11 tips, trends and traps for 2012

Energy security expert Matthew Hulbert and European Energy Review's chief editor Karel Beckman got together to provide a quick guide to 2012 for European energy decision-makers. Their most important recommendations: check your plan B, prepare the International Energy Agency for a new future, launch an Apollo programme for energy efficiency, free ...

A quick guide for energy decision-makers

11 tips, trends and traps for 2012

1 World Energy Market

Tip: Check your emergency planning procedures

One thing is certain: 2012 is going to be a year of unprecedented uncertainty.

This is not a new insight perhaps: energy business executives and policymakers have been complaining a lot in recent years about the growing (geo-)political and economic uncertainty they are facing. But the words of Ronald Reagan have never rung truer than now: you ain’t seen nothing yet!

On the geopolitical front, what started out as a local protest in Tunisia morphed into an Arab Spring and then into a Global Revolt spreading from Wall Street to Red Square, from rough oil towns in Kazakhstan to sedate sheikhdoms in the Middle East, and from the ancient Capital of Democracy to the crowded, polluted streets of the Middle Kingdom. The motives of the protesters may differ, but everywhere the infectious call for reform is heard and rulers are put under pressure.

The downside of this otherwise heart-warming activism is growing instability, which has now reached the energy heartlands of the planet in the Middle East, Central Asia and Russia.

Throw in a Eurozone crisis, a global debt crisis, severely reduced American “policing” capabilities, daunting domestic challenges in China, a possible environmental crisis as well as a possible disastrous war with Iran and it is clear that the first question decision-makers should ask themselves in the new year is: what is our plan B?

The answer to this question depends on the circumstances of course, but any plan should at the very least include plentiful alternative energy supplies in case oil prices go through the roof. In this context, the drive for renewable energy makes eminent sense – as does the drive for unconventional gas and oil.

2 Energy PolicyTip:Reach out to the public

In the current climate of uncertainty, policymakers – whether in democratic or undemocratic countries – are strongly tempted to go populist. They know they cannot afford to go against the vox populi for fear of losing their power. This means that public opinion, rather than business interests, has become the overriding factor in political decision-making.

The German government’s abrupt decision last year to phase out its nuclear power capacity is the quintessential example. Chancellor Merkel sent the clear message that doing the popular thing is infinitely more important to her than any other “rational economic” considerations.

German politicians are by no means an exception to this rule. Think of the French Parliament’s decision to forbid any kind of shale gas exploitation. Or the Dutch government’s decision to cancel several carbon storage projects.

And it applies to non-democratic countries just as much. Witness the ubiquitous energy price subsidy schemes in oil exporting countries like Russia and Iran. Increased resource nationalism to pay for social spending programs is another example of energy populism in action.

Such populist measures tend to have rather counterproductive results in the energy field. Price subsidies, for instance, have devastating effects on energy efficiency, as the International Energy Agency (IEA) has demonstrated. And while countries like Germany and France are unnecessarily undermining their own capability to diversify and decarbonize their energy supply.

Nevertheless, looking at the state of the world today, it is safe to predict that populism won’t go away anytime soon. Rather the reverse. So here’s a tip for anyone who wants to realize a more or less controversial project: convince the public first – politicians will automatically follow.

3 International Energy AgencyTip: Prepare the IEA for a new future

Talking about geopolitical instability, the question arises what kind of international institutions do importing countries have to deal with a possible energy crisis? Well, there is really only one: the International Energy Agency.

But the scope of the IEA is limited. For one thing, it is an OECD organization and does not include major emerging economies like China and India. In addition, it operates emergency procedures only for oil, not for any other form of energy, such as natural gas. As gas is becoming increasingly important for the world’s energy supply, a gas crisis mechanism should be considered.

The limited possibilities that the IEA has to intervene in the market, has probably led it to evolve more and more into the direction of energy research. The IEA is as much a think tank nowadays as an instrument to deal with an energy crisis. And although it has gained a good reputation in this field, what the world needs is an international institution that can cope with a worldwide energy crisis. But this will have to be an institution that covers at least all the major energy-importing nations, including China and India, and that is able to operate a crisis a response mechanism not just for oil, but for energy in general.

To be sure, the IEA itself has been trying to expand in this direction, but it is ultimately controlled by the member governments that make up its governing board. It is only the political leadership of the OECD countries that has the ability to upgrade the IEA into a truly international institution at the level of the IMF or the World Bank.

So here is tip number 3: now that the rather colourless Executive Director of the IEA, Nobuo Tanaka, has been succeeded by the former Dutch politician Maria van der Hoeven, the moment seems ripe for a transformation of the IEA. That will mean some serious rethinking and political engagement in some of the OECD capitals, not least in Washington DC.

4 US Energy Policy

Trap: Going it alone

What Washington will do about energy is another big question mark in the 2012 yearbook. At this moment the mood in the US Capital seems optimistic, despite Keystone XL and Solyndra mishaps. The US thinks it’s on the brink of energy independence, floating on a sea of unconventional gas and a potential 19 million barrels a day oil production (as against 7 million today). Meaning the import deficit can be fixed, OPEC will become obsolete. Oil will flow from North to South and South to North across the America’s. The scorecard shows 6.5 trillion unconventional barrels of oil in the America’s versus 1.2 trillion conventional plays in the Middle East and North Africa (MENA).

Nice stuff, but this narrative carries a number of downside risks for the US. The first is that the lead time for much of this production is 2020-ish for some, 2030-ish for others. Over the next decade OPEC market share is actually going to reach historic highs. What the US also needs to consider is that their cousins on the American continents have little interest in only feeding US markets. They realise that relying on a single source of supply and a single source of demand isn’t smart. Brazil, Argentina, Bolivia, Ecuador, Venezuela, Canada, Mexico all have an overriding interest in keeping hydrocarbons as a globally traded, fungible good.

Also worth mentioning is that Beijing has been the major overseas investor in the America’s hydrocarbon rush. The Chinese have snapped up new plays in Canada, Brazil, Venezuela, and even now in the US via Chesapeake energy. If the US keeps up the rhetoric, expect a backlash to come in 2012; Asian outlets will be the obvious hedge of choice for Latino leaders that remain far from smitten on the US.

Tip for Europe: if the US continues to believe its own energy independence press, don’t expect Washington to provide too much heavy geopolitical lifting to secure European supplies. Think Libya as a first case in point.

5 Worldwide oil market

Trend: no trend

So what to think of the oil market? Frankly, nobody has a clue where benchmark prices will go. Political debris from 2011 is still littering the energy world into 2012. The Arab Spring is the obvious supply side space to watch alongside new-found cracks in Russia and Central Asia, with some new security risks chucked into the mix from an accelerating Iraqi implosion and a threatening Iranian explosion. Stratosphere here we come?

But that’s only half the picture. Amid serious supply side creaks there are massive demand side cracks opening up. Eurozone is top of the list, but the US dollar is also clearly out of sync with fundamentals, while China needs to prevent a ‘hard landing’ in its succession year as power changes hands in the CCP.

That leaves us with a $50-150 per barrel outlook (roughly!), with swings beyond this ‘price band’ eminently possible. Where things ultimately end up will be a process of which part of the supply-demand equation proves to be most dysfunctional, not what’s working best. Either upside or downside momentum could gather pace.

The next question is whether OPEC would be in a position to moderate prices at the top – or set a floor at the bottom. On today’s evidence, the chances suggest not. The problem is that $100 per barrel for oil isn’t deemed particularly expensive across OPEC ranks, but merely a necessary price to balance budgets and win support through state handouts. The Saudi’s purportedly need around $90/b to keep budgets in check. In this sense there are no ‘doves’ left in OPEC, only gradations of hawks.

Conversely, if we see prices plunge on the back of weakening fundamentals in Asia, they will almost certainly overshoot on the downside once investors exit positions and release liquidity. Like 2008, it will be about keeping investors in the black, not ensuring global oil production (and investment) remains on the straight and narrow. Producer states will be caught seriously short if this happens. It will see Russia out of the money, Central Asian budgets rapidly denuded, and uncomfortable price ranges for the bulk of MENA and West African producers.

What we then might see develop is the political paradox of heightened instability across producer states underpinning prices (rather than conventional supply restraint calmly being agreed in Vienna). The price of crude will be determined by political unrest clipping production rather than supply restraint. ‘Cyclical’ could thus take on a whole new definition in the energy world: the lower the price, the greater the instability – the higher the price. 2012 could provide an interesting test case for this theory.

6 Global gas market

Trend: it's a gas, gas, gas

With oil in trouble, gas is increasingly emerging as an alternative. You have probably noticed that the international oil industry, headed by Shell in Europe and ExxonMobil in the US, has been waging a publicity campaign to promote the virtues of gas. This could make one suspicious, but the mere fact that the big oil companies are doing so, tells us that gas is here to stay. As ExxonMobil puts it on a special website devoted to promoting gas: ‘natural gas will be the fastest-growing major fuel source through 2030, when it will supply 25 percent of the world’s energy needs’.

The fact is that global gas supplies are more plentiful and less concentrated than for oil, and demand is certain to grow. Current soft prices could make investment sticky for a while, but Europe needs gas for environmental reasons, Asia both for environmental reasons (to replace coal) and to drive growth, the US to reduce its paranoia about energy dependence, and many countries in the Middle East, North and West Africa and Latin America to meet growing domestic demand and support economic diversification.

On the supply side, the shale revolution has offered the international oil companies (IOCs) another bite at the upstream cherry. Assuming the shale gas ‘revolution’ continues to gather pace in multiple jurisdictions, whether we’ll be referring to ‘big oil’ or ‘big gas’ in the next few years is up for debate. Shell already derives roughly half of its production from gas (although interestingly its gas production is much more volatile than its oil production). ExxonMobil relied for 45% on gas production in 2010.

So, IOCs aren’t going to let up on this. Asset valuations might become more realistic for what were originally lumps of useless rock and environmental concerns over fracking will need to be addressed. Such concerns will vary from market to market, and it will be up to home governments as to how high they want to set the environmental bar relative to prospective economic and political gains.

In Europe, the logic is simple enough. The closer you get to the Russian border, the more likely it is that shale gas will be made to work. China, India and Indonesia are also likely to follow the unconventional suit.

Yet the bigger plays remain elsewhere. The US will maintain its position as a shale frontrunner, while Australia will continue to push coalbed methane developments and could well surpass Qatar as the LNG heavyweight of the world down the line. The Middle East will also see incremental LNG growth over the next decade, as will some of the larger African players. This should see LNG growth outstrip other forms of gas production.

Where does all this leave Russia? It will have to weather the storm, and maybe even start to accept that independent gas benchmarks might have merit.

7 EU gas market

Tip: victory for TAP, slip for Russia

In Europe, 2012 is at long last going to see some Final Investment Decisions play out in the Southern Corridor. This is because the time has come for Azeri gas to plump for one of the competing pipeline consortia littering the region.

Our odds on favourite to win the first leg of the Southern Corridor race is the 10-20 bcm (billion cubic metres) Trans Adriatic Pipeline (TAP), which looks to be ahead of ITGI (Interconnector Turkey, Greece, Italy), SEEP (BP’s South East Europe Pipeline) or some more farfetched proposals. The EU-inspired Nabucco pipeline will be the biggest casualty, unless fresh funding is provided to put European designs on a more credible footing. Brussels basically needs to decide whether to put up or shut up in the Southern Corridor race.

Even if TAP ‘wins’, that doesn’t mean Russia is going to give up on its expensive South Stream designs. Russia is as keen as ever to maximise control and rent over European supplies, particularly as Gazprom will continue to feel severe pain from European spot market pressures. There is as yet no indication that Russia will be willing to strike a gentleman’s agreement on oil indexation pricing with its large European clients.

Yet the pressure on Russia to abandon its strategy of relying exclusively on long-term contracts is growing. It is not only coming from the international market (see point 6), but also from the European Union which is slowly but surely creating a European gas market structure that will strongly favour spot markets. See the "Gas Target Model" that was proposed by the Council of European Energy Regulators (CEER) in December last year.

Russia’s gas problems come at a particularly awkward time for Vladimir Putin, who is facing hotly contested presidential elections in March of this year. Giving up South Stream in this context seems, well, not very Putin-like.

8 Nuclear power in Europe

Tip: Free our nukes!

Everyone knows that the future of nuclear power looks bleak – in Europe (and Japan) at any rate. (In other parts of the world it’s a different story, most notably in China.) But Belgium, Germany, Spain and Switzerland are all phasing out their nuclear power production, Italy will not return to nuclear power, even France has doubts.

Most instructive are the cases of the UK and the Netherlands, where governments have actively been trying to induce energy companies to build new nuclear power stations – without success. The major reason for this failure is the same in both countries: their governments have made it clear that they will not give financial support to any new projects. Private companies have to put up all the funds – and take all the risks.

The problem is that no private company could take such a risk in the current economic and political climate. This is not necessarily because nuclear power is uncompetitive, as its opponents claim, but because it is an area where political intervention (and thus political risk) is all-pervasive. It is governments that determine safety standards, liability laws, waste processing requirements, etcetera. And governments have a habit of changing their minds: they can pull the rug out from under any nuclear project at a moment’s notice, as we have all witnessed.

Traditionally, nuclear power production has always been controlled by the State in Europe. This is one of the reasons why it has run into problems: as Europe has liberalized its energy markets, nuclear power has lost its political cover. See Germany. As a result, energy producers in Europe have invested massively in gas-fired power stations and have left nukes well enough alone. Note also that there does not exist a strong private nuclear power sector as there is in oil and gas. It is no coincidence that the Shell’s, Total’s and BP’s of this world are not active in nuclear energy.

So how bad is it if Europe leaves nuclear power to die? Well, the EU-27 has the largest number of nuclear power stations in the world, some 150, providing around 30% of the EU’s electricity and no less than 60% of its low-carbon electricity. Given the hugely ambitious decarbonisation targets that the EU has set itself, and its increasing import dependency in oil and gas, a European nuclear blackout comes with much heavier costs than people might realise. (It also makes it all the more ironic that carbon prices are not high enough, or indeed long term enough to support nuclear new build.)

So here’s another tip: perhaps it’s time for Europe to think of some way to free its nuclear power sector from the deadly embrace of the State. Either that, or to nationalize it altogether.

9 German energy transformation

Trap: it could wreck the European economy

Talking about nuclear power naturally brings us to the German “Energiewende”. Can an industrial economy run predominantly on solar and wind energy? That’s the daring gamble Germany is taking with its great Energy Transformation.

The goal of the plan, announced last year, is to get 80% of energy from renewable sources in 2050. “Most of our electricity supply will come from wind energy and from solar energy”, says the transformation plan. Gas and coal-fired power plants will “solely have the purpose of compensating for fluctuations in energy generation from renewables”.

How much this transformation will cost is not clear from the plan. No overall cost-benefit analysis seems to have been made. The Environment Ministry boasts that the renewable energies sector “already employs about 370,000 people”, and that this number could “rise further to more than half a million”. Economically of course the more people are employed to produce a given output, the less efficient it is. According to a study from GerdGanteför from the Universität Konstanz 133,000 people in the German photovoltaic sector produced 12 billion kWh of electricity in 2010. In the single brown coal power plant Niederaussem 700 people produced 27 billion kWh.

The risks for Europe are almost as large as for Germany itself. Trouble in the German industrial heartland means trouble for the rest of the EU. What about the German energy-intensive industry, which incidentally employed a million people in 2010?

How future German energy supply will fit into the wider European system is another urgent question for the EU that does not seem to have been addressed yet. Germany is planning to invest massively in the expansion of offshore wind power – but so are Denmark, France, Sweden, and the UK.

The major German energy companies for their part have decided that they will not fight the renewable energy trend. EON on 15 December last year announced “a multi-billion euro program for energy transformation”. The largest German energy company outlined “a comprehensive program for helping to transform Germany’s and Europe’s energy landscape”. EON has earmarked €7 billion for investments in renewables over the next five years. It wants to build a new offshore wind farm every 18 months.

Number two RWE has made no such official announcement yet, but behind the scenes the company is preparing for a similar move. Expect announcements to this effect later in the year from the new CEO Peter Terium, the Dutchman who will succeed Jürgen Grossmann in 2012. But RWE will rely much heavier on biomass than Eon.

If any of this has you worried, you can worry some more – or stop worrying – for the entire EU has embarked on a similar energy transformation…

10 EU energy policy

Tip: take energy efficiency seriously or forget it

Well, actually, the EU’s 2050 Energy Roadmap, published in December, may have equally ambitious decarbonisation targets, but it does differ in important respects from the German plan. It does emphasize, for instance, an important role for nuclear power. It also assigns a “pivotal” role for carbon capture and storage (CCS), which the German plan is virtually silent about.

This makes it probably more realistic than the German plan, but it still raises plenty of questions, which will no doubt be at the heart of the European energy debate in 2012. Perhaps the most important question is what sort of “policy framework” the EU envisions for its energy revolution. Will it rely on mandates or markets?

This is a point that is also raised in the final report of the high-level Advisory Group which was set up to advise the Commission on the project. This Group has made a lot of interesting recommendations to the Commission, many of which seem to have been ignored in the Roadmap.

On the framework question, the Advisory Group says that the EU should focus primarily on “setting the policy framework”, but it then adds that “the choice of detailed policy instruments” should be left largely to the member states. This recommendation hardly squares with the idea of an integrated European energy market. The Roadmap itself largely ignores the question altogether.

Another striking point of the Roadmap, which few have commented on, is the enormously optimistic assumptions that the Commission makes when it comes to energy efficiency. Even though the Roadmap assumes 1.7% per annum GDP growth, it still assumes that energy use in 2050 will be between 32% and 41% lower than in 2005. That is, in absolute terms! This obviously means that huge reductions in “energy intensity” will have to be made.

There is no historical precedent for such a feat. Yet the Roadmap does not supply a detailed analysis how this can be done. Malcolm Keay of the Oxford Institute for Energy Studies recently published a thoughtful paper entitled Energy Efficiency, Should we take it seriously? The answer is: it should be taken much, much more seriously if the EU’s Energy Roadmap is to get anywhere near being realized. An Apollo programme for energy efficiency is the least Brussels can do!

11 Climate policy

Tip: Stop the Cops

The various European energy transformations are made above all of course for the sake of the climate. This is perhaps the most troublesome energy issue for Europe.

All countries seemed to be very glad of the outcome of the climate conference in “Durban”. That’s enough to make anyone suspicious. The US, China and India were glad they don’t have to bother about the climate for the time being. The developing countries were glad they got a pile of money under the Green Climate Fund. The EU were glad that there will be a global climate treaty in the future. But what will be in that treaty, no one knows.

What will happen now is not hard to guess. The non-EU countries (most of the world) will use the time between now and 2020 as a window of opportunity to develop their fossil fuel sources (especially the unconventional ones) as quickly as they can. The EU will continue on its decarbonisation path alone. There will be no international carbon market.

What about that treaty in 2020? Well, its fate will probably depend a lot on the weather. If the climate has shown additional significant warming by then, the climate problem will move from being an “externality” to a genuine domestic problem for most countries, including the US, India and China – and they will be a lot more motivated to take action. If not, then the problem might indeed not be deemed as bad as people now believe.

From this perspective, the outcome of Durban may indeed be not too bad after all. However, for those who are not satisfied with the status quo, we have a final tip: stop the COPs! (Conference of the Parties, as the climate conferences are called.)There have been 17 of these huge conferences by now, providing fantastic junkets to exotic places for a lot of people who produce very little value for money. Durban had no less than 14,570 registered participants, including 5,884 members of NGO’s. Greenpeace alone had a party of no fewer than 65 (!) delegates in Durban, not counting the Greenpeace-people that were part of national delegations, as with Belgium, Brazil and Thailand.

If Greenpeace and the rest are serious about climate change, they should end this lucrative junketing. They should work to replace the COPs by real summits attended by real world political leaders, the Obamas and Hu Jintaos of this world. They are the ones who make the decisions after all. And they won’t be able to cop out if they are put personally on the spot.