The energy transition cannot be resisted but it could be a source of some of the greatest political instability

It is always good to have different perspectives on the dynamics in the energy sector. While recognising that the energy transition is underway, Nick Butler writes in the Financial Times that there could be some disruptions that make the path a bit bumpy. Let us know your views.

 

Don’t count on an orderly transition to a low carbon world

Remember the Arab Spring and the heady promise of freedom and peace in the Middle East? Many normally sensible observers were carried away by the excitement of the internet-led revolution in Tahrir Square and across the region. Now, a similarly happy transformation is promised in the energy market as the world moves away from oil, gas and coal. The transition is certainly coming but its implications will be as disruptive and dangerous as those of the Arab Spring. We should be prepared for the consequences rather than misled by wishful thinking.

The shift to a low-carbon energy system will be smooth, orderly and beneficial for most of the global economy: that is the view of a new set of papers from the Global Agenda on the Future of Oil and Gas – a group set up by the World Economic Forum, the organisers of Davos. Unfortunately, all the evidence so far points in the opposite direction. The shift may be beneficial in terms of the world’s environment, but economically and politically the result could be dramatically destructive.

Five years ago, the obsession of oil market analysts and commentators was with peak oil, meaning peak supply as finite resources were used up. The argument influenced price speculation and encouraged some companies to invest in expensive projects. Times change and now the common view is that demand will peak before supply, although there is no agreement on when that will occur.

A new contribution to the debate written for the Global Agenda group says that the transition will have many benefits for the global economy. With a diminished role for oil, energy and financial markets will become more stable. Vulnerabilities to supply disruptions and price shocks will be things of the past.

The authors of the paper, Amy Myers Jaffe, the executive director of energy and sustainability at University of California, Davis, and Jereon van der Veer, the former chief executive of Royal Dutch Shell, are serious and well-respected individuals. Their expert knowledge, however, and that of most of the group of which they are part, is based on the world of the past 40 years when oil in particular has been at high tide, with demand continuously rising.

Hydrocarbon consumption across the world has risen by 80 per cent since Mr Van der Veer joined Shell in 1971. Prices have been volatile but the importance of oil, gas and coal to the global economy has never been in doubt. Companies could take risks investing in oil and gas in the confidence that the world market would keep growing; governments could allow their economies to remain dependent on oil and gas because they believed it would always generate the revenues needed to keep things going. Many came to believe that despite occasional volatility, scarcity of supply would continue to drive underlying prices upward over time.

The world described in the Global Agenda paper is very different. Oil demand peaks and then falls back to 80m barrels a day or less by 2040, with further falls to come beyond that. This is intended to be a directional projection, not a detailed forecast. I have no quarrel with the direction, but I do have three specific doubts about the anticipated pace of change and about the authors’ confident expectation of an orderly and positive transition.

First, the papers are correct in saying that the transition is coming. On the timing, however, I think they are far too cautious. Once the tipping point comes, driven primarily as the paper argues by the market penetration of electric vehicles, I don’t think it will take long for the new technologies to spread across the world. Globalisation transfers knowledge and new products very quickly and in the process reduces unit costs. We are not at the tipping point yet, but it is not that far away and once we are past it the downhill slide of oil demand could be dramatic.

Gradualists tend to believe that the embedded investment in the existing capital stock will be a sufficient drag to slow down the process of change. I don’t agree. If the new products are cheaper and more convenient they will dominate the market very quickly. Ask the makers of typewriters or fax machines.

The second point concerns the ability of the oil- and gas-dependent economies to adjust. It is not difficult to think of a dozen countries that are currently overwhelmingly dependent on oil and gas revenue and very ill prepared for this transition – Russia, Saudi Arabia, Nigeria, Algeria, Libya, Venezuela, Angola, Iran, Iraq, Azerbaijan Kazakhstan and Mexico. In almost every case, national economies are completely centred on oil and gas with subsidiary activity dependent on subsidies of one sort or another. For all of them, the scenario painted by Global Agenda will reduce export revenue (and therefore the ability to buy imports), employment, tax revenue and the capacity for public spending.

A few well-run oil producers such as Abu Dhabi might make the transition smoothly. A few more, like Saudi, should have low enough costs to remain competitive in a shrinking oil market. But the rest are vulnerable to any downturn in demand. In addition, of course, significant parts of numerous countries from Colombia to South Africa to Indonesia live off trade in coal, which will also decline and experience intense price competition.

My third point of doubt, arising from the second, concerns the overall cost-benefit analysis. The broad assumption of the paper is that since there are more consumers than producers there must be a net gain in economic welfare. But that disregards the question of timing.

The citizens of producing countries that have come to depend on oil and gas revenue start to lose immediately. Those in importing countries gain slowly over a much longer period. In many countries, such as India, those gains are less than one might expect because prices – for instance of petrol – have been heavily subsidised. Plus, any gains must be balanced against the costs of managing new security concerns arising from the impoverishment of countries in regions that are already unstable. The sweeping assumption of the paper is that markets will be more stable, but this ignores the risk of potentially disruptive responses such as a new wave of mass migration – this time away from the oil-producing countries.

From the World Economic Forum’s lovely headquarters looking out over Lake Geneva, change can be viewed as a beneficial process. The outlook does not look so rosy if you live in the Niger Delta or in Tripoli.

What we are seeing today is a forerunner of what will happen when the transition comes. For the moment, oil demand continues to rise – although the rate of this is dangerously dependent on what happens in a single country: China. But energy supply is increasing by more than demand – particularly in natural gas. The result is weak prices, low revenue and widespread political instability. Just wait until demand starts to fall year by year.

The transition cannot be resisted and it could be very rapid. It should be recognised as a likely source of some of the greatest political instability of the coming half century. There will be winners for sure, but the losers will more evident and more dangerous. The notion of a smooth transition is a ridiculous example of wishful thinking. Remember Tahrir Square.

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