Two central themes have dominated the global energy economy over the past twelve months: supply security and climate security. Both six-month presidencies of the EU Council and Russia’s chairmanship of the Group of Eight summit focussed on these themes, while a European Commission Energy Green Paper in March and the UK’s Energy Review in July both structured their consultations around these themes. And as the year came to a close, two more reports rammed home concerns on both these themes in near apocalyptic fashion. The Stern review of the economic impact of climate change warned of future economic meltdown if action to redress climate change was not taken now, while the latest edition of the International Energy Agency’s World Energy Outlook warned of an “under-invested, vulnerable and dirty” energy future if the current business-as-usual approach is maintained. So the message of 2006 is clear: change now or face an uncertain, unstable and expensive future. The question for the market is whether it can collectively initiate the required changes.
Supply concerns have been evident since the first day of the year when Russia briefly turned off its gas exports to the Ukraine and look like ending in similar fashion with Georgia now facing similar retribution for refusing to pay inflated gas import fees. In between these two developments the EU has been trying to get Russia to ratify the Energy Charter Treaty, but without success. The contention of Brussels is that Europe provides the revenue from Russian energy exports that is needed by the Kremlin to build its economy. Such arrogance. Russia effectively separates Europe from Asia and, as Moscow pointedly explained, it could switch direction of its export flows to Asia and, in particular, China.
It is hardly surprising that no EU progress was achieved with Russia. Not only does Brussels believe that the EU is a honey pot of gold for Russian exports, but the EU25 does not speak with a collective voice. Each member state (Italy, Germany, Austria etc.) is seeking to tie up its own deals. But perhaps the main reason that no progress on energy was achieved during the year was the lack of reciprocity. Russia wants access to the EU downstream market; Brussels wants access to Russia’s energy market. Neither is prepared to accede to the other’s demands.
Amid concerns from the US that Russia is using its vast energy reserves as a new political weapon some have suggested that energy could be the new cold war. But dramatics aside, what has become more evident over the past year is the growing overlap between energy and foreign policy, with the energy market becoming increasingly reactive to foreign policy. The standoff between a US-led UN and Iran on the development of its nuclear programme, the refusal of the US and UK to promptly call for a quick ceasefire in the Israel-Lebanon war during the summer, and the ongoing conflict in Iraq with its wider knock-on effect in the Middle East have all impacted the energy market during the year. And as indigenous energy supplies reduce there will of course be a greater fusion between energy and foreign policy, as some economies become more import dependent.
Climate concerns have also been high on the global agenda in the past year and last month the World Meteorological Organisation underlined the challenges faced when it announced that global average concentrations of CO2 in the atmosphere were at their highest levels ever recorded in 2005. The UN Framework Convention on Climate Change also reported greenhouse gas emissions increasing by 2.4% between 2000 and 2004 for Annex1 parties. Some now believe that China’s emissions could exceed those of the US by the turn of the decade, although not on a per capita basis, yet the US, China and India, which collectively produce over 40% of global emissions, refuse to implement carbon caps. And even the EU, which is the most progressive economic region in regard to carbon caps and mitigation, saw its emissions increase.
The common factor that underpins both energy supply and climate security is the economy. Last year, as in previous years, the economy was the primary driver of the global energy market. In the emerging Asian economies, led by China, surging economic growth has maintained strong energy demand, which in turn supported energy price increases, with the knock-on effect of increased emissions. In the US, continuing concerns surrounding the impact of carbon constraints on economic growth had a strong influence on US energy policy with the market becoming more isolationist. And Europe, meanwhile, continued to be influenced by both US and Asian economic developments.
But there has also been little evidence of inelasticity between energy prices and economic growth. All the forecasts that energy prices would be capped once they became a drag on the economy proved unfounded. Indeed the opposite was the case – the economy continually readjusted to rising energy prices. What remains less certain is the relationship between climate security and the economy. The imposition of EU carbon constraints did not adversely impact the economy although the poor forecasting of business-as-usual emissions leading to the over-allocation of free allowances would have rendered any analysis of the relationship between carbon constraints and economic growth largely meaningless.
In tandem with economic drivers has been the continued growth in market consolidation through both mergers and acquisitions, with most of the consolidation being intra-region. Yet again this consolidation was most evident in the EU market as concerns surfaced that the market was in danger of moving towards economic protectionism. This further consolidation also led the European Commission to state its support of European national champions, as opposed to national (domestic) champions, as the best route to increased market competition. But EU energy competition did not improve in 2006 and if intra-regional consolidation is continued next year and beyond, the prospects of a competitive global energy market, let alone an EU energy market, look extremely limited.
What this past year has yet again illustrated is the fragmented regional nature of the global energy market with regard to both supply and climate security, and competition. Yet as both the Stern and IEA World Energy Outlook reports underlined, a global energy market requires a global solution. But any global solution also has to include a convergent approach to supply and climate security, and therein lies the fundamental challenge faced by the global energy market in the coming year, and beyond.