Introduction to Prices

What are the factors that determine energy prices? What are the issues that cause energy price volatility? What are impacts of volatility?

Energy’s importance to human progress is critical; reliable and affordable energy supplies are a major factor in ensuring economic growth and development. At the same time, the global economic system generally favors competition and free market enterprise as the most efficient means of providing high quality goods and services (including energy). While there are varying degrees of regulatory oversight across political boundaries and throughout the value chain, energy prices at the wholesale level are largely determined by the laws of economics: supply and demand. At the retail level, motor fuel prices range from heavily taxed in some places to greatly subsidized in others; home-heating and cooking fuels and electricity are also sometimes subsidized. Because energy demand is projected to grow in the long run (unless price elasticity or efficiency improvements are much greater than we have anticipated), and because new supplies are expected to cost more, it is anticipated that while volatile, there will be long term upward pressure on prices. Higher energy prices do two things: 1) they directionally reduce demand via price elasticity effects, and 2) they create the economic incentives necessary for investment in new energy sources, which eventually provide future supplies of reliable and affordable energy. (See The Energy Portfolio).