Non-renewable resources

1
Non-renewable resources energy

• Economics, management, and policy

2
Non-renewable resources

• No sustainable yield dx/dt -h
• Recall
• Fisheries how much to harvest?
• Forestry when to harvest?, how to harvest?
• Can we say anything in general about how
  non-renewables will be extracted by the private
  sector?
• Predict prices? Predict adoption of renewables?
  Predict resource use over time?

3
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)

4

• If p1gt31.5, wait
• If p1lt31.5, sell today
• In equilibrium
• p1p0(1r)

5
Hotelling rent

• 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
• Present value of rents through time.
• Indifferent between selling barrel today or any
  point in future.

6
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
7
Prices and quantities over time
Price
Quantity
time
time
8
New discoveries
Rent p-MC
With new discoveries, resource becomes less
scarce, so scarcity rent drops.
time
9
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.

10
The effect of a backstop technology

MCb
Price path with backstop
time
11
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.

12
The monopoly case
Price
Quantity
Monopoly
MCb
Time
Time
13
Are we running out of resources?
14
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.

15
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.

16
Stock pollution

• Consumption of oil generates pollution
• Stock of carbon in atmosphere xt
• Rate of natural decay d
• xt1 xt dxt st
• Where st is flow of pollution
• Climate change caused by x (not s)
• But cannot directly control x.

17
Consider two policies

• Tax consumption of oil (e.g. gas tax)
• Subsidize alternative, renewable energy sources.
• How would each policy alter the stock pollutant
  (carbon) that causes global climate change?
• What are the pros/cons of each?

18
Taxing oil consumption

• Remember, damage is caused by x.
• Standard economic argument internalize the
  externality.
• If we can charge polluters the social cost of
  pollution, then it will be internalized.
• Taxing oil consumption raises the price of oil
  can internalize the externality.

19
Gas taxes in the real world

• Strong political opposition to gas tax.
• RFF discussion paper gas tax that would
  internalize externalities 1.01 per
  gallonprobably an underestimate.
• Federal gasoline tax 0.18
• California gasoline tax 0.18
• Highest Montana (0.27)
• Lowest Wyoming (0.09)

20
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.

21
The effect of decreasing MCb
Price path with high backstop price
MCb0
MCb1
Price path with low backstop price
time
22
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.

23
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?

24
The Prisoners Dilemma
Saudi Arabia
cooperate
defect
30
40
cooperate
30
5
Kuwait
10
5
defect
10
40
25
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.

26
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)

27
Restructuring electricity

• Designed competitive wholesale market
• 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.

28
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
29
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)

30
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.

31
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