1. Energy Economics and Policy
Spring 2012
Instructors: Chu Xiaodong , Zhang Wen
Office Tel.:

2. Markets for Coal
During the twentieth century, coal moved from the principal general-use fuel to one whose use increasingly was concentrated in generation of electricity
Many historically heavily coal-dependent countries reduced total coal consumption

3. Problems of Coal
Limited and changed geographic scope is among the important aspects of coal economics
China is the world’s largest producer of coal now
The United States is a major producer concentrating in electricity generation
Several countries are leading middle-rank producers of coal including India, Australia, South Africa, and Indonesia
Western European producers undergo massive decreases in production, e.g., France, Belgium, the Netherlands, Italy, Great Britain, Germany, and Spain
Japan and Canada have ceased production

4. Problems of Coal Hard coal production from 1971 to 2010 by region (Mt)
Producers of coal

5. Problems of Coal
Environmental impacts of burning coal are another problem
Particulate matter
Sulfur oxide
Nitrogen oxide
Carbon dioxide
Control measures for the above pollutants are required

6. Problems of Coal
Profound changes in ownership patterns of the coal companies are those away from socialism
Entry and exit of the major oil companies and some other companies
Acquisitions of existing companies and creation of new companies, e.g., coal markets in US, Australia, South Africa, etc.
What is the situation in China?

7. World Coal Trade There is a profound change in world coal trade
In 1913, inter-European coal trade dominated
About 75 million tonnes from the UK and 35 million tonnes from Germany, largely staying in Europe
About 23 million tonnes from the US
In 1929, the total amount of coal exported was 147 million with decreases of all three of 1913 leaders
In 1952, world trade decreased to 105 million tonnes
The US was the largest exporter
Canada was the largest market, and Europe and Japan purchased almost as much

8. World Coal Trade There is a profound change in world coal trade
In 1959, there was 93 million tonnes
In 1973, the coal trade hit 190 million tonnes
In 2006, the IEA reported 815 million tonnes
Australia, 231 million tonnes; Indonesia, 129 million tonnes; Russia, 92 million tonnes; South Africa, 69 million tonnes; China, 63 million tonnes
The major importers are in Asia and OECD Europe

9. World Coal Trade
Net exporters and net importers of coal

10. Coal-mine Health and Safety: Case of US
Control was made more stringent on regulations of mining health and safety
Rules for operating mines and federal inspection of the mines
There were initial productivity declines after the commence of the coal mine health and safety act

11. Coal-mine Health and Safety: Case of US
Land disturbance is a vital policy concern
Protection of public health, safety, and property from adverse effects of coal mining practices
Restoration of land and water resources and the environment
Prohibition of mining on certain types of land, e.g., prime agricultural land

12. Coal-mine Health and Safety: Case of US
Coal leasing pattern is influenced deeply by federal land policy
Protection of public health, safety, and property from adverse effects of coal mining practices
Restoration of land and water resources and the environment
Prohibition of mining on certain types of land, e.g., prime agricultural land

13. Coal-mine Health and Safety: Case of US
Coal leasing pattern is influenced deeply by federal land policy
Protection of public health, safety, and property from adverse effects of coal mining practices
Restoration of land and water resources and the environment
Prohibition of mining on certain types of land, e.g., prime agricultural land

14. Markets for Crude Oil
Posted prices from the major oil exchanges are used as the price against which the price of all these other is established
It is done through a combination of administrated pricing and comparing against the other
The crude oil is priced more or less against one of the existing marketed benchmark crudes
How are the prices of these benchmarks established?
What elements are involved in their pricing?
What does a crude benchmark price really represent, and to what extent is it a reflection of the actual marginal cost in production?

15. Benchmark Crude Oils
The role of benchmark crude oils is to discover the willingness to pay a given price per barrel (bbl) for the next barrel of crude and equate it with the willingness to supply the next barrel of crude when the market offers a specified price per barrel sold
Is it true for oil to use first principles of economics?
The price for an exchanged good or service is where the marginal cost in its production for the supplier is equated to its marginal value in use for the demander

16. Benchmark Crude Oils
The oil market truth is that crude oil seems to sell at approximately its highest marginal cost of production rather than its lowest, which contradicts with first principles
Oil is sold at a price reflecting its value in use rather than its marginal cost of production
Consumers are competing for the world’s supply of crude oil

17. Benchmark Crude Oils
Benchmark crude oils are used as price insurance to track price changes expected during the transaction period of the physically traded crude oil stream
The world’s main benchmarks associated with the particular market
West Texas Intermediate
ICE Brent
DME Oman

18. Benchmark Crude Oils
The benchmark crude oil market is actually a market for price risk insurance, wherein risk is bought and sold
On any given day, WTI’s barrels have contracts outstanding equaling barrels
Very few of these traded contracts are actually delivered against
They act as surrogates in tracking the prices of the oil the buyers or sellers actually market

19. Crude Oil Futures Markets
The importance of the crude oil futures markets is in their dominance in determining cash prices, because it is the expected future price which is used to price things in the present
The futures markets for crude are the largest futures commodity markets there are in terms of exchanged volume

20. Crude Oil Futures Markets
There are hedgers, who are in the market to offset their price risks, and speculators, who seek risk in order to profit from it
Hedgers are physical users of crude oil or its products in one form or another, attempting to pre-buy or pre-sell a surrogate oil at an acceptable price today, to insure against financial loss in the physical market
Speculators accept price risk from the hedgers and attempt to make a profit from price moves in oil, acting as a facilitator of economic wealth creation, by taking the price risk

21. Crude Oil Price
Prices are formed and maintained by market participants
Individuals ordinarily act rationally and do not normally repeat errors systematically
Groups of these rational individuals routinely and repeatedly commit systematic errors in judgment
Participants operate under various strong and weak rules of behavior among themselves, causing them to trade so as to maximize profits

22. Crude Oil Price
Key crude oil cash (or spot) prices in USD/barrel

23. Crude Oil Price
Expectations concerning future prices influence cash or spot market prices for oil, even if based solely upon expectations of other traders’ reactions to exogenous stimuli, and on the nature of the stimuli themselves
For instance, a news item reports that temperatures are expected to fall this winter in the US Northeast and in Europe, the primary consumers of heating oil
What will be the expected response for crude prices?

24. Crude Oil Market Participants
Market participants in crude oil futures markets can be divided into ‘commercials’ and ‘non-commercials’.
A commercial trader is ‘An entity involved in the production, processing, or merchandising of a commodity’, which include oil producers, processors, wholesale sellers and buyers, and retail sellers of petroleum products
Non-commercials have no business directly with buying or selling physical quantities of petroleum, but they have indirect linkages and exposure to price risks in that a sudden fall or rise in crude prices could impact on their businesses

25. Crude Oil Market Participants
It is important for the cash and futures market regulators is the distinction between price takers and price makers
The real difficulty for commercials using futures and options markets is the number of large-position inexperienced players who increase market instability and volatility

26. Price Behavior in Futures Markets
Cash (or spot) pricing has replaced long-term contracting for the large majority of crude selling, and futures market prices dominate cash price formation
If the market believes that there is sufficient surplus supply capacity for any expected set of eventualities, then the fundamentals of supply and demand dominate
If excess production capacity has fallen below some perceived tipping point, then markets abandon supply–demand analysis and fall back on fear-and-greed analysis

27. Price Behavior in Futures Markets
With transaction costs falling, making it possible for vast sums of money to be put in or pulled out of various trades and investments at a moment’s notice, all markets have become less stable with ‘hot money’ chasing the best trade
This situation increases market price sensitivity to news and makes it harder to play these markets due to increasing instability, as distinct from market price volatility, which is easier to manage

28. Price Behavior in Futures Markets
Attributes of price behavior
Crude oil price aggregated time-series distributions are heterogeneous
Critical events in crude oil price time series, which are predicted to occur extremely rarely, happen more often than predicted by standard models
Critical events occur in swift succession, with one extreme-valued event presaging another
Periods of calm in oil market price behavior are generally associated with low relative prices and the presence of large quantities of surplus oil production in reserve which can be placed on the market within a few weeks or months

29. Price Behavior in Futures Markets
Attributes of price behavior
Crude oil price aggregated time-series distributions are heterogeneous
Critical events in crude oil price time series, which are predicted to occur extremely rarely, happen more often than predicted by standard models
Critical events occur in swift succession, with one extreme-valued event presaging another …
They are dominated by psychological characteristics rather than supply and demand analytics

30. Fear and Greed in Oil Markets
When available surplus crude oil production in the daily oil balance falls below some psychologically important level in light of geopolitical and economic risks, then fundamental analysis gives way to fear-and-greed analysis and psychological reaction functions become paramount
Key to understanding price behavior is knowing which market regime is presently ascendant – bullish tendencies or bearishness – particularly during times when expectations are the governing tendencies

31. Fundamental Analysis of Oil Markets
Fundamental analysis of supply and demand represents the starting point for any price theory of oil pricing
Such analysis reveals information to all market participants; of interest is the relative rather than the absolute value of the goods traded
The efficient market hypothesis holds that markets are efficient and that all costs and resource returns are reflected in the market price

32. Supply, Demand and the Current Oil Price
Oil production, distribution and refining taken as a single venture is a cyclical industry.
When prices for crude are low, there is little incentive to increase investment and infrastructural expansion; but when prices rise, such expansion will take five years, causing prices to spike
The result is for there to be either too little production capacity to meet demand at moderate prices or too much capacity to maintain prices that are capable of making such infrastructural investments profitable

33. Supply, Demand and the Current Oil Price
Relationship between production supply and production demand

34. Next Lecture The main topic will be Natural Gas Markets
You are recommended to read in advance Chapter 20 of [Evans & Hunt, 2009]