LOOKING BEYOND UPHEAVAL

ENERGY PRICES are extraordinarily volatile, and have recently hit record highs. Economists worry about the effects on gross domestic product (GDP) growth. Politicians raise alarms about energy dependence and the security of foreign oil and gas supplies. Scientists warn of irreversible damage to the earth from the uncontrolled use of fossil fuels. There is much talk about conservation and alternative energy sources.

Welcome to . . . the late 1970s. For anyone who remembers that time, the crisis atmosphere surrounding energy since 2006 evokes more than a little déjà vu. It is tempting to take comfort in the fact that there was no economic apocalypse after the energy crises of the 1970s. Instead, most energy prices fell back to their earlier levels within a few years; governments, businesses, and consumers and the world economy not only survived but prospered. It’s reasonable to wonder: why can’t things go back to normal now, just as they did then?

But the similarities between the current energy situation and the 1970’s oil crises are limited and somewhat superficial, and the differences are more pronounced. To be sure, many of the most critical factors are uncertain, particularly when the time it takes to change large-scale infrastructure is taken into account. But there’s one thing we can say with confidence: the energy situation is not going back to normal, at least if “normal” means the industry structure and stability of the 1990s.

Every chief executive and senior manager today will be forced to confront the reality of uncertain and unstable energy markets over the next two decades or more. For leaders in organizations that are involved in energy production or that use energy as a key input, the impact will be immense. The structure of their industry will undergo significant change—slowly at first, but accelerating over time as early innovations succeed and the rest of the industry falls in step. All other businesses will be affected as well. The goods we produce, the devices we create, the computer systems we rely on, the transportation and logistics networks we use—all will depend on what happens to energy supply, demand, and prices.

This book will help you understand the major forces that are shaping the future of energy and the choices that will face leaders in all walks of life. It will help you distinguish the myths and misconceptions that you read in the newspaper from the actual situation and its implications for any business or organization, from the smallest local enterprise to the largest multinational.

MYTHS AND REALITIES

If the energy realities are more daunting today than they were in the 1980s, the solutions are also very different. Last time, there was a pervasive move toward energy efficiency in some parts of the world (such as Japan) and ultimately a “return to normalcy” that took place naturally when OPEC’s prices fell. A resolution of the current crisis will not happen by itself. It means finding a solution that ensures two seemingly incompatible things: first, that the world will have sufficient energy supplies to enable continued economic growth in the developed world and continued opportunity for newly industrializing nations, and second, that industrial society can slow or, better still, reverse the increase in energy-related greenhouse gas emissions.

The only way this will happen is by accomplishing an energy shift that is unprecedented in history—a transition away from the carbon-intense fuels and technologies of the past. The shift has already started, as can be seen in everything from the rise of biofuels and hybrid autos to the building of large wind farms to the popular opposition against the construction of new coal-burning power plants. But what we have seen so far is only the beginning of a vast reshaping of the energy landscape. The landscape as we know it took more than a century to develop, and it will take decades to shift to its new form. This transition will shape every aspect of business and daily life between now and 2030.

Life during an energy shift is rife with tension, and for good reason: the forces that are affecting this shift, and that will determine how quickly it can be accomplished, are still difficult to see clearly. A huge amount of information and analysis about the upheaval in the energy markets is churned out each month, but much of it reflects the biases of different industries, interest groups, and other constituencies. A good deal of this material is also imperfectly grounded in economic and business reality, and some of it is naïve.

One useful way to better understand your options is to start examining some of the persistent myths about energy, and the constituencies that benefit from their promulgation. These myths are relevant because they can drive public opinion, and hence public policy; and because business practices will also be based on these myths, in some cases leading to severe competitive disadvantage.

The Global Oil Depletion Myth
The world is running out of oil.

Reality
This myth has become popular among some environmentalists, antigrowth activists, and others promoting alternative energy sources and conservation and, in some cases, opposing industrialization and unfettered economic growth. It has also been popularized by an ongoing argument (often referred to as “peak oil”), based on some supply estimates, that the world has passed the maximum global petroleum production rate.

Belief in this myth is tempting, and it makes a compelling story. But it’s not true. Despite the current imbalance between supply and demand in oil and other fossil fuels, and despite the peak oil view, the world is not running out of this substance. No matter what happens, long-term supplies will be available. There are plenty of fossil fuels still in the ground in existing reserves, and new reserves continue to be discovered in regions like Central Asia and South America. There are also vast proven reserves of “unconventional oil,” which can be derived from oil sands, oil shale, and even coal. Using known technology, these sources could provide enough hydrocarbons to fuel a petroleum-based economy for many decades to come—if companies and policy makers are willing to deal with the environmental costs and higher prices. These sources could enhance energy security for many countries, including the United States, Brazil, Russia, China, and India.

However, in one sense, the depletion argument is right. The short- to medium-term constraints on oil supply are significant, especially those on cheap, easily recoverable oil. Unconventional oil sources are more expensive and are also likely to prove unacceptable from an environmental perspective unless expensive new technologies are deployed to limit greenhouse gas emissions. Therefore, while oil will remain abundant, it will not necessarily be the “easy oil” we have seen in the past, and oil will most likely play a much more limited role in the global economy post-2030.

The China Myth
Rising prices are all Asia’s fault.

Reality
This myth has gained currency because it makes it easier for people in the West to ignore their own role in boosting energy prices. It places all the blame on the newly industrializing nations of Asia. It is true that the growth in energy demand in China—as well as in India and other industrializing nations—has been significant. And mainstream forecasts envision that energy demand in developing Asian countries will more than double over the next 30 years. A new middle class is rapidly acquiring cars, major appliances, and a more energy-intensive lifestyle, and its demands will echo those of consumers in the West.

But the full truth is more complicated. For one thing, price pressures can just as easily be blamed on growing energy demand in the developed world. Petroleum usage in North America, for instance, has increased as much as in China in the past 20 years. And underlying demand will continue to grow in the United States and other mature economies.

Also, demand is only part of the price equation. One reason that prices remained low during the 1980s and 1990s was that oil production from nations outside OPEC and the former Soviet Union was growing steadily. This reflected the development of new reserves in the North Sea, Canada, Mexico, and Brazil, among other places. Non-OPEC and non-FSU production, however, began to flatten in the late 1990s and actually declined starting after 2002, as output and reserves in established oil-producing nations like the United States dwindled and fewer new reserves were found. Since then, the OPEC producers who control the most economic and easily recoverable oil and gas reserves in the Middle East have been straining to increase their capacity to produce more oil, but they have not been able (or willing) to do so quickly enough to keep pace with demand. More broadly, the supply crunch has extended across the energy spectrum. The costs of supplying other forms of energy have also climbed in recent years as a result of a dramatic rise in the costs of production equipment such as coal-mining machinery, liquid natural gas (LNG) terminals, refinery vessels, and infrastructure of all kinds.

The “Easy Ethanol” Myth
Biofuels are the green solution for transportation.

Reality
This myth is promoted by those in the agricultural sector who stand to benefit from the development of biofuels, and by those in countries like the United States and Brazil whose first priority is energy security. It is also a seemingly attractive story for environmentalists. And there are some reasons to be optimistic about the biofuel potential. Ethanol made from sugarcane, in particular, is a viable alternative today to petroleum; biofuels made from other sources such as cellulose, algae, and waste products could contribute a significant volume to the fuel pool, especially if the supply of agricultural land expands.

But from an environmental perspective, the biofuels available today are estimated to save from 20 percent (corn ethanol) to 80 percent or higher (sugarcane and cellulosic ethanol) in greenhouse gas emissions. This is at best neutral, and in some cases harmful, once the effects of land use are factored in: the impact on climate change of continuing to farm land that would otherwise revert to grassland or forest. Biofuels have also been implicated in food shortages and rising food prices. Since food and petroleum prices are inevitably linked, the impact of biofuels on gasoline prices may be muted. And there are water scarcity issues as well; countries that face water shortages may simply not be able to expand into biofuel production.

Even the next generation of cellulosic biofuels may not solve these problems in the short run. In the long run, with enough technological development, some futuristic biofuel approaches, like algae-derived biofuels that don’t require large amounts of land, could someday prove to be a long-term alternative to petroleum. But these will take decades to come to fruition, with many obstacles along the way.

The Carbon-Free Power Myth
We can meet the world’s needs for electric power and reduce greenhouse gas emissions within a decade or two relatively painlessly by switching to carbon-free renewable energy sources such as solar, wind, and geothermal energy.

Reality
This myth resonates deeply with those who are concerned about the environment, because it tells people what they most want to hear. And it’s true that these renewable energy sources—especially wind and solar power—hold tremendous promise for the future, and ultimately may hold much of the answer to global climate change (and to many countries’ concerns about energy security). But today they supply only a few percent of electric power generation, and significant technological breakthroughs in storage and efficiency, as well as massive investments in transmission infrastructure, will need to be made before renewables can compete on a wide scale, cost-effectively, with traditional fuels. Even using optimistic assumptions about renewables, much of the world’s electric power needs in 2030 will be filled, as they are today, by fossil fuels. However, the next 20 years are likely to see renewables taking larger percentage shares in power generation, and will lay the groundwork for a more significant shift to lower-carbon and carbon-free sources in the future.

The No-Nukes Myth
Nuclear energy is dead.

Reality
This myth plays on the safety fears that grew out of past nuclear power accidents. It still has currency among some environmentalists (although others are now less opposed, as a result of their awareness of global climate change). As a result, much of the debate about meeting future energy needs tends to ignore the positive potential for more nuclear capacity.
Today, nuclear energy from 439 reactors supplies some 15 percent of power-generation needs around the world. In some nations, it commands a very large market share.

France derives more than 80 percent of its electricity from nuclear energy; Japan’s nuclear share is 35 percent; in the United States, it is 20 percent. Moreover, despite persistent fears about safety, the nuclear industry has an excellent record, with the exception of the Chernobyl disaster of 1986. Concerns remain about the proliferation and storage of nuclear waste, about the availability of uranium for nuclear fuel, and about the potential link between nuclear energy production and nuclear weapons production, but these issues, while significant, may not in themselves slow down the advance of this technology.

The main advantages of nuclear energy are that it is a dependable, around-the-clock power supply, and that it produces no greenhouse gases, making it the most scalable current power-generation technology that does not contribute to global warming. Currently, there are plans to build more than 200 new nuclear plants worldwide, although rising costs and supply-chain problems are slowing the industry’s growth. In light of concerns about global warming, nuclear energy will remain an essential part of the electric power mix in the future.

The Private-Sector Solution Myth
Industry alone can bring about the energy shift.

Reality
This myth is the result of the mistrust concerning the ability of government to play a positive role in resolving long-term economic problems that have grown up in some major countries, including the United States. It is promulgated by supporters of a limited role for the public sector. But while it is true that private entrepreneurs and corporations accomplish most of the world’s innovation and operate many of its energy businesses, it is also true that historically, major shifts in energy markets have been driven by governments executing long-term strategies. Developments like France’s embrace of nuclear power, Brazil’s creation of a sugarcane-based ethanol industry, the rise of wind power in Denmark (and now in the United States), and the development of solar power in Germany were all rooted in government policy choices. Given the magnitude of the challenge that the energy shift presents, it’s clear that government decisions, public-private initiatives, and tax incentives will be necessary components in achieving major technological breakthroughs and building new energy infrastructure. The current electric power grid and transportation systems could not have been constructed without heavy government involvement; the same is true of the emerging infrastructure that will replace them.