Wednesday, July 31, 2013

Energy Return on Energy Invested: Peak Oil, Liquid Fuels, and the Possibility of Sustained Economic Decline

I have been away doing some serious research into energy and oil supplies. The failure of GMX Resources - which was close enough to the core of the Bakken that they did produce oil and plausibly claimed to have economic acreage - was something of an alarm bell that tight oil supplies may not be the panacea we thought.

There's an excellent blog by a physics professor named Tom Murphy at UCSD called Do the Math.  I recommend reading the archive of posts (he no longer writes) as they are thought provoking and contain some unique insights into our energy situation.

He writes a good, rational summary of the peak oil debate. The peak oil skeptics are now crowing because some of the peak oil proponents claims were overstated, or were early, or haven't happened yet. However, the understated peak oil case has some arguments that simply cannot be rebutted.

First, unless you believe in continual abiogenic synthesis of oil deep within the earth, then it is a fact that the supply of oil is finite and therefore the rate of production will someday peak. Second, there are some reasons to believe that this peak is in the process of happening now. Starting in the early 1980′s, the world began to find less new oil every year than it used. Also, you may have noticed that the recent 3x increase in the price of oil was not able to increase world production by more than a few percent.

Another important post to read is about his concept of "the energy trap." He points out that as petroleum prices rise (assuming peak oil is true), it will not be easy to divert resources into developing alternative energy sources. The alternative energy sources now under consideration offer lower energy return on energy invested (EROEI) than fossil fuels do. Lower EROEI means a longer payback period on the investment in the new energy source. We will be faced with significant upfront energy requirements in order to replace existing sources.

My latest thinking is that our biggest problem is going to be liquid fuels. The math on biofuels is just brutal. Human power consumption is ~13 TW and the total photosynthetic activity on land is only ~4 times that. He points out that replacing the U.S. liquid fuel consumption with corn ethanol would require 1400 square kilometers of land devoted to growing corn. Even in the U.S. there is not enough room, and the rest of the world with less arable land per capita would be in worse shape.

Murphy quotes a researcher at Caltech who argues that "because no other renewables come close to solar in terms of total energy availability, together with the fact that liquid fuels are by far the most energy-dense means of storage (short of nuclear), some day we will have a way to convert sunlight to liquid fuels directly". We will certainly want to sell our oil interests if someone develops a competitive solar to liquids process.

The alternative to liquid fuels of course is electric vehicles. The problem so far is that batteries just are not up to the job. As he points out, "the specific energy of gasoline—measured in kWh per kg, for instance—is about 400 times higher than that of a lead-acid battery, and about 200 times better than the Lithium-ion battery in the Chevrolet Volt."

Now, obviously there are working electric vehicles. They are just expensive (because of the batteries) and have limited range. The other problem is that, even if EV prices fall, we cannot just clap our hands and have an electric vehicle fleet. There are 200 million passenger vehicles in the U.S. alone. If you assume half of them are used regularly, replacing just those at a cost of $30,000 each would cost $3 trillion. The oil consumed by the U.S. annually is worth $700 billion.

From an investment perspective, I think it is clear that even with a compelling EV alternative (which we don't have yet), the installed base of gasoline engine vehicles is going to be with us for some time.

One thing Murphy does not really address but that I find captivating is the effect of increasing populations and development in the exporting countries: the Export Land Model. We see this right now with Nigeria, for example. Nigeria exports ~2MM bbl/d and is the 4th most important source of U.S. imports. Nigeria has a very young population and a total fertility rate of close to 6, with the result that their population is doubling roughly every 20 years. Combine that with increasing development (only 30 cars per 1000; even Cuba and Iraq have more) and you will see a ferocious increase in oil consumption. During our lifetimes, Nigeria will transition from oil exporter to oil importer.

Back to energy return on energy invested (EROEI). When EROEI falls from 100:1 to 10:1, as the energy requirements of oil production roughly have over the past century, it means that producing 100 barrels requires 10 times as much capital expenditure. Deeper wells, more days spent drilling, more materials. A comment on The Oil Drum sheds light on this:

"Bakken oil has low EROEI, perhaps only 7 or 8 IMO, but still better than tar sands. I just returned from eastern ND. My customer in Fargo is shipping diesel fuel to Bismark to relieve shortage there. The oil operations, along with agriculture demand, is sucking up all the production of Tesoro's local refinery. Read that about 20,000 trucks are consuming about 2 million gallons of diesel fuel per day keeping Bakken oil E/P operating. That's 50,000 barrels a day fuel consumed (more if you include trains hauling supplies in and oil out, plus personal trucks hauling work crews) versus about 600,000 barrels of oil production."
By the way... for TOD to be shutting down is an interesting sentiment indicator. Just to reality check that number of trucks:
"The first thing you notice in North Dakota's oil patch are trucks [...] Drillers inject 1 million to 3.5 million gallons of pressurized water into each well to shatter the rock and free the oil. More of the trucks you see are carrying water than anything else, some 400 to 800 truckloads per well."
The falling EROEI of oil resources is consistent with the peak oil theory. As supplies become tighter, the price rises, and previously uneconomic (lower EROEI) resources become economic... and are exploited. Looking at the photos of oil sands mining (not drilling!), you can certainly see why oil sands have a much lower (~10x) EROEI than good ol' conventional oil. For one thing, the sand is only a few percent oil by weight.

Murphy ends with an decent theory of the 2008 crash:
"As supply [of petroleum] failed to meet demand and prices rose (amplified by speculation, yes), the transportation, airline, tourism, automotive, and other directly related industries began to suffer and fold under pressure. The resulting economic slowdown deprived the sub-prime racket of oxygen, forcing the house of cards to collapse on itself. The racket worked as long as growth continued and housing prices did not falter. So we may have seen our first peak-oil economic disruption."
My only problem with this is that subprime crashed long before the 2008 price spike. However, isn't it interesting that our 13 years of economic malaise (booms and busts) began the same time as oil prices started climbing?


freude bud said...

James Hamilton of UCSD and the blog Econbrowser calculates that all of the demand decline seen in 2007-8 can be attributed to the price spike/supply shock of that period in oil ..., FYI. I don't think $30k is a reasonable avg price for half the vehicle fleet, after all, they lose 1/3 of their value the minute they leave the lot and only roughly 15 million will be sold this year -- most have lost most of their oroiginal selling value, like diamonds :).

HeresyValue said...

Awesome post. Been a big fan and voracious reader of TOD myself and disapointed to see it go. While I'm no believer in what most people generally agree to be THE 'peak oil' there certainly is A 'peak oil'. Another interesting thing I picked up from TOD over the years was the highly controversial reserve modelling being employed in shales, particularly use of 'b' well decline rates based upon historical wells that were more prolific/different geo/non-shale in order to come up with better reserve potential which, when combined with massive shale IP rates, proved to be an easy sell for dupable investors in this space.

CP said...

$30k was a generous estimate of the replacement cost of new electric vehicles. The point was that the existing stock of gasoline and diesel fueled vehicles will be around for a long time.

Yes, the decline curve modeling seems to be very dubious sometimes.

Looking back on it, all you needed to know was that certain companies were reporting *only* peak IP rates.

You guys have other good sources that you are monitoring now that TOD is gone?

This guy is an amusing cornucopian:

whydibuy said...

Its also interesting to note that there are analysts who present the case that what the fed did has only, somewhat, counterbalanced the shockwaves these inexorably rising energy costs have produced.
But the fed can only do so much as the inflation that rising oil prices cause will overpower paper. Oil and energy are real, limited resources whereas money can be printed up indefinitely. It is actually scary to attempt to understand the ramifications of scarce energy. The world will become battleground over declining resources. I know, skeptics say its just a repeat of 1970 but as the late Matt Simmons said, the world today is much different than 1970. Every country is now a oil consumer where in 1970 there were only a few oil users.
The final observation of mine is how people are taking higher gas prices in stride. SUV and big truck sales are stronger than ever. This leads me to think the situation will get dramatically worse since the "herd" is so ambivalent about energy. Another shockwave will be needed. Maybe a spike to 200.00 oil and 5-6.00 gas.

CP said...

Yes, the SUV and truck thing is hilarious.

In fact, a couple years back I declared this economic recovery to consist basically of people saying "fuck it, I'm buying an ipad".

eah said...

During our lifetimes, Nigeria will transition from oil exporter to oil importer.

Why do you believe that? And how do you see it happening? Via increased demand due to raw population growth? Or decreased output? Some combination of the above?

I ask because I do not see Nigeria as particularly, let's say, economically dynamic. So it's hard to see them increasing their wealth-creating economic output -- which would presumably raise their standard of living and increase domestic demand for oil -- enough to result in that kind of dramatic turnaround. And it does not seem like the kind of place that will attract a great deal more foreign investment; it has, uhh, a big demographic problem.

CP said...

Nigeria's population doubles every 20 years. If you assume that they can grow to have as many cars per capita as Cuba (1.5x) then those two assumptions plus eventual production decline will mean no net exports.

Even Saudi Arabia will stop being a net exporter some day.

AllanF said...

RE: Nigeria

Would you believe Egypt was once an oil exporter? They aren't anymore. Might explain a lot.

Mexico, I haven't looked at in a while, but they don't export like they used to either, and in fact are on a trajectory to be a net importer relatively soon.

I think we'll switch over to LFTR (liquid flouride thorium reactors) eventually, but it's not going to be an easy transition and it's not going to be led by the USA. My money is on Japan or China. Maybe S. Korea.

CP said...

Great example. The population of Egypt has doubled since 1976.

It was a net exporter of about 500k bbl/day (a little less than Bakken production) until both production and consumption moved sharply and it became a net importer in ~2006.

Almost all of these countries are going to become net importers.

The worst part is that the decent substitute technologies like solar or LFTR aren't any help with liquid fuels!

CP said...

New high on the crude oil contract:

Bye bye quantitative easing!

CP said...

The out-year futures contracts have been doing well: