WORLD ENERGY MODEL - METHODOLOGY AND ASSUMPTIONS

Background
Since 1993, the IEA has provided medium to long-term energy projections using a World Energy Model (WEM). The WEM a large-scale mathematical construct designed to replicate how energy markets function is the principal tool used to generate detailed sector-by-sector and region-by region projections for both the Reference and Alternative Policy Scenarios. The model, which has been developed over many years, is made up of six main modules: final energy demand; power generation; refinery and other transformation; fossil-fuel supply; CO2 emissions and investment. The development and running of the WEM requires access to huge quantities of historical data on economic and energy variables. Most of the data are obtained from the IEAs own databases of energy and economic statistics, available at www.iea.org/Textbase/stats/index.asp. The IEA has gained recognition as one of the worlds most authoritative sources for energy statistics. Additional data from a wide range of external sources is also used. These sources are indicated in the relevant sections of this report. The World Energy Model is updated constantly. The development of the WEM benefits from expert review and the IEA works closely with colleagues in the modeling community, for example, by participating in the annual Energy Modeling Forum, which will be held at IEA Headquarters in 2007. The current World Energy Model, which is comprised of nearly 16,000 equations, is the tenth version of the model. It covers 21 regions (Annex 1). The WEM is designed to analyse: Global energy prospects: These include trends in demand, supply availability and constraints, international trade and energy balances by sector and by fuel to 2030. Environmental impact of energy use: CO2 emissions from fuel combustion are derived from the detailed projections of energy consumption. Effects of policy actions and technological changes: Alternative policy scenarios analyse the impact of policy actions and technological developments on energy demand, supply, trade, investments and emissions. Investment in the energy sector: The model evaluates investment requirements in the fuel supply chain needed to satisfy projected energy demand to 2030. It also evaluates demand-side investment requirements in the Alternative Policy Scenario.

New Features in World Energy Outlook 2006

The WEM was expanded for the WEO-2006 and now includes the following new features: Greater regional disaggregation, with the development of new, detailed models for the United States and Japan. Separate models for Canada, Korea and North Africa. Projections to 2015 and 2030. More detailed sectoral representation of end-use sectors for non-OECD countries, including aviation and detailed transport-stock models. Detailed analysis of the use of cooking fuels in developing countries. More sophisticated treatment of biofuels use and supply, and of renewables for heating in end-use sectors. An updated analysis of power-generation capital and operating costs, including a more detailed assessment of nuclear power and renewable energy technologies. Calibration of the oil and gas production and oil-refining models to the results of a detailed analysis of the near-term prospects for investment.

The Reference and Alternative Policy Scenarios

The Reference Scenario takes account of government policies and measures that have been enacted or adopted in the case of the WEO 2006, by mid-2006 though many of them have not yet been fully implemented. Thus, the Reference Scenario projections should not be considered forecasts, but rather a baseline vision of how energy markets would evolve if governments do nothing beyond what they have already committed themselves to doing to influence long-term energy trends. By contrast, the Alternative Policy Scenario analyses the impact of a range of policies and measures that countries in all regions are considering adopting or might reasonably be expected to adopt at some point over the projection period. A key reason for implementing these improvements has been to deepen the analysis contained in the Alternative Policy Scenario. With the revised WEM, the impact of specific policies and measures on energy demand, production, trade, investment needs, supply costs and emissions can be evaluated with greater precision. A policies and measures database, with over 1,400 policies in OECD and non-OECD countries, was compiled to support this new scenario. This database is available at www.worldenergyoutlook.org/dbase.asp

Previous Improvements to the World Energy Model

The WEM underwent a significant transformation for the WEO-2002, extending the time horizon to 2030. The model was further extended for the WEO-2004, including among other developments twenty regional models, more detailed

sub-models for industry, transport, residential and services sectors in the major non-OECD countries, a new renewable energy model, a separate CHP model and a new coal production model. The model for the 2005 Outlook was further expanded to include nine country models: Algeria, Egypt, Iran, Iraq, Kuwait, Libya, Qatar, Saudi Arabia and UAE, and two new regional aggregates, other Middle East and other North Africa, to cover the entire Middle East and North Africa (MENA) region. Other important additions included: an oil and gas fieldby-field production analysis for the key countries in the MENA region; a water desalination module to project energy demand for desalination in the Saudi Arabia, Qatar, the UAE, Kuwait, Algeria and Libya; and a global refinery model to project product demand and capacity additions to 2030.

World Energy Model Structure

The WEM is a mathematical model made up of six main modules: final energy demand; power generation; refinery and other transformation; fossil fuel supply; CO2 emissions, and investment. Figure 1 provides a simplified overview of the structure of the model.

Figure 1: World Energy Model Overview

The main exogenous assumptions concern economic growth, demographics, international fossil fuel prices and technological developments. Electricity consumption and electricity prices dynamically link the final energy demand and power generation modules. The refinery model projects throughput and capacity requirements based on global oil demand. Primary demand for fossil fuels serves as input for the supply modules. Complete energy balances are compiled at a

regional level and the CO2 emissions of each region are then calculated using derived carbon factors.

Technical Aspects and Key Assumptions

The parameters of the equations of the demand-side modules are estimated econometrically, usually using data for the period 1971-2004. Shorter periods are sometimes used where data are unavailable or significant structural breaks have occurred. To take into account expected changes in structure, policy or technology, adjustments to these parameters are sometimes made over the Outlook period, using econometric and other modelling techniques. Simulations are carried out on an annual basis. Demand modules can be isolated and simulations run separately. This is particularly useful in the adjustment process and in sensitivity analyses related to specific factors. The WEM makes use of a wide range of software, including specific database management tools, econometric software and simulation programmes. The same macroeconomic and population assumptions are used in the Reference and Alternative Policy Scenarios. The projections are based on the average retail prices of each fuel used in final uses, power generation and other transformation sectors. These prices are derived from assumptions about the international prices of fossil fuels. The price assumptions in WEO-2006 are significantly higher than assumed in the last edition of the Outlook. This revision reflects the continuing recent tightness of crude oil and refined-product markets, resulting, to a large extent, from tight product-upgrading capacity.

Population Assumptions
Rates of population growth for each region are based on the most recent projections contained in the United Nations report, World Population Prospects: The 2004 Revision. In the WEO-2006, global population is projected to grow by 1% per year on average (Table 1), from an estimated 6.4 billion in mid-2004 to over 8.1 billion in 2030. Population growth slows progressively over the projection period, as it did in the last three decades, from 1.1% per year in 2004-2015 to 0.8% in 2015-2030. Population expanded by 1.5% per year from 1980 to 2004.

Table 1: World Population Growth (average annual growth rates, %)

19801990 OECD North America United States 0.8 1.2 0.9 19902004 0.8 1.3 1.2 20042015 0.5 0.9 0.9 20152030 0.3 0.7 0.7 20042030 0.4 0.8 0.8

Europe Pacific Japan Transition economies Russia Developing countries Developing Asia China India Middle East Africa Latin America Brazil World European Union

0.5 0.8 0.6 0.8 0.6 2.1 1.8 1.5 2.1 3.6 2.9 2.0 2.1 1.7 0.3

0.5 0.5 0.2 -0.2 -0.2 1.7 1.5 1.0 1.7 2.4 2.4 1.6 1.5 1.4 0.3

0.3 0.2 0.0 -0.2 -0.5 1.3 1.1 0.6 1.3 2.0 2.1 1.3 1.2 1.1 0.1

0.1 -0.1 -0.3 -0.3 -0.6 1.0 0.8 0.3 0.9 1.6 1.8 0.9 0.8 0.8 0.0

0.2 0.0 -0.2 -0.3 -0.5 1.2 0.9 0.4 1.1 1.7 1.9 1.1 0.9 1.0 0.0

Macroeconomic Factors
Economic growth assumptions for the short to medium term are based largely on those prepared by the Organisation for Economic Co-operation and Development, the International Monetary Fund and the World Bank. Over the long term, growth in each region is assumed to converge to an annual long-term rate. This is dependent on demographic and productivity trends, macroeconomic conditions and the pace of technological change. In the WEO-2006, GDP growth is expected to slow gradually over the projection period in all regions (Table 2). World GDP is assumed to grow by an average of 3.4% per year over the period 2004-2030. Growth drops from an average of 4% in 2004-2015 to 2.9% in 2015-2030. Developing Asian countries are expected to continue to grow faster than any other region, followed by the Middle East and Africa. The Chinese economy is assumed to grow fastest at 5.5% per year over the projection period, overtaking the United States as the worlds largest economy in PPP terms by around 2015. Growth nonetheless slows as the economy matures and population levels off. GDP in the OECD as a whole is assumed to grow by 2.2% per year over the projection period. Growth rates in the three OECD regions are expected to slow progressively over the projection period, as population growth slows or reverses and their economies mature. All regions continue to experience a decline in the share of energy-intensive heavy manufacturing in economic output and a rise in the share of lighter industries and services, particularly in the developing world where the process is least advanced.

Table 2: World Real GDP Growth (average annual growth rates, %)

19801990 OECD North America United States Europe Pacific Japan Transition economies Russia Developing countries Developing Asia China India Middle East Africa Latin America Brazil World European Union 3.0 3.1 3.2 2.4 4.2 3.9 -0.5 3.9 6.6 9.1 6.0 -0.4 2.1 1.3 1.5 2.9 2.4 19902004 2.5 3.0 3.0 2.2 2.2 1.3 -0.8 0.6* 5.7 7.3 10.1 5.7 3.9 2.8 2.8 2.6 3.4 2.1 20042015 2.6 2.9 2.9 2.3 2.3 1.7 4.4 4.2 5.8 6.4 7.3 6.4 5.0 4.4 3.5 3.3 4.0 2.2 20152030 1.9 2.0 1.9 1.8 1.6 1.3 2.9 2.9 3.9 4.1 4.3 4.2 3.2 3.6 2.9 2.8 2.9 1.8 20042030 2.2 2.4 2.3 2.0 1.9 1.4 3.6 3.4 4.7 5.1 5.5 5.1 4.0 3.9 3.2 3.0 3.4 2.0

* 1992-2004.

Description of the Modules

Final Energy Demand
The OECD regions and the major non-OECD regions are modelled in considerable sectoral and end-use detail. Specifically: Industry is separated into six sub-sectors, allowing a more detailed analysis of trends and drivers in the industrial sector. Residential energy demand is separated into five end-uses by fuel. Services demand is modelled as three end-uses by fuel. Transport demand is modelled in detail by mode and fuel.

Final energy demand is modelled at the sectoral level for each of the WEO regions, but not at such a disaggregated end-use level.

Total final energy demand is the sum of energy consumption in each final demand sector. In each sub-sector or end-use, at least six types of energy are shown: coal, oil, gas, electricity, heat and renewables. However, this level of aggregation conceals more detail. For example, the different oil products are modelled separately as an input to the refinery model. Within each sub-sector or end-use, energy demand is estimated as the product of an energy intensity and an activity variable. In most of the equations, energy demand is a function of the following variables: Activity variables: This is often a GDP or GDP-per-capita variable. In many cases, however, a specific activity variable, which is usually driven by GDP, is used. Prices: End-user prices are calculated from assumed international energy prices. They take into account both variable and fixed taxes, as well as transformation and distribution costs. For each sector, a representative price (usually a weighted average) is derived. This takes account of the product mix in final consumption and differences between countries. This representative price is then used as an explanatory variable directly, with a lag, or as a moving average. Other variables: Other variables are used to take into account structural and technological changes, saturation effects or other important drivers.

Industry Sector
The industrial sector in the OECD regions is split into six sub-sectors: iron and steel, chemicals, paper and pulp, food and beverages, non-metallic minerals and other industry. For the non-OECD regions, the breakdown is typically based on four instead of six sub-sectors. The intensity of fuel consumption per unit of each sub-sectors output is projected on an econometric basis. The output level of each sub-sector is modelled separately and is combined with projections of its fuel intensity to derive the consumption of each fuel by sub-sector. This allows more detailed analysis of the drivers of demand and of the impact of structural change on fuel consumption trends. The increased disaggregation also facilitates the modelling of alternative scenarios, where end-use shares and technology descriptions are applied in conjunction with capital stock turnover models to analyse in detail the impact of alternative policies or different choices of technology.

Transport Sector

For WEO 2006 we have greatly expanded the analysis of the transportation section of the model to include a detailed car stock sub-model and aviation submodel. The WEM fully incorporates a detailed bottom-up approach for the transport sector in all OECD and major non-OECD regions. Transport energy demand is split between passenger and freight and is broken down among light duty vehicles, buses, trucks, rail, aviation and navigation. Passenger cars and light trucks are subdivided by fuel used gasoline, diesel, alternative fuels or hybrids of these. Freight trucks are divided between gasoline- and diesel-driven. The gap between test and on-road fuel efficiency is also estimated and projected. As the largest share of energy demand in transport comes from oil use for road transport we have updated the WEM with a detailed sub-model based on an Sshaped Gompertz function, proposed in a paper titled "Vehicle Ownership and Income Growth, Worldwide: 1960-2030" by Dargay et al. This model gives the vehicle ownership based on income (our GDP assumptions through to 2030) and 2 variables: the saturation level (assumed to be the maximum vehicle ownership of a country/region) and the speed at which the saturation level is reached. The equation used is:

Vt = ye ae

bGDP t

Where V is the vehicle ownership (expressed as number of vehicles per 1000 people), y is the saturation level (expressed as number of vehicles per 1000 people), a and b are negative parameters defining the shape of the function (i.e. the speed of reaching saturation). The saturation level is based on several country/region specific factors such as population density, urbanisation and infrastructure development. Passenger car ownership is then calculated based on the vehicle breakdown from World Road Statistics 2005 from the International Road Federation plus other regional statistics. Using the equation above, changes in passenger car ownership over time are modelled, based on the average current global passenger car ownership. Both total vehicle stock and passenger vehicle stock projections are then derived based on our population assumptions. For each region, activity levels for each mode of transport are estimated econometrically as a function of population, GDP and price. Transport activity is linked to price through elasticity of fuel cost per km, which is estimated for all modes except passenger buses and trains and inland navigation. This elasticity variable accounts for the rebound effect of increased car use that follows improved fuel efficiency. Energy intensity is projected by transport mode, taking into account changes in energy efficiency and fuel prices.

The light-duty vehicle section of the model has been enlarged by the addition a module that analyses the contribution of different vehicle technologies to fuel economy improvements, using projections on the evolution of energy efficiency. The module incorporates an evaluation of the potential available from several technology options, as well as the likelihood of their market penetration. The technologies considered include lightweighting, improved combustion in internal combustion engines, energy-efficient tyres, improved aerodynamics, and reduced energy load due to the use of efficient on-board appliances. The contribution of advanced powertrain technologies as hybrid-electric vehicles has also been taken into account. The aviation sub-model has been vastly expanded for WEO 2006. A database or all global regions of projected traffic measured in revenue passenger kilometres was compiled based on data from Boeing and Airbus. The traffic projections allow for modal shift in Europe, Japan and China due to policies considered in the Alternative Policy Scenario. We have calculated current and projected regional average aircraft fleet efficiency based on data from The Intergovernmental Panel on Climate Change, the Annual Review of Energy and the Environment and the International Air Transport Association. The projected traffic growth combined with the assumed efficiency improvements in both the Reference and Alternative Policy Scenarios allow the projected oil aviation demand to be calculated region by region.

Residential and Services Sectors

The energy demand model for the residential and services sectors has been significantly increased for the major non-OECD regions (Figure 2). For the other non-OECD regions, energy consumption in these sectors has been calculated econometrically for each fuel as a function of GDP, the related fuel price and the lag of energy consumption. The services sector model splits consumption by fuel into three end-uses: heating, hot water and cooking use (HHC); personal computer (PC) use (including related equipment); and other electricity end-uses, including ventilation, space cooling and lighting. The total fuel demand for HHC is projected per square metre of floor area. Floor area in services is estimated as a function of value-added in the sector, which in turn is projected from GDP assumptions. The total demand for HHC is then allocated to two components: an existing stock model determines energy consumption based on the historical shares of each fuel, while a portion of demand is allocated to new stock, where fuel shares are a function of both relative prices and existing shares of each fuel. Projections of PC-related electricity use and per-square-metre electricity use for the other electricity end-uses are combined to calculate their total electricity

demand. The estimation of PC numbers is based on the growth in services sector employment and the size of the working population.

Figure 2: Structure of the Residential and Services Sectors Demand Modules

Refinery Module
For each WEO region, the module estimates a base case refinery output, given past domestic demand and the regions share in global trade. Demand in the medium term is based on existing projects in all WEO regions. On the basis of information obtained regarding these projects and on regional capacity utilisation rates, the model determines the additional capacity needed by region. Historical capacity figures for the module are based on data from the Oil and Gas Journal and British Petroleum. Current capacity figures are from the IEAs Oil Market Report, company sources, industry journals and national statistics. Throughput and capacity projections are based on the Reference Scenario oil demand projections by world region/country. The model adjusts global refinery demand among the major regions: OECD, transition economies, China, India, Middle East, North Africa and other developing regions. Capacities are then disaggregated according to production, demand, exports of crude and refined products, and costs. Figure 3 shows the structure of the refinery module. After determining individual refinery output and capacity, the module calculates the global oil products balance. Total demand for oil products (excluding direct use of crude) is matched with the total supply of oil products, including products from NGLs and GTLs. Thus, at the global level: Total refinery output = total oil product demand (NGLs + GTL products) + (own-use of refineries) The refinery model balances supply and demand through an optimisation process. Excess demand is split according to an optimisation matrix which takes into account unit costs, environmental and political constraints and capacity constraints.

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Figure 3: Structure of the Refinery Module

Oil product demand from WEM
Oil Supply Non-refinery Oil Products from NGL and GTL processes

Light product demand Middle distillates demand Heavy product demand

Distillation Capacity

Refinery Output by Region

Conversion capacity

Additions and Conversion Investment

There are three types of distillation capacity additions: new refinery (highest cost); added capacity at an existing refinery; and capacity creep (lowest cost). Distillation capacity refers to calendar day capacity. Investment requirements are separated between additions investments and conversion investments. Additions investments are based on current costs which vary among regions/countries. For additions investment, the model projects the share of distillation capacity additions for each region/country and allocates costs accordingly. Conversion investments are based on the estimated costs of modifying existing capacity to cope with new demand (lighter products) or new environmental restrictions on products (sulphur content). Demand is divided into three products: light, middle and heavy. The model uses the sectoral breakdown and the region/country specification to project product demand. The refinery module projects the necessary capacity conversions, based on the demand projections for light, middle and heavy products and on anticipated environmental regulations. The projections are used to calculate investment in cost per million barrels per day converted. We calculated a weighted average technology cost, taking into account the cost of each different technology such as catalytic crackers and hydro-skimmers, from industry sources. The refinery investments do not include maintenance costs.

Power Generation and Heat Plants

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The power generation module calculates the following: Electricity demand. Amount of electricity generated by each type of plant to meet electricity demand. Amount of new generating capacity needed. Type of new plants to be built. Fuel consumption of the power generation sector. Electricity prices.

Electricity Demand
For each region, electricity demand is computed in the demand module by sector (see above). Various factors influence demand for electricity services, including electricity price, household income, and the possibility to switch to others energy sources to provide the same service. The long-term own-price elasticity of electricity demand is very low, ranging from -0.01 to -0.14 for the 21 WEO regions. Economic activity is the main driver of electricity demand in all regions. Average income elasticities of demand across all end-use sectors, using per-capita GDP as a proxy for income, range from 0.4 to 1.3. Elasticities are generally highest in non-OECD regions: on average, their electricity demand rises faster than income. OECD electricity demand is income-inelastic. This difference reflects saturation effects in the OECD and catching-up by the poorer developing countries. It also reflects changes in the structure of economic activities. Heavy electricityintensive industry has contributed more of the increase in GDP in non-OECD countries than in the OECD. The energy efficiency of electrical equipment and appliances in non-OECD countries is also generally lower, boosting electricity intensity.

Electricity Generation and Power Prices

The structure of the power generation module is described in Figure 4. For each region, electricity generation is calculated by adding to the electricity demand projection, electricity used by power plants themselves and network losses.. Existing capacity is based on a database of all world power plants. For each region, a load curve is assumed.. New generating capacity is computed as the difference between total capacity requirements and plant retirements. Plant lives are assumed to be 45 years for most existing fossil fuel plants and up to 60 for nuclear plants.

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Figure 4: Structure of the Power Generation Module

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Capacities for nuclear power plants and renewable plants are based on assumptions, which are in turn based on an assessment of government plans and the relative competitiveness of these technologies with fossil fuel generation technologies. Where market conditions prevail, the assumptions are influenced by international fossil fuel prices. When new fossil fuel plant is needed, the model makes its choice between different fossil fuel options on the basis of total electricity generating costs, which combine capital, operating, and fuel costs over the whole operating life of a plant, using lifelong generating costs based on the levelised cost modelling approach, as well as assumptions on plant efficiency and plant utilisation rate for the different regions. The levelised cost methodology is the traditional approach for comparing the competitiveness of different generation technologies. The levelised electricity generating costs is the constant real wholesale price of electricity that meets a private investors financing cost, debt repayment, income tax, and associated cash flow constraints. The levelised cost model computes lifelong generating costs for the following types of plant: Coal, oil and gas steam boilers. Combined-cycle gas turbine (CCGT). Open-cycle gas turbine (OCGT). Integrated gasification combined cycle (IGCC). Oil and gas internal combustion. Fuel cell. Nuclear. Biomass. Geothermal. Wind (onshore). Wind (offshore). Hydro (conventional). Hydro (pumped storage). Solar (photovoltaics). Solar (thermal). Tidal/wave.

Generating Costs of Baseload Technologies

For the World Energy Outlook 2006, the levelised cost model of electricity generating cost has been improved to provide a detailed picture of the competitiveness of various base load technologies in liberalized electricity markets.

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Greater desegregation of fixed and variable capital and operating costs has been added, and the costs values for each region of the model have been updated using a survey of recent industry projects. The cost of producing electricity from different generating technologies varies from one country to another, since it strongly depends upon how local engineering and financial kills and resources are brought together, in conjunction with local regulatory requirements. Besides, capital cost assumptions have been adjusted for the impact of primary materials and commodity price increases over the past couple of years. The cost assumptions shown in Table 3 are based on expectations over the next ten to fifteen years. The construction cost of IGCC power plants and wind farms is lower than today by about 10% to 15%. The fossil-fuel starting prices and incremental annual increases are in line with the international price assumptions used throughout the WEO-2006. Natural gas prices are assumed to be in the range of $6 to $7 per MBtu in the period to 2030. The coal price refers to the international market price for coal imported into the OECD, but some countries, including the United States and Canada, have access to cheaper indigenous coal, making coal-fired generation more competitive. For nuclear plants, a range of construction costs has been used to reflect the uncertainty in the cost estimates for reactors that would enter commercial operation in 2015.

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Table 3: Main Cost and Technology Parameters of Plants Starting Commercial Operation in 2015
Parameter Capacity factor Thermal efficiency (net, LHV)1 Investment cost2 Construction period Plant life Decommissioning3 Annual incremental capital cost Unit cost of fuel4 Fuel escalation rate Waste management Total O&M5 O&M escalation rate Carbon intensity of the fuel6 % % $ per kW months Years $ million $ per kW $ per MBtu or tonne annual, % cents per kWh $ per kW annual % t CO2 per toe Unit Nuclear 85 33 2 000 - 2 500 60 40 350 20 0.50 per MBtu 0.0% 0.1 65 0.5% CCGT 85 58 650 36 25 0 6 6.00 per MBtu 0.5% 25 0.5% 2.43 Coal steam 85 44 1 400 48 40 0 12 55 per tonne 0.5% 50 0.5% 4.21 IGCC 85 46 1 600 54 40 0 14 55 per tonne 0.5% 55 0.5% 4.21 Wind onshore 28 900 18 20 0 10 20 0.5% -

1. Lower heating value (LHV) is the heat liberated by the complete combustion of a unit of fuel when the water produced is assumed to remain as a vapor and the heat is not recovered. For coal and oil, the difference between lower and higher calorific value is approximately 5%; for most natural gas and manufactured gas it is approximately 9-10%. 2. Total capital expenditure for the project, excluding the cost of finance. 3. Assumes a fund is accumulated over the first 20 years of operation. 4. Coal and gas prices refer to import prices. They are increased by about 10% in the model to reflect the cost of delivery to power stations. A coal price of $55 per tonne corresponds to $2.20 per MBtu. Nuclear fuel cost includes uranium, enrichment, conversion, and fabrication. 5. Total non-fuel operating and maintenance costs are assumed to be fixed. 6. CO2 intensity refers to electricity generation only. Life-cycle emissions are somewhat higher and are not zero for wind and nuclear power (but still negligible compared with coal or gas). Sources: IEA databases and NEA/IEA (2005).

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The second major focus to improve the generating cost model for the World Energy Outlook 2006 has been to refine the financing aspects of the model. The treatment of the corporate income tax has been improved, and a set of different options for plant depreciation introduced. The treatment of depreciation is important in the calculation of the annual tax liability, since asset depreciation is a tax-deductible expense. In the base case parameters we use straight line depreciation over 15 years. The total capital expenditure (excluding interest during construction) is used as the depreciable asset base. A more detailed treatment of the weighted average cost of capital has also been introduced to explore the impact of different financing mechanisms on the generating costs of different technologies in liberalized electricity markets. Depending on the extent of the risks borne by investors in the power plant, whether they are the shareholders of the operating company or outside financiers, they will seek different returns on investment. The two cases analysed in the 2006 World Energy Outlook are: A low discount rate case, corresponding to a moderate risk investment environment, where construction and operating risks are shared between the plant purchaser, the plant vendor, outside financiers and electricity users, through arrangements such as long-term power-purchase agreements. A high discount rate case, representing a more risky investment framework in which the plant purchaser and financial investors and lenders bear a higher proportion of the construction and operating risks.

The financial parameters for the two cases are shown in Table 4. In the low discount rate case, the plant purchaser is assumed to have access to relatively cheap finance in the form of debt and to accept a relatively low return on equity, given that the construction and operating risks have been appropriately mitigated. In the high discount rate case, it is assumed that lenders will require higher debt interest rates and that there will need to be higher return on equity to compensate for the higher risks associated with the higher proportion of equity funding required to satisfy lenders conditions. The financing parameters are therefore more demanding. The capital recovery period (debt payback) is assumed to be 40 years in the low discount rate and 25 years in the high discount rate cases.1

These two cases represent commercial discount rates. Publicly owned companies or private companies benefiting from government support might have access to cheaper financing and the use of a lower discount rate might be appropriate.

Table 4: Summary of Financial Parameters

Parameter Inflation rate Cost of debt capital (nominal) Required net return on equity (nominal) Debt fraction Capital recovery period* Marginal corporate tax rate Tax depreciation schedule Tax depreciation period Real after-tax weighted average cost of capital Unit annual % annual % annual % % years annual % years annual % Low discount rate 2.0 8.0 12.0 50.0 40 30.0 straight line 15 6.7 High discount rate 2.0 10.0 15.0 40.0 25 30.0 straight line 15 9.6

* In the low discount rate case, the capital recovery period corresponds to the plants physical life, while it is 25 years for all technologies but wind in the high discount rate case.

Renewables, Combined Heat and Power and Distributed Generation Modules

The projections for renewable electricity generation, combined heat and power (CHP), and distributed generation (DG) are derived in separate sub modules. The future deployment of these technologies and the investment needed for such deployment were assessed on the basis of the renewable energy potential in each country/region. The combined heat and power option is considered for fossil fuel and biomass plants. The CHP sub-module uses the potential for heat production in industry and buildings together with heat demand projections, which are estimated econometrically in the demand modules. The distributed generation sub-module is based on assumptions about market penetration of DG technologies. The development of renewables is based on an assessment of the potential and costs for each source (biomass, hydro, photovoltaics, solar thermal electricity, geothermal electricity, on- and offshore wind, tidal and wave) in each of twenty world regions. By including financial incentives for the use of renewables and nonfinancial barriers in each market, as well as technical and social constraints, the model calculates deployment as well as the resulting investment needs on a yearly base for each renewable source in each region. The projections of renewable electricity generation were derived in a separate model. We have assessed the future deployment of renewable energies for

electricity generation and the investment needed for such deployment.2 The methodology is illustrated in Figure 5. The model uses a database of dynamic cost-resource curves. The development of renewables is based on an assessment of potentials and costs for each source (biomass, hydro, photovoltaics, solar thermal electricity, geothermal electricity, onand offshore wind, tidal and wave) in each of twenty world regions. By defining financial incentives for the use of renewables and non-financial barriers in each market, as well as technical and societal constraints, the model calculates deployment as well as the resulting investment needs on a yearly base for each renewable source in each region. The model includes the concept of technological learning. This concept holds that a certain increase in the production and sale of new technology will lead to a given decrease of the price.

Box 1: Long-term Potential of Renewables

The starting point for deriving future deployment of renewables is the assessment of long-term realisable potentials for each type of renewable and for each world region. The assessment is based on a review of the existing literature and on the refinement of available data. It includes the following steps: 1. The theoretical potentials for each region are derived. General physical parameters are taken into account to determine the theoretical upper limit of what can be produced from a certain energy, based on current scientific knowledge. 2. The technical potential can be derived from an observation of such boundary conditions as the efficiency of conversion technologies and the available land area to install wind turbines. For most resources, technical potential is a changing factor. With increased research and development, conversion technologies might be improved and the technical potential increased. Long-term realisable potential is the fraction of the overall technical potential that can be actually realised in the long term. To estimate it, overall constraints like technical feasibility, social acceptance, planning requirements and industrial growth are taken into consideration.

For a detailed description of this model developed by Energy Economics Group (EEG) at Vienna University of Technology in cooperation with Wiener Zentrum fr Energie, Umwelt und Klima see Resch et.al. (2004).

Figure 5: Method of Approach for the Renewables Module

The model uses dynamic cost-resource curves3. The approach consists of two parts: First, for each renewable source within each region, static cost-resource curves4 are developed. For new plant, we determine long-term marginal generation costs. Realisable long-term potentials have been assessed for each type of renewable in each region. Next, the model develops for each year a dynamic assessment of the previously described static cost-resource curves, consisting of: Dynamic cost assessment: The dynamic adaptation of costs (in particular the investment and the operation and maintenance components) is based on the approach known as technological learning. Learning rates are assumed by decade for specific technologies. Dynamic restrictions: To derive realisable potentials for each year of the simulation, dynamic restrictions are applied to the predefined overall long-term potentials. Default figures are derived from an assessment of the historical development of renewables and the barriers they must overcome, which include: Market constraints: The penetration of renewables follows an S-curve pattern, which is typical of any new commodity.5 Within the model, a polynomial function has been chosen to describe this impact representing the market and administrative constraints by region. Technical barriers: Grid constraints are implemented as annual restrictions which limit the penetration to a certain percentage of the overall realisable potential.

CO2 Emissions
As energy related CO2 account for the lion's share of global greenhouse gas emissions one of the most important outputs of the World Energy Model is region by region energy related CO2 emissions. For each region, sector and fuel,
The concept of dynamic cost-resource curves in the field of energy policy modelling was originally devised for the research project Green-X, a joint European research project funded by the European Unions fifth Research and Technological Development Framework Programme for details see www.green-x.at. 4 Renewable energy sources are characterised by limited resources. Costs rise with increased utilization, as in the case of wind power. One tool to describe both costs and potentials is the (static) cost-resource curve. It describes the relationship between (categories of) available potentials (wind energy, biomass, hydropower) and the corresponding (full) costs of utilisation of this potential at a given point-of-time. 5 An S-curve shows relatively modest growth in the early stage of deployment, as the costs of technologies are gradually reduced. As this is achieved, there will be accelerating deployment. This will finally be followed by a slowing-down, corresponding to near saturation of the market.
3

CO2 emissions are calculated by multiplying energy demand by an implied carbon emission factor. Implied emission factors for coal, oil and gas differ between sectors and regions, reflecting the product mix. They have been calculated from year-2004 IEA emissions data for all regions and are assumed to remain constant over the projection period.

Fossil Fuel Supply Reference Scenario Oil Module

The purpose of this module is to determine the level of oil production in each region. Production is split into three categories:6 Non-MENA. MENA. Non-conventional oil production.

Total oil demand is the sum of regional oil demand, world bunkers and stock changes. MENA conventional oil production is assumed to fill the gap between non-MENA production and non-conventional and total world oil demand (Figure 6). The field-by-field analysis is a bottom-up approach that serves to support our top-down results for the call on Middle East and North African (MENA) countries and on other major non-OECD oil and gas producers.

Figure 6: Structure of the Oil Supply Module

MENA and non-MENA production includes crude oil, NGLs and condensates.

The derivation of non-MENA production of conventional oil (crude and natural gas liquids) uses a long-term approach. This approach involves the determination of production according to the level of ultimately recoverable resources and a depletion rate estimated by using historical data and industry sources. Ultimately recoverable resources depend on a recovery factor. This recovery factor reflects reserves growth, which results from, among other things, improvements in drilling, exploration and production technologies. The trend in the recovery rate is, in turn, a function of the oil price and of a technological improvement factor. Non-conventional oil supply is determined mainly by the oil price. Higher oil prices bring forth greater non-conventional oil supply over time.

Field-by-Field Analysis
In WEO-2005, we analysed some 200 fields in the MENA region according to a two-step methodology: i) a supply curve analysis, then ii) judgment and modifications based on existing or planned projects for a specific field. This analysis was used for both oil and gas fields. The analysis was expanded in WEO-2006 to major non-OECD oil and gas producing countries. Projected output from each field is a function of the field discovery year, yearly crude oil, condensates and gas production, recoverable reserves and hydrocarbons initially in place. Data have been checked and verified to ensure internal consistency. The primary source was the IHS Energy database. Additional information was obtained from a number of other sources, including international oilfield service companies, national and international oil companies, consultants and the IEAs own databases. For each field, supply projections are based on a time series of production in that field and are adjusted after an assessment of planned and current field development projects. Production decline-curve analysis is used to regress the historical data and to forecast production over the next 25 years (2005-2030). The following equation for the exponential decline has been used:
Q t0 +n = Q
t0 e k n

where Q is the production volume, n is the number of years following the initial year, t0, and k is a coefficient calculated as:
k=

ln [Q t / Q t + T ] T

T is the number of past production years which are used in the calculation of the k coefficient. The coefficient k is the slope of the production curve.

Figure 7 shows the projection for Saudi Arabias super-giant Abqaiq field using the exponential function above.

Figure 7: Abqaiq Production Historical and Forecast

Abqaiq Production - Historical and Forecast
1.00

Production, billion bbl/year

Production forecast

0.10

Production data

0.01 1970

1980

1990

2000 Years

2010

2020

2030

Historical production data are shown in the scatter diagram in Figure 7 Output from the field peaked at more than 1 mb/d in 1973 and then maintained an average of 0.8 mb/d in the 1970s. Production declined dramatically in the 1980s, due to the oil price collapse and to the introduction of OPEC quotas. Saudi Arabia acted as a swing producer, reducing significantly the production from its fields. In the 1990s, production recovered to around 0.6 mb/d. Output in 2003 was slightly less than 0.4 mb/d. In the regression analysis, only data from 1970 to 1980 and from 1990 to 2003 are used. The lower production rates in the 1980s are the result of political/commercial upheavals and do not reflect reservoir performance. Based on the historical trend, production would decline at an effective rate of 2.25% per year (annual decline rate = 1 - ek), falling to 0.24 mb/d in 2030. However, given the fields huge reserves and improved oil recovery technologies, Abqaiq can easily increase its production over the next 5 to 10 years. Thus, the WEO2005 projected that production would be higher than 0.24 mb/d in 2030, largely because improved technology implies an upward shift of the production forecast curve.

Gas Module
In the Reference Scenario, gas fields in MENA countries and in key non-OECD countries are analysed according to the field by field analysis described above

for oil. Gas output projections are based on the level of ultimately recoverable resources and a depletion rate. There are some important differences within the oil module. In particular, three regional gas markets are considered America, Europe and Asia whereas oil is modelled as a single international market. Two country types are modelled: net importers and net exporters. Once gas production from each netimporting region is estimated, taking into account ultimately recoverable resources and depletion rates, the remaining regional demand is derived and then allocated to the net-exporting regions, again according to recoverable resources and depletion rates. Production in the net-exporting regions is subsequently calculated from their own demand projections and export needs. Trade is split between LNG and pipelines according to: The terms of existing long-term contracts; and the pattern of LNG and pipeline projects, under construction or being built. The less costly option. Minimisation of transportation distances.

Coal Module
The coal module is a combination of a resources approach and an assessment of the development of domestic and international markets, based on the international coal price. Production, imports and exports are based on coal demand projections and historical data, on a country basis. Three markets are considered: coking coal, steam coal and brown coal. World coal trade, principally constituted of coking coal and steam coal, is separately modelled for the two markets and balanced on an annual basis.

Investment Investment in the Energy Supply Chains

The estimates of supply-side investment requirements in WEO-2006 cover the period 2005-2030 and are derived from the projections of energy supply and demand of the Reference and Alternative Policy Scenarios. The quantification of capital requirements, notably the compilation of unit capital cost estimates and capacity needs for each fuel, component and region, involved compiling and processing large quantities of data. A significant contribution to this work has been made by a number of organisations in the energy sector and in the financial community. The component cost and capacity estimates may prove to equal in value the final investment numbers. The calculation of the investment requirements involved the following steps for each fuel and region:

New capacity needs for production, transportation and (where appropriate) transformation were calculated on the basis of projected supply trends, estimated rates of retirement of the existing supply infrastructure and decline rates for oil and gas production. Unit capital cost estimates were compiled for each component in the supply chain. These costs were then adjusted for each year of the projection period using projected rates of change based on a detailed analysis of the potential for technology-driven cost reductions and on country-specific factors. Incremental capacity needs were multiplied by unit costs to yield the amount of investment needed.

The results are presented by decade in year 2005 dollars. The estimates of investment in the current decade take account of projects that have already been decided and expenditures that have already been incurred. The convention of attributing capital expenditures to the year in which the plant in question becomes operational has been adopted. In other words, no attempt has been made to estimate the lead times for each category of project. This is because of the difficulties in estimating lead times and how they might evolve in the future. For the purposes of this study, investment is defined as capital expenditure only. It does not include spending that is usually classified as operation and maintenance.

Short-term Oil and Gas Investment

In addition to the long-term analysis of energy investment in the Reference and Alternative Policy Scenarios, a detailed analysis was been made in the WEO2006 of oil and gas industry investment over the period 2000 to 2010. The objective was first, to assess whether the industry is planning to invest more in response to higher prices and the need for more capacity in the upstream and downstream, and second, to quantify the resulting additions to oil production and refining capacity. This involved four main tasks: A survey of the capital spending programmes of 40 major oil and gas companies, covering actual capital spending from 2000 to 2005 and their own forecasts of spending through to 2010. These companies included the major international oil and gas companies, independent producers and national oil companies. The selection of the companies was based on their size as measured by their production and reserves, though geographical spread and data availability also played a role. The surveyed companies account for about three-quarters of world oil production and reserves, 65% of gas production and 55% of gas

reserves. Total industry investment was calculated by adjusting upwards the spending of the 40 companies, according to their share of world oil and gas production for each year. Downstream investment was adjusted using project databases. A review of all major upstream projects worldwide that are due to be on stream by 2010. The sanctioned (approved by the company board) and planned projects covered total over 120. They include conventional oil and gas production and non-conventional oil sands. For each project, data were compiled on the amount and timing of capital spending and the amount of capacity to be added per year from 2006 to 2010. A survey of 500 oil-refinery projects, including greenfield refineries, refinery expansions and additions to upgrading capacity. A survey of 45 sanctioned and planned LNG liquefaction and gas-toliquids projects as well as LNG shipping and regasification-terminal investments worldwide.

For each task, data were obtained from the companies annual and financial reports, corporate presentations, press reports, trade publications and direct contacts in the industry. The year 2010 was chosen as the end-date for this analysis, because almost all the capacity that will be brought on stream by then is already under construction or at an advanced stage of planning due to the long lead times for large-scale projects.

Demand-Side Investments
For the Alternative Policy Scenario, the latest version of the WEM incorporates an economic analysis of the net change in investment by energy suppliers and energy consumers; the net change in energy import bills and export revenues; and how the cost to consumers of investing in more energy-efficient equipment compares with the savings they make through lower expenditure on energy bills. Demand-side investments are consumers outlays for the purchase of durable goods, that is, end-use equipment. Increases in demand-side investments are thus increases in cash outlays on durable goods. All investments and consumers savings in energy bills are expressed in year-2005 dollars. Consumers outlays are attributed to the year in which the equipment is purchased, but their savings are spread over a number of years. An analysis of the policies under consideration, combined with the modelling of their impact on final energy demand, leads to a reduction in demand in the Alternative Policy Scenario versus the Reference Scenario. More capital investment is needed to move to more efficient energy using equipment. For the 21 WEO regions and for five sectors, the capital needs to move to greater efficiency levels have been analysed. The analysis takes into account the level of efficiency in the Reference Scenario, the policy-driven demand

reductions in the APS, the costs of more efficient equipment, the useful lifetime of equipment and ownership levels. The five sectors are: Transport Electrical appliances in residential and services sectors Fuel burning equipment in residential and services sectors Electrical equipment in industrial sectors Fuel burning equipment in industrial sectors. To account for the different structure and development stage of each world region, we engaged in several partnerships and made use of various data sources. The estimates of capital costs for end-use technology used in this analysis are based on the results of work carried out in co-operation with a number of organisations, including the UNEP Risoe Centre on Energy, Climate and Sustainable Development, the European Environment Agency, Centro Clima at COPPE/UFRJ, the Indian Institute of Management and the Energy Research Institute in China. The estimates of capital costs also benefited from collaboration with the Argonne Laboratory in the United States (Hanson and Laitner, 2006). Argonne Laboratorys AMIGA model calculates the additional capital needed for many types of energy-using equipment to move to less energy consumption. A number of independent sources were used for consistency-checking. Given the variability in the quality of many of the specific regional and sectoral data used, there are many uncertainties surrounding these estimates. Due to the large share of transport in additional oil demand over the Outlook period, we further expanded the analysis for road transport. Based on the efficiency improvements needed, the best technological options were assessed and priced. The investment needs for the transport sector were determined by linking this information with the stock model of the WEMs transport demand module. Detailed figures from Airbus/Boeing were used to assess the need for new planes and the increased capital cost of increasing efficiency in the aviation sector. Outputs include the additional annual capital needs for the 21 regions and 5 sectors. The impact of the energy savings on consumers bills is analysed. The sectoral end-use prices (incl. taxes) have been used to assess the overall impact of the policies on consumers over time. The results also include the impact on main importing countries.

Annex 1: WEO Regional Definitions

Other Africa Angola, Benin, Botswana, Burkina Faso, Burundi, Cameroon, Cape Verde, Central African Republic, Chad, Comoros, Congo, Democratic Republic of Congo, Cte dIvoire, Djibouti, Equatorial Guinea, Eritrea, Ethiopia, Gabon, Gambia, Ghana, Guinea, Guinea-Bissau, Kenya, Lesotho, Liberia, Madagascar, Malawi, Mali, Mauritania, Mauritius, Mozambique, Namibia, Niger, Nigeria, Reunion, Rwanda, Sao Tome and Principe, Senegal, Seychelles, Sierra Leone, Somalia, South Africa, Sudan, Swaziland, United Republic of Tanzania, Togo, Uganda, Zambia, and Zimbabwe. North Africa Algeria, Egypt, Libya, Morocco and Tunisia. China China refers to the People's Republic of China, including Hong Kong. Other Developing Asia Afghanistan, Bangladesh, Bhutan, Brunei, Cambodia, Chinese Taipei, Fiji, French Polynesia, Kiribati, the Democratic Peoples Republic of Korea, Laos, Macau, Malaysia, Maldives, Mongolia, Myanmar, Nepal, New Caledonia, Pakistan, Papua New Guinea, the Philippines, Samoa, Singapore, Solomon Islands, Sri Lanka, Thailand, Tonga, Vietnam, and Vanuatu. Developing Countries Includes countries in the Africa, Developing Asia, Latin America and Middle East regional groupings. European Union Austria, Belgium, Cyprus, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Poland, Portugal, the Slovak Republic, Slovenia, Spain, Sweden, and the United Kingdom. Other Latin America Antigua and Barbuda, Argentina, Bahamas, Barbados, Belize, Bermuda, Bolivia, Chile, Colombia, Costa Rica, Cuba, Dominica, the Dominican Republic, Ecuador, El Salvador, French Guyana, Grenada, Guadeloupe, Guatemala, Guyana, Haiti, Honduras, Jamaica, Martinique, Netherlands Antilles, Nicaragua, Panama, Paraguay, Peru, St. Kitts and Nevis, Saint Lucia, St. Vincent and Grenadines, Suriname, Trinidad and Tobago, Uruguay, and Venezuela.

Middle East Bahrain, Iran, Iraq, Israel, Jordan, Kuwait, Lebanon, Oman, Qatar, Saudi Arabia, Syria, the United Arab Emirates and Yemen. It includes the neutral zone between Saudi Arabia and Iraq. OECD Pacific Japan and Korea. OECD Europe Austria, Belgium, the Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Poland, Portugal, the Slovak Republic, Spain, Sweden, Switzerland, Turkey, and the United Kingdom. OECD North America The United States, Canada and Mexico. OECD Oceania Australia and New Zealand. OECD Pacific Japan, Korea, Australia and New Zealand. Other Transition Economies Albania, Armenia, Azerbaijan, Belarus, Bosnia-Herzegovina, Bulgaria, Croatia, Estonia, Serbia and Montenegro, the former Yugoslav Republic of Macedonia, Georgia, Kazakhstan, Kyrgyzstan, Latvia, Lithuania, Moldova, Romania, Slovenia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan. For statistical reasons, this region also includes Cyprus, Gibraltar, and Malta.

Figure 8: WEM Regions

Annex 2: References
Airbus Industries S.A.S. (2004), Global Market Forecast 2004-2023, available at www.airbus.com. Boeing Commercial Airplanes (2005), Boeing Current Market Outlook 2005, available at www.boeing.com. Dargay, J., Gately, D and Sommer, M. (2006), Vehicle Ownership and Income Growth, Worldwide: 1960-2030, Available at: www.econ.nyu.edu/dept/. Gately, Dermot (2006), What Should We Expect from OPEC? New York University, New York. Hanson, Donald A. and John A. Laitner (2006), The Amiga Modelling System, Version 4.2: Disaggregated Capital and Physical Flows of Energy within a General Equilibrium Framework, Argonne National Laboratory, Argonne, Illinois. Intergovernmental Panel on Climate Change (IPCC) (1999), Aviation and the Global Atmosphere, IPCC, New York. Lee, J.J., S. P. Lukachko, I. A. Waitz and A. Schafer (2001), Historical and Future Trends in Aircraft Performance, Cost, and Emissions, Annual Review of Energy and the Environment, Volume 26, Annual Reviews, Palo Alto. NEA/IEA (2005), Projected Costs of Generating Electricity: 2005 Update, OECD, Paris. Resch, Gustav et al. (2004), Forecasts of the Future Deployment of Renewable Energy Sources for Electricity Generation a World-Wide Approach, Working Paper published by Energy Economics Group, Vienna University of Technology. Available at http://eeg.tuwien.ac.at