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World energy outlook 2001: assessing today's supplies to fuel tomorrow's growth.



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World Energy Outlook 2001:

Assessing Today’s Supplies to Fuel Tomorrow’s Growth

Dr. Fatih Birol

Head, Economic Analysis Division International Energy Agency/OECD

This paper is based on IEA’s recently published World Energy Outlook 2001.* Three key findings of this Outlook are:

• The world has abundant supplies of energy. Energy reserves are adequate to meet demand at least until beyond 2020. • But, while resources are ample, supply is not guaranteed. Mature oil reservoirs in OECD countries will soon peak and decline. Consumers will grow more

dependent on a small number of Middle East oil suppliers. Huge infrastructure additions are needed to bring natural gas to market and to burn coal more cleanly. The cost of renewable energy sources must fall so that they can compete with fossil fuels. Fears about plant safety and waste disposal still inhibit the use of nuclear energy. • To exploit the favourable reserves situation, massive investments will be

required in infrastructure and technology.

Overview of WEO 2001

Fuelling Tomorrow’s World The world has abundant supplies of energy. Energy reserves are adequate to meet demand at least until 2020 and well beyond. Oil will be available throughout the period, although unconventional oil is likely to play a growing role. Proven reserves of natural gas and coal are abundant. There will be no lack of uranium for nuclear power production in the foreseeable future. Renewable energy sources are plentiful and will be more widely used. Beyond 2020, new technologies, such as hydrogen-based fuel cells and carbon sequestration, hold out the prospect of plentiful, clean energy supplies in a carbon-constrained world.

The principal uncertainty in global energy prospects is the cost. Advances in technology and productivity are driving production and transportation costs lower, but the depletion of the cheapest reserves and the growing distances over which new supplies must be transported are, in many cases, pushing delivered energy costs up. The net effect on supply costs varies among fuels and regions. The cost of supplying natural gas to markets is also starting to rise with the depletion of near-to-market reserves and the growing need to ship gas from further afield. On the other hand, renewable energy

* World Energy Outlook 2001, IEA, Paris. For more information on this book, www.iea.org

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sources, which are usually exploited at a local or regional level, are generally becoming less costly to produce. The other key factor in the energy-supply picture is the price. Energy prices play a major role in determining the timing and the amount of investment that goes into expanding energy supply capacity. Current supply, in turn, influences price. Because the oil market is partially cartelised, prices are well above the marginal cost of oil supply. Since gas competes with oil products, the oil price, as well as monopolistic elements in many markets, keeps the price of gas above its marginal costs too. Future oil prices are very uncertain since they depend heavily on the pricing and production policies of the major producing countries.

Massive Investment in Energy Infrastructure Will Be Needed Financing for the development of energy-infrastructure is a major challenge. Massive investment in the production, transformation, transportation and distribution of energy will be needed to meet growing demand. The bulk of this investment is needed in developing countries, but the scale of investment will require major capital inflows from industrialised countries.

Mobilising this investment in a timely fashion will require the lowering of regulatory and market barriers. Most major oil and gas producers in Africa, the Middle East and Latin America recognise the need for foreign involvement. Algeria, Egypt, Libya and Nigeria, among others, have changed their upstream policies and practices to attract joint-venture investment by international oil companies. Since 1992, Venezuela has sought private investment in the oil and gas sectors. Saudi Arabia has recently started to open its upstream sector to foreign companies. Key coal producers, including China and India, will need to attract huge amounts of capital to meet their medium-term production targets. Increased foreign direct investment and partnerships between international and national energy companies would make possible more supply projects and would limit investment risk for all participants.

Growing International Trade Must Overcome Security Concerns Growing international trade in energy, especially fossil fuels, will have major geopolitical implications. Trade is poised to grow rapidly as a result of the regional mismatch between the location of demand and production. Dependence on the Middle East will continue to grow in the net oil-consuming regions, essentially the three OECD regions and some parts of Asia. This situation will increase mutual dependence, but can also be expected to intensify concerns about the world’s vulnerability to a price shock induced by a supply disruption. Oil-supply chains will lengthen, and maintaining the security of international sea-lanes will become more important.

Increasing dependence on imports of natural gas in Europe, North America and other regions will heighten those concerns. The recent disruption in liquified natural gas (LNG) supplies from Indonesia has brought home everywhere the risks associated with relying on imports of gas from politically sensitive regions. On the other hand, the expected expansion of international LNG trade could help alleviate the supply risks associated with long-distance rigid supply chains if it spurs more short term LNG trading and more flexible supply.

Governments Will Shape the Energy-Supply Landscape Global energy supply trends have major implications for the governments of producer and consumer countries alike. Governments will play a key role in

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addressing supply-security issues, in creating appropriate regulatory and market frameworks and in encouraging technology development and deployment. Environmental policies, including penalties on carbon emissions, will affect energy supply by dampening demand and changing the fuel mix.

The governments of oil- and gas-importing countries are likely to place greater emphasis on improving relations with suppliers; they will also step up measures to deal with short -term supply emergencies or price shocks. The Seventh International Energy Forum, held in Riyadh in November 2000, provided an opportunity for oil producers and consumers to discuss oil market developments. Both sides called for stability, transparency and better data to reduce oil price volatility. Governments and end users are, nonetheless, likely to continue to accept a degree of risk in return for competitively priced oil and gas supplies.

Regulatory and structural reforms in the energy sector will have a major impact on supply prospects. These reforms include the privatisation of state-owned enterprise, the opening up of the energy sector to private capital, the removal of trade barriers and the introduction of competition in gas and electricity through mandatory third-party access to grids. Regulatory reform will increase investment opportunities and encourage the development of new supply projects.

Harmonisation of trade and tariff rules will be especially important to cross-border pipeline projects. Punitive transit fees increase the cost of supply, while geo-political risk can undermine investor confidence and raise the cost of capital. In the transition economies, the implementation of the Energy Charter Treaty could play a key role in improving the trade environment and in encouraging new oil-and-gas pipeline projects from the Caspian Sea area.

Research and development and will be vital to reducing energy-supply costs. Governments can influence the pace of supply cost reduction by encouraging research and development expenditures. Both public - and private-sector R&D expenditures have declined in the past decade. Increased spending on R&D could have a major positive effect on energy-supply technology and security.

Conventional Oil Reserves Can Comfortably Meet Demand to 2020, But Considerable Investment is Needed Proven oil reserves are sufficient to satisfy projected demand for the next two decades. By 2020, oil production is projected in our World Energy Outlook 2000 to reach 115 million barrels per day, or 40% of the world’s total energy supply. Oil will retain its position as the single largest sour ce of primary energy. Over the next two decades, most of expected demand growth over the next two decades will come from the transport sector, where the potential for replacing oil with another fuel is very limited. International trade is expected to double due to the increasing concentration of production capacity in a small number of countries with large, low-cost reserves.

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Figure 1: Impact of Decline Rate on Investment

Further reductions are expected in the cost of producing unconventional oil, such as synthetic crude from oil sands and gas-to-liquids conversion. Unconventional oil may well exceed current projections and account for a much greater share of total oil resources and supply in the period to 2020. Enormous volumes of unconventional oil lie in oil sands in Canada and in heavy and extra-heavy oil deposits in Venezuela.

Global oil production need not peak in the next two decades if necessary investments are made. Declining production in ageing oil reservoirs means that much new capacity will be needed to offset expected production declines and to meet demand growth (see Figure 1). Future oil prices and trends in production costs will be critical factors in attracting investment in new oil-production capacity.

But the pattern of decline needs to be better understood. Advances in technology allow production from new reservoirs to peak higher and earlier, thereby improving investment returns. But this leads to faster rates of decline. The overall rate of decline will also be strongly influenced by declining production from ageing giant oil reservoirs. Both these effects need close scrutiny.

Major Middle East oil producers have an opportunity and challenge to exploit their low-cost resources, but their ability to mobilise capital is uncertain. Their production and investment plans will be closely linked to their pricing policies. They will need to establish a framework that is attractive to foreign investors, where domestic sources of capital are inadequate.

Producers, somewhat paradoxically, do better when prices are moderate rather than when they are very high or very low. The impact of oil prices on supply and demand was analysed using high- and low -price scenarios in the World Energy Model. The results of these scenarios were compared with the WEO 2000 Reference Scenario (see Figure 2). The analysis suggests that neither very high nor very low oil prices would improve cumulative revenues for the major producers over what they can earn under the moderate-price conditions envisaged in the Reference Scenario.

Figure 2: OPEC Annual Oil Revenues

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The development and deployment of new technology will be crucial to reducing supply costs and improving productivity. In recent years, technology has improved the efficiency of finding, developing and producing oil. New technology, including underground sensors and controls, will reduce production cost and improve ultimate oil and gas recovery.

Government policy and industry restructuring will also influence upstream investment. Increased productivity and improvements in market conditions could lead to major increases in production from several countries outside OPEC. Russia has the largest growth potential, particularly given the strong performance in recent years.

Natural Gas Markets Are Poised for Rapid Growth, But the Cost of Transporting Gas Could Rise Natural-gas resources are abundant and can easily meet the expected surge in demand in the next two decades. Proven gas reserves have doubled over the past twenty years, and the ratio of global reserves to production now stands at 60:1. Estimated remaining resources, including undiscovered gas, represent from 170 to 200 years of supply. Most of today’s gas reserves were discovered in the course of exploration for oil. But exploration specifically for gas accounts for a growing proportion of overall exploration spending by international oil companies. There is also a trend toward deeper-water exploration and development.

Exploiting the world’s gas resources will require massive investment in production facilities and infrastructure to transport gas to market. The share of transportation in total supply costs will rise, as supply chains lengthen after the depletion of reserves located closest to markets. Pipelines will remain the principal means of transport for gas in North America, Europe and Latin America, but liquefied natural gas is likely to play a growing role. LNG trade is set to expand dramatically in the Asia/Pacific and Atlantic Basin regions.

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Figure 3: Indicative Costs for Potential New Sources of Gas Delivered to the German Border, 2010 ($/Mbtu)

Gas prices to producers, both in absolute terms and relative to oil prices and gas supply costs, will be the key driver of investment in gas projects. Higher wellhead prices than in the 1990s will probably be needed to elicit the necessary investment in supply infrastructure, as costs rise. Nonetheless, there is scope for prices to fall from the peaks reached in late 2000 and early 2001.

Technology will be crucial in moderating supply costs. Advanced technology, improved management practices and project design and gains in productivity have sharply reduced gas costs. Advances in technology will be needed to reduce supply costs further and open up new supply sources. Costs may drop more slowly in the coming decade than in the last, especially if research budgets continue to decline. On the other hand, innovative technology could open up opportunities for exploiting resources that current technologies cannot tap. Continued advances in gas-to-liquids technology could allow the development of some reserves currently considered to be “stranded” due to their small size and remoteness from markets.

The impact of competition on investment in gas -supply projects is highly uncertain. The spread of competition will stimulate the development of spot markets and hasten the de-coupling of gas from oil prices in long-term contracts. Although long-term contracts will become shorter, they will still be used. To the extent that competition lowers prices at the wellhead and at borders, it can discourage some potential upstream developments. At the same time, however, competitive markets provide new opportunities for producers to market their gas. By reducing transportation costs, competition may also allow for higher netbacks at the wellhead.

Market growth and new supply chains will promote market integration. Rising demand and expanding transportation networks will intensify market integration at the regional and global level. Physical connections between the main regio nal markets will expand, with the prospect of rapid expansion in LNG trade. Changes in the way new LNG projects are structured, including tying less capacity to specific supply chains, could lead to greater commercial opportunities for LNG projects.

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Coal-Supply Prospects Hinge on the Environmental Acceptability of

Coal Use World reserves of coal are enormous and well dispersed geographically compared with oil and natural gas. Economically recoverable proven coal reserves are close to one trillion tonnes, representing about 200 years of production at current rates. Almost half the world’s reserves are located in OECD countries. The size and distribution of these reserves virtually obviates supply-security concerns about coal. The quality of coal deposits determines the cost of, and the prospects for, production, rather than the actual size of a country’s reserves.

The most uncertain factor affecting future coal supply is the impact of environmental policies on demand, especially in power generation. Demand will depend largely on whether clean-coal technologies in the power sector can meet environmental concerns while simultaneously producing coal that is competitive with that produced using other fuels. Concerns about future environmental regulations, including carbon-emission constraints, could deter investment in new mining projects.

Technology is expected to drive continuing improvements in efficiency and reductions in the cost of coal extraction and preparation. Health and safety concerns will encourage further automation which will reduce labour costs. Technology will help to lower the costs of meeting increasingly stringent environmental regulations. Continued growth in the size of mines is also expected to improve productivity.

Figure 4: Coal Mining Productivity

Subsidies to the coal industry will remain an important feature in some countries. A number of hard-coal producing countries in the OECD still subsidise indigenous producers, to support local economies that were originally built around coal. The amount of subsidised production has declined over the past decade, but the complete elimination of subsidies is unlikely in the foreseeable future. Subsidies are common in countries outside the OECD, although many of these countries are also

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reforming and restructuring their coal industry in order to improve performance and investment prospects.

Further Cost Reductions Are Needed to Boost the Role of Renewables Production of primary energy from renewable sources is expected to grow rapidly over the next two decades. Nonetheless, their share in the global energy mix will probably remain small in the absence of determined government interventions. In the OECD, most of the growth is expected to come from wind and bioenergy, supported by policies and measur es to curb climate-destabilising greenhouse-gas emissions and to diversify the energy mix. Hydropower is expected to be the fastest-growing renewable energy supply source in developing countries, based on further development of economically exploitable resources.

Renewable energy has the technical potential to meet large portions of the world’s energy demand, but under current market conditions, the economic potential of renewables is much lower. Over the next twenty years, the economics of renewables are expected to improve as a result of technological improvements and the economies of scale resulting from expanded markets. Market valuations of carbon emissions can also favour renewables.

The most important benefits from using renewable energy sources are environmental protection and greater security of supply. Renewable energy plays a key role in strategies to fight global warming. Their use will be boosted if a market value for carbon emissions is introduced. Renewable energy can often enhance security of supply, since most renewable energy sources are indigenous.

Developing renewable energy resources will require sustained investment in infrastructure. In the OECD, investment in renewables to achieve a 4% share in electricity generation in 2020 is expected to be $90 billion. This is equivalent to 10% of the total power sector investment over the next twenty years. If very strong efforts are make by governments to promote and subsidise renewables, their share could rise to 9% in 2020. The necessary investment requirements would be about $230 billion.

The costs of renewable -energy technologies have already fallen but further reductions are needed for them to compete with fossil fuels. The rate at which costs will decline in the future is uncertain. If fossil-fuel prices do not increase sharply and if governments do not introduce radical new policies, few renewable energy sources will be able to compete with fossil fuels in the near term. Renewable energy can, however, be cost-effective in specific applications. Some technologies, such as wind, are close to being competitive (see Figure 5), while others need to see dramatic cost reductions. Competing land uses and constraints on dispatchability may limit supply.

Figure 5: OECD Europe Electricity Generating Costs for Wind and Fossil Fuels (Cheapest fossil fuel alternative in the base year equals 1)

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Uranium Resources for Nuclear-Power Production Are Ample The needs of nuclear-power generation are currently met by primary production of uranium and by stockpiles and inventories. While supply from stockpiles has increased, uranium production has declined over the past few years. Known reserves and uranium from secondary sources guarantee a secure supply for the next twenty years.

Uranium production is likely to rise in the medium term. Low prices over the last few years have meant that only low-cost uranium deposits have been mined. Uranium production in the near term will come from the most efficient producers, Canada and Australia. There remains considerable uncertainty about future production in the countries of the former Soviet Union, will have ample resources, but face problems in securing funding.

There is considerable uncertainty about secondary supplies. Much of this uncertainty is due to the amount of defence-related uranium that may eventually reach the commercial market. Low-enriched uranium blended from highly-enriched uranium from Russian warheads will help supply the market over the next several years.

Uranium prices will remain modest in the medium term, but they may rise over the longer term as secondary supplies are depleted. As secondary supplies are drawn down, prices will probably rise to better reflect production costs. Because of the long lead time between the discovery and production of uranium, ten to fifteen years in most cases, producers must be assured that prices will remain high enough to cover exploration and development expenses.

The Energy Supply Outlook Beyond 2020 Will Depend on Technology Production costs will be more important to the long-term energy-supply outlook than will the resource-base. Resources will not limit natural gas and coal production until well beyond 2020, although costs may increase as the lowest-cost

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reserves are depleted. Production of conventional oil is expected to peak first. But unconventional oil could fill any supply shortfall, albeit probably at higher cost. The coal-supply outlook depends largely on whether ways can be found to use coal in an environmentally acceptable way.

The extent to which governments encourage technologies that generate low- or zero-carbon emissions and the costs involved are key issues in the long term. Fossil-fuel resources are more than adequate to meet energy demand well beyond 2020, but continued reliance on them may require the large -scale introduction of technologies to capture carbon. How much this will cost is very uncertain.

Beyond 2020, the role of renewable energy in global energy supply is likely to become much more important. The increasing need for new power-generation capacity will create real opportunities for renewable energy to penetrate the power sector. How rapidly it does so will depend on its cost relative to that of competing technologies, taking account of any carbon taxes or penalties that may be imposed. Technological innovation will be needed to get costs down.

The future of nuclear power is uncertain. Some governments may seek to expand or introduce its use as a way of reducing carbon emissions or enhancing fuel diversification. But there will be countervailing pressures to abandon nuclear energy altogether unless concerns over environmental impact and safety are met. Most of today’s nuclear plants will reach the end of their life some time beyond 2020. Decisions about their replacement will need to be taken well in advance.

A number of technologies under consideration or active development could radically alter the long-term supply picture. The main focus of current research on new supply technologies is on hydrogen production and use. Hydrogen technology holds out the prospect of large -scale energy supply with minimal environmental impact. The amount of carbon and other emissions from hydrogen-based energy will depend on how the hydrogen is produced. Fossil fuels may provide the initial source of energy for producing hydrogen for use in fuel cells. Much later, depending on how technology advances, hydrogen production may be based on electrolysis of water using nuclear or renewable energy. In that case, net carbon emissions could be negligible. Carbon sequestration - the separation of CO2 from fuels and its storage in ocean or geological formations - could also have a profound impact on the long-term prospects for energy supply, if technologies are competitive.

Governments will play an important role in encouraging technological progress. Technology development and deployment are strongly influenced by government actions, including pricing and taxation policies and direct funding of research. All governments have expressed their commitment to step up efforts to reduce CO2 emissions. Government policies aimed at reducing the risk of a supply disruption or promoting more efficient markets will also affect the long-term supply outlook.