Assignment- Energy Economics

1. Assume OPEC countries can produce oil at very low marginal cost and seek to exercise some monopoly power in the global oil market. Use the dominant producer framework discussed in class to answer the following.

a. Look up and plot the change in global oil demand from 2005 through 2014 (see www.eia.gov). What influence should this have on the price of crude oil? Illustrate using the dominant firm framework.

b. Look up and plot the change in US oil production (see www.eia.gov). Knowing that this was triggered by major improvements in the commercial extraction of oil from shale (so-called light tight oil (LTO)) in the US, illustrate the effects of increased elasticity of fringe supply on OPEC production, fringe production and the price of oil.

C. Illustrate the long run effect of a major breakthrough in mobile battery technologies for use in motor vehicles. What can you say about OPEC production, fringe production, and the price of oil? What might this mean for the pace of adoption of the new technology?

d. Considering the model of OPEC as a dominant firm, illustrate and discuss what happens to price and OPEC market share when world demand is highly inelastic (versus highly elastic).

2. Consider the following information regarding power plants. There are six types of power plants we have the option to build. Their characteristics are given in the table below.

a. Fill in the missing fields in the above table.

b. Find the minimum capacity factors at which each plant will be constructed.

C. Give a graphical explanation for the ordering of these facilities, and demonstrate how this is related to the supply stack for this region.

d. Draw a typical load schedule for electricity demand. Which generating plants will be used to satisfy the different levels of demand depicted in your load curve?

e. Now , assume there is a tax policy proposal to discourage the construction of coal power plants. What "cost of carbon" (in $/kWh) would be needed to do this? What is this in $/ton? Explain.

3. Assume you own and operate a refinery in the US, and you are considering an expansion of capacity. To build a new refinery (aka greenfield expansion), the fixed cost of capacity is given as FC = 34x² - 73x + 78 (eql) where x = capacity and is defined in units of million barrels per day (note the economies of scale implied by the expression for fixed cost). To add capacity at an existing refinery (aka brownfield expansion), the fixed cost of capacity up to 650,000 barrels per day is given as FC = 85x (eq2). In your planning, you assume the long run average acquisition cost of crude will be $75/bbl. You also assume the weighted average price of your product output is given as p_t = 1.13 p_{oil, t} - 4.15x (eq3). Thus, as you add capacity, the price you receive for your output falls, i.e. - the refining margin is squeezed. The payback period on your upfront fixed costs is given by management to be 20 years, and the required rate of return is 12%. The marginal investment in capacity must satisfy the following equation to be profitable:

FC = _t=1Σ^T[(p_t -vc_t) / (1 + r)^t]                                           (eq4)

where FC is the fixed cost as given above in equations (1) or (2), variable cost, vc_t, is simply the cost of purchasing crude oil (to keep matters simple), and the price, p_t , is the weighted average price of the products.

a. At what capacity will you be indifferent between a greenfield and brownfield expansion? (HINT: Graph the fixed cost functions and you will see an intersection. Simply solve for the common x.)

b. What is the maximum profitable refinery capacity addition? (HINT: Find the x at which (eq4) is satisfied.) Is this a greenfield or brownfield expansion?

c. Download monthly refinery capacity data from the EIA website (www.eia.gov). Also, using data from the EIA website on the refiner acquisition cost of crude oil (RACC price), refinery yield, and the prices of refined products calculate a representative monthly refining margin as

(Θ^1,tp1,t + Θ^2,tp2,t + Θ^3,tp3,t + Θ^4,tp4,t ) - poil,t

Where Θ^{^}_{1,t =} Θ_1,t/(Θ_1,t + Θ_{2,t +} Θ_3,t + Θ_4,t)

and Θ_i,t is just the refinery yield for product i. So, you are simply renormalizing the share data to account for the four products that account for the majority of refinery output - gasoline, distillate, jet fuel, and residual fuel oil. Next, plot the time series data for refinery capacity, noting the year-on-year changes, and plot the representative refining margin. Based on the data, what type of refinery expansions does it appear industry has executed brownfield or greenfield? Is this consistent with the constructed data for the representative refining margin? Is this consistent with the analysis in parts a and b?

4. Commodity prices, transportation and storage.

a. Download and plot monthly Brent and WTI crude oil prices from the EIA website (www.eia.gov) from 1990-present. What pattern emerges in recent years in the relationship between these prices? Why? Discuss two ways this can be arbitraged.

b. Download and plot daily data for the price of conventional gasoline from the EIA website for 1990-present. What is the correlation between the price of gasoline and the price of crude oil? Plot the normalized relative price of gasoline to crude, constructed as

Pgasollne,t / P_crude,t - Average (P_gasoline / P_crude)_{1990 - present}.

What pattern do you see?

c. Using the "stock-flow" model from class, explain what you think should happen to gasoline prices as the summer approaches. Is this consistent with what you see in your answer to part b?

d. If the economy is sluggish and inventory levels are high, what do you expect to happen to the price of gasoline relative to crude oil? Do you see evidence for this in your answer to part b? Explain.