the case. But this does not prevent people (usually geologists) from taking these moneyless concepts to make economic forecasts of higher prices.
A general rule of thumb: If it doesn’t take into account money prices, then it isn’t about the real-world economy as it exists today.
That’s my biggest objection to EROEI. But I’m not making a comprehensive case against EROEI here. That would take too long. I won’t get into how EROEI is calculated: there is no agreement and when you think about it, maybe it’s impossible to know with any accuracy worth relying on.
In the end, I think Morgan doesn’t really get modern money. He repeats an old myth about its origins. He doesn’t seem to know why fiat currency has value. (He says money is a “claim on real goods and services,” which only begs the question: Why do people accept dollars in exchange for real goods?) He doesn’t seem to understand the primacy of making a monetary profit in a market economy.
Contrary to Morgan, you can’t take money out and hope to understand the modern economy. You have to study money. And in markets, you have to make a money surplus (a profit) — or you are out of the game before long. I can’t say the same is true for EROEI, which is perhaps the best I can say against it.
You can ignore EROEI, but you can’t ignore money.
Sincerely,
Chris Mayer
for The Daily Reckoning
19 Comments on "EROEI: Economics Without the Money"
Nony on Wed, 5th Mar 2014 8:40 pm
Agreed. Good article, guys.
Also, EROI ignores time value of money. Two projects could have the same total energy input and return but go from a negative to a positive NPV based on discounting. Even if the energy forms were exactly the same for input and output (just different timing).
AWB on Wed, 5th Mar 2014 8:51 pm
What are you smoking?
gordianus on Wed, 5th Mar 2014 9:01 pm
Wow, let’s try and untangle this thicket of straw-men:
“Households and firms make decisions based on money. They certainly don’t use EROEI, nor should they”
That’s right – and I don’t recall anyone proposing that they should use EROEI for financial decisions.
“People value electricity more than they value the inputs. Looked at through an EROEI lens, though, it doesn’t make sense.”
It makes perfect sense – price is a function of supply and demand, not input costs, and the demand is driven by the relative utility of the inputs and outputs. EROEI provides some insight into the costs of production.
“A lower mix of EROEI sources means higher prices for many commodities, because “it will take more energy to produce them.” It means nothing of the kind.”
It means the production costs will be higher. It doesn’t say anything about prices.
“If, say, falling ore grades were predictive of prices, then we would see continually rising prices for copper and other resources.”
No, you wouldn’t. You would see continually rising costs of extraction, which would likely become visible in economic terms when the investment required to extract one unit of copper increases over time whilst the ore grades diminish – and this is exactly what we do see.
I haven’t read the book mentioned in the article, so I don’t know it proposes these arguments. Perhaps someone who has read it can let us know.
EROEI is not for financial decision-making or predicting prices and if you try to use it for that you will get the wrong answer.
Pops on Wed, 5th Mar 2014 9:16 pm
Yes ‘money is everything’ can’t argue with that.
consequently when the cost to find and extract oil is greater than the price the consumer can afford to pay for that oil, oil extraction stops.
No need for fancy formulas or theoretical theorems or convoluted conversions.
rockman on Wed, 5th Mar 2014 9:56 pm
And for what it’s worth, as we’ve estimated before, the EROEI of an oil/NG drilling project can’t fall much below 5 – 7 before the economic analysis kills it. And that includes the embedded energy.
Nony on Wed, 5th Mar 2014 10:21 pm
Does anyone even calculate it? I mean when they do an investment decision?
Harquebus on Wed, 5th Mar 2014 10:36 pm
Energy makes money, money does not make energy. You can spend as much money on renewables as you like, they will never provide positive energy returns.
peakyeast on Wed, 5th Mar 2014 11:18 pm
Money is imagination. Energy is reality.
You can ignore reality, but you cant ignore the effects of reality.
You can ignore imaginations and its a mutual choice to not ignore imagination and thats why money has any value.
JB on Wed, 5th Mar 2014 11:52 pm
Chatter. “Energy = Money” – Mike Ruppert
ERoEI is the same as Return on Investment (ROI). If it costs more to produce a given amount of energy, that cost will have to be passed on with higher prices.
Dave Thompson on Thu, 6th Mar 2014 12:20 am
Money is a concept as a medium of exchange for convenience purposes and control. The energy inputs of the economy stop flowing once the ability to maintain an energy surplus over inputs stops being possible.
Davy, Hermann, MO on Thu, 6th Mar 2014 12:40 am
Another Wall Street Wonk trying to be critical and in the process he shows his lack of understanding of the meaning of scientific formula. The analysis is best used from a societal standpoint to determine the sustainability and resilience of its energy sources in relation to a societies energy requirements. I might add at a certain point a low EROI falls off the cliff and it should be a warning sign to society and investors alike. Just witness the whole oil shale fiasco in the 80’s. It is a powerful formulation for society to understand itself. It is not meant as a formula for a Wall Street algorithm.
Makati1 on Thu, 6th Mar 2014 12:48 am
Most of our modern world exists because the EROEI was high. At first there was surplus that allowed religions to have hired priests, and then kings, who produced nothing and lived off of the excess production (money) provided by farming. That was the limit until we started to harness the stored energy of the sun in the hydrocarbon deposits. Then we went crazy with unnecessary careers. (Unnecessary meaning not an actual necessity like food, shelter, clothing, etc.)
Now we have hit the limits and those unnecessary careers will disappear. First to go will be people in fields like: travel agencies, airline staff, Disney employees, hotel staff, factory workers making unnecessary stuff, investment consultants, insurance companies, etc. Anyone not involved in producing necessities will eventually disappear, along with hydrocarbon contraction. That is about 90% of the people in the Western world. Maybe 40-50% in the 3rd world. They will turn farmers or die.
Money was ‘invented’ to handle the excess in trade and allow the bankers to rig the system in their favor. ‘For profit’ Capitalism was invented when there was enough excess money to make it possible. That too is dying as excess energy contracts.
We have lived in a brief (200-300) year bubble where many things were possible from the stored hydrocarbon wealth. Now we have to get used to the idea that we are returning to the pre-hydrocarbon lifestyle . That is IF we do not go nuclear and destroy what is left of our world.
Stilgar Wilcox on Thu, 6th Mar 2014 1:33 am
EROEI is wrong, but money is right?
Why do we even bother extracting oil then? Why not just set up a huge building printing money and make everybody a trillionaire. When we need to fill up our vehicles we’ll stuff them with 20’s. When we launch something into space we’ll stuff the bottom with 100’s. Maybe I’ll start tomorrow morning by energizing myself with a bowl of 5’s.
Poordogabone on Thu, 6th Mar 2014 3:58 am
“I noted that such ratios were falling and concluded that a lower mix of EROEI sources means higher prices for many commodities, because “it will take more energy to produce them.”
It means nothing of the kind.”
You had it right the first time. The increasing energy needed to produce energy is adding to the energy demand, any economist knows the correlation between prices and demand.
rollin on Thu, 6th Mar 2014 5:34 am
Net energy is falling across the board. Money is a representation of exchange value. So we exchange energy for other products or services, all of which use energy. Food is a net energy negative due to dependence on farm machinery and therefor large amounts of energy to create small amounts of energy.
And yet a cantaloupe sells for more than a gallon of gasoline even though it contains only a small fraction of the energy in gasoline. Money does not equal energy. Money is a representation of perceived value.
GregT on Thu, 6th Mar 2014 5:52 am
What an absolute utter complete load of horse hooey.
If we expended all of our energy growing the food necessary to keep ourselves alive, there would be no trade, no economy, and no money.
Energy is everything, without enough energy, we wouldn’t even be able to survive. One more example of the economists ignoring reality. The real world is bound by the laws of physics, not the pseudo scientific cult of modern economics. 🙄
rollin on Thu, 6th Mar 2014 12:35 pm
How did you suddenly come up with the boundary value statement “if we expended all our energy growing food ..”?
Missed the point entirely and totally misinterpreted the statements.
GregT on Thu, 6th Mar 2014 4:28 pm
Sorry rollin,
I was commenting on the article, not your comment. I agree with you.
rollin on Thu, 6th Mar 2014 10:20 pm
Ok Greg, I got my exercise jumping to conclusions.