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Lecture

Managing Energy Insecurity

Speech presented at the Institute for International Economics
Washington, DC

John Browne, Group Chief Executive, BP plc

February 23, 2005


Summary

The Institute hosted a luncheon meeting February 23,2005 in honor of Lord John Browne, Group Chief Executive of BP plc. Lord Browne spoke on the topic of “Managing Energy Insecurity.”

Lord Browne is widely regarded as one of the most innovative leaders in the energy industry. His merger agreements with Amoco, Arco, and Castrol in the late 1990s made BP both the largest producer of oil and gas in the United States and the largest non-US company quoted on the New York Stock Exchange, and triggered a wave of consolidation throughout the industry. He has also adopted creative approaches to climate change and other environmental issues, breaking ranks with some others in the industry on these topics. Lord Browne has been at BP since 1966 and in his present position since 1995, and he became a member of the House of Lords in 2001. He is Chairman of the International Advisory Board of the School of Economics and Management at Tsinghua University and Emeritus Chairman of the Advisory Board of the Stanford Graduate School of Business.


Transcript

It is great to be in Washington again and a privilege to be invited to speak here for the first time. You asked me to talk about energy security, and I think the basic question is whether, to use the words of one of your recent papers, there is “a gathering storm” around energy supply, and what, if anything, should and could be done to avert that storm.

It is important, I believe, to start with the context and the reality of the recent past. We have now lived with oil prices above $35 a barrel for almost a full year. That represents a significant change from the average of the 1990s, which was around $18 to $20 a barrel. It is also a change from the period between April 2000 and the beginning of last year, when the Organization of the Petroleum Exporting Countries (OPEC) reasserted its discipline in terms of production and prices increased to around $25 a barrel.

Why has that shift occurred? There has been no physical shortage of oil at any time over the last year. Despite continuing conflict in Iraq, production there and everywhere else has been sustained.

The reason for the price increase is the growth in demand, particularly in China. Chinese oil demand has risen by around 1.6 million barrels of oil per day in the last two years, with almost 90 percent of that increase coming from imports.

Demand pressure reduced the normal cushion of surplus capacity from an average of around 3 million to around 1 million barrels a day at some points last year. At 1 million barrels a day, the surplus is less than the production from a number of countries such as Iraq and Nigeria, where, for different reasons, the stability of output was at risk.

Those are the reasons for the upward shift in oil prices.

Will current prices be sustained? Forecasting is probably one of the most dangerous jobs in the whole energy sector. Events always throw off any carefully prepared analysis. All you can do is look at the fundamentals and then be prepared for anything to happen—positive or negative. The fundamentals now suggest that, close in, prices might remain relatively high against the long-run average but perhaps not so high as they have been in the last year.

Production is growing. This year will see new fields on-stream in the Caspian, the deepwater Gulf of Mexico, and Angola. We should see more production from Russia as well. Demand is growing too, but perhaps not quite so fast as in 2004—in China or across the world as a whole.

So there is some shift in the balance, with some renewal of the historic levels of spare capacity but also—and this is the other fundamental element we cannot ignore—with an obvious determination on the part of the OPEC producing states to sustain a price that supports the needs of their young and growing populations. The result indicates a price that stabilizes at around $30 a barrel. But that is not a forecast. Events always override the fundamentals.

But even if that relatively calm outlook does become reality, I do not think it would remove the concern about energy security. That concern is not driven by shortage—there has been no physical shortage. Nor is it driven by price—the world seems to have adjusted remarkably smoothly to the increases experienced over the last year. I find it remarkable that despite the increase in oil prices, world economic growth in 2004 exceeded 4 percent—a 30-year high. The concern about energy security is really driven by the continued growth in demand and the fact that, on two crucial dimensions, we have not adjusted to what that growth implies.

Demand is set to increase. According to the International Energy Agency, world oil demand will grow by 32 percent by 2020 and world gas demand by a remarkable 48 percent. That growth is driven by population numbers and by the increase in effective demand—the fact that more and more people can buy the supplies of commercial energy they need for heat, light, and mobility.

Energy demand growth will be focused on oil and gas because there are no ready alternatives. Nuclear power will continue to supply a proportion of the world's energy needs, but there are still questions over public confidence, commerciality, and waste disposal. Renewables and alternative sources of energy will supply an increasing proportion of the total, but the figures are small. Last year solar, wind, and all the other alternatives (excluding hydro) provided just 1.1 percent of America's energy needs, with biomass contributing another 2.5 percent. By 2020, on the same independent forecast, that contribution will rise, but biomass and all the alternatives together will still produce only 3.8 percent. For the moment, there is no alternative to hydrocarbons, oil and gas in particular.

The mood of energy insecurity then flows from two unresolved issues. First, the pattern of trade. The United States, Europe, Japan, and now China are all reliant on imported oil. In every case, that reliance will increase in volume terms over the next decade. On the other side of the equation, the supplies of oil and gas available for export are concentrated in just three main regions—West Africa, Russia, and of course the Middle East—in particular, the Gulf States. Within the next decade, those three areas will be supplying four in every five barrels of traded oil. The unresolved question is whether those areas can indeed provide the energy security that the world needs.

Trade is one source of insecurity. The environment, and in particular climate change, is the other. Can we be confident that we can use ever increasing volumes of hydrocarbons without damaging our common environment?

By 2020 there will be another 1.5 billion citizens in the world. The demand for electric power is set to rise by perhaps 50 percent, and there will be perhaps another 700 million additional vehicles on the world's roads. What impact will that have on the environment and on the world's climate? We do not quite know. The science of climate change remains provisional. There is no certainty, but all science, even the science of economics, is always provisional, and what matters is the weight of evidence, which suggests that increasing carbon concentrations in the atmosphere could threaten the sustainability of the climate. The best current scientific judgment suggests that the level above which sustainability could be threatened is around 500 to 550 ppm of carbon in the atmosphere. Today the level is around 370 ppm, and that figure is rising.

Those are the factors driving the sense of energy insecurity. What, if anything, can we do about those things? Can we avert the storm?

I think we can do quite a lot. It is possible to identify what needs to be done, and we have some of the tools readily available. We also have some time.

There is a case for precautionary action on climate change because the evidence is strong. Some people fear the idea of taking action because they are worried that action would damage the process of economic growth. But this is a long-term challenge, and, if we act carefully and apply resources efficiently, I do not believe there would be a lasting negative economic impact. In fact, the real risk is to do nothing, and then to find that reality has crept up on us and that urgent, drastic action that really does cause economic damage is necessary.

The same approach is true in terms of energy trade and physical supplies. The most dangerous approach would be simply to allow a situation to develop in which the importing countries are dependent on, and indeed begin to compete for, supplies from a very limited number of places. Precautionary action to avert that risk is also necessary and possible.

I believe there are three practical steps that can be taken. Each is necessary, but it is the combination of the three together that would restore genuine long-term energy security.

The first practical step is to diversify the sources of supply to the world market to the maximum extent. The private sector of the industry is already doing a great deal. The industry has invested almost $100 billion in new sources of supply in the last four years alone. For the top three publicly quoted companies in the industry alone, the investment rate in exploration and development activity is running at more than $30 billion each year. That investment is bringing on-stream oil and gas from the Caspian, West Africa, Latin America, North Africa, Indonesia, and Russia.

The private sector is also building infrastructure—pipelines and terminals—for oil and gas, including, of course, the receiving facilities here in the United States and in other importing countries. That infrastructure is crucial for energy security.

But we need to sustain and extend that process, and we can only do so if we can invest freely and with confidence in the countries where the resources are available. Many of those countries are in transition—from autarky and central control and from civil war and conflict. The successful completion of that transition is important if the resources are to be developed successfully. The process of transition is most likely to be successful when the countries concerned have the human capacity and the quality of governance to manage the wealth that resources can bring.

Business has a great role to play in that transition. We can support education and training and the development of individuals. We can also provide a lead in terms of the way we work, and the best example of that is transparency. We believe that transparency is the best way in which to conduct business because it is the only possible basis for the development of long-term mutual advantage. That is why BP publishes what we pay. It is why we have strict rules against bribery and facilitation payments. We have every interest in eradicating corruption because corruption is a business cost. We will continue to publish what we pay, and wherever possible we will do so on a disaggregated basis.

But transparency on one side is not enough. We need to ensure that “publish what you pay” is matched with the publication of what is spent. And just as transparency and good standards of reporting have built the trust that underpins economic success here in the United States and in Europe, so now we need to ensure that those standards are applied throughout the world. Without that, private companies will not be able to invest sufficiently in areas where resources exist, and energy security will be put in jeopardy.

Supporting the process of transition is a matter both for companies and for governments. There is one particular example on which I would like to focus. That is Russia, which holds a greater volume of oil and gas reserves and resources than any other single country. It is just 20 years since Mikhail Gorbachev came to power and began the process of glasnost and perestroika. Those 20 years have been a period of remarkable change and progress.

Throughout that period, despite the breakup of the old Soviet Union and successive changes of government, Russian trade, particularly in energy, has been maintained. Russia has opened its oil industry to international investment and technology, and that opening is producing spectacular results. Output is rising, and reserves are being added. I think it is fair to say that without the recent increases in Russian production, the oil market would have been much more unstable in 2004, and prices could have been much higher.

There is much more to do in Russia. The resources are readily available, and once on-stream they could help meet the needs of both Europe and Asia.

Oil and gas development is also fundamental to the future of the Russian economy. It is important that the rules governing that development—the role of the government, the role of the state companies, and the roles and responsibilities of international investors—should be clear and secure. So should the fiscal regime.

Energy security will depend on the development of a strong and enduring relationship of mutual advantage between Russia and the rest of the world. That relationship has begun with business investment. Currently BP is the largest single international investor in Russia through TNK/BP, but many other companies from around the world are involved.

I can only speak for BP, but I think it is fair to say that the experience of investing in Russia generally has been very positive, with the usual ups and downs of normal life. In our case, in response to an investment of not just capital but also technology and people, we have seen a dramatic increase in production and in efficiency and, most important of all, in the base of reserves that will provide the production of the future. Within TNK/BP, we have established a new level of governance, and the company is now operating on the basis of international standards of transparency.

We have already invested almost $8 billion, and we are ready now to do more. But, of course, for many potential investors and for many commentators and observers, Russia remains a dark and hostile place—a source of risk rather than of opportunity. That is why it is so important to underpin the security of existing and future investment with a closer political relationship.

Later this year, Russia will assume the leadership of the G8, and that will be a great opportunity to recognize the strength of the common interests we have, to acknowledge the progress Russia has made in the last 20 years, and to provide support for continued progress by bringing Russia into the World Trade Organization (WTO) and all the other relevant institutions. As well as formalizing direct trade arrangements, accession to the WTO would help to confirm the rule of law, the development of transparency, the spread of the best international standards, and the process of good governance.

The WTO and the other international institutions have underpinned the development of the transatlantic economy over the last half-century, as the work done here at the Institute has demonstrated very clearly. Now they have a new role to play: giving new and very important players a stake in the global economy.

Russia has come a remarkably long way in the last 20 years—and the challenge for all of us is to help sustain that progress and to make the next 20 years even more positive.

The first strand of practical action in support of energy security is the development of diverse supplies and infrastructure on the basis of private investment backed by government engagement.

The second strand is precautionary action to avert the environmental risks associated with growing energy consumption—and beginning to take action now, the benefits of which will come in the medium to long term.

A great deal is already being done. People are reducing waste and improving energy efficiency. We have seen over the last decade that you can, for instance, eliminate the flaring of the natural gas that is produced in association with oil and thus reduce emissions and make good use of the gas. You can shift the energy mix—substituting gas for coal, for instance, in the generation of electricity. And you can use advances in refining technology to improve the quality of energy products such as gasoline and diesel. All those things are already happening.

It is also possible to begin to see what can be done next: improvements in the fuel efficiency of cars, the development of energy-efficient grids, the production of cleaner products, and the development of alternative technologies such as photovoltaics. All those steps, which are based on known technology, can make a contribution, and, at scale, the steps could in aggregate make a material difference.

But then, and most exciting of all, there are the possibilities that flow from advances in technology. Let me reference just one. We are beginning to see advances in the technology of carbon sequestration—the capture and storage of carbon dioxide so that it never enters the atmosphere. We are experimenting with carbon sequestration in Algeria in a joint venture with our partner, Sonatrach. The carbon dioxide produced from a natural gas development is separated and reinjected into a gas reservoir at a depth of 1,800 meters.

Over the lifetime of the project, the plan is that 17 million tons of carbon dioxide be geologically stored, the equivalent of the carbon dioxide produced by about 4 million cars in a year. This project is an experiment. Could it have widespread application? Probably yes.

There needs to be a concentrated source of carbon dioxide, as created in industrial processes or power generation. There needs to be an efficient way of capturing, compressing, and transporting carbon dioxide to a place of storage. Then there needs to be a place to store it. And logically, reservoirs from which most of the hydrocarbons have been taken would be ideal. After all, they rather effectively stored the hydrocarbons for millions of years. If the idea works, the potential exists to store very substantial volumes of carbon dioxide—and in the process, to increase production of oil and gas from some existing fields.

We are planning to develop another experiment in this area. This technology is particularly important if hydrogen is to be made and used. The most likely way in which hydrogen will be made is from natural gas or coal.

Just suppose we could produce hydrogen, make electricity from it, store the carbon dioxide in an old oil field, and then use the hydrogen to produce significant volumes of carbon-free electricity. That is the idea we want to test. We will start with a project in the North Sea, but I hope we can soon do something here in the United States as well.

So the second strand of practical action is using available and emerging technology to reduce the amount of carbon going into the atmosphere. The third strand is about going beyond what appears possible today in order to achieve a more sustainable long-term outcome.

At many different points in history, people have looked ahead and believed that the pattern of development was unsustainable. Malthus came to that conclusion 200 years ago when he wrote about the “periodic misery which would inevitably be inflicted on mankind as human procreation exceeds the capacity of subsistence.”

The status quo projected forward is often unsustainable, but what the predictions of gloom ignore is human ingenuity—the capacity to find a different way forward, to go beyond the status quo. And that ingenuity is what, I believe, will emerge in this case. I do not believe the world will allow itself to become dependent on a tiny number of suppliers for products and services that are absolutely vital to the economic activity of every nation-state. I do not believe the world will just tolerate the risks associated with global warming.

I suppose, in economic language, this is about a supply-side reaction to a pattern of expectations that is becoming unacceptable. I am not an economist, so I can only bring this back to business, and the fundamental purpose of business is to supply the goods and services that people want at prices they can afford and in a manner that is mutually advantageous to everyone involved.

I do not think we would be fulfilling our purpose if we just allowed a pattern of dependence and therefore of insecurity to develop. Our purpose implies that we should look for other solutions. And that is what we are doing. I believe those solutions will be found in the concept of substitution, not in substituting oil and gas with wind power or some completely different technology requiring a huge change in the capital stock of vehicles and equipment, but rather in substituting the sources of the fuel products on which we currently rely with other sources that do not bring with them the risks we now face.

It is clear, for instance, that gasoline and other products can be produced not just from petroleum but from other sources such as coal and biomass waste. That technology is advancing at a remarkable pace. We have been working in this area with the Academy of Sciences in China—a country that of course shares the concern we all have about energy security.

The challenge is to put the technologies together—the technology of converting different forms of hydrocarbons into fuel and the challenge of capturing and storing the carbon dioxide. If you could bring those two technologies together, you could both produce energy with far reduced levels of emissions and, equally important, you could shift the geographic pattern of activity. Instead of energy-consuming nations relying on ever growing volumes of imports from a shrinking number of suppliers, you could develop energy in different forms and different places in ways that match local resources and local economic needs. This change will take time, and no doubt the technology will produce surprises—new challenges and new opportunities. This is a process that is starting now and that I expect will have a material impact in 10 or 20 years. But that is the right timescale on which to think and to work, provided we recognize what needs to be done and start now.

The investment in energy security for tomorrow, and the day after tomorrow, has to begin today. Energy insecurity is not inevitable. It is a real issue, but there is no cause for doom and despair. There are real, practical answers.