Energy Economics Revision Notes PDF

EXAMPLES QUESTIONS CHAPTER 1: INTRODUCTION Which are the critical aspects of the energy sector that make it useful a specific course of energy economics? The energy sector has unique characteristics that require specialized economic study, including:...

EXAMPLES QUESTIONS CHAPTER 1: INTRODUCTION Which are the critical aspects of the energy sector that make it useful a specific course of energy economics? The energy sector has unique characteristics that require specialized economic study, including: Strategic Importance: Energy drives the economy, and access to reliable energy is vital for maintaining quality of life. Economic Relevance: Energy is a major sector in national spending, involving high costs and long-term investments. Exhaustibility: Many energy sources, particularly fossil fuels, are finite and must be carefully managed to avoid depletion. Equity and Access: There are challenges in ensuring equitable distribution of resources, both geographically and over time. Environmental Impact: Energy use significantly affects ecosystems and contributes to climate change. Rapid Technological Change: Innovations in energy extraction, storage, and generation make the sector highly dynamic. Geopolitical Influence: Control over energy resources has substantial implications for international relations. With reference to the exhaustible resources, what do we mean with P90 or P50? For exhaustible resources like fossil fuels, P90 and P50 refer to levels of confidence in reserve estimates: P90 (Proven Reserves): There is a 90% probability that the estimated amount of resource is at least this amount. It represents a conservative and reliable estimate. P50 (Probable Reserves): There is a 50% probability that the estimated resource amount is accurate. This estimate is less certain but still likely to be accurate. These probability-based estimates help assess the available quantity of exhaustible resources with varying levels of certainty. What is the Mc Kelvey box? The McKelvey Box is a model used to classify fossil fuel resources based on two dimensions: economic feasibility (cost of extraction) and geological certainty. It organizes resources into four main categories: Proven Reserves: High certainty and economically feasible to extract with current technology. Probable Reserves: Moderate certainty, and extraction may be economically feasible in the near term. Inferred Resources: Less certain and may require technological advances to extract cost-effectively. Speculative Resources: Low certainty, with unclear feasibility and often high extraction costs. The McKelvey Box helps decision-makers understand both the cost and uncertainty associated with different fossil fuel resources.  Explain the difference between reserves and resources o Resources: The total amount of an energy source (e.g., coal, oil) that exists in nature, regardless of current economic viability or extraction technology. Resources include both discovered and undiscovered quantities. o Reserves: The portion of resources that is known, measured, and economically feasible to extract with existing technology. Reserves are a subset of resources and are categorized by their certainty levels (e.g., proven, probable). In short, all reserves are resources, but not all resources qualify as reserves due to economic and technological constraints. How can we classify energy sources? Energy sources are classified into two main categories: Renewable Sources: Naturally replenished and do not deplete over time, such as solar, wind, hydro, and geothermal energy. They are usually intermittent and depend on environmental conditions. Non-Renewable (Exhaustible) Sources: Finite resources that will eventually deplete, such as coal, oil, and natural gas. These are often transportable and tradable. Additionally: Primary Sources: Directly available in nature (e.g., sunlight, crude oil). Secondary Sources: Created through conversion processes from primary sources (e.g., electricity from coal). How does energy intensity plays in CO2 emissions? Energy intensity measures the amount of energy used per unit of economic output (often GDP). It affects CO₂ emissions in the following ways: Higher Energy Intensity: Indicates more energy consumption per GDP unit, typically resulting in higher CO₂ emissions if fossil fuels dominate the energy mix. Lower Energy Intensity: Implies more efficient energy use, which can reduce CO₂ emissions if combined with cleaner energy sources. Reducing energy intensity is an essential goal in climate policy as it can lower overall emissions without necessarily sacrificing economic growth. What is the ratio R/P? The R/P ratio (Reserves-to-Production ratio) estimates how long current reserves will last at the present rate of production: R (Reserves): The total amount of a resource that can be extracted with current technology and is economically feasible. P (Production Rate): The annual production level of the resource. Formula: This ratio gives a rough estimate of how many years the reserves will last if the production rate remains constant. It is useful for assessing the longevity of exhaustible resources, though it does not account for potential future discoveries, changes in demand, or advancements in extraction technology.  CHAPTER 2: Statistics in Energy Economics What is the difference between real and nominal prices? o Nominal Prices: Represent the current price of a good or service at the time of sale, without adjusting for inflation. They reflect the actual amount paid but do not consider changes in purchasing power over time. o Real Prices: Adjusted for inflation to reflect a constant purchasing power, usually based on a base year. This adjustment makes it possible to compare prices across different years by accounting for the effects of inflation. o Importance: Real prices are essential in long-term economic analysis as they allow for a clear understanding of price trends over time by removing the effects of inflation, making comparisons more accurate. How can we distinguish the different kind of oil companies? o National Oil Companies (NOCs): These are state-owned companies that control reserves and production, often within their own countries. Examples include Saudi Aramco (Saudi Arabia) and Gazprom (Russia). NOCs may prioritize national policy goals over profitability. o Majors: Large, integrated multinational corporations like ExxonMobil, BP, and Shell. Majors operate globally and are involved in all stages of oil production and refining, and they aim for both profitability and market influence. o Private-Owned Companies: Smaller, often independent companies that may focus on specific segments of the oil market, such as exploration or production. They are typically more flexible and adaptable to market conditions but may lack the scale and resources of NOCs and Majors. What role plays the shale oil in the oil market? o Increased Supply Flexibility: Shale oil has introduced significant flexibility in the oil market, especially in the U.S., where advancements in hydraulic fracturing and horizontal drilling have made it economically viable to access shale resources. o Impact on Global Prices: Shale oil production can be quickly scaled up or down in response to price changes, which helps stabilize prices but also increases competition with conventional oil producers, particularly OPEC. o Reduction in OPEC’s Influence: The rise of shale oil has reduced the dependency of the U.S. and other countries on OPEC oil, giving the U.S. a more independent and influential role in the global oil market. How did the ratio R/P change in the last 40 years? o Historical Trends: The R/P ratio has fluctuated over the past four decades due to several factors, including new oil discoveries, technological advances in extraction, and changes in global demand. o Effect of Technology: Technologies like deep-water drilling, enhanced oil recovery, and shale oil extraction have extended the life of known reserves, often increasing the R/P ratio despite rising consumption. o Economic and Environmental Influence: Economic cycles, environmental regulations, and the push for renewable energy sources have also affected production rates and the overall R/P ratio, as countries increasingly explore alternatives to fossil fuels.  What is the energy consumption trend in industrialized countries? o Stable or Slight Decline: Energy consumption in industrialized countries has generally stabilized or slightly declined over recent years due to improved energy efficiency and a shift towards less energy-intensive industries. o Transition to Renewables: Many developed nations are reducing fossil fuel consumption and investing heavily in renewable energy sources like wind, solar, and hydro, which reduces overall energy demand from traditional sources. o Efficiency Improvements: Advances in technology, energy policies, and energy- efficient appliances and infrastructure have allowed industrialized countries to maintain or grow their economies without proportionally increasing energy consumption. CHAPTER 3 What is the relationship between price and quantity in a perfect competition market? In a perfect competition market, price is determined by the intersection of the market’s aggregate supply and demand curves. Individual firms are price-takers, meaning they accept the market price as given. They sell at this price, and the quantity supplied by each firm increases as long as the price covers their marginal costs. As price rises, the quantity supplied generally increases, but each firm produces up to the point where price equals marginal cost. How does a consumer decide the quantity of a given good they aim to consume? Consumers decide the quantity based on maximizing their utility, given their budget constraints. This is achieved by consuming quantities where the marginal utility per unit of currency spent is equal across all goods. Mathematically, a consumer consumes up to the point where the marginal utility (additional satisfaction from one more unit) divided by the price is equal for all goods. What is the relationship between utility and income for a consumer? Utility typically increases with income since more income allows a consumer to purchase more goods and services, increasing satisfaction. However, the relationship follows the law of diminishing marginal utility, meaning each additional unit of income yields less additional utility than the previous unit. How does a company producing more products decide the quantity of each to produce? A company maximizes profit by producing each product up to the point where marginal cost equals marginal revenue for that product. If the marginal revenue of producing one more unit is greater than the marginal cost, the company will increase production. When marginal cost exceeds marginal revenue, the company reduces output. Why does the marginal cost curve intersect the average cost curve at its minimum? The marginal cost (MC) curve intersects the average cost (AC) curve at its minimum because when MC is below AC, producing additional units reduces the average cost. When MC is above AC, additional units increase the average cost. Therefore, the point of intersection is the lowest point on the AC curve, where it is minimized. What are the conditions for a perfect competition?  The conditions for perfect competition include: o Many small buyers and sellers. o Homogeneous products (no differentiation). o Perfect information (buyers and sellers have full knowledge). o No barriers to entry or exit. o No single firm or buyer has market power to influence prices. o Prices reflect marginal costs, ensuring optimal resource allocation. Why does a perfect competition market maximize social surplus? In perfect competition, price equals marginal cost, meaning resources are allocated efficiently, with no underproduction or overproduction. Social surplus, the sum of consumer and producer surplus, is maximized because the market operates at an equilibrium where the total welfare (benefit to society) is as high as possible. What is the elasticity of demand to prices? Price elasticity of demand measures the responsiveness of the quantity demanded to a change in price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price. If demand is elastic, a small price change results in a significant quantity change. If inelastic, demand changes little with price. Draw a perfect competition market equilibrium, showing marginal and average costs and the demand curve for a company and the whole market. Imagine two graphs: o For the whole market, equilibrium occurs where the aggregate supply and demand curves intersect, determining the market price. o For the individual firm, which is a price-taker, the demand curve is a horizontal line at the market price level. The firm’s marginal cost (MC) curve intersects its average total cost (ATC) curve at the minimum ATC, indicating profit maximization at this output level where MC = Price. What is the difference between short and long periods? In economics: o The short period refers to the time frame in which some production factors are fixed, and only variable costs change with output. o The long period is when all inputs can be adjusted, allowing firms to enter or exit the market freely. Long-term adjustments often lead to the establishment of new equilibrium at the minimum point of the average cost curve. Show two different cases of acceptable equilibria in the short term, one valid also in the long term, the other not. o Short-term equilibrium with positive economic profit: If market demand is high, firms may make profits as price exceeds average cost. This is not sustainable in the long term because new firms will enter, increasing supply and reducing the price until only normal profit (zero economic profit) remains. o Short-term equilibrium with normal profit: If demand is such that price equals average total cost at the profit-maximizing output, then the firm earns normal profit, which is sustainable in the long term as no new firms will enter  Why is the price in a perfect competition market equal to the marginal production cost? In perfect competition, firms are price-takers and can only sell at the market price. To maximize profit, they produce up to the point where marginal cost equals the price. If marginal cost were higher, the firm would reduce output to avoid loss; if it were lower, the firm could increase profit by expanding production. What is the shadow price of a good in a market? The shadow price represents the true societal value of an additional unit of a good or resource, considering all costs and benefits. In a perfectly competitive market, the shadow price equals the market price. However, with externalities or constraints, the shadow price may diverge from the market price, reflecting the true cost or value to society. What do we mean by “Pareto Optimum”? A Pareto Optimum is a situation where no one can be made better off without making someone else worse off. This concept of efficiency is central to welfare economics, indicating a point where resources are allocated in the most socially beneficial way under the given constraints. In a perfectly competitive market without externalities, the equilibrium typically represents a Pareto optimal allocation CHAPTER 4: Market failures and stakeholders’ choices What are the causes of market failure? Market failure occurs when a market does not allocate resources efficiently, leading to a reduction in overall social welfare. The main causes include: 1. Imperfect Competition: When the market does not meet all conditions of perfect competition, such as monopolies, oligopolies, or monopolistic competition, prices are often higher, and quantities lower than in competitive markets, reducing social welfare. 2. Externalities: These are costs or benefits from an activity that affect third parties not directly involved in the transaction. Negative externalities (e.g., pollution) cause overproduction, while positive externalities (e.g., education) cause underproduction. 3. Public Goods: Public goods are both non-rivalrous and non-excludable, meaning individuals cannot be excluded from their use, and one person’s use does not reduce their availability to others. This leads to underproduction in markets as firms cannot charge for each user’s benefit. 4. Scale Economies: In industries with significant economies of scale, such as utilities, large firms can produce at lower costs than multiple smaller firms. This can create “natural monopolies” where competition is inefficient. 5. Resource Exhaustibility: When markets do not consider the depletion of finite resources (e.g., fossil fuels), production may exceed sustainable levels, impacting future availability and leading to inefficient long-term resource allocation.  What happens in the presence of positive/negative externalities? How does the market equilibrium change? o Negative Externalities: When a negative externality exists, like pollution, the social cost of production (social marginal cost) is higher than the private cost paid by producers. This discrepancy results in overproduction relative to the socially optimal level. The market price Pm is lower than the social price Pe, and quantity Qm is greater than the efficient quantity Qe. This causes a social welfare loss as the additional units produced add costs (like environmental damage) that are not reflected in the market price. o Positive Externalities: When a positive externality exists, like vaccination, the social benefit (social marginal benefit) is higher than the private benefit. This discrepancy results in underproduction relative to the socially optimal level. The market price Pm is lower than the socially efficient price Pe, and the market quantity Qm is less than the efficient quantity Qe. Increasing production would benefit society, as the added units yield additional social benefits not captured in the price. What do we mean by scale economies? Scale Economies occur when increasing the production scale (output) reduces the average cost per unit due to factors like operational efficiency, bulk purchasing, or better use of resources. This can lead to the formation of large firms that have cost advantages over smaller ones. Economies of scale are crucial in industries like utilities, where large initial investments create lower unit costs with higher production. Scale economies can lead to natural monopolies, where one large firm serves the market more efficiently than multiple smaller firms could. What is the condition for elasticity to have a rent in a monopoly? Why? In a monopoly, demand elasticity must be greater than one (elastic demand) for the monopolist to gain economic rent (profit). When demand is elastic, the quantity demanded responds significantly to price changes. This elasticity allows the monopolist to increase price without a proportionate drop in quantity demanded, maximizing revenue. If demand were inelastic (elasticity < 1), raising prices would result in a decrease in total revenue as consumers would not respond well to price increases, making it harder for the monopolist to generate substantial profit. What is a natural monopoly? A natural monopoly occurs in an industry where one firm can supply the entire market at a lower cost than two or more competing firms due to high fixed costs and significant economies of scale. Examples include utilities like electricity, water, or gas. In such markets, duplicating infrastructure (e.g., separate water pipes or power lines) is inefficient and costly. The presence of a single provider minimizes average costs by spreading the large fixed costs over a larger quantity of output, making it economically efficient for only one firm to operate.  How does a monopolist choose the quantity to produce? A monopolist maximizes profit by producing the quantity where marginal revenue (MR) equals marginal cost (MC). Since the monopolist controls the price, it faces a downward-sloping demand curve, meaning additional units can only be sold at lower prices. As output increases, MR falls below the price (because lowering the price to sell one more unit reduces revenue from previous units). The optimal quantity is found where MR = MC; at this point, any additional production would increase costs more than revenue, so the monopolist stops producing. How does a producer in a perfect competition market decide the quantity to produce? In perfect competition, a firm is a price-taker and can sell as much as it wants at the market price. The firm maximizes profit by producing up to the point where marginal cost (MC) equals the market price (P). Since the market price is fixed and horizontal, each firm adjusts its output to where MC = P. If MC is below the price, the firm can increase output profitably; if MC exceeds the price, the firm reduces output to avoid losses. This condition (MC = P) ensures that the firm operates at maximum efficiency in the competitive market. What is the minimum efficient scale of a market? The Minimum Efficient Scale (MES) is the smallest quantity of production at which a firm can achieve the lowest possible average cost. At this scale, the firm fully exploits economies of scale and cannot reduce average costs by expanding further. The MES depends on the industry and production technology. In markets with a high MES relative to demand, it can lead to natural monopolies, as only a few firms can achieve these efficiencies. In other cases, MES sets the threshold for optimal firm size and affects the number of firms that can efficiently operate in the market.  CHAPTER 5: Oligopoly and Duopoly Explain the different oligopoly equilibria Oligopolies are markets with few producers where firms’ decisions are interdependent. The main models of equilibrium are: 1. Cournot Model: Firms compete by choosing quantities simultaneously. Each firm assumes the other will not change its output. The equilibrium occurs when both firms' quantities stabilize at a point where neither can improve profit by changing its output. 2. Bertrand Model: Firms compete on price instead of quantity. In equilibrium, prices are driven down to marginal cost, resembling perfect competition, because each firm tries to undercut the other. 3. Stackelberg Model: One firm (leader) moves first, setting its output. The other firm (follower) reacts to maximize its profit based on the leader’s decision. The leader has a strategic advantage, leading to higher profit for it. 4. Chamberlin Model: Firms collaborate to maximize joint profit as if they were a single monopolist. This requires cooperation and results in higher profits than in Cournot but is less stable due to incentives to cheat. What is a Nash-Cournot equilibrium? A Nash-Cournot equilibrium occurs when firms in a Cournot oligopoly choose production levels that maximize their individual profits, assuming competitors’ outputs are fixed. At equilibrium: No firm can improve its profit by unilaterally changing its output. It’s a stable point where firms’ response functions (showing optimal output based on competitors’ actions) intersect.  Why is a Nash-Cournot equilibrium Pareto optimal? A Nash-Cournot equilibrium is Pareto optimal within the constraints of the firms’ strategies because: No firm can increase its profit without reducing the other firm’s profit, given the strategic interdependence. However, it is not globally Pareto optimal for society, as the total output is lower, and prices are higher than in perfect competition, leading to a loss of social surplus. How is a reply function made by an enterprise? A reply function (or reaction function) represents the optimal output level a firm will produce in response to the output level chosen by its competitor. To construct it: 1. The firm calculates its profit-maximizing output, assuming the competitor’s output is fixed. 2. The profit maximization condition is where marginal revenue equals marginal cost. 3. The resulting equation relates the firm’s optimal output to the competitor’s output. For example: If the market demand is Q=a−bP, and the competitor produces Q2Q2, the residual demand for firm 1 is Q1=Q−Q2. The firm’s profit maximization leads to its reply function Q1=f(Q2). How can the real interest rate be calculated when inflation f is present? The real interest rate irir adjusts the nominal interest rate ii to account for inflation ff. The formula is: o If f is small, ir ≈ i−f. o This adjustment ensures purchasing power is accurately reflected in financial evaluations. Depreciation factor: F, Q, S, and their relationship In the context of depreciation and time value of money: o S: Present value of money. o F: Future value of money after nn periods. o Q: Constant annual installment over nn periods. Relationships: 1. Future value is: Where aa is the depreciation rate.  2. Present value of Q is: 3. Continuous depreciation (continuous compounding) uses e to express decay or growth over time, with These formulas calculate how money values or installments are distributed or accumulated over time considering the depreciation rate. CHAPTER 6: Energy Balance Structure of an energy balance (EB) An energy balance (EB) is a comprehensive statistical framework that organizes data on energy production, transformation, and consumption. Its structure typically includes: 1. Primary Energy Sources: o The top section accounts for energy extracted from natural sources (e.g., crude oil, coal, wind, solar, natural gas). o These sources are categorized by energy type and measured in physical or energy units. 2. Transformation Processes: o The middle section shows how primary energy is transformed into secondary forms (e.g., crude oil refined into gasoline, coal converted to electricity). o It also includes losses incurred during transformation, such as heat losses in power generation. 3. Final Energy Uses: o The bottom section presents energy delivered to end-users (industry, transport, residential, services). o Final consumption is split into energy use (e.g., fuel for heating) and non- energy use (e.g., oil for producing plastics). Energy balances are structured as a matrix: Columns: Energy products (fuels, electricity, heat). Rows: Energy flows (e.g., production, transformation, consumption). This standard structure ensures clarity and comparability across countries and time periods. Criteria to make an EB Constructing an energy balance requires several steps and criteria: 1. Complete and Accurate Data: o Energy statistics must be validated to ensure no major errors or gaps. This includes tracking all energy flows entering and exiting the system. 2. Consistent Methodology: o Apply uniform rules to measure energy flows, including calorific values for different fuels and common units for comparison (e.g., TJ, ktoe). 3. Law of Thermodynamics:  o Follow the first law of thermodynamics (energy conservation), ensuring that the total energy entering the system equals the energy used or lost. Discrepancies indicate errors in data collection or methodology. 4. Appropriate Conversion Factors: o Convert various energy sources into a standard unit, like joules or tonnes of oil equivalent, using precise conversion factors (e.g., 1 GWh = 3.6 TJ). 5. Avoid Double Counting: o Ensure transformation outputs (e.g., electricity) are not double counted in primary energy production and final consumption. 6. Primary Energy Form Definition: o Define the first usable energy form in production (e.g., electricity for wind and solar, heat for geothermal). By adhering to these criteria, energy balances provide reliable data for policy decisions and energy market analysis. What is useful energy Useful energy refers to the energy actually utilized by end-users after all conversions and losses. Unlike primary or secondary energy, which are intermediate forms, useful energy directly powers tasks such as heating, lighting, and mechanical work. Transformation Losses: Energy is lost at each stage of transformation (e.g., power generation, transmission). Efficiency: Conversion efficiency affects the proportion of primary energy that becomes useful energy (e.g., an electric heater’s efficiency determines the useful heat delivered). Examples of Useful Energy: o Heat for residential or industrial heating. o Light produced by a lamp. o Mechanical energy from a motor. Key Insights: Useful energy reflects the quality and suitability of energy for specific applications. It highlights inefficiencies in the energy system, helping engineers and policymakers identify areas for improvement, such as reducing losses in electricity generation or improving heating system efficiency. CHAPTER 7: Reserves, resources of fossil fuels and market structures How do we calculate the dynamic exhaustion time Te from the static T0? The dynamic exhaustion time accounts for increasing demand at a growth rate aa. It is calculated using the formula: Where: tatic exhaustion time (reserves divided by annual production) and a: Annual growth rate of demand. Example: For a static exhaustion time T0=17.5 years and a=2%,  What does the Gini index measure? The Gini index quantifies the inequality of a distribution. In the context of energy resources: A Gini index of 0 indicates perfect equality (resources equally distributed). A Gini index of 1 indicates complete inequality (one country controls all resources). It measures the area between the Lorenz curve (cumulative distribution) and the line of perfect equality. Which criteria do we have to measure the level of concentration of resources or market shares? o Common criteria include: 1. Concentration Ratio (C4 or C8): Sum of the market shares of the top 4 or 8 firms or countries. Higher values indicate greater concentration. 2. Number of entities controlling a specific share: For example, countries controlling 50% or 90% of reserves. 3. Herfindahl-Hirschman Index (HHI): Sum of squared market shares. It reflects market concentration more precisely. 4. Gini Index: Measures inequality in resource distribution using the Lorenz curve. How is the HH index is calculated? What does it mean it inverse? The Herfindahl-Hirschman Index (HHI) is calculated as: Where qiqi is the market share of each entity. HHI ranges: From 0 (perfect competition) to 1 (monopoly). The inverse of the HHI represents the equivalent number of equally sized entities: Example: If HHI=0.091, the inverse is approximately 11, meaning the concentration is equivalent to 11 equally sized players. What is the condition on the growth of reserves to keep the exhaustion time constant if the demand grows with rate a? To maintain a constant exhaustion time (Te), the growth in reserves (A) must equal the growth in demand (aP):  How can we evaluate the level of concentration of energy resources or market supply? Concentration can be evaluated using: Concentration curves: Plot the cumulative share of reserves against the number of countries. Indices: Use metrics like HHI, Gini index, and concentration ratios. Lorenz curves: Compare actual distribution with a line of perfect equality. Concessions vs contracts: explain the difference in fossil fuel extraction Concessions: The investor owns the extracted resources once they reach the surface. Governments earn royalties and taxes. Investors bear restoration costs post-activity. Contracts: The state retains ownership of resources, and companies are compensated with a portion of the production (e.g., through service fees or production shares). Which kind of contracts are adopted tor fossil fuel extraction in partnership with private companies? Common contracts include: 1. Production Sharing Agreements (PSA): Companies recover costs (cost oil) and share profit oil with the government. 2. Service Contracts: Companies are paid a service fee for exploration and extraction without ownership of the resource. 3. Joint Ventures: National Oil Companies (NOCs) and International Oil Companies (IOCs) share investment, risks, and revenues. Explain how the revenues from an oil field are split between the government and a private company Revenues are divided based on: 1. Cost Oil: Portion of production used to reimburse operational and capital costs. 2. Profit Oil: Remaining production after cost recovery, shared between the government and the contractor according to contractual terms. Explain the difference between production sharing agreements and service contracts Production Sharing Agreements: o Companies recover costs through "cost oil." o Remaining production (profit oil) is shared between the government and contractor. o Contractors face exploration risks but have potential for higher profits. Service Contracts: o Contractors are paid a fixed fee for their services. o The government retains full ownership of the resource. o Lower risk but also limited upside for the contractor.  Fixed split vs profit-based mechanism for profit oil between contractor and government, explain the difference Fixed Split: o Profit oil is divided based on a pre-agreed percentage, irrespective of costs or prices. o Simple but unresponsive to market changes. Profit-Based Mechanism: o Profit oil shares vary based on project profitability, using metrics like the R-factor (cumulative revenues/cumulative costs) or internal rate of return (IRR). o Allows for flexibility and adjusts to changing costs or prices. What is the ratio factor in the split between Government and Contractor in oil production split The R-factor measures cumulative revenues relative to cumulative costs: When R1, the government’s share increases, reflecting profitability. Example: R=0.5R=0.5: Contractor’s share is high to recover costs. R=5R=5: Government receives a larger share, reflecting mature profitability. CHAPTER 8: Concessions and PSA How can we estimate the correlation of demand for different fuels, given a energy demand growth? To estimate the correlation of demand for different fuels: 1. Market Shares: Analyze the shares of total energy consumption represented by each fuel ( ), where Qi is the quantity of fuel ii, and Qt is total energy demand. 2. Regression Analysis: Use regression equations to model the evolution of each fuel’s share over time: where ai is the growth or decline rate, and bi is the initial share. 3. Substitution Effects: Measure the substitution between fuels using: where mijj is the substitution coefficient (marginal rate of substitution). 4. Elasticity of Demand: Include cross-price elasticities to evaluate how changes in the price of one fuel affect demand for others.  Which are the factors of price for an exhaustible source? The price of an exhaustible resource is influenced by the following factors: 1. Technical Production Cost: Includes exploration, extraction, processing, and transportation costs. 2. Differential Rent: Variations in costs due to: o Geographical differences (e.g., remote locations). o Resource quality (e.g., high-sulfur vs. low-sulfur oil). 3. User Cost (Scarcity Rent): Reflects the opportunity cost of depleting the resource today rather than in the future. 4. Market Structure: o In perfect competition, price equals marginal cost-plus scarcity rent. o In monopolies/oligopolies, prices include monopoly rents. 5. Interest Rate: Affects the growth rate of the user cost and the intertemporal allocation of resources. 6. Backstop Technology: The price of alternative energy sources sets an upper limit on resource prices. What is the cost of use for an exhaustible resource? The cost of use (or user cost) is the opportunity cost of extracting a resource today instead of preserving it for future use. It accounts for: The forgone future profits from selling the resource later. The value growth of the resource due to scarcity over time. Mathematically: Where UCtUCt is the user cost, Pt is the price, and MCt is the marginal cost. It grows exponentially at the interest rate: What do we mean with opportunity cost? Opportunity cost is the value of the best alternative foregone when a resource is used for a specific purpose. In the context of exhaustible resources: Extracting and selling the resource today means losing the opportunity to benefit from higher future prices. Opportunity cost ensures that the resource is allocated efficiently over time by balancing current and future benefits. What kind of differential rents do exist? Differential rents arise from variations in production conditions and include: 1. Geographical Rent: Differences in transportation and location costs. 2. Quality Rent: Based on the quality of the resource (e.g., lighter crude oils require less refining). 3. Mining Rent: Due to variations in technical extraction costs across reserves. 4. Inter-Source Rent: Rent generated when resources compete in the same market (e.g., oil vs. gas). These rents reflect disparities in production costs and determine the profitability of different fields.  Who is it interested to keep the rent existing in fossil fuel exploitation, and how? The following stakeholders benefit from maintaining rents in fossil fuel exploitation: 1. Resource Owners (Governments): o Collect rents through royalties, taxes, and production-sharing agreements. o Regulate extraction rates to maximize long-term revenues. 2. Producers: o Extract rents by operating fields with lower costs or higher quality resources. o Control production (monopolies or cartels like OPEC) to influence prices. 3. Consumers: o Benefit indirectly when differential rents lower production costs and stabilize prices. 4. Investors: o Seek returns through dividends or capital gains derived from resource rents. What is a backstop technology? A backstop technology is an alternative energy source that becomes economically viable when the price of a primary exhaustible resource (e.g., oil) rises above a certain threshold. Examples include: Renewable energy (solar, wind, geothermal) replacing fossil fuels. Hydrogen or nuclear power as substitutes for hydrocarbons. Key characteristics: Sets an upper limit on the price of the exhaustible resource. Advances in backstop technologies (e.g., cost reductions) can lower the maximum price and accelerate the transition away from exhaustible resources. CHAPTER 8 et 9: The price of an exhaustible resource (on a les même questions) What does the Hotelling rule say? The Hotelling rule states that the price of an exhaustible resource increases over time at a rate equal to the interest rate, assuming perfect competition and no uncertainty. This reflects the opportunity cost of depleting the resource today rather than preserving it for future use. Mathematically: Where: P: Price of the resource. r: Interest rate. This ensures resource owners are indifferent between extracting today or in the future, as the value of the resource in situ grows at the same rate as the return on alternative investments. How can we express the Hotelling rule for a oligopoly? In an oligopoly, the Hotelling rule is modified to include the oligopoly rent in addition to the user cost. The price evolves as:  Where: MCt: Marginal cost. UC0: Initial user cost. ε: Demand elasticity. n: Number of firms in the oligopoly. This equation shows that the oligopoly rent and demand elasticity influence the price path in an oligopolistic market, making it more complex than under perfect competition. What is the role of the interest rate in the evolution of the price of an exhaustible resource? The interest rate determines the rate at which the price of the exhaustible resource increases over time. If the price of the resource grows at a rate below the interest rate, producers will prefer to extract and sell immediately, investing the proceeds elsewhere. Conversely, if the price grows faster than the interest rate, producers will delay extraction to benefit from higher future prices. What is the effect of an increase of the interest rate on the evolution of the oil price? When the interest rate increases: Future resources become less valuable today because they are discounted more heavily. Producers extract more oil now rather than in the future, increasing current supply. This leads to a decrease in the current oil price but results in a steeper price increase over time as resources become scarcer due to accelerated depletion. How does a change of the costs of the backstop technology affect the oil price? The backstop technology represents an alternative energy source that can replace the exhaustible resource. If the cost of the backstop technology changes: If backstop costs decrease: The price of oil will decrease because the maximum price oil can reach is limited by the cost of the backstop technology. If backstop costs increase: Oil prices can rise higher without being replaced, delaying the transition to the backstop technology and extending the depletion timeline of oil reserves. What is the user cost? The user cost (or scarcity rent) represents the opportunity cost of extracting and selling a resource today rather than leaving it in the ground for future use. It is the difference between the price of the resource and its marginal production cost. Mathematically: o User cost grows exponentially over time at a rate equal to the interest rate (rr). o It reflects the economic value of preserving the resource for future extraction, ensuring efficient intertemporal allocation.  CHAPTER 10: The INPUT – OUTPUT model of the economy What is a matrix of technical coefficients? The matrix of technical coefficients (AA) is derived from the input-output (I/O) table and represents the proportion of inputs from each sector required to produce one unit of output in another sector. Each element aij is calculated as: Where: zij: Value of goods or services provided by sector i to sector j (intermediate consumption). xj: Total output of sector j. The matrix describes the "recipe" of the economy, showing the interdependencies among sectors. What is an activation coefficient matrix? The activation coefficient matrix (also known as the Leontief inverse matrix, BB) quantifies the total production impact (direct and indirect) of a change in final demand across all sectors. It is calculated as: What is the difference between a closed and an open model according to Leontiev input/output analysis? Open Model: Final demand (e.g., household consumption, exports) is considered external to the system. The model focuses on how intermediate goods and final demands interact. Closed Model: Final demand elements such as private consumption are internalized into the model. Adds a row for wages and a column for household consumption, linking labor income to spending. Allows analysis of induced effects (e.g., how increased wages lead to higher consumption). How can we estimate the effect on employment of a new industrial investment? To estimate employment effects, the model combines production changes with employment coefficients: 1. Calculate Change in Production: Where: o B=(I−A)−1: Activation matrix. o Δf: Change in final demand.  2. Apply Employment Coefficients: Employment coefficients ei (jobs per unit of output in each sector) are used to estimate employment changes: What do we mean with direct, indirect and induced employment? Direct Employment: Jobs created directly by the investment (e.g., factory workers, engineers). Indirect Employment: Jobs created in the supply chain due to increased demand for intermediate goods. Induced Employment: Jobs created as higher household incomes lead to increased consumption (calculated using the closed model). Where B′ is the Leontief inverse for the closed model. Each component represents different levels of economic ripple effects caused by the investment. CHAPTER 11: ENERGY – ECONOMY relationship Scenarios’ design Which factors affect the energy intensity? Energy intensity is influenced by: Technological changes that modify energy efficiency. Structural changes in the composition of final demand. Simultaneous changes in demand structure and technology What is the relationship between elasticity to income and energy intensity? The energy intensity of GDP changes depending on the elasticity of energy consumption to income (ey): If ey>1, energy intensity increases. If ey=1, energy intensity remains stable. If ey0: Substitute goods. o eijIRR, then NPV