Last week I discussed what EROEI is-and how to use it.
This week I'd like to talk about how this key metric affects the balance of your energy investment portfolio.
Now, this is certainly not the only element in determining preferable stock moves, but it's critical that you know the EROEI because it could make you a lot of money.
Recognizing the real elements that determine the genuine cost of energy production, EROEI is becoming an important factor in estimating profit margins.
And those margins certainly influence the performance of a stock as we've seen all across the energy value chain in recent months.
EROEI refers to the amount of energy used to produce energy.
If this ratio produces a figure of 1.0, EROEI is telling us that it takes one barrel of oil equivalent to produce one barrel as a result.
Anything under 1.0 means that more energy is consumed in the production process than is gained as an end product.
EROEI has the advantage of being a useful yardstick throughout the energy curve – from upstream production sites (wellheads, generating facilities) through midstream (gathering, transit, storage and initial processing) to downstream (refineries, terminals, wholesale and retail distribution, end use).
Some applications of EROEI are already in wide usage, although we don't tend to think about them in these terms. Energy-efficiency ratings on appliances, heating and cooling systems, windows, or building supplies are an application at the end of the energy curve.
But how can we use this to fine-tune an investment portfolio?
How to Deal With EROEI
There are several stages in a response, and we can only consider some general perspectives today. This is more an exercise in introducing how one should deal with the EROEI factor.
The broadest stage talks about how much (in energy) it costs to produce an energy flow. Here we would be interested in determining the amount of energy required to run an operation – extracting oil or gas, generating electricity, refining product, moving oil, gas or electricity from production site to centralized gathering, or distribution for actual use.
All such processes require the consumption of energy. At a wellhead, for example, it is emerging as a primary cost distinction between conventional and unconventional oil and gas production.
Both the processes at a conventional well site and those attending the exploitation of oil and gas from shale use powered equipment for well drilling and work overs, separating hydrocarbons from water, tailings and value-added product, introducing secondary and enhanced recovery techniques (water, associated gas, chemicals, biological agents), and maintaining flow on pipelines, among other considerations.
However, unconventional production requires the use of fracking. In addition to pushing a lot of water downhole, there is an added need for considerable pressure. That is accomplished by serializing a number of pumper trucks on the surface, which run on diesel. In addition, there is the need for compressor stations at the lifting location.
The key in determining profitability remains the calculations of costs versus price – what it takes to bring the energy on line versus how much can be charged for its sale on the other end.
But the cutoff for what price is warranted to make an intelligent choice on one producer over another is progressively focusing upon EROEI.
If it costs more to produce at one location than another, absent any other factor, the EROEI will reduce the attractiveness of some investments over others.
Electricity, Oil and EROEI
Then we have the actual transmission costs (once again in terms of energy expended). Obviously, there is a range of factors to be considered, but let's focus on two: electricity and oil.
First, consider these factors in the transmission of electricity:
- The high inefficiency in moving electricity generated in DC to the AC current required by the grid; and,
- The loss of electricity during high voltage wire transmission.
Here, EROEI entices the investor to look at developments in technology and application as a primary way to reduce the loss of energy during the transfer process. Stated simply, we could improve EROEI by increasing efficiency in how things are done.
Next, consider the issues involved in the transmission of oil and oil products. Attempts to play market cost in raw materials or finished products mean midstream companies, refineries, wholesalers, and distributors will stockpile volume. Maintaining inventory remains the second largest expense (after labor). The cost of storage can contribute significantly to EROEI.
And then there is getting it to the end user, which involves expending oil products to move and deliver oil products. The gasoline must be trucked to wholesale storage and retail outlets, as does heating oil, diesel, and jet fuel. As the cost of the product goes up, so does the cost of transporting it.
We must also factor in two overarching EROEI considerations.
- First, equipment and infrastructure are aging. As they do, there is added energy consumption and outright loss resulting from each refinery shutdown, pipeline leak, or well stoppage.
- The second is the most encompassing and most difficult to calculate. Earlier, I referred to labor as the single greatest expense. This is also the exertion of physical and intellectual energy. But how can we factor this one into the equation?
For now, we can only use surrogates that look a lot like traditional labor cost factors or translate into laboratory/computer/educational expenses. But to discount this is to ignore yet another element in the rising EROEI impact.
I have been injecting EROEI considerations into determining the balance in both the Energy Advantage and Energy Inner Circle calculations.
Already, these are producing some interesting (and profitable) investment directions. To learn more about this research click here.
Related Articles and Links:
- Money Morning:
Why Gas Prices are Heading Higher
- Money Morning:
Oil Prices Look For Steady Rebound
- Money Morning:
Four Things Suppressing Crude Oil Prices Today
- Money Morning:
The Trajectory is for Oil Prices to Rise
About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.