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The Economic Times: ‘Look for unconventional energy options’

AMIT BHANDARI AND SHIVOM CHAKRAVARTI

[MONDAY, SEPTEMBER 04, 2006 12:08:08 AM]
 
The Foreign Hand has featured some of the leading economists to bring you a flavour of the global economy. This week, Sunday ET spoke to Mattia Romani, senior economist, Royal Dutch Shell, the world’s second largest oil company.

He obtained his MSc from the London School of Economics and his PhD from the University of Oxford, where his research focused on the role of innovation in enhancing productivity in agricultural commodity markets. Mr Mattia says that the energy market has changed fundamentally because of the growing demand and rising cost of the marginal barrel.

Shell has focused on three possible scenarios that could emerge going forward. Can you elaborate on that? Which of these do you see as the most likely, given the recent developments?

Shell has focused on three drivers of the world economy — market incentives, force of the community and power of the state. In simpler words, societies seek efficiency, fairness and security. Unfortunately, all the three cannot be achieved at once – at best, two of them can be achieved, which is where the scenarios come in. The interplay of these forces could lead to three possibilities – open doors, low trust globalisation and flags.

The ‘open doors’ scenario is when market incentives and the force of the community play a strong role in shaping the global economy. It is a world where trust and security are high, and globalisation progresses further. Low trust globalisation is where market incentives and the power of state dominate the global environment.

In this scenario, there is a basic lack of trust between entities and the barriers to entry are high. There is a general preference towards debt financing rather than equity financing. Power of the state and the force of the community dominate the ‘flag’ scenario, and the pace of growth slows.

We use them as signals that indicate where the world is headed. Many of the recent signals indicate that we are moving away from a benign world to a world of flags. Cohesion and force are the most important forces in this world.

There is a strong belief that the oil/energy market has undergone a permanent shift towards higher prices. What’s your view on that?

As an economist, I cannot but look at the fundamental changes of supply and demand, especially demand. Demand for energy over the past five years has increased massively — mainly thanks to huge growth in emerging countries like India and China, and also due to the strongest four years of growth that the world has seen since the 1970s.

Both the industrialised and the developing countries have gone through a remarkable period of growth that has created a huge push for energy.

A lot has been said about how demand is going up in India and China; industrialised countries have also contributed massively to the increasing energy demand. If you talk about supply, there are concerns on security. What we are seeing is that the easy oil is over or is available in inaccessible places.

The cost of the marginal barrel of oil or the next unit of natural gas is also going up steadily. The reason is that the easy oil and easy gas are not there any more. With these two constraints, the fundamentals are there for a structural change in the energy market and the price that creates the market.

If we accept this premise, what does it mean for energy-intensive industries such as automobiles and aviation?

This trend of increasing energy consumption poses a big challenge and is also a huge opportunity. The challenge is there because many of the industries we are used to seeing around are very energy-intensive and were developed during years when there was expectation of low energy prices. Shifting these to a more energy-efficient operation will require huge investments.

We have the capital and the technology to do it. We could see, over the next 15-20 years, a huge investment in transforming the industry in the developed countries.

However, big gains can be made in the developing countries, which are industrialising for the first time. For instance, China has a certain level of energy intensity, which is not bad compared to where it stands on the development ladder.

However, if you look at the energy data of China for the past few years, you find that the energy efficiency is getting better and better very quickly. Other countries like South Korea and Taiwan have also gone through a similar phase.

One of the reasons could be that outsourcing process to China allows companies to export fuel efficient technology also, which allows for some element of leap-frogging in the industrial sector.

What does this mean for other fossil fuels like coal or renewable energy like hydel and wind power?

Let me go back to the scenarios to answer this question. At least two of the scenarios, open doors and flags, have a very important element of indigenous energy, be it other fossil fuels or renewable energy. The ‘open doors’ scenario is characterised by high growth all over.

The demand for energy will be so huge that it will require coal and unconventional oil in addition to conventional oil & gas resources. On the opposite side, we have ‘flags’. Countries tend to be more independent in this scenario and globalisation takes a backseat.

‘Flags’ is a world where unconventional energy and other fossil fuels develop strongly — pushed by security concerns. Across the range of scenarios, even while oil and gas will play a big role, unconventional energy, coal and renewables will play a bigger role.

Have higher oil prices resulted in increased spending by oil exporting countries, & in which areas?

We have seen a surge of revenue streams in exporting nations and in the ability to accumulate from oil and gas revenue. But the big difference this time is that part of the money is being used to accumulate reserves into stabilisation funds.

There is also a trend towards high oil exploration spending by the national oil companies. Funds from these countries are also helping in keeping the global imbalances scenario in check, by inventing in equities and bond markets.
 

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