Monday, February 20, 2012

what EROI tells us about ROI

SmartPlanet | The relationship between ROI and EROI is actually very simple and logical. The more energy you have to invest to produce a fuel, the lower your EROI will be. The energy you invest has a cost. Therefore, the profit on the same barrel of oil will be higher when it’s produced from a high EROI source than when produced from a low EROI source.

This simple concept gets lost, however, in the complex accounting of fuels in the real world. The financial return on all unconventional fuels is distorted in one fashion or another by subsidies designed to encourage new development, debt acquired to finance the projects, and complex accounting of the investments and returns. For example, as I discussed previously, the accounting methods used in shale gas development allow operators to roll over gains and losses creatively and amortize them across older and newer wells, wet and dry wells alike. Initial development costs tend to be intermixed with long-term operational and maintenance costs, debt servicing expenses, and so on. Initial exploration costs and even production itself can be offset by tax credits. Ultimately, the profitability of production tends to resemble a picture of cash flow more than pure ROI, and the EROI of some fuels becomes very murky indeed.

Corn ethanol offers a fine example of the problem. More than $20 billion in subsidies over the past three decades have ultimately turned nearly 40 percent of the U.S. corn crop into less than 10 percent of the country’s fuel needs by volume, and less than 7 percent by energy content. In 2009, the U.S. taxpayer subsidized 75 percent of the price of each gallon of gasoline replaced with ethanol. It has proven to be an expensive way to make a low-quality fuel (ethanol has about two-thirds the energy content of gasoline) which reaches its scaling limit at a fairly low level.

Careful observers who did the math on the EROI of corn ethanol knew it would run into cost and scalability limitations literally decades before legislators and investors did. With a generally accepted EROI of around 1.4 (also variously estimated between 0.8 and 1.6), it was just barely a net energy-positive fuel at best. In the pithy observation of veteran energy analyst Robert Hirsch six years ago, making ethanol from corn is a process in which a certain amount of energy in the forms of natural gas and diesel fuel are used to create an equivalent amount of energy in the form of ethanol, with the primary output being money from government subsidies (not to mention soil erosion). Such a low EROI would imply a low profit margin, thin enough to be swamped by the volatility of both corn and oil prices, as indeed it was in recent years. However, only the ROI, in the form of increased “energy independence,” was taken into consideration in the politically-motivated push for biofuels.

With the tax credit finally expiring at the end of 2011, we should now see the real costs of producing corn ethanol begin to be priced in to the cost of gasoline. Its EROI has been “hidden away in the attic like a crazy aunt,” as my friend Gregor Macdonald quipped to me this week. Without subsidies, the ROI of corn ethanol must begin to converge upon its EROI.


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