Energy Markets and Pricing

The global market for energy is the means by which energy resources are traded among countries and within entities that supply, produce, and distribute energy. Most nations do not have domestic natural resources available to support their energy needs, so they buy energy from other countries. These transactions are most often carried out by large energy companies. Transactions are complex and constantly changing to reflect variable energy prices and investor attitudes. Energy giants, such as the oil companies of BP, Shell, and Exxon-Mobil, dominate the global energy markets. Oil is not the only thing sold by energy companies, which make an incredible amount of money selling energy resources and services. It is important to consider the power wielded by energy giants when thinking about the problems associated with global energy dynamics. This section describes why energy pricing is important and how governments work to stabilize prices.

Energy prices are important because cheap energy allows for economic growth. Nations strive for continuous economic growth because it increases the quality of life for citizens and provides greater trade opportunities. High energy prices and market volatility make it difficult for some countries to obtain the necessary resources. Hence, it is in a nation's best interest to keep energy prices stable.

The most common way that prices are manipulated by governments is through energy subsidies. These are payments or rewards granted by governments to energy companies for the purpose of minimizing the cost of energy produced for public con-

FIGURE 2.2

General Trends in Energy Intensity during Industrial Development

Energy Intensity (EI)

Peak of energy intensity: GDP increasing, energy consumption high, EI high

GDP continues to increase, improvements in energy efficiency result in lower EI

Initial period of industrial activity: GDP low, energy consumption low, EI low

Time sumption. They are important components of national energy policies because they are thought to promote economic growth. Subsidies can be in the form of direct payments, tax exemptions, or funding for research and development that may provide potential energy sources in the future (EIA 1999). Since energy prices, particularly for crude oil, are determined from fluctuations in demand and supply curves, subsidies affect prices because they encourage a supply increase in a particular energy resource on the market. By subsidizing certain resources, a government can influence which energy sources are utilized in society.

The main problem that arises with subsidies is that it makes it more difficult to determine real energy prices based on costs of production. Because of subsidies, people do not pay the real price that it costs to produce the resource. Furthermore, the largest subsidies go to energy sources that are damaging to the environment. As a result, pricing schemes are distorted because they do not reflect the environmental and health costs associated with energy production. Another aspect of energy subsidies is that they encourage wasteful energy consumption. When energy is cheap, people aren't concerned about conserving resources. Moreover, energy companies often promote excessive consumption because they receive larger subsidies if they can supply more energy. Proposed solutions to these issues are discussed a little later.

An interesting point to note regarding energy markets is that the most traded energy commodity in the world today is crude oil. About 65 percent of the oil that is produced globally is exported to more than 130 countries (Smil 2003, 45). Approximately 85 million barrels of oil per day were traded on the market in December 2005 at an average price of $59.45 per barrel (IEA 2006). As of this publication, the only accepted currency for oil trade is the U.S. dollar. This means that countries must have U.S. currency in their treasuries or banks to purchase crude oil; they cannot use their own national currencies. (The "petrodollar" was established with the "As-Is" Agreement [see chapter 1].) The use of petrodollars is particularly advantageous to the United States, as it gives U.S. companies dominance in the oil markets. However, it is inevitable that this standard will be challenged as markets become increasingly globalized.

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