Energy security and climate policy: two sides of the same coin?

Energy security and climate policy: two sides of the same coin? Peter R. Hartley Kenneth B. Medlock III Rice University

“We must treat energy security and climate security as two sides of the same coin.” Tony Blair, October 20, 2006

A basis for the claim • Dependence on imported sources of energy can have negative macroeconomic and strategic consequences • Most of these imported sources are fossil fuels, the combustion of which increases CO2 emissions thereby contributing to global climate change • Both undesirable consequences can be reduced by reducing fossil fuel use • What is wrong with this idea? • Burning less fossil fuel may not be a very efficient policy response to the threat of climate change, especially if it is implemented in an inefficient way • A policy discouraging the burning of fossil fuel may decrease energy security, especially in the short run and especially for North America • We will focus on the US, but some of our remarks will also be relevant especially for Japan and the EU

Possible meanings of energy security • Related to national security as usually interpreted: • Reduce the need to maintain influence in areas, such as the Middle East, that are rich in natural energy resources but politically unstable or hostile to the US • Reduce dependence on foreign energy suppliers, such as Venezuela and West Africa, which have sovereign risks that are not very predictable • Modern military forces require a substantial amount of oil products (in the case of the US, 130 million barrels of oil products a year) • Energy security also is related to economic security, with energy price shocks having been implicated in macroeconomic disturbances • Large oil price shocks also produce large financial flows between importers and exporters that can disrupt financial markets • Price uncertainty further reduces investment in safer sources of supply, tending to exacerbate initial instability

Policies to promote energy security • Emergency stocks (such as the SPR) can accommodate short-term shocks • In a worldwide energy market, however, any change in supply or demand will affect prices everywhere • The distinction between reliable and unreliable partners is dubious • Nevertheless, security is enhanced when there are more suppliers and when developed economies supply a higher proportion of world energy • Transparent rules, good information, and absence of trade barriers produce integrated energy markets with many suppliers and demanders • In the long term, national energy security is also enhanced by a greater variety of domestic energy supply sources and by greater substitutability between energy sources

Climate policies • Take it as given that anthropogenic CO2 emissions will change climate, possibly in ways that could be significantly harmful on net • It need not follow, however, that limiting CO2 emissions is the best policy response or even part of the optimal policy response • Actions regarding climate change can be classified into five categories • Reducing the emissions of greenhouse gases, particularly CO2 • Increased sequestration of greenhouse gases, particularly CO2 • Geo-engineering projects to offset the warming effects of greenhouse gases • Limiting the chance of harmful consequences from climate change of a given magnitude • Improved remediation of damages resulting from climate change

Reducing emissions of CO2 • For emission cuts to make sense as part of climate policy, they would need to be more cost effective than the alternatives • Costs include lost benefits from increases in CO2, including in particular the aerial fertilizer benefits and any climate changes that are beneficial • The same criticism applies to sequestration • Measures restricted in geographic scope need to take account of “leakage”, which could increase world-wide CO2 emissions on net • If emission cuts reduce the variety of fuels or the range of suppliers, they will reduce energy security • These indirect costs also need to be counted

Coal and unconventional oil in the US

The Rice World Energy Model (RWEM):A Framework for Analysis

RWEM • The Rice World Energy Model (RWEM) is a dynamic spatial equilibrium model that eliminates arbitrage opportunities by investing in and utilizing energy resources, energy-using capital, and delivery infrastructure • Data for conventional and unconventional energy resources (coal, oil, and natural gas) are obtained from the USGS and the World Energy Council • Data for renewable resource potential (hydro, geothermal, wind, solar) is obtained from a variety of sources, including NREL, GWEC, and DOE • Capital costs for different technologies in the electricity industry were collected from industry sources, and compared to DOE reported costs • Industry relocation potential is parameterized using the GTAP database • Industry is broadly classified as Chemicals, Refining and Processing, Metals and Manufacturing, and Other • Each sector has a unique set of parameters and proportion that is identified as “re-locatable”

RWEM (cont.) • The RWEM divides the world into 17 regions • Changing energy demand, supply and trade among regions • Investments in existing and new energy resources and technologies

Energy Market Consequences of CO2 Abatement • A scenario approach was used to examine and compare various outcomes under different sets of assumptions: • Degree of CO2 emissions cuts (no clear policy yet, so we investigate effects by degrees) • Safety valves and offset programs • The operating and capital costs of various end-use technologies (there is wide disagreement between government and industry here) • Elasticity of supply of various fuels • Elasticity of demand in different sectors • Rate of technological innovation • Regional policies versus harmonized federal and international policies. • “CO2 leakage”

CO2 Price is Sensitive to Policy Design • Increasing restrictions raise the price • CCS deployment, demand reduction, and offset mechanisms are critical! • CO2 caps result in more volatility than a tax, but allowing offsets reduces volatility by allowing the “supply” of CO2 credits to be more elastic

CO2 Emissions are Sensitive to Policy Design • Biggest impact on emissions occur through stringent caps without offsets • Thus, if net emissions are the target, offsets must be real to be effective

Energy Demand is Sensitive to Policy Design • Energy demand reduction is significant under aggressive emissions reduction policies • Allowing offsets results in less demand erosion, which is directly related to the economic loss associated with the policy

CO2 constraints cause CO2 Leakage • A large portion of demand reduction occurs due to industrial relocation • More binding constraints on CO2 emissions result in greater relocation of industry, which reduces demand and hence CO2 emissions

Oil Demand is Sensitive to Policy Design • Oil demand reduction could be significant under aggressive policies. Allowing offsets results in substantially less demand erosion

Trends in the US Power Sector: 2010-2050 Reference Case 50X50 Case with Offsets

Key Results under CO2 constraints • North American demand for oil and coal decrease • CO2 caps ultimately render oil demand lower as electric vehicles (EVs) must penetrate to shift CO2 from mobile-sources to point-sources • Coal demand is reduced most by policies that raise the price of CO2 until CCS becomes a commercially viable option, restoring coal use • Industrial load is shed via direct demand reductions and“leakage” • The demand for natural gas in North America increases • Largest increases are in the scenarios in which CO2 pricing does not encourage the adoption of CCS technologies but does encourage switching from coal to gas in the power sector • Scenarios in which EVs penetrate the transportation sector favor natural gas demand as the primary source for electricity generation • EVs are a more effective way of using natural gas for transport than are CNG vehicles

Key Results under CO2 constraints (cont.) • North American production of coal and oil – particularly heavy oil from bitumen and oil shales – are significantly lower • CO2 caps raise the cost of production • In the Reference Case, the balance of global oil production shifts to the Western Hemisphere post-2050 • With CO2 caps, this does not happen • The production of natural gas in North America increases as a result of shale gas, but so do LNG imports post 2030 • CO2 controls that do not encourage CCS can also raise LNG imports to North America by stimulating demand • The big winners when North American LNG imports rise are Iran, Venezuela, and Russia (by displacement) • This has obvious trade-offs with energy security

Alternative Policy: Mitigation and remediation of damages from weather events • Measures to reduce the likelihood of large damages from climate change could include • building dykes to protect vulnerable coastlines, • improving evacuation plans and procedures, • changing building codes to increase structural integrity, • developing crops more resilient to altered climate, • removing subsidies to activities that increase the harm, such as policies that encourage people to live nearer the coast • Examples of improved remediation of damages could include: • better disaster relief preparation, • improved cooperation between disaster relief teams, • developing a better civil reconstruction capability • These alternatives do not impinge on energy security • They also allow us to retain the beneficial effects of increased CO2 such as the aerial fertilizer benefits and any climate changes that turn out to be beneficial

Other issues to consider • How much climate change is natural, how much is attributable to anthropogenic non-CO2 sources, and how much results from the accumulation of CO2? • The larger the non-CO2 components of climate change, the stronger the case for mitigation or remediation of damages • Mitigation or remediation of damages help protect against non-CO2 as well as CO2 sources of climate change, while limiting CO2 addresses only one source • Many remediation measures are also valuable for handling other disasters like earthquakes, tsunamis or terrorist attacks that have no relationship to climate • Controlling emissions in the future is a substitute for controlling them today • If much uncertainty about the extent and timing of potential damages may be resolved in the near future, the case for delay is strengthened • The possibility that uncertainty about future technologies for controlling emissions, sequestering CO2, reducing consequences etc. will be resolved also increases the option value of delay

Are policies toward energy security and climate change complementary? • Increases in energy efficiency serve both policy goals • Increasing the use of non-fossil sources of energy also serves both goals • In the long term, new energy technologies are essential for energy security, but more basic research is needed to make them competitive suppliers of bulk energy • It is doubtful whether limiting diversity of fossil fuel sources in the US can actually reduce global CO2 emissions given the likelihood of “CO2 leakage” • Coal and unconventional oil in particular provide potential energy security benefits for the US and Canada, but these are relatively CO2-intensive fuels

Instruments and targets • Some policies can further both goals: • Increasing energy efficiency • Increasing non-fossil fuel sources • Some policies have conflicting effects: • Directly limiting the use of coal and unconventional oil • CO2 emissions constraints, which will shift energy production away from the developed world • Climate change policies with no effect on energy security: • Increased sequestration • Climate damage mitigation and remediation

Two policies compared • Constraints on CO2 emissions would tend to: • Encourage energy efficiency by raising the overall price of energy • Encourage investments in non-fossil energy sources by disadvantaging fossil fuels • A similar effect could be achieved by directly taxing all energy and using the proceeds in part to subsidize investments in non-fossil energy technologies • There are three major differences between these two options: • The tax plus subsidy option would not disadvantage CO2-intensive fossil fuels in the short term, thus assisting with energy security albeit at the expense of more CO2 • The energy tax policy could provide revenue for climate change mitigation and remediation strategies and subsidizing research into alternative energy technologies • Constraints on CO2 emissions will favor non-fossil alternatives that are currently the most competitive whereas subsidies could be directed toward non-fossil sources that have the greatest long term prospects

Conclusion • Policies to address climate change and energy security are not necessarily “two sides of the same coin” • For the US at least, the goals are as likely to conflict as coincide, while some measures could further one goal with little effect on the remaining goal • Perhaps the conflict in goals is less significant for Europe and Japan, where coal and unconventional oil is less prevalent • Mitigation, remediation and sequestration also address climate change without affecting energy security • The goals are more complementary when it comes to encouraging energy efficiency and non-fossil energy sources • Taxing energy use encourages energy efficiency, while the revenue could be used to • mitigate and remediate harmful effects of climate change; and • subsidize basic R&D into alternative energy technologies • If energy security is a concern, this could make more sense than constraining the use of coal and unconventional oil

Energy security and climate policy: two sides of the same coin?