Download Non-renewable resources & energy

Non-renewable resources &
energy
Economics, management, and
policy
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?
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)
If p1>$31.5, wait
If p1<$31.5, sell today
In equilibrium:
p1=p0(1+r)
Hotelling “rent”
Prices should rise at rate of interest. If
think they won’t, firms would deplete
reserves today.
What about extraction costs?
Rt = Pt – MCt implies Rt+1 = Rt(1+r)
Also called “user cost”, “royalty”
Present value of rents = through time.
Indifferent between selling barrel today or
any point in future.
What about quantity extracted?
Recall demand curve:
If price increases through time,
quantity must decrease.
$
D
Barrels of oil
Confounding factors:
1. Shifts in demand
2. New discoveries
3. New extraction technology
4. Backstop technology
Prices and quantities over time
Price
Quantity
time
time
New discoveries
Rent
p-MC
With new discoveries, resource becomes
less scarce, so “scarcity rent” drops.
time
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, we’ll switch.
The effect of a backstop technology
$
MCb
Price path with
backstop
time
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.
The monopoly case
Price
Quantity
Monopoly
MCb
Time
Time
Are we running out of resources?
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.
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.
Stock pollution
Consumption of oil generates pollution
Stock of carbon in atmosphere = xt
Rate of natural decay d
xt+1 = xt – dxt + st
Where st is flow of pollution
Climate change caused by x (not s)
But cannot directly control x.
Consider two policies
1. Tax consumption of oil (e.g. gas tax)
2. 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?
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.
Gas taxes in the real world
Strong political opposition to gas tax.
RFF discussion paper: gas tax that would
internalize externalities = $1.01 per
gallon…probably an underestimate.
Federal gasoline tax: $0.18
California gasoline tax: $0.18
Highest: Montana ($0.27)
Lowest: Wyoming ($0.09)
Subsidizing renewable energy
Remember our model: Price of non-
renewable rises until it reaches price of
backstop.
If extraction cost = 0, extract all nonrenewable before switching (more likely,
won’t extract all of it).
If MCb decrease from subsidy, current price of
oil will decrease, and consumption of oil will
increase.
The effect of decreasing MCb
Price path with
high backstop price
MCb0
MCb1
Price path with
low backstop price
time
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.
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?
The “Prisoner’s Dilemma”
Saudi Arabia
cooperate
cooperate
defect
30
30
40
5
Kuwait
5
defect
40
10
10
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.
The California energy crisis
Pre-1999
3 regulated monopolies that owned and
operated generation, transmission,
distribution (PG&E, SCE, SDG&E)
Federal Energy Regulatory Commission
regulates wholesale power transactions
(one utility to another)
California Public Utilities Commission
regulates retail prices (to consumers)
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.
Didn’t work
Prices skyrocketed over 500% between 19992000.
Utilities paying far more than consumers paid.
State had to bail out industry, cost $60 billion.
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”
Price
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450
400
350
300
250
200
150
100
50
0
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)
Why didn’t 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.
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 PG&E effectively bankrupt.
Replaced deregulated wholesale with
state procurement and regulated prices