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Suman Bery: The cost of energy

Fossil fuels overall - and oil from West Asia in particular - will be no less important going forward

Suman Bery 

Suman Bery

With its large population, low per capita income and energy consumption, future economic growth and limited domestic resources, India will be a central player in global energy over the next few decades. A new special report by the Paris-based International Energy Agency (IEA) on the prospects and issues in global energy investment till 2035 accordingly provides compelling reading for those interested in the energy choices facing India, and the country’s place in the global energy landscape. Numbers provided below from the report are in 2012 dollars. I should mention that my part of Shell seconds a staff member to the group at the IEA (under their Chief Economist Fatih Birol) that has produced this report.

I will begin with the salient findings at the global level, before turning to the implications for India. Before I do so, however, it is worth indicating what the IEA includes in its concept of “investment in energy”. First of all, this is investment in capital expenditure (capex) and does not include associated operational expenditure. The report defines capex as “the creation or refurbishment of assets that extract, transform or transport energy”. This includes, inter alia, costs of engineering, procurement and construction; of equipment and other material; labour costs; and ancillary costs, such as planning, feasibility studies, external advisory services, the cost of land, and costs of licensing and approval, including environmental approvals. By convention, these expenses are recorded in the year that the project concerned is commissioned.

Secondly, the costs covered include all parts of the energy value chain, both upstream (the provision of fuel) and downstream, including delivery of “energy services” to the final user. In addition, and more ambitiously, the report also attempts to quantify capex toward improvements in energy efficiency, presumably on the grounds that a barrel of oil saved is equivalent to one found. The measure used is “the amount that is spent to procure equipment that is more efficient than a baseline ... [reflecting] the additional amount that consumers have to pay for higher energy efficiency over the period to 2035”.

Third, the projections of the IEA cited below are those that are consistent with their so-called “New Policies Scenario”. The IEA also constructs a so-called “450 Scenario”, which attempts to simulate the investment trajectory that would be consistent with the international goal to limit long-term increase in average global temperature to no more than two degrees Celsius when compared with the pre-industrial era, but these results are not reported below.

Using these concepts and drawing on a wide range of sources, the IEA calculates that $1.6 trillion was invested for the provision of energy for the world’s consumers in 2013, with an additional $130 billion invested toward increased energy efficiency. These numbers may carry little meaning for the non-specialist reader, so it may be worth putting them in context. $1.6 trillion is just slightly lower than the size of India’s current gross domestic product (GDP) measured at market prices and exchange rates. Put another way, world GDP is currently estimated at around $72 trillion; so energy investment accounts for about two per cent of world GDP, provided that the IEA’s numbers are roughly equal to measures of value-added used in GDP. Of this figure of $1.6 trillion in energy capex, 70 per cent is connected in some way to the fossil fuel chain, from extraction to transformation (refining), or the use of fossil energy in power generation; the remaining 30 per cent is evenly divided between non-fossil sources (renewables, nuclear power and biofuels), and electricity transmission and distribution. As the report delicately observes, the estimates “do not show a clear diminishing trend in the share of investment going to fossil fuels since 2000” despite a quadrupling of the volume of investment in non-fossil energy supply.

Against this background, what are the prospects for the period from 2014 till 2035? While the aggregate figures ($40 trillion for energy supply and $8 trillion for energy efficiency) are of some interest, it is the underlying detail that deserves greater attention. The first point to note is that two-thirds of this investment is due to take place in emerging economies. Second, less than half of the $40 trillion goes to meet growth in demand. The larger share is needed to offset declining production from existing oil and gas fields, and to replace power plants and other assets that have reached the end of their productive life. Third, investment in natural gas supply is globally well distributed; however, for oil incremental demand is largely dependent on West Asia, as the supply from countries not members of the Organization of the Petroleum Exporting Countries runs out of steam in the 2020s. The report estimates that the investment needed to supply India and China with imported oil and gas is of the order of $2 trillion over the next two decades. Fourth, even by the end of the period, the share of fossil fuels in primary energy demand is still 76 per cent of the total, even though low-carbon sources account for as much as 45 per cent of the growth in demand over this period.

Within this overall picture, the prospects for the electricity system are also challenging — not only in the developing world but also in Europe. The report carries a special section on India’s power sector, noting both the impressive progress made in new generation capacity (up fourfold since 2000) and the progress in renewables. But the Achilles heel of the system remains inadequate cost recovery in distribution. Owing to the unwillingness to sanction price increases, distribution utilities are incurring losses equal to one quarter of their average cost of supply; the situation has been getting worse, not better, in recent years. Surprisingly, Europe has a similar affliction: the wholesale price for electricity is too low, at present, to provide incentives for the required investment in new thermal plants, despite widespread public concern about high prices for end-users.

What are the implications for India? First, fossil energy will remain an important part of global energy even as renewables grow in importance. Second, West Asia will remain crucial for global oil supplies, with implications for diplomacy and energy security. Third, rapid electrification is one way of expanding the range of India’s energy supply options. The new Union government will need to exercise considerable ingenuity to reconcile incentives for investment with wider access, and will need to carry the states with it.

The writer is group chief economist, Royal Dutch Shell. These views are personal

First Published: Tue, July 01 2014. 21:50 IST