Energy Realpolitik

It’s a geopolitical jungle out there in the oil world right now and only the fittest will survive. The new oil Darwinism is replacing the older thesis that all producers can succeed over time because the current lack of adequate capital investment is going to create an oil supply gap in the future that will once again boost oil prices (the so-called supply hole thesis). There are still some active looming supply crunch proponents who are talking down the potential of U.S. unconventional oil and gas, but recent announcements by ExxonMobil and Chevron about robust plans for U.S. onshore drilling appear to dispel the notion that a debt-ridden U.S. industry is on the verge of potential failure. Projected Permian oil production for the two American oil majors alone is 1.9 million barrels a day by 2024, on top of already robust output from U.S. independent oil companies. Citi estimates that U.S. oil production increases could fill most of the expected increase in oil demand for the next five years. That could leave OPEC in a bind, Citi suggests, since the producer group could lose up to three million b/d of market share to U.S. producers if it chooses to cut production to defend $65 oil prices, according to Citi estimates. The unexpected success of U.S. shale has - for the time being - been ameliorated by the dramatic demise of output from within OPEC’s ranks. A variety of ongoing problems from civil unrest to sector mismanagement have created supply disruptions from Nigeria, Libya, Algeria, Venezuela, and Iran, the latter two impacted additionally most recently by U.S. sanctions policy. The situation prompted one Middle East oil leader to note privately that OPEC’s stronger members will take market share from smaller, more troubled OPEC members whose sectors are continuing to stumble. In the past, OPEC’s largest producers Saudi Arabia, the United Arab Emirates, and Kuwait have stepped in to replace fellow OPEC member oil exports disrupted by sanctions or war. The process has often created acrimony inside the producer group, especially when new production sharing agreements are required when and if a disrupted producer’s oil output is restored. This time around is no different. Iran, whose oil exports have recently been curtailed by U.S. sanctions, threatened to quit the organization at OPEC’s end of year meeting last December in Vienna amid accusations that Saudi Arabia and Russia were taking advantage of its conflict with the United States. A last minute compromise, orchestrated by Russian energy minister Alexander Novak, salvaged the tense situation by promoting a compromise, which exempted Iran from the wider OPEC-Russian production cut agreement. In the longer run, cohesion might become more difficult for the current OPEC grouping as divisions arise between members whose industries are deteriorating and need sharply higher prices to offset declines and those who can cope with new competitive forces and still be able to expand. For the time being, OPEC’s larger members are trying to preserve the organization while at the same time, embarking on strategies to cope with future challenges. Abu Dhabi’s national oil company (ADNOC) is partnering with Western firms to apply new technologies to boost capacity to five million b/d by 2030 and is looking for refining assets abroad. Saudi Aramco is pursuing a sophisticated strategy that includes diversification into natural gas, petrochemicals and trading as well as making sure to keep its production costs low to extract as much revenue as possible from legacy assets. But beyond diversification strategies, officials from OPEC’s big guns - Saudi Arabia, Kuwait, UAE and Iraq - have such low cost production that they are assuming that they can be the last ones standing. But while it might be tempting among Middle East producers to forge a policy to wait for U.S. shale to peak and sputter out in the coming years, it is early days on drilling technology innovation with new ideas on how to tap improved data, automation, lasers and CO2 injection to improve recovery rates not only in the United States, but around the globe. All that technology might mean that pure geology (e.g. ultimate size of reserves) might not matter as much as stable access to capital as a new winning characteristic of the future Darwinian challenge in oil. Thus, in the new Darwinian oil world, we can expect to see continued announcements about how low the largest players can go on costs. ExxonMobil threw down the gauntlet recently by stating its next Texas Permian oil increment will come at price tag of $15 a barrel, substantially below break evens for some of the smaller U.S. companies operating in the Texas shale. It’s also well below the kind of oil prices needed for OPEC’s member fiscal budgets which require oil prices to range from at least $45 to as high as $80 a barrel, depending on the country. As a new report published by Council on Foreign Relations on the Tech Enabled Energy Future notes, the convergence of automation, artificial intelligence, advanced manufacturing and big data analytics is poised to remake the transportation, electricity, and manufacturing sectors in ways that could eliminate oil use just at the same moment when those same technologies could make it easier and cheaper to extract oil and gas. As digital energy technologies take hold, large oil producers will have to consider whether their reserves could depreciate in value over time if they delay oil production and development in an effort to hold up prices in the present and garner short-term revenues. This reality is adding to the challenges many oil producer governments already face from mounting budgetary stress, prompting widespread calls for energy sector reforms in a host of oil states around the world. In the new digital energy world, fittest is being redefined and access to the largest reserve base will no longer be the overwhelming metric for success. The winners and losers could prove surprising.

This is a guest post by Benjamin Silliman, research associate for Energy Security and Climate Change at the Council on Foreign Relations.  Amid controversy whether the Green New Deal manifesto is too broad, Senator Edward Markey (D-MA) spoke out in an interview published yesterday to elaborate on direct Congressional actions that might come about in alignment with the resolution’s chief environmental focus. Distinguishing the resolution’s aims from his past efforts to pass cap-and-trade market pricing carbon emissions credits, Markey noted, “We could wind up putting a price on carbon, but we have to protect the most vulnerable simultaneously.” Markey’s suggestions in the interview may give a hint at what Democrats think is possible to pass right now: “Practically speaking, we could pass a tax-extender bill for tax breaks for wind, solar, batteries, electric vehicles. We could pass an infrastructure bill that would be a green infrastructure bill. We can take the appropriations process, and in each individual area insert funding for green programs. We can make a down payment on what we need to do now on infrastructure, on taxes, on appropriations. And that is the beginning of a pragmatic way of looking at this existential challenge.”  Markey’s words might resonate with many members of Congress, from both parties, who are frustrated with the executive branch’s inability to respond effectively to the pressing issue of climate change. Congress could exercise its authority over the budget to start funding green infrastructure programs within the U.S. Department of Defense, the Federal Emergency Management Agency (FEMA), and federally funded projects through companies like the Tennessee Valley Authority or the Export-Import Bank of the United States. Current U.S. government support for infrastructure is woefully inadequate. The nation’s energy, rail, water, road, communications, and industrial systems are in need of significant investment. The American Society of Civil Engineers estimates that there is an infrastructure spending gap in the United States of nearly $1.5 trillion needed by 2025 just to maintain the quality of current infrastructure. These estimates mean there is a tremendous opportunity to authorize appropriations that could be used more wisely to address transportation, energy, water, and defense infrastructure in a manner that is more resilient to climate change and supports the transition to cleaner forms of energy as upgrades are needed. To do this successfully, data-driven metrics clearly evaluating previous infrastructure’s cost, effectiveness, vulnerabilities, and environmental impact are needed, and should be a high priority for congressional research to establish. Developing a procedural and flexible evaluation structure will allow for optimal technologies to be deployed, maximizing environmental gain for cost. The U.S. Department of Defense (DoD) has openly and repeatedly raised concern about the effects of climate change. According to the U.S. Government Accountability Office, DoD maintains a portfolio of $1.2 trillion of infrastructure across 4,800 sites worldwide as of 2017. During the next round of budget increases, infrastructure spending should be tied to green spending and research. The Trump administration has also made it clear it plans to “rebuild” the military. To do so will require substantial infrastructure investment. Ensuring that infrastructure is resilient to climate risks is vital. Congress should look for low-hanging fruit elsewhere in the budget as well. Disaster relief organizations, like FEMA, that participate in large-scale infrastructure investment for repair after damaging events, would benefit from requirements that consider climate change. In 2017, the National Oceanic and Atmospheric Administration (NOAA) estimated that natural disasters caused $300 billion in damages. To supplement relief resources, Congress appropriated an additional $34.5 billion in post-disaster funds and forgave $16 billion of debt for the National Flood Insurance Program. In the future, when designating supplemental relief funds, a green infrastructure or increased weatherization requirement would help ensure that damaged infrastructure is replaced with buildings and energy systems that are better prepared for extreme weather events. The damages experienced by Californians after utility PG&E failed to upgrade its equipment against heat and fire is a telling lesson in the liability risks that come when infrastructure cannot meet current environmental conditions. Initial funds allowing for better planning and access to capital to make needed weatherization and energy efficiency upgrades could potentially reduce the extent of future relief needed in the future. Congress also can use its budget influence on federally-funded infrastructure projects to require certain environmental standards as a prerequisite. That could include environmental targets on state-owned entities like the Tennessee Valley Authority (TVA), a government-backed company that built power projects during the original New Deal and recently opted to shutdown coal plants. TVA is already managing liabilities from coal ash spills. Activists looking for bold, comprehensive action won’t be satisfied with the U.S. Congress taking these incremental steps.  However, such steps are immediately implementable and would avoid one of the biggest problems confronting our ability to implement climate solutions, mainly that infrastructure is long-lasting. Once it is built, it is harder to allocate funds to replace it. Forcing greener choices in current appropriations would help pave a path towards broader legislation.

This guest post is co-authored by Sarang Shidore, a visiting scholar at the LBJ School at the University of Texas at Austin, and Joshua Busby, associate professor of public affairs at the Robert S. Strauss Center for International Security and Law at the LBJ School at the University of Texas at Austin. For four years, we have been tracking the solar sector in India as it seeks to scale up to meet the government’s 100GW target by 2022. Although rooftop additions continue apace, there has been slower growth at the utility scale. The next stage of growth in India will be difficult to achieve without major reform across the electricity sector as a whole. But an upcoming national election in May could bring in a weaker coalition government, adding to the sector’s already large challenges that include land acquisition and problems with the existing auction system. Utility-Scale Slowdown Implies 2022 Goal is a Stretch India’s annualized solar capacity addition was 8.2 GW in 2018, down from the previous year’s all-time high of 9.6 GW. Though utility-scale additions dropped by nearly 20%, rooftop solar showed a remarkable surge of more than 70% over the previous year from a smaller base. However, India’s rooftop growth is focused mainly in the commercial & industrial sectors – residential solar has yet to take off in the country. As of January 2018, India had more than 26 GW of capacity of solar electricity, dramatically higher than the 2.5GW in 2014 when Prime Minister Modi took office. However, as we wrote last year, 100GW is a stretch goal that India likely won’t reach by 2022, and that continues to be the consensus among industry-watchers. The latest forecasts estimate that India will reach 65GW of installed solar capacity by 2022, of which 51GW will be utility scale and the remainder divided between rooftop, open access, and off-grid solar. While that is below the announced target, it is still impressive, especially where such progress was thought unlikely just a few years ago. Constraints, Old and New Given a backlog of approved projects, there will likely be more capacity installed in 2019 than 2018. However, a number of developments have undermined developers’ confidence. Reverse auctions, in which prices are continuously bid down until prices fall no further, have driven solar prices down in India to less than 3 rupees (4.3 cents) per kilowatt hour. A new import tariff as high as 25% kicked in this year, aimed at solar panel imports from China and Malaysia. China accounts for 90% of panel installations in India, so this, along with a depreciating rupee, has raised costs across the board and lowered the returns that developers and investors can earn. The increasingly challenging economics of large-scale Indian solar development has forced consolidation in the market. In 2019, just 4 players Azure, Acme, NLC, and Japan’s SoftBank are expected to provide more than 40% of new utility-scale capacity. Increasingly, there are instances of auctions being run and then canceled after the market-discovered auction price was deemed too high, making the business of bidding for projects more risky for developers.  This has happened both at the state and central level and is damaging the investment environment for solar. Despite these hurdles, significant interest remains from foreign investors from Japan, the Persian Gulf, and Europe. American investors who are earning better returns at home have largely steered clear of the Indian market. Land acquisition issues continue to dog plans for some large-scale solar parks. More than 40 such parks are in various stages of planning and development. Though land forms less than 5% of typical project costs, it is often the most complex and time-consuming step.  For instance, a 500 MW park in the large state of Maharashtra was scaled back this year after a farmer protesting inadequate compensation committed suicide. A large 2 GW solar park, located in the desert state of Rajasthan, is expanding more slowly than planned due to land disputes. Also, developers often opt for acquiring fertile land rather than wasteland, as it is typically closer to existing grid infrastructure. This further increases the chances of farmer resistance. An ambitious “green corridor” project to strengthen the grid between states with large generation potential and centers of high electricity demand is ongoing, and allocations for it increased by nearly 20% this past year to $92 million. Yet, as new renewable energy gets added to the grid, the demand for greater inter-state capacity is also growing. The green corridor is effectively a moving target and is currently lagging well behind additions of new capacity. India’s electricity sector, mostly organized at the state level in India, has undergone major reforms since the 1990s. From being integrated and almost entirely government-owned in each state, the sector was “unbundled” or split up with different companies handling generation, transmission, and distribution. Along with unbundling, privatization was also pushed. However, while generation was substantially privatized, transmission and distribution remain predominantly state-owned. However, electricity subsidies for agricultural use among India’s vast farming population have also increased steadily. What that means is that distribution companies (Discoms) in most large states face significant under-recovery of costs and are saddled with huge debts. This acts as a major constraint on the expansion of solar power, as Discoms are highly reluctant to buy more electricity from renewables in the face of existing long-term contracts with coal plants. The central government launched a key initiative in 2015 to rescue Discoms from their financial distress, called UDAY. However, UDAY is largely a failure. Though stricken Discoms have temporarily regained much of their health by transferring 75% of their existing debt to state governments, the Discoms have not implemented other reforms like reducing grid losses to improve their long-run profitability. The distribution companies’ generally poor financial health thus constitutes a major barrier for renewables penetration going forward. Moreover, there are challenges and costs of grid integration associated with renewable power because of intermittency, the fact that the sun doesn’t always shine and the wind doesn’t always blow. In the absence of affordable energy storage, grid managers have to ramp up other sources of electricity to act as balancers when there is no sun or wind. Hydropower and natural gas are ideal balancing sources for variable renewable electricity. Some states such as Karnataka do have sufficient hydropower to balance their renewables generation. But, many others do not, and, in the absence of viable natural gas plants, coal plants have to play this role. However, ramping coal plants up and down is expensive. As renewables penetration increases in the Indian electricity system, these challenges will get more serious. New Solar Models – Seeds of Change? New innovative approaches suggest a different path forward. While they tend to be smaller scale, they meet the electricity needs of key constituencies and can help overcome problems of land acquisition and below-cost electricity for agricultural users.  Madhya Pradesh, a poorer state in the central part of the country, is pursuing demand aggregation to reduce rooftop solar costs and is rolling out solar pumps for farmers. The rooftop program is initially oriented towards public buildings, such as government departments, schools, universities, and hospitals. The unique aspect has been to aggregate demand for would-be developers by bundling sites together Before the bidding process, the state surveyed the sites to estimate their technical requirements and made that information available to developers. This has led to electricity price bids of less than 2 rupees per kilowatt hour in some cases, which is as much as 5 rupees cheaper than standard Discom rates. While significant subsidies of more than 40% helped facilitate lower bids, state officials argue their preparatory work and transparency of information brought costs down even further by reducing investors’ uncertainty. The agricultural sector is responsible for more than 30% of electricity demand in a number of states as many farmers rely on groundwater for irrigation. Because farmers tend to get subsidized power, many of India’s Discoms perennially lose money. However, farmers also get unreliable power for limited hours, often at night rather than during the day. The wealthier state of Maharashtra, which includes the India’s financial capital Mumbai but is also heavily agricultural, is experimenting with solar agricultural schemes to offer farmers more convenient and reliable daytime power and should help Discoms improve their balance sheets. Maharashtra has developed a solar feeder scheme which sets up a small scale solar plant of 1-10MW in the community. Farmers connect to this power plant to run their pumps. The southern state of Karnataka, which includes the national IT hub Bangalore, has innovated a semi-distributed solar model by building smaller scale parks of 10 MW to 100 MW at the taluk level (taluks are clusters of villages). Taluk-level solar plants do not require large parcels of land and can be located more closely to the rural consumers. The model could ease the land challenge, lower grid losses, and reduce Discoms’ financial losses. Karnataka also innovated a land leasing model for its large 2 GW Pavagada solar park located in a poor drought-stricken region. Instead of acquiring farmer-held land outright, it offered 28-year leasing deals. 13,000 acres were acquired this way, with thousands of farmers signing lease contracts. In exchange, farmers are paid an annual rent with a periodic escalation clause. This eased farmer concerns over permanently losing their land and assured them a steady income regardless of the weather. Pavagada helped Karnataka become the leader of all Indian states in net solar capacity. The Current Pathway - More Solar, More Coal From a climate change and air quality perspective, the more important question is whether India’s renewables growth will displace coal as soon as is practically feasible. From that point of view, the growth of the last few years of the solar sector looks less impressive. However, from an energy security perspective (the primary driver of India’s energy policy), solar has provided a welcome, cleaner domestic source of electricity and has significantly alleviated power deficits triggered by uneven supplies of domestic coal in states such as Karnataka. Coal still retains its preeminence in India’s electricity mix, responsible for close to 75% of electricity generation. Even as some old coal burning power plants are being taken off-line, some new coal plants are being built. In recent years, renewables additions have outpaced coal; for example in 2018, renewables additions were 11.2 GW (of which solar was 8.2 GW) compared to coal additions of 4.5 GW. Though the new coal plants are more efficient supercritical and ultrasupercritical plants with greenhouse gas emissions reductions of more than 25%, they are still net carbon additive. In 2018, the Council on Energy, Environment, and Water (CEEW), a prominent Indian think tank, developed scenarios of low carbon development for India. In the most pessimistic scenario where renewables projects have to bear the cost of integrating their power into the grid, the non-fossil share of electricity will rise to at least 48% in 2030, up from around 20% today. In the most optimistic scenario in which renewables do not have to bear any cost of grid integration and coal plants operate under a new market design, the share will be as much as 79%. This is a large spread of possible scenarios, and speaks to the high sensitivity of sector pathways to policy and regulatory initiatives. In other words, much can be done to bend the curve. Peering Ahead In spite of sector headwinds, more than 13 GW of solar will be added this year according to Bridge to India, of which 10.9 GW will be utility scale and 2.4 GW rooftop. This surge is largely due to legacy effects of intense tendering activity in late 2017 and early 2018 coming online in 2019. But the overall trends of 2018 point to serious risks of a solar slowdown. If renewables are going to displace a larger share of coal in the medium-run, then some more transformational changes in how the electricity space is regulated and organized will have to be pursued. As we argue in an article forthcoming in Energy Policy, the significant growth of renewable energy in India since 2014 has very much been a top-down affair greatly driven by policy innovation and high prioritization by the central government and some key states. This policy push was driven by multiple factors including global pressures leading up to the Paris agreement, the leadership of Prime Minister Modi, and energy security and investment factors. However, the upcoming national election will likely return a more fractious coalition government, reducing the appetite for ambitious energy sector reform, all in the context of flagging global climate action. The question of electricity reform in India highlights the challenges for democracies of reconciling diverse interests and voter groups with the need to move to cleaner sources of energy.  This challenge is not unique to India. Witness the prolonged discussions in Germany over the timing and terms of phasing out coal production. The United States, with the deregulatory pushback in the Trump era, is also facing similar challenges. Solving this puzzle will be a key challenge of national and global governance in the years ahead. The authors would like to acknowledge the support of the IC² Institute, the LBJ School, and the Strauss and Clements Centers at the University of Texas.