Energy Return on Investment

on Feb 26 in Uncategorized tagged by Trevor Hicks

Energy Return on Investment (EROI) is a very important concept, but one not often mentioned in the popular press in discussion about oil supply.  I read today at the very end of a discussion on Forbes.com that mentioned tar sands production is not economic at today’s prices.  While it is certainly true that the marginal cost of production is the number in the standard economic supply and demand model that determines economic viability, the problem mentioning a price target for economic viability of a certain type of supply like tar sands, or shale oil or arctic oil treat this cost like a constant.

As we’ve seen in 2004 through 2008, price inflation is a major issue in the oil and gas industry.  As prices rise, activity increases and the global service industry becomes capacity constrained who then start dictating higher prices to the producers.  So the relationship between oil price and the marginal cost of production is not a constant, it’s not even linear because the price of oil is itself an input into the cost function.  In other words, if you look at today’s cost structure, maybe you can say that tar sands are economically viable at $65 oil, but the fact is that $65 oil will alter the cost structure and in ways that aren’t easily predictable.

A better way to look at production potential of unconventional hydrocarbon sources is with EROI.  EROI is a computation of the amount of energy that must be invested in exploration, production, refining and transportation of a fuel compared to the usable energy contained in the fuel.  Now this number is also flawed in that the energy consumption of all the various processes is necessarily an estimate and subject to interpretation about what should and shouldn’t count towards the energy investment.  To take an extreme example, do you count the commuting energy used by office workers in a refining company?

But if the absolute numbers are suspect, a consistent methodology should yield good relative numbers.  You could argue this is true of the price points, but the advantage of EROI for comparing energy sources is the linearity of relationships meaning that small errors or disputes in computation are not likely to add up to massive differences in output that are possible using price comparisons because EROI avoids the non-linear relationships I described above.

Whether you are concerned about Peak Oil or Climate Change, this is quite relevant to keeping our decision makers focused on making investments that have the highest potential benefit.