Allies, game changers and category killers

Moisés Naím / World Energy & Oil

The dominance of petroleum as a source of energy has lasted almost a century and most analysts expect that it will continue. Oil, gas and coal are each expected to account for about a quarter of the global energy market in 2030.

Yet, while current trends point to the persistence of this dominance, it is equally clearthat there are many powerful forces at work that can disrupt the status quo. Climate change, for example, may create unprecedented incentives to alterthe production and use of energy. New technologies that can “change everything” are always a possibility. And geopolitical surprises, as transformational as they are hard to anticipate, have long been a feature of energy markets.

TECHNOLOGICAL INNOVATIONS
The technological innovations that are currently attracting most of the efforts fall into three broad areas. The first is the search for alternatives that could be defined as allies of the current market structure, since they do not seek to disrupt current arrangements and institutions, but rather boost the efficiency of hydrocarbon usage and ameliorate its undesirable side-effects, thus prolonging its life as an indispensable resource. A second set of efforts aims at finding energy sources, new production techniques and, very importantly, creating energy products that are friendlier to the environment.

These efforts can yield game changers that could significantly disrupt existing patterns of demand and supply. Finally, a third area of research is aimed at finding a radically different energy source that could actually renderthe use of petroleum obsolete; this is what can be called a category killer.

Obviously an innovation that can be considered a game changer will have different effects from one that facilitates the workings of the current system. Innovations in each of these three areas will have different consequences–many of which are impossible to anticipate. But some of their impacts on the current energy market structure, on oil exporting countries or on those that are dependent on foreign sources of energy are possible to envision at a very general level and thus give us a glimpse of their likely ripple effects.

ALLIES
Perhaps the best example of this type of technological innovation is the improved Internal Combustion Engine, ICE, which will make it possible for automakers to double petroleum use efficiency of cars, from a current 27 miles per gallon to some 55 miles per gallon by 2025.

This development will maintain petroleum as the main source of energy, notably in the transport sector. It will extend the life of existing petroleum reserves and promote stability in the existing markets, by allowing traditional petroleum producers to remain important actors in the global energy scene. The main beneficiaries will be the producers of light, high quality oil in the Middle East, while countries with large heavy or unconventional oil reserves, such as Canada or Venezuela, will find it harder to retain their traditional market share due to the high cost of upgrading their reserves. Countries like the U.S. and Japan, that have limited traditional oil reserves but whose consumers have the capacity to quickly switch and adopt early and massively to new products that consume less fossil fuel, are also bound to benefit greatly.

GAME CHANGERS
Technological innovations that promote the development of cleaner alternatives to oil such as hydrofracking, the result of the perseverant and pioneering work of George Mitchell, are making accessible the vast, previously unrecoverable natural gas resources of North America. Particularly in the U.S., there is a boom in the development of this alternative to petroleum and its impact on the global energy landscape is already being felt. As is well known, the world’s largest petroleum importer, the U.S., israpidly replacing imported oil with domestic production of natural gas, an environmentally friendlier energy source. This is having a large impact on the availability of petroleum for other markets such as China and Europe, pressuring global oil prices downwards. The development of shale gas in China and in some European and Latin American countries could further contribute to the displacement of petroleum as a source of energy in those countries. Naturally, countries such as the U.S., China, Mexico and Argentina, which can develop their domestic natural gas resources, increasing their energy security and decreasing their dependence on petroleum, will greatly benefit. Once again, however, producers of lower grade or more expensive petroleum, such as Canada, Russia and Venezuela, will face a less benevolent marketplace than the booming one they enjoyed in the first decade of this century.

There are, of course, otherinnovative alternatives to fossil fuels, which, although in a less advanced stage of development, have already shown to be economically viable under the right conditions. Solar and wind energy are a good example. Initially, the exaggerated promises of governments and companies overstated the readiness of these sources, which eventually led to widespread disappointment. Now, however, a more sober and realistic set of expectations has emerged and more economically sustainable approaches are being tested.

Wind and solar energy are already capturing an increasing share of energy production in Europe and the U.S. In America, the solar market has grown by 40 percent since 2009, thanks to the establishment of more efficient economic incentives, also being tried in Europe and China. Major challenges and obstacles still exist, but countries where favorable climactic conditions coexist with sound and sustainable government policies that provide strong incentives and effective regulation are poised to greatly benefit from innovations in this field.

Not just large energy consumers such as China but also small consumers with limited or no hydrocarbon resources of their own, like the Central African or Caribbean countries, will come ahead as a result Another innovation that provides a good illustration of a potential game changer is clean coal. In May 2011, draft legislation wasintroduced before the U.S. Congress, requiring the inclusion of coal-derived fuel at certain volumes in aviation, motor vehicle, home heating and boiler fuels. The bill seeks to promote the use of Coal to Liquids technology, CTL, which according to the document presented to the U.S. Congress, is already economically viable. The fact that the U.S., China and Russia possess the largest coal reserves in the world and are also among the largest energy consumers could make Clean Coal technologies a substantial game changer –if the promises of its sponsors prove to be valid.

CATEGORY KILLERS
This type of technological innovation would create more efficient, more economic and cleaner energy sources than oil, thus making the use of fossil fuels a historic relic. One of these potential category killers is fusion energy, through laser bombardment. This is being hailed as a major breakthrough by scientists, for its ability to generate more energy than the one used to put the process in motion. The scientific team at the federallyfunded Livermore National laboratory in California revealed, in February 2014, that they had conducted experiments using a laser to “compress a pellet of fuel and generate a reaction in which more energy came out of the fuel core than went into it,” according to a report by the Washington Post. The lead author of the study, Physicist Omar Hurricane, said: “We’re closer than anyone’s gotten before.”

WHAT IS NEXT?
In the coming decade the energy market is more likely to be transformed by disruptive innovationsthan wasthe case in the past twenty years. The demand forsuch innovations–and therefore the incentivesto create these new technologies—is clearly there. The supply of innovationsto satisfy the enlarged demand will also be there, especially as non- traditional players, even outsiders to the oil industry, are actively investing in new energy technologies. Perhaps the most sobering example of how outsiders can upend the oil business is that the most disruptive innovation of recent times— fracking—did not originate in the R and D labs of the oil industry majors but was the brainchild of a dogged inventor with a strong entrepreneurial drive. In fact, the dominant players in the energy markets have been able to thrive and sustain their dominance without making R and D the priority that it is in other industries. Guy Chazan, the Energy editor of the Financial Times has noted that “according to the Breakthrough Institute, a California-based think-tank, US energy firmsreinvest lessthan 1 per cent of revenues in research, development. In contrast, sectors such as IT, semiconductors and pharmaceuticalstypically reinvest 15 to 20 per cent of turnover in R&D and product development.” Chazan also cites a study by the Boston Consulting Group (BCG) that found that only 64 per cent of energy companies rank R and D as a priority a figure. That stands in sharp contrast with the automotive sector, where 91 percent of companies make it a priority, or for companies in media and entertainment, where 85 percent do so.

We have entered a new era when innovations in energy production and use will be in high demand. And where there is demand, supply always emerges.