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Day of reckoning nears for energy markets

06/02/05

Op-Ed by Spencer Abraham, Financial Times

As high oil and natural gas prices continue to take their toll on the bottom lines of households and key industrial sectors, a great deal of speculation is taking place in the business and political worlds about energy markets.
Conventional wisdom and traditional market economic theory suggest high prices and profits will ultimately produce a correction on both the demand and supply side of the energy equation to bring prices back in line.
Yet many believe this analysis is not applicable to today's challenges. Credible experts are even predicting that oil will reach $100 a barrel. Count me on the side of those who believe that, without significant changes in energy policy, tight markets are likely to continue and potentially worsen.

Several factors are likely to prevent traditional market corrections from occurring. It is improbable that worldwide demand for energy will be as price sensitive as in the past. First, the prices of some fuels - such as petrol in the US - have not really kept pace with inflation. Moreover, much of the growth in demand is a function of cultural and social changes in developing countries that have made acquiring motor vehicles and appliances far more acceptable and desirable. This is why even higher prices and slower economic growth in the developing world are unlikely to lessen the growth of energy consumption there.

As a result, over the next 20 years worldwide oil demand is expected to increase to 121m-130m barrels per day from the current 82m-84m, electricity consumption to grow by 100 per cent and natural gas demand to increase by 67 per cent.

Meanwhile, a variety of natural and self-imposed factors is constraining supply. In the US, moratoria on energy development in offshore areas and on federal territory are keeping huge natural gas and oil reserves off limits. Furthermore, in both the US and Europe, opposition to nuclear energy and coal-fired generation has taken its toll on energy supply, as have "not in my backyard" challenges to new energy infrastructure projects. Middle East tensions and factors such as Iran's nuclear stand-off with the west continue to cast a shadow over future supply levels.

Expect markets to stay tight for the foreseeable future unless we act boldly. So what needs to be done?
First, we need more nuclear power. Substantially increasing supply worldwide and doubling it in the US over the next 25-30 years are worthy targets. To get there in America we must provide risk insurance to those who build new nuclear plants, as President George W. Bush has suggested, and reform the regulatory process to ensure the safety of new units and reduce the regulatory uncertainty that is preventing investment. In Europe and elsewhere, it is time to recognise that meeting Kyoto protocol carbon targets and significantly moderating dependence on imported energy will be almost impossible without increased nuclear supply.

Second, we must re-examine the regulatory constraints on exploration in areas that hold vast reserves of oil and natural gas. In America, federal land and offshore areas contain more than 100,000bn cubic feet of natural gas that are subject to moratoria. While we certainly should take legitimate environmental concerns into account, we simply cannot continue to keep all these important energy resources off limits.

Third, we must enhance international energy partnerships. America needs even stronger energy relationships with Canada, Mexico and Australia. And it must build on the energy working relationship begun with China in the past two years. Both countries stand to benefit greatly from co-operation on the new technologies and alternative fuels that will help them meet their needs without becoming unacceptably dependent on imports.

We also need to increase substantially international investments in clean coal, carbon sequestration, renewables and hydrogen technology. The best chance America has to lessen its dependence on energy imports and increase supply is to ensure that coal remains an integral and environmentally safe part of its energy mix and to introduce new sources - from wind and solar to hydrogen fuel cells.

In 2001, when Mr Bush unveiled his energy plan, critics argued that he was exaggerating the problem in order to advance unnecessary policy ideas. The result has been deadlock over energy legislation. Necessary energy security proposals have too often been debated without significant action. Unfortunately, the day of reckoning is near. Today's energy prices will seem tame in comparison with what might well ensue unless we act decisively now.

The writer, the former US secretary of energy, is a distinguished visiting fellow at Stanford University's Hoover Institution