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September 2011 Agcapita Update


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EROEI and Economic Growth

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September 2011 Agcapita Update

  1. 1. Agcapita UpdateSeptember 2011
  2. 2. Agcapita UpdateHaven’t heard of EROEI? You can be forgiven if its not atopic that is on the tip of your tongue with issues of sovereigninsolvency, QE3 and the like dominating the airwaves.I feel confident that EROEI is an acronym that will receive muchwider recognition over the next decade. What is EROEI youask? It requires energy to produce energy and that relationship isexpressed as “Energy Return On Energy Invested” or EROEI forshort. Why is EROEI important? Because we are in the processof transitioning from high EROEI sources of hydrocarbon energyto low EROEI sources - think Saudi Arabia versus the Alberta oilsands.Even if you don’t believe that peak oil is an issue, I wouldargue that EROEI decay is most certainly one. Discoveries ofconventional oil total around 2 trillion barrels, of which around 1trillion barrels have been extracted, leaving approximately 1 trillionbarrels remaining. However the first trillion barrels was found onshore or nearby, shallow and concentrated in large reservoirsand generally in politically stable regions - the “easy” oil. Theremaining oil is far offshore or deep underground, in smaller,harder-to-find reservoirs and mostly in politically unstable locations- the “difficult” oil.I believe an increasing dependence on “difficult” oil has someserious consequences for the global economy.– The amount capable of being produced from a given quantity of reserves - the delivery capacity - will be reduced. This will make it harder to increase overall production even where reserves remain theoretically abundant.– The cost of extracting remaining reserves will escalate in terms of the energy inputs required which in turn will drive real energy prices upwards.Current production is around 86 million barrels of oil per day(“BOPD”). However an 86 million BOPD oil production profile ofhigh EROEI sources is very different from 86 million BOPD of low 1
  3. 3. Agcapita Update (continued)EROEI sources. Effectively the net energy left over for machinery, irrigation, fertilizers, herbicides, storageto drive economic growth is significantly lower in the and transportation. Here are just a few examples:latter scenario. Here are some highly approximateEROEI ratios for various energy sources: – The US and Canada export million of tons of grain every year - grain that contains large quantities– 1970s oil & gas discoveries - 30 to 1 of nitrogen, phosphorus, and potassium. The– Current conventional oil & gas discoveries - 20 to 1 ongoing export of grain would slowly drain the– 1980 coal - 20 to 1 inherent fertility from cropland if the nutrients were– Oil Sands - 5 to 1 not replaced with man-made fertilizers.– Nuclear - 4 to 1 – Irrigation accounts for approximately 20% of US– Photovoltaics - 4 to 1 farm energy use and in water constrained locales– Biofuels - 2 to 1 such as India over half of all electricity is used to drive irrigation pumps.To engage in a simplistic piece of analysis, assuming86 million BOPD composed of 1970s oil & gas A rhetorical question - if declining EROEI drives upreserves - there is around 83 million BOPD net to fuel the real cost of agricultural commodities will it confergrowth. Assuming 100% biofuels then this drops a competitive advantage on land with lower energyto 43 million BOPD. The farther down the list we intensity - e.g. no need for irrigation and low fertilizermust go to maintain supply the worse the net energy use - such as Canadian prairie farmland?situation becomes. I believe the twentieth century trend of low realWhy do we care about this? commodities prices is in large part a reflection of the abundant, high EROEI supplies of energy that wereEconomic growth is in large part a surplus energy available during that period. Without new sources offunction as well summarized by Chris Martenson high EROEI energy I would argue that this favorablein his book “Crash Course”. A reduction in surplus trend will will increase energy prices at the same timeit is putting pressure on growth. If the real cost of If this is the case then significant amounts of wealthhydrocarbon energy is going to increase then the will be transferred from commodity consumers toreal cost of other commodities will also increase as commodity producers - particularly to producersmost have significant energy inputs. On balance, I of commodities with the most inelastic demandbelieve the net result will be a transfer of wealth from curves. Declining EROEI is in part why I believe in 1)commodity consumers to commodity producers. direct investments in western Canadian commodity production assets and 2) in investments that serve asIn less vague terms, the prospect of deteriorating proxies for the increasing real cost of commodities -EROEI will certainly increase food prices, as modern e.g. businesses linked to commodity production.agriculture depends heavily on the use of fossil fuels - 2
  4. 4. DISCLAIMER: The information, opinions, estimates, projections and other materials contained herein are provided as of the date hereof and are subject to change without notice. Some of the information, opinions, estimates, projections and other materials contained herein have been obtained from numerous sources and Agcapita Partners LP (“AGCAPITA”) and its affiliates make every effort to ensure that the contents hereof have been compiled or derived from sources believed to be reliable and to contain information and opinions which are accurate and complete. However, neither AGCAPITA nor its affiliates have independently verified or make any representation or warranty, express or implied, in respect thereof, take no responsibility for any errors and omissions which maybe contained herein or accept any liability whatsoever for any loss arising from any use of or reliance on the information, opinions, estimates, projections and other materials contained herein whether relied upon by the recipient or user or any other third party (including, without limitation, any customer of the recipient or user). Information may be available to AGCAPITA and/or its affiliates that is not reflected herein. The information, opinions, estimates, projections and other materials contained herein are not to be construed as an offer to sell, a solicitation for or an offer to buy, any products or services referenced herein (including, without limitation, any commodities, securities or other financial instruments), nor shall such information, opinions, estimates, projections and other materials be considered as investment advice or as a recommendation to enter into any transaction. Additional information is available by contacting AGCAPITA or its relevant affiliate directly.#205, 120 Country Hills Landing NW Tel: +1.403.608.1256 www.agcapita.comCalgary, AB T3K 5P3 Fax: +1.403.648.2776Canada