INNOVATION AND ENERGY PRICES (Encyclopedia)

In the wide contest of the energy sector, oil is the energy consumers, both institutional and private, use the most (40% of the energy demand). This is due to different factors and to its specific characteristics linked to its structure, its easily transportable liquid status and utilisability as compared to carbon, low production costs, and the wide use through the energy sector. All these features make this resource still now indispensable and unavoidable despite the huge investments in the renewable energy resources. 
Recent data indicate a global energy consume of 11 billion of Gtoe (GigaTons Oil Equivalent) per year, divided into oil (40%), carbon (25%), gas (25%), water and nuclear (each one around 5%). 
Nowadays, there is a steady rise in the energy demand, characterized both by continuous ups and downs from the demand point of view, and continuous price oscillations that, even if in a different way, have distinguished the previous strong energy consume growth between the 1960s and 1970s, resulting in the important shocks of 1973 and 1979. 
A further important element to take into account is the difficulty of prediction of oil prices, where Hamilton (2008) affirms that: "It is sometimes argued that if economists really understand something, they should be able to predict what will happen next. But oil prices are an interesting example (stock prices are another) of an economic variable which, if our theory is correct, we should be completely unable to predict". 
Behind the objective difficulty to predict oil price behaviour, there is the need to analyse two different variables affecting side by side the dynamicity of  oil prices first, and energy prices then, in the short and long run. 
On one side, we find the demand and supply curve relative to determinant factors such as the behaviour of the production marginal cost, investment levels, the economic growth and the oil sustainability with other resources. On the other side, both the structure of the international market and the economic policy decisions with their speculative element play a key role in formulating the price level. The effects of the behaviour of these variables into the most important financial exchanges, like New York (New York Mercantile Exchange – NYMEX) or London (London Commodity Exchange – LCE), the staggering exchanges and the spread of new energy derivatives products make it practically impossible to determine the fundamental value of the oil price or even "who and what determines what"1
The role of expectations, of price increases and reductions are a key-determinant both for the evaluation of the price itself, and for price forecasts in the short and long run. Marginal variations of the fundamentals, or of the price expectations, generate disruptive effects both on the supply and demand side.
During the last years, market operators have reassessed their theories about the elasticity of the energy supply with respect to the price increments, given the low level of investments and the fact that the big oil companies find extremely difficult to plan the management of their reserves. The unsatisfactory level of investments in new technologies and the growing trend of the marginal cost curve of oil production and transportation of the oil take unitary costs of the energy supply to non-easily predictable oscillations in an ineluctable way, despite the sophisticated theoretic and econometric techniques which are widely used for the forecasts.
If on one side there is no doubt about the character of exhaustibility of the fossil fuels and in particular of oil, it is important, on the other side, to establish if the investment on renewable resources comes from the effective oil unavailability, or from policy and economic reasons. 
About the oil availability, recent estimates given by the Exxon Mobil or "Oil and gas Journal" assess the so-called "ascertained oil reserves" in about 1200 billion barrels. There are wide discussions about these data, in particular about the concentration of the reserves and the character of uneven distribution in a few middle-west countries. Behind the character of the ascertained reserves, there is also another key element to notice: the "probable reserves" and the "unconventional reserves" as sands. On this topic, it is important to focus on the role played by industrial and economic policies in starting a virtuous circle between investments and research in new technologies in order to turn the probable and unconditional reserves in effective reserves able to account in a substantial manner on the world supply energy.
In order to minimize costs for exploration and research activities, which are necessary to build up new wells in some remote areas, oil companies tend to acquire small firms working in limited fields, neglecting the need to invest in the direction of a new energy path. 
A further very important element is the concentration level of the oil industry that is able to advantage an oligopolistic coordination of the current and future energy supply. In this regard, being the energy market one of the most oligopolistic in the world and one of the most controversial, and considering that the production, exploration and distribution are concentrated among a small number of oil companies, the investors operating in this sector tend to have a distortion to the underinvestment facing asymmetric incentives. 
Considered the scarce level of investments, as a consequence of a shock taking the energy demand to an unexpected level different from the forecasts, the flow of revenues will immediately increase. 
The oil price, although it remains the pillar of a whole international price structure, is not the only parameter to be considered. The quotations of natural gas and carbon are unavoidable elements both in forecast scenarios and for investment decisions. 
In this framework, energy technology investments are considered key factors for a sustainable development both from a microeconomic, for the effects on a single consumer, and a macroeconomic point of view, being the monetary costs of the energy supply a fundamental component of the gross internal product, which is able to affect in a significant way the balance of payments of the energy dependent countries. 
The role of innovation and R&D in changing the path of the energy economy is extraordinarily important although this process does not assume a linear path, where through n inputs it is possible to obtain n outputs. This is due to an absence of direct results given by predefined investment levels. 
Policy makers, operators and market participants in the energy world affirm that innovation is a pervading and continuous activity for firms in a global economy that is constantly more competitive. Investments in this direction reduce energy supply costs both at a macro and micro level, with the aim of facilitating the commercialisation and the widespread of low energy consume products, and an even lower oil dependency. 
In the current scenario, the continuous oscillations between energy demand and supply in the last months have produced an important turmoil in the financial markets, where the high price levels have been the cause of a recession and a reduction of the energy demand reflecting a supply cut. 
Nowadays, the high oil prices are defined by different factors such as a growing energy demand, a less energy-intensive global economy, a low price elasticity and the failure of the government policies to increase the energy production in case of unforeseen shocks. 
Therefore, it is legitimate to believe that a concrete and sustainable answer over the mid-long term comes form innovations in the sector, rather than a steady increase in the supply of conventional energy, or even less, from an hypothetical fall of the demand in the short run. Oil and natural gas will not be able to represent the 60 or 70% of the whole energy demand anymore, and there will be the need to invest and use alternative resources. The adoption of the necessary policies to face the challenge of the energetic issue in an exhaustive and winning way will not set aside from virtuous policies in matter of energy savings, the development of generation systems and the increasing competition between operators in the energy context. 
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1Alberto Clò, "Il rebus energetico" 2008, edizioni Il Mulino Contemporanea. 
Bibliography
Hamilton, J.D (2008) "Understanding Crude Oil Prices" NBER Working Paper n.14492.
Sagar, A.D., Holdren, J.P (2002) "Assessing the global energy innovation system: some key issues. Energy Policy 30, 465-469. 
Ambuj D. Sagara, Van der Zwaan, B. (2006) "Technological innovation in the energy sector: R&D, deployment, and learning-by-doing" Energy Policy 34, 2601–2608.
Elekdag, S., Lalonde, R., Laxton, D., Muir, D., Pesenti, P., (2008) "Oil price movements and the global economy: A model based-assessment", Working Paper 13792 Nber.
 
Editor: Claudio DICEMBRINO
© 2009 ASSONEBB