Opinion

6.6.08

High oil prices are here to stay

Oil – and other primary commodity – prices are being squeezed by two powerful fundamental market forces: strong demand and tight supply. On the demand side, China and India are transforming the structure of the global economy bringing 2.5bn aspiring consumers to market. On the supply side, political constraints and rising costs inhibit investment in new production and refinery capacity, helping to force oil prices up. Neither is likely to ease significantly in the next five to ten years.

Despite rising oil prices, demand continues to grow strongly in China and India fuelled by a combination of rapid economic growth and domestic price controls and subsidies. Last year, China’s economy expanded by 12pc and India’s by 9pc – and oil use grew by 5pc in China and 7pc in India. Together two countries accounted for half of world oil demand growth of just over 1mn b/d in 2007. As consumers in China and India are protected from rising oil market prices by domestic controls and subsidies there is little incentive for them to become more efficient. Oil is also widely used for electricity generation – especially small diesel generators used to avoid grid blackouts.

At the same time, oil supply is getting tighter. Upstream, crude oil production outside the Opec countries is now falling, creating a gap that only Opec can fill. In the first four months of this year, non-Opec crude supply fell by 600,000 b/d (1.5pc). But, despite much higher oil revenues, Opec member governments are still not investing enough in new production capacity as they prefer to spend the money for other purposes. And with so much of the world’s remaining untapped oil reserves concentrated in Opec countries – especially in the Middle East – and controlled by state companies, it is becoming increasingly difficult to expand supply.

Oil prices collapsed after the two oil shocks of the 1970s because both demand and supply ultimately reacted to higher prices. Industrialised countries became much less dependent on oil as industry and power generation switched to other fuels, especially natural gas. And Opec lost its grip on the market as the international oil industry developed new fields in Alaska and the North Sea that kept a lid on oil prices. But this is unlikely to be repeated.

Demand is now concentrated in the transport sector where there are no cheap substitutes and most of the growth in oil consumption is coming from developing countries which need oil to fuel their transition to a more advanced economy. Oil remains a uniquely flexible fuel that can be easily distributed without the need for expensive infrastructure and applied to many end-uses. As a result, oil demand is less responsive to higher oil prices than it was in the 1980s, forcing oil prices even higher to slow the rate of growth of demand.

And there are no easy alternatives to Opec oil now that production has peaked in Alaska and the North Sea and started to fall in Russia and Mexico. Opec now supplies just over half of the world’s crude oil production and its members own just over three-quarters of the world’s proven oil reserves. And as governments in both Opec and non-Opec countries become more nationalistic about who develops their oil reserves, the international oil industry is finding it impossible to boost production. Growing barriers to investment together with rising costs, higher taxes and shortages of equipment and skilled staff mean that the industry cannot find enough new sources of oil to weaken Opec’s grip.

But that is not all. This year, oil prices are being forced even higher by a shortage of diesel. Diesel demand is growing at an unsustainable rate as oil refiners cannot make enough of the product. In the first quarter of this year, demand for diesel grew by 8pc compared with the same period a year ago. But demand for other key refinery products was either flat (gasoline) or fell (heating oil and residual fuel oil). Demand is growing fastest in China and India where diesel is being used both for transport and electricity generation – especially in small generators. Diesel demand was up 14pc in these two countries in the first quarter.

Oil refiners cannot cope with such a wide disparity in demand for the different joint products that they make. Although oil refineries have some flexibility to vary the mix of product yields, they cannot keep pace with surging diesel demand without producing a surplus of other unwanted products – especially residual fuel oil – that undermines their processing margins. In addition, diesel is becoming much more difficult to make as more countries require lower sulphur content for environmental reasons. As a result, diesel fuel is not only becoming more and more expensive relative to other products, but also driving up the price of oil in general.

Rapidly growing demand for energy and other primary commodities from developing countries is one of the biggest challenges facing the global economy. If everybody in China used as much oil per capita as the citizens of the United States, then China’s oil consumption would be equivalent to the entire world’s oil consumption today. Although more investment in upstream production and refinery capacity is urgently needed to ease the current tightness in the oil market, the fundamental problem remains – there is not going to be enough supply to meet potential demand unless we all become much more efficient in how we use oil and other sources of energy. Which is why the era of cheap oil is over.

David Long

David is an independent consultant and writer specialising in the oil, gas and carbon markets. He is the editor of the Oil Trading Manual (OTM), a widely-used and well-known comprehensive guide to the world oil market and Director of Oxford Petroleum Research Associates (www.oxfordpetroleum.com).

24.4.08

Government Policy Confusion on Nuclear and Wind

In the past three months, John Hutton, the UK's government minister in charge of industry, has publicly backed an expansion of both nuclear and of offshore wind. Is this good for the UK's climate targets? Possibly not.

One issue never gets mentioned. Both wind and nuclear need to operate as many hours as they can. For it to make financial sense to invest £60bn in offshore wind, operators need to be able to sell the power whenever the wind blows. Similarly, nuclear plants need to be 'baseload' and kept running day and night. Other plants, such as gas turbine generators can be turned on and off easily. The majority of their costs are fuel and it doesn’t matter very much if they work for ten hours a day, or twenty. They are a good complement to wind, whereas nuclear is in direct competition.

So Hutton's support both for 32 gigawatts of wind and for a substantial increase in nuclear generation over and above today's level is inconsistent. In early mornings, total UK demand for electricity falls to well below 30 gigawatts. In the first eight days of last month (March), for example, UK electricity demand varied between highs of 55 gigawatts at the tea-time peak and early morning lows of 32 gigawatts. During much of this period winds were blowing reasonably strongly over the whole of the UK. I believe that offshore wind farms with a rated capacity of 32 gigawatts would have been producing outputs of 20-25 gigawatts much of the time. UK nuclear plants have a total generating capacity of about 10 gigawatts today, although some are out of service for maintenance. So if we simply replaced the aging existing new nuclear stations, we would have too much power for the early mornings without considering any other generating plants. And John Hutton says he wants much more than this.

The implication of this is not understood. If we encourage large amounts of new nuclear capacity, we are likely to reduce the attraction of offshore wind to the point where it simply doesn’t get built.

The rest of the world is avoiding this problem by installing transmission lines to move electricity very long distances. This will guarantee that when the sun stops shining in Spain, the wind from Denmark can provide the power in Madrid. And when neither source is available, we can take electricity from Norwegian hydo plants which can be turned on and off at five second's notice. But for the foreseeable future, the UK is effectively isolated from the main European transmission grids. Our cables to France and Ireland have very limited capacity. So when the winds blow and UK demand is too low, wind turbines will simply be disconnected from the National Grid's transmission system

Unless we change this, pushing nuclear means we simply won’t get much more offshore (or onshore) wind. What's possibly as important, we are also increasing the UK's vulnerability to power shortages in the second half of the next decade. There are many things we need to alter if we are to get real growth in renewables generation, but the crucial task is to invest heavily in transmission infrastructure now.

Chris Goodall, an Ebico customer, is a writer on climate change. This article is a shorter version of a piece written for his newsletter, available free from www.carboncommnentary.com. His book on the most promising new technologies to reduce carbon emissions will be published by Profile in September.

1.2.08

2020 vision for renewable energy

THE EU HAS SET NEW TARGETS for cutting Europe’s overall carbon emissions by 2020. The goal is at least a 20 per cent reduction from 1990 levels, while aiming to generate 20 per cent of Europe’s energy from renewable sources.

For Britain, the challenge will be to increase ‘green’ energy generation to 15 per cent, while cutting emissions by 16 per cent.

The EU commission’s president, Jose Manuel Barroso, stated that European governments are now leading the way internationally with their package of plans to make Europe ‘the first economy for the low-carbon age’.

Barroso said that the plans would mean a cost of only €3 (£2.10) a week for every citizen in Europe – which adds up to around the price of three tanks of petrol over a year. There will be a 10–15 per cent rise in electricity prices – but Europe will no longer be so heavily reliant on energy imports.

The price rise will result from the EU carbon trading scheme, which is designed to achieve significant reductions in carbon dioxide and other greenhouse gas emissions. Europe’s biggest industrial polluters, such as power generators and oil refineries, must now buy and sell emission permits. As the price of carbon rises, the hope is that market forces will enforce the necessary cuts.

For industries such as farming, transport and construction, which are outside the carbon trading scheme, national caps will be enforced.

Member state targets

The EU executive has laid out varying targets for each of the 27 member countries in order to achieve both the 20 per cent emissions cuts and 20 per cent increase in renewable energy. After endorsement by MEPs and individual member governments, the targets will be enforced in 2009.

While richer nations must cut their emissions – Denmark and the Irish Republic each have a target of 20 per cent reduction – the poorer nations will still be able to increase emissions by a limited amount.

Britain must source 10 per cent of road transport fuel from biofuels, although this is provisional on establishing agricultural best practice for the process – they must not be grown on ‘land of high biodiversity’. The UK is also committed to developing other forms of renewable energy.

The British government is committed to achieving the EU targets and is already reviewing plans under way for further offshore wind farms and a major scheme to make use of tidal energy, particularly on the Severn estuary.

The EU commission claims the overall plans will both increase energy security and have a positive impact on climate change, while creating many new businesses and hundreds of thousands of jobs in the process. Barroso encouraged EU firms to lead the way in developing innovative green technologies.

Reactions

Reactions to the EU announcements have been mixed. While many see it as an encouraging step towards the projected 60 per cent cut in emissions by 2050, environmental groups believe the commission should be aiming for the higher target of 30 per cent by 2020 proposed in discussions in Bali in December.

However, the scheme is said to include ‘automatic triggers’ to take Europe’s cuts to the level of 30 per cent if the rest of the world comes on board with the protocol outlined in Bali.

Meanwhile leading scientists are arguing that all current targets are based on out-of-date science – and that we should be aiming for 80 per cent cuts in emissions by 2050 if we are going to act against the major devastation threatened by an increasingly unpredictable climate, melting ice caps and rising sea levels.

EBICO directors