FT Energy Source Reader Q&A with Dr Fatih Birol, IEA chief economist

Q. The future of the planet depends on making correct energy decisions. We, the people, rely on governments to make these decisions. Unfortunately, governments are composed of politicians who, often, only act when the public demand action. Hence, it is surely imperative that the IEA raise public awareness and understanding of the energy challenges facing all of us. If the IEA is serious about pushing for new energy policies then why do they charge the public for downloading the World Energy Outlook? I would like to read it but can’t afford €120 per year. – Chris Bleakley

A. Dear Chris Bleakley, the IEA would be delighted to offer all of its publications and other work for free, but we depend on these revenues to supplement our budget.  We are a small international organisation funded by our member country governments from public funds which as you will know are currently under severe pressure.  Every year, the demand for our work increases, often outpacing the growth in our budget.  Publication sales are an important revenue stream for us. At the same time, we strive to ensure that the key messages from our work are accessible and began, several years ago, making the executive summary of all of our books (including the World Energy Outlook) available for free on our website.  The Executive Summary of this year’s Outlook is already available in 9 languages on our website. We also offer discounts on all publications to educational establishments, other non-profit organisations and developing countries.  In addition, we are offering an increasing amount of information for free on our web site.

Q. The link between oil and natural gas prices is getting very frayed. Do you see it breaking permanently?
Nick Grealy

A. Dear Nick Grealy, in Europe and Asia-Pacific, gas is imported mainly under long-term contracts, which, in most cases, link the price of the gas to changes in the prices of oil under what are called indexation formulae. The original logic behind this arrangement is that gas competes against oil products, though increasingly gas competes more against other fuels, including coal and electricity. For now, the exporters and many importers are happy to stick with oil indexation. But the glut of gas that is building up does could put increasing pressure on both sides to adjust their pricing terms and even move towards an alternative pricing system, the most obvious of which would be direct indexation to spot or future gas prices. Russia’s Gazprom and Algeria’s Sonatrach – the two biggest external suppliers to Europe – have lost market share over the past year to cheaper spot LNG. They may decide at some point that enough is enough, and opt to move away form oil indexation, though they have made it absolutely clear that they have no intention of doing so for the time being. And the big importers may also start asking for it, as the gap between the price of cheaper spot gas and the price of gas under their long-term contracts widens. For now they don’t want to upset the status quo, but again that could change – especially if their confidence in pricing on the basis of spot markets increase. Certainly, the gas glut proves a window of opportunity for Europe and Asia to move to a more rational system of market-based pricing.

Q. Dear Mr. Birol, regarding WEO 2009 and its differences on predictions of consumption growth and CO2 output between the Reference and 450ppm scenarios: As an energy economist, with understanding of energy demand and demand rebound effects… Do you think it is possible to stay within the 450pp limits by applying a 65% abatement by 2030 by efficiency alone? That is, do you think that rebound limiting dis-incentives or other forms of caps are needed to make sure that the savings generated from abatement efforts stick and are not negated by usage rebound generated from cheaper fuel prices? That is, is the efficiency solution alone enough to get us to the 450ppm scenario in your opinion?

A. This is a very good question, as rebound effects could indeed partly offset the efficiency gains achieved, in particular in the transport sector. In fact, we found that rebound effects in the transport sector alone could offset one-quarter of the oil savings achieved through setting efficiency targets in a 450 Scenario. Therefore, we clearly state in our Outlook that governments must take deliberate action to avoid such rebound effects by giving appropriate price signals to consumers: setting efficiency targets alone are not enough to achieve climate goals. The IEA has long called for a removal of subsidies on fuel prices, and for achieving climate policy targets, this is more actual than ever.

Q. From which sources does IEA receive its funding?  What portion of IEA’s funding comes directly or indirectly from the United States?  Have representatives of the United States ever suggested possible changes to future funding of the IEA?  Does IEA pay IHS-CERA to use the IHS-CERA database? Does IEA publish an accounting of both its funding, and its expenses?

A. Regarding from which sources does IEA receive its funding, please consult the following document on our website http://www.iea.org/about/docs/IEA_Budget.pdf

This document answers also the second question.

The United States and other IEA members have suggested reviewing how we are funded to better reflect current budgetary constraints in public finance and this review is currently underway.

The IEA has obtained certain data from IHS CERA in the past under an information-exchange arrangement. This has not involved the IEA paying for any data.

The IEA does not publicly publish an accounting of both its funding, and its expenses.  We operate within the same financial statutes as the OECD.  The financial statements of the OECD and IEA are prepared in accordance with the accounting requirements of International Public Sector Accounting Standards (IPSAS) and implemented by the International Federation of Accountants Public Sector Committee (PSC) and based on International Accounting Standards (IAS) issued by the IAS Committee. When IPSAS do not include any specific standard, International Accounting Standards (IAS) are applied. The financial statements are prepared on a going-concern basis.

Our operations are monitored by our Member countries, in particular the Committee on Budget and Expenditure.  IEA uses the OECD audit framework. Audits may be conducted up to five years after the closing of accounts for a particular expenditure. Thus, all records must be maintained and easily retrievable for up to six years.  Internal Audit is carried out by the OECD Internal Audit Office, which reports directly to the OECD Secretary-General. External Audit is carried out by a Board of Auditors, being representatives of four Member states nominated by the Member State and approved by the OECD Council. Under the responsibility of the OECD Secretariat, audits by external experts are carried out in accordance with internationally recognised auditing standards. Selection of auditors is by international call for tender procedure. The contract is annual and may be renewed or sent out again for international tender. The report of the external expert is presented to the Organisation’s Secretary-General and Board of Auditors.

Q. If oil production is lower in 2015 than today, does this not mean that global Peak Oil could be imminent (before 2015)?

A. In fact, we do not project oil production globally to peak before 2015 in either of our scenarios. What we do say is that, if there are no new discoveries of oil, global conventional oil production would peak around 2020, but only if demand grows as sharply as we project in our Reference Scenario (which we assume no change in government policies). In that scenario, output (excluding processing gains) rises from 83 mb/d in 2008 to 103 mb/d in 2030; in the 450 Scenario, which assumes that the world implements a deal to limit the increase in global temperature to 2 degrees Celsius, output reaches 87 mb/d. We do expect non-OPEC output to peak within the next few years (conventional crude oil production probably already has), but OPEC countries – which are sitting on large, relatively low-cost resources – are expected to fill the gap. I think it is important to bear in mind that peak oil is not just about supply; it implies a peak in demand too. Price is the key that will balance both. It is our view that higher prices will be needed to allow supply to rise as we need to exploit more difficult and costly resources; we assume that the average crude oil price reaches $115 per barrel in today’s money by 2030 in our Reference Scenario, and $190 per barrel in nominal terms.

Q. Hi FT, Here is my question for Fatih Birol: Dr. Birol: I have seen your prediction that a glut of natural gas is on the horizon.  Does this mean that customers in Europe don’t have to worry about a recurrence of the disruptions we have seen in recent years?

A. No, I wouldn’t go as far as to say that we don’t have to worry about another supply disruption, which is an entirely different matter from the overall adequacy of supply. When a particular channel of supply is disrupted, there are usually constraints on how much of the shortfall can be made up with gas from other sources and along other supply routes. That was why many countries in Central and Eastern Europe that are heavily dependent on pipeline capacity from the East were so badly affected by the cut-off in Russian supplies earlier this year. Europe needs to continue to improve its responsiveness and ability to handle to such emergencies.

Q. I was stunned by your finding that combating climate change requires hybrids and electric vehicles to make up 60% of all car sales by 2030.  How could such a dramatic shift be achieved? Thanks for taking the time to respond.

A. The example of light duty vehicles shows the extent of the challenge that we are facing. What we really need is essentially a revolution in the energy sector. To achieve the 60% share of hybrid and electric cars, we will need appropriate signals coming from policy-makers. These signals must include stringent efficiency targets for passenger cars, feebates (i.e. subsidies on the purchase of more efficient cars), and appropriate fuel price signals, which incentivise the purchase of fuel efficient cars and promote fuel savings. In addition, we must make sure that the power sector is decarbonised in a timely manner – to avoid simply moving the emissions from the tailpipe to the power station smokestack as the transport sector moves towards electric vehicles.

Q. The subject of energy subsidies in Asia and their removal, in particular in India and China because of the scale of energy consumption, has been salient in policy discussions, including at the G20. What might be the impact on world energy prices of the removal or substantial reduction of much of Asia’s energy subsidies, as called for, and the subsequent impact on emissions given a new, lower equilibrium price?  Could you describe the dynamics? Thanks & regards, Andrew Jones

A. Dear Andrew Jones, the removal of subsidies on energy that keep prices to consumers below true market levels would ordinarily result in lower demand and a lower price than would otherwise be the case.  In language economists would understand, the demand shift would shift backwards, resulting in a lower equilibrium price and volume at the point demand intersects with supply. Several Asian countries continue to subsidise oil, gas and coal heavily, so the consumption of these fuels is higher than would otherwise be the case. This means that emissions of carbon dioxide and other pollutants are higher. Analysis we have carried out recently with the OECD shows that removing these subsidies could sharply reduce emissions and, at the same time, bring broader economic benefits. At the world level, eliminating all the fossil energy subsidies in the 20 largest non-OECD countries that we looked, including China, India, Indonesia, Pakistan, Thailand, Malaysia, Chinese Taipei and Vietnam, would drive down global carbon-dioxide emissions by 13% by 2050. We are currently undertaking more analysis of the scope of energy subsidies and their effects at the request of the G20 and will be reporting back to them at their next summit in June next year.

Q. Qs to Mr Birol: When will global oil production peak? How grave will be the impact upon different societies in the world? How should we prepare?

A. As I have already said, we do not project total oil production (including crude oil, natural gas liquids and unconventional oil) globally to peak before 2030 in either of our scenarios – provided that adequate investments are made in exploration and development. But the uncertainties with respect to remaining oil resources and investment are so great that we cannot be entirely confident that it will be possible to continue to increase world production. Most of the increase in output we project over the next two decades will probably have to come from OPEC countries and they may not be willing or able to make all of the required production growth. This is an important issue we have highlighted several times in the past. Under-investment could lead to much higher prices, exerting a heavy burden on the world economy. That is one reason why we need to act now to curb the growth in demand for oil; lower oil use would not just contribute to meeting climate goals, but would bring enhance our energy security and bring long-term economic benefits.

Q. The climate policies recommended in the 2009 Outlook appear likely to be more costly and risky than necessary. For example, the recommended policies do not appear to be very efficient across sectors or countries. The recommended 450 PPM Scenario (based on the early release publication) calls for about $4.7 trillion of incremental investment in the transport sector and about $5.8 trillion in all other sectors. The recommended transport investments appear to be about 5 times as costly per unit of CO2 reduction achieved as are the recommended incremental investments in the non-transport sectors. Similarly, the recommended incremental investments are roughly the same for the U.S. and China, but the projected CO2 reductions achieved by China are about twice those for the U.S. These inefficiencies seem to be driven by objectives other than managing climate change, such as promoting specific technologies, energy independence or other political, environmental or social objectives. It seems we are risking the affordability and effectiveness of climate change policies by burdening them with too many extraneous objectives. This could damage public confidence in the integrity of the whole program. Do you think that a model of a least-cost, focused 450 climate program (perhaps modeled as a harmonized carbon tax) would be a useful benchmark? Are there other ways you would recommend to drive policy toward imposing the lowest costs and loss of utility on ordinary citizens, while achieving the targeted GHG reductions? Thank you and your colleagues at the IEA for continuing to work on this very challenging and important policy problem. By John Hendricks

A. Dear John Hendricks, as economic theory suggests, a global carbon market would be the most cost effective way to achieve a 450 ppm scenario. In this case, which we have analysed, global CO2 prices would reach $70 in 2030. However a global carbon market is very far from where current negotiations are leading. This is why we decided to provide insights on the economic consequences of a more complex framework – that to the best of our knowledge reflects the current negotiations. In our analysis, we adopted a framework that assumes different country groups committing to economy-wide emission targets in different moments in time, reflecting their different stages of economic development and their responsibility in cumulative emissions. OECD+ countries take on as of 2013 economy wide targets for 2020. In 2021 other major economies such as China, the countries in the Middle East and South Africa also institute a cap-and-trade regime. In this case CO2 prices reach already $50 in OECD+ countries in 2020 and they rise to $110 in 2030. In this respect, this is not the first best solution in terms of cost minimisation – but as it stands it is more likely to see the light of the day than a global carbon tax. It is also very important to note that the investment in the 450 Scenario are largely offset by fuel cost savings. The marginal abatement cost by region and sector are now available on the World Energy Outlook web site, and you will clearly see that even in the transport sector there is significant scope to reduce emissions at negative costs – when fully incorporating the fuel savings.
Q. Dear Dr Birol, You mention a carbon price rising to $50/tonne by 2030. This is only $1000 for 20 tonnes, the current very high level generated by the average US citizen, or $500 for the 10 tonnes typically produced by the average European. It seems a remarkably small disincentive to pollute, completely dwarfed for example by the cost of bailing out the banks. What is the true cost of carbon in damage to the world ecosystem?

A. The $50 per tonne is the CO2 price for OECD+ countries in the power generation and industry sectors in the year 2020. This price increases to $110 in 2030. WEO-2009 describes the complexity of our approach, which reflects the complexity of the negotiations! In short, our analysis suggests that this CO2 price is necessary for those sectors to make the investments in clean technologies that are consistent with a 450 parts per million scenario, limiting the global temperature increase to around 2 degrees Celsius. As you rightly imply, the cost of action is modest compared to the cost of inaction, but let us not underestimate the challenge in bringing this about. While “bailing out the banks” is hopefully a one-off, climate action needs to be sustained, and indeed intensified, year after year.

Q. Mr Birol, I would be appreciative if you could answer another one of my questions. I saw your interview in which you talked about what is needed to give everyone in the world access to electricity. Does your climate scenario take into account all the extra energy and emissions that this would lead to? Can we really solve both problems at once? Mick

A. Dear Mick, thank you for your question.  Climate change and Energy and Poverty are indeed two key challenges the energy world is facing today, and I do believe that a major international concerted effort can deliver a solution with co-benefits for both the issues. Bringing electricity to everyone by 2030 would require electricity generation in 2030 to be only 3% higher than generation in our Reference Scenario.  An annual additional investment of $35 billion would be sufficient to meet this challenge. Also impact on energy-related CO2 emissions is disproportionately modest compared with the number of people affected.  If the generation fuel mix to supply the additional demand were that of the 450 Scenario, the increase in energy-related global CO2 emissions would be a mere 0.9% by 2030. Alleviating poverty can and must be part of an international effort for fighting Climate Change.