The Determination of Energy Price

Figure 1. A standard supply and demand curve

The energy price is directly affected by the energy consumption used in the industry, household, commercial, electricity, and transportation sector. Due to its significant influence on the lives of many people, analysis of the energy price has to be well considered in the energy sector policymaking process.

The energy price is first determined by using a standard economic perspective from the supply and demand fundamentals. The optimum point from the supply and demand curve is often called “the Efficient Price” (see Figure 1). It represents the optimum resources allocation between the demand from the consumer and the supply from the producer. Understanding “the Efficient Price” mechanism is important for the government to determine the acceptable Economic Surplus (Economic Rent). The producer rent will be shared between government and producer through fiscal policy without inflicting any financial loss to the energy producer.

In the energy sector, “the Efficient Price” is merely an economic concept regarding the ideal price level. In reality, the price level in the market is shifted due to several distortions such as tax implementation, price subsidy, quantity limitation (quota) or direct price determination. With such distortions, the energy price is no longer an equilibrium price in the supply and demand curve. The distorted price is called “the Financial Price.” From the producer’s point of view, “the Financial Price” is the minimum level for the producer to produce a profit at the desired Rate-of-Return (ROR). While from the consumer’s point of view, “the Financial Price” is the maximum level that they are willing to pay the energy.

Thus, the calculation of “the Financial Price” is necessary for energy stakeholders. The calculation is important for the government to model its tax income plan and scenario. It is also an important aspect for energy producers. Given that energy industries are known for their vast capital amount and projects’ high risk, an analysis of “the Financial Price” is important to ensure sufficient capital return and to maintain their profit ratio is well above the production cost. The “Financial Price” can also guarantee the financial sustainability of the exploration and production stage of their project.

“The Financial Price” is used by the Government and the energy producer to make an analysis on the agreed price in the Cooperation Contract. However, the level of financial price in the upstream oil and gas industry depends on the form of the Cooperation Contract, such as Production Sharing Contract (PSC) based on the net split, Joint Operation Contract and Service Contract. Currently, the government is also implementing PSC based on the gross split. The contracts are varied for different projects and are based on their respective risk, business analysis, supporting infrastructure, regulations in place, as well as the type of resources. The differentiation was made to create an acceptable trade-off between both the government and investor’s responsibility. For example in Indonesia, there are different contract forms for different energy resources. In Indonesia’s coal mining sector, the implemented Cooperation Contract is called Perjanjian Karya Pengusaha Pertambangan Batubara (PKP2B) while in oil and gas industry, the Cooperation Contract is similar to the PSC Gross Split. These cooperation contracts are based on a certain royalty percentage from the gross income which is related to “the Financial Price” analysis result.

To summarize, “the Efficient Price” is an idealistic economic concept for energy stakeholders to consider in their decision-making process for energy pricing. Additionally, energy stakeholders should also calculate “the Financial Price” to determine the energy price. By assessing both of these prices, the government can model its tax income plan as well as other policy related to the energy sector, while energy industries can determine the financial security of their project. It is also important to note that “the Financial Price” is an essential factor to be considered to achieve an agreement in the Cooperation Contract between the government and the energy producer, in which the contract includes a certain royalty of the gross income from the natural resources production.

References

Yusgiantoro, P. (2009). Ekonomi Energi: Teori dan Praktik. Jakarta: LP3ES.

Yusgiantoro, P. (2018). Energy Pricing Policy. Presentation. Indonesia: Indonesia University of Defense.

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