Read the full article here. In my role as Energy Policy Adviser to the Institute of Directors, here is my latest contribution with my excellent co-author, Corin Taylor. Unfortunately, far too many people in the energy industry and energy policy circles are stuck in a pre-recessionary timewarp. They just don’t seem to have caught up with the fact that our current raft of energy policies are running far ahead of ordinary people’s budgets and the balance sheet strength of our utilities. Energy policy is not just a question of political will and it really shouldn’t be immune from cost-benefit analysis and some open criticism of the underlying energy assumptions. Sometimes I wonder, does our energy policy have no clothes?

Read the full article here – Energy policy for a less affluent age.

Read the full pdf here.  A special thanks to our brilliant Space Fellow, Jim Bennett – as well as many others – on helping me with this wide-ranging feature article in the latest quarterly publiction of the Institute of Directors. Truth to tell, if you want a positive story about the UK Economy, this is almost the only one going.

It’s fascinating as well to realise that some of the best places for Spaceports in the UK are in Scotland – which now comes with a new kind risk for investors should it become independent. It seems we are a long way from really fully understanding the costs and benefits of Scottish independence. But with my energy hat on, I for one wouldn’t bet on renewable energy subsidies and oil prices remaining high and stable into the future – which together form a big part of  the Scots Nationalists’ calculations.  Permanence, after all, is the illusion of every age.

Read the full pdf here - The UK Spaece economy: the present and exciting future.

Download from here.

1. Iraq – really surprised almost no one has picked up on this. Iraqi production is currently around 2.7m bpd but could well reach 9m bpd by the middle of the next decade. This will massively alter the balance of power in OPEC – the Saudis won’t be too thrilled – as Iraq is not part of OPEC’s allocation system. I picked this up in yesterday’s Wall Street Journal Europe in a section by IHS Cambridge Energy Research Associates – of Daniel Yergin fame.

2. Shale oil – the technology that revolutionised the US natural gas industry – hydraulic fracturing – is now coming to oil. Optimists are saying that shale oil production could cut US oil import needs by 20% within 5-6 years.

I don’t share the pessimism of many about the revolts in Tunisia, Egypt and Libya. So what if it is somewhat directionless and entirely unanticipated – that part of the world has tried foreign rule, autocracy, military and religous dictatorships and found them all wanting. Virtually none of these protesters are crying out for a return to or enhancement of any of those systems.

It’s not a fashionable view, but I’m increasingly convinced that Francis Fukuyama will be proven correct that the end of history – i.e. that all paths will eventually lead to the least bad system – liberal democracy – because everything else is deemed to have failed. It is a question of time, albeit a long one.

Having said that, I certainly don’t share the optimism which seems a little too prevalent on oil prices and here’s why;

Optimist argument No. 1 – Libya is only 1.7% of world output and Saudi Arabia can easily close the gap.

Wrong for the following reasons.

The cut of crude that comes out from Saudi is high sulphur and harder to refine. Refineries are built to refine a certain type of crude and they can’t easily switch over.

Although oil is a globally fungible commodity, this has a highly regional impact because most of Libya’s exported crude went to Italy, Germany and Spain.

Even if Saudi cranks up production the oil will still have to be extracted, refined and transported. That takes time and would require a change of existing agreements.

Optimist argument no. 2. The IEA will release up to 1.6 billion barrels of spare inventory which will keep prices down.

Wrong again. If you reduce the cushion for supply disruptions by lowering reserves the market will price in higher risk and higher prices. The real question is who can lift supply and immediately? Answer – no one really.

Optimist argument no. 3. OPEC are sensible enough not to drive the world economy into recession and will quickly agree to lift production.

Even more wrong. OPEC have a terrible record of controlling prices – they can’t – and they are not slated to meet to discuss new quotas until June 2nd 2010 in Vienna. And that’s assuming that they would agree in the first place about what an acceptable price is and not cheat on their quotas.

This unrest also has long-term implications for the investment risk models of the sorts of long-term fixed capital projects needed to meet future oil demand. Typically it’s a 10 year gap between oil discovery and bringing it to market. I wonder how much money is going to be written off in Libya?

Of course, this is a one-sided post meant to take issue with received opinion.

I’ll be balancing it with a grounds for optimism angle later in the week.

Faith Birol, Chief Economist of the IEA  is worried about the impact of oil prices

OPEC is always walking a tightrope between the higher oil prices demands of its producers and finding a price low enough to suit mostly Western consumers without turning them away. Would that they know where precisely that balance was and even more, reach it !

And for all that, it’s not like they even agree amongst themselves – at the last OPEC meeting in December, the Saudi Oil Minister, Al Naimi, said he favoured an oil price of “$70 and $80 a barrel” whilst his neighbouring Kuwaiti confrere, Sheikh Ahmad al-Abdullah al-Sabah, today said he considered oil at $80 to $100 a barrel to be fair price. Is that just because it’s gone up in the meantime?

Anyone who asserts they know what the oil price is going to do is foolish in the extreme. But we can sketch out scenarios of what might happen. The first point is that OPEC are not scheduled to meet again to discuss quotas until June 2011. That may well change. The second is that some analysts believe that the US Summer driving season just might lift the price of oil to $120. And the third influence that outweighs everything else are extreme events like;

i) A Mideast War – involving Iran trying to close down the Straits of Hormuz in response to a US and/or Israeli attack

ii) A trade dispute between the USA and China – forcing China to revalue its currency upwards and thus effecitvely make oil cheaper (because it’s priced in dollars) and massively increase Chinese demand for the black stuff

iii) Tensions going hot between the 2 Koreas

iv) Some sort of collapse of the Euro – leading to mass selling of Euros and a retreat to quality – commodities like oil and gold

Hopefully, none of these will happen. But the risk is there and higher oil prices will come with them or even some inkling of their possibility.

One way or another, we do seem to have reached a new trading range – where $80 is the new $70 – as a recent note from Lombard Street Research made clear. Maybe next year OPEC leaders will be saying a fair price is more like $110 a barrel . . . Plus ca change !

“We have all but lost the capacity to think strategically . . . we have simply fallen out of the habit, and have lost the culture of strategy making.”

So says, according to Philip Johnston of the Daily Telegraph,  a report of our Parliament’s Public Administration Select Committee -  not yet up on their website, please let me know when it is – and it’s hard to disagree.

For me the answer is quite stark – government has placed far too much emphasis on cost rather than value. Only if this is rebalanced with long-term incentives, will we ever develop large, long lifespan strategic assets. And as Johnston rightly points out, nowhere is this more true than post the Comprehensive Spending Review,  in energy or defence.

What is the value of aircraft carriers’ conventional deterrence, low and high intensity warfare air support and disaster relief capabilities over 40 years that these mobile airbases can bring to anywhere in the world?

Equally, what is the value of a Severn Tidal Barrage’s 100% predictable power output with zero fuel costs throughout its 120 year lifetime?

So if you’ll forgive the pun, I’d like to crudely summarize some of the best points from Bower’s book thus;

1. There’s actually plenty of oil – it’s just in the wrong place, too many restrictions on its extraction, limited finance and bottlenecks in refineries
2. The immensely diverse oil industry – downstream, upstream, traders, engineers, accountants, politicians, economists, refinery workers etc. all work in silos and don’t interact, less still understand each other
3. So no one apart from the occasional brilliant or lucky trader has any lasting insight on the price of oil which has a massive impact on the investment horizon
4. As for the IOCs (Independent Oil Companies)
5. BP under Lord Browne was very go-ahead trying to boost reserves and sloppy on safety and outsourcing engineering (this before Deepwater Horizon)
6. Shell prospered but was often beset by Anglo-Dutch internal squabbles and having rings run round it by  Oligarchs, Greenpeace etc.
7. Exxon is a stultifyingly dull bureaucracy, obssessed with safety, has absolute faith in itself and is usually right
8. As for the NOCs (National Oil Companies)
9. They may have the oil, but they don’t have the technology or the finances and tend to overstate their reserves
10. And they constantly strive to renegotiate settled deals with scant regard to reputation or the balance sheets of their partners
11. Oil producers are ultimately far more dependent on consumers than the opposite
12. It’s all about achieving an elusive balance between governments, regulators, markets and nature

For all that, compared to preceeding years, oil prices have now gone through a year of relatively high stability, largely in the $65-$80 range which makes me think it won’t last.

So I keep wondering about this piece in the Wall Street Journal a few days ago, The Trade and Tax Doomsday Clocks. Whilst being critical of the Currency Reform for Fair Trade Act which would mandate the US Department of Commerce to take a foreign country’s currency interventions into account in determining whether its trading practices are unfair (crazy in my view – see my earlier post) it makes a fascinating point about the impact such a policy would have on the price of oil;

“…an unintended consequence is that it will make China an even more voracious competitor for oil. That’s because oil is priced in dollars, so a revaluation would make it cheaper in yuan terms. Remember, during the period from 2005 to 2008 when the yuan was revalued under similar political pressures from the U.S., the price of oil rose, not coincidentally, to $147 per barrel from $60. That could happen again—and it would be another inflationary tax on U.S. consumers.”

I looked at this chart (CNY:USD 5 years)  and this seems to be true. The roughly 16% gain in the Yuan over the last 5 years against the dollar is quite well correlated to the jump in oil prices that we had over that period. So maybe we now have a clearer idea with recent history in mind of what can cause oil prices to go up again?

The bottom line is that the USA has had all the benefits of having the global currency – cheap credit, low transaction costs and enormous diplomatic leverage for too long to now turn round and demand China revalues their own which will cost the Chinese and the USA dearly if not managed gradually. And should such a dispute kick off, all sorts of unintended consequences like higher oil prices will hurt the rest of us. I really hope America’s politicians pull back from the brink on this one. Because as I wrote back in Spring 2007 for World Finance magazine, The nightmare of a Chinese economic collapse, the consequences could be very ugly.

That said, I couldn’t help but laugh when I found out how unpopular Greenpeace is in Greenland. The route cause of this is their opposition to seal-hunting which pretty much shut down one of their two export industries – seal furs. So I’m not surprised they’re not getting a good reception this time round.  And let’s face it, Greenlanders aren’t the sort of people to care what outsiders think of them – they are the only territory to have joined and left the European Union. I can just see Brussels Eurocrats choking on the audacity of that one !

Right now, the biggest industry in Greenland is prawn processing – so it’s only natural they’d want some diversity away from that.

“The £200 billion generation game: Can the electricity market deliver our energy policy goals?”

To which of course, my answer was an emphatic no. The money is just not there. And no one in the audience seemed to register even a flicker of disagreement.  A real shame then that none of this politicians are giving it a mention during the general election, less still the leaders TV debate last night.

However where I respectfully disagreed with my fellow panellsts and some in the audience was on the security  of future UK gas supplies and the implication of the non-delivery of renewables targets around the middle of the next decade when the energy gap is forecast to kick in. It seems to me fairly obvious that the coal fired power stations due to close down in 2015 thanks to the EU’s Large Combustion Plant Directive will have to remain open for a few more years until cleaner plant becomes available and the 2020 target will have to be renegotiated.

However some of those in the gas industry would disagree. Their view is that because plenty of CCGT and LNG terminal capacity is being installed, the gas will be also there.  But I would have much more confidence in their rosy predictions if I didn’t know that the UK will have to compete in the spot market for LNG cargoes, which last year were 87% sewn up in long-term supply contracts and destined mostly for the Pacific Basin.

Thanks to the West’s recession, US shale gas discoveries and a consequent LNG supply surge, there’s no denying that there is a global gas glut at the moment. Yet as it is not yet a truly fungible commodity, it’s a very long way from solving local and pricey shortages which the UK is overexposed to. We are still at the wrong end of European  gas pipelines, a long way from the LNG target market of the Pacific Basin and demand is going to rise, not fall, especially with a population destined to reach 70m by 2030.

That’s why I fear, due to our own mismanagement, the UK’s power supply just might be at the mercy of external events over which we have little control from 2015/16.