Speech by Mr. Mandil in Davos... - IEA

The Key Challenges to Energy Security
Energy Summit Ministerial Address
World Economic Forum, Davos
26, January 2006
Session Chair: Abdallah S. Jum’ah, President and CEO, Saudi Aramco
Speakers: Claude Mandil and Edmund Daukoru (Minister for Petroleum and Energy of
Nigeria, President of OPEC)
I’m delighted to share the floor today with my good friends Abdallah Jum’ah and
Edmund Daukoru and would like to start by congratulating Dr. Daukoru on his election as
President of the OPEC Conference and offer him my best wishes for the year ahead.
Today I will share my thoughts on the key challenges to energy security. Or more specifically,
what are the main threats to reliable energy supplies at affordable prices? This is an important
question upon which our economies are becoming increasingly dependent.
Despite the recent turmoil in energy markets I believe the main challenges remain the same. At
the top of the list is that large consuming countries are growing more and more reliant on oil and
gas imports from an ever-smaller group of often distant suppliers. This trend is soberly
portrayed each year in the IEA’s World Energy Outlook. Trade is to be welcomed as it binds
suppliers and customers in mutually beneficial relationships. But, at the same time, the risk of a
major supply disruption will undoubtedly increase. Disruptions could arise from producer
countries seeking to use their market position to force up prices or by deliberately withholding
supplies for political reasons. Or they could occur due to the exacerbated risks that wells,
pipelines or sea lanes could be blocked by terrorism, piracy, or accidents.

Since 1970, there have been 17 serious oil-supply disruptions. All but three of these were
related to events in Middle Eastern or North African countries. We cannot turn our back on
imports from any part of the world, especially this region as its vast and low cost resources are
essential to meeting our future energy needs and its producers have often stepped up to
stabilize the market in times of need. We need to recognise that for most of us energy self
sufficiency is an impossible and probably unnecessary goal. But we need to acknowledge the risks
involved and be prepared to deal with them. I must insist here that this is not just about oil. It
also concerns electricity and as we have seen recently, gas is not immune.
But today my focus is mainly on oil.
A key factor that will impact the severity of any future oil supply disruption is the relatively low
level of spare capacity available to counteract any unpleasant surprises. Experience has shown
that the sudden loss of even a modest volume of oil can lead to sharp increases in prices if spare
capacity is limited or stock levels are low.
Although spare oil production capacity has been worryingly low it is now improving. There are a
number of upstream projects coming to fruition that will soon boost supply. But will they do
enough? Our view is that spare capacity will still fall short of the 3 mb/d comfort zone until at
least 2009. International oil companies must play a role in increasing supply but more is also
needed from producing countries. They have the largest and least expensive reserves on earth.
There is a need to invest, and if possible, with clear timetables and with a priority for light
crudes. I take a moment to applaud OPEC’s recent decision to report upstream developments.
This kind of transparency reduces uncertainty from markets and is welcome.

But the problem is not only limited oil production capacity. Lack of spare oil refining capacity is
just as troubling. Effective capacity is now almost fully utilised. Upgrading capacity is needed
even more than distillation capacity as demand is shifting to lighter products and production is
becoming heavier and more sour. In many countries environmental and planning regulations and
public opposition are making it difficult to build new refineries. Once again investment is needed
or the market will continue to experience bottlenecks and instability and volatility will persist.
Here we are encouraged to see several refinery projects in both producing and consuming
countries.
Not only is the likelihood of a supply disruption set to increase but so is its impact. This is
largely due to growing rigidity of oil demand. During the oil shocks in the seventies and early
eighties much oil was still being used for power generation or in industrial applications and much
could be substituted by natural gas or coal. This is no longer the case. Oil is increasingly
concentrated in transport and existing vehicles simply cannot switch fuels during a supply crisis.
Even with the most prudent of energy policies in place oil supply disruptions may still occur. This
pragmatism was the driving force behind the creation of the IEA soon after the first oil shock.
Since then the world and oil markets have changed dramatically. We have steadily built up oil
stocks and developed a sophisticated set of emergency response measures. These proved their
effectiveness in the later part of 2005 after the two hurricanes knocked-out much of the
production and refining capacity in the Gulf of Mexico. In the decades ahead, as the world
confronts rising oil-import dependence, we will have to increase our preparedness, and find ways
to work with other large consuming nations like China and India. This will be costly but also
essential if an appropriate level of emergency security is to be maintained.

As recent events have highlighted, it is not just increasing reliance on oil imports that pose
challenges to energy security. Russia’s decision to turn off gas supplies to Ukraine sent shivers
far beyond Kiev. By these actions Russia put its reputation as a reliable energy supplier in
question and raised doubts about how Europe would deal with a more prolonged disruption.
Over half of European gas imports come from Russia. This in itself is not a concern. After all,
the two are natural energy partners. The concern is that all of the natural gas exported from
Russia comes from or through Gazprom. For several years now the IEA has doubted whether
this state gas monopoly is making sufficient investment to meet rising export demand. We have
also been troubled by its expansion strategy which has delivered it control of much of the
supply chain from the wellhead to the consumer thus denying competitors from exporting
Russian gas.
Now that Gazprom has demonstrated its willingness to exploit this market power it makes sense
for European countries to re-examine the nature of their exposure to this risk and the options
for mitigating it. Europe should start looking to other suppliers or to other fuels unless market
reforms allow Russian oil companies – with their increasing associated gas production - and
Russian independent gas producers to compete in its lucrative market. Europe could also reevaluate
its fuel mix for power generation. Coal and nuclear both require another look and
renewables are a continuing option. Development of emergency gas stockpiles has also been
suggested as a way of mitigating the risks. These could well be part of the solution but would be
up to 10 times more expensive than oil stocks on a comparable basis and, until the flexibility of
distribution system is improved, much less effective.

I have been focusing on threats to energy security posed by energy imports but let us not
ignore those closer to home. Energy market liberalisation should reinforce energy security by
promoting efficiency and increasing the diversity of supply. But is this always the case? The
major blackouts that struck North America and Europe during 2003 and 2004 raised some valid
questions. While large blackouts are by no means a new phenomenon and happened well before
electricity reform, these disruptions underscored the need for liberalized markets to offer
investors sufficient incentives to provide customers with a sufficient degree of security.
In closing I would like to reiterate the central role governments must play in ensuring the
security of all energy forms. Firstly, they must create an investment environment where the
private sector is able to accomplish its task of providing secure, affordable, clean energy whilst
making a decent return. Governments will have to look at new ways of diversifying their fuels, as
well as the geographic sources of those fuels. They need to exercise leadership in dealing with
the energy-security risks inherent in energy trade. Strategic oil stocks are a key safety net but
relations with energy suppliers will also have to be strengthened. Finally, the most secure energy
is clearly that which we do not consume. Governments must therefore continue to peruse
stronger demand-side policies to reduce energy use through conservation and improved
efficiency.
Thank you.