Energy Security Through the Eyes of the World Energy Outlook

I had the pleasure of attending Dr. Fatih Birol’s presentation at the Canadian launch of the 2012 World Energy Outlook, the International Energy Agency’s annual analysis of the state of the global energy market. I had planned to write earlier, but the crucial factors for energy security remain quite timely.

The message of the IEA is loud and clear: the energy sector is shifting rapidly, and traditional expectations are being rapidly overtaken by events. Energy is a constant fixture in security policy, and in the next few years, the energy sector will transform in such a way that many of our existing assumptions will prove obsolete.

Rising United States

Every major economy in the world is set to increase its reliance on imports, except the United States. The rise of unconventional oil and gas technologies has been a dramatic success story for the United States. By 2017, the IEA predicts that the United States will overtake Russia as a producer of natural gas, and dethrone Saudi Arabia as the world’s largest oil producer. This will not only have major implications for the American economy, but will change how the United States looks at the regions on which it has traditionally depended for oil.

The Middle East Pivot

Middle Eastern exports of fossil fuels are in the process of a dramatic shift away from traditional markets in Europe and North America and toward India and China. OECD countries will decline to one third share of world energy use by 2035 as compared with two thirds in 1975, while China and India take the lion’s share of the difference. 90% of Middle Eastern fossil fuel exports will soon go to Asia. At the same time, American imports from the Middle East will drop to an all-time minimum as the United States develops unconventional oil sources with new extraction technologies.

Rising Iraq

Iraq has huge oil resources that were unexplored under the old regime. It has been inviting foreign investment in the energy sector, and enjoys comparative advantages that should help it to do rather well. Production costs per barrel of oil are much lower than in other countries (15 times cheaper than Russia, 13 times cheaper than the Canadian oilsands) due to a lack of geological obstacles.

Because China is the largest expanding market, it is expected that most of Iraq’s oil will go to China. Chinese investment in the country has risen accordingly, and 30% of expanding oilfields in Iraq are owned directly or indirectly by Chinese companies. One cannot help but think of the old charge that the United States went to war in Iraq to get oil. It seems that China will be the main beneficiary.

When China Coughs, the World Shakes

When China closed a series of coal mines due to unsafe working conditions last year, China’s share of imported coal rose by 2.7%. It was an unnoticeable difference domestically, but for a six-month period, global average coal prices jumped to $120 from $90. This was a taste of things to come. As China grows, it will become the lynchpin of the global energy market, and its policies and decisions will have global repercussions.

The good news is that China has invested heavily in renewable energy, so much so that it will account for almost a third of its added power generation capacity by 2035. In that time, China will have added the equivalent of the entire US and Japanese power grids to its capacity. Given such enormous expansion, any measure taken by China to reduce its call on limited resources is good news for the world. Better still, its massive investment in renewable and efficient technologies will yield global benefits as the price of these technologies drops and development costs are absorbed.

The bad news is that China is destined to depend heavily on imported fossil fuels, a situation in which neither China nor anyone else feels secure for reasons that are all too familiar to security analysts. The Chinese economy depends on oil coming through the Indian Ocean and the Malacca Strait, a strategic supply line which China is keen to protect. It also makes China all the more hungry for closer fossil fuel resources, bad news for the region as disputes over oil chains with offshore drilling potential heat up.

China currently imports about 15% of its natural gas and about 50% of its oil. By 2035, it will import more than 80% of its oil with a corresponding increase in gas. Some of this will come from overland pipelines, but much will still have to transit the Indian Ocean, and China has already begun to expand its involvement in oil-producing countries throughout the Middle East and Africa.

The Big Picture is in the Details

At the moment, world oil prices are at an all-time high, going by annual average rather than daily prices. This high, however, is not consistent. Developed economies are introducing carbon taxes, making oil more expensive to the consumer, while developing countries pour in fossil fuel subsidies. In this tug of war, carbon taxes lose, imposing a $10 cost per ton of CO2, as compared with a $110 per ton incentive from subsidies.

The IEA’s message, however, is that efficiency measures pay for themselves by reducing costs and increasing energy security. The United States’ expected shift toward energy self-sufficiency is possible not only because of new extraction technologies, but because it has been underwritten by new efficiency standards, which are reducing domestic consumption.

Natural gas prices remain indexed to oil, which in turn raises household heating and power costs as well as input costs for industry, degrading the competitiveness of the most-affected regions. This indexing may not last much longer, however, as many new countries become exporters of natural gas using unconventional extraction technologies and the market becomes more competitive.

The outlook is worst for Europe. Europe’s economic state may have much to do with energy prices, and particularly with natural gas prices, which are vastly higher than in North America or China. Still, the IEA predicts that household utility prices will continue to rise in Europe even as they fall in China and elsewhere.

Renewable energy sources will account for half of new global capacity by 2035, but the central questions are where this growth will take place and how efficient we can make our continued use of fossil fuels. 1.3 billion people in countries with high and rising populations have no access to electricity, notably in Sub-Saharan Africa and India. The pollution generated by rising economies, notably China, is already an international issue, and with the continued expansion of automobile ownership and road transportation, things will certainly get worse before they get better.