Appendix A:

Industrial Fuel Prices

Baseline and Scenario Information

This appendix presents three categories of industrial energy price information. The first section provides 1994 data on average industrial energy prices for the U.S., OECD Europe, and Japan together with recent information regarding the relationship between average industrial energy prices and prices paid by specific industries in the United States. The second section provides a brief discussion of industrial energy price projections for the U.S. and other regions of the world through 2015. The final section outlines the scenarios for increases in OECD fuel prices assumed to result from greenhouse mitigation policy.

A. 1994 Industrial Fuel Prices in OECD Countries

Table 1 presents recent data on average industrial fuel prices in key OECD markets.

Source: International Energy Agency, Energy Prices and Taxes, 3rd Quarter, 1995

* Steam coal value for United Kingdom, which may be a more appropriate base value for forwardlooking projections (see text).

The substantial differences across national markets reflect factors such as domestic abundance of fuels, proximity to fuel supplies at low transportation costs, exchange rate movements, taxation differences, differences in the efficiency of energy distribution and electricity generating systems, and possibly other factors. Changes in these factors are inherently difficult to project into the future.

Energy costs faced by particular energy-intensive industries may diverge substantially from the average price to all industrial users. Table 2 compares U.S. industrial fuel prices for the six industries being considered in this project to the all-manufacturing average. Industry analysts may also wish to consider their own knowledge of the relationship between industry-specific and average industrial energy costs in other regions of the world, taking account of the actual location of plants within those regions.

Source: Derived from Manufacturing Energy Consumption Survey, 1991, Table A25

A.2 Baseline (No Mitigation) Industrial Fuel Price Projections

For purposes of characterizing industrial energy price structures, the world is characterized as consisting of several regions. For the three main OECD economic groupings (the United States, OECD Europe, and Japan) we consider both a baseline price path that starts from the actual 1994 prices outlined above and two alternative sets of price "add factors" that reflect the assumed impact of greenhouse mitigation policies on industrial energy prices. For the remaining regions, which are assumed to be unaffected by new mitigation commitments over the time period addressed in this study, only baseline industrial fuel prices are discussed. However, these regions are still relevant to the analysis by experts because they are possible sources of production from existing or new plants that compete with production in OECD regions.

U.S. Baseline Price Projections to 2015:

Industrial fuel price projections from the 1996 EIA Annual Energy Outlook Reference Case are summarized in Table 3.

Oil: Because crude oil is traded on well-functioning global markets, an increase in crude prices that increases oil product prices in the U.S. should also push up prices in foreign markets. For purposes of the baseline, we might assume that absolute increases in oil product prices to U.S. industry projected by EIA in the 1996 Annual Energy Outlook would also be reflected in other OECD markets. Under this approach the 1994 differences in oil prices between countries can be used as an "add factor" for future year prices.

Coal: The AEO96 reference case projects a 10 percent decrease in coal prices faced by U.S. industry to 2000, and then assumes that these prices fluctuate in a narrow band from their new lower level. For baseline purposes, experts might assume a similar pattern for other OECD regions, starting from their actual 1994 levels. One exception might be the case of OECD Europe, where the 1994 average price is strongly influenced by Germany's reliance on high-cost domestic coal. Given the expected phaseout of high-cost German coal, the U.K. coal price, provided in parentheses in Table 1, might be used as the 1994 base value relevant to the determination of future coal prices to industry in Europe.

Natural Gas: The AEO96 reference case projects only modest changes in natural gas prices to U.S. industry through 2010, with a fairly pronounced upturn after that date. Because natural gas markets are significantly affected by local supply conditions, it is difficult to assess the relative position of other OECD markets. For baseline purposes, we suggest a parallel assumption of near baseline industrial gas prices through 2010, followed by an increase in absolute terms equal to that projected in the EIA reference case between 2010 and 2015.

Electricity: The AEO96 projects a small decrease in U.S. industrial electricity prices from their 1994 level, averaging 2 percent by 2005 and 4 percent by 2015. Other OECD countries, starting from a much higher base level of prices, are likely to secure at least as large a change in percentage terms.

Industrial Energy Price Paths Outside the OECD

It is nearly impossible to adequately characterize energy market conditions in the extremely diverse group of non-OECD countries in a simple manner. Nonetheless, to provide a starting point for experts, a fuel-by-fuel discussion is provided below. Experts should feel free to identify and apply information regarding current or projected country- or industry-specific energy pricing practices that may be relevant to their analysis even in cases where it differs significantly from the default characterizations provided below.

For coal and oil, a general working assumption might be that non-OECD industrial energy price trends to 2015 are similar to those projected for the United States. One important exception might be the Middle East, where oil exporters with high reserves to production ratios and extremely low production costs might place a very low implicit price on oil that could be used by industry within its borders.

For natural gas, the situation will likely depend significantly on local conditions. For markets dependent on LNG, natural gas price trends might follow those in Japan, the largest LNG market. For Russia, which has the world's largest proved reserves of natural gas, industrial use at prices substantially below export values could be a reasonable strategy given the world's largest reserves, constraints on export market absorption and transmission capability. In the Middle East, where considerable by-product gas and unexploited gas reserves exist and marketing opportunities are limited, some countries appear to be willing to supply industrial gas for prices that are a small fraction of current U.S. prices into the indefinite future.

For electricity, subsidies and fuel prices, which vary widely across countries, play a key role in determining prices to industry. Capital and construction costs in markets that are not welldeveloped can be higher than those in OECD countries, but costs related to environmental compliance may be lower. Recognizing that there will be significant differences across countries, a working assumption might be that baseline industrial electricity prices outside the OECD follow the U.S. experience.

A.3 Scenarios for Impact of Greenhouse Mitigation on OECD Energy Prices

The effect of greenhouse gas mitigation commitments on industrial energy prices is highly speculative. It can be affected by the choice of the greenhouse goal, the degree of flexibility provided in meeting that goal, national decisions regarding the allocation of necessary reductions between industry and other sectors, substitution possibilities, and technology developments. These factors, all of which are uncertain, are not at issue in the present analysis, which starts from an assumed level of industrial energy price impact.

The industrial energy price scenarios for this study assume that price impacts for individual fossil fuels in each OECD region that are directly related to their carbon content. Effects on industrial fuel prices are assumed to be phased in beginning in 2000. Half of the effect is realized by 2005, and the full effect is realized by 2010.

For electricity, price effects depend on the baseline fuel mix, flexibility in dispatch, fuel and heat rate parameters for new capacity, and the supply curves for current and potential fuels, all of which differ across regions. In the calculation provided below that reflects only the current fuel mix, electricity has a higher average carbon content in the U.S. than in Europe or Japan.

The actual extent to which the average industrial energy price “add factors" presented below would be reflected in the prices paid by the individual industries that are the focus of this study is dependent on specific implementation details of actual mitigation policies that are beyond the scope of this study. For the present study, a default assumption might be that the relationship between industry-specific energy prices and the all-industry average price within the United States adheres to the recent historical experience as outlined in Table 2 above. However, industry analysts are free to posit and adopt alternative assumptions based on their industry-specific knowledge.

Tables 4 and 5 outline the assumed energy price "add factors" for the two scenarios outlined in section 4 of the technical guidance paper.