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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) 1 -Uganda 80 -Venezuela 5 -Japan 78 -Saudi Arabia 12 -France 73 -Mexico 15 -Germany 67 -Canada 22 -UK 39 -US 29 -Bangladesh 97 -Kazakstan 94 -Russia 88 -China 86 -UAE 70 -India © UHCBA Energy Institute 5
Energy & GDP (low - low) Lithuania Bahrain Slovenia Nica. Nepal Morocco Bangladesh Uganda © UHCBA Energy Institute 6
Energy & GDP (low - middle) Belarus Bulgaria Finland Denmark Hong Kong Peru © 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 Instead of competitive profit max rule of P=MC, we have P=MC+OC AB = user cost (Hotelling rent) © 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 © UHCBA Energy Institute 25
Reserves to Production Ratios Source: www. bpamoco. com/worldenergy/primary/ © UHCBA Energy Institute 26
Years of Current Consumption © UHCBA Energy Institute 27
World Crude Oil Replenishment (billion barrels) © UHCBA Energy Institute 28
World Natural Gas Replenishment (trillion cubic feet) © UHCBA Energy Institute 29
World Coal Replenishment (billion short tons) © UHCBA Energy Institute 30
U. S. Crude Oil Replenishment (billion barrels) © UHCBA Energy Institute 31
U. S. Natural Gas Replenishment (trillion cubic feet) © UHCBA Energy Institute 32
Canadian Natural Gas Replenishment (trillion cubic feet) © UHCBA Energy Institute 33
Plus Ça Change, Plus C’est la Même Chose Source: www. eia. doe. gov/oiaf/ieo 99/highlights. html © UHCBA Energy Institute 34
Bermuda Triangle: Energy-Economy. Environment • 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 © 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
BUT © UHCBA Energy Institute 38
OPEC (Saudi Arabia) has potential © 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 © UHCBA Energy Institute 41
Reactions to High Prices in the 1970 s • 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 10, 000 ft? Virtual environments? Laser drilling? 4 -d seismic, offshore below 5, 000 ft 3 -d seismic, horizontal drilling, measurement while drilling, offshore below 1, 000 ft Pipeline trenching and welding, compression, pressure control, metering Cumulative U. S. oil production Directional drilling, offshore below 250 ft 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) © 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 9/4/2021 Jurisdictional Boundary Diminishing Monopoly Power 46 © 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) Favorable High Oil and Gas Reserves Low E. Canada Strong Argentina, Texas Angola, Norway Government Colombia Motivation Policies China? Brazil? Venezuela Russia, Other NIS India Saudi Arabia, Mexico Weak Unfavorable Low High G&G, Engineering Risk © UHCBA Energy Institute 48
It’s a Tough Neighborhood. . . Worldwide Oil and Gas Reserves 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) 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 © 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
New System Old System • Vertically integrated • Unbundled because competitive because of efficiencies in supply economies of scale & retail are expected • Regulated (or to surpass benefits of VI national) monopoly • Cost-of-service (rate • T&D remain natural monopolies with -of-return) regulation regulated open access © UHCBA Energy Institute 55
Why Does Deregulation Happen? Ø Profit incentive for new firms to enter the marketplace Ø Technology drives industry economics drives policy Ø New technologies facilitate the rise of competition Ø “Contestability” and the limits to monopoly Ø The threat of “potential competition” © UHCBA Energy Institute 56
Technical Change Shifts the Production Function Technology Industry Economics Policy © UHCBA Energy Institute 57
Market Failure Externality P MSC=MPC+MEC H E B A P* Pe R V S = MPC 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 realistically debated politically debated – Timing based on evidence public opinion – 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
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