Managing energy risks

Christoph Frei, 03 Nov 2015

We are living in a time of great energy uncertainty. This was illustrated last year when the price of oil fell by 50% in just a few days. This rise in uncertainty is the result of a combination of increasing complexity and speed.

In 2015, the speed of change in the energy sector has become much faster than it was 20 years ago, when the turnaround of transportation and the effects it had on the consumer market were then seen as fast. Now, there is a new reality demonstrated by examples that include the collapse of oil prices in a matter of days, the Fukushima incident which changed the nuclear outlook in a number of places and the collapse of solar prices collapsing from USD 4.7 to 0.6/watt-peak in five years.

Complexity has grown because of the increased number of drivers affecting investment in the energy industry. Twenty years ago there really was only one driver of investment, namely the price of oil, but that no longer is the case. Whilst the oil price remains very important, gas prices and their divergence across regions are affecting investment decisions. Uncertainty over CO₂ and solar prices, together with possible future increases in water prices are further affecting investment.

The move from one driver to many different drivers increases complexity of the market. This why the World Energy Council is saying now is the time of greatest energy uncertainty.

What keeps world energy leaders awake at night?

The World Energy Council works with 3,000 organisations in almost 100 countries and we have feedback from a thousand energy leaders on what we call the energy issues monitor.

Energy price volatility is the number one issue keeping energy leaders awake at night. Climate framework uncertainty is also high on the agenda of energy leaders as it drives CO₂ price uncertainty. If prices are highly volatile, you do not know where to put your money and that creates uncertainty.

The issues keeping these energy leaders most busy include renewables, energy efficiency, energy subsidies and fossil fuel subsidies. Other areas high on the agenda are the different levels of renewable subsidies and the question of how growth in major emerging markets such as China and India will affect energy markets globally.  

Furthermore, investments are a key area for action. We estimate energy efficiency investments of USD 1.7 trillion will be needed, in addition to existing requirements of the energy infrastructure side, in order to achieve a sustainable energy supply for the future.

Across the world there is a divergence of opinion on how geopolitical developments and regional issues in countries such as Russia, China, India and the Middle East will affect the top critical issues of uncertainty: energy prices, climate framework, commodity prices and electricity storage.

The importance of the role of storage in securing the supply of electricity cannot be overestimated, especially in countries where there is geopolitical risk. There needs to be more incentives to invest in smart innovation that brings new technologies to market which will deliver the required storage and back-up capacity. Currently electric storage is a high concern issue, mainly because the sector has converged to the view that electricity storage is the single technology that could change most fundamentally the energy outlook.

Figure1: What keeps world energy leaders awake at night

If you look ahead to the long term future, one of the most important issues on the agenda of global leaders should be carbon capture storage. However, despite it being a key climate change solution, particularly when it comes to coal, at the moment leaders are not giving it much attention – their attention is focused on renewables and energy efficiency.

The scale and importance of the issues highlighted in this monitor are heavily influenced by region. For example, whilst North America is very concerned about climate change uncertainty, Africa is perhaps one of the least concerned regions.  However, extreme weather risk in Africa, as well as in Asia, has arguably the most need for action with events ranging from storms and floods to dust storms and droughts increasingly impacting the way of life.  We have seen over the past year in Brazil, which depends for 80% of its energy on hydropower, the impact of droughts on the ability to provide reliable energy services.

Another growing risk is the threat of cyber-attacks. It is high on the OECD agenda and in regions such as North America and the UK where there are developed infrastructures which are heavily dependent on Information Technology for operations. Whereas it is much lower on the agenda in regions such as Africa where there are less developed infrastructures.

Scenarios - where is the world going?

At the World Energy Council we see two worlds which we describe in terms of 'jazz and symphony'. The symphony is a top down orchestrated world. For example, the Chinese government taking technology and energy access decisions to address the pollution agenda. The jazz world, by contrast, has only a basic rhythm. If you think of shale gas, this is a basic rhythm, but when technology is applied, it develops. These are two very different ways of looking at the world.

In our scenarios we try to envisage what could happen by 2050. At present, we have an 80% dependence on fossil fuels, but by 2050 we envisage that our dependence on fossil fuels will drop to between 60 and 75% with consequent CO₂ implications. However, within the fossil fuels market, there are many discrepancies. We believe that the use of oil will stagnate, the production volume uncertainty by 2050 being around plus/minus 15%. This is because transportation depends on it and we see transportation demand only going up. However, efficiency is improving, which in turn will keep the oil demand relatively stable.

As I have mentioned before, one of the most important breakthroughs will be in storage. If we develop cheap electricity storage, this would be a boom for electric mobility, which could be transformative in emerging economies. However, the short story is oil plus/minus 15% production volume uncertainty, gas between plus 50% and plus 100% of volume output. That is a massive growth for gas and the so called “golden age of gas”, we see as a reality. For coal we see plus/minus 40% production volume uncertainty which means we go from cheap coal to uncertain coal. If you are an investor in coal, you better think twice. Coal investors must enjoy risk. The main reasons for coal uncertainty are local pollution, a high water footprint, and high CO2 emissions.

So what is going to happen in the renewables marketplace?

Today, the primary energy contribution of renewables is 15%, which we see rising to between 20 and 30% by 2050. Solar energy currently contributes 0.2% to the primary energy mix, but we predict that by 2050 this contribution will grow dramatically by a factor of 200 with solar energy making a primary energy contribution of between 6 and 16%. Solar energy will become as important, or even more important, than nuclear and hydropower, and all within a very short period of time.

There will be major changes in the contribution that renewables make to the global energy mix, which consequently will affect risk factors. Think of a world in which we have an important share of the energy mix being provided at zero marginal cost and the impact that this will have on aspects of the energy value chain. That is obviously one of the next areas of risk.

What does this all mean for CO₂ and for energy access?

The UN Framework Convention on Climate change has set a 2⁰C target for the future, but with current technology and policies, and the present rate of innovation, whether in a symphony or jazz scenario, we will not keep the global temperature rise to below this 2⁰C target. We need a great deal more effort in innovation and policy making if we are to achieve a 2⁰C future. If the projections of the scientists on the Intergovernmental Panel on Climate Change are to be believed, missing this target will have a significant impact for global risk assessment.

On the energy access side there is some good news. At the moment there are 1.2 billion people without access to commercial energy, but by 2050 this will reduce to between 300 - 530 million.  The majority without access will remain in Africa where for policy, financial, skills and rural reasons, energy access will remain a problem. Rural issues particularly affect Africa where it can be hundreds of kilometres before a grid is reached, making it a very difficult region to provide access to electricity. This brings the debate to what we call the trilemma challenge.

The trilemma challenge and the need for better political risk management.

Figure 2: The trilemma challenge and the need for better political risk management

The trilemma challenge is the need to balance the three dimensions of energy - energy security, energy equity and environmental sustainability. Neglect of one or more of the three dimensions and you create the breeding ground for political risk.

With the World Energy Council Energy Trilemma index we measure risk in 129 countries where we can clearly see which countries are potentially exposed to such risks. With better understanding of these risk factors we can work at the national level to inform policymaking, manage risks and develop a more suitable outlook for the energy sector.  

We need to invest half of world’s GDP over the next two decades if we are to secure a sustainable supply and use of energy for the greatest benefit of all people. That is the challenge we face, and that is why we need to find the best ways of managing risk.

References

Figure 1. 2015 World Energy Issues Monitor
Figure 2. World Energy Trilemma

Author

Christoph Frei

Secretary General, World Energy Council

Christoph Frei has been Secretary General of the World Energy Council since April 2009. He has led the development of the WEC through a number of initiatives, including the initiation of the WEC’s on-going World Energy Scenarios and World Energy Trilemma flagship studies, as well as the facilitation of high-level World Energy Leaders’ Summits to enhance the relevance and impact of the organisation. Dr Frei was previously a member of the Executive Council of the World Economic Forum and its Senior Director in charge of Energy. He is also an Adjunct Professor and Advisor to the President of EPFL and continues as a member of WEF’s Global Agenda Council on Energy Security. Previously he held various positions as Research Fellow and Lecturer at ETHZ, EPFL, and PSI. Dr Frei regularly speaks at international energy conferences and as well as at board and strategy meetings of international energy companies. His own publications cover fields including energy scenarios, energy poverty, and urban innovation. Dr Frei received his PhD es sc. from EPFL in 2001 and holds degrees in Electrical Engineering and Econometrics, and a masters in Energy Systems and Applied Ethics.

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