Oil as Money and the Decline of Energy Earnings

The Oil Drum has posted a must read essay today by Chris Cook, formerly of the International Petroleum Exchange.  Cook suggests that the only real money is in fact energy. And, that the world should eventually migrate to a monetary system based on that reality.

Whether one agrees, disagrees, or simply needs more time to digest such an idea, let’s contemplate the 10 Year chart of the Dow Jones Industrial Average in terms of the price of Oil.

indu-in-oil-terms-620

There are myriad observations to make here. I don’t wish to be either too simplistic or reductionist. However, one simply has to wonder that that the decline in Net Energy globally is what ails the global economy. The Dow was at its highest when oil was cheap near the turn of the millennium. The Dow, expressed as a cash equivalent, was buying 600-700 bbls in that period. Now the Dow is buying about 150 bbls of oil.

If we can free our minds for a moment of how many bbls of oil the world produces, and the current dollar level of the Dow, and think more about Net Energy, then certain insights can unfold over the above chart. It’s good to think generally here, and thematically. So here goes: we know that the Energy Return on Energy Invested–the EROEI–of nearly all energy resources is in decline, globally. In other words, it used to take only a single barrel’s worth of energy to extract a hundred barrel’s of oil. My Twitter pal @alexismadrigal is currently reading Dan Yergin’s The Prize, and is finding some juicy examples of the high rates of return found, in the early days of oil. But now, in this century, we find that the EROEI for Oil, Natural Gas and Coal is now in steep decline. While complex, the answer is obvious: it takes alot more energy to drill for deepwater oil, to vibrate rock to release Natural Gas, and to extract Coal from old mines where the easy coal was sucked dry 100 years ago. The global EROEI of oil has descended to an average now of 12 to 1.

In the last 10 years, global EROEI has gone into steeper decline.

And that’s what the DOW chart may be expressing. Again, there are myriad other factors in play that have produced the chart you see above. But the primacy of energy is without question a major influence here. Industrial companies need to extract profits from their activity that is over and above their energy costs. If their business-wide costs are infused with energy–from the food their employees need to eat to the heating and cooling of buildings–then their earnings, and their earning quality is going to decline. While that concept will be obvious to all, now add in the notion that the quality of energy earnings is also in decline.

If energy costs to an economy are rising in nominal terms, and the quality of energy earnings (EROEI) is now also in steep decline, then we would want to look for signs that the aggregate profits of the entire economy are in decline. And the above chart of the DOW may be an expression of this phenomenon.

–Gregor

Updating: Monday 06 April at 11:45am NY Time: Chris Cook, author of the above referenced article, has made helpful remarks in the comments section this morning and correctly pointed out that, in my intro to this post–which was intended as a more generalized on-ramp to the subject as a whole–I potentially confine Mr. Cook’s idea into a more prescriptive corner that is too narrow. Chris Cook is not saying that energy is the only real money. Rather, in Mr. Cook’s own words, he is saying, and I quote from his posted remarks…. I’m not quite saying that energy is the only real money. I’m saying firstly that energy is a good common standard for exchange, and secondly that energy-based currency could be a useful global reserve currency alternative to the dollar. ie it could be a good common currency, but certainly not a single currency.

I encourage readers to read Mr. Cook’s comments to this post. And, to read the commentary thread to his original post at The Oil Drum which has filled up now quite nicely.  –Gregor