Energy Pricing Scenarios

Abstract

Abstract Current intense interest in the subject of prices is in part related to recent developments in the world oil market and their jarring impact on Canada's energy sector. Where is the world oil price headed? What are the implications of the world oil market situation as at the beginning of January 1983 for the Alberta/Canada oil pricing agreement of September 1981, and domestic natural gas prices (closely tied by regulation to oil prices)? Because the oil price is the key to energy pricing patterns in today's environment, this paper will focus on likely oil pricing developments-with some reference to gas. One must, however, not forget that the prices of energy commodities which compete with oil and gas —especially electric power rates —are not insensitive to movements in the oil price. While not directly linked to the oil price, regulated electric power rates can, in general, be expected to rise more or less rapidly as the rate of domestic oil price increase accelerates or slows. The linkages are embedded in the economic system. As oil and gas prices rise relative to electric power rates, the demand for electricity can be expected to rise. In turn, this will increase electric power generation capacity requirements, the construction of which will put additional pressure on power rates. The world oil price Figure 1 shows that the official price of Saudi Arabian light marker crude has risen about threefold since 1978. Most of the price increase occurred through 1979 and 1980. Increased crude oil demand among the industrialized countries and a decline to deliveries from Iran because of the revolution, caused the spot price to take a sharp jump. OPEC responded by raising its official marker crude price. It was assumed by many that increases in the OPEC price would continue through the 1980s with annual gains at least equal, on average, to the inflation rate in the major industrialized countries. It is, however, doubtful that this will occur. In fact, if OPEC, led by Saudi Arabia, had not moved to reduce its total production rate drastically (from 10.0 MMB/D to 5.5 MMB/D) beginning in the second half of 1981, (Fig. 1A) the glut in the world oil market would have been even greater and the average spot price might have fallen back to 1978 levels or even further. As it happened, the production cutbacks kept the price from rumbling. Assuming that world economic recovery will be slow, it is unlikely that OPEC will opt for, or be able to achieve, price increases in excess of inflation rates over the next two years. A more rapid increase in the oil price would damage prospects for economic recovery and prolong the need for continued severe production quotas on OPEC members. It would also increase the incentive for OPEC customers to develop their oil sands, heavy oil, relatively costly frontier petroleum resources, and even alternative energy sources such as solar, wind hydrogen and compressed natural gas.