By Chris Cook, for Trend:
As ever at such major energy events, a great deal more heat than light has been generated here at the World Energy Congress (WEC) in Istanbul. I have been attending the WEC as an expert participant in two Round Tables: firstly the influential Bosphorus Energy Club, and secondly, a Round Table convened jointly by the International Energy Charter Treaty (ECT) organization and the Economic Co-operation Organization (ECO) grouping of ten nations.
The tectonic shifts in global energy markets which I have been observing for some time, appear now to be increasingly discussed, but are not quite yet mainstream. The influential Head of Research of the King Abdullah Petroleum Studies and Research Center, David Hobbs was perhaps the clearest in expressing his view that electricity is a service, and not a commodity capable of being transacted for profit.
This reality is not well reflected by electricity market instruments and structures and Scott Foster of UNECE has been advancing a similar analysis for some time. Anyone familiar with my views will know that I have believed (and said) that this market paradigm for electricity is fundamentally misconceived since it was adopted over 20 years ago. My analysis is shared by my colleague Mahmood Khaghani who accepted it at least a dozen years ago in his official role at the Iranian oil ministry.
However, there are some interesting questions to be addressed, such as what would such energy market as a service look like; why would energy market participants wish to adopt it; and what would be the route of Road Map to implementation?
The Fifth Fuel
Discussions during the Bosphorus Energy Club Round Table and afterwards over dinner were artfully and dexterously chaired by Mehmet Ogutcu – the Club's influential and urbane founder. A clear recognition from this private sector gathering emerged that the transformation from a role of energy commodity intermediaries (middlemen) to a role of energy service providers has a very simple financial rationale.
This is that since service providers take neither market risk nor credit risk then their need for finance capital is reduced to that necessary for operating costs. In other words, finance capital is being replaced by (Smart) intellectual capital. In my view what is increasingly being termed the Fifth Fuel – fuel savings – comes about from the use of intellectual capital such as knowledge and know how.
The other crucial attribute of this Fifth Fuel which emerged in discussion during and after the Round Table was that the more expensive that finite resources such as fossil fuels become in dollar and euro terms then the more valuable become fossil fuel savings from the Fifth Fuel.
Energy Charter Treaty & Iran
The ECT/ECO Round Table was focused upon the further development of continuing bilateral discussions between senior officials from Turkey and Iran in relation to the development of the existing energy corridor between the two countries and its extension into ECO physical and financial energy markets.
Since the aim of the ECT organization is to provide the necessary frameworks to promote investment in sustainable and resilient energy infrastructure enabling transition to a low carbon economy, the existence of functioning physical and financial markets is essential.
However, while Turkey has long been a full member of the ECT, and Iran first entered into dialogue with ECT well over a decade ago, this dialogue came to an end with sanctions, and has only recently restarted. The ECT proposes that Iran should – like many other countries - sign the non-binding political declaration which would allow them to take up a form of associate observer status. However, there remains considerable suspicion within Iran in relation to such engagement with any institution identified with Western markets and there is a continuing debate between Iran's Reform and Resistance factions.
Professor Hossein Iranmanesh (an expert in intelligent systems and Director of two Iranian energy research institutes), my colleague Mahmood Khaghani (an expert in regional physical energy markets) and I outlined a proposal for a framework and instruments for a Smart Market which could deliver Energy as a Service.
The first element of a Smart Market is the use of energy swaps or exchanges of energy flows, and these come in several types. The first is a Category Swap, where raw energy such as oil or gas is converted into energy as a service: examples would be the gas/power swap such as that where Iran supplies gas to Armenia in return for electricity; another variant is Gas by Wire, which is gas powered generation and export of electricity such as that between Turkmenistan and Iran.
More interesting is the Location Swap, where energy delivered into one location is exchanged for energy delivered out of another: Iran's Caspian Oil Swap is one such (but lacked transparency); but it will be seen that the outcome is essentially Energy by Fibre, where energy does not physically flow between locations through cables, pipelines or transport, but is in practice transmitted via the Internet. Finally, there are many possible hybrids such as oil swapped for oil products; and combined Category and Location Swaps.
The Smart Swap
However, perhaps the most important Swap is that of the Fifth Fuel for the value of Carbon Fuel savings. The best example of this, which emerged from my historical research, was that of the great Scottish engineer James Watt from 1778 onward, who refused to sell his steam engines to tin mines in South West UK to pump out water, but instead supplied the use of his pumps in exchange for a third of coal savings.
This Smart Swap of intellectual value for the value of carbon fuel is well described as Pumping as a Service and the outcome was that Watt was incentivised to ensure that his engine was properly maintained and continually improved since to do so increased his income from coal savings.
By way of a modern application of this approach the savings from replacing legacy power generation and pipeline compressors with up to date technology enable a phenomenal return in energy savings as efficiency is increased from 25% to 30% to some 60% in the case of modern gas turbines. However, conventional funding frameworks and instruments face insuperable problems in monetizing these savings. The use of Smart Swaps offer a simple generation as a service mechanism for the funding of the necessary system upgrades where Iran alone has a funding requirement approaching many hundreds of millions of US dollars.
The question is how would those who provide the use of technology access their entitlements and this is where the simple instrument of prepay energy credit instruments come in.
An energy credit instrument is simply a promise issued by an energy producer in exchange for value received from an acceptor of his promise. Such a promise is not a debt instrument (since there is no enforceable obligation to deliver money); it is not a derivative (forward) instrument since there is no obligation to deliver energy; and it is not an equity (ownership) instrument over flows of energy.
The energy producer is simply obliged to accept his own promise when presented to him in payment for supply instead of (say) dollars or euros: such a promise represents an energy credit.
Provided there is a robust framework of mutual guarantee, energy producers will be prepared to accept each others' promises and to account among themselves in respect of balances. Such a system - an ECO Energy Clearing Union - requires administration, risk management (to avoid over-issuance), dispute resolution and a suitable regulatory standards of behavior.
This illustration of a possible future networked energy market operating under the principle of resource resilience received a good reception. When combined with the patient explanations in respect of the ECT and the diplomacy of the cosmopolitan and talented Marat Terterov – the Principal Coordinator of the ECT who chaired the meeting – an avenue for accelerated development of the bilateral energy relationship between Turkey and Iran appears to have opened up.
My instinct is that Iran's reservations in relation to the Energy Charter may have been sufficiently addressed that they may now regard signing the political declaration in of the International Energy Charter and assuming Observer status.
In my view, such a smart move could be the catalyst for the creation of a Smart Market, where energy is generated and consumed on the basis of Least Resource Cost economic decisions, rather than conventional Least $ or € Cost decisions.
There appears to be a consensus that work should be undertaken by ECO with ECT and expert assistance to develop the necessary frameworks and instruments, undoubtedly through practical Proof of Concept energy projects, probably in border areas. The possibility of Energy Free Zones on ECO national borders has also been raised.
I believe that the 2016 Istanbul World Energy Congress may come to be seen as an inflection point in market development and possibly even as the beginning of a paradigm shift in energy markets to energy as a service.
Chris Cook is a former director of the International Petroleum Exchange. He is now a strategic market consultant, entrepreneur and a commentator.