1. Chapter 7 Energy: The Transition from Depletable to Renewable Resources

2. Chapter 7: Energy: The Transition from Depletable to Renewable Resources
Introduction
Natural Gas: Price Controls
Oil: The Cartel Problem
Fossil Fuels: National Security and Climate Considerations
The Other Depletable Sources: Unconventional Oil and Gas, Coal, and Nuclear Energy
Electricity
Energy Efficiency
Transitioning to Renewables 7-
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3. Introduction
Energy is a complex subject and the chapter covers a large amount material and concepts.
This chapter examines some of the issues associated with the efficient allocation of energy resources and shows how economic analysis can be used in policy making. 7-
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4. EXAMPLE 7.1 7-
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5. EXAMPLE 7.1 (cont.) 7-
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6. Natural Gas: Price Controls
A natural gas shortage of 2 trillion cubic feet, or 10 percent of the marketed production, occurred in 1974–1975.
In 1938 the Natural Gas Act was passed.
The Federal Power Commission (FPC) was charged with maintaining “just” prices.
Price controls were imposed on natural gas shipped across state lines.
In Phillips Petroleum Co., v. Wisconsin (1954), the Supreme Court forced the FPC to extend its price control regulations to the producers. 7-
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7. Natural Gas: Price Controls
Price ceilings were imposed which prevented prices from reaching their normal levels:
low price >> overconsumption of natural gas, causing shortages,
causing more of the resource to be used in earlier years and with a sudden jump in price.
On the supply side, producers who expect price ceilings to be lifted have incentives to slow production and wait for higher prices, thus exacerbating existing shortages. 7-
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8. FIGURE 7.1 (a) Increasing Marginal Extraction Cost with Substitute Resource in the Presence of Price Controls: Quantity Profile. (b) Increasing Marginal Extraction Cost with Substitute Resource in the Presence of Price Controls: Price Profile 7-
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9. Natural Gas: Price Controls
More of the resource is left in the ground.
The rate of consumption is too high
The time of transition is earlier
The transition is abrupt, with prices suddenly jumping to new, higher levels
Discontinuous jump to a new tech can place a burden on consumers, who invested a lot encouraged by low prices. 7-
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10. Natural Gas: Price Controls
Artificially low prices of natural gas created a bias toward substitutes that could be blended with natural gas and away from substitutes that could not.
This inefficient policy was pursued based on rent-seeking behavior. 7-
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11. FIGURE 7.2 The Effect of Price Controls
D>B?
A+B+C>A+B+C+D
Lost of scarcity rent due to overproduction under price ceiling.
Future consumers are worse off, due to increasing marginal extraction cost.
So, this is not good way of transferring scarcity rent from producers to consumers 7-
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12. Oil: The Cartel Problem
The member countries of the international cartel called the Organization of Petroleum Exporting Countries (OPEC) collude in order to gain monopoly power.
Effective cartelization needs to consider:
Price elasticity of demand for OPEC oil
Income elasticity of demand for oil
Competitiveness from non-OPEC producers
Compatibility among OPEC member countries
Discount factor 7-
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13. FIGURE 7.3 Real Crude Oil Price (1973–2009)7-
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14. Oil: The Cartel Problem
Price elasticity of demand for oil
The lower the price elasticity of demand (in absolute value), the larger the potential gains from cartelization.
Oil and oil products are price inelastic.
Price elasticity of demand depends in part on the availability of substitutes.
Substitutes for oil are expensive and transition times are long. Solar energy sets a long-run upper limit on the ability of OPEC to raise prices. 7-
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15. Oil: The Cartel Problem
Income elasticity of demand
At constant prices, as income grows, oil demand should grow.
The higher the income elasticity of demand, the more sensitive demand is to the business cycle.
Recessions can thus put pressure on OPEC and expansions are beneficial to the cartel. 7-
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16. Oil: The Cartel Problem
Non-OPEC Suppliers
OPEC (45%) must take non-OPEC members into account when setting prices.
Pressure on the cartel was evident in the mid- 1980s when production was down and prices fell.
Dominant vs competitive fringe
Low price in the beginning, then allow price to rise rapidly,
Thus competitive fringe will deplete its resources earlier. 7-
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17. Oil: The Cartel Problem
Compatibility of Member Interest
Individual cartel members have incentives to cheat on production agreements.
Price elasticity of demand facing each individual member is higher than for the cartel. With higher price elasticity, lowering price maximizes profit.
Enforcing the collusive agreement is essential for the success of the cartel.
Discount rate 7-
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18. TABLE 7.1 The World’s Largest Oil Reserves7-
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19. Fossil Fuels: National Security and Climate Considerations
Climate Dimension
Carbon dioxide is a contributor to climate change.
Climate considerations affect energy policy:
Level of energy consumption mix matters
The mix of energy sources matters
Market-based energy choices imposes externality to energy users. 7-
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20. TABLE 7.2 Carbon Content of Fuels7-
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21. Fossil Fuels: National Security and Climate Considerations
National Security Dimension
National security is a public good. The market would generally result in an excessive dependence on imports.
The long run domestic supply curve of oil reflects increasing availability of domestic oil at higher prices. 7-
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22. FIGURE 7.4 The National Security Problem7-
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23. Fossil Fuels: National Security and Climate Considerations
The net benefits from self-sufficiency (TS at C) are lower than the net benefits from the optimal allocation (TS at Sd1 and D intersection). The vulnerability premium is lower than the cost of being self-sufficient for three reasons:
1. Embargoes are not certain events.
2. Vulnerability can be reduced.
3. Increasing domestic production imposes a cost on future users. 7-
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24. Fossil Fuels: National Security and Climate Considerations
To reduce the potential damage of an embargo, the U.S. has developed a stockpile called the strategic petroleum reserve.
Conservation can help decrease reliance on foreign imports. A tax on energy consumption is one tool that can be used to encourage conservation.
Domestic subsidies are another possible tool.
A final option is the use of tariffs and quotas on imports. 7-
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25. EXAMPLE 7.2 7-
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26. Unconventional Oil Sources
The Other Depletable Sources: Unconventional Oil, Coal and Nuclear Energy
Unconventional Oil Sources
Sources that are typically more difficult and expensive to extract
Concerns on their environmental impact
Using more energy to extract the resource
Emission of air pollutants 7-
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27. EXAMPLE 7.3 7-
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28. Coal An abundant energy source
The Other Depletable Sources: Unconventional Oil, Coal and Nuclear Energy
Coal
An abundant energy source
Air pollution: sulfur dioxide, particulate, mercury and carbon dioxide emissions
Current technological progress on carbon sequestration
Implementation of technologies calls for policy support 7-
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29. The Other Depletable Sources: Unconventional Oil, Coal and Nuclear Energy
Uranium
Safety is the major concern.
Sources of concern: nuclear accidents and storage of radioactive waste
The market will not make the correct choice for nuclear power.
The U.S. government has underwritten liability since the passage of the Price-Anderson Act in 1957.
Price-Anderson Act reduces the expected cost of nuclear power to utilities.
The U.S. government established the Nuclear Regulatory Commission. 7-
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30. FIGURE 7.5 The Efficient Level of Precaution7-
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31. Electricity
Average cost pricing entails averaging high cost sources with lower-cost sources. The resulting rate will be lower than the true marginal cost of power and thus is inefficient.
Peak-load pricing is a pricing structure where consumers using power during peak periods are charged higher rates during the peak periods 7-
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32. Electricity Deregulation of electricity production
Prices are not always lower
Environmental concerns 7-
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33. EXAMPLE 7.4 7-
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34. Electricity Renewable energy credits (REC)
Deregulation and environmental concerns
Two saleable commodities: the electricity itself, which can be sold to the grid, and the renewable energy credit that turns the environmental attributes into a legally recognized form of property
Voluntary markets and compliance markets
Effects of renewable energy credits in U.S. 7-
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35. Electricity Other approaches to promote the use of renewable resources
Forward capacity market
Feed-in tariff 7-
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36. EXAMPLE 7.5 7-
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37. EXAMPLE 7.6 7-
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38. Energy Efficiency
Improving energy efficiency reduces greenhouse gases emissions and dependence on foreign oil.
While new technologies emerge, the level of energy efficiency chosen by the market is low. 7-
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39. Transitioning to Renewables
Hydroelectric Power
Clean energy source
Helpful with national security concerns
Having impact on ecosystem
Wind
Cost effective in favorable sites
Environmental effects have triggered debates
(insert Debate 7.2)
Photovoltaics
Direct conversion of solar energy into electricity
Attractive in developing countries 7-
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40. Transitioning to Renewables
Active and Passive Solar Energy for heating
Input energy is costless while transformation and distribution requires capital investment.
Ocean Tidal Power
The plant has impact on coastal ecosystem.
Construction costs are high.
Liquid Biofuels
Have the potential to reduce greenhouse gases and imports on oil
They include two alcohols: ethanol and methanol, and biodiesel. 7-
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41. Transitioning to Renewables
Geothermal Energy
Derived from the earth’s heat
Initial cost is high, the payback periods vary from 2-10 years.
Hydrogen
Technologies of using hydrogen is expensive, and the infrastructure is undeveloped.
Using government subsidies has impact on promoting the renewable energy resources. 7-
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42. Summary Price control and energy conservation
Transition to a sustainable-energy future
National security and climate change concerns on oil
Environmental difficulties on oil, coal and uranium
Government’s role and energy efficiency, conservation and electric load-management 7-
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