Energy, the Environment and the Oil Market: An Asia-Pacific Perspective 9789814345866

Table of contents :
Contents
Acknowledgements
1 Introduction Energy, the Environment and the Oil Market
2 Greenhouse Gases and Energy Policies in the Asia-Pacific
3 Energy Technologies and Policies for Limiting Greenhouse Gas Emissions in Asia
4 Global Climate Change Policy Some Economic Considerations
5 Adjusting to Volatile Oil Prices An Agenda for the Producer-Consumer Dialogue
6 Growth of Oil Demand in the Asia-Pacific Perception of the International Energy Agency
7 The Asia-Pacific Oil Market Trends and Outlook
Appendix Energy and the Environment Study Summary
Contributors

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Energy, the Environ ment and the Oil Market

The Institute of Southeast Asian Studies (ISEAS) was established as an autonomous organization in 1968. It is a regional research centre for scholars and other specialists concerned with modern Southeast Asia, particularly the many-faceted problems of stability and security, economic development, and political and social change. The Institute is governed by a twenty-two-member Board of Trustees comprising nominees from the Singapore Government, the National University of Singapore, the various Chambers of Commerce, and professional and civic organizations. A ten-man Executive Committee oversees day-to-day operations; it is chaired by the Director, the Institute's chief academic and administrative officer. The ASEAN Economic Research Unit is an integral part of the Institute, corning under the overall supervision of the Director who is also the Chairperson of its Management Committee. The Unit was formed in 1979 in response to the need to deepen understanding of economic change and political developments in ASEAN. A Regional Advisory Committee, consisting of a senior economist from each of the ASEAN countries, guides the work of the Unit.

ISEAS Environment and Development Series

Energy, the Environm.ent and the Oil Market An Asia-Pacific Perspective edited by

SHANKAR SHARMA

1~111!!!!

ASEAN Economic Research Unit

liilliiilliil INSTITUTE OF SOUTHEAST ASIAN STUDIES

Published by Institute of Southeast Asian Studies Heng Mui Keng Terrace Pasir Panjang Singapore 0511 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the Institute of Southeast Asian Studies. © 1994 Institute of Southeast Asian Studies

The responsibility for facts and opinions expressed in this publication rests exclusively with the authors and their interpretations do not necessarily reflect the views or the policy of the Institute or its supporters.

Cataloguing in Publication Data Energy, the environment and the oil market: an Asia-Pacific perspective/ edited by Shankar Sharma. (ISEAS environment and development series) 1. Energy policy -Asia. 2. Energy policy- Pacific Area. 3. Environmental policy- Asia. 4. Environmental policy- Pacific Area. 5. Petroleum industry and trade- Environmental aspects- Asia. 6. Petroleum industry and trade - Environmental aspects - Pacific Area. I. Sharma, Shankar. II. Series. HC79 E5E62 1993 1994 sls93-67825 ISBN 981-3016-53-1 (soft cover) ISBN 981-3016-54-X (hard cover) ISSN 0219-3486 Typeset by Superskill Graphics Pte Ltd Printed in Singapore by Scapa Pte Ltd

Contents Acknowledgements Chapter 1 Introduction: Energy, the Environment and the Oil Market

vii

1

Chapter 2 Greenhouse Gases and Energy Policies in the Asia-Pacific

13

Chapter 3 Energy Technologies and Policies for Limiting Greenhouse Gas Emissions in Asia

39

Chapter4 Global Climate Change Policy: Some Economic Considerations

77

Chapter 5 Adjusting to Volatile Oil Prices: An Agenda for the Producer-Consumer Dialogue

101

Chapter 6 Growth of Oil Demand in the Asia-Pacific: Perception of the International Energy Agency

127

Chapter 7 The Asia-Pacific Oil Market: Trends and Outlook

147

Appendix

159

Contributors

166

Acknowledgements The original versions of three chapters (by Philip K. Verleger, John P. Ferriter, and Hugh E. Norton) of this book were first presented at the Seventh Asia-Pacific Petroleum Conference, 23-25 September 1991, Singapore, organized by Times Conferences, under the auspices ofthe Institute of Southeast Asian Studies and supported by the Singapore Economic Development Board, Singapore Trade Development Board, and the Port of Singapore Authority. Remaining chapters by Shankar Sharma, Urooj Malik, and Arnold B. Baker were written specially for this volume. We are most appreciative of the time and effort committed to the contribution and revision of the papers by the authors. We would also like to thank Graham Duxbury, Director, Petroleum Economics Limited, London for providing us the summary of their recent Energy and the Environment study which has been published as an appendix in the book. Finally, we would like to acknowledge co-operation of the institutions to which the contributors are affiliated.

Jl Introduction Energy, the Environment and the Oil Market Shankar Sharma

Demand for energy, especially fossil fuel, has continued to grow in almost all regions rapidly, but the Asia-Pacific region's growth rate was the highest in the world particularly in the last two decades. Energy development was guided mainly by the demands of the economy. Environmental aspects of energy development were largely neglected. The development and use of energy contributed negatively to the environment. It is widely believed that if the present trend of energy consumption continues, it will create environmental problems which in the longer run could become a constraint itselffor economic growth and social well-being. Environmental problems could cause irreversible problems especially in the ecosystem. Oil is the main source of energy and accounts for about 39 per cent in global energy consumption. Its share is even higher (47 per cent) in the Asia-Pacific region's energy demand if China is excluded. Coal is the main source of energy in China and accounts for more than 75 per cent of total energy consumption. However, the more important point is that the Asia-Pacific region accounts for only about one-fifth of the world oil consumption, but almost one-half of the future increase in world oil demand is expected to come from this region. Therefore, it is important to know the main environmental challenge of energy development and use, and its impact on the oil industry.

2 Shankar Sharma

Energy and Environment As concluded by Petroleum Economics Limited (London) in a recent study on energy and environment, of which the summary is provided as an appendix in this book, there are three broad but distinct environmental issues related to energy. Pollution related to energy mining and transportation comes under the first category. Pollutants like methane and sulphur oxides are emitted from energy mining whereas oil spills are caused mainly by the transportation of crude and products. Oil spills, although declining in terms of both the number of major incidence as well as in terms of total quantity, is still considered a major environmental anxiety. The discharge from day-to-day transportation of oil from tankers, pipelines, and offshore platforms is also high. Second is the problem of clean air. Combustion of fossil fuel generates a variety of pollutants which affect human health and the natural environment. Table 1.1 provides some information on the environmental impact of various types offuel consumption. Although the problems mentioned in the table are typical of those urban areas, rural areas could suffer problems of air pollution. Combustion of biomass, which is the main source of cooking and heating in rural areas, produces smoke containing particulates, polycyclic organic materials and carbon monoxides, etc. which are hazardous to human health. The impact is greater at the household level and affects more women and children. Similarly, fossil fuel fired power plants also create several local and regional problems. In addition to the emission of sulfur oxides (SO), nitrogen oxides (NO), carbon monoxide (CO), carbon dioxide ceo), and particulates, th; power plants create the problem of acid rain. Acid rain can harm trees, agricultural crops, the aquatic biota and other vegetation. In addition to the physical environment, acid rain can also affect human health. However, the damage done by acid rain to the physical environment and human health will differ from place to place and may depend on acid precipitation. It is both a local as well as a regional problem. If the power plant is coal-fired it creates an additional problem of waste disposal. The large coal consuming countries like China and India generate millions of tons of ash every year. Large amounts of land is required for the disposal of ash.

TABLE 1.1 Urban Energy Demand and Environmental Impact Matrix

Fuel

Representative end-use

Environmental impact

Environmental indicator

Level of impact

Firewood/ Other Biomass

Cooking

Respiratory health, fire

Particulates, polycyclic organics, CO/ CO

Househokl , neighboufhood

Charcoal

Water heating

Asphyxiation, respiratory health

C0 2, CO

Household

Kerosene

Lighting

Respiratory health, fire

C0 2, other pollutants

Household, neighbourhood

Gasoline

Autos , motor cycles

Respiratory health, acid deposition, lead, heart ailments

S02, NOX, HC, CO, SPM, ozone, lead, aldehydes

Neighbourhood, local, regional

Diesel

Trucks, buses

Same as gasoline

Particulates, CO

Same asgasoline

Other petroleum products

Industry

Same as gasoline

Same as gasoline, particulates

Same asgasoline

Coal

Space heating

Respiratory health, acid deposition

SOX, CO, C02, PH

Household to global

Electricity

Manufacturing

Safety

Incidence of shocks

Household, workplace

Source: Leitmann (1991).

4 Shankar Sharma

Third, but the most important, is the problem of greenhouse gases. Carbon dioxide, methane, and nitrous oxide, which are the main greenhouse gases, are emitted mainly from the combustion of fossil fuels. Energy is estimated to account for more than 50 per cent of the global greenhouse gas emissions. Rising concentration of these gases could possibly raise global temperature. It has been predicted that if global warming continues at the present rate, then the sea level will rise by nearly one metre by the end of the next century. If this happens, part of the world could be submerged by rising sea waters. The effect of global climate change on human welfare and the natural environment is difficult to assess, but it is widely believed that the impact of climate change, at least to certain parts of the world, in general, could be catastrophic. Environmental consciousness is bringing a new challenge to the energy industry. Securing a safe and sustainable supply of energy has become the challenge for the future. The oil industry is not spared from the complex issues of energy and environment. The industry is threatened by environmental awareness and various government legislation. Since oil dominates the energy consumption scene, how these emerging environmental challenges affect the oil industry has become a major concern.

Oil and Environment Two areas - oil spills and ground level pollution generated by the combustion of oil - are expected to attract greater attention in future. Countries have become and will continue to be more strict in dealing with oil spills resulting from transportation of oil, but the incremental costs of tighter control in these areas could be significant especially for the developing countries. Countries have also started tightening product specifications over sulfur content, lead, etc. Asian countries are very heterogeneous over environmental standards of oil products. OECD member countries of the region- Japan, Australia, and New Zealand- have stricter specifications. The second tier of countries are the newly industrialized economies (Hong Kong, Singapore, South Korea, and Taiwan) and ASEAN-5 (Malaysia, Indonesia, Thailand, Philippines and Brunei); product standards in these countries are moderate. South

TABLE 1.2 Average Sulfur Content in Petroleum Products in Asian Countries (Percentage weight) Countries

Motor gasoline

Kerosene Mobile

Gas/Diesel oil Industry Navigation

Residual fuel oil

1. 2. 3. 4. 5.

China Japan India Indonesia S. Korea

0.120• 0.004 0.180• 0.005 0.005

0.032• 0.004 0.200• 0.160• 0.012•

0.16• 0.40 0.80• 0.50 0.40

0.40• 0.40 1.44• 0.50 0.40

1.20• 0.40 1.44• 0.50 0.40

1.50• 1.09 3.20b 2.80• 2.64

6. 7. 8. 9. 10.

N. Korea Taiwan Thailand Pakistan Philippines

0.120b 0.125 0.035 0.001 0.035

0.032b 0.080• 0.020 0.160• 0.020b

0.16b 0.50 0.66 1.00 1.00

0.40b 1.00 0.50 1.00 1.00

1.20b 1.00 1.00 1.00

1.50b 1.70 2.92 3.20b 3.20•

11. 12. 13. 14. 15.

Malaysia · Bangladeshb Vietnamb Hong Kong Singapore

0.140 0.180 0.120 0.020 0.140

0.160 0.200 0.032 0.080b 0.020b

0.96 0.80 0.16 0.50 0.46

0.96 1.44 0.40 0.50 0.46

0.96 1.44 1.20 0.50 0.46

3.20• 3.20 1.50 2.20b 1.60•

16. 17. 18. 19. 20.

Nepal Myanmar Sri Lanka Afghanistan Mongolia

0.180 0.180 0.180 0.180 0.120

0.200 0.200 0.200 0.200 0.032

0.80 0.80 0.80 0.80 0.16

1.44 1.44 1.44 1.44 0.40

1.44 1.44 1.44 1.44 1.20

3.20 3.20 3.20 3.20 1.50

21. 22. 23. 24. 25.

Brunei0.005 Kampuchea Laos0.120 Maldives Macau

0.160 0.120 0.200 0.180 0.020

0.50 0.032 0.80 0.200 0.032

0.50 0.16 0.40 0.80 0.50

0.50 0.40 1.20 1.44 0.50

2.80 1.20 1.50 1.44 0.50

1.50 3.20 2.20

• Specifications are available, but the actual data is not available. Eighty per cent of the specification figure is applied referring to the rate of the actual data against the specification. b The values in similar countries are applied. Indian data applied to Afghanistan, Bangladesh, Burma, Sri Lanka, Maldives, Nepal, and Lao; China to North Korea, Mongolia, Vietnam, Laos, Cambodia, and Macau; Taiwan to Hong Kong, Hong Kong to Macau; the Philippines to Indonesia and Pakistan; and Thailand to the Philippines and Singapore. The average sulfur level in 1986 and 1987 is applied to fuel oils of Hong Kong and Macau. The sulfur levels of fuel oils in Japan, South Korea and Taiwan and gas oil in South Korea are those in 1987, and those in the other years are listed in a different table. Source: National Institute of Science and Technology Policy, Japan (1991).

6

Shankar Sharma

Asian countries and China, in general, have lower standards in product specification. For example, the variation in the sulfur content in petroleum products in Asian countries is very high. In gasoline, sulfur content varies from 0.001-0.005 per cent of weight in Japan, Indonesia, South Korea, Pakistan, and Brunei to 0.18 mostly in South Asian countries (Table 1.2). Similarly, the differences in standards are wider in other products like kerosene, diesel, and fuel oil. The problem is similar in coal. However, all Asian countries in future are expected to move faster in improved product specification. The other area of concern is the emission of greenhouse gases, and a number of policy options are available to reduce greenhouse gases. Among the important ones are: improvement of energy efficiency, development and use of alternative energy resources, and introduction of a carbon tax (see Chapter Two by Shankar Sharma in this volume). The last option has been widely discussed in recent years and is worth mentioning here. The primary objective of the carbon tax is to internalize the costs of carbon emissions. But it has two main problems. First, the costs and benefits of global warming are not known. Second, even if the objective of the carbon tax is to stabilize carbon dioxide emissions to 1990 levels by the year 2000 or 2010, the tax to be levied must be high. The results of a recent study (Low, Thorpe and Fisher 1992) which estimated the costs of achieving a 20 per cent emission reduction in 2000 for selected Asian countries are shown in Table 1.3. The figures are based on the general assumption that the energy and carbon intensities do not change between 1987 and 2000. This policy, if adopted, could reduce economic growth significantly. In particular, the developing countries would be hit hardest with the proposed tax. Implementation of the carbon tax policy is not easy. It has political, economic, and institutional problems. However, even if the carbon tax policy is adopted, oil will be preferred to coal; oil will continue to play a dominant role in the foreseeable future. As for sectoral issues, the transport sector is the largest contributor of, and accounts for more than one-fifth of, global carbon dioxide emissions. A specific policy discussed in developed countries is the promotion of electric cars. However, there are constraints to its implementation; for example, if the carbon tax were to be levied on

Introduction 7 consumers in an attempt to encourage them to substitute a gasoline car for an electric one, the tax must be equivalent to US$2.40 to US$3.00 per U.S. gallon. In addition to the operating costs, the price of an electric car is still more expensive than gasoline-driven vehicles (Mitchell 1992). Other alternatives like compressed natural gas, methanol and ethanol, to a certain extent, are substitutes for oil. But given the present status of their development and economies it is unlikely that these alternatives will have a major impact on the demand for oil in transportation. The other main oil consuming sector is the electricity sector. Fossil fuels account for almost two-thirds of the electricity generation in the world, but oil's contribution has already shrunk. Its share is less than

TABLE 1.3 Costs of Achieving a 20 Per Cent Emission Reduction

Republic of Korea Taiwan Hong Kong Singapore Thailand Philippines Malaysia Indonesia China Japan New Zealand Australia

Cost of required emission reduction (1985, US$bJ

Cost as percentage of GOP in the year 2000

3.8 1.2 0.2 0.4 0.8 0.3 0.5 1.0 148.2 6.5 0.0 1.3

1.58 0.64 0.24 0.94 0.89 0.47 0.83 0.63 27.38 0.29 0.03 0.28

Source: Low, Thorpe and Fisher (1992).

(%)

8 Shankar Sharma

one-fifth in the developing countries, only about 4 per cent in United States and about 8 per cent in Western Europe. The demand for oil (especially fuel oil) for power generation started declining after 1973 and more sharply after the second oil crisis. This was mainly due to the substitution of oil by coal, natural gas, nuclear power and hydroelectricity in many countries. Governments through regulations and fiscal measures also encouraged the utility industries in these countries to move away from fuel oil. This process is expected to continue in the future. In the Asia-Pacific region, declining oil production, rising environmental concerns, and a relatively high reserve life of natural gas provide better prospects for the development and domestic utilization of natural gas. The trend in the region is not different from the global trend; less oil is expected to be used in the power sector in future in the region. But, if coal is rejected for environmental reasons, then the importance of oil will rise. These issues are discussed in detail in the following chapters of this book. In particular, Chapter Two by Shankar Sharma reviews the environmental problems created by rising energy usage in the Asia-Pacific region, but the focus of the chapter is greenhouse gases. Policy options available to minimize energy-related environmental problems are also discussed. The author suggests that political, economic, financial, and institutional problems may inhibit the rapid change in the pattern of energy development and use. At least in terms of greenhouse gases, the main policy option would be to increase energy efficiency and promote conservation. In the third chapter, which deals especially with energy technologies and policies for limiting greenhouse gas emissions, Urooj Malik observes that the interaction between energy and environment is highly complex. However, since greenhouse gases pose the potential threat of global climate change the design of appropriate energyenvironment policies is essential for sustainable development. After discussing these problems in detail, Malik presents options for choosing various energy technologies and policies for limiting greenhouse gas emissions. Arnold B. Baker in Chapter Four observes that the larger the required reductions in greenhouse gases, the higher the cost to achieve it and the greater the negative effect on world economies. Therefore, he warns that economic implications should be carefully

Introduction

9

considered before committing to climate change policies. The author discusses these issues in terms of policy considerations, economic issues, and the process and mechanism for multilateral agreement. By discussing various policy options in greater detail, Baker suggests that given the present uncertainties surrounding both the science and the economics, it would be more appropriate to focus on policies that are cost effective and make sense in their own right regardless of whether or not in the future climate change from fossil fuel emissions was found to be a serious problem. After discussing general energy-environment problems, the three remaining chapters discuss the general outlook and specific features of the future oil market. Among other things, environmental concern has created the need for a dialogue between oil producers and consumers. Oil producers are concerned about the plan proposed by industrialized countries, especially the European Community, to introduce a new energy tax to limit the emissions of carbon dioxide. If the plan is adopted, the oil exporting countries could lose a substantial amount of oil revenue due to decline in both the volume of sales as well as crude prices. Oil exporting countries oppose this type of policy and seek producerconsumer dialogue to solve the problem. In Chapter Five, Philip K. Verleger examines the prospects for a dialogue between oil producers and consumers in the broader context. In doing so he examines the oil market from the consumer as well as the producer's perspectives. Following Verleger's discussion of the complex issue of producerconsumer dialogue, the last two chapters focus on the Asia-Pacific energy and oil market. Environmental consensus will affect the oil industry but the effects could be of a different nature in the AsiaPacific region. The conclusions of the last two chapters by John P. Ferriter and Hugh E . Norton about the Asia-Pacific region on the oil industry are similar. The region with the highest potential for economic growth is expected to be the main source for global energy and oil demand. However, rising environmental concerns, declining oil production, and a relatively high reserve life of natural gas provide better prospects for the development and domestic utilization of natural gas in the region.

10 Shankar Sharma

Rising environmental concerns will put emphasis on the production of oil products that are "friendly" to the environment. Many countries have started tightening up standards on various oil products, and the region as a whole will further tighten standards on them. Substantial investments are required for the improvement of the quality of oil products and the expansion and upgrading of such products. Rising energy demand and increasing import dependence will put more pressure on the need to increase efficiency in energy use. Hugh E. Norton makes a further point on the environmental impact on the energy industries. According to him choices between competing fuels based on their environmental credentials will continue in future. This implies that these considerations should be taken seriously into investment and operational planning. However, these investments sometimes can be very large; therefore it is necessary to ensure that the returns on those costly investments must be worthwhile to the national economies. In Chapter Six, John P. Ferriter points out that the governments of the developing countries can play a substantial role in improving environmental problems of energy use by setting clear guidelines, formulating policies, and through facilitating investments. Many of the problems that are being faced by developing countries today have already been faced by Organization for Economic Co-operation and Development (OECD) countries a long time ago. The experiences of OECD countries- both the successes and failures- in this area can be useful to the less developed countries.

Conclusions The greatest challenge to the petroleum industry in the 1990s and beyond is expected to come from the concern about the environmental implications of energy use, but the impact will be different in different parts of the world. The oil industry of the Asia-Pacific region is also expected to be affected by energy-related environmental problems. Countries in the region will have to pay some attention to the areas of energy conservation and efficiency, and the problems of oil spills but greater importance will have to be given to improved product specifications.

Introduction

11

Product specifications are expected to be tightened rapidly. However, as oil is the main source of energy, its dominance is not expected to change in the foreseeable future. The region, with the biggest population and the highest potential for economic growth in the world, will continue to boost oil demand. References

Low, John, Sally Thorpe and Brian S. Fisher. Sustainable Energy Issues in the Asia Pacific Region. Canberra: Australian Bureau of Agriculture and Resource Economics Conference Paper 92.46, 1992. Mitchell, John V. "Preserving Oil's Competitiveness in the Face of Environmental Regulations". OPEC Bulletin, May 1992. National Institute of Science and Technology Policy (NISTEP). Analysis of the Structure of Energy Consumption and the Dynamics of Emissions of Atmospheric Species Related to the Global Environmental Change (S0 2, NOx, & CO) in Asia. NISTEP Report No. 21, Science and Technology Agency, Japan, 1991. Leitmann, Josef. Energy-Environment Linkages in the Urban Sector. New York: UNDP/World Bank Urban Management and Environment Paper Series, April 1991.

Greenhouse Gases and Energy Policies in the Asia-Pacific Shankar Sharma

Production, consumption, and distribution of energy, especially fossil fuels, adversely affect the environment. In particular, combustion of fossil fuels generates pollutants like lead, sulfur oxides, carbon monoxide, and other greenhouse gases that are the major causes of local air pollution, regional problems like acid rain, and global climate change. Among the various pollutants, greenhouse gases are of major concern to the international community because the increase in concentration of these gases in the atmosphere threatens to change the climate, mainly through global warming. The implications of climate change could be catastrophic. Energy is the main source of, and accounts for, about 50 per cent of global greenhouse gas emissions (World Resource Institute 1990), and its contribution is rising. Energy policy, thus, has a primary role

The author is grateful to David O'Connor, OECD Development Centre, Paris; Stein Hansen, Nordic Consulting Group, Norway; Budi Sudarsono, UN ESCAP, Bangkok; Ng Kee Seng, Ministry of Environment, Singapore and Geoffrey Hainsworth, University of British Columbia, Canada for their helpful comments and suggestions on the earlier draft. However, any remaining errors are attributed to the author alone.

14 Shankar Sharma

to play in controlling emission of greenhouse gases and in reducing local and regional air pollution. The Asia-Pacific region plays an important role in the global emission of greenhouse gases because of its rising energy demand. The region's growth rate for energy demand has been the highest in the world for the last two decades. Emissions of some of the pollutants are rising at rates much higher than those of the industrialized countries. The increasing importance of the Asia-Pacific region in the global energy market and the stronger energy-environment linkage make it essential for the region to have a deeper understanding of energy-environment relations. The main objective of this chapter is to review the environmental problems created by rising energy usage in the Asia-Pacific region. Policy options available to minimize energy-related environmental problems are also discussed. However, because of the importance of greenhouse gases on global ecological stability, the focus of this chapter is on greenhouse gases.

Energy, Environment and Emissions of Greenhouse Gases When sunlight (solar radiation) reaches the earth, some of it is absorbed and part of it is reflected by the atmosphere and the surface. The atmosphere and earth surface reradiates some of the heat absorbed in the form of infra-red radiation and cools down the earth. Greenhouse gases allow sunlight to come in but absorb a percentage of energy radiated out from the earth. The transparency to incoming sunlight and opacity to outgoing infra-red radiation is called the greenhouse effect, and this produces global warming. The greenhouse gases comprise carbon dioxide (C0 2 ), methane (CH) , chloro-fluorocarbons (CFCs), nitrous oxide CNp), and ozone (0 3 ). Among the greenhouse gases generated by human activities, C02 is the number one culprit (Figure 2.1). Methane, produced from agricultural and industrial wastes, coal mining, and gas flaring and leaks, and CFCs, used mostly in industries, are also major contributors of greenhouse gases. Nitrous oxide, generated mainly by deforestation and burning of fossil fuel, and ozone, produced mainly by biomass burning, also contribute significantly to global greenhouse emissions.

Greenhouse Gases and Energy Policies

15

FIGURE 2.1 Greenhouse Gases Generated by Human Activity

Nitrogen oxide Chloro-fluorocarbons 20%

6%

Methane

16%

Ozone

8%

Source: World Resources Institute (1990).

Energy is the main source of greenhouse gases. It is difficult to give accurate estimates, but if we attribute CH4 and C02 emissions to the energy sector then this sector's contribution will be more than 50 per cent in the global emission of greenhouse gases (Ayres 1991; WRI 1990).

Similarly, energy accounts for about 70 per cent of global C02 emissions. Deforestation, which is the second major source, adds another 20 per cent. While trees and other vegetation absorb C02 , C02 is released into the atmosphere during forest clearance by burning. The remaining 10 per cent is contributed by industries and agriculture.

Asia-Pacific Region and Greenhouse Gases A breakdown of sources by geographical region shows that the AsiaPacific accounts for about one-quarter of global emissions of

16 Shankar Sharma

greenhouse gases. China, India, Japan, Indonesia, and Myanmar are the top five emitters in the region. Together, they account for about 75 per cent of the region's greenhouse gas emission. The Asia-Pacific region's pattern of greenhouse gas (as well as CO) emission is not different from the global trend. Energy, in particular fossil fuels, is the main source of greenhouse gases in the region, contributing about 38 per cent of regional emissions. However, there are differences in regional emission rates. In Japan, Australia, and New-Zealand, the industrialized countries of the region, CFCs and fossil fuels generate almost equal amounts of greenhouse gases. Emission of methane, though significant, contributes very little, while deforestation does not produce significant amounts to the total emission of greenhouse gases in these countries. On the other hand, the developing countries of the Asia-Pacific have different patterns of emission. Combustion of fossil fuels accounts for about 36 per cent of the gases released in the atmosphere. Land use changes (mainly deforestation) are responsible for another 33 per cent of the emissions. The balance 31 per cent is derived from methane emitted from wet rice cultivation and cattle, energy mining, transportation and CFCs. The contribution of CFCs is only 5 per cent (ADB 1991; WRI 1990) of the total emission of greenhouse gases. However, within developing countries, there are differences. Fossil fuels account for almost two-thirds of the emission of greenhouse gases in NIEs (Singapore, Hong Kong, South Korea, and Taiwan). In contrast, land use changes, especially deforestation, account for more than 70 per cent of the emissions in Southeast Asia. This is because most of the Asian tropical forests are in Southeast Asia and the region's deforestation rate is one of the highest in the world (Table 2.1). The contribution of fossil fuels is only about 8.5 per cent (ADB 1991; WRI 1990). Whatever the pattern, emission of greenhouse gases in the AsiaPacific region is rising at a rate faster than that of other regions and the contribution of energy is growing. Between 1975 and 1987, fossil fuel related emission of C02 increased at a rate of about 3.9 per cent in Asia, whereas its emission in industrialized countries rose only by a rate of about 0.6 per cent (National Institute of Science and Technology Policy 1991). The amount of energy related greenhouse gases is increasing and is mainly due to rising energy demand.

Greenhouse Gases and Energy Policies

17

TABLE 2.1 Deforestation by Region, 1980s Total forest and woodlands ('000 ha)

Africa North and Central America South America Asia (Southeast Asia Europe USSR Oceania

Average annual deforestation, 1980s ('000 ha) %

684,402

3,822

0.6

802,285 858,125 491,565 231,400 158,892 928,600 157,669

1,251 11,180 4,405 2,725 NA NA 26

0.1 1.3 0.9 1.2) NA NA 0.0

Notes (1) Regional figures are based on the available data. Data for many countries are not available. (2) The deforestation numbers from WRI are highly disputed and it is generally felt that they are far too high, especially in South America. Source : World Resources Institute (1990).

There are a number of reasons for the higher energy demand in the region. The agricultural sector became more commercialized; the industrial sector expanded significantly; and the economies of the region grew rapidly. The higher demand was also due to higher population growth, rapid urbanization, and increasing use of electrical appliances. The substitution of commercial energy for traditional fuel woods and charcoal by kerosene and liquefied petroleum gas (LPG) also raised the share of commercial energy. Disproportionate reliance on high-carbon fuels like coal is another reason for higher emission of energy related greenhouse gases. Coal has remained a dominant fuel especially in terms of C02 emission (Table 2.2). China is a major consumer and producer of coal. The

18 Shankar Sharma

TABLE 2.2 Average Annual Growth Rates of Sulfur Oxide, Nitrogen Oxide and Carbon Dioxide Emissions in Asia

1975-80

1980-87

1975-87

Sulfur oxides

5.1

3.8

4.9

Nitrogen oxides

4.2

5.2

5.4

Carbon dioxide

4.5

4.0

4.8

Note Carbon emissions are in carbon equivalent. It excludes emissions from vegetal fuels (fuel wood, bagasse, etc.) Source: National Institute of Science and Technology Policy (1991).

country accounts for 62 and 67 per cent in the production and consumption of coal in the region. China, because of the size of its population and the dominance of coal in the energy mix accounts for about 49 per cent of C02 emissions from fossil fuels in the region. The share of oil has declined, but the contribution of natural gas in the emission of these pollutants has increased significantly. This could be mainly due to reduced share of oil and increased share of natural gas in energy consumption and more stringent environmental standards imposed on oil products in Asian countries. Despite the rising emission of greenhouse gases, regional per capita emission of these gases is not alarming. The region, which has more than 50 per cent ofthe world population, accounts for only about 27 per cent of greenhouse gases. However, there are three special characteristics of the region that are of major international concern. First, C02 emission per unit of gross national product (GNP) in developing Asian countries is significantly higher than that in industrialized countries. Average fossil fuel consumption measured in kilograms of carbon emission per US$1 gross domestic product (GDP) for selected Asian countries in 1988 was 0.38. This figure was 0.17 for

Greenhouse Gases and Energy Policies

19

the OECD countries during the same year (UNEP 1991), the result of both higher energy intensity as well as a disproportionate reliance on high carbon fuels in the region. Energy intensity (per ton of oil equivalent per thousand US$ at 1980 prices) in developing Asia was 0. 77 (Asian Development Bank 1989) compared to 0.4 7 (Tabti and Brennand 1988) in OECD countries. Similarly, coal, which has the highest carbon content per British Thermal Unit (BTU), is the dominant fuel and accounts for about 4 7 per cent in energy consumption of the Asia-Pacific region. The share of coal was only about 25 per cent in OECD in 1988. Second, the region's rate of deforestation, especially in Southeast Asia, is one of the highest in the world. The contribution of deforestation to the emission of greenhouse gases is very high in the developing Asian countries; its contribution is predominant in SoutheastAsia. Third, the Asia-Pacific region's growth rate for energy demand during 1973-90 was the highest in the world. The average annual growth rate of energy demand was 5.4 per cent in the Asia-Pacific region compared to the world growth rate of 2 per cent. Similarly, the demand for oil grew by about 3 per cent in the Asia-Pacific region compared to the world's growth rate of about 0.5 per cent (Table 2.3). In addition to greenhouse gases, the energy sector is responsible for pollutants like sulfur dioxide, nitrogen oxides, lead, carbon monoxide (CO), and a number of other harmful atmospheric pollutants which are the main causes of acid rain and local ground level pollution. Table 2.4, which provides SOx, NOx, and C02 emissions by fuel type for 1975 and 1987, shows that coal has remained a dominant fuel in terms of these emissions. Thus, even if the share of fossil fuels in the emission of greenhouse gases is small it occupies a prominent role in local and regional air pollution.

The Changing Energy-Environmental Outlook What will be the likely characteristics of the energy market in the 1990s and beyond, and what will be the implication for environmental problems? This is a difficult question to answer. There are still uncertainties in the understanding of the mechanism which causes the build-up of greenhouse gases, and the process by which it will

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TABLE 2.3 World Energy Demand by Source, 1973 and 1991 (Percentages) 1973 World Asia-Pacific Oil Natural Gas Coal Nuclear Hydro Total Total Demand (million tons of oil equivalent)

48.5 18.6 30.6 0.4 1.9 100.0

47.7 2.4 45.7 4.2* 100.0

5,705.3

911.2

1991 World Asia-Pacific

40.2 22.7 28.0 6.6 2.5 100.0

37.3 7.9 48.3 4.4 2.1 100.0

7,807.6 (2.0)

1,800.6 (5.4)

Notes Numbers in parentheses are average annual energy consumption growth rates between 1973 and 1990. * Hydro and Nuclear together Source: British Petroleum (various issues); United Nations (various issues).

affect the climate. The difficulty in building the climatic model by capturing interactions between the atmosphere and other natural factors creates problems in predicting weather conditions (IPIECAIUNEP 1991; WRI 1990; and the chapter by Baker in this volume). Similarly, when the issues of climate change and ecological instability are discussed the time frame is long - the units are in decades and centuries. Rapid development of carbon free resources or technological breakthroughs in energy can change the future environmental outlook. It could also alter the prediction about climatic change. However, in the absence of technological breakthroughs, if global warming follows the present trend then following the IPCC (Intergovernmental Panel on Climate Change [WMO/UNEP] "business

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TABLE 2.4 Emission of Sulfur Oxides, Nitrogen Oxides and Carbon Dioxide by Fuel, 1975 and 1987 (Percentages)

Coal

1975 Oil Gas

Total

Coal

1987 Oil Gas

Total

Sulfur

61.4 38.6 0.0 100.0

77.8 22.2 0.0 100.0

NOX

49.4 50.0 0.6 100.0

60.9 37.8 1.3 100.0

C0 2

55.3 42.2 2.4 100.0

61.7 33.2 5.1

100.0

Note Numbers may not add due to rounding. Source: National Institute of Science and Technology Policy (1991).

as usual scenario" the sea level could rise between 10 and 30 centimetres over the next 40 years. If the trend continues, the sea level could rise by nearly one metre at the end of next century. If this comes true many parts of the world will be submerged by rising sea waters. This would be catastrophic to nations including the countries in the Asia-Pacific region. In addition to the increase in sea level, the process could affect regional temperature, wind, rainfall, and storm patterns. Rising energy demand is expected to be the main cause for all these ecological problems. The Asia-Pacific region's growth rate for energy demand is expected to be one of the highest in the world. Population and economic growth of the Asia-Pacific region will be the major factors for higher energy demand in the region. The region, which accounts for 52 per cent of the world population, is expected to grow by 4-5 per cent per annum between 1990 and 2000, as against the expected world economic growth rate of about 3 per cent (Sharma 1991). Various predictions are available on energy demand in the AsiaPacific region (Levine et al. 1991; ESCAP 1991; Tomitate 1991; Fesharaki and Yamaguchi 1991; Imran and Barnes 1990). The

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annual energy demand growth rate for the region has been predicted to be between 3.5 per cent to 5.4 per cent for the next 20-30 years. The geographical coverage and time horizon are different for different studies, but all studies conclude that energy demand from the Asia-Pacific region will be the highest in the world. Similarly, oil demand for the region is projected to be one of the highest in the world. At present the region accounts for about 20 per cent of the oil consumption, but almost 50 per cent ofthe future world oil demand is expected to come from this region. One study suggests that between 1989 and 1995 the demand for oil in the Asia-Pacific region will grow by about 3.6 per cent per annum in contrast to the growth rate of about 1.2 per cent in the rest of the world (Sharma 1991). Rising fossil fuel combustion is expected to increase the severity of a number of environmental problems including greenhouse gases. The future rate of emissions of C02 in the Asia-Pacific region is estimated to be the highest in the world. As a consequence, the region's share in global C02 emissions will rise. If C0 2 emission follows the current trend then emissions from the Asia-Pacific region could grow from 1.12 gigaton of carbon (GTC) (1 GTC equals 109 tons of carbon) in 1985 to 3.97 GTC in 2025- an increase of more than 250 per cent (Figure 2.2). Within the AsiaPacific region the highest growth is expected to come from the developing economies. The developing countries of the Asia-Pacific region are expected to increase their emissions by 500 per cent whereas the global C02 emissions is expected to increase only by 140 per cent during the same period (IPIECAIUNEP 1991). C02 emissions from China alone would exceed that of the entire OECD by the middle of the next century. However, because of the structure of energy consumption, developing countries will continue to remain the lowest per capita emitters of C02 even in 2025, but they are expected to become the major source for total emissions. In addition to C02 other pollutants such as S02 , NOx, CO and lead, which are also related to the combustion of fossil fuels, are increasing in the region. According to the United Nations Environment Programme's Global Environment Monitoring Systems (GEMS), more than 600 million urban people live in cities where S02 concentration is at unacceptable levels and more than 1.25 billion people are exposed to unacceptably high levels of other pollutants like

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FIGURE 2.2 Greenhouse Gas Emissions, 1985 and 2025 (In gigatons of carbon)

1985

2025

Source: IPIECA/UNEP (1991).

24 Shankar Sharma

particulate matter and smoke (Leitmann 1991). These will have an enormous impact on the health of urban people. For example in Bangkok, excessive emission of particulates, CO, and lead, which originate from motor vehicles, are estimated to cause 300-1,400 cases of excess mortality per year, 200,000--500,000 cases of hypertension per year, 300--800 first heart attacks/strokes and several other health problems (UNEPA/USAID 1990). Similarly, the environmental impact of acid rain which is caused by the fallout of airborne sulfuric acid could be manifold. Agricultural crops, vegetation, and trees could be damaged. It could also have an adverse impact on human health such as visibility impairment, etc. How much damage is caused by acid rain to physical, environmental, and human health, and the economic and social implications are unknown, but awareness about acid rain is rising.

Policy Issues The challenges of energy usage on environmental degradation, especially threats of global climate change discussed above, raise some policy questions. From a longer term perspective, there are a number of policy options available to reduce the concentration of C02 • They include the following: Improving efficiency in energy production and use. Shifting the fuel mix. Reducing the rate of deforestation and increasing afforestation (increasing the C02 sink). • Developing and using alternate energy sources. • Introducing carbon tax: or tradable emission permits. • • •

However, the appropriateness of these policies for each country will vary according to the nature and scale of the problems each faces.

Improvement in Energy Efficiency Improvement in energy efficiency is the most promising policy perspective for minimizing greenhouse gases and other energy related

Greenhouse Gases and Energy Policies

25

pollutants. According to a study, 20-25 per cent savings in energy can be achieved within a payback period of two years or less in the developing countries and Eastern Europe (Levine et al. 1991). Thirty to 60 per cent energy savings are possible in the longer run as investments are made in new capital equipment (automobiles, power generators and distribution grids, industrial facilities, etc.). Other studies also confirm the possibility of significant energy savings in developing countries (O'Connor and Turnham 1992, Atlantic Council of the United States 1991; ESCAP 1991; Hansen 1991; Imran and Barnes 1990; WRI 1990). There is great scope for improving energy efficiency not only in developing economies, but also in industrialized countries. For example, research done by the Energy Technology Support Unit at the U.K. Atomic Energy Research Establishment shows that there is a possibility of reducing C02 emissions in the United Kingdom by up to 50 per cent in the next 30 years. Among the various options available for reducing C02 , 35-40 per cent of the targeted reduction could come from energy efficiency (IPIECNUNEP 1991). Table 2.5, prepared by the working group on greenhouse gases in Sweden, provides some idea on where end-use efficiency can be achieved. All sectors, agricultural, commercial, residential, services, transportation, and industry have energy savings potential. The major areas where energy savings can be improved are discussed below.

Power, Industrial, and Agricultural The cost effective prospect for improving energy efficiency in developing countries in the power, industrial, and agricultural sectors include the following (Levine et al. 1991): 1. Fuel required per kilowatt-hour (kWh) of output can be reduced

significantly by replacing existing inefficient plants with efficient ones. Transmission and distribution (T&D) losses in developing countries are often very high, about 17 per cent, whereas they are about 5-10 per cent in the developed world. The technology required for this improvement is available and has proven to be highly cost effective.

26 Shankar Sharma

TABLE 2.5 Potential Savings Worldwide from End-Use Efficiency Measures Area

Percentage potential savings

Residential Lighting Refrigeration Electrical space heating Gas space heating Air conditioning Electric water heating Gas water heating Electric cooking Gas cooking Biomass cooking

75 40-50 40-60 45-55 40-50 50-65 25-40 30-40 40 75

(E) (E) (E)

Commercial/Services Incandescent lighting Fluorescent lighting Heating and air conditioning

75 70-85 40-70

(E) (E) (E)

Transportation Cars (technical) Passenger aircraft

40-50 55

Industry Motors (70% of energy sector) Lighting

2-40 70-80

(E) (E) (E) (E)

(E) (E)

Note E represents savings in electrical energy. Source: Stockholm Environment Institute, "Report of Working Group 1, Advisory Group on Greenhouse Gases" (Stockholm: 1990).

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2. Non-technical causes such as theft and inadequate billing procedures account for as much as 50 per cent of T&D losses in some developing countries. These can be reduced drastically with improvement in management. 3. Comparison of different energy and industrial systems are difficult to make; however, with the existing technology many industrial plants in developing countries could reduce their energy consumption by 30 per cent or more. Energy efficiency can also be raised by improving existing industrial plants themselves. 4. Similarly, improvement in tubewell efficiency, dryer efficiency, fertilizer efficiency, and other factors can lead to major differences in energy requirements in agriculture. The prospect for energy savings is excellent in these areas. 5. Buildings and other residential consumption also account for a substantial part in total energy consumption. The main sources of inefficiency in buildings include poor insulation, use of inefficient lighting, poorer quality of appliances, air-conditioners and heaters, poorer construction quality and high infiltration rates. A considerable amount of energy can be saved with simple changes which are highly cost effective. Technologies discussed above are economically viable in developing countries. However, economic viability does not guarantee the transfer. Decision makers as well as individuals should be made aware of the benefits associated with the new technology, and the investments that could help them. Similarly, the technology receiving institutions which are poorly developed in these countries must be strengthened. These efforts not only will help to protect the environment but will also save scarce capital in these countries. By way of illustration, fluorescent lamps are great energy savers. Compared to incandescent lamps, they use only 20 per cent of the power to give the same light output. If fluorescent lamps replace incandescent lamps, the energy savings will be enormous. According to Lovins and Gadgil (1991) the output of a US$7.5 million fluorescent lamp factory saves as much electricity as a billion U.S. dollar 700-megawatt plant generates. The lamp factory needs 140 times less capital investment than the power plant. Similarly, a study done by the World Bank in Sudan indicates that the installation of static capacitors, costing about US$1 million,

28 Shankar Sharma

would produce generating capacity savings of over US$12 million (Levine et al. 1991). Numerous examples similar to these can be found in developing countries.

Transportation Intensive use of oil in the transportation sector has declined significantly, especially after the oil crises of the 1970s mainly as a result of direct technological shift in car manufacture. Technological development, however, is expected to continue and may further reduce the intensive use of energy in transportation. Despite the less intensive use of oil intensity, the transportation sector still has been the largest contributor of, and accounts for, about 22.5 per cent of global C02 emissions (IPIECAIUNEP 1991). This sector also is a dominant source for local air pollution. Road vehicles are increasing at unprecedented rates especially in the developing countries; for example, the number of motor vehicles in many developing countries are growing at a rate of more than 13 per cent per annum (OTA 1991) includingASEAN countries (Sharma 1991). If the current trend continues, air pollution caused by motor vehicles in many large cities of developing countries will be much worse in future . In addition to the problem of alarming growth rates of vehicles, vehicle pollution is increasing as a result of (1) lack of emission control; (2) increasing stocks of older, less well maintained and less efficient vehicles; (3) slower speed due to increasing levels of congestion, and (4) rising use of leaded gas (Faiz et al. 1990). Therefore, the scope for energy savings with effective traffic management and by improved emission control regulations exists even if the growth of vehicles cannot be curtailed very much. Singapore is an example of how motor vehicle pollution can be reduced by regulatory and market related measures. Road congestion has been reduced by various policies. The area licensing scheme, which requires vehicles entering the central business district during rush hours to purchase a daily or monthly licence, was introduced. Daytime parking fees within the boundaries of the area licensing scheme were also raised. In addition, the car registration fee was raised and higher road taxes were introduced.

Greenhouse Gases and Energy Policies

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These measures have helped to reduce road congestion. In Singapore, average annual growth rate of motor vehicles was close to 3 per cent during 1973-89 and was the lowest in the Association of Southeast Asian Nations. Future growth rate of vehicles is targeted at 2.5-3 per cent per annum. In addition to the problem of congestion, Singapore has controlled other transportation related environmental problems by various regulatory measures. The lead content in petrol sold in Singapore was reduced from 0.84 grams per litre in 1980 to 0.15 grams per litre in 1987. All petrol-driven vehicles imported for use in Singapore must be able to use unleaded petrol. From July 1992, all petrol-driven vehicles were required to comply with the United Nations Economic Commission for Europe Regulation No (ECE 83) or the Japanese JIS 78 exhaust emission standards before being allowed on the roads in Singapore. These standards generally require users to install catalytic converters in their vehicles. Emission standards for vehicles are also stringent in Singapore. Smoke levels have been maintained at 50 Hartridge Smoke Units. Regulations are enforced strictly even on visiting vehicles registered in other countries. Similarly, the government provides disincentives to the use of old vehicles. Old vehicles add to pollution, vehicle breakdowns and accidents, and are better kept off the roads. Despite all these measures, it was difficult to maintain the vehicle growth rate at a targeted level of 3 per cent per annum. Singapore's vehicle population grew by 4.6 per cent per annum between 1987 and 1990. To curb the high growth rate of the vehicle population, the Singapore Government from May 1991 introduced the vehicle quota system whereby prospective owners of new vehicles have to bid for a limited number of certificates of entitlement. Furthermore, Singapore is planning to use an electronic road pricing system from 1996 to ration the available road space. If used, the country will be the first in the world to use this kind of system. In the meantime, the public transport system comprising an extensive network of buses and subways was improved drastically. All these schemes have environmental benefits. Air pollution is under control and is well below WHO and the United States EPA recommended levels (Ministry of Environment, Singapore 1990). In contrast to Singapore, other countries mostly developing ones,

30 Shankar Sharma

are having problems in controlling traffic and the traffic problem is creating severe environmental problems. For example, in Bangkok, 70 per cent of pollution is caused by cars, buses, trucks, and twostroke engine motorcycles. The levels of exhaust fumes that have been measured are much higher than acceptable safety standards (Asian Energy News 1991). Similarly, in India diesel vehicles buses and trucks - are responsible for over 90 per cent of nitrogen oxide emissions in the urban areas, and the two- and three-wheeler vehicles are mainly responsible for 85 per cent of hydrocarbons in the air from fossil fuels (OTA 1991).

Shifting the Fuel Mix From the environmental perspective, switching fuel from coal and oil to natural gas is appealing. On an average, the burning of natural gas produces about one-third less C02 than the burning of oil products and about two-thirds less C02 than the burning of coal. However, the problem with natural gas is that it is largely a local energy. Most of the natural gas (90 per cent of it in 1988) is consumed in the country of production or nearby state (this figure was 90 per cent in 1988 [Ball 1989]). It is not easily tradable in the international market because of transportation problemE?. Natural gas is transported either in the form of liquefied natural gas (LNG) or through pipelines which need very large investments. Despite the constraint, the prospects for natural gas production and utilization are bright in the Asia-Pacific region mainly because of the short life of oil reserves, rising dependence on the Middle East for oil imports, rising environmental concerns, and the large natural gas deposits in the region. The life expectancy of natural gas reserves is more than 60 years compared to that of oil which is about 20 years. The demand for natural gas increased by 12.3 per cent per annum between 1980 to 1990 and is expected to increase by more than 10 per cent between 1990 and 2010. The most dramatic increase in natural gas use is expected to come from the power sector. Natural gas will continue to be the main substitute for oil in many Asian countrier. and its use should be encouraged in the interests of a cleaner environment.

Greenhouse Gases and Energy Policies

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Development of Alternative Energy Resources In the near future, unless there is a technical breakthrough, scope for the development and utilization of carbon-free energy resources suffers many limitations. The development of both non-fossil alternatives to power generation - hydro power and nuclear power - have problems. Hydro power development damages land and the ecological system. It also creates the problem ofthe displacement of indigenous people, as well as having long lead times. Similarly, the use of nuclear power has engendered increasing public concern about its safety and the problem of radioactive waste disposal. Even developed countries, which are in a better position than developing countries to replace nuclear power plants, have not done so. However, the demand for electricity has been increasing and is expected to increase at a rate faster than energy. The advent of electric cars would accentuate this development. These developments, in the longer run, could force nuclear energy to play a larger role. Other forms of energy like wind power and solar photovoltaic systems also have problems. They are either still not cost effective or have limited applications.

Carbon Dioxide Sinks One of the practical ways to control and reduce the concentration of global C02 is by reducing deforestation and accelerating afforestation. Deforestation especially in the developing countries is caused by (1) rising demand for agricultural land for rising food needs; (2) increasing energy needs (fuel wood and fodder) in the rural areas, and (3) rising demand for wood for different residential, industrial, and export purposes. Forest harvest, therefore, is positively related with export revenues and economic development in most of the developing countries which are rich in forest resources . Therefore, reducing the concentration of C02 by preserving the forest to protect against climate change may be of little interest to the majority of the people in developing countries where the main problem is poverty and satisfaction of basic needs.

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Shankar Sharma

Data for all countries are not available, but it has been estimated that at least 20 million hectares of forests were lost due to deforestation each year in the 1980s. In the Asian countries alone more than four million hectares of forest were cleared each year (WRI 1990). The problem of deforestation is severe mainly in the developing countries. The present rate of afforestation is minimal; the replacement rate is less than 10 per cent. To reduce the current annual additions of C02 emitted by combustion offossil fuels, about 0.49 billion hectares (1.2 billion acres) of new biomass growth is estimated to be needed. About 20 per cent of the land (unused but useful for forestry) can be made available from the United States alone (Klass 1990). Availability of land for afforestation may not be a problem, but financing afforestation and reducing deforestation, which is tightly linked with the economies of developing countries, could be a constraint in increasing C02 sinks.

Carbon Tax The purpose of the carbon tax is to internalize the environmental externalities arising from the excessive use of fossil fuels. This measure, if used, will also provide some incentives for people to adopt cleaner technology and energy conservation. Since C0 2 emissions from combustion of various fuels are different, the tax rate will vary by energy type. It also depends on the quality of fuel. However, for illustrative purposes, if the carbon tax on electricity generation is estimated in terms of dollars per ton of carbon emission per billion BTU then the tax rates for oil and natural gas will be about one-third and two-thirds less than that of coal. But there are problems in imposing a carbon tax. How much price increase is necessary to stabilize C0 2 emissions? Who should pay? What should be the mechanism for paying tax - in proportion to population or in proportion to emission levels? These are very complicated questions, and are discussed by Arnold Baker and other contributors in this volume. Various scenarios have been analysed on how much tax has to be imposed on C02 emissions (Pearce 1991 and references cited therein) to reduce or stabilize C02 emissions. According to one estimate by the Institute of Energy Economics, in Japan a carbon tax of US$90.3 (in

Greenhouse Gases and Energy Policies 33

1985 U.S. dollars) per ton of carbon has to be imposed in the year 2000 and should be increased to US$288 in 2025 to stabilize C02 emissions at the 1988level. If the target is to stabilize C02 emissions in individual regions then the Asian developing countries must pay approximately US$500 per ton (in 1985 U.S. dollars) of carbon in 2050 (Tomitate 1991). It shows that the tax rate must be very high, especially to stabilize C0 2 emissions at the present level. This could be a major constraint to the economic development of the developing countries. Another related scheme proposed as an alternative to taxation is to issue tradable permits to emit permissible amounts of carbon dioxide. It can be done either by allocating a certain emission quota to countries or by distributing tradable rights in accordance with some "equitable" criterion such as equal emissions per capita (Schelling 1992). The main problem with the tradable permits scheme is that the initial distribution of quotas will be highly problematic. Second, the scheme has to be revised frequently as the conditions of the countries on which quotas would be allocated change. If the quota is shared n the basis of population, then according to the World Development Report 1992 the developed countries should pay about US$70 billion to the developing countries to get the permit to emit at 1988 levels, which may not be easily acceptable to the developed countries.

Conclusions Data and evidence suggest that human activities are increasingly contributing to different sorts of environmental problems. Those activities related to energy are of main concern. Environmental problems created by production and usage of energy are rising at all levels - local, regional, and global. The Asia-Pacific region, which accounts for more than 50 per cent of the world's population, is experiencing one of the fastest rates of economic growth in the world and the trend is expected to continue in the future. As a consequence, the demand for energy is expected to increase rapidly. This could elevate the region's contribution to local, regional as well as global environmental problems. Deforestation, if continued at the present rate, will further intensify the problem.

34 Shankar Sharma

There are a number of policy options available to reduce greenhouse gases. Among them, improvement in energy efficiency and conservation plays a critical role. Benefits associated with the improvement of energy efficiency are manifold. First of all, if energy efficiency can be improved by about 30-40 per cent in the developing Asia-Pacific region, the capital requirements to meet the growing energy needs can be reduced from an estimated US$57 billion per year (in 1990 dollars) during 19852025 to about US$26 billion per year (Levine et al. 1991), which is a reduction of mor.e than 54 per cent from the "business as usual scenario". Second, C0 2 emissions will decline substantially and will reduce the risk of global climate change. The reduction of C02 emissions could be as high as 45 per cent from the "business as usual scenario". However, this measure may not be enough to stabilize C02 emissions. Total C02 emissions will still be about 30 per cent higher in 2025 from the 1985 level. Third, it will reduce the burden of the proposed carbon tax, which if implemented can have disastrous impact on the economies of developing countries. Fourth, most of the efficient improvement in energy use can be achieved simply by transferring technology from Japan, Western Europe, and the United States. Similarly, to limit the concentration of greenhouse gases forestry policy (if implemented correctly and decisively) can play an important role. In addition to numerous other benefits, increased biomass will help to absorb rising C02 emissions and reduce the concentration of existing C02 • However, there are constraints in each strategy. The policy options on their own will not be effective. They have to be translated into action programmes that can be implemented effectively. Energy intensities in developed countries have undergone a peaking and they are now in the process of decreasing their intensities. However, in the developing countries where the rural and informal economies are being transferred rapidly to market economies, the demand for fossil fuels is expected to increase and hence the energy intensities as well. Additionally, it may be difficult to identify the sectors where energy savings can be made due to lack of data especially in the developing countries. Furthermore, there are financial, technical, and institutional

Greenhouse Gases and Energy Policies

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obstacles in transferring energy efficient technology from industrialized countries to developing countries. One example is that even if fluorescent lamps are 80 per cent efficient compared to incandescent bulbs, these lamps are priced several times higher than the incandescent bulbs. The high price of fluorescent lamps makes the market penetration of these lamps slow especially among population of developing countries where a majority of population spend more than 50 per cent of their income on food. These factors could make it difficult to achieve desirable levels of energy efficiency in the developing countries. Similarly, the problem of deforestation is linked to the political and economic conditions of a particular country. Price distortion (prices set and regulated without considering the market signals) created by government intervention have led to excessive exploitation of forest resources in most of the countries. The problem of the millions of people currently living and cultivating in logged out forests is a complex one. Furthermore, Asian countries which are dependent on primary products such as timber for export will find it difficult in the short term to prevent deforestation. On the other hand, afforestation also has problems; financial requirements for massive afforestation will be very high. There are difficulties in reconciling economic growth with environmental concerns. When it is seen that economic growth almost inevitably results in an increase in energy consumption and emission of greenhouse gases the reduction of these gases appears to be costly. The World Development Report 1992 reveals that the cost of reducing greenhouse gases might be between 3 to 7 per cent of world GDP. This figure could be higher in developing countries. Given the difficulties in each of the policy options, countries, depending upon their resources, nature of their economies and levels of development, should develop their own strategy to reduce greenhouse gases. The scope for the improvement of environment is substantial. However, to have effective and accelerated transfer of energy efficient technology and to prevent deforestation, developing countries need considerable assistance from the industrialized countries. Only increasing international co-operation will be able to help smoothen this process.

36 Shankar Sharma

References Asian Development Bank (ADB). Asian Development Outlook 1991. Manila: ADB, 1991. _ _ . Energy Indicators of Major Developing Member Countries. Manila: ADB, 1989. Asian Energy News. "Motor Vehicle Pollution at Critical Level". Asian Institute of Technology, Bangkok, August 1991. Atlantic Council of the United States. "Global Climate Change: U.S.Japan Cooperative Leadership for Environmental Protection". Occasional Paper. Washington, D.C. : The Atlantic Council ofthe United States 1991. Ayres, Robert U. "No Regret Options for Greenhouse Gas Abetment". Paper presented at CICERO Workshop on A Comprehensive Approach to Climate Change Policy. University of Oslo, 1-3 July 1991. Ball, James. "The Competitive Gas Price Principle: Its Relevance for Gas Development in the Asia-Pacific Region". ASEAN Economic Bulletin 6, no. 2 (November 1989). British Petroleum. BP Statistical Review of World Energy. London, various years. Economic and Social Commission for Asia and the Pacific (ESCAP). Energy Policy Implications of the Climatic Effects of Fossil Fuel Use in the Asia-Pacific Region. Bangkok: ESCAP, 1991. Faiz, Asif et al. "Automotive Air Pollution: Issues and Options for Developing Countries". World Bank Working Paper Series No 492. Washington, D.C., August 1990. Fesharaki, F. and N. Yamaguchi. "A Decade of Change in the AsianPacific Region: The Energy Outlook and Emerging Supply/ Demand Imbalance". In Energy Market and Policies in ASEAN, edited by Shankar Sharma and Fereidun Fesharaki. Singapore: Institute of Southeast Asian Studies, 1991. Hansen, Stein. "Trends of Economic and Energy Policy Associated with Environmental Challenge". Paper presented at SUSPI MIGAS Training Program. Surabaya, August 1991.

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Imran, Mudassar and Philip Barnes. Energy Demand in the Developing Countries: Prospects for the Future. World Bank Staff Commodity Working Paper Number 23. Washington, D.C. : World Bank, 1990. International Petroleum Industry Environmental Conservation Association (IPIECA) and United Nations Environment Programme (UNEP) Industry and Environment Office. Climate Change and Energy Efficiency in Industry. London: IPIECA, 1991. Klass, D.L. "Fossil Fuel Usage and the Environment". Paper presented at the Conference on Asian Natural Gas II: For a Brighter 1990s, 9-11 April1990, Singapore. Lovins, Amory B. andAshok Gadgil. "The Negawatt Revolution: Electric Efficiency and Asian Development". Rocky Mountain Institute Newsletter, USA 1991. Ministry of the Environment, Singapore. Annual Report 1989. Singapore 1990. National Institute of Science and Technology Policy (NISTEP). Analysis of the Structure of Energy Consumption and the Dynamics of Emissions of Atmospheric Species Related to the Global Environmental Change (Sox' NOx' & CO~ in Asia. NISTEP Report No. 21, Science and Technology Agency, Japan, 1991. O'Connor, David and David Turnham. "Managing the Environment in Developing Countries". OECD Development Centre Policy BriefNo. 2. Paris: OECD, 1992. Office of Technology Assesment (OTA). Energy in Developing Countries. Washington, D.C.: U.S. Congress, Office of Technology Assessment, 1991. Leitmann, Josef. "Energy-Environment Linkages in the Urban Sector". Discussion Paper, UNDP/World Bank, 1991. Levine, Mark D. et al. Energy Efficiency, Developing Nations, and Eastern Europe: A Report to the U.S. Working Group on Global Energy Efficiency. Washington, D.C.: International Institute for Energy Conservation, 1991. Pearce, David. "The Role of Carbon Taxes in Adjusting to Global Warming''. The Economic Journal (July 1991).

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Sharma, Shankar. "Development of the Oil-Refining Industry in the Asia-Pacific Region". In Global Oil Trends: The Asia-Pacific Market in the 1990s, edited by Shankar Sharma and Joseph L.H. Tan. Singapore: Institute of Southeast Asian Studies, 1991. Sharma, Shankar and Fereidun Fesharaki eds. Energy Market and Policies in ASEAN. Singapore: Institute of Southeast Asian Studies, 1991. Sharma, Shankar and Joseph L.H. Tan, eds. Global Oil Trends: The Asia-Pacific Market in the 1990s. Singapore: Institute of Southeast Asian Studies, 1991. Schelling, Thomas C. "Some Economics of Global Warming''. American Economic Review (March 1992). Stockholm Environment Institute. "Report of Working Group 1, Advisory Group on Greenhouse Gases". Stockholm: 1990. Tabti, Mohamed-Tahar and Garry Brennand. "Energy Indicators". OPEC Review XII, no. 3 (1988). Tomitate, Takao. "Energy and Global Warming Issues: A Japanese View". In Energy Policy Implications of the Climatic Effects of Fossil Fuel Use in the Asia-Pacific Region. Bangkok: ESCAP, 1991. United Nations. Energy Statistics Yearbook. New York, various years. United Nations Environmental Programme Environmental Data Report (UNEP). Prepared for UNEP by the GEMS Monitoring and Assesment Research Centre, London, UK in co-operation with World Resources Institute, Washington D.C. and UK Department of the Environment, London. London: Blackwell, 1991. UNEPA/USAID. "Ranking Environmental Health Risks in Bangkok, Thailand". USAID Office of Housing and Urban Programs, December 1990. World Development Report 1992. Washington D.C.: The World Bank, 1992. World Resources Institute (WRI). World Resources 1990-91. New York: Oxford University Press, 1990.

Energy Technologies and Policies for Limiting Greenhouse Gas Emissions in Asia Urooj Malik

Asia's economic performance during the last three decades was remarkable. Overall gross domestic product (GDP) growth rates increased from about 5 per cent in the 1960s to 6.5 per cent in the 1970s and to 7.3 per cent in the 1980s. Both external and internal factors have contributed to the high rates of growth. The external factors included buoyant export markets and transfer of capital and technology to the Asian countries from the industrialized countries. As all Asian countries faced the same external environment, differences in growth rates within countries can be explained by internal factors such as varying resource endowments, stage of economic development, access to technology, and most importantly, the growth strategies and economic policies pursued by these countries. During 1990, however, the Asian countries were adversely affected by generally slower growth in the global economy and higher energy prices following the onset of the Gulf crisis. To cope with these difficulties the Asian countries have continued to respond quickly

An earlier version of this paper was presented at the International Sym-

posium on Environmentally Sound Energy Technologies and Their Transfer to Developing Countries and European Economies in Transition, 21-25 October 1991, Milan, Italy.

40

Urooj Malik

through prudent macroeconomic and sectoral policies. Consequently, despite the slow-down in the world economy in 1990 and the adverse impact of the Gulf crisis, the pace of economic growth remained unabated in developing Asia, which continued to be the fastest growing region in the world. The average economic growth rate of 5.8 per cent registered in 1990 was about the same as that recorded in 1989 and much higher than the average growth of 2.4 per cent achieved by the developing world as a whole in 1990 (Table 3.1) (ADB 1991). Rapid economic progress and development in Asia, however, has not been achieved without cost to the natural environment. The type of activity and the pattern of economic development pursued by different groups within Asia, whether they be small tribes or larger countries, were influenced by their resource endowments. These activities, in turn, affected the resource base and the environment. It has now been established that societies can no longer operate on the assumption that economics and ecology are two separate disciplines; there is a need to incorporate insights from both disciplines during the process of development. Energy is critical to the process of economic development. Energy investments imply changes in the physical, social and economic environment. These changes affect not only the immediate environment of the investment site but may extend geographically far beyond national boundaries. There are indeed risks and uncertainties associated with these investments. Proper evaluation and measurement of the associated costs and benefits of these investments must be conducted at different stages of the energy cycle of specific fuels to achieve adequate understanding of how risks can be managed. Basic understanding and appreciation of the impact of energy production and use on the environment, choices of technologies that minimize pollution and design of appropriate energy-environment policies are essential elements of sustainability. In this context, a comprehensive approach premised on an integrated energy-environment policy planning framework is the key to sustainable development (ADB/ECED 1991).

41

Limiting Greenhouse Gas Emi ssions

TABLE 3.1 Selected Indicators of the World Economy (Annual changes in percentages, unless otherwise specified)

GNP World Industrialized Countries United States Japan Germany Developing Countries Africa Asia• Latin America Middle East Eastern Europe and USSR World Trade Volume Non-oil primary commodity prices Oil prices Manufactured export prices OECD Inflation Six-month LIBOR (%)

1989

1990

1991

1992

3.1 3.3 2.5 4.9 3.9 3.6 2.6 5.7 1.0 3.7 1.5

1.7 2.5 0.9 5.6 4.6 2.4 3.1 5.8 -1.2 -2.6 -5.6

1.0 1.4 0.5 3.1 2.8 3.4 2.9 5.7 1.4 -1.0 -5.3

2.7 2.8 2.3 4.0 2.6 4.7 2.5 6.0 3.8 4.0 -0.7

7.3 -0.3 21.4 -0.3 4.4 9.3

5.7 -8.1 28.3 6.3 4.8 8.4

5.3 -0.4 -9.3 4.0 4.4 7.8

6.0 3.0 2.0 1.1 4.2 8.2

• GOP figures. Sources : International Monetary Fund, World Economic Outlook (Washington, D.C.: IMF, October 1990); Organization for Economic Co-operation and Development, OECD Economic Outlook (Paris: OECD, December 1990); United Nations and University of Pennsylvania, "Project LINK World Outlook" (New York: Fall 1990 and Spring 1991 ); Asian Development Bank staff estimates; and Asian Development Outlook (1991).

42 Urooj Malik

Salient Features of Asia's Energy Sector Resources and Reserves The proven recoverable reserves of the Asian Development Bank's developing member countries (DMCs) amounted to about 30 billion barrels of oil and 5 trillion cubic metres of natural gas. Proven coal reserves in place are estimated at about 930 billion tons. At current rates of production, the reserves of oil, gas and coal are expected to last for 15 years, 45 years and some 800 years, respectively. Table 3.2 shows the hydrocarbon reserve status of selected DMCs of the Bank. The region is far better endowed with coal and lignite reserves compared to oil and natural gas. It is estimated that about 63 per cent of the world's proven recoverable reserves of coal and 24 per cent of the world's proven recoverable reserves of lignite are located in the region. The region, as a whole, however, is relatively poor in its endowment of fossil fuels. The large reserves of coal and lignite that do exist are concentrated in the three largest DMCs, namely, the People's Republic of China (PRC), India and Indonesia. The lack of indigenous sources of fossil fuels means that the region is heavily dependent on the Middle East for oil and, therefore, is vulnerable to disruptions in supply. The use of coal and lignite raises environmental concerns. Local and regional acid deposition may cause damage to forests, crops and property, and globally, the carbon dioxide (C0 2) generated from coal burning would add to the greenhouse gases that threaten the global climate.

Consumption and Energy Mix For the region as a whole, energy consumption is estimated to have increased by about 75 per cent over the 1977-87 period. The regional energy mix is coal-dominant. Coal accounted for approximately 60 per cent of commercial energy consumption in 1987, mainly attributed to its consumption in the PRC and India. Share of coal in their total energy consumption was 76 per cent and 54 per cent, respectively. However, in the rest of the region, excluding the PRC and India, oil dominated with its share at 52 per cent, while coal was only at 13 per cent. Table 3.3 shows primary energy consumption in selected DMCs of the Bank. Energy consumption per capita and per unit of gross

TABLE 3.2 Regional Energy Reserves and Resources

Natural gas Coal Oil and condensates (million tons) (billion cubic metres) (million barrels) Proved Proved Proved Proved Proved Proved reserves reserves reserves reserves reserves reserves in place recoverable in place recoverable in place recoverable NICs Hong Kong 1,612 Korea, Rep. of 18-26 220 9 Taiwan Southeast Asia 3,012 1,400-3,012 3,453 4,852 Indonesia 1,464 311 2,922 Malaysia 369 0.3 149 57 Philippines 57-210 43-101 Thailand South Asia 192 1,054 326 18 Bangladesh 541 65,320 4,240 India 253 2,100 382 624 Myanmar Nepal 150 462 139 489 Pakistan Sri Lanka South Pacific Developing Member Countries (SPDMCs) Fiji China, People's Rep. of

18,400

850 859,390

Hydropower (megawatts) Gross theoretical capacity

751 182-200

3,000 5,300

1,200 28 370 487-900

75,064

Exploitable capacity

10,900 27,481

Geothermal (megawatts) Gross Theoretical Exploitable capacity capacity

1,000 29,000 6, 131

10,000 6,025

1,431

300 89,600 100,000 27,000 83,000 85 20,000-40,000 10,000-20,000 2,000

46,630

676,000

379,000

1. For oil and condensates, a conversion factor of 7.3 barrels per metric ton is used for Bangladesh, People's Republic of China, Indonesia, and

Thailand. For Paki stan, a conversion factor of 7.45 barrels per ton is used. 2. Oil and natural gas data of India, Malaysia and Pakistan are reported as net recoverable/remaining recovera ble. Source: "Energy Indicators of Developing Member Countries of ADB", Draft Edition (1 99 1).

TABLE 3.3 Primary Commercial Energy Consumption (Thousand standard tons of oil equivalent)

NICs Hong Kong Korea, Rep. of Taiwan Sub-total Southeast Asia Indonesia Malaysia Philippines Thailand Vietnam Sub-total South Asia Bangladesh India Myanmar Nepal Pakistan Sri Lanka Sub-total SPDMCs Fiji China, People's Rep. of Total Total (excludes India and People's Republic of China)

1977

1979

1981

1983

1985

1987

1988

1989

1990

30,967 20,40 1 55,3 18

4,572 40,462 26,377 71 ,411

5,1 75 43,645 26, 485 75 ,305

6,259 47, 173 30,326 83,758

6,827 54,725 33,488 95,040

8,302 66,908 38,369 11 3,579

8,690 72,25 1 40,270 121,2 11

9,816 77,316 44,820 131,952

10,044 81,800 47,070 138,914

20,46 1 7,124 11 ,253 10,949

25,880 8,784 12,420 12,519

30,301 9,959 12,093 12,666

34,013 11 ,058 12,332 14,204

53,546

63,489

68,972

76,185

38, 154 12,570 10,997 16,282 6,550 84,553

43, 128 15,5 10 12,305 19,646 7,274 97,863

44,739 16,279 13,166 22,017 6,868 103,069

43,800 18,019 14,090 25,965 5,966 107,840

44,500 19,680 15,106 29,459 6,502 115,248

2,477 92,353

2,782 101,266

3,3 50 11 6, 770

139 10,437 1,286 107,992

194 12,335 1,478 119,455

191 14,876 1,737 138,574

3, 562 129,583 1,779 22 5 17,909 1,888 154,946

4,331 143,5 16 2, 106 298 20,047 1,808 172,107

5,244 161,012 2, 164 393 22,90 1 1,931 193,645

5,540 170,960 1,802 433 24, 774 2,000 205,509

5,940 199,000 1,973 430 27,590 1,941 236,874

6,368 230,000 2,303 445 29,91 7 2,092 271 ,125

245 366,478 583,572

265 410,116 664,736

278 425,125 699,258

25 1 462,280 77 7,420

274 539,1 40 89 1,11 4

124,741

153,354

157,363

185,557

208,458

Note: Total figures are adjusted for unavailable data. Source: "Energy Indicators of Developing Member Countries of ADB", Draft Edition (1991).

243 255 65 1,575 623,30 1 1,028,644 1,081,607 244,331

259,072

293 289 695,050 675,090 1,152,045 1,220,630 277,955

295,580

Limiting Greenhouse Gas Emissions

45

national product (GNP) are important environmental parameters as they determine a country's comparative contribution to greenhouse gases. In terms of C02 emissions, the critical distinction in the energy mix is between the fossil fuels and other energy sources such as hydroelectric, nuclear and geothermal power. It is estimated that almost 80 per cent of electricity in the region is generated by burning fossil fuels. Nuclear energy is unimportant except in the Republic of Korea, and geothermal energy is important only in the Philippines. Hydropower is the only major alternative source of energy for the production of electricity in the region and solar energy for electricity production has played a very small role in electricity generation, with the exception of India, where solar thermal technology is being introduced through the construction of an 80 megawatt modular facility.

Status and Projections of Greenhouse Gas Emissions Greenhouse Gas Emissions by Region and Source The largest source of greenhouse gases is fossil fuels. In the scenario presented by the Intergovernmental Panel on Climate Change (IPCC), annual global primary energy supply increases from about 306 exajoules (EJ) in 1985 to 473 EJ (lower growth scenario), and up to 737 EJ (higher growth scenario) by the year 2025. Historically, global energy requirements were met primarily by fossil fuels. In the IPCC scenario, where no action to respond to climate change is assumed, fossil fuels continue to be the dominant energy source, supplying over 80 per cent of the total energy requirement through 2025. C02 emissions from energy use are estimated to produce an estimated amount ranging between 30,000-45,000 million metric tons in the year 2025, equivalent to about 60 per cent of total greenhouse gas emission from all sources in 2025. On a region-wide basis, as a result of major increases in fossil energy consumption, C02 emissions from energy activities in non-OECD countries are expected to increase from 9,800 million metric tons C02 in 1985 to 17,900-29,300 million metric tons C02 by 2025. This increases the percentage of global C02 emissions attributable to energy activities in non-OECD countries from over 50 per cent in 1985 to 60-70 per cent by 2025, depending

46 Urooj Malik

TABLE 3.4 Baseline Cases of Emissions from Major Greenhouse-Gas-Producing Activities (Million metric tons on C0 2 -equivalent basis) C02 from deforestation

C02 from energy

1985

2025

1985

2025

CFC 3

1985

2025

1,350 1,275 510 710

1,675 2,340 935 1,735

90

650

40

275

United States OECD Europe/Canada OECD Pacific Eastern Europe/USSR Poland

5, 100 2,900 1,100 5,100 436

6,200-7,700 4,000-5, 100 I ,500-2,200 8,400-10,300 935

Centrally Planned Asia China

1,900 1,844

3,700-7,300 6,303

Middle East

400

1,800-2,600

Africa Zaire

700

700-2,900

620

660-1,210

200

1,400

Latin America Brazil Mexico Rest of Central America

700 473 249

1,500-3,300

1,260

1,950-3,040

140

990

1,100 359 81

1,800-5,900 2,273 517

550

630-1,690

270

1,890

19,100

29,700-45,500

2,670

3,500-6,600

4,580

11 ,890

South and East Asia India Indonesia Pakistan Philippines Thailand World

220

250-660

730

Source: U.S/Japan Expert Group Report (1990); USAID, "Task AReports" (19901.

Limiting Greenhouse Gas Emissions 47

TABLE 3.4 (continued) CH, from rice

CH, from animals

Np from fertilizer

Total

1985

2025

1985

2025

1985

2025

17 15 38 34

21 15 27 38

206 311 97 277

267 397 168 344

128 136 11 142

156 268 16 266

6,801 8,319-9,819 4,637 7,020-8,120 1,756 2,646-3,346 6,263 10,783-12,683

674 561

687 571

145 134

279 254

139 129

230 211

3,168

13

17

21

59

11

27

55

116

107

277

25

124 86 2 34

147 78 4 63

200 57 23 59

441 92 63 176

1,331 653 153 25

2,056 1,084 302 34

212 111 10 61

2,297

3,124

1,576

1985

2025

Tons per capita

1985

2025

28 11 12 15

29-34 14-17 16-20 21-25

5, 796-9,806

3

3-6

485

2,178-2,978

4

8-11

95

1,707

3,248-5,998

3

2-4

33 8 13 12

93 14 46 28

2,477

5,121-8,011

6

7-11

384 189 23 13

99 53 12 75

427 144 155

3,562

7,187-12,347

2

3-5

2,617

723

1,580

30,946 52,411-71,311

6

6-9

48 Urooj Malik

on the lower or higher growth scenario. On a per capita basis, however, the industrialized countries continue to produce much higher levels of C02 emissions. In terms of overall greenhouse gas (GHG) emissions per capita as well, the industrialized countries have much higher emissions: 14-20 tons GHG per capita for the OECD countries; 21-25 tons GHG per capita for Eastern Europe and the USSR; and 3-5 tons GHG per capita for the developing countries of Asia (Table 3.4) (USAID 1990).

Greenhouse Gas Emissions in the DMCs The relative importance of the various sources of greenhouse gases generated by the DMCs differ from those of the industrialized countries. For example, while Japan's emissions are equally divided between C0 2 from fossil fuels and chloro-fluorocarbons (CFCs), for the DMCs, 34 per cent of C02 emissions come from land use changes and 26 per cent from methane. About 35 per cent come from the combustion of fossil fuels (Figure 3.1). In general, fossil fuels and CFCs are more important sources of greenhouse gases in the more industrialized DMCs, while land use changes and methane are more important contributors in the agriculture sector, which is often reflective of the lesser developed countries. While the region's contribution to the greenhouse effect may be limited, any global warming and resultant rise in the sea level would have significant impact on the region (ADB 1991). Figures 3.2 and 3.3 show greenhouse gas emissions, as of 1987, for Asia and the world, respectively.

Carbon Emissions Carbon dioxide emissions are estimated to account for approximately 50 per cent of the overall greenhouse effect (UNEP 1987) and therefore, particular attention is focused on the key activities to which they are linked. These activities include power generation, industrial production and transportation through the use of fossil fuels. The emissions are also linked to the problem of deforestation although there is no clear consensus on the overall significance of net deforestation to the global carbon balance (UNESCAP 1990). There is

Limiting Greenhouse Gas Emissions

49

considerable pressure to move towards some form of international agreement, possibly mirroring that already in place for CFC emissions, to address the key dimensions of the greenhouse gas problem, most notably the carbon emissions. The Law of Atmosphere (Siddiqi 1986) may be the most desirable course to take although this will not be easily achieved because of the difficulties inherent in developing a framework for determining emission allocations, especially between the industrialized countries and the developing countries (Tables 3.5 and 3.6).

FIGURE 3.1 Sources of Greenhouse Gas Emission in the DMCs, 1987

Fossil fuels 35%

Methane, wet rice 26%

Source: World Resources Institute (1990).

50

Urooj Malik

FIGURE 3.2 Greenhouse Gas Emission in Asia, 1987

South Asia 26%

Source : World Resources Institute (1990).

Southeast Asia 26%

FIGURE 3.3 World Greenhouse Gas Emission, 1987

Africa 6%

Source: World Resources Institute (1990).

Limiting Greenhouse Gas Emissions 51

TABLE 3.5 Greenhouse Gases Concentration (Parts per billion)

Carbon dioxide Methane Nitrous oxide Methyl chloroform Ozone CFC 11 CFC 12 Carbon tetrachloride Carbon monoxide

344,000 1,650 304 0.13 variable 0.23 0.4 0.125 variable

Annual rate of increase (%)

0.4

1.0

0.25

7.0

5.0 5.0

1.0

Source: United Nations Environment Programme (1987).

TABLE 3.6 Fossil Energy Carbon Emission, 1986 Country

China India Indonesia Pakistan Philippines Thailand Japan Federal Republic of Germany United Kingdom United States World Source: Barron and Hills (1990).

Tons carbon per person

Tons carbon per US$1 ,000 GNP

0.5 0.2 0.2 0.1 0.1 0.3

0.5 0.4 0.4 0.2 0.3

2.0 3.0 2.9 4.9 1.1

1.7

0.1 0.3 0.2 0.3

52

Urooj Malik

Fossil Fuel Carbon Emissions in Asia During the period 1977-87, global fossil fuel carbon emissions increased from approximately 4. 7 gigaton (GT) to about 5.4 GT, representing an annual average growth rate of 1.5 per cent . Energy-related emissions among OECD countries are estimated to have declined, while in the Eastern Europe these emissions are estimated to have increased by almost 2 per cent a year. Among other countries, combined, the annual growth rate in emissions is estimated at about 4.3 per cent (Fulkerson et al. 1989). Analysis of selected Asian countries indicates that growth rates within the region are approaching about 5 per cent a year, which is one of the highest in the world. An increasing number of projections and scenarios of energy use and carbon emissions are becoming available. The broad picture that emerges from these projections is that the "Business As Usual" (BAU) scenario could result in a two-fold to three-fold increase in fossil carbon emissions by the year 2010, compared to the late 1980s. Moderately effective control scenarios have been projected to result in, at worst, a 20-30 per cent increase in emissions by 2010. A recent study of the UNESCAP focusing on C0 2 emissions from energy use in the Asia-Pacific region concluded that the developing countries of the region will add to gross atmospheric C0 2 emissions about 2.5 GT per year of carbon equivalent by the year 2010 or roughly trebling current rates under the BAU scenario. Further, with the assumed maximum feasible intervention, including energy efficiency and fuel substitution, this could only be reduced to no less than 1.8 GT per year (Table 3. 7). It has become increasingly apparent that nations should be seriously concerned about the implications of the build-up of greenhouse gases and, as a prudent measure, should move towards slowing the growth rates in emissions while research on the phenomenon of climate change continues. Consequently, a number of initiatives to implement energy technologies and policies for enhancing energy efficiency and conservation and for undertaking fuel substitution in the developing countries of the Asia-Pacific region are being taken. The following sections of this chapter identify the types of energy technologies which would be beneficial to the developing countries, the issues and constraints to implementing efficiency and conservation and renewable energy programmes, and the policy instruments needed to achieve sustainable energy development.

Limiting Greenhouse Gas Emissions 53

TABLE 3.7 Summary of Total Carbon Emissions (Million tonnes of carbon) Country/ Area

Group A China Demo. People's Rep . of Korea India Indonesia Iran (Islamic Rep . of) Republic of Korea Taiwan Group B Bangladesh Hong Kong Malaysia Pakistan Philippines Singapore Thailand Vietnam Group C Afghanistan All other Southeast Asian countries Maldives Nepal Pacific Islands Sri Lanka Total (A+B+C)

2000

Actual

Sl

S2

Sl

2010 S2

548.90

937.50

789.70

1,353.40

1,047.20

993.60

35.50 119.12 26.98 36.02 47.90 23.50

53.70 225.62 67.08 61.91 99.10 49.20

43.00 199.80 60.40 54.86 89.70 39.90

72.40 394.75 127.30 86.83 126.90 63.20

50.70 298.89 99.23 67.10 106.50 48.30

44.00 277.17 95.52 65 .72 93.40 44.80

3.30 7.50 8.85 13.10 6.96 10.04 12.16 4.48

5.80 11.00 15.82 31.00 14.42 14.55 41.75 8.88

5.00 9.60 14.19 26.50 12.77 13.49 36.84 8.43

8.10 16.40 29.27 48.90 24.16 19.04 93.74 14.49

6.30 13.40 22.73 37.70 18.05 16.02 71.94 13.04

6.10 9.90 21.32 35.20 17.38 15.67 65.75 13.04

0.70

1.60

1.40

2.70

2.10

2.00

3.06 0.00 0.20 2.10 0.90

6.31 0.10 0.40 3.50 2.80

6.00 0.10 0.40 3.00 2.40

10.23 0.10 0.60 4.90 4.30

9.20 0.10 0.50 3.80 3.30

9.20 0.10 0.40 3.40 2.50

911.27

1,652.04

1,417.48

2,501. 71

1,936.10

1,816.17

1986

S3

Notes: Sl is base case scenario {all countries); S2 is energy efficiency scenario {all countries); S3 is low cabon scenario {all countries) Sources: UNESCAP, Draft Report {1990); Asian Development Bank {1989); International Energy Agency {1989); World Resources Institute {1988-90).

54 Urooj Malik

Technological Dimensions Technology Plan in the Development Strategy The development strategy of a country is determined by its socioeconomic development goals and its endowment of capital and natural resources. The strategy has a major influence on the choice of the technology plan. The feasibility of the technology choice is dependent on the availability of human, financial and natural resources. As a result, two divergent development strategies may be pursued by a developing country: 1. Countries such as the Republic of Korea, which have limited land

area and inadequate natural resources, have followed export-led industrialization. The strategy for industrial technology development was to introduce the most advanced technologies that are necessary for industrialization. Such a strategy has required the development and/or acquisition of capital-intensive technologies. 2. In countries like the PRC and India where the land area is vast, the binding constraint in these countries is the lack of large investment required to acquire advanced, appropriate technologies that can facilitate industrial growth. Important in these countries is the mobilization of capital for domestic industry, and manpower development to effectively implement the acquired foreign technology for developing natural resources. Generally, labour-intensive technologies have been used in these countries.

Technology and Energy Development Before investigating the types of technologies needed, it is necessary to review some of the prevailing issues and constraints in the energy sectors of Asian developing countries, which should be analysed from the point of view of developing appropriate policy responses to limiting greenhouse gas emissions.

Reasons for High Energy-Intensity In some Asian countries, such as the PRC and to a lesser extent India, one of the important factors responsible for their fast growth is

Limiting Greenhouse Gas Emissions 55

the relatively high energy intensity of their industrial and transport sectors, as well as the rapidly growing energy intensity of the agricultural sector. Two main factors accounting for the high energy intensity in the industrial sector are the following: 1. Some of the Asian countries have pursued a policy of greater selfreliance to reduce dependence on imports. Consequently, large investments were made in the 1960s and 1970s in basic energy intensive industries, such as steel, cement, aluminium, fertilizers , and heavy chemicals. 2. The technologies and equipment used in their industries were developed at a time when energy was relatively inexpensive, and which by today's standards are outdated and energy inefficient. Increasing energy intensity in the transport sectors of certain Asian countries is partly due to the growing demand for energy in this sector while increased mechanization has contributed to the rapid growth in demand for electricity and petroleum products in the agricultural sector.

Barriers to Energy Efficiency The potential for improved energy efficiency will increase as the relative price of energy rises and as technology becomes more energy efficient, making additional energy conservation investments more attractive. This was evidenced by the oil price rises of the 1970s which generated large potential for improved efficiency and triggered rapid technological improvements although such energy efficient measures were hindered, to some extent, by capital budgeting constraints in the Asian developing countries. However, a number of technical, economic, financial and institutional barriers dissociate public and private costs, creating barriers to efficient allocation of energy resources. In addition, inappropriate policy interventions can weaken functioning markets and exacerbate the situation. These, among others, include the following: 1. Technical barriers as a result of the lack of the skills and equipment necessary to determine the returns on energy conservation investments. Even if the returns are known, the design skills

56 Urooj Malik

required to carry out the retrofitting of inefficient plants may not be available . Energy service companies, more common in the industrialized countries, are just emerging in some of the DMCs. 2. Prices which do not reflect economic scarcity, both for energy and alternative factors of production, and environmental externalities which are not reflected in market prices are economic barriers to efficient energy use. In some Asian countries, the "cost-plus" pricing system has resulted in lack of incentive to the enterprises (particularly the larger state-owned enterprises) to invest in energy-saving devices. 3. Financial barriers due to the investment bias that may exist in favour of larger energy producers as against small-scale producers, high risk associated with retrofitting investments, high interest rates or lack of access to capital especially foreign exchange (faced by energy consumers relative to energy producers), and the lack of visibility of energy conservation investments which tend to comprise a number of relatively small pieces of equipment. 4. Institutional weaknesses due to the lack of a co-ordinated energy conservation effort on the part of government. This requires the establishment of a central agency to co-ordinate energy conservation efforts which otherwise tend to be fragmented among various ministries. Constraints to Renewable Energy Development Constraints to the development of renewable sources of energy can be broken down into three broad categories, namely, technological, economic and institutional barriers.

Technological The relative newness of renewable energy sources raises questions about their technical viability. There also appear to be a lack of clarity on how renewable energy sources can be integrated technically into existing energy-economic systems. Economic The uncertainties surrounding the capital and operating costs of renewable energy sources relate to the broader question of the overall economics of the technologies. Sceptics argue that renewable energy

Limiting Greenhouse Ga s Emi ssion s 57

projects are expensive, particularly those producing electricity. The economics of renewable energy sources often discourage the granting of research and development (R&D) resources to this sector and the current low level of R&D in the Asian developing countries translates into renewable energy sources not being cheap enough to compete with other energy sources.

Institutional Action by the government is a critical factor for allocating funds through budget allocations. Further, unless there is sufficient momentum behind the promotion of renewables, it is unlikely to gain much attention.

Implementing Technologies to Limit Greenhouse Gas Emissions Energy technologies for limiting greenhouse gas emissions include those that improve energy efficiency, reduce energy requirement, use less carbon-intensive fuels, or that capture the gases before or following release of the same into the atmosphere (lEA 1991). The major determinants of greenhouse gas emissions from energy sources are the level of energy demand and the energy mix. Fossil fuels presently supply about 70 per cent of global primary energy. As a result of the dominance of fossil fuels as a source of greenhouse gas emission, energy efficient technologies that may reduce these emissions require special attention.

Phased Implementation Plan As discussed elsewhere in this chapter, there exist several barriers to energy efficient investments that will need to be overcome in a timebound manner. Global climate change by nature is a long-term phenomenon that may require development of new energy sources and other major technology breakthroughs. The pursuit of a phased plan to implement energy efficient technologies will enable broadening of the range of technologies which can combat global climate change, and will also help in the application of these technologies in a more cost-effective manner.

58 Urooj Malik

Based on the approach suggested by the International Energy Agency (lEA), it is useful to group the energy technologies according to their current status: (1) first-wave technologies which are clearly economic but not yet fully marketed, which would be mainly implemented in the near-term time frame (up to 2005); (2) second-wave technologies which are available but not yet clearly economic, which would be mainly implemented in the medium-term time frame (2005-30) but could be introduced sooner if closer to being economically viable or particularly beneficial to the environment; and (3) third-wave technologies which are not yet available, but which may emerge in the long-term (post-2030) as a result of R&D efforts. The first-wave technologies would focus on marketing efforts to expand the scope of technology application. These technologies would generally be worth applying irrespective of direct environmental benefits. In second-wave technologies, the primary need is for further development efforts, leading to lower costs and increased reliability. Such technologies could be best applied where costs can be substantially reduced. Finally, for the third-wave technologies, the main need is for basic and applied research which can ultimately demonstrate its technical and economic feasibility.

Factors Affecting Technology Choice and its Implementation The evaluation of appropriate technology choice in the context of the proposed phased implementation plan requires determining the technology's potential contribution to limiting greenhouse gases. This potential can be defined in three ways: 1. Technical potential of an energy technology is its capacity to bring about a reduction in greenhouse gases, or to reduce the potential contribution of such emissions to global climate change. 2. Economic potential of a technology can be determined by its effectiveness in reducing greenhouse gas emissions as well as by its capital and operating costs compared with those of competing technologies. 3. Market potential of a technology can be determined by direct and indirect actions taken to influence the technology rate of uptake in the market-place.

Limiting Greenhouse Gas Emi ssion s 59

An overall evaluation of these types of potential is critical to the selection of an appropriate technology and its effective implementation. Some examples of technology options to reduce the accumulation of greenhouse gases, in particular C02 emissions, in the proposed time frame and for a typical market are presented in Table 3.8.

Measures for the Application of Energy Technologies Specific courses of action which can be applied in the proposed phased implementation plan include: (1) Efficient improvements in energy supply, conversion and end-use; (2) fuel substitution by energy source which are lower in greenhouse gas emissions; and (3) reduction of greenhouse gas emissions by removal, recirculation and fixation. Items (1) and (2) which appear to be more feasible for near-term implementation in the Asian developing countries are discussed in detail below.

Energy Efficiency Improvements Improvements in energy efficiency may result from technological development as well as prudent energy management. Actual reduction in greenhouse gas emissions will, however, depend upon the extent of the efficiency gains and the type of energy being saved. For any given fuel, it will also depend to some degree on the nature of the energy conversion process and operating practices, especially in the case of nitrous oxide (NO) and carbon monoxide (CO) whose production is dependent on the choice of technology. A summary list of areas of opportunity for improving efficiency in various sectors of the economy is presented below:

Transport Sector • Improved fuel efficiency of vehicles. • Promotion of public transport. Residential I Commercial S ector • Improved energy utilizing equipment and systems. • Improved heat efficiency in buildings.

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TABLE 3.8 Technology Options to Reduce the Accumulation of Energy-related Greenhouse Gases Improved efficiency End use and conversion

Fuel substitution by lower carbon and carbon-free energy sources Nuclear power

Time frame up to 2005 Accelerated Improved application of operational demonstrated performance, energy end-use fuel cycle, and technologies safety

Time frame 2005-30 Second-wave Advanced and technologies : modular nuclear reactors for the • power electronics production of • new materials power, heat or • artificial both intelligence • local area Hydrogen networks production (water pyrolysis • energy cascading by solar and/ or • super heat nuclear sources) pumps • new industrial processes

Reduction of carbon dioxide volumes

Hydropower, geothermal, wind and solar

Natural gas and biomass

Stack removal and disposal

Absorption in biomass

Implement costeffective hydro, geothermal and wind projects

Shift to natural Research and gas with development increased use of clean-coal technologies

Stop deforestation

Use of biogas

Reforestation and afforestation

Expanded use of hydro, geothermal and wind power

C0 2-efficient C0 2 scrubbing Selection of energy systems species, genetic (and cycles) screening and engineering, life-cycle control

Advanced solar Use of natural heating and gas and cooling systems biomass

Photovoltaic energy conversion

Understanding of C0 2 cycle

Oxygenated fuels from biomass

C0 2 separation (cryogenic storage, disposal)

Geological and marine disposal C0 2 removal with H2 production

Limiting Greenhouse Gas Emissions 61

TABLE 3.8 (continued) Improved efficiency

Fuel substitution by lower carbon and carbon-free energy sources Hydropower, geothermal, wind and solar

End use and conversion

Nuclear power

Time frame beyond Third-wave technologies • high-temperature superconductors • chemical energy storage • advanced fuel cells

2030 Nuclear (fission) Large-scale breeders integration of wind and solar energy systems dioxide) Nuclear fusion reactors and High-efficiency power systems solar energy conversion Hydrogen as an intermediate energy vector

Reduction of carbon dioxide volumes

Natural gas and biomass

Stack removal and disposal

Absorption in biomass

Advanced fuel use (end products other than carbon disposal

Integrated fluegas, scrubbing (C0 2, Np and others) and

Chemical control of greenhouse gas interactions in the atmosphere

Hydrogen as an intermediate energy vector

Artificial photosynthesis

Unconventional natural gas resources

Note: Time frame refers to significant penetration (up to 20-30 per cent) of the technology in its typical market by the end of the period. Source : International Energy Agency (1991).

62 Urooj Malik

• Improved lighting. • Co-generation and district heating.

Improved Recycling of Resources • Recycling and re-use of carbonaceous materials (paper, plastics, lubricants). • Recycling of metals (aluminium, iron, steel, rare metals). • Recycling of glass. • Landfill and coal seam gas extraction and utilization. Industrial Sector • Improved efficiency in production processes. • Recycling of waste heating production processes. Electricity Generation Sector • Increased efficiency of fossil fuelled power plants. • Development and introduction of fuel cells. • Co-generation of electricity and heat. Transmission and Storage of Energy • Development and introduction of heat storage equipment. • Research and development of hydrogen storage for vehicles. • Development and introduction of large-scale electricity storage facilities. • Improved electric transmission efficiency. • Reducing losses in natural action and transmission. Fuel Substitution

Carbon Energy Sources Reduction of C02 emissions can be achieved by substituting lower carbon fuels such as oil or natural gas for coal, since oil and natural gas produce an estimated 80 per cent and 60 per cent of C02 , respectively, compared with coal on a unit energy production basis. It should be noted, however, that emission coefficients for other greenhouse gases are influenced by combustion conditions and technology rather than carbon fraction of the fuel. Technology areas relevant to the

Limiting Greenhouse Gas Emissions

63

increased use oflower carbon energy sources include the following: Natural Gas • Increased use of natural gas fuels in transport. • Substitution of natural gas for coal in electric generating plant. • Substitution of natural gas for heating oil in buildings and industry. Biomass Energy • Facilitate use of biomass fuels in transport. • Lower cost production of biomass fuels from agricultural products.

Non-Carbon and Renewable Energy Sources Non-carbon and non-fossil fuel energy sources include nuclear energy and a variety of renewable energy technologies. The latter include: hydroelectric power, geothermal, wind power, solar power (solar thermal and solar photovoltaic), hydrogen and wave and tidal power. All of these technologies provide power or heat with negligible net C02 emissions. C02 Removal The amount of C02 contained in the exhaust gases of combustion plants is vastly greater than other pollutants. Effective C02 removal will require extremely wide-scale application of technology and large capital expenditure. Fixation of C02 in terrestrial or aquatic vegetation (through natural photosynthesis) could increase the storage of carbon in the cycle, thereby gradually diminishing atmospheric concentration and restoring climatic equilibrium. The technological options described above, which may be applied in the end-use sectors of transport, residential and commercial buildings, and industry, as well as in the power sector, are summarized in Table 3.9. It is noted that the most promising technological applications include those for energy efficiency, natural gas utilization, nuclear power, advanced battery and hydrogen storage, and renewable energy options (lEA 1991).

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TABLE 3.9 Technology Strategies and Actions in Major Energy Sectors to Cope with Possible Global Climate Change Electricity sector

Transport sector

Industrial sector

Residential sector

1. Increase efficiency of primary generation (about 35% at present on average, 55% in perspective with new combined cycles)

1. Improve end-use efficiency of engines and vehicles (about 20 miles per gallon average today, 40 mpg may be economic with today's technology, 100 mpg technically achievable)

1. Improve end-use efficiency of industrial processes (highly integrated systems)

1. Improve end-use efficiency of re sidential applications (highly integrated systems)

2. Use conservation and load management technologies to increase efficiency of electricity distribution and consumption

2. Promote intermodal shifts in the transport system to save energy and decrease greenhouse gas production

2. Search for biocompatible industrial processes

2. Super heat pumps

3. Shift to natural gas

3. Adopt hydrogen-rich fuels (natural gas and oxygenates)

3. Adopt hydrogen-rich

3. Adopt hydrogen-rich fuels (natural gas and oxygenates)

4. Remove C0 2 from power plant stacks

4. Adopt "clean" electric powered vehicles

4. C0 2 removal from selected processes

4. Use more "clean" district heating

5. Expand application of renewable energy for power generation

5. Use hydrogen as fuel

5. Expand application of renewable energy sources

5. Expand application of

6. Adopt "clean"

6. Adopt "clean"

fuel for power plants

6. Use advanced batteries to store intermittent renewable energy

fuels (natural gas and oxygenates)

electricity and hydrogen as intermediate energy

renewable energy sources electricity and hydrogen as intermediate energy source

Limiting Greenhouse Gas Emissions 65

TABLE 3.9 (continued) Electricity sector

Transport sector

7. Expand use of standardized nuclear power plants with passive safety features 8. Fusion energy systems Source: International Energy Agency (1991).

Industrial sector 7. Use nuclear reactors for cogeneration and process heat

Residential sector

66 Urooj Malik

Strategic Technology Options and Policy Instruments for Developing Countries Energy Technology Options Demand-Side Measures In many developing countries there are distinct modern and traditional sectors. Commercially marketed fossil fuels and electricity provide the energy input for a similar mix of energy services: air conditioning, water heating, lighting, and appliances for cooking, refrigeration, etc. A major source in the traditional sector is fossil fuel, used primarily for cooking and heating while kerosene is widely used for lighting. The task of development projects in these poorer sectors is to increase the level of energy services available for residential and commercial applications. The important issue from a climate perspective is to increase energy services without increasing greenhouse gas emissions (USAID 1990). Emission-reducing strategies can be promoted in the modern sectors of the developing countries as per capita energy production and use in these countries continue to rise, thereby implying higher greenhouse gas emissions. Strategies suitable for the traditional sectors could be integrated into ongoing development programmes, provided they are acceptable to the local population. Technical options for reducing greenhouse gas emissions must not only be efficient, they must also be designed to increase energy services to the poorer sectors. The developing countries are expanding energy- and materialintensive industries to raise per capita income levels. As mentioned elsewhere, industries in these countries use energy less efficiently. In several cases, this is also due to the prevailing energy pricing system, lack of access to hard currency and to modern technologies, and lack of management skills for identifying and implementing efficiency options. Technically proven, cost-effective energy conservation techniques and processes can save developing countries an estimated 10-30 per cent of industrial sector energy and 10-25 per cent of power sector energy consumption. For example, in Pakistan, some US$9. 7 million worth of energy savings were identified through a series of energy audits, of which US$2 million was captured by 1990.

Limiting Greenhouse Gas Emi ssions 67

Supply-Side Options Reduction in greenhouse gas emissions in the electricity sector is possible through improvements in generation efficiency, and by fuel substitution. It is estimated that improved fossil fuel electricity generation technology, such as advanced combustion turbines, combined cycle systems and co-generation can increase fuel efficiency by 25 per cent or more. The supply-side technology options are discussed below.

Clean Coal Technologies Some of the technologies can improve fuel efficiency by an estimated 10-25 per cent relative to conventional coal combustion technologies, thereby reducing the associated C0 2 emissions. Three of these technologies currently in the advanced development phase are Atmospheric Fluidized Bed Combustion (AFBC), Pressurized Fluidized Bed Combustion (PFBC), and Integrated Gasification Combined Cycles (IGCC). AFBC power plants are similar in efficiency to conventional technology, and therefore minimally beneficial to reducing C0 2 emissions. PFBC and IGCC systems are projected to increase conversion efficiency by up to 10-20 per cent, with corresponding reductions in C02 emissions per unit of electricity produced. Co-generation Co-generation is the production of both steam and electricity from the same source, with the steam used to meet on-site heating and process requirements and the electricity used on-site or sold to electricity customers. Co-generation has been very popular with large industrial energy users as one approach for reducing their overall energy costs. Most of the approximately 18 GW of currently operating co-generation projects in the United States and an additional 29 GW under active development fall into this category. Advanced Gas-Fired Combustion Technologies An option for increasing natural gas use is the construction of new gas-fired combined cycle or combustion turbine power plants. These power plants cost significantly less to build than coal power plants and are typically more energy efficient. They could also be part of a near-term solution since the lead times for plant siting and construction average about two to four years versus six to ten years for coal-fired power plants.

68 Urooj Malik

Renewable or Nuclear Technology Options Global climate change is a long-term problem. Reducing and ultimately stabilizing the anthropogenic emission of C0 2 and other greenhouse gases at acceptable levels may eventually require the very large-scale use [at the equivalent rate of perhaps 10-30 Terra Watt (TW) (th)] of advanced renewable and nuclear energy technologies for production of electricity and fuels. Both renewable energy and nuclear energy systems appear to be more expensive currently than fossil fuel alternatives for most applications. However, using present energy and technology prices as a basis for assessing long-term technological and policy alternatives is misleading since neither the present environmental costs of fossil fuel pollution nor the future costs of climate change are reflected in present prices of goods and services. The relative economics of alternative energy options will shift as the environmental costs and benefits of these options are internalized in their prices (USAID 1990).

Energy Policy Instruments Economic, Financial and Market-based Incentives Ensuring energy efficiency and conservation requires fundamental changes in the current policy framework. Energy users need to have clear economic and financial incentives to use energy efficiently. This requires governments to phase out the cost-plus pricing system existing in some Asian countries, and to allow competitive markets to set prices. Various forms of tradable energy (fuel and electric power) need to be priced in line with market principles, and non-tradable energy sources should reflect the long-run marginal cost (LRMC) pricing principles, plus a depletion premium to reflect the exhaustible nature of resources. Policy change will also require that producers face internal or external competition, thus eliminating the opportunity of absorbing increases in the cost of energy through monopolistic profits. Introducing greater competition in energy markets, particularly between supply and demand-side services, could help limit greenhouse gas emissions. For example, competitive bidding for new capacity in a utility system is a relatively new approach that allows all interested parties to offer various means (for example

Limiting Greenhouse Gas Emissions 69

both energy-efficiency and supply options) to meet projected demand. In these transactions, the evaluation of new supply options can take into account concerns with greenhouse gas emissions. The application of economic instruments to electric utilities can affect overall energy consumption, and consequently greenhouse gas emissions, in end use sectors. In the United States, for example, the federal law imposes a 10 per cent surcharge on all generation in the Pacific Northwest. This encourages utility planners to pursue energy efficiency measures whose marginal costs are not greater than 110 per cent of power generation costs. Such surcharges can alter the calculation of marginal benefits for investing in efficiency measures within a utility generating system as against an additional new generating capacity. Special tax incentives aimed at accelerating efficiency improvements, fuel substitution and emission abatement in industry can shorten the economic payback periods critical to capital investment decisions. Tax incentives or subsidies that facilitate market penetration of effective and clean technologies can help advance the infrastructure of suppliers available to provide these technologies. Credit through loans and grants could be made available by the governments to stimulate discrete energy conservation investments. Tax systems that involve credits, special depreciation rates and lower rates for specific energy efficiency improvements (such as that introduced in Japan) could also be introduced in developing countries as financial incentives for industries and electric utilities. However, it would be important to keep in context the economic and budgetary implications of such policy measures. Government policy should also be directed towards requiring periodic energy audits in selected energy-intensive industries and the development of energy conservation programmes with possible assistance from the donor agencies. Designing fuel substitution policies to achieve overall environmental objectives requires careful investigation of the major effects on the longer-term security of energy supply, as well as consideration of resource-economic factors, such as the need to diversify the energy base due to depletion of reserves. The development of government policies which minimize additional costs (or maximize environmental benefits) also needs assessment of the effects of alternative fuel substitution possibilities on the various stages of production, transport, conversion and final end-use of the different energy sources. Two opportunities for fuel substitution in some Asian countries need to be

70 Urooj Malik

further examined, namely increased utilization of natural gas, and substitution in electricity generation and use. Many of the Asian Developing Bank's DMCs and in particular the largest three DMCs, the PRC, India and Indonesia, also have considerable amounts of natural gas reserves. Although natural gas consumption has increased steadily over time in these countries, there remains ample scope for accelerating its production and use. A coherent policy agenda will be required to undertake investments in natural gas infrastructure. These, among others, would include the following: 1. Supporting public information campaigns which explain the benefits of using gas by consumers. 2. ModifYing the pricing system to allow greater financial incentives to electric power utilities to convert to natural gas or to a dualfired capability. · 3. Providing a proper mandate to a natural gas agency authorized to develop and promote the use of natural gas. 4. Mandating the use of natural gas in specific subsectors of the economy, such as new homes in urban areas and/or in new power plants (particularly for those to be located in regions where the emission levels are already high. 5. Allowing for greater private sector participation in gas exploration and development and providing them with attractive terms and conditions for undertaking joint venture arrangements with public sector companies. 6. Measures for reducing gas flaring (where this is being done) through design of appropriate projects and programmes.

Regulatory and Institutional Measures Regulations, through reference to technology, have strong influence on the choice of technologies and ultimately their availability. This is due to the impact that regulations have on stimulating innovation and the dissemination of new technologies. Standards and regulations can be set by Asian governments. The purpose of these standards is to prescribe to industry an objective benchmark to measure acceptable performance or to undertake environmental quality control, and the use of energy efficiency standards and emission

Limiting Greenh ouse Gas Emi ssions 71

standards are powerful policy instruments. However, it is noted that the introduction and upgrading of standards pose financial and economic difficulties, even though there may be cost-effective technologies available. Governments could develop an institutional set-up which can provide unbiased comparisons of available products and technologies through product testing and providing information to users about energy consumption and pollutant emissions of equipment and technologies. The policy of establishing information programmes to clarify the nature of technology and its costs and benefits can be an effective way of achieving the environmental goals. Training programmes organized by governments and with private sector participation can assist in increasing the effectiveness and commercial orientation of operations. Such programmes can include aspects relating to energy demand management or facilitate the design and construction of power utilities, buildings, etc. in an energy-efficient manner. Greater involvement of national consulting teams can also help in augmenting the expertise available within the Asian developing countries.

Technology Transfer and Adaptation Incentives Add-on technologies, both existing and those under development, can play an important role in controlling air pollution. Even though some energy consumers may use other means to reduce emissions, such as fuel substitution to meet specific standards, there is a market for addon technologies in the industrial, transport and electricity generation sectors. For vehicles, the retrofit market is often the only means of meeting emission reduction requirements without structural and lifestyle changes. Processes for capturing C02 from gases (and liquids) are currently available in the industrialized countries, although more R&D efforts are required to diminish the overall costs of such technology applications. While additional expenditures in the industrialized countries for R&D work may be forthcoming more easily, particularly if there already exists a strong involvement of the private sector, developing countries lack the resources needed for both research on indigenous technology development capability and purchase of such advanced technologies from industrialized countries. A conscious effort to control pollution would necessarily require governments to give

72 Urooj Malik

increasing priority not only to technology assessment and management, but also include in their annual development plans the acquisition of such technologies through assistance from donor agencies. Transfer of expensive technology could also be facilitated through the recently established global environment facility (GEF) which enables availability of loans on softer terms. Such GEF projects, which are geared towards minimizing damage to the global environment, deserve merit as a policy consideration by governments to facilitate technology transfer and adaptation.

Conclusions The impact offast growing population and rapid economic growth will result in sharp increases in energy consumption in Asia. Using only 20 per cent of the primary energy consumed in the world but accounting for some 40 per cent of the world's population, per capita energy use in the region is small, thus leaving potential for large per capita increases in the future. Recent projections show that electricity demand in Asia will grow at a rate of about 7.5 per cent per annum during the 1990s, assuming no major efforts are made in the area of energy conservation. This growth in demand for electricity translates into the investment needs to the tune of about US$450 billion to the year 2000 or US$45 billion per annum (World Bank 1990). The growth in energy demand together with the importance of coal as the major energy source available in the region foreshadows severe environmental consequences, at the regional and global levels, unless corrective measures are taken. The interlocking system of energy and the environment waran integrated approach to assessing the impact of energy taking rants the environment and economic development. The interon activities development and energy-related activities and global between actions to greenhouse gas emissions are highly complex. due climate change is essential from a policy decision-making viewit purpose, this For a framework that can help in structuring an formulate to point the quantitative assessment of greenhouse gas for model integrated underlying assumption of an integrated critical The emissions. for policy analysis is that the overall framework t energy-environmen in the Asian developing countries development goal of socio-economic

FIGURE 3.4 Proposed Integrated Energy-Environment Policy Planning Framework for Limiting Greenhouse Gas Emissions

,

FT~

1

Sources: EAJ, Global Warming Response Project; modified version by the author (1991).

74 UrooJ Malik

continues at environmentally sustainable levels. The framework should provide guidance on choosing between various policy scenarios within the energy sector and across other sectors and subsectors of the economy. In terms of the global climatic effects due to greenhouse gas emissions, the framework should be structured to account for Asian energy demand as one component of world energy demand and the global energy-economic system (Figure 3.4). Energy technologies and policies can play an effective role in limiting greenhouse gas emissions. Each technology will produce a profile of such gases. The profile will depend on the technical performance of the technology used and the performance of that technology and nature of primary energy supply. To carry out a robust analysis of comparison among technologies, it is necessary to consider each technology in the context of its entire fuel cycle. Energy policy measures which focus on end-use efficiency and fuel substitution are powerful policy tools for addressing the problem of global climate change, and are also beneficial in the context of overall efficient energy-economic development. Initiative for providing the associated institutional set-up within the energy sector to undertake projects and programmes for energy conservation and related R&D work on technologies can assist in providing a stimulus to sustainable energy development. Access to capital through soft loans by donor agencies and the establishment of global and regional environment trust funds can make available such needed resources for acquisition of technologies from industrialized countries. In this context, a collaborative international effort on the part of all agencies concerned cannot be overemphasized.

References Asian Development Bank (ADB) . Asian Development Outlook. Manila: ADB, 1991. _ _ . Energy Indicators of Developing Member Countries of ADB, 1989 and Draft Edition, 1991. Manila: ADB, various years. _ _ ."Environmental Considerations in Energy Development (ECED)". Manila: ADB, May 1991. Desai, VV and U. Malik. Energy, Environment and Economic Development: Role of the Bank". Paper prepared for the Coal and the

Limiting Greenhou se Gas Emissions 75

Environment Conference: Asia 2010, organized by the EastWest Center and the U.S. Department of Energy, Honolulu, Hawaii, 10-12 July 1991. Energy Policy. Special Issue on Climate Change: Policy Implications (March 1991). _ _ .Special Issue on Energy Efficiency in Electricity (April1991). _ _ . Various editions. Institute of Energy Economics. Energy in Japan. Various Editions. Kohli, K.N. and Ifzal Ali. Science and Technology for Development: Role of the Bank. Economic Staff Paper No. 32. Manila: ADB, 1986. Malik, U. "PRC Indepth Country Study for Environmental Considerations in Energy Development, Phase II". Manila: ADB, 1991. _ _ . "Energy-Environment Interface : Strategic Initiatives, Proposed Policy Options and Responses". Paper presented at the Symposium organized by UNESCAP in co-operation with the Government of Japan, Tokyo, 12-14 December 1990. Organization for Economic Co-operation and Development (OECD) and International Energy Agency (lEA). Greenhouse Gas Emissions: The Energy Dimension. Paris: OECD, 1991. _ _ . and _ _ . Energy and the Environment: Policy Overview. Paris: OECD, 1989. Siddiqi, T.A. and S. Shihua, eds. New Coal Technologies: Implications for Energy Development Policies in Asia and the Pacific. Honolulu: East-West Center, 1986. Streets, D.G. and T.A. Siddiqi, eds. Global Warming: Options for the Pacific and Asia. Proceedings of a Workshop Sponsored by Argonne National Laboratory and Environment and Policy Institute, East-West Center, June 21-27, 1989. Honolulu: EastWest Center, University of Hawaii, 1989. Tsuneyuki, M. "Outline of Asia-Pacific Integrated Model (AIM) to Evaluate Policy Options". Global Warming Response Project, Environment Agency of Japan, 1991. UNESCAP. "Energy Policy Implications of the Climatic Effects of Increased Fossil Fuel Burning in the Asia-Pacific". Draft Report, Bangkok, 1990.

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U.S. Agency for International Development (USAID). Greenhouse Gas Emissions and the Developing Countries: Strategic Options and the USAID Response. Washington, D.C.: USAID, 1990. World Bank. Capital Expenditures for Electric Power in the Developing Countries in the 1990s . Energy Series Paper No. 21. Washington, D.C.: The World Bank, 1990. World Resources Institute (WRI). World Resources, 1990-1991 . New York: WRI, 1990.

Global Climate Change Policy Some Economic Considerations Arnold B. Baker

World policy-makers are currently struggling with the issue of global climate change and its relationship to man's activities. While there is no scientific debate on the greenhouse effect itself, climate change is quite another matter. The greenhouse effect describes atmospheric greenhouse gases (water vapour, carbon dioxide, methane, oxides of nitrogen, and manmade chloro-fluorocarbons or CFCs) which trap heat radiating from the earth's surface. Carbon dioxide is currently thought to account for about half of the effective warming potential of these gases, excluding water vapour (a major, though uncontrollable natural greenhouse gas). Without the layer of greenhouse gases, this heat would radiate out into space. Average world temperatures would be some 30 degrees Celsius cooler, and life as we know it would not exist. The climate change issue, however, concerns the anticipated rate of build-up of greenhouse gases over the very long term- 50 to 100 years or more - and how that will affect future climates. Appropriate policy action to deal with climate change is highly complex and requires answers to some fundamental questions, including: How rapidly will greenhouse gas emissions likely build up in the atmosphere? How would a significant atmospheric build-up of such gases alter current regional temperature, precipitation, and sea level patterns? How will regional societies and economies be affected? And,

78 Arnold B. Baker

what are the most cost-effective policies for coping with this potential climate change? Volumes have been, and will, continue to be written about these key questions, but unfortunately we do not have hard answers today. We do know how rapidly greenhouse gases will build up in the atmosphere over the next 50 to 100 years or more. We can only rely on scenarios, which are not forecasts or scientific facts, but rather are consistent, integrated stories about the rate of emissions build-up, containing assumptions about very long term political, economic, energy, sociological, and technological trends. Nor do we know with any real certainty how such a build-up will affect specific regional climate patterns. Fifty to one hundred or more years in the future is a very long time. And while many of today's scientists expect a global warming of 1.5 to 4.5 degrees Celsius to occur when atmospheric concentration of carbon dioxide doubles (the next 50 years or so, in many current scenarios), scientists in the 1970s, just 20 years ago, were forecasting a long-term global cooling. These scientific issues are critical to current public policy debate. If there were certainty or near certainty on the rate of atmospheric build-up of greenhouse gas emissions and how that would affect regional climates and sea levels, at least theoretically it would be possible to measure the economic cost of climate change and its impact on individual regions. This knowledge, in turn, would help individual countries estimate how much they might be willing to pay out of current income to avoid future long-term climate change if it would adversely affect them. Such payments could be made both for policies that directly reduce greenhouse gas emissions and for policies that help countries adapt to new climates. Other countries that could benefit from new climates actually might be willing to pay to bring the new climates about. Despite the current lack of such information, public concern over the possibility of global warming and its potential irreversibility is so high that world policy-makers completed international negotiations on a climate change framework convention. This treaty was negotiated through the United Nations International Negotiating Committee (INC), and signed in June 1992 at the United Nations Conference on Environment and Development, held in Rio De Janeiro. The treaty is expected to be ratified and come into force by 1994.

Global Climate Change Policy 79

This treaty provides a framework for long term international co-operation to deal with the climate change issue. While some countries sought to limit world carbon dioxide and other greenhouse gas emissions to 1990 levels by the year 2000, the treaty does not impose such requirements. None the less, a number of countries continue to support this policy approach. Thus the outcome of this treaty profoundly could affect all of the peoples of the world, depending on the specific commitments ultimately made to reduce greenhouse gas emissions. Reducing greenhouse gas emissions is not without cost. In general, the larger the required reductions, the higher the cost to achieve them, and the greater the negative effect on world economies. And even if treaty implementation should be delayed and individual countries impose major greenhouse gas emission reductions within their own borders, their decisions, through economic linkages, could drastically affect the economic well-being of their trading partners. These issues, which will be discussed in the following pages, have particular importance for the developing Asia-Pacific region. As shown in Table 4.1, developing countries in this region have almost 50 per cent of the world's population, but only about 10 per cent of its gross domestic product (GDP). Yet, most of the major developing countries in this region have averaged 6 per cent or better real GDP growth per year over the last 20 years, and the future of the region looks bright, especially for the four tigers (Hong Kong, Singapore, South Korea, and Taiwan), China, Indonesia, Malaysia, and Thailand. But like it or not, that future is highly dependent on the economies and markets ofNorthAmerica and Europe, and on maintaining open international trade and cost competitiveness, particularly on manufactured goods. Yet, policies under discussion to deal with climate change radically could affect that relationship. The purpose of this chapter is not to debate the science of climate change nor to predict which climate change policies will be adopted. Rather, it is to focus on economic issues that carefully should be considered before committing to specific climate change policies, and to highlight the importance for the Asia-Pacific region. These issues will be discussed in terms of the policy problem, economic issues, processes and mechanisms, as well as some general policy considerations.

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Arnold B. Baker

TABLE 4.1 Estimated World Population and GOP, 1988 (Percentage shares) Region/Group

Population

GDP

North America Other OECD

5.6 10.2

25.5 40.1

Centrally Planned Europe* Centrally Planned Asia

8.6 26.5

12.5 4.2

South and East Asia Other Developing Countries

22.7 26.4

6.1 11.6

100.0

100.0

Total *Indicates "Formerly". Source: ARCO Corporate Planning.

The Policy Problem Climate change is a very long-tenn issue. It may take 50 to 100 years or more to seriously manifest itself, and it could still be an issue 200 or 300 years beyond that. Climate may change significantly 'because of mankind or in spite of mankind's best and most costly efforts to prevent it. The degree and consequences of climate change are presently uncertain, but could be highly significant and perhaps irreversible. As noted, carbon dioxide currently is thought to make up about half of the effective wanning potential of anthropogenic atmospheric greenhouse gases. Methane, man-made CFCs, carbon monoxide, and oxides of nitrogen make up the remainder. Currently, some 215 billion tons of carbon move in and out of the atmosphere each year as carbon dioxide through the natural carbon cycle. Sources of this carbon include decay and respiration, desorption from the oceans, cement manufacturing, fossil fuel combustion, and

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deforestation. Processes that remove this carbon from the atmosphere include plant growth or photosynthesis, and absorption by the oceans. Carbon dioxide from fossil fuel use (coal, oil, and natural gas) contributes about 5 billion tons of the estimated 215 billion ton annual flux. Deforestation contributes about 1 billion tons by removing trees that would otherwise absorb carbon dioxide and carbon. Decay, respiration and ocean desorption account for 120 billion tons and 90 billion tons, respectively. While this 215 billion tons of carbon move in and out of the atmosphere each year, increasing amounts of carbon are remaining in the atmosphere. Over the last 100 years, the concentration of atmospheric carbon dioxide has increased 25 per cent, and over the last 30 years, it has increased 10 per cent. The 10 per cent increase in atmospheric carbon dioxide over the last 30 years is equivalent to about 2.5 billion tons of carbon per year. The concern of some scientists and policy-makers is that the natural carbon cycle may not be able to absorb increasing amounts of carbon dioxide from increasing fossil fuel use. While the natural carbon cycle has been around as long as the earth, fossil fuel use has become significant only since the industrial revolution. Thus, there is concern that increasing fossil energy use will produce increased carbon dioxide emissions, which in turn will build up in the atmosphere and change the global climate, increasing temperatures, changing precipitation patterns and raising sea levels. Yet, in this century, economic growth and development had been strongly linked to fossil fuel use. 'lbday, some 87 per cent of world primary energy consumption is fossil fuels. Coal accounts for 27 per cent, oil38 per cent, and natural gas 22 per cent. The balance of world primary energy consumption is made up by nuclear (6 per cent) and hydroelectric (7 per cent). And while the industrialized countries (OECD) account for half of world fossil fuel use, they also account for 65 per cent of world GDP. Asia is 90 per cent dependent on fossil fuels for primary energy (47 per cent coal, 36 per cent oil, and 7 per cent natural gas), with 4 per cent from nuclear and 6 per cent from hydroelectric. Asia also consumes 36 per cent of the world's coal, with China alone consuming 24 per cent. Yet the rate of technological change is uncertain. How rapidly will the world develop new energy sources that do not produce carbon

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dioxide or that absorb carbon dioxide in the process? How rapidly will the world develop and use technologies that significantly increase energy efficiency and thus reduce carbon dioxide emissions directly? What will the new energy technologies be in the twenty-first and twenty-second centuries? How and in what ways countries and their people will need to adapt to future climate change, and how much that adaptation will cost are also uncertain. There seems to be general agreement among most policy-makers that further research is needed to reduce these uncertainties. But if research were the only policy issue, the debate would be relatively short- except perhaps for agreeing on who should pay for how much research. The heart of the climate change policy issue today is about a very different issue. It is about fossil energy use and the world economy. Simply stated: Given the long term nature of this issue and current scientific, technological, and adaptation uncertainties, should the world limit the use of fossil fuels and greenhouse gas emissions? In economic terms, should the world raise the relative cost of using fossil fuels and other greenhouse gas emissions? And if so, how?

Economic Issues These are not simple questions to answer, and each country needs to answer them for itself. Countries are in different stages of economic development, with different income and different sets of societal problems. They have different economic and political structures , investment climates, and different roles for technology. They have different social and religious values, energy resources options and current and expected future greenhouse gas emissions. And they have different vulnerabilities to potential climate change. These differences need to be considered as each country approaches the climate change issue and approaches the question of raising the relative cost of fossil fuel use and other greenhouse gas emissions today in the hopes of avoiding climate change in the long term future. Answering this question, in turn, requires answering several related questions : Who should pay the higher cost? Who should get any revenues raised? How much should the cost be raised? And what are some of the international economic implications?

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Who Should Pay? Should the country or the person using fossil fuels and producing carbon dioxide emissions pay the higher costs (or the higher prices resulting from imposing higher costs)? This ties emissions directly to user cost. Or, because many countries using fossil fuels have relatively low incomes, such as China, should only the developed countries and their people pay, but based on individual developed country fossil fuel use? Or, if this truly is an issue for the world at large, should all the people of the developed world pay, regardless of individual country fossil fuel use? How should the four tigers- Hong Kong, South Korea, Singapore and Taiwan - be treated? They are growing industrial manufacturers and exporters, with rapidly rising incomes. If required payments are to be tied to carbon dioxide emissions, should they be based on gross emissions or net emissions (to reduce payments by monies spent on carbon dioxide sinks, such as tree planting)? Should they be based on per capita emissions, to avoid penalizing large populations, or based on per unit of GDP emissions, to avoid penalizing large emitters whose emissions are due to contributing large shares of world GDP? Should payments be based on actual emissions in a current base year, relative to future baseline emission targets - that is, emissions "from this day forward" relative to some "allowed" future trend, ignoring past policies that may have reduced emissions? Or, should payments include credit for policies already in place, relative to some historical base year? These questions are quite important. As Table 4.2 shows, based on total carbon dioxide emissions, the United States, the former USSR, China and Japan are the top four emitters, with India the sixth largest. Based on per capita emissions, the former East Germany, United States, Canada, and Czechoslovakia are the top four emitters, with India and China near the bottom of the list. And based on emissions per unit of GDP, China, South Mrica, Romania and Poland are the top four emitters, with India fifth. On this basis, South Korea has half the level of India and one-sixth the level of China, while the United States is below South Korea. But over the next 20 years and beyond, most scenarios suggest that the developed country share of carbon dioxide emission from fossil fuel burning will fall, while the share of the developing

TABLE 4.2 _ Carbon Dioxide Emissions, 1988 Country United States USSR* China Japan West Germany India United Kingdom Poland Canada Italy East Germany* France Mexico South Africa Australia Czechoslovakia Romania South Korea Brazil Spain

Total

4,804 3,982 2,236 989 670 601 559 459 438 360 327 320 307 284 241 234 221 205 202 188

Country East Germany* United States Canada Czechoslovakia Australia USSR* Poland West Germany United Kingdom Romania South Africa Japan Italy France South Korea Spain Mexico China Brazil India

Per capita 19.8 19.4 16.9 15.0 14.7 13.9 12.1 11.0 9.9 9.5 8.4 8.1 6.2 5.9 4.8 4.8 3.7 2.1 1.5 0.7

Country China South Africa Romania Poland India East Germany* Czechoslovakia Mexico USSR* South Korea Canada United States Australia United Kingdom Brazil West Germany Spain Italy Japan France

*Indicates a former country designation. Carbon dioxide emissions are expressed in metric tons. Source: National Academy of Science, Policy Implications of Greenhouse Warming (1991)_

Per US$1,000 GNP 6.01 3.60 2.77 2.66 2.52 2.05 1.90 1.74 1.50 1.19 1.00 0.98 0.98 0.80 0.63 0.56 0.55 0.43 0.35 0.34

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countries, particularly Asian countries, will rise considerably, and these rankings will change. Table 4.3 shows a reference scenario for carbon dioxide emissions from fossil fuel burning issued by the Intergovernmental Panel on Climate Change (IPCC) in 1990. It is based on ''business as usual" assumptions - that is, it assumes that current policies and trends continue. The chart indicates that between 1985 and 2025, North America's share of carbon dioxide emissions from fossil fuel burning falls from 26 to 19 per cent. For the OECD as a whole, the share falls from 49 per cent to 34 per cent. Over the same period, the share of the formerly centrally planned Europe falls slightly, from 26 to 22 per cent. However, the share of other developing countries is projected to grow from 10 to 17 per cent,

TABLE 4.3 IPCC Reference Scenario: Gross Carbon Dioxide Emissions from the Energy Sector

1985

2000

North America Other OECD

1.34 1.16

1.71 1.46

2.37 1.81

26 23

19 15

Centrally Planned Europe* Centrally Planned Asia

1.33 0.54

1.78 0.88

2.77 1.80

26 10

22 15

South and East Asia Other Developing Countries

0.27

0.56

1.55

5

12

0.52

0.90

2.12

10

17

Total

5.16

7.29

12.42

100

100

Region/Group

2025 1985 2025 (Billion tons carbon per year) (Percentage share)

*Indicates "formerly". Source: IPCC Reference Scenario, IPCC Working Group Ill Report, June 1990.

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while the share of Asian developing economies grows from 15 to 27 per cent. By 2025 the Asian developing economies would have approximately the same share as North America has today, and would have a 40 per cent larger share than North America would have in 2025. Thus, who should pay ahd the basis for such payments are very important considerations.

Who Should Get Any Revenues Raised? The other side of the payments question is: Who should receive any revenues raised from imposing higher carbon dioxide emission costs on fossil fuel use and other greenhouse gas emissions? Should the poorer developing countries receive the revenues raised? They need income and capital investment for basic human needs, for new technologies, for adapting to climate change, and for increased energy and fossil fuel conservation. Should these revenues go to the advanced developing countries, such as the four Asian tigers? They are expected to provide increasing shares of world manufacturing output, which most likely will require increasing energy and fossil fuel use. They could use the revenue for increased energy efficiency in the manufacturing sector, which would help reduce world carbon dioxide emissions. They could also use it to facilitate their economic development processes. As some of these countries are densely populated coastal nations, they may need this revenue for long-term adaptation to climate change, including potential sea level rises. Should the revenues go to developed countries, despite their large share of world income? Developed countries could use this revenue to increase energy and fossil fuel conservation programmes. They also could use it to stimulate development of new technologies to reduce world-wide greenhouse gas emissions and to advance the understanding of climate science. Improving climate science would help clarify the long term risks and opportunities of climate change and allow more cost-effective policies to be designed to deal with it. Perhaps more importantly, if such revenues were taken away from industrial countries, their economies would be reduced, and through world trade and financial linkages, this could negatively affect the economies of both advanced developing and less developed countries.

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Or, perhaps this revenue should be made available to all countries as a reward and incentive for future greenhouse gas emission reductions, relative to today's level or a baseline trend level. The greater the reduction relative to today or to the agreed trend, the greater the financial reward. If no single one of these possibilities is the "correct" answer, what combination of them or other possibilities would be "correct", and how should any revenue allocation be decided?

How Much to Raise the Cost? How much should the cost of carbon dioxide fossil fuel emissions and emissions of other greenhouse gases be raised? In a simple theoretical approach, the economic costs of raising emission costs to different levels could be compared with the costs of adapting to alternative future climates and to the benefits of reduced climate change. Also, the costs of future climate change, if no special policy actions were taken, could be compared to the economic costs of forcing reductions in fossil fuel use and in other greenhouse gas emissions. But this situation is much more complex. First, there is considerable uncertainty about the timing, intensity and regional effects of climate change, and how strongly it is or will be linked to fossil fuel use. Second, climate change is an ongoing process, which will continue over hundreds of years and may not be clearly evident for 50 years or more. How should the time value of benefits of trying to prevent climate change that far in the future, which will accrue to future generations, be compared to the costs, borne by today's generation? Third, what elements should be included in "costs" and ''benefits", and for whom should these costs and benefits be determined? One country's benefit may be another country's cost. Relatively little analytical work has been done on the economic consequences of climate change and the costs of adaptation. And reducing carbon dioxide emissions may be a mixed blessing. Results of considerable analytical and experimental work suggests that increasing carbon dioxide emissions, aside from potential climate change effects, would have positive effects on the world, by increasing food production.

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Some of these questions are so complex, it may be tempting to ignore them and to make policy anyway. Yet, energy use is such a fundamental part of the modern world economy and world-wide food production is so critical that without analytical answers to these questions, policies imposed to restrict energy use run the risk of doing much more harm than good. As a practical matter, our economic tools today are best suited for shorter term macroeconomic "forecasts" and for relative policy analysis, which examines how a new policy might impact an economy relative to a base case. Our economic tools are also best suited for examining the microeconomics of alternative investment decisions what type of plant should be built, where should it be located, how many years will it take to recover the initial capital investment, and what is the expected rate of return relative to a different investment opportunity requiring the same capital investment. Our economic tools are also helpful in building alternative scenarios ofthe next 10-20 years and using them to develop and test alternative strategies for operating in that future. Such scenarios are not forecasts, but are internally consistent descriptions of alternative futures, containing integrated information on political, economic, sociological, technological and other key elements. As that future comes closer, the strategies can be updated and refined, using the latest data, macroeconomic forecasts, and policy analysis. We do not have the ability to "forecast" economies 50 to 100 years or more in the future . To do so would require credible models of future political systems, long-term economic structural change, natural systems evolution, population and, most importantly, technological change. In the world of the 1890s, it would have been quite difficult to imagine the events and the technologies of the twentieth century. And with today's seemingly increasing technological acceleration, it is even more difficult to imagine what the next 100 years will hold in store, and how different the world's political structure, economy and energy use patterns may be in 2100. Despite the shortcomings of today's economic tools for very long term economic analysis, attempts have been made to study and measure the economic cost of reducing fossil fuel emissions. As might be expected, there is little unanimity here, although for reasons discussed below, I believe that more weight needs to be given to the near-term macroeconomic results.

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One group of such studies is "technology based". It concludes that fossil fuel use can be significantly reduced with little or no economic costs. These studies consider the best technology available today and tend to "assume" that it can and will be implemented for all applicable uses. Such studies also tend to further assume that little or no capital cost is required to make and use this technology, and, equally important, that no cost is required to change consumer behaviour. To take a simple example, there are cars manufactured today that can travel 50 miles per gallon (mpg) or more on gasoline. Yet, in the United States today, the average new car sold travels 28.2 mpg. If one simply assumes that all consumers will switch to 50 mpg cars and that no new capital investment will be required to make them, the "costs" of switching to these high mileage cars would be very low. Yet, there are reasons why U.S. citizens are purchasing new cars that average 28.2 mpg, rather than 50 mpg. Perhaps it is due to preferences for different automobile services such as interior room, road ride, accessories, safety, etc. Whatever the cause, some subsidy or penalty either on the vehicle or on the gasoline used may be required to cause people to purchase 50 mpg cars, instead of those averaging 28.2 mpg. This cost of changing consumer behaviour, which is generally ignored in such technology models, needs to be included: Other analyses have been done with more economic based models, such as long-term optimization models and macroeconomic models. Long-term optimization models tend to be somewhat simplified. They may assume perfect knowledge and economic efficiency, rates of future technological change, and autonomous increases in energy efficiency. They also tend to contain a very simplified economic structure, and are the economic model types generally used to explore energy economic trade-offs 50 to 100 years in the future . Macroeconomic models tend to be more detailed, and they are frequently used to evaluate near-term economic and energy policy options. As such, they have greater near-term credibility, particularly if evaluating the impact of tax policies for reducing carbon emissions, though they still may not adequately model important economic sectors, such as international trade and payments effects. In addition, these models are designed for 10 to 20 year analysis at most, and extending them for 50 to 100 years in the future is well beyond their credibility. For simplicity, the greater part of the analysis of carbon dioxide reduction performed to date with economic models has assumed that

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carbon dioxide emissions are achieved through a simple carbon tax on fossil fuels. AB a practical matter, carbon dioxide emissions can be reduced through a variety of means, including command and control mandates, tradable emission permits, and alternative tax forms. These approaches are discussed below in the section on mechanisms. Results from both economic model types, which, as noted, assume economic efficiency and a simple world tax on carbon, generally suggest that to reduce world carbon dioxide emissions perhaps 20 per cent over the next 20 years and then stabilize them, could result in at least an annual long term 2-4 per cent loss in real GDP, with annual losses for individual countries or regions considerably higher. To achieve such emission reductions and stabilization, if all countries paid their fair share, could require a doubling, or tripling or more, of real oil prices, with comparable, carbon adjusted real price increases for coal and natural gas. One study by the OECD, however, suggested that if the OECD alone wanted to cut world carbon dioxide emissions by 20 per cent by 2010 (perhaps because the developing world could not afford to contribute) and then stabilize them at that level, it would require a carbon tax of US$2,200 per ton in 2020 - the equivalent of increasing real oil prices by US$286 per barrel, real natural gas prices by US$36 per thousand cubic feet (MCF) and real coal prices by US$1,400 per ton. If this OECD analysis of OECD "action alone" is correct, the economic impact seems truly staggering. But even if the whole world agreed to reduce carbon emissions by 20 per cent from today's levels and then stabilize it, so that only a doubling or tripling of real oil and other fossil energy prices were required, the economic costs are still quite large. And there is no guarantee that long-term carbon dioxide emissions would remain stabilized and that climate would not change. Other recent analysis suggests that the cost of delaying forced reductions in carbon dioxide emissions to permit the science to become clearer and for improved non-fossil fuel technologies to be developed is relatively low, if indeed there is a cost in prudent delays at all. For example, for the United States, while delays of 10-20 years actually could cost 25-40 per cent less than not delaying, on a cumulative discounted basis, such delays could result in only a 4-9 per cent increase in cumulative carbon dioxide emissions.

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Some International Economic Implications As Table 4.1 indicates, the developed world today accounts for some two-thirds of world GDP. These countries are the engines of economic growth and technological development. If their economies were reduced to pay for reducing greenhouse gas emissions, demand for the exports of developing countries would fall as well. If only selected countries raised their fossil fuel prices in industrial goods, world terms of trade would change. Those countries that raised the cost of industrial fossil fuels and feedstocks would now be at a relative competitive disadvantage to those countries that did not. Moreover, countries that raised their own fossil energy costs would now find it cheaper to import energy intensive products such as cars, steel, machinery and equipment. But how could their own domestic industry compete with these cheaper imports? There would likely be growing political pressure for protectionist fees against those countries that did not raise their own fossil energy costs. Or, perhaps there would be incentives to cheat and to secretly lower industrial fossil fuel prices to pre-climate change policy levels in those countries that had previously agreed to raise them. And, there would be growing economic pressure to shift jobs and industries from high cost energy countries to low cost ones. There could also be some impact on fossil fuel markets themselves. If raising fossil energy costs (and prices to consumers) is successful in reducing fossil energy demand, excess world supplies of internationally traded oil, coal and natural gas could cause their prices to fall. Fossil energy consuming countries would have to continually increase their fossil energy costs (for example, through taxes that raised domestic energy prices) to offset those price reductions. And the economies of those countries that depended on energy exports would be seriously hurt which, in tum, would reduce their demand and ability to pay for imports from other countries.

Processes and Mechanisms There are two general types of international processes under discussion for raising the cost of carbon dioxide and other greenhouse gas emissions: targets and timetables, and national sovereignty. There

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are also four basic mechanisms under discussion: Deregulation/subsidy removal, mandates, taxes, and marketable permits. Each of these will be discussed in turn.

International Processes Targets and timetables establish fixed quantitative emission reduction targets by country or region relative to a base year and a fixed timetable for meeting those targets. For example, stabilizing emissions at 1990 levels by year 2000; reducing 1990 emission levels by 20 per cent by 2000; reducing 1990 emission levels by 40 per cent by 2010. This approach has generally been advocated by certain members of the European Community and certain environmental groups. Such targets and timetables have the advantage of setting a clear objective for reducing emissions, which can be applied across the board to all country participants. They also can create the political impression that "something is being done" about reducing greenhouse gas emissions. The major disadvantage of targets and timetables, at this stage of scientific and economic knowledge about climate change, is that they do not consider the economic and human costs of implementation. Most countries still do not know what their base year greenhouse gas emissions are, let alone the economic implications of specific forced future emissions reductions. Because of the vast differences among countries, individual country efforts to meet a specific internationally agreed target could impose widely different costs. For example, countries that have considerable nuclear or hydro power already planned to come on stream over the next 10 or 20 years might meet such targets with little or no extra effort. Other countries, because of more limited options, might be forced to rely on fossil fuels as a key input to their future economic growth and development. Having to cut their fossil fuel use a specific 20 or 40 per cent could force very high, non-competitive energy prices on their economy and cost them much of their economic growth. The other general approach is based on country sovereignty. Country sovereignty recognizes the considerable differences that exist among countries and the considerable uncertainty that currently exists in climate change science and economics. This approach

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requires that each country assess its own current emission level and determine what future emission reductions are consistent with national economic, environmental, energy and other objectives. Each country would then provide some sort of international emission commitment, consistent with its own circumstances. These commitments and initial emission levels would be reviewed by some international body, much like the International Energy Agency reviews of national energy policies, which originated following the oil price shocks of the early 1970s. The primary advantage of this approach is that it recognizes individual country political and economic circumstances, and does not force countries to commit to international policies that could radically conflict with domestic objectives. It also recognizes that each country has many important policy objective to meet for its people - economic, health, environment, education, etc. - and climate change may only be one of many such objectives, rather than the primary one. This approach also allows countries to contribute what they can afford. The major disadvantage is that there is no single quantitative target to point towards and from which to receive political benefit. While some also might argue that another disadvantage of this approach is that it would lead to less emission reduction than targets and timetables, that is not necessarily the case. With the country sovereignty approach, each country has the opportunity to analyse what it can afford and commit to that. Targets and timetables simply require that commitments be made before the analysis is done. Any country that commits to targets and timetables and then discovers unexpected and intolerable high cost in meeting that commitment will simply walk away from the commitment and run the risk that any international agreement may fall apart. Country sovereignty, while seeming to take longer to agree and implement, allows a firmer basis for a lasting international agreement. It also allows a better understanding of the costs of meeting alternative emission reduction levels, which in tum, can be compared with the costs of adapting to climate change.

Mechanisms Whichever international process is used, there are four general

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categories of mechanisms that can be used to raise costs and reduce greenhouse gas emissions. Whichever mechanism individual countries choose will depend on their view of economic cost-effectiveness (including monitoring and enforcement costs) and equity of the costs imposed among the various energy consumer groups. Deregulating domestic energy industries and removing energy industry subsidies is perhaps the most cost-effective mechanism. It stimulates energy efficiency, sends the correct price signals to energy consumers and producers, and prevents over-consumption of artificially cheap energy. Countries which have such controls and subsidies, whether in the industrial, commercial, residential or consumer sector, have already distorted energy consumption and investment. Removing this distortion may not be politically easy because of sunk investment patterns and consumer expectations about cheap energy. Thus, some transition may be needed to ease inequitable situations. Mandates are generally a high cost economic mechanism for reducing emissions. Mandates simply prohibit use, whether or not citizens wish to and can afford to pay higher prices. They can be popular in political circles because they force a visible reduction in use, while hiding from public view the related price increases required to achieve that reduction. They also may freeze specific demand patterns and technologies in place, restricting the ability of the market to adjust over time, and to introduce more efficient technologies and processes. However, these implicit price increases, just as direct ones, still must be paid and must work their way through the economy. Thus, mandates do not allow the market to work to achieve a desired level of emissions in the most cost-effective way. For example, countries could mandate that coal could not be burned, even though it may be the lowest cost and most available fuel. The economic effect in the market would be equivalent to imposing an "infinite" tax on coal use. Those employed in the coal industry would be instantly out of a job, while those in other energy industries would instantly reap a windfall. And if there were no ready energy substitutes, the economy would suffer greatly from an energy shortage. Also, if there were an unforeseen oil supply interruption in the future , the economy would be particularly vulnerable because it would not have the opportunity to use coal. Per unit taxes are frequently described as the most cost-effective

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mechanism for reducing emissions, after deregulation and subsidy removal. Per unit taxes explicitly provide direct price signals to consumers to consume less. With a phase-in period, manufacturers and consumers can plan ahead to develop and purchase equipment that emit less. Consumers and manufacturers still have the option of purchasing higher priced goods that emit more, if those goods better meet their requirements, and if they wish to pay the higher price for them. And taxes provide sources of government revenue to further help reduce emissions, to be refunded to consumers, or to pay for general government spending. For example, per unit taxes have been applied on a per gallon basis for some time to motor transportation fuels, to fund road building and maintenance as well as to encourage increased transportation fuel efficiency and reduced emissions. Such taxes could be increased further, if additional monies for these purposes were needed, and if appropriate, to reduce carbon dioxide emissions from the transportation sector. Among other taxes currently under discussion to reduce carbon dioxide emissions from fossil fuel burning are carbon taxes and BTU taxes. Because burning similar amounts of coal and oil produce 1.8 and 1.5 times as much carbon dioxide as burning the same amount of natural gas, carbon taxes would tax coal and oil 80 and 50 per cent higher per BTU (British Thermal Unit) respectively than natural gas. Such a tax would discourage coal and oil use relative to natural gas, as well as discourage natural gas use relative to nuclear, hydropower, solar, and other zero or low carbon dioxide emitting energy sources. A carbon tax is based on the premise that carbon dioxide emissions from fossil fuel burning are the problem. This premise ignores other important issues related to energy consumption, such as other pollutants from energy use, foreign energy dependency, desirability of nuclear power, traffic congestion, and so forth. For example, a carbon tax could force a country highly dependent on domestic coal to substitute lower taxed imported oil for domestic coal. As a result, the country would become more dependent on insecure energy sources, while reducing domestic employment in the coal industry. A carbon tax also could shift electricity generation toward less politically popular nuclear energy or other, less costeffective non-fos sil energy sources, and would not encourage increased energy efficiency in using non fossil fuels. Even if a carbon

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tax caused, for example, some substitution of natural gas or electric cars (with nuclear electricity generation) for petroleum based cars, there would not be much direct incentive to drive private cars less. And as with any new major tax mechanism, the microeconomic and macroeconomic consequences of the tax and uses of revenues would need careful evaluation. A British Thermal Unit (BTU) tax would put the same tax on all energy consumed on an equivalent heat content basis. Its focus would be to increase efficient energy consumption, regardless of the source. Countries and consumers would have the incentive to reduce all energy use. This tax would not artificially change energy use patterns, and the least cost energy sources would be used. Through increased energy conservation, less fossil fuel would be burned and carbon dioxide emissions would be reduced. Since a BTU tax would apply to all energy consumption, it could be very complex and costly to collect and administer. Another question to be considered is whether such a tax should be levied at the point of energy end use, to discourage consumption, or at the point of energy production, for ease of collection (though it could also discourage energy production). Again, the appropriate size of such a tax and how the revenues would be spent would need careful consideration. Another approach under discussion for reducing carbon dioxide emissions from fossil fuel use is marketable permits. This approach combines some of characteristics of mandates and taxes, while adding some new features of its own. A carbon dioxide target would be mandated. Then permits would be issued to carbon dioxide emitters each year. Over time, the quantity of permits issued would shrink towards the mandated target. These permits could be bought or sold at free market prices through organized exchanges, similar to stock or commodity exchanges. Those needing excess permits, for example, to build a new manufacturing plant, could buy them; those having excess permits, for example, from buying a more efficient car, could sell them. Permits could also be granted for establishing carbon dioxide sinks, such as planting trees. Through this market process, resources would be allocated efficiently to meet the overall carbon dioxide mandate. This approach focuses solely on the carbon dioxide aspect of energy use, as does the carbon tax. However, one difference in this approach compared to carbon or BTU taxes is that income would be

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transferred between energy consumers and producers, .not between energy consumers and the government. Still, it is possible that governments could secure a portion of the monies through a permit fee or tax as well. Another difference from the tax approach is that the market price of the permit is unknown and remains unknown until after the market trades take place. Thus, consumers and industry would be burdened with unknown fossil energy costs each year, as would be governments, in trying to plan or forecast economic growth. Over time, however, it is possible that futures markets might develop to handle that uncertainty, as they have already done in other commodities. Another difference from the tax approach is that marketable permits would encourage the development of carbon sinks, since permits (credits) would be offered for establishing sinks, such as tree planting. But perhaps the greatest difference in the marketable permits approach from the taxation approach is the costly degree of monitoring and enforcement required. Someone would have to keep track of all permits for each emitter - each consumer, each car, each industrial plant, each store, each planted tree to absorb carbon dioxide, etc. Someone would also have to police all emitters to ensure that they are not emitting carbon dioxide without a permit. Emissions without a permit would have to be made a crime, with appropriate penalties, which, in turn, would have to be enforced through the court system. Since consumers would have incentives to falsify permits and sell them, mechanisms to prevent counterfeiting would have to be put in place. These enforcement mechanisms would entail an unknown cost, presumably high, because of the detailed level of enforcement required. And if this approach were extended across national boundaries, as some proponents suggest, the monitoring and enforcement costs would increase substantially.

Some General Policy Considerations Noted economist Thomas Robert Malthus, writing at the beginning of the 1800s, observed that population grew geometrically, while food supply grew arithmetically. He had hard data and was technically

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correct in his day. Yet, based on this data, he and other economists were convinced that the world was doomed to starvation and a subsistence level of existence, because population would outgrow food supply. As we know, Malthus was wrong because he did not adequately consider technological change in food production and population control. The world would have been much worse off if policy-makers in his time had fashioned and implemented political economic policies based on the long-run extrapolation of his short-run conclusions. For example, what if policy-makers had drastically reduced medical research or opposed improving squalid living conditions, fearing that such research or improvement in living conditions would prolong life, increase the birth rate and then doom even more people to starvation? Formulating climate change policy today has many of the parallels and pitfalls of Malthus's "dismal science". To avoid making the same mistakes he did, we need to have a much better understanding of climate science. We need increased policy research and development of long-term economic models, and long-term population growth, societal, technology models that allow these features to be integrated with each other and with the evolving climate and natural balance. We also need additional research and economic analysis of mitigation and adaptation options, including how implementation of certain options in individual countries will affect the economic wellbeing of other countries, through international trade and financial mechanisms. Each country is facing its own complex economic, energy, environmental, security and social issues. National policy objectives for these and other important issues need to be integrated, in an appropriate and balanced way, along with climate change and other external considerations. Until the present uncertainties surrounding both the science and the economics are reduced, it would seem prudent to design and implement policies that are cost-effective and make sense in their own right, regardless of whether or not climate change from fossil fuel emissions is later found to be a serious problem. In effect, such policies would cause policy-makers "no regrets" over having imposed them. These policies could include the types of research noted above, as well as policies to improve energy efficiency.

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Policies to improve energy efficiency should be evaluated within each country for cost-effectiveness in achieving desired policy objectives. Just as with policies to reduce carbon emissions, policy-makers will need to consider how much it is worth to a country to reduce its energy use by a given amount and what are the most cost-effective ways to get there. Such considerations will need to be consistent with a country's political, economic, environmental and social framework, as well as its needs and aspirations. To achieve market efficiencies, energy policies should send energy consumers and producers "correct" market signals. Such policies could include: price decontrol and subsidy removal; electric utility regulatory reform; improving building and appliance efficiency standards and information; and providing public information and assistance on how to save energy through energy audits and industry "how to" materials and seminars. In addition, consistent transportation policies, including ridesharing, appropriate traffic reduction incentives and mass transit policies, could be considered. Appropriate land use planning and plant siting regulations also could be considered. And technology co-operation, which would help to apply specific technologies tailored to individual country needs and uses, as well as the funding of energy efficiency technology research and development, could be considered as well. Adopting a "shoot now and ask questions later strategy", which some climate change activists are urging, could easily point the gun in the wrong direction. Instead, we need to recognize that climate change is a long-term issue with no easy solution. Flexible policies that can adapt to changed circumstances over the next 50-100 years or more need to be developed and implemented in a thoughtful, reasoned manner.

References Bradley, Richard A., Edward C. Watts, and Edward R. Williams, eds. Limiting Net Greenhouse Gas Emissions in the United States. U.S. Department of Energy, September 1991. British Petroleum. BP Statistical Review of World Energy. June 1991. The Economist. "Asia's Emerging Economies". 16 November 1991.

100 Arnold B. Baker

_ _ . "Energy and the Environment". 31 August 1991. Grubb, Michael. Energy Policies and the Greenhouse Effect, Volume One: Policy Appraisal. Dartmouth: The Royal Institute of International Affairs, 1990. Institute of Energy Economics. "Energy Demand Forecast for the Asian-Pacific Countries, 1987-2020". The Energy Data and Modeling Center, the Institute of Energy Economics, Japan, July 1991. Manne, Alan S. and Richard G. Richels. "Global C02 Emission Reductions: The Impacts of Rising Energy Costs". The Energy Journal 12, no. 1 (1991). _ _ . and _ _ . "Reducing U.S. C02 Emissions: The Value of Flexibility in Timing". Paper presented at the IPIECA Climate Change Symposium, Rome, 1992. Montgomery, W. David. "The Cost of Controlling Carbon Dioxide Emissions". Charles River Associates, December 1991. Nordhouse, William D. "The Cost of Slowing Climate Change: A Survey''. The Energy Journal12, no. 1 (1991). Policy Implications of Greenhouse Warming - Synthesis Panel. Washington, D.C.: Committee on Science, Engineering, and Public Policy, National Academy of Sciences, National Academy of Engineering, Institute of Medicine, National Academy Press, 1991. Intergovernmental Panel On Climate Change. "Policy-makers Summary of the Formulation of Response Strategies". IPCC, Working Group III, June 1990. "Workshop on Global Constraints in the Oil Industry in the 1990s". Selected papers, mimeo., Salalah, Oman, 24-28 September 1991.

Adjusting to Volatile Oil Prices An Agenda for the Producer-Consumer Dialogue Philip K. Verleger, Jr.

Interest in reform of energy market institutions developed as a result of the 1986 oil price collapse and the 1990 crisis caused by Iraq's invasion of Kuwait. The price collapse forced uncomfortable economic rationalizations on exporting nations while Iraq's invasion caused dislocations to consuming nations. These disruptions led to a dialogue between oil producers and consumers, a dialogue some hope will lead to a formal producer-consumer agreement. Proponents of the dialogue had convened four informal meetings to exchange data. However, meetings between producers and consumers are seldom convened solely for "exchanging data" and to "improve information flows". Inevitably some of the participants have ulterior motives and often that motive is quite simply to rein in the forces of supply and demand. Indeed, the formation of a producer-consumer agreement having characteristics similar to the international coffee, cocoa, tin and rubber agreements was proposed. The idea is especially appealing to some oil exporting nations despite the fact that most other agreements have failed, causing great harm to the long-term interests of producers. Copyright 1992 by the Institute for International Economics. All rights reserved.

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However, negotiation of an agreement between oil exporting and oil importing nations will be extraordinarily complicated. The size of the oil market (relative to other commodity markets), the market's complexity, the fiscal importance of the oil sector to consuming countries, the sensitivity of consuming nations to security of supply and the environmental impact of oil combustion will combine to make the negotiations difficult. Already, conflicting interests have motivated producers and consumers to pursue very different types of negotiations. The first approach, led by members of the Organization of Petroleum Exporting Countries (OPEC), had focused on the creation of a traditional price stabilization agreement, one which would theoretically "tame" the oil market and reduce price volatility. The second effort seeks to establish arrangements setting rules of access and investment guarantees for companies investing in producing nations. The European Energy Charter is the first of this latter type of agreement. Negotiation of an agreement on the terms envisioned by producers or the European Economic Community (EEC) could contribute to an improved world economy under certain circumstances. The world's consumers or consuming nations could benefit through the reduction in the price of energy. Simultaneously the world's producers could benefit from more favourable access to capital, increased sales and more stable (and possibly higher) incomes. However, an agreement could also have adverse consequences. Adoption of an agreement in the form put forward in proposals by representatives of some oil exporting nations would burden consumers with excessively high costs and result in lower, not higher, incomes to producing nations. Such losses would be incurred if the parties attempted to stabilize prices and adopted programmes similar to the schemes tried in the past for coffee, rubber, cocoa and tin. Producers and consumers even stand to lose if negotiators adopt the more moderate proposals put forward by those who only want to create surplus productive capacity. 1 This chapter examines the prospects for a dialogue between producers and consumers. It begins by asking the fundamental question: Is there a problem? It then proceeds by identifying both the areas where there is potential for progress and those for which there is none. A number of areas where real progress could be achieved is noted.

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Why a Dialogue? Iraq's invasion of Kuwait ignited a renewed interest in energy policy. Volatile prices, shortages - whether real or imaginary, a recession and a war created a perceived need "to do something more about energy". In response, many governments introduced legislation to change the fundamental nature of the energy economy. Some proposals became law. On the international front there have been calls for a renewed dialogue between producers and consumers. Jacques Delors, President of the European Commission, expressed the views of many in September 1990 when he asked, "Are we concerned that an excessive fall in the price of oil and its purchasing power, because of inflation, might lead to a revolt?" Delors continued, ".. . Isn't it time to think about a new way of organizing the petroleum market, and, by the way, of controlling the speculative abuses that we have witnessed?" 2 Iran's oil minister, Mr Gholamreza Aghazadeh, expressed similar views when he noted, "The majority of oil exporting nations are in need of demand security and a guaranteed level of oil income for their economic development." 3 Indirectly and directly he and other representatives of producing nations complained that oil exporting nations had experienced neither a stable level of demand nor a guaranteed level of income in the recent past. These views established a basis for negotiations. Four meetings have already taken place. In general, participants of these affairs have expressed a distaste for volatile oil prices. This dislike of volatility has led to a number of proposals to control prices. While efforts to limit price volatility are probably doomed to failure, there are reasons to proceed further with a dialogue. As is noted below, financial innovation, removal of barriers to trade and increased foreign investment by all parties could lead to an overall improvement in the world economy. It is these goals, discussed by some negotiators, that ought to be pursued.

Objectives of the Participants Dialogues on commodity markets and negotiations of producerconsumer agreements have always had complex agendas. On the

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surface, discussions always focus on supply, demand, and prices. However, as McNicol (1978) notes, both parties have usually been interested in additional matters. The focus of developing countries, for example, has been on issues such as the transfer of technology, activities of the multinational corporations, rescheduling of debts to industrialized nations, access to the markets of developed nations (including elimination of tariff and non-tariff barriers) and development assistance. Industrialized nations have been concerned with maintaining access to the markets for their exports, strengthening world trade, ensuring the continued supplies of raw materials, and stabilizing prices. McNicol also suggests that the developed nations' interest in international commodity agreements extends beyond economic issues to matters of international stability and national security. 4 McNicol concludes that most meetings between producers and consumers have turned to negotiation of agreements to establish mechanisms for the stabilization of prices (commodity agreements) for two reasons. First, commodity exporters believed (and continue to believe) that the terms of trade have turned against them as commodity prices have declined. Second, many participants from both sides have accepted the premise that instability of commodity prices and the resulting instability in export earnings constitute a serious impediment to economic growth. The dialogue between the exporters and importers of oil promises to contain all of these components. Representatives of Third World nations have already put forward proposals to stabilize prices (or establish a permissible band for price fluctuations), to guarantee access to the markets of consuming nations, to obtain capital from consuming nations for the purpose of expanding their capacity and to ensure that they can achieve some stable level of income. Representatives of consuming nations have raised the traditional issues of price stability, access to the resources of exporting nations and creation of surplus capacity. However, five factors relating to economic rents, the environment, monopsony power in consuming nations, sanctity of contracts, and introduction of new financial instruments make the dialogue far more complex than earlier negotiations over other commodities. The first of these five unique factors is economic rent. Much of the revenue stream associated with the oil industry constitute economic rent. A portion of the rent is captured by low cost exporters of oil, but

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an even larger share is extracted by consuming nations as taxes and, in some cases, excessive manufacturing margins. Producing nations now seek a greater share of these rents. 5 The second unusual aspect of the dialogue relates to environmental concerns. Many consuming nations have concluded that some limits must be placed on carbon emissions. Invariably these limits will constrain the use of oil with the result that consumption of petroleum will be limited. Such restraints on the use of oil will cut the income of oil exporting nations both by reducing the volume sold and the price per unit received. Oil exporting nations seek to limit potential future damage that might result from the imposition of such restrictions through the producer-consumer dialogue. Third, oil exporting nations seek the removal of trade barriers they believe limit their access to markets. Exporting nations seek the withdrawal of differential tariffs and quota systems that favour imports of raw materials and discriminate against imports of refined products and petrochemicals. Fourth, both parties implicitly seek to reform and perfect commercial contracts between buyers and sellers of oil. Several participants have called for reform in international law or the establishment of insurance mechanisms to enforce performance of contracts between governments and commercial parties. This concept is embraced in the outline of the European Energy Charter and the North American Free Trade Agreement. Both accords eliminate or limit the immunity of sovereign states in their commercial activities. Finally, the introduction of new and unique financial instruments during the 1980s has made many of the problems faced by producers and consumers obsolete. The introduction of swaps, options, futures as well as forward contracts provide producers with financial instruments that can be used to achieve the stability of income previously sought through commodity stabilization schemes. Stijn Claessens and Ponos Varangis (1991) suggest that oil exporting nations as well as oil importing nations can achieve the goals they seek by using these instruments.

Earlier Attempts to Stabilize Prices The ideas expressed by proponents of the current negotiations are not

106 Philip K. Verleger, Jr.

new. Price stabilization has been thoroughly discussed by economic theorists and the theories tested on actual markets. Both theoretical studies and the real experience offer little promise for an oil price stabilization agreement. Attempts to stabilize commodity prices have almost always failed, often with calamitous results for commodity exporting nations. Discussion among modern economists on the subject extends back to John Maynard Keynes (1938) whose articles on the international control of raw materials have formed the foundation of a long, complicated, and frequently obscure debate that continues to this day. Keynes, ironically sounding more like a beleaguered minister of an oil exporting nation in 1991 than a Cambridge don, wrote that "the outstanding fault of the competitive system is that there is no sufficient incentive to the individual enterprise to store stocks of materials, so as to maintain continuity of output and to average, as far as possible, periods of high and of low demand". 6 He went on to note that the competitive market "abhorred" the existence of stocks because they yielded a negative return. The absence of incentive for private firms to hold inventories was the primary cause of price instability according to Keynes. In his view firms failed to hold stocks because costs associated with holding stocks were thought to be high, particularly "for surplus stocks which strain capacity''. Keynes also asserted that buyers accepted "speculative risk" as prices fell, profiting by waiting for further price declines rather than acquiring additional stocks at current prices. He noted, "Thus, even if it would pay him [the speculative purchaser] to buy at the existing price on long-period considerations, it will often pay him to wait for a still lower price."7 Finally, Keynes concluded that there was a lack of incentive for processors and retailers to make purchases in advance as long as the buyer is able to acquire raw materials at the prevailing current price and recover the current costs from the market. Keynes suggested that the adverse impact of fluctuations on trade and stability resulting from the absence of adequate stocks was great. In language similar to that used by Professor Mabro more than 50 years later he commented, "Prices rush up, uneconomic and excessive output is stimulated and the seeds are sown of a subsequent collapse."8 According to Keynes, the solution to the problem of instability lies in the creation of buffer stocks of various commodities. These stocks

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could be used to dampen price increases during periods of strong demand while being increased at those times when demand was weak. Keynes preferred such arrangements to cartels, quotas, or price arrangements because the alternative mechanisms resulted in higher prices and welfare losses to consumers. In 1942 Keynes proposed creating an international agency that would undertake the creation and management of buffer stocks. The essence of the plan should be that prices are subject to gradual changes but are fixed within a reasonable range over short periods; those producers who find the ruling price attractive being allowed a gradual expansion at the expense of those who find it unattractive. Thus we should aim at combining a short-period stabilization of prices with a long-period policy which balances supply and demand and allows a steady rate of expansion to the cheaper-cost producers. 9

The agency proposed by Keynes would be permitted to assign output quotas to producing nations under certain circumstances when excessive drops in demand occurred. However, such limits were to be of short-term duration: "Stabilization must not rest on the absurd assumption that conditions of demand and of supply are fixed, or that the chief purpose is to protect the increasingly uneconomic producer from the natural effects of world competition."10 Keynes's two papers form the nucleus of a major area of economic research. The seminal work of David Newbery and Joseph Stiglitz published in 1981 contains over 120 references to papers and books that have addressed Keynes's assertions. These studies conclude that Keynes's assertions on the benefits of buffer stocks are overstated in the absence of some externality. More recent research also finds that Keynes overstated the effect of volatile prices on economic activity, especially in light of the possibilities created by the introduction of new financial instruments. This research does, however, support Keynes' preferences for buffer stocks to policies which limit production. However, Keynes' theory has never been tested. The creation of a system of pure buffer stocks has never been the concern of advocates of producer-consumer co-operation. Instead, most international programmes have involved a combination of buffer stocks and limits on production. As Bosworth and Lawrence (1982) note, "In practice, a pure buffer stock (without production controls) has attracted little

108 Philip K. Verleger, Jr.

support in international negotiations because it does not address the fundamental concern of producing countries: the desire to achieve a higher long-run average price." 11 Keynes' earlier warning has been ignored. Two reviews of the historical experience of stabilization schemes are particularly relevant. McNicol (1978) examined the workings of eighteen international agreements established between 1920 and 1975. He found that restrictions on supply, not buffer stocks, dominated these efforts. Agreements were negotiated as restrictive commodity agreements between importing and exporting nations. Usually these agreements called for the creation of an international commodity organization which was granted powers to limit exports. 12 Eckbo's detailed 1975 examination of the performance of international commodity cartels showed that most failed within four years. Using data extending back to the turn of the century Eckbo was able to construct quantitative performance data on 51 cartels. He concluded that less than half of the cartels were "efficient" in raising prices but reports that efficient cartels did not last for long. 13 The most important factor governing success in the arrangements reviewed by Eckbo was concentration of production. Eckbo found that the top four producers controlled more than 50 per cent of production in 90 per cent of the cartels examined in one of his two samples. The individual experiences of five recent commodity agreements confirm these earlier findings. Three of the agreements (for tin, coffee and cocoa) failed while two others (for rubber and diamonds) are on the ·ropes. 14 At least one agreement, the International Rubber Agreement (INRA) offers the example of a "successful" agreement. However, its "success" offers sobering lessons for those in the oil industry pushing producer-consumer co-operation. INRA adheres closely to the model put forward by Keynes by including a buffer stock but no limitation on output. As a result it has succeeded when other agreements have failed. 15 A major reason for the success is the extraordinarily wide price bands which were established. The buffer stock manager may buy rubber only when the prices are more than 15 per cent above or below the target level and must buy only if prices deviate by more than 20 per cent from the target level. Whether price volatility would have been even greater in the absence of an agreement cannot be known. What is known, though, is

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that rubber price fluctuations were as great as the fluctuation of other commodities. A comparison of the variation of prices of five commodities - coffee, cocoa, tin, rubber and oil - shows very little difference in either year-to-year fluctuations or level of prices with or without restrictive commodity agreements. Statistics on movements of commodity prices (Table 5.1) reveal that the standard deviations of individual commodity prices for the period from 1970 to 1990 are remarkably close despite the fact that some were theoretically protected by stabilization agreements while others were not. Further, the standard deviations of prices are all higher during the decade of the 1970s than during the 1980s.

Petroleum Commodity Markets The volatility of oil prices during the Kuwait crisis of 1990 triggered interest in the dialogue. Sharp price increases during the first weeks of the crisis were viewed as excessive and unjustified in light of the high level of inventories available at the start of the crisis. Blame for much of the price increase was assigned to excessive speculation by oil companies or market participants. Subsequently this criticism was broadened by the assertion that petroleum markets are either inefficient, incomplete, manipulated or too small. These criticisms demonstrate a lack of understanding of the basic function of a dynamic market in which large amounts of a commodity can be carried forward from one period to the next. The evidence suggests that petroleum markets are efficient but subject to larger fluctuations than financial markets due to the higher cost of storage, time and cost of transportation, and extreme heterogeneity of the products traded. Much of the criticism directed at oil markets results from the confusion - or outright hostility - to the function performed by these institutions. That function is (1) to discover the market clearing price for the commodity today and (2) to transfer stocks from the current period to the next. This latter role is often overlooked. However, as Williams (1986), Williams and Wright (1991) and Wymar (1968) demonstrate, it is the difference between spot and futures prices which indicates the condition of the market, whether stocks are perceived to be ample or tight and whether the participants anticipate future shortages or gluts. Spot prices of a commodity will increase relative

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TABLE 5.1 Indices of Five Commodity Prices (1985:100)

1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 Standard Deviations 1970to 1990 1970 to 1980 1980 to 1990

Coffee

Cocoa

Tin

Rubber

Oil

35.7 30.9 34.6 42.8 45.2 44.9 98.1 161.2 111.9 119.2 105.9 88.0 96.0 90.5 99.0 100.0 132.4 77.1 92.8 73.5 61.2

29.9 23.9 28.5 50.2 69.2 55.3 90.7 168.2 151.0 146.1 115.5 92.1 77.3 94.0 106.3 100.0 91.7 88.6 70.2 55.1 56.2

31.8 30.4 32 .4 41.6 71.0 59.6 65.8 93.7 111.6 133.9 145.5 122.8 111.2 112.6 106.0 100.0 56.3 60.3 63.3 75.5 53.7

53.7 43.8 43.7 89.4 99.1 73.9 102.0 107.4 129.9 166.3 187.8 148.0 113.0 140.3 126.2 100.0 106.3 129.8 156.2 127.8 114.0

6.3 7.9 8.7 9.6 38.0 36.7 40.4 43.5 44.6 55.0 94.7 112.3 119.3 110.5 101.8 100.0 50.5 64.7 52.5 63.9 83.5

34.3 42.8 17.8

38.5 50.7 18.6

34.1 39.6 29.7

37.1 45.0 24.2

35.7 25.3 23.8

Sources: IMF, International Financial Statistics; BP, BP Statistical Review of World Energy.

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to forward prices, according to this theory, when market participants conclude that the likelihood of a "stockout"16 has increased while spot prices will decline when these same participants conclude that the probability of a stockout has declined. Petroleum economists have generally failed to understand this function of dynamic markets. This failure can be observed in the criticisms levelled at petroleum commodity markets during the crisis following Iraq's invasion of Kuwait. For example, the EEC Energy Commissioner asserted, "The increases in oil prices . . . are totally unjustified and indefensible" noting, "Oil stocks in Europe and elsewhere are at unusually high levels. Everyone in the market knows this." 17 In fact, the high level of spot prices was a natural and correct response of a dynamic market when future supplies were expected to fall short of demand. The decreases in prices that occurred in 1986 and the increases in prices recorded in 1990 were entirely consistent with the optimal behaviour of a dynamic market in which some portion of production can be carried forward to the next period through storage. As Williams and Wright (1991), Deaton and Laroque (1990) and Wymar (1968) show, the distinction between static and dynamic markets occurs because surplus production can be carried forward in stocks to the next period but cannot be borrowed from future periods to make up for a lack of adequate stocks when current output falls short of demand. This inability to borrow from the future creates a fundamental asymmetry in market behaviour. Prices can and will escalate sharply in any period when supply is reduced and stocks are exhausted. However, prices will not fall as dramatically during periods of oversupply because buyers will expand stocks, effectively transferring production from one period to the next. The fundamental asymmetry between markets with storage and those without is demonstrated by Williams and Wright. They note that large increases in prices can occur if current production is disrupted at a time when available stocks are low or non-existent. However, these increases do not necessarily carry over to prices quoted in the current period for supplies to be delivered in future periods. Instead, the authors show that prices quoted for forward supplies will tend to ignore the current shortfall of supply and tend to reflect the market's long-run, steady state conditions. In this model

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differences between spot and futures prices (spreads) will reflect the probability of a stockout in the next period. Williams and Wright comment that backwardation18 in the price of a commodity will increase as the probability of having a small amount available in the next period increases. 19 This model explains the behaviour of oil prices during 1990. At the time of the invasion stocks were thought to be extremely high. In its end of July report the International Energy Agency (lEA) noted that forward coverage of stocks held in consuming countries was three days higher than at the same time the year earlier. This high level of stocks led policy-makers to conclude that no intervention was required to offset the embargo imposed on Iraq. The predominant view was that high stocks should eliminate the need for immediate action. However, the high level of stocks of crude and product in early September were thought by many to be potentially insufficient to meet higher seasonal demand in the coming winter, a possibility that was acknowledged by the lEA's Chairman, Mr ffirick Engleman. 20 During August and September the spread between spot and 18-month forward oil widened as the probability of shortages (stockouts) increased, just the behaviour predicted by models of commodity markets. The market that was so strongly criticized in 1990 consists of more than a hundred discrete formal and informal institutions that include both spot markets, well established but informal forward markets, formal futures markets, a wide variety of over-the-counter markets, and newly emerging spot markets. The volume of trade in these markets ranges from a few transactions per month to thousands of transactions a day. 21 Mentre (1991) estimates that total volume amounts to 200-300 million barrels a day, six times current consumption with two-thirds of the transactions on formal futures markets. 22 However, Mentre's figure can only be a guess because many transactions in the various informal markets remain private. The volume of trade on petroleum markets has increased dramatically over the last decade. Over this period it is estimated that the number of daily transactions may have increased from 10 million barrels per day to between 200 and 300 million barrels per day.23 Despite it size many experts still view the market as "immature". Mabro (1991) complains that the oil markets are not efficient because no futures or forward market has developed for Arab light crude oil

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while Mr M. Camdessus, Managing Director of the International Monetary Fund, concludes that oil markets "still have some way to go to match the universality, depth and breadth of international financial markets". However, there is another, simpler explanation for the problems identified by Mabro, Camdessus and others. According to this view, the market's problems result from the oil industry's structure, not its immaturity. The oil market is large by comparison to all other physical commodity markets. Daily trade in oil amounts to 300 million barrels, roughly five times consumption, and is worth US$6 to US$8 billion dollars. These sums exceed the amounts traded on all other commodity markets except currencies where trade amounts to hundreds of billions of dollars. At the macro level the oil market works quite well. Futures and forward markets today provide appropriate signals on market conditions. Further, these markets provide a means by which producers, processors and consumers can engage in traditional hedging activities. These hedging activities permit non-integrated firms to operate on an even or almost even basis with larger and more integrated companies.

The Market Alternative to Integrated Commodity Price Stabilization Schemes New instruments 24 developed by the world financial and commodity markets during the 1980s provide the means for achieving the effect of price stabilization and risk management currently sought by oil producers and consumers. Used properly these instruments allow oil exporting nations and consumers to construct their own "self-help" price stabilization schemes. These new instruments also provide the mechanism that allows producers to raise capital without special assistance from international organizations. While some of these instruments are relatively new, there are already many publicized examples of their successful use by oil producing nations and companies, the most well known of which is Mexico's use of over-the-counter puts to hedge its exposure to price fluctuations during 1991. Lesser known examples are to be found in Sohio's sale of oil indexed bonds, BP's forward sale of production from Alaska, and Algeria's use of options to secure financing.

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Mexico's purchase of over-the-counter puts occurred between November 1990 and January 1991. According to reports in the financial and petroleum press the Mexican finance ministry became concerned in late 1990 that the price of oil would fall during 1991. 25 The Treasury, mindful of the importance of oil exports to the nation, elected to purchase puts to set a floor on the nation's 1991 income of US$17 per barrel. If the details of the transactions are correct, it would appear that the Mexican Government profited handsomely from the transaction. I calculate that the purchase of puts that protected the government from a fall in the average price below US$17 per barrel would have increased receipts from the sale of oil by US$1 billion (Table 5.2). Since the puts were reported to have cost only US$200 million, the net savings amounts to US$800 million. The British Petroleum Prudhoe Bay Royalty Trust offers another example. In May 1989 BP sold an undivided interest in 17 per cent of the first 90,000 barrels a day of production from its Prudhoe Bay field in Alaska to investors. In technical terms the trust is identical to a liquidating limited partnership in which the owners receive payments that represent both a return of income and capital over a finite period of time. However, it differs from most other royalty arrangements in that the price of oil used to value the production is totally unrelated to the price received for the Alaskan oil. Further, investors are exposed to a few unexpected costs that could adversely affect cash flow from the unit. Thus the trust offers a means of speculating or locking in on the future price of a commodity crude oil, WTI, secured by production from Prudhoe Bay. Algeria used commodity indexed financing to secure more favourable terms in its 1989 financing of Sonatrach according to the World Bank (1991). This investment involved the arrangement of a conventional US$100 million seven-year loan. Algeria was able to obtain a very favourable interest rate on the loan because the facility included long dated call options which obligated Algeria to make additional payments if prices exceed specific levels. 26 World Bank economists note that the interest rate on the loan was "significantly below the expected cost of funds for Sonatrach without the options scheme". 27 The three examples provide important illustrations of the way in which financial instruments could be used by oil producers (especially exporting nations) to reduce their exposure to price volatility.

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TABLE 5.2 Estimate of Additional Revenue Paid to Mexico on Its Hedge of 1991 Crude Sales Crude Prices ($/bbl)

Extra revenue Isthmus Maya-22 0/meca Average Savings (million dollars) January February March April May June July August September October November December

20.88 16.62 16.80 17.90 17.91 17.11 18.21 18.45 19.26 20.38 18.56 15.86

16.09 11.18 11.55 12.79 12.80 12.36 13.39 13.05 13.41 14.38 13.54 10.70

23.45 18.46 18.56 19.56 19.66 18.88 20.03 20.51 21.01 22.30 21.09 18.49

18.22 13.48 13.58 14.95 14.90 14.30 15.34 15.17 15.65 16.67 15.55 12.78

0.00 3.52 3.42 2.05 2.10 2.70 1.66 1.83 1.35 0.33 1.45 4.22

0 134 142 83 91 114 71 78 56 14 59 178

Average total

18.16

12.94

20.17

15.05

2.05

1,020

However, producing nations face several serious difficulties in using such instruments, the most important of which relate to the risk aversion of bureaucrats, the credit rating of oil exporting nations (and the related absence of contractual guarantees), legislated impediments on the use of futures by producing counties and the effect on prices. A primary factor that impedes implementation of various hedging strategies is the bureaucrat's natural fear of negative publicity. Officials of many governments and publicly held companies will naturally fear the negative publicity that may accompany an adverse move in the market. Claessens and Varangis (1991) offer several suggestions for

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overcoming this difficulty. In the optimal situation they suggest that hedging strategies adopted by a government should have a broad governmental mandate which can be achieved in their view by establishing a high-level committee that consists of representatives from oil companies or the state oil company, the ministry of finance, the central bank, and possibly the ministry of energy. They propose that this committee establish the parameters for hedging activities followed by the agency implementing the policy. Where problems of negative publicity are too great Claessens and Varangis suggest that options can be used. Thus, through purchase of puts or calls a producing country can achieve many of the benefits of hedging. Petroleum exporting nations also face a problem of credibility in implementing any type of price insurance programme. Many countries are viewed as bad credit risks. In addition, there is a widespread view that oil producing countries will exercise force majeure to take advantage of better opportunities, especially since they enjoy limited legal immunities due to their status as sovereigns. In many cases the lack of credit of specific exporting nations is valid. Nigeria, Ecuador, Iran, Iraq, and Libya do not, for example, enjoy access to commercial credit markets. Further, Mexico, Venezuela and several other nations must watch their situations very closely. These nations will require some type of third party backing if they are to engage in active hedging. Economists at the World Bank have suggested that funds pledged to the First Account of the Common Fund in the early 1980s be used to underwrite some of these financial obligations. They note that the funds were originally dedicated for the creation of a buffer fund that would be used in the stabilization of prices of a number of commodities but that the arrangement has never been implemented because of the failure to establish the international commodity agreements proposed under UNCTAD's International Program for Commodities. As an alternative they suggest that monies in the fund could be used to guarantee the performance risk of Third World countries (including oil exporters and importers) entering into long-dated derivatives such as commodity swaps. The guarantee of performance can be further strengthened by inserting an insurance agency such as the World Bank's Multilateral Investment Guarantee Agency (MIGA) between the producing nation and the investor. In many cases the guarantees will have to be specially tailored to the nature of the financial obligations because

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traditional insurance programmes usually repay only the principal and thus would not substitute for the price insurance an investor might have purchased from a commodity exporting country. For example, under its current programme MIGA would return the monies invested in country X's commodity indexed bonds but would not refund any appreciation in the bond's value due to increases in the price of the commodity.

Framing a Dialogue The materials presented in the previous section suggest that financial and commodity markets now contain instruments that can be used by producers to achieve the effect of stable prices without need of a producer-consumer agreement. Use of these instruments would enable producers to achieve all oftheir goals save one - abnormally high prices. Under such circumstances there would appear to be little reason for negotiations between producers and consumers to proceed. However, a basis for a dialogue may still exist. Indeed, there are three areas where changes in current relationships between producers and consumers would benefit both parties: investment, competition and trade. Removal of barriers to investment can also yield benefits to both parties with consumers gaining from more supplies (and lower prices) and producers enjoying a higher level of sales. Removal ofthe barriers to competition will also help both consumers and producers with consumers gaining from lower prices and producers gaining entry into markets. Removal of barriers to trade - particularly in petroleum products - will benefit both producers and consumers with the former realizing better sales and the latter enjoying lower prices. The issue of foreign direct investment (FDI) was widely debated in industrialized nations during the 1980s. The literature on the subject generally focuses on "industrial-organizational" motivations to explain investments by firms from one nation in a second. It is argued that the investing firm from the first country supplies capital, technology and management skill to the second nation, presumably increasing the GDP of the second nation and generating profits that are repatriated to the first. Graham and Krugman (1991) conclude that this explanation applies to the inflow of foreign investment experienced by the United States in the 1980s.

118 Philip K. Verleger, Jr.

In the case of oil and natural gas production, FDI is required in many Third World oil producing nations because these countries lack both the managerial skills and the investment capital to rapidly develop their resources. Despite recognition of the potential benefits of such investments, barriers exist in many producing nations. Investments in refining and marketing in consuming nations by national oil companies of oil exporting nations constitute a second type of foreign direct investment. These activities offer exporting nations a form of portfolio diversification while potentially providing capital to consuming nations. Exporting nations have additional reasons for acquiring downstream refining assets. Some oil exporting nations seek to diversify as a means to overcome the effects of monopsony, perceiving that oil importing nations systematically discriminate among oil exporters to achieve lower prices of imported oil. Other exporting nations endowed with particularly heavy or otherwise unattractive crude oils believe that they are put at an economic disadvantage because only a few buyers have the capacity to process their crude oils. Other nations pursue ownership of refining and marketing assets to reduce the variability of their income. They see acquisition of refining and marketing assets as a means to adjust the asset mix of their portfolios. Acquisition of refining and marketing assets can also yield benefits to consumers by injecting greater competition into the distribution of petroleum · products. Such increased competition should theoretically result in lower prices. These benefits from competition can result if the oil exporting nation builds new facilities in a consuming nation or, more likely, acquires an existing firm and reinvigorates it. In the United States Venezuela has aggressively entered the market by acquiring shares in CITGO Refining, expanding it to become a more dominant supplier in the southeast and eastern United States. Consumers in Europe benefited from Kuwait's acquisition of the refining and marketing assets of Gulf Oil. The benefit of increased competition can be measured by examining the relationship between competition and margins earned in refining and marketing. Other things being equal, an increase in the activities of one firm with a small share of the market (or group of firms with small market shares) that leads to an increase in the

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market shares of the firm (or firms ) will increase the competitiveness of an industry and should, in tum, be associated with a decline in margins. Thus the coefficients from a regression of refining margins on indices of competition should be positive if higher values of the index are associated with diminished competition. This hypothesis, confirmed in regressions of margins earned in refining and marketing in fourteen OECD countries, are regressed on the Herfindahl/ Hershman indices (HHis) for those countries. 28 The results show that refining margins for the four principal petroleum products are positively correlated with the concentration indices supporting the hypothesis that consumers would benefit from increased competition. 29 Using these results we calculate that a modest 100 point reduction in concentration in the OECD that resulted from investment by producing nations would yield benefits of US$10 billion per year to consumers. The dialogue between producers and consumers should also focus on issues relating to trade in products and crude. Movements of crude and especially products are limited by a complicated system of formal and informal barriers. These limits include outright barriers or quotas imposed on imports of specific products, more subtle obstructions contained in unique product specifications which make products manufactured in one nation unmarketable in a second, grants of special preferences to the imports from one group of nations or regions at the expense of others, and exclusionary restrictions on foreigners from certain activities. Benefits to producers and consumers would be greater if some of these restrictions were eliminated or reduced. The most important barriers to trade are the limits imposed on the imports of products. A number of nations (mostly in Asia) impose such limits. Quotas, tariffs or the use of "administrative guidance", are imposed in these nations, effectively denying market access to refiners located in exporting nations and burdening consumers with higher prices. The most extreme example of this policy is to be found in Japan. The degree of protection can be measured by the difference between Japanese consumer prices and prices in other countries. Japanese retail prices exclusive of taxes are almost 50 per cent higher than prices in Europe or the United States for gasoline, 20 per cent higher for heating oil, and 50 per cent higher for heavy fuel oil. The higher prices contribute to refining and distribution margins that are almost

120 Philip K. Verleger, Jr.

twice as large in Japan as any other country. In the absence of barriers to trade, such large margins would lead to increased imports of products. However, the Japanese market is closed. Samuels (1987) describes extreme steps that the Ministry of International Trade (MITI) took to protect domestic firms when an independent marketer, Lion Oil, attempted to import a cargo of gasoline to market at its stations. 30 The cost of protection to Japanese consumers can be approximated using data on refining margins in Japan and other industrialized nations. Such a computation takes account of the direct costs of protection assuming that there would be no change in consumption but does not adjust for changes in consumer surplus. My calculations indicate that protection cost Japanese consumers US$19 billion in 1990.31

Conclusion The three areas of negotiation can be described best by drawing an analogy to the current Uruguay trade negotiations taking place under the General Agreements on Trade and Tariffs. The goals of the Uruguay Round are to remove impediments to trade, to eliminate or curtail subsidies given to certain industries and to protect intellectual property rights. Negotiations among consumers and producers of petroleum (and other forms of energy) should seek to achieve similar, if not broader, goals for energy markets. The energy negotiations should seek to eliminate barriers to trade, reduce or abolish subsidies, remove impediments to the movement of capital and strengthen international markets. These negotiations would ideally be conducted among all producers and consumers but could also be undertaken on a bilateral basis or between groups of countries. For lack of a more eloquent term the process will be referred to here as the Energy Trade and Investment (ETI) negotiations. The economic benefits that result from the successful completion of an ETI agreement could be very large. Consuming nations would reap large benefits from lower prices that result from increased investment and production from low cost producers. Consuming nations and consumers adversely affected by the volatility of energy prices would also benefit by being able to reduce their exposure to

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price volatility by using the various financial instruments available in the petroleum markets. Additional environmental and economic benefits may be realized if negotiators of an ETI agreement achieve an accord which commits consuming nations to abandon subsidies to highly polluting indigenous fuels such as coal. Producing nations would benefit through the increase in demand for their exports, easier access to international capital markets, greater diversification in their portfolios and, if they choose, a lessened exposure to price volatility. The precise magnitude of the benefits achievable from such an agreement are difficult to calculate. Rough estimates made by the author suggest the gains could be huge - on the order of two-tenths to five-tenths of a per cent of the combined GDP of industrialized nations per year or US$30 to US$50 billion per year. The potential for such gains would seem to make the effort to establish an ETI worthwhile. On a conservative basis the annual gain for the United States is estimated here to be roughly one-half of one per cent of real GDP, or US$25 billion (in 1987 dollars). Based on Hutchison's 1991 results it would appear that smaller gains of perhaps US$12 to US$15 billion (again in 1987 dollars) might be realized in other industrialized nations. Third World oil importing nations would realize benefits amounting to perhaps US$15 billion per year. Thus, the aggregate benefit to consuming in the form of higher rates of growth from such an agreement would appear to exceed US$40 billion a year due to price effects alone. Four types of benefits to oil exporting nations can be identified from these proposals. These are greater access to investment capital, greater stability of income, and greater diversification of income. In addition, the aggregate income of oil exporting nations from the sale of oil may be increased. The combined impact of these actions may increase the revenues of oil exporting nations by as much as US$25 billion per year. Further, by lowering the barriers to investment, the agreement may also cut the investment costs incurred by these nations and thus yield additional benefits. An agreement on energy trade and investment as outlined here is put forward as a modest proposal for an agenda for the producerconsumer dialogue. The thrust of the analysis is that the petroleum market is efficient enough to enable producers and consumers to accomplish many of the goals that once were thought to require a

122 Philip K. Verleger, Jr.

formal producer-consumer agreement. Further, it has been suggested that consumers and producers can both realize gains that may aggregate to US$100 billion per year through the negotiation of agreements on trade and investment. Such gains do not appear at all modest in the scheme of things today. Notes 1. See for example Mabro (1991) or Robinson (1991). 2. Speech by Jacques Delors to the European Commission, 12 September 1990. Translation by M. Treadway. 3. Energy Compass, Fax file, 31 May 1991. 4. McNicol (1978), pp. 3-5. 5. To some extent this problem occurs with every commodity. However, the taxes on oil are often as large or larger than the raw material cost. 6. Keynes (1938), pp. 456-70. 7. Keynes (1938), p. 459. 8. Ibid. 9. Keynes (1942), p. 114. 10. Keynes (1942), p. 126. 11. Bosworth and Lawrence (1982), p. 156. 12. McNicol (1978), p. 67. 13. Under Eckbo's definition a cartel is efficient if it is able to raise prices at least 200 per cent above the unit cost of production. 14. The diamond agreement worked well for several decades but has recently been threatened by excess production in countries that were not governed by the agreement. 15. The absence of a limit of output reduces the potential threat to price levels and producer incomes that have occurred in other markets when prices collapsed after agreements failed. 16. The term "stockout" refers to the condition that occurs when inventories are exhausted. As Williams and Wright (1991) note such conditions actually occur in markets when stocks of a commodity are down to the minimum working levels. 17. "EC Energy Official Says Oil Price Rise Unjustified", Reuters dispatch, 25 September 1990 quoted in Verleger (1993), p. 27. 18. Backwardation defines a condition that occurs when spot prices are greater than forward prices. Mathematically, backwardation exists if P 1 > F 1 where P 1 is the price of supply of the commodity to be delivered in the current period and F 1 is the price paid today for a supply of the commodity to be delivered in a future period. The opposite of backwardation is contango which is said to exist when P 1 < F 1•

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19. Williams and Wright (1991), p. 137. 20. "lEA Won't Revive Emergency Steps; Says Fall Supplies Should be Okay", Platt's Oilgram News 68 no. 171, 4 September 1990, p. 1. 21. Verleger (1992). 22. Mentre (1991), p. 3. 23. Verleger (1992). 24. These instruments include futures, options, swaps and commodity indexed debt. 25. See "Mexico Locks in Price of $17 a barrel on Oil", Washington Post, 27 March 1991, p. C1; "Mexico 'Hedged Against Oil Price Fall"', The Financial Times, 5 March 1991; "Mexico's Moves to Lock in Oil Prices in Gulf Crisis Mean It Can Stay Calm Now as the Market Softens", Wall Street Journal, 11 March 1991; "Mexican Hedge Locks in Oil Revenues", Energy Compass 2, no. 12, p. 7; and "The Quest for Stability", Petroleum Intelligence Weekly, 1 April1991, p. 9. 26. World Bank (1991), p. 15. 27. Ibid. 28. The fourteen countries were the United States, Germany, France, Italy, Japan, The Netherlands, Switzerland, United Kingdom, Denmark, Canada, Sweden, Austria, and Norway. Other smaller countries such as Finland and New Zealand were excluded from the calculation because the markets in these nations was considered too small to sustain a sufficient number of firms that are of efficient scale. 29. The results are omitted here but are presented in full in Verleger (1992). 30. Samuels (1987), p. 224. 31. It may be argued that the benefits of lower refining margins would not accrue to the consumer but would be captured in the form of higher taxes. Such a conclusion may be the case. However, this merely implies that protectionism cost the Japanese Government US$19 billion in 1990. Further, the fact remains that the consumer ultimately bore this burden, since it is the consumer who ultimately bears the cost of government.

References Bosworth, Barry P. and Robert Z. Lawrence. Commodity Prices and the New Inflation. Washington, D.C.: The Brookings Institution, 1982. Camdessus, M. "Opening Remarks to the Ministerial Seminar of Oil Producing and Consuming Countries". Washington, D.C.: International Monetary Fund, 1991.

124 Philip K. Verleger, Jr.

Claessens, Stijn and Panos Varangis. "Hedging Crude Oil Imports in Developing Countries". Working Paper WPS 755. World Bank Policy, Research and External Affairs Department, 1991. Deaton, Angus and Guy Laroque. "On the Behavior of Commodity Prices". Princeton, N.J.: Princeton University, 1990. Dominguez, Katheryn. "Forecasting Strategies in Oil Financial Markets". In Oil Markets in a Thrbulent Era, by Katheryn M. Dominguez, William Hogan, Bijan Mossavar-Rahmani, Gordon M. Phillips and Robert J. Weiner. Cambridge, MA: Energy and Environmental Policy Center, Harvard University, 1991. Eckbo, Paul Leo. The Future of World Oil. Cambridge, MA: Ballinger, 1975. Graham, Edward M. and Paul R. Krugman. Foreign Direct Investment in the United States . Washington, D.C.: Institute for International Economics, 1991. Keynes, J.M. "The Policy of Government Storage of Foodstuffs and Raw Materials". The Economic Journal, September 1938. Reprinted in The Collected Writings of John Maynard Keynes, Volume 25, edited by Donald Moggridge. London: The Cambridge University Press, 1982. - -. "The International Control of Raw Materials" Reprinted in The Collected Writings of John Maynard Keynes, Volume 27, edited by Donald Moggridge. London: The Cambridge University Press, 1982. Mabro, Robert. A Dialogue Between Oil Producers and Consumers: The Why and the How. Oxford: Oxford Institute for Energy Studies, 1991. McNicol, David. Commodity Agreements and Price Stabilization. Boston: Lexington Books, 1978. Mentre, Paul. "Transparency and the Stability on the Oil Market". Paper prepared for the 2 July 1991 Producer Consumer Meeting in Paris, France. Newbery, David and Joseph Stiglitz. The Theory of Commodity Price Stabilization, A Study in the Economics of Risk. Oxford: Oxford University Press, 1981.

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Samuels, Richard J. The Business of the Japanese State, Energy Markets in Comparative and Historical Perspective. Ithaca, New York: Cornell University Press, 1987. Verleger, Philip K., Jr. Adjusting to Volatile Oil Prices. Washington, D.C.: Institute for International Economics, 1993. _ _ . "Statement before the Committee on Energy and Natural Resources of the United States Senate". Hearings before the Committee on Energy and Natural Resources of the United States Senate. 20 March 1988. Williams, Jeffery. The Economic Function of Futures Markets. Cambridge: Cambridge University Press, 1986. Williams, Jeffery C. and Brian D. Wright. Storage and Commodity Markets. Cambridge: Cambridge University Press, 1991. World Bank. "The Management of Commodity Price Risk and the Bank's Role". Washington, D.C.: The World Bank, 1991. Weymar, F. Helmut. The Dynamics of the World Cocoa Market. Cambridge: The MIT Press, 1968.

Growth of Oil Demand in the Asia-Pacific Perception of the International Energy Agency John P. Ferriter

Oil demand in the Asia-Pacific region has grown much more rapidly in recent years than the world average. Between 1973 and 1989, global oil consumption increased at an average annual rate of0.9 per cent. Driven by rapid rates of industrialization in some parts of the region and by high rates of population growth in others, oil consumption in the Asia-Pacific area grew by 1.6 per cent per year, although all the growth occurred in non-OECD (Organization for Economic Co-operation and Development) countries. As a result, the Asia-Pacific's share of global oil consumption increased from 14 per cent to 16 per cent over this period. Analysis by the International Energy Agency (lEA) on future energy consumption indicates that the increase in energy and oil demand in the region will continue to be greater here than in other regions over the coming decade. Given the magnitude of these changes, it is clear that what happens to energy, and especially oil, consumption in this region will have important implications for global as well as regional energy security, and for the protection of the global environment over the coming decade. The lEA is, therefore, giving increasing attention to monitoring and analysing developments in non-member countries in the region. The following sections of this chapter briefly describe the lENs projections of total energy and oil demand in the Asia-Pacific region based on its world energy outlook and the assumptions underlying

128 John P. Ferriter

this outlook. This chapter provides some thoughts on how oil demand in the region will be supplied and concludes by looking at some of the key issues and implications arising from the outlook. Clearly, there is enormous diversity among the countries in the Asia-Pacific region. We are concerned, however, with only two groupings - the OECD Pacific countries (Australia, New Zealand, Japan) and the remaining Asia-Pacific countries, with the exception of China.

lEA Energy Outlook The lEA Secretariat analyses on a periodic basis the medium- and long-term outlook for world energy demand and supply for periods of 15 to 20 years into the future under a number of different assumptions. The principal assumptions are those regarding the price of crude oil and rates of economic growth. The projections presented here are based on analyses completed in late 1990. Forecasting energy developments, particularly over the longer term, is fraught with considerable uncertainty and the outlook presented below is intended to be only indicative of the general direction and possible evolution of energy trends. Given the extent of uncertainty surrounding future movements in oil prices, the lEA has developed two main oil prices scenarios. The first of these, referred to below as the rising price case, assumes that prices settle at around US$21 per barrel in 1992 (in constant 1990 U.S. dollars) and then rise gradually to about US$35 by early the next decade, remaining at the level thereafter. This particular scenario assumes that real oil prices will begin to rise as excess production capacity outside the Gulf producing region is reduced. As this occurs, supply and price will depend on the extent to which Middle East production and, ultimately, capacity are increased. A price of US$35 per barrel is roughly equivalent to the average price which prevailed in the mid-1970s in real terms. This is significantly less than the 1980-81 peak when prices were over US$50 per barrel in 1990 terms, but higher than the pre-1973 level of about US$10 per barrel. The second price scenario assumes that crude oil prices remain constant in real terms throughout the 1990s at around US$21 per barrel, in 1990 U.S. dollars (Figure 6.1). The price assumptions underlying these scenarios represent only two of a number of plausible price

FIGURE 6.1 Crude Oil Price (In 1990 constant US$)

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130 John P. Ferriter

paths. Clearly, the future path of crude prices is likely to be anything but smooth and will depend upon a variety of factors including the rate at which crude production capacity is expanded. It is considered, however, that these two cases produce a reasonable range of possible price developments. A second important assumption of the lEA's outlook relates to economic growth. During the 1980s, rates of growth in economic output fluctuated significantly but averaged 4.3 per cent per year in OECD Pacific countries and 5.8 per cent per year in other Asia-Pacific countries. The Secretariat anticipates that economic growth will continue to be strong during the 1990s, albeit at a somewhat slower rate than in the previous decade. In the increasing crude price case we assume average growth rates of3.8 per cent and 5 per cent per year for OECD Pacific and Asia-Pacific countries respectively. The lower oil prices assumed in the constant price case lead to somewhat higher economic growth rates of 4.1 per cent and 5.2 per cent respectively, reflecting lower input costs and improved trade balances. The projections also assume that current government energy policies and current trends in environmental protection continue unchanged. In the absence of unforeseen events, continuation of current environmental protection policies would not be expected to have a major impact on energy availability or the fuel mix. This is because the projections assume continued use of add-on and clean energy technologies as the main mechanisms for pollution control. These tend to affect energy demand and the fuel mix less than environmental policies or technological developments targeted to achieve large energy efficiency improvements and fuel substitution. However, if environmental concerns were to lead to major technological breakthroughs or if environmental policies resulted in aggressive promotion of energy efficiency and fuel substitution, the implications for energy demand and supply could be significant. Many OECD governments, for example, are currently contemplating far-reaching changes to stem the growth of energy-related greenhouse gas emissions. Some of these changes, if adopted, could have a major impact on how energy is produced and consumed and, hence, on the energy markets facing non-OECD countries as well. It is also worth noting that the projections relate only to the supply and demand of commercial fuels. Non-commercial fuels, which are used extensively in some non-OECD Asia-Pacific countries are

Growth of Oil Demand in Asia-Pacific

131

excluded from the analysis. 1 The projections assume, however, that incremental energy demand in developing countries will be met increasingly by commercial energy substitutes. The implications of changes in some of these assumptions are discussed below, but first the outlook for energy and oil demand in the region is presented.

Energy Intensity Energy intensity is here defined as the amount of energy required to produce a given unit of GDP. In the 1960s and early 1970s, energy use grew at roughly the same rate as economic output in OECD Pacific countries. Since then, energy intensity has declined by about one-third due to a combination of factors including improvements in energy efficiency and conservation, a reduction in the share of heavy, energy-intensive industry in total economic output and a slow down in the rate of increase in personal transportation. In the 1980s, this resulted in an energy growth rate of 1.1 per cent per year compared with 4.3 per cent for economic growth. This trend is expected to continue through the 1990s, with energy demand growing at 2.2-2. 7 per cent depending on the oil price assumption, roughly two-thirds the rate of GDP growth (Figure 6.2). In contrast, the average rate of growth of energy consumption in the rest of the Asia-Pacific region since 1971 has been essentially the same as that of economic growth. Improvements in energy efficiency have to a large extent been offset by increased energy use associated with industrialization and higher standards of living. These trends have been far more disparate, of course, at the individual country level. One clearly identifiable group of countries, for example, is the low-income developing economies oftheAsia-Pacific including Bangladesh, India, Indonesia and Pakistan. Energy intensities in these countries have generally risen consistently over the period since the early 1970s, although the rate of increase has fallen since the mid1980s. The reasons for increasing intensities in these countries vary but are in large part related to pressures of population growth and rising living standards. Increasing energy demand from expanding industrial sectors has also been an important factor in India and Indonesia.

FIGURE 6.2 Energy Intensity

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Growth of Oil Demand in Asia-Pacific

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At the other extreme is a group of countries where overall energy intensity has fallen since the early 1970s_ This group consists of most of the Dynamic Asian Economies (DAEs), including Hong Kong, 'Singapore, South Korea, Taiwan and Thailand. In these cases, intensity improvements have generally been associated with structural transformations. In Hong Kong, for example, the share of services in total GDP increased at the expense of industry between 1973 and 1989. In South Korea, increases in energy intensity during the 1970s were associated with a period of rapid, heavy industrial development which was followed in the 1980s by diversification into lighter industry and the services sector. While energy intensities can be expected to decline over time in the DAEs, this is likely to be offset by growth in other countries. The lEA outlook projects that, on average, energy consumption will continue to grow at roughly the same rate as economic output in the region as a whole. This interrelationshop between economic growth and energy consumption is very similar to that experienced in OECD Pacific countries in the 1960s when they were broadly passing through a similar stage of economic development. At the regional level, the net effect of the stronger economic growth and essentially unchanged energy intensity is that the nonOECD countries' share of total energy in the region grew from a third in 1971 to roughly half in 1990. It is expected to approach 60 per cent by 2000.

Oil Demand The evolution over time of oil use per unit of GDP in OECD and nonOECD countries has been remarkably different (Figure 6.3). Taking intensity in 1971 as an arbitrary reference point, oil intensity in OECD Pacific countries almost halved between 1971 and 1990, and by 2000 is expected to be 55-60 per cent below 1971 levels. In contrast, oil intensity in non-OECD countries in 1990 was only 6 per cent below the level in 1971 and is projected to be only around 10 per cent below the 1971level by 2000. In 1973, the share of oil in the Asia-Pacific region's total energy consumption was 67 per cent. In the OECD Pacific, oil accounted for 73 per cent of consumption and was 56 per cent in the non-OECD

FIGURE 6.3 Oil Intensity

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Growth of Oil Demand in Asia-Pacific

135

countries of the region (Figure 6.4). Stimulated by the 1970s price shocks, the early 1980s was a period of significant substitution of oil by other fuels- gas, coal and, primarily in Japan, nuclear power. A slowing in substitution and strong growth in the non-substitutable transportation sector following the 1985 oil price decline led to a slight increase in oil's share in the second half of the 1980s in the OECD part of the region. By 1989, however, the share of oil in total regional consumption had fallen to 50 per cent, consisting of 54 per cent in the OECD countries and 46 per cent in the non-OECD. Looking to the future, oil's share of energy consumption will be subject to opposing trends: growth in the transportation sector offset by substitution in other sectors. The net effect in the lEA outlook for the region as a whole is for oil's share to remain about constant in the early 1990s and to decline in the second half of the decade, the extent of the decline being dependent on the oil price assumption. In absolute terms, oil demand in OECD Pacific countries declined following the 1979 price shock but rose after the 1986 price decline to reach about 1979-80 levels in 1990 (Figure 6.5). Growth in demand is projected to continue throughout the first half of the 1990s but its continuation in the 1995-2000 period is dependent on the oil price assumption. In the non-OECD part of the region, oil demand continued to grow even in the 1980s, accelerating in the second half of the decade. Demand is expected to continue increasing at an average annual rate of 4-5 per cent over the 1990s. Most of incremental oil demand in non-OECD countries will be for heavy fuel oil for power generation as well as for transport fuels whereas in OECD markets, transport fuels will experience the most rapid growth. In summary, we expect that the global region showing the greatest absolute increase in oil demand will be the Asia-Pacific, and within that region, most of the growth will occur in non-OECD countries. This is primarily due to a combination of higher economic growth than the OECD countries as well as less scope to decrease oil intensity as living standards rise and industrialization continues. The way in which this expected growth in oil demand will be met is important for energy security issues at both the regional and the global level. The lEA outlook shows total oil demand for the region growing by around 2.4 million barrels per day (mbd) by 1995 compared with 1990 levels. By 2000, we expect oil demand to be 3.3-4.6 mbd higher than in 1990 (equivalent to average growth rates of

FIGURE 6.4 Oil's Share of Total Energy Demand

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138 John P. Ferriter

2.7-3.6 per cent per year). Thtal regional oil production, however, is likely to grow only slowly. The region's proven oil reserves are very small, amounting to about 26 billion barrels at the end of 1990.2 This is equal to approximately 3 per cent of world reserves and represents a reserves/production ratio of about 20 years. Of total reserves, the OECD countries account for 1.9 bb, with the greater part of the rest in Indonesia, India, Malaysia and Brunei. In the region as a whole, the lEA projections point to average annual increases in oil production of about 1. 7 per cent to 2000, with by far the major proportion of incremental output from non-OECD countries. As a result of the differential growth rates in oil production and consumption in the region, more than 80 per cent of the increase in oil demand over the decade will need to be imported. Most of these imports will be sourced from the Middle East. The region's import dependency is thereby expected to increase from around 65 per cent in 1990 to approaching 70 per cent in 2000.

Demand for Oil Products In addition to the supply of total oil, it is important to consider how the demand for individual oil product grades will be met (Figure 6.6). World distillation capacity was in heavy surplus in the early 1980s as a result of lower oil consumption and the commencement of largescale refining activity in the Middle East. The amount of spare capacity declined significantly, however, in the second half of the decade as a result of growing demand. In addition to distillation capacity, conversion capacity has also been tightening as the incremental demand for oil has primarily been for light products. In the total Asia-Pacific region, the oil demand decline in the early 1980s was concentrated on the most easily substitutable product, namely fuel oil. Although fuel oil demand began to grow again in the second half of the decade, mainly for power generation, it represented only about a quarter of oil demand, appreciably less than the yield obtained by primary distillation of incremental crude. The growth of transport fuels, in particular, far outstripped the ability of regional refiners to supply such products to local markets as expansions in refinery capacity lagged the growth in regional demand. Between 1985 and 1990, for example, oil demand rose an estimated 1.3 mbd

FIGURE 6.6 Incremental Oil Demand for Total Asia-Pacific Region

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140 John P. Ferriter

yet over the same period distillation capacity increased just 0.15 mbd, largely as a result of clearing the bottlenecks at existing facilities rather than the building of new units. The growth in demand during the 1990-95 period is expected to be somewhat better balanced but, over the decade as a whole, it is clear that to balance supply and demand, additional refinery conversion capacity will be needed. The loss of 750 thousand barrels per day (kbd) of high conversion refinery capacity in Kuwait at the beginning of the recent Gulf crisis and a further 100 kbd in the Neutral Zone highlighted the basic tightness of product supplies in the Asia-Pacific region as those countries which had been dependent on Kuwait's product exports sought replacement supplies and raised domestic throughputs where possible. Japan was the only country in the Asia-Pacific region, however, with significant spare capacity at the beginning of the crisis and its refinery utilization rate increased sharply. One outcome of the situation was that, in addition to increases in absolute product prices, the price differential between light products and fuel oil increased rapidly. Given the projections for oil demand and supply in the region, it is clear that there will be need for a substantial increase in distillation and conversion capacity during the coming decade, both in the AsiaPacific region and in the main region supplying future product imports, namely the Middle East. From a refinery conversion standpoint, the critical products are likely to be middle distillates. It is worth nothing that there appears to be scope for increasing the utilization of existing conversion capacity in some countries and this could help meet requirements for additional conversion throughputs and reduce the risk of fuel oil surpluses developing.

Refinery Outlook A large number of refinery projects have been announced in both the Asia Pacific region and, to a lesser extent, in the Middle East. The crucial question in the Middle East is how soon Kuwait's capacity will come back on stream and, indeed, to what extent it will be rebuilt. Increased capacity has also been proposed in Iran, the UAE and Saudi Arabia. In the Asia-Pacific region, the construction of additional refinery capacity has been announced in the majority of major

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oil consuming countries. Existing projects under construction and firm plans, for example, exist in Indonesia, South Korea, India and Thailand. Current projects to expand capacity incorporate new conversion and octane capacity to a greater extent than those implemented in the 1980s. Past experience suggests that many other projects currently under discussion will, in practice, be delayed or cancelled. Our best judgment is that refinery capacity is likely to continue to be tight, with the region becoming increasingly dependent on product imports. In many cases, governments can play a key role in facilitating project development by ensuring that there are no excessive delays in obtaining planning permission, and that commercial terms and environmental requirements are clear.

Environmental Considerations One of the key issues which might affect the energy supply and demand outlook, not only in the Asia-Pacific region but globally, is the question of environmental protection. There are many areas of environmental concern where energy plays a major or important role. These range from localized air, water and land pollution, waste disposal, low-level pollutants which are hazardous to health, accidental releases of polluting or hazardous substances and, finally, emissions contributing to transboundary or global pollution. Of particular concern at this time, and reflecting current public and political preoccupations, are the problems of localized air pollution and the contributions of greenhouse gas emissions to global climate change. As is well known, "conventional" atmospheric pollution is reaching unacceptable levels in an increasing number oflarge conurbations in the Asia-Pacific region. The problem arises from the levels of sulfur dioxide (80 2 ) , nitrogen oxides (NO ) and particulate emissions from vehicles, industry and power plants. A range of steps are being taken to reduce atmospheric pollution particularly in OECD countries which have been working on these problems for many years. Environmental pressures have also been rising in many non-OECD countries, including the least developed ones in the region. This has been evidenced particularly in tighter sulfur specifications for oil

142 John P. Ferriter

products in many countries as well as increasing controls over the lead content of gasoline. It is clear that substantial refinery investment will be required to meet more restrictive product quality standards. As already discussed, most of the additional crude oil required to meet growing oil demand in the region will need to be imported. Most of these imports will, inevitably, be sourced from the Middle East, and will be of relatively high sulfur content. This will add to the refinery investments needed to achieve lower sulfur specifications. In view of the potential for a fuel oil surplus to develop, it seems likely that in many cases it will be economically more attractive to make refinery investments aimed at converting the surplus high sulfur residue rather than simply desulfurizing it. Considerable investment will also be needed to meet more restrictive automotive fuel specifications. Improving the local environment is a vital but costly process and efforts by individual countries to ensure that the most cost-effective solutions are found are to be encouraged. In most cases, the optimal solution involves improvements to the vehicles or plant using the fuel in addition to the quality and quantity of the fuel burnt by them. In addition to local environmental problems, there are clearly global problems, notably the greenhouse effect. While OECD countries currently contribute about half the carbon dioxide resulting from the burning of fossil fuels, future growth in greenhouse gas emissions will come primarily from those countries where energy growth is expected to be greatest, namely the non-OECD countries. lEA analysis indicates that, within the Asia-Pacific region in 2000, 60 per cent of carbon dioxide emissions will come from non-OECD countries, compared with 40 per cent from non-OECD countries. The equivalent shares in 1989 were 54 per cent and 46 per cent, respectively.

Meeting the Environmental Challenge Increasing energy efficiency and conservation are the most constructive means of slowing the growth in carbon dioxide emissions and will have additional benefits such as reducing other environmental problems, increasing the security of energy supply and potentially improving the balance of payments position of individual countries. Clearly, one way of influencing the efficiency of oil use and oil demand

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growth is through the prices being charged for oil products. In the past, consumers have enjoyed subsidized prices for oil products in many countries in the region. This practice inevitably distorts market forces and leads to higher oil consumption. Several countries in the region have begun phasing out subsidies, and a continuation of this process should be encouraged. Diversification of fuel supplies can make a major contribution to increasing the security of energy supplies while reducing dependency on oil. Diversification choices are constrained in some countries in the region by policies which prevent the introduction or expansion of nuclear power. The expansion of coal consumption is also problematic on environmental grounds, although coal will inevitably continue to have an important role in several countries, notably India, Japan, Australia and South Korea. In order to minimize the environmental effects of coal consumption it will be necessary to ensure that growth in coal-fired electricity capacity will use efficient, clean technology. The fuel with the greatest potential to contribute to growing energy demands while meeting stricter environmental standards is natural gas. With lower levels of conventional pollutants and greenhouse gas emissions, natural gas generates substantial environmental credits compared with other fossil fuels. For the Asia-Pacific region, the added advantage of abundant indigenous reserves of natural gas enhances the energy security situation. In its outlook, the lEA assumes that natural gas demand in the region will grow at around 7 per cent per year - a high rate but one which results in natural gas averaging only around 13 per cent of total regional energy demand in 2000, less than one-third of the share forecast for oil. Even at this level, however, substantial investment in the gas supply infrastructure will be needed but there are many attractive projects which merit development. There are also clearly projects where international co-operation will be essential. The best example is probably the ambitious Trans-Asian pipeline project which would do much to maximize the use of indigenous natural gas supplies. Additional supplies from the Middle East are also under consideration not only in the form of liquefied natural gas but also via pipeline to Pakistan and India. The greatest energy investments required in the region in the next decade will be those needed to meet rapidly growing electricity demand. If these are not made, there will be the risk of both slowing

144 John P. Ferriter

economic growth and increasing oil use as old inefficient plants are maintained in service in order to maximize electricity production. Power generation represents a major growth market for natural gas. Modern gas combined cycle plants have many advantages including low investment cost, speed of construction, high efficiency and low emissions.

The China Factor A further key issue which may have a substantial impact on the world energy outlook is potential developments in the country with the largest coal use in the world, namely China. Any substantial shift in current trends in industrialization, population growth or such standard of living improvements as increased private transportation could have a noticeable impact on global energy balances. While China's total energy consumption is overwhelmingly dominated by coal, oil is still important in absolute terms. Oil consumption in 1989 was 114 million tonnes of oil equivalent (mtoe) compared with 232 mtoe in the rest of the non-OECD Asia-Pacific and 270 mtoe in the OECD Asia-Pacific countries. On a global basis, oil consumption is exceeded only by the United States, the Soviet Union and Germany. The lEA's analysis assumes that China's oil demand will roughly match supply during the 1990s, that is the country will be selfsufficient with only limited oil export potential. Clearly, the range of uncertainty related to this assumption is substantial in terms of both oil production and demand. On the demand side, the consumption of oil in the power generation sector is discouraged officially but it is expected that its use in industry, particularly the petrochemical sector, will increase sharply. Oil consumption in the transport sector is also likely to grow strongly with some shift away from the bicycle towards the motor cycle as a mode of private transport. On the supply side, production of oil is expected to increase by around two per cent per year through 2000. While its ultimate recoverable reserves are still to be defined by comprehensive geological surveys, China's proven oil reserves at the end of 1990 were estimated to be 24 billion barrels, giving a reserves/production ratio of about 23 years. The realization of production targets will require continued exploration and development with consequent demands on

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investment funds. With increasing cuts in the government's investment budget, the possibility of expanding financing is limited and low administered prices for oil are generally not sufficient to provide the upstream sector with internal investment funds. While foreign investment in offshore areas has been encouraged since the early 1980s, it has not made a significant contribution to oil production and the government's current attitude to foreign investment in on-shore fields remains to be clarified. In addition, China faces similar refinery sector problems as the rest of the Asia-Pacific region and in order to meet the expected shifts in oil product demand, a considerable expansion and upgrading ofthe domestic refinery system will be required. The refinery sector is currently geared mainly to the throughput of heavy, low sulfur domestic crudes for the production of fuel oil. As the demand for gasoline and diesel fuel increases, as well as demand for petrochemicai feedstocks, the refinery system is likely to come under increasing pressure.

Summary and Conclusions 1. The Asia-Pacific region is expected to be the main engine for global oil demand growth in the 1990s with oil demand growing 3.3 4.6 mbd, depending on the oil price assumption. With limited scope to increase regional oil production, the dependency of the region on imported oil will increase. Substantial refinery investments will be required to meet the growth in oil product demand. There are sufficient projects announced in both the Asia-Pacific and Middle East regions to meet the growth in demand, but recognizing past cancellations and postponements, refinery capacity is expected to continue to be tight. 2. Environmental issues are likely to become increasingly important and the most cost-effective solutions will involve improving the efficiency of the fuel used as well as the quality offuel used. 3. Strong growth in the use of natural gas is seen as desirable to increase diversity of energy supply, to reduce environmental problems and to assist in meeting the rapidly growing demand for electricity. 4. Increased efficiency in energy use is seen as a major contributor to solving a range of problems, improving the environment,

146 John P. Ferriter

decreasing energy import dependency and hence potentially improving the balance of payments of individual countries. 5. Governments clearly have a substantial part to play in meeting these challenges through facilitating investments and setting clear guidelines on environmental and other policy issues. Many of the issues confronting non-OECD countries today have already been faced by OECD countries and we hope that non-OECD countries can learn both from the latter successes and their failures. The lEA are anxious to facilitate that process in any way which would be helpful. The world's energy markets are truly global and developments in this region will affect the energy security and environment for us all. Notes 1. In 1989, available data indicate that non-commercial fuels provided about a quarter of the non-OECD Asia-Pacific's total energy requirements . This proportion ranged from near zero to over 50 per cent in some countries, including Bangladesh, Myanmar and Nepal. 2. BP Statistical Review of World Energy, June 1991.

References

British Petroleum Company. BP Statistical Review of World Energy, June1991. International Energy Agency (lEA). Energy Balances of OECD Countries, 1980-1989. Paris: OECD, 1991a. _ _ . Energy Statistics and Balances ofNon-OECD Countries. Paris: OECD, 1991b. _ _ . Energy in Non-OECD Countries. Paris: OECD, 1991c. _ _ .Energy Policies of lEA Countries. Paris: OECD, 1991d. _ _ . Energy and the Environment: Policy Overview. Paris: OECD, 1990. _ _ . World Energy Statistics and Balances, 1971-1987. Paris: OECD, 1989. _ _ .Energy Balances of OECD Countries, 1970-1985. Paris: OECD, 1987.

The Asia-Pacific Oil Market Trends and Outlook Hugh E. Norton

It is commonplace to say that the Asia-Pacific is now regarded as vital in the strategic calculations of many global companies. In particular, East Asia, a region which we may define by the triangle stretching roughly between Japan, Myanmar, and Indonesia (Figure 7.1), has fully emerged as the star performer in the global economy. It has been the world's fastest growing economic region for the last three decades. Since 1960, annual growth has averaged 6.4 per cent which is approximately double that of Western Europe and the United States of America. Many economists believe East Asia will continue to achieve growth well above the world average for the next 20 years (Figure 7 .2). Even if the phrase "Pacific Century" is not on as many lips now as five years ago, few observers from outside this region - let alone inside it - doubt its capacity to grow impressively well into the next century. Yet while it supports a third of the world's population and accounts for 20 per cent of the world's gross domestic product (GDP), a proportion that is clearly going to increase, it has only some 4 per cent and 5 per cent of world proven oil and gas reserves respectively. Thus policy issues such as how far and by what means to encourage exploration and production, what priority to give to restraining consumption, and, what is the optimal target energy "mix" and the optimal spread of refinery capacity, will continue to dominate our agenda for years.

148 Hugh E. Norton

FIGURE 7.1 The East Asian Region

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Picking our way through these obvious issues, we can see that a shift of priorities for the oil industry in the Asia-Pacific region has taken place in recent years. Not long ago, discussions about the state of the industry centred on the question of security of crude oil supply. Many East Asian countries are heavily dependent on imported crude, and the region overall is net supply deficit. And added to the above average economic growth rates were the region's low share of global proved and probable reserves and the relatively (or totally) underexplored frontier regions. The result was a lot of debate about accelerating the finding and development of indigenous hydrocarbon reserves. For Japan, Korea and Taiwan, there was also some degree of choice between dependence on imported oil and imported gas, a choice which has recently been accentuated by environmental pressures favouring gas over oil- which is discussed later.

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