Transcript UHCBA Energy Institute


www.uh.edu/energyinstitute
UNIVERSITY of
HOUSTON
BAUER
COLLEGE of BUSINESS
ADMINISTRATION
Economics and Politics of
Energy Industries –
Setting the Stage
ENERGY
INSTITUTE
© UHCBA Energy Institute 1

State of the World
• Energy is necessary for economic growth 
– Energy resources and industries have been
considered strategic and/or national
– Energy industries have been vertically integrated
– But, there is now deregulation / restructuring
• Fossil fuels have been the major source for
generating energy, but
– These resources are increasingly concentrated in
politically sensitive parts of the world
– Burning of these fuels are increasingly blamed for
a variety of environmental problems
© UHCBA Energy Institute 2

State of the World
• So, how do you address environmental
concerns in a more competitive industry?
– Fossil fuels-based technologies have cost
advantages to “clean” alternatives
– Developing economies want to use these
technologies and their fossil resources
– Developed economies do not want to risk
slow-down with heavy regulation
© UHCBA Energy Institute 3

Energy and GDP
Correlation = 0.89
© UHCBA Energy Institute 4
Energy Consumption
per dollar of GDP (Btu)

160
140
120
100
80
60
40
20
0
1-Uganda
97-Kazakstan
80-Venezuela
5-Japan
78-Saudi Arabia
12-France
73-Mexico
15-Germany
67-Canada
22-UK
39-US
29-Bangladesh
94-Russia
88-China
86-UAE
70-India
0
10
20
30
40
50
60
70
80
90
100
© UHCBA Energy Institute 5
Energy & GDP
(low - low)

0.40
Morocco
Bangladesh
Lithuania
0.35
Bahrain
Slovenia
0.30
0.25
0.20
0.1 5
0.1 0
Nica.
0.05
Uganda
Nepal
0.00
0
5000
1 0000
1 5000
20000
25000
30000
© UHCBA Energy Institute 6
Energy & GDP
(low - middle)

Belarus
1.10
1.00
Finland
Bulgaria
0.90
Denmark
0.80
0.70
Hong Kong
0.60
0.50
Peru
0.40
0
20000
40000
60000
80000
100000
120000
140000
© UHCBA Energy Institute 7
Energy & GDP
(middle - middle)

Belgium
Venezuela
Kazak.
Czech
Sweden
Austria
Switz.
© UHCBA Energy Institute 8
Energy & GDP
(high - high)

Canada
India
UK
France
Italy
© UHCBA Energy Institute 9
Energy & GDP
(high - high)

US
China
Russia
Germany
Japan
© UHCBA Energy Institute 10

Energy Today (primary)
Source: http://www.bp.com/worldenergy/index.htm
© UHCBA Energy Institute 11

Energy Today II
(primary)
Source: http://www.bp.com/worldenergy/index.htm
© UHCBA Energy Institute 12

Energy Today IV
(primary)
Source: http://www.bp.com/worldenergy/index.htm
© UHCBA Energy Institute 13

Energy Today V (oil)
Source: http://www.bp.com/worldenergy/index.htm
© UHCBA Energy Institute 14

Energy Today VI (oil)
Source: http://www.bp.com/worldenergy/index.htm
© UHCBA Energy Institute 15

Energy Today VII (oil)
Source: http://www.bp.com/worldenergy/index.htm
© UHCBA Energy Institute 16

Energy Today VIII (gas)
Source: http://www.bp.com/worldenergy/index.htm
© UHCBA Energy Institute 17

Energy Today IX (gas)
Source: http://www.bp.com/worldenergy/index.htm
© UHCBA Energy Institute 18

Energy Today X (gas)
Source: http://www.bp.com/worldenergy/index.htm
© UHCBA Energy Institute 19

Energy Today XI (coal)
Source: http://www.bp.com/worldenergy/index.htm
© UHCBA Energy Institute 20

Energy Today XII (coal)
Source: http://www.bp.com/worldenergy/index.htm
© UHCBA Energy Institute 21
Natural Resource
Economics

Price
Instead of competitive profit max
rule of P=MC, we have P=MC+OC
Pe
AB = user cost (Hotelling rent)
A
P*
B
Marginal Cost
Demand
Q*
Qe
Quantity
© UHCBA Energy Institute 22

Natural Resource
Economics
• The behavior of this rent over time is
important: a barrel of oil not produced today
will be worth something tomorrow.
• What is, then, the profit maximizing resource
extraction pattern?
• Output will be decreasing over time as the
price increases over time.
• Hotelling rule: the rent will increase at the rate
of interest (discount rate)
© UHCBA Energy Institute 23
Natural Resource
Economics

Price,
Output
Price
Backstop
technologies
Output
Time
© UHCBA Energy Institute 24
Natural Resource
Economics

140
120
Actual
1979
1987
1990
1982
100
80
1992$/b
60
40
20
0
1950
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
© UHCBA Energy Institute 25

Reserves to Production
Ratios
Source: www.bpamoco.com/worldenergy/primary/
© UHCBA Energy Institute 26
Years of Current
Consumption

1884
Proved
Probable
216
200
43
114
62
Coal
Natural Gas
Crude Oil
© UHCBA Energy Institute 27
World Crude Oil
Replenishment

(billion barrels)
1200
1050
1000
783
800
600
400
68
200
0
1947 Reserves
1948-98
Production
1998 Reserves
© UHCBA Energy Institute 28
World Natural Gas
Replenishment

(trillion cubic feet)
6000
5145
5000
4000
3000
2000
1883
1041
1000
0
1966 Reserves
1967-98
Production
1998 Reserves
© UHCBA Energy Institute 29
World Coal
Replenishment

(billion short tons)
1200
1087
1000
800
600
256
400
168
200
0
1949 Reserves
1950-98
Production
1998 Reserves
© UHCBA Energy Institute 30
U.S. Crude Oil
Replenishment

(billion barrels)
160
143
140
120
100
80
60
40
23
20
20
0
1944 Reserves
1945-98
Production
1998 Reserves
© UHCBA Energy Institute 31
U.S. Natural Gas
Replenishment

(trillion cubic feet)
900
800
809
700
600
500
400
300
200
167
147
100
0
1944 Reserves
1945-98
Production
1998 Reserves
© UHCBA Energy Institute 32
Canadian Natural Gas
Replenishment

(trillion cubic feet)
90
80
88
70
60
61
46
50
40
30
20
10
0
1964 Reserves
1965-98
Production
1998 Reserves
© UHCBA Energy Institute 33

Plus Ça Change, Plus
C’est la Même Chose
Source: www.eia.doe.gov/oiaf/ieo99/highlights.html
© UHCBA Energy Institute 34

Bermuda Triangle:
Energy-EconomyEnvironment
• OPEC or Other Producer Collusion Price of Oil & Role of Technology
• Globalization, Liberalization & Economic
Crises (e.g., Asian Crisis of 1998)
• Economic Sanctions - Political Risk
• Environmental Concerns - Global
Warming
© UHCBA Energy Institute 35
Cartels Don’t Work

Nominal commodity prices, indexed
14
12
10
8
6
4
Cocoa
Coffee
Sugar
Tin
Copper
Oil
2
19
60
19
63
19
66
19
69
19
72
19
75
19
78
19
81
19
84
19
87
19
90
19
93
19
96
0
© UHCBA Energy Institute 36

Because an Effective
Cartel Requires
Minimum conditions:
• Narrowly defined target
• A good with no easy substitutes
• An entry cost for new producers that is
very high relative to the marginal cost of
cartel producers
• Incentives to cooperate
© UHCBA Energy Institute 37
million barrels a day
40
40
35
35
30
30
25
25
20
20
15
15
10
$/barrel
BUT

10
Price
OPEC output
5
5
0
0
1960
1965
1970
1975
1980
1985
1990
1995
© UHCBA Energy Institute 38
OPEC (Saudi Arabia)
has potential

80
70
Percent
60
50
40
Production
Reserves
30
20
1960
1965
1970
1975
1980
1985
1990
1995
© UHCBA Energy Institute 39

A Question of
Perspective
• Short-term perspective: higher price
now is better (shared by companies and
countries)
• Long-term perspective: can live with
lower prices for a while (should make
sense for Saudi Arabia, but for
companies?)
© UHCBA Energy Institute 40
Market Shares

40
35
30
Non-OPEC
Non-Saudi OPEC
25
Saudi Arabia
20
15
10
5
0
72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97
© UHCBA Energy Institute 41

Reactions to High
Prices in the 1970s
• Increased non-OPEC production
• Improvements and deployment of new
technology
• Increased use of alternatives, especially
natural gas
• Increased energy efficiency
• Initially, lower D for oil due to economic
recessions in importing countries caused by
high prices
© UHCBA Energy Institute 42
Adversity is the Mother
of Invention Offshore below

2500
87
84
81
78
75
72
69
66
63
0
96
500
93
1000
90
1500
60
10,000ft? Virtual
environments?
Laser drilling?
4-d seismic, offshore
below 5,000ft
3-d seismic, horizontal drilling, measurement
while drilling, offshore below 1,000ft
Pipeline trenching and welding, compression,
pressure control, metering
Cumulative U.S.
oil production
2000
Directional drilling, offshore below 250ft water depth
Long-line pipe transmission
Advances in drilling, early seismic, shallow offshore E&P
Oil and gas discovered in U.S. (Titusville, 1859; Spindletop, 1901)
Romanian oil production from hand-dug wells (1854)
Mainframes
Minis
1859
1870
1935 1938 1947
54
Micros
78
83
Work Stations
85
90 92
?
98 2000
© UHCBA Energy Institute 43
The Core Belief
System...

Shell Interdisciplinary Scholars Program
(Hypothesis)
HIGH
Tendency Toward Energy
Sector Reform
LOW
Energy products are
commodities
Small resource base
Energy products are
strategic materials
Large resource base
Strong imperatives
Weak imperatives
Strong institutional
setting
Weak institutional
setting
© UHCBA Energy Institute 44

…Dictates Energy
Sector Organization...
Shell Interdisciplinary Scholars Program
(Hypothesis)
Tendency
toward centrally
planned
economies.
Tendency
toward marketbased
economies.
Energy is a
strategic
material.
Energy is a
commodity.
A
B
Moderate to
Low
High
C
Moderate to
Low
D
High
Governmentbased solutions
for energy.
Market-based
solutions for
energy.
© UHCBA Energy Institute 45
…and Relative Strength
of the State

Shell Interdisciplinary Scholars Program
(Hypothesis)
Trade Laws
Pressure from
Trade Flows
Regulation
Strength of
State
Ownership/
Control
Open Access
Jurisdictional
Boundary
Diminishing
Monopoly Power
© UHCBA Energy Institute 46

But Whose Core Belief
System Is It?
• Notable examples of backpedaling on
energy sector reform are found
– in Russia and other NIS
– in Latin America
– in Western Europe (natural gas)
– in the U.S. and Canada (electricity)
• Where energy is considered a “free
good,” the transition is more tenuous
Plan for disruptions in development scenarios!
© UHCBA Energy Institute 47
Motivation Can Move
Mountains

Shell Interdisciplinary Scholars Program
(Hypothesis)
High
Favorable
Oil and Gas Reserves
Low
E. Canada
Argentina, Texas
Angola, Norway
Government
Colombia
Policies
China? Brazil?
Venezuela
Russia, Other NIS
India
Saudi Arabia, Mexico
Unfavorable
Low
High
G&G, Engineering Risk
Strong
Government
Motivation
Weak
© UHCBA Energy Institute 48
It’s a Tough
Neighborhood...

Worldwide Oil and Gas Reserves
Mexico
China
Kuwait
UAE Nigeria
10 IOCs
Venezuela
Iraq
R/D Shell (16.8), Exxon
(13.7), BP (8.3), Mobil
(6.4), Chevron (6.0),
Amoco (5.5), Total (4.2),
ARCO (3.8), Texaco (3.7),
Elf (3.5)
Iran
FSU
Saudi Arabia
2,642 billion barrels oil equivalent
© UHCBA Energy Institute 49

…but it’s an Even
TOUGHER Neighborhood
• Countries slated for major oil and gas
transportation projects
– Central Asia
– Azerbaijan and Georgia
– Afghanistan and Pakistan
– Myanmar
– Colombia and Bolivia
© UHCBA Energy Institute 50

Sanctions Don’t
Work…but the Market Will
• The debate: Does investment lead to better
“country behavior”? No clear evidence
• Are there market incentives for good “country
behavior”? Better evidence
– New, highly publicized “corruption” ratings
– Credit ratings reflect country behavior
– Foreign direct investment flows
• Market incentives also drive corporate
behavior
Sanctioned countries are higher risks regardless!
© UHCBA Energy Institute 51
Market Failure Natural Monopoly

$
Demand
PA
D
PD
C
ATC
PC
A
B
PB
MC
MR
QA
QD
QC
QB
Q
© UHCBA Energy Institute 52

Possible Solutions
• A, natural monopoly outcome, is what
we want to avoid
• B (P=MC) is equivalent to perfect
competition, but negative profits
• C yields zero economic profit  no
incentive to maintain service quality
• D provides a positive return: cost-ofservice (or, rate-of-return regulation)
© UHCBA Energy Institute 53

Deregulation
ISO
Pool /
Exchange
Gridco
Transco
© UHCBA Energy Institute 54

Old System
• Vertically integrated
because of
economies of scale
• Regulated (or
national) monopoly
• Cost-of-service
(rate-of-return)
regulation
New System
• Unbundled
because competitive
efficiencies in supply
& retail are expected
to surpass benefits
of VI
• T&D remain natural
monopolies with
regulated open
access
© UHCBA Energy Institute 55

Why Does Deregulation
Happen?
 Profit incentive for new firms to enter the
marketplace
 Technology drives industry economics drives
policy
 New technologies facilitate the rise of competition
 “Contestability” and the limits to monopoly
 The threat of “potential competition”
© UHCBA Energy Institute 56
Technical Change Shifts the
Production Function

Technology
Industry Economics
Output per
worker-hour
C
1
Q
Q2
K1
11
t=2
t=1
B
Society as a
whole
A
0
Policy
K2
22
Capital per worker-hour
© UHCBA Energy Institute 57
Market Failure Externality

P
MSC=MPC+MEC
H
E
B
A
P*
Pe
R
S = MPC
V
D=MPB=MSB
C
Q
Q*
Qe
© UHCBA Energy Institute 58

Private Outcome (Pe,Qe)
• Total social benefits (consumer and
producer surpluses): OEAQe
• Total social costs: OCRHQe
• Net social benefits: CEBR - BHA
© UHCBA Energy Institute 59

Socially efficient
outcome (P*,Q*)
• Total social benefits: OEBQ*
• Total social costs: OCRBQ*
• Net social benefits: CEBR
• Difference between the two: BHA,
welfare loss due to externality
© UHCBA Energy Institute 60

Solutions to externality
• No government
• Government
– Moral suasion
– Government production
– Command & control
– Market incentives
© UHCBA Energy Institute 61

Pigovian tax
• Set a tax equal to the difference
between MSC and MPC at the socially
optimum level of output, i.e., BV
• But, there are problems:
– How to calculate MSC?
– Who bears the burden of tax?
© UHCBA Energy Institute 62

Global Warming
• Global warming as a
scientific event
• Global warming as a
political event
– Rational objective
– No consensus on
analysis to confirm
scientific basis or
or refute
approach
– Policy prescriptives
– Policy prescriptives
realistically debated
politically debated
– Timing based on
– Timing based on
evidence
public opinion
– Adjust accordingly
– Adjust accordingly
Both views can lead to market-based solutions!
© UHCBA Energy Institute 63

Clean Energy
• AFVs
• Nuclear Power
• Renewable Power Technologies
– Regional/Economic Differences
– Deregulation of Power Industry
• New Sources of Energy: hydrogen?
© UHCBA Energy Institute 64

Energy Tomorrow:
Food for Thought
• New era in energy: Competitive Electricity
• Consumers of oil are now more powerful:
choices
• Last line of defense for oil, transportation,
is under attack
• Low price of oil may help (or, not!)
• Oil Co.  Energy Co.  Utility Co. (Enron
as a water utility!)
© UHCBA Energy Institute 65