APEC Energy Ministers have met twice in the last two years to discuss the impact of rising oil prices. Ways of reducing oil dependency dominated the recent Ministerial Meetings in Gyeongju, Korea, in October. At that meeting, APEC's Energy Ministers agreed that effective responses to high and increasingly volatile oil prices require a broad range of supply and demand-side measures. These include creating strategic oil stocks for supply disruption response; the facilitation of investment in oil exploration, production and refining; and measures to promote energy efficiency and diversification, including vehicle fuel efficiency and alternative transport fuels.

"What came out of the Ministerial Meeting is the broad level of agreement not only on the nature of the challenge that is ahead of economies in terms of supply and demand, but there was a broad level of agreement on the range of strategies that need to be progressed to actually do it," says Aidan Storer, manager of the Energy Working Group's Secretariat. "Work needs to be undertaken on a whole level of fronts."

APEC set up its Energy Working Group (EWG) in 1990 to maximize the energy sector's contribution to the region's economic and social well-being, while mitigating the environmental effects of energy supply and use. In the last eighteen months alone the EWG has hosted a huge variety of meetings, workshops and projects. In April this year, EWG held a workshop in Chinese Taipei on how to get more LNG and natural gas traded in the region. In July the U.S. hosted a workshop looking at strategic oil stocks and how to help economies put them in place, and in September the EWG Business Network held the first APEC Gas Forum in Australia, which looked more closely at issues such as the security and safety of LNG transportation. Others have included workshops on bio-fuels and how to better network and share information on alternative energy technologies; how to better the measurement of energy efficiency; how to address bottlenecks in the refining sector; and how to remove investment barriers.

The urgency underlying EWG's work is clear. Between 2002 and 2005 the percentage increases in the prices of different grades of oil has more than tripled. Both real and nominal oil prices are at their highest level since the early 1990s. And increases in oil prices have brought with them price hikes for gas and coal.

That's a global problem but nowhere more so than for the 21 member economies of APEC, where annual energy consumption accounts for approximately 59% of the world energy total. For most APEC economies, the key economic impacts of higher sustained oil prices range from a decline in economic output to a deterioration in the terms of trade. While there are a few major oil exporters, the majority of APEC economies are net oil importers, importing between 13% and 100% of the oil consumed in their domestic markets. Some economies, such as Hong Kong China, Japan, the Republic of Korea, Singapore, the Philippines and Chinese Taipei rely on imports for 100% of their oil consumption.

Higher world oil prices are likely to place downward pressure on exchange rates in some oil importing economies as their balance of payments deteriorate. Higher oil prices and the subsequent depreciation of developing economies' currencies against the U.S. dollar also raise the cost of servicing external debt in those economies. Finally, high oil prices can lead to increased wage and inflationary pressures in many economies. There could be upward pressure on interest rates as central banks attempt to limit inflation. Yet overly contractionary policies could exacerbate the decline in economic growth and jack up unemployment in many countries.

The highest rates of demand for oil have come from the United States, China, and other parts of Asia. Rising demand is strongly linked to the growth in the desire for transport fuels, especially gasoline and diesel, as incomes have grown. Those scenarios show no sign of changing in the near future.

Regional dependence on imported oil will increase to 55% by 2020 from its current level of 36%, according to the Asia Pacific Energy Research Centre, or APERC. "Consumption of oil is going to go up over time," says Don Gunasekera, manager and lead author of a recent study commissioned by APEC to study the impact of high oil prices. "How can we at least slow down that growth, especially in the transport sector?"

APEC Energy Ministers have met seven times since their first meeting in Sydney in 1996. In 2004, APEC Leaders identified the risks to the world economy posed by volatility in the oil market and called for the continued implementation of the APEC Energy Security Initiative (ESI). Established in 2000, the ESI's short-term measures include improving transparency in the global oil market; monitoring efforts to strengthen sea-lane security; implementing a real-time emergency information sharing system and encouraging member economies to have emergency mechanisms and contingency plans in place. (The Real Time Emergency Information Sharing System is a web-based tool to share information in the event of energy emergencies and disruptions.)

The ESI's longer-term policy responses include: facilitating investment, trade and technology cooperation in energy infrastructure; natural gas (LNG); energy efficiency; clean fossil energy; renewable energy and hydrogen and fuel cells.

Certainly the time to act is now. Spare production capacity of the world's oil has declined to its lowest levels since the 1980s. In the U.S., the last refinery built was in 1976 and there are no current plans to build new ones.

The demand for refined products is projected to increase faster than refining capacity is expanded, which will continue to put upward pressure on the prices of refined products. "In the U.S., it's a financial and environmental issue," explains Gunasekera of the Australian Bureau of Agriculture and Resource Economics, or ABARE. "The Chinese have plans to build new refineries and some developing countries have plans too, but apparently it takes five to seven years to build a new one, (so) it's not very quick. What's likely to happen is that people are going to refurbish existing facilities rather than build new ones [and] that may not be enough."

Production of the oil in most demand (light, low sulfur oil) may have peaked and downstream facilities lack sufficient capacity to refine enough heavy, high sulfur oil to meet global demand. Demand for oil in many markets, particularly transport markets in developed economies, has increasingly been for light, sweet crude oils. This has largely been the result of regulations mandating lower levels of sulfur in petrol and diesel fuels. Already there have been changes to regulations in Canada, Europe, Japan and the U.S. restricting the level of sulfur in fuels. In order to increase the volume of heavy, sour crude refined into light, sweet petroleum products, existing facilities will require upgrading, replacement and expansion.

Estimates of the level of investment needed to meet global demand vary, but the IEA projects that annual investment of US$105 billion will be required by the oil industry between 2005 and 2030. Of this projected investment, only 25% would be directed toward meeting new demand; the rest would be for maintaining or replacing existing production areas, refineries, pipelines and other facilities.

Levels of investment, however, have simply not kept pace with demand.

Investment barriers are partly to blame. These can include restrictions on foreign and domestic ownership, performance requirements, long lead times and volatile prices. Barriers include limits on the percentage of foreign ownership, discriminatory screening processes and performance requirements.

Even in areas where investment is legally permitted, there may remain certain environmental requirements that influence the level of investment.
As a result, there has been insufficient investment in the oil and gas sectors.

In the oil producing economies of China, Chile, Malaysia, Mexico, Thailand, and Vietnam, for example, oil production involves state-owned firms.

Governments in APEC are also involved in downstream activities including ownership of facilities, the regulation of prices, control of trade in petroleum products and the regulation of retail supply activities. In Mexico state-owned monopolies dominate the energy sector and some activities are considered to be strategic activities that are reserved exclusively for the state, while in Canada, a benefits plan must be approved by the government to get authorization to proceed with any oil and gas development.

In addition to the direct restrictions, foreign investment laws in many APEC economies are not transparent about the obligations of foreign investors, making such investors uncertain about the application of existing laws. The World Bank Investment Climate Surveys of firms recently indicated that in developing economies, policy- related risks are the main concern of firms, surpassing macroeconomic instability and taxation.

"It's mainly some of the governance arrangements," explains Gunasekera. "Do economies have fairly robust financial regulations, competition clauses, political and economic stability? These countries will have to improve their regulatory framework and governance framework that will safeguard the investment and facilitate foreign investment. These are long-term investments and very high capital investments."

At the end of the day, the barriers to investment are expected to constrain investment in alternative fuels, such as natural gas and coal, and renewable energy sources. They will also limit the introduction and use of new energy saving technologies that can be adapted in high oil intensive areas such as transport. An analysis of the Bogor Declaration in 2000 found that as a region, trade liberalization in APEC could result in increased regional production of fossil fuels in 2020.

"In the case of oil it's a long-term investment," says Gunasekera. "They [investors] have to make sure they have the proper framework before they invest. We have to start thinking about these issues now because they are long-term issues. Feasibility studies take time. These are things we have to think through. What can APEC do to entice foreign investment? Can we encourage them? Do economies have proper guidance?"

Energy Ministers have directed the Energy Working Group to collaborate more closely with the Organization of Petroleum Exporting Countries, or OPEC, other producers, the International Energy Agency and other international energy organizations as part of efforts to improve the transparency of energy markets and reduce price volatility. Notes Storer: "APEC Ministers agreed that the EWG can more closely engage with other international energy organizations through sharing information and collaborating in areas of mutual interest. OPEC's attendance at the Ministers' meeting was an important step in this regard."

The Ministers also encouraged APEC economies to facilitate cross-border energy trade, energy investment and energy emergency preparedness, and to share information and help build the capacity of economies to implement these objectives. They also encouraged APEC economies to accelerate cooperation to develop and deploy technologies that allow for more efficient energy use and energy diversification.

The Energy Ministers agreed that oil price subsidization distorts market signals. It prevents demand from properly responding to market prices and diverts government resources away from other priorities. Subsidies tend to encourage consumption and increases the oil intensity of economic activities. Of the three fuel-subsidizing economies of Indonesia, Thailand and Malaysia, for instance, the highest petroleum consumption per unit of gross domestic product is in Indonesia and that country had the largest fuel subsidy among the three economies in 2004. "In Indonesia, they have realized that the budget deficit has increased more and more because they have had to subsidize," says Gunasekera. "You need to show the cost of subsidization to the total economy and that is one way of convincing these economies [to stop subsidizing]. Indonesia has lowered the subsidies recently. Thailand and Malaysia might follow."

Effective responses to oil supply disruptions may include establishing strategic oil stocks; developing emergency preparedness plans; and information sharing and real-time communication. Oil stockpiling is essential.

The good news is that high oil prices may also increase the potential for exploration and production from unconventional sources. They may also lead to more cost-effective improvements in vehicle fuel efficiency and to the development of alternative transport fuels. Higher oil prices have made alternative transport fuels such as bio-fuels, hydrogen and dimethylether more economically competitive and provide major incentives to further diversify away from using oil in power generation, buildings and industry.

The Ministers encouraged APEC economies to remove market impediments to oil exploration and development and support capacity building efforts. They urged economies to promote the facilitation of new investments as well as more effectively utilize existing, downstream oil infrastructure. The Ministers encouraged economies to report timely and quality data under the Joint Oil Data Initiative (JODI) and directed the EWG to continue to build the capacity of APEC economies to undertake this task.

The Ministers also supported APEC efforts to remove barriers to oil trade in the region and directed the EWG to support initiatives regarding the freer trade of oil products. They also urged economies to participate in the Real-Time Emergency Information Sharing System, to develop emergency mechanisms and contingency plans; and to move towards best practice for the establishment and management of strategic oil stocks.

Practical measures to enhance cooperation supporting the development of alternative transport fuels, including the establishment of a Biofuels Task Force, were also endorsed. And Ministers urged economies to look at ways in which transport and vehicle efficiency might be improved.

The meeting also encouraged APEC economies to join the Renewable Energy and Energy Efficiency Financing Task Force to support efforts to facilitate investment in renewable energy and energy efficiency projects, including an initiative to facilitate the construction of high performance, energy efficient buildings and communities through innovative financing approaches.

It also encouraged APEC economies to create conditions that facilitate energy infrastructure investment, working with the business and financial communities.

According to estimates from ABARE, adopting more advanced energy technologies could reduce growth in energy consumption of the region's electricity sectors by 40% to 2030, saving 460 million tons of oil equivalent. APEC economies are global leaders in the development of many energy technologies and the challenge is to leverage and build on this strength through effective cooperation and collaboration.

The meeting directed the EWG to increase its cooperative activities to support the development and uptake of technologies for new and renewable energy, clean fossil energy including clean coal; carbon capture and storage, hydrogen and fuel cells and methane hydrates and it encouraged APEC economies to join the ad hoc group on nuclear energy.

Sizable fuel cost savings and major energy security benefits could be achieved in the medium to long-term for example by encouraging the use of more efficient fuel technologies, such as hybrid vehicles. Recent increases in hybrid vehicle sales in the U.S. indicate that hybrid vehicles are gradually becoming competitive with traditional vehicles and that consumers are willing to embrace this technology. Hybrid vehicles can reduce fuel use by up to 60% when compared with conventional internal combustion engine vehicles. By 2004 Toyota had sales of more than 100,000 hybrid vehicles with most sales being in North America and Japan. There are now indications that Toyota is beginning to break even on the cost of its hybrids. Indeed, sales of hybrids in the U.S. increased nearly tenfold from 9,350 in 2000 to 88,000 in 2004. And sales are expected to more than double this year (2005) to more than 200,000 according to auto consultants J.D. Power and Associates. "Can APEC countries economies take any policy initiatives to increase the penetration of hybrid vehicles over the next five to ten years time," asks Gunasekera. The whole issue of energy -- both petroleum and other energy technology -- is a key factor."

Fuel cell vehicles, meanwhile, offer higher efficiency levels and can convert 40%-60% of a fuel's energy to useful power depending on the fuel and components used. Hydrogen fuel cell vehicles can potentially achieve a level of fuel economy three times greater than conventional internal combustion engines.

In addition, a range of technologies is currently available that have the potential to produce liquid fuels from alternative sources, not requiring crude oil. Unconventional reserves such as tar sands, gas-to-liquids and coal-to-liquids are used by some of these technologies. A key attraction of coal to liquids technology in APEC is the sizable coal deposits including in the U.S., China, Australia, Canada and Indonesia.

China is already developing DCL technology, which involves making a partially refined synthetic crude oil from coal, which is further refined into synthetic gasoline and diesel as well as liquefied petroleum gas (LPG).

Shenhua Group Corporation, China's largest coal producer, is building the world's first commercial DCL facility in Inner Mongolia Autonomous Region.

An estimated US$850 million investment in the initial phase of the project is expected to transform 7,110 tons of bituminous coal into 20,000 barrels of ultra-clean, low sulfur, diesel and gasoline per day by 2007.