Technology will continue to profoundly affect energy industry

PETROLEUM IN THE NEXT CENTURY-4

Kjell Roland
ECON Centre for Economic Analysis
Oslo

For decades, technological progress has contributed to major productivity gains in energy supplies and improved efficiency in energy use.

As Fig. 1 [34,675 bytes] shows, the hours an average worker works to pay for artificial lighting has dropped dramatically in the past 200 years.

Any study on future energy developments needs to bear in mind the crucial role of technology. Technological trends are important not only for technical efficiency in supply and consumption, but also for industrial structures and for the design of regulatory regimes and policy.

The impact of technology on energy markets has profoundly affected costs and quality of supplying energy services. One kilowatt-hour of electricity can today be delivered to individual households at a much lower price, with greater regularity, with less variance in frequency, and often with less harm to the environment than only 2 or 3 decades ago.

Technological progress has enhanced the use of electricity in end uses previously served by direct use of coal, wood, or petroleum.

New technologies have brought to the market new forms of energy such as nuclear power and solar energy. To judge by current research and development (R&D) efforts, future energy options may include hydrogen, fuel cells, improved nuclear power designs, and, not least, improvements in conventional technologies that can drastically alter their operational characteristics.

Technology and structure of industries

As technology progressed in the postwar period, there was an increase in the optimal size of units in energy production, particularly in electricity generation. The organizational and structural counterpart to economies of scale was the growth of large integrated companies which were granted de facto or de jure monopoly in markets for electricity and gas. This, in turn, was paired with tight public control.

The capital intensity of production and monopolistic structures in the vertical chains acted to deter new entrants.

Recent technological developments have begun to challenge this pattern. Gas-fired technologies in power production, for example, the combined-cycle gas turbines, (CCGT) capture economies of scale in comparatively small units (Fig. 2 [28,074 bytes]). Both capital costs and environmental attractiveness (including difficulties in finding sites) make them competitive with, for example, larger coal-fired plants.

Cogeneration of heat and power in modular, small-scale energy systems in the hands of consumers may in the near future gain in economic attractiveness. Solar and wind power owned and operated by consumers or small-scale independent producers may also come to challenge the power of electric utilities.

Modern information technology reduces economies of scope (i.e., cost advantage of producing a bundle vs. a single service) in grid-operated energy systems. Before, economies of scope were important in utilities selling a bundle of services-electricity, transmission, distribution, measuring, and billing. This could be done more cheaply by one company, compared to the same services being offered by separate entities.

This is no longer the case. Computer technology has made unbundling of services possible by allowing coordination between independent commercial actors in closely interconnected systems. Coordination between competitors requires that large volumes of information be shifted around at low cost.

A trend towards smaller units in energy supply will undermine the dominant position of large and often vertically integrated energy enterprises. Increases in cogeneration with surplus energy available to the grid will in many countries call for regulatory changes that will affect the interface between grid owners and independent producers.

If the trend towards "clean and cheap" small-scale technologies continues at today's rapid pace, this would represent a major force for radical changes to the structure of the energy sector.

Further development and improvement of existing technologies is also likely to change their relative attractiveness in terms of both costs and environmental impacts. Clean-coal technology is within reach, and widespread use is likely over the next decade without adding to the cost of electricity generation.

The costs of solar power and other renewables are coming down rapidly, which could make such technologies commercially attractive in many end uses at a large scale early in the next century. The most far-reaching perspective on the horizon today is the possibility that the menu of technologies available in the future could undermine the firmly held tenet in energy industries that big is beautiful-and cheap.

Scope for improvement-the gas sector

Technological improvements may radically alter the competitive position of the different energy carriers, reduce environmental damages from energy use, and reduce the cost of supplying energy and in particular energy services. The natural gas industry is a good illustration for the general trend in energy industries.

Gas is chosen because this industry provides good examples in this respect.

Competitive pressure

In industries with competitive markets, there is an incentive to reduce costs in order to maximize profits. Declining prices give an extra impetus to reduce costs. When the European gas industry was developed in the 1950s and 1960s, it was based on domestic resources that were relatively cheap to produce.

Imports of gas from more-remote sources received a boost from the oil price hikes in the 1970s and the first half of the 1980s, but new projects all of a sudden were severely threatened by the oil price crunch in 1986. The Troll project is a good example of this: The first gas sales agreements were negotiated before 1986. At this point, the sellers expected a healthy return on the investment. All of a sudden the project looked more dubious. Import prices from 1980 to 1993 are shown in Fig. 3 [28,480 bytes].

Thanks to long lead times, however, modifications of project design to shave costs were still possible. Reductions in the gas price, in fact, spawned a new drive to reduce costs in the whole gas chain all over the world.

This event, combined with the prospect of having to take gas from more hostile and remote locations, which normally imply higher costs, has forced the gas industry to focus on cost reduction to a much higher degree than before. So, when the gas companies in Norway are still keen to develop new gas fields despite a gas price (in constant dollars) only half of what it was only 10 years ago, it is because better management and improved technology have reduced costs to a level which can justify development.

Cost reduction in the gas chain

Fig. 4 [78,238 bytes] shows the gas chain from the exploration phase to the burner tip, and indicates areas where technology has brought substantial cost reductions.

The exploration phase-Judged by development of reserve/production (R/P) ratios for gas, exploration over the past decades has been a success. The global R/P ratio went from 35 years in 1960 to 45 years in 1980, and it is now 70. Increased exploration for gas is one explanation for this, but more important is improved technology and management.

An example of improved technology is that exploration is now done more efficiently and cheaply thanks to 3D seismic. It is more expensive than traditional 2D seismic, but it has a higher success ratio. Experience from the Gulf of Mexico suggests an increase in the success ratio from 42 to 70% with 3D seismic. Similar success stories are told elsewhere in the world.

The applicability of 3D seismic is not confined to exploration, it also contributes to addition of new reserves and increased production in existing fields.

A study of crude oil finding costs (Fragan, 1997) shows the importance of technology to understand the race between depletion and the cost of finding more oil. The U.S. is the most well-explored and mature geological region of the world. Even in this region, reduction in finding costs outpace the increase in efforts that are required to find oil due to depletion.

Depletion costs relate to the fact that extraction is moving into marginal resources such as smaller fields in more-remote areas. During 1977-1994, average onshore finding costs decreased by 15% while resource depletion increased costs by 7%. Similar figures apply to gas exploration.

The development phase-This part of the upstream business holds the highest costs and involves long lead times. Cost reductions and shortening of the development cycle are, therefore, very important. Extensive efforts have been undertaken in this area. A good example is a number of offshore gas fields in the U.K. North Sea, where development costs for gas fields of comparable size, location, and production rates were reduced by more than 50% over a period of 4 years. Similar figures have been realized in the Norwegian part of the North Sea as well.

Such cost reductions are achieved through various measures, some of them from technical breakthroughs. One interesting example is directional drilling and its further refinements into horizontal drilling and horizontal drilling with multiple fracing. This technology significantly extends the area that can be drilled from one single platform and may even reduce the number of platforms required.

Development of satellite fields close to existing installations can also be facilitated by this technology. The National Petroleum Council in the U.S. estimates that ongoing drilling technology developments will allow future savings of about 4%/year compared to the cost of using present-day methods. This would cut drilling costs in half within 10 years.

The production phase-The experience on the Norwegian shelf offers a good example of what it has been possible to achieve in terms of cost reductions in this phase: between 1993 and 1996, costs were reduced by some 40% for oil, as well as gas.

Transportation of gas-The pipeline transportation part of the gas chain has not seen major technological breakthroughs over the last few decades. Still, gradual cost reductions have been made possible. One example is the pipeline installation costs in the Norwegian part of the North Sea. The cost of installing the NorFra pipeline to France (to be commissioned in 1998) is some 44% lower per kilometer than the corresponding cost for Statpipe, which was commissioned in 1985 (Fig. 5 [39,804 bytes]).

Substantial progress has also been made in reducing the costs involved in transporting gas as LNG. Over the past 25 years, a steady decrease in gas liquefaction costs has taken place because of improved technology and improved scale economics.

Compared to 1969, liquefaction costs in 1995 were reduced by about 60%. Cost reductions are also taking place in the transportation part of the LNG chain. It has been estimated that during the decade from 1990 to 2000, LNG shipping costs will decrease by about 40%, mainly through larger vessels, new tank designs, and more-efficient use of space.

Distribution, marketing and end use-As is the case of gas transportation in general, gas distribution to end consumers has not shown any spectacular breakthroughs in basic technology over the past 25 years. However, improved technologies for pipe laying, line inspection, and welding have been introduced and contributed to lower costs. Marketing and meter reading have been vastly improved by more-advanced computer technology. Progress in efficiency in end use is, however, perhaps even more spectacular. In less than 25 years, private consumers using natural gas boilers have seen the efficiency in new boilers increasing substantially. Today, consumers are able to squeeze more than 50% of more-useful energy out of the same volume of natural gas.

The improvements that have taken place in combined cycle technology over the past 2 decades have led to drastically changed prospects for gas in power generation. From an efficiency of less than 40% in traditional gas-fired thermal power plants, combined-cycle, gas turbine-fired plants now obtain an efficiency close to 60%. Conversion efficiency may improve further to more than 90% in combined heat and power facilities. This technological development has made CCGT facilities the preferred solution for new power generation capacity in many countries.

The need for change moving downstream-Looking at the cost components of the price to end user, one will in most markets find that value added in transportation and distribution constitutes a higher share than the revenue to the producer. For this reason, the absolute potential for cost reductions-and therefore the need for technological improvements-is more urgent in transportation and distribution than in production.

The fact that upstream operators in most countries up to now have been more exposed to competition than operators further downstream indicates that the relative potential for cost reductions is bigger in transportation and distribution than in production.

Two important factors driving the need for technological innovations and cost reductions are the geographical mismatch between gas reserves and consumption, and the regulatory reform process in the gas sector of most countries:

Logistical challenges. As gas consumption increases, the need to transport gas from more remote areas to the main consumption centers increase even more. Europe's dependence on imports from extra-European sources will increase considerably over the next 25 years. Further expansion of gas use in Asia is to a large extent dependent on further LNG developments in the Middle East. As transportation of natural gas still is very expensive in comparison with oil, there will be a tremendous pressure to reduce those costs in the future. Both pipeline and LNG costs will certainly come down gradually, but the industry is also looking for technological breakthroughs that could bring costs down more radically. One interesting concept, transportation of gas in hydrate form by specially built vessels, has been proposed by a group of researchers at the Norwegian University of Science & Technology. The transportation cost under this concept is claimed to be some 25% lower than for traditional LNG, and its optimum size is smaller than for LNG.
Unbundling and competition. The global trend towards competition and privatization extends to all energy sectors, and will no doubt also influence the gas sector profoundly over the next 25 years. The major policy objective behind this process is a more-efficient energy sector and lower prices to end consumers.

Corporatization, demonopolization, unbundling of services, and privatization are key words in this context. Added to this should be a development towards tougher and more-efficient regulatory regimes. For energy companies, this often combines with tightened environmental standards and requirements to increased customer orientation.

This, in its turn, will give an impetus to improve the hardware part of the industry. Distribution in particular will require widespread application of advanced information technology.

The restructuring measures undertaken in the U.S. and the U.K. illustrate this. In the U.S., introduction of third-party access and release of spare capacity in interstate pipelines led to the creation of markets for such capacity. Their functioning turned out to be dependent on the introduction of electronic bulletin boards with online monitoring of spare capacity. The creation of such markets would not have been possible without technology that did not exist just a few years ago.

It is also interesting to note that one of the major obstacles to the recent introduction of competition in the residential sector in the U.K. was availability of software to facilitate enforcement of the network code.

Developments in information technology will enable companies to tailor-make energy services and respond to demands for more-sophisticated services. Progress in metering technology will determine what kind of services energy companies may offer. On-line metering will, for example, allow for sophisticated tariff systems.

As gas markets mature, the need for storage increases. Total world gas working storage amounts to some 11% of total consumption; in mature gas markets this figure is around 20%. Unbundling and introduction of competition will probably increase the need for storage even further.

Storage, however, is expensive to build and many countries do not possess good natural conditions for underground gas storage. The natural gas industry is therefore faced with major challenges in this area both in terms of new technology and lower costs.

New applications for gas

It would take us too long to discuss all the areas where new technology will make new uses of gas possible or where widespread use is feasible over the next 25 years. Today, some areas can be identified where the technology exists but where there are still obstacles to large-scale commercial use. Some of them are the use of natural gas:

As a vehicle fuel
In fuel cells for decentralized production of heat and power
For production of synthetic fuels
To produce food (proteins) for animals as well as humans.

Intensive research is under way in all these areas and will certainly materialize in some way in the years to come. Similar developments may be observed for other sources of energy.

Intensified competition

The general conclusions to be drawn are: Energy, and energy services in particular, will most likely be offered to consumers at lower prices; new applications will surface; and the competitive position of fuels and technology will change continuously.

Competition between different sources of energy in a 25 year perspective is very much a moving target, where the winners are those who lead in reducing costs and improving convenience, reliability, and environmental standards.

For example, many people pay attention to the fact that some of the renewable technologies have improved substantially in terms of costs over the last decade. However, so have traditional technologies, and they are likely to go on doing so. Who will take the lead in this race over the next couple of decades remains to be seen. Today, and most likely in the near future, gas is an aggressive competitor, increasing market shares for environmental and economic reasons in large parts of the world.

The environment

The environment first developed into an oil industry business variable in the 1950s, when people were suffering from smog caused by vehicles and industrial plants in large cities.

First generation environmental concerns

Smog was identified as the cause of health problems, mainly pulmonary diseases. This prompted the adoption of emission controls to reduce air pollution. Los Angeles pioneered this legislative process which culminated with the U.S. federal government promulgation of the Clean Air Act in 1963 and the Motor Vehicle Air Pollution Control Act in 1965. Within this early period of environmental awareness, however, concern was not directed towards the oil industry as such but to oil consumption through combustion processes (in transport and industry).

Growing pressures led to the 1970 amendments to the Clean Air Act, which introduced ambitious measures to abate CO, NOx, and VOC emissions. Lead in gasoline became a regulatory concern. In 1970, the U.S. Environmental Protection Agency made catalytic converters mandatory for all new cars built after 1975.

Second wave of concern

Estrada, et al., (1998 ) label the period leading up to the early 1970s the first generation of environmental concern. The 1972 UN environmental conference in Stockholm in many ways represents the launching of a second generation, or "wave," of such concern. It was duly acknowledged that regulations introduced to date had no chance of tackling pollution stemming from the solid economic growth throughout the western world.

Environmental ministries were set up in most OECD countries, with environmental regulations widened and intensified. Oil was singled out as one of the major culprits, as it was suggested that gasoline and diesel were responsible for about half of all pollutant-related human exposure to airborne carcinogens.

Priorities differed between the U.S. and Europe. While environmental regulation affecting the oil industry in the U.S. was driven by local air quality concerns, acid rain was the main European impetus for enhanced environmental regulation.

In the early 1970s, the Nordic countries had already started to pass legislation to curb SO₂ emissions. Increasing evidence of harm to large European forest areas made countries like Germany follow suit, and in 1988, the European Community adopted its first set of directives specifically aimed at regulating the sulfur content of oil products and NO_xemission levels from large combustion plants.

Overall, environmental concerns in Europe and the U.S. were on a downward trend in the late 1970s. Due to factors such as acid rain and nuclear accidents (1979, 1986), however, the concern was soon to resume. It became clear, within the framework of what we called the second wave of environmental concern, that public outcrys about oil-related (and other) pollution were not isolated events.

From being mainly an individual health concern during the first environmental wave, it was now developing into a broader mobilization of social groups seeking to address prime causes and effects of environmental degradation. This meant increasing levels of conflicts between environmental groups and institutions and interests linked to energy.

All the same, few oil companies at the time perceived the effects of environmental policies as an important emerging trend.

Third wave

A variety of developments combined to change this and catapult environmental concerns to the top of both government and corporate agendas. The report of the Brundtland commission in 1987 and the Toronto climate conference in 1988 came to represent major catalysts for increasing concern about transboundary and global environmental problems. Tensions were intensified between these concerns and modern consumption patterns and lifestyles. "Sustainable development" became the catchword of the day, a concept which epitomizes the content of what we might call the third wave of environmental concern.

From the late 1980s, the environmental agenda has grown ever wider (greenhouse effect), become genuinely global, and made NGOs (non-governmental organizations) and the media important political actors. Also, we have seen the level of political attention and conflict grow significantly. Because of the influence of environmental NGOs on government policies, the environment has developed over the last decade into a serious business variable that no one can afford to ignore.

The issues raised by the third environmental wave that are particularly challenging for the oil and gas industry are:

The growing power of NGOs and modern mass media-Extensive media coverage of local and global environmental issues are reinforcing the political potency of environmental NGOs. Political pressures have spilled over to governments who, in turn, support the scientific research needed in order to understand and propose solutions to complex environmental threats.

Moreover, the media now tend to treat local environmental problems, such as oil spills, as issues that concern the international audience. NGOs capitalize on such images, translating global threats into salient local political challenges and bringing local violations firmly into the international spotlight.

Royal Dutch Shell's heated controversies with NGOs over what to do with the Brent Spar platform and its presence and political responsibilities in Nigeria are just two examples of the changes in global influence patterns brought about by the third environmental wave.

The Nigeria example also demonstrates the extent to which environmental concerns on the one hand, and social and political concerns on the other, are mutually reinforcing-bringing a growing number of complex cases to the attention of corporate boards.

The global nature of present environmental threats and treaties-Globalization means opportunities as well as challenges to the oil and gas industry. And globalization of environmental concerns is no longer a prospect, but a fact. Statoil, formerly a squarely "national" company created to extract North Sea petroleum resources, now has operations in 25 countries. This global coverage, however, serves to expose companies to an ever toughening political agenda.

At the same time, the globalization of environmental concerns means that domestic regulations are no longer the only rules to play by for oil and gas companies.

With regard to global warming, for instance, this means that investments in any part of the world may have to take into account future provisions under the Climate Convention. This may fundamentally impact corporate strategies.

Global warming, however, may also bring new opportunities for forward-looking energy companies, with increased marked shares for lower carbon fuels and technologies and involvement in joint implementation and emissions trading.

The overall sustainability of fossil fuel-based energy futures-The adoption by Greenpeace of the "no more oil exploration" slogan in 1997 is but one expression of the present fundamental questioning of fossil fuel-based energy futures. Radical factions of the environmental NGO community mobilize in order to question and block further exploration of petroleum resources. Even if not representative of the overall environmental movement, the perceived need to plan today for a rapid transfer from fossil fuels to renewable alternatives is gaining hold in broad segments of international political opinion.