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

Chapter 7

Energy: The Transition from Depletable to Renewable Resources

© 2012 Pearson Education, Inc. All rights reserved. 7-

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


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.


EXAMPLE 7.1


EXAMPLE 7.1 (cont.)


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.


• 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.



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


• 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.



• 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.



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


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


FIGURE 7.3 Real Crude Oil Price (1973–2009)


• 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.



• 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.



• 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.



• 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



TABLE 7.1 The World’s Largest Oil Reserves


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.


TABLE 7.2 Carbon Content of Fuels


• 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.



FIGURE 7.4 The National Security Problem


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.



• 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.



EXAMPLE 7.2


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


EXAMPLE 7.3


• 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



• 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.



FIGURE 7.5 The Efficient Level of Precaution


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


• Deregulation of electricity production– Prices are not always lower– Environmental concerns

Electricity


EXAMPLE 7.4


• 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.

Electricity


• Other approaches to promote the use of renewable resources– Forward capacity market– Feed-in tariff

Electricity


EXAMPLE 7.5


EXAMPLE 7.6


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.


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


• 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.



• 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.



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

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

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