Journal of Energy Markets

Derek W. Bunn
London Business School

In this issue of The Journal of Energy Markets, we cover a wider variety of themes than usual. Our first two papers look at the corporate effects of government policies: we have an analysis of the potential impact of carbon reduction policies at the corporate level, and an analysis of incentive regulation for networks. We then offer a sector-level analysis of the aluminum industry, looking at the effect of energy costs on relative competitiveness. I am pleased to see papers that provide interesting work on company-level impacts alongside our more usual range of papers on market-level behavior. The issue’s final two papers focus on market-level behavior, but with regard to a new area that is of interest in the energy sector: cryptocurrencies.

Our first paper, “Estimating financial risks from the energy transition: potential impacts from decarbonization in the European power sector” by Chris Cormack, Charles Donovan, Alexandre Köberle and Anastasiya Ostrovnaya, looks at how carbon reduction policies adopted by governments could have a significant impact on the profitability of companies. Anticipating these impacts is a growing concern for both investors and regulators. The authors of this paper present an integrated assessment of energy transition risk that links future energy scenarios to a structural economic model. The methodology allows for a comprehensive evaluation of potential financial stresses on firms subject to binding emissions constraints. The authors apply this methodology to electric utilities in the EU-28, and their results show that aggressive climate mitigation policies affect both net profit margins and the required rate of capital expenditure. They also present initial estimates of changes in equity returns and credit quality for these firms, as well as going into implications for future policy-making.

Next, we turn to infrastructure. In the issue’s second paper, “An empirical analysis of the Brazilian Transmission Service Operators incentive regulation”, Aline Veronese da Silva, Matheus Machado de Almeida and Marcelo Azevedo Costa review the evolution of network regulation in Brazil since the 1990s. Major changes occurred after arbitrary interventions by the government in 2012, which raised the level of risk perceived by investors. The negative impacts of this event on the transmission market notwithstanding, the regulatory framework finally improved its incentive power. The authors analyze the results and discuss the effectiveness of the regulatory signals, showing that, despite the immediate losses that the arbitrary changes imposed on the system, the long-term impact has tended to be positive. They discuss some critical issues regarding the economic incentive framework, and they conclude that a gradual change of regulatory practices, or even an agreement within the existing contract’s terms, could reduce the short-term damage experienced by companies.

This focus on company-level performance continues in our third paper: “The impact of energy costs on industrial performance: identifying price and quantity effects in the aluminum industry using a data envelopment analysis approach” by Nadia Kpondjo, Frédéric Lantz, Anna Créti and Christian Pham Van Cang. Here, the authors measure the impact of energy costs on competitiveness in the aluminum industry. They use a frontier function approach with technical and cost-efficiency measures. First, they estimate a data envelopment analysis model and measure the efficiency scores using the approaches of Farrell from 1957 and Tone from 2002. Second, the efficiency scores are explained through a set of environmental factors using a truncated regression model, applying the double bootstrap method proposed by Simar and Wilson in 2007. By considering the Tone efficiency scores, the authors highlight the fact that efficiencies are differentiated depending on geographic region and production technologies. This could explain the loss of competitiveness observed in certain industrial units in recent years. The authors then highlight other factors that impact cost efficiency, such as global market share, multinational status and the local exchange rate with respect to the US dollar. These latter factors have a significant, positive effect on relative efficiency in terms of aluminum smelter costs. These results provide a better understanding of the reasons for changes in this industry, which has been marked by major technological and economic shifts, and they permit an assessment of the role that energy has played in those changes.

Returning to the analysis of markets, the fourth paper in the issue – “Estimating the hedging potentials of Bitcoin and energy returns” by Moussa Wajdi, Regaieg Rym and Mgadmi Nidhal – investigates the significance of oil, gold and coal returns on Bitcoin returns for January 2011 to September 2018 on a monthly periodic basis. The authors assess the long-run relationship among oil, gold, coal and Bitcoin using the ESTAR approach. Gold is used as a significant control variable in this study. The empirical results show that gold, crude oil and Brent Crude, along with West Texas Intermediate prices, have negative and remarkable effects on the natural logarithm of Bitcoin. Coal and natural gas have positive effects on Bitcoin. Natural gas has an insignificant impact on Bitcoin’s returns compared with coal. The findings indicate that both Bitcoin and coal could serve as hedges for oil and gold. For Bitcoin investors, the results imply that data about oil, gold and coal returns can be used to improve predictions regarding Bitcoin returns. Despite the dissimilarities shown, hedging strategies using gold, oil, coal and Bitcoin are potentially useful when considering overall portfolio risk variance.

A different perspective on cryptocurrencies is provided by Niranjan Sapkota and Klaus Grobys in their paper, “Blockchain consensus protocols, energy consumption and cryptocurrency prices”, the last in this issue. They start from the observation that blockchain cryptocurrencies employ different consensus protocols to verify transactions. While the proof-of-work consensus protocol is the most energy-consuming protocol, both the proof-of-stake protocol and a hybrid of these two consensus protocols have been introduced, and they both consume considerably less energy. They employ portfolio analysis to explore whether energy is a fundamental economic factor affecting cryptocurrency prices. Surprisingly, the results suggest that, on average, cryptocurrencies employing proof-of-work consensus protocols do not generate returns that are significantly different from those that incorporate proof-of-stake consensus protocols. What is more, the results show that cryptocurrencies that incorporate hybrid versions of these consensus protocols generate significantly higher average returns than the other groups.

These five papers are all timely publications with substantial implications. We expect they will attract wide interest.