see that the price we pay tends to increase every year. In order to understand where fossil fuel prices are heading, we first have to understand what has happened in the past. Having a handle on energy price inflation is basic to understanding the economic impacts of investing in solar thermal energy systems.
A Brief History of Fossil Fuels
Soon after oil was first discovered in the mid-1800s there was a glut, keeping its price very low. With the advent of mass-produced automobiles, there was a steady demand for oil, and prices became stable, rising at a rate at or slightly above the inflation rate. During World War II, fossil fuels were diverted to the war effort, so they became hard to get and more expensive. After the war, fuel again became plentiful and relatively inexpensive. During the postwar period, per-capita consumption of fossil fuels skyrocketed.
It is important to note that until the 1970s, almost all the oil used in the United States was produced here. In 1970 the United States reached peak oil production while demand continued to escalate. About 1996, imported oil overtook domestically produced oil for use in US consumption.
The Oil Embargo
Beginning in 1973, political factors caused a shortage of oil in the worldwide market, followed by a global recession. The shortage continued through the early 1980s. The OPEC oil embargo made people think about how they used energy, and energy conservation became common practice. For the first time, people began to talk about running out of oil on a large scale. In fact, though, during this period there was plenty of oil available and in the ground. The oil spigots could have been opened at any time and the crisis would have been over in a day. In fact, this is essentially what happened in the mid-1980s.
Peak Oil and Natural Gas
Today we are facing an oil shortage much different than that of the ’70s and ’80s. We are entering the era of peak oil. There are many good books on this subject, such as The Party’s Over by Richard Heinberg, so we will not go into a lot of detail here. But essentially, today we are at a turning point in the history of modern civilization because the production of oil is at its peak; it will never grow larger, as it has in the past. At the same time, worldwide demand for oil is growing faster than at any time in history. As a result, the price of oil will continue to rise while the supply will decrease. It is important to note that Earth’s oil supply is not entirely depleted. About one-half of all the oil there ever was is still left in the ground. The reality is that we have reached peak oil production, while demand for oil continues to rise at record levels. For some time there will still be oil to be had, but producing it will become increasingly more expensive.
You are probably wondering why we have been discussing oil at such length. Though oil is rarely used to heat water, the price of oil affects the price of all other forms of energy. When it goes up, they do too. This is especially true for electricity. It takes large amounts of oil to mine coal, the basic feedstock of most of our electrical generating capacity in the US. It takes oil to mine and process uranium to feed our nuclear power plants. Oil is used in the natural gas exploration and distribution industry. Our society is completely and utterly dependent on a constant flow of cheap oil. As we enter the peak oil era, its price will continue to rise, with no end in sight.
The same holds true for natural gas, which is used to heat water. We have now reached peak natural gas production in North America, where all the natural gas used in the United States is produced. We will never be able to produce more natural gas than today, even if demand rises (which it is doing). When the United States reached peak oil production in 1970, this was a significant milestone, but it was not devastating to our economy or culture. The oil companies could inexpensively import oil from other parts of the world. All they had to do was to build inexpensive oil tankers to ship foreign oil to the US. This is not the case for natural gas. It takes very sophisticated and expensive ships to import natural gas from foreign sources. Also, expensive and sophisticated terminals must be built at both the shipping and receiving ports. This infrastructure is not in place and it will take many years and a substantial investment to create it. This will significantly affect the price of natural gas in the future. The bottom line is that the cost of natural gas will also continue to rise, with no end in sight.
Life-Cycle Costing
People often ask, “Why would I consider purchasing a solar water heater that costs several thousand dollars when I can purchase a gas or electric water heater for only several hundred dollars?” The answer lies in the fact that they do not think about life-cycle costing. Life-cycle costing adds the original cost of a piece of equipment to its operating cost over the equipment’s lifetime, or at least over a certain amount of time. Using an analysis like life-cycle costing gives an accurate analysis of the real overall cost of a purchase and allows you to make accurate and informed comparisons.
This is why it is important to figure out the energy inflation rate. We know, for example, that natural gas prices will increase rapidly. The question remains: by how much? The energy inflation rate is simply the percentage more you have to pay each year for the same amount of energy. The average energy inflation rate over the past 35 years for natural gas in the residential sector was about 7.5 percent. At the time of this writing, natural gas prices have been flat for a little while. This is primarily a result of a bad economy in which manufacturing has declined, so the use of natural gas has declined too. Do not be fooled into thinking that there is no longer a problem with natural gas supplies. The fact is that the production of new wells is not keeping up with depletion of older wells.
Figure 2.1: US residential gas price trends
Figure 2.1 graphs the price of natural gas over that time period. You can see the effects of the oil embargo in the late ’70s and early ’80s and how the surplus led to a rate decrease. You can also see what has been happening lately — the sharpest rate increases since the oil embargo, with inflation rates that surpass those of that era. Over the past five years natural gas has increased at an average rate of 10 percent, and this is just the start.
When calculating energy savings, you can’t just use the cost of energy during the first year for each additional year because we know that the cost is rising at such a sharp rate. The lowest energy inflation rate that should be used is the historical average of about 7.5 percent for natural gas and oil and 5.5 percent for electricity. However, using this rate does not take into account the fact that dwindling supplies and increased demand will have a strong impact on rate increases. Conversely, using an inflation rate in the 20 percent range, as we have seen in the last couple of years, may result in unrealistic estimates. We made that mistake before, during the oil embargo. Nevertheless, it is best to err on the side of caution and try to be conservative in your estimates without being unrealistic. When estimating life-cycle costs, we use 10 percent as the energy inflation rate for natural gas and fuel oil, and 7 percent for electricity. We believe that this is the lowest it will realistically be over the next 30 years. Most likely we will see the next 30-year average in the 15- to 20-percent range.
In Figure 2.2 you can see an example of life-cycle costing. This example compares both an electric water heater and a natural gas water heater to a solar water heater. All three systems are producing exactly the same amount of hot water. But solar water heaters have no operating costs. You do not have a monthly bill to pay because the solar resource is free. Like any other piece of mechanical equipment, they do require some maintenance, but this amounts to only about $2 per month.
As you can see in the table, viewing the systems in the long term makes for a more fair comparison. The cost of the solar water heater is equal to the operating