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Energy and the environment: the oil producers' viewpoint.

Energy and the Environment: The Oil Producers' Viewpoint

This article* by Saadalla A. Al-Fathi, Head of the Energy Studies Department of the OPEC Secretariat, attempts to remedy a major deficiency in the current debate on the environment, namely how to take account of the legitimate interests of hydrocarbons producers.

Concern about the environment and its association with energy use has been a topical issue for a few years now. The Brundtland Report intensified the debate in 1987, touching upon various dimensions of environmental deterioration, including mass poverty in various parts of the world, population growth, pollution, etc. It concluded that something needed to be done in order to check the deterioration brought about by these several factors.

However, in recent years the emphasis has been rather more on the environmental pollution and climate change attributed to the use of fossil fuels. The combustion of fossil fuels has been at the core of the economic growth and development of the world for centuries, especially since the Industrial Revolution. While, on the one hand, this has underscored growth, the waste products, in the form of CO2, NOx, CH4, SOx etc, are thought to be responsible for the so-called "green-house effect" and acid rain. The task now facing mankind is to learn how to make judicious use of the fuel resources available to it in order to promote economic advancement, while, at the same time, maintaining environmental equilibrium.

Most of the proposals aimed at protecting the environment seem to centre on measures designed to restrict that amount of greenhouse gas emissions to a certain level by a certain date. The Toronto Conference called for a 20 per cent reduction in CO2 emissions, from 1988 levels, by 2005. In order to achieve this, various proposals have been put forward, including a carbon tax, a switch to cleaner-burning fuels, fuel reformulation, increased efficiency or even emission permits.

There is hardly any doubt that such policies would affect the demand for all forms of energy, including oil. In the debate so far, the issue and policy options have not been properly addressed from the perspective of the producers, especially those countries which depend solely on the extraction and sale of oil or other fossil fuels. An effort is needed in this direction, so as to generate sufficient interest, not only for oil producers, but also for other fossil fuel producers and environmental policy-makers.

The Emerging Protocols

Although recognizing the element of uncertainty which still surrounds the scientific evidence, virtually all proposals advocate the need for some international effort to reduce the rate of growth of pollutants. The underlying reasoning is that the predicted consequences of non-action could be so serious that mankind should adopt measures now to reduce the risk. The emerging protocols set emission limits and timeframes for achieving them, with some countries carrying out their own programmes along the lines of these targets, while others remain at the deciding stage.

The important point so far is that there is as yet no international consensus on CO2 emission targets or timetables. But, it can be argued that the Toronto target roughly encompasses the policy aspirations of most of the countries that have announced a plan. It should be emphasized that individual action on the greenhouse effect problem is unlikely to have a noticeable impact, but will definitely harm the economy of the country concerned. The need for collective action has always been stressed at international meetings.

As for the issues related to clean air and acid rain - which are related mostly to sulphur dioxide (SO2), nitrogen oxide (NOx) and volatile organic compound emissions - the energy industry may have to face great legislative pressure in the next few years. As oil producers, we recognize that the industry must move to reduce these pollutants in its operations. The oil refining industry has already made great strides in cleaning up and upgrading its light products and even, in certain countries, it heavier ones. It will have to continue to match the pace of ever-changing product specifications, as well as improve its operations. Obviously, this can only be achieved at a cost which, ultimately, the consumers will have to meet. For example, to satisfy the 1993 West German regulations, the cost of petroleum products would be as much as $14-$21 per ton higher, depending on the product. In the power generation industry, flue gas desulphurization (FGD) and denitrification units would become increasingly used, especially in large plants.

While the increased costs may reduce the demand for petroleum products, it must be remembered that all these processes require additional energy which may moderate any impact on demand. Thus, the issue related to climate change, as emphasized by the call to reduce CO2 emissions, remains the greater concern in the long run.

As previously stated, the Toronto targets call for a 20 per cent reduction in CO2 emissions, from the 1988 level, by 2005. Under its proposals, increased energy efficiency, extensive fuel substitution and probably even an accelerated pace of technological advancement are expected to be the main instruments for achieving the target. How feasible are the Toronto targets? Many analysts have concluded that they are either unrealistic or extremely difficult to achieve. Some have even gone as far as calling them too radical, cruel and harsh, and declaring that they severely threaten economic growth.

Our best estimate of world primary energy demand, developed for a moderate economic growth rate and price increases over time and with a bias towards the environment, using 1988 as base year, has the following features: energy demand grows at 1.1 per cent per annum for oil; 3.5 per cent for gas: 1.6 per cent for coal; 1.8 per cent for electricity and 1.9 per cent for total primary energy. The "green" bias in this scenario is reflected in the disproportionately high growth rate for gas and relatively low ones for oil and coal. the resulting level of world oil demand is expected to be 79 million barrels per day (m b/d) in 2005, from a 1988 base level of 64m b/d.

Meeting the Toronto Targets

The OECD region is best suited to demonstrate the feasibility, or otherwise, of meeting the Toronto targets. In saying this, we are cognizant of the fact that the OECD is in a better position to cope with the expected adjustments than other countries. Depending on policy decisions over how to reduce CO2 emissions and how this reduction is distributed among fossil fuel sources, we expect that OECD oil demand, for instance, could fall from 40m b/d in the normal projection for 2005, to as low as 27-31m b/d. m b/d. Coal will also suffer a proportional loss in its contribution to energy demand.

In the case, energy intensity will have to improve by as much as 24 per cent, which is comparable to the improvement achieved between 1973 and 1988. But, in order to sustain economic growth (at current rates of about 2.8 per cent per annum), the total primary energy requirement may have to be close to 97m barrels of oil equivalent per day (boe/d) in 2005 for the OECD region, and to satisfy this level of energy need, primary electricity will have to grow from 12m boe/d in 1988 to between 38 and 42m boe/d in 2005. This is equivalent to an annual growth rate of 7-8 per cent and does not appear to be possible under the prevailing climate of nuclear energy, with regard to safety, public acceptance, costs and the sheer physical size of the investment requirement. Most of the growth in primary electricity has to be allocated to nuclear energy. At best, there would be a need for about 1,000 nuclear power stations of 1,000 MW, each, operating at a 70 per cent load factor.

Even if more energy efficiency improvements could be achieved, beyond the level stated above, and the level of energy requirements in 2005 were to equal that of 1988, then primary electricity might still have to grow from 12m boe/d in 1988 to between 22 and 26m boe/d in 2005. Although such growth rates may appear modest, compared with the trends in the 1970s and early 1980s, they are, in our view, still impractical and unattainable. Moreover, economic growth is predicted to decline from 2.8 per cent to about 0.7 per cent per annum.

One area of consensus that does exist in the environmental issue is the fact that the problem is global, and it is thus essential that a global approach is adopted in the quest for solutions. For one thing, logic and the available evidence indicate that the present pattern of CO2 emissions is shifting from the industrialized nations to CPEs and developing countries, and will continue to do so.

Even if we assume that the OECD region will be successful in meeting the CO2 emission targets, the same cannot be assumed for the CPEs or the developing countries. The CPEs are passing through a period of profound political and economic change, which is likely to top their agenda throughout the decade. But, due to their concern over the environment and likely public pressure, it may be possible for them to go half-way towards matching the OECD's achievement in curtailing oil demand by substitution with gas or nuclear energy in the next 15 years.

The developing countries need a period of grace before any demand restriction on account of the environment can be achieved. But, if financial and technological assistance were forthcoming from the industrialized countries to help them face up to the environmental challenge, oil demand may be moderated by 10 per cent of the levels achieved in the OECD.

Thus, even if all these programmes turn out to be successful, global oil demand in the year 2005 could be close to 64m b/d, which is more or less the same level as 1988. Obviously supply would be available to meet this level of demand, but if OPEC were to continue to play the role of residual supplier, with non-OPEC producers producing up to their full capacity, then the call on OPEC oil is likely to fall from the expected 37m b/d in 2005 to 23m b/d, with a commensurate loss of market share.

Since the global nature of the environmental problem makes it imperative that any solutions should adopt a global approach, the co-operation of all groups-producers and consumers - is important. The corollary of this is that the diverse interests of all parties must be taken into account in arriving at an equitable solution.

A clean environment is a common good, the enjoyment of which individuals cannot usually be denied, on the grounds of not having contributed to its maintenance. Since there is no cost to the individual for polluting the environment, its use or abuse is effectively priced at zero. There is, thus, no incentive for individuals to take any remedial steps to reduce their polluting activities. This, briefly, was precisely how the world arrived at the present situation.

|Polluter Pays' Principle

It should perhaps also be pointed out that the process of polluting the atmosphere was accelerated by the rapid industrialization activities of the present advanced countries in the last two-and-a-half centuries. Based purely on the |polluter pays' principle, which is currently being canvassed at various policy-making forums, these countries should bear the overwhelming burden of cleaning up the environment. Alternatively, seeking to tax different fuels according to how much pollution they cause is in our view an unsatisfactory approach, as it seeks to tackle the problem as though it started only today and fails to take account of the legitimate interests of oil producers, whose dependence on oil revenues is almost total. Such an approach is unlikely to command the full cooperation of the international community - especially developing countries, which must either sell oil or burn it or both, in order to transform their economies.

Of course, there are proposals on how to handle some of these problems, including the tradeable emission permits. But these have their own drawbacks. The real cost of a global environmental policy touches not only the consumer in terms of higher fuel prices, but also producers in terms of potential losses of revenue and market share. It is fairly clear that industrialized countries with large deposits of coal are not planning to abandon its use, even though it is more polluting than any other fossil fuel.

The alternative approach, which we believe is both objective and equitable, consists of allocation the implied production cuts among all oil producers. Another way of looking at this is that the limited allowable production is allocated as |production permits' on the basis of proven reserves, and an adjustment could also be made for self-sufficiency, the availability of foreign exchange reserves to pay for imported oil, etc.

Under such a scheme, OPEC, being the major producer of crude oil and natural gas liquids, may suffer very little from its perceived production of 37m b/d in 2005 because of its huge reserve base, which is expected to be around 920 billion barrels or 80 per cent of total world reserves by 2005. This means that the developing countries of OPEC can still maintain their revenues and market share and will have sufficient funds to import from the industrialized countries what they need for their economic development and trade.

Aside from the issue of equity, the above proposal has a sound theoretical foundation. An important aspect of exhaustible resource theory is that oil extraction should start in the least-cost fields and gradually go on to higher-cost area. It is an accepted fact that the most prolific fields are situated in the rich-reserve fields of OPEC Member States, and that their cost of production is as low as $2-3/b, compared with $ 9/b in America or $ 7.50/b in the North Sea. This would ensure that investments are channelled mostly into developing new production capacity in the areas likely to yield the best returns in terms of oil output. We are, of course, aware of the fact that there may be legitimate worries about the security of these investments in foreign, as against domestic, oil fields, but this could be alleviated, and the burden of meeting the CO2 target reduction should be borne by all groups.

Regrettably, in the prevailing climate of world politics, the above approach may meet some resistance, especially from consuming countries, on the grounds of supply security, energy dependence, financial constraints and the investment that has already gone into production facilities.

In order to take account of these concerns and find a middle ground between the contending interests, the current production capacity of OPEC renders a useful basis. It has often been suggested that, in order to stabilize the oil market, OPEC needs to have some surplus capacity, with its production not exceeding 95 per cent of total capacity. The current capacity of crude oil production and natural gas liquids is somewhere around 30m b/d. OPEC could be guaranteed 85 per cent of this capacity, which happens to be close to the upper limit of the call on its oil in the restricted CO2 emission case, and further cuts would then be undertaken by other producers in relation to their reserves base, as suggested before. Accordingly, other producers will either not suffer any production cuts at the upper limits of demand, or their cuts will be less severe. In either case, their production level is more reassuring, and should alleviate some of their concerns of supply security, etc.

If these principles are accepted, in order to foster producer co-operation on the environmental front, they can be applied to individual countries within each group. If OPEC is destined to live with tight quota agreements in the 1990s, as it did in the 1980s, there is no reason why other producers should not chip in, especially in facing such a noble common objective as the clean environment.

Agreement on such principles needs to be put in place as early as possible, to avoid investment in production capacity that may not be required and which, if carried out, may overhang the market and contribute to prolonged instability in the future.

Conclusions

A major deficiency in the debate on the environment, both at the analytical and policy levels, has been the conspicuous absence of any work that explicitly takes the interest of producers into account. In this seminar, we have attempted to propose an approach that is both objective and equitable. This entails sharing the output reduction necessary to meet a given target. The global nature of the environmental problem makes it imperative that the co-operation of every group is enlisted. This is more likely to be forthcoming if the proposed solution is perceived as fair. Failure to achieve such co-operation may frustrate major producer groups who cannot have their "greenhouse" now and continue to live in it, in order that the richer countries can have their "dreamhouse" in 50 years time.
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Author:Al-Fathi, Saadalla A.
Publication:Economic Review
Date:Feb 1, 1991
Words:2843
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