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Fuel Prices: Headed for a Bull Market

The price cycle is turning skyward for gas, coal, and crude oil.
Fortnightly Magazine - September 1 2002

favoring the buyer to one favoring the seller.

How To Plan For The Future

The trend is your friend until the trend ends. Consumers of energy need to prepare for a market environment that is likely to be quite different from that which they have experienced during the past 20 years. It is not likely to be "business as usual."

There are time-proven ways to deal with market uncertainty, and they do not involve complex derivative transactions. They do require that the energy consumer have a good understanding of the fuel producer's cost structure. In turn, the producer needs to better understand the increasingly competitive market into which the power generator is selling electricity.

In developing and implementing a long-term coal procurement strategy, buyers are often heavily influenced by the trend in prices during the past year. If history is our guide, many will procrastinate before they act. By then it will be too late, and they will be forced to take what a seller's market is willing to offer. This will most likely be what coal buyers have sought to rid themselves of during the past 20 years-a 10- or 15-year long-term contract with terms and provisions favorable to the seller. Why? Because those who provide the capital for developing a new coal mine, such as bankers and investors, will require it.

Long-term contracts are not necessarily good or bad, but their provisions can be economically devastating, if they are not drafted properly. Negotiating a good long-term contract requires that the buyer not focus on the daily changes in the price of fuel, but rather, on realistic provisions that are capable of dealing with the uncertainties of the future. Being able to negotiate good provisions requires that the buyer act now-before tomorrow becomes yesterday.

The opinions expressed in this article are those of the author, not necessarily those of the Energy Sector Consulting Services group of the Energy Services Division at Black & Veatch.

  1. For example, see "Economic Evaluation of Alternative Coal Supplies," American Power Conference, April, 1980; "Economics of Coal Utilization for Power Generation in Southeast Asia and Pacific Rim Countries," World Energy Conference, March 1986; "Fuel Supply Options-The Economics of Interfuel Competition," PowerGen '89, December 1989; "Considerations in Coal Switching," Utility Coal Conference, February 1993./li>
  2. Nominal prices are deflated using a broad measure of inflation such as the Gross Domestic Product Implicit Price Deflator.
  3. Resource depletion is the upward pressure on market-clearing prices over time, relative to what the price would normally be if there were an infinite supply under geological conditions similar to current conditions.
  4. The peak in coal prices occurred in August 2001 and the most recent low in February 2002.
  5. "Drowning in Oil," The Economist, March 6, 1999, pp. 19, 23-25.
  6. For example, between 1981 (crude oil price high) and 1994, the number of people employed in the oil and gas industries declined by 60 percent.
  7. Phillips Petroleum v. Wisconsin, 347 U.S. 672 (1954).
  8. Energy Information Administration, U.S. Department of Energy, Annual Energy Outlook 2002 with Projections to 2020, December 2001.
  9. Other independent forecasts published in