Nonrenewable resources

1
Non-renewable resources energy

• Economics, management, and policy

2
Motivating Group Project

• California Renewable Energy Requirement for
  Electricity Legislation requires that 20 of
  generation be from renewables by 2020. How can
  this best be achieved?
• 2003-4 Bren Group Project

3
Key Characterisics of Nonrenewables

• Fixed endowment of given quality
• Stock declines over time
• For minerals
• Costly process of discovery
• Costly process of extraction
• Technical change decreases costs of exploration
  and extraction over time
• Key Results
• Physical Stocks Decline over time
• Price eventually increases with time
• Technical change may cause prices to decrease
  initially

4
Time paths
Production ceases Substitutes enter
p
t
tc dominates
exhaust dom
Stock
t
5
Scarcity value of non-renewables

• Since limited supply, non-renewable resource
  command a scarcity value
• Problem You own a barrel of oil. Can sell today
  for 30. Should you sell today, or wait for next
  year? (r.05)

6
Intertemporal Arbitrage Hotellings Rule

• Price today p0 (30)
• Price tomorrow p1
• If p1gt31.50, wait
• If p1lt31.50, sell today
• In equilibrium
• p1p0(1r)

7
Hotelling rent

• Real Prices should rise at rate of interest. If
  think they wont, firms would deplete reserves
  today.
• What about extraction costs?
• Rt Pt MCt implies Rt1 Rt(1r)
• Also called user cost, royalty, rent
• Hotelling It is actually rent which rises at
  rate of interest
• Present value of rents equal through time.
• Indifferent between selling barrel today or any
  point in future.

8
What about quantity extracted?

• Recall demand curve

If price increases through time, quantity must
decrease.

• Confounding factors
• Shifts in demand
• New discoveries
• New extraction technology
• Backstop technology

D
Barrels of oil
9
Prices and quantities over time
Seek Price path that follows Hotelling Rule,
such that stock is just exhausted when quantity
demanded drops to zero
Price
Quantity Produced
time
time
10
Switching to a backstop

• Backstop technology a perfect substitute for
  non-renewable resource that can be produced in
  any amount at constant (usually high) price.
• When price of non-renewable price of backstop,
  well switch.

11
The effect of a backstop technology
Question If you know backstop price And stock
of resource, how do you Find initial price?

MCb
Price path with backstop
time
12
Other factors that affect price path with a
backstop technology

• Decreasing extraction cost
• Lower price initially, then rises more quickly
• Sudden increase in demand
• Price jumps suddenly, decreases current
  consumption.
• Monopoly
• Price higher but rises more slowly, but
  extraction is slower so extends life of the
  resource.

13
The monopoly case
Price
Quantity
Monopoly
MCb
Time
Time
What do they mean when they say A monopolist is
a conservationists best friend?
14
Are we running out of resources?
15
Physical measures of scarcity

• Reserves known amount that can be profitably
  extracted.
• Changes with tech, discoveries, cost, price.
  Inventory constant through time
• Reserves/Production
• Assumes constant demand
• Crustal abundance total amt in crust.
• Ignores cost of extraction
• Ultimately recoverable total to 1 km depth
• Arbitrary, different for all resources, no new
  tech.

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Economic measures of scarcity

• Marginal cost of extraction
• likely to increase as stock decreases, but ignore
  price
• Price
• Ignores extraction cost.
• Hotelling rent
• Difficult to observe, but probably best measure
  of scarcity.
• Confounding factor
• Technology of extraction continues to improve

17
Studies of Scarcity

• Barnett and Morse (Scarcity and Growth)
• Looked at natural resource prices over 100 yrs
• Nearly all resources getting less scarce
• Timber only exceptin
• Slade
• Extraction tends to drive price up
• Technological change tends to drive price down
• Eventually exhaustion overcomes tech change
• Simon-Ehrlich Bet
• Question If we made the same bet today, who
  would be on Ehrlichs side and who on Simons?

18
Subsidizing renewable energy

• Remember our model Price of non-renewable rises
  until it reaches price of backstop.
• If extraction cost 0, extract all non-renewable
  before switching (more likely, wont extract all
  of it).
• If MCb decrease from subsidy, current price of
  oil will decrease, and consumption of oil will
  increase.

19
The effect of decreasing MCb
Price path with high backstop price
MCb0
MCb1
Price path with low backstop price
time
20
Comparing the two policies

• Taxing the thing that causes damage (oil
  consumption) can internalize externality.
• Subsidizing renewables may have unintended
  consequence of pushing consumption of fossil
  fuels to the present!
• Principle of targeting design regulation or
  policy to target (internalize) the externality.

21
OPEC

• Organization of petroleum exporting countries
• Algeria, Indonesia, Iran, Iraq, Kuwait, Libya,
  Nigeria, Qatar, Saudi Arabia, United Arab
  Emirates, Venezuela
• Controls most of world oil production.
• Maintain low production to keep prices (profits)
  high.
• Why would prices ever drop?

22
The Prisoners Dilemma
Saudi Arabia
cooperate
defect
30
40
cooperate
30
5
Kuwait
10
5
defect
10
40
23
Maintaining cooperation

• An example of a Nash Equilibrium both
  countries do what is in their best interest given
  what the other does.
• Defecting from the original agreement is a
  dominant strategy for both countries.
• Intuitively, incentive to cheat (by
  overproducing) is very high.
• Because other countries restrict output to keep
  prices high.

24
Electricity Markets Basic Conditions

• Demand energy vs. power
• Reliability

Area under curve is energy
Power
24 hours
time
Probability Density
Loss of load probability
Power system demand (kw)
25
Basic Questions

• What demand level should system be designed for?
• Electricity power energy reliability
• Supply 3 activities
• Generation
• Transmission
• Distribution

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Operation of Power System
Load Duration Curve Area under LDC is energy
Peak Load
Power at Least this high
Intermediate Load
Baseload
100 Fraction of Year
27
Regulation of Electricity Markets

• Historically natural monopoly
• Rate of Return Regulation
• Utilities allowed to price to achieve fair rate
  of return
• Problems
• Gold plating
• Inefficient
• Average Cost Pricing
• More recently (worldwide) deregulation

28
The California energy crisis

• Pre-1999
• 3 regulated monopolies that owned and operated
  generation, transmission, distribution (PGE,
  SCE, SDGE)
• Federal Energy Regulatory Commission regulates
  wholesale power transactions (one utility to
  another)
• California Public Utilities Commission regulates
  retail prices (to consumers)

29
Restructuring electricity

• Designed competitive wholesale market
• Suppliers bid to supply electricity on daily
  basis
• Grid accepts lowest bids price at margin
• Goal more competitive California
• Argued it would decrease prices
• Could pass savings on to consumers by giving them
  a choice of supplier
• But consumer side still regulated.
• Didnt work
• Prices skyrocketed over 500 between 1999-2000.
• Utilities paying far more than consumers paid.
• State had to bail out industry, cost 60 billion.

30
From Joskow
The wholesale prices prevailing between June
and September 2000 were much higher than the
fixed retail price that the utilities were
permitted to charge
31
Why did wholesale prices rise?

• Rising natural gas prices (natural gas is an
  input to electricity production)
• Large increase in demand in CA (growth)
• Reduced imports from other states (heat waves)
• Rising prices for NOx emissions credits (costs of
  producing electricity)
• Market power (in wholesale spot mkt)

32
Why didnt it work lessons

• Technically challenging to create competitive
  wholesale market
• Consumers were insulated from wholesale market
  prices (because retail market still regulated).
• Deregulated wholesale, failed to deregulate
  retail prices or to allow forward contracts.
• Required utilities to buy at unregulated price
  and sell at regulated retail price.

33
What next?

• State committed to long-term contracts at
  unreasonably high prices cost 60 billion.
• Prices likely to remain high to pay off.
• Prices dropped in 2001 due to increased supply,
  decreased demand.
• SCE and PGE effectively bankrupt.
• Replaced deregulated wholesale with state
  procurement and regulated prices