Lecture 16 Energy

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Lecture 16Energy

• AEDE/NR 531
• Spring Quarter, 2006

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The Economics of Energy

• Why are certain fuel sources used?
• Do energy prices in existing markets fully
  incorporate all social benefits and costs of
  production and consumption?
• How much should governments interfere in markets
  to accelerate the transition to renewable fuel
  sources?
• Will require combining theory used to analyze
  renewable and non-renewable resources.

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Topics

• Background statistics
• Basic model of energy use
• Energy and economic growth
• Transitioning between energy fuel sources

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Figure 11-1 in Field (Text)
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Simple Model of Energy Supply and Demand
q1 total quantity consumed q1-q2
imports (q1-q2)/q2 import dependency ratio
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Simple Model of Energy Supply and Demand

• Domestic supply is upward sloping because
  supplies cannot be increased without increasing
  costs. This is an assumption relevant to the
  U.S. now.
• Flat international supply curve assumes greater
  supplies could be achieved at the current price.
  True in the past but possibly not now.
• Does the domestic energy price depend on domestic
  supply?
• How to decrease import dependency?
• Increase world price
• Increase domestic supply
• Shift demand back (decrease).

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Optimal Use of a Depletable Energy Source

• Optimal energy resource provision is met by using
  the resource in a way that maximizes the present
  value of the stream of economic returns.
• Energy companies seek to maximize profit knowing
  they can sell a certain amount of supply now and
  in the future.
• Tradeoff between potentially higher prices in the
  future as supplies decrease and the discounting
  of future profits.
• Remember, in the non-renewable resource lecture
  we showed that optimal extraction over two
  periods occurs when change in marg. benefit of
  extracting a unit in the future is equal to the
  marg. cost of waiting.
• This can be extended to multiple periods where
  net revenue is maximized by producing so that
  profit in each period after discounting is the
  same.

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Optimal Use of a Depletable Energy Source

• Simply states that the net stream of profits are
  maximized when rising profits due to a price
  increase resulting from greater scarcity are
  exactly offset by discounting.
• Fossil fuels produce two types of externalities
• Flow externality Directly tied to the current
  rate of consumption of fossil fuel. Such as
  localized air pollution and acid rain.
• Stock externality Externalities that build over
  time with consumption that are persistent. Such
  as groundwater contamination, atmospheric carbon
  dioxide contributing to climate change.
• Given the characteristics of each, different
  policies will be more affective in addressing
  each. CC may be more successful in solving
  localized stock externality problems.

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Efficiency of Energy Use

• Clearly, a direct correlation exists between
  increased energy use and welfare. Wealthier
  countries consume more energy.
• Energy Conservation
• Def Reduction in energy use per dollar of
  income.
• Often use energy per unit of GDP (gross domestic
  product).
• A price increase will create incentives to
  achieve greater efficiency in energy use.
  Because
• Increasing energy efficiency has an opportunity
  cost because it takes resources away from another
  objective. Higher energy prices increase the
  returns from efficiency increasing efforts.
• Efficiency seeking efforts will be greater the
  steeper is the energy demand curve.

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http//www.pewclimate.org/global-warming-basics/fa
cts_and_figures/fig18.cfm By focusing on GDP, do
you think there may be something the graph below
isnt considering? Hint Think multinational
companies.
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As a result of the 1970s energy crisis
Supply cuts from OPEC increased prices. The
entire demand curve shifted down, and quantity
demanded moved from q1 to q2. Once OPEC
increased supply, prices went back down but
quantity demanded only went back up to q3, not q1
due to efforts to increase efficiency. Cheap
energy prices through the 80s and 90s probably
shifted the demand curve back up.
D
D1
p2
p1
q2
q3
q1
Energy Consumed
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Transitioning Between Energy Supplies

• Economic theory says that as long as all costs
  and benefits of energy consumption are included
  in the supply and demand curves current use is
  optimal.
• Most arguments for expediting the transition away
  from fossil fuel based energy assumes many
  externalities from pollution have not been
  internalized.
• Can accelerate the transition in two ways
• Accurately price fossil fuels by internalizing
  pollution damage into the price. Has already
  started to be done through policies such as acid
  rain program and carbon markets.
• Subsidize RD in renewable energy to lower its
  price.

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Transitioning Between Energy Supplies Demand
Side/Taxing Bads

• Taxing Fossil Fuels
• Increasing prices both promotes conservation and
  decreases the relative prices of renewable fuel
  sources.
• Raising fossil fuel prices can backfire
  (citation RFF-DP-02-52)
• Estimates show that doubling energy prices
  requires 50 years to achieve 50 increase in
  energy efficiency.
• Technology adoption is reduced when profits are
  low. 50 reduction in profits more than offsets
  the effects of a 10 increase in energy prices in
  terms of technology adoption.

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Transitioning Between Energy Supplies

• Technology adoption typically follows an S-shaped
  curve. Slow at first followed by rapid adoption,
  which has been found to typically occur after 10
  of total have adopted.

Adoption
time
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Transitioning Between Energy Supplies Supply
Side/Subsidizing Goods

• Subsidy Policy Targets
• Subsidize exploratory research.
• Subsidize research into incremental improvements
  in existing technology.
• Subsidize the adoption of specific technologies.
• Subsidize general improvements in efficiency.

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Transitioning Between Energy Suplies Electricity
Generation

• 40 of all carbon dioxide produced in the U.S.
  from human activities results from electricity
  generation.
• Alternative Energy Sources
• Biomass
• Geothermal
• Wind
• Nonhydroelectric renewables produce only 2 of
  electricity generation.
• Two policies to promote renewables
• Renewable Energy Production Credit (REPC)
• Renewable Portfolio Standard (RPS)

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Marginal Cost Over Time of Different Energy
Sources
Marginal Cost of Depletable Fuel Source 1

MC1
MC2
Marginal Cost of Depletable Fuel Source 2
Time
t time of conversion
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Marginal Cost Over Time of Different Energy
Sources

MC1
MC2
MCRenew
Time
t0
t1
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Marginal Cost Over Time of Different Energy
Sources

MC1
MC2
Energy Price Path Over Time
MCRenew
Time
t0
t1
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Transitioning Between Energy Suplies Comparing
Alternative Policies

• REPC
• Federal tax credit to electricity generators for
  adopting renewables.
• 1.5 cents/kWh produced from nonhydroelectric
  renewable.
• RPS
• State level policy requiring a percentage of the
  states electricity generating capacity to come
  from renewables.
• Typically set at 5 to 20 to be met between 2010
  and 2020.
• Renewable credits typically can be traded so it
  is not a CC policy in most states.
• Will also compare REPC and RPS to a carbon
  abatement policy.

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Transitioning Between Energy Suplies Comparing
Alternative Policies

• Both policies provide continual incentives to
  increase renewable capacity.
• Compare changes in consumer and producer surplus
  under RPS.
• Consumers always lose surplus under the RPS
  because electricity prices increase. IMPORTANT!!
  Not accounting for increased environmental
  quality.
• Producers may or may not lose surplus. Likely to
  lose surplus at higher RPS limits, say around
  15.
• Under RPS, electricity prices will increase at
  different rates at different limits. Small
  increases around 5 as easy options are taken
  first.

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Cost of Meeting RPS Standard

• It is likely that producers can pass most of the
  costs onto consumers early on, but less so as
  renewables capacity reaches 20 where price
  elasticity of demand will become more elastic.
• As a result, costs reduce consumer surplus more
  early on and producer surplus later.

Cost per increase in renewables
0
20
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REPC Requirements

• Compare changes in consumer and producer surplus
• REPC tax credit represents a transfer in surplus
  from the government to producers.
• Significant gain in consumer surplus under REPC
  due to lower electricity prices
• Producers likely will not lose surplus under
  REPC.
• Significant loss in government revenue. Whether
  this takes away from consumer or producer surplus
  depends on what that revenue would have been used
  for if not for REPC.
• Note, producers will not adopt renewables even
  with the subsidy if they are still more expensive
  than fossil fuels
• If the tax subsidy is high enough, likely to get
  rapid adoption of more mature technologies such
  as wind.

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REPC vs. RPS

• Efficiency depends on REPC government revenue
  use.
• RPS will raise electricity prices, while REPC
  will lower prices.
• As a result of above point, RPS is likely to be
  more effective in mitigating carbon emissions.
• RPS will likely be more efficient than REPC since
  firms that can adopt renewables more cheaply (say
  those near optimal wind locations) can sell
  credits to other producers.

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REPC vs. RPS

• RPS is more easily adjusted to promote less
  development technologies by requiring that they
  constitute a percentage of renewables at some
  time in the future.
• Note that the relative cost of either policy will
  depend on the natural gas prices in the future.
  Higher natural gas prices make the cost to
  society of switching to renewables lower.

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Figure 89. Lower 48 crude oil reserve additions
in three cases, 1970-2020 (billion barrels)
                                                  
                                    
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Figure 84. Lower 48 crude oil wellhead prices in
three cases, 1970-2020 (1998 dollars per
barrel)                                         
                                       
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Relative Competitiveness of Renewable Energy
Sources

• Early 1980s, wind energy cost 30 cents/kWh. Now
  it is down to 5 cents/kWh not including the 1.5
  cent/kWh production tax credit.
• 1996 Levelized costs (cents/kWh)
• Coal 4.8 5.5
• Gas 3.9 4.4
• Hydro 5.1 11.3
• Biomass 5.8 11.6
• Nuclear 11.1 14.5
• Wind (w/0 PTC) 4 6
• Natural Gas prices have increased significantly
  since 1996.
• Are there environmental externalities to wind
  power?

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Current Costs of Electricity from Large Power
Plants, Renewable and Conventional, cents per kWh
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A Projection of Global Renewable Energy Growth