World Energy Outlook 2004

Date December 16, 2004 Noe van HULST(Director, Long-Term Co-Operation and Policy Analysis Office, International Energy Agency (IEA)) TANABE Yasuo(Vice-President, RIETI)

Summary

What I am going to do is to present to you the main findings of the "World Energy Outlook," which was published nearly two months ago for the first time. Since then we have actually been on a "roadshow around the world" to present it. Let me start with global energy trends before turning to focus on what is happening and what we see happening up to 2030 in Asia.

First, on the global level and the reference scenario, which means the business-as-usual scenario, and the question of what the global energy picture looks like assuming that you are simply making projections based on no changes in policy: There are a lot of other assumptions being made, among others, that we use based on the best projections for economic and population growth from the best sources, such as the United Nations (U.N.), International Monetary Fund (IMF), World Bank and Organisation for Economic Co-operation and Development (OECD), and we do not make our own projections.

In the period up to 2030, if nothing changes, we will see still a big increase in energy demand worldwide, projected to be 60%, which is a bit slower than in the past, but nevertheless a big increase. We also project fossil fuels to dominate the energy mix, with oil remaining the most important fuel. This does not mean that there are no changes. There are changes. For instance, natural gas is projected to grow significantly faster than oil and to overtake coal after 2010. Although renewables are increasing, as they start from a very low base, they will remain less important than the fossil fuels.

What we are basically experiencing, and what we will see up to 2030, is a major shift in the regional shares in world energy demand. This is something that is reflected in many areas, but you see it quite significantly now in the energy picture. Two-thirds of the increase in world energy demand is basically coming from developing countries, especially in Asia. Up to now OECD countries have dominated, with over half of energy demand.

On the supply side, we will also see a dramatic shift in the contribution from the OECD in the growth of energy production, as we have in the past 30 years, because wherever it may be, production in oil and gas is peaking. The growth in demand cannot be met by the OECD and will have to come from outside the OECD, from developing countries.

One of the implications is that this will lead to a drastic increase in energy trade as the centers of demand and production become more dispersed than in the past. So trade in oil as well as gas will go up. An implication to take notice of is that the risks in trading oil are increasing as the same "dire straits" (routes, choke points) are used, the two main ones being the Strait of Hormuz at the head of the Persian Gulf and the Strait of Malacca in Southeast Asia, through which today flow more than 26 million barrels of oil a day (b/d). These straits are known to be dangerous with accidents and piracy occurring, and the risks of these kinds of disruptions will certainly increase.

As for oil reserves and related high oil prices, we made an in-depth analysis in our "World Energy Outlook" and clearly concluded the world is not running out of oil. There is still a lot of oil in proven and undiscovered resources. We are, however, concerned about oil - not so much the size of the reserves, but about the investments taking place to get the oil out of the ground and into the market in a timely manner. Also, the fact that discoveries have fallen in recent years has to do with the strange phenomenon that the drill locations of oil and gas wells are mostly in the regions of the world that do not necessarily have the biggest undiscovered resources. For instance, only 2% of the wells have been drilled in the Middle East. Another problem is that many countries do not allow foreign investment, limiting the access to the big existing oil reserves, such as in Saudi Arabia. This makes us increasingly dependent on whether their national oil companies will do the necessary and timely investments to get the oil.

This all adds up to our initiative, in which we call on all parties concerned to increase the transparency of oil reserves and investments through more comprehensive and standardized reporting systems. Many international oil companies are still struggling with a lack of standardization for booking of oil reserves, which is distorting the level playing field between oil companies. More importantly, the issue of the amount of reserves in the Middle East and their development is not sufficiently clear and should be improved a lot.

In looking at oil prices, we have assumed that they will come down even further in the coming years and then gradually increase again. On average, we assume in our reference scenario an oil price of $25 a barrel (nominal WTI of$31). In light of the difficulties and uncertainties, especially in the Middle East, we have looked at a high oil price case of a nominal WTI of $41, which is pretty close to the average of 2004. Not surprisingly to economists, oil demand in this case will be significantly lower than in the reference case scenario with the lower oil price; and we expect the lower oil demand to rise from the present 80 million b/d to 100 million b/d in 2030. We expect production by the Organization of the Petroleum Exporting Countries (OPEC) to be significantly lower and harder hit because with high oil prices, there would be a huge incentive for oil production to come forward from non-OPEC regions and non-conventional sources. Paradoxically, this would mean the total revenue of OPEC would be much lower in the case of high oil prices. Thus, more moderate oil prices would be in the interest of both consumers and producers. Turning to gas, the demand for which is increasing very rapidly and cannot be met from OECD countries, it has to come from those countries in the Middle East (Iran, Qatar) with their big gas reserves, and also Russia, which we have analyzed in depth. It is quite clear that to meet the increasing demand for gas, Russia could potentially play a very big role, especially as a supplier to the European Union (EU), provided they can get the investment forthcoming to meet that increased demand. In other words, they should increase their production and exports significantly between now and 2030. But this is very uncertain since already about 80% of Russian gas production presently comes from three large fields that peaked a number of years ago. In order to even sustain production they would have to compensate by developing new fields that are more expensive and in less attractive regions in Siberia. What Gazprom is doing now is buying up gas from Central Asian republics (Turkmenistan, Uzbekistan, Kazakhstan) for export to European customers, which firstly is not a long-term solution, and they need to make investments in new fields; and secondly, it also cuts off potential competition. It is not only the case that Europe becomes increasingly dependent on Russian gas, but they increasingly become dependent on a single supplier. The present situation in Ukraine has already raised awareness a lot as 85% of Russian gas passes through Ukraine. Another problem is that contrary to statements about desiring to become a diversified economy, Russia is becoming increasingly dependent on oil and gas, which now account for 25% of gross domestic product (GDP), a share approaching some of the OPEC countries. This means Russia can be expected to behave as an OPEC country and will be increasingly tempted to put upward pressure on prices. Another highlight in the "World Energy Outlook 2004" is that we still need huge energy investments: We estimate the power sector will absorb 62% of global energy investment through 2030. With respect to carbon dioxide emissions, contrary to popular belief, it is simply not true that the rich industrialized world is responsible for all CO2 emissions and hence should solve the whole problem by themselves. With the shifting centers of gravity in the world and the increasing energy demand in developing countries in Asia, those countries' CO2 emissions are also increasing incredibly fast. After 2020, total emissions outside the OECD will be larger than those inside the OECD. In order to fight global warming, there is no alternative to finding ways to involve the developing countries. Turning to the Asia-Pacific and the huge surge of China, the growth figures are very significant, with consumption at 13 million b/d in 2030 according to our reference scenario. Again, they are not able to produce that oil themselves and have to import 10 million b/d, which is equivalent to the U.S. level now. Chinese oil companies now are everywhere, investing all over the place, going into countries which no Western company would dare go into and they are outbidding Western companies from a strategic point of view because they feel it is necessary to get the oil in. In terms of Japan and in line with the projections by the Ministry of Economy, Trade and Industry (METI), energy demand is still growing, but a lot more slowly than before. As for Japan and Korea, we foresee changes in the fuel mix, with increased use of gas and nuclear for power generation. Primary gas demand is also going up. Also, there is an increase in CO2 emissions, but not dramatically, which makes it easier to change the trends more significantly than in other regions of the world. Then, focusing on the Alternative Policy Scenario, we looked more intensely than ever at the case of government policies changing. What if governments are uncomfortable with this increasing dependence on the Middle East for oil and gas and the increasing CO2 emissions trends? We assumed and detailed, first of all, for OECD countries, that governments would step up their policies; that they would put into place more energy conservation measures (renewables, CHP and nuclear) - not that countries will newly adopt nuclear power, but that countries that already use nuclear power would use it a bit more. This is not a utopian scenario. These measures are already being extensively discussed in the public domain in the OECD but have not yet been implemented. For the developing world we assumed the same kind of thing, especially in India and China. As for the alternative scenario for Japan and Korea, they will be able to drive CO2 emissions levels back to the level of 2002, which does not reach the Kyoto target, but sends a significant message that it is possible. This emissions reduction trend also translates for the EU and the OECD as a whole; so there is a real decoupling of economic growth and CO2 emissions. Globally however, even in the alternative scenario for China, with a lot of new policies, for example in fuel efficiency standards, you will still see a rise in CO2 emissions. This is due to China's phenomenal economic growth and increasing energy demand, and its huge use of coal. The gains of the alternative scenario come significantly from energy efficiency. At least at the worldwide level, we are talking about nearly 60% of the reduction in CO2 emissions and the dampening of energy demand coming from end-use efficiency gains. Of course, renewables also contribute to that improvement in the performance. This potential impact is important. What this means is that without any change in policies we will see energy demand rising 60%. The problem is not that we do not have enough resources. We do have enough resources, in our view, until 2030 and well beyond. However, that does not mean we do not have problems. We have a lot of problems because we will be increasingly vulnerable to supply disruptions, as we foresee that all of the increase in demand has to be met from outside of OECD countries, which are relatively unstable regions in the world, such as the Middle East, Russia, and the former Soviet republics. Therefore, an increasing number of countries is becoming dependent on an increasingly small number of producer countries, which will also give rise to already evident geopolitical tensions. There is also the problem of global warming and still rising CO2 emissions, and the huge challenge of getting the necessary energy investment. It is also expected that we will see persistent energy poverty, with one quarter of the world population still having no access to electricity, which could be considered a security risk. More vigorous policies would indeed curb, or even bring down in OECD, the rate of increase in demand and emissions. But because of the increasing power of developing countries, it will not completely change the picture. Therefore, in the long-run, we need technology to solve the problem for a sustainable energy system. For this, urgent government action is needed to put all of that in place. To sum up, Asia will continue to become increasingly important in world energy markets and for that reason in CO2 emissions. The picture of energy demand here in Japan is much more modest, and everybody will face this situation of increasing net imports of oil and gas. New policies would reverse this trend in East Asia, but not in China and India. Questions and Answers Q: Could you explain further your concern about oil reserves as to the uncertainty of whether sufficient investment will flow to the right location at the right time? A: I was trying to point out that the big reserves of oil are concentrated in the Middle East, and this is something that is not always well understood. Some people think that, for instance, Russia is some kind of alternative to the Middle East. I did talk about Russia with regard to gas, but not oil. It is absolutely not the case that oil reserves in Russia are sufficient to meet this kind of energy demand. It is also quite uncertain whether there will be enough investment in the Middle East countries to get the oil out of the ground, and at the time when we need it. Looking at the investment coming forward now, it is very limited. Saudi Aramco's investment plans are very modest, and they tend to defend the position that they first want to see the increase in demand before making the investment and increasing their production capacity. As such, timing is important because if they continue with that approach, there will be enormous delays and a scarcity situation. That is in fact the situation now. One of the big reasons we have these high oil prices is that there was a surprising increase in Chinese demand this year and not enough production capacity to meet that demand. Still today, the spare capacity in the system is very small, and this is one of the reasons that the market jumps with any news from the Middle East or Nigeria and the dangers of their shares falling out of the system. Q: You talked about the need for large investments in energy and also in research and development related to energy, and particularly interestingly, about the need for government action. Could you please comment on why the private sector seems reluctant to invest in energy given that prices are so high at the moment? Also, could you elaborate on the types of things that governments might do to address some of the incentive issues. A: To start again from oil, there are two problems with investment. First, when you look at international oil companies, they tend to take the longer-term view. They do not invest on the basis of WTI now, but rather on their own future projections. Therefore, they have not increased their exploration too much because they may think the higher prices are temporary. However, their price projections are moving upward. For instance, Shell and ChevronTexaco have increased their projected price for investment to$25. Whether that is sufficient remains to be seen. They may run into the same problems in that they are more or less forced to invest in areas which carry a much higher cost. But in the long-run that will not solve the problem unless we get access to those reserves where they are.

There is also the issue of booking those reserves and the way in which the financial market perceives those efforts. Oil companies' actions could be misinterpreted as increased capital expenditure and share prices could drop. There is a sort of paradox between micro assessment and macro assessment. This could be bad for the majors and they have to explain why they are making their investments.

In the oil-producing countries, we would be more or less "saved" if they did a lot of investment, which they are not. They are under political pressures as they struggle to keep their social stability. Saudi Arabia, for example, has one of the highest birthrates in the world but there is a lot of youth unemployment and a lot of pressure on these oil revenues that are not coming back in large amounts in investment.

When you look at R&D that is certainly a problem, although I am a bit less concerned since R&D expenditures on hydrogen, for example, are estimated at about $1 billion a year, and the big automobile companies, such as those in Japan, are investing a lot in new, cleaner cars. On the public R&D side it is perhaps a bit more problematic with declining budgets. Q: On the Shell investment announcement you mentioned, it could be interpreted as being the financial market's voice that it does not want international oil companies to make that kind of investment? Is that strange or is it a rational view? A: That is the big question because the markets also criticize Shell for not being able to hold their competitive position because they have fewer reserves on their books. It is paradoxical that if a company announces it is going to do something about that, for the market to react by criticizing the company for investing, as opposed to seeking the short-term gains of a share buyback. It has a lot to do with the short-term focus of important hedge funds nowadays, which is not an issue only for the energy market. Q: You seemed rather gloomy about the prospects of gas reserves in Russia. Here in Japan there is a lot of attention on the Sakhalin projects. Are those not good examples of the way it should be done? A: Everybody who reads the newspapers and tries to digest what is going on in Russia cannot possibly be very optimistic about what is going on there. The speed with which the state is coming back into the energy sector is breathtaking. Take, for example, what is happening with Yukos, which is sometimes misinterpreted because of the situation with Khodorkovsky in jail, but it is an issue about how property rights are handled. We should be very worried about what the endgame of all this is. Everything is moving in the direction of Yukos' largest oil assets ending up with Gazprom, which has very big ambitions to dominate in oil and gas. This apparently is considered by the Russian government to be a very desirable development, but I think for the investment climate and for attracting foreign investment - that is very questionable. Concerning Sakhalin, the big question is whether Gazprom will get into those areas as well because there is talk that they want to be part of that development and form joint ventures there, whereas the licenses have already been given out to private, Western oil companies. It is not the most cheerful subject at the present moment, I am afraid. Q: If my understanding is correct, the Sakhalin II projects are based on a production sharing agreement (PSA) passed under Russian law, and there is a supply purchase contract with Japanese buyers. In that sense, I think that the Sakhalin project is a bit exceptional to the Russian situation in general as you explained it, is it not? A: I do not want to make people nervous about Sakhalin, but the way that other cases are now being handled is not something that is very encouraging for the investment climate. Aside from Sakhalin, other projects will need much more investment from Western companies. It is therefore questionable whether the government is creating or stabilizing the investment climate in a way to make that really happen. That is what we are trying to signal: for discussion within Russia to take place, as we see happening now. Q: On the Malacca Strait, some people in Japan have already started to consider the capacity issue. Does the figure you mentioned consider the capacity or the forecast for the necessary supply to Southeast Asia? My second question is about investment and the reluctance of private companies to invest, especially upstream. I think that oil and natural gas investment will depend on their prices. In your forecast for the investment for 2030, what are some of the assumptions that you made on the price? A: On your first question, it is a projection on the oil flow and not capacity. It has to do with the increasing trade which has to take that route. As for the second, price, I tried to explain what the underlying oil price assumption is in our reference scenario, in which we expect the price to come down in the next two years, more than now, and then to go up again. On average, it would mean something like$25 b/d in real terms (\$31 nominal) and staying at that level.

Q: You explained the alternative scenario and the contributory factors in CO2 reduction vis-a-vis the reference scenario. As you said, the major contributor is end-use efficiency gains. What is your view on policies of energy efficiency? Also, what is your view on increased nuclear power generation, especially where, how, how much, et cetera?

A: First, Japan is definitely well-known for having a very high level of energy efficiency and many countries admire Japan for that. I was pleasantly surprised to hear that Japan is considering stepping up its efforts still further, and that it has concrete plans to do so. That will certainly send a very important message to other countries as well that much more can be done. On the other hand, we should not assume that it is something you can get for free. In many countries, such efforts would mean stepping up the standards, using more expensive equipment, and all kinds of other measures that have a cost to them. We can see, however, that increased energy efficiency is desirable from an energy security point of view, and that from an environmental point of view it is highly cost-efficient.

Second, it is true that in the alternative scenario we also assumed increasing utilization of nuclear power compared to the reference scenario and that certainly also includes Japan and Korea, among others. We did not assume that countries not using nuclear now will suddenly turn nuclear because that is not very realistic. However, I must say one of the reactions around the world is that non-nuclear countries are discussing whether they should not at least restart a debate on nuclear power. This is quite surprising to us and I do not know how important this trend is, but it could significantly change the picture.

Q: Is the nuclear power increase coming from green-field investment, or replacement investment, or increasing operational hours?

A: Most of it is not really new plant investment but more effective utilization and prolongation of the lifetime of plants. Those kinds of measures are more common than entirely new nuclear power plants, as far as I remember.

Q: What were the assumptions you made about Japan in driving CO2 emissions down? Also, how do those assumptions compare to current Japanese policy?

In relation to that, did you also approach it from the other side: that this scenario does not really lead to Japan's fulfilling its commitments under the Kyoto Protocol? In other words, what would Japan need to do in order to reach the Kyoto targets?

A: We detailed all of the measures in the alternative scenario, so we assumed that, for example, the standards of existing programs would be stepped up, such as in the "Top Runner" program. We have heard that these are among the things currently being discussed.

Again, we did not do the reverse Kyoto scenario because we do not think Kyoto is some kind of Holy Grail that solves the problem. If there is one message from this book concerning CO2 emissions, it is that there is no way out without finding a way to involve developing countries in some kind of post-Kyoto negotiations.

*This transcript was compiled by RIETI Editorial staff.

*This summary was compiled by RIETI Editorial staff.