Global warming is dire oil industry issue

PETROLEUM IN THE NEXT CENTURY-Conclusion

Kjell Roland
ECON Centre for Economic Analysis
Oslo

Concern over possible climate change caused by emissions of green house gasses (GHGs), primarily consisting of CO₂ from the burning of fossil fuels, may fundamentally change energy industries and markets over the next 2 or 3 decades.

Many are of the opinion that a serious and effective CO₂-abatement strategy could put an end to fossil fuel use, in particular coal and oil, in the foreseeable future, long before the resource base is exhausted. This is in a sense contrary to our prior concern that we ought to limit the use of nonrenewable resources (i.e., oil and gas) and thereby preserve them for coming generations. Now the problem is there are more fossil fuels than many want to see put to use.

Much intellectual effort has, over the past decade, been devoted to understanding how the global climate will be affected by changes in the chemical composition of the atmosphere.

Even if scientific knowledge is still far from perfect and serious uncertainties remain in terms of the scale and effects of climate change in the future, a large majority of scientists agree that a continuation of the present trends in anthropogenic emissions will significantly warm the globe by the middle of the next century.

Much attention in the international debate has been focused so far on our scientific knowledge of the problem. The petroleum industry's focus should shift from the scientific debate towards the possible means by which the international community might act on the issue.

Knowing the complexity and difficulties of negotiating international agreements and later, how they may be implemented on a national level, are vital to understanding the implications for the petroleum industry.

The process from Rio to Kyoto should be regarded as only the first step of a several decades long struggle to develop international institutions and agreements to limit man-made emissions of GHGs. While economic growth is closely correlated to energy use, the kind of energy carrier used in different countries and at different levels of economic development is not the same.

GHG growth ties directly to this economic growth via the energy use. A major curb on global emissions of GHGs, in particular CO₂, will affect the global economy and have ramifications for the energy industry. In scope and complexity, it resembles the process toward international cooperation in areas like free trade, where the present World Trade Organization (WTO) trading regime had been negotiated over 50 years.

Growth vs. CO₂

The overall task in energy/environment policy will be to decouple economic growth and CO₂ emissions. This could either be done by decoupling energy use from economic growth, or delinking emissions of CO₂ from energy use (Fig. 1 [ 72,385 bytes]).

,Neither seems possible for political and economic reasons with today's technical and economic options. Rather, if the world in the near term (next decade or more) has to severely limit emissions, the policies needed to be implemented would significantly impact economic growth, particularly the distribution of wealth between nations.

Winners and losers

The latter is the case for several reasons. Of course, if demand for energy is changed significantly by depressing demand for fossil fuels, energy prices will be affected and fossil fuel prices depressed.

Countries heavily dependent on export of these commodities would hurt; importing nations would gain. The price gains could be significant for importing countries, particularly countries that have not agreed to commitments to reduce their own GHG emissions. This is likely to be the case for most developing countries.

However, changes in economic growth and trading patterns for all other goods and services may be significant. Even if actions to curb emissions in the first phase are limited to industrialized countries, studies indicate that reduced economic growth-and thus imports in the Organization for Economic Cooperation and Development (OECD) area-will reduce demand for developing countries' exports and thus their export revenues.

Slow progress

Due to the strong and conflicting interests that are involved in any kind of cooperative international effort to limit emissions of GHGs, one should expect that progress towards a workable and efficient international regime will be slow and very time-consuming. Nothing like the success of the negotiations over ozone depletion (the Montreal Protocol) is likely, at least not unless major technological breakthroughs are made.

The more global warming moves up the policy agenda in the OECD countries, the more attention will be paid to research and development (R&D). At least this seems highly plausible judged on past experience. When energy policy (for different reasons at different times) has been regarded as important, budget allocations for R&D always seem to increase.

Many wonder why progress to limit man-made emissions of GHGs has been so slow. After the Rio Conference in 1992, governments and green non-governmental organizations (NGOs) returned home with clear commitments to act on the issue. But by the end of 1997, not much had been achieved. Emissions in a few industrialized countries have declined; most other countries are on an increasing trend.

Abatement policies

By 2000, probably only England and Germany among the OECD nations will have reduced carbon emissions compared to the 1990 base year. The reason Germany and England will achieve the target is due to factors outside any specific climate measures.

In Germany, emissions are being reduced as a result of the reunion of East and West Germany, the concurrent economic downturn and restructuring of the Eastern "L?nder." In the U.K., downsizing of the domestic coal industry in the 1980s and the subsequent "dash for gas" in the power sector in the 1990s reduced CO₂ emissions very significantly.

The message here is that no countries have yet initiated abatement policies that in their own right have significantly altered base line emissions, i.e., emissions that would occur if no GHG abatement measures were put in place. This is not to say that no new policies have been adopted. In many countries, renewable energy receives more generous support than before, industry and government have negotiated agreements for "voluntary" actions, performance standards for energy-consuming equipment have been tightened, codes for insulation of buildings have been reassessed, and carbon taxes have been introduced in Scandinavia and the Netherlands.

However, despite these initiatives, stabilization by 2000 will not be accomplished. The present half-hearted policy response is not likely to change before an agreement with binding commitments on targets and timetables has come into force.

The agreement reached in Kyoto in December 1997 has little chance of being ratified as it now stands without any commitments from developing countries. The negotiations are likely to go on for years before an agreement that governments will act on is put into place.

Taking emissions down to the year 1990 level by 2010 will necessitate drastically different policy measures than those adopted so far. What these measures may be if industrialized countries get serious on global warming and how they may alter the energy business and energy markets is hard to predict. To the extent that it is possible to draw on past experience, the following seem likely:

• Governments will maintain full autonomy on the choice of the policy instruments they choose to employ and the mix of instruments that in sum could be labeled each country's GHG abatement strategy. This does not rule out coordinating efforts on a sectoral or regional basis. However, such initiatives are likely to have only limited success due to the strong and often different political as well as economic interests involved.

• Industry exposed to international competition and energy sector interests will tend to be sheltered or less-severely affected. To the degree possible, the competitive position of energy-intensive industries will be affected as little as possible.

• The same goes for energy sectors competing internationally, like generation of power in a more-liberalized market. In primary energy production, domestic producers (i.e., the coal sector) are likely to be favorably treated compared to imports.

One should also expect policies to be structured directly and indirectly in such a way as to not only hit oil use particularly hard, but also affect seriously other imported energy carriers such as gas and internationally traded coal.

However, with the present set of technological options in energy production, conversion, and use, significant reductions in OECD carbon emissions will prove both economically and politically expensive. This will represent an obstacle to short and medium-term emission reductions, and further enhance the trend observed over the last few years to increase the focus on R&D. Arguments to support such a reorientation, as opposed to a heavy reliance on taxation as the remedy to the problem, are twofold:

On the one hand, technology forcing (i.e., demanding that polluters develop technology that enable them to meet ambitious targets for emission reductions in the future) was very important to control local air and water pollution from manufacturing industries. Targets to significantly reduce CO₂ emissions from fossil fuel use 10 to 20 years ahead are likely to spur very significant actions from industries affected, and would start the search for technologies that are able to do what we cannot do today.

Secondly, when considering global warming and given the present state of cost and technology, a decoupling of economic growth and GHG emissions does not seem very likely. It would entail some very fundamental tensions between countries (think of coal-based economies like India and China or the oil producers in OPEC), between energy carriers (actively favoring some at the expense of others) and between service industries and more carbon-intensive industries.

If abatement policies are structured so as to confront the very existence or fundamental interests of fossil fuels, one should expect that countries and vested interests systematically discriminated against by such policies will be able to mobilize very significant opposition.

Neither countries nor industries should be expected to give in easily in such a political fight. The accumulated power that potentially could be mobilized to oppose an efficient and well-implemented abatement policy is significant, and perhaps overwhelming.

Among the options that could be put into use to limit emissions, R&D could prove to be very productive and less likely to be opposed by industry, indeed perhaps supported.

Srategic R&D vision

A strategic R&D vision for the energy sector should attack energy production and use on a broad scale. The "solution" is not likely to be found in one technology or one area (Fig. 2 [58,960 bytes]). R&D directed to significantly reduce emissions of GHG from the energy sector should:

• Increase the efficiency of all energy use
• Commercialize renewable technologies
• Reduce specific emissions of GHGs from the energy sector itself
• Decarbonize fossil fuel in the long term.

R&D policy agenda

Both the energy industries and governments are developing strategies along these lines. A novel and very interesting proposal is put forward in the report "Federal Energy R&D for the Challenges of the Twenty-First Century," which has recently been submitted to the U.S. President by the President's Committee on Science and Technology (Pcast, 1997).

This report portrays a wide range of technology options in the short as well as the long term. For the oil and gas industry, the idea called Vision 21 is of particular interest, with "the objective (to develop) economical coal and gas power and fuels technology with zero-to-small CO₂ emissions." The centerpiece of the logic outlined, is a future whereby CO₂ emissions by the middle of the next century are very significantly reduced; in fact a future where fossil fuel use is decoupled from CO₂ emissions.

Strategic approaches along similar lines are also put forward by the petroleum industry. In Norway, Saga Petroleum ASA has adopted the vision of a zero emission platform as the target for the next generation of offshore developments. Den Norske Stats Oljeselskap A.S. (Statoil) is developing an ambitious R&D program to develop technologies that could separate carbon from exhaust gases and reinject the carbon into the ground, develop the fuel cell technology, or even move towards hydrogen-fueled systems.

To summarize, it may prove to be the case that global warming becomes the final stumbling block for fossil fuel industries. To significantly reduce (not just stabilize) emissions which is what science tells us is required to control global warming, is the most fundamental challenge that the oil and gas industry has ever faced.

To company executives, the choice is to fight the problem, and policies put in place, to do something with them, or to mobilize resources and skills to search the horizon of new technical options.

To policy makers, the choice is to fight fossil industries (and countries heavily dependent on these industries) head on, or to work with the industry to find solutions that could radically alter the way we use energy.

To executives, the choice should be simple. If radical breakthroughs are made, the hope is that in a decade or two, oil and gas may earn the label "sustainable." If not, the possibility remains that their own company may develop technology and insights that could form the platform for new business opportunities.

Global warming is a true long-term issue; so are solutions. The oil and gas industries are fortunate that the world in any case will need their products for decades. No alternatives are able to substitute for oil and gas in large scale over the next two decades. Thus, there is time, but commitment and visionary executives are called for.

Why the oil industry will survive

In the pecking order of the energy industries, oil tends to be the energy industry that always attracts the most attention for the wrong (and right) reasons. When energy is high on the policy agenda and pressure builds up behind claims that political action is needed, this pressure is often ventured by adopting new policies solely or primarily directed towards the oil sector (and the nuclear industry).

There is good and bad in this. This industry developed a poor public image problem in the 1960s, when multinational oil companies became a symbol of oppression and exploitation of the poor countries and foreign control of their natural resources. OPEC's fight to increase host country take in the rent generated in oil production and the subsequent nationalization of production fall well into the picture of North-South divide and antagonistic view of the liberation movements in the former colonies.

Due to the oil crisis in the 1970s, oil became the focal point for concerns over security of energy supplies. Again, trouble was associated with oil traded internationally in chains controlled by multinational companies which often were assumed to pursue goals not in the interests of either the producing countries, nor the consuming nations.

Oil, supplied by international oil companies from places far away used to be cheap, but for sure was less reliable and controllable than domestic sources. Thus, security of supplies turned out to be synonymous with unreliable oil.

Many feel mass mobility, made possible by private cars, is the primary threat to the environment and ecology.

In Europe, there is widespread popular discontent with the side effects of private car use such as air pollution, lead, accidents, noise, the huge areas committed to roads and infrastructure, and the impact on the design of cities, etc.

Despite our appreciation for the freedom that mobility in itself represents, this resentment has facilitated an environment where high taxes on fuels have become acceptable. Gradually, over time, oil products have turned out to be the treasury's favorite. Over the past decade, subsequent to the oil price fall in 1986, increasing taxation on petroleum products has shifted a substantial share of the rent in this sector from producing to consuming countries (Fig. 3 [38,133 bytes]).

Also over time, the tax burden on energy has increasingly turned out to discriminate against oil. Nuclear was introduced to the market by heavy government subsidies and a favorable regulatory framework.

Coal could not be taxed, it is a domestic industry with strong vested interests. In fact, coal in many countries needed protection not only from internationally traded coal, but also from domestic competition with other sources of energy. Subsidies to the coal industry increased dramatically. To illustrate the point, by the mid-1990s, average costs of German coal were close to three times the price on the world market.

Energy policy in industrialized countries has for a long time focused attention on oil. Policies to conserve energy, taxes or levies on energy introduced for environmental or other reasons, and other policy measures are, with few exceptions, focused on oil-sometimes even beyond what is justified by the issue at hand. The oil industry should not be surprised if global warming abatement policies start out with particular attention paid to oil products.

Comparative advantages of oil

Policies to curb oil demand did affect consumption in industrialized countries, in particular in stationary uses. Growth in consumption of 7.3% in the 1950s and 1960s was reduced to 1.1% from 1972 to 1996.

However, taking into account the attention paid to energy policy (for different reasons) over the past 25 years and the strong "anti" oil bias embedded, the surprising question is why the oil industry is still up and going. Oil consumption is growing rapidly in less-developed countries. Evidence from the last few years suggests that consumption in the OECD area is back on a continuous increase (Fig. 4 [45,997 bytes]).

Oil consumption by region

A number of reasons explain why oil competes favorably with other sources of energy in many end uses. Petroleum products:

• Are cheap to move
• Are easy to store
• Have no real substitutes in transportation
• Have responded to environmental concerns about consumption through modifications of products and technology
• Are consumed in technologies which are globally available and manageable even in the most remote places in the third world.

All together, even in the decades ahead, there is good reason to believe that petroleum products will remain the dominant fuel in transportation and will be needed to supply an increasing feedstock demand in petrochemical industries.

They will prove competitive in a vast number of stationary uses and may even prove to be attractive in the power sector in a number of locations.

In particular, oil is very attractive and even necessary to fuel economic growth in developing countries and in applications where other sources of energy are preferred in the OECD area.

Important to note in this regard is the fact that oil, as opposed to gas, electricity, and also to some extend to coal, is less demanding in terms of infrastructure and regulatory framework. This very much favors oil in poorer developing countries.

Copyright 1998 Oil & Gas Journal. All Rights Reserved.