What Factors Impact Prices?

Impacts of Demand on Prices

As noted in the Demand section, up until recently, worldwide energy requirements were growing at unprecedented rates, contributing to social and economic development and technological progress. There are a variety of long term influences on demand, including:

• Worldwide population growth
• Rising incomes, increasing access to energy and improving standards of living
• Globalization and increased transportation demands
• Economic and technological progress requiring (or procuring) energy
• Future regulations and policy decisions

In addition to the longer term drivers of demand noted above, there are a number of short term factors that can influence energy price levels (assuming supply and/or storage is unresponsive in the short run). For example, seasonal heating and cooling requirements can impact energy prices, as can severe changes in weather. The latter can also interrupt supply causing outages, delivery problems, and abrupt increases in heating and cooling needs, often exacerbating price volatility. Similarly, unexpectedly high summer and holiday driving peaks can impact retail gasoline prices in the short term.

Overall, there is an iterative relationship between energy prices and demand as illustrated in the following graphic. If prices increase to levels beyond what consumers can or are willing to pay, demand will drop in the short run. In the long-term, if enhanced energy efficiency takes hold, or consumers are able to use alternative fuels, a reduction in a fuel’s price is likely (depending of what is happening to the fuel’s supply costs).1

Impacts of Supply on Prices

At any given moment, energy prices are determined by the market’s assessment of available supply and demand. Supplies are deemed commercially available if they are developed and can be processed, transported, and delivered to end users. If any part of the supply chain for a given energy resource is not in place, then the resource won’t be considered in the short term price determinations. (It will be considered in futures prices.) Any disruption in the overall supply chain (fuel production, transportation, distribution and marketing, etc.) can result in temporary or longer term spikes in energy prices.2 In the longer run though, an ongoing disruption can only have a lasting effect on price if there are shortages in production capacity. Examples of natural disasters include hurricanes, technical failures, and political violence that cause disruption to energy operating facilities or pipelines.3 Currently, the global energy system only has an ample cushion of surplus capacity, so any supply disruption in 2009 is likely to have only a miniscule impact on prices.4

• Natural Resource Availability & Related Infrastructure: As noted in the Supply section, levels of existing or anticipated energy supplies are influenced by geology/physical constraints, geopolitical and environmental issues, time lags in bringing projects on stream, and infrastructure limitations. While an individual project will not typically impact energy prices, the combined availability of supply at any given time does impact the market’s price setting mechanisms.
• Commercializing New Energy Sources: New technologies (deepwater, enhanced oil recovery, others), investments in unconventional fuel sources (oil sands, coal bed methane, others), and improvements in delivery infrastructure are factors at work that will help to increase available fuel supplies. In addition, many believe that nuclear energy holds significant potential for meeting growth in demand, subject to addressing concerns about safety and the disposal of nuclear waste. Other fuel supplies including integrated gasification combined cycle (IGCC) coal power plants with carbon dioxide capture and storage (CCS) capabilities, hydroelectric, geothermal, wind, solar, and biomass offer promise but face the challenges of larger scale commercialization. (See The Energy Portfolio).
• Natural resource commodity prices: As the figure on the left illustrates, the single largest contributor to the price of a gallon of gasoline is crude oil prices. These crude oil prices are impacted by the overall supply of crude oil as described above, but are also affected by a host of other factors including geopolitical events and conditions, weather, events such as hurricanes which can affect operations, transportation costs, and the value of a country’s currency vis-à-vis that of other countries.6 Crude oil markets react to geopolitical events because of the possibility that supplies may become curtailed or more accessible.

1. 1 World Energy Outlook 2006, IEA, p. 285. http://www.iea.org/textbase/nppdf/free/2006/weo2006.pdf
2. 2 "The Price of Fuel" http://www.thepriceoffuel.com/whataffectsfuelpricing/#governmentRegulations
3. 3 "Energy Security: Oil Security Resources," EIA, http://www.eia.doe.gov/emeu/security/Oil/index.html#disruptions
4. 4 "Short Term Energy Outlook Supplement: Why are oil prices so high?" EIA. http://www.eia.doe.gov/emeu/steo/pub/special/high-oil-price.html
5. 5 Oil Price History and Analysis, WTRG Economics ©1998-2006, http://www.wtrg.com/prices.htm
6. 6 "The Truth About Oil and Gasoline: An API Primer," API, 8 June, 2008, p.3. http://energytomorrow.org/energy_issues/truth_about_oil_gasoline_primer.pdf