Modelling energy transition risk: The impact of declining energy return on investment (EROI)

A number of papers in the field of net energy analysis have argued that declines in energy return on investment (EROI) could lead to increasing energy prices and a fall in economic growth. This paper develops a model (TranSim) which can simulate the economic and financial implications of an energy technology transition involving a reduction in EROI, by combining the stock-flow consistent (SFC) approach with an input-output (IO) model.

The TranSim model has the following key features. First, it includes three firm sectors, that produce energy, capital, and other (non-energy, non-capital) goods. Second, an IO model and an Almost Ideal Demand System are integrated into the SFC model. Third, capital vintages have embedded levels of labour productivity and inter- mediate good requirements that depend on the economic conditions in the period the vintage was produced.

Simulations are characterised by an initial increase in output (due to higher investment), followed by periods of recession and below trend growth (due to price inflation and changes to the functional income distribution).

The work shows that the negative effects associated with the transition—recession, stagnation, stagflation, increasing inequality and asset stranding—are positively related to the capital intensity of green energy production and reductions in EROI.

Policy makers should pay close attention to the overall EROI of the entire energy system when determining energy policy. If significant reductions in EROI are unavoidable, then policy could be used to mitigate some of its negative economic effects.