Introduction

• No economic activity without the provision of energy

• Meeting basic needs (progress)

• High level of government influence (energy sources, utilities)

• High concentration/dependence of energy reserves in certain regions

• Negative externalities (e.g. emissions)

• Exhaustibility and sustainability (incl. intergenerational equity)

• Competition issues

• In 2030, more than 60% of oil supplies will come from OPEC countries (2000: 40%) (strong re-concentration)

• Increase in oil production by 65%, doubling of gas and coal production from 2000 to 2030

• decentralised Coordination of supply and demand

• No central information necessary as in a planned economy (market price is sufficient)

• No Pareto optimal state → Market failure in energy supply → Governmental energy policy (market intervention)

• Magical triangle of the most important energy policy target dimensions:

The systematic, quantitative recording of the energy flows of the technical energy system, subdivided into:

• Output(energy production, imports, exports)Primary energy balance(TPES: Total Primary Energysupply)

• Conversion balance

• Use(according to end-user groups) - final energy balance (TFC: Total Final Consumption)

• Sum of domestic extraction of energy sources, changes in stocks and foreign trade balance

• Gross domestic energy supply shown by source and type of energy carrier

• Input, output, and consumption of energy carriers in the various conversion processes, as well as consumption during energy production and flare and line losses

• Gross domestic is available energy converted to secondary energy

• Final energy consumption, i.e., the use of energy carriers after conversion for the direct generation of useful energy, broken down by final energy carriers

• The sum of all primary energy quantities for the production, use and disposal

  → Ratio of final energy (electricity) to energy expended in the plant life cycle (CED)

• Measures to reduce the energy consumption of economic goods

• The energy balance of a country

• Power plants (Esp. solar and wind)

• The period of time that a power plant must be operated until the energy required for its production and disposal is recovered by the plant

• Indicates how often a plant returns the CED during its lifetime. Values > 1 mean an overall positive energy balance

• Coal-powered PP: ca. 0,3

• Wind PP: ca. 30.200

• Process chain analysis:

  • All process elements for the production of a good are broken down in detail up to its disposal, and the energy flows involved are added up

• Energy input/output analysis (I/O-Graph):

  • National economy is divided into economic sectors

  • The goods and services exchanged between sectors are recorded in input/output tables, i.e., characteristic relationship between energy input and price for certain sectors of the economy is calculated

  • Statistical data are used to assign specific energy expenditures to the monetary values of goods

    
    

• Nuclear Power plant NPP: 3,08kWh

  • To generate 1 kWh of nuclear power 3,08 kWh of energy must be used

• Wind Power plant WPP (onshore): 1,01 kWh

• I/O model presents the relation between sectors in the form of equilibrium equations (Model assumption – there is a given relationship between sectoral inputs and outputs)

  • Input coefficient – indicates how many monetary units of sector i are needed to obtain one monetary unit of output in sector j

  • Xi – total output of sector i

  • Fi – Final demand for goods or services in the sector i

  • N – number of sectors

  • In matrix notation: 𝑋 = 𝐴𝑋 + 𝐹

    If I is the unit matrix (identity matrix), then: (𝐼 − 𝐴) 𝑋 = 𝐹

    To determine the output vector (X) at the given vector F (final demand):

    𝑋 = (𝐼 − 𝐴)−1∙ 𝐹 (6)

    𝐿 = (𝐼 − 𝐴)−1 (7)

    𝑋 = 𝐿 ∙ 𝐹 (8)

    (L – Leontief-Inverse)

  • While the (input) coefficients shown in matrix A remain constant over the years, final demand and outputs may change over time:

    demand vector (F) when the new output vector (X) is entered? -> Eq. (5)

    output vector (X) when the new demand vector (F) is entered? -> Eq. (6) and (8)

• can be obtained in natural form

• e.g. coal, mineral oil, natural gas, wood, uranium, hydropower

• usually not homogeneous → conversion

• primary energy sources converted

• better for end users

• e.g. electricity, fuels, heating oil, natural gas (with homogeneous calorific value)

p–electricity price

Q = Cap*v*8760 – annual output quantity Cap–installed capacity in the power plant

R = p*Q = p (Cap*v*8760) – sales revenue

oc = c/Q operating costs incl. fuel costs per output unit

• Long-term nature of investments in the energy sector makes the choice of the calculation interest rate enormously important.

• results from the interaction of capital supply and capital demand

• Capital supply → depending on the marginal time preference qs(limiting is qs = i)

• Capital demand → depending on the expected return on investment ROI (limiting is ROI = i)

Special types of risk in investments:

▪Construction and installation risks

▪Financing risks

▪Technical (operational) risks

▪Sales and customer risks (payment defaults, economic downturn)

▪Supplier risks (disruptions)

▪Price and exchange rate risks

▪Social and political risks (strikes, regulatory intervention)

• Each state of risk can be assigned asubjective probability of occurrence wk with 0 ≤ wk ≤ 1 and the sum of it = 1

• the so-called capital market line can be used to establish a linear relationship between the risk (standard deviation of the securities return) of an efficient total portfolio p and its expected return ROI^e of p

▪Uncertainty

▪Flexibility of the investor regarding the timing of the upcoming investment

▪Irreversibility of the investment (opportunity costs, „value of waiting“)

▪NPV Monte-Carlo analysis (95% NPVs >0) – can be used to consolidate cash flow calculation uncertainties; computationally expensive

▪Decision tree analysis (dynamic programming)

▪Formal option valuation (NPV, option premium)

▪Pricing model for call option on dividend-free financial market product (so-called European option)

▪Price of security (underlying) follows a Wiener process with drift

▪Price changes between t and T are log-normally distributed

▪Limiting case of the binomial approach

▪Justified when the probability distribution of the underlying asset is normal, and if the price trajectory of the asset is continuous and has no jumps

▪Option to defer (Defer Investment)– possibility to postpone an investment within a certain period of time

▪Option to build (Time-to-Build Option) – possibility to enter the next phase if the project progresses successfully in one stage

▪Expansion/Reduction option (Expand/Contract)–possibility to expand/downsize an existing project

▪Option for temporary closure and reopening (Temporary Shut-down and Restart)

▪Option to sale (abandon for salvage value)

▪Switch option (switch use)–possibility to vary input/output factors depending on demand and development of prices

▪Option to growth (corporate growth)–possibility to follow an initial investment with a new investment

1. Stock of energy-consuming goods

2. Intensity of use

   -Time of day effects

   -Seasonal effects

   -Temperature and radiation fluctuations, weather

   -Production fluctuations

   -Energy management variables

   -Special events

   -Energy price fluctuations

   -Economic development

3. Equipment-specific efficiency

   
   

▪Energy carrier (electricity, heating oil, natural gas, hydrogen, biomass...)

▪Energy customer (industry, households, transport)

▪Consumption areas/sectors (low/high temperature heat, work, lightning, electrolysis)

Long-term factors:

▪Demographic and sociological variables

▪Economic factors

Short-term factors:

▪Effects on the intensity of use

Improving energy efficiency:

▪Technical progress

▪Policy interventions

▪Conscious investment/purchase decisions

▪Direct effects – increase in demand for an energy service induced by cost savings due to higher energy efficiency

▪Indirect effects – increase in the budget that can be spent on the consumption of all (energy consuming) goods and services because the cost of the energy service has become lower

▪Macroeconomic effects – supply/demand adjustments due to changes in relative prices in all sectors – affect both firms and households

• Costly initial assessment

• At the beginning there is a stocktaking and a search for possible improvementpossibilities is necessary

• Fluctuating energy demand

• Energy consumption could increase despite savings measures, e.g. due toincreased production or changed user behavior (rebound effect!)

• Rights and obligations of the contracting parties

• Contracts can never cover all possible developments, so the question ofresponsibility then arises

• Changes in the legal framework

• Changes in the law during the term of the contract may result in incalculableadditional claims

• Credit risk of the customer

• The contractor receives no recourse under property law and fully shares the riskof the customer's insolvency

• Legal uncertainties

• Landlords are not legally allowed to pass on contracting costs to tenants withoutdifficulty

• Mistrust

• Contractor will hardly make any investments towards the end of the contract,which the customer may anticipate. This makes the contracting business moredifficult

• output growth that cannot be attributed to greater labor, more capital, or other factors of production; the most important resource for increasing efficiency in energy use

▪ Laws of nature

▪ Existing technical knowledge

▪ Problem pressure (rising energy prices, supply bottlenecks, environmentalproblems)

▪ Government regulation and incentives

->Effects of these factors doesn’t necessarily lead to increased innovation

▪ Bottom-up Analysis:

− Poses high data requirements

− Requires many assumptions and

− A very detailed analysis

▪ Energy demand is influenced by macro variables such as prices, income, grossvalue added, etc. -> top-down

…estimating income and price elasticities of energy demand for policy makers and energy supplier. E.g.:

▪If price of electricity raises by x%, what happens to the demand of electricity?

▪If income increases by x%, what happens to the demand and price of electricity?

▪Insufficient data

▪Unstable/unclear interrelationships

(e.g., production factors <-> energy demand)

▪Unclear causalities (e.g.,GDP <-> energy prices or supply)

▪Asymmetric price reactions (elasticities)

▪Energy is disproportionately in demand by people with low income

→income distribution more skewed than energy distribution

▪People with low income turn to noncommercial sources of energy to meet their needs

→energy demand grows less than proportionately with increasing income

• Growing energy use leads to an improvement in the ability to pay for energy

  
  

Decisive for energy demand are the relative energy prices and their changes over time

→Problem: range of energy prices even for one energy source

→(Real) energy price index: average price weighted with market shares, based on macroeconomic price index (CPI, PPI, price index of GDP, etc.)

• Elasticity of substitution measures how easily, given constant output Q, the factors of production can be substituted for each other in pairs.

  
  

  
  

▪Energy resources – all total existing (presumed) usable energy resources even if they are not yet economically exploitable

▪Energy reserves – part of the energy resources that is very likely to be available and economically exploitable (low extraction costs, marketable at cost - covering prices)

▪Estimated Ultimate Recoverable Resources (EUR) = cumulative production + remaining resources + reserves

▪P (Proven)->probability of extraction > 90%

▪2P (Proven + Probable)->probability of extraction > 50%

▪3P (Proven + Probable + Possible)->probability of extraction > 10%

The cumulative discoveries correspond to a logistic growth path

▪Initially, only a few occurrences are discovered

▪With increasing experience (and decreasing exploration costs) the discovery rate increases

▪At some point, most of the deposits will be known and fewer new deposits will be discovered

▪Cumulative discoveries grow ever more slowly, converge against estimated ultimate recoverable resources (EUR)

Critique:

▪Changes in exploration costs not taken into account

▪Changes in resource prices are not observed

▪No changes in institutional framework conditions

▪New exploration technologies are disregarded

▪Symmetrical development isn’t realistic

• the increase in reserves depends on the ratio of exploration costs to the expected price.

→Exploration costs increase as the number of reserves (still to be discovered) decreases, and decrease with the introduction of better technologies

▪Higher prices and better technologies increase reserves

▪Reserves represent an asset position in order to secure long-term production planning, delivery capability, market presence and credit worthiness for investments

▪Economically considered, exploration expenditures should only be driven to the extent they don’t exceed the present value of the expected return

▪Static range (SR) – no (qualified) statement about how long energy reserves will last is feasible (energy efficiency, alternative energy sources can increase SR)

▪Dynamic range (DR) – consideration of reserve additions and departures

Economic model for the optimal extraction from an exhaustible deposit

Alternative actions:

1. Leave the reserves in the ground and wait for the market price of this reserve to rise as a result of declining availability

2. Extract the reserve and invest the profit in the capital market (securities, fixed assets)

▪But can intertemporal welfare-optimal resource allocation be controlled by markets (without government intervention)?

▪Weak sustainability(Brundtland-Bericht 1987)

-only conceivable if regenerative energy can cover the demand in the long term „Sustainable development is development that meets the needs of the present without compromising the ability of future generations to meet their own needs.“

▪Strong sustainability

-preservation of a minimum stock of resources for the benefit of future generations (prohibits further use of non-renewable resources once minimum stock is reached)

Ideally, the Hotelling model leads to an overall economic optimum. However, the ideal conditions are often not present, e.g., due to:

▪Emissions – outgoing impacts on the environment (e.g., noise, odors, exhaust gases)

▪‘Imissions’ – feedback of emissions on humans and the environment

▪Damage – imissions perceived as negative by humans

▪Externalities - the effects of an action of an economic entity on third parties, which are not evaluated through the market operations

• Positive – external benefits

• Negative – external costs that affect a third party without the polluter paying

▪External costs – monetary valuation of negative externalities that supplements the economic costs by the environmental and social costs it causes

→they should be internalized, since they aren’t booked

Mineral oil products

▪Gasoline

▪Kerosene

▪Diesel

▪Heating oil

Biogenic fuels

▪Biodiesel

▪Bioethanol

▪Synthetic fuels

▪Approx. 65% of conventional oil reserves are located the Middle East and Central Asia (“Energy ellipses”), however they are only responsible for 50% of the global crude oil production

▪South and Central America have the second largest reserves of crude oil in the world, and the highest R/P ratio, followed by Middle East

▪Currently 90% of the global oil production has a marginal cost of <8 US $ per barrel

Hubbert theorized that production of oil will reach a maximum in 1970s and then shrink, which happened.

▪Production will decline when half of the total recoverable oil reserves have been depleted (“depletion midpoint”). This is attributed to the decreasing pressure in the reservoirs. Water, steam and CO2 are pumped to re-increase the pressure (Enhanced Oil Recovery)

Types:

▪Oil sand (tar sand /Canada/)

▪Shale oil

▪Liquid gas (Natural gas liquid)

Characteristics:

▪Reserves estimates claim that the tar sands deposits in Canada and Venezuela alone hold >300 bln. barrels of oil (compared to a total of 1200 bln. of conventional reserves)

▪Competitive prices of 35-40$

▪No exploration costs for unconventional deposits in the future

▪Two extraction processes

• Open pit

• “In-situ” (Latin: on site) – most often referred to Steam-Assisted Gravity Drainage

Challenges:

▪More expensive than conventional oil production

▪Production consumes enormous amounts of energy and thus, reduces the extracted amount

▪Greater ecological risks due to high land and water requirements etc.

Advantages

▪Reduction of oil imports

→improved energy supply security

▪Reduction of greenhouse gas (GHG) emissions

→reduction of air pollution

▪Increasing income/employment in rural/weak areas

▪Reduction of solid organic waste

Disadvantages

▪Higher production costs

→need for subsidies

▪Retrofitscan be expensive (vehicles, logistics)

▪Partially higher pollutant emissions

▪Competition for land, which could be instead used agriculturally, commercially, or recreationally

▪Rapeseed oil methyl ester (RME)

• Input materials are plant components (rapeseed, soybean, sunflower) – used cooking oils

• Blending of up to 100%, however engine retrofits might be required

• Biodiesel blending reduces most emissions compared to conventional diesel

• Economic viability at $100/barrel of WTI crude oil, due to equal tax treatment. Production costs at €0.55-0.69/l

▪Ethanol

• With up to 10% bio-ethanol blended into conventional gasoline, engines don’t need modifications

• This reduces emissions of most pollutants, however also increases some

  →overall positive net balance

• USA and Brazil are the world’s largest producers

• Economic viability at $140/barrel of WTI crude oil in EU ($50 in Brazil). Production costs at $0.20-0.55/l

▪Second generation biofuel

• input materials could be the entire plant mass (biomass-to-liquid (BtL)), instead of oil-and starch-containing plant components; Fischer-Tropsch synthesis

• Economic viability at $160/barrel of WTI crude oil

Vertically integrated monopoly due to relatively homogenous goods and economies of scale

→control over both the sales and logistics

▪Factor-specific character of investment

(asset specificity) – refineries can only be used for further processing of crude oil, so that their investment is most profitable through utilization of capacity

▪High level of information asymmetry – reservoir owners control the information about inventory reserves, which is crucial for sensible production and investment planning

• in 1928 the companies BP, Shell, Exxon, Mobil, Gulf, Texaco, and Chevron reached an agreement to “freeze” market shares and share all new customers equally with the others (quantity cartel). The cartel controlled the oil markets until the 1970s, when the rise of the OPEC, among other things, ended it.

• an intergovernmental organization that aims to coordinate, unify and stabilize the petroleum policies, consisting of 13 countries (Iran, Iraq, Saudi Arabia, Venezuela, Kuwait...) (OPEC+ 23 countries, among Russia, Mexico, Bahrain, Kazakhstan...).

→

OPEC is accounted for 44% of global oil production and 81.5% of global proven oil reserves.

▪Posted price – some of the extraction companies’ profit taxes were increased to 85%, which then had to lead to higher oil price as these additional costs had to be passed on

▪Nationalization of oil companies

▪Modified form of the quota system – defended upper ($28/l) and lower ($22/l) price had to be defended. Abandoned in 2004

▪Service contracts (buy-back) – funding companies agree on an investment budget with the state to develop a new funding field (subsidies). At the start, the investment is property of the state and in return the company provides payment, and sometimes bears the exploration risk.

▪Concessions – foreign production companies are granted licenses for a limited time, allowing them to explore, extract and export the oil. The concessionaire (company) pays the investment, fees and profit taxes

▪Product sharing agreements – a production company develops and produces oil under the supervision of the national oil company. As a reward, it is allowed to keep a fixed quota at its free disposal

Spot contracts/trading – conclusion of the contract, delivery and payment coincide in time

Forward transactions/futures trading – delivery and payment at a different point in time from the conclusion of the contract

▪Forwards (over-the-counter) – individually negotiated price, quantity, and time between the contracting parties

▪Futures – standardized transactions, in which the exchanges are the contracting party (clearing house); the transaction costs represent the cos of assuming the default risk

▪Global economic growth

▪Quality requirements due to environmental considerations

▪Inventories

▪Other – peak oil thesis, short-term disruptions, strikes, weather, taxes

▪Marginal costs

▪Spare capacity – price level above MC possible in case of shortage; influenced by strikes, conflicts, weather, OPEC, etc.

▪OPEC cartel – can function as a markup

→price volatility

▪Non-renewability

▪Expectations – buyers expect higher future prices, so they try to avoid them by increasing present procurement, which actually increases the price further (self-reinforcing)

▪Logistics

▪Contango (=positive slope of the forward curve) – futures prices are higher than the spot price

→stocks are bought as much as possible to avoid the expected price increase

▪Backwardation (=negative slope of the forward curve) – futures prices are lower than the spot price

→people will switch orders from “just-in-time” in order to hold as little as possible of the currently expensive oil as stock.

→price volatility and probability for price shocks

wholesale price of petroleum products is composed of crude oil prices, refinery costs and margins

Types of refinery margins:

▪Spread – difference between product price and used crude oil price

▪Cash margin – difference between product revenue and cash operating costs for production