Over the past two days, I’ve been wrestling with a problem. That made the 19 hours it took me to drive down to our residence in Florida a bit easier. Nothing like a little exercise for the mind when the rest of you is being held hostage by an automobile.
And the problem I’ve been thinking about is the shortcoming in the way the values of energy sources are currently measured.
Finding a new way to measure energy has not been a primary concern until recently because the standard method required little more than measuring the consumption of it.
And then a very new way of regarding energy parity emerged.
We’ve discussed the concept of parity in Oil & Energy Investor before. Basically, it refers to the compared costs of producing energy.
These days, “parity” has become quite the buzzword among energy analysts. As crude oil continues to hover around $45 a barrel in the United States, more interest is being shown in determining the net effective value of other energy sources.
But is there any real way to expand this notion of parity to identify incremental values between energy types?
Thanks to my long drive, I’m on the verge of creating a new yardstick to do just this.
And for investors, this new way of comparing energy will make a world of difference…
Comparing BTUs Isn’t Adequate
From the standpoint of the investor, the reason for creating a new method is rather straightforward. The net comparative advantage of one energy stock over another is difficult to determine unless a real difference in value can be calculated for the energy being produced, transmitted, or consumed.
Simply put, unless there is a common way of gauging what the common denominator is, it ends up looking more like apples and oranges.
Traditionally, energy parity was determined by calculating an exchange value using British thermal units (BTUs). A BTU is the amount of heat required to raise one pound of water one degree Fahrenheit. The use of BTU levels for each energy (or application of energy) could be compared and a rough distinction made.
This was always a very static view of energy – essentially comparing types by equating what happened when you actually (or in some surrogate fashion) “burned” them.
The problem, of course, arises when you acknowledge that heat is not the only factor influencing the selection of an energy source. Two sources could generate the same “heat” but still not be considered interchangeable.
BTU comparisons also assumed that the energies being compared were used in the same way. Both power generation and transport require energy, but the usages are not interchangeable (although these two examples might converge in the current world with the advent of electric cars and the infrastructure needed to support them).
The problem with the BTU approach is that it focuses on the exchange of energy into heat rather than the wider implications of what position energy actually holds in an economy.
What may appear as parity from the perspective of generating the same energy product (electricity, for example) – while of some value in determining the efficiency of a process – tells us next to nothing about the broader investment picture.
EROEI Metrics Don’t Work Either
Comparing energy received on energy invested (EROEI) is another method that has been around for some time. It allows us to determine how much excess energy actually emerges from what is expended in generating it.
EROEI is realized by dividing the energy produced by the energy used to produce it. An EROEI of 1 means the energy realized equals the energy used. Anything below 1 means more energy is used than the process actually produces.
This approach is still used to estimate the advantage of drilling for oil in one location rather than another, or opting for a hydroelectric dam over burning coal to produce power.
The problem still arises in any genuine comparison of different energies, just as in a BTU application – where, for example, natural gas and oil can be equated, but only if there is a common usage.
The shortcoming is obvious. A BTU comparison (considering only the “heat” expended) notwithstanding, it costs more to use oil products rather than natural gas.
The same goes for an EROEI calculation. Factoring in the human energy required, the energy demanded to attend adverse environmental impact, or the discount rate (what some energy expended in generation could have realized if applied to something else), changes the entire calculus.
Creating a New Yardstick for Energy Parity
To find a solution to this problem, I have begun revising another standard energy efficiency measurement.
What the energy sector requires is a single universal yardstick. As it turns out, this is also an essential component of any broader way to differentiate among targets for energy investment.
Short of that, we continue to be dragged about by swings in raw material prices or immediate “punditry” on each change in circumstances.
The requirement of something better and more comprehensive than BTUs or EROEI is a necessary bridge between those who work in energy and those who invest in it.
Later this year, I’ll be meeting in the Persian Gulf with some other specialists to exchange approaches on a new matrix to achieve a new yardstick. I’m going to present my solutions from this week’s drive.
And I intend to take you along.
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