Introduction to Energy Economics

and financial management

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What Is Economics?
Scarcity
All economic questions arise from a single and
inescapable fact: you can't always get what you want. We
live in a world of scarcity.
Scarcity means that wants always exceed resources
available to satisfy them.
People get involved in Economic Activity to cope with
Scarcity.

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What Is Economics1?
Economics is the study of how people use their limited
resources to try to satisfy unlimited wants.
Faced with scarcity, we have to make choices because
we can't have all what we want. Balancing the wants
and the resources available is called economizing or
optimizing.

1: Microeconomics, chapters 1 & 2

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What Is Energy Economics?
What is competition ?
Competition is the contest for command over scarce
resources.
For human life and the production processes, a
sufficiently available of energy is the highest
priority. Human beings can live without other
things, but not without energy resources. Energy
resources are also scarce and hence, needs its
optimization and it is dealt in energy economics.

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What is energy economics?
Energy economics is the field that studies human utilization of energy
resources and energy commodities, and the consequences of that
utilization. In physical science terminology, ‘energy’ is the capacity for
doing work, for example, lifting, accelerating, or heating material. In
economic terminology, ‘energy’ includes all energy commodities and
energy resources, commodities or resources that embody significant
amounts of physical energy and thus offer the ability to perform work.
Energy commodities—for example, gasoline, diesel fuel, natural gas,
propane, coal, or electricity—can be used to provide energy services for
human activities, such as lighting, space heating, water heating,
cooking, motive power, or electronic activity. Energy resources—for
example, crude oil, natural gas, coal, biomass, hydro, uranium, wind,
sunlight, or geothermal deposits—can be harvested to produce energy
commodities.
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What is Financial Management?
The main objective of modern financial
management:
To maximize the wealth of shareholders
Financial management is the study how an enterprise manages
its finances in order to maximize shareholder’s value
Financial management plays a vital role in the following
managerial activities:
 Strategic management ( developing long- term plans and possible
course of actions ie strategies)
 Operations management (routine day to day work in the
organization/enterprise as per strategies)

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What is Financial Management?
 Risk management ( dealing with the risk faced by the
organization/enterprise and risk faced in financing).
 Wealth is the net worth of a person or firm.
 Net worth is the total assets minus total liabilities.

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What is Financial Management?
Key activities of financial management:
 Financial planning (developing financial projections
and plans such as cash flow and profit statements for
assessing viable course of actions)
 Investment project appraisals ( evaluating
investments in different projects and risks associated
with them)
 Financing decisions (identifying the financial
requirements of the organization and the sources of
finance; finding out optimal capital structure of the
company)
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What is Financial Management?
 Capital market operations (raising capital from the
market and understanding the financial markets)
 Financial control (exercising control on financial
investments and financing decisions)

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Activities of financial management

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Enhancing shareholder value

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Enhancing shareholder value

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Enhancing shareholder value
A firm has 1,000 common shares outstanding and after-
tax profits of $ 1,000 per year, yielding earnings per share
$1. Assume that a further 1,000 shares are sold that net
company $7,000 and that the proceeds are then invested
to generate an additional after-tax profit of $500 per year.
Thus, although total profits have increased significantly
to a new total of $1,500 per year, the position of the
original shareholders has been diluted. Earnings per
share have dipped from the original $1 to $0.75.
Did the second public offering (SPO) enhance
shareholder value?
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Shareholders vs. stakeholders
Stakeholders are:
 Shareholders
 Employees
 Managers
 Suppliers
 Customers
 Community/society

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Corporate Governance and Agency problem
Corporate governance means how the businesses are
governed and controlled. Companies are run by
professional managers called agents and are owned by
shareholders called principals.
Given the agency problem, companies are governed by
the board of directors who monitor the activities of the
professional managers.
The principals may introduce incentives for the managers
such as ESOP (employee stock option plan) in order to
curtail agency problems and increase shareholder value.

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Corporate Governance and Agency problem
Wealth maximization and managerial social ethics –
self-study (page 9 of Atrill’s book).
Enron, Inside job, and Gasland documentaries.
Wall street (movie) parts I & II.

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Some queries related to financial
management

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Types of Firms
Three basic types of firm
Sole proprietorship
Partnership
Corporation or limited company
Sole proprietorship
It is the oldest form of business organization. A single person
owns the business, holds title to all its assets, and is
responsible for all of its liabilities.

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Sole Proprietorship
Disadvantages
Advantages

Good for small firms and not good for big firms such as
Simplicity
energy Cos.
Quicker decision-making
Responsible for all liabilities
Easy to establish
Difficult to raise capital
Cost of capital is high

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Partnership
A partners hip i s sim il ar to a proprietors hip in all as pects except that there i s more than one ow ner.

Disadvantages
Advantages
Responsible
Decision made
forthrough
all liabilities
consensus, hence low risk
Slower
Can raise
decision-making
higher capital process than single
proprietorship
Easy to establish but more complex than single
proprietorship
Difficult to raise capital

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 Corporation or Limited Company
A company is an impersonal entity created by law, which can own assets and liabilities.
The main feature of this form is that the Co. is separate from its owners. A owner’s
liability is limited to his/her shareholding only.

Disadvantages
Advantages
Slow
Limited
decision-making
liability
Difficult
Can raiseto
higher
set upcapital (a kind for energy Cos.)
Lower cost of capital
Decision-making through consensus

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 Equity capital

Raising Finances Preference capital

Equity
Internal
accruals

Source of
capital Term Loan

Debentures/
Debt bonds

Working capital
advances

Miscellaneous
sources
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Equity Capital
Equity capital represents ownership capital as
equity (common) shareholders collectively own
the company.
Authorized capital – The amount of capital that a
Co. can potentially issue, as per its memorandum
of association.
Issued capital – the amount offered by the Co. to
the shareholders.
Subscribed capital – The part of the issued capital
which has been subscribed to the investors.

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Equity Capital
Paid-up capital – The actual amount paid up by
the investors.
Par value – It is the value stated in the
memorandum and the share certificate.
Book value – It is the sum of the paid-up capital
and retained earnings divided by the number of
outstanding shares.
Market Value – It is the value of the share at which
it is traded in the stock exchange or the market.

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Equity Capital
Initial Public Offering (IPO) – The initial public
issue of the shares to the members of the public.
Subsequent offering is called Secondary public
offering (SPO).
Rights Issue –It is the selling of the security in the
primary market by issuing shares to the existing
shareholders.

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Rights of equity shareholders
Right to income – The equity shareholders have residual
claim to the income of the firm after paying the debt
obligation and preferred share dividends. The residual
income can be withheld by the Co. as retained earnings or
paid out as dividend.
Right to control – Equity shareholders are the actual
owners of the Co. and have the right to vote on every
resolution placed before the Co.
Pre-emptive rights – It enables the existing shareholders to
maintain their proportional ownership of the shares if the
Co. issued additional shares in the market.

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Preferential Capital (Preferred shares)
Preferred shares are hybrid forms of capital. They
have the characteristics of both the equity
(common shares) and the debt such as debentures.
Main features are (1) preferred share dividend is
payable after net income, (2) it is cumulative
(dividend if not paid in year, will be accumulated
next year), and (3) it is taxable and has no voting
rights.

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Internal Accruals (retained earnings)
The internal accruals consist of depreciation and
retained earnings. Retained earnings are much more
expensive than bank loans, because they are retained
without paying out the dividend and cost of capital
(interest rate) of equity is higher than that of the loan.

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Term Loans/debentures
Terms are given by financial institutions such as
banks and have term of less than 10 years.
Debentures (bonds) are loans raised from the
public and the interest (called here as coupon) is
paid every six months. It can be secured and
unsecured. Debentures can be convertible into
common shares.

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Working capital advances (loans)
Under a cash credit or overdraft arrangement, a
company can borrow required amount if it is within its
limit in the agreement with the financial institution or
the bank.
(Chapter 11, Finance for Non- financial Manager)

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Readings
Peter Atrill’s book: Chapter 1 & 6
Chapter 10 : I. M. Pandey’s book on Financial
Management
Microeconomics, Parkin: Chapter 10

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