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Springer Texts in Business and Economics Peter Zweifel Aaron Praktiknjo Georg Erdmann Energy Economics Theory and Applications Springer Texts in Business and Economics Moreinformationaboutthisseriesathttp://www.springer.com/series/10099 Peter Zweifel (cid:129) Aaron Praktiknjo (cid:129) Georg Erdmann Energy Economics Theory and Applications PeterZweifel AaronPraktiknjo BadBleiberg,Austria E.ONEnergyResearchCenter RWTHAachenUniversity Aachen,Germany GeorgErdmann DepartmentofEnergySystems BerlinUniversityofTechnology Berlin,Germany ISSN2192-4333 ISSN2192-4341 (electronic) SpringerTextsinBusinessandEconomics ISBN978-3-662-53020-7 ISBN978-3-662-53022-1 (eBook) DOI10.1007/978-3-662-53022-1 LibraryofCongressControlNumber:2017934524 #SpringerInternationalPublishingAG2017 Thisworkissubjecttocopyright.AllrightsarereservedbythePublisher,whetherthewholeorpartof the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilarmethodologynowknownorhereafterdeveloped. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publicationdoesnotimply,evenintheabsenceofaspecificstatement,thatsuchnamesareexempt fromtherelevantprotectivelawsandregulationsandthereforefreeforgeneraluse. Thepublisher,theauthorsandtheeditorsaresafetoassumethattheadviceandinformationinthis book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained hereinor for anyerrors oromissionsthat may havebeenmade. Thepublisher remainsneutralwith regardtojurisdictionalclaimsinpublishedmapsandinstitutionalaffiliations. Printedonacid-freepaper ThisSpringerimprintispublishedbySpringerNature TheregisteredcompanyisSpringer-VerlagGmbHGermany Theregisteredcompanyaddressis:HeidelbergerPlatz3,14197Berlin,Germany Preface Access to energy resources, energy supply security, high and increasing prices of energy, lack of competition, slow market entry of renewables, insufficient invest- ment in energy efficiency, and sluggish progress in reducing greenhouse gas emissions are all well-known issues and concerns characterizing energy markets. Yet, what are the possibilities of finding effective, efficient, and sustainable solutions to these problems? The fundamental claim of this book is that solutions cannotbefoundwithoutanin-depthanalysisofenergymarketsthatacknowledges not only their physical and technological constraints but also their structural idiosyncrasiesandthebehaviorofmarketparticipants. This text is the result of 30 years of teaching and research performed by the authors at both German- and English-speaking universities in Europe. It therefore adoptsadistinctlyEuropeanapproach,yetwithoutneglectingdevelopmentsworld- wide. While firmly anchored in economic theory, it also presents empirical evi- dence enabling readers to assess the relevance of predicted relationships. For instance,itiscertainlyofinteresttoknowthattheso-calledelasticityofsubstitution is a crucial parameter for answering the question whether man-made capital can replace energyquicklyenoughtoassuresustainabilityintermsofconsumptionin spiteofthefactthatenergyconstitutesanultimatelylimitedresource.Inaddition,it is also important to see whether the estimated elasticities of substitution are typicallybelowone(makingsustainabilityquestionable)oraboveone(suggesting sustainabilitycanbeattained). Debates about energy policy tend to be short-lived, reflecting the interests of governments who wish to demonstrate to their electorate that they are “on top of things.” By way of contrast, this text focuses on the basic conditions and mechanismsthat allpublic interventions intheenergysector have todeal with. It provides readers with the tools enabling them to assess the chance of these interventionsreachingtheirobjectives.Turningtotheprivatesector,onecondition isthatmanagementdecisionsconcerningenergyareeconomicallyviable,lestthey failtocontributetotheeconomicsurvivalofthecompany.Thisbookistherefore alsoofinteresttobusinesspractitionerswhomaybeconfrontedwiththequestion whetherinvestmentinanenergy-savingtechnologyhasasufficientlyhighreturnto be worthwhile. Analysts of the energy industry, energy traders, and other professionals acting in and on behalf of the energy sector will benefit from this v vi Preface textaswell.Likethemakersofpublicpolicy,theyareconfrontedwithshocksofall sortsimpingingonenergymarketswithunprecedentedfrequency,exposingthemto increasingbusinessrisks. Finally,thisworkalsotargetsfutureresearcherswithaninterestinenergy.The distinctpropertiesofenergysources(rangingfromcoaltosolar)needtobetaken into account when modeling the behavior of businesses and consumers. The correspondingmarketsaredistincttoasufficientdegreetowarrantapartial(rather thangeneral-equilibrium)approachfortheiranalysis,atleastasafirstapproxima- tion. The statistical documentation of energy is excellent both at the national and internationallevel,pavingthewayforempiricalresearch.Moreover,animportant motivationmaybethatresearchrevolvingaroundtheeconomicsofenergyismet withconsiderableinterestbysocietyandpublicpolicy. StudentsattheSwissFederalInstituteofTechnologyETHZurich(Switzerland), theUniversityoftheArmedForcesinMunich(Germany),theTechnicalUniversity of Berlin (Germany), the RWTH Aachen University (Germany), and the Diplo- matic Academy of Vienna (Austria), as well as participants in international conferences, have all contributed to this volume through their suggestions and criticisms.ItsoriginalGermanversionhasbeenwellreceivedbybothEngineering and Economics students (future leaders and decision-makers in energy markets), thus motivating our attempt to make this work accessible to English-speaking readers. This text is somewhat voluminous because in addition to expounding the theoretical groundwork, it also addresses each of the several energy sources. However, individual chapters are self-contained, with cross-references to other topics. This broad approach has theadvantage ofprovidingareference especially forbusinesspractitionerswhoneedtoobtaininsightintoaparticularmarket.Atthe same time, readers never lose sight of the consequences of public regulation and liberalization,whichfrequentlycutacrosssectors(notleastcausedbysubstitution processesthatdependontheelasticityofsubstitutionalludedtoabove).Atatime whenenergymarketschangeanddevelopatanunprecedentedpace,thisguidance through the maze is particularly valuable, and when new market developments challenge received wisdom, new economic insights develop. We will therefore provide on our website www.energy-economics.eu additional material reflecting newdatasourcesandthescientificprogressinthefield. This joint effort would not have been possible without the support of many colleagues and collaborators, which is sincerely acknowledged. Of course, the authorsremainresponsibleforallremainingerrors. BadBleiberg,Austria PeterZweifel Aachen,Germany AaronPraktiknjo Berlin,Germany GeorgErdmann October2016 Contents 1 Introduction. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.1 PhilosophicalandEvolutionaryAspectsofEnergy. . . . . . . . . 1 1.2 WhyEnergyEconomics?. . . . . . . . . . . . . . . . . . . . . . . . . . . 4 1.2.1 PriceMechanismandMarketCoordination. . . . . . . . 5 1.2.2 ParticularitiesofEnergyMarkets. . . . . . . . . . . . . . . 7 1.2.3 EnergyPolicy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 1.3 HistoryofEnergyEconomics. . . . . . . . . . . . . . . . . . . . . . . . 12 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 2 EnergyinScienceandEngineering. .. . . . . . . . .. . . . . . . .. . . . . 15 2.1 EnergyandtheNaturalSciences. . . . . . . . . . . . . . . . . . . . . . 16 2.1.1 Physics. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 2.1.2 Chemistry. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 2.1.3 Biology. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 2.2 EngineeringandEnergy. . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 2.2.1 EnergyUnits. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 2.2.2 EnergyConversion. . . . . . . . . . . . . . . . . . . . . . . . . 21 2.3 EnergyBalance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 2.3.1 GrossEnergy(PrimaryEnergy). . . . . . . . . . . . . . . . 23 2.3.2 FinalEnergyConsumption. . . . . . . . . . . . . . . . . . . . 26 2.3.3 DataSources. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 2.3.4 UsefulEnergy(NetEnergy)andEnergyServices. . . 27 2.4 CumulatedEnergyRequirement. . . . . . . . . . . . . . . . . . . . . . 28 2.5 EnergyInput-OutputAnalysis. . . . . . . . . . . . . . . . . . . . . . . . 29 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 3 InvestmentandProfitabilityCalculation. . . . . . . . . . . . . . . . . . . 37 3.1 Basics. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 3.2 InterestRateandPriceofCapital. . . . . . . . . . . . . . . . . . . . . 44 3.3 Inflation-AdjustedInterestRate. . . . . . . . . . . . . . . . . . . . . . . 45 3.4 SocialTimePreference. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47 vii viii Contents 3.5 InterestRateandRisk. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49 3.5.1 CapitalAssetPricingModel(CAPM). . . . . . . . . . . . 50 3.5.2 NewAssetPricingMethods. . . . . . . . . . . . . . . . . . . 53 3.6 RealOptionValuation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54 3.6.1 EnergyInvestmentsasRealOptions. . . . . . . . . . . . . 55 3.6.2 Black-ScholesModel. . . . . . . . . . . . . . . . . . . . . . . . 58 3.6.3 ApplicationtoBalancingPowerSupply. . . . . . . . . . 60 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63 4 Bottom-UpAnalysisofEnergyDemand. . . . . . . . . . . . . . . . . . . . 65 4.1 ProcessAnalysis. . . .. . . . . . .. . . . . .. . . . . .. . . . . .. . . . . 66 4.2 StockofAppliances,Buildings,Vehicles,andMachineries. . . 68 4.3 EnergyEfficiency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 4.3.1 Definitions.. . . .. . . .. . . .. . . .. . . .. . . .. . . .. . . 77 4.3.2 DeterminingEnergyEfficiencyPotential. . . . . . . . . . 81 4.3.3 EnergyEfficiency:ACaseofMarketFailure?. . . . . . 82 4.3.4 Contracting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87 5 Top-DownAnalysisofEnergyDemand. . . . . . . . . . . . . . . . . . . . 89 5.1 PopulationGrowth. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 5.2 EconomicGrowth. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92 5.3 ThePriceofEnergy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 5.3.1 Short-TermandLong-TermPriceElasticities. . . . . . 95 5.3.2 APartialEnergyDemandModel. . . . . . . . . . . . . . . 96 5.3.3 SubstitutionBetweenEnergyandCapital. . . . . . . . . 102 5.4 TechnologicalChange. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110 6 EnergyReservesandSustainability. . . . . . . . . . . . . . . . . . . . . . . 111 6.1 ResourcesandReserves. . . . . . . . . . . . . . . . . . . . . . . . . . . . 112 6.1.1 Resources. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 113 6.1.2 StaticRangeofFossilEnergyReserves. . . . . .. . . . . 115 6.2 Profit-MaximizingResourceExtraction. . . . . . . . . . . . . . . . . 117 6.2.1 HotellingPriceTrajectory. . . . . . . . . . . . . . . . . . . . 117 6.2.2 RoleofBackstopTechnologies. . . . . . . . . . . . . . . . 120 6.2.3 RoleofExpectationsandExpectationErrors. . . . . . . 122 6.3 OptimalResourceExtraction:SocialWelfareView. . . . . . . . 123 6.3.1 TheOptimalConsumptionPath. . . . . . . . . . . . . . . . 126 6.3.2 TheOptimalDepletionPathoftheReserve. . . . . . . . 128 6.3.3 CausesandImplicationsofMarketFailure. . . . . . . . 129 6.4 Sustainability. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131 6.4.1 PotentialofRenewableEnergySources. . . . . . . . . . 131 6.4.2 HartwickRuleforWeakSustainability. . . . . . . . . . . 132 6.4.3 PopulationGrowthandTechnologicalChange. . . . . 137 6.4.4 IstheHartwickRuleSatisfied?. . . . . . . . . . . . . . . . . 138 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140 Contents ix 7 ExternalCosts. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143 7.1 TheCoaseTheorem. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144 7.2 AggregateEmissions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147 7.3 InstrumentsofEnvironmentalPolicy. . . . . . . . . . . . . . . . . . . 150 7.3.1 InternalizationApproaches. . . . . . . . . . . . . . . . . . . . 150 7.3.2 Standard-OrientedApproaches. . . . . . . . . . . . . . . . . 152 7.4 MeasuringExternalCostsofEnergyUse. . . . . . . . . . . . . . . . 154 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157 8 MarketsforLiquidFuels. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 159 8.1 TypesofLiquidFuelsandTheirProperties. . . . . . . . . . . . . . 160 8.1.1 PropertiesofCrudeOil. . . . . . . . . . . . . . . . . . . . . . 160 8.1.2 ReservesandExtractionofConventionalOil. . . . . . . 161 8.1.3 PeakOilHypothesis.. . . . .. . . . . .. . . . .. . . . .. . . 163 8.1.4 UnconventionalOil. . . . . . . . . . . . . . . . . . . . . . . . . 166 8.1.5 RefineriesandOilProducts. . . . . . . . . . . . . . . . . . . 167 8.1.6 BiogenicLiquidFuels. . . . . . . . . . . . . . . . . . . . . . . 168 8.2 CrudeOilMarket. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171 8.2.1 VerticallyIntegratedMonopoly. . . . . . . . . . . . . . . . 171 8.2.2 GlobalOligopolyofVerticallyIntegratedMajors. . . 174 8.2.3 TheOPECCartelofOil-ExportingCountries. . . . . . 176 8.2.4 State-OwnedOilCompanies. . . . . .. . . . . . . .. . . . . 180 8.3 OilPriceFormation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 182 8.3.1 OilSpotMarketsandtheEfficientMarket Hypothesis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183 8.3.2 Long-TermOilPriceForecastsandScenarios. . . . . . 185 8.3.3 PricesofCrudeOilFutures. . . . . . . . . . . . . . . . . . . 190 8.3.4 WholesalePricesofOilProducts. . . . . . . . . . . . . . . 192 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195 9 MarketsforGaseousFuels. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197 9.1 GaseousFuelsandGasInfrastructures. . . . . . . . . . . . . . . . . . 198 9.1.1 PropertiesofGaseousFuels. . . . . . . . . . . . . . . . . . . 199 9.1.2 ReservesandExtractionofNaturalGas. . . . . . . . . . 200 9.1.3 BiogasandRenewableNaturalGas. . . . . . . . . . . . . 202 9.1.4 Hydrogen. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203 9.2 NaturalGasEconomy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204 9.2.1 TransportbyPipeline. . . . . . . . . . . . . . . . . . . . . . . . 205 9.2.2 LNGTransportandTrade. . . . . . . . . . . . . . . . . . . . 211 9.3 GasMarketsandGasPriceFormation. . . . . . . . . . . . . . . . . . 213 9.3.1 Long-TermTake-or-PayContracts. . . . . . . . . . . . . . 214 9.3.2 NaturalGasSpotTrade. . . . . . . . . . . . . . . . . . . . . . 216 9.4 ThirdPartyAccesstotheGasInfrastructure. . . . . . . . . . . . . 221 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224

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