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Achieving competitive, sustainable

and guaranteed energy

Presentation

Prologue

Conclusions and recommendations of the

energy document

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PRESENTATION

The search for competitive and sustainable energy from guaranteed supplies is

doubtless a basic demand of any modern, competitive economy. The economic growth

of a country, the development of its companies and the wellbeing of its citizens are

intimately linked to the way this important matter is resolved.

Here at the Círculo de Empresarios –whose proposals have always clearly

reflected a marked concern for the interests of society as a whole– we have often

reflected on this subject, in both specific documents and others of a more general

nature. In our Barometer of the Círculos, we recently noted the need for “a regulatory

framework for infrastructures that is transparent, predictable and stable so as to

create prices, especially for energy, that do not cause a competitive disadvantage in

the international setting.”

There are many factors –technological, geopolitical and environmental– that

affect this highly complex subject. And there are many consequences, both positive

and negative, from the way it is approached. The future of energy is something that

must be dealt with in a combined, coordinated way and on a global scale. Regarding

Spain, for example, there is a clear need for not only its own energy policy but for a

European policy. This is one of those areas where private initiative must be perfectly

coordinated with what the public powers are doing, on both the national and

international levels.

In Spain, and at the Círculo de Empresarios, we have companies that are in the

international forefront. Thanks to this, a first-class team directed by Josu Jon Imaz –

and including representatives of energy producers, distributors, important consumers

and consultancy firms– has taken several months to produce a thoroughly

documented, rigorous study that contains important conclusions and

recommendations. My thanks everyone for their dedication and effort. And, above all,

for what I consider most important: future guidance in a subject that is essential for

our economy and our society. All of us – citizens, companies and public

administrations– should take it very much into account.

Mónica de Oriol

President of the Círculo de Empresarios

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PROLOGUE

What would we do in a world without energy? Of course this is a rhetorical question,

but it’s one that’s been with human beings forever. Every great step forward in the

world has been propelled by energy. Almost a million years ago Man harnessed fire

and realized that this “magic” gave him the independence to prosper. Energy is just

that: progress, evolution.

We are in a tremendously changing global context on all levels, and this too is

related to energy. We’re seeing highly variable prices, and as emerging powers awaken

from their lethargy to pursue development and progress, they will concentrate on

consuming energy in the coming decades. There are geopolitical conflicts caused by

energy, or where energy is used as a bargaining chip; there is a disproportionate

distribution of energy that should make us react and think rapidly.

This is a challenging time when energy companies, working with political decision

makers, must rise to the occasion and give society what it demands of us. We should

provide the energy that the world needs –and do so in the most sustainable manner.

In this new setting of increasing demand by countries outside the OECD –countries

with very different patterns of growth– all the different energy sources should be

present, making optimal contributions to the different sectors. To achieve a more

developed and balanced world, the answer is not just one source of energy. There is

no single correct answer, no silver bullet. The solution is to use all sources, with each

one fulfilling its potential wherever necessary.

For this reason, and because we share responsibility, this publication has enlisted

the help of energy supply firms from different fields, as well as companies that

consume energy. We share a vision of energy and its future, and together we have

reflected on those aims that energy policies should guarantee: a reliable supply,

competition in industry and society, and sustainability. I want to thank all the

companies for the responsible way in which they participated: from the point of view

of the general interest rather than for sectorial gain. This contribution is especially

relevant in the Spanish context, where economic recovery has begun and where

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energy is an important factor in competitiveness. We have also considered the role of

Spain and our energy challenges within the European context.

The different energy sources are like the pieces in a puzzle, and we should work

together to find all of them, because they are all essential. There’s never been a puzzle

where all the parts are equal; each one is different but complementary. And that must

be our goal: to fit each one of them in the right place and thus achieve the best final

result.

Josu Jon Imaz

President of the Energy Committee and CEO of Repsol

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CONCLUSIONS AND RECOMMENDATIONS

INTRODUCTION

The most recent estimates by the International Energy Agency foresee an increase of

33% in world energy demand by the year 2035. During this increase, the center of

gravity will move toward the emerging economies, especially China, India, Southeast

Asia and the Middle East. In addition to this heightened demand there are two

determining factors. First, it will be more difficult to obtain traditional energy sources,

both because it is harder to access some of them (for example, there are more difficult

conditions for exploring and exploiting) and because of uncertainty (i.e., geopolitical

reasons). And second, increasing concern about whether the current global energy

model is environmentally sustainable. These factors have created an enormous

challenge to those organizations that are responsible for energy policy and supply

(governments, agencies, public and private companies) as they try to satisfy the

expected demand.

In this context, the Energy Committee of the Círculo de Empresarios has made

some proposals to meet the challenges to the Spanish and European energy systems.

The proposals seek to advance in a balanced and rational way in three areas: (i)

improving economic competitiveness; (ii) making the supply more reliable, and (iii)

increasing sustainability.

Competitiveness in the cost of energy is essential for developing any energy

policy because it directly impacts Spain’s GDP and trade balance. In Spain, the energy-

intensive industries (metallurgy, chemicals, paper) represent 2.3% of the total GDP.

This figure is low in comparison to other European countries (for example Germany,

with 3.8%, and The Netherlands, with 3.2%) and similar to that in other countries (the

United Kingdom and France). However, the impact on the Spanish economy is very

important, because the industrial sector has a significant knock-on and multiplying

effect on GDP due to the network of its suppliers, as well as an indirect effect through

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the greater income and socio-economic wellbeing that it brings. In addition, Spain will

have to reinforce its industrial sector so that the economy will grow and be more

diverse and stable in the middle and short term. In this sense, the energy sector and

big industry share important challenges in maintaining economic sustainability and

competitiveness. Both sectors are essential for economic development in Spain and

have complementary challenges. A competitive energy sector –one that is

economically sustainable and adequately integrated with the domestic energy market–

will be able to offer Spanish consumers competitive electricity and gas prices. This will

allow Spanish industry to reach the necessary levels of activity and consumption

without which the sustainability of the energy sector would be at risk.

Gas accounts for an important percentage of the production costs in industries

like ceramics, glass, steel and part of the chemical sector. The drop in the demand for

gas, and the inclusion of new exogenous costs, could mean a change in costs for the

eventual consumer. Thus Spain should develop the necessary means for favoring the

use of indigenous gas at competitive market prices.

Another significant part of energy costs is in electricity, one of the most

important factors when defining Spain’s competitiveness on a global level. In recent

years in Spain the price of electricity has increased because of factors not directly

related to its supply but to environmental, industrial or social policies –or directly

because of higher taxes on electrical consumption or production. In spite of the fact

that the electricity wholesale market is fluid and its prices are competitive when

compared to those in the principal European markets –and that the network costs are

much lower than what’s common in Europe– strong regulatory and fiscal pressures

increase the final price that the consumer must pay for electricity. Following successive

reformation in the sector, the regulated component of the prices of electricity has

been reduced (for example renewable sources, transport and distribution payments,

cogeneration, interruptibility). Nevertheless, in an effort to lower public deficits, taxes

on energy have risen sharply. This increasing fiscal pressure threatens the

competitiveness if industry and the energy sector.

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Security in supplying energy is currently at the top of the list of geopolitical

concerns, and recent events like the instability in Ukraine have brought this home to

the general public and affected the markets. Spain depends almost 100% on imports

for its two principal sources of primary energy, petroleum and gas, and in the

European Union as a whole dependence on exterior sources is very high (i.e., 86% of

petroleum and 66% of gas in 2012). Although the EU has diversified its sources of oil

and gas in recent years, the considerable dependence on Russia for gas –and on the

OPEP for oil– illustrates Europe’s delicate energy situation. Nevertheless, with regard

to natural gas Spain has some uniquely diverse sources thanks to its six regasification

plants; in 2013 it received natural gas from 11 different places.

Environmental sustainability is a key, undisputed factor in the EU’s energy

agenda. Proof of this is the launch of its Climate and Energy Package, which seeks to

reduce greenhouse gases, promote renewable sources of energy, and increase overall

energy efficiency in Europe.

Following deliberation by its members, the Energy Committee of the Círculo de

Empresarios proposes a series of measures to advance Spanish and European energy

policy in the three areas mentioned earlier. These proposals, contained in this

document, can be structured along three lines of action:

■ Energy efficiency

■ Renewable energies

■ Natural gas

■ Traditional fuels

■ Non-conventional fossil fuels

■ Interconnections

PROMOTING ENERGY EFFICIENCY

These measures in energy efficiency simultaneously achieve an important reduction in:

(i) Europe’s energy bill (promoting energy competitiveness); (ii) Europe’s energy

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dependence, and; (iii) the emission of greenhouse gases. It should also be

remembered that in October of 2014 the European Council proposed that energy

efficiency be improved by at least 27% by the year 2030.

Most of the measures considered under the energy efficiency heading achieve

substantial savings. That is, they yield a positive economic balance or “pay for

themselves.” Simultaneously, it is easy to apply most of these energy-efficient

measures, for three reasons: (i) since most can be applied in stages, they require

relatively small investments (unlike many “upstream” measures in economic policy);

(ii) this type of measure is attractive to investors because many of them yield high

returns in the short/medium term, and; (iii) it is easy for users, investors and other

parties to measure their impact.

In this sense, all the characteristics and reasons listed earlier support the thesis

that energy-efficient measure must be chosen based on a cost/investment/profit

analysis of each one of them and how the fit in the system as a whole. For example,

the principal measures will increase energy efficiency in public, private and commercial

buildings (e.g., lighting, air conditioning, insulation), in energy-intensive industrial

processes (for example the repair of engines and stoves and in cogeneration) and

transportation mobility (renewing cars by incorporating new engine technology,

improving collective passenger and merchandise transport by rail). In sum, measures

for energy efficiency not only make costs more competitive (many of them earn

money or “pay for themselves”) but also reduce energy dependence (by at least 10% in

what the European Union imports) and the levels of emissions.

Finally, it should be mentioned that public support for energy efficiency through

adequate regulation (for example, energy regulation in buildings) and incentives (like

tax breaks and favorable financing plans) has been an essential tool in other countries

and has been effective and sustainable in Ireland and Denmark (in residential and

industrial areas) and in Norway and Spain (in mobility and transportation, for example

the PIVE Plans in Spain to stimulate car sales).

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REVISED STRATEGY FOR RENEWABLES

For years the European Union has been supporting renewable technology, and has

unquestionably become the world’s leading region in promoting this kind of energy, in

line with its ambitious aims to reduce energy dependence and greenhouse gases. At

present in Europe, renewable energy provides a little more than 10% of all primary

energy and 20% of all the electric energy. This commitment was recently reinforced by

the 2030 Climate and Energy Policy Framework and by the new support from the

European Commission for the renewable sector.

In Spain, these new technologies for generating energy are notable, as is their

impact on industry. This is especially true in the case of wind technology: in 2013 it was

the leading source for generating electricity, providing 20.9% per cent of the demand.

On the industrial level, Spain is the world’s third most important exporter of wind

turbines (after Germany and Denmark) and the world’s fifth country in wind generator

patents. In addition, Spain’s high degree of energy dependence makes it even more

necessary to back these local inexhaustible sources like wind, sun and water.

This triple commitment –to reducing energy dependence and CO2 emissions and

supporting a new industrial sector– has benefited from advances in the learning curve

in these technologies. In recent years many of the renewable energy technologies have

reduced their costs. And it is hoped that in coming years they can become more

economically competitive, for several reasons: the technology will improve, supply

chains will be more efficient, and there will be continual improvement in operation

and maintenance and in the internalization of the costs of other technologies. Support

for these sources of energy is thus not only strategic but also increasingly efficient.

In the future, the people responsible for energy policy in Europe and Spain have

to guarantee that this development, along with the increasing price of CO2, results in a

greater development of the most tried and efficient renewable technologies. This will

make it possible to balance the market and boost more competitive entry models of

agents and technologies and the allocation of capacity models (for example,

competitive auctions) depending on the maturity of the technology and its potential

for reducing costs. At the same time, there should be research and development of the

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renewable technologies that seem most promising but which are currently not

technically and economically feasible. And all this should be done within the

framework of R+D.

AN OVERALL VIEW OF NATURAL GAS

In line with recent trends, the demand for natural gas is expected to continue to

increase all over the world, although 80% of this increase will be in countries outside

the OECD. Because of its relatively low CO2 emissions, natural gas is an ideal fuel for

achieving a low-carbon economy. Besides being used in the residential and industrial

sectors, it will continue to play a key role in generating electricity by means of the

combined cycles that are necessary for support in a new model where there is a strong

presence of renewable energies (they represent 25% of this power in Spain).

At present, with the European Union importing two-thirds of the natural gas it

consumes, it is necessary to take steps to reduce this vulnerability. In this sense,

liquefied natural gas (LNG) can be a very important factor in mitigating this uncertain

supply. This gas comes from diverse sources, there are more and more suppliers, and

the supply is flexible. If necessary, or through price arbitrage, it can be diverted to

other markets.

Spain’s unique geographical location, as well as the important role of LNG in its

gas market and network of pipelines, makes the country an important point of entry

for gas from Algeria into Europe. But to make this a reality, it will be necessary to

increase the connection between the Iberian Peninsula and France. At the same time,

the other European countries must increase their capacity to transport and store this

gas if they are to have access to diverse, efficient energy sources.

Besides increasing this interconnection, Spain must create an organized gas

market (hub) like the ones in other countries, where daily and longer-term market gas

prices are published in a transparent way. These price listings will help strengthen the

competitiveness of Spanish companies with regard to their European counterparts.

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OPTIMIZING “TRADITIONAL” FUELS

In a context in which many of the proposed solutions will only be viable over the

middle and long term, it is necessary to reflect on today’s energy sources, which will

continue to dominate the European energy system. According to the International

Energy Agency, in the EU ‘traditional’ fuels will represent almost 61% of the total

primary energy supply in 2030. For this reason it is necessary to analyze in detail the

energy that comes from petroleum (32% of this total primary energy in 2030), coal

(14%) or nuclear power (15%) so as to extract the greatest value from these sources in

the short and middle term.

In this context, it is of great importance to exploit the conventional local

resources in Europe and Spain so as to improve trade balances. To accomplish this,

public administrations and private companies need to increase joint efforts to locate

and assess these resources and strictly enforce environmental requirements so as to

sustainably access and extract their energy.

For its part, energy based on coal will be facing a problematic situation in coming

years. At the present market prices, which are expected to continue in coming years,

the economic margins of the technologies that permit the integration of renewables

are considerably reduced or negative. In order for these technologies to survive and to

attract investment, including the environmental investment required by the Industrial

Emissions Directive (IED), there is the possibility of offering some kind of incentives (for

example: environmental, increase of capacity payment), measures which naturally

should be coordinated with the European Commission. But if the necessary

investments to adapt the coal-fired power plants to the IED emission levels are not

carried out, all the coal production will cease between 2018 and 2023, with a loss in

power that has not been taken into account in current predictions about energy

demand in Spain. If this were to happen, it would be necessary to invest in new power

sources, and the mix of different energy sources would be less robust and diverse,

based almost exclusively on gas and nuclear power.

In the case of nuclear energy, we must consider extending the active life of the

existing plants. Spain’s nuclear plants were built to last some 40 years. But they have

turned out to be very reliable, and there has been continual investment, updating and

improvement. As a result, extending their life would be very efficient economically for

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the system (because the greatest cost was in the initial investment). For this reason,

Spain is considering following the examples of other countries, and extending the life

of these nuclear plants to the age of 60. Naturally, any such extensions are subject to

the approval and terms of the pertinent safety agencies.

DEVELOPING NON-CONVENTIONAL FOSSIL FUELS

By using local non-conventional fuels, it would be possible to do away with imports

and thus reduce energy dependence. While this possibility seems initially attractive, it

would be necessary to overcome a series of barriers with regard to cost

competitiveness. It would also be necessary to inform the general public about the

measures to protect the environment that are involved with these new energy

sources.

The most feasible of these options is shale gas, which has revolutionized the

energy scene in North America. In Europe, it appears that shale gas has considerable

potential, principally in Poland and France, and possibly in Spain. The experts make

widely varying estimates of this potential: it could satisfy anything from 5% to 13% of

the total gas demand in Europe in 2013. In any case, and even while recognizing that

there are doubts about its sustainability over the middle and long term, shale gas could

significantly affect costs, and so it’s an energy source that Europe and Spain should try

to develop.

As might be expected, developing non-conventional fossil fuels at freely

competing market prices demands the right energy policies. In the case of shale gas, it

would be necessary to draft specific regulations (perhaps based on the successful

system in the United States). This would make it possible to develop this energy source

while at the same time assuring that the projects are sustainable and that they provide

adequate environmental protection.

DEVELOPING INTERCONNECTIONS IN EUROPE

Spain is considered an “energy island” –our electrical interconnection is around 3% of

the installed power– and this increases our costs when it comes to receiving a reliable

and sustainable energy supply. At the same time, it prevents Europe from benefitting

from Spain’s unique geographical location (to make use of gas imported from Algeria

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and LNG, or Spain’s renewable sources) and impedes Spain from using more efficiently

that capacity.

In the case of electricity, the interconnection capacity (1.4%) has not increased

in the last 30 years –although by 2015 the new interconnection with France should be

functioning– and is far from achieving the targets recently set by the European Union

(i.e., 10% by 2020 and 15% by 2030). This situation increases costs and volatility in the

Spanish market because we are unable to access nuclear energy from France. At the

same time, it prevents us from exporting our surplus renewable energy at certain

times, which is economically inefficient for the European Union as a whole because

that energy has a marginal cost that is close to zero. In this sense it will be important to

again promote electrical interconnection projects with Europe and seek the protection

of the EU in overcoming opposition to their development.

In the gas sector, the situation seems to be more positive. There are effective

plans to increase the interconnection with France from the current 5.4 bcm to 7.1 bcm

in 2015 by means of the planned enlargement scheduled for Irún; and up to 14.3 bcm

if the Midcat project materializes. (The EU has included it as a Project of Common

Interest). This interconnection, along with development of the hub, could turn the

Iberian Peninsula into an important gateway for gas into Europe, and achieve a more

efficient, transparent and fluid gas market in southern Europe. The development of

these markets, along with more interconnections, would make supply more reliable. In

addition, market exchanges and integration would improve, thus achieving more

unified prices and finally developing an internal gas market that is efficient and

competitive.

These proposals should be executed in a regulatory framework that favors:

1. Stability. In this way, when making decisions all the consumers and companies in

the energy sector would benefit from stability in the legal and regulatory

framework, and from a transparent and predictable process for the future. It would

be possible to avoid the abrupt changes that upset the smooth flow of the market

and discourage investors. To achieve this stability, there should be a pact between

the political parties about energy policy and climate change. This would protect

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structural policies, which require long-term investments, from the recurring

changes caused by political developments.

2. A pro-market, pro-competition vision. In this sense, it is necessary to identify all the

different kinds of subsidies to the sector and to technologies so as to limit their

impact as much as possible, especially those subsidies that distort the markets. If

the government or regulators decide to grant subsidies for different reasons –

whether social, industrial, managerial or environmental– they should do so in a

clear way and minimizing their size, duration and market impact. Likewise, the

general rule for choosing these supports should be based on competitive

procedures, so as to guarantee that they have a minimal impact on energy costs

3. Transparency in Spain and the countries in the European Union. (For example, with

regard to energy costs, taxes and charges, and exemptions from their payment.)

This will be the best way to promote loyal competition, innovation and

competitiveness in global markets.

4. Lower taxes and regulatory burden for all consumers. To achieve this, it is

necessary to consider transferring some of these burdens to the national budget

or reducing or eliminating charges and taxes for all consumers and agents.

We hope these recommendations will be useful for regulators, public

administrations and the public in general when it is time to promote or support

different measures on energy policy.