Energy security: it’s not only oil
The security of energy supplies is once again right at the top of the list of energy policy subjects, following the political tensions in the Middle East, as well as major electricity failures of recent years, the hurricanes of August and September 2005 and the gas dispute between Russia and Ukraine. Even if the system of strategic oil stocks managed by the International Energy Agency has proved to be efficient, today’s keywords for guarding against the risks are diversification (of energy, of its sources, its suppliers and of its supply lines) and flexibility. Dialogue with the producers is essential.
Worries about energy security were at the origins of the International Energy Agency (IEA), an inter-governmental organisation created in 1974, which comprises most of the members of the OECD, including France since 1991. The first oil crisis had shaken the industrialised countries and caused them to act so as never again to find themselves in such a vulnerable situation in the face of a major disruption of oil supplies. From this came the creation of strategic stocks and their management by the IEA.
2006 is not 1974. The oil market is no longer regional and has assumed worldwide dimensions. The fundamental cleavage between the Eastern and Western blocs has disappeared. Progress in information technology has abolished distance. OPEC and the IEA have found wide areas of agreement, in spite of differences of view on the harmonious functioning of the international oil market. Finally, some countries outside the OECD, notably China, India and Russia, are acquiring growing weight in the world energy balance.
In spite of all these changes and the turbulence which has recently buffeted the energy markets, we think that the most serious threats to the reliability of energy supplies at an affordable price remain the same today. First among these is the continuing growth of the major consumer countries, increasingly dependent on oil and gas imports from fewer and fewer, often far-distant, suppliers.
Forecasts of the long-term availability of and the demand for oil presented in the IAE’s World Energy Outlook 1 allow a glimpse of a development which hardly arouses optimism. Certainly, they show that world energy resources are more than adequate to cope with the growth in energy requirements from now to 2030 and beyond. On the other hand, the geographic location of the sources of energy production is changing with time due to the combined effects of costs, geopolitics and technology. In an increasing proportion, energy will be produced in countries which are non-members of the OECD, in particular in the Middle East and the former Soviet Union. Latin America—above all Venezuela and Brazil—as well as Africa will also see a distinct rise in their production of oil and gas.
Increases in flows and risks
The growing regional imbalance between demand and production will bring a very large increase in international trading of oil and gas, both in absolute terms and as a percentage of total supply. There is reason to welcome the development of trade, to the extent that it engages suppliers and consumers in mutually advantageous relations. But at the same time, the risk of serious interruptions of supply is increasing. These disruptions could arise from producer countries seeking to exploit their market position to increase the price or deliberately refusing to supply for political reasons, from the interruption of supplies from wells, pipelines or maritime routes by acts of terrorism or piracy, or simply from accidents.
Although the terrorist threat has led producer countries to reinforce the security of their oil installations, the corresponding risks have not disappeared. Hence, the repeated attacks on production and transport installations in Iraq continue seriously to affect production and exports. Equally, during the Iran-Iraq War and Iraq’s invasion of Kuwait in 1990, oil installations were deliberately and systematically targeted. Recent attempts by al-Qaeda to damage Saudi installations confirm this trend.
Since 1970, there have been 17 serious disruptions in oil supplies. Apart from three, they were all connected to events in Middle Eastern countries or North Africa. We cannot do without imports whatever region of the world they come from, but even less so when the region is the Middle East, whose abundant and cheap resources are essential to meet our future energy needs and in which the producer countries have often stepped up production to stabilise the market in times when this has been necessary. We have to recognise that for most consumer countries self-sufficiency in energy is an unattainable goal. But we must be aware of the risks involved and be ready to face them. In this respect, I must emphasise that oil is not the only commodity involved. There are also risks to electricity supplies and, as has been seen recently, gas supplies are not immune either.
Increase spare capacity
A key element in security of supply is the existence of spare capacity, enabling us to cope with the unexpected. Currently, this is inadequate. Events have proved that a sudden reduction in oil supplies, even a small one, can set off a spike in prices if the spare capacity is limited or stock levels are not adequate.
It is true that the situation is improving. A number of upstream projects, which will increase supplies in the short term, are coming to fruition. Will they be sufficient, however? From our point of view, at any rate up to 2009, spare capacity will be less than the three million barrels per day needed to have a comfortable margin available. The international oil companies certainly have a role to play in increasing availability but more effort is also indispensable on the part of the producer countries which possess the largest and most accessible reserves on the planet. Investment is vital and, if possible, a precise timetable should be established for the commissioning of new installations, with priority given to light crude. The recent decision by OPEC to announce its projects in gestation is welcome; such transparency reduces the uncertainty affecting the market and should be acclaimed.
The problem is not confined to constraints on oil production capacity. It is also alarming to note that spare refining capacity is also insufficient. Currently, refineries are effectively working flat out. What is termed conversion capacity is even more necessary than distillation capacity as demand is increasingly for light products (vehicle fuels), whereas production includes a growing proportion of heavy, sulphurous products. In many countries, it is becoming difficult to construct new refineries because of environmental regulation, planning rules and public opposition. Here too, investment is necessary, without which the market will continue to suffer from bottlenecks and instability and volatility will persist. In this area, it is encouraging to hear of the launch of several new refinery projects, recently announced, in producer and consumer countries.
Unfortunately, it is not only the probability of a disruption of supply which is likely to increase but also the scale of its repercussions. This phenomenon is explained largely by growing inflexibility in the demand for oil. During the oil crises of the 1970s and the beginning of the 1980s, large quantities of oil were still being used for electricity generation or industrial applications Although since then we have been able, to a large extent, to substitute natural gas, coal or nuclear power for oil, this is no longer possible today. The consumption of oil products is becoming increasingly concentrated in the transport sector, and existing vehicles cannot convert from one type of fuel to another at the drop of a hat in the event of a supply crisis.
Even the most prudent existing energy policies cannot prevent disruptions in supply from happening. With this eventuality in mind, since the creation of the IEA our member countries have sought to improve the mechanism for intervention in the case of an emergency. Each member country is obliged to hold oil stocks equivalent to at least 90 days’ net imports, based on the previous year’s figures. Collectively, these reserves currently represent 4 billion barrels of oil, of which some 1.4 billion barrels are under direct governmental control. The member countries are also obliged, in the event of a crisis, to be ready to cut demand, replace oil with other forms of energy, increase domestic production and share the available oil.
Proof of the efficiency of this emergency preparedness system was forthcoming in September 2005, after the destruction of considerable production and refining capacity in the Gulf of Mexico by hurricanes Katrina and Rita. In the decades to come, when the world will be faced with more and more dependence in respect of its oil imports, we will have to strengthen our intervention mechanisms still further and find ways to collaborate with other major consuming countries, such as China and India. This approach will be costly, but it will be of vital importance in preserving an appropriate degree of security in an emergency.
As recent events have shown, the growing reliance on oil imports is only one peril among others from the energy security point of view. Russia’s decision to cease supplying gas to Ukraine caused apprehension well beyond Kiev. By actions of this sort, Russia is compromising its reputation as a reliable energy supplier and has provoked concerns about the means available to Europe to face a more prolonged interruption.
It is timely to recall that more than half of Europe’s gas imports come from Russia. This is not a worry in itself since these are, after all, two natural partners in energy matters. The problem stems from the fact that all the natural gas exported by Russia is produced or transported by Gazprom. For several years the IEA has doubted whether this state gas monopoly has invested sufficiently to be able to meet the export requirement, which is increasing. We are also concerned by its strategy of expansion, which has enabled it to control a large part of the supply chain from the well-head to the consumer, thus depriving its competitors of the possibility of exporting Russian gas.
Gazprom having now shown that it is ready to use its market power, it is logical that the European countries should re-examine the risk to which they are exposed and the solutions capable of reducing it. Europe should, to begin with, seek other suppliers or other fuels, unless market reforms allow Russian oil companies— which increasingly produce associated gas—and independent Russian gas producers to compete with Gazprom in its lucrative market. The G7 finance ministers have requested this change. In addition, Europe could re-evaluate the composition of its electricity generating installations. Coal and nuclear energy should be reviewed, and the renewable energy route remains open. Some have also put forward the idea of constituting emergency gas reserves to compensate for the risks involved. This would be a partial solution, but would cost ten times as much as oil reserves stored in comparable conditions. Besides, as long as the flexibility of the distribution system has not improved, its real effect will be markedly diminished.
Thus far, we have emphasised the dangers that energy imports constitute for energy security, but we cannot ignore those which appear closer to home. The liberalisation of the energy markets should reinforce energy security by stimulating efficiency and the diversification of supply. And yet, is this always the case? In the electricity sector energy security depends on adequate investment made in good time in the production and distribution infrastructure. The markets are a powerful instrument for achieving this objective in an effective way, but their ability to mobilise investment in electricity production has been the subject of fierce debate since the widespread breakdowns which occurred in North America and Europe in 2003 and 2004. Major breakdowns are certainly not a new phenomenon and happened well before the reform of the electricity sector. The lesson to be drawn from these failures of electricity systems is that liberalised markets must offer sufficient incentives to investors to guarantee an adequate degree of security to consumers.
Before the reforms, electricity markets in most OECD countries were characterised by a comfortable margin of installed capacity in spite of constant growth in demand. When the markets were opened this margin reduced the risks to the security of supply but, as it dwindled, the problem of investment arose. The situation is even more precarious regarding the high-tension distribution system. Investment in the network has lagged behind the rise in electricity consumption. Moreover, distribution networks were intended from the start to serve national territories, so that today bottlenecks are appearing at frontiers. The experience of other countries, Australia for example, shows that competitive electricity markets can function satisfactorily, on condition that they are well organised and adequately regulated.
To conclude, I would like to reaffirm the key role of governments in guaranteeing the security of all forms of energy. Above all, they must create a favourable climate for investment so that the private sector can provide safe, affordable and clean energy, in cost-effective conditions. Using market mechanisms, governments must diversify the forms of energy used in their countries as well as their geographical sources of supply. They must show initiative in the face of the risks created by the trade in energy commodities. Strategic oil reserves constitute an essential safety net but it will also be necessary to improve relations with the energy-producing countries. Finally, the safest energy is obviously that which we do not consume. That is why governments must continue systematically to put in place more vigorous policies to control demand in order to reduce energy consumption.