Energy market liberalisation and pricing

It is difficult to speak of the price of an energy product, because one price does not exist.

Energy products, according to the investment theory, can be put in the category commodities.

Commodity prices are determined by many fundamental factors, foremost among which is quality. For instance North Sea Brent and West Texas Intermediate (light sweet crude) are different types of oil.

Quality of commodities can vary very much. Electricity however, is an exception because the quality is always the same. Electricity is a 'strange' type of commodity, because it can not be found naturally, but has to be produced by human beings.

Besides quality, fundamental price driving factors are demography and economy. More people and a growing economy leads to more demand for products, thus more demand for commodities. Because prices are finally determined by supply and demand, prices will rise if supply stays equal.

Demographic effects

Demographic developments show that the global population growth can be qualified as 'explosive'. Not only in absolute terms, but also in relative terms, demand [for commodities] is rising.

An increasing prosperity leads to an increase of commodity consumption per capita. For instance, Americans nowadays consume approximately 25 barrels of oil per person per year, while the average Chinese person consumes just 10% of this. The same applies to the consumption of electricity. As soon as economies grow, the consumption of electricity will increase even if population growth slows.

(Underground) reserves and the availability of commodities, which are factors on the 'supply side' are the next important factors of pricing. The availability of reserves depends very much of the level of technology. If we are able to produce oil and gas at very difficult reachable locations like deep sea wells, official reserves will increase and supply will rise. In that case, we might expect a fall in prices.

Production capacity

Another important supply determining factor is production capacity. When commodities are produced with a 100% utilisation of capacity, an increase of production is not possible. This will result in higher, if not exploding, prices.

On the other hand, excess of capacity will result in falling prices. Because of the severe financial crisis (and economic downturn), Opec's reserve capacity has increased from minimal levels to an excess of reserves.

Social turmoil, because it can lead to uncertainty of supply, can also result in rising prices, or in extreme situations, lead to exploding prices.

Transport and transport capacity are also important factors. A shortage of vessels and qualified employees, and/or limited excess to (whether or not cross border) pipelines or electricity grids are price increasing factors. The Dutch 'grid custodian' TenneT, therefore invests in the expansion and improvement of the electricity grid between the Netherlands and neighbouring Germany, aiming to increase the transport of electricity. For example: As long as at the national electricity grid markets are subject to restrictions, the (European) energy markets will remain fragmentised, with local characteristics and important price differences.

Numerous other factors play an important role in pricing of commodities. Weather and season are influential, substitution-effects and the currency in which a commodity is denominated, are also relevant.

As shown, the pricing of commodities is very complex, because all factors always run different courses, thus influencing prices in different ways. Nevertheless, it is important to pay attention to these factors, because those have a significant impact on the profitability of business, the level of investments and the switch to sustainability.