Hamish McRae: Our focus is on oil, but Old King Coal is very much alive and kicking

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The Independent Online

BP chose a good time to publish its annual Statistical Review of World Energy yesterday – for it came just after the spike in oil prices to a record $139 a barrel last week, and a warning from the chief executive of Russia's Gazprom that oil might go to $250 a barrel next year.

BP's analysis of the production and demand not just for oil but also for other energy sources goes back for 57 years. That is prior to the first oil shock in 1973/4, and even the founding of Opec in 1960, so it has a long perspective on the twists and turns of the energy market. This review is the most thorough source of information on the energy market that there is.

The big picture first. Oil remains the largest single source of energy, but for the past six years it has been losing ground to coal. Total energy consumption last year rose by 2.4 per cent, with China, up 7.7 per cent, accounting for more than half that growth. North American consumption rose by 1.6 per cent, India by 6.8 per cent, with the EU actually cutting energy use by 2.2 per cent. Germany achieved the biggest reduction in energy use, 5.6 per cent. The UK managed to cut energy use by 3.8 per cent, but we had rather faster overall economic growth last year than Germany, so our improvement in energy efficiency relative to GDP would have been about the same.

You can see the balance of energy consumption in the first graph. The thing that most stands out is the extent to which the world economy is still driven by fossil fuels. Nuclear and hydro power matter, but their combined output is very small when compared with oil, coal and natural gas.

According to BP there are still reasonable supplies of the big three. Proven oil reserves were basically steady last year at 41.6 years' output, with the bulk of those reserves in the Middle East (see pie chart). Gas reserves were down a little at 60.3 years' output, with most split between the Middle East and Russia (see other pie chart). As for coal, that is more plentiful, at 133 years' output. Old King Coal is very much alive and kicking.

We tend to forget this. All our focus is on oil, for the obvious reason that it is the fuel that we see the price of in large figures on every filling station in the land. Most of us have to stump up every week or fortnight to fill the car. But gas and coal are coming to matter more and more, with coal growing fastest. The principal reason for that is that coal is the principal fuel for China and to a lesser extent India. There are obvious implications for air pollution and more generally for carbon emissions. Europe is doing pretty well at cutting energy use; Asia is different.

The question that follows on is: to what extent will higher energy prices curb demand? The long graph shows what has happened to the oil price since 1861, both in current money and adjusted for inflation. As you can see, the graph only goes up to the end of last year, those distant days when oil was "only" $80 a barrel. At that stage it was still in real terms a little cheaper than at the late 1970s peak, and the first peak in 1961. Now it is well above both those. We are in uncharted territory. The oil price has risen for six years in a row, the longest such period in history, and oil has never been as expensive as it is now.

That must have a profound effect on both supply and demand. As far as supply is concerned, the view of the western oil companies, including BP, is that this is a signal for more investment in improving the extraction rates from existing fuels and finding new ones. BP has the best record for finding oil of any company in the world, so its perspective on this deserves to be taken seriously. Nevertheless, the harsh fact remains that the world's largest single oil field, the giant Ghawar field in Saudi Arabia, was discovered back in 1948. Nothing as big has been found since.

This leads into a discussion about "peak oil": is the world close to reaching the maximum output it can ever achieve? A group of geologists believe it is; most oil experts disagree. This discussion goes beyond the scope of BP's work here, for this is a review of what has been happening, not what might happen in the future. Oil production did fall last year, but I don't think many people think that it will fall inexorably from now on. However, what I think everyone would be agreed on is that the age of easy oil is past.

What about demand? One of the encouraging features about last year was the ability of some of the major economies, including our own, to achieve decent growth despite using less overall energy. The UK managed to cut its oil consumption and its total energy use, with the result that we stayed just about self-sufficient in oil despite the decline in output from the North Sea. (We have stopped being self-sufficient in gas, but that is another problem.)

Energy demand can be cut in two ways, a nice way and a nasty one. The nice way is to achieve greater efficiency; the nasty to have slower growth. Last year we did the first; this year it will, I suppose, be a bit of both. But of course the more that the energy bill can be cut by improving efficiency, the less the impact on growth. So this year is going to be fascinating, for it will give a guide as to whether western developed nations, including our own, can really keep finding new efficiencies. Pressure to do so was ratcheted up last year but it is much greater now.

The statistics for last year give no easy answers, but they do show how some economies are better at achieving efficiencies than others. Germany is a case in point. France is excellent in its low use of fossil fuels, the result of having nearly 80 per cent of its electricity generated by nuclear power stations. But the star performer in terms of overall energy use relative to GDP is Japan, which is somewhat more efficient than Western Europe and massively more so than North America. The moral for China, India and other fast-growing nations is what aspects of the Japanese model might be applied to their own circumstances. That does not solve the core problem that increasing the living standards in these nations will inevitably require more energy, but it might make it more manageable.

The encouraging aspect of last year's experience is that when prices rise, behaviour does change. The main countries where oil demand did increase were those that subsidised it. Many of those subsidies are now being eliminated or reduced. The discouraging aspect was that carbon emissions seem set to carry on increasing, and will do for some years yet. Higher energy prices may help to cut demand, but they can't fix that one.

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