Shopping for a Market

By Keith Heyde

Energy economics is baffling. From a microeconomics perspective, there are just so many ways you can manufacture energy that it is rather difficult for us even to fully understand where our energy is coming from. This makes it difficult to set accurate prices for different energy ‘quality’, even though all electricity is really the same. This inability to differentiate on product ‘quality’, or perhaps more accurately quality of manufacturing, has caused the energy industry to be a cost driven market. With no distinct quality differentiation, the only difference between suppliers is price. This not only lowers the capacity for capital expenditures, and therefore positive infrastructure replacement, but it also keeps the margins to low that new entrants into the field are stuck battling at commodity prices for what could not be commodity goods.

                                                                                       

However, the microeconomics behind energy pricing is just the tip of the iceberg. Energy sales can come in a variety of patterns. At times, energy sales come from a bilateral agreement between two parties. For instance, Russia sells its gas to its Asian clients on a contract basis. This means that a set price is established and exclusive sales rights ensue. Especially in a climate where gas prices are decreasing, this can be to the seller’s advantage.

 

Contract markets also decrease (and often eliminate) the threat of competition. Because the major Chinese consumers are locked into long term engagement, there is very little extra money flowing towards energy startups. This creates a conservative system in which the entrenched clients maintain huge (monopolistic) market share and therefore have little incentive for innovation beyond reducing operational costs. Needless to say, this is not a good market for a changing, and rapidly greening energy climate.

 

On the other hand, some markets, such as the gas market in Europe, center on a more flexible climate. Although the prices are not set on a day to day basis, there are multiple vendors as well as a decent degree of vendor competition. As a consequence, price is less regulated and fluxuates in accordance to market demand. This drives a system where the impact of increased supply, say from exploitation of shale gas, has a positive impact on a buyer’s end line.

 

Finally, there are systems such as that which exist in the United States where energy sales are entirely deregulated. Within the U.S., this depends on a state-to-state basis, but in states where there is deregulation, it means that a consumer can purchase their electricity from any client. This gives a lot of incentives for coming up with the most efficient pricing model and quality as many consumers have choice in their purchase. With the advent of carbon offset pricing, this creates a system in which there are nuances associated with choice (as discussed earlier).

 

Energy markets are complex regardless of the type of system. As well as being complex, they are also horribly vulnerable to manipulation. As we saw in the 2000 black outs in California, energy manipulation for the sake of greed can cause not only strife but also fatality. It is important to understand that when it comes to energy, it is very much a commodity that people’s livelihoods and wellbeing are dependent upon in today’s modern age.

 

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