Since the turn of the 18th century, the exploitation of fossil fuels for industrial and transportation purposes has brought an increase in living standards and leisure time for hundreds of millions of people in the Western world of a magnitude inconceivable to previous generations.

But the era of cheap, readily available fossil-fuel energy is ending. Reserves of oil and gas are diminishing, and fossil-fuel use is causing potentially catastrophic climate change. Within decades, these two looming problems will raise the cost of using fossil fuels enough to make renewable alternatives economically superior. But waiting for market forces to bring about the shift to renewable energy will make this transition difficult and painful, in part because of the volatility of fossil-fuel prices. A far better policy is to begin subsidizing alternative fuels now using the energy surplus from conventional fossil fuels, especially crude oil, while this is still high enough.

The key concept underlying this argument is a measure called energy return on energy invested (EROEI).¹ Pre-industrial societies, dependent on wood and organic waste for their heat, light, and energy, had very low EROEI levels. The amount of usable energy acquired from a particular energy source barely exceeded the energy expended to obtain that source, leaving only a small energy surplus. Only a privileged few enjoyed the fruits of this surplus, with most people condemned to gruelling and monotonous labour just to survive.

The use of coal, oil, and other fossil fuels changed all this. With industrialization, the EROEI soared, creating ever-greater energy surpluses. This, in turn, made possible exponentially higher standards of material well-being for all members of society. And as the strengths of the Western industrial model became apparent, the rush to industrialize became a global phenomenon in the 20th century, with the Soviet Union, Japan and, later on, South Korea and Taiwan, all playing catch-up.

As the 21st century begins, this trend continues stronger than ever with the rapid industrialization of the world’s two largest countries, China and India, and of many other large emerging countries (such as Brazil, Indonesia, Mexico, and South Africa).

Yet peak EROEI levels have already been reached. The greatest energy return comes during the early part of a given field’s exploitation, and the overall supply of exploitable oil, coal, and gas fields is finite. Hydrocarbons are highly concentrated reserves of energy representing the accumulation of hundreds of millions of years of solar energy.

In effect, they are batteries charged on a one-off basis by the sun’s energy, and, as a consequence, they are only rechargeable on a geological timescale once exhausted.

And the world is now increasing its demands on this one-off solar-energy battery at an unprecedented rate, just as it is also becoming increasingly conscious of its non-rechargeable nature. M. King Hubbert’s concept of “peak oil” has now entered mainstream discourse, its implications given fresh impetus by the violent price spike seen in global oil markets in the summer of 2008. Global hydrocarbon reserves will be exhausted within a few generations.

At the same time, the world is now becoming increasingly aware of the potentially fatal side-effects of burning fossil fuels: a warming of the planet induced by the trapping in the atmosphere of CO₂ and other greenhouse gases (GHGs) emitted in the process of combusting hydrocarbons. If the world continues to burn fossil fuels at the current rate—let alone accelerate it—the inevitable consequence, in the words of the Intergovernmental Panel on Climate Change (IPCC), will be “irreversible and catastrophic” climate change.

In short, the problems of climate change and fossil-fuel depletion are inextricably interwoven, and, if left unaddressed, represent an enormous challenge for industrial civilization. Countries risk coming into ever more frequent conflict with each other over access to the increasingly precious remaining hydrocarbon reserves. And as ecosystems are damaged by planetary warming, countries also may fight over access to the most basic resources of all, food and water.

With all of this in mind the rational response is to realize that climate change and peak oil have at root a common cause—a pattern of energy consumption that is fundamentally unsustainable—and that, accordingly, the solution to both lies in developing an alternative energy system that delivers a relatively high and sustainable EROEI while reducing CO₂ emissions.

So, how can this alternative energy system be created?

By using today’s energy surplus to invest in a sustainable future while there is still time, rather than continuing the unsustainable consumption patterns this energy surplus has made possible. In other words, the time to invest in alternatives to hydrocarbons is precisely when the hydrocarbons themselves are still relatively inexpensive in physical terms (i.e., when their EROEI levels are still high), rather than waiting until these costs are higher.

At first sight, this seems counterintuitive. After all, economic theory would dictate that energy resources of one kind are no different from energy resources of any other kind, and that the market price prevailing at any given moment should therefore determine which fuels should be consumed.

According to this rationale, it only makes sense to develop renewable-energy sources when they are commercially viable on a stand-alone basis. That will occur when fossil fuels have become sufficiently expensive that renewable alternatives can compete with them without subsidies.

But the problem with relying exclusively on market prices to guide long-term investment decisions is that market prices are extraordinarily volatile. The prices of fossil fuels change over the course of days and weeks, sometimes—as we have been reminded in the last few months—gyrating violently in a manner that could be considered disconnected from fundamentals.

That volatility, and the accompanying uncertainty about future prices, undercuts investments in alternative energy sources. If we wait until the market prices for fossil fuels are so high that renewables are already competitive, it could be too late to develop an alternative energy system in an orderly manner (i.e. without an extremely disruptive dislocation of the global political and economic system).

By contrast, the EROEI of a given fuel changes only slowly over years or even decades, because it reflects the underlying physical challenge of exploiting a resource over time. As such, the EROEI of a given fuel sends reliable signals of relative energy costs for long periods into the future. As a result, it might make more sense to base long-term investment decisions not just on prevailing market prices, but also on the EROEI levels of different resources.

In other words, a rational approach to all of this would look for a solution that complements the axioms of economics with the laws of physics. Such an approach would indicate that the most sensible thing we can do today is to accelerate the development of a renewable-energy system with a sustainable EROEI with the higher but declining EROEI levels of fossil fuels.

When viewed in this way, the subsidised shift to a sustainable renewable-energy system is a matter of basic and essential risk management—with respect to both climate change and the security of future energy supplies—rather than an unjustified interference with free markets. Such subsidies would enable the sustainable energy system of the future to evolve much more quickly than it would otherwise do if required to rely exclusively on market forces, and would thereby avoid the pain that would inevitably be incurred by leaving the sustainable energy system of the future to pull itself up by its own bootstraps.

This idea has been recognized by one of the world’s largest producers of hydrocarbons, Abu Dhabi. In January 2008, Abu Dhabi announced that it would invest $15 billion in Masdar, a fund it set up in 2006 to invest in “renewable and sustainable energy technologies.” Part of the Masdar plan is creating a new zero-carbon-emitting city that relies on renewable energy. This is a clear acknowledgement on the part of Abu Dhabi that its oil reserves will one day run dry and that it must plan for a sustainable future based on renewable energy.

If other major producers of hydrocarbons follow Abu Dhabi’s example, the world will greatly increase its chances of avoiding both “irreversible and catastrophic” climate change and the depletion of fossil fuel reserves before an alternative energy system has been established.²

The opinions or recommendations expressed in this article constitute the current judgement of the author as of the date of this article. They do not necessarily reflect the opinions of Deutsche Bank as a whole and are subject to change without notice. Deutsche Bank does not accept liability for any direct, consequential, or other loss arising from reliance on this article.

¹ The pioneering study of EROEI is the 1984 paper by Cutler J. Cleveland, Robert Costanza, Charles A. S. Hall, and Robert Kaufmann, “Energy and the US Economy: A Biophysical Perspective,” Science, New Series, 1984, Volume 225, Number 4665. The literature on EROEI has generated a certain amount of controversy, mostly centred on the difficulty inherent in defining the boundaries of EROEI analysis (i.e., how many layers of energy inputs in the production process should be included in the EROEI equation). For the purpose of this essay, we are concerned only with the conceptual insights of an EROEI perspective on climate change and fossil-fuel depletion rates, and our central point—that the concept of EROEI will be an increasingly vital complement to standard economic analysis for policymakers addressing the growing climate and energy crises—is methodological rather than empirical in nature.

² As well as governmental agencies like Masdar, such hydrocarbon producers could be publicly quoted energy companies. Indeed, to the extent that many of the world’s energy companies are already using the profits from their traditional hydrocarbon activities to subsidize investment in renewable technologies, they are following the same logic as Masdar. The point is to accelerate this trend and make it more widely adopted.

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