Taking on the Energy Dystopia

If you think Harry Dent is a bit of a doom and gloomer, he hasn’t got much on Dmitry Orlov. Dent sees Aussie housing falling by 50%. Ok. Orlov sees the United States collapsing in the same way as the Soviet Union. Touche!

At least he did back in 2008. Dan Denning put his book Reinventing Collapse in our hands earlier this week. We’ll take up his case in a future Weekend Markets and Money. For now, we won’t go past his introductory thoughts on oil. Once again time and life conspire to make another forecast flat out wrong.  But will he be wrong forever?

Here’s Orlov describing part of his US collapse scenario thanks to the oil market (in 2008 remember): ‘a severe and chronic shortfall in the production of crude oil (that magic addictive elixir of industrial economies)…US crude oil production peaked in 1970 and global (conventional) crude oil production appears to have peaked sometime in 2005, with all of the largest oil fields in terminal decline and global exports set to start crashing.

Now take a look at what’s happened in the US oil space since, with special attention to the right hand side of the chart.

click to enlarge
Source: EIA, Outstanding Investments

2012, for example, was a record in terms of US oil production. The country, in terms of oil at least, has never had it so good. Considering that the oil industry in the US goes all the way back to 1859, that’s saying something.

But the majority of wells America is exploiting today are ‘unconventional’ in the industry parlance. As a broad brushstroke, the oil and gas are trapped in shale rock formations. They need different drilling techniques and equipment to extract them than conventional oil and gas fields. 

These wells cost more to drill. They decline faster than conventional wells. Their lifespan is short and expensive. US shale oil needs a breakeven oil price of US$70-$80.  In contrast, Saudi Arabia can get oil out of the desert for, or so they say, around $10 a barrel. (The other $90 a barrel is needed to keep the Saud family in palaces, women and gold).

That means US oil companies are spending more to get less than they have in the past. It has also introduced the notion of energy return on energy invested (EROEI). Our own Vern Gowdie put it like this just the other week in these very pages: how much energy is used to extract the energy source?

Now, you might be inclined to think the academic debates of the energy industry can stay in the boardrooms of Exxon and the papers of academics.

But EROEI is central to arguments that costly energy will leash future economic growth as tightly as a handcuff on the wrist. This is the simple idea Bill Bonner often points out. The boom in human wealth over the last two hundred years came more than anything else from the spectacular payoff of fossil fuels.

Or as Bill wrote recently:

‘At $15 an hour, a gallon of gasoline replaces about $6,000 of human labour. That’s a return on investment of 40,000%. Multiply this by millions of gallons of fuel… moving things, making things, digging things out of the earth and turning them into usable, marketable wealth. This is how we were able – in the space of just a few generations – to go from barely feeding 1 billion people in 1800, to feeding, housing, transporting and entertaining 7 billion today.

A new book, Life After Growth, by Tim Morgan, is also riding off this meme.

It makes a kind of intuitive sense. Energy like shale oil IS more difficult to get at. But is EROEI true all the same? If the returns on energy investment are declining because energy is harder to find and more expensive to produce, is the world inevitably doomed to a new dark (or darker) age?

We ask the question because our colleague Chris Mayer cut the Morgan’s ‘energy dystopia’ argument to pieces this week.  What’s interesting is Chris originally believed in the EROEI idea, and even wrote an issue about it. Now he calls the entire idea ‘fatally flawed’.

His objection to the EROEI argument is simple. Its proponents attempt to measure the economy and projects in terms of EROEI, instead of money and prices. This is what Chris calls the ‘moneyless abstraction’ of geologists and academics. Their resource analysis is technically correct but not predictive of where prices or markets actually go. The relationship between falling grades and declining wells to higher prices and lower output isn’t as clear as they suggest. 

And looking at the world through this lens leads to some strange conclusions.

Chris gives this example:

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.

Chris also punctures the notion that EROEI numbers are actually reliable figures. There is no agreement or set methodology on how you figure them out. It’s almost impossible to know.  Because where do you start and where do you end in the chain of production? 

Hmm. These seem valid critiques of any doomsday EROEI scenario. As Mr Orlov above discovered, the market makes a mockery of these all the time.

IF the EROEI IS flawed, the future looks a lot brighter. But it wouldn’t be fair not to give right of reply to one of those pesky geologists. We know one of them. His name’s Byron King. He’s also an energy analyst. Next week we’ll give you his take. Stay tuned.


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Callum Newman

Callum Newman

Originally graduating with a degree in Communications, Callum decided financial markets were far more fascinating than anything Marshall McLuhan (the ‘medium is the message’) ever came up with.

Today Callum spends his day reading and researching why currencies, commodities and stocks move like they do. So far he’s discovered it’s often in a way you least expect.

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5 Comments on "Taking on the Energy Dystopia"

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Global oil production has been flat since 2008, even the I.E.A production ghraphs show this. If the market stopped being pussies and demanded a full audit of all oil reserves then it would become clear oil production has peaked, as for America, its oil production (all liquids) still looks like a bell curve with the shale production having a small rise then peak at the the end, it is still far below the nation’s 1971 peak. Shale production in the US is set to peak in 2014-2015 and the poroduction figures when graphed clearly show the ‘mountain top’ view, with… Read more »
I worked for several decades for major petroleum companies and their largest exploration/production subcontractors. Later I became mostly a consultant for the same. Orlov is right, although his dates might be a little off. EROEI is right, it is just physics and engineering. Like anything in else in engineering estimates vary by a few percent depending on models and assumptions. Overall, it is correct. I also note the major petroleum companies are NOT involved in CSG or shale schemes. They closely examined such schemes in the 70’s and early 80’s and concluded they were “net energy negative”. Nothing has changed… Read more »

The “majors” know this, why do you think they are selling off their petrol stations and refineries? Do you think they are stupid? “”

Added to this, it seems to have escaped many financial spectators, that pretty well all of them have major programs to buy back their own shares


2012 wasn’t a record in US oil production. US peaked in 1970. The shale production IS impressive though.


That shale production won’t last for long. Long enough perhaps for the promoters to abscond with investors (i.e. mullets) money.

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