Energy Economics Final Study Guide

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Many types of risk make energy markets susceptible to price volatility.

There is very elastic demand for energy.

Price volatility is represented by the diagram, indicating that price goes up when supply goes down.

Price volatility is represented by the diagram because when elasticity of supply changes price does not, meaning the energy market is usually stable.

The shapes of the supply and demand curves are representative of the total units available for sale. If there are a greater number of units available then the length of the supply line increases.

The shapes of the supply and demand curves are representative of the elasticity of supply and demand. If a curve is inelastic it will have a very steep slope. Inelastic behavior of demand means it is less responsive in the short term to changes in supply.

production will be scheduled so that the asset bears its highest return

production will be scheduled so that the price is lowest during the asset extraction, so it may be sold later at a higher price

Price development is based on the first order condition, where Marginal User Cost (MUC) plus Marginal Extraction Cost (MEC) is the price at time t. The resource owner must be fairly compensated for the decision to extract today and forgo the marginal value of extraction tomorrow.

Price development happens at the intersection of the shadow price and the demand in the same period, t. The resource owner must be fairly compensated for the decision to hold reserves today for the future use of national interests.

The pricing of green power or energy efficiency have parity with a brown power investment. After the subsidies for energy efficiency investments sunset then the technological investment will remain profitable.

The pricing of energy efficiency will be lower than an investment in brown power but the investor believes it is the right thing to do for the good of the planet. The subsidies for the energy efficiency investment are irrelevant to the benevolent financier.

Using net present value. If NPV is positive, then the investment is made.

Using loan payoff periods. If the loan payoff period is within a reasonable time frame then the project is profitable and the investment is made.

Using the expected revenue formula. By estimating the revenue the investor determines the monthly profitability of the project then adds the expected profitability to determine when they will fill their bank accounts.

Market failure is where a competitive market does not yield the socially efficient outcome. Government subsidies of green power lead to over consumption of electricity and disincentives for energy efficiency. The underlying market failure is under pricing of brown power, not overpricing of green power, artificially depressing the price of power and discouraging energy efficient consumption.

Market failure is where a competitive market does not yield the socially efficient outcome. When the government does not subsidize energy efficiency then society losses out by not having enough power to deploy luxury lighting of their properties.

Market failure is where a competitive market does not yield the socially efficient outcome. In energy efficiency the biggest market failure happens when policy makers fail to forward payments to brown power producers and there is not enough electricity to power the new generation of LED products.

Subsidies, Feed-in Tariffs, command-and-control regulation, market-based credit trading schemes

legislative quagmire, legal precedent, direct taxes on consumers, grants for economists

Prices do not fully reflect scarcity due to wholesale price caps.

Prices do not fully reflect scarcity due to retail price caps.

Prices do not fully reflect scarcity due to privatization of industry.

Prices do not fully reflect scarcity because consumers are unwilling to pay wholesale rates above a certain price.

In demand response, voluntary rationing is accomplished by price incentives. Involuntary rationing, if employed, would be accomplished via rolling blackouts during peak load periods. If distributors are forced to pay distributed generators at retail rates, they are free-riding the grid and voluntary price signaling fails, leading to a higher potential for involuntary rationing.

One kind of rationing is to curtail renewable energy supply. Another kind of rationing is to curtail distributed generators and make them pay for feeding power into the grid. This solves the missing money problem.

In a system where rationing by price was not possible, but the available capacity will equal to K, the shaded area would represent non-price rationing in the form of power cuts

In a system where rationing by price was not possible, but the available capacity will equal to D, the area B would represent non-price rationing in the form of power cuts

In a system where rationing by price was not possible, but the available capacity will equal to K, the area B would be brought offline to accommodate a peaking only generation environment

Such pricing rules serve as benchmarks when evaluating actual pricing of electricity and the value of hydropower reservoirs. Actual prices may not reflect the socially optimal prices, especially in the case of market power or price regulation. The ability to store water implies that it is optimal to use water in the highest price periods to bring down prices and create greater social surplus

Such pricing rules serve as benchmarks when evaluating actual pricing of electricity and the value of hydropower reservoirs. The socially optimal pricing rules ensure that all water is used today to produce as much electricity from renewable resources over one period, as possible.

Such pricing rules serve as benchmarks when evaluating actual pricing of electricity and the value of hydropower reservoirs. The socially optimal pricing scheme involves pumped storage using nuclear reactors to mitigate the effects of carbon intensive electricity production.

Assumptions: We will assume there is unlimited transferability of water between the periods Water is measured in energy units, kWh, and no conversion from water to electricity is shown The marginal utility, measured in monetary units is the marginal willingness to pay This is our demand function for electricity The water values for period t-1 and t must be equal when no hydro-related constraint is binding. The hydro contribution is the amount of water, AB, locked in to be used in period 1 and a full reservoir BC is left for period 2. The water value for period 1 is equal to the price. It is a general result that the water value in a period is equal to the marginal cost of the partially utilized technology.

Assumptions: We will assume there is limited transferability of water between the periods Water is measured in mass units, kg, and no conversion from water to electricity is shown The marginal utility, measured in mass units is the marginal willingness to pay This is our supply function for electricity The water values for period t-1 and t must be unequal when no hydro-related constraint is binding. The hydro contribution is the amount of water, AB, locked in to be used in period 1 and a full reservoir BC is left for period 2. The water value for period 1 is equal to the price. It is a general result that the water value in a period is equal to the marginal cost of the fully utilized technology.

The general effect is that the price in the period with a binding storage restriction will be higher than without such a restriction, and in the multi-period case more water has to be transferred to the period after the period with the storage capacity constraint. Storage capacity is BC In the first period, water available is equal to AC Second period inflow equal to CD The optimal allocation is to store maximal amount BC in period 1 and consume what cannot be stored (AB) Consume BD in period 2 What was stored from period 1 plus the inflow in period 2=BD

The general effect is that the price in the period with a binding storage restriction will be lower than without such a restriction, and in the multi-period case more water has to be transferred to the period after the period with the storage capacity constraint. Storage capacity is BC In the first period, water available is equal to AC Second period inflow equal to BD The optimal allocation is to store maximal amount BC in period 1 and consume what cannot be stored (AB) Consume BD in period 1 What was stored from period 1 plus the inflow in period 2=AC

The general effect is that the price in the period with a binding storage restriction will be equal than without such a restriction, and in the multi-period case no more water has to be transferred to the period after the period with the storage capacity constraint.

Hubbert predicted in 1956 that US oil production would peak in the early 1970s He was right. Hubbert set forth two educated guesses for the amount of US oil : 150 and 200 billion barrels Then he made plausible estimates of future oil production rates for each of the two guesses Predicted a peak of US oil production in the early 1970s Actual peak turned out around 1969

Hubbert predicted in 1956 that US oil production would peak in the early 1970s but he was wrong. Oil production continues to increase every year since that prediction

The switch from growth to decline in oil production will almost certainly create economic and political tension. Market share of OPEC in the Middle East will rise rapidly. World production will have to fall and radical increases in oil prices.

OPEC will increase exploration and discover new oil reserves capable of supplying the world for centuries to come. US energy supply will continue increasing only if the tax rates go down.

Proven world oil reserves need to be accurately surveyed.

OPEC needs to increase production

Oil recovery maximum across the world must be known

Estimates of future discoveries must be accurate

US joins the OPEC cartel to control a political peak oil

Market failure is where a competitive market does not yield the socially efficient outcome. By not reflecting the social cost of carbon energy markets became rampant fossil fuel consumers. The energy markets failed to account for circular economics and therefore are rapid increase in greenhouse gases resulted. Today: RES targets are not equitably allocating the cost of RD&D across all countries. Climate science has made a push for increased efforts to develop low-carbon technologies to reduce the emissions of GHG. The policy problem is how to transform the electricity system to introduce these new technologies and support their large scale diffusion. Innovation and technical change are at the center of climate change and energy policy debate.

The underlying market failure in energy markets is the result of the high cost of scrubbing coal smoke stack carbon emissions. If the price of carbon scrubbing from coal fired power plants were lower than that would eliminate the energy market failure related to climate change.

Pigou proposed a per unit tax on a good generating negative externalities equal to the marginal externality at the socially efficiency quantity Example: if at the socially efficient quantity, and marginal external cost (MEC) is $1, then a $1 per unit tax would lead to the right outcome As a result, the new competitive equilibrium, taking account of the tax, is efficient The tax level need not equal the MEC at other quantities

Pigou proposed a tiered-volume tax on goods generating negative externalities equal to the marginal externality at the socially efficiency quantity Example: if at the socially efficient quantity, and marginal external cost (MEC) is $1, then a $1 per 1000 units tax would lead to the right outcome As a result, the new competitive equilibrium, taking account of the tax, is efficient The tax level needs to equal the MEC at all other quantities

LACE and LCOE can be used to determine which project provides the best net economic value. LCOE is an estimate of the revenue requirements for a given resource By definition, a project´s equivalent annual cost Cn is the product of the LCOE and the quantity of electricity generated by the system in that year, Qn Cn=Qn*LCOE Can include installation, operation and maintenance, financial costs and fees, and taxes and also account for incentives and salvage value. LCOE allows alternative technologies to be compared with different scales of operation, different investment and operating time periods. For example, the LCOE could be used to compare cost of energy generated by renewable resource with that of standard fueled generating unit. The LCOE is that cost that, if assigned to every unit of energy produced by the system over the analysis period will equal the Total Life-Cycle Cost (TLCC) if discounted back to the base year. LCOE is recommended for use when ranking alternatives given a limited budget simply because the measure will provide a proper ordering of alternatives.

LACE and LCOE can be used to determine which project provides the best profit value. LCOE is an estimate of the profit requirements for a given resource By definition, a project´s equivalent annual profit Pn is the product of the LCOE and the quantity of electricity generated by the system in that year, Qn Pn=Qn*LCOE Can include installation, operation and maintenance, financial profits and fees, and taxes and also account for incentives and salvage value. LCOE does not allow alternative technologies to be compared with different scales of operation, or the same investment and operating time periods. For example, the LCOE could be used to compare profit of energy generated by renewable resource with that of standard fueled generating unit. The LCOE is that cost that, if assigned to every unit of energy produced by the system over the analysis period will equal the Total Life-Cycle Cost (TLCC) if discounted back to the base year. LCOE is not recommended for use when ranking alternatives given a limited budget simply because the measure will provide an improper ordering of alternatives.

Key inputs to calculating LCOE include capital costs, fuel costs, fixed and variable operations and maintenance (O&M) costs, financing costs, and an assumed utilization rate for each plant type.For technologies with no fuel costs and relatively small variable O&M costs, such as solar and wind electric generating technologies, LCOE changes nearly in proportion to the estimated capital cost of the technology. For technologies with significant fuel cost, both fuel cost and capital cost estimates significantly affect LCOE.

Key inputs to calculating LCOE include policy, environmental rule making procedure, administrative oversight, bank regulation, and an assumed payback period for each plant type. For technologies with fuel costs and relatively small variable O&M costs, such as solar and wind electric generating technologies, LCOE changes nearly in proportion to the estimated capital cost of the technology. For technologies with no fuel cost, both fuel cost and capital cost estimates significantly affect LCOE.

In the first best economic world: Pricing externalities is likely to be the best way to move behavior towards efficiency Pollution rights would be an input to the production of electricity Automatically included in the levelized cost calculation Most levelized costs do not include the costs of emissions directly LCOE generally include the costs of technology that must be installed in order to meet the command and control regulations Implications of the social LCOE: no need for anti-competitive subsidies example - LCOE for fossil fuel: $45/MWh LSCOE for fossil fuel: $ 55/MWh LCOE for renewables: $50/MWh, then renewables could compete with fossil fuels.

In the first best economic world: Price of carbon is a regulatory mandate that is controlled outside of the marketplace to prevent corruption. There is little incentive to include the social cost if there is no command-and-control regulation.

lower environmental impact Impact energy security green jobs Primary public policy argument for renewable electricity generation is externalities from burning fossil fuels. The main arguments, though problematic, favor subsidies for renewable energy. The truth of the matter is that the market failure of emissions is the underpricing of brown power, not the overpricing of green power.

higher environmental impact Impact energy security green jobs Primary public policy argument for renewable electricity generation is externalities from job automation in the oil industry. The main arguments, though problematic, favor subsidies for renewable energy. The truth of the matter is that the market failure of emissions is the overpricing of brown power, not the underpricing of green power.

Subsidizing green energy is not a solution to under-taxing brown power near-term upward pressure on electricity market prices Difficult to control overall policy costs

New products are always coming to market to take advantage of the latest subsidy consumer choice is limited to those products that lawmakers endow with a subsidy energy security is drastically increased with subsidies

distorts wholesale electricity market prices FITs do not directly address the high up-front costs of RE technology

FITs are not "market-oriented" - payment levels offered are frequently independent from market price signals FITs may exclude lower income individuals from participating

do not encourage direct competition between project developers difficult to equitably share costs across ratepayer classes

There is little incentive for the distributed generator to buy renewables The subsidies leave the grid unprepared for the coming electric car revolution

Feed-in tariff is an energy supply policy focused on supporting the development of new renewable energy projects by offering long-term purchase agreements for the sale of RE electricity (10-25 years) It has 3 key provisions: 1. Guaranteed access to the grid 2. Stable, long-term purchase agreements (10-25 years) 3. payment levels based on the costs of RE generation

Feed-in tariff is an energy supply policy focused on supporting the development of new renewable energy projects by offering short-term purchase agreements for the sale of RE electricity (10-25 months) It has 3 key provisions: 1. provisional grid access when available 2. Stable, short-term purchase agreements (10-25 months) 3. payment levels based on the costs of fuel

an association of firms that explicitly coordinates its pricing or output activities

a collaboration of renewable energy generators

benevolent dictators that seek to maximize output of oil to a socially efficient level

government program to funnel public dollars into the oil industry to increase tax revenue

net present value involves a conversion of all benefits and cost streams occurring at different points in time to their present value equivalent

net present value involves a division of all benefits and cost streams occurring at the same point in a year to their real dollar equivalents

net present value involves a division of all benefits and cost streams occurring at the same point in a year to determine the payback period in weeks

transaction

effect

benefits

future

nonexcludable

nonrivalrous

public good

private good

corporate good

good Samaritan

Determine water allocation and the development of the electricity price over time. Provides a graphic illustration of multi-period water allocation using a hydropower reservoir. Plus the standard objective - that is to maximize consumer plus producer surplus with the quantities produced as endogenous variables .

Determine price allocation when water is used over one period. Provides a graphic illustration of price as a function of the nuclear power baseload.

Price 1

Price 2

Water level 1

Price 1

Price 2

Water level 2

Consumer surplus 1

Consumer surplus 2

Producer surplus 2

Producer surplus 2

Producer surplus 1

Water deficit 1

The water used in period 1 is the area below the line from the Price 1 on the left hand vertical axis to the intersection of the two demand curves. The water used in period 2 is the area below the line from the Price 2 on the right hand vertical axis to the intersection of the two demand curves. The total water used will be the total area below the horizontal line from Price 1 to Price 2, down to the horizontal axis.

The water used in period 2 is the area below the line from the Price 1 on the left hand vertical axis to the intersection of the two demand curves. The water used in period 1 is the area below the line from the Price 2 on the right hand vertical axis to the intersection of the two demand curves. The total water used will be the total area above the horizontal line from Price 1 to Price 2.

Storage capacity is BC In the first period, water available is equal to AC Second period inflow equal to CD The optimal allocation is to store maximal amount BC in period 1 and consume what cannot be stored (AB) Consume BD in period 2 What was stored from period 1 plus the inflow in period 2=BD

Storage is BC The first period is the red section AB The second period is the red section CD The reservoir is the Blue section, reserved over both period. The total water is represented in red

Storage capacity is BC In the first period, water available is equal to AC Second period inflow equal to CD The optimal allocation is to use maximal amount AC in period 1 Consume CD in period 2 No water was stored in period 1

The price is represented by P1 or P2, for period 1, period 2 prices.

The price is represented by P1 or P2, for period 1, period 2 prices.

The price is represented by P1 or P2, for period 1, period 2 prices.

The baseload power plant is z. This is because the variable cost is very low and the annual operation is the lowest, even after having very high fixed costs.

The baseload power plant is x. This is because the variable costs are very high but the fixed costs are very low, which make it the best to run all the time.

learning rate

The cost per unit decreases with an increasing production rate. The rule of thumb is that unit cost reductions of 20% associated with doubling of capacity has been typical for energy generation technologies, with the exception of nuclear power

The cost per unit increases with a decreasing production rate. The rule of thumb is that unit cost reductions of 50% are associated with a tripling of the capacity, typical of energy generation technologies, with the exception of nuclear power.

Relatively simply calculations Hubbert assumed that the US had been comprehensively surveyed then modeled particular field depletion, extrapolated to the US as a whole US production has not followed the path dictated by the Hubbert´s curve The peak is only one statistical parameter. The tail of the production is what matters The point is to emphasize the uncertainty and to highlight the extent to which the constraints are technical and economic, rather than about physical limits. No practical physical limit

The Hubbert analysis did not go far enough in defining the peak oil scenario. Physical peak oil is more readily measured with modern data and the threat is larger than Hubbert predicted. The analysis is missing more quantitative data on the now decreasing reservoir recovery factors.

Pricing externalities is likely to be the best way to move behavior towards efficiency Pollution rights would be an input to the production of electricity Automatically included in the levelized cost calculation Most levelized costs do not include the costs of emissions directly LCOE generally include the costs of technology that must be installed in order to meet the command and control regulations

Pricing externalities is likely to be the best way to move behavior towards inefficiency Pollution rights would be an output to the production of electricity Automatically included in the levelized avoided cost calculation Most levelized avoided costs do not include the costs of emissions directly LACE generally include the costs of technology that must be installed in order to meet the command and control regulations

Feed-in tariff is an energy supply policy focused on supporting the development of new renewable energy projects by offering long-term purchase agreements for the sale of RE electricity (10-25 years) It is a support mechanism There are three key provisions of FITs: Guaranteed Access to the grid Stable, long-term purchase agreements (10-25 years) payment levels based on the cost of RE generation There are 4 different calculation approaches: 1 based on actual levelized cost of renewable energy generation 2. based on the "value" of renewable energy generation - avoided costs 3. offered as a fixed-price incentive 4. based on the results of an auction or bidding process FITs are adjusted over time according to market trends and evolving political priorities and increased installation. Today there are more differentiations in the tariff amounts based on technology type, project size, and project location.

Feed-in tariffs are taxes on cattle feed. The higher the taxes on cattle feed the lower the greenhouse gas emissions.

secure and stable market for investors

growth of local industry and job creation

increasing quantity of coal to natural gas conversions

only cost money if projects actually operate

lower transaction costs

fixed-price benefits of RE generation for utility's customers

distorts wholesale electricity market prices

equitable cost and development benefits, geographically

settle uncertainties related to grid access and interconnection

enhance market access

near-term upward pressure on electricity prices

distorts wholesale electricity market prices

FITs do not directly address the high up-front costs of RE technology

FITs are not "market-oriented" - payment levels offered are frequently independent from market price signals

enhance market access

settle uncertainties related to grid access and interconnection

FITs may exclude lower income individuals from participating

Difficult to control overall policy costs

do not encourage direct competition between project developers

difficult to equitably share costs across ratepayer classes

Two structural types of feed-in tariffs are: 1. percentage of retail price; 2. fixed-price FIT model

Two structural types of feed-in tariffs are: 1. make-up period price; 2 fixed-payback period FIT model

market failure

externality

socially efficient quantity

Opportunity Cost

Market equilibrium

externality

Marginal cost

Price elasticity of demand

Price elasticity of supply

Marginal change in revenue

Incremental cost function

The backstop price

The equilibrium price

The market failure price

Cartel

Government

Monopoly

Dictator

P= 9 Q= 3

P=3 Q=9

P=4 Q=8

P=8 Q=4 Price is higher in the monopoly scenario Quantity supplied is higher in competitive market

P=9 Q=3 Price is higher in the monopoly scenario Quantity supplied is higher in competitive market

P=9 Q=4 Price is higher in the monopoly scenario Quantity supplied is higher in competitive market

P=8 Q=3 Price is higher in the monopoly scenario Quantity supplied is higher in competitive market

It is a general result that the water value in a period is equal to the marginal cost of the partially utilized technology. Value of water when there is overflow = 0

It is a general result that the water value in a period is equal to the marginal cost of the fully utilized technology. Value of water when there is overflow = 0

Area represented by blue is total water consumed in period 1

Area represented by blue is total water consumed in period 1

Area represented by blue will be total water consumed during period 2.

Area represented by blue will be total water consumed during period 2.

No water will be used in period 2.

Area represented by xD will be the total water consumed during period 2.

Pigou proposed a per unit tax on a good generating negative externalities equal to the marginal externality at the socially efficiency quantity Example: if at the socially efficient quantity, and marginal external cost (MEC) is $1, then a $1 per unit tax would lead to the right outcome As a result, the new competitive equilibrium, taking account of the tax, is efficient The tax level need not equal the MEC at other quantities

Pigou proposed a flat tax on goods generating negative externalities equal to the marginal externality at the socially efficiency quantity Example: if at the socially efficient quantity, and marginal external cost (MEC) is $1, then a $1 per unit tax would lead to the right outcome As a result, the new taxed equilibrium is pseudo competitive The tax level needs to equal the MEC at other quantities

Derivative contracts are financial instruments which derive their value from an underlying asset. Futures contracts and forward contracts are both derivatives. Forward contracts are a simple extension of a cash transaction where delivery of commodity takes place in the future. Forward contracts are between two parties. In futures contracts, unlike forward contracts, buyers and sellers of futures contracts deal with an exchange, not with each other. Futures contracts are standardized, which enables traders to focus on one variable, price.

Futures and forward contracts are both derivatives. Futures contracts are between two parties. Forward contracts are exchanged on a market, unlike futures contracts, buyers and sellers deal with the exchange, not each other. Forward contracts are standardized, which enables traders to focus on one variable, price.

Delivery ties the price of the expiring futures to the price of the physical commodity at delivery. In a cash-settled contract, at expiration the buyer pays the seller the difference between the fixed price established in the contract and the reference price prevailing on payment.

Physical delivery ensures that all parties comply with the terms of the contract. If the product on contract is not delivered, the buyer has the right to sue the seller, given a futures contract.