Madrid, 1999 III · private sector. Repsol’s most recent step in the process, successfully...

CONTENTS

FOREWORD ............................................................................... VII

EDITOR’S NOTE ......................................................................... XI

OPENING SESSION

WELCOME

MR. ALFONSO CORTINA......................................... 1

«ENERGY AND THE COMMUNITY OF MADRID»

THE HONOURABLE ALBERTO RUIZ-GALLARDÓN....... 7

«DEFINING THE DECADE: ENERGY MARKETS AND ENERGY POLICY»

PROFESSOR WILLIAM W. HOGAN ........................... 11

KEYNOTE ADDRESS

«THE POLITICAL ECONOMY OF MEXICO´S ENERGY REFORMS»

THE HONOURABLE DR. LUIS TÉLLEZ ........................ 17

DISCUSSION ............................................................................. 25

SESSION IHOW WE GOT HERE AND WHERE WE ARE GOING: OIL

INTRODUCTORY REMARKS

MR. JOSÉ LUIS DÍAZ FERNÁNDEZ............................. 31

«THE PAST IS PROLOGUE: BACK TO THE FUTURE»

MR. BIJAN MOSSAVAR-RAHMANI............................ 33

«THE OPEC FACTOR»

MR. NADER H. SULTAN .......................................... 39

«OIL INDUSTRY CONSOLIDATION: DOES SIZE MATTER?»

DR. J.J. TRAYNOR................................................... 47

IIIMadrid, 1999

«MERGERS AND MARKETS»

DR. IRWIN M. STELZER ........................................... 53

DISCUSSION ............................................................................. 61

SESSION IIHOW WE GOT HERE AND WHERE WE ARE GOING:NATURAL GAS, ELECTRICITY, AND REGULATION


MR. PABLO BENAVIDES........................................... 67

«THE COMING AGE OF ENERGY GASES»

MR. ROBERT A. HEFNER III ..................................... 71

«RESTRUCTURING NATURAL GAS MARKETS: THE VIEW FROM SPAIN»

MR. ANTONIO BRUFAU .......................................... 77

«PRIVATIZING ELECTRICITY MARKETS: OPPORTUNITIES

PAST AND FUTURE»

MR. ROGER W. SANT............................................. 85

«THE ROLE OF GOVERNMENT: REGULATION AND REGULATORS»

THE HONOURABLE WILLIAM L. MASSEY .................. 91

DISCUSSION ............................................................................. 97

SESSION IIITHE ENVIRONMENT: CLEAN, CLEANER, CLEANER STILL


THE HONORABLE MARIA TERESA ESTEVAN BOLEA.... 107

«BUSINESS AND ENVIROMENTALISM»

MR. MICHEL DE FABIANI ........................................ 109

«INGREDIENTS OF A PROACTIVE REGULATORY POLICY»

DR. STUART L. DOMBEY ......................................... 115

«CLEAN FUELS»

MR. JAN J.F. TIMMERMAN...................................... 123

«CLEAN CARS»

MR. JUAN ANTONIO MORAL GONZÁLEZ................. 131

IV

DISCUSSION ............................................................................. 139

CLOSING SESSION

SUMMARY AND COMMENT

DR. IRWIN M. STELZER ........................................... 149

BIOGRAPHIES OF SPEAKERS ..................................................... 163

LIST OF PARTICIPANTS ............................................................. 171

V

FOREWORD

The Tenth Repsol-Harvard Seminar, whose Proceedings you will findin this volume, marks a special anniversary, a milestone in our seriesof meetings focused on international energy policy. As such, it pro-vided an opportunity to look back to past Seminars: to reflect on pos-itive achievements as well as on occasionally failed prognoses. It wasalso an occasion to look ahead: to analyze and preview the changesand challenges the international energy industries may expect at thedawn of a new century.

When the initial Repsol-Harvard Seminar took place in 1987, Spainwas far less integrated into global energy markets. Instead, most oil,gas, and electric companies were either state-owned or operated asmonopolies. Today, however, Spain is a free and open market wherea great many international energy companies are active in a compe-titive environment.

Repsol, too, has experienced deep structural change and significantgrowth during that period, becoming one of the leaders of Spain’s

VII

private sector. Repsol’s most recent step in the process, successfullyconcluded in June 1999 (even as the Seminar was taking place), wasthe merger between Repsol and YPF, the leading energy company of Argentina. The new corporation, Repsol YPF, is a member of the top ten oil companies worldwide. This merger was not a goal in itself, but an important stage in our company’s growth and international expansion.

Coming back to the milestone Tenth Seminar, I would like to brieflyhighlight some of the guidelines for strategic planning that emergedfrom the discussions of those days. (Please be sure that I do not attempt to compete with the brilliant conclusions that Irwin Stelzerpresented at the Seminar’s close.)

• Liberalization, privatization, and free markets have producedhuge benefits, but regulation and regulators are omnipresentand are likely to remain so for the foreseeable future.

• The recent wave of mergers and acquisitions in the oil industryhas created a number of enormous companies, but well man-aged second-tier companies will also have a chance to grow, toexpand, and to be profitable.

• At future Seminars, it will not be enough to predict the future;we will need to discover tools and mechanisms to influence thatfuture.

• The oil industry has a promising future despite the uncertaintiesit faces. However, the development of alternative fuels and thepresence of increasingly stringent environmental regulation willbe a part of the future landscape.

• Finally, we must be aware of the incredible pace at which the energy industry is changing. Indeed, we should expect that our Twentieth Seminar will differ from this Tenth Seminareven more than our first meeting in 1987 differed from our 1999 conference.

ForewordVIII

I would like to acknowledge and to thank Bill Hogan and his Harvardteam, Irwin Stelzer, and Bijan Mossavar-Rahmani, not only for theirplanning and organizing of this Seminar but for their commitment tothe Seminars from the very beginning. Their vision of what thesemeetings might accomplish is surely evident.

Finally, I would like to extend special thanks to all our distinguishedspeakers and guests for their active participation during the Seminar,particularly in the open debates following each session. These parti-cipants, like all those who have attended earlier Seminars, have inspired us to continue the series for the past decade and to look for-ward to future meetings. I hope to see you in Seminars in the nextcentury.

Alfonso CortinaChairman and CEORepsol YPF

Foreword IX

EDITORS´ NOTE

In 1987, our group from Harvard first met with officials from INH toconsider the idea of holding a seminar in Spain on petroleum policy.Our goal was to bring together leaders from the oil industry, govern-ment, and academia —men and women who shape, even as theyare shaped by, the ongoing rush of events in this turbulent industry—and to allow them to pause, step back a bit, and reflect on currentdevelopments and plan for future ones. The seminar idea grew intothe Repsol-Harvard Seminars on Energy Policy.

In subsequent years, INH became Repsol, and Repsol has becomeRepsol YPF. But whatever its form, the corporation has continued tosupport the goal and sponsor the Seminars. With serendipitous timing,the recent tenth anniversary Repsol-Harvard Seminar in Madridcoincided with the merger negotiations between Repsol and YPF ofArgentina. We can only admire Alfonso Cortina for his consummateélan and intelligence as he simultaneously hosted the Seminar andshaped the future course of his company.

To capture the substance of the presentations, the vitality of the dis-cussions, and the broadening nature of the energy industry, we publisha volume of the Proceedings from each Seminar. One of the Semi-nar’s founders, Bijan Mossavar-Rahmani, formerly of Harvard

XI

and now of Mondoil Corporation, has been as instrumental in editingand producing the Proceedings as he has been in creating the Semi-nars, and no acknowledgments would be complete without mentionof him. His ongoing contributions have been crucial ingredients inthe success of this series.

Those of us who have been fortunate to participate in these pro-grams —and to partake of the accompanying marvelous Spanishhospitality— are indebted to the leadership of Repsol YPF headed byits chairman Alfonso Cortina, and assisted by Jorge Segrelles, SimeónVadillo Zaballos, and lván Cieker, and to Fundación Repsol and its pres-ident, José Luis Díaz Fernández, for their generosity in sponsoring thisseries. Once again we express our thanks to Susan Meyers of RepsolYPF and Pilar Suárez-Careño of SC Comunicación, for the tireless workthey contribute every year to make this Seminar such a sparkling event.

A brief word about the ground rules of our sessions. They are alwaysstrictly off-the-record; presenters and participants represent them-selves, not their organizations. All can and do speak freely, and noth-ing said in any session has been attributed herein without permission.In editing these Proceedings, the revised versions have been presentedto the speakers for their amendment and approval.

For editorial assistance, we want to thank Patricia Bull of Cambridge,Massachusetts, who, for the third year, has served with distinction ascopyeditor, and Michael Ames and his team at Puritan Press of Hollis,New Hampshire, who have made the editorial process of this publica-tion a pleasure.

William W. Hogan, Guest EditorHarvard University

Irwin M. Stelzer, Guest EditorHudson Institute

Constance Burns, Series EditorHarvard University

Editors´ Note XII

PREPARING FOR THE

TWENTY-FIRST CENTURY

OPENING SESSION

WELCOME

MR. ALFONSO CORTINA

REPSOL YPF

It gives me great pleasure to welcome you to the Tenth Repsol- Harvard Seminar on Energy Policy. Our ambitious theme this year is“Preparing for the Twenty-First Century.” Throughout the course ofthe Seminar we will review and examine recent developments in theoil, gas, and electricity industries, and in the areas of energy and envi-ronmental policy, and then speculate on what directions the futuremay take, as the new century begins. To fulfill this challenging task,we are fortunate to have with us a group of brilliant speakers whowill analyze the topics, and an audience of distinguished guests whowill contribute to the discussions that will follow each panel.

Since these Seminars were launched in 1987, we have met in a seriesof delightful Spanish cities —Segovia, Toledo, Barcelona, S’Agaró,Granada, Seville, and Santiago de Compostela— all of them fondlyremembered by those who were present at the time. It is not bychance that the Tenth Repsol-Harvard Seminar, the final one of thisentury, is being held in Madrid. This special anniversary Seminar

1

required a very special setting; what better than young and cos-mopolitan Madrid, a city that is also full of history and rich in art andculture. In the past, Madrid was the capital of an empire; today it isSpain’s political and business center.

Madrid was established as a fortified town in the ninth century dur-ing the Moslem rule of Spain. For 200 years Madrid was a defensivecenter and starting point for the holy war in the Christian territoriesin the north. Even after Madrid’s conquest by Fernando I in theeleventh century, the city did not lose its border and military charac-ter, being constantly attacked and besieged. Finally, after the Christian reconquest in the South, it began to grow; it was made theroyal seat by Philip II in 1561.

However, I will say no more about Madrid’s history because I amsure that the events we have planned for you here —a visit to the Thyssen- Bornemisza Museum; a dinner hosted by the HonorableAlberto Ruiz-Gallardón, President of the Autonomous Community ofMadrid, in the historic Casa de Correos; a tour of the Prado Museum;and, finally, a special tour of the Royal Palace— will enable you toappreciate Madrid far better than my words can do.

PRESSURES AND RESPONSES

Now to turn to the essence of the Seminar. Oil companies will remember 1998 as one of the worst years in industry history: pricesfell continuously from more than $16 a barrel to around $10 by theend of the year. Although prices have recovered somewhat in thefirst half of 1999 —thanks to the agreements among oil producers tolimit their output— the situation is still far from being resolved.

However, factors such as the buoyant U.S. economy, an improvingsituation in Europe, the upswing in Asia, and the positive developments in Latin American markets still emerging from crisis, enable us to be moderately optimistic about the second halfof the year.

Opening Session2

Other developments also significantly influenced the positioning andperformance of industry players. As major oil companies took drasticmeasures to reverse the sharp decline of their earnings, two alterna-tive actions —mergers and restructuring— became prominent. Wehave seen the merger, acquisition, or absorption of major companies, notably BP with Amoco and then with Arco, Exxon with Mobil, andTOTAL with Fina. Other companies such as Shell have undertakenwidespread restructuring, reducing corporate segments to achievesignificant cost savings. In many mergers, the lack of real synergiesbetween the companies was obvious. In such cases, the decisionswere directed toward increasing corporate size (not to be confusedwith growth) and eliminating overlapping business segments. In thecase of restructuring, the first goal has been to boost margins andthe second to cut costs.

REPSOL’S PHILOSOPHY

At this point I would like to make a few comments about Repsol’sperspective on mergers. We have always believed that mergers inthemselves are not a magic solution to corporate or industry prob-lems. And purely defensive mergers —to make hostile takeovers bythird parties more difficult by simply increasing the market value ofthe new company— are certainly not a guarantee of success. Indeed,many mergers based on this criterion have failed. To acquire compa-nies because they are up for sale, without any analysis of the poten-tial advantages to all parties, is to run the risk of a short lifespan. Toensure a successful outcome from a merger, decision makers mustconsider the affinities of the corporate cultures, the degree of com-plementary elements and synergies, and consequently, the realgrowth possibilities of the resulting new company.

Repsol’s ambitious operation currently taking place —our acquisitionof Argentina’s YPF— provides a useful case study of a merger thatpromises a successful future. Repsol raised the idea of merging withYPF or of buying YPF not because all or part of it was up for sale. Wedid it because the strong and weak attributes of each company fit

Welcome 3

almost perfectly, producing a new company that is not only largerbut also better balanced. It has a larger international presence in areas of common priority that offer significant growth potential.

YPF’s contributions strengthen three of Repsol’s four strategic pillars:oil and gas reserves rise from 1,000 million barrels of oil equivalent(mboe) to 4,200 mboe; the international presence is reinforced, par-ticularly in Latin America; and the integrated gas chain, includinggeneration of electricity, is increased. And YPF will benefit, as Repsolplans to invest more than $3 billion in the new company.

This is a good example of one plus one being much greater thantwo. In addition, cultural affinities between the two companies andthe two countries of Spain and Argentina will make it easier for theemployees of Repsol and YPF to work together to position the newinstitution among the world’s largest, most effective oil companies.

TOWARD THE TWENTY-FIRST CENTURY

With this as background, I will briefly note the topics that will be dis-cussed at each session as our speakers look at the past and the fu-ture, the challenges and opportunities, underlying the competitiveand fast-changing energy industries. Their analysis, coupled with thediscussions that follow the panels, will enable us all to consider howto better direct our activities on the threshold of the twenty-first cen-tury. I invite all our guests to participate actively in the discussions:collectively you represent the highest levels of industry, government,and regulation, and the worlds of academia and research.

• In the Opening Session, the Honorable Alberto Ruiz-Gallardón,President of the Autonomous Community of Madrid, will wel-come us to Madrid and provide some comments on the achieve-ments and status of the energy sector in his region. He will befollowed by Professor William Hogan of Harvard University, whowill extend Harvard’s welcome and offer a careful analysis of de-velopments of the past decade that have affected the energy world.

Opening Session4

• For our Keynote speaker we are honored to have with us theHonorable Dr. Luis Téllez, Secretary of Energy of Mexico. Dr.Téllez will outline Mexico’s ongoing program of energy reform inthe context of its own political economy and pressures from theoutside world.

• The first session, “How We Got Here and Where We Are Going:Oil,” will be chaired by Mr. José Luis Díaz Fernández, Presidentof Fundación Repsol and a person of wide experience in the energyworld. The panel will take a broad look at world oil markets andthe likely direction of their evolution.

• The second session, “How We Got Here and Where We Are Going: Natural Gas, Electricity, and Regulation,” will be chairedby Mr. Pablo Benavides, Director-General for Energy in the European Commission, who will share his personal observationsas an experienced regulator. Our panel of senior executives andregulators of these industries will give us their perspectives andoffer comments on the future.

• As has been our tradition, the third session is focused entirely onone specific issue: “The Environment: Clean, Cleaner, CleanerStill.” We at Repsol attach the greatest importance to this topic,as underscored by the unilateral measures for environmentalprotection that we have adopted, and will continue to adopt, inadvance of government regulations.

This session will be chaired by the Honorable María Teresa EstevanBolea, member of the European Parliament, whose experience onthe European Parliament’s Energy and Environmental Committeesmakes her particularly well qualified to chair the session which will include industry executives on the forefront of regulatoryactivities.

• The Closing Session will once again provide an authoritativesumming up and comment by Dr. Irwin Stelzer, Director of Regulatory Policy Studies at the Hudson Institute. Once again Irwin

Welcome 5

will assume the challenging dual responsibility of summarizingall that has been said, debated, and concluded over the course ofthese two days, and also of editing with Bill Hogan the Proceedingsof this Tenth Seminar.

Lastly, I do not want to end without thanking Bill Hogan, his team atthe Kennedy School of Government at Harvard University, BijanMossavar-Rahmani, and Irwin Stelzer for the hard work and enthusi-asm that they brought to the planning and production of this TenthSeminar. Together, I trust, we will maintain —and even surpass, ifthat is possible— the high quality of the previous Seminars.

Opening Session6

«ENERGY AND THE COMMUNITYOF MADRID»

THE HONORABLE ALBERTO RUIZ-GALLARDÓN

AUTONOMOUS COMMUNITY OF MADRID

I want to express my thanks to Repsol, the Fundación Repsol, andRepsol YPF Chairman Alfonso Cortina for choosing the Region ofMadrid, and its capital city Madrid, as the location for the TenthRepsol-Harvard Seminar on Energy Policy.

The Madrid Regional Government endorses the measures to liberalizethe Spanish economy, particularly the energy sector. We are sure thatthis is the best path to take into the next millennium —one that offerscompetitive prices and high-quality services to all our citizens. In accord with the directives of both the European Union and the Spanish government, Madrid’s policy is to consolidate liberalization inthe energy sector, to make it more transparent and competitive, thusbringing lower prices.

Liberalization of oil and oil products in Spain began in 1992 and hasaccelerated with the passage of the recent Hydrocarbons Law. This lawalso liberalizes the natural gas sector. Liberalization of the electricity

7

sector was implemented by the Electricity Protocol of 1996, and wasstrengthened further by laws passed in 1997 and 1999. However, thegovernment retains its interest in security of supply, the rights ofconsumers, and the obligations of the parties to the larger society.

ENERGY USE IN THE MADRID REGION

I would like to talk briefly about energy in the Community of Madrid.Our region, the capital region of Spain, and to a great extent its eco-nomic engine, is a huge energy consumer. The latest data indicate anannual consumption close to 7.3 million tons of oil equivalent (mtoe).But the Madrid region produces very little energy itself, making it almost totally dependent on outside sources.

Consumption data clearly establish the importance of the oil sector inthe Madrid region. In recent years, oil and gasoline consumption hasbeen increasing at an annual average rate of 1.54 percent. Sixty-seven percent of regional energy consumption is from oil and oilproducts, 20 percent from electricity, 9 percent from gas, and only 4 percent from solid fuels. The largest energy consumer is the transportation sector (52 percent); our region has three million carsand is the nation’s communications center. The next largest con-sumer of energy, the residential heating and air conditioning sector,follows at 21 percent, and the industrial sector is third at 16 percent.Although Madrid’s industrial sector is the second largest in Spain, itconsumes relatively little energy because it consists primarily oftechnologically advanced companies.

To create wider energy diversification, we are working to increasenatural gas consumption. Currently there are over one million naturalgas consumers in the Madrid region, and we expect pipeline gasconsumption to increase 11 percent annually in the coming years.This has been a recent development, for it was not until May 1987that natural gas first came to Madrid through the construction of theEnagas Northern Gas Pipeline. That pipeline is now connected to thesouth and, via the Cordoba connection, to the Magreb-Europe

Opening Session8

pipeline. We are also expanding the gas network infrastructure,which now extends 4,550 kilometers.

Let me turn now to the region’s electricity sector. The electricity in-frastructure in the Community of Madrid is good; there is no areawithout electricity, in part because the Madrid system is part of theRed EIéctrica de España. We still depend heavily on power importedfrom other regions, as the 36 power stations in our region produceonly 4 to 5 percent of the electricity we consume. We expect the demand for electricity this year to grow by 3 percent in Spain, andslightly more in Madrid, due to our higher economic growth.

PLANS AND PROGRAMS

The Community of Madrid is working to implement the EC energydirectives and the programs of the Spanish Ministry of Industry andEnergy, as well as our own local initiatives. In the electricity sector,our Plan for Improvement in the Quality of Electricity Supply has replaced the old rural electrification plans and mandates infrastruc-ture improvements in many areas. Further, the Community has estab-lished incentive programs for achieving savings in electricity con-sumption, for example, by increased use of energy-efficientequipment and for reduction in the use of installed power. The Savings and Energy Efficiency Plan has defined three goals: increasethe use of renewable energy; diversify sources of energy; and improve energy savings. Finally, we have begun a study on the struc-ture of energy consumption in our region that will serve as a basis fordesigning future energy planning measures.

We are particularly pleased about our agreement with Repsol to locatethe Repsol Technology Center and the Repsol Energy Institute inMóstoles, near the campus of King Juan Carlos University, a public uni-versity of the Community of Madrid. The citizens and government ofthe Community are grateful to Alfonso Cortina and to Repsol for establishing these two pioneering energy research centers in our region. The Repsol Technology Center will be the first of its kind in

«Energy and the Community of Madrid» 9

Spain, able to compete with the best energy research centers in Europe. Repsol’s choice is logical because Madrid accounts for over32 percent of the R&D work in the nation. The company plans to in-vest nearly 11 billion pesetas in the center project, which will open in2001.

IN SUMMARY

As the new century dawns and our nation moves to increase com-petition among energy companies, the Community of Madrid is developing policies in support of this goal. Further, we are workingto promote increased diversification to guarantee security of supplyand to increase the market share of renewable energy sources. TheCommunity of Madrid offers an outstanding environment in whichconsumers and industries alike can take advantage of the benefits ofliberalization.

Members of the Tenth Repsol-Harvard Seminar on Energy Policy,I am delighted to welcome you to Madrid.

Opening Session10

«DEFINING THE DECADE:ENERGY MARKETS AND ENERGY POLICY»

PROFESOR WILLIAM W. HOGAN

HARVARD UNIVERSITY

This seminar series began little more than a decade ago. Our discus-sions and the development of energy policy in the last years of themillennium followed a trend already underway and likely to continuewell into the future. Energy policy and the role of governmentchanged from working against markets to working with markets asthe instrument of public purposes. Market forces dominate. Bycontrast, many public policies that have been effective in divertingmarket forces have been counterproductive, exacerbating energyshortages. Activist public policies that might be effective in improvingenergy market outcomes have been unpopular and rare. There havebeen exceptions, but in the domain of energy, the most successfulpublic policies have been those leading to a narrowing of publicresponsibility and an expansion of the market. The experience helpsguide the formulation of good questions for the analysis of energy policy problems.

11

GOOD ANSWERS AND GOOD QUESTIONS

At the end of the Repsol-Harvard Seminar of 1988, Irwin Stelzer captured his summary of the meeting with the apocryphal story ofthe last words of a famous wise person. In short, the story goes: Atthe final moment, after a lifetime of contemplation and thinking, awise person was approached by a humble disciple who asked “Whatis the answer?” The wise person responded “What is the question?”

This framework provides a good beginning for the X Repsol-HarvardSeminar on Energy Policy. It resonates with the advice given regularlyto doctoral students anticipating dissertation preparation. Before theexperience, students view the process as linear. Somewhere or some-how, a good question presents itself, and the task of the researcheris to dig into the details and find a good answer. After the experience,however, the new scholar has learned that the process is much moreiterative. Good answers are easy to find once you have a good question.Proper formulation, and reformulation, of the question is the realchallenge. Typically, the more you learn about a subject, the more yourealize that the initial question that focused the search for an answerwas not quite right. Rather, a slightly different formulation of thequestion, theory or model, would be in order. The new questionchanges the direction of inquiry, often in small ways that turn out tobe important. And the process reinvigorates the researcher. It is alwaysa great moment when you recognize that you have asked the wrongquestion, and understand why a new theory or model would be better.

The debates in energy policy of the last decade, reflected in the evo-lution of this Seminar, have had this same character of redefining thequestions and refocusing the inquiry. By its very nature, the processis never complete. However, as we look ahead to the discussion hereand to the developments to come in energy markets and energy pol-icy, it is useful to be mindful of the crucial task of formulating —andreformulating— the right questions.

The subtitle of this presentation captures an element of this story. Ourseminar series began in the early days of what would become known

Opening Session12

as the period of low oil prices. Before that time, any energy policy dis-cussion would have been dominated by the tasks of government inmanaging the problems of high prices and energy security throughmandates and stockpiles. But the force of the market changed thefocus from one of government intervention to government facilitationof markets. Now we talk more about energy policy in terms of restruc-turing the rules and regulations for greater market flexibility and trans-parency, or using the market to achieve environmental objectives.

The questions have changed because we have learned more aboutthe subject. The public policy focus on energy issues continues todefine those areas where markets work poorly or not at all. But thenature of the inquiry has advanced to identifying the role of govern-ment in changing the rules of the market to achieve indirectly whatcannot be obtained directly.

The questions that interest us in these Seminars have identifiable fea-tures. A reminder of the interactions between energy markets andenergy policy sets the stage for illustrations of good and bad ques-tions from the past, as we look ahead to the future.

PUBLIC POLICY AND ENERGY MARKETS

An organizing view of the role of public policy in any market, includ-ing that for energy, is the concept of market failure, where market failure is described in terms of the inability of a market to achieve thebest outcome from the perspective of the aggregate impact on socialwelfare. This is to distinguish between the more general use of theterm “policy” as applied to energy markets, where the actions ofmany private actors may be described as a policy, presumably withthe goal of making a profit. If the market has no “defects,” these pri-vate policies will also serve the public good. Public policy has a rolewhen this equation does not apply.

A typical example of market failure is in the existence and treatmentof externalities. These externalities produce a gap between the private

«Defining the Decade» 13

and social costs of production. Private costs for capital, labor, andmaterials are internalized in production decisions. Added social costsarising from pollution or security of supply concerns do not affect private production decisions. From the perspective of society as a whole, the total social cost should be the relevant measure, but theunfettered market decision would focus on the private cost, understating the impact of production and consumption.

The conventional theory of externalities looks to government andpublic policy to internalize social costs. According to the conventionalargument, the market will produce an outcome where the price ofdemand and private production marginal cost intersect. However, thewelfare maximizing point would equate the price of demand andmarginal social cost, perhaps through the imposition of an optimaltax on consumption. Externality value and the optimal tax can varywith quantity of consumption. Imposing the optimal tax would in-crease welfare despite a reduction in conventional measures of GNP.

The theory of externalities and market failure is not limited to thecase of pollution and welfare-enhancing taxation. Over the lastdecade, energy policy developments have emphasized another keyrole for the public sector in making the rules and designing the insti-tutions for market interactions. All but the most ardent libertariansrecognize that the magic of the market depends on the context of institutions and rules. For instance, the foundation constructed ofproperty rights and contract law supports markets where entrepre-neurs can innovate and capture the benefits of their ideas and efforts. Too often the public policy discussion assumes away the importance of these institutional changes, arguing that the marketalone can bring a panacea.

But both scholarship and common sense teach that markets may notbe able to develop the essential institutions needed to create andenforce property rights. As Douglass C. North, the Nobel Prize winningeconomist, noted, “Without conscious government action inefficientinstitutions can emerge, persist, and produce economic stagnation.”[Institutions, Institutional Change and Economic Performance, Cam-

Opening Session14

bridge University Press, 1990, p. 7.] Only a glance at the past decadein the former Soviet Union should be all that is needed to illustratethe failure of markets when government fails to define and enforcethe rules, or when market-supporting institutions do not even exist. Inthe United States, the recent resurgence of antitrust activities is anexample of this understanding. And the development of energy mar-ket restructuring and regulation provides another.

If public policy must examine, and change, the rules for operationof the market, then the subject of public policy analysis extends toinclude the operations of the market. It is important to understandthe workings of the market and the activities of the market partici-pants. Hence, those who participate in the market and those whostudy public policy have overlapping interests. Both need a sophisti-cated and broad understanding of what is happening. The marketparticipants can benefit from a periodic change of perspective to lookat the forest containing the many trees of their immediate attention,and the policy analysts need to make sure that their model of the forest contains the right trees.

Hence, the value of our conversations in this Seminar. The marketparticipants bring a wealth of knowledge and wisdom. The analystsbring their models and theories. Together we try to reformulate thequestions. Once we know the question, the answer should be easy,even obvious. If the answer isn’t obvious, we don’t yet have the rightquestion.

SUMMARY

These Seminars have seen significant changes in the focus of energypolicy discussions. We continue to have an interest in the self-educationrequired to understand trends in the operation of markets. Many ofthe sessions have this character of conveying new understandings ofthe dominant forces facing, and employed by the market participants.From a public policy perspective, the dominant thrust of this experi-ence has been to focus efforts on defining the role of government in

«Defining the Decade» 15

facilitating the use of markets to achieve public purposes, rather thanusing government to overcome the incentives and almost irresistiblepressures that the market produces. The new emphasis is on devel-oping institutions and rules that will support efficient competitivemarkets. Where necessary, the task of government in addressingmarket failures is to indirectly affect the results by changing the in-centives, rather than to directly mandate what the market or thepolitical process will not support.

This text is an abridgement of the longer paper written for this Seminar, “Defining the Decade: Energy Markets and Energy Policy.”The complete paper is available from the author.

Opening Session16

KEYNOTE ADDRESS

«THE POLITICAL ECONOMY OF MEXICO´SENERGY REFORMS»

THE HONORABLE DR. LUIS TÉLLEZ

MINISTRY OF ENERGY, MEXICO

I would like to thank Alfonso Cortina of Repsol and Bill Hogan ofHarvard for inviting me to Madrid to give the Keynote Address atthis tenth anniversary Seminar. I am honored to present the case ofMexico’s energy reform policy to this distinguished gathering.

MEXICO’S MODERN ECONOMY

Mexico has experienced a radical transformation of its economy overrecent years. Under the leadership of the Institutional RevolutionaryParty (PRI), the nation has turned into one of the most dynamicemerging economies in the world, with an annual growth rate ofmore than 5 percent over the past three years. More than a decadeago, the nation took its first significant steps on the path of economicreform and development with the commitment to stabilize the nation’s public finances. As proof of our success, note that in the1980s the public deficit was more than 10 percent annually; duringthe 1990s, the average will be less than 1 percent.

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A second important step in our modernization effort was the inte-gration of Mexico into the world economy. We joined the GeneralAgreement on Tariffs and Trade (GATT) in 1986 and the NorthAmerican Free Trade Agreement (NAFTA) in 1994; we negotiatedother free-trade agreements with Latin American countries; and weagreed to participate in the Asia-Pacific Economic Cooperation Forum (APEC). Today, we are negotiating with the European Unionto enter into a free-trade agreement, an opportunity that will furtherenhance Mexico’s role as a global player. Simultaneously, we havefollowed an aggressive program of structural reform at home: we areworking to change the role of the government from a supplier ofgoods and services to a promoter of the private sector, within a com-petitive environment with well-defined property rights.

Challenges for the Zedillo AdministrationIn 1994, Dr. Ernesto Zedillo, the PRI candidate, was elected presidentof Mexico. The Zedillo administration came into office committed tocontinuing the process of widespread reform that has been so importantin the nation’s economic growth. The administration’s record confirmsthis commitment. Important reforms can be seen, for example, in thetelecommunications and transportation sectors. Between 1995 and1998, we received around $7 billion in investments, and we changedthe ownership and managerial organization of the basic infrastructureof railroads, ports, airports, and telecommunications systems. Anotherimportant reform was directed to our national pension system. During our first year in office, the Zedillo administration changed thepension system from a pay-as-you-go system to a fully-funded system, and established the basis for increasing our savings rate byabout 5 percent of GDP.

However, the immediate and daunting task that the administrationfaced in our first days in office was to deal with the most severe finan-cial crisis in the history of contemporary Mexico. We faced potentialeconomic disaster —of a magnitude that has since been experienced inseveral Asian and other Latin American countries. Short-term gover-ment obligations came to more than $30 billion, and short-term private

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obligations were roughly $20 billion. It was clear that we neededthe full support of the United States and of international financial institutions like the IMF to support the short-term debt. With thehelp of officials in the Clinton administration, we received a short-term loan of $20 billion from the United States. I am pleased to notethat we repaid the loan at the end of the year. In short, we spent ourfirst year in office working to achieve economic stabilization andavoid a major collapse of our economy. And we succeeded.

Yet, despite the all-engrossing economic crisis of that year, we alsoworked on domestic reforms, making major changes in the areas thatI have mentioned: telecommunications, transportation, the pensionfund system. These reforms were not politically sensitive and couldbe passed in Congress without too much opposition.

TURNING TOWARD ENERGY REFORM

With the economy stabilized and the reform process continuing inconsensual areas, the Zedillo administration turned to the energy sec-tor. The energy sector plays a fundamental role in the development ofany country, providing the foundation for all productive and daily activities. Even more, in a global economy a nation’s success dependsstrongly on the competitiveness of its energy sector. In recent years,on a worldwide scale, technological change and sweeping shifts ingovernmental regulatory policies have helped transform the energyindustry. In most countries, energy companies have evolved fromsimple input providers to integrated global service providers, and activi-ties formerly carried out by fully integrated monopolies are todayopen to competition. Overall, these changes have resulted in impor-tant benefits to end users and to society in general.

The Mexican energy sector, we believe, should be both a resourcebase for governmental social programs and a driving force for ourcountry’s economic growth. But if it is to fulfill these functions,the sector will need to undergo considerable structural reform. For his-torical and ideological reasons, no significant effort in energy reform

«The Political Economy of Mexico´s Energy Reforms» 19

had occurred prior to President Zedillo’s administration; our state energymonopolies in hydrocarbons and in electricity remained largely intact.Considering these realities, the Zedillo administration developed astrategy for the entire energy sector —oil, natural gas, petrochemi-cals, liquefied petroleum gas and, most important, electricity. Thegoal is to create the necessary conditions for growth and increasedcompetitiveness.

Oil and International DiplomacyIn the oil sector, the Zedillo administration has undertaken importantsteps to strengthen and modernize Mexico’s oil industry. By takingadvantage of our low oil production costs, we are working to opti-mize the present value of our hydrocarbon wealth by expanding thereserves base, increasing the production of oil and natural gas, andmodernizing and expanding the national refinery system and thestate-owned petrochemicals industry. It is important to note thatthese efforts in the oil sector did not present major political problemsin that they did not require constitutional amendments and the political consensus that this process requires.

Despite severe budgetary constraints, the administration increasedMexico’s oil production from 1995 to 1998 by 17 percent. Averageannual oil production in 1998 measured more than three million barrels a day (mbd), the highest level in Mexican history. During thefive years of the Zedillo administration, we will have invested about$31 billion in our oil industry. However, we have not tried to openthe industry to private investment, foreign or domestic; such a programwould have no chance of getting through Congress.

In the international oil market, from late 1997 through the first quarterof 1999, crude oil prices fell sharply, severely affecting Mexico’s bud-get. We are not dependent on oil in terms of our GDP or our exports:oil accounts for less than 2 percent of Mexico’s GDP and less than 6percent of our exports. But we are still very dependent on oil for ourfiscal revenues: oil accounts for around 30 percent of government in-come. That is why Mexico took important initiatives in international

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oil diplomacy, promoting international agreements to reduce worldoil supply and balance the market in order to stabilize prices.

On March 12, 1999, at a conference in The Hague, we entered intoan agreement with other principal oil producers to cut output signif-icantly —our own included, of course. After much discussion, weagreed to cut 125,000 barrels a day, as part of the overall agreementwith Saudi Arabia and Venezuela. Administration officials were skep-tical that this decrease in production would raise our revenue, but infact, prices have moved up, resulting in an overall increase of about70 percent in the price of the Mexican oil basket between Februaryand March of 1999. If all the parties continue to comply with theagreement through the end of 1999, the market will be stabilized.

Domestic Oil and Natural Gas ReformsIn addition to expanding the oil industry, we have worked to openother energy sectors to private investment and international compe-tition. For natural gas, laws enacted in 1995 allowed greater privatecapital participation in infrastructure developments for transporting,storing, and distributing natural gas. This has enabled us to meet ourgrowing natural gas demand by providing a reliable legal framework.

In the petrochemicals industry, the government proposed measures forsome privatization, but they were met with strong political opposition.Congress required the government to continue holding the majoritystake in the plants to be sold off. This restriction made it difficult to guar-antee the necessary stability to private investors, and we were unableto sell the 49 percent stake in the plants we had hoped to privatize.

ElectricityMexico faces its most formidable challenge in the electricity sector,and that is where President Zedillo has undertaken his major reform effort. In the next six years, demand for electricity in Mexicowill grow at a rate of no less than 6 percent a year. This implies notonly that a minimum of 13 gigawatts of additional generation


capacity must be installed, but also that the government will need toinvest approximately $5 billion each year, merely to keep up with demand. Any attempt to meet these requirements solely with publicresources will not only risk the modernization and expansion of Mexico’s power sector, but will also divert funds essential to meetingother needs of Mexicans.

To deal with this challenge, the president has courageously embarked on Mexico’s most ambitious energy reform program. InFebruary 1999, he submitted a proposal to Congress to amend twoarticles of the Constitution in order to restructure and liberalize theMexican electricity industry. It was clear from the beginning that pas-sage of this most ambitious reform would be difficult, especially sincethe administration no longer held a majority in Congress. However,even opening the discussion on such a vital reform, regardless of itsintensity or ultimate success, is a worthwhile endeavor in itself.

The reform proposal for electricity has the following objectives:

• The reorganization of the electricity industry to allow a greaterdegree of competition, with national and international private investors participating under a mixed-participation scheme.

• The establishment of a short-term wholesale electricity market inwhich generators will sell their energy under competitive condi-tions and in which prices will be freely determined.

• The strengthening of governmental authority to guarantee alevel playing field and to avoid any conflicts of interest and thusassure competition.

• The creation of a transparent and efficient subsidy policy for res-idential and agricultural consumers, with explicit welfare aims.

• The development of a transparent and reliable legal frameworkto offer security to private investors and to allow the NationalEnergy Regulatory Commission to regulate transmission and

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distribution systems in terms of pricing, investment, and qualityof service for the benefit of final consumers.

We designed this proposal to allow Mexico to join in the technologicaland regulatory advances in the electricity sector so prevalent aroundthe world. If Congress approves this reform, it will guarantee theelectricity supply that Mexico will require in the future, with the bestpossible quality and price, in an open and competitive environment.

WINDS OF POLITICAL CHANGE

During the last few years, as a consequence of the consolidation ofMexico’s political life, the PRI has lost its majority in Congress andfaces increased opposition from all sides, slowing the pace of the energyreforms. Facing opposition from other leading parties, especially onthe left and even from within our own party, we lack a decisive con-sensus on the need to promote structural change in the energy sector.Ideological, historical, and political factors have all delayed our plans.

Electricity reform in particular generated an intense political debate,and its main proposals have been strongly politicized by the parties,legislators, and electricity labor unions, which have a strong influencein the Mexican union movement. The electricity proposal also gaverise to a broad left-wing mobilization, mainly by the Mexican Electricity Workers Union, composed of workers at one of the oldestunions in the country, in the distribution company of Mexico City.On the other hand, we have had the support of the other electricityunion, made up of employees of the Federal Electricity Commission(CFE), the largest generating company, which also owns transmissionlines and distributes electricity outside of Mexico City.

Congressional committees are currently analyzing the proposed bill,and the Ministry of Energy continues to work closely with the differentparties to reach a favorable legislative consensus. Despite initial support from the Sole Electrical Workers Union of the Mexican Republic (SUTERM), the union of workers in the generation and the


transmission sectors, some of our colleagues in the PRI, and somemembers of the center-right National Action Party (PAN), the pro-posal was not included in the legislative agenda. While the proposalis still being scrutinized, the Ministry is moving to increase generationcapacity, promote competition, and encourage cogeneration.

TOWARD THE TWENTY-FIRST CENTURY

To attain sustained economic growth, a modern economy needs toachieve three goals: economic stability; integration with the rest ofthe world on favorable terms; and ongoing structural change. Regardless of the short-term legislative outcome of this electricityreform proposal, substantial achievement has already been made to-ward these goals. I have no doubt that the effort to reform our electricity industry is only a first step in the opening of Mexico’s energy sector. We will achieve these goals, sooner rather than later.

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DISCUSSION

DR. STELZERYou speak glowingly of free markets and competition and equallyglowingly of an oil cartel that is designed to reduce production andartificially raise prices. How can you reconcile those two preferences?

DR. TÉLLEZThat is a difficult question. We want free markets and competitionwithin our energy sector, but Mexico is a paradigm of how difficult itis to change an area of the economy that is loaded with politics, his-tory, and ideology. During Ernesto Zedillo’s campaign for the presi-dency, we proposed a program to open up the whole energy sectorto market forces because it was clear that an economy as large asMexico’s could not work well with a single, completely vertically-inte-grated monopoly in hydrocarbons. The energy reforms that we haveworked for —in the distribution and transportation of natural gas,the privatization of petrochemicals, the creation of an open market

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in electricity— have all been on the margins of the current political consensus.

At the same time, the government does have a real interest in our oilwealth and oil revenues. We were concerned that the severe eco-nomic difficulties in Asia and Latin America would cause a slowdownin world economic growth and, consequently, we would face loweroil prices. Our hard-won fiscal stability would be threatened. To stabilize prices and avert another financial crisis, it was clear that, forthe short term, we would have to work with other oil producers tolimit production. So, for the first time in Mexican history, we chartedan aggressive diplomatic policy to bring together several importantoil producers that had been at odds within OPEC. But we undertookthis policy as a pragmatic action, with a clear understanding that itwould be temporary. We believe in free markets and competition.

QUESTIONWe are all aware that as markets begin to open up, “the devil is inthe details.” For example, how much of its traditional role can a government keep and still enable markets to work? Where should agovernment retain control? What are the limits to the market?

DR. TÉLLEZThe limits that we faced were not economic but political and ideo-logical. It is an article of faith in Mexico that electricity and oil shouldbelong to the state. So, to promote energy reform, we have had toconvince Congress that change was needed. On the other hand, letme note that there was only minimal resistance to NAFTA and to privatizing other parts of the economy. But energy reform facesenormous political resistance.

We will not attempt to institute a working market until we have puta complete and well-designed regulatory structure in place. The orderof the steps to be taken is very important. First, create the legalframe work and then establish the regulatory institutions. Only then

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start the process of opening up and privatizing the different genera-tion and distribution companies and allowing the wholesale marketto work. Some countries have had problems because they haveopened up their electricity markets and privatized their distributioncompanies before designing a regulatory framework.

We have designed a competitive environment for the electricity sector, and we are moving forward to create the complete structure. Inour initial proposals, the government’s role was that of regulator, andprivate companies comprised the entire electricity chain. Congress responded that the national grid and the hydroelectric system shouldbe kept within the public sector. We could accept that stipulation because, with good regulation and credible institutions, a govern-ment-owned transmission monopoly can work well.

One of the most difficult tasks that we have ahead of us if we are to besuccessful politically (which I think we will be, at the end of the day),is dealing with the government electricity monopoly which produces92 percent of the country’s electricity generation and distributes 82percent. (The remainder is distributed by another state owned com-pany in Mexico City.) Our proposal restricts the overall holdings agenerating company can have, as well as cross-holdings betweengeneration and distribution companies. The decision about how manygenerating firms and how many distribution firms to create out ofthat monopoly will be an important and difficult one to make.

Mexico today receives $10 billion a year in foreign investment. If thereform were to take place and all the investments it would generatewere to come from foreign capital, we would be getting additionalforeign investment of $5 to $7 billion a year.

QUESTIONYou mentioned the difficulties that President Zedillo´s government facesin pushing forward with oil sector liberalization.Accepting that liberaliz-ing upstream oil will be extremely difficult, is there any hope of seeingpartial or total liberalization of the downstream oil market in Mexico?

Discussion 27

DR. TÉLLEZMexico, with a $450 billion economy, relies entirely on PEMEX for itssupply of oil and refined products. An economy as large as Mexico’s,and one that we expect to grow at perhaps 5 percent annually, cannot rely on a state monopoly. One of the most important tasksfor the next president will be to open up both the downstream andupstream markets. He should do this in the first two years of his administration. Energy reform will depend very much on the politicalclout that the new president can bring to the government and onwhether his majority in Congress is large enough to pass constitu-tional amendments.

Liberalization will continue to face enormous political opposition.Our proposal takes this reality into account. It is similar to the Nor-wegian system and does not privatize the basic resources. PEMEXwould not be privatized —that is politically impossible. But the up-stream market would be opened up with a system that retains therents from oil production and incorporates a bidding system. Wehave invested more than $30 billion in PEMEX over the last fiveyears, but that is not enough. Opening up the oil sector has a muchgreater net present value for the Mexican economy than keepingPEMEX as a monopoly. But this is more of a question of politics thanof policy.

Speaking for myself, as a public official, an economist, and a Mexican,I am convinced that if we do not open up our oil facilities completely,our economy will be much less competitive.

QUESTIONTrying to assess the probability of the success of the current propos-als, does the entire PRI support the administration’s proposals?

DR. TÉLLEZThe PRI is the government’s party, and it is my party. It has been in power for 70 years. We have the full support of the PRI for the

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electricity reforms, with the few exceptions that I noted. The PRI is acenter-left party, and in the current political situation we need tomake an alliance with a party on the right, the PAN. The problem lieswith garnering the necessary votes from the PAN. Its members favorelectricity reform, and if they had a majority in Congress, they wouldpass the bill. With the present balance of power, however, we willhave to negotiate with the PAN to pass the reform measure. If weare not successful, we will have to present a very tight budget at theend of the year, one in which the electricity companies will have their$1 billion governmental subsidy sharply cut. This may put politicalpressure on Congress.

QUESTIONI have a comment on alternate paths to privatization. We are allaware of the examples of successful partial privatizations that tookplace in Norway and Sweden. I would add another interesting ex-ample, that of Bolivia. As part of an agreement with the WorldBank, Bolivia restructured its power markets, using what they calleda “capitalization process.” Bolivia sold 50 percent of the govern-ment- owned companies to the private sector and put 50 percentinto a pension fund. The plan was well received by American andSpanish investors, and the Bolivian government had no difficulty inselling these companies, even as it retained governmental oversight.What is your opinion of this option?

DR. TÉLLEZIn the electricity sector, we need to have a competitive generationmarket. For that to happen, the Mexican government will have togive up its position as the predominant generating entity. The government would not be a credible competitor if it maintainedits present 80 or 90 percent of generating capacity, so we think thatit is important to open the system completely to private investment.Whether it is privatized in the markets with a minority shareholderwho holds control for operational reasons, or privatized through afull-scale bidding process, is a matter that we still need to discuss.

Discussion 29

PROF. HOGANI have had an opportunity to examine the Mexican proposals. I cantell you from my experience in comparing such plans in many partsof the world, that the White Paper on energy reform in Mexico thatLuis TéIlez and his colleagues have put together is both very sophis-ticated and very subtle. In their entirety, and in those all importantdetails such as the sequencing of reforms, the legal structure, and themarket design, the Mexican proposals are an impressive effort.

We are very grateful to Secretary TélIez for coming to Madrid to tellus about the Mexican government’s energy reform and to participatein this open discussion. Thank you very much.

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SESSION I

«HOW WE GOT HEREAND WHERE WE ARE GOING: OIL»


MR. JOSÉ LUIS DÍAZ FERNÁNDEZ

FUNDACIÓN REPSOL

SESSION CHAIR

The subject of Session I is of great interest to us at a time when profound changes are taking place in the industry. Let me first notesome of the major changes that have occurred.

Important mergers are sweeping the industry. The poor results achievedby petroleum companies in 1998 and in the first quarter of 1999 arepromoting concentrations in which the basic assumption seems to bethat “bigger is better.” This assumption may result in a valid goalwhen the merging companies are complementary, but not when thecombinations are formed only for increased size, leading to companiesso large that management effectiveness will suffer. In any case, it isa new, apparently unstoppable trend which has not run its course.

Markets are being liberalized in many countries, and governmentalregulation and environmental politics are increasingly affecting the energy industry. The greening of the world’s politicians is here to stay,and pressures to change the environmental status quo will continue.

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The outlook of producer nations has evolved from nationalistic to realistic —opening production to outside investors who can con-tribute technology, management skills, capital, and markets. MiddleEast governments are almost ready to invite private investors to par-ticipate in developing their energy resources, and OPEC is once again a major influence.

I turn now to our distinguished panel, who will discuss these devel-opments at greater length, and attempt to assess the future directionof the industry.

• Bijan Mossavar-Rahmani will analyze the changing relationshipsbetween producer nations and private oil companies. Then hewill consider future developments and the implications they willhave for the industry.

• Nader Sultan will give a brief history of OPEC; its past, present,and future objectives; the power it now holds to influence oilsupplies and prices; and the power it is likely to have in the future.

• J. J. Traynor will consider whether the current restructuring of theindustry into larger companies foretells increased efficiency orcumbersome bureaucracies, and then he will judge if size matters.

• Finally, Irwin Stelzer, as the wrap-up speaker, will first give us hiswell-seasoned observations on the recent wave of mergers andacquisitions and then will ponder their real causes and askwhether they will affect competition.

Session I32

«THE PAST IS PROLOGUE:BACK TO THE FUTURE»

MR. BIJAN MOSSAVAR-RAHMANI

MONDOIL CORPORATION

That the world oil market is cyclical is generally accepted, at leastwith respect to the behavior of supply, demand, and prices. In thepast three decades, the seventies, eighties, and nineties, the periodmost of us here are of an age to remember or even to have experi-enced, a now-too-familiar pattern has repeated itself numeroustimes: weak oil prices lead to increased consumption and less invest-ment in supply, creating tight market conditions and eventual pricerun-ups, resulting either from a production disruption somewhere orat least a change in market sentiment. Higher prices, in turn, dampenconsumption growth and trigger new investments in drilling which,in turn, lead to more supply chasing fewer buyers and creating theconditions for weaker prices.

These cycles also invariably translate into short-term reversals of fortune for the various players in the world oil market —the produc-ers at one end of the pipeline, the consumers at the other end— andthe pipeline itself, that is, the international oil companies.

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Since the inception of these Seminars, the market has been throughperhaps three such cycles, and we have come together annually todiscuss —and often to lament— the implications of higher or loweroil prices on our respective companies or governments and to review alternative strategies to insulate ourselves —or even to take advan-tage of— the ups and downs of the world oil market.

And while the oil market continues to cycle, there appears to be asecular downward movement in oil prices in real terms. Price spikes—when they occur— appear only as hiccups on the long-term pricelines, nuisances that eventually go away.

That realization —whether stated explicitly or recognized implicitly—together with the certainty, and indeed the growing frequency, ofthese cycles, is leading to profound changes in the structure and organization of the world oil market. It affects, among other things,producer-consumer relations, producer-producer relations, and therelationship between producers and the international oil companies.

The last is the focus of my presentation.

BREAKING THE BARRIERS

I well remember addressing one of the first Repsol-Harvard Seminarsin 1989. I had just left Harvard to join the oil industry, and reportedto this group about what I saw as the exciting new opportunitiesthen becoming available in the international oil and gas explorationand production business. The barriers to entry to outside investment—the legacy of the nationalizations and expropriations of the1970s— were beginning to come down. Only about 20 or so coun-tries remained off-limits, I reported enthusiastically, in the Sovietbloc, in much of OPEC, and in a sprinkling of countries in Africa,South America, and Asia.

In subsequent Seminars, we discussed how that list continued toshrink, virtually year-by-year, but we never anticipated that by the

Session I34

end of the 1990s the list would be down to less than a handful ofcountries. Of those, only two matter —Saudi Arabia and Mexico. ButSaudi Arabia, too, is toying with arrangements —albeit limited ones —for outside private investments in its oil and gas sector, while Mexicorelies on outside technical services, often paid for with outside credits.

The doors are being flung open, and the international oil companiesare walking through. The past seems prologue.

Still, the reversal of the OPEC decade is not total or complete, in thesense that the new arrangements for international upstream invest-ment do not exactly mirror those prevalent in the 1950s or 1960s.

In the earlier period, only a handful of companies —principally the“Seven Sisters“— dominated the international industry. They en-joyed the substantial support of their own governments, they madeor destroyed host country regimes to suit their business interests,they carved up the world into zones of influence and activity, and theynegotiated attractive concessions or production-sharing agreementsdesigned to be in force for decades. The world looks very differenttoday. Or does it?

Well, yes and no.

A RETURN TO THE MIDDLE EAST

There is no question that the largest companies are back —and thatthey are becoming larger —and probably more dominant— still. BigOil is becoming Enormous Oil. The implications of a BP Amoco Arco orof an Exxon-Mobil —even of a Repsol YPF— on the international up-stream picture have yet to be measured. But this concentration ofmoney, technology, and political muscle cannot fail to shape the land-scape. Of course, the oil industry today has far more players than in thepast —dozens of state oil companies and hundreds of independents ofvarious nationalities— all vying for a piece of the pie. But with the cre-ation of the super-majors and the opening of low-cost, high-reserves

«The Past is Prologue» 35

countries in the Middle East, for example, most other players are likelyto be relegated to supporting roles or to less prospective places.

For the super-majors will again focus on the super countries —thelow-cost, high-reserves, easily accessible countries of the PersianGulf. That is to say, on their traditional playgrounds —the countriesof their own birth— or at least of their adolescence or growth.

Let me recite some statistics with which most of us are familiar. Fivecountries in the Persian Gulf —Saudi Arabia, Iran, Iraq, Kuwait, andthe United Arab Emirates— hold over two-thirds of the world’s provenoil reserves. Much of these reserves are low cost —no more than $1to $2 a barrel to extract. Global production outside these five coun-tries appears to have peaked, while the share of the Big Five grows,up from about 15 percent in 1985 to about 30 percent at present.Let me repeat: the share of Persian Gulf oil in total global supply hasdoubled in the past 15 years. And that share will continue to grow.

A SEARCH FOR PARTNERS

It will do so in part because the oil sectors of these countries as agroup are likely to become beneficiaries of substantial injections ofoutside capital, technology, and management know-how in thecoming years, as they trip over each other —while bulldozing overothers— to create partnerships with Big Oil —Enormous Oil— to addto their reserves and production capacity through new explorationand more efficient extraction from existing fields.

Each country is choosing a different model for now, but these approaches are likely to converge over time to look more like thoseof the good oil days. For now, mostly for political reasons, Kuwait andIran, at least, are offering not the risk- and production-sharing con-tracts of the past, which are now common almost everywhere else,but essentially risk-free service contracts designed to keep the own-ership of the underground reserves in the hands of the state, whileassuring the companies a competitive rate of return on their

Session I36

investments. Most companies are willing to sign on, given the opportunity to establish a knowledge base and relationships thatmight prove useful in future expansion of activities. A few compa-nies, though, are shying away from such deals as they see their ownraison d’être as risk-taking for huge possible rewards. The downsideto the state from such service contracts, of course, is that with guaranteed returns to the investors, certain project risks, includingprice risk, shift to the state.

Why should the state be in the business of taking investment riskwhen the companies are so much better able and willing to do so?The answer lies in the history of relations —that is a polite term inthis context— between the states of the Middle East and the inter-national oil companies during the first seven decades of this century.The companies took, by hook and by crook, more than their fairshare of the oil and made the whole effort seem so easy.

Today there is more transparency in the operations of the companies,and governments are more sophisticated about creating risk-rewardsharing mechanisms, which tie the rewards to the risks of individualprojects. But other pressures are at work. In many producers, nationalbudgets have come under extreme pressure with rising populationsand weaker prices. The oil sector is one sector where outside money isreadily available, freeing up resources for other needs. There has beena realization that their own national oil companies have not kept pacewith the international industry. In many instances, pushing out the in-ternational companies in the 1970s resulted in a giant step backwards.

Take Iran as an example. This country has had no real exploration activity in some 30 years, and its production technology, for the mostpart, is just as old. In the upstream arena, 30 years represents many,many generations of technological change. To put this in perspec-tive, the advances in exploration and production technology —thatis, in three dimensional seismic evaluation, directional drilling, computer hardware and software capability, offshore drilling reach,and platform design— in the past five years have exceeded all the improvements of the previous 25. And Iran has had limited

«The Past is Prologue» 37

access to the technology of those past 25 years, much less to thelatest advances.

Despite its long history of oil production, therefore, Iran is virgin terri-tory in oil terms, at least by the standards of 1999. Many internationaloil companies drill more wells each in a month, some in a week, thanIran drills in a year. So in 1998 Iran offered some 40 buy- back projectsin which investors are guaranteed a negotiated rate of return and areoffered long-term access to oil. Next door, Iraq has offered equitydeals to those prepared to negotiate now for the post-sanctions period.Kuwait is talking —mostly to large companies— about taking over themanagement of fields near the Iraq border under long-term servicecontracts. First we had buffer stocks, now we have buffer fields. SaudiArabia has been flirting with unspecified ideas for outside investmentin a range of projects, probably initially involving only gas.

Eventually these different models will converge on some commonand familiar mechanism for a sharing of risk and reward.

THE PAST IS PROLOGUE...

The world’s large, cheap, accessible oil reserves remain in the MiddleEast. The hype of the past few years, coming out of Washington andLondon, that the Caspian Sea was the next Persian Gulf, the newGreat Game —well, that was largely hype. The oil that is beingtapped in Central Asia is largely the oil Soviet geologists had alreadyfound but Soviet engineers and planners could not get out to mar-ket. As someone said, the Great Game, for better or for worse, stillinvolves the states of the Persian Gulf.

Now, as 30 or 40 or 50 years ago, oil is cheap, the producing countriesare technologically, financially, and in some instances, territoriallychallenged, and looking to the West for help. Enormous Oil and itssmaller siblings are chomping at the bit to get in.

It’s back to the future. Again.

Session I38

«THE OPEC FACTOR»

MR. NADER H. SULTAN

KWAIT PETROLEUM CORPORATION

I have been given the considerable challenge to cover the past, present,and future of OPEC —in less than 15 minutes! So— let me begin. Iwill start with the past, with OPEC’s original objectives, and add afew observations on its track record from our present perspective.Then I will turn to the future and suggest what appear to be the keyissues facing OPEC: the division of interests among members, theimpact of technology, the continued dependence on oil, and theenvironmental challenge.

INITIAL OBJECTIVES

When Venezuela, Saudi Arabia, Kuwait, Iran, and Iraq formed OPECin Baghdad 39 years ago, its objectives were as follows:

• to coordinate and unify petroleum policies of member countriesand to determine the best ways of safeguarding their interests,individually and collectively;

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• to stabilize prices to avoid harmful and unnecessary fluctua-tions;

• to secure a steady income to the producing countries;

• to ensure an economic, efficient, and regular supply of petro-leum to the consuming countries; and

• to ensure a fair return to those investing in the petroleum industry.

REVIEWING THE HISTORICAL RECORD

In reviewing OPEC’s track record, it is important first to note itschanging ability to control or influence the market. Despite 39 yearsof growth in oil demand, OPEC’s percentage of supply in the worldmarket is the same today as it was in 1961: about 40 percent. How-ever, OPEC’s share has varied greatly from year to year —in 1973,for example, OPEC produced 56 percent of world supply, but in1985 that figure dropped to only 29 percent. Yet the organizationholds 72 percent of the world’s reserves. This erosion of OPEC dom-inance, and the resulting rise in non-OPEC production, had its foun-dation in OPEC’s policy of nationalization and in the price spikes ofthe 1970s. Nationalization forced the oil companies to invest else-where, and the price spikes created the price umbrella that allowednon-OPEC production to flourish.

Shifts in Member RankingThe historical record shows a change in the relative positions of thefive founding members over the decades. As Table 1 shows, in 1961,the largest producer was Venezuela, followed by Kuwait, Saudi Ara-bia,Iran, and Iraq. The data show rises and declines in production lev-els, and currently all the founders are producing below their peaklevel. Venezuela is producing at a level below its 1961 output, whichprobably explains its drive to expand its production capability and in-crease its relative share within OPEC.

Session I40

In 1961, all OPEC members had relatively equal status, but since thattime member positions have shifted significantly, Today there is oneclear political and production leader, Saudi Arabia. Currently Saudi Arabiaproduces 30 percent of OPEC’s volume, up from 16 percent in 1961.

Stability or VolatilityOPEC’s main poIicy emphasis has been in the area of oil prices: in theearly years, by setting prices, and in later years, by controlling pro-duction to support prices. Regarding OPEC’s success in price stabi-lization, the jury is probably still out. In the peak year of 1979, OPECcountries earned $673 billion (in 1998 dollars). In 1998, their earn-ings were only about $100 billion.

A related issue is price volatility, When OPEC was formed, the worldconsensus was that oil was a scarce resource. Eventually, it was believed, oil would run out, and its price would rise dramatically assupply tightened and demand grew. Today we have a different con-sensus. We believe that there are more than abundant oil and gas reserves, and that the real challenge is how to extract these resourcesby the most efficient means.

«The OPEC Factor» 41

Table 1Changes in OPEC Member Positions

OPECCountry

1961Production

MillionBarrels a

Day (mbd)

1961Share ofOPEC

Production(percentage

PeakProduction

Year

PeakProduction

(mbd)

1998Production

(mbd)

1998Share ofOPEC

Production(percentage)

Iran 1.20 12.82% 1974 6.02 3.63 12.62%Iraq 1.01 10.79% 1979 3.48 2.15 7.47%Kuwait 1.74 18.58% 1972 3.28 2.09 7.26%Saudi Arabia 1.48 15.81% 1980 9.90 8.39 29.17%Venezuela 2.92 31.19% 1970 3.71 3.17 11.02%

OPEC Total: 9.36 28.76World Total: 22.45 66.87

Source: Annual Energy Review 1998, Energy lnformation Administration (EIA).

From its earlier status as a scarce resource, oil has been transformedinto just another commodity, subject to both short-term and long-term volatility, So it should come as no surprise that OPEC hasbeen unsuccessful in minimizing price fluctuations. Nobody in OPEC,or inthe industry itself, could have anticipated the advent of the futures market and its dramatic impact on volatility.

Notwithstanding the substantial investment to expand capacity,regional politics and conflicts have caused serious disruptions in theOPEC objective of a steady supply of petroleum to the consumingcountries. It is particularly sad to note that Iraq, one of the fivefounding members, actually chose to wage war on two other founders,Iran and Kuwait.

The Fortieth AnniversaryWhat then has OPEC achieved? For one, the fact that it is approach-ing its fortieth anniversary is remarkable in itself. A year ago, manyanalysts felt that the OPEC era was over, that OPEC was dead. Yet twomonths ago (March 1999), OPEC was able to take action to sucessfullyreverse a steep price decline. To understand the true measure ofOPEC’s continuing power, one simply has to ask, where would oilprices really be if OPEC released its spare capacity onto the market?

Another achievement was the creation of new alliances. In the lasttwo years,OPEC has reached out to other producing countries whoseoil exports also play a crucial role in their national economies. Thisnew step has enabled OPEC to increase its influence on the worldmarketplace.

TOMORROW’S WORLD

So much for the past —what about the future? A key issue now fac-ing OPEC is to create a long-term strategy, The organization has beenmuch better at putting out fires than preventing them. Recently, aninvestment analyst quipped that OPEC is like a tea bag: it works well

Session I42

when you put it in hot water. Although we give OPEC credit for itsrecent decisions, it still does not have a coherent policy.

As Sheik Yamani recently asked, does OPEC want higher prices orhigher volumes? These are two mutually exclusive routes to the goalof higher revenues, yet they have different effects and put differentpressures on policymakers: higher prices require collective output,restraint, and collective discipline; higher volumes, on the otherhand, require expanding markets, concurrent production capacity,and patience to accept that prices might not rise until the time isright. At the last few meetings OPEC went for higher prices.

Internal Conflicts of InterestThe fact is, key OPEC members have very different interests. OPECobservers divide the membership into two groups: the volumechasers and the price chasers. It is said that the interests of large reserve holders (like Kuwait, Saudi Arabia, and the UAE) lie in highproduction volumes, low prices, and expanding oil markets. Everytime these members cut production in defense of higher prices, theylose market share to the other producers, since large reserve holdersmust bear a disproportionate share of the output cuts. Conversely,producers with limited potential to expand output show little inter-est in higher volumes and expanding oil markets. Their immediate interest lies in higher oil prices now.

This industry is perhaps the only one in the world where high-costproducers do not shut in capacity when prices fall. It is, in fact, thelow-cost producers who shut in capacity, Such a situation is eco-nomically unstable and is a constant source of frustration amonglow-cost producers.

Pressures from TechnologyTechnology directly impacts OPEC in two areas: costs and productsubstitution. More efficient technology helps to reduce the cost ofproduction for every producer, so the relative low-cost advantage of


OPEC is eroded. And efficiency gained by lowering costs shifts thecost flow to prices. The major growth in non-OPEC producers overthe last 15 to 20 years is attributable to advances in technology. Justfive years ago, it was assumed that deep-water production below1,000 feet of water would be accessible only at a price level of $30a barrel. In March 1999, a Shell field, in 4,000 feet of water, startedproducing at a total capital cost of $3.25 a barrel. At $4 a barrel op-erating cost, you can see how technology has an impact on price.

It has been estimated, however, that the majority of new developersworldwide require a break-even price of $10 a barrel to sustain them.Some would argue that if the large OPEC producers, such as SaudiArabia, Iran, and Kuwait, were to open their doors to heavy produc-tion, then even new technology would not have much impact onhalting this decline in production costs. Under such a scenario therewould be very few incentives to look elsewhere for oil. Certainly aprojected cost of $2 a barrel in the Arabian Peninsula makes it diffi-cult to justify spending $9 a barrel in the Caspian region, $10 a bar-rel in West Africa, or $18 a barrel in some parts of Latin America.

Another impact of technology is the creation of potential substitutesfor oil. Spurred by environmental pressures, automobile manufactur-ers are developing “greener” automotive technologies. Conventionalvehicles with direct injection now have greater fuel efficiencies, andwe are seeing electric vehicles, hybrid vehicles with both internalcombustion engines and electric motors, and vehicles powered byfuel cells. As an OPEC producer, I was sobered by an observationmade by Professor Robert Mabro of the Oxford Institute of EnergyStudies, who noted that the Stone Age did not end because of a lackof stones, and the Coal Age did not end because of a lack of coal.What will cause the end of the Oil Age?

Diversifying National EconomiesAnother long-term challenge for OPEC members is to reduce theirdependence on oil income by diversifying their national economies.Currently the oil dependence is overwhelming. In Kuwait, for exampIe,

Session I44

93 percent of our revenue comes from oil, producing 80 percent ofour GDP. To look at the problem from another perspective, considerthat Switzerland has a GDP which is larger than the combined GDPsof all the Gulf Cooperation Council (GCC) nations together.

Oil prices have come down in real terms, and national expenditureshave increased in real terms, so that real income has been reduced.However, lower-cost production is not the key dimension for OPECcountries. The $2 a barrel prodzuction cost is not what matters —what really matters to the OPEC producers is the price level that al-low them to have the minimum politically acceptable level of gov-ernment expenditure. It is certainly not $2 a barrel— it is probablycloser to $15 or $16 a barrel. Below that figure, there are tremen-dous pressures on their economies and societies.

Climate ChangeOPEC also faces environmental challenges. It is no secret that the organization considers the Kyoto Protocol, issued in December 1997by the United Nations Framework Convention on Climate Change,to be a major threat to its well-being. The problem for OPEC is thatoil is clearly linked with the downside of the climate change problem.The challenge is to ensure that measures taken to manage climatechange do not place an unfair burden on the oil industry.

Dr. Rilwanu Lukman, secretary-general of OPEC, recently stated thatone of the main aims of the global warming theorists is to cut fossil-fuel consumption, and that OPEC nations stand to lose more thanmost from such a solution. He also expressed OPEC’s continuingfrustration that the finance ministers of consumer countries derivemuch more revenue from a barrel of oil than do the OPEC and non-OPEC producers. (In Europe, as much as 80 percent of the final pricepaid by the consumer is made up of duties and taxes.) In addition,Dr. Lukman made a strong case for continued dialogue, and offeredthis admonition: if OPEC invests heavily to ensure future supply wellinto the twenty-first century, then the organization requires high-levelconsultations about the security of demand as well.


MEETING NEW REALITIES

OPEC is still alive and well. Its original objectives have not been fullyrealized and, as the coalition has grown, so have the differencesamong its members. Nevertheless, the strong common interestsshared by OPEC members should encourage them to face futurechallenges together. OPEC’s recent outreach to other leading oil exporters to achieve common aims has demonstrated a willingness tomeet the realities of the changing world marketplace.

Session I46

47

«OIL INDUSTRY CONSOLIDATION:DOES SIZE MATTER?»

DR. J.J. TRAYNOR

DEUTSCHE BANK

As we know, 1998 was notable for the wave of mergers that crestedin the oil industry, leaving behind it three super-majors: BP AmocoArco, Exxon Mobil, and Royal Dutch Shell. I have been asked to talkabout these dramatic consolidations —their causes and their implica-tions for the industry— and to speculate on how much the size of acompany actually matters. What I can do, in the time allotted me, isto give a stock market perspective on the combinations and then toanswer whether size does matter.

DRIVERS FOR CONSOLIDATION

As well as the merger wave, the year 1998 was also notable for thedramatic collapse of oil prices, the most drastic since 1986, which resulted in sharp drops in earnings for oil companies. These headlinedevelopments occurred more or less together; prompting a queryabout causality. Did the sharp fall in revenues provoke the mergers, ordid it simply provide the evaluation opportunity that pushed theconsolidations to their final stage? I would suggest that the second answer is more on point: that a series of longer-term trends became

48

clear by 1998, and the industry responded to these trends by majorconsolidations. The concurrent price and revenue drops providedconfirmation for the aggregations.

Even as deterioration of oil prices gave the oil industry its biggestshock since the 1980s, the cost bases of most companies were rising,indicating that the cost-cutting programs put in place earlier in thedecade were running out of momentum. Earnings per barrel duringthe 1990s, as shown in Figure 1, indicate that cost cutting had notbeen enough to protect company returns when oil prices dipped to$10 a barrel. In particular, finding and development costs for new oiland gas fields were rising, indicating that cost cutting in the explo-ration and production sector (E&P) was not as successful as we hadbeen led to believe.

Further, these rising costs in new fields have been linked to the check-ered results of the international exploration programs of the major oil

Session I48

Figure 1Earnings Per Barrel vs. Oil Prices

1990 to 1998

Brent Spot Price$ Per Barrel

6.00

5.00

4.00

3.00

2.00

1.00

0199819971996199519941993199219911990

0.00

5.00

10.00

15.00

20.00

25.00

Earnings$ Per Barrel

Brent Spot Price $ Per BarrelEarnings (Net Income) $ Per Barrel

Source: Deutsche Bank

companies over the last five or six years. International activities haveproduced some tremendous success stories (North Africa, deep-waterWest Africa, deep-water Gulf of Mexico, for example), but many newareas have been disappointments. The Caspian is one example, andRussia is another. (Who is making any money out of Russia?) Otherareas, such as Asia and Latin America, have ambiguous track records.

Another development that promises longer-term problems stems,ironically, from the technological breakthroughs that have brought somany economic benefits and so much optimism. The new technolo-gies for drilling and production, notably seismic 3D and horizontaldrilling, allowed companies to target very specific new areas for exploration; they also enabled companies to extract more oil, morequickly, from their old fields. Financially, of course, this producedwonderful news. But in the long term, the new technologies havedepleted reserves more quickly than anticipated. In terms of the average reserves life, the decade will end with a lower average figurethan when it began, despite new technologies and massive spending.

By contrast, some significant developments appear not to have beendirect catalysts for consolidation. For example, developments in thegas industry, particularly in Europe where the EU is looking to createmore competition, imply considerable long-term adjustments by theindustry. But these have not driven the mergers in the way that ris-ing costs and falling reserves have done.

A NEW CLASS OF COMPANY

What can we say about these new companies —the super-majors orthe “Three Sisters” that now dominate the industry? The stock mar-ket offers a useful judgment; it shows steady outperformance by thethree super-majors. Their market capitalization totals about $600 bil-lion, more than the rest of the oil industry put together. Their annualshareholder returns have averaged 20 percent over the past decade,certainly an attractive number. The smaller integrated companies,Chevron and Texaco for example, have produced returns of between

49«Oil Industry Consolidation»

10 percent and 15 percent; good, but not exciting. The E&P compa-nies have averaged only 5 percent. The stock market is clearly rewarding the sheer size of these super-majors.

In terms of scale, the super-majors are a different class of company.When integrated oil companies and their total market value arecompared in terms of enterprise value and reserves bases, the figuresmust be drawn on two different scales because the super-majors are so much larger. Their prospective earnings also set themapart; within the next three or four years, the super-majors couldproduce in excess of $10 billion each. And they will supply about 10percent of total world oil and gas demand. The gap between thesuper-majors and the rest of the companies is so great that it wouldbe difficult to create another giant without combining several other companies.

A SEARCH FOR STABILITY

How do these super-majors plan to use their dominance? They seemto be moving into a period of restraint, when they will not try togrow their volumes as aggressively as in the past, but rather willwork to control their capital expenditures and their costs, therebyconsolidating their gains.

Less Capital SpendingConsider capital spending plans, for example. The majors increasedtheir oil and gas capital expenditure significantly in the 1990s, butsince these expenditures have not generated the sort of volumegrowth that the companies had desired, they are being curtailed. Thesame data analyzed in a different light —capital expenditures as afunction of depreciation— also confirm that the sharp increase incapex in the mid-1990s did not result in the expected volumes. Thecurrent message coming from the aggregation of capex plans for themajors is that less money will be spent —and, of course, it will bespent by fewer companies. The future seems to be a picture of capital

50 Session I

restraint with only gradual increases in capex and a focus on returns rather than volume growth.

As capital expenditures are cut, we expect another round of redun-dancies in the industry. This is particularly significant in the super-majors which employ 45 percent of all of the people in the integratedoil industry today. These employees represent a valuable resourcepool that would enable companies to capitalize on major new invest-ment opportunities, perhaps in the Middle East, perhaps in theCaspian. But unfortunately, overall, employee numbers seem to beconsidered a controllable cost.

Lower VolumesAll that restraint, all that cost cutting, have implications for volume tar-gets. During the past year we have altered our forecasts for companyvolumes and are now predicting an abrupt downward revision inproduct expectations for most companies. With Shell, for example, wehave dropped our volume targets by 10 percent in the last 12 months.

VOLATILITY AND RETURNS

All these shifts appear to be part of a larger search for stability in a tra-ditionally volatile industry. This volatility is often reflected in the fluc-tuating average returns for the industry sectors of E&P, refining andmarketing (R&M), and petrochemicals. We can speculate how muchof the recent consolidation is aimed at getting the right kind of bal-ance among upstream, downstream, and petrochemicals.Today thestock market is not very keen on petrochemicals because of the cycli-cal downturn, but the sector is clearly an important part of the inte-gration balance. Even though oil price have risen in E&P, companyvalues have not recovered. That suggests that may see more acqui-sitions, with the larger integrated companies buying E&P stocks.

Again we sense that much of the consolidation has been aimed atlinking stable earning streams to growth. There is a strong correlation

51«Oil Industry Consolidation»

between volatility of earnings and the returns that the companies aredelivering in the market. The message is simple: companies with thelowest volatilities generate the best returns over time. But this is thecase only for the super-majors —and for the French oil companies.We see the same result when we measure the price that markets areprepared to pay for companies that deliver a higher level of return oncapital expended. Again, the larger companies have higher ratingsbecause their returns are more stable over the course of the cycle.

SIZE DOES MATTER

To strike a balance between growth and returns, the integrated majors have moved away from seeking volume growth and areworking on capital discipline —returns, balance sheets, and sharebuy-backs. (Significantly, this parallels a similar shift in the OPEC countries, as they focus more on price than volume.)

From a market perspective, size does matter; the market is pre-paredto pay more for larger companies. There are reasons for thisbias. We see the potential for very large economies of scale, coupledwith the ability to cut costs and institute share buy-backs. Thesecompanies have global positions in R&M and petrochemicals, as wellas in the upstream, which will allow them to deliver world-class in-tegrated energy projects. The result should be higher returns andlower earnings volatility.

Much of the push behind the mega-mergers has been the goal ofstriking a balance between more stable earning streams and a goodmeasure of earnings growth. This balance will provide a positive andstabilizing force. The oil industry has come through the phase of lowoil prices stronger and more attractive to investors than it had been before.

52 Session I52

«MERGERS AND MARKETS»

DR. IRWIN M. STELZER

HUDSON INSTITUTE

Since my background is in competition policy, my first reaction to therecent oil industry mergers was to consider whether they are likely tohave anti-competitive effects. If they do, they will probably bestopped by one of the many regulatory agencies that must reviewthem in the United States, Europe, and Latin America. Thus the needfor further analysis would end —as would the need for this talk.

But in the broad, it is difficult to divine any such effects. True, there areaspects of these mergers that the competition authorities will findobjectionable, but a few judicious disposals of some petrol stationshere, and perhaps a refinery there, should give the antitrust authoritiessufficient comfort to allow these deals to go forward —even thoughone of them, the merger of Exxon and Mobil, reunites the two largestcomponents of the Standard Oil Trust that the U.S. government brokeup in 1911. True, too, it is not completely foolish to worry about theshrinkage in the number of sources of independent thinking in the oilindustry at a time when such thinking is very much needed. But suchworries are insufficient to call a halt to these mergers, at least insofaras we can tell, based on current published information.

53

For as the “Seven Sisters” have morphed into what some are callingthe “Three Witches “ —Exxon Mobil, Royal Dutch Shell, and BPAmoco Arco— we find an industry with fewer players, but still quitecompetitive, for several reasons. First, state-owned companies re-main as important rivals. For example, BP Amoco Arco is the largestnon-state-owned oil producer, pumping some 2.6 million barrels aday. Saudi Aramco produces more than three times as much —andcould produce more if it chose to do so. Second, the newly mergedcompanies must always face competition from other companies thatare consolidating their positions, Repsol being the most notable example, with its acquisition of YPF.

WHY CONSOLIDATE?

So the question is not whether the oil industry will remain competi-tive after the bigger have absorbed the merely big. It will —with themain impediment to free and open competition coming from theOPEC cartel, newly emboldened to collude to restrict output in orderto raise prices. The real question is: What is driving these mergers,and where will it all end? I think it is fair to classify the mergers intotwo groups. The very largest of the consolidations represent retreat—a shrinking of the industry, a withdrawal of human and other as-sets; the next tier represents the opposite— a desire to grow.

Low Oil PricesVarious explanations are given for the very largest mergers. The first islow oil prices. In this theory, low oil prices are forcing cost-saving con-solidations upon the industry. As proof, we are offered estimates ofthe billions to be saved by elimination of duplicative facilities. Indeed,so great has been the attrition at Amoco after its acquisition by BPand a $2 billion cost-cutting exercise, that the industry joke is: “Howdo you pronounce BP Amoco?” Answer: “The Amoco is silent.”

Although it certainly is the case that fewer resources should and willbe devoted to finding, say, $10 oil, than to finding $30 oil, such

54 Session I

«Mergers and Markets»

prices do not necessarily force mergers upon the industry. Low oilprices, one way or another, would force capacity from the industry ifmanagements responded to such low prices in the interests of theirshareholders —that is, by maximizing profits rather than by maximizingorganizational size. Viewed this way, mergers give managements anexcuse to do what they should be doing in any event— and probablywould, sooner or later, be forced to do: scale back exploration anddevelopment and reduce investment in downstream facilities.

And become more efficient. For many years at these Seminars wehave heard how oil companies are developing cost-cutting technolo-gies and managerial strategies to keep costs in line with availableprices; but those moves are quite independent of, and indeed pre-ceded, the current wave of mergers.

So a low oil price is not a very satisfactory explanation of what is going on among the very largest companies. Indeed, since several ofthese mergers have occurred, crude prices have risen some 60 per-cent, but the ardor for combination remains undiminished. Rather, Ithink the explanation lies in a series of institutional factors that havecome together to threaten the industry into believing that the statusquo is unsustainable, and that somehow there is safety in size. Thesefactors then became grafted onto the organizational imperative thatprompts managers to maximize size and perks rather than efficiencyand profits —what economists call an “agency problem.”

Return to the Middle EastThe first of these factors is the possibility that Middle East govern-ments are once again prepared to invite private sector companies toparticipate in the development of their national resources. Oil industry executives offer two reasons why this development de-mands that their companies be big. First, any projects that do be-come available are likely to be large, so large, that only the biggestcompanies will have the resources required to undertake them. Sec-ond, Middle East governments prefer to do business with only thelargest companies.

55

I find these justifications for mergers unpersuasive. If capital marketswork, capital will be available for these projects to any company orpartnership of companies, large or small, that can win the right toparticipate in the development of these resources. Capital is flowinginto Internet companies and genetic research companies; there is noreason why it cannot flow into any oil ventures that promise a returncommensurate with the risk.

As for the preferences of Middle East governments for business part-ners, I wonder why, in the interests of their own sovereignty, they donot prefer to deal with smaller companies, rather than with giantswhose worldwide reach gives them greater bargaining power thantheir smaller, but nevertheless substantial, rivals.

In short, the argument that already-large companies must get largerstill to participate in the re-opening of the Middle East to private en-terprise does not seem entirely persuasive —coming as it does fromcompanies that have already reached the size of say, pre-merger BPor Exxon.

The Advance of the GreensThe second institutional factor that seems to be causing some sleepless nights to oil industry executives is the increasing greening of the world’s politicians. This is not the forum to decide whetherthese public servants are convinced by the scientific arguments thatthe earth is warming, as Sir John Browne of BP Amoco seems to be,or are attracted by the tax revenues and economic controls that professed belief in such warming might justify, as one might fairlyconclude from listening to the analysis of Exxon Mobil’s Lee Raymond. Nor is it the place to decide whether the age of the inter-nal combustion engine is over, as Vice President Al Gore fondlyhopes, while being chauffeured around Washington amidst a fleet of sports utility vehicles, or whether the advances being announcedby Ford (among others) truly promise engines sufficiently low in emissions and high in performance to preserve a role for these en-gines in the future.

56 Session I56

All we need to agree is that the industry believes that the greeningof the automobile and other fossil fuel-using devices is upon us, withdire consequences for its principal markets. In short, let’s assume thatoil industry executives believe that they are in a declining industry,that they are in “the last days of the Age of Oil.” Thus, oil companyrevenues will decline slowly over time, but capital expenditures willdecline more quickly as the opportunities for investment in oil pro-duction and in new refining and marketing facilities shrink. SalomonSmith Barney estimates that the 175 companies it follows will cut exploration and development spending worldwide by 25 percent in1999. BP Amoco-Arco has budgeted $3.6 billion for exploration andproduction this year, versus $6.3 billion in 1998. The result, otherthings being equal: enormous cash flow.

In this case, it seems to me that one option for industry executives isto make a graceful exit —return the money to the shareholders, acknowledge the grateful applause of the people who, after all, ownthe business— and pursue their hobbies or alternative careers in thepublic or private sectors. I have often suggested just such a course ofaction to my friends in the electric utility industry —to leaders ofcompanies that have sold off their generation assets and are wallow-ing in cash— only to find that their opinion of my wisdom, and, in-deed, of my sanity, has been adversely affected. Shareholders, itseems, are not viewed by many managements as having a legitimateclaim on corporate cash flow.

So it comes as no surprise to me that the new, greener hue of national policies is used as a justification for using freed-up oil indus-try cash to diversify into solar and other technologies that are notself-evidently related to the oil business. And to garner public praisefor farsightedness.

Political CloutThis is not to say that there is no sense to this policy. In the future,environmental regulation and environmental politics will increasinglyaffect the industry. Big companies do have more political clout and a

57«Mergers and Markets»

greater ability to cope with the regulatory behemoth than do smallercompanies. Sir John Browne will find it far easier to get an appoint-ment with the prime minister than will an executive in some tiny oilcompany, and Lee Raymond is likely to have greater access to theWhite House, and to be better able to position his troops around theEnvironmental Protection Agency, than will some small wildcatter.

The argument that size brings with it political clout also makes sensein the context of developments in those parts of the world wherepolitics trump economics —in Russia and the Caspian, for example.Big companies are better positioned than smaller ones to do whathas to be done to win the favor of the political powers-that-be in remote corners of the world.

In short, there may be good political and institutional reasons for thevery largest of mergers, but the proffered economic reasons are notconvincing. And it is not even clear that the BPs and Exxons had togrow even larger than they were in order to reap the institutional andpolitical strengths they will need in an increasingly politicized industry,and one which, as Richard Perle pointed out to us last year, is notrenowned for its political acumen. In sum, I view the mega-mergersas a combination of retrenchment with honor and management positioning for diversification into new ventures, without the annoy-ance of going to capital markets for funds.

MERGERS IN THE SECOND TIER

The situation confronting the next tier of companies is different. Remember, the BPs, Shells, and Exxons were highly diversified geo-graphically before they began the latest wave of takeovers. Butsmaller companies, such as Repsol, found themselves dangerouslyundiversified in a world that is changing rapidly, and with manage-ment talents that have now been honed in the private sector and arerestless for new worlds to conquer. For Repsol and for companies like it, an increase in size means greater geographic diversity,greater enthusiasm from investors, and sufficient scale to vie with its

58 Session I

increasingly bigger rivals. It is interesting to note the announcementsof mergers of the largest companies emphasize costs to be saved,while announcements of mergers of second-tier companies speak ofgrowth opportunities to be grasped.

And unlike the larger companies that acquire organizations that duplicate their own resources, second-tier companies are acquiringfirms that complement their skills and resources, positioning them forgrowth. In the case of Repsol, it can teach YPF about marketing, andYPF can teach it about production.

A PERSONAL CONCLUSION

Much of what I have said is based as much on intuition as on hardempirical data —not because I am lazy, or because the people ofRepsol are marvelous hosts, but for other reasons. I distrust estimatesof cost savings to be had as a consequence of the largest mergers, inthe sense that I fail to see that these mergers are a necessary meansof cost cutting. I equally distrust what investment analysts and invest-ment bankers tell us about investors’ preferences; such informationseems to vary as much with the analyst as with market conditions. I prefer to rely on a distinction between mergers aimed at retrench-ment, which promise cost savings but little else for the long-term fu-ture, and those aimed at positioning a company for future growth.And I believe there are limits to economies of scale in management.

Finally, I have a soft spot in my heart for the Davids of the world asthey take on the Goliaths, and rather hope that they will be as suc-cessful as the biblical wielder of the proverbial slingshot.

59«Mergers and Markets»

DISCUSSION

MR. DE FABIANII think the use of the term “Three Sisters” is not appropriate. It makesreference to the former “Seven Sisters,” but the world that they onceso dominated no longer exists. The new oil majors are three globalcompanies; nothing more, nothing less. Second, cost cutting is notnew. I have had the privilege of working at BP for many years, and Ican tell you that from the very beginning I have been inculcated withthe goal of competitiveness which includes cost cutting. My thirdcomment is about employment and growth. Including the outsourcingof many activities, we employ, directly or indirectly, a large and in-creasing number of people. We do not live in a black-and-white worldof growth or cost cutting; in reality, it is growth and cost cutting.

Let me ask the panelists if these mergers in the energy industry areso very different from what is happening in the automobile industry,the pharmaceuticals industry, or the banking industry. Are they notsimply the consequence of the globalization of markets?

MR. SULTANI agree that the oil mergers reflect worldwide trends: indeed, wemight really wonder why the consolidations have been so long in

61

coming. Until the BP Amoco merger, the same “Seven Sisters,” withthe same rankings (except for Chevron buying Gulf in the mid-1980s), led the industry for two decades. No other industry has remained that stable. And we should remember that even after thesemega-mergers, the market share of the new companies is small rela-tive to those of, say, the Microsofts, the Boeings, the Airbuses, or thebig multinational banks.

DR. TRAYNORWe have been surprised that the cost cutting is continuing after themergers. I agree that cost cutting already existed in the oil industry,but the scale has accelerated dramatically as a result of the mergers.

Further, we should remember that shareholders exist. The super-majors are the companies that have balance sheets to allow growthas well as share buy-backs. The smaller companies just don’t havethe balance-sheet strength to deliver both robust growth and returnsto their shareholders.

QUESTIONHow large is large enough? If you are a large player, how do you po-sition yourself? What focus do you choose, what access? It may wellbe that even these large players are insufficiently large, that they donot have portfolio structures that would allow them to exercise allthe options that they would wish, particularly in light of the scale andscope of energy businesses across the board, from upstream to thevariety and complexity of downstream positions.

Will these new publicly owned super-majors be able to build interfaces with companies that are still strongly affected by governmentpolicy and ownership? I am thinking particularly of Gulf State entities,but there are others, too, which you could well imagine coming to-gether with private companies in joint ventures. What is likely to be thefuture relationship between the players with large oil and gas resourcesand the new super-majors that want to play on the global scene?

62 Session I62

MR.MOSSAVAR-RAHMANIIrwin Stelzer suggested that some of the low-cost, large-reservescountries should, in fact, be seeking private capital from smaller,more agile, less politically dominant companies. He raised an impor-tant point, but as he himself said, the fact is that governments stillprefer to work with the biggest players who have better technology,broader management, and deeper pockets over a longer time hori-zon, thus allowing them to stay the course. Smaller, more agile play-ers do not have these assets.

More important, the largest companies have developed substantialpolitical capital, while the smaller players have not. Recall that I ref-erenced the Kuwaiti policy of trying to bring in large companies on aservice-project basis to create a buffer zone with Iraq. The politicalleverage that the largest companies bring to the table in their nego-tiations, discussions, and arrangements —with the Persian Gulfcountries at least, where political clout is critical to the survival oftheir own regimes— means that size does matter very much.

QUESTIONI would like to respond to some of Nader Sultan’s insightful comments.When oil prices were $10 or $11 a barrel, many analysts concludedthat OPEC was under no real pressure to drive oil prices higher. Thatwas wrong. Nader Sultan offered the correct analysis:the major play-ers in OPEC remain completely dependent upon oil as their primarysource of income, unable to diversify their economies. His observa-tion that Switzerland has a larger GDP than the combined GCCcountries was particularly telling when you consider that Switzerlandhas virtually no natural resources. You could call that “the oil curse.”

Nader stated that $1 5 to $1 6 a barrel is the social-stability pricerange, the real price range for most of the oil-dependent countries.From that perspective, the GCC countries are among the higher-costproducers. Because government takes in OPEC nations are so high,realized value is greater in higher-cost places than it is in the lower-cost ones. Therefore, active developers and investors in oil tend to

63Discussion

operate in non-OPEC countries. How will the Middle East attract theinvestments needed to develop its oil?

MR. SULTANYou referred to an “oil curse,” but probably 90 percent of the worldwould like to have that curse! However, you were correct in saying thata price of $13 to $15 a barrel is about right, for Kuwait government ob-jectives. Unfortunately, when oil is at $15 a barrel, governments arelulled into a comfort zone that precludes them from seriously consid-ering diversification from oil. With regard to attracting invesments,Kuwait, Iran, and other countries do want to attract international oilcompanies. But to do so, we must be realists and offer a competitiverate of return on their investments.

QUESTIONMany of us who developed our careers in an OPEC country are realiz-ing that OPEC as we knew it is dead. What we see now is a new organization rising from the ashes of the old OPEC, one that musttackle the issues the old OPEC failed to confront. Would you com-ment on how Kuwait and other countries are evaluating the future?

MR. SULTANInitially I was surprised that Mexico joined the alliance. In relativeterms, Mexico’s revenues from oil are small compared to the bigOPEC countries. Then I realized the common denominator amongSaudi Arabia, Mexico, and Venezuela: the U.S. market. The allianceis not so much about OPEC and oil as it is about the fact that SaudiArabia and Venezuela cannot take action to cut supply, if in so doingthey lose market share in the United States, their biggest market.

As for OPEC’s future, it is going to move forward under the leader-ship of Saudi Arabia. It is difficult to think strategically if your houseis on fire; first you have to focus on putting out the fire. We havenow done that with our recent production agreements. With that

64 Session I

achievement and with a rising demand, we now have the luxury tothink strategically. I do not think OPEC is dead; rather, it has devel-oped into a broader alliance.

QUESTIONMy question is for Nader Sultan. You said that OPEC had not beenable to achieve the objectives set by the founding partners —at leastnot in their totality. What mistakes did OPEC make? Or were its initial objectives simply unattainable?

MR. SULTANOPEC has evolved over time, with changing leadership, changingpolicies in individual countries, and changing regional groupings.Every time OPEC has tried to move forward, it has been sidetrackedby major political and regional conflicts. But in the last two yearsOPEC members have rallied, because everybody has been hurt bythe low prices. In the future, however, the problem of coordinatingthe interests of different groups will re-emerge.

QUESTIONWith the advent of the super-majors, geographically diversified, fullyintegrated, and well financed, will we see a few big companies forc-ing down the price of oil and taking their profit margins in other ar-eas of the industry —like power generation?

MR. SULTANWe do not know what will happen as the super-majors go back totheir roots in the Middle East, where, with less capital invested, theycan explore, develop, and extract much more oil. These develop-ments may pose a dilemma for the Middle East producers if the su-per-majors are moving towards a strategy of volume rather thanprice. As to whether the net effect will be greater or less revenue,I do not know.

65Discussion

QUESTIONI am concerned about the state of reserves: at the end of this decadewe have fewer reserves than we did at the beginning. Yet alternativefuels are not increasing their share of energy markets because tech-nology has created better ways of increasing production of conven-tional fuels. So we have accelerated the rate at which we drain ourreserves rather than developing new reserves to substitute for whathas been produced.

I am not optimistic about these mega-mergers: they are often madeprimarily for short-term stock market gains rather than for the long-term future. When we talk about the oil industry, we should talkabout the future. The giant companies will not develop any reservebelow a certain size, so I see the future in mid- and small-sized com-panies; producing countries may do better with them.

MRS. ESTEVANAs a member of the European Parliament’s Energy and EnvironmentalCommittees, I receive a great deal of information about the amazingtechnological advances that have occurred throughout the entire pe-troleum chain. This is one reason that I see a splendid future for oil.Another reason for my optimism comes from potential increases indemand, particularly if you include the huge amounts of consump-tion that the underdeveloped countries will require.

DR. STELZERIf governments do not interfere with the markets by promulgatinginefficient regulations, I agree that oil does have a spectacular future —in terms of volume. Whether it has a spectacular future as asource of profits for private shareholders is harder to predict. And Iagree that, unless we do something bizarre, the huge developingworld will indeed have a great appetite for energy. What that energysource will be —coal, or natural gas, or oil, or alternative fuels— themarkets will determine, if the regulators let them.

66 Session I

SESSION II

«HOW WE GOT HEREAND WHERE WE ARE GOING:NATURAL GAS, ELECTRICITY, AND REGULATION»


MR. PABLO BENAVIDES

DG XVII ENERGY, EUROPEAN COMMISSION

SESSION CHAIR

In 1997, at the Repsol-Harvard Seminar in Seville, I described theprogress of the European Union in establishing internal markets ingas and in electricity, and predicted the course of future develop-ments. Today it is with some satisfaction that I can report my fore-casts, in general, proved to be accurate.

The electricity internal market in the European Union is now up andrunning, and the liberalization process is underway, although two orthree member-states have not yet implemented the directives intonational law. Prices are falling, and exchanges of electricity are takingplace, and I expect these developments to continue. A number of sensitive mechanisms for the electricity market remain to be put intoplace, dealing with exchanges of electricity, transmission prices andtariffs, congestion, and transmission capacity. We are working with allthe principal EU players —transmission operators, regulators, marketoperators, and so on— to complete these final details.

67

In natural gas, the process has been slower, but the Gas Directivewas approved in June 1998. We will soon meet here in Madrid to work out details concerning transmission capacity, third-partyaccess, tariffs, and take-or-pay or ship-or-pay contracts. We ex-pect the gas market will be up and running in the next fewmonths.

LOOKING AHEAD

What of the future? Let me make some new predictions.

LiberalizationLiberalization in the European Union will continue, and possibly accelerate. In three years’ time we will review the implementationof both details of liberalization in all the member-states. What wewant for the EU is not 15 different liberalized markets but one single, liberalized market.

RegulationRegulation will not decrease. Paradoxically, a liberalized market oftencalls for more regulation than does a non-liberalized market. A monopoly market does not need much regulation: you just do what-ever you are told to do. The issue is what kind of regulation we willhave; national or EU. The European Commission does not plan tolaunch new EU secondary regulation; rather, we expect the member-states to implement both the Gas and Electricity Directives in a harmonized fashion.

Prices and ServicesPrices will continue to go down, albeit more slowly than they havefallen up to now. The liberalized milieu will motivate the utilities tooffer new and better services to consumers, as competition bringsabout new ways of thinking in the EU market.

68 Session II

Introductory Remarks

Industry StructureIntegration will continue in several forms: geographic, intersectoral,and vertical. Vertical integration, of course, must be accompaniedwith necessary unbundling, in order to avoid cross-subsidizationamong different activities of any single utility.

Outside PressuresThis liberalized framework will have to be reconciled with a numberof new challenges from outside the industry, among them environ-mental problems and the likely social and labor effects. We also haveto address security of supply, which is a growing concern in some ofthe member-states.

WHERE WE ARE GOING

With this information as background, let me introduce our panel,who will give us a larger —indeed worldwide— perspective as theseenergy industries move from a highly regulated environment into alarger arena for market forces to operate.

• Robert Hefner has long believed that natural gas, once regardedas a scarce and wasting resource, has a key role to play in theworld energy scene. Mr. Hefner will describe the forces that havebrought natural gas to the fore as a fuel of choice and will offerhis prediction of its role in coming years.

• Antonio Brufau will help us to see Spain as a case study in the restructuring of the natural gas market. Discussions from pastSeminars have shown us that Spain is moving into the future ata rapid rate, deregulating more quickly than was once thoughtpossible, and restructuring to meet new circumstances in localand international markets.

• Roger Sant, a pioneer in seizing opportunities created by electric-ity deregulation and market openings, will discuss the factors

69

that have enabled his company to thrive globally —in marketsonce reserved for regulated utility monopolies— and will specu-late a bit on future opportunities.

• Finally, William Massey of the U.S. Federal Energy RegulatoryCommission will discuss where regulation is going, especially as itrelates to the wires and pipe businesses that retain strong mo-nopoly elements. He will also outline the fundamental principleson which he and his colleagues rely when they review the issuesthat come before them.

70 Session II

«THE COMING AGE OF ENERGY GASES»

MR. ROBERT A. HEFNER III

THE GHK COMPANY

Conventional forecasts of world energy production for the next cen-tury have consistently depicted natural gas remaining below bothcoal and oil as a percentage of global production. Moreover, theseforecasts have often shown natural gas below even nuclear energyfor the second half of the next century. But I predict a significantlydifferent scenario unfolding: increased consumption of energy gases(including methane and eventually hydrogen) will displace oil, coal,and nuclear as the world’s principal sources of energy. By 2050, theconsumption of energy gases will surpass both coal and oil; by theend of the century, these energy gases will have captured, like coalin its heyday, more than 75 percent of the global energy market. Weare entering the “Age of Energy Gases.”

For more than 100 years, free markets and human ingenuity workedefficiently to decarbonize our energy systems. But, beginning in the1950s, government (here I refer to the U.S. government) began tousurp the market —by tinkering with price controls, for example, andby allocating use of fuels among sectors of consumers. The result

71

was a recarbonization of the energy systems. Only now, after adecade of deregulation, are the energy systems beginning to returnto their natural evolution, continuing the decarbonization process.

THE PERIOD OF RECARBONIZATION

From the 1950s through the 1980s, natural gas supply shortages occurred because of stringent, politically-motivated price controls,coupled with artificial increases in demand. As a result, the UnitedStates nearly regulated its cleanest fuel out of existence. During theyears of price control, natural gas, compared to oil on a Btu basis,sold for only 30 percent of the price of oil. Yet natural gas in a freemarket would normally bring a premium because it is a cleaner andmore efficient fuel than coal or oil.

Because both oil and natural gas companies during this period believed that the United States was running out of natural gas, theyassumed we could not sustain its increased use. In 1978, for exam-ple, prestigious members of the energy industry gathered at the Aspen Institute in Colorado and heard presentations of woe predict-ing the end of natural gas in the United States. One noted economiststated, “We are running out [of natural gas], and it will be soon.”

Until the early 1970s, natural gas was considered at best a margin-ally economic by-product of the oil industry, in danger of total deple-tion. However, the sources that were being depleted were either natural gas produced in association with oil and discovered becauseof the non-regulated and profitable price of oil, or natural gas fromgiant shallow fields that could be discovered and produced profitablyat very low, regulated prices.

At the same time, the Federal Power Commission published projectionsof pitiful, declining natural gas resources. These projections also con-tributed to the consensus that we were in the midst of a supply short-age of natural gas. Later forecasters predicted sharply higher prices, andthe collective wisdom of the day was that even on the chance that there

Session II72

was enough natural gas to meet demand, it would be too expensive;hence there was no alternative to coal or nuclear for power generation.The resulting projection, therefore, showed natural gas prices skyrock-eting at approximately the same rate that supplies were plunging.

THE TURN TO NATURAL GAS

During the past 20 years, however, two developments occurred: nat-ural gas began to achieve independent economic value; and in the1990s, the abundance of the natural gas resource base was con-firmed by published governmental and institutional assessments.

Yet, in my opinion, virtually all the current estimates of fuel con-sumption and the mix of fuels to meet demand through the nextcentury are as much in error as those of the 1970s. One such con-ventional forecast is shown in Figure 1.

«The Coming Age of Energy Gases» 73

Figure 1"Conventional" Forecast:

Energy Production 1910 to 2090

Percentage ofTotal Market

100%

80%

60%

40%

20%

0%

Solar Power

Hydroelectric

Natural Gas

Oil

Coal

Nuclear Electric Power20%

0%

40%

60%

80%

100%


Source: Dr. John D. Edwards, University of Colorado, Oil & Gas Investor (January 1999)2090205019501910 2000

I believe this type of projection is wrong for three fundamentalreasons. First, I believe that current rates of population growth arenot likely to be sustained during the next century. The educationalinformation that will be disseminated to people around the worldvia the new communication technologies will cause birthrates tobegin to fall. Second, I believe that we will find efficiencies in theenergy systems well beyond our imagination and total demand willnot be as large as projected. Finally, the conventional projectionsare wrong because the fuel mix will not come close to what is typ-ically depicted in forecasts.

If governments do not step in again to legislate energy markets, thefree markets coming into existence around the world will work theirmagic to join in the decarbonizing of our energy systems over thenext century and beyond. This will usher in what I call the “Age ofEnergy Gases.” In this new world, nuclear power will go nowhere; itis dirty, dinosauric, and too capital intensive; and coal will revert to itsdeclining percentage of the market.

China and India are generally thought to be exceptions to the declin-ing use of coal. But I believe they, too, will turn to natural gas soonerthan is forecast. China has ample supplies of easily accessible coal.Since coal deposits are usually linked to natural gas, I believe thatChina is heavily endowed with natural gas. I base this judgment notonly upon China’s enormous quantities of coal and the coal/gas re-lationship, but also upon research I conducted in the mid-1980swhen I traveled in China. However, in the 1980s, China’s leaders didnot believe my reports of abundant natural gas resources in theircountry any more than American leaders did when I estimated abundant U.S. natural gas resources in the 1970s.

Nevertheless, I believe China will soon begin to explore, produce,and consume its vast natural gas resources. The Chinese people willnot tolerate pollution from coal much longer; they want clean airand blue skies as much as everyone else. Within the next fewdecades, I forecast that China will begin its conversion from coal to natural gas.

Session II74

As for oil, I believe it has peaked in its percentage contribution to theglobal energy market. So today natural gas is the only abundant cleanfuel that is continuing to set new consumption records around theworld. Several years ago, at the International Institute for Applied Sys-tems Analysis (IIASA) in Austria, I worked closely with Dr. Cesare Mar-chetti and Dr. Nebojsa Nakicenovic, who have done fine energy fore-casting work for over a decade, using market penetration models.Never subscribing to the herd mentality, they have forecast that thenatural gas share of the energy market will move toward 70 percent inthe late twenty-first century. If this forecast is even close to what ourfuture holds —and I believe their models are on the right course—other fuels will be significantly displaced from the global energy system.

So if we combine lower population growth, more efficiency in theenergy production-consumption systems, and natural gas assumingthe lion’s share of the market, we will see curves that should lookdramatically different, as shown in Figure 2.

«The Coming Age of Energy Gases» 75

Figure 2"Unbounded Thinking" Forecast:Energy Production 1910 to 2090


100%

80%

60%

40%

20%

0%

Solar Hydrogen Power

Hydroelectric

Natural Gas-Methane

Coal

Nuclear Electric20%

0%

40%

60%

80%

100%


Source: Robert A. Hefner III, (May 1999)2090205019501910 2000

Oil

HAVING IT ALL

The earth, the solar system, and the universe are basically composedof two forms of matter, solids and gases. Liquids are simply a transi-tional state of matter. Therefore, in the big scheme of things, I believethe “Age of Oil” to be only a liquid transition between the “Age ofSolids” (animal dung, wood, coal) and the “Age of Energy Gases.”Over the last 150 years we have moved from energy systems thatare capital intensive, localized, inefficient, chemically complex, dirty,macro, and immobile, toward energy systems that increasingly aredecentralized, distributed, efficient, chemically simple, clean, micro,and more mobile. The future has already arrived.

The future path of energy consumption will have continuing increasednatural gas use, transitioning over time to hydrogen. Hydrogen is theultimate renewable energy source because its combustion produceswater and oxygen. I forecast that hydrogen will be produced fromsea water by efficient, low-cost solar technology and will be usedboth as a primary fuel and for the generation of electricity.

The Age of Energy Gases, together with revolutionary advances incommunications, information, and education, will enable the worldeconomies to become increasingly capable of sustaining economicgrowth while enhancing the global environment, possibly even despite population growth. Our future is bright!

This text is an abridgement of the paper written for this Seminar,“The Age of Energy Gases.” The complete paper is available fromthe author.

Session II76

«RESTRUCTURING NATURAL GAS MARKETS:THE VIEW FROM SPAIN»

MR. ANTONIO BRUFAU

GAS NATURAL GROUP

Just as coal was the main energy source of the nineteenth century,and oil of the twentieth century, the most important energy sourceof the twenty-first century will be natural gas. Yet the history of natural gas in Europe is barely 30 years old —from the first discoveriesin the Groningen gas fields in the Netherlands and construction ofthe pipelines to the European markets in the 1960s and the pipelineslinking the former Soviet Union to Europe in the 1970s.

Even as the industry looks forward to the dominant role that naturalgas will play in the next century, we recognize that there will bemany challenges to face as gas assumes this new primacy. In my presentation today, I will begin with a brief review of the current sta-tus of natural gas in the European energy market; discuss thechanges in governmental legislation related to these developments;turn to the growing consumption of natural gas in Spain; and,finally,comment on strategies for the new market environment.

77

NATURAL GAS IN THE EUROPEAN ENERGY MARKET

Today, natural gas accounts for 21 percent of primary energy consumption worldwide, compared to solid fuels (25 percent) and oil(36 percent). In the last 20 years, worldwide consumption of naturalgas has increased by 60 percent. By contrast, consumption of oil has increased by 10 percent. If current trends continue, within the next25 years consumption of natural gas will equal that of oil. Growingdemand from power generation based on new technologies is par-ticularly significant; it could account for 25 percent of total con-sumption growth. Proven world gas reserves of 146 trillion cubic meters (Tcm) would provide for more than 60 years of production atcurrent levels. The extent to which natural gas resources will be exploited in the future will depend not on supply but on economic, political, and technological factors.

The increase in demand in the European Union (EU) over the period1997 to 2020 is predicted to be almost 35 percent, rising from 364to 483 billion cubic meters (Bcm). Of this total, 25 percent is expected to come from power generation. The gas combined cycle(GCC) turbines, with their improved efficiency, environmental advantages, and lower cost, will provide the basic equipment formost new generating plants.

At the same time, this growth in demand will be accompanied by adecline in domestic production and an increase in imports from non-EU countries. Total imports are predicted to reach 344 Bcm by 2020,increasing import dependency from 43 percent in 1998 to 71 per-cent. This growing dependence on imports will be met by just threeprincipal sources of supply: an oligopoly of Algeria, Norway, andRussia. Each of these countries has but a single monopoly exporter:Sonatrach in Algeria, GFU in Norway, and Gazprom in Russia. Currently these three suppliers produce 42 percent of the natural gasconsumed in the European market.

In markets with gas-to-gas competition —Argentina, Australia,Canada, Great Britain, and the United States— ample domestic

Session II78

supplies exist, and suppliers are subject to national regulations. European governments seeking to create a competitive gas marketwithin Europe do not, of course, have similar powers to regulate theirsupply side.

REGULATORY CHANGES IN THE EUROPEAN GAS SECTOR

European gas markets have traditionally operated with a balance between an oligopoly of sellers and an oligopoly of buyers: a limitednumber of suppliers, each controlling the entire export capacity of itscountry-source, and a limited number of buyers, each aggregating itsnational demand. The transmission companies have sold gas to localdistribution companies, often municipally owned or with mixed public-private capital, and directly to large industrial consumers andpower generation companies.

In this market, the suppliers and the national transmission compa-nies have been able to create the infrastructure and develop themarket for natural gas: they have built pipelines and LNG facilities,marketed the gas at a price competitive with other sources, and established long-term supply agreements. Leaving aside questionsabout the increased efficiency or lower prices that gas-to-gas competition might have produced, the achievements of this pre-lib-eralized system have been considerable: long-term security of supply has been achieved, and Europe has developed a competitivegas sector in record time.

The European Gas DirectiveAt the dawn of the new century, pressures for liberalization arebringing about sweeping changes in gas markets. In June 1998 thelong-awaited European Gas Directive was enacted, designed to createa single domestic gas market to conform with the European singlemarket principles. Although delayed in coming, this directive is theresult of many years of deliberation by the best experts in this field,and it addresses all the complexities of balancing supply and demand.

«Restructuring Natural Gas Markets» 79

The European Gas Directive mandates creation of a system to autho-rize construction and operation of additions to the gas infrastructure;unbundling of accounts for different activities; third-party access tonetworks; and the progressive liberalization of gas markets. The directive will certainly stimulate the emergence of new suppliers, andeven new exporters, from the three major producer countries. However, there must be a transition period during which the currentlong-term take-or-pay (TOP) contracts are protected and invest-ments in new infrastructure are initiated.

National ResponsesThese mandates are to be implemented by national legislation ineach member-state before August 2000. Spain and the UnitedKingdom have already adopted their laws, and other nations are in

process. As Figure 1 shows, the Spanish timetable for liberalization isconsiderably more ambitious than that of the EU.

Session II80

Figure 1Opening Up of Natural Gas Markets

Spain and European Union: 1998 to 2013

New Spanish Liberalization Measures

Spanish Hydrocarbon Law

EU Directive

25 Mm3

10 Mm35 Mm3

5 Mm3

3 Mm35 Mm3

3 Mm3

15 Mm3

15 Mm3

20 Mm3

Percentage (%)

100

90

80

70

60

50

40

30

20

10

10/98 4/992000 2003 2005 2008 2010 2013

Source: Gas Natural Group

Spain´s record of conformity with the European Gas Directive hasbeen impressive. Following the passage of the directive, Spain movedto implement liberalization. The Hydrocarbons Law was passed inNovember 1998 and was amended in April 1999. Starting immedi-ately (1999), all consumers in Spain of more than 10 million cubicmeters (10Mm3) —approximately 60 percent of the natural gas mar-ket— can choose their own suppliers. In 2008, all consumers (the en-tire market) will be eligible to make their own choice of suppliers. Bycontrast, the initial threshold for EU consumers is 25 Mm3—approximately 30 percent of the market. At the end of the transitionperiod in 2013, the threshold will remain at 5 Mm3 or just 45 percentof the market.

THE PICTURE IN SPAIN

Spain has recently reversed its pattern of low gas consumption: the de-mand for natural gas has surged. From 1985 through 1998, gas con-sumption increased fivefold, from 2.3 Bcm to 13 Bcm, and this sharprate of increase is expected to continue. Current use is heavily weightedin the industrial sector (78 percent). Demand in the residential/ com-mercial markets is 17 percent, compared to an average of 40 percentin other major EU countries. Demand in electricity generation is no-tably low, just 5 percent, versus the 15 percent average of the EU.

The most conservative forecasts for future demand assume at least adoubling of the market (including power demand) in the next quartercentury, from the current 13 Bcm to at least 27 Bcm, depending onthe demand for power generation. More optimistic forecasts suggesta demand as high as 32 Bcm. This contrasts with the 40 percent increase expected for all the EU countries together.

Spain must import virtually all of its natural gas: current sources are Algeria (62 percent), Norway (16 percent), and Libya (7 percent). Domestic supplies were only 4 percent in 1998 and they are expectedto be phased out during the next two or three years. LNG comprises43 percent of current supply, and Enagas is the principal distributor.


To handle the expected increase in demand, the Gas Natural Group isdeveloping a major investment program of $4 billion (3,546 millioneuros) over the next five years. Approximately 40 percent will be allo-cated to investments in infrastructure and 60 percent to local distribu-tion networks. Figure 2 shows the current and planned infrastructure.The current infrastructure includes five gas entry points via two pipe-lines: from Lacq in France to Calahorra in Spain (Lacq-Calahorra) andfrom Hassi R’Mel in Algeria to Cordoba in Spain (Maghreb-Europe);three regasification plants at Barcelona, Cartagena, and Huelva; threeunderground gas storage sites; and the main pipeline grid (30,000 kmlong as of early 1999).

STRATEGIES FOR THE NEW MARKET ENVIROMENT

Governments worldwide have embraced the principles of the neweconomics, including deregulation, globalization, and competition

Session II82

Figure 21998 Iberian Natural Gas Infrastructure

(Current and Planned)

Granada

ALGERIA

Hassi R´MelMOROCCO

Tangiers

Source: Gas Natural Group

Málaga

CádizPoseidón

Huelva

Córdoba Murcia

Cartagena

Valencia

Madrid

Lisbon

SalamancaSegovia

Zamora

Calahorra

ZaragozaBarcelona

Serrablo

BilbaoOviedo

León

La CoruñaSantander

Gaviota

Lacq

Pipeline in iperation

Pipeline planned orbeing built

System entry points

Underground storagefacilities

Natural gas fields

Regasification plants

Regasification plantsbeing studied

Import pipelines:Lacq-CalahorraMaghreb-Europe

as catalysts for the energy sector. In the EU, the creation of the single internal market is an additional catalyst to break the traditionalmonopolies in the electricity and natural gas sectors. But legal initiatives are not the only forces for change.

Market forces also bring competition. There is no way to preventlarge industrial consumers, already active in a competitive environ-ment, from looking for alternative sources of supply beyond theirtraditional gas suppliers. New gas producers will do their best to findnew markets for their output as well as seeking a share of existingmarkets. Consumer and producer pressure, combined with reducedgovernmental concern for security of supply, will inevitably enlargemarkets for gas demand.

The new market structure will influence the way that the gas sectoris organized as well. In those countries with liberalized gas markets,companies still offering bundled services are on the way out. Thenew structure will clearly differentiate among production, transmis-sion, distribution, trading and marketing, and other energy-relatedbusinesses.

On the other hand, differentiation among energy sectors is expectedto fade away. Oil and gas companies have generally maintained closerelations via cross shareholding and joint participation in common oiland gas fields. Closer cooperation will result from the developmentsin cogeneration and in transport. The current race for mergers andacquisitions among energy companies confirms this convergence.


«PRIVATIZING ELECTRICITY MARKETS:OPPORTUNITIES PAST AND FUTURE»

MR. ROGER W.SANT

AES CORPORATION

Thus far, this session sounds like a commercial for natural gas, so Ishould begin with a disclaimer that I do not have any vested interestin the gas industry. My company, AES, is in the electricity business,and originally we were in coal. Nevertheless, many of my conclusionsare similar to those of my colleagues from the gas industry.

THE 1990s IN PERSPECTIVE

The electricity sector has been explosive —truly amazing develop-ments have occurred during the last decade. If I had been at the first Repsol-Harvard Seminar in 1987, I would not have predicted any ofthese changes. In retrospect, though, it seems clear that there havebeen three principal drivers of this explosion. The first is restructuring,and everything accompanying it: competition, liberalization, andopening up of the developing countries to private investment. Thesecond agent of change has been technology. The impact of techno-logical innovation, particularly the gas turbine, has been extraordinary,

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beyond anyone’s imagination. Efficiencies from these turbines in thecombined cycle mode are now surpassing the 60 percent level, versus40 percent ten years ago. The third driver has been low, stable gasprices. Let me expand on each of these factors.

The enormous worldwide liberalization of the electricity sector tookplace in just a decade. In 1989 the picture was bleak; the majority ofcountries were closed to foreign investment. Only the United States,possibly the United Kingdom (just emerging from a nationalizedregime), and Chile offered any opportunities. Today almost thewhole world is open, with the exception of a few African countries.

Of course, not all countries open to liberalization offer competition orhave real restructuring underway. In China, for instance, there are fewgood opportunities for private investment, with little chance of changeanytime soon. At the other extreme is a country like Argentina,where there are almost no constraints on investment: you can buildanything that you can get a permit for, and you take your chances inthe pool as to whether you can sell the power you generate.

Turning to the second driver of change, technology, let me mentionits impact on the price of electricity, specifically for electricity gener-ation using combined cycle technology. As Figure 1 shows, in themid-1980s, most of the projects we looked at offered about 6.1cents/kwh. Today we are looking at 2.8 cents/kwh —less than halfof what we had seen in the 1980s in nominal terms, and even less inreal terms. That price drop came from all three components of cost:fuel, operation and management, and capital. The capital cost im-provement reflects the greater efficiency from the turbines.

I do not know how many of you, ten years ago, would have pre-dicted a price of 2.8 cents/kwh in 1999. But that is the price availablein any country that has natural gas for electricity generation. I am nottalking only about the United Kingdom or the United States; I amtalking about Bangladesh, Egypt, Bolivia —any place where naturalgas is available. The only caveat is that when you use LNG, you mustadd extra cost. Nevertheless, 2.8 cents/kwh is a stunning number.

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One heartening effect of the new gas combined cycle (GCC) plantshas been the environmental benefits they bring, particularly in reduc-tion of CO2. As we replace the present generating capacity with GCCplants, we will get significant reductions in pollution and will be inaccord with the Kyoto Protocol guidelines.

Robert Hefner has already discussed what has happened to wellheadgas prices, so I will just add that delivered prices have shown a simi-lar decline. Instead of doubling the price that we would have forecastin 1989, we have actually seen a 15 percent decline in the deliveredprice of natural gas for power generation in the United States.Hefner’s point is well taken: every year the predictions for gas priceshave been wrong —prices have continued to decline.

All these factors have combined to produce an interesting picture inthe electricity capacity markets. As Table 1 shows, existing capacity in1997 was about 3100 gigawatts. Since then, there has been a further

«Privatizing Electricity Markets» 87

6.1

4.8

2.8

Levelized Cost:cents per kwh

Levelized Cost:cents per kwh

8.0

6.0

4.0

2.0

0.0

8.0

6.0

4.0

2.0

0.0

Fuel Operation and Management Capital

1999Late 1980sMid 1980s

Source: AES Corporation

Figure 1The Price of Electricity GenerationNew Gas Combined Cycle Plants

expansion of 29 percent in announced additional capacity —an un-precedented increase. All that capacity will not be built, of course,but it shows how the market has grown and where it is going. Alsosignificant is where it is happening: not in Europe and North Americawhere you would expect the big markets, but in Central and SouthAmerica, Africa, the Middle East and, of course, Asia.

LOOKING AHEAD: THE NEXT DECADE

As I look at the next ten years, I am excited about the new trends Isee. The past is prologue of course, and the important developmentsof the past decade will continue. What captures my imagination nowis the shift in focus to the customer. Wholesale marketing has alwaysbeen with us to some degree, but it has expanded. Power/gas com-modity trading has grown at an extraordinary rate in the UnitedStates, and it is starting in other places as well. But the move in retailpower is toward a much more sophisticated marketing strategy:offering energy services instead of just Btus or kilowatt hours.

Recently I looked up the market capitalization of America Online(AOL). If you take AOL’s market cap divided by its 18 million cus-

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Table 11997 Worldwide Electricity Capacity

Existing and Projected

Number ofNew PlantsAnnounced

PercentageIncreaseRegion

Existing Capacity(in thousand mwh)

Europe 1040 84 8%

North America 931 79 9%

Asia 766 551 72%

Africa and the Middle East 181 92 51%

Central and South America 158 78 50%

Worldwide Totals 3076 884 29%

Source: U.S. Department of Energy (DOE) and U.S. Information Administration (EIA)

tomers, it appears that the market is valuing each customer at about$7000. That is a striking number, if correct. If we were to make thesame calculation for our 14 million customers, we would be worthabout seven times our current value. I think the AOL exampleteaches a very interesting lesson about the value of customers andindicates a potential goldmine that we ought to explore.

We utility people have always taken our customers for granted. Anyopportunity to offer new services (if AOL is any indication) ought tobe explored. We could well come up with ideas that we had neverconsidered before. Of course, this shift is still nascent; few people aregiving much thought to the services sector. But ten years from now,some companies will emerge as having done an extraordinary job ofproviding new services to their customers.

Let me summarize. All the developments that we mentioned —restructuring, technology improvements, lower (or at least stable)gas prices— are likely to continue for the next decade. With thebreakthrough GCC technology now capable of surpassing the 60percent efficiency barrier —the energy equivalent to running a four-minute mile— we can only guess at how much farther efficienciescan go. Restructuring will continue, and the process will offer lucrativeopportunities throughout the world.

Finally, the new businesses that I mentioned —power/gas commod-ity trading and developments in customer services— are the newbenchmarks that will define success in the electricity industry of thenext century.

«Privatizing Electricity Markets» 89

«THE ROLE OF GOVERNMENT:REGULATION AND REGULATORS»

THE HONORABLE WILLIAM L. MASSEY

U.S. FEDERAL ENERGY REGULATORY COMMISSION

Let me begin with some basic information about the U.S. Federal Energy Regulatory Commission (FERC) and the industries we reguIate.FERC is an independent regulatory agency of the U.S. governmentthat has broad and diverse responsibilities. Five commissioners, appointed by the president, set policy and resolve disputes by majorityvote. We regulate the rates, terms, and conditions of service of over80 interstate natural gas pipelines and also approve the siting andconstruction of pipeline facilities, taking environmental issues into account. For the electric industry, FERC has jurisdiction over whole-sale bulk power sales and over the high voltage transmission wires of 166 electric utilities. FERC also issues licenses to over 2,100 hydroelectric facilities.

TOWARD A PRO-COMPETITION POLICY

The landmark year in the shift to a more competitive policy came in1987 with the adoption of Order No. 436, which introduced

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open-access transportation concepts to the interstate pipeline industry.Order No. 636, adopted in 1992, mandated the unbundling of gassales and transportation, and adopted open-access requirements asthe new model for transportation services. We also created a secondary market for pipeline capacity through capacity release. Thesuccess of our gas restructuring efforts is now taken for granted.There is robust competition for supply over a highly reliable trans-portation grid, which will grow by 35 percent over the next 20 years.

FERC has followed a similar course in electric restructuring policythrough Order No. 888, issued in 1996, in which 166 electric utilitieswere required to open their transmission wires on a non-discriminatorybasis. As with our natural gas restructuring, we required utilities to func-tionally unbundle their merchant and transmission operations. We alsoprovided for the utilities to recover their stranded costs from customersdeparting to take advantage of competitive supply opportunities.

Emerging MarketsDynamic commodity markets have developed in gas and electricity. Avibrant national market has developed for natural gas, accompaniedby significant price transparency and financial transactions. The num-ber of gas and electric marketers has multiplied tenfold. Our electricitypolicies are facilitating robust regional bulk power markets.

Industry ConsolidationMergers in the gas and electric sectors totaled $120 billion in 1998,double the 1996 level. The U.S. industry is rapidly consolidating, creating large market participants. Pipeline conglomerates are beingformed, and traditional electric utilities are merging. In 1998, $30 bil-lion in so-called convergence mergers took place —electric marketersand utilities merging with gas pipelines and gas distribution compa-nies. Several market participants, particularly gas and electric mar-keters such as Enron and generation companies such as AES, are nownational in scope. El Paso Energy’s pipeline facilities, for example,now stretch from California to New England.

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Pipeline HubsA national transportation network with market hubs has emerged.There are now 40 hubs where pipelines intersect, facilitating marketsfor both commodity and capacity transactions and a new array ofmarket-responsive products and services (e.g., parking, loaning, titletransfers, and hedging).

Natural Gas-Fired GenerationNatural gas will virtually fuel a new generation of electricity, for botheconomic and environmental reasons. Gas use for electric generationwill triple to 9.2 trillion cubic feet (Tcf) by the year 2020. Many ofthese facilities are merchant plants, built to sell into a market ratherthan to particular customers. These gas-fired facilities are creatingdemand to increase pipeline capacity by 35 percent over the next 20years.

Regional Power MarketsIn electricity, FERC’s policy of promoting regional transmission orga-nizations (RTOs) facilitates large, transparent regional power marketssuch as the Pennsylvania-New Jersey-Maryland Interconnector(PJM), which dispatches 50,000 megawatts (mw) daily. An RTOwould operate and maintain the reliability of the grid, create real-timebalancing and ancillary services markets, and monitor for marketpower abuses. FERC’s goal is for an RTO to operate in every regionby December 15, 2001.

Grid IndependenceThe objective of FERC’s RTO policy is that the electric transmissiongrid be operated (or owned and operated) by a corporate entity, notcontrolled by any seller of generation or other market participant.Such a corporate entity may be an independent system operator(ISO) or an independent transmission company (Transco). Roughly80,000 mw of generation are in the process of being divested orhave already been sold by vertically integrated utilities.

«The Role of Government» 93

CORE PRINCIPLES

Five core principles have guided our natural gas and electric restructur-ing policies. These five principles will continue to be the driving forcebehind FERC policies as we address the complex second-and third-gen-eration issues that have arisen as a result of our open-access initiatives.

Commodity markets are best regulated by the forces of com-petition. The price of natural gas as a commodity was deregulated com-pletely by Congress, and gas now is bought and sold at market- clearingprices unencumbered by regulation. The retail sale of electricity continuesto be regulated, but is sold wholesale at market-based rates. Federal pol-icymakers believe that natural gas and electricity can be supplied throughcompetitive markets; that competition can discipline commodity pricebetter than regulation; and that competition unleashes the creative ener-gies of market participants to develop innovative products and services.

Regulatory policies should facilitate larger markets havingmany commodity sellers. There is a vigorous North American mar-ket for natural gas. Through our policy promoting RTOs with efficienttransmission pricing, we are attempting to eliminate balkanization andfacilitate large regional markets for bulk power. RTOs will also be re-quired to eliminate any barriers to trading with market participants inneighboring RTO regions. By increasing the number of competing sell-ers, larger markets can also mitigate horizontal market power concerns.

Pipelines and wires have monopoly characteristics and mustbe appropriately regulated to prevent monopoly abuse. FERCwill continue to regulate rates, terms, and conditions of service forpipelines and electric transmission facilities. In addition, we have pro-posed more flexible rates and the use of negotiation for terms andconditions of pipelines. Performance-based rates may be appropriatefor electric transmission, and congestion must be managed efficientlyvia techniques such as locational marginal pricing.

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Pipeline transmission and electric transmission must be operatedwithout discrimination or preference. Commodity markets requirenon-discriminatory access through the transmission network.Open-ac-cess tariffs with clear and non-discriminatory terms and conditions of ser-vice are key to creating vibrant commodity markets. FERC has pro-posed that the electric transmission grid be operated by RTO entitiessuch as ISOs or Transcos that are independent of market participants.

Merger policy must be consistent with FERC’s broad pro-com-petition goals. The pace of mergers is likely to accelerate in the UnitedStates as energy companies position themselves to meet the demandsof a competitive marketplace. We are not authorized to questionwhether a proposed merger reflects a sound business judgement: in themerger context, FERC’s core concern is with market power. A mergerthat raises concerns about horizontal or vertical market power will ei-ther be rejected or conditioned with appropriate and effective mitiga-tion measures such as asset divestiture or participation in an RTO.

QUESTIONS FOR REGULATORS

In conclusion, federal regulators in the United States are committedto pro-competition policies. As the marketplace continues to evolve,we face a number of challenging questions. Some of these questionsmay also be relevant to other countries.

When dealing with gas and electric companies that have been pri-vately owned for a century, should regulators mandate restructuringor use a combination of “carrots” and “sticks”? There is a philosophi-cal divide on this question. FERC Orders 636 and 888 were mandatoryprograms, but our recent generic proposal promoting RTOs couples avoluntary program with the possibility of rate incentives for utilitiesthat “volunteer” to form RTOs. We expect the utilities to volunteer.

Should regulators call the shots on critical market structure issues, orshould they let the marketplace evolve naturally according to the

«The Role of Government» 95

desires of market participants? Stated another way: How do we de-fine the role of regulation in shaping the competitive landscape?

Will pipelines and electric wires continue to be defined by monopolycharacteristics? The answer to this question may first seem to be“yes.” Yet, with any given U.S. pipeline, there are now a number ofmarket participants competing to sell capacity in a highly activesecondary market. A secondary market for electric transmission is de-veloping as well. To some extent, these developments help lessenthe monopoly power.

Can pro-competition goals be achieved in a reasonable time framewhen authority is split between federal and state policymakers?Roughly 80 percent of electric utility revenues are regulated by 50state regulatory bodies. FERC has jurisdiction over wholesale powersales and unbundled electric transmission, and states have authorityover retail sales, bundled retail transmission, local distribution, andthe siting of all electric transmission facilities. Consequently, no singleregulatory body is in charge of the electric restructuring debate. Thisis a critical issue in the United States.

How can international markets be effectively structured and regu-lated? Again we must live with divided regulatory jurisdiction. Forexample, since the energy systems in the United States are physicallyconnected to Mexico and Canada, we have declared that Canadianelectric marketers selling into the United States must comply withU.S. market rules. But tensions may develop among U.S., Canadian,and Mexican electric policies.

What information about market participants and transactions shouldregulators require to be disclosed? What information is so commer-cially sensitive that it should be exempt from disclosure? Informationis the fuel of a competitive marketplace, yet disclosure of commer-cially sensitive information may diminish competition. What is theappropriate standard for disclosure?

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DISCUSSION

MR. DÍAZ FERNÁNDEZMr. Benavides noted how satisfied European Community memberswere with the effects of competition on electricity rates. I would liketo mention three other factors that have contributed significantly tothese rate reductions. First is the cost of money: in Spain, for instance, it has fallen five to seven points. Second, the cost of pri-mary energy from fossil fuels has declined dramatically. Third, production costs have dropped, due to technological advances suchas combined cycle turbines. Can the EC evaluate the relative impactsof these factors in producing the beneficial effects of liberalization,for example, in electricity?

MR. BENAVIDESCertainly the reduction in rates cannot be attributed exclusively, oreven principally, to liberalization. The factors you mentioned —lowerfinancial costs, fuel prices, and production costs— are significant.

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There are local factors as well; for example, in Spain we have hadtwo good hydrological years, which had a positive influence on Spanishelectric rates. Furthermore, I believe that the advent of liberalizationcaused utilities to offer lower rates and better services in advance ofliberalization.

QUESTIONI think that we have placed too much emphasis on natural gas at thisSeminar. Instead, I suggest that we enlarge our focus to includerenewable energy sources, solar energy, for instance.

MR. SANTSince I am chairman of the World Wildlife Fund in addition to my jobat AES, I have some credentials to talk on the subject of renewables.Currently the emphasis is on markets, and markets are not driving renewables right now. There is no renewable out there that cancompete in the marketplace with the new, cheap energy from con-ventional fuels.

My opinion is that we have focused much too much on the term “renewable” rather than on the emissions that we are trying toeliminate. As an environmentalist, I would like to concentrate ourefforts on the things that we really care about, such as air quality,and work to reduce the polluting emissions. In any event, the term“renewable” is too broad for my taste, particularly after havingseen the environmental damage that hydroelectric dams can cause.

MR. HEFNERI agree with Roger Sant that if we focus on the issue of emissions,we must agree that natural gas is doing a fine job. I do not thinkthat we have to worry that natural gas is in danger of being totallyused up. We do not run out of a particular resource; rather, an al-ternative becomes better priced and more efficient. As we haveheard, “the Stone Age did not end because we ran out of stones.”

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QUESTIONI have a few questions about natural gas deregulation in Europe andthe United States. First, how do you compare deregulation in Europe(with a very limited number of suppliers) to deregulation in theUnited States (with so many suppliers)? Second, how can we encourage the huge investments needed to develop new infrastructureto meet the expected demand? Finally, how can we handle the arbitra-tion between the TOP contracts and the new competitors?

MR. MASSEYCertainly the U.S. policy for restructuring natural gas is successful inlarge part because there are so many competing suppliers. If therewere only a handful, I would have much greater concern about market power problems. But literally there are thousands of suppliers.

MR. BRUFAUSpeaking from the Spanish perspective, I agree that the expected increase in demand will require huge investments for infrastructure. Onthe TOP issue, both the EC Gas Directive and the Spanish Hydrocar-bons Law acknowledged the need to protect these contracts. But theycannot factor in the risk of an open market, which is a business risk. Ifwe open 60 to 70 percent of the market on Day 1 and expect that mar-ket to grow at a 30 to 40 percent rate, then we have to be very surewe do not damage businesses at the expense of competition. Theremust be a balance between opening up the market and developing theinfrastructure of the system, and these processes must be synchronized.

QUESTIONWhen Mr. Massey talked about restructuring electricity and naturalgas, he noted that regulation of transmission will continue because itis a natural monopoly. Yet not long ago, we believed the same wastrue of telephone wires, and we also thought that large, central-sta-tion coal plants were necessary to capture economies of scale in gen-eration. Technological changes have eroded these beliefs, although

Discussion 99

in some cases regulators were slow to pay attention. If distributed gen-eration were to become competitive with traditional transmission anddistribution systems, how confident are you that regulators will juststop regulating transmission and distribution, and get out of the way?

MR. MASSEYI think there will be a big role in U.S. markets for distributed genera-tion. Would FERC be willing to cease its regulation if the monopolycharacteristics of pipes or wires appeared to be seriously diminished?Yes.

We are not wedded to any particular form of regulation, but we dowant to see vibrant markets. As long as our current policies producesuch markets or assist them to develop, I think we will continue withthe current form of regulation. Over time, the perceived monopolyof pipes and wires will certainly diminish, in part because of distributedgeneration. But there will always be a role for regulation in settingterms and conditions for service, ensuring that third-party access isnon-discriminatory, and determining key issues of market structure.

QUESTIONSome analysts are predicting higher prices for natural gas, based onlower productivity, reduced levels of exploration, and the necessity ofimporting substantial supplies from more distant areas. Does anyoneon the panel expect higher prices?

MR. HEFNERDiminishing returns from current wells and a decline in proven reserves have been predicted for several decades now, but our research and activities have conclusively demonstrated otherwise.There are vast amounts of gas still to be tapped. I estimate U.S. resources at 3,000 to 4,000 Tcf. If you add to that the resources inMexico, Canada, and South America, it is clear that there are amplegas resources to meet the demand for the future.

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As to prices, when regulations on natural gas were finally phased outin the 1980s, the industry went back to normal, market-based pat-terns of activity. By incorporating technological enhancements —drilling in the shallow levels of gas fields, for example— we easilymet the increased demand. Recently, however, drilling has fallen offa little due to the price collapse of both gas and oil, resulting in atighter supply-demand balance that should lead to moderatelyhigher natural gas prices.

QUESTIONI would like first to comment on how natural monopolies can bederegulated. In the United Kingdom, British Gas was the sole ownerof gas storage facilities. But in April 1999, this function was com-pletely deregulated, after British Gas agreed to auction off its capac-ity. In return, the regulators have deregulated everything, includingcentral service and prices. Now they are looking to do the same thingwith the gas pipelines: auctioning capacity on the inputs, on the out-lets, and on the storage facilities. If this proves to be successful, itmay offer a model of how to deregulate even natural monopolies.

My question is for Robert Hefner: you stated that your predictionsfor natural gas prices have always been for downturns, yet now youseem to be predicting an upturn. Why have you changed your view?

MR. HEFNERI think natural gas prices have bottomed out. The next step might bemoving from wellhead prices of about $2/tcf to $3/tcf in the nearterm. If Roger Sant’s number of 2.8 cents/kwh for electricity gener-ated by natural gas turns out to be correct, the marketplace can easily handle a small price increase in that commodity.

QUESTIONYou know that I have reservations about the EC Gas Directive, basedon my experience in the United Kingdom. The U.K. law allowing

Discussion 101

competition in the gas industry was passed in 1982 and was later reinforced in 1986. Yet the first competitive gas contract was notsigned until 1991. When I inherited the gas regulator’s job in 1993, I found a key error in the system. To correct this, we had to make arather dramatic intervention, which forced the separation of theownership of the commodity from the ownership of the natural monopoly infrastructure —the pipelines. That action was what really got competition underway. I would like to see something likethis happen in Spain, even though I realize that Spain is much more ofan emerging market than the United Kingdom was in the early 1990s.

Today retail competition in the U.K. gas and electricity markets isthriving. Over 20 percent of British Gas customers have moved to independent suppliers for their gas. And in the electricity market,British Gas has almost two million customers, more than many of theregional companies. So these markets are quite robust.

MR. BRUFAUI think that comparisons between Spain and the United Kingdomare not really valid. It took 12 years to open the U.K. market —an extremely slow process, particularly for a country with its own domestic gas suppliers and a fully developed infrastructure.Spain, by contrast, is the first instance in which a system has been opened to competition while the sector is still in the process of development.

QUESTIONMy question to Mr. Massey is about the controversial issue ofstranded costs —what we call “costs of transition to competition”(CTC) in Spain. In our country they have been awarded only toelectric utilities. So we are interested in learning how stranded costsare handled in the United States. What criteria have been used todefine the level of stranded costs and how are they allocated to in-dividual companies? When is a company considered to have beenrepaid?

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MR. MASSEYRecovery of stranded costs certainly has been one of the more con-troversial aspects of restructuring policy in the United States. FERCwas well aware that, to the extent you allow the recovery of strandedcosts, you may get less competition. But outweighing any possible reduction of competition was our belief that this was a matter of equity.And, from the standpoint of political realism, there was no way to ef-fect restructuring at the federal level without this policy.

When restructuring of the natural gas industry began in the 1980s,pipeline companies had several billion dollars invested in high-pricedTOP contracts. Under FERC Order 636 they were allowed to recoverthese costs, which they generally did by raising their customers’transmission rates. Most pipeline companies settled for a recoveryrate of between 50 to 75 percent of those costs, most of which havenow been passed through the pipeline system.

FERC adopted a similar policy for the electric side. This policy wascontroversial in an economic sense, but it was politically popular andallowed us to reach an agreement and issue Order 888. This orderrequired open access but granted cost recovery. Rather than spread-ing the costs out to all customers, we required that the departingcustomers pay the stranded cost charges. This was also controversial.Yet another contentious issue was the size of these stranded costs.Many utilities are selling their generation facilities and are gettingback three or four times their book value. Such returns will substan-tially diminish the potential stranded cost charges.

PROF. HOGANThe details of the structure for newly opened markets are exceptionallycritical in the electricity sector because there are so man complicatedtechnical characteristics in this industry. I am particularly concernedabout who determines market structure —markets or regulators.

If you look around the world at the countries that have producedreasonably good designs for market structure, you see that they

Discussion 103

share two characteristics. One is that a relatively small group of peoplehas led, or at least dominated, the process; people who shared theview that they were working to promote the public interest to set upan efficient market. The second shared characteristic is that thesesmall groups have had technically competent people working withthem, principally electrical engineers who understood how the system really worked and were able to explain which proposals werefeasible and which were not.

On the other hand, to find models of flawed design you have only tolook at places where large groups of stakeholders, motivated by avariety of interests, have designed the system. One example that Iwould call the “least common denominator” model is the MidwestIndependent System Operator (MISO). Another model with a flaweddesign can be found in California where planners tried to separatemarkets that could not be separated.

Certainly regulators can get it wrong, so there is no guarantee in allowing them to set the rules. But it seems to me that it is the regulators who have the final responsibility to look after the public interest. Given the complexity of this problem, in the end they willhave to scrutinize the details and say clearly which ones are essential,which systems work, and which do not work.

MR. MASSEYIn the United States there is a huge philosophical divide over this issue. I would be inclined to have FERC set more market rules for theelectricity industry in our new regional transmission organization(RTO) policy. As you know, we require the RTOs to operate a real-time balancing market, which is a step toward the model you aretalking about. My guess is that in the upcoming hearings on the issue, we will be strongly urged to drop that provision. A significantpart of the industry does not want that much structure and is not enamored of the pool concept. My view is we should move more ag-gressively in that direction. However, I don’t believe the votes arethere to pass it.

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We have the desire to create RTOs with the real-time balancing provi-sion, but beyond that, I do not know. It may be that these pools will bedesigned using a collaborative, least-cost, lowest common denomina-tor aproach, because politically that is about the best we can do rightnow. Or perhaps the politics will evolve. In any event, you are right inthat the most critical question in restructuring right now is the extent towhich regulators are willing to aggressively shape market institutions.

QUESTIONMr. Hefner, in your presentation you forecast increased consumptionof gases with low or no emissions (natural gas, alternative energies,and nuclear energy) and declining consumption of solid and liquidfossil fuels. Nevertheless, I am reminded of the comment about coal’slarge share in the worldwide production of electricity today. Wouldyou estimate what the energy mix will be in the next century?

MR. HEFNERI do not have specific figures, but I believe that energy demand in thenext century will be lower than is generally estimated. I do not believewe will have a straight-line population increase over the next hundredyears. I believe we will make significant improvements in the efficiencyof the entire energy system, particularly in the convesion of naturalgas to electricity, which will lower demand per unit of GDP. As to thefuel mix, I subscribe to the evolutionary idea of solids to gases, withliquids as transition. It just seems to be the natural course of things.

I would like to correct one point you made: I do not include nuclear en-ergy in the category of energy having sustainable growth. Nuclear isnot clean and has many other problems as well. To me, nuclear is oneof the dinosaurs remaining at the end of the age of solid fuels.

QUESTIONI am interested in the implications of carbon emissions trading for various fuels. At a figure of perhaps $25 per ton of carbon, particularly

Discussion 105

in the context of the power industry, there will be a tremendous eco-nomic motivation for pushing out oil and coal. My question for Mr.Massey is, do you see emissions trading as just another market de-vice? Or is it something more substantial— a vehicle that attacks theguts of some industries —like the coal industry— that enjoy a rela-tively protected position?

MR. MASSEYThe SO2 trading process in the United States has worked fairly well.But I agree with you that it is not neutral with respect to its impacton particular fuels. If we move further in that direction, I think coalwould take a big hit, so policymakers certainly need to recognize thatcould be a consequence.

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SESSION III

«THE ENVIROMENT:CLEAN,CLEANER,CLEANER STILL»


THE HONORABLE MARÍA TERESA ESTEVAN BOLEA

EUROPEAN PARLIAMENT

SESSION CHAIR

The relevance of our session title derives from the fact that environ-mental concerns are having an increasing impact on all aspects of theenergy business —costs, prices, the marketability of products, the competitive position of various fuels, and the future structure ofenergy companies.

As a member of the European Parliament, I am particularly aware ofthis impact. Perhaps 40 percent of all EU legislation deals with theenvironment, and there are more than 320 Community Acts on thebooks. Now we face the prospect of widespread revision of many ofthese laws. There are many reasons for all this environment-focusedactivity. First, despite enormous legislative and financial efforts, envi-ronmental problems are still very much in evidence. Continuing eco-nomic growth worldwide —causing increased energy demand— is another factor. Technological change is an added factor, paradoxi-cally solving some old problems and creating new ones.

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But it is important that we see these environmental problems notonly as responsibilities, but also as opportunities: opportunities forbrilliant research by industry and for creative policymaking by gov-ernments. I am convinced that the oil industry has a splendid future,and Parliament is eager to work with you in creating workable, effective regulations for the new century.

Our distinguished panel of industry representatives will offer the latest thinking on how to meet these pressures and opportunities,and how to make the regulatory process work better for both societyand industry.

• Michel de Fabiani will provide BP Amoco’s perspective on theimpact of these challenges. He will outline his company’s contin-uing proactive policies to deal with the changing regulatory andpolitical environment.

• Stuart Dombey from the pharmaceutical industry knows a greatdeal about what makes for successful proactive participation inthe regulatory and legislative processes. He will offer some guide-lines to energy companies that also face a myriad of regulatorychallenges in multiple jurisdictions.

• Jan Timmerman and Juan Antonio Moral, from the petroleum industry and the automobile industry, respectively, are on thefront lines of environmental regulation. They will tell us how theirindustries are dealing with these challenges.

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«BUSINESS ENVIROMENTALISM»

MR. MICHEL DE FABIANI

BP AMOCO

BP Amoco, looking ahead 50 years, expects an increasing demandfor energy, and we believe that oil and gas will be key in meeting thatdemand well into the twenty-first century. We intend to play a majorrole in supplying those commodities in response to our customers’expanding energy needs. However, we also recognize that the extraction, refining, and use of hydrocarbons have environmentalimpacts. We have, therefore, assumed the dual responsibilities ofmeeting the demand for energy and striving continuously to reducethe environmental impact of our operations.

DEFINING AND DOING THE RIGHT THING

Our company is interested in taking the lead in creating positive andpractical responses to environmental challenges. Passively awaiting government legislation in response to public pressure about environ-mental concerns is not the hallmark of a successful business; it is the

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path to failure. Should this sound sanctimonious, let me stress thatwe also believe environmentalism and good business are closelylinked. Doing “the right thing” because our staff, our customers, andthe communities in which we operate expect it of us, positions us asa responsible corporate citizen in today’s society. Delivering a dis-tinctive business performance that impresses our shareholders re-quires us to be at the forefront of the environmental debate.

In short, we believe business should be competitive, successful, anda force for good. Our company policies, the foundation on which weconduct our business, apply to our more than 90,000 employees,and to 126 largely autonomous business units operating in morethan 100 countries worldwide. They define what our companystrives for and what society can expect from us.

Our people support these policies. Surveys indicated that more than60 percent of our employees regard the most important issue thatdefines the quality of the company they work for is the use of BPAmoco’s skills and knowledge to address the environmentalagenda. This is in line with public attitudes in the United States,where more than 70 percent of the public see business skills andtechnology as the answer to environmental challenges. Unfortu-nately, Europeans generally still believe environmental solutions arefound in regulation and control. BP Amoco hopes to change thisperception.

Our goals for health, safety, and environmental (HSE) performanceare simply “ no accidents, no harm to people, and no damage to theenvironment.” These are commitments to minimize the environ-mental and health impact of our operations by reducing waste,emissions, and discharges, and by using energy efficiently. Specifi-cally, we have promised open consultation and dialogue with publicinterest groups, our customers, employees, and neighbors. We willwork closely on environmental issues with our partners, suppliers,and competitors, as well as regulators. Finally, we will openly andhonestly report our HSE performance —whether we meet, exceed,or fall short of our objectives.

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INITIATIVES AND INVESTMENTS

Recently, BP Amoco held an environmental forum to hear the viewsof a number of nongovernmental organizations (NGOs), amongthem Amnesty International, Oxfam, and Birdlife and Fauna andFlora International. The meeting coincided with the publication ofour first Environmental and Social Report, which demonstrates ourpolicies in action. The report noted, for example, that in 1998 our total air emissions fell 12 percent from 1997 levels, with the largestdecreases in hydrocarbons (HC) and sulfur oxides (SOx) emissions.These reductions resulted from investments in pollution preventionequipment at all our business sites.

Such investments do, however, pose questions as to how a companyresponds to environmental problems. On the one hand is the ratio-nal approach toward environmental spending —allocating funds onlyto those projects clearly identified as cost-effective. On the otherhand is the insistence on investment in “best-available” technol-ogy— regardless of cost or the significance of gains produced. BPAmoco is working to achieve a balance between these two approaches.

In 1998, BP (not including Amoco) had 54 more spills than in 1997,but more than 70 percent of the spilled oil — from vessels, pipes,tanks, ships, or trucks— was recovered. Also on the debit side in1998, BP paid almost $250,000 for breaches of environmental regu-lations, and the combined BP Amoco bill totalled almost $2 million.Needless to say, these are stark reminders of the link between goodenvironmental performance and good financial performance.

To further our goal of “no damage to the environment,” we intendto have the environmental management systems at all our major operating sites around the world certified to the ISOP 14001 international environment management standard. This standard hasnow been met by 30 of our operations; in addition, another 12 haveachieved certification by the European Eco-Management AuditScheme (EMAS).

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CHOICES FOR PROGRESS

In April 1999, Sir John Browne, our group chief executive; receivedthe award for individual environmental leadership sponsored by theUnited Nations Environmental Program (UNEP) and Earth Day NewYork. Sir Browne told the audience at the UN presentation that thenotion that “you can have economic growth and pollution —or youcan have a clean environment, but no growth” was an unacceptabletrade-off for a progressive company. Not only was it politically andpractically unacceptable in the United States and Europe, it wasalso morally unacceptable in the developing world, where peoplelacking decent housing and clean water have the right to have botheconomic growth and a healthy environment.

Our belief is that business can bypass the trap of this apparenttradeoff by transcending this “either/or” philosophy. We can offerpeople better choices for both growth and environmental protec-tion. While BP Amoco does not have all the answers, there areseveral areas where we are offering choices and providing innova-tion and leadership: climate change, emissions trading, and cleanerfuels.

Climate ChangeRarely in our industry has an issue spawned such divergent views asclimate change. Even now, the science of climate change remainsprovisional. However, BP Amoco believes that there is enough evidence to suggest that precautionary actions are prudent. I havealready mentioned our target set in 1998 to reduce carbon dioxide (CO2) emissions by 10 percent by 2010. Perhaps 10 percent doesnot sound impressive at first, but note that without this target, ourCO2 emissions in 2010 were forecast to be 110 million tons, growing from 77 million tons in 1990. By seeking a 10 percent re-duction on the 1990 figure (from 77 million tons to about 70 million tons), we are actually targeting a total reduction of some 40million tons —a 36 percent reduction on what our emissions wouldhave been without the target.

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Emissions TradingOur goal is to bring about meaningful and measurable CO2 emissionsreduction in the most cost-efficient way. The system we devised forour internal use allows those business units that exceed their emissions-reduction targets to “sell” the reductions to another site, therebyhelping that site to meet its goal. Thus our business units are offeredthe choice of financing emissions-reduction projects or buying thereductions from another site. The advantage is that each individualoperating site can find the lowest-cost method of meeting its GHGemissions-reduction goal.

Our pilot trading scheme, involving an initial 12 business units, waslaunched in September 1998. Trades are now being settled at be-tween $17 and $25 a ton of CO2. We are developing the scheme asa real choice, working in partnership with the Environmental DefenseFund (EDF), to extend trading to all 126 business units by June 2000.We are more convinced than ever that emissions trading will be anintegral part of how our businesses can meet their targets. We arenot only eager to share our experience with others, but actively in-vite them to join us.

Cleaner FuelsWe at BP Amoco believe that the oil industry and the automobileindustry share the responsibility of moving people without pollutingthe air. BP Amoco is doing its part by introducing cleaner fuels, initially in 40 cities around the world where the problem is mostacute, to optimize the performance of vehicle technology. We aredoing this now, rather than waiting for legislation to come into force, because we are committed to continuous reduction of CO2 emissionsand because we want to offer the public the option of using fuelsthat are lead-free and low in sulfur. We have just begun the programin the United Kingdom; soon we will launch clean fuels in cities elsewhere in Europe and in the United States.

Another example of our determination to offer choice is in our development of solar power. Today, BP Amoco is one of the world’s

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largest solar companies, having invested $150 million over the pastfive years in capital expenditure and R&D. At present, solar powercan only produce a small fraction of global energy needs; but it is estimated that within 50 years, solar power and other renewablesources of energy could meet half the world’s energy needs.

Finally, I would like to mention our goal to encourage the use of natural gas to provide an alternative choice to coal and the heavyemissions associated with it, particularly in emerging economies. Bylinking available resources to known markets, we can give people achoice by offering both a direct environmental improvement, re-duced CO2 emissions, and security of supply. In June 1999, BPAmoco announced the creation of a global natural gas marketingbusiness, reflecting the growing importance of natural gas in thecompany’s portfolio. Following BP’s merger with Amoco, gas hasrisen from 19 to 35 percent of our company’s production.

HEALTHY ENERGY

I trust that I have made it clear that the initiatives taken by BP Amocoare not driven by shallow public relations or empty rhetoric but arebased on defined and measurable targets, decisive action, leadership,and a commitment deeply rooted in our company culture. Let meconclude by quoting Sir John Browne from his 1998 Elliott Lecture atSt. Anthony’s College (Oxford): “The world needs energy just aspeople need food, but we can help keep the diet healthy.”

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«INGREDIENTS OF A PROACTIVEREGULATORY POLICY»

DR. STUART L. DOMBEY

PARKE-DAVIS

While reflecting on what constitutes a proactive regulatory policy inthe pharmaceutical industry, I became impressed with the similaritiesbetween the energy industry and the pharmaceutical industry. Weare both global in scope, and we are both experiencing consolidationsthrough mergers and acquisitions. We also live in a world of externalpressures where risks and rewards must be reevaluated constantly.And both industries live in a time of scientific and technologicalchange so dynamic that regulators and regulations often cannot keepup with it. In this world of rapid change, we have the obligation toanticipate, and even lead, the regulators, rather than simply follow-ing them. This evolving relationship is what I want to discuss today.

THE IMPORTANCE OF INDUSTRY STRUCTURE

Before a company or an industry can deal successfully with regula-tory bodies, it must be clear about its own goals. We need to knowwhat we are trying to achieve. In response to increasing global scopeand omnipresent regulatory pressures, the pharmaceutical industryhas come to realize the value of structure: structure within one’s own

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company, and structure within the industry. As a company, we findthat the home office is critical for coordinating a common agendaand communicating discussions and conclusions. The real challengeis to reach company consensus —whether working on new legisla-tion or participating in ongoing negotiations. It may seem easy to decide on specific goals, yet with multiple options and committedpeople, accommodation of views within a large company can be difficult. With electronic communication and teleconferencing, how-ever, we have found that it has become easier to communicate among ourselves around the world.

As a global company we have representatives in every country, andwe also have regional offices. Particularly in Europe, Latin America,and Asia, these regional offices develop and capitalize on synergiesand efficiencies among countries. Regions can overlap in their activitiesas well: our Washington office also deals with European affairsthrough the U.S. Departments of Commerce, State, Treasury, andHealth and Human Services, as well as through European embassies.

In addition, we work through trade associations. Examples are thePharmaceutical Research and Manufacturers of America (PhRMA)and the Association of the British Pharmaceutical Industry (ABPI),which are active locally but also have global outreach. There are alsoregional trade associations such as the European Federation of Phar-maceutical Industry Associations (EFPIA) that offer committed supportin Europe. And finally, we work through a global trade association,the International Federation of Pharmaceutical Manufacturer Associa-tions (IFPMA), on global intellectual property protection, and throughthe World Health Association (WHO) on international health issues.

INFLUENCING REGULATION

For the pharmaceutical industry this is not an era of deregulation.Rather, directives and statutes increase in scope and complexity asagencies and legislatures keep adding layer upon layer of new regu-lations. It often appears deceptively easy to simplify legislation, but

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this is not so: the devil is in the details, and working out those detailsrequires an ongoing dialogue between regulators and industry. It ispossible that we know what we do better than the regulators whoare trying to make us do it better. So dialogue between the two enti-ties is crucial for our industry to get good laws and good regulations.

We work to influence legislation and regulation at all levels of gov-ernment. But our primary tasks are to be accessible to legislators andregulators and to keep them informed about industry developments.Our world is very complex and fast changing, so it up to us to provideupdates on all new developments to politicians and their staffs aswell as the staffs of the regulatory agencies.

We need to appreciate the pressures on legislators and regulators.They live in a world that demands rapid response to fast-breakingdevelopments. Because some of our products do lead to unexpectedadverse events and because regulators are under pressure to respondto such situations, we must keep them informed about the adverseand positive effects of our products. There are, of course, legal oblig-ations, but it is also in our interest to update regulators proactively.Protecting the public is a mission we share with regulators. Increas-ingly, we are working to change the emphasis of that mission fromone of keeping products off the market to a broader objective ofbringing innovative products to market as quickly as possible.

Transparency is an important issue that has several dimensions. Webelieve that regulators have an obligation to carry out their work in atransparent manner. The American system is more open than the Eu-ropean system. In Europe, decisions are still made behind closed doors.In the United States, there are public meetings with wide media cov-erage, and information on all decisions is immediately made available.

Another facet of transparency involves the disclosure of sensitive information. Since much of our data concerns individual patients, weare increasingly confronted with the issue of privacy versus freedomof information. We face a serious dilemma in deciding how open ourresearch procedures and results should be and how much information

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should be divulged. The current debate on the European Directive onPrivacy reflects this dilemma.

Pricing is another major issue. In Europe, our primary purchasers aregovernments, and they are sensitive about the rising costs of healthcare. Their pricing decisions often produce serious distortions in themarket, including parallel trade. This has caused the development ofa whole new science of pharmacoeconomics to develop methods tosupport the value of new products.

And, finally, we must take into account the concept of intellectualproperty. We pride ourselves not only on our products but also onthe basic research that enables us to create them. It can take tenyears to get a drug to market, a process requiring a huge expenditureof resources. We expect that regulators will be sensitive in using theresearch information appropriately.

INNOVATIONS FOR GREATER INTERACTION

The regulatory process, while necessary, too often has pitted industryagainst regulators, a scenario that has been to no one’s advantage.However, recent innovations offer hope for improving this relationship.

In EuropeFirst of all, let me mention European harmonization. After decades oftentative moves toward harmonization, the movement began inearnest in the late 1980s. The years from 1987 to 1993 were spentin a sustained effort to generate a single system for regulation in Europe, with extensive discussions taking place among member-states, the European Commission (EC), the pharmaceutical industry,and all other interested parties.

For pharmaceuticals, the effort culminated in a 1993 directive, creatingthe European Medicines Evaluation Agency (EMEA), now housed inLondon, whose activities eventually began in 1995. Even with

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industry, national governments, and the EC all working together, ittook eight years to implement a program. Although valuable, that directive is still not completely effective, because differences about interpretations remain among the member-states. Many countriesprefer a national solution to a European solution.

In 1995, the EMEA was mandated to assess its own effectiveness afterfive years of operation. But now the European pharmaceutical industryhas come forvvard with its own proposal. “Regulation 2000” outlines anew regulatory model and environment for the year 2000 and beyond,and is a good example of industry acting in a proactive manner.

In the United StatesFollowing collaborative efforts among the pharmaceutical industry,government, and regulators, the Prescription Drug User Fee Act(PDUFA) was passed in 1992 to allow user fees from the industry topay for additional reviewers at the Food and Drug Administration(FDA). This act had a sunset provision, but it was renewed in 1997because it was so successful in improving the FDA’s statistics. Thepotential downside is that it may be a future temptation for govern-ment to slash its funding because of the industry’s contribution.

Another cooperative initiative is the Food and Drug AdministrationModernization Act (FDAMA). Passed by Congress in 1997, this actprovides a charter outlining the relationship between the FDA andthe pharmaceutical industry, and has resulted in greater understand-ing of controversial regulatory issues.

International EffortsThe International Conference on Harmonization of Technical Requirements for Registration of Pharmaceuticals for Human Use (ICH)has been another major initiative of the last decade by the pharmaceutical industry working with regulators. In an ongoing ef-fort since 1991, representatives from American, European, andJapanese industries and governments have been working together to


agree on the scientific basis for new product approvals. Previously, be-cause the details of regulations were different from country to country,the standard product testing process had been to perform similar testsseveral times, each involving only minor differences in methodology.

During the early meetings, many of us were skeptical that therewould be any agreement —but, thankfully, we were wrong. Work-ing together, Americans, Europeans, and Japanese have agreed onmore than 30 harmonized codes, a major accomplishment. This now enables a single set of scientific principles to form the basis of globalnew product development. A byproduct of the harmonization negotiations has been that regulators from different countries and industry experts came to know each other as people and were ableto build trust and mutual respect that had been lacking before.

The Transatlantic Business Dialogue (TABD) is not a pharmaceutical or-ganization but a collaboration by businesses on both sides of the Atlanticto reach agreement on regulations regarding many issues —whether itbe taxes, telecommunications, or automobiles. The European and U.S.industries worked together to persuade their governments to simplifyregulatory procedures. One such example was a memorandum of un-derstanding to accept inspections of pharmaceutical facilities by Euro-pean government inspectors in the United States, and vice versa.

This seemed like a small step, but it has proved to be a major hurdle,causing a great deal of anxiety in Washington. Finally, all the partiesagreed to establishment of a three-year transitional period beforeany final decisions are made. Despite the delays, the industry is con-vinced that this has been a small step in the right direction of remov-ing unnecessary regulation.

LEARNING FROM EXPERIENCE

As we look forward to the new era of globalization in our respectiveindustries, and hopefully in regulation, we have much to learn fromour experiences. I would suggest the following conclusions:

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• In response to complexity, regulation is increasing and is likely tokeep increasing.

• Our dealings with regulators should continue to be open: thiswill increase understanding and trust.

• Our relationships with regulators need to be considered in thelong term. We have to work with regulators to influence them.

• Because regulatory change is a slow process, we must be con-stantly vigilant to anticipate and influence proposed changes andto ensure the final result is acceptable to all parties.

• There are opportunities for innovation within the regulatory field.

• We prefer regional and even global regulation to national regu-lation, because it results in more efficient programs for industryand more consistent decisionmaking by governments.


«CLEAN FUELS»

MR. JAN J.F. TIMMERMAN

EUROPIA

As I begin my talk on the important issue of oil and the environment,I remind myself that I am in a very unusual setting: I am simultane-ously speaking to a senior representative of the European Commis-sion, Pablo Benavides, director-general of DG XVII; a member of the European Parliament, Marfa Theresa Estevan; the president of theAssociation of Spanish Automobile Manufacturers (ANFAC), Juan Antonio Moral; and many members of the oil industry, the peoplewho pay my salary. These are all stakeholders with whom I normallyspeak separately on sensitive issues. At the end of this joint meeting,I trust I will still be on speaking terms with all of you.

The question I have been asked to address is how environmental regulation is formulated in Europe. To do this, I will review the regula-tory milieu; I will reference the Auto-Oil Programme to show how theoil industry can affect that process; and I will conclude with reflec-tions on how we can go forward to present our case more effectively.

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OIL, CARS, AND THE ENVIRONMENT

Let me begin with some background on the European oil industry.The European Union countries (EU-15) consume 20 percent of theworld’s oil; on a per capita basis, this is half the amount consumed bythe United States. Oil is still, by far, the principal energy source in Eu-rope, accounting for just over 40 percent of the energy balance —about twice as much as the second largest energy source, natural gas.Oil is a major European export sector; in the EU-15 countries, the in-dustry employs —either directly or indirectly— some two million peo-ple and is a major contributor to Europe’s continued economic growth.

It is not news to any of us that oil is the favorite commodity of everynation’s revenue seekers: energy taxation has been at the top of theagenda of European policymakers for decades. Since 1980, for example, taxes in the EU-15 on gasoline have more than doubled,and taxes on diesel fuel have more than tripled. (My colleagues inBrussels sometimes perceive me as the representative of the world’slargest tax collector.)

THE PUBLIC’S PRIORITIES

In general, we believe that the public —those people who drive carsand buy petrol and pay taxes— want both clean air and good trans-portation. For their own transport, they want efficiency and econ-omy as well as overall vehicle performance and durability. They also,naturally, want the environment to be protected. But that priority isnot at the top of their list. As an example, in an opinion poll takenshortly before the June 1999 European Parliament elections, respon-dents were asked what issues they wanted the newly elected repre-sentatives to focus on. More than half (56 percent) of the respon-dents said their first priority should be reducing unemployment; tiedin second place (33 percent) were reducing poverty and exclusion,and combating insecurity and violence; and tied in third place (16percent) were fighting illegal immigration and fighting corruption.The sixth priority was preserving the environment.

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THE AUTO-OIL PROGRAMME

The oil industry is eager to find ways to both protect the environ-ment and contribute to effective private transportation and mobility—not an easy balance to achieve. In the early 1990s, the oil and automobile industries joined the European Commission in a joint ef-fort to lessen air pollution from vehicular emissions. Their goal was todevelop changes in engine technology and fuel formulation thatwould lessen emissions. Thus the Auto-Oil Programme was created.

The Programme, which began in 1993, had the specific focus ofachieving European air quality targets. It was based on several important principles: it would bring together industry with its techni-cal expertise and governments with their regulatory authority; its activities would be founded on sound and sufficient science; it wouldbe concerned with cost-effectiveness; and it would include provisionsfor ongoing evaluation of its results. The Programme published itsfirst results in 1996. As a tribute to its effectiveness, a new version,Auto-Oil II, is planned for the new century.

The Auto-Oil I Programme has achieved some notable successes.The base case study for the Auto-Oil II Programme shows that theeffect of measures implemented since 1990, up to and includingthose from Auto-Oil I, has been to reduce pollutants such as nitrogenoxides (NOx), particulate matter (PM10), carbon monoxide (CO), hydrocarbons (HC), and benzene by up to 80 percent. Figure 1 illus-trates the reduction of one of these pollutants, NOx.

The Auto-Oil Programme has demonstrated that the oil industry isaware of its social responsibilities and will continue to be an enthusi-astic and positive contributor to such efforts. It was unfortunate thatParliament was unwilling to allow the total Auto-Oil I process to finishbefore setting their new standards in 1998 for 2000 and 2005.

The follow-up Auto-Oil II Programme should confirm that no furthersignificant environmental benefits can be obtained from the transportsector and that off-road measures will be more cost-effective.

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BROADER REGULATORY ISSUES

In May 1999 (in accordance with the Maastricht and AmsterdamTreaties), the European environmental regulatory process entered anew phase when the powers of the European Parliament were increased. All environmental matters must now be jointly approvedby the Council of Ministers and the Parliament.

In creating legislation, we believe that a rational, scientific, and cost-effective approach is the best basis for good legislation. We also believe that regulators should set targets rather than prescribe spe-cific goals, leaving it to the creativity of our industry to develop inno-vations to meet those targets.

As it now stands, the legislative process is not sufficiently transparentand lacks a structured procedure by which technical and economicinformation can reach the proper regulatory authorities.

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Source: EUROPIA, Emissions Base Case Data.

Agriculture Energy Combustion

Industry CombustionNon-Industry Combustion

Other Mobile

Process

Road Transport

Figure 1Reductions NOx Emissions Levels

1990 to 2020

Nitrogen Oxides (NOx)Kilotons (Kt) per year

16,000

14,000

12,000

10,000

8,000

6,000

4,000

2,000

01990 1995 2000 2005 2010 2015 2020

We need to evaluate the economic and social impacts of environ-mental legislation —just as we integrate environmental criteria into energy, agricultural, industrial, and transportation legislation. We facean ongoing debate with those who take more drastic positions —forexample, urging that only the best-available technology should bemandated by legislation— without concern for the larger effects onthe economy or society as a whole. We need to remember that although competition, employment, and the environment are all veryhigh on the public agenda, they are not always easily compatiblewith each other —despite what some may profess.

All legislation should address the concept of subsidiarity, which is animportant principle not only in the Maastricht Treaty but in other European treaties as well. If Scandinavia has a concern over acid rain,for example, why impose emissions legislation in Spain where it is nota problem? If Rome and Athens have problems with motorbikes,why impose legislation on Scandinavia? Local solutions for local circumstances are more appropriate and more cost-effective for society at large.

LOBBYING OUR AGENDA

The oil industry needs to improve its reputation. After just oneyear as an industry representative, I acquired a new perspective onthe agenda of the European oil industry. Whether justified or not, theoil industry’s reputation in Europe is not a positive one. We need tospend more time explaining the oil industry’s role in society and thecontributions we make. In an increasingly value-driven society, reputation means credibility and credibility means influence in theregulatory process.

We need to be involved in Parliament’s legislative processmuch earlier, offering information and suggesting programs.And we must be positive. We can no longer say, “it is too expensive”or “the technology does not exist.” Increased activity by EUROPIA

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will help Parliament to be better informed. We need to actively fol-low the work of Parliamentary committees to learn the concerns ofindividual representatives. The policies of individual member-statesalso play a major role in the legislative process.

We need to become more fluent in the language of politics.Many people in our industry are engineers. We tend to think we havethe right solution, that we know what is best. Technically, in a limitedsense, that may be true, but it also reflects professional arrogance.Politicians have different educational backgrounds and experiences.Too often we talk at each other, rather than to each other. And weshould not be surprised when politicians take political positions: they,too, have their visions of what future is best for society.

We should be proactive on broad social issues. It is no longerenough to limit our discussions to parts per million (ppm) of sulfur; wemust show our interest in social matters such as human rights, biodi-versity, and globalization, which are critical issues to internationalcompanies as well as to non-governmental organizations (NGOs) andsociety at large. We should talk more with NGOs and understandtheir language and concerns. We should become good listeners.

We should dialogue with all the stakeholders on these socialissues. We should affiliate ourselves with groups that perform scientific and economic analysis of the impact of regulatory measures, as is more often done in the United States. And we needto constantly emphasize the impact of legislation on the economy:What good will it be if we make Europe into an impenetrable fortresssurrounded by environmental regulatory barriers, and our productsare unable to compete with those of other countries?

Finally, we must showcase our achievements. Many environ-mentalists dismiss our efforts as nothing more than “business as

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usual.” But as just one example indicates —reduction of sulfur from5000 ppm to 50 ppm— our efforts are much more than business asusual. We should involve the media continuously and not just on theday that we believe we have a message. Today, many oil companiespublish environmental reports, track and report results of health,safety, and environmental (HSE) initiatives, and involve themselves inclimate change and human rights issues. We have always been toomodest.

IN SUMMARY

Motor fuels in their reformulated versions will continue to be the major source of energy for transportation well into the next millennium. This continued dominance reflects several basic attributes of oil products:

• they are cheap to move and store (in terms of infrastructure);

• they are consumed globally;

• they rely on manageable technologies available in the most remote places; and

• they have no real competition or substitute in the transportationsector.

The European oil industry makes an essential contribution to sustain-able growth through the supply of clean and affordable energy by

• acting with care for the environment;

• stimulating technical innovation;

• providing employment; and

• representing a major source of export revenue.

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The oil industry increasingly accomplishes its mission in a transparentprocess of interaction with society at large, consumers, NGOs, polit-ical institutions, and shareholders alike.

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«CLEAN CARS»

MR. JUAN ANTONIO MORAL GONZÁLEZ

FASA-RENAULT, S.A.

Despite having been in use for more than 100 years, the automobilecontinues to be a young product with a promising future. The auto-mobile is an efficient means of transportation, and it responds to ourdesire for freedom and need for mobility in ways public transporta-tion cannot. At the same time, the automobile symbolizes the con-tradictions of progress: it offers unequalled freedom of mobility but itthreatens the environment and livable conditions in our cities. Reconciling these contradictions poses a daunting challenge to theautomobile industry as it seeks to produce vehicles that are useful forthe public and non-threatening to the environment. Today I wouldlike to summarize the industry’s responses to this dual challenge.

GROWING CONCERN AND RESPONSES

The second half of the twentieth century has been notable for aheightened awareness of mankind’s damage to the environment.

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In the 1950s, concerns about air quality, particularly smog, began inindividual areas. By the 1970s, evidence of the harmful effects ofpollutants had become widely obvious, including harmful air qualityin major cities and acid rain in forests. By the 1980s, the influence ofpollutants on perceived changes in climate gave the problem a globalscale.

Emissions from motor vehicles, both from fuels that are burnt andfrom engine technology, are a major factor in these problems. Gaso-line produces pollutants, including sulfur oxides (SOx) and nitrogenoxides (NOx), that affect air locally. The classic internal combustionengine emits carbon dioxide (CO2), thus contributing significantly toglobal warming. In addition, the NOx produced by the high tem-peratures and pressures in the engine’s cylinders cause acid rain. And,combined with oxygen, NOx produce tropospheric ozone, one of thecomponents of smog. There are also fuel by-products that contributeto pollution, such as anhydrous sulfates and traces of motor oil.

It should be noted that although emissions from motor vehicles are amajor factor in environmental problems, they are not the onlysources. The automobile, for example, is responsible for only 50 per-cent of the atmospheric pollution in urban centers; heating, cooking,domestic sprays, and biological gases are also contributors.

The Auto-Oil ProgrammeThis increasingly serious situation has prompted widespread effortsfor improvement. In the 1970s, the European Commission (EC) beganto set standards to curtail emissions, and the European Association ofAutomobile Manufacturers (ACEA) and the European Association ofthe Oil Industry (EUROPIA) began the search for improved enginetechnology and cleaner fuels to reduce emissions. These groupscame together to initiate formal programs for improvement: theAuto-Oil Programme and the European Programme on Engine Tech-nology, Fuels, and Emissions. Their objectives have been to investigateand implement the most effective methods to improve the impactsof highway transportation on the environment.

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As a result, increasingly rigorous standards have been formally set foremissions: in 1993 with the Euro 1 standards, followed by Euro 2 in1996. Euro 3 and Euro 4 will be implemented in 2000 and 2005. Asa result of these efforts, noxious emissions including sulfur, carbonmonoxide (CO), NOx, and “free” hydrocarbons (HC) have declinedsignificantly. By 1996, pollutants had been reduced to one-tenth thelevel of the 1970s, as Table 1 shows, and will diminish even morewith implementation of Euro 3 and Euro 4 standards.

CONTINUING THE SEARCH FOR SOLUTIONS

Environmental problems continue to call for further solutions whichmust focus on both emissions control and fuel efficiency. Althoughthe automobile is responsible for only 22 percent of the CO2 emittedin the atmosphere by human activities, the ACEA made a commitmentto the EC to reduce CO2 emissions by the year 2008 to 140 grams perkilometer driven (g/km), a 25 percent reduction from the current level.

To meet this pledge, the automobile industry is considering a num-ber of possible solutions. Let me mention five: (i) improved internalcombustion engines; (ii) exhaust emissions treatment; (iii) cleaner fuels;(iv) alternative fuels; and (v) zero-emission vehicles.

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Table 1Evolution of Fuel Emission Limits, EU-15

in grams per kilometer driven (g/km)Euro 0 through Euro 4

Euro 0:1970s 1980s

Euro 1:1993

Euro 2:1996

Euro 32000

Euro 4:2005

CO 23.35 14.24 4.07 3.29 2.30 1.00

NOx + HC 9.88 3.36 1.12 0.58 0.35 0.18

NOx - - - - 0.15 0.08

HC - - - - 0.20 0.10

Source: Fasa-Renault, S.A.

Improving Internal Combustion EnginesBecause of ignition requirements, traditional internal combustion engines use a mixture of fuel and air richer than what is strictly nec-essary. Consequently, the thermal output is not optimal, producingresidual CO and HC which must be oxidated to CO2 and water in acatalytic converter. It also produces NOx, which must be reduced tomolecular nitrogen.

To meet the emission limits for Euro 2 in 1996 and Euro 3 in 2000,the three-way catalytic converter (TWC) was developed. The TWCrequires a rich (stoichiometric) mix (14.7:1) to balance the reaction ofthe NOx reduction with the oxidation of unburnt HC and CO.

A poorer fuel mix that is rich in air would allow the burning of all thefuel, thus improving performance; however, not only would it be dif-ficult to achieve ignition, but more NOx would be produced, whichwould have to be treated under very difficult conditions, for whichthe TWC does not work.

To employ a poor fuel mix efficiently, direct fuel injection engines arebeing developed for both diesel and gas use. The key to the solution isfuel injection: introducing into the cylinders a jet of poor (but stratified)fuel mixture —one having richer layers of fuel next to the ignition zone.

The new direct fuel injection engines will allow us to achieve the ob-jective of emissions of 140 g/km. To achieve further reductions willrequire a drastically lower vehicle weight. Although very lightweightmaterials do exist, they are used only in the aerospace industry andwould be prohibitively expensive for routine automobile manufacture.

Treatment of Exhaust EmissionsThe current TWC is adequate for meeting the Euro 3 norm, as long asthe engines do not use a poor mix. In these engines —with a poor fuelmix and direct fuel injection— the excess of NOx and CO2 and the rel-atively low temperatures make the reduction very difficult. To resolve thisproblem, two different strategies are being developed for gas engines.

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The first is the NOx catalytic converters or lean nitrogen catalyzers(LNC). These reduce NOx in the presence of excess oxygen due topartially recycled hydrocarbons from the exhaust. The second strat-egy consists of using “NOx traps”: the NOx are caught in a poor environment in order to reduce them in cycles of a rich mix and hightemperatures which occur periodically. For diesel engines, in additionto the NOx convertors, systems of “non-thermal plasma” and trapsfor particulate filters are being developed.

Cleaner FuelsHowever, the new catalytic converters have problems dealing withSO2. Thus, the Auto-Oil Programme is considering further refinementsin fuel formulation to allow even less sulfur and other pollutants andto utilize the converter to reduce fuel consumption.

Further, the American, European, and Japanese associations of automobile manufacturers have proposed a World-Wide FuelCharter that would standardize three levels of fuels. The first levelis for fuel with requirements for engine performance only. The sec-ond level, which meets the standards of Euro 1 and Euro 2, addsimportant sulfur reductions and some olefin reductions. The thirdlevel, meeting the Euro 3 and Euro 4 norms, includes direct injec-tion and poor mixture engines to meet the requirements of 30 ppmfor sulfur.

Use of Alternative FuelsAlternative fuels include liquified natural gas (LNG), liquified petro-leum gas (LPG), biofuels (methanol, ethanol, and biodiesel), and hydrogen. Car manufacturers are prepared to produce vehiclesadapted to these fuels —with the exception of hydrogen, because of the storage difficulties it entails. But there are drawbacks or uncertainties connected with each.

LNG and LPG offer some reduction in pollution but only slight reduction in consumption. LNG offers limited range and also requires

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costly deposits due to the high pressure necessary. LPG needs lowerstorage pressure, but it requires a costly service infrastructure.

Among the biofuels, methanol is a relatively clean fuel but is unsuit-able for cold climates, is hard on engines, and is 50 percent more ex-pensive than gasoline. Ethanol is a viable fuel used in some countries(e.g., Brazil) in a 10 percent mix with gasoline. It has fewer problemsthan pure methanol, but it is very expensive. Biodiesel (gas-oil pro-duced from vegetable oils) is very low in sulfur and aromatics, but itis not competitive when crude oil is less than $30 a barrel.

Hydrogen poses enormous storage problems, is expensive to pro-duce, does not reduce CO2 emissions, and does not avoid formationof NOx.

From a practical standpoint, all these fuels present economic, tax, andinfrastructure problems. For the next ten years, alternative fuels willprobably not exceed 5 percent of consumption in the OECD countries.

Zero -Emission VehiclesZero-emission vehicles include electric vehicles, hybrid vehicles, andfuel-cell vehicles. Although these vehicles resolve the problems of lo-cal pollution, they do not resolve the CO2 emission problem at theglobal level, because their energy is usually produced in electric generation plants and through hydrogen generation.

Pure electric vehicles are efficient in their traction but not in their en-ergy storage. Their range and recharge time are unacceptable fornormal consumer use. Important prototypes of batteries are beingdesigned, but no definitive solutions have been reached.

Hybrid vehicles, dual-powered by combustion and electricity, can runin the combustion mode in unprohibited zones, with an unlimitedrange; then the batteries can be recharged to switch to the electricmode in prohibited urban center zones. These vehicles are currentlyavailable for consumer use, but their price is not competitive.

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In the long run, the fuel cell for the battery-powered vehicle appearsto offer the best solution. The technology offers a direct hydrogenreaction with oxygen from the air, producing water and electric en-ergy without passing through the thermal energy phase. However,hydrogen poses formidable storage and generation problems, andthe current prototype is expensive and heavy. Nevertheless, the in-dustry is betting on fuel cells as the long-term solution.

CONCLUSION

The fight for clean air continues. The work of several decades hasresulted in decreased pollution in large European cities, and we expect further improvements. This allows us to be guardedly opti-mistic about the future.

Drawing on this experience, we can establish priorities for reducingboth local and global pollution caused by the automobile. These priorities will best be met by coordinated efforts among govern-ments, regulators, and the industries involved.

• Renewing auto fleets. This is the quickest and most efficientstep. More than one-third of vehicles on the road are over tenyears old, and 20 percent of these vehicles cause 80 percent ofthe pollution. Moreover, they are not subject to the new stan-dards.

• Utilizing direct fuel injection gas and diesel engines. Developingnew fuels and new catalytic converters to meet the Euro 3 andEuro 4 norms.

• Fueling city buses, corporate fleets, and taxis with LPG and LNG.

• Encouraging the use of biofuels mixed with other fuels.

• Offering incentives for using zero-emission vehicles in corporatefleets.

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DISCUSSION

QUESTIONIn a 1998 poll conducted in the United States, people were asked toname the companies they most respected. Those at the top were Microsoft, IBM, General Motors, AT&T, Ford, Wal-Mart, GeneralElectric, Coca-Cola, Intel, and Boeing. You will notice there was nomention of an oil or gas company or electricity utility in the topgroup. Why not? Possibly because people still equate oil companieswith pollution. If that is so, we have a great deal of work to do: wemust put an updated picture of our industry before the public. Wecan no longer rank scientific and technical progress higher than theprotection of the environment. Nor should we perceive environmen-tal activities as constraints or additional costs.

MR. TIMMERMANI agree. Yesterday, one speaker commented that in the 1960s big oilcompanies obtained what they wanted “by hook and by crook.”

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That language, and expressions like the “Seven Sisters” or the“Three Witches,” speak volumes about how the oil industry is stillperceived. So I agree that the reputation of our industry is a problem.But how can we solve it? Some companies believe it is futile to spendtime and money trying to improve our reputation, while others be-lieve such efforts are essential. I agree with the latter. We need toimprove the image of our industry.

Communication is the answer. We must be prepared to engage inthe wider societal debates —on topics like environmental issues andhuman rights— not as some kind of public relations gimmick but outof genuine concern, even if we remain divided on the timing of suchactions. I think Michel de Fabiani’s description of work by one of theworld’s largest oil groups (BP Amoco) is certainly a good example ofthe benefits which can accrue to such a policy.

QUESTIONOne aspect of environmental protection is a growing concern to oil-producing countries: ever higher taxes. As a result of pressures to decrease consumption, energy taxes in the consuming countrieshave been pushed to exorbitant levels, ranging as high as 60 to 80percent of the end user price. Such taxes certainly benefit consumergovernments, but they do not benefit either end users or the oil pro-ducers. Are energy taxes being used to fund the protection of theenvironment, or to reduce the budget deficits of the consumingcountries?

MR. DE FABIANIWe all have heard the saying that there is still “a little bit of gasolinein one liter of tax.” And we all know that the tax on oil products inEurope is prohibitively high. However, we live where we live. Whatwe can do is make adjustments over the long term, by improving ourimage and thus gaining fairer taxation. The best way to correct anegative image is to broadcast the many specific actions we are tak-ing, step by step, to protect the environment.

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MR. BENAVIDESI have several comments on the pollution issue; the first deals with alternative mechanisms for control. Of the possible mechanismslisted in the Kyoto Protocol, tradeable permits for emissions areamong the most widely discussed and also among the most difficultto implement. I seriously doubt that they can be implemented before, say, 2005. But we have not heard much about other mecha-nisms which could be used more easily: the joint implementation (JI)mechanism, for example, or the clean development mechanism(CDM). Obviously these necessitate a huge involvement by energycompanies, in terms of technology transfers and so on. Would youcomment on the possibility of JIs and CDMs being used in the nearfuture? And we have not heard much about “sinks.” Is it really possible to rely on sinks, specifically reforestation, as a method of decreasing carbon emissions?

My second comment is on the car as a source of pollution. Over thenext 15 to 20 years, CO2 emissions are expected to grow at a vertigi-nous rate. It is true that CO2 emissions from the transport sector cur-rently do not represent more than 25 percent of total emissions. How-ever, all the studies we have done in DG XVII show that it will soon bepossible to reduce a large percentage of stationary emissions. So ourworry is about the future when emissions from the transportationsector will become the principal source of these growing pollutants.

Third, the role of alternative fuels. Mr. Moral suggested that alterna-tive fuels such as biofuels might constitute 5 percent of the OECDgas consumption in the next few years. I am skeptical about this. Ourinformation indicates that the use of biofuels is decreasing and thatbiofuel plants may close entirely. This precariousness is due, ofcourse, to their non-competitive pricing.

My final comment is that we in the DG XVII feel the lack of an on-going dialogue among the Directorate, the automobile sector, andthe fuel sector. Currently we have individual dialogues with each sec-tor, but what we need is a conversation —a “trialogue”— amongEUROPIA, ACEA, and the EC.

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MR. DE FABIANIWe concur in principle on using alternative mechanisms for emissionscontrol. Tradeable permits are one mechanism; JIs and CDMs areothers. However, what one company alone can do is very differentfrom what can be implemented within the larger scope of a general-ized program. You also mentioned reforestation. BP Amoco has aprogram in Turkey where we sponsor and support reforestation, butreforestation is probably an option only on a case-by-case basis. Andyou asked about biofuels. We welcome any fuel that can contributeto a clean environment on a fair economic basis, but I am not surethat biofuels fit in this category.

MR. TIMMERMANWhen we talk about renewables, we need to identify our real goals.Are we principally concerned with increasing the use of renewablesto aid in preserving the supply of conventional fuels —or to aid in de-creasing emissions? As one of our speakers noted, the Coal Age didnot end because we ran out of coal. And we do not believe the OilAge will end because we will run out of oil. According to the latestforecasts, there will be enough oil for the next 40 years or so, at thepresent development rate.

So if we do not need to encourage renewable energy, since oil is notrunning out, why make all these investments and spend taxpayers´money for development of renewables? If, on the other hand,the principal goal is the reduction of emissions, that is a very different matter. If that is our target, then a great deal can be doneto develop cleaner fuels, with the added benefit of prolonging the internal combustion engine.

Turning to taxes, government officials often justify increased energytaxation as a means of reducing pollution by reducing consumption.However, the data show that while taxes on automotive fuels in Europe have more than doubled over the last 20 years, oil consumptionhas increased at an annual rate of 1.3 percent. Higher taxes have notresulted in lower consumption.

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MR. MORALThe automobile industry is working to develop vehicles that can operate on any of these alternative fuels except hydrogen. As I notedearlier, such vehicles do exist, but the fuels present many difficulties.Methanol is a clean fuel, but it cannot be used in central and north-ern Europe because it has a problem igniting in cold weather.Ethanol’s energy level is closer to that of gasoline, but its principaldrawback is its serious adverse effects on the vehicle’s motor. Andthe problem with biodiesel derives not from the automobile industrybut from the fiscal and agricultural policies of individual nations.Would biofuels be considered seriously if government subsidies andresources were not available?

QUESTIONThere is no one magic bullet to solve environmental problems. Everyalternative solution comes with its own drawbacks. In all complexenvironmental problems, and certainly climate change, we shouldconsider solutions from every available sector instead of placing the fullresponsibility onto any one sector. We all have contributions to make.

One such solution may be solar energy. When we speak of zero-emis-sion vehicles, it is important to remember that even though the carsthemselves will produce no emissions, the fuel they use (electricity)has been generated elsewhere, and this traditional generationprocess produces CO2 emissions. However, using solar energy in thegeneration of electricity could contribute to reducing emissions.

MR. MORALI think the use of solar energy for vehicles is not technologically fea-sible at the present time. The power generated per square meter sim-ply does not permit this technology to be used in an ordinary car.

Even with a time horizon of ten years, we do not see a solution to thestorage problem that would produce the mobility required by mostmotorists. At the present time, a set of solar batteries for a private car

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provides a maximum distance of 120 to 150 km (75 to 94 miles) and re-quires six hours of recharging time. Even when energy generation by so-lar panels arrives on the scene —and this is just a matter of time— we donot foresee technical advances that will offer adequate mobility. But thisis not the case for delivery fleets or other urban vehicles that travel lim-ited distances and have access to technical assistance and recharge zones.

QUESTIONThe EC directives affecting the automobile and oil sectors were approved in 1998 and will be modified after joint discussions by theEC and the Parliament before the end of 1999. Do you worry thatthe final legislation will pass without adequate discussion?

MRS. ESTEVANThere may well be preliminary negotiations among the EC, the General Directorates (of Energy, Investigation, Industry, and the Environment), and the Parliament. I agree strongly that both EUROPIA and ACEA should be present at these sessions. But I emphasize that almost all the current directives will be modified dur-ing the next few years: there will be a great deal of new —and morestringent— legislation. The current environmental regulations are notbeing met, so we must be tougher.

MR. TIMMERMANThe oil industry is prepared and eager to cooperate with the EC, theParliament, and the automobile industry. We strongly believe that acooperative effort will lead to the best technical solutions, at thelowest cost to society.

MR. MORALI am quite sure also that the automobile industry would be eager tojoin the Parliament, the EC, and our friends in the oil industry toframe this new round of legislation.

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PROF. HOGANMy question is for Mr. de Fabiani. One interpretation of the approach that BP Amoco is taking is that it produces better products,lower costs, and a happier workforce, which is beneficial for thecompany, versus other kinds of direct benefits that profit the com-pany. If that is what you were saying, it seems to me that there is aninherent contradiction in the fact that the internal trading permitprice has a positive price, at the moment, as opposed to zero.

Another interpretation is that you see an important role for govern-ment and regulation, because in the long run most companies willnot take action unless coerced or mandated to do so. I think therewill be need for regulation to make companies act responsibly. Al-though it is not inherently profitable, it may be wise for a companyto invest in advance of the regulatory and legislative process in orderto get a headstart on what you see coming down the road, or toshape future regulation. Could you comment?

MR. DE FABIANIWe need to make a profit and deliver dividends and added value toour shareholders, but we have other objectives as well. Trading permits have a price; there is no market when the price of anythingis zero. Every commodity in every market fluctuates, and so will thevalue of trading permits. This is a pilot program: I have no idea whatnext year’s price will be of CO2 trading permits within our company.But we want to give the program a fighting chance to succeed.

On regulation, let me emphasize the value of having regulatorsformulate ambitious targets with specific dates. Visible deadlines allow the industry (which has always been a long-term industry) toanticipate and plan accordingly, to meet or exceed these targets. Inthe final analysis, regulations directed toward targets are useful fordefining what the public wants from its regulators. Nonetheless,these targets should allow flexibility for the industry to decide whatmeans it will use to meet them. We must also have the choice as towhether we enact changes close to the deadline or proactively,

Discussion 145

depending on an individual company’s structural basis. We cannotreinvent or relocate our companies.

MR. SULTANI would like to add two brief comments. I recall an economist at our1997 Seminar making a pithy comment about energy taxes: “Taxesdo not clean the air; they clean the pocket.” He cited the experiencein United States, which has both lower energy taxes and lower emis-sions than Europe.

My second comment is about the public’s perception of the oil industry. A colleague of mine, a director at one of the super-majors,recently attended his son’s graduation from Cambridge University.Afterwards, at a graduation party that was expected to be a pleasantsocial occasion, he ended up having to defend the reputation of theoil industry for hours. His son’s friends categorically declared thatthey would never work for the oil industry!

Yet our communication problem is not one of the oil industry versusthe environment or the oil industry versus the community. We arepart and parcel of the community. Wherever you live or work ortravel, oil and related industries —pharmaceuticals and chemicals—are among the major employers, whether in small towns or majorcities. We are the community, so we have inherent respect for theenvironment.

MR. TIMMERMANIn reference to the growth of government regulation, I would like topoint out a disconnection between governments and the public.Governments appear to have a strong urge, even a compulsion, todwell on environmental issues, but the public has a more balancedset of concerns, among which the environment is only one of many.Perhaps the governmental urge for creating rules and regulations isexacerbated by the structure of European politics and by the ongoingneed of politicians for headlines. In such a milieu they find it tempting

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to focus on the environment and on the related issue of energy tax-ation. And yet polls throughout Europe show that concern about theenvironment is not high on the public agenda.

QUESTIONGasoline seems to be included in the same group as tobacco and alcohol: it is taxed for punitive or moral reasons. Once gasoline taxeswere justified as a means to decrease consumption and aid securityof supply. Now the justification is the environment.

My question is for Mrs. Estevan. When will governments becomesensitive to consumers’ needs, pay less attention to treasury depart-ments, and push for a reduction in these taxes?

MRS. ESTEVANYou should not expect energy taxes to decrease —they will not.Europe has a very important social welfare system, and we are notgoing to abandon it. With a large aging population, requiringenormous costs in pensions and related expenses, where can themoney come from? From a splendid product, with a rigid demandcurve, which the average consumer does not want to do without:gasoline.

You do not have to worry about prices; the consumers will pay whatis asked if they can receive dependable supplies of energy, goodelectrical service, and enough pure water. However, we should notforget that in the European Union, people worry first about employ-ment and economic issues. Environmental issues are tacked onto thisbasic concern.

In closing, let me repeat my earlier comment. Oil contributes greatlyto the quality of life; that is the message you should give to the public. The energy industry plays a vital role in society, and I expectthis role to increase in the next century. Your future promises to be brilliant.

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CLOSING SESSION

SUMMARY AND COMMENT

DR. IRWIN M. STELZER

HUDSON INSTITUTE

Mr. Cortina opened this year’s Seminar by reminding us that ourRepsol-Harvard Seminars have always had “ambitious goals.” And sothey have. We have dared to look into the future, not only to predictwhat might occur in the various industries in which we are all inter-ested, but also to determine how we might devise policies to affectthe future. In that sense we have been very much like our host:Repsol, too, has shaped a future very different from the one that existed when Harvard and Repsol first came together more than adecade ago to launch this seminar series.

As the Seminars have grown each year —despite our efforts to keepthem to a manageable size— and have become more important, so,too has our host. As the issues we confront become more compli-cated, so too does the world in which Repsol operates. As the inter-national reach of these Seminars has expanded, so, too, has theglobal reach of Repsol. I cannot help believing that the similaritiesbetween the development of Repsol and the development of theseconferences is more than mere coincidence. Rather I think these

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similarities are the result of the intense intellectual exchange betweenthe Harvard organizers and the Repsol sponsors, of the marvelousfriendships that have grown up among the participants, and of thedeeper understanding of Spain’s history and culture that Repsol hasencouraged. For all this, we thank Alfonso Cortina and his staff.

This Tenth Seminar (in our series of what Bill Hogan called “an on-going conversation”) is perhaps more difficult to summarize than anyof the previous ones. This is the case because we have treated sub-jects of extraordinary complexity, producing more contradictions,than did any of our previous gatherings.

THE MAGIC OF THE MARKETPLACE

The first of these contradictions deals with the roles to be accordedto markets and to regulation. Bill Hogan began with the cheeringthought that over the course of the Seminars we have moved fromdiscussing government actions to discussing market forces, from asking ourselves what governments can do for the energy industry toasking how we might formulate rules so that markets can work theirmagic for us. That formulation appealed sufficiently to Robert Hefnerto have him, too, talk of the “natural magic of the marketplace.”

Other participants eagerly signed on, either directly or by implication,to the proposition that free, competitive markets are far superior toregulation in producing efficiency and in maximizing consumerwelfare. Pablo Benavides spoke glowingly of the liberalization of theEuropean Union’s gas and electricity markets, and looked forwardto the day when the EU would have one single, linked, liberalizedmarket —perhaps even including France.

Roger Sant joined the ranks of those extolling the virtues of liberal-ization and privatization by pointing to the consequences of thosedevelopments. Combined with technology and low gas prices, liberalization and privatization have driven electricity prices down, insome places by 50 percent, and have made gas cheaper and electricity

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cleaner. Bill Massey also joined in the pro-competition choir, andwith good reason. He pointed out that his agency, the U.S. FederalEnergy Regulatory Commission, has helped introduce what he called“vibrant competition” in both natural gas and electric markets by ad-hering to a list of core principles, the first item being that “commod-ity markets are best regulated by the forces of competition.”

Those of us who are always looking for ways to put regulators out ofbusiness —a God-given task that one has to assume through life—might consider the suggestion made by a former regulator whoseems intent on living down her questionable past by returning tothe real world. She suggested that we might follow a procedure thatwas used when deregulating gas storage facilities on which BritishGas held a monopoly. As I understand it, the U.K. regulators set theterms by which British Gas was required to auction off capacity, andthen they departed the scene, leaving it to the auction process to setprices. Whether that procedure is applicable to other monopoly facil-ities, I do not know. But it is something we ought to consider as away of reducing the burden of regulation.

LIBERALIZATION —YET MORE REGULATION

All this is enough to warm an economist’s heart. And yet, with all thistalk of competition, there was also much talk about the need for reg-ulation, indeed, for more regulation than ever. Bill Massey, conceal-ing a sigh of relief, said there will always be a role for regulators.Among other things, he wants to regulate international markets —not having enough to do at home— and feels that there are sufficientmonopoly elements in the wires and pipeline businesses to requirecontinued regulation.

I am inclined to agree with that latter assertion, but I am also inclinedto be skeptical of his response to the question as to whether regula-tors will know when to go away: “Will you recognize when distrib-uted energy is providing sufficient competition for you to let go?” BillMassey said he thought that they would, but I am a bit skeptical. A

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wonderful little book by Alfred Kahn, Letting Go, describes how difficult it is for regulators to do just that. I worry that if the timecomes when distributed energy is a real force, and if the utilities findthemselves with stranded assets in the wires business, the regulatorswill once again step in and decide that consumers should bear thecost of managerial mistakes and reimburse the companies for thosenewly stranded costs.

It is not only monopoly facilities that would seem to require moreregulation. According to María Theresa Estevan, a member of theEuropean Parliament from Spain’s conservative Partido Popular, gov-ernment has the responsibility to see that consumers get secure,high-quality supplies of energy, suggesting that this task cannot beleft to market forces alone. Antonio Brufau worried that competitionmight interfere with the development of the gas business. And PabloBenavides, who is director-general for energy in the European Com-mission, went further. He told us that regulation will not decrease;rather, it will increase because “liberalization requires more regula-tion than a monopoly market.” When a man who is justly proud ofhis role in liberalizing markets warns us that liberalization meansmore regulation, it behooves us to listen. Regulation is not going togo away.

Finally, my colleague Bill Hogan spoke glowingly of the magic thatmarkets can produce. That was on Friday morning. By Friday after-noon, he was questioning just how we could avoid democratic pro-cedures in restructuring markets. I should say at the outset that BillHogan has every right to want to avoid the intrusion of others intohis restructuring schemes —events have proved him right and hiscritics wrong. But still, his proposition has to give us pause. Bill wantsmarkets to work (possibly under the direction of some wise centraldispatcher, perhaps Jan Moen), but only after “a small group of peopletakes it upon itself to set up something that is in the public interest.”

That is a terrifying statement to those of us who know a little Euro-pean history! The elite group would be advised, of course, by com-petent technical people, which probably makes the prospect a

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bit worse. Interested parties like stakeholders need not apply to beheard in this process. This is an arrogation of power that even FederalReserve Board Chairman Alan Greenspan would not dare attempt.That does not mean it is wrong, but it does suggest that it will bewise men, not free markets, that restructure the electric industry inthe world in which Bill would have us live.

“STABILIZING” OIL PRICES

All these proposals for regulation, if adopted, would merely slow theunstoppable march toward competitive electricity and gas markets.These are trivial impediments compared with the proposals we heardabout oil prices and the need to impose what is called stability on themarket for crude oil, a subject that was raised by our first panel.

When discussing the oil business, we generally agree that certainfacts cannot be ignored. First, words do not always mean what theyseem. For example, several panelists spoke of the need to “stabilize”oil prices. By that, they mean they want to raise prices, from $10 abarrel to $18 a barrel. So spell “stabilize” as “ra-i-s-e” when youhear that people want to stabilize oil prices.

Second, technology has driven down the cost of finding, developing,and producing crude oil. Nader Sultan pointed out that the oil indus-try is the world’s largest consumer of information technology, and heestimated that the cost of finding, developing, and producing oil fromthe next field capable of producing half a billion barrels a day is onthe order of $2 a barrel. That is a stunning number to keep in mind.

Third, we may be on the verge of developments that will bring dis-covery of massive, new, low-cost reserves. Bijan Mossavar-Rahmaniagreed with Nader Sultan’s $2 a barrel cost estimate and said that thePersian Gulf nations are groping for ways of once again permittingthe major oil companies to participate in the development of their re-sources. The five countries in the Persian Gulf (Saudi Arabia, Iran,Iraq, Kuwait, and the United Arab Emirates) hold over two-thirds of

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the world’s proven oil reserves. Allowed to play in that area afteryears of exclusion, the majors or the super-majors will inject capitaland technical know-how into a region that needs both. This will increase its importance as an oil supply area, and will take us, asBijan Mossavar-Rahmani said, “back to the future again.”

These developments in the Persian Gulf will raise questions for con-suming nations about security of supply. It will also force us to con-sider that issue once again at some future Seminar, after years ofcomplacency brought on by low prices and a world awash in crudeoil. Bill Hogan may have to dust off some of his old energy securitymodels, sooner rather than later.

Fourth, we have witnessed a substantial secular decline in the realprice of oil. As Alfonso Cortina pointed out, in 1998 oil prices fellcontinuously from more than $16 a barrel to around $10, causing amassive transfer of wealth from producing nations to consuming na-tions. This transfer was, in part, responsible for the continuation ofAmerica’s long-running economic growth, since lower oil prices arethe equivalent of a tax cut to American consumers. And it was a crucial factor in allowing America to be the consumer of last resortduring the Russian, Asian, and Brazilian crises.

All of these facts are indisputable. But we heard little applause fromthe oil producers present at this Seminar for the market forces thatcreated these low oil prices and these benefits to consumers. Instead,we heard a discussion of plans to “rationalize” the oil markets, tostabilize prices. We heard pleas for an end to confrontation and for anew era of cooperation between OPEC members and non-members,and between producers and consumers. Bijan Mossavar-Rahmanithought that something must be done to stabiIize —and he used theword in the correct sense— oil prices to provide sufficient assuranceto companies contemplating long-term investments, which he be-lieves futures markets are incapable of providing.

Even Luis TéIlez found that his responsibility for the well-being of hisnation’s citizens overrides the economics he learned at MIT and this

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led him to broker the oil cartel’s price-raising production cutbacks.The enthusiasm for free-floating oil prices is not universal.

In short, this tenth session of our seminar series reflected conflictingviews: sincere talk of the magic produced by markets versus equally sin-cere arguments that the invisible hand of the market must, at times, bereplaced by the long arm of government regulators or private cartelists.

THE OIL INDUSTRY: PRESSURES AND PROSPECTS

Our tenth gathering also produced another set of contradictorytrends. What is the future of the oil industry? Nader Sultan, not aman given to easy exaggeration, feared that oil might not play a ma-jor role in the next century and that substitutes might be developed,even for automotive use. Others worried that the agreementsreached in Kyoto mark the beginning of an assault on the use of allfossil fuels, including oil. But those views were far from unanimous.Dr. Traynor felt that the oil industry has emerged from the latest pe-riod of low prices stronger than ever. Mrs. Estevan believes that oilhas a spectacular future, because as the developing world becomesricher, its inhabitants will want millions of cars and energy-consumingappliances. This will come as good news to the two million peoplethat Jan Timmerman told us are employed in Europe’s industry.

There can be no doubt that the oil industry will find itself under siegefrom regulators, from environmentalists, from tax-prone politicians,and, in some markets, from fuel substitutes. I do not think an industryof this size will suddenly disappear; but there are enough exampIesof industries that have disappeared to give us pause.

The fact is that we have not integrated all the information that wenow have about the role of natural gas, about the impact of responsesto the possibility of global warming, about the budgetary problems ofproducing nations, about the role of OPEC. We have not put all thesetogether into a systematic look at where the oil industry might be go-ing. And that is something we might want to consider for the future.

Summary and Comment

EMERGENCE OF THE SUPER-MAJORS

We do know at least one thing: the industry that will exist when weconvene our Twentieth Seminar will be as different from the one thatexists now, as the industry is today from that of ten years ago.Among other changes, it will be home to much larger companies.Bijan Mossavar-Rahmani pointed out that big oil has become enor-mous oil. And Dr. Traynor noted that the three largest companieshave a market capitalization of $600 billion, which is more than therest of the industry combined. These are very big companies.

But Bijan, who in earlier years extolled the role of swift, flexible, in-dependent companies, apparently has come around to the view thatsize is necessary, at least for those companies that want to deal withhost governments of producing nations. Those governments believethat larger companies have better technology, longer-term horizons,and greater political clout in their own home countries. This explainsthe attraction of having American companies along the border withIraq. If their assets are threatened by Iraq, these companies will bringpressure on the U.S. government to protect them and, not inciden-tally, the countries themselves.

On this score, we received a warning from one participant who urgedus not to overdo the role of political muscle. But he neverthelessagreed that size will be a crucial component in the years to come be-cause we are moving into a world “where the large players may notbe large enough to exercise all of the options available to them.”Commercial life is no different from private life in this particular. Itconsists of choosing among alternative options, weighing the oppor-tunity costs associated with each choice. Bigger companies apparentlyhave wider choices, but inevitably these choices will not be unlimited.

THE IMPORTANT SECOND TIER

Although our Seminar participants agreed that size will matter, therewas no clear agreement on just how big is big enough to survive and

156 Closing Session156

prosper. The largest three companies have continued cost-cuttin-campaigns that they began before their mergers (not unlike thebanking, auto, and other industries). But J.J. Traynor says that thosecost-cutting campaigns are running out of steam. I do not know ifthat is true, nor do I think the companies know either.

It is fair to conclude that there will be enough room in the oil indus-try of the future for “Enormous Oil” (as Bijan calls it), for smaller butvery substantial integrated global companies, such as Repsol, and forindependents, although I do not think we have sufficiently exploredthe survival prospects of the independents to reach more than an in-tuitive conclusion about their prospects. For the moment, I will relyon the judgment of José Luis Díaz Fernández, who told us in 1998that different companies are taking different paths: some are con-centrating on specialization, others on diversification —expandingtheir product lines and the geographic scope of their operations. Butwhatever their paths, there will be no room for companies that, weare told, “do not keep their word to shareholders.”

A NEW OPEC FOR A NEW CENTURY?

Whether there is also room for OPEC in the oil industry of the futureis a more difficult question. Dr. TélIez believed there is room forOPEC. He prided himself on what he called the “aggressive diplo-macy that he used in reawakening both OPEC and non-OPEC pro-ducers to the need to curtail output to force prices up. Nader Sultanreminded us that the cartel has survived for 40 years, has kept some40 mbd of capacity off the market, and has forged a new relation-ship with non-members. Nevertheless, he believed that OPEC mustchange if it is to be an effective force in the twenty-first century.

Success for OPEC would, he argued, consist of keeping prices highenough to provide producing nations with sufficient revenues for thesocial services demanded by their populations. And he fixed thatnumber at about $15 a barrel (in 1999 dollars). At the same time,these nations must not become so comfortable as to ignore the

157Summary and Comment

longer-term problems presented by their undiversified economies.This is a difficult balancing act. He was reasonably optimistic thatOPEC will be able to achieve this so-called balance, which is very badnews for consumers. I think his phrase was, “having put out the fire,OPEC can now plan for the future,” the “fire” being the $10 oil pricesthat existed in early 1999.

Another participant noted that the OPEC future must include plansto cope with four issues: the threat of fuel substitution; technologicalchange; environmental issues; and the role of futures markets in oilpricing. In reviewing past volumes of Seminar Proceedings, I foundthat we first considered the role of futures trading in oil prices atToledo in 1989. Perhaps we should take another look at that topic.

NATURAL GAS: THE EMERGING CONSENSUS

I am not sure we have to give more thought to the natural gas in-dustry. We have given much consideration to that industry in theseSeminars, and the fact that agreement is so broad makes me wonderwhether there are any questions that remain to be considered. Antonio Brufau summarized the consensus when he said that naturalgas is the energy of the twenty-first century. Robert Hefner predictedthe day when natural gas would have a higher share of energy marketsthan oil. Roger Sant pointed out that gas combined cycle turbinescan produce electricity at a cost of 2.8 cents/kwh. The low cost ofnatural gas for primary energy use and for generating low-cost elec-tricity may be why renewables are not assuming the role predictedfor them some years ago.

But that is not to write off renewables. Mr. de Fabiani expressed faithin the future of solar energy —a faith reflected in the hundreds of millions of dollars that BP Amoco is committing to solar develop-ment. In any event, if Bob Hefner was right that we are in a transi-tion from solid to liquid to gas as fuels— from dirty, expensive, cen-tralized systems to clean, efficient, decentralized systems —we donot have to worry about alternative fuels at all.


There are two issues in the gas industry, however, that are worth further consideration. Pablo Benavides informed us that the liberal-ization of the European gas market is not proceeding as rapidly as isthe liberalization of electricity markets. There seems to be a conflictbetween the desire to liberalize and the desire to maintain security ofsupply in nations that are not self-sufficient in gas resources. Coun-tries that have liberalized, such as the United Kingdom and theUnited States, have reliable domestic sources. So the question thatarises is whether countries dependent on imports can rely on freemarkets to deliver sufficient security of supply to warrant repealingthe regulations now in place. It is a question that will prove of con-siderable importance to the oil industry, too, if we become increas-ingly reliant on Persian Gulf supplies.

The second issue for the gas industry, one that we have not fully explored, is the relationship between the price of natural gas and theprice of oil. One participant thinks the price of gas will be “a decisivefactor in determining the price of oil.” If I understand Roger Santcorrectly, he thinks they are decoupled at the moment. We maywant to consider this issue.

THE ENVIRONMENT: DEFINING “PROACTIVE”

In our final session, on the environment, Michel de Fabiani kept usinformed of BP Amoco’s progress in developing an internal tradeablepermit program, an initiative in which we are all intensely interested.And he made a powerful case for a proactive policy that puts a company out in front, ahead of government. There seems to be awide agreement with this view, as Jan Timmerman concurred. Buthow can a company get out front, and stay there?

We might learn some lessons from Stuart Dombey, who offered threesuggestions that might be applicable to the energy industry. First, international cooperation among regulators can be cost-effective.For the energy industry it would be useful to have international cooperation among regulators for specifying engine types, emission


standards, fuel standards, and so on. After all, the automobile andthe fuels markets are international. Second, Dr. Dombey suggestedthat ongoing education of legislators and regulators (a/k/a lobbying)is essential. Third, a “no secrets” policy and candor build credibilityover the years. Stuart Dombey emphasized that credibility is a key,and Jan Timmerman agreed.

Stuart also noted that regulation must be based on “sound science.”Here we do have a problem because Mr. de Fabiani reminded us quite properly that at times it is essential to go forward even if thescience is uncertain. Jan Timmerman bemoaned the poor public image of the oil industry. Juan Antonio Moral detailed the environ-mental issues raised by the automobile: these are products that intrude on the environment. There is no way to make them com-pletely benign.

But the overall impression is one of substantial progress. Mr. de Fabiani described how one company can develop programs thatcope with the possibility of greenhouse gases; Mr. Timmermanshowed how much cleaner fuels have become; and Mr. Moral informed us of the auto industry’s plans to reduce pollution stillmore. In other words, progress is being made.

AN ECONOMIST’S FOOTNOTE

Permit me one footnote to this meeting —a warning to economistsabout excessive hubris. Economic analysis can inform but cannot determine policy decisions.

An important additional factor is history: history matters. Bijan saidthat the international oil companies “took by hook and by crookmore than their fair share” of oil revenues, particularly in the MiddleEast. That is a widely-held perception that colors the relationship between producing countries and companies that want to operatethere in the future, even though there is a clear economic advantage,to both parties, of full cooperation.


A second factor is politics: politics matter. Dr. TéIlez made it veryclear that politics in his country make it nearly impossible to do whatan economist would want to do with the energy industries.

Third, culture matters. Alfonso Cortina pointed out that the mergerof Repsol and YPF had been smoothed over by their common culture, and that absence of a shared culture has caused many mergers to fail.

So we economists have to keep in mind that history matters, politicsmatter, culture matters. We can be advisors, we can supply numbers,we can suggest what is economically rational, but we cannot, in theend, make the decisions.

In sum, what have we learned? Let me list six points:

• Liberalization and free markets have produced enormous bene-fits, but regulation is here to stay and may increase.

• The oil industry is now characterized by enormous companies,but well-managed second-tier companies can grow and pros-per.

• OPEC has succeeded in raising prices recently, but will have todevelop a new strategy if it is to survive through the next cen-tury.

• The oil industry is under threat from substitutes and environ-mental regulation, but nevertheless has a glowing future.

• Fossil fuels and the automobile create environmental problems,but solutions are being developed.

• Repsol continues to succeed both as an oil company and as ahost. There are no caveats, no buts to follow that final lesson.


BIOGRAPHIES OF SPEAKERS

Pablo Benavides has been director-general for energy, DG XVII, inthe European Commission since 1996. He entered the Spanish diplo-matic service in 1964 and held a series of positions with wide-rang-ing responsibilities, including secretary to the Spanish delegationfrom the Ministry of Foreign Affairs, responsible for negotiationswith the EEC (1966-1968), and secretary of the Negotiating Confer-ence for Spanish Accession Negotiations (1979-1981). In 1994, Mr.Benavides became director of the newly-created Directorate-Generalfor External Political Relations of the European Commission, incharge of relations with the countries of Central Europe and theCommonwealth of Independent States. Mr. Benavides holds a lawdegree from Central University, Madrid.

Antonio Brufau has been chairman of Gas Natural Group since 1997and president and CEO of Caja de Ahorros y Pensiones de Barcelona“La Caixa Group” since January 1999. After receiving his undergraduatedegree in economics from the University of Barcelona, Mr. Brufau

163

joined Arthur Andersen & Co., S.R.C., and was made partner in1980. Based in Barcelona, he headed the firm’s audit division from1980 to 1988, and also served on the firm’s worldwide advisorycouncil. He served as chairman of Port Aventura from 1994 to 1997and as senior executive vice president of La Caixa from 1988 to1999. Mr. Brufau presently serves on the boards of directors of Rep-sol YPF, Aigües de Barcelona, Acesa, Inmobilaria Colonial, and BancoHerrero.

Alfonso Cortina de Alcocer has been chairman and CEO of RepsolS.A. (now Repsol YPF) since June 1996. From 1984 to 1996, heserved as vice chairman, chairman, then managing director of PortlandValderrivas, S.A., as well as chairman of the firm’s delegate commis-sion. Mr. Cortina has had extensive experience in the banking industry,including executive positions at Banco de Vizcaya Group,Banco His-pano Americano, Banco Central, and Banco Zaragozano. His profes-sional activities have included chairmanship of the AsociaciónHipotecaria Española. He was honored by the Madrid Official Cham-ber of Commerce and Industry as “Businessman of the Year” in1995. Mr. Cortina holds degrees in advanced industrial engineeringand in economics from ETSII and Madrid University, respectively.

Michel de Fabiani is regional president Europe for BP Amoco and isalso vice president of the European Petroleum Industry Association(EUROPIA). Mr. de Fabiani joined BP in 1969 and served in a varietyof national assignments within Europe. In 1991, his career took on abroadly European focus when he went to Brussels as services andcontrol director of BP Oil Europe. In 1997, Mr. de Fabiani was ap-pointed CEO for BP Oil Europe, and in January 1999, he was alsomade regional president Europe of the newly-merged BP Amoco.Mr.de Fabiani is a graduate of the Paris Business School.

José Luis Díaz Fernández has been president of Fundación Repsolsince its creation in January 1996, with a mission to coordinate Rep-sol’s work in promoting educational, cultural, and research activitiesrelating to energy and society. After serving in the public sector asthe director general for energy in the Ministry of Industry, Mr. Díaz

Biographies of Speakers164

Fernández moved to the private sector in 1975 and then to Repsolafter its founding in 1987. He has served Repsol in many roles, in-cluding chairman and CEO of Repsol Petróleo and chairman andCEO of Campsa. Mr. Díaz Fernández has a Ph.D. in mining engi-neering from the Polytechnic University of Madrid, where he serveson the faculty of the School of Mines, and is a member of the SpanishAcademy of Engineering.

Stuart L. Dombey has been vice president of international regula-tory affairs at Parke-Davis in Ann Arbor, Michigan, since 1990, re-sponsible for new-product approvals worldwide and for Europeanregulatory strategy. Prior to joining Parke-Davis, Dr. Dombeyworked at Squibb and Hoechst in a variety of medical and regulatoryroles. He qualified in medicine at Liverpool University and is a fellowof the Royal College of Physicians of Edinburgh.

María Teresa Estevan Bolea is a member of the European Parliamentwhere she serves on the Research, Technological Development, andEnergy Committee and on the Environmental, Public Health, andConsumer Protection Committee. A member of Spain’s Partido Pop-ular, she was a representative from Madrid to the Spanish Parliamentfrom 1987 to 1993, where she was a spokeswoman for her party onenergy, environment, and equal opportunities for women. Mrs. Este-van is an industrial engineer by profession, and has worked on thedesign and construction of many large projects including chemicalplants and refineries, and oil and gas pipelines. She has also served inthe Ministry of Public Works as general director of environment. Ed-ucated at the Polytechnic University of Barcelona, Mrs. Estevanteaches graduate courses on energy and the environment at Spanishand Latin American universities.

Robert A. Hefner III is owner and managing partner of The GHKCompany and chairman of the board, managing director, and CEOof Houston-based Seven Seas Petroleum Inc. After graduating witha geology degree from the University of Oklahoma, he formedGHK, a private natural gas and oil exploration and prodution firmwith offices in Oklahoma City. GHK became known for its pioneering

165Biographies of Speakers 165

deep high-pressure gas drilling and production in western Oklahomaand the Texas Panhandle, and for leading the industry in techno-logical drilling innovations. Exploration in Colombia culminated insignificant discoveries in the Magdalena River basin. GHK subse-quently consolidated its Colombian oil interests with Seven Seas Pe-troleum Inc., a publicly-traded oil and gas exploration and produc-tion company. Mr. Hefner was a founding member of the board ofdirectors of the Business Council for Sustainable Energy, and hasserved on the advisory council for the School of Advanced Interna-tional Studies (SAIS) at Johns Hopkins University, and the advisoryboard of the International Institute for Applied Systems Analysis(IIASA) in Austria.

William W. Hogan is Lucius N. Littauer Professor of Public Policy andAdministration at the John F. Kennedy School of Government, Harvard University. Professor Hogan is also research director of the Harvard Electricity Policy Group (HEPG), which is developing alter-native strategies for the transition to amore competitive electricitymarket. As a director of Navigant Consulting, Inc., he is involved inresearch and consulting activities on topics such as major energyindustry restructuring, network pricing and access issues, and privati-zation worldwide. Professor Hogan received his undergraduate degreefrom the U.S. Air Force Academy and his Ph.D. from UCLA.

William L. Massey has served as a commissioner of the U.S. FederalEnergy Regulatory Commission (FE RC) since 1993. He has activelyparticipated in FERC’s restructuring of the natural gas industry, notably via Order No. 636, and was an architect in the developmentof Order No. 888, FERC’s historic electric restructuring initiative.Since 1997, Mr. Massey has served as FERC’s lead commissioner onthe subject of merger policy. He has had extensive legal and policy-making experience in both judicial and legislative branches of thefederal government, including service as senior member of the U.S.Senate Committee on Energy and Natural Resources. Before joiningFERC, Mr. Massey was in private legal practice. He received an LL.M.from Georgetown University Law Center and a J.D. from the Univer-sity of Arkansas School of Law.

Biographies of Speakers166

Juan Antonio Moral GonzáIez is president of Fasa-Renault, S.A. andalso serves as president of the Association of Spanish AutomobileManufacturers (ANFAC). Mr. Moral joined Fasa-Renault in 1961 ashead of manufacturing, and subsequently held a series of posts inclu-ing industrial director and director of mechanical manufacturing ofthe Renault Group. In 1994, he was named president of Fasa-Re-nault. Mr. Moral holds a Ph.D. in engineering and a Licentiate degreein computer science. He is a knight of the Legion of Honor of Franceand has also been awarded the French Labor Medal.

Bijan Mossavar-Rahmani is Chairman of Mondoil Corporation. From 1988 to 1996, he was president of Apache International, Inc.Prior to joining Apache,Mr. Mossavar-Rahmani was assistant directorfor International Energy Studies at the John F. Kennedy School ofGovernment, Harvard University. He is a director of both Compagniedes Energies Nouvelles de Cóte d’lvoire and Apache Cóte d’lvoire Pe-troleum LDC, and is active in industry and international affairs as amember of the Council of the U.S. International Executive ServiceCorps and the International Consultative Group on the Middle East.A former delegate to OPEC ministerial conferences, Mr. Mossavar-Rahmani has published numerous books and articles on internationaloil and gas markets. He holds degrees from Princeton and HarvardUniversities.

Alberto Ruiz-Gallardón is president of the Autonomous Communityof Madrid. A lawyer by profession and a member of the national executive committee of the Partido Popular, Mr. Ruiz-Gallardón haslong been active in Spanish politics and government: in 1983, electedas a councillor to the Madrid Town Hall; in 1987, elected as a repre-sentative to the Madrid Assembly; and in 1987, elected as a senatorto the National Parliament representing the Community of Madrid.

Roger W. Sant is chairman of the board of the AES Corporation, aleading global power company, which he co-founded in 1981. AES isdedicated to providing electricity worldwide in a socially responsibleway. With assets in excess of $10 billion and projects under con-struction valued at $5 billion, AES currently owns or has an interest

167Biographies of Speakers

in 91 power facilities worldwide. Prior to founding AES, Mr. Sant wasdirector of the Mellon Institute’s Energy Productivity Center andserved in the Ford administration, where he was a key developer ofearly initiatives to fashion a U.S. energy policy. Mr. Sant received aB.S. from Brigham Young University and an M.B.A. from the HarvardGraduate School of Business Administration. Since 1994, he haschaired the board of the World Wildlife Fund US, and is chairman ofThe Summit Foundation. Mr. Sant is co-author of Creating Abun-dance: America’s Least-Cost Energy Strategy (1984).

Irwin M. Stelzer is senior fellow and director of regulatory policystudies at the Hudson Institute in Washington, DC. He is a U.S.economic and political columnist for The Sunday Times (London)and The Courier Mail (Australia), and a columnist for The New YorkPost. Dr. Stelzer has written and lectured widely on economic andpolicy developments in the United States and the United Kingdom,particularly as they relate to privatization and competition policy. In1961, he founded National Economic Research Associates, Inc.(NERA) and served as its president from 1961 to 1983. In addition,he served as director of the Energy and Environmental Policy Centerat Harvard University and as director of regulatory policy studies atthe American Enterprise Institute (AEI). Dr. Stelzer received a B.A.and an M.A. in economics from New York University and a Ph.D. ineconomics from Cornell University.

Nader H. Sultan is deputy chairman and CEO of Kuwait PetroleumCorporation. He began his career at the Kuwait Petroleum Companyin 1971, and when the Kuwait Petroleum Corporation was formed in1980, he was appointed executive assistant manager for WorldwideProduct Sales. Mr. Sultan later served as the executive assistant man-aging director for planning and international downstream in theMarketing Division, and simultaneously, as president of Kuwait Petroleum International Limited (KPI), upon its formation in July 1993.Mr. Sultan received a B.Sc. in economics from the University of London.

Luis TélIez Kuenzler was appointed Mexico’s secretary of energy inOctober 1997, after having served for three years as chief of staff to

168 Biographies of Speakers

President Ernesto Zedillo, as deputy secretary for agriculture(1990-1994), and as chief economist at the Ministry of the Treasury.Dr. Téllez did his graduate work at MIT, where he earned a Ph.D. in economics, concentrating on international economy, econometrics,and private finance. He has taught at the Autonomous TechnologicalInstitute of Mexico (ITAM) and at MIT, and is the author of numerouspublications, including The Open Economy: Tools for Policymakers inDeveloping Countries (1998) with co-author Rudiger Dornbush; TheModernization of the Agricultural Livestock and Forestry Sector(1994); New Legislation on Land, Forest and Water (1993); andFighting Inflation (1993) with co-author Carlos Jarque.

Jan J.F. Timmerman has been secretary general of the European Petroleum Industry Association (EUROPIA), headquartered in Brussels,since June 1998. Earlier, during a lengthy career at Shell Internationalspanning more than three decades, Mr. Timmerman worked aroundthe world for a variety of Shell business groups, including chemicals,marketing, and communications. He concluded his career at Shell aspresident of Shell Belgium-Luxembourg. Mr. Timmerman is a gradu-ate of Brussels University with a degree in economics.

J.J. Traynor is senior oil and gas equity analyst for Deutsche Bankbased in Edinburgh. Dr. Traynor has a specific analytical interest inthe European oils sector, conducting research on companies includingEni, Norsk Hydro, OMV, Repsol-YPF and TOTAL Fina. Before becoming a financial analyst, he worked at BP Exploration for eightyears, where he was involved in international exploration activities inthe United Kingdom, the former Soviet Union, Southeast Asia, anddeep-water West Africa. A geologist by training, Dr. Traynor holdsan undergraduate degree from Imperial College in London and aPh.D. from Cambridge University.

169Biographies of Speakers

H. H. Shaikh Abdulrahman binSaud al-ThaniDirector of Political AffairsAmir DiwanDoha PalaceP0 Box 1Doha, Qatar

Mr. Enrique Aldama y MiñónPresidentLAIN336 Arturo Soria28033 Madrid, Spain

H. H. Salman AI-KhalifaDeputy ChairmanBahrain Petroleum CompanyManana, Bahrain

Mr. Isaac Álvarez FernándezDirectorTechnical Staff and AcquisitionsRepsol YPFAvenida Presidente Roque777 Sáenz PeñaC1035 AAC Buenos Aires, Argentina

Mr. Gonzalo Anes5 Recoletos28001 Madrid, Spain

Mr. Abdelmadjid AttarChairman and CEOEntreprise Nationale Sonatrach10 rue du SaharaHydra, Algeria

171

LIST OF PARTICIPANTS

Mr. Abdel Khaled AyadChairmanEgyptian General PetroleumCorporationPalestine Street, 4th sectorNew Maadi Cairo, Egypt

Mr. Juan Bachiller AraqueDirectorEU Representative OfficeRepsol YPF327 Avenue Louise1050 Brussels, Belgium

Mr. Juan BadosaChief ExecutiveLP GasRepsol YPF10 Arcipreste de Hita28015 Madrid, Spain

Hon. Vicky BaileyCommissionerU.S. Federal EnergyRegulatory Commission888 First Street N.E.Washington, DC 20426, USA

H. E. Safiatou Ba-N’DawMinister of EnergyMinistry of Energy, Ivory Coast40 B.P.V.Abidjan, Ivory Coast

Mr. Raimundo Bassols JacasAdvisor in Foreign AffairsRepsol YPF278 Paseo de la Castellana28046 Madrid, Spain

Mr. Pablo BenavidesDirector-GeneralDGXVII, EnergyEuropean Commission226-236 Avenue du Tervuren1150 Brussels, Belgium

Mr. Michel BénezitChairman and CEOTOTAL Overseas51 Esplanade du Géneral de Gaulle92907 Paris, France

Mr. Antonio BrufauChairmanGas Natural Group22 Avenida Puerta del Angel08002 Barcelona, Spain

Mr. Luis Carmona ElizaldeHead of the Libyan DelegationRepsol YPFDat El Imad ComplexTower 3Tripoli, Libya

Mr. lván CiekerAdvisor for International RelationsRepsol YPF278 Paseo de la Castellana28046 Madrid, Spain

Mr. Guillermo ColinoSubdirector GeneralBanco Bilbao Vizcaya1 Gran Vía48001 Bilbao, Spain

List of Participants172

Mr. Alfonso Cortina de AlcocerChairman and CEORepsol YPF278 Paseo de Ia Castellana28046 Madrid, Spain

Mr. Ged DavisVice PresidentGlobal Business EnvironmentShell International LimitedShell CentreLondon SE1 7NA, UK

Mr. Michel de FabianiRegional President EuropeBP Amoco455 MechelsesteenwegB-1950 Kraainem, Belgium

Mr. José Luis Díaz FernándezPresidentFundación Repsol38 Juan Bravo28006 Madrid, Spain

Dr. Stuart L. DombeyVice PresidentInternational Regulatory AffairsParke-DavisPharmaceutical Research Division2800 Plymouth RoadAnn Arbour, MI 48105, USA

Mr. Hammouda EI-AswadChairman of the BoardNational Oil CorporationBashir Saadawi StreetBenghaziTripoli, Libyan Arab Jamahiriya

Mr. Pablo EspresateManaging DirectorPEMEX Services Europe Ltd.4 Grosvenor PlaceLondon SW1X 7HB, UK

Hon. Maria Teresa EstevanBoleaMember of the European ParliamentRue Wiertz1047 Brussels, Belgium

Mr. G. Steven FarrisPresident and COOApache Corporation2000 Post Oak BoulevardHouston, TX 77056, USA

Mr. Jesús Fernández de IaVegaCorporate DirectorHuman ResouresRepsol YPF278 Paseo de Ia Castellana28046 Madrid, Spain

Mr. Antonio Gomis SáezDirector General of EnergyMinistry of Industry and Energy160 Paseo de Ia Castellana28046 Madrid, Spain

Mr. Antonio González-AdalidExecutive Vice PresidentChemicalsRepsol YPF280 Paseo de Ia Castellana28046 Madrid, Spain

List of Participants 173

Mr. Robert A. Hefner IIIOwner and Managing partnerThe GHK Company6305 Waterford BoulevardOklahoma City, OK 73118, USA

Mr. Antonio Hernández-GilVice ChairmanRepsol YPF87 Serrano28006 Madrid, Spain

Prof. William W. HoganJohn F. Kennedy School of GovernmentHarvard University79 JFK StreetCambridge, MA 02138, USA

Mr. Fulgencio Jiménez de IaPeñaPresidentRepsol Exploración Egypt, S.A.58 Road 105MaadiCairo, Egypt

Ms. Eija MalmivirtaChairmanMerei Energy Consulting Oy Ltd.2F EsterinporttiHelsinki F-00240, Finland

Hon. William L. MasseyCommissionerU.S. Federal EnergyRegulatory Commission888 First Street N.E.Washington, DC 20426, USA

Mr. Jan MoenDirector of Regulation and DSMNorwegian Water Resourcesand Energy DirectorateP.O. Box 5091 MajorstuaN-0301 Oslo, Norway

Mr. Jacinto MongeExecutive OfficerEUROPIAMadou Plaza1 Place MadouB-1030 Brussels, Belgium

Mr. Juan Antonio MoralGónzalezPresidentFasa-Renault, S.A.24 Fray Bernardino Sahagún28036 Madrid, Spain

Mr. Gian Marco MorattiPresidentSaras SpA Raffinerie Sarde8 Galleria de Cristoforis1-20122 Milan, Italy

Mr. Massimo MorattiVice President-Member of the BoardSaras SpA Raffinerie Sarde8 Galleria de Cristoforis1-20122 Milan, Italy

Mr. Carmelo de las MorenasLópezCorporate Director of FinanceRepsol YPF278 Paseo de Ia Castellana28046 Madrid, Spain


Mr. Gwyn MorganPresident and CEOAlberta Energy Company Ltd.3900, 421 7th Avenue S.WCalgary, Alberta T2P 4K9, Canada

Mr. Bijan Mossavar-RahmaniChairmanMondoil CorporationMonte AplanadoMora, NM 87732-0744, USA

Mr. Luis Javier NavarroPresidentBP Oil España6 Maria de Molina28006 Madrid, Spain

Mr. Ramón Pérez SimarroCorporate Directorof Information SystemsRepsol YPF278 Paseo de Ia Castellana28046 Madrid, Spain

Mr. Richard N. PerleResident FellowAmerican Enterprise Institute5 Grafton StreetChevy Chase, MD 2081 5, USA

Dr. Paul R. PortneyPresidentResources for the Future1616 P Street N.W.Washington, DC 20036, USA

Mr. Miguel Angel RemónSenior Vice-PresidentPlanning, Control andStrategic DevelopmentRepsol YPF278 Paseo de Ia Castellana28046 Madrid, Spain

Mr. José Manuel RevueltaCorporate Directorand Assistant to the ChairmanRepsol YPF278 Paseo de Ia Castellana28046 Madrid, Spain

Mr. Juan Sancho RofExecutive Vice-PresidentRefining and MarketingRepsol YPF278 Paseo de Ia Castellana28046 Madrid, Spain

Dr. Evanán RomeroVisiting ScholarJohn F. Kennedy Schoolof GovernmentHarvard University79 JFK StreetCambridge, MA 02138, USA

Mr. Juan Manuel RomeroCorporate Director of FinancePEMEX329 Avenida Marina Nacional11311 Mexico DF, Mexico

Hon. Alberto Ruiz-GallardónPresidentAutonomous Community of Madrid7 Puerta del Sol28013 Madrid, Spain

List of Participants 175

Mr. Roger W. SantChairmanAES Corporation1001 N. 19th StreetArlington, VA 22209, USA

Mr. Jorge SegrellesCorporate Director for Externaland Investor Relationsand Managing Director ofRefining and Marketing for EuropeRepsol YPF278 Paseo de Ia Castellana28046 Madrid, Spain

Mr. Guzmán SolanaExecutive Vice-PresidentNatural Gas and ElectricityRepsol YPF38 Avenida de América28028 Madrid, Spain

Ms. Clare SpottiswoodePA Consulting Group123 Buckingham Palace RoadLondon SWIW 9SR, UK

Prof. Robert N. StavinsJohn F. Kennedy Schoolof GovernmentHarvard University79 JFK StreetCambridge, MA 02138, USA

Dr. Irwin M. StelzerSenior Fellow and DirectorRegulatory StudiesHudson Institute1101 17th Street N.W.Washington, DC 20036, USA

Mr. Nader H. SultanDeputy Chairman and CEOKuwait Petroleum CorporationP.O. Box 2656513126 Safat, Kuwait

Hon. Dr. Luis Téllez KuenzlerSecretary of EnergyMinistry of Energy. Mexico890 Insurgentes SurColonia del ValleDelegacion Benito Juarez03100 Mexico DF, Mexico

Mr. Jan J.F. TimmermanSecretary GeneralEUROPIA1 Place Madou1210 Brussels, Belgium

Dr. J.J. TraynorSenior Oil and Gas Equity AnalystDeutsche Bank74 Kintore House77 Queen StreetEdinburgh EH2 4NS, UK

Mr. Simeón Vadillo ZaballosDirector for Investorand Media RelationsRepsol YPF278 Paseo de Ia Castellana28046 Madrid, Spain

Mr. Emilio Ybarra y ChurrucaVice ChairmanRepsol YPF81 Paseo de Ia Castellana28046 Madrid, Spain


Ms. Constance BurnsConference CoordinatorJohn F. Kennedy School of GovernmentHarvard University79 JFK StreetCambridge, MA 02138, USA

Ms. Susan MeyersConference CoordinatorInternational RelationsRepsol YPF278 Paseo de Ia Castellana28046 Madrid, Spain

Ms. Pilar Suaréz-CarreñoPresidentSC Comunicación20 Velázquez28001 Madrid, Spain

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CONFERENCE COORDINATORS

178

FOR ADDITIONAL INFORMATION

SERVICIO DE PUBLICACIONES DIRECCIÓN CORPORATIVA DEFUNDACIÓN REPSOL YPF ASUNTOS INSTITUCIONALES Y

CORPORATIVOS REPSOL YPF

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Madrid, 1999 III · private sector. Repsol’s most recent step in the process, successfully...

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