Economics and Politics of Energy Industries – Setting the Stage

1. www.uh.edu/energyinstitute UNIVERSITY of HOUSTON Economics and Politics of Energy Industries – Setting the Stage BAUER COLLEGE of BUSINESS ADMINISTRATION ENERGY INSTITUTE

2. 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

3. 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

4. Energy and GDP Correlation = 0.89

5. Energy Consumption per dollar of GDP (Btu) 97-Kazakstan 1-Uganda 80-Venezuela 5-Japan 78-Saudi Arabia 94-Russia 12-France 73-Mexico 15-Germany 67-Canada 88-China 22-UK 39-US 29-Bangladesh 86-UAE 70-India

6. Energy & GDP (low - low) Morocco Lithuania Bangladesh Bahrain Slovenia Nica. Uganda Nepal

7. Energy & GDP (low - middle) Belarus Finland Bulgaria Denmark Hong Kong Peru

8. Energy & GDP (middle - middle) Belgium Venezuela Czech Kazak. Sweden Switz. Austria

9. Energy & GDP (high - high) Canada India UK France Italy

10. Energy & GDP (high - high) US China Germany Japan Russia

11. Energy Today (primary) Source: http://www.bp.com/worldenergy/index.htm

12. Energy Today II (primary) Source: http://www.bp.com/worldenergy/index.htm

13. Energy Today IV (primary) Source: http://www.bp.com/worldenergy/index.htm

14. Energy Today V (oil) Source: http://www.bp.com/worldenergy/index.htm

15. Energy Today VI (oil) Source: http://www.bp.com/worldenergy/index.htm

16. Energy Today VII (oil) Source: http://www.bp.com/worldenergy/index.htm

17. Energy Today VIII (gas) Source: http://www.bp.com/worldenergy/index.htm

18. Energy Today IX (gas) Source: http://www.bp.com/worldenergy/index.htm

19. Energy Today X (gas) Source: http://www.bp.com/worldenergy/index.htm

20. Energy Today XI (coal) Source: http://www.bp.com/worldenergy/index.htm

21. Energy Today XII (coal) Source: http://www.bp.com/worldenergy/index.htm

22. Natural Resource Economics Instead of competitive profit max rule of P=MC, we have P=MC+OC AB = user cost (Hotelling rent)

23. 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)

24. Natural Resource Economics Price, Output Backstop technologies Price Output Time

25. Natural Resource Economics

26. Reserves to Production Ratios Source: www.bpamoco.com/worldenergy/primary/

27. Years of Current Consumption

28. World Crude Oil Replenishment(billion barrels)

29. World Natural Gas Replenishment(trillion cubic feet)

30. World Coal Replenishment(billion short tons)

31. U.S. Crude Oil Replenishment(billion barrels)

32. U.S. Natural Gas Replenishment(trillion cubic feet)

33. Canadian Natural Gas Replenishment(trillion cubic feet)

34. Plus Ça Change, Plus C’est la Même Chose Source: www.eia.doe.gov/oiaf/ieo99/highlights.html

35. 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

36. Cartels Don’t Work Nominal commodity prices, indexed

37. 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

38. BUT

39. OPEC (Saudi Arabia) has potential

40. 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?)

41. Market Shares

42. 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

43. Pipeline trenching and welding, compression, pressure control, metering Adversity is the Mother of Invention Offshore below 10,000ft? Virtual environments? Laser drilling? Cumulative U.S. oil production 4-d seismic, offshore below 5,000ft 3-d seismic, horizontal drilling, measurement while drilling, offshore below 1,000ft 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 Micros Work Stations ? 1859 1870 1935 1938 1947 54 78 83 85 90 92 98 2000

44. The Core Belief System...Shell Interdisciplinary Scholars Program (Hypothesis) Tendency Toward Energy Sector Reform HIGH LOW Energy products are commodities Energy products are strategic materials Small resource base Large resource base Weak imperatives Strong imperatives Strong institutional setting Weak institutional setting

45. …Dictates Energy Sector Organization...Shell Interdisciplinary Scholars Program (Hypothesis)

46. …and Relative Strength of the StateShell Interdisciplinary Scholars Program (Hypothesis) Trade Laws Pressure from Trade Flows Regulation Strength of State Ownership/ Control Open Access Jurisdictional Boundary Diminishing Monopoly Power

47. 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!

48. Motivation Can Move MountainsShell Interdisciplinary Scholars Program (Hypothesis) Oil and Gas Reserves Low High Favorable Strong E. Canada Argentina, Texas Angola, Norway Government Motivation Government Policies Colombia Brazil? China? Venezuela Russia, Other NIS India Saudi Arabia, Mexico Weak Unfavorable Low High G&G, Engineering Risk

49. 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

50. …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