Five complex forces could change structure of industry

PETROLEUM IN THE NEXT CENTURY-5

Kjell Roland
ECON Centre for Economic Analysis
Oslo

• Classes of future energy projections [65,163 bytes]

Projections about the future of energy fall into Conventional or environmental (Green) categories. Although the issue of global warming dominates the Green projections, there are other forces in addition to the environment that are capable of undermining the current structure of the industry.

Before going into some scenarios of the future and discussion of the forces that may be faced, here is an historic review of economic growth and energy demand.

Energy intensity

Energy is vital for economic development and social progress. Without an increase in the supply of energy services-lighting, heating, motive power, etc.-economic growth and improvement in the quality of life for a growing world population will come to a halt. Growth in the demand for energy services does not necessarily mean that the consumption of energy needs to grow at the same rate. Improvement in energy efficiency implies that energy services can be provided with less energy.

In addition, growth in consumption of energy is sensitive to structural changes in the economy. For example, a shift from industrial goods to production of services tends to lower growth in energy demand.

Energy intensities-energy consumption per unit of gross domestic product (GDP)-is a measure which combines these two effects; i.e., both improvements in energy efficiency and structural change towards less energy-intensive sectors. Historical evidence has shown that countries follow a "normal path" in energy use: rising energy intensity at the early stage of development followed by a decline (Fig. 1 [53,308 bytes]). The rise and fall in energy intensity is from the following causes:

• Rising-Commercial energy products replace noncommercial fuels in the household sector. Industrialization and large investments in infrastructure give strong growth in high energy-consuming industries.
• Falling-Production patterns change towards less energy-intensive activities. Access to modern technologies improves energy efficiency. Saturation is observed for some energy services.

Decoupling

Another typical feature is that energy intensity peaks at a substantially lower level than it did some decades ago. This is because more-energy-efficient technology is available now, and the quality of materials has improved, so that, for example, one unit of infrastructure can be provided with less use of steel, cement, etc.

The stylized development of energy intensity does not apply uniformly to all countries, but in a longer historical perspective, this path helps explain the underlying determinants of energy use, and in particular why energy consumption increased over the past century and most likely will continue to do so in the future.

Some parts of energy consumption growth tend to be more stable than others. Energy used in transportation and for electricity generation follows very closely the growth in world economic output.

By contrast, fossil fuels used for stationary purposes show an average growth below that of GDP. Over the past 25 years, a decoupling of stationary energy consumption growth and economic growth has taken place in the countries of the Organization of Economic Cooperation & Development (OECD). Also, in many developing countries, the growth in stationary energy consumption (excluding electricity) has been below economic growth.

In China, for example, the growth in energy demand has been less than half of the economic growth since 1980. The development in China is to a large extent a result of economic reforms and modernization from an extremely backwards and wasteful economic structure. On the other hand, in Central and Eastern Europe and the FSU, energy intensity has not fallen much despite a decisive departure from the system of central planning. Energy consumption has declined but generally less than the fall in economic output.

Decades of growth

Global energy consumption increased from 3,700 to 8,100 million tons of oil equivalent (mtoe) over the 3 decades since 1965, equivalent to 2.6% annually (Fig. 2 [47,368 bytes]). Over the period, oil use grew approximately in line with the total, and contributed 40% of the total despite the substantial impacts that oil price had on consumption. Gas, on the other hand, increased its share from 17 to 24%, while coal decreased from 40 to 27%.

Nuclear and hydro power made up the rest of global commercial energy consumption.

On a regional level, patterns differ somewhat (Fig. 3 [61,862 bytes]). Growth in consumption declined for a few years subsequent to the oil price hikes, but began increasing again from the early 1980s. In FSU/Central and Eastern Europe, the downfall of the communist systems in the late 1980s initiated a period of decline. However, in Rest of World (ROW), growth has been fairly stable, but at a somewhat increased pace in the 1990s.

Expectations for the coming decade

Historically, much effort has been devoted to looking at the future of energy, particularly for oil. Despite an impressive amount of intellectual effort and sophisticated computer methodologies, the reputation of energy forecasting has been in decline.

Predictions

Clearly humbleness is warranted with respect to the ability of forecasting and estimating in quantitative terms where energy markets are heading decades into the future.

However, as was explained previously, the long-term trends in energy consumption display some remarkable resilience in the underlying structures that determine energy growth. The havoc that oil price hikes created in the 1970s and 1980s, and the collapse of communist regimes of the early 1990s, were admittedly more than blips in the curves, but they hardly caused fundamental changes to the relationship between economic activity and energy use.

The role of oil relative to other energy sources has not changed in any permanent and fundamental way. However, climate policy may eventually call for a change in historical trends, and this is currently reflected in forecasts of energy futures.

Collection of projections

To illustrate this, we have collected projections or scenarios from a number of respected and well known institutions involved in analysis of future energy developments. We do not maintain that what follows is an authoritative view or the "best-guess" of future energy developments. Rather, it illustrates some basic features and trends in present perceptions of tomorrow's energy scene.

Because of the potential importance and impacts that the environment, in particular global warming, may have on energy markets, we have made a distinction between projections dominated by environmental concerns, called "Green Scenarios" and other projections, which we have labeled "Conventional Futures" (see box).

Global use

Starting with overall energy consumption, most scenarios, even most Green Scenarios, predict a continued energy growth (Fig. 4 [59,177 bytes]). In Conventional Futures, energy consumption increases from 7,850 mtoe in 1990 to 12,550 mtoe in 2020, by 1.5% annually. This compares with 1.0% per year to a total of 10,550 mtoe in Green Scenarios. Relative to historical trends, both projections are low. In the past 3 decades, global total primary energy (TPE) increased more than 2.5% annually (1965-1996 = 2.6%, 1970-1996 = 2.1%).

The difference between Green Scenarios and Conventional Futures is 2022 mtoe in 2020. If, by contrast, energy consumption from 1990 to 2020 stays at the historical 2.1% per annum, the consumption level would be 2155 mtoe above the Conventional Futures.

Higher energy intensities

It is interesting to note that the implied development in energy intensity in Conventional Futures and Green Scenarios future is considerably higher than in the period 1970 to 1995 despite large actual and expected price increases during the future period (Fig. 5 [59,477 bytes]). The assumption of an increased speed at which new technology and management practices are spread across the globe seem to be shared by all forecasts that we have reviewed.

However, why this is a reasonable assumption is often not well argued. In particular assumptions regarding future developments in the world outside OECD, where energy intensities have been increasing due to industrialization and modernization in the past, imply a break with observed historical trends. From an environmental point of view, this portrays a desirable change that significantly lowers growth in energy use below historical trends. However, it should be pointed out that if this does not materialize, we may observe very significant upwards revisions of projections of energy demand in the future.

Moderate growth assumptions

In addition to the development of energy intensity, the level of growth is of course extremely important for overall energy consumption. Also, in terms of economic growth, many of the projections reviewed are based on the premise of a certain slow down compared to what has been observed over the past decades.

The growth rate assumptions may be especially low for China. Economic growth in China since 1978 has, on average, been 10.1%/year, and it is feasible that it will remain at this level for the next couple of decades. As a comparison, South Korea had an economic growth rate from 1960 to 1990 of 9.1%, and Singapore and Thailand grew by 8.2 and 7.3%, respectively. It appears that only a political setback can prevent China from copying this. On the other hand, there are indications that growth in some of the Asian tigers is slowing down. The share of world energy consumption up to 1995 in China and the rest of Asia is shown in Fig. 6 [60,900 bytes].

Forecast may be low

The Conventional Futures energy growth of China (IEA, 1996a) is set at 4.2% per annum to 2010 based on a GDP growth rate of 7.8. Keeping the same energy intensity decline as in the International Energy Agency (IEA) forecast, an economic growth of 10.1% would imply an energy consumption level in 2010 of 1,800 mtoe, 23% higher than in the IEA forecast and 176% above the 1990 level. This illustrates that if China, and other developing countries for that matter, succeed in their striving for modernization and economic development, energy demand growth may turn out to be notably higher than forecasts shown in Conventional Futures.

Exit fossil fuels?

Many seem to believe that the oil age will soon be over. Green Scenarios show lower overall growth in energy consumption than Conventional Futures, albeit not drastically lower. But do Green Scenarios predict substantial shifts in the fuel mix? Are fossil fuels, and the main target of recent energy policy-oil-on their way out? The answer is no, judged by the studies reviewed. In the Green Scenarios, global oil consumption grows by 0.5% per annum from 3,180 mtoe in 1990 to 3,714 mtoe in 2020 (Fig. 7 [63,968 bytes]). At the end of the forecasting period, oil demand approaches a plateau and further growth in developing countries is offset by a decline in consumption in industrialized countries.

For gas, the situation appears to be even less dramatic. Global consumption grows by an annual rate of 1.5% to 2020 in Green Scenarios, compared to 1.9% in Conventional Future. Gas is less vulnerable to environmental measures than oil and coal because a number of environmental policies may result in a change in the fuel mix in its favor.

CO₂ emissions

Green Scenarios contain vigorous environmental policy efforts, and as a result, stretch our imagination compared to what has been observed in energy/environmental policies. Still, they are less radical than many environmentalists would like to see, and less alarming than some industrialists fear.

This is largely because of relatively cautious environmental measures assumed to be imposed in developing countries. Globally, carbon emissions increase from 23,471 billion metric tons (mt) of CO₂ in 1996 to 32,625 billion by 2020 in Conventional Futures (Fig. 8 [60,709 bytes]). Compared to historical trends, annual growth is 1.4% in the period, while from 1970 to 1996 growth was 1.7% per annum. In the Green Scenarios, emission grew to 28,171 billion mt by 2020, or by 0.8% annually. Thus, CO₂ emissions are only reduced by 14% compared to Conventional Futures, and emissions are still some 26% above the 1990 level.

On a regional level, some very interesting differences appear (Fig. 9 [65,583 bytes]). In OECD countries, emissions are significantly lower in the Green Scenarios, and are also declining in absolute terms. The difference between the two scenarios is 4.2 billion mt by 2020, and the level is then 9% below the 1990 level. In the FSU/CEE area, emissions stabilize at around the present level. Also, the differences between the scenarios are significant, with emissions declining in Green Scenarios. However, growth in ROW, which is strongly influenced by China, India, and Brazil, is paramount and dominates the outcome at the global level. In Conventional Futures, emissions in ROW increase from 8.0 billion mt in 1996 to 15.9 in 2020, 2.9% annually. In Green Scenarios, annual growth is reduced to 2.4%, and the level in 2020 to 14.0 billion mt. However, this is still 7.8 billion mt above the 1990 level.

Shifting priorities, agendas

Concern with energy supplies dates back to at least the 19th century, when Jevons (1865) predicted the end of the industrial revolution because England would run out of coal.

In most societies, access to cheap and reliable sources of energy has been and still is a major public concern. But governments also have other interests in energy, as we can see from the evolution of the energy policy agenda over the past 50 years. Since World War II, three major issues have shaped the direction of energy development in Western Europe. This is illustrated in Fig. 10 [60,300 bytes] (Haugland, et. al., 1998).

Reconstruction, industrialization

The immediate postwar period was characterized by government planning and control of most economic activities. The pivotal role played by the energy sector in reconstruction and industrialization made energy policy a major priority.

In the 1950s and 1960s, the predominant issue in energy policy was how to provide sufficient energy to fuel rapid economic growth. The technological and financial challenges in building adequate energy supply capacity were immense. This period saw the emergence of large and often vertically integrated energy enterprises able to master modern capital-intensive, large-scale technologies.

Security of supply

The oil crisis developed a generation of policy makers obsessed with security of supplies. In the late 1960s and in the 1970s, the geopolitical aspects of energy supplies came to the forefront. Growing trade in oil and natural gas called for national control of the supply chain for energy traded internationally. The oil sector became a target of government intervention, as explained earlier. The oil crises of the 1970s established an entire generation of policy makers with a world-view centered around energy security. Both balance of payment and security of supply considerations led to a strengthening of government control over imports and exports, storage, distribution, and pricing of oil and natural gas.

Furthermore, the oil price shocks, combined with public R&D initiatives and political influence over the electricity sector, led to a significant shift in fuel mix, away from oil.

Environmental concerns

Environmental issues have gradually grown in influence on energy policy. The rise in popular pressures for preserving the natural environment is a strong indication of this trend. Smog and acid rain were early concerns. Another issue was concern over the effects of oil spills in open waters as well as in coastal areas on marine life.

Controversies over the siting of thermal power plants and transmission lines also became widespread, creating major complications for investment programs in the power sector. Health and safety risks related to nuclear power became a top priority after the Three Mile Island accident in 1979. Today, the major new issue on the agenda is global warming. This will be addressed in the concluding article of this series.

New priorities emerge in a sequential manner

From this brief historical sketch, we can see that policies and priorities directed towards the energy sector have changed substantially in recent decades. In some cases, political shifts have occurred abruptly, with little warning and with profound effects on energy markets.

Important to note is the sequential manner in which the main political priorities surfaced and succeeded each other. In most countries, the energy sector was exposed to a relatively coherent set of policy priorities at a time. Thus, the direction in which to move and the thrust of the measures to be undertaken were, if not obvious, at least clearly discernible to most of the actors involved.

Complex, conflicting agenda

Since the mid-1980s, the strategic challenges facing the energy sector have gradually become more complex and onerous.

Mention has already been made of the major unresolved environmental problems related to energy supply and consumption. The threat of global warming has now moved to the top of the agenda in both international and national politics.

In addition, several other political and economic highpriority issues with potentially large impacts for the energy sector have surfaced. All of these new challenges call into question today's national confinement of energy markets and energy/environmental policies. Despite a free flow of technology, extensive trade in energy, and shifting political priorities in the postwar period, the energy sector still, by and large, is in the hands of nation states.

In many respects, differences in industrial structure, fuel mix, and technology are more easily explained by reference to the country of location than by the particular energy industry in question.

This strong national bent in policies and industries has come under severe strain from several angles. The need to move beyond the nation state in energy policy for environmental and economic reasons falls well in line with the general trend towards globalization of the economy.

Policy agenda

To understand the complex and often inconsistent policies that the energy industry is confronted with today and in the years to come, it is important to keep in mind the major challenges that could easily be transformed into forces capable of undermining the current structure of the energy sector (Fig. 11 [74,067 bytes]):

1. Regional economic integration, in the European Union, North American Free Trade Association, and Asia-Pacific Economic Cooperation (APEC)
2. The transition from planned to market economies in the former communist countries
3. New technological options that will open up for new competitors and challenge the present industry structure
4. Deregulation and competition.

This new agenda does not imply that the old one has disappeared. Reliable and predictable supplies will remain a prerequisite for all governments. An energy sector that neglects this objective will not be acceptable in the long term, regardless of ownership structure or whatever policy issue may be high on the agenda.

Security of supply remains a prerequisite for stability and acceptability.

Complex and diverse

Important to note is the fact that the trends in energy policy priorities outlined above are very much a reflection of the mind sets in the OECD. The agendas are strikingly different in the less-developed parts of the world (Fig. 12 [68,072 bytes]). In developing countries, economic growth and reduction of incidence of poverty, access to commercial energy and the finance needed to achieve this, access to technology, and finally reduction in local environmental problems are the priorities.

In the Central and Eastern European (CEE) countries and the Commonwealth of Independent States (CIS), priorities are more on modernization of existing supply infrastructure, promotion of more-rational use of energy, transition to a market-based environment, development of stable legal and fiscal regimes that promote private sector involvement, and abatement of local and regional pollution.

Tomorrow's agenda

Corporate planners and public policy makers should prepare mentally for an energy scene where single-minded strategies or one-dimensional solutions based on past experience will not survive (Fig. 13 [70,057 bytes]).

The energy company will:

• Need to keep an eye on technological developments that may change business opportunities or open up for low cost (often small scale) competitors in home markets
• Have to pay far more attention to servicing customer's needs than before
• Move internationally (if they are not there already) but respect differing policy priorities in different countries and in particular in different parts of the world
• Ask and hope for consistency in energy/environment policies but plan for inconsistency
• Prepare for a broader policy agenda not only encompassing energy and environment objects, but including human rights and social aspects as well.

Classes of future energy projections

Conventional futures

• International Energy Agency (1996), capital constraints case
• World Energy Council/International Institute for Applied System Analysis (1995), Case B
• World Energy Council (1993), Case B
• European Union (1992), Reference case

Green scenarios

• International Energy Agency (1996), energy savings case
• World Energy Council/International Institute for Applied System Analysis (1995), Case C
• World Energy Council (1993), Case C

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