Energy reform in major emerging economies: new models for sustained growth:
Building long-term resilience
Major emerging economies in the global energy system
Over the last two decades, the rise of emerging markets and developing economies has transformed the global economy, and in the process, reshaped the world’s energy system.24 With annual growth rates reaching 7.6% during the 2000s,25 emerging economies grew nine times faster than advanced economies between 2007 and 2014; today, they account for 57% of global output.26 With 90% of net energy demand growth until 2035 expected to come from emerging economies, understanding the key trends shaping the energy landscape of these economies offers valuable insights for the future of the global energy system.27
This section focuses on seven of the largest emerging economies when measured at GDP (2013) at purchasing power parity (PPP): Brazil, the Russian Federation, India, China – the BRICs – as well as Mexico, Indonesia and Turkey.28 These countries have a higher combined GDP (at PPP) than the current G7; this report refers to this cluster of countries as the “E7”.29 The economic power of the E7 economies is reflected in the energy sector today, with these seven countries accounting for close to 40% of total primary energy consumption (Figure 5) and 43% of total CO2 emissions (Figure 6).30
This dominance brings its own challenges; the EAPI serves to highlight some of the chokepoints these economies face across their energy systems (Figure 7). In particular, the EAPI underscores opportunities to improve environmental sustainability (average score of 0.53) while increasing economic growth and development (average score of 0.53). The analysis of the BRICs in the previous section also highlighted that improving energy intensity, reducing carbon emissions and continuing to diversity the energy mix are some of the areas of performance-lag within these energy systems.
The EAPI presents one snapshot in time. As economic, social and political forces across these markets continue to shift, so will the overall parameters of these energy systems. Growth, industrialization and urbanization create new pressures, including substantial local air pollution, congestion and other stresses, to which increasingly vocal civil society groups are demanding solutions.
These shifts constitute some of the drivers behind energy reforms enacted over the last decades. Most have focused on the market liberalization in the electricity or oil and gas sectors, including the reform of state monopolies, the introduction of more competition, and the reform of energy pricing mechanisms and subsidies. However, the velocity and long-term implementation of these changes has been underwhelming, with many structural weaknesses left unaddressed.
Energy reform in an era of slower growth – avoiding a “trapped transition”
The changing nature of today’s global economy has increased the stakes involved in following through with successful energy reforms. The rapid “catch up” phase of the past decade is drawing to a close: growth across emerging markets is now forecast to be 1.5 percentage points lower than 2011, industrial output is stalling, and consumer spending has fallen to its lowest since 2009.31 The International Monetary Fund (IMF)’s Chief Economist Olivier Blanchard describes this slowdown as the “dominating factor” driving the future shape of emerging market economies.32 External factors and macroeconomic trends – including drops in commodity prices and protracted global trade – have contributed to this slowdown.33 But internal conditions have also played a role, with structural weaknesses too often left unaddressed in many large economies. Stalled or abandoned reforms have left many markets susceptible to stresses in the energy system.
Major emerging economies should continue to build capacity for resilience by going through with required reforms, including in the energy sector. Those who fail to act risk becoming “trapped in transition”. Shell’s New Lens Scenarios describe the stark choice facing many major emerging economies: build financial, technological, social and political capital through effective reforms to better withstand crises in the long term by adapting to changing conditions (through “room for manoeuvre”), or continue along the path of business as usual by postponing change, and risk having to passively react to changes within a trapped transition scenario.34 Ultimately, the latter option – reflecting “decision-making for the short term” – is not a valuable path forward; instead, those with the foresight to opt for the former will reap the greatest rewards.
Business as usual is no longer sufficient to regain the fast growth of the 2000s into the next decades, or to avoid growth from slowing down too much. In the “Report on the Work of the Government”, delivered at the Fifth Session of the Eleventh National People’s Congress in March 2012, former Chinese Premier Wen Jiabao remarked that the country’s economic model is likely to prove “unbalanced, uncoordinated and unsustainable”.35 Deep reforms of the energy sector are central to China’s broader structural reforms of the economy. Likewise, the ambitious energy reforms on which Mexico has embarked provide a strong example of the importance that energy reforms can play in a broader set of economic restructuring and modernization.
The prize: architecting a competitive energy system for the long term
Avoiding this trap will require new approaches. There is no simple reform formula; countries will need to find their own right path, drawing on the successes and failures of others, and balancing the trade-offs across the energy triangle. Addressing areas of value lag and identifying new sources of value are possible starting points to enable sustained growth. Ultimately, the right energy reforms have huge potential to positively impact a country’s economy, and put competitiveness back on track.
To address areas of value lag, governments will need to push forward existing reforms, with a particular focus on removing energy subsidies, improving the energy intensity of their economies, and making progress with market reform. Energy subsidies divert government revenues that could be utilized more productively within the energy sector or in other parts of the economy. For example, in Indonesia – which this year overtook the United Kingdom to join the ranks of top 10 economies by GDP at PPP36 – energy subsidies represented 18.8% of government spend in 2013 (up from 15% in 2006), the near equivalent of the UK government’s spend on the National Health Service.37 This is a huge political challenge for many emerging economies, so the removal of these needs to be carefully managed and synchronized with other reforms of the public sector to facilitate change while avoiding stirring protest movements. Energy intensity can be addressed through energy efficiency measures and economic fundamentals – the shift to a post-industrial economy that requires free trade, skilled labour and increased flows of investments. Market reforms involve both deregulation and/or increased regulation, to support decarbonization and diversification (e.g. through renewable targets or carbon prices) for example.
New imperatives also present an opportunity to better prepare for the future by creating new sources of value. This will include increased technological innovation and support for the development of new sources of supply, with emerging economies playing a key role – two-thirds of energy supply investment is expected to take place in these countries by 2035.38 China, for example, is successfully building new value chains in clean energy. It has become a market leader in solar power through a combination of government policies and market guidance, with the Golden Sun Programme, the Building Integrated PV subsidy programme and the Feed-in Tariffs for solar projects playing an instrumental role.39 China is now the largest solar PV market, doubling in 2013 and expected to grow by 30% in 2014.40 Transitioning to an energy system that provides more opportunities, as China’s solar programme shows, requires considerable investment and policies supporting the research and development of new technologies (including digital).
A number of governments are already exploring these opportunities. Most notably, in December last year, Mexico’s President Enrique Peña Nieto announced a number of far-reaching energy reforms across two main areas. First, private investment will be permitted throughout the entire oil, gas and power value chains. Second, the energy sector’s public entities – Pemex and CFE – will be transformed to improve their efficiency and profitability.
Other countries may soon follow suit. With growth in India falling below 5% for two consecutive years,41 the new government has a strong mandate to accelerate development and strengthen public service delivery. Prime Minister Modi has called for a “saffron revolution” to address India’s growing energy demand with renewable energy sources, primarily solar.42 The power sector is also changing, with new policies paving the way for the coal industry to gradually open up to private players.
These reform architects should bear in mind that effective energy policy design is not sufficient; pragmatic implementation is critical for long-term success. The energy reforms implemented under their watch will survive their time in office; effective reform in this context will be based on maintaining the long-sightedness required to think beyond the immediate future.
The next sections offer today’s reformers in emerging economies a number of insights gleaned from past energy reforms across three key areas: strengthening institutional capacity (“enacting sound policies in solid institutions”); attracting inward investment (“signalling market readiness”) and engaging with the public (“mastering public engagement”). This analysis is based on case studies spanning different types of energy policies (energy subsidies, changes to fiscal regime, air pollution regulations, etc.) across a portfolio of energy sectors (electricity, oil and gas) with six emerging economies: India, Brazil, Colombia, Nigeria, China and Indonesia. The overview of all case studies is shown in Figure 8.