Globalization of Energy Demand

Nayan Chanda: We are delighted to have in our studio Daniel Yergin, one of the world’s leading experts on energy. He is the Founder and Chairman of Cambridge Energy Research Associates and a Pulitzer Prize winning author of books. The latest one is The Prize. And The Prize has just been reissued with a new epilogue written by Daniel Yergin looking at globalization of demand. So, welcome to Yale.

Daniel Yergin: Thank you.

Chanda: Since the 2008 crisis, the worldwide worry about the shooting price of oil and the world running out of oil has subsided, but now recently the price of oil is once again going up. Today I think it was eighty-five dollars and it could be ninety. How do you see the prospect of the price of oil and how does it relate to the economic recovery that we so badly need?

Yergin: Whenever you get into a market where the price is going up fast and it seems to be a tight market, you get the worries about running out of oil, peak oil. And it peaked - those concerns with the peak in price of $147.27 in July of 2008. Then, of course, the price collapsed. The world economy went into its tailspin. And what we are seeing now is an oil price, like equity markets, very much focused not on the here and now of how the economy is functioning now, but the expectation of a strong economic recovery and an oil market that is very much looking towards China, in particular, India and other countries as a source of growth. So this is an expectations-led rally in the price of oil.

Chanda: I see. But once the price of oil starts going up wouldn’t that then crimp the growth that they expect?

Yergin: Well, I think that is. If we went back to 2008, there were those who said the price of oil is going to go up but the way it is going up, it is going to have a negative effect on the economy. And it delivered a wallop to the automobile industry, to the airline industry, to people of moderate incomes before Lehman Brothers collapsed. It created a lot of problems for countries like India that subsidize energy prices and billions of subsidies. So, I think people forget that it has those impacts and at some point a rise in oil price does act as a drag on the world economy. We found that last time. I don’t think we are at that point now. But, higher prices would act as a drag. You either think prices matter or they don’t matter, and I think prices matter a lot.

Chanda: In a recent report, your center for energy research has reported that OECD demand for oil has peaked and it is kind of trending down. That could be good news for the market, because if OECD demand is declining, so the rising demand from the emerging…

Yergin: Yes, it acts as an offset. And that again is one of the things that I point out in this new edition of The Prize. When the oil prices were going up, demand was weakening. And in fact, we passed through a period of peak demand in the OECD countries, in the United States, in Europe, Japan. We’ll see some recovery with recovery. But there are very important trends at work from more efficient cars, biofuels, perhaps electric cars, changes in demographics, populations aging, which tell us that we are going to have peak demands in the established countries. So you have the world almost split in two when it comes to the future of oil.

Chanda: This is very interesting research. If you could give a little more detail as to how, for instance, demography is affecting the world demand?

Yergin: As an example, if we look at it for instance in a developed country, like the United States, an aging population drives less. Second thing that happened is that a big source of demand growth in the United States was women entering the labor force over a period of about thirty years. That’s now saturated. So, those are two examples.

On the other hand, you look at a country like China and what you are looking at is rapidly rising incomes and rapidly rising incomes are associated with motorization. I think one of the most extraordinary statistics from the year 2009 was that millions of more new cars were sold in China than in the United States. People always knew that was going to happen but they thought it would happen in 2019 or 2020, not in 2009, and that trend continues. And then you look at a country like India, where the structure of the demographics [shows] it’s a much younger nation and that will have impact on economic growth in India and of course also, again, in the appetite for cars. So one big question for the future of world energy demand is not only “Will people buy cars?,” because they will, but “What kind of cars?”

Chanda: Whether these cars will be the gas guzz;ers or more electric cars or..

Yergin: Or just more efficiency. One of the certain trends, one of the other major themes that I focused on this new edition of The Prize and continue to work on, is that we see an emphasis on energy efficiency across the world to the degree that we’ve really never seen before. So it may be talked about in Europe, Japan, the United States, but it’s also at the top of the list in China and so, yes, there’ll be more cars, but it makes a real difference whether those cars get twenty miles to the gallon or forty miles to the gallon.

Chanda: Now, what is driving this push towards efficiency? Is it the price or is it concern about CO₂ emissions?

Yergin: I think what the change is [is that] traditionally the emphasis in efficiency came from price, concerns about security, general views on the environment, and also particularly in the industrial sector – engineers want to be more efficient rather than less efficient, a little different when it comes to SUVs. I think there are two new factors that are at work in it. One is the concern about climate change and the biggest short term thing you can do is to be a lot more efficient. And the other is the sense that with the BRICs, with the success of globalization, you are going to have with these large population countries, if you are not more efficient, the call on resources is just going to be enormous.

Chanda: And what is this concern about global warming, as well as energy shortfall, is perhaps driving the search for alternative energy. And in that area, what are we seeing, what are the prospects?

Yergin: The biggest development in renewables, the one that is sort of galloping along, is wind. You are almost hard-pressed to say that wind is an alternative anymore because it is possible that 40 percent of the new capacity being added in the United States in the near term will be wind, although there are new competitive factors at work. For photovoltaics, certainly the cost has come down a lot, getting more widespread; costs have to come down more. But if you are an electric utility and you have to meet renewable standards, and you have wind supply in your region, wind is the way to do it. However, if you ask the question “What is the biggest energy innovation since the year 2000?,” it’s not wind, it’s not solar. If you look at it in volumetric terms, it’s what is called unconventional natural gas and so-called shale gas which has really sort of taken the US by surprise, is beginning to take Canada by surprise and is now of great interest both in Europe and in China to see how extensive it is.

Chanda: This is the gas that can be extracted with some technology that is there but has not been tapped so far because…?

Yergin: It required technological innovation to do it. I remember when I was first working on The Prize, and people asked me “What’s the book about?,” and I realized that when you are writing about energy you are also writing about the history of innovation because again and again people think “We have now come to the end, there is nowhere to go.” And what happens? Innovation – problems get solved. We see it with the entrance of Silicon Valley, venture capital, now under this continuing step-up which began under the Bush administration and really accelerated now with Obama to increase spending on research and development. All of that is going to lead to surprises. And certainly, we have never seen the emphasis on innovation all across the energy spectrum that we are seeing today.

Chanda: Now, I’ve seen some report that this new technology that is being used to tap gas could be creating some unintended consequences in terms of creating a weak strata, which may not support the strata above, some geological turbulence can be caused.

Yergin: The major issue you hear being discussed is water, and in shale gas, as with all energy developments, you have to manage your water very carefully and it’s a pretty highly regulated activity as it is.

Chanda: So you don’t see any sort of bad consequence coming out of this?

Yergin: No. There have been a million wells that have been “fracked” – they use the term “fracked” in the United States. So it’s not a new technology.

Chanda: But apart from this new gas extraction technology, we have some reports about researchable algae. How do you see the prospect of that?

Yergin: It’s been a subject of – I say, go back five, six, seven years, people have been working on it, you’ve seen some major companies now starting to spend very significant dollars on it. The challenge there is – again, if you take the United States – a biofuels requirement that by the year 2022 about 20% of US motor fuels should be biofuels. You can’t do that with conventional crops, [like] ethanol, there are just limits to it. Therefore, there is a great desire to and drive to find a so-called second or even third generation of biofuels and that’s going to take [time]. Algae is one of it. We’ve seen companies, like Exxon Mobil, committing six hundred million dollars over a ten year period to work on it, which is significant. But I think that people working on it say that it, like all these things, does not happen overnight. It really takes development. You can do things in a laboratory but the challenge of energy is that it is big. You need scale and it has to be economically competitive. And that’s the role of research and development.

Chanda: And how about jatropha?

Yergin: Again, it gets talked about. I think it was more of a hot subject a few years ago than it seems to be today. And you get all these things that become hot. The big thing right now, of course, is what is going to happen with the electric car - what’s going to happen with batteries in terms of ability to drive long distances, weight, efficiency. And if you say “Where is the biggest emphasis now?” that’s a very big emphasis when you look at what the automobile industry is doing and what governments are encouraging. I would say that is probably the hottest subject today.

Chanda: A more efficient battery and the ability to charge it fast?

Yergin: Yeah, fast charge. You need a fast charge and you want to bring down the weight. I think those are the two things.

Chanda: So, the other concern that was pretty high about a year ago, about the Chinese going around and acquiring reserves of oil in many places of the world and that the Chinese are coming and are going to take over the energy. How do you see that fear has played out?

Yergin: I think it has subsided. There is no question that the Chinese are continuing to spend money. And it’s almost as though they are playing a game of catch-up. They are looking at their demand now – the second largest consumer of oil in the world. They have very capable oil companies. They have been in the oil business for many decades now. So in a way you sort of say it would almost be expected. And given the world’s needs, if the Chinese were consuming so much and not investing in new supplies, that would be a bigger problem.

So I think we have to look at this at two levels. There is the commercial challenge, and if you are a company competing against the Chinese you are very aware of that and you are aware that they may pay a higher price than you. But I think it’s important that we see these in commercial terms and not turn it into a zero sum, kind of mercantilist view, and rather see it as part of a larger web, a nexus of economic relations. I would share your perception that there was a lot more concern about this a few years ago than today.

Chanda: The other aspect is the refining capability. The Chinese are the world’s second largest consumer, but how much of this is do they actually refine and how much are they buying from others?

Yergin: Well, I don’t have that number in my head. They’ve been building some big refineries to meet their needs. Again, a few years ago there was a lot more concern that the world was short of refining capacity. But for instance, demand in the United States has roughly fallen by about 10 percent in the last couple of years, partly because of the recession. And suddenly those concerns that there isn’t enough refining capacity have turned around now to view that there are a surplus of refining capacity.

Chanda: Reliance has built a huge refinery in India.

Yergin: Yeah, I believe it is the largest refinery in the world.

Chanda: And it just came on stream last year, at the time when the prices collapsed and demand collapsed.

Yergin: It is a very efficient, state of the art, modern refinery and it has the capacity to supply Asia, to supply the growth markets both in India [and China] and as incomes go up in India - today, probably, India only consumes about a third as much oil as China - that number will go up. Again, of course, it’s a very interesting question about what kind of cars will there be in India and secondly, will the infrastructure be there because the Chinese have put an enormous investment into a highway system. Even without, you can see that when those people in Beijing who buy cars but leave it at home because it takes too long to drive it.

Chanda: Last two questions. When the Iraq war began, there was a lot of commentary about “This war is about oil. The Americans have gone to Iraq to get Iraq’s oil.” Now, how is the Iraqi oil industry currently doing?

Yergin: It looks like the companies who have won the biggest position in the Iraqi oil industry are the Chinese oil companies. So the notion [of] oil is never very clear. People say “It’s about oil,” and then you say “What do you mean it’s about oil?” Oil is a commodity that you can buy. Is it about concessions? What is it about? Clearly there is this whole set of strategic issues that surround the Persian Gulf and the role of Persian Gulf oil in the world economy. But, if you just look at the outcome, in the current round when all these big contracts have now been done in Iraq, American companies are almost at the bottom of the list.

Chanda: Meaning they could not compete?

Yergin: Well, because the Chinese were willing to give better deals. The way the Iraqis constructed it, they really looked for the low cost and also the Chinese are prepared to put a lot of people into Iraq. In many of these new concessions that have been done, the Chinese partners are very prominent.

The oil business has a lot of risk in it. And so companies tend to team up in consortia to work together. So you’ll see Chinese companies in partnership with European companies or US companies in partnership with Asian companies. It’s a way of sharing risk because when you go in you are going to spend billions of dollars and you want to kind of spread that out.

Chanda: Spread the risk.

Yergin: Yeah.

Chanda: Iran. What percentage of world oil is supplied by Iran?

Yergin: Roughly, in terms of production, it’s probably about 5 percent of world oil. They consume a lot of it and so roughly around 3 percent is exported.

Chanda: And gas?

Yergin: Gas – it’s very interesting. Iran has enormous supplies of natural gas. They don’t really need nuclear power because they have so much natural gas. But, unlike their neighbors, they have not been able to organize themselves to become an exporter of natural gas. In fact, I believe they are an importer of natural gas. It has to do with their own disorganization within their own energy industry.

Chanda: Now this is a question that, of course, is beyond energy expertise and is for expertise in strategy, which you have, If the Obama administration’s attempt to impose hard sanctions on Iran holds, what do you expect in terms of impact on the oil market?

Yergin: Less than if there is conflict - I think that would be the first thing. I think Iran at the end of the day needs revenues so it will seek to export if it can. Will it be able to invest in its industry, will it be able to benefit from being part of the global economy if it doesn’t want to be part of a global nuclear regime? – that will be the test. But there is a lot of surplus capacity in the world and it’s clear that other countries could easily step in and more than make up for any missing Iranian oil. There is a lot of a security cushion in the world market, partly the result of investment in new capacity and partly a result of the downturn in consumption because of the recession and greater efficiency.

Chanda: So, from that perspective, this may not be a bad time to put the squeeze on Iran?

Yergin: If you are just thinking strategically, you would say there is less impact on the world markets than doing it during a tight market. It would have been a lot more difficult to do it in 2005.

So often in history you see that crises or problems arise because people don’t understand other people or their communications just pass each other by, and so we are, I think, at one of those times. I think the Iranians certainly have a strategy or game that they are playing, but I think they seem to be moving, at least at this moment, towards a tighter sanction regime and it kind of poses for Iran a series of choices.

It’s interesting. To go back to your question about natural gas, Iran has enormous natural gas reserves. It should be a player in it, but as so often happens, it’s not a question of the resources you have on the ground, but it’s a result of the decisions that governments make above ground, and this is certainly one of those times.

Chanda: You mentioned “globalization of demand”, in which you have addressed in your epilogue of The Prize. Can you elaborate as to what you mean by “globalization of demand?”

Yergin: Well this really goes to the fundamental themes of YaleGlobal, your online journal about how globalization is changing the world and how we make sense of what’s happening. We are seeing a subset of that in terms of energy. The success of globalization, it’s rapidly rising incomes, which are a product of the kind of globalization that we have and with all of the other issues of the world economy and opening up of the world economy. One consequence of that, of rising incomes, is reflected in rising energy demand. In the old days, even as late as the 1990s, when we talked about oil demand, we were talking about the OECD countries, we were talking about the industrial world. China and India were not figuring in that. But if you look at the period between 2000 and 2007, 85 percent of the growth of oil demand was in developing countries.

And so this has major consequences in terms of where the markets are, the relations, who the players are – we see new players on the world market – and it also has very interesting, not only economic questions, but geopolitical questions. In a sense, when we talk about “globalization of demand”, what we are seeing in oil is really one mirror of these vast changes in the world that every week YaleGlobal tries to make sense of.

Chanda: That is a very interesting observation.

Yergin: Thank you.

Chanda: Well, Daniel Yergin, thank you so much for your very illuminating comments.