Global energy analysts are revising their forecasts for the coming decade. Industrialization in developing countries, followed by a serious recession, a “shale gas revolution” in the U.S., the development of new production technologies, and the emergence of new market players have all led to a shift in the balance of forces. IMR’s Olga Khvostunova spoke to Professor Leonid Grigoriev, advisor to the director of the Russian Energy Agency, about the current situation and its implications for the Russian oil and gas market.
Olga Khvostunova (OK): Everyone is talking about the “shale gas revolution.” What is its impact on the global energy market?
Leonid Grigoriev (LG): If the oil prices hadn’t hiked up to $100 per barrel and consequently gas prices hadn’t reached $300–$400 per thousand cubic meters, there would have been no “shale gas revolution.” New technologies of shale gas production would have been too costly. Such costs could be justified in the interests of energy security, but things didn’t go by the worst-case scenario. The combination of high prices, intellectual breakthroughs, and opportunities created by the Anglo-Saxon investment climate allowed for the “shale gas revolution” to happen. You can say this is Anglo-Saxon gas. But today, we are probably on the threshold of not just the “shale gas revolution,” but also the “shale oil revolution.” Considering that U.S. energy security is viewed in terms of exports from Canada and Mexico (and quite soon from Brazil, which is emerging as a new energy exporter), both North and South America will achieve energy independence in the next few years. In five to ten years, the U.S. might not need the amounts of oil that it is now importing from the Middle East. Overall, the U.S. has never been closer to the goal that President Carter set back in 1976, following the first big oil crisis.
OK: If the U.S. starts exporting shale gas, will it alter the balance of power in the global energy market?
LG: Energy analysts expect that by 2014–2015, the U.S. will open the first port terminal on the Pacific shore to export shale gas to Asia. The amount of exports will be around 30 to 40 billion cubic meters of gas per year. This is not a large amount, but it’s a very important moment in terms of strategic development. Naturally, the U.S. will not export gas at the current domestic price of $100 per thousand cubic meters. Since gas prices in Japan have already hit $600, the U.S. will export there, and it will make prices drop a little bit. Thus, the main result will not be export deficiency problems, but rather a drop in gas prices in Japan and China. In terms of revitalization of economic growth and re-industrialization, it will benefit the U.S more if they keep this cheap gas for the domestic market. At the price of $100 per thousand cubic meters, the power-consuming industries that used to be unprofitable have all of a sudden started to revive.
Both North and South America will achieve energy independence in the next few years.
OK: Can the U.S. start to export shale gas to Europe?
LG: It’s unlikely at the moment. Why would the U.S. export gas to Europe where it’s traded for $300, if it can export it to Japan where it costs $600? In the upcoming five or six years, the situation will remain as it is now, and we shall see what happens next.
OK: Can Europe switch to producing shale gas on its territory?
LG: For now, Europe cannot do this for a number of reasons. First, shale gas production is rather dirty, and European territories are quite densely populated. Secondly, shale gas production requires large territories for the purpose of drilling numerous wells. This means that the production company would have to buy land, which is very expensive in Europe. European countries will try to reduce energy consumption, but technically the opportunity remains—as a fallback option.
OK: Has the “shale gas revolution” changed the energy consumption structure in Europe?
LG: Cheap U.S. shale gas has partially replaced more expensive coal in the local market. The excess amounts of American coal went to Europe, where it drove the more expensive gas out (at $300–$400 per thousand cubic meters). As a result, Europe started switching from the expensive gas to the cheap coal. And, incidentally, we see that CO2 emissions in Europe have started to grow in the coal production sector. Thus, we see chain reactions across the entire market. This situation is a paradise for economists who research the field of fuel competition.
OK: Besides the “shale gas revolution,” what factors are affecting the global energy balance?
LG: We can observe quite specific developments in energy demand. And the problem is not just oil or gas, but the primary energy in total, which is a sum of all the produced energy. For a long time, until the 2000s, the 2–3 percent increase of the global GDP led to a 1.5–2 percent growth in primary energy consumption. In the 2000s, right before the big recession started, the GDP growth rate hiked to almost 4 percent, and hence the proportion of about 2:1 was broken. As it turned out, the additional fourth percent of GDP growth required a full percent of additional increase in energy production.
OK: Where did this additional percent in GDP growth come from?
LG: It was created by industrialization in large developing countries. It was developing at the same pace and in the same mode as it had previously done in developed countries. And it required an additional full percent of energy production growth.
OK: But why did the system break?
LG: Global energy cannot grow at the annual rate of 3 percent for a period of five to seven years. The amounts of energy produced would be simply insane. As a result, the situation was destabilized, and oil prices went up to a new high level—more than $100 per barrel. Before, from 1986 to 2002, oil prices had been fluctuating around $20 per barrel. At this price it was unprofitable to invest in the industry.
OK: In other words, the price hike was not artificial?
LG: In terms of the economy, the business cycle theory, and the history of fluctuations, it was completely natural. First, industrialization, combined with low capital investments in the energy sector over the course of 20 years, had led to a price hike and then to the crisis. As a result, the world was divided into two parts. The first part includes fast-growing Asia and moderately growing Latin America and the Middle East. There is high demand for energy in these countries, where a new middle class has started buying cars. But what is even more important is that in the southern countries, people have started to install air-conditioners. And this is an irreversible process for world energy. The second part is the developed countries that are simultaneously pursuing energy efficiency and energy security—security both from the Middle East and, to an extent, from Russia. These countries have another common problem: they are looking into how to decrease physical volumes of energy consumption.
Russia’s role in the global energy structure is much bigger than that of Saudi Arabia.
OK: So the main demand for energy comes from the developing countries?
LG: Yes. Today, out of 7 billion people on the planet Earth, 1.3 billion live without electricity, and 2.6 billion without normal water, kitchen, etc. And if industrialization in India, China, and some other countries continues at the same pace, if the problem of energy poverty (which means that average energy consumption per household is about 200 kW per hour) is resolved, and if these 2.6 billion people who compose one-third of the earth’s population achieve the welfare they deserve, then the world energy market in its current form, with its existing specific consumption mode and other factors, will be blown into pieces.
OK: Some market analysts point out that the growing demand for energy in developing countries can lead to irreversible climate change. Do you think that world leaders take this problem seriously?
LG: Unfortunately, the world is not solving its climate problems. Since I am also chairman of World Wildlife Fund—Russia, I have to deal with this issue directly. By 2015, global warming on the order of 2° Celsius is almost irreversible. And the reason for this is that China and some other countries are increasing their emissions faster than the U.S. and Europe are decreasing theirs. Overall, the share of coal production in Asia’s energy structure has increased from 50 percent to 70 percent. Today, global CO2 emissions have already exceeded 34 billion tons per year.
OK: At the same time, China has been speaking of how it’s looking for ways of solving the emissions problem.
LG: Well, the Chinese are trying to decrease energy consumption and to increase energy efficiency, but they have not been very successful so far. China’s energy consumption is growing in parallel with its GDP: 1 percent of GDP growth brings 1 percent of growth in energy consumption. Considering that most of the country’s production is coal-based, China has gotten held up by a new problem: railroad capacity. They need to transport 3 billion tons of coal per year. And while they used to export coal, they now have to import it. China is currently in a very vulnerable position.
OK: As you know, for several decades now, energy analysts have been predicting that the world oil reserves might soon run out. The forecasts are adjusted all the time, but the oil doesn’t seem to end. What is the real situation?
LG: These forecasts are nothing but speculations. There are no problems with oil reserves; we have plenty of them—shale oil and other types. The only problem is that oil is becoming more expensive.
OK: What are the forecasts for oil and gas prices? Can they drop?
LG: In the foreseeable future, oil prices cannot drop below $80 per barrel for two critical reasons: first, it would mean that Saudi Arabia would get a budget deficit; second, oil from any of the new oilfields doesn’t cost less than $80 to $90 per barrel. All of these factors are determined by the investment barriers and budget requirements of the OPEC countries that account for more than 40 percent of the world oil production, and for even more in terms of traded share. Their budgets are, of course, inflated, but can you persuade any government in the world to cut its budget? Even in the U.S., this process is very difficult. There has been no decline in oil production either, and therefore forecasts are quite easy here. 25–30 percent of the produced oil goes to the chemical industry, and the rest to the production of transportation fuel (airplane kerosene, diesel, gasoline, and heating oil). Since the world car fleet is growing and its mileage is increasing, no decline in oil production can be foreseen, although increasing energy efficiency diminishes the growth rate of production.
OK: In this context, what is happening in Russia? Will its role as a key supplier to Europe change?
LG: Russia still plays an important role. If you take 100 percent of the global energy consumption, you’ll see that the U.S. is number one (consuming 22 percent) and China is number two (17 percent). Russia consumes around 5 percent, but it produces 10 percent. About half of the latter is exported. If you break this amount down into fuel types, then Russia exports about one-third of the produced coal (100 million tons out of 300 million); one-third of the produced gas (200 billion cubic meters out of 600 billion); and two-thirds of produced oil (350 million tons out of 500 million), half of which is crude oil and the other half residual oil. Thus, judging by the amount of primary energy, Russia’s role in the global energy structure is much bigger than, say, that of Saudi Arabia, which is often used as a comparison in terms of produced oil.
OK: When you look at Russia’s domestic energy problems, the energy industry is usually criticized for low efficiency. Will this problem be solved?
LG: You know, we inherited the energy industry in its current shape from the Soviet Union. It was cheap to build capacities at those times, and now it’s very expensive. Costs of repair and equipment replacement are insane. Thus, Russia is tied to the Soviet energy machine: we have to lubricate and polish it. But that machine gives the country two-thirds of its export revenues, almost half of its budget receipts, and other things. And many people are satisfied with the situation.
OK: What do you think needs to be done to modernize the Russian energy industry?
LG: Most energy losses come from providing electricity and heating in the cities; plus, there is the problem of 40,000 villages that need a supply of residual oil. The primary solutions would be to change buildings’ insulation, replace old pipes, install meters in residential buildings, and replace turbines at the heating plants. These solutions have been known for a long time and have been proven effective. In Russia, for example, the majority of the old turbines at the heating plants have an efficiency factor of 30 percent—they need to be replaced by new ones with an efficiency factor of 70 percent. These solutions might help to save up to 40 percent of domestic energy consumption. But they cost insane amounts of money. According to 2005 estimates, they could cost around $350 billion. Today, it would be even more. In other words, if Russia had an extra half a trillion dollars, we could have saved 2 percent of the global primary energy.
Europe will preserve its energy dependence, and it will depend on oil rather than on gas.
OK: The Russian government has been talking about the necessity to switch to alternative energy sources. Is this prospect real?
LG: In every country such a switch takes place only by means of subsidies, because renewable energy costs much more. As soon as Spain, Portugal, and Ireland stopped subsidizing this sector of energy, their windmills stopped. Rich countries, like Sweden, Norway, Denmark, and Germany, where the population is ready to pay more for energy, can afford such a transformation, while others cannot. It’s hard to imagine that Russia can afford such a switch to alternative energy sources: Russia’s GDP per capita is $17,000, which is less than half of that of the European Union. People are not ready to pay more for energy. But to be fair, it’s worth saying that Russia produces a lot of renewable energy in its hydraulic power industry. Besides, 16 percent is provided by nuclear energy, and in St. Petersburg this figure rises to 35 percent. It’s a specific industry, though. Also, in 2011, Russia produced about one million tons of wood pellets, 90 percent of which were exported. And this is the quintessential Russian situation: to create a whole new industry and export the fuel, instead of using it at home.
OK: What are the implications of the “shale gas revolution” for Russia?
LG: None so far. The “shale gas revolution” will bring energy independence to the United States. Europe will preserve its energy dependence, and it will depend on oil rather than on gas. At its current consumption levels, Western Europe feels quite comfortable importing about 10–15 percent of its gas from Russia. It’s the Eastern European states (that are 100 percent dependent on Russian gas) that worry. So Europe is using Russian gas, coal, and oil. It wants lower prices, but so far these wishes remain unsatisfied. One needs to be able to tell the difference between the real situation in the energy markets, and the public claims of certain politicians.