Memorandum by John Mitchell
Part of the material in this submission has
also been submitted to the House of Lords Committee on Energy,
Industry and Transport, Sub-Committee B.
John Mitchell is Chairman and Associate Fellow
of the Energy and Environment Programme of the Royal Institute
of International Affairs, Adviser to the Oxford Institute of Energy
Studies and Honorary Fellow of the Centre of Petroleum and Mineral
Law and Policy of the University of Dundee. He worked for BP from
1966 to 1993, where his positions included Head of the Policy
Analysis Staff and Special Adviser to the Managing Directors.
He makes this submission in his personal capacity and not as representative
of any organisation.
1. Energy supply for Europe and the United
Kingdom within it will be best secured by continuing participation
in the global system of energy trade and investment.
2. This approach has three major advantages
over the 1970s approach, which focussed on national supply and
demand, and regarded imports as a problem rather than an opportunity.
It is realistic, and likely to be
the cheapest policy in the long term;
It enables importers to benefit from
competition between diverse suppliers across the world, and exporters
to have access to markets which combine size and diversity;
It can be meshed with the foreign
and trade policy of the UK as a member of the EU and the WTO.
3. However, the "system" is nether
perfect nor complete. It is necessary to be prepared for circumstances
when it temporarily fails to deliver the expected benefits of
competitive prices and flexible supply.
4. The September 11 attack on the US does
not alter the merits of this approach. There has been no change
in the long run availability of fossil fuels, their environmental
effects, or the structural factors which support the maintenance
of competitive energy markets. It may be necessary to address
the risk that some oil exporting countries may find their gradual
assimilation to the international trade and investment system
interrupted or reversed by domestic reactions to the "war
5. It is inappropriate to try today to determine
the mix of fuels in the UK which would maximise energy security
for the UK over a fifty-year period. The priority should be to
develop a framework of policy to maintain a diversity of UK and
foreign supply options. Policies affecting investment in the UK
in vehicles, roads, buildings, power stations and energy use which
affect primary energy demand are of equal importance and because
of the long lead times involved should receive priority: it is
easier to switch fuel supplies than to change modes of transport,
types of power generators, or the location of factories and cities.
6. The essential elements of such policies
are the promotion of competition, proper attribution of direct
and "external" costs, and the use of private investment
consistent with the general structure of the economy. To maximise
the freedom of suppliers and consumers the greatest possible diversity
is likely to be achieved by participation in, and development
of a competitive and liberal system of international trade and
investment, with appropriate fail-safe mechanisms.
7. "Fail-safe" mechanisms may
include government intervention either nationally or at an EU
or international level. Such intervention may be necessary to
protect competition and provide opportunities for certain types
of investmentfor example in infrastructure, reserve capacity
and long-term researchwhich might not otherwise arise in
liberalised competitive markets. Governmentcentral or local,
is also responsible for investment which shapes its own demand
for public sector activities, for regulations which shape energy
demand though protecting the environment, allocating rights to
the use of land, air or sea by consumers, enterprises, and subsidiary
levels of government.
8. International trade remains a major source
of energy supplies in most major consuming countries (see chart
1). The classic advantages of trade apply to fuels produced from
natural resources: the resources are where they are, and cannot
be reproduced by the application of labour and capital anywhere
else. For the export-dependent energy producers, likewise, the
economic benefits of the world market are enormous. Chart 2 shows
their dependence on exports for their energy markets. China and
the UK are exceptional in their low energy trade.
9. Even if countries like the UK and China
were to introduce policies to maintain a rough balance between
physical imports and exports of energy fuels, or reduce imports
to zero, world energy trade would continue. World prices for traded
sources of energy such as oil, gas and coal would affect the "self-sufficient"
countries. Isolation from such prices could not be achieved without
constructing trade barriers, which would be incompatible with
the UK's membership of the EU and the WTO and China's forthcoming
membership of the WTO.
10. Energy exporting countries have a strong
interest in maintaining and expanding international energy markets.
Without energy exports they could not achieve the GDP, and their
government could not achieve the budgets, which they have. This
is especially true in the case of oil, where prices in the international
market significantly exceed the average cost of production in
the main exporting countries. International oil trade is equivalent
to roughly 60 per cent of production and consumption. Oil exporters
are dependent on the international market. Chart 3 shows that
70 per cent of the world's oil exports originate in countries
each of which depends on the international market to buy 70 per
cent or more of its production.
Price spikes and dips
11. Oil supplies (from a major exporter
to the international market) have been seriously cut back or stopped
for a period of 3-18 months at times during the past 50 years
because of political disruptions (Iran 1951 and 1979-80, Iraq
and Kuwait 1990-91, Suez canal crisis 1956, Arab oil embargo 1973).
Price spikes may be generated by local and temporary supply problems
(as in North-East-US heating oil, or US West-coast gasoline, in
2000). Commercial factors can also cause price spikes. Commercial
factors may also cause price collapses (as in 1985 and 1998),
which are damaging to investment in future oil and other energy
supplies. Fluctuations in the spot price of oil spill over onto
domestic oil and gas prices and imported gas prices.
12. Financial pressures have tended to minimise
commercial stocks (both in the distribution chain and at the point
of use). When local and temporary shortages occur there is intense
bidding for marginal supplies and these prices are rapidly transmitted
to the international oil market.
13. The probability of such spikes is high.
14. The main impact of future price spikes
would be economic. In an inflationary situation there could be
a knock-on effect through the RPI. The spike in transport costs
would affect certain sectors such as haulage and farming, as in
15. Since government revenues in European
countries will be boosted through VAT revenues on higher prices,
there would be scope for mitigating the inflation effect by temporarily
lowering fuel duties.
16. There may also be scope for considering
some insurance-type mechanism by which those directly and immediately
affected could access the government-controlled compulsory oil
stocks (see para 19 below).
17. IEA sharing mechanisms, including the
release of government controlled compulsory stocks, should make
it possible to mitigate the effects of very large disruptions
of oil supply.
18. The probability of such disruptions
is low but not zero.
19. There is a higher probability that oil
supplies, and prices, can be temporarily affected by smaller political
disruptions, as in 1980, or local disruptions caused by protests
(as in Europe in 2000), or strikes (as in the UK in 1974). Price
spikes can also be caused by extreme weather conditions affecting
demand or distribution, or disasters (such as a nuclear accident)
affecting other energy supplies.
20. For the UK the main physical response
at the level of local distribution is the national emergency planning
put in place in 2000. The price problem cannot be solved in the
21. The level of IEA and national compulsory
oil stocks may be less important than the rules about when and
how they should be used. IEA mechanisms are automatically triggered
only when supply shortfalls exceed seven per cent, either for
the whole IEA group, or for an individual country. This means
in practice that the compulsory stocks can be used only in an
international emergency and under conditions and in quantities
determined by agreement between governments acting through the
IEA. They do not provide insurance against smaller disruptions
which may nevertheless have significant effects on spot oil prices
and all that depends on them.
22. There are many dangers in governments
trying to target stock releases directly against prices. They
become politically responsible for the prices. Their actions may
be ineffective. Speculators will bet against the Government. However,
there may be an alternative. Some of the compulsory stocks could
be made available to distributors or large consumers under defined
conditions of specific disruption. This possibility would reduce
their uncertainties about future supply, and lessen the likelihood
of their resorting to the spot market, while leaving the decisions
of whether to call on the insurance or use the stocks as an individual
commercial matter. A scheme of this kind was put to the IEA in
the early 1980s. The idea should be re-examined.
Embargoes of supply
23. Unless very widely targeted and widely
observed embargoes by oil exporting countries (as in 1973) will
simply bring about reallocation of supplies in the international
market. If widely targeted, the problem becomes a major political
problem on the Gulf War model.
24. Distortion of international trade could
also occur through a UN or US embargo against supplies from selected
exporting countries or against foreign investment of funds or
technology in their oil industries (UN sanctions on Iraq, US sanctions
on Iran, Sudan, Burma, Libya). On the historic record, the probability
of UN or US embargoes against exporters is higher than of exporters'
embargoes against importers, which last occurred in 1973. The
UK would be involved in the international political situation
created by such embargoes even if the UK were not an importer.
25. The remedy is to focus on the political
situations likely to give rise to embargoes.
26. The international trading and investment
system will not guarantee stable oil prices over the medium term:
investment cycles are inevitable.
27. The risk is that import prices could
be distorted by collusion among major exporters.
28. Some degree of collusion can be expected
to protect a floor price (as in 1999-2000). For the future, the
scope for managing permanently higher prices by collusion among
exporters is limited by the possibilities of international competition
and demand response in liberalised domestic energy markets. Also,
the uneven distribution of resources among exporters means that
they have different interests in expanding supply and are likely
to find it difficult to restrain expansion and competition between
them. For a cartel to work it needs rules for sharing markets.
In crises of over-supply and very low prices (1985-86, 1998-99)
OPEC members have eventually cut production more or less in line
with pre-crisis production. They have no precedent for allocating
the expansion of production which is currently predicted for the
period 2005 onwards. Different countries have different potential
for expansion, and their oil reserves are not distributed according
to their populations and needs for revenue, as Chart 4 shows.
Competition is inevitable. Regional and national rivalries will
also support such competition. The
probability of raising prices by sustained collusion is therefore
29. The (small) risks of successful medium-term
collusion may be countered by enlarging the international market
with policies to promote trade and investment. This involves understanding
the energy exporters' problems, arising from insecurity of markets,
and their need for broadly based development. A dialogue with
energy exporters is more likely to be successful if it focuses
on a common recognition of the benefits of continuing energy trade
than if importing countries enter the dialogue with the objective
of reducing their "import dependence".
30. The risk is "short-termism".
Oil and gas production capacity might "plateau" before
sufficient investment has been made in long term projects for
heavy oil, gas infrastructure, alternative energies, or less intensive
energy demand. There would then be a prolonged period of high-energy
prices which will cause avoidable economic damage before creating
a surplus of new capacitya prolonged and exaggerated version
of a commodity investment cycle.
31. Probability is uncertain.
32. The policy debate is about the cost
of anticipating a problem which might not occur versus the cost
of catching up if everybody waits for trouble to happen. One of
the main themes of The New Economy of Oil is that there
are many options for "catching up" which would be economic
if oil prices rise significantly above their 1986-99 average of
about $20-22 in today's money. The small role of oil in the main
importing economies now means that they could stand a period of
prices above that range during the lead-time of new investments
to correct the imbalance. The alternative, expensive anticipation,
would be very difficult: it would require heavy government intervention,
and the more successful it was, the more expensive it would appear,
as the short term oil price against which the policy is measured
would be lower.
33. This scenario is one where damaging
effects of climate change become politically credible in many
countries and there is a rush to impose climate protection policies
to make up for lost time. Demand restrictions policies would thus
be severe, and based on "command and control" (rather
than economic instruments) to achieve early, certain results.
34. Oil and energy prices would probably
fall (from what they otherwise would be) in response to the demand
measures. This in turn would create a need for even stronger intervention
in demand. To the extent that taxes were used to reinforce demand
restraints, there would be political challenges in recycling government
revenue: hypothecation of money towards investment in demand reduction
and alternate energies would be likely. If there is no co-ordination
at least across the EU, broader trade and investment flows and
open markets might be compromised.
35. This scenario thus presents a political
and institutional threat to the multilateral and European open
economic systems as well as a threat of economic damage through
the "stranding" of old energy consuming technology and
infrastructure, and a medium term welfare damage in diverting
resources from consumption to new investment.
36. Probabilityincreasing with failure
to develop real global climate protection policies.
37. The policy challenge from this scenario
is like that of the "resource shock": anticipation versus
"wait and see".
38. "Keeping options open" remedies
Avoiding early closedown of nuclear
plants and recognising the climate benefits in proposals for new
nuclear plants in the UK and elsewhere;
To make early progress with globally
acceptable climate protection policies;
To construct mechanisms for establishing
options (learning-by-doing, pilot schemes) and market oriented
mechanisms for enabling the application of low energy technologies;
For public authorities to take a
lead in their unprivatisable responsibilities for transport systems:
making the conditions for investment in infrastructure and in
allocating space with a long term lower energy system in view.
11 ATTACK ON
US AND THE
39. In the short term the US and UK attacks
against Afghanistan are unlikely to affect oil supplies. The main
effect will be on demand through the effect of uncertainty on
consumer spending and investment in many countries. This should
lead to lower prices in the short term as OPEC governments are
likely to delay cuts in production rather than being seen to add
to the recession by trying to keep prices high.
40. In the medium term (up to five years
from now) the main risk is in those oil exporting countries, which
are exposed to internal conflicts about their government's relations
with the US alliance against terrorism. In my book The New
Geopolitics of Energy
I argued that the Middle East oil exporting states' relations
with the rest of the world depend on the domestic equilibria between
various conflicting forces: social (religious versus secular);
constitutional (democratic versus monarchical); and relations
with modern industrial countries (co-operation versus distancing).
The US attacks on Afghanistan in response to the terrorist attacks
on the US clearly add to these tensions. They also focus other
hostility towards the USnotably regarding its support for
Israel at the time when the "Peace process" has ceased
and Palestinians are under continuous attack from superior Israeli
41. Saudi Arabia has been uniquely successful
in maintaining these internal and external balances. As a result
Saudi Arabia has been able to get the western technology and investment
that it wanted on its own terms. The Saudi ability to rebalance
and continue balancing these domestic tensions is important. Saudi
Arabia supplied 12 per cent of world oil production in 2000, but
about 20 per cent of world exports. The existing spare production
capacity in Saudi Arabia is a buffer against unexpected reductions
in supply from other countries. Saudi Arabia's reserves account
for over a quarter of the expansion of world oil supply foreseen
by conventional projections over the next 20 years.
42. The international system of energy trade
and investment which is the basis of global energy security is
founded on co-operation between secular and democratic states
with market economies, where the rule of law protects these characteristics.
The extent to which the Middle Eastern oil exporting countries
continue to increase their participation in this system will have
a big effect on what the system can deliver and what needs to
be done to strengthen it.
43. The international trade and financial
markets will continue to provide the cheapest security of energy
supply for the UK and Europe, but the short and medium term risks
have increased. Consumers have to be prepared to deal with them
without attempting the futile task of breaking up the international
energy system. So, just as we have to get smarter about preventing
terrorism, we have to get smarter about minimising market destabilisation
in the future.
44. What to do? I believe the keys are:
Reinforce the international energy
trading and investment system: attack the obstacles (lack of open
markets, problems of infrastructure investment);
Strengthen the old safeguardsstocks,
and infrastructure for diversificationthrough interventions
which preserve competition and international access; the idea
of allowing individual access to national compulsory stocks as
an insurance against local or temporary disruptions should be
Review the determinants of long lead-time
demand: especially in the transport and buildings: The EU Green
Paper on Energy Supply Security suggests approaches to this problem;
Attend to foreign policy, which now
is critical to energy security for importers as well as exporters.
In the light of this analysis, my views of the
questions set out in Press Notice 3 of 20 September are as follows:
Given the imminent dependence of the UK on energy
imports, how can the UK maintain a secure energy supply? What
mix of fuels would maximise security?
45. Security is relative. Reverting to the
pre-1975 use of imports is still likely to leave the UK relatively
less engaged in international energy trade and therefore less
exposed to its risks.
Is there a conflict between achieving security
of supply and environmental policy? What is the role for renewables,
and Combined Heat and Power schemes?
46. Certain environmental policiesfor
example the reduction of greenhouse gas emissionsare likely
to reduce the use of high-carbon fuels such as coal (whether domestic
or imported). This would reduce the potential diversity of energy
supply. On the other hand, carbon-targeted policies would increase
the relative attractiveness of nuclear energy and the potential
market for renewables. The merits of combined heat and power schemes
are heavily dependent on the nature of the electricity supply
system and its capacity to provide secure and competitively priced
supplies from decentralised sources dependent either on the weather,
on agricultural results, or on heat-using demand. The key is reasonable
and consistent pricing of "externalities" such as carbon,
the costs of decentralised versus central electricity generating
systems, and the management of weather-dependent supplies.
What scope is there for further energy conservation?
47. There is always scope for further energy
conservation: the question is at what cost. The EU Green Paper
on Security of Energy Supply and its related initiatives on building
and transport could have a long-term effect on the energy intensity
of the European economy, if applied in the UK.
What impact would any changes have on industrial
competitiveness and on efforts to tackle fuel poverty?
48. The impact on competitiveness depends
on the changes. Policies aimed at exploiting the benefits of international
energy trade and investment should minimise the risk of disadvantage.
49. Fuel poverty is a different problem:
addressing the poor insulation and ventilation standard of the
UK building stockif necessary by direct subsidies or by
tax incentives for redevelopmentwill help the "fuel
poor". The problem of the "transport poor" is more
difficult, since UK fuel taxesprobably beyond the level
justified by externalities, bear heavily on poor users of vehicles.
Is any change of Government policy necessary?
How could/should Government influence commercial decisions in
order to achieve a secure and diverse supply of energy?
50. My key recommendation is to focus on
making the international energy trade and investment system work
better rather than to try to reduce the UK participation in it.
Necessarily this involves seeking a similar
policy in the EU on the matters within EU competence.
Specifically, I suggest consideration of the
(para 12) Price spikes: Mitigating
the inflationary effect of temporary price spikes in transport
fuels by recycling the higher VAT revenues which they generate
through reductions in motor fuel duties.
(para 19) Local disruptions: Study
possibility of using part of compulsory stocks to provide insurance
of supplies for those specifically affected.
(para 22) Embargoes: Focus on political
remedies for situations likely to give rise to embargoes against
(para 26) Cartel risk: Enlarge the
international energy trade and investment system to engage countries
with exportable cheap energy to engage more closely in it. This
means abandoning the objective of "reducing import dependence"
in favour of a policy of stabilising inter-dependence. Open, liberal
energy markets facilitate the diversification of competing supplies
Resource shock (para 29) and climate
shock (para 35). The key is to keep options open: The EU Green
paper recommends an approach to long lead-time demand in transport
and buildings. This should be supported and made operational in
ways consistent with competitive markets and consumer choice.
On the supply side the main risk is the failure to provide policies
which could in future support maintaining and possibly increasing
the use of nuclear energy in Europe if a rapid reduction in carbon
emissions is decided upon.
29 October 2001
35 This case is argued in detail in The New Economy
of Oil, John V Mitchell and others, RIIA/Earthscan 2001, p
with Peter Beck and Michael Grubb, RIIA/Earthscan, 1996. Back