tightening for both world oil and U.S. natural gas, with resulting upward pressure on prices. If so, projections made in future years will begin to reflect the higher base year energy prices."

The long-term significance of the current events in the Middle East is still indeterminate (Exhibit 1). The basic political instability has always been present. This instability has produced major wars and incidents before and is likely to do so in the future. Meanwhile, unless there is sustained combat in the major oil fields that destroys production capability and terminals, once the situation stabilizes, oil production capacity will again exceed demand. The fundamentals of the oil trade have not changed. Therefore, it is worthwhile to step back from the current price situation, which may prove to be as transitory as the $12 per barrel of oil price we experienced in mid-1986, and consider the relationship between the world oil situation and the U.S. energy system.

The GRI Baseline Projection examines the fundamentals of energy markets-the factors driving energy demand, the cost of supplying fuels, the impact of regulation on marketplaces, and the importance of technology in providing the required energy services. The 1991 edition of the projection continues to indicate that natural gas will play a major role in a highly competitive energy mix well into the next century. As summarized in Exhibit 2, growth in total energy consumption is projected through the year 2010. This is despite strong improvements in energy conservation in all demand sectors. Total primary energy consumption is expected to grow at an average annual rate of 1.4 percent per year. This results in an increase from 1989 base-year levels of 84.1 quads to 111.8 quads by the year 2010. Delivered gas to end-use sectors increases from 19.4 quads in 1989 to 23.3 quads in 2010.

figures include consumption estimates for a few specific, identifiable environmental uses, such as gas use for reburn/sorbent injection emission control in coal-fired powerplants. More importantly, the overall projection reflects a number of technical and economic assumptions that introduce environmental constraints into the fuel choice decisions for the industrial and electric utility sectors.

The projection confirms the viability of a strong gas role in the future. Low-cost supply options and efficiency of end-use technologies are robust strategies in all reasonably possible future scenarios. Ultimately, however, the role of gas will rest upon competent service and competitive prices.

Policy Implications of the Projection

The 1991 edition of the baseline projection highlights three issues that are important not only to GRI's R&D strategy, but also more generally to energy consumers, energy companies, and policy makers.

• The first issue is the impact of the recent Middle East turmoil on the expected price of crude oil and the potential for increased gas demand. At this point, the outcome of the geopolitical and military moves in response to Iraq's seizure of Kuwait could lead to an infinite number of nearterm scenarios. However, the potential solutions to the current crisis can be characterized within three generic outcomes: (1) a worst case scenario in which intense and protracted combat in the Persian Gulf area would physically impair or destroy the oil production and transport capability of Iraq, Kuwait, Saudi Arabia, the United Arab Emirates, and perhaps Iran, (2) a scenario in which the militant elements of OPEC dominate future oil price policies, and (3) a return to the pre-invasion status quo. These three scenarios have somewhat differing implications for oil prices and for the

future market and political settings for U.S. energy industries.

• The second issue is the sustainability of the recent strong growth in industrial gas demand and its implications for future demand growth. The history of industrial energy consumption has been influenced by many factors. Long-term trends in the composition of U.S. industrial activity and changes in the technologies of industrial processes have altered the intensity of energy use. Oil price shocks, gas curtailments, and environmental regulations affecting coal have altered fuel choice preferences from time to time. The increase in industrial energy consumption over the past three years probably reflects some long-term factors. It may also reflect some transitory factors. Longterm projections do not capture the timing of economic cycles or of transitory fuel price fluctuations. They predict the underlying trend line which is indicated by fundamental factors. The strong growth of the past three years must be examined to consider whether it represents a sustainable new growth trend from which to make a long-term projection of future industrial gas demand.

• The third issue is the impact of the projected tightening interfuel price competition between natural gas and petroleum in the mid-1990s. The cost-based analysis done for this projection indicates that the current average acquisition price for natural gas is insufficient to attract the increased level of investment in drilling that will be required to sustain deliverability over the next 10 years. At some point in the early 1990s, depending upon the rate of demand growth, wellhead gas prices will undergo an upward adjustment to the replacement cost for new gas. That price must include a competitive rate of return on new drilling investment. If, after the current turmoil in the Middle East is resolved, world oil prices return to lower levels, the requirement for higher gas prices

will result in increasing price competition with petroleum products in some uses. If oil prices remain somewhat higher in the aftermath of the crisis, the constraint will be relieved, but demand for gas may be greater. The critical challenge for the gas industry will be to deliver the increasing amounts of gas that U.S. energy markets seem likely to require, but to do so within whatever price constraints are imposed by future oil prices.

Implications for R&D Strategy

Recent historical load growth, the emerging environmental bias, and the current oil crisis signal a larger potential role for natural gas in the national energy mix. The fundamentals of the world oil trade, however, indicate that in the aftermath of the current crisis, oil prices will return to a track near that adopted for this projection. For gas to meet its full share of U.S. energy requirements, new technologies must be employed to reduce the costs and improve the efficiency of producing and transporting gas. Especially in the late 1990s, technology must expand the opportunities to profitably add to gas deliverability at prices competitive with oil products.

The environmental preoccupation in public policy is likely to evolve quickly into an aggressive policy thrust toward energy conservation and efficiency. Conservation will receive an additional impetus from the national security considerations being affirmed in the Middle East. The most Btu-efficient technologies are likely to be singled out for policy support through regulations and price subsidies. In the case of natural gas, the competitive pricing challenge will also place increasing emphasis upon the efficient use of gas in all its applications. To the extent that the efficiency of the technologies for using gas can be improved, those technologies will be more favored in future policies and more frequently chosen by energy users.

Petroleum. GRI's projected track of the U.S. refiner's acquisition cost (RAC) of crude oil, which was adopted before the current Middle East turmoil, is shown in Exhibit 4. It reflects a gradual increase in the near term starting from 1989 levels. After the mid-1990s, real prices (1990$) are projected to increase more rapidly as Middle East sources again dominate supply. U.S. refiner's acquisition costs per barrel of oil in real dollars reach about $23 in 2000 and $35 in 2010. In nominal dollars, the prices that would be quoted in newspapers, these

The baseline projection projects a gradual erosion in residential gas demand as older, less efficient space-conditioning systems are replaced by more efficient equipment. The average fuel use efficiency of the existing stock of residential gas-fired heating equipment is about 65 percent. The efficiency of new systems now being installed averages 75 percent. It will increase to over 85 percent by 2010. The simple replacement of the existing stock of equipment with today's average system would reduce residential gas demand by the equivalent of 15 percent. When combined with future improvement in the efficiency of equipment, the average efficiency of the stock of gas-fired spaceheating systems is projected to reach 83 percent by the year 2010. This improved efficiency more than offsets the growth in the total number of gas customers from about 48 million in 1989 to 58 million by the year 2010. Residential gas demand is projected to decline from 4.9 quads in 1989 to 4.6 quads by 2010.

Commercial Sector. The commercial sector is projected to be a growth market for natural gas. Gas demand in the commercial sector (Exhibit 7) is projected to grow from 2.8 quads in 1989 to 3.8 quads by 2010.

In 1989, over 50 percent of the gas consumed in the commercial sector was for space heating. As building design has improved, however, the spacecooling load in commercial buildings has more frequently dictated the choice of space-conditioning equipment. Gas is used for space cooling in only about 2 or 3 percent of this cooling load.

The potential for gas demand in the commercial sector lies in new and improved gas-cooling technologies, including gas-fired cogeneration/ cooling systems, heat pumps, engine-driven chillers, and absorption systems. These