The basic premise of all living beings is that they have surplus Energy all the time. This surplus energy is the net remainder of energy invested against energy received. For humans the energy received is mainly through food we eat against the energy we invest in our daily lives at office, home and otherwise.
The calorie intake minus calorie burned needs to have a positive balance for us to remain alive. Some have a high positive balance and often end up being obese!!! Same principle can be applied to the world we see around. Our world also suffers from obesity, having 7 billion people and plenty of waste around.
All modern activities are funded by energy, mainly fossil fuels. It is quite evident that we have a current surplus of energy and thus are able to feed 7 billion people plus invest heavily in modern technologies and infrastructure expansion. The dense, rich source of fossil energy has provided tremendous leverage to humans to live life king size. However, it is worth estimating how long will the party continue and what indicator seems most promising to tell us when the lights are gonna go dim.
Energy Return on Energy Invested (EROEI)
The current Energy Return on Energy Invested for Crude Oil is in the range of 20 (State of the World 2013, pg 107) implying for every 1 barrel of oil energy invested we get 20 barrels back. Now if the EROEI starts coming down, which it will because finding new oil is becoming increasingly difficult owing mainly due to geological reasons, the math says that oil prices would continue to go up, stay at high levels and arrest world economy growth. Lets take an example.
The relation between Profitability and EROEI for oil production.
As we write this, the prices of oil (WTI & Brent Crude) are in range from $100-110 per barrel (www.oil-price.net) with global average cost of production (excluding energy cost) being $40 a barrel[i]. For every 1 barrel of energy invested we are getting 20 barrels back, thus a revenue of $2000 (20*$100) for every 1 barrel of energy input. The other costs for extracting and processing 20 barrels is around $800 ($40*20), add to this the 1 barrel of energy input $100.
So a total investment of $900(800+100) fetches $2000 of revenue, making for a profit margin of around 125 percent. At such prolific rates of return we have close to $50 trillion world economy growing at modest rates of 2-3% annually (Wikipedia).
Now as the easy oil available in the wells is used up what remains is the deep, heavy, viscous oil which requires more energy to extract and process. So we will have a higher energy input, higher operating costs resulting in higher selling prices. Now let’s see what happens to profitability if EROEI falls from 20 to 15, estimating cost of production increases to $50 per barrel keeping the selling price constant.
At EROEI of 15 barrels for every 1 barrel, the revenue would be $1500 (15*$100) for every 1 barrel of energy input, with other costs of $750 (15*$50) plus $100 of energy cost. So the total investment of $850 would fetch a revenue of $1500, making for a profit margin of around 75 percent.
To sum up, profitability falls by 50 percent with a 25 percent fall in EROEI.
This indicates that a falling EROEI has a high degree of negative impact on profitability which then puts pressure on oil prices to go up. Now in order to maintain the same levels profitability, the prices of oil has to be adjusted upwards. Thus, in the above case, to maintain a desired profitability of 125 percent, the oil prices would have to soar and reach $130 a barrel. With every fall in EROEI the oil prices would keep increasing, further if EROEI falls to 10 then in to maintain a 125% profitability the prices would have to go up to $175 a barrel (estimating cost of production to increase to $60 a barrel).
This implies that oil prices may never be able to come down and the world would have to accept inflating oil prices.
With the more difficult forms of oil produced from tar sand, shale oil etc. coming online for supply, the EROEI would definitely witness declines. Soon Light Sweet Crude will be a thing of the past and the world would have to submit to the heavy, waxy and viscous quality of oil which may not yield the same amount of net energy. This indicates that cheap oil era is coming to an end.
Under such circumstances, maintaining economic growth at current rates seems rather difficult since there is hardly any potential substitute close enough to replace crude oil which currently represents 35 percent of the world’s primary energy source and contributes 90 percent fuel to the world transport industry.[ii]
Relying only on monetary/economic indicators to understand the state of the world may not enable us to take proactive steps to adapt to the decline in energy curve and an uncertain economic future.
[i]Oil and Gas, Global Cost Study by BMO Capital Research, Fall 2007 http://energypolitics.org/view.htm