Business
2. Energy
2.2 Supply of energy
consumption expressed in miles per gallon; and the car usage expressed in average miles per car. Two types of vehicle are also shown: passenger cars and vans and SUVs (sports utility vehicles). As one can see, mileage was not affected substantially, despite the oil price hikes in 1973 and 1979. The rapid increase in car fuel efficiency, assisted by the mass introduction of Japanese cars in the American market, helped sustain the great love affair of US consumers with the automotive industry and provide endless material for ‘road movies’ to Hollywood scriptwriters.
Transportation is not of course limited to road only. The other two major consumers are air and seaborne transportation. The former has risen to prominence, due to the general increase in passenger and cargo air-miles travelled and due to the fact that the fuel used (aviation turbine fuel or jet kerosene) is one of the most valuable refined petroleum products. However, the importance of shipping fuel consumption (in the form of either heavy fuel oil of marine diesel) cannot be underestimated, given that an estimated 75% of the world merchandise trade is seaborne.
2.1.4 Other consumption
This category encompasses all the remaining sectors of the economy, primarily energy consumption for agricultural use and commercial buildings. Parameters affecting this segment of consumption include fuel efficiency and the degree of mechanisation of agriculture.
extraction – which includes marginal1 cost and user2 cost – is lower or equal to the price3 paid for the resource plus the marginal utility of present consumption.4 Like in most production processes, extractive firms benefit initially from increasing returns to scale, then their average total cost curve stays flat for some time after reaching the minimum efficient scale, and if they decide to increase output further they are usually faced with decreasing returns to scale. In the long-run, production tends to stabilise along the bottom of their long-run average total cost curve (see Figure 5).
The theory, as it stands, implies that high-cost producers – which usually also have limited reserves – should be the first to be squeezed out of the market when energy prices fall and operating costs are not covered. It also implies that large low-cost producers should be relatively immune to price downswings, and continue to produce under all – but the most extreme – market conditions.
Alas, real life is not as clear-cut as this model suggests. To take yet another example from the oil industry; although Arab OPEC countries are indisputably the lowest-cost producers, it is high-cost producers that seem to be operating at full capacity, while low-cost competitors seem to play the role of “swing’
producer”5 balancing demand and supply.
The picture becomes even more complicated when government economic policies are taken into account. Energy supplies are of strategic importance to every government worldwide. If they are in abundance, they will be used to cover domestic needs and the balance will probably be exported; if they are in short supply, the government will resort to imports and a certain amount of stockpiling for security reasons.
Figure 5: Long-run average total cost curve
If security of supplies is a major issue on the energy agenda, demand will tend to be biased towards certain (perhaps low-cost) producers, and “secure” (perhaps high-cost) suppliers will realise this and step up their production. Finally, if financial flows from exports and/or export taxes are considered as well, national fiscal and monetary policies may distort the picture even further.
In any project for the extraction of mineral resources there are three main stages: exploration, development, and production. Exploration may last a few years, until proper geological surveys point with high probability to the existence of reserves. Several exploratory wells/shafts may have to be drilled in order to assess the quality and extent of the deposits. Costs at this stage can be substantial and are sunk. The development stage involves extensive drilling in the case of oil and gas, and construction of an open pit or underground mine in the case of coal. Again, costs at this stage are sunk, and further costs might have to be incurred at later stages of a project, in order to improve and/or extend capacity.
At the production stage, most of the costs are operating costs, which tend to increase as reserves are being depleted and more effort is required to extract them. This is particularly true for coal, especially when underground mining is the method of production.
Energy projects use capital quite intensively and embody a substantial amount of risk. Even when adequate reserves are found, the high rate of discount applied to such projects makes the extraction of the commodity more desirable sooner rather than later. This argument is often used to explain the intensive exploitation of high-cost oil
reserves like the ones in Alaska or the North Sea, in order to maximise oil recovery as quickly as possible.
Another important characteristic of the energy sector – and the mineral sector in general – is the large extent of heterogeneity in production costs. Depending on the geomorphy of the field and local climatic conditions costs can vary considerably from one region to the next. In the oil sector, for instance, capital expenditure for field development may range from “low-cost” to “frontier areas”, as it is shown in Table 1.
A similar situation is evident in the coal industry, with Venezuela, Indonesia and South Africa in the low to medium-cost producers, while countries like
USA, Germany, UK and France are at the other end.
3. Oil
With a share of 35% in world primary energy consumption, oil remains the leading energy commodity, and has been so for at least the past four decades. Oil reserves currently amount to just over one and a quarter trillion barrels, over half of which are located in the Middle East. Latin America is the second largest reserve holder, with deposits mainly in Mexico, Venezuela and, more recently, Brazil. The other dominant reserve holder is the former Soviet Union, particularly Russia and Kazakhstan.
What is remarkable about the oil sector is its imbalance in terms of reserves. It has to be noted, however, that production by different countries has never been proportional to their reserves, as technology, investment capital, and finance are not freely available to all producers, and political conditions have often distorted economic principles of production.