Introduction to Energy

Economics

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Main Points
▪ History of energy economics.

▪ Energy and Multidimensional Interactions

▪ Energy markets

▪ Energy Policy

▪ Definition of energy

▪ Classification of energy
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 History of Energy Economics

◼ Energy economics is a branch of applied economics

where economic principles and tools are applied to
ask the right questions and to analyze them
logically and systematically to develop a well-
informed understanding of the issues.
◼ Like any branch of economics, energy economics is
concerned with the basic economic issue of allocating
scarce resources in the economy.

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 History of Energy Economics
◼ Energy economics is a comparatively young field of teaching
and research.
◼ Interest in it was triggered by a study published by the Club

of Rome in 1972. Written by Dennis Meadows, it was titled

“The Limits to Growth”
◼ His work used approaches borrowed from system dynamics

to predict the collapse of the world economy as a consequence

of declining oil reserves and increasing emissions harmful to
the environment.
◼ Shortly after this publication, the two oil price shocks of

1973 and 1979 appalled the world, seemingly confirming this

pessimistic view.
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 History of Energy Economics
◼ Analyses of energy problems have attracted researchers from
various fields and energy issues have been analyzed from an
economic perspective for more than a century now.
◼ But energy economics did not develop as a specialized
branch until the first oil shock in the 1970s .
◼ The dramatic increase in oil prices in the 1973–1974
highlighted the importance of energy in economic
development of countries.
◼ Since then, researchers, academics and even policymakers
have taken a keen interest in energy studies and today energy
economics has emerged as a recognized branch on its own.

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 History of Energy Economics
In the 1970s
◼ The focus was on understanding the energy industry (especially the oil
industry) and to some extent on renewable energies.
◼ Few economists began to develop new models.

◼ According to these models, the relative price of oil would have to rise and

global oil consumption would decline, stimulating substitution processes long

before the world runs out of oil. Therefore, the increase in the oil price was to
be seen as a step towards the solution of the energy problem.
◼ In fact, global oil consumption began to decline, as predicted by the

economic models.
◼ Among the best-known contributions of the time are the Hudson-Jorgensen

model and the ETA-MACRO model. These and other early models improved
the understanding of energy markets as well as the quality of
recommendations guiding energy policy.
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 History of Energy Economics
In early 1986
◼ The attention shifted to environmental problems.
◼ Environmental concerns of energy use and economic development
became a major concern, and the environmental dimension dominated
the policy debate.
◼ From the economist’s viewpoint, the price mechanism should again

help to solve them. Energy prices were to not only reflect cost as
calculated by the energy industry but also the external costs associated
with environmental damage caused by producing, transporting, and
using energy. Energy economists put considerable effort into the
conceptualization and quantification of externalities and their
evaluation as external costs.
◼ The fruit of these efforts was the introduction of ecological taxes

followed by tradable emission rights. 7

 History of Energy Economics
In the 1990s
◼ Liberalization of energy markets and restructuring swept

through the entire world although climate change and other

global and local environmental issues also continued.
At present
◼ Ongoing reforms of electricity markets, volatile prices of

fossil fuels and ever more frequent government interventions

in terms of market regulation (emission trading- taxes…),
and renewable energy challenge actors in energy markets.

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 Energy and Multidimensional Interactions
The energy sector is complex because of a number of factors:
1) Each industry of the sector has its own specific features which
requires special attention.
2) Energy being an ingredient for any economic activity, its
availability or lack of it affects the society and consequently,
there are greater societal concerns and influences affecting
the sector.
3) The sector is influenced by interactions at different levels
(international, regional and even local), most of which go
beyond the subject of one discipline.
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 Energy and Multidimensional Interactions
◼ The multidimensional nature of the energy-related interactions is
indicated. At the global level, three influences can be easily
identified
A. Energy trade
All transactions involving energy commodities are due to the
differences in the natural endowments of energy resources
across countries and the gaps in domestic supply and demands;
similarly flow of technologies, human resources, financial and
other resources as well as pollutants generated from energy and
other material use can also be considered at this level.

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 Energy and Multidimensional Interactions
B. International institutional influences
Various influences through international institutions affect
interactions among countries and govern transactions. These include
the legal frameworks, treaties and conventions, international
organizations such as the United Nations (UN), the World Bank and
the International Monetary Fund (IMF), the judicial system and the
like.

C. Other interaction
Other interactions among countries (co-operation, competition and
conflicts) involving their governments or other entities (such as the
firms) also influence the energy sector.
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 Energy and Multidimensional Interactions

◼ These influences are neither mutually exclusive nor static

in nature. Consequently, the relative importance of one or

more of these influences on a particular country would

vary and changes in the importance of one or the other

over time could modify the relationships extensively.

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 Energy Markets
◼ Most markets for energy have particularities due to physical,
geological, geographical, and technical properties of the energy source,
making them deviate from the idealized economic model (perfect
competition). The following list contains some of these characteristics:
➢ Without energy, no economic activity is possible.
Energy is an essential factor of production. Disruptions of energy supply
(e.g. the oil crisis of 1973/1974, electricity blackouts) can cause severe
damages to the economy and society.
➢ Energy is necessary to satisfy basic human needs.
Economic progress in many poor societies is hampered by an insufficient
supply of energy, which in turn is often caused by a lack of ability to pay.
Therefore, low incomes lead to unavailability of energy which in turn
depresses productivity and hence incomes—the classical example of a
poverty trap. 13
 Energy Markets
➢ Most energy infrastructure is characterized by long periods of
planning, investment, and operation.
Consequently, its adjustment to economic and social change is slow.

➢ In many countries property rights of underground resources and

hydropower are vested with the public rather than the private
sector.
The construction of infrastructure (e.g. pipelines or transmission lines)
often requires the right to use public grounds such as streets. Depending
on the authority in charge (local, regional, or national government), energy
markets are generally more dependent on political decisions compared to
other markets.

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 Energy Markets
➢ Reserves of fossil energy reserves such as crude oil and natural gas
are concentrated in a few countries, whose economy is dominated by
the extraction industry.
This facilitates a symbiosis between (often multinational) companies and
domestic politicians which may be beset by corruption. In addition,
resource-abundant countries face a major challenge when their extraction
industry starts to decline due to the depletion of resource deposits.
➢ Negative environmental impacts of the extraction, transformation,
transmission, and use of energy.
The energy sector is the largest single source of emissions into air, water,
and soil. In economic terms, these emissions represent negative
externalities which are normally not reflected in the prices of energy
sources, causing markets not to be Pareto-efficient.
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 Energy Markets
➢ Many renewable energy technologies presently are not fully
competitive .
So, government can possibly subsidize these resources in the aim of
ensuring a sufficient future supply of energy.

➢ Many energy markets are characterized by monopolies or

oligopolies rather than perfect competition.
In the transmission and distribution grid industries (natural gas, electricity,
and district heat), the monopoly can even be said to be ‘natural’ since the
establishment of competing infrastructures would be wasteful. The
downside is a potential abuse of power by the single provider. In order to
prevent this, governments generally regulate these industries.

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 Energy Policy

◼ In cases where self-interested behavior of market participants

alone fails to reach a Pareto-optimal state due to

particularities of energy markets, the term ‘market failure’

applies.

◼ Market failures are an argument for energy policy to

intervene into markets in order to correct market failures.

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 Energy Policy
Public energy policy has been in existence for a long time.
➢ Prior to the first oil price shock in 1973, its basic aim was to
secure the supply of energy by stimulating investment in
coal mining, oil extraction, as well as transmission and
distribution grids.
➢ In the 1980s, the new themes were regarding nuclear power
generation and the development of renewable energy
supplies.
➢ Since the 1990s, the energy policy of many countries has
been focusing on the liberalization of energy markets,
abatement of greenhouse gas emissions, and sustainable
development.
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 Magical Triangle of energy policy goals

According to magical triangle, energy policy has

a triple mission:

◼ It should secure the supply of energy.

◼ Contribute to economic competitiveness.

◼ Render the use of energy compatible with the

environment.
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Magical Triangle of energy policy goals

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 Definition of Energy
◼ Energy is commonly defined as the ability to do
work or to produce heat.
◼ Normally heat could be derived by burning a fossil

fuel or through other means such as by capturing the

sun’s rays.
◼ The ability to do work may represent the

capability (or potential) of doing work (known as

potential energy as in stored water in a dam)

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 Classifications of Energy
◼ As energy can be obtained from various
sources, it is customary to classify them
under different categories

1. Primary and Secondary.

2. Renewable and Non-Renewable

3. Commercial and Non-Commercial.

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 Primary and Secondary forms
Of Energy
Primary
◼ It is extracted from a stock
of natural resources or captured
from a flow of resources that
has not undergone any
transformation or conversion
other than separation and
cleaning.
◼ Examples: coal, crude oil,
natural gas, solar power,
nuclear power, etc.
Secondary
◼ It is any energy that is
obtained from a primary
energy source employing a
transformation or conversion
process.
◼ Examples: oil products or
electricity are secondary
energies as these require
refining or electric generators
to produce them.
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 Renewable and non-renewable
forms of energy

Renewable Non-Renewable
◼ It is any primary energy ◼ It is one where the primary energy
comes from a finite stock of
obtained from a constantly
resources. So drawing down one unit
available flow of energy. of the stock leaves lesser units for

◼ Examples: Solar energy, future consumption in this case.

◼ Examples: coal or crude oil comes
wind, and the like are
from a finite physical stock that was
renewable energies. formed under the earth’s crust in the
geological past and hence these are
non-renewable energies.
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 Commercial and non Commercial
forms of energy
Commercial
◼ They are those that are
traded wholly or almost
entirely in the market
place and therefore would
command a market price.
Examples include coal, oil,
gas and electricity
Non-commercial
◼ They are those which do not pass
through the market place and
accordingly, do not have a market price.
◼ Common examples include energies
collected by people for their own use.
➢ Earlier fuel-wood was just collected and
not sold in the market. It was hence a
non-commercial form of energy.
➢ Now in many urban (and even in rural)
areas, fuel-wood is sold in the market
and hence it has become a commercial
energy. At other places, it is still
collected and hence a non- commercial
form of energy. This creates overlaps in
coverage.
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