April 2016

Oil and gas in the capitals

Europe’s energy equation
Dr. Øystein Noreng / Contributing Editor

EU energy policy aims to raise self‐sufficiency and reduce import dependence, while improving energy efficiency and shrinking carbon emissions. The policy is based on assumptions about higher world oil and gas prices, and that Europe can make a difference in saving the global climate. External oil and gas supplies have been considered unreliable and increasingly expensive. Instead, world energy prices have fallen. Europe constitutes only a small part of the world’s greenhouse gas emissions, and climate concerns have had limited political impact elsewhere.

Objectives. The key objective is to reduce greenhouse gas emissions 85%–90% by 2050 from 1990 levels. Other aims are to increase competitiveness and supply security. Insofar as cutting emissions is primary, EU energy policy appears to be an instrument of climate concerns, rather than economics. Consequently, cost reduction and supply security, meaning stable volumes and prices, are subordinate to emission reductions.

As a major importer, with energy self-sufficiency just below 40%, the EU economy is more exposed to the vagaries of world markets, driven by oil prices, than is the U.S. or Russia. By moving ahead in the preference for renewable energy, EU policymakers implicitly gamble that a short-term cost disadvantage will turn into a long-term competitive advantage.

The argument is that climate policy also makes sound economic policy. Insofar as fossil fuel supplies are limited, world market forces will drive oil and gas prices higher, making energy-saving and decarbonization economically sensible, and investment in renewable energy a profitable business. Insofar as climate change will be increasingly serious and ever-more countries will adapt decarbonization policies, radical and early decarbonization will strengthen EU industrial competitiveness, when other world regions wake up belatedly to the challenge. Implicitly, EU policymakers have placed a double bet—using oil and gas will be increasingly expensive, due to scarce supplies, and be progressively more damaging, with effects ever more harmful to the environment.

After years of exceptionally high oil prices, the market strikes back, imposing new realities. For more than 10 years, high oil prices have given incentives to energy efficiency and to investment in more energy provisions, so that world markets experience supplies rising more than demand, driving prices down. In a cyclical market, this is not sustainable in the long run, but huge oil inventories and the breakthrough for shale oil and gas mean that any price upturn would be precarious and limited in scope. Therefore, the EU policymakers’ bet may be, at best, a limited success.

Shale technology and gas liquefaction create a worldwide LNG market. Regional gas markets are being connected by sea-borne trade, as gas prices align. Multiple sources reduce supply risk. North America is becoming a net exporter. With moderate prices, gas demand is growing in most parts of the world, except in Europe, where it is falling. Gas is a preferred power generation fuel, except in Europe. Prospects are for rising gas supplies from multiple sources, ensuring competition and moderate prices, as well as reduced dependence on Russia.

The EU’s share. In 2014, the EU emitted about 10% of total global CO2, down 19% since the peak in 2006, at an average annual rate of 2.6%. The EU performance shows that reducing emissions is feasible, but at a high economic and social cost. From 2006 to 2014, the cumulative EU economic growth was 4.6%, at an annual rate of 0.6%. EU energy consumption fell 12%, indicating real decarbonization. Electricity generation declined 6%, indicating a depressed economy. Support for wind, and especially solar power, has reached levels where the implicit price of CO2 not emitted is many times the traded carbon quota price. The policy provides the EU with the world’s most expensive electricity, without corresponding reliability, at a huge social cost.

In 2014, the average electricity cost to industry in major EU countries was two to three times that of the U.S. Households paid as much; German households paid, on the average, more than three times as much for electricity as in the U.S. Gas prices are a similar; U.S. industry paid less than one-half what European firms had to pay. Likewise, U.S. households paid about half the European prices.

As the climate issue is global, EU efforts have limited impact. Globally, emissions continue to increase, especially in newly industrializing countries. Insofar as Europe, through arduous and costly measures, should manage to reduce CO2 emissions 85% from 1990 levels by 2050, the risk is that it would be outweighed several times by emissions growth elsewhere. The figures are brutal—in 2014 non-OECD countries accounted for 61% of global emissions, but per-capita energy use was a fraction of OECD levels. In the global balance, the EU achieving the long-term goal would mean a reduction of about 3 billion tonnes of CO2 emissions by 2050, but the non-OECD countries, continuing a rise of 1.8%/year in their emissions, would mean a supplement of about 20 billion tonnes.

Even if the emissions increase in the developing economies should taper off, it is evident that the EU, alone, cannot save the planet. So far, no other major countries have announced carbon reduction ambitions on the EU’s scale. Major Asian economies continue to expand coal-fired power generation. The U.S. Senate made it clear that President Obama had no mandate to enter into any binding agreement in Paris. Consequently, the focus on climate, and reducing CO2 emissions in practice, appears as a European preoccupation. The issue is global, and the EU contribution is limited. wo-box_blue.gif 

About the Authors
Dr. Øystein Noreng
Contributing Editor
Dr. Øystein Noreng is a professor emeritus at BI Norwegian Business School. He has been an advisor or consultant to the International Monetary Fund; The World Bank; the governments of Canada, Denmark, Norway, Sweden and the U.S.; and energy companies, including Equinor, PDVSA and Saudi Aramco.
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