ECO 4386 Fall 2011 Semester

Term Paper

Summary of APEC Energy Pricing Practices

Prepared For

Prof. Dr. A. K. Enamul Haque

Prepared By

Ontiq Dey
ID # 121 092 012

Date of submission: January 11, 2012

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Contents
Page List of abbreviations List of figures List of tables Introduction APERC Research Energy Pricing Practices: Theories Pricing alternatives available to energy industries Policy tools available to governments Energy Pricing Practices: Coal, Petroleum, Natural Gas and Electricity Coal pricing practices Petroleum products pricing practices Natural gas pricing practices Electricity pricing practices Conclusion Reference 3 3 3 4 5 6 8 9 10 10 12 14 15 17 17

List of Abbreviations
y y APEC: Asia-Pacific Economic Cooperation APERC: Asia Pacific Energy Research Centre

List of Figures
y y APEC Coal Demand by Sector Coal Price Trend in selected Member Economies Cost Component of Average End-User Gas Price

List of Tables
y Electricity Price Regulation in APEC Economies

Introduction
Regional energy markets became more vibrant due to the rapid economic growth in the APEC region in the last two decades. Regional energy demand got a significant boost particularly because of the strong economics growth n the Southeast and Northeast Asian economies. Hence there was need for large investment in the energy supply side in both APEC and non-APEC economies. Between 1980 and 1995, APEC regional energy consumption grew by 35 %; it is expected to grow by a further 41 % over the period from 1995 to 2010 (APERC, 1998b).

Not only energy security issues, but also issues like energy efficiency and environmental conservation came into focus as energy policies were being developed. Market liberalization and governments moving away from direct intervention and towards the creation of re-regulated competitive markets were prescribed medication for achieving these policies. This led to many governments privatizing their energy assets. With gradual transformation in energy markets, energy pricing practices managed to facilitate the harmony between demand and supply.

APERC Research
Of the 14 Non Binding Energy Policy Principles that were adopted for consideration by APEC economies in the formulation of energy policies, Principle 5 specifically points out the importance of energy pricing for APEC member economies.

Principle 5: Consider reducing energy subsidies progressively and promote implementation of pricing practices which reflect the economic cost of supplying and using energy across the full energy cycle, having regard to environmental costs.

Since energy pricing was an important issue, the APEC Energy Working Group (EWG) divided APERCs research in to (i) energy pricing and (ii) the implications for energy efficiency, the environment and supply infrastructure.

The pricing practices research program addressed the following three fundamental objectives: y develop information and data bases adequate for analysis of energy prices and pricing practices in the APEC member economies; y analyze the energy pricing practices in the APEC member economies on both empirical and theoretical bases; and y derive policy implications for energy pricing policies for energy efficiency, the environment, and supply infrastructures for the APEC member economies

Energy Pricing Practices: Theories

Energy pricing is important not only at the level of individual economies, but also at the regional and global level. Reforms to restructure the energy sector and provide competitive energy markets have been undertaken (or are in the process of undertaking) in many economies in the APEC region.

Environmental objectives, such as greenhouse gas emission abatement, are being targeted by governments; they are studying and reviewing the effectiveness of energy pricing policies as an instrument to achieve this target.

Government and private sector objectives, as well as external factors, influence energy pricing. Wish for increasing market share, ensuring financial viability and providing profits to shareholders are the primary objectives of the private sector. Differences in pricing also arise due to the different cost structures of energy utilities. From the governments point of view, a wide range of economic, social and political goals can be achieved through energy pricing policies. External influences, like exchange rate variations, also can significantly affect the energy pricing process.

In the APEC region, energy policies have an effect on the final end-use energy price through: y y y y subsidies, cross-subsidies, import tariffs, taxes, levies, and setting required standards and regulations

In most cases the subsidies and tariffs on energy products are not high; however, the overall effect is significant and results in lower economic efficiency and welfare. The energy policy objectives and the mechanisms for achieving the objectives will be different for each economy and for different energy markets. Therefore, applying a uniform energy pricing system to each economy in the APEC region is quite impossible. Since there is a strong connection between the
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energy sector and the economic and social well-being of an economy, the governments have special interest in this sector. Schramm (1995) highlights three basic objectives of energy pricing policies with respect to energy pricing: y Economic efficiency: the efficiency principle aims to ensure that the regulation of prices is done in a manner that will allocate the societys resources to the energy sector in such a way that it fully reflects their values in alternative uses. y Social equity: the equity principle relates to welfare and income distribution considerations. Implementing differential pricing schemes on the basis of essential needs, or establishing uniform prices to specific user groups regardless of the differences in costs of supply, can be some of the ways to go. y Financial viability: the financial principle points out that energy supply systems should be designed in such a way that they are able to raise sufficient revenues to remain financially viable; continuity and quality of service must be ensured, and it must be kept in mind that future investment requirements are achieved.

Currently, there is no specific energy-related environment tax (carbon tax) in any APEC member economy. Many empirical studies have shown that not all the efficiency gains can be attributed to prices effects, and also not to tax-induced price effects. Particularly for developing economies, income variables were found to be more significant than price variables in energy demand modeling. GDP per capita was a better explanatory variable for increased CO2 emissions than energy prices. Due to the inelastic nature of energy prices it is difficult to use this as a policy instrument for reducing greenhouse gas emissions.

PRICING ALTERNATIVES AVAILABLE TO ENERGY INDUSTRIES

Marginal cost pricing Marginal cost pricing attempts to maximize social welfare by pricing energy products such that additional benefit of additional units of energy is equal to the additional cost (short run marginal cost) of providing the extra unit of energy.

Historical cost recovery pricing Historical cost recovery pricing refers to pricing energy products so that an acceptable market rate of return can be earned and past expenditures can be recovered.

Market pricing A central market can be created where bundles of energy can be traded between suppliers and consumers of energy at the nominated market price.

Discriminatory energy pricing Price discrimination can be used to extract higher revenues by differentiating prices according to the consumer groups preferences (Schramm, 1985).

Promotional pricing This refers to temporarily lowering energy prices to selected customer groups below the long-run marginal cost.

Government price intervention Government intervention in energy markets is done to carry out community service responsibilities and obligations.

POLICY TOOLS AVAILABLE TO GOVERNMENTS

Energy taxation Where demand for energy is relatively inelastic (consumption of energy does not fall significantly due to rise in price), taxation of energy can be used to raise revenue.

Cross-subsidies This refers to charging some users excess charges to subsidize other users of the same product. Cross subsidies represent a consumption tax and consumption subsidy for different energy consumers.

Concessional domestic tariffs Concessional domestic tariffs can be used to transfer income from a small number of high volume, low cost, industrial and commercial energy users to a large number of small volume, high cost, domestic users.

Direct subsidies Direct budget subsidy refers to funding selected groups directly from taxation revenue. Unlike cross-subsidies, there are no distortionary effects associated with incorrect pricing of services of direct budget funding.

Levies on users Energy consumption levies are imposed by governments to generate revenue for specific purposes. The explicit nature of levies increases transparency, and funds received can be explicitly directed to the purpose or reimbursed to selected recipients rather than hidden by a system of indirect cross subsidies.

Environmental energy pricing An environmental component to energy pricing reflects the significant negative externalities of production of energy (air pollution, land degradation and water contamination).

Energy Pricing Practices: Coal, Petroleum, Natural Gas and Electricity

The economies in the APEC region are quite diverse in terms of the level of economic development, social and political systems, culture, climate and resource endowments. Likewise, energy pricing policies of individual APEC member economies are quite varied. Different economies have different regulatory systems, different policies and fiscal means, as well as different policy goals and energy pricing objectives.

COAL PRICING PRACTICES

Coal demand steadily rose in APEC member economies till now. From 1980 to 1996, increase was 2.5 % per year, as the figure below shows; this was mainly due to rise in power sector demand annual increase of 4.9 %(1980-1996). Power sector coal demand accounted for 61 % of total demand in 1996. The industry sectors (particularly the steel industry) consumption of coal showed 2.8 % growth (1980-1996) with 30 per cent share in total demand in 1996.

China was the largest coal consuming economy from 1980 to 1996 (77.7 % of total APEC regions coal consumption in 1996). Japan was 7.5 % and the United States 4.7 %.

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Prices of coal products consist of various elements, such as: y y y y y Mine mouth costs: labor cost, production cost, royalty and capital cost; Transportation costs: rail cost; Port costs; Retail profit margins; Taxes and levies

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PETROLEUM PRODUCTS PRICING PRACTICES

Depending on the industrial structure of the domestic oil sector, market environment and the government policy, pricing mechanisms for petroleum products in the APEC member economies range from market pricing to controlled pricing ones.

The oil industry is privately owned and fully deregulated in the developed APEC economies to assist the operation of a competitive and free market. Prices for oil products in these economies are determined in the market with very less government interventions. Among developing economies, the Philippines somewhat deregulated prices for petroleum products in February 1997. Recently, Korea also removed the government intervention in the oil sector; price for petroleum products (except for LPG) were fully deregulated since February 1998. Chinese Taipei and Thailand have started liberalization programs and gradually market forces are being used to set energy prices in these economies. Chinese Taipei partially liberalized petroleum product prices, such as LPG, jet fuel and fuel oil, from the beginning of 1999; its targets full liberalization of the oil sector by 2000. Recently Thailand introduced a floated energy price system to sell gasoline, diesel and LPG at the same price nationwide.

The government in some developing economies (e.g. Brunei Darussalam, China, Indonesia, Malaysia and Viet Nam) heavily controls oil product prices in the APEC region; here a government monopoly structure characterizes the oil industry.

Prices of petroleum products are generally determined by various components accounting for costs, taxes and profit margins of oil companies and retailers, which include: y y y y y Cost for crude oil procurements (production and imports); Refinery production costs and margin; Taxes and other levies; Transportation costs; and; Retailers profit margin

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Taxation practices on petroleum products differ across economies in the APEC region. Taxation on petroleum products are imposed in several ways: y y y y y duties on imported crude oil and associated products, income taxes on producers and refineries, value-added taxes, excise taxes, and other surcharges and levies aimed at achieving particular purposes

Subsidy on petroleum products can act as a policy instrument in industry and trade, in both developing and developed economies. Subsidy lowers price of energy products and services below the market price; this is used as an economic policy instrument to address welfare and poverty issues in many developing economies. These practices can be observed, for example, in Indonesia and Brunei Darussalam. However, it is difficult to determine the incidence of such subsidy enjoyed by the lower income groups. A large part of the subsidy, apparently, leaks out to the relatively better-off urban households.

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NATURAL GAS PRICING PRACTICES

The determination of domestic natural gas prices differs by economy in the APEC region; pricing is done depending on: y y y y demand and supply balance, cost of supply (local and international), prices of competing fuels such as oil and coal, and concerns for social welfare in the particular economy

A number of economies went for natural gas reforms; they are often accompanied by reforms in electricity sector as natural gas is an important input in many electricity production plants. Competitive market for natural gas benefits the end-users in terms of increased range of services available and lower prices. Average gas prices to end-users have been stable or fallen; however, volume of natural gas distribution has increased.

Canada and the United States were the first economies to initiate these reforms in the late 1970s and early 1980s. Restructuring of the wholesale gas industry is under process in both these economies. They are also considering extending competition in the retail market to include the smallest consumers. Australia and Thailand are also going for extensive natural gas sector reforms.

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ELECTRICITY PRICING PRACTICES

Electricity has played its role in the industrialization of the most APEC economies in the last century. Major technology development in all sectors of an economy is based on electric power. Share of electricity consumption out of total energy consumption has been on the rise in most APEC member economies. The dynamics of current technological development is likely to extend the present trend of rising electricity share to an indefinite future, which incorporates semiconductors, computers, telecommunications and information technologies (Rosenburg, 1998).

In the household sector, income effect and the fact that electricity is convenient to use is likely to increase its share of consumption among all types of energy. As electricity consumption demand rise with respect to other energies, electricity pricing practices becomes an important policy tool to impact economic development, technology development and energy consumption behavior.

Some developed economies in the APEC region initiated regulatory reform in the electricity sector to cope with increased competition in the world. Other developing economies went for regulation in electricity sector to attract foreign capital for infrastructure development and to lower government expenditure. Restructuring including regulatory reforms and changes in ownership structure are being pursed in the electricity industry in the APEC region. There is a general trend towards privatization and a shift towards a competitive market in most APEC economies. The speed of these reforms is different across economies because of the differences in national variables such as maturity of the industry, the level of technology development, and the extent of infrastructure development.

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The current state of regulatory reform and privatization processes among the APEC member economies is summarized in the following table:

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Conclusion
The APEC member economies are immensely diverse in terms of the level of economic development, social and political systems, culture, climate and resource endowments. Thus it is obvious that the energy pricing mechanisms of individual APEC member economies vary, ranging from market pricing to controlled pricing ones. APERC has made an effort to draw policy implications of energy pricing practices for energy efficiency, the environment, and energy supply infrastructure in the APEC region. The existing energy pricing practices in the member economies, related regulatory regimes, and tax and subsidy structures of energy provision have been studied by APERC.

Coal price consists of: capital cost, labor cost and royalty; transportation cost (railway and port costs); producer profit margin; and various taxes and levies. Petroleum products prices consist of cost of crude oil procurement, refinery cost and margins, transportation costs, retailer margins, taxes and levies, and subsidies. Processing and transportation costs represent a significant part of the end-user natural gas price. The electricity price is determined in a similar way to that of natural gas; the electricity industry structure is similar to that of natural gas.

Reference
APEC ENERGY PRICING PRACTICES: implications for energy efficiency, the environment and supply infrastructure, March 2000, Asia Pacific Energy Research Centre, Institute of Energy Economics, Japan

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