The UK’s Energy Supply: security or independence?

Memorandum submitted by Dr. Vlasios Voudouris (UKES 04)

Dr. Vlasios Voudouris,

Centre for International Business and Sustainability (CIBS),

London Met Business School, London Met University, UK

INTRODUCTION

1. This evidence is presented to the Select Committee to provide a perspective in terms of the threats, vulnerability and consequences of the UK Energy Supply System within a global-national context characterized by unprecedented uncertainties and increasingly complex intertwines. This contribution is based upon the ACEGES project (www.aceges.org). ACEGES stands for Agent-based Computational Economics of the Global Energy System. The ACEGES models the energy demand and supply of 216 countries.

2. The aim is not to present another set of quantifications for policymaking, as there are a number of reports and papers published in recent years. Rather the aim is to provide a coherent overview of i) the assumptions of the energy models used to produce the published quantifications and ii) the approach used to develop energy scenarios for the assessment of the UK’s Energy Supply.

3. I am a specialist in the modelling of fuzzy phenomena and complex adaptive systems such as the Energy System. My research work aims to support evidence-based energy policy by means of controlled computational experiments. Currently, I am the Deputy Director of the Centre for International Business and Sustainability (CIBS) at the London Metropolitan Business School. I am also the organise of the "UK Energy Day: Sustainable Supply" which is part of the European network of events led by the Intelligent Energy Europe (IEE) agency of the European Commission (EC).

4. It is evident today that the long-term sustainability of the UK’s energy system is under acute strain. Therefore the comments that follow mainly deal with the need to enhance:

a. The existing energy models to assess the sensitivity of the UK’s energy supply.

b. The way of developing multidimensional global-national continuous scenarios for long-term assessment of the resilient of the UK energy system to international events.

I will start with the latter.

Energy Scenarios

5. Energy scenarios are empirical frameworks that provide summaries of possible futures. Scenarios should reflect past history (e.g., political, social, economic, technical) and should be based on informed views about past history. Scenarios also need to reflect current realities and not reflect naïve views based on fashion or hope. Scenarios shed useful light on future possibilities as far as the country is concerned and should incorporate ‘low (subjective) probability’ futures where these may have significant impacts on the country. Scenarios aim to assist policy makers making long-term energy (and environment) related policies. These policies frequently involve investments with long payback periods, or investments of such a large size that basic uncertainties, which have been overlooked, can prove very costly.

6. Conventionally, scenarios are based on a sequence of events – meaning that discontinuities happen one after the other. However in times of unprecedented uncertainties and increasingly complex intertwines, scenarios should be based on networks of events – meaning that discontinuities happen almost simultaneously. A recent example is the current geopolitical events in MENA (the Middle East and North Africa).

7. Conventionally, global and national energy scenarios attempt to portray future possibilities using the concept of ‘representative country’ and conceptualise the country-specific energy systems as consisting of several identical and isolated components. This means that based on, for example, historical oil production of key producers (e.g., the US), the world oil production is assumed to have (more or less) the same production characteristics. This is effectively the attribution of properties to a different level than where the property is observed.

8. Conventional scenarios attempt to assess the pathways and impact of global and national drivers using the concept of ‘multi pathways’. Selecting specific values for the most uncertain and important driving forces does this. An example of this is given in Exhibit 1 below.

9. Exhibit 1 demonstrates that by:

a. Fixing two of the key uncertainties (growth at 2% and reserve/production at 10 based upon the US experience)

b. Taking three different estimates of ultimately recoverable oil reserves

three different pathways are plausible.

10. A key problem, for policy making, of the approach shown in Exhibit 1 is that it fails to emphasise the inevitable uncertainty around the outlooks for energy supply. It also fails to provide an assessment of the balance of risk between the different pathways. At a more technical level, the uncertainty is reduced to finite sets of certain values.

Exhibit 1: Discrete scenarios for evidence-based energy policy

11. To emphasise the inherent uncertainty of the future outlook of energy supply and to avoid oversimplifying the heterogeneity of the energy system, a new approach has been develop by the ACEGES project at the Centre for International Business and Sustainability at the London Metropolitan Business School. This new approach suggests the use of continuous scenarios that emphasise the uncertainty and give an assessment of the balance of risk. Exhibit 2 demonstrates this approach, which adopts the approach used by the Bank of England for its ‘Inflation Report’.

Exhibit 2: Continuous scenarios for evidence-based energy policy

12. Exhibit 2 provides probabilistic pathways associated with world oil production. The use of probabilistic pathways avoids suggesting a degree of precision that would be spurious and are appropriate when exactitude is elusive (while being approximately right is still helpful for policy making). If required, I am happy to provide further and more specific continuous scenarios to the Select Committee. These types of (both global and national) scenarios should be developed at regular intervals to reflect ‘forces in the pipeline’. Using a flexible decision-support tool such as the ACEGES tool (www.aceges.org), the anticipated overheads should be minimal.

13. To assess, for example, the exposure of the UK’s Energy Security of supply to international events, both global and national scenarios are required. In particular, the national scenarios should not only include the main energy trading partners of the UK. This is because events that are not directly related to the exposure of the UK’s Energy Security of supply can affect the exposure of the UK’s Energy Security through secondary and tertiary routes.

14. For example, taking Europe as a sing entity, 90% of oil is imported from the Middle East, North Africa, West Africa and Former Soviet Union. For the UK in 2010, 58% of gas was imported from Norway (98% was transported with pipeline) and 75% of all imported gas was transported with pipelines. These realities can change as we move towards 2050 given the increasing demand for electricity and transport fuels for the UK and other European countries.

15. Qatar (with substantial export capacity) might start to play, for example, a very important role by means of LNG imports to the UK, if home-grown energy sources for electricity generation and transport fuels are not well targeted. This reality clearly can have significant implications for the UK’s Energy Supply as diversification of resources (oil and gas) could lead to over concentration for energy imports on specific countries (e.g., over reliance on OPEC countries for oil and gas) and the need to update the UK’s infrastructure for imported energy.

16. The implications can become even more important if a ‘low (subjective) probability with significant impact’ scenario is developed to explore the threat, vulnerability and consequence of extended OPEC to include gas: The Organization of the Petroleum and Gas Exporting Countries (OPGEC). Similar risks and hedging strategies should be assessed if ‘renewable energy projects’ (e.g., DESERTEC Concept) are located in countries that already dominate the energy market.

17. Exhibit 3 shows country-specific conventional (cheap – also termed the Gucci oil by traders) oil productions (left column) and their corresponding export capacity (right column). For conventional oil production:

a. The green colour means no production,

b. The grey colour means production less than 1 million barrels per year and greater than zero.

c. The darkest colours represent, the higher production of conventional oil

For conventional oil export capacity:

d. Grey represents no export capacity (net importing countries).

e. The darkest colours, the higher the conventional oil export capacity of the country.

18. It is important to emphasize that these results are the output of a single simulation rather than the summary of a specific energy scenario. The aim of presenting them is to demonstrate the type of scenarios needed to assess the UK’s Energy Supply. The Select Committee can experiment with additional simulations using the ACEGES tool from www.aceges.org.

19. Given the outlook of the UK’s oil and gas production and the increased demand for flexible energy services of the potential energy trading partners is demonstrated in a visual way to assess the UK’s Energy Supply in terms of fossil fuels (a similar figure can supplied for gas). Note that although MENA accounts for more than one-third of the world’s oil production, their share of world’s oil export capacity (e.g., domestic production minus domestic demand) is substantially higher, particularly as we move towards 2050.

Exhibit 3 – Conventional oil production and export capacity

20. Given the geographically concentrated production of cheap oil and gas, the exposure of the UK’s energy security of supply to international events will be substantial after 2030 (possibly earlier) unless a significant acceleration of home-grown energy production for electricity and transport fuels starts soon with a realistic evaluation of the speed of the diffusion of new technologies and their claimed capacity for energy supply. This should be checked against the UK’s energy demand and the need for a sustainable energy import policy. This will have the combined benefits of improving energy security and resilience, addressing climate change and improving the sustainability of the UK’s trade balance.

21. Assessing the robustness of the UK’s energy policy and identifying plausible but unanticipated issues that can challenge the level of robustness of the UK’s energy policy requires further evidence based upon an understanding and informed view of the past and a systematic exploration of the significance of the ‘driving forces in the pipeline’. This requires a rethinking of how to support the UK’s Energy Policy. It requires an exploratory and iterative energy policy supported by controlled computational experiments. This will allow policy makers to rehearse the future and use the computational experiments as ‘early warning systems’.

22. To the best of my knowledge, this exploratory and iterative approach to assess the "threat, vulnerability and consequence" to the UK’s energy policy has not been fully employed. The ACEGES offers a way forward by allowing UK policy makers to simulate an artificial energy system under different UK policy scenarios and quantitatively explore how likely is the energy system to react under different policies or international events (e.g., geopolitical unrest south of MENA and/or north-east of MENA).

23. A country-specific tool to meet the UK’s targets for greenhouse gas emissions reductions for public use is HM Government's 2050 Pathways Analysis. The ACEGES is a global-national decision-support tool to assess the UK’s energy supply within a global-national context as it models the demand and production of 216 countries around the world (Exhibit 4).

24. I argue that a country-specific representation of the world energy demand and supply system using the concepts from complexity science (see ‘Energy Models’ below) can substantially support the UK’s energy policy in:

a. Assessing where the UK Energy Policy might be out of alignment with emerging megatrends.

b. Assessing the effectiveness of any hedging strategies for the UK’s Energy Supply System.

Exhibit 4 – The ACEGES laboratory for Energy Policy

Energy Models

25. For energy policy, energy supply modelling techniques can be classified into two broad categories, namely i) Resource-constrained models and ii) Econometric models. The most widely used models for long-term policy are resource-constrained models. Resource-constrained models are of two classes, namely a) curve-fitting models and b) heuristic models. Exhibit 1 shows the results of a heuristic model. The most popular curve-fitting model is the Hubbert curve or the oil mountain in the form of a normal distribution. The majority of publicly available evidence for the UK’s Energy Policy (particularly oil and gas outlooks) is based on the curve-fitting models.

26. Conventional energy models use computation for the empirical analysis of observational data and the calculation of the equilibria of systems of equations approximating (poorly) the energy system. They conceptualise the energy system as consisting of several identical and isolated components from which the solution is obtained by a simple summation of least-cost optimization through the operation of the Walrasian Auctioneer. These conventional models have a sorry history in terms of anticipating discontinuities because they are successful as long as things stay more or less the same. These models assume a perfect world, and by their very nature rule out crises of the type we are experiencing now.

27. It is important to make a distinction between models that assess the potential profit and the risk of individual trades or investments and the models that aim to assemble heterogeneous pieces and understand the behaviour of the whole national energy system within a multidimensional global-national environment. Conventional models can be useful for the former rather than the latter.

28. Fortunately, there is a better way: Agent-Based Computational Economics (ACE) models based on complexity science. ACE is the computational study of systems modelled as dynamic networks of interacting and heterogeneous agents with bounded rationality. Agents operate in an environment on which they live and with which they interact. Thus, the main building blocks of ACE are: i) the agent (e.g., country, multinational energy companies, national energy companies), network of agents (e.g. OPEC) and the Environment (e.g., Estimated Ultimate Recovery of fossil fuels).

29. ACE models do not rely on the assumption that the energy supply system will move towards a predetermined equilibrium state, as other models do. Instead, at any given time, each agent acts according to its current situation (e.g., domestic energy production and demand), the state of the world around (e.g., net demand for electricity and transport fuels) it and the rules governing its behaviour (these rules are primarily defined by policy initiatives).

30. To the best of my knowledge, the only ACE model of the global-national energy system is the ACEGES model. The ACEGES model has been developed to support iterative and exploratory energy policy by means of continuous energy scenarios. The ACEGES laboratory is a 'wind tunnel' that allows regulators to test policies and explore their emergent effects on the energy system. As a result, policymakers can use a computational laboratory to rehearse plausible futures and use it as an ‘early warning computational system’.

SUMMARY

31. I hope I have convinced you that the UK’s Energy Policy should be supported by controlled computational experiments simulating increasingly complex intertwines within a multidimensional global-national environment. The UK’s Energy Policy should not rely on evidence based upon over simplified models that assume that the energy supply system will move towards a predetermined state or profile (e.g., Hubbert curve or a variant of an oil mountain).

32. The history of energy supply is complex, and the interplay of climate, economy, investment, geopolitics, and many other factors defies simplistic analysis for evidence-based policy. A creative and organized modelling of energy resources is urgently required to better support evidence-based energy policy, regardless of future climate change.

33. In seeking to explore the indirectly and uncertain, and in some respects unknowable, future, the use of scenarios offers a solution. However, the UK’s Energy Policy needs to move away from discrete scenarios that fail to emphasise the inherent uncertainties and the balance of risk. Assessment of the UK’s Energy Supply needs to move towards continuous scenarios satisfying the ‘generative explanation’ as a new way of i) explaining the past and the present and ii) structuring the uncertainties of the future. Only then policy makers will be able to realistically assess where the outlook of the UK’s Energy Supply might be out of alignment with emerging megatrends, particularly in relation to electricity generation and transport fuels.

34. Given the current state of knowledge, there is an urgent need to rethink the balance of home-grown energy and energy imports (in relation to transport fuels and electricity generation) to improve energy security, address climate change and improve the sustainability of the UK’s balance of trade.

35. I should emphasize that diversification of energy sources (e.g., oil, gas and clean energy from desert) does not necessarily lead to an improved energy system if these diversified energy sources are located in a small number of countries. This still results in reduced market diversity in terms of production capacity. This might also lead to a new and more powerful organization such as the Organization of the Energy Exporting Countries (OEEC) as opposed to the Organization of the Petroleum Exporting Countries (OPEC). The creation of the OEEC will add a substantially higher geopolitical risk premium in the energy market.

36. I should also emphasize that spare production capacity for fossil fuels might run out without a war, say in the Arabian Gulf, as evidenced in 2008. Therefore, the UK’s Energy Supply is interlinked with national and bilateral political relationships, particularly in periods of squeezed production capacity. The UK’s Energy Supply should be assessed within an environment of increasingly complex intertwines rather than within an environment characterized by sequential events.

37. Furthermore, local patterns of supply and demand can generate price spikes within price spikes as exemplified by the price differential between Brent crude and West Texas Intermediate (WTI) in 2011. These local patterns of supply and demand emerge in situations where the opportunities for substitutions between qualities of, for example, oil will be fewer (e.g., Saudi crude oil by its heavier and more sulphurous quality, in general, is more suited to the Asian market than those of Europe). This implies that the UK’s Energy Supply needs to be assessed within a global-national multidimensional environment, as regional and national co-ordination is a key issue towards increased opportunities for substitutions in the energy market.

38. Diversification of energy supply needs to take into account the increasing energy demand for flexible energy services, particularly electricity generation and (land, air and sea) transport fuels.

39. Demand growth for flexible energy services should be checked against the excessive placing of wind turbines where mean wind speeds are relatively low, lack of overall cross-border plan for electric cars, lack of support for ultra-high voltage direct current transmission and inadequate efforts to promote second-generation biofuel technologies to name a few.

40. This emphasises that to effectively support the UK’s Energy Policy, scenarios should be developed in ways that encapsulate rational and sub-optimal decision-making rather than assume that all the future decisions will be optimal (bounded rationality is part of reality).

41. As a matter of extreme urgency to address short-term energy challenges, the UK’ s Energy Supply policy must certainly include a ‘global depletion study’ for oil and gas to:

a. Assess at what rate over time can the oil and gas from geographically dispersed nations be supplied to the marketplace.

b. Develop a sustainable trading strategy for the UK’s Energy Supply System.

Fossil-fuel-based electricity generation for base load and oil-fuelled (land, air and sea) transport systems will play a dominant role in the UK’s Energy Mix as we move towards 2030.

March 2011