Gas-propelled competitiveness

Energy has always been a hot political issue, but recently the temperature has been cranked up another notch. Large, persistent differences in natural gas and electricity prices across regions, coupled with a sustained period of high oil prices–unparalleled in market history–have many governments on edge. 

The shale gas revolution has significantly lowered natural gas prices in the US, boosting the country’s industrial and economic competitiveness and raising hopes of a sustained economic recovery on the back of the manufacturing sector. Conversely, higher energy prices in Europe and parts of Asia, particularly Japan, are setting off alarm bells, with politicians calling for urgent action to prevent the demise of their industrial heartlands. Are these hopes and fears justified?

The results of new analysis by the International Energy Agency (IEA), recently published in the 2013 edition of the World Energy Outlook (WEO), suggest that shifts in energy competitiveness could indeed have far-reaching effects on investment, production, employment and trade patterns. In most sectors and in most countries, energy plays a relatively small role in competitiveness. But its cost can be crucial to energy-intensive industries such as chemicals, oil refining, iron and steel, paper, cement, glass, and aluminium. For those sectors, differences in prices across regions can lead to significant differences in operating margins and potential returns on investment, especially where the output is easily traded internationally. So while factors such as labour, capital and raw material costs are important, energy-intensive industries tend to migrate to where energy costs are lowest.

In recent years, regional differences in natural gas prices have ballooned as a result of falling prices in North America, thanks to booming production of shale gas, and rising prices in Europe and Asia, where gas prices remain largely indexed to expensive oil. By mid-2012, the price of gas imported into Europe reached a level more than five times higher than in the US, while Japanese prices were an astonishing eight times higher. US prices have since rebounded, but are still three times lower than in Europe and almost five times lower than in Japan. These price differences are contributing to significant variations in electricity prices across regions, too, as gas is often an important fuel input to power generation. Industrial electricity prices in Japan, Europe and China remain roughly twice as high as in the US. In the WEO central scenario, the IEA projects that gas price differentials will narrow somewhat in the coming years, though nonetheless remain substantial through to 2035, while electricity price differentials will largely stay the same. So what we see today reflects a structural issue, not a one-off.

There are signs that these price divergences are already starting to affect investment in a new capacity, especially in the petrochemicals sector, and our analysis indicates that this is set to continue over the next two decades. In many emerging economies across Asia, we project that strong growth in domestic demand for energy-intensive goods will boost their production, and consequently push up exports. But relative energy costs play a more decisive role in shaping developments elsewhere, in the US for instance. There, the share of global exports of energy-intensive goods is projected to increase, providing the clearest indication of the link between relative low energy prices and the industrial outlook. In contrast, the EU and Japan both see a strong decline in their export shares–a combined loss of around one-third of their current share. Such shifts in industrial competitiveness can have important knock-on effects for the rest of an economy. Lower industrial costs mean lower input prices into other economic activities, and improvement in terms of trade and higher income.

An energy boost to the economy Fortunately, there is considerable scope for action to enhance energy competitiveness, both by putting downward pressure on energy prices and by mitigating the impact of price increases. The challenge is to identify solutions that improve energy competitiveness, or at least mitigate part of the impact of energy price disparities, while maintaining an eye on energy security and environmental concerns. Improving energy efficiency is at the top of the list. As well as bringing down costs for industry, efficiency measures ease the impact of energy prices on household budgets (the share of energy in household spending has reached very high levels in the EU) and on import bills (the share of energy imports in Japan’s GDP has risen sharply). But for the full economic potential of efficiency to be realised, it is necessary to break down the various barriers to investment in energy efficiency. This includes phasing out subsidies for fossil-fuel consumption, which the IEA estimates rose to US$544 billion worldwide in 2012.

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Encouraging the development of indigenous sources of energy is yet another way to boost energy competitiveness by helping meet domestic demand at a lower cost. In several regions–including parts of Europe, China and Latin America–countries have the potential to replicate, at least in part, the US success in developing its unconventional gas and oil resources. But there are considerable uncertainties regarding the quality of these resources and the cost of producing them. Moreover, for large-scale production to take place, a number of technical and regulatory hurdles would need to be overcome. The recent World Energy Outlook Special Report “Golden Rules for a Golden Age of Gas” addresses what can be done to achieve this, while allaying legitimate public concerns about the potential environmental impact.

Other low-carbon sources of energy, such as nuclear power and renewables, can also contribute both to enhancing energy competitiveness and to achieving climate change goals. The 2014 edition of the World Energy Outlook, to be released next November, will include an in-depth focus on prospects for nuclear power. Governments need to be attentive to the design of their subsidies for renewables, which surpassed $100 billion in 2012. As renewables become increasingly competitive on their own merits, it is important that subsidy schemes allow for their multiple benefits to be realised without placing excessive burdens on those that cover the additional costs.

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Finally, minimising the cost of energy for an economy requires efficient, competitive markets. In many countries, market reforms aimed at liberalising the energy supply and increasing competition in wholesale and retail markets for gas and electricity are far from complete, and therefore result in an inefficient allocation of resources and higher prices to end users. In this vein, Europe and particularly Asia could improve their energy competitiveness by renegotiating pricing terms in both existing and future import contracts for natural gas.

This all highlights that energy policy choices will continue to be just as important in unleashing or frustrating economic growth in developed countries as they are in emerging economies. By making the right choices, governments can see to it that relatively high energy prices do not necessarily mean high energy costs to consumers or national economies. They can help their firms compete internationally while ensuring affordable energy services for their households by pushing to invest in energy efficiency, promoting a diversification away from expensive sources of energy, and developing transparent, free and open energy markets.

References

IEA (2013), World Energy Outlook, OECD Publishing.

OECD (2012), “Energy efficiency: A true alternative”, in OECD Observer No 293, Q4. 

See www.iea.org/ and www.oecd.org/greengrowth/greening-energy/greengrowthandenergy.htm

© OECD Observer No 297, Q4 2013




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