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Enhancing the evaluation of Energy Investments by supplementing traditional discounted cash flow

Jan-Pieter Oosterom and Charles A. S. Hall

Energy companies, like companies more generally, routinely have to make investment decisions by comparing alternative investment projects. In the face of the uncertainty of the current energy transition, traditional economic tools, such as discounted cash flow (DCF) analysis, that depend on long term cash forecasting, offer limited, deterministic and potentially misleading insights. Additionally there are many pressures on companies to expand decision making criteria to “ESG (Environmental, Social and Governance) considerations. But these are often qualitative with no clear standards, leaving investors often forced to make significant investments based on poorly understood and even self-defeating considerations. We explore the application of Biophysical Economics (BPE), an approach to economics based on the natural sciences, as an alternative to provide an additional lens that cuts through the uncertainty and political pressures to help companies navigate this uncertainty and make more robust long term investment decisions. The most immediately useful tool within BPE is the concept of Energy Return on Energy Invested (EROI). Specifically we compare an investment case in oil sands with one in microbial-enhanced oil recovery, applying the two methodologies in parallel. Results from a traditional economic perspective weakly favor the oil sands, whereas biophysical economics strongly favors the microbial case due to is significantly lower energy requirement to produce the energy that it yields. A close examination indicates that EROI can be used effectively and practically next to DCF to provide better insights and identify cases that are fundamentally less sustainable for society. We then consider how the concept can be applied more widely throughout society.This stock and flow consistency, similar to conservation laws from the natural sciences, ensures that unsustainable financial developments are accounted for in the overall dynamics. This is fundamental given the recent importance given to green finance. Our new model shares a certain number of similarities with the one of Jackson and Jackson [5] but differs in several aspects. First, our model is not UK- specific but at world level and is based on very different EROI curves. Most importantly, it explicitly includes the major role which the State has to play in the energy transition and its financing. Thanks to this, we can discuss the feasibility of the energy transition, together with several financing strategies and their impacts on debt, inflation, employment, and income distribution.




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