Energy transition in developing countries: Larger investments and more efficient use needed
Author: Yves Rovani

Contributor Notes

Issues in adjusting to higher prices and exploiting potential energy resources

This paper highlights the sources of payments problems in less developed countries. Growth in the industrial countries has a direct impact on the current account of the developing countries through its influence on both the prices and volumes of their exports. An increase in the real effective exchange rate is clearly a fundamental determinant of a deteriorating current account since, other things being equal, it tends to raise domestic demand for imports and to reduce foreign demand for exports.

Abstract

This paper highlights the sources of payments problems in less developed countries. Growth in the industrial countries has a direct impact on the current account of the developing countries through its influence on both the prices and volumes of their exports. An increase in the real effective exchange rate is clearly a fundamental determinant of a deteriorating current account since, other things being equal, it tends to raise domestic demand for imports and to reduce foreign demand for exports.

Yves Rovani

Since the dramatic change in energy prices in 1973, the world economy has been volatile and uncertain. After the initial shock, many felt that the problem would be a short-term financial one—manageable because the international money market was flexible, commodity prices were booming, and interest rates lagging behind inflation. Since the late 1970s, however, the problem has become more complex: inflation and the measures taken to combat it have contributed to a slowdown and eventual recession in the rich countries; world trade has stagnated, commodity prices have slumped; and protectionist pressures have intensified. Developing countries have experienced lower export earnings, vastly increased indebtedness, a reduced flow of external capital, and lower economic growth.

One of the most difficult tasks facing the majority of these countries (but one that is unavoidable if they are to resume healthy growth) is to adjust their economies to the higher costs of energy. For many, expanded investments to increase energy production and to raise the efficiency of their energy use will be central to the process of economic growth. These investments require:

• The mobilization of funds on an unprecedented scale, both externally and from domestic sources, particularly through operating surpluses in energy enterprises; and

• The upgrading of human resources to ensure that investments in energy development form part of a rational strategy, and that energy programs and projects are designed and executed in a cost-effective manner.

Moreover, these extra investments have to be made at a time when the aggregate oil import bill of the oil importing developing world has risen to $62 billion per annum (absorbing almost a quarter of total export earnings and over 50 percent for some countries). Further, borrowing for energy investments is double the level it was five years ago, and the creditworthiness of many of these countries has been eroded.

Two recent developments—the slowdown in world energy consumption and the significant softening in international oil prices—give the developing countries a temporary respite from the rising financial burden of importing energy. They do not, however, lessen the need for adjustment to higher prices.

Since 1980, global energy consumption has risen hardly at all and oil demand has fallen significantly. This is due partly to energy conservation and oil substitution measures, particularly in the industrial countries, and partly to the slowdown in economic activity. But though it is difficult to establish the relative importance of these two factors, it is widely agreed that even with continued conservation, the revival of global economic activity will result in a higher rate of energy consumption. As Chart 1 shows, the World Bank estimates that between 1980 and 1995 the developing countries’ commercial energy consumption will almost double. This is an annual growth of about 4.5 percent on average, or about the same rate as their projected growth in GDP over this period (of 4.8 percent).

Chart 1
Chart 1

Commercial primary energy consumption in developing countries, 1970–95

Citation: Finance & Development 0020, 004; 10.5089/9781616353551.022.A007

Sources: United Nations J Series and World Bank estimates.1Tons of oil equivalent.

As in the rest of the world, the developing countries’ oil consumption will grow much more slowly than total commercial energy consumption (at about 2.7 percent per annum, which is less than half the comparable rate for the 1970s). Nevertheless, this will still entail a 50 percent increase in their oil consumption in absolute terms by 1995. Moreover, despite this slowing down in the growth for oil demand and notwithstanding the major efforts that are planned to increase indigenous oil production, the oil importing developing countries will still need to increase their oil imports by over 30 percent between 1980 and 1995. These trends will make the developing countries a major global oil consumer. In incremental terms, these countries will account for the whole of the projected global increase in oil demand, offsetting declines in oil use by other country groups. Their share of global oil consumption will also rise from 20 percent in 1980 to 27 percent by 1995.

This expected revival in oil demand in the developing world is one important factor why the long-run trend of international oil prices is forecast to be rising. Obviously, short-term fluctuations in oil prices cannot be ruled out, but low prices, say in the range of $20–25 per barrel, are not expected to be sustainable in the longer run. Such prices would cause the growth in total energy demand to accelerate again and the demand for oil to increase even more sharply, since the price of oil would be lower than those of other fuels. On the supply side, much of this additional demand for oil could eventually only be met outside OPEC sources by developing petroleum resources costing, at the margin, more than $20-25 a barrel. Moreover, it is now generally agreed that giant oil fields that could be developed at lower costs than this are highly unlikely to be discovered. Recent experience has also shown that synthetic substitutes for oil are likely to be much more expensive than was initially envisaged.

Managing demand

Developing countries have already made progress in adjusting to higher energy prices. It is crucial for their future development that this adjustment be not only sustained but given additional momentum. The key elements of an adjustment strategy consist of: increasing the efficiency of energy use through rational pricing and demand management measures; undertaking an expanded and diversified program of investments to expand the supply of indigenous energy; raising resources to meet these new investment needs; and, finally, in order to carry out these tasks effectively, strengthening the management and institutional capacity in the energy sector.

Developing countries can improve the efficiency of energy use in virtually all sectors. There are many ways of achieving this, ranging from appropriate pricing policy to the provision of technical assistance and information to the main users. Experience has shown clearly that appropriate energy pricing is the single most effective way of managing demand. In many oil importing developing countries, changes in oil costs have been quickly reflected in the prices paid by final users; between 1975 and 1981, the growth in their real domestic prices kept pace with international prices. In contrast, in many oil exporting developing countries, retail petroleum product prices are still well below international prices. Moreover, in both groups of countries there are still distortions in the relative retail prices of different petroleum products. In the sector as a whole, more efforts need to be made in most countries to bring the price of domestically produced “fuels” (principally electricity but also coal and gas) more in line with the opportunity costs of supply.

Appropriate pricing usually needs to be supplemented by demand management programs. There are several reasons for this. First, energy users may be unaware of the potential for using energy more efficiently, or of the technical options available for doing so. Second, institutional or policy factors may reduce interest in saving energy—this is particularly true in state enterprises that are protected from competition and have their input and output prices regulated. Third, shortages of finance, or imperfections in the systems allocating finance, may make it difficult to finance economically attractive projects that improve the efficiency of energy use but do not expand production capacity. For the larger energy users—such as industrial plants, large public and private transport enterprises, and electric power utilities- direct government assistance and support may be necessary to identify and realize savings through such low-cost improvements as better energy management and maintenance, as well as through large investments in retrofitting and process change. For smaller users, the priority will be to develop policies conducive to efficient utilization as well as suitable institutions to provide firms and households with the information, incentives, and know-how to improve their own energy efficiency.

In the broader economic sense, a whole range of strategic and policy choices affect the future pattern and growth of energy demand in each country. The increased cost of energy requires a more critical review than is customary of the expansion plans of energy-intensive industries, the policies affecting the choice of transport modes, the design of commercial and institutional buildings, the urbanization patterns, the sources of primary energy for electric power, and the design and operation of petroleum refining facilities.

Increasing supply

Since 1973, developing countries have recognized that higher international oil prices make it worthwhile to exploit and develop indigenous energy resources that had previously been uneconomic, and most of them have strengthened programs to increase domestic energy supply. Analysis of the supply potential and market requirements of the developing countries indicates that their production of commercial energy could rise to almost double the 1980 levels, reaching 3.1 billion tons of oil equivalent, in 1995. About a third of this increase would be in the production of oil, 27 percent in coal, 22 percent in natural gas, and 19 percent in primary electricity drawn mainly from hydro and nuclear power (Chart 2). In the aggregate, this projected increase amounts to half of the projected global incremental commercial energy production over 1980–95 and it will result in the developing countries supplying over a third of the world’s commercial energy supply by 1995, as compared with one fourth in the 1970s. These projected increases in supply are based on an in-depth country-by-country evaluation of energy resources and production potential and take into account the limitations imposed by the growth of energy demand and the pace of fuel substitution programs in the developing countries. They reflect the fact that only a fraction of the enormous potential for exploiting indigenous energy sources in the developing world has been realized to date.

Chart 2
Chart 2

Commercial primary energy production in developing countries, 1970–951

Citation: Finance & Development 0020, 004; 10.5089/9781616353551.022.A007

Sources: United Nations J series and World Bank estimates.1 Total excludes alcohol, oil shale, tar sands, and other non-conventional primary energy sources that may add a small amount (up to 10 million toe, or less than 0.5 percent) to developing country energy production by 1995, but whose prospects are too uncertain to quantify.2 Tons of oil equivalent.3 Includes natural gas liquids and oil production from secondary recovery techniques.4 Includes hydropower, nuclear, and geothermal electricity.

Financing energy investment

Realizing the necessary investments will pose an enormous financing problem and will require far-reaching changes in the way energy operations are managed. Several developing countries have substantially increased their investments in energy. In Turkey, investments (in 1980 dollars) rose from $780 million in 1973 to $2.2 billion in 1980; in India, investments in the oil and gas sector grew at an average annual rate of about 25 percent, while overall energy investment during the same period grew about 19 percent per annum. In Pakistan, the share of energy in national investment increased from 15 percent in 1975 to 21 percent in 1981.

However, the investments of the past few years are dwarfed by the requirements for the future. Countries will need to devote a much larger share of their total resources to energy development than in the past. As a rough guide, energy investments may claim 4 percent of GDP in the 1980s compared with 2-3 percent in the late 1970s. The World Bank estimates that developing countries will need to invest $30 billion a year in energy production (in 1982 dollars) during 1982–92 (see table). About $60 billion of this required investment is in electric power, which is becoming more capital-intensive because of an increasing reliance on hydro resources and coal-fired thermal generation. Investments in oil are also likely to rise dramatically from historical levels and amount to about $40 billion a year, while gas and coal account for the remainder.

Commercial energy investment requirements in developing countries, 1982–92

(In billions of U.S. dollars)

article image
Source: World Bank estimates.Note: These estimates are for the investments required during 1982–92 to achieve the energy production levels set out in Chart 2. Some additional investments amounting to $13 billion per annum will be required in 1993–95 to complete the projects for 1995 production. Expenditures shown in this table do not include investments for fuel storage and retail distribution (except for pipeline investments for domestic distribution of natural gas) and for infrastructure associated with energy imports.

Includes maintenance of old fields, enhanced and secondary oil recovery, pipelines, and infrastructure.

Estimates include investments in refinery modifications necessary to achieve a balance between petroleum product supply and demand within developing countries, as well as investments in refinery rehabilitation and replacement of old plant and in energy conservation measures. These estimates could vary by as much as 20 percent, depending on assumptions concerning the refinery mix in China, and on the extent to which product imbalances in the developing countries are met through direct trade in refined products. Estimates exclude investments in infrastructural development, which amount to about $10 billion.

Distribution of gas from major transmission pipelines to residential and commercial users.

Two general points need to be emphasized about these estimates of investment costs. One is that energy investments are becoming more and more expensive. For example, to generate a kilowatt of hydro-electricity can require three to four times as much investment as to generate a kilowatt by burning oil. Second, costly as they are, the investments projected are not only necessary and technically feasible—they will also remain economically attractive under a wide range of oil prices. Most of them would still be profitable even if the world oil price settled at a much lower level, that is, at $25 a barrel in 1983 dollars.

Just over half of the total sum required by developing countries, or $66 billion a year, is needed in domestic currencies. Especially in power and coal, where 60-75 percent of the financing needed is for local costs, expansion programs will stand or fall on the ability to raise domestic resources. This calls for strong action, first, to reform pricing policies, so that consumers pay the economic costs of supply, allowing enterprises to finance expansion; and, second, to modernize management, so that enterprises are more efficiently run.

The other part of the resource requirement—$64 billion a year—is for foreign exchange. At present, the foreign exchange flows to developing countries for these purposes amount to only $25 billion a year. The size of the difference speaks for itself.

But there is an additional difficulty, which concerns the distribution of investment flows among countries and among “fuels.” The middle-income countries will, by and large, be creditworthy enough to borrow from commercial banks and to obtain export-related credits on commercial terms. As a group, they currently obtain 50 percent of their external energy financing from these two sources. Most of those exporting oil can also obtain equity financing from international oil companies.

Low-income countries, by contrast, receive very little direct private investment and obtain 80 percent of their external energy borrowing from multilateral and concessional bilateral sources. For many of them, the viability of future energy development programs will depend on the expansion of financing from these sources. In 1975–80, official sources provided about S4 billion a year (in 1982 dollars) for energy in developing countries at all income levels. The low-income countries need about $8.6 billion annually in foreign exchange, but if present external financing patterns for energy continue, they can expect a total of less than half this amount from all sources.

Perhaps the most vulnerable part of the projected investment program—though frequently the most promising from the point of view of national development—is that for oil and gas in oil importing countries. The estimated foreign exchange requirement of $9 billion a year for oil and gas projects in these countries is about equal to the current publicly guaranteed financing flows for the whole energy sector in these countries.

Improving energy management

Throughout the developing world, making the best use of the resources available for energy investments will be a complex task for governments. The sheer increase in the number of potential energy projects and the size of energy investment programs poses a major management challenge. Added to this, there are several reasons why energy investments, at the national and enterprise levels, can be peculiarly difficult to plan and manage:

• The resource base is uncertain;

• The technologies to be used are often new, rapidly changing, and risky;

• Investments are lumpy, often large in relation to GDP, and mistakes are expensive;

• The investments need a long planning horizon. Over 10-20 years, there is a wide range of possible patterns of growth and demand for energy. It is risky, but often worthwhile, to keep some strategic options open as long as possible;

• Last, energy is an input or an output in almost all productive activity. Not only do energy investments compete with those in other sectors—decisions on them cannot be taken without considering their relationships with trends and policies in the rest of the economy.

Energy investments thus need to be conceived as part of a national energy development strategy that clearly defines supply and demand objectives, the measures that will be used to achieve them, and the respective roles of the various public and private agencies involved. Planning and implementing such a strategy, and ensuring that investments are designed and implemented in a cost-effective manner, requires a supportive policy environment and, extremely important, people with training and experience.

The World Bank’s role

The principal objective of the Bank’s energy program is to assist developing countries to define and implement an appropriate development strategy for the energy sector. The urgency and the magnitude of the necessary structural adjustments demand greater attention to policy and management issues, preinvestment studies to formulate better strategies for energy supply and utilization, and the mobilization of financing. The Bank functions as a catalyst in promoting strategy formulation, policy reform, and institutional improvements; and in mobilizing external sources of technology and finance to implement effectively the changed investment priorities in developing countries. It has expanded and diversified its energy lending and is putting greater emphasis on assisting borrowers in the choice and use of new technologies, strengthening institutions, and improving the policy framework in the energy sector.

The Bank’s dialogue with national policymakers covers a wide range of issues; these may include demand management and pricing, interfuel substitution, investment planning, resource mobilization, and the respective roles of public and private agencies in the development of the sector. This work has made an important contribution in helping to define “energy” as an integrated sector in many developing countries. Because of the unfamiliar issues posed by a sudden change in relative costs of different forms of energy, there was a clear need for assistance to developing countries in evaluating their main energy issues and options. To meet this need, the Bank collaborated with the United Nations Development Program in launching the Energy Sector Assessment Program, which is designed also to serve as a framework for further multilateral and bilateral assistance in the sector. Studies of 21 countries have been completed under this program and another 14 are in an advanced stage of processing. This program is being followed by an Energy Sector Management Program designed to provide a rapid and flexible response to governments who request technical or management assistance in implementing the strategy proposed in the energy assessments and in carrying out prefeasibility studies to identify priority energy projects.

The Bank’s advice is backed by a significant amount of lending for energy projects, making it the single most important official source of external capital for energy development in the developing countries. Its energy lending has risen from $1.5 billion in fiscal year 1979 to about $3 billion in fiscal year 1983 (including $343.8 million in concessional IDA credits). Further, the Bank has made a special effort to mobilize additional external financing and promote opportunities for direct private investment. During fiscal year 1979–83, the $12.9 billion of Bank lending for energy was associated with another $12 billion of cofinancing from other external sources. A key feature of the Bank’s energy lending in recent years has been the increase in lending for oil and gas exploration and development, from $112 million in 4 projects in fiscal year 1979 to $1 billion in 17 projects in fiscal year 1983. In this period, the Bank has supported petroleum projects in 36 countries. Energy lending has also been diversified to support the development of coal and other primary energy sources.

While the need and the scope for increasing the scale of Bank involvement in the energy sector is clearly considerable, the Bank’s financial contribution will be a limited one: energy cannot claim more than 25 percent of its total lending without compromising programs in other sectors. Despite the scarcity of IBRD and IDA resources, continuation of Bank involvement at this level is justified by the priority that the energy sector has in the overall adjustment process for many developing countries, by the complex and substantial adjustment that is urgently required within the energy sector in member countries, and by the very large volume of financing necessary to carry out such adjustment.

Finance & Development, December 1983
Author: International Monetary Fund. External Relations Dept.
  • View in gallery

    Commercial primary energy consumption in developing countries, 1970–95

  • View in gallery

    Commercial primary energy production in developing countries, 1970–951