Quantitatively estimating the cost of converting now or later

By Charles Cresson Wood

Once management at business firms, government agencies and non-profit organisations acknowledge that there is a substantial body of evidence to support the "peak oil theory," as some people refer to it, they will soon thereafter be asking: "When should our organisation transition away from petroleum?"

In other words, given the assumption that an organisation will at some future point in time be forced to transition to alternative sources of energy, at what future point in time would it be most prudent to make this conversion? This question can be answered quantitatively, with a formal decision making model using decision trees and/or influence diagrams.

Generally the most difficult part of this process is convincing management that such a model should in fact be developed. But if you look for it, the quantitative evidence supporting the "peak oil theory" is readily available. For example, the Energy Information Administration website shows that worldwide production of oil has been effectively flat at about 74 million barrels per day since 2005.

Making reference to the actual historical total world petroleum production data by year, actual number of discoveries of large oil fields by year, and similar indisputable quantitative data, is the recommended strategy. Discussion of how it is likely that the total world oil production curve is expected to show up something like the historical United States total oil production curve is also helpful. Stick with the facts, and avoid estimates and projections. This means avoidance of estimated remaining petroleum reserves, number of years of estimated supplies remaining, etc.

The development of a model to provide guidance about the timing of a transition away from petroleum can be approached as a capital budgeting decision. Since such a project involves a considerable amount of time and money, it deserves a detailed analysis. To simplify the model development process, we can focus on the date when substantially all of an organisation's critical business processes are converted away from petroleum. This approach assumes the organisation already knows which critical business processes are dependent on petroleum-based fuels such as gasoline and petro-diesel (if it does not, an inventory of these dependent business processes is advisable).

For example, five specific conversion projects could be proposed to top management. They could involve a completed transition within (1) one year, (2) two years, (3) five years, (4) ten years, and (5) twenty-five years. The net present value, internal rate of return, payback or some other financial measure of expected value can be calculated for each of these five projects. The project with the greatest expected value would then indicate the timeframe when it would be best to have transitioned away from petroleum.

To get to this single numerical ranking of the alternative projects, the analyst developing a model will need to gather additional information. While a listing of the additional information needed in order to construct such a model is clearly beyond the scope of this brief article, a number of data points that will be important to the model are provided below.

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