Thursday, July 14, 2011

Very Low Cost Electricity -- Impacts on Commodity Prices

What impact would very low cost electricity have on commodity markets? First let's consider on commodity prices that are used for electricity generation -- mainly coal and natural gas. This is to say, if, the great scientist John Von Neumann was correct in the previous post, nuclear energy had become extremely abundant to the extent that natural gas and coal were mainly used for chemical feedstocks, then the expenditure that was used for natural gas and coal for electricity would be diverted to (costless) nuclear fuel -- or another costless source of electrical power.

However note, that the previous post calculated the savings from electricity, which should include the expenditures for coal and natural gas. This is to say, as almost all of the coal and natural gas in the United States is purchased by power utilities as inputs, and then sold to consumers through electricity as kilowatt hours, savings in electricity costs would include the savings in costs spent on natural gas and coal (interestingly, this calcualtion makes sense, the entire natural gas market in the United States in 2010 was 24.1 billion cubic feet, which at a price of $5 per cubic foot is approximately $120Bn. The price of all electricity sold in the US in 2009 was $383Bn (about 4.5 Billion megawatt/hours at 9.7 cents per megawatt -- the total expenditure on electricity includes the expenditure on natural gas and coal).

Further we will assume that electric power has become so abundant that natural gas is not even used for heating, but for chemical feedstock purposes only. This usage represents actual cost savings however (not included in electricity), so in 2010, the US according to the EIA supplied 8.2 Billion cubic feet to residential and office and commercial buildings, which at a price of $5 per cubic foot would be cost savings of $41Bn.

Natural gas in particular is used as a feedstock for chemical synthesis, as is oil -- approximately 20% of the oil consumed by the United States is used as a feedstock for petrochemicals. According to the EIA, the US supplied Industry with 6.6B cubic feet. Let's assume without the recent rise in natural gas prices over the last decade, with very low cost energy, natural gas would average long term prices from 1980-1999, of approximately $1.50 per cubic foot (much natural gas is produced along with oil, and producers of oil could supply natural gas as a side business to chemical producers). This would mean savings of ($5-$1.50)*6.6Bn = $23.1Bn

According to the EIA, only approximately 2% of coal was used for non-electricity generation purposes in 2010, so the vast majority of cost savings that are not already calculated by savings in electricity costs.

How would the price of Oil be affected by very low cost electricity?

Oil prices are determined by supply and demand. Demand: Oil on the demand side is mainly used for transportation (80% in the US) and petrochemicals (20%) in the US. As oil is a world market, the world demand for oil determines world prices, and world demand is a higher percentage for transportation (as the United States is the world's largest producer of petrochemicals).

It is not clear if a large number of cars would be converted to electrical (battery-operated if electricity was very low cost, and whether this would encourage more public transport dependent on electricity (trains, trams, etc). Currently the firm "A Better Place" is undertaking projects to convert a large percentage of cars in several countries (Israel, Denmark, Australia) to battery powered -- in light of high oil prices. With extremely low electricity costs, more battery powered vehicles is more feasible.

On the supply side, low cost electricity would assist exploration and production through lower cost drilling as well as refining and marketing, through lower electricity costs.

How much would oil prices be lowered in a world of very low electricity costs, stemming from these factors? It is very difficult to tell. Supply would be incentivitzed to increase by a small amount, while demand would likely decline, by what amount is very difficult to tell. One could say that China would be more likely to build a transportation infrastructure highly dependent on electricity, in light of its relatively low domestic reserves of petroleum, which would likely have reduced demand by a great deal throughout the decade of the 2000's. China has been cited as one of the main drivers of higher oil prices, by several commentators.

For the purposes of this analysis, oil prices with very low electricity costs are assumed to decline to levels averaging in the 1990's, of approximately $20 per barrel (this is a large assumption! But also shows how much oil prices have risen over the last decade). With prices of $20 per barrel, the US would save ($90 per barrel approximately currently - $20 per barrel)*19.5M barrels consumed per day*365 = approximately $498Bn per year.

Would the prices of non-energy related commodities such as food (grains) and metals decline with very low cost energy?

As the prices of all commodities are determined by supply and demand, one would go through the sources of supply and demand for each commodity to determine what direction the prices would move. It would be very difficult to argue that prices would actually go up with very low cost and abundant electricity. For the purposes of this analysis, I will leave out the cost savings as an impact on GDP (as this post is getting very lengthy:).

Environmental Impacts from Low Cost, Clean Energy:

An additional benefit to GDP would be from environmental impacts. Carbon production would be significantly lower, as most carbon in the atmosphere is due to coal production and oil production (coal consumption would be much lower, oil consumption would be debatable, how much it would decline, as argued above).

Oddly, GDP impacts from lower carbon would not be dramatic as of 2011, as very few companies engage in carbon trading/credits, however if some publications and scientists are to be believed -- such as the late Steven Schneider of Stanford University, a lower amount of carbon in the atmosphere is an extremely -- extraordinarily -- serious matter.

Some countries' GDP such as Norway includes environmental degradation, but the US' GDP to a large extent does not, so this would not be directly added to GDP. I will look for environmental estimates of the impact on GDP from other published sources.

Additional Technological Breakthroughs from Very Low Cost Electricity:

Very low cost electricity would likely lead to more scientific breakthroughs (besides the knowledge of low cost nuclear energy in itself) with more funds being available for scientific research grants, and lower costs to research labs (which depend on electricity as a cost and an input to experiments). This is likely a critical outcome of lower cost electricity, but I won't go into detail on this as this time as this post is getting quite lengthy.

Conclusion: Calculation of Additional Savings from Lower Oil and Natural Gas Prices:

In addition, to the GDP benefit calculated from lower electricity costs in the previous post, the additional lower oil and natural gas prices are assumed to add an additional (pre-multiplier) $498Bn + $41Bn + $23Bn = $592.1Bn. At different multiplier effects (see previous post for a discussion):

At a MPC of 0.94, additional $9368 Bn of GDP
At a MPC of 0.5, additional 1242Bn of GDP

Combined with the previous gain in GDP from lower electricity costs:

At a MPC of 0.94, total GDP gain of 122.7% (more than twice as large of a GDP with zero cost electricity)
At a MPC of 0.5, a total GDP gain of 58.53%

What Does of This Discussion of low cost electricity have to do with stocks?

Well, this discussion is somewhat removed from stocks but has been inspired by a thought experiment of why the economy is not performing as expected currently with lower consumer expenditures on the horizon, and a shaky recovery (the recent Federal Reserve minutes demonstrated significant concern on the economy, and employment is disappointing). If electricity was available at a very low cost, likely the economy would be doing significantly better now and the stock market (as an index, with perhaps different/additional firms in it) would be much higher. As many economists have stated, GDP over the long term is determined by productivity, and productivity would be enhanced by low cost electricity -- and a higher GDP means that we would all be wealthier.

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Haley McAdams said...

I think making use of our natural resources will decrease cost in electricity. Although it is a really a costly investment. Taking Electrical Continuing Education will help people have a job in electrical jobs.

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