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December 20, 2012

Development Strategy

The New Energy Economy

By Nitin Desai


Two recent developments in the global energy dialogue require us to reexamine some old verities about the strategic dimensions of energy policy. The first is the 2012 World Energy Outlook Report from the International Energy Agency which requires a serious reconsideration of the geopolitics of the world oil economy. The second is the disappointing outcome at the recent Climate Convention meeting in Doha which heightens the risks of catastrophic climate change and requires a geopolitical response from countries like India that will be severely affected.

The key projection here  the IEABReport is about where additional oil will come from over the next few decades.  In round numbers, Saudi Arabia and Russia, the two largest producers of crude oil, pump out about 10 million barrels a day (mbd), each, and are the dominant suppliers capable of adjusting production up or down. By the 2020s their combined output was expected to go up by around 6 mbd. But now the current IEA projection suggests that it will remain more or less at the present level.

How will rising demands be met then? A big part of the answer lies in a dramatic transformation of the North American energy economy from growing import dependence to near self sufficiency. US crude oil production is expected to rise by an additional 3.5 mbd or so by the mid 2020s. In fact it will displace Saudi Arabia and Russia as the world's largest oil producer. It's dependence on Middle East oil will be greatly reduced and supply increases and higher fuel efficiency standards mean that by 2030 North America will become a net exporter. This would be a massive switch around in the world oil trade as at present USA and Canada together are a net importer of about 7 mbd. The scale at which  shale gas  exploitation is now contemplated in USA and Canada could reduce both coal and crude oil demand and bring about yet a further reduction in import dependence.

The other big story in the IEA Report is its projection of Iraqi oil production more than doubling to over  8 mbd by 2035 which would place Iraq in the big league of potential game changers. In fact the contracts already in the works imply an even bigger increase over an even shorter time frame.  These IEA projections imply that 45% of the increase in global crude oil output will come from this one country and it would emerge as the second largest crude oil exporter in the world, displacing Russia. The big potential is in a giant field near Basrah, which is in the Shia southern third of Iraq. The other big source is in the north of the country where the Kurdistan Regional Authority is in de facto control.  A lot depends then on the continued viability of the fragile federation that has been put in place after the overthrow of Sadaam.

These two developments will alter the geostrategic landscape in the Middle East. The US will continue to police the region, even though its dependence on its oil will come down, because of its huge oil investments and its commitment to Israel. Yet one has to accept that their willingness to bear the human and financial cost will be affected and they may well expect countries like India, whose dependence on Middle East oil will go up, to share in these costs. The other big change is in the relative power of the three big players, Saudi Arabia, Iran and Iraq, with Iraq being the big gainer.  Whether Iraq exercises this power through the Federal Government in Baghdad or through the Regional Authorities is a moot question.  It is clear that India has to rethink its priorities in the Middle East focusing as much attention on building relationships in Iraq as in Iran or Saudi Arabia. It may also have to accept a larger role in the protection of sea lanes for ensuring the flow of oil.

The IEA projections bode ill for the risks of climate change.  The postponement of any serious action on reducing emissions, which is what the Doha outcome has done, reinforces these concerns.  As of now we are not on track for attaining the Copenhagen goal of limiting the increase in average global temperature to 2 degree centigrade and a  temperature change of 3.5 degrees centigrade or more looks unavoidable on present trends.  This is particularly alarming given the fact that the increase of 0.8 degrees centigrade that we have already experienced is leading to consequences like the more rapid and widespread summer melting of Arctic ice coming.  There are also some reasons for believing that the intensity of adverse weather events has increased already because of this temperature increase.

In the USA shale gas has already led to a decline in investor interest in renewables. The de facto postponement of emission commitments at Doha will reduce the policy pressure to expedite the introduction of renewables and nuclear energy and  invest in related research.  Fossil fuels, which today attract $523 billion of subsidies, six times more than for renewables, will continue to dominate the fuel mix, particularly in India and China which will account for a very large part of global energy and emission growth.

An alternative more sensible future is possible. The IEA Report outlines an Efficient World Scenario that rests mainly on removing the barriers to energy efficiency investment rather than on technological breakthroughs. Compared to their central projection, in this scenario the growth in global primary energy demand to 2035 would be halved, oil demand would peak just before 2020 and would be almost 13 mb/d lower by 2035, the economic gains from energy efficiency would boost cumulative economic output to 2035 by $18 trillion, universal access to modern energy would be easier, local air quality would improve, and energy-related carbon-dioxide (CO2) emissions would peak before 2020, with a decline thereafter consistent with a long-term temperature increase of 3 °C. A stalemate on climate is not in India's interest and it must act to unlock the global negotiations. Nor should it relax on pursuing its own low carbon growth options, as promised in the Twelfth Plan,  as the domestic gains from such low carbon strategies are enough to justify the effort.

The world energy economy is in a state of flux and India must move beyond old assumptions and respond with flexibility.

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