Challenge of Energy Transition


Andrew McKillop

Former Expert-Programming, Div A-Policy, DG XVII-Energy, European Commission, Brussels

Submission to FINSIA for JASSA journal, Version 3.1, Jan 2009


Costs for moving away from fossil fuels, on a worldwide base, can be quantified and estimated in various ways, using different hypotheses on methods, targets, technology and policies to be applied over various periods of forward time. Most scenarios compare existing energy systems and infrastructures, on the upstream, and downstream economic and social energy needs and uses, with hypothetical future supplies, systems, and specific energy needs per unit GDP. To be sure, varying scenarios for GDP growth or change through the forecasting period are also utilised. These include other measures or yardsticks, such as ‘environment wellbeing indices’ incorporating various targets for reduced CO2 emissions, and scenarios for energy demand under ‘constant economic structure’ – which for estimates covering 25 or 30 years forward are necessarily approximate and unsure. Due to the many factors in play, it is therefore difficult to set fixed estimates of the cost for this process of Energy Transition. However, simply taking the case of oil and gas substitution needed due to geological depletion of reserves during the 25-30 years forward period we cover, very approximate Energy Transition investment costs in 2008 US dollar terms may well be as high as, or above 450 Billion USD-per-year, for a total investment amount, also expressed in 2008 USD terms, of about 12 000 Bn USD. This amount can be compared with recent OECD International Energy Agency (IEA) cost estimates for needed global oil and gas sector investment through 2008-2035, of about 26 000 Bn USD in 2008 USD terms.

Rather obviously, these two spending amounts cannot be considered cumulative, generating around 1350 Bn USD-per-year requirements on a ’straight line’ annual basis, for the simple reason that global energy sector investment, depending on data source and coverage of the estimate, is running at well below 750 Bn USD/yr, including all forms and types of energy, both fossil and ‘alternate and renewable’ (ARE), both upstream and downstream. Of this approximate total, we can note, oil and gas took about 400 Bn USD/yr, in 2006-2007, but will take considerably less in 2008-2009, due to global economic crisis, the collapse of oil and energy prices, and massive falls in investment of all kinds. Using various sources of data (including Thomson-Reuters, Clean Edge, the US IEER and remaining US investment banks such as Goldman Sachs) total economic activity in 2007-2008, in the very loosely defined ‘cleantech and ARE sector’, of which more than 50% concerned asset refinancing, start-ups and IPOs, M&A activity, LBOs, etc., was approximately 150 Bn USD. Estimates for the year forward (2008-2009) suggest a large fall in this ‘cleantech and ARE sector’ investment and spending. Put another way, global investment in the energy sector is falling more rapidly and radically than world energy demand, which in the absence of very serious oil-saving and gas-saving in the economy, will ensure spectacular rebound of energy prices, shortly after any economic recovery starts, if it starts.

The Goals and tasks of Energy Transition

Energy intensity (average demand per capita): The main goal of Energy Transition is reducing fossil energy intensity of the economy and society in OECD countries, developing all feasible sources of renewable, non-fossil energy to substitute oil and gas, and eliminating or reducing CO2 and other greenhouse gases (GHG) produced by current fossil fuel burning, and future, probably increased dependence on coal and lignite. This last point, to be sure, is already ‘controversial’ due to the absence of economically-viable clean coal, carbon capture and sequestration technologies and methods (CCT, CCS), but increased dependence on coal and lignite is probably certain, due to their larger remaining world reserves, relative to oil and gas. At present, about 55% of world electricity is coal-based, and only about 11% of world electricity, or 6%-7% of world commercial energy is renewable hydropower based, using US EIA data indicating about 1.8 PWh of world total hydroelectric production, and total electric power demand of about 16 PWh in 2007. Electricity accounts for about 20%-40% of final commercial energy demand, depending on country and economic structure.

Energy Economic structure: Due to extreme high growth rates for electricity consumption in many countries, specially the Emerging Economies, with around 55% electric power demand growth in the Mid East region, and 100% growth for Vietnamese, 110% for Chinese, and 120% growth for Thai electricity consumption in 1998-2005 (UN source data), renewable hydroelectricity’s part of global commercial electricity, and therefore global energy demand has in fact tended to decline in recent years. Other renewables, specially the ‘new renewables’ such as fast-growing wind electric power, and emerging solar thermal and photovoltaic account only for another 1.25% of world total commercial energy, in 2008, according to the OECD’s IEA. One major problem with substituting the approximate 55% of world electricity presently supplied by coal burning (more than 75% of Chinese electricity, 2008), by non-coal or non-fossil primary energy sources, is electric power demand growth. This is very closely linked with GDP growth. The ‘electricity coefficient’, or percent growth of power demand per unit GDP growth, for current structure economic growth, is well above unity ( 1 ) in many countries, while oil and gas coefficients are much lower, and in recession can even turn negative, that is GDP can weakly grow in some quarterly periods, while oil and gas demand continue to fall. The steady and long-term shift to higher electricity intensity of the economy on a worldwide basis presents as many problems, as solutions– for example the claimed advantage of electricity-dependent economic growth for developing the ARE, because many renewable energy sources are converted only to electricty, as the final commercial energy output. Study by this author of relatively electricity intensive, versus less electricity intensive OECD economies during and after the 1980s economic recession (France and Germany versus Japan and Italy) clearly shows that electricity demand in the economy operates a kind of ‘ratchet effect’, increasing overall or total commercial energy dependence of the economy, coming out of recession. As recent (2005-2007) global economic growth trends clearly revealed, conventional economic growth is obligatorily oil-intensive, suggesting energy economic structural change is needed to reduce this dependence. Quantities of fossil fuels to be substituted : Taking the fossil fuels of oil, coal and natural gas it is sometimes not understood that coal and lignite, which have the highest ‘carbon footprint’, that is CO2 and other greenhouse gas (GHG) emissions, and heavy metals, radionuclides and particulate emissions per unit commercial energy delivered, have demand growth profiles far higher than oil. Also due to simple cost difference – natural gas is ‘historically’ cheaper than oil – global natural gas demand has grown much faster than oil. Gas demand more than tripled (to about 2800 M tons oil equivalent, including losses) through 1969-2008, but oil demand ‘only’ doubled (to about 31.9 Bn barrels, including losses) in the same period.Only during recession, we can note, is oil intensity reduced, with a contraction of global oil demand of about 9.6% through the 3 most-intense years of economic recession in the 1980s (1980-1982). Conversely, due to price, world gas demand showed no contraction at all in the same period ! Coal and lignite, which are even cheaper than gas, now supply about 28.5% of world commercial energy demand, and demand for these fossil fuels, at least until the onset of global economic recession in late 2008 was growing fast. In approximate terms and excluding the petrochemicals and coal-based or gas-based chemicals, the weight of energy hydrocarbons burnt each year is around 11 Billion tons, roughly 5.5 Bn tons for coal and lignite, 3.5 for oil, and 2.5 for natural gas. About 1.4% of world energy is also supplied by capital intensive nuclear power, using non-renewable uranium, thorium and other rare minerals, with unknown “end of cycle” or decommissioning costs, and ultimate (ie. permanent) waste disposal risks and costs.

Climate change mitigation : CO2 and other GHG emissions from fossil fuel burning and release of unburnt methane (natural gas), probably total about 28 Bn tons annual. These emissions are vastly higher than all natural volcanic, tectonic, seismic and geological sources of GHG, which likely total less than 0.5 Bn tons annual. This estimate, of around 28 Bn tons CO2 equivalent, annual, is certainly underestimated for one reason because of massive natural gas losses throughout the chain “from well to final user”. At least 10% of world nameplate natural gas capacity is simply vented and flared into the sky, or lost in transmission along the world’s estimated 175 000 kilometres of gas pipelines, needing gas-fueled compressor stations at regular intervals along each line. These gas losses are rivaled, in sheer resource wastage and climate change impact, by loss, venting, and flaring of ‘associated gas’ in oil production. This was estimated by the World Bank at around 160 Bn cubic meters in 2006, equivalent to world total LNG trade the same year. Equally intense in climate change impact, coal production and transport losses, worldwide, total at least 90 – 150 M tons-per-year, much of it lost in underground fires, in abandoned mines, with inevitable and massive CO2 emissions. While having less impact on the world’s climate, but massively polluting the world’s oceans, and some land areas, at least 1.4 Million barrels-per-day (Md) of oil is lost “from well to wheel”, and this rate is increasing much faster than production, due to extreme depth offshore production, tar sand based ’syn crude’ production, and production in what are called ‘hostile or extreme’ environments. Few persons, economic or consumer interest groups, or political parties today still reject the link between fossil fuel burning and climate change – although it has taken at least 16 years since the 1992 Rio conference to arrive at this open acknowledgment. Despite this “late awakening”, the reality of near-unlimited risks and economic damage from runaway climate change has now penetrated public opinion and political decision making, usually concerned only with attempts at increasing personal consumption and economic growth.

Reliance on ‘Free Market’ mechanisms: Reports such as the 2006 report by Lord Stern (UK) present various economic methodologies, and costing for not avoiding, or not mitigating climate change sufficiently, or in a relatively rapid forward timeframe. One of Lord Stern’s scenarios suggests that economic losses due to insufficient or absent climate change mitigation, could climb to around 50 000 Bn USD/year (2006 USD value), by around 2040, this being approximately equivalent to world total GNP in 2007. This ‘avoidable cost’ could be utilised for estimating rational spending and investment targets for ARE and non-fossil energy through the next 30 years. However the Stern report, like others, gives major prominence to what is the only present and market-based process for supposedly ‘reducing or limiting’ GHG emissions. This process, it is implied, will lead to ’spontaneous’ or ‘market induced’ growth of the ARE or non-fossil energy supplies and systems, under various cost and time horizon scenarios. This ‘market-based process’ is the European ETS (emissions trading scheme), which apart from being a very small market, relative to other markets such as equities, currencies, government paper, raw materials, etc, is remarkable by its opacity and volatility. Operating since 2005, the European ETS has manifestly had zero impact on fossil energy consumption in Europe, with many EU ratifying countries ‘robustly’ increasing their oil, gas and coal burn through the 2005-2007 period of fast economic growth, and only trimming their fossil energy demand with the near collapse of their banking systems and entry to global economic recession, from 2007-2008 ! One clear impact of European ETS, we can suggest, has been to accelerate the construction of gas-fueled power plants, as well as wind electric plants, making the ETS a process for increasing gas demand and developing one major ARE, in a context of growing electricity demand and consumption, often accompanied by growing total commercial energy demand.

Dimensions of the Problem

Substituting oil, then natural gas, and preferably coal and lignite, presents huge challenges including massive, long-term financial mobilization and global-scale effort to achieve Energy Transition without catastrophic economic impacts, or further geopolitical conflict, specially in the Middle East, central Asia and Africa. Adding the pressing need to quickly develop, and utilise CCT and CCS (“clean coal”) to reduce impacts from coal and lignite burning worldwide, the rising problem of world car fleet energy and fuel supply, and very serious challenges for at least maintaining, if not increasing world food supply, the immense challenge of Energy Transition becomes clearer.

Unfortunately, the current financial mechanisms to achieve this end remain vague, volatile, speculative and insubstantial. To date in early 2009, speculative ‘investment’, that is asset creation and trading, and ‘financial engineering’ activities including private venture start-up and debt refinancing of alternate energy companies, M&A activity, LBOs, etc, has already led to collapse of the so-called ‘biofuels boom’. Financial instruments linked to carbon finance trading, mainly European ETS CO2 credits and derived instruments, and CDM (clean development mechanism) operations in Associated Countries (mostly nonOECD), are all typified by extreme price volatility, highly speculative and opaque trading, and very small market size. Due in part to the ’success’ of European ETS, to high electricity prices in Europe, and early investor enthusiasm for wind power, this has helped create a large and growing overcapacity of wind electric installations in several European countries, followed by a sharp fall-off in new orders. Efficiently using wind energy resources will necessitate large infrastructure spending on electric power grid interconnexion, sometimes called ’smart grids’. Featured in the 825 Bn USD Obama program to restore US economic growth, grid interconnexion investment on a huge scale is unlikely, to say the least, by speculative free market ‘players’ seeking a quick rand large return on their play. The potential for a similar free market ‘boom-and-slump’ with solar PV (photovoltaic) electric power production is now also growing quite rapidly. World effort to develop renewable, and low-carbon energy sources and systems are currently concentrated in the OECD countries, despite the very large resource potentials in low-latitude countries. As noted above, the ‘boom-and-slump’ sequences that have already taken place, with biofuels, with wind electric power development, specially in Europe, and probably soon with emerging solar photovoltaic electric power, current global investment in alternate and renewable energy is hostage to the whims of private market players, and victim to their very classic financial, short-term oriented, profit-maximising behavior. This strongly suggests the need for urgent attention to creating automatically funded multilateral frameworks, with adequate planning, regulation, and control, in a truly global and necessarily long-term process. This requirement for state intervention, and state funding can be compared with the vast ‘injections’ of public money into the world banking and finance system, to limit the catastrophic economic damage resulting from ‘exuberant’ free market trading.


Various data sources, including the IEA and ASPO suggest that due to oil and gas depletion, potential

continued energy demand increase, rising costs of ‘new oil and gas’, climate change mitigation, and other factors such as increased environment protection, imply that about 25 Mbd, oil equivalent of ARE or alternate and renewable energy supplies may be needed by 2035-2040. Again using IEA estimates, the cost of its projected ca. 63 Mbd of “new, replacement or additional” oil supply capacity needed by about 2035 comes to about 26 000 Billion US dollars, 2008 value. Assuming similar costs for alternate energy, and perhaps only 25%-40% of this oil equivalent energy supply being derived from the ARE, this would suggest total financing needs for the “alternatives” at about 12 000 Billion US dollars, 2008 value in the period of about 2009-2037. On a “straight line” annual basis, in 2008 dollars, this would amount to about 400 – 450 Bn USD/year. The above ‘modest contribution’ from the ARE, not attempting to project complete transition to the ARE over the period to around 2037, will necessarily assume very large energy savings being made, mostly in the OECD countries. Using data and forecasts from sources such as McKinsey & Co, world energy saving or ‘Negawatts not Megawatts’ could or might represent a new industry with spending and turnover attaining about 30 to 40 Bn USDper- year by the period 2025-2030. At that time, oil, gas and coal substitution due to energy saving may in fact reduce world total energy consumption relative to today – unlike IEA and other forecasts assuming continued, if slower growth. However, costing what is in effect a massive Energy Transition effort, far bigger than changes in world energy in the previous 30 years, encounters the difficulty of integrating a myriad of decisions that will be made, at all levels from final users to government deciders, concerning energy saving versus energy supply substitution, and the type of energy used to substute present demand.

Under any hypothesis, however, it is necessary to assume that large energy savings, or demand side management will occur. In an economic and social context where “only the market will decide”, as we have found through 2005-2008, outright and massive economic recession is the sole guaranteed way to obtain real cuts in oil and energy demand !

Using a reference target of 25 Mbdoe of ARE for oil, coal and gas energy substitution by about 2035, and comparing this with recent performance in the world oil and gas industry (outside the OPEC NOCs and Russia) we find that about 400 Billion USD/year of investment delivered supply increments of about 2.1 Mbd oil equivalent/year (about 1.1 Mbd oil, and 1 Mbdoe gas in 2006 and 2007). This suggests an apparently lower cost for ARE fossil energy substitution, than 12 000 Bn USD to 2035, perhaps less than 6000 Bn USD through the period – but these investment costs relate to oil and gas supplies with a far lower cost per unit delivered energy, than the ARE. Performance in substituting 25 Mbdoe of oil and gas energy, we can at this stage conclude, would rather conservatively imply a spending need of up to, or more than 400 Bn USD per year in the period 2009-2035. Expecting that current financial structures and systems, and operating methods can cope with long-term Energy Transition is at best foolish, and at worst disingenuous or cynical. For this reason it is wise to start,

very quickly, to consider multilateral frameworks and mechanisms for energy transition. To this end, this author has made numerous proposals. These address the central questions of targeting a fast but orderly reduction in the oil and gas intensity (average consumption per capita) of the OECD countries, and the worldwide, automatically financed, transparent and regulated development of all alternate and renewable energy sources and systems, using an Energy Levy on multilaterally controlled oil and gas supplies and their pricing.

Copyright Andrew McKillop and FINSIA,

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About the Author

Andrew McKillop is an energy sector professional, with over 30 years experience covering multiple domains in the energy sector of key interest to investment and equity managers, strategists, fund owners, analysts and policy setters. He is currently an independent consultant, journalist, broadcaster and author, with long experience as an energy theme presenter at major conferences and meetings covering oil/gas energy, renewable energy and energy investment strategy. As in-house consultant, often for long periods in major state, semi-public and private capital entities in the energy and energy investment studies and planning sectors - including the Canada Science Council, UN ILO, and the OAPEC organisation and its industrial subsidiary AREC - Andrew McKillop has provided constant and precise data and reports to deciders. Mr McKillop has for more than 20 years been associated with the concept of net energy analysis, energy economics analysis, and downstream investment decision advice. A founder member of the International Association of Energy Economists, in 1981, Mr McKillop has for many years pioneered new concepts for energy economic system analysis, oil inventory analysis, and energy industry analysis. One recent 'ahead of the pack' insight provided by Mr McKillop at international conferences and in widely published articles concerned his early 2007 warning of acute risks for the 'biofuels boom'. The analytic methods and approach proposed by Mr McKillop will be highly useful to fund and equity managers risking their own, or customers funds in the now partly overheated Alternate & Renewable Energy investor sector. Mr McKillop is regularly interviewed by such media as and European financial and mainstream newspapers such as 'The Observer'.