Cambridge Philosophical Society & Cambridge Energy Forum. December 1st 2006

Notes from Nick Butler's presentation

My comments will be focused on the international scene rather than the UK specifically because the UK is just participant in the international energy markets and essentially in economic terms a price taker. The process of transition from high to low carbon forms of energy is unlikely to take a dramatically different path in this country from that in the rest of the world.

The first question to ask is why is the present energy mix unsustainable. ?

What has changed from 1990s - when there seemed to be no problems. The market was providing what was needed, the price was falling, energy companies were being privatised, and energy ministries were being closed.

Now energy issues are in the newspapers every day. Energy ministries are being reopened. Every country is debating energy policy and the UK has an energy minister in the cabinet for the first time in 25 years.

The first factor is demand. Energy demand has gone up 15 per cent worldwide since 2000. Oil consumption has risen by almost 1.5 per cent a year - more than 1 million barrels per day extra every year. Gas demand is up 2.5 per cent per annum over the same period. The reasons behind this are population growth which runs at 10,000 an hour plus the spread of prosperity especially in Asia. Each year there are some 200 to 250 million new customers for commercial energy. It is no accident that China accounted for 49 per cent of energy demand growth last year.

And there are still 1 to 1.5 bn people outside commercial energy market. So demand is set to continue growing.

The second factor concerns prices . The oil price has risen threefold between 2003 to 2006. It was below $ 20 at the end of 2002. Over $ 70 at times this year.

Is that an indicator of shortage.? No. There has been no short term shortage - the surge in prices has been driven by expectations and fears provoked by the civil conflict in Nigeria, by the stance of the government in Venezuela and by concern about what could happen in Iran among many other issues.

Equally there is no shortage of resources longer term. Quoting the figures of the US Geological Survey which is an authoritative source. To date some 1 trillion bbl of oil have been produced. But another 1.3 trillion of proven, identified reserves remain to be produced. And there are at least another 1 trillion bbl of conventional resources still to be found. For gas the figures are even larger. 80 per cent of total resources remain to be produced. In addition there are enormous volumes of heavy oil, which can be processed using known technology.

The key point is that there is no truth in theory of peak oil. Oil will peak but not because it runs out. Its use will peak as it is replaced by substitutes.

The real problem is the location of the remaining resources and the externalities associated with growing consumption based on the current mix of fuels.

On location. The International Energy Agency forecasts show that within ten years the balance will be tighter than it is today. There will be four major importers - the US, Japan, Europe and China. Trade will be required to meet two thirds of their needs. On the other side of the equation will be just three major exporting regions - Africa, including countries such as Nigeria and Angola; Russia and the five states around the Persian Gulf including Iran, Iraq and Saudi Arabia.

Few of those countries are democratic or pluralist and to come back to economics even fewer are accessible for international investment. There is plenty of capital available but the resources not being developed to meet rising demand because investments cannot be made freely in areas such as Russia, Iraq, Iran, Saudi, Venezuela. 80 per cent of remaining reserves and the resources yet to be found lie in areas under strict government control. In many areas there is simply no incentive for producers and owners to invest in order to expand production.

There is also a major issue of infrastructure with a number of narrow and vulnerable trade flows. The most obvious are the infrastructure which brings gas into Europe from Russia and the Straits of Hormuz.

An associated issue is the potential, in a tight market, for producers to use energy supply as a tool in wider relationships.

Then there is the separate issue of climate change and the impact of emissions on the environment. The concentration of carbon in the atmosphere is rising, and has been pushed on in the last two years by the strong growth in coal demand, and the opening of new coal fired power stations in China and now in the US.

There is an emerging consensus reflected in the work of the National Academies including the Royal Society behind the case for precautionary action. Nick Stern has argued that precautionary action could be undertaken at a reasonable cost. But as yet very little action is being taken.

For these reasons the energy situation doesn't feel sustainable.

The mixture of pressures varies from one country to another. In Europe including the UK the primary concern is about the threat to the climate, in China it is about the risks to the set path of development, in the US and in a very different way Poland it is about vulnerability and dependence.

There is no single cause of unsustainability - and no single response. But overall change seems inevitable.

Where and how will the transition come ?

There are many ways of approaching that question

We could start with Science. Will Biology provide the answer through the development of biofuels ? Will Chemistry help through sequestration ? Will there be advances in Solar or in the technology of batteries enabling storage on a greater scale than is possible now; Will the Nuclear industry make great technical advances. ? Other speakers will address those issues.

Alternatively we could start with business and technology. Can the advances in science be moved to application at scale. ?

Or we could focus on public policy. On the impact of opinion and local politics. How is opinion shifting and how will Governments respond.

In the US there seems to be a realisation that energy security can't be achieved through military means. There is as yet no willingness to accept pain in the form of higher gasoline prices and therefore the answer is seen to lie in technology.

In Europe there is focus on climate change, but the instruments deployed are not yet powerful enough and there is a continuing resistance to nuclear.

In China security of supply is the dominant theme leading to extensive state to state deals - with a potentially negative impact on attempts to improve governance standards in Africa.

I will approach the subject as an economist, with a business background. From that perspective I would make four points.

First the transition is not likely to be achieved by a cut back in consumption or conservation, however desirable that might be Some conservation will come with the turnover of capital stock in different sectors. But any conservation will be swamped by the growth of demand from China and India. The projection is that there will 600m new cars by 2020, the majority in those two countries. There is also rapid urbanisation.

Secondly that although at some level prices must have an impact it is clear we are nowhere near that level yet. Energy and oil demand continues to grow worldwide despite the 3 fold rise in prices. As wealth increases spending on energy diminishes as a proportion of disposal income while the use of energy and its centrality to the economy becomes ever more important. The world economy is set to grow by 3.8 per cent this year despite the highest prices since the early 80s.

That means that the two most powerful forces likely to be political - fear of dependence on insecure suppliers

And cost in the sense of a lower cost alternative which can displace oil, gas and coal not through subsidy or through constraints but simply through the price mechanism encouraging customers by offer a cheaper form of energy.

That suggests that transition will not take us from a fixed pattern A to a fixed pattern B.

There won't be quick exit from oil and gas. Both are set to grow and the focus over the next decade will be on maximising the diversity of supplies and infrastructure. There will also be some emphasis on new links between state and private companies to encourage the timely development of resources.

Even in the longer term we are not likely to see the replacement of oil and hyrdocarbons by one alternative. The new balance won't be fixed or stable. It will be a changing mix dictated by the costs of competing and probably shifting sets of alternative fuels. In such circumstances the process of substitution between fuels will become important - allowing consumers to adjust their inputs as relative prices change.

Different countries will use different mixes but there will be two dominant directional themes. The development of energy which is both more local ( thereby reducing dependence ) and more green ( with a lower carbon content.

The transition will be accomplished through a combination of market forces and public policy. In some places carbon will be priced. In others there will be an effective premium for security. In all cases business, public and private sector alike, will respond to the signals given.

What do we not know. ?

That leaves a number of open questions for a forum such as this.

a. will the transition come in time to prevent climate change or should we simultaneously be preparing to adapt to a new and uncertain world. If so how - given the uncertainties of the physical impacts?

b. Can states and private companies work together to develop conventional resources or are the differences in objectives too far apart ?.

c. Will areas such as Iraq and Iran be accessible in timescale required.? Can we get through the short term ( the next ten to fifteen years ) to a period when a wider set of alternative fuels becomes available. ?

d. what are the true economics of alternatives. Can we draw a cost curve and put in place the dynamics which are moving different energy sources along that curve. Everyone has a different view. Related to that - how permanent are high prices - would a price fall in the next few years put off the investment and policy changes required. ?

e. Can the concerns about security of supply and about climate change be melded in policies which answer both concerns. Long term focus on alternatives says yes - but in the short term the practical reality is that people are moving to coal on cost and security grounds.

f. This clearly not an area where action required is limited to one element of society. Can the timetables and interests of science, business and Governments be aligned. ?

g. What are the prospects of moving towards a global/ partially global pricing of externalities. Can you really create trading mechanisms ? If we price carbon how do different countries respond ? can we establish flows of funds between countries to respond to differential need/opportunity. Can we create an institutional framework comparable to that create to achieve financial sustainability at Bretton Woods. ?

h. What is the most effective way of incentivising science ?. I have spoken as if economics were all important. Of course I don't quite believe that and I am fascinated by the link between advances in science and the availability of resources. If the challenge were given the status of a war, or the moonshot would science respond more rapidly. ?