Energy Economics: Concepts, Issues, Markets And Governance

854 Pages·2019·16.5 MB·english

by  Subhes C. Bhattacharyya

Subhes C. Bhattacharyya
Energy
Economics
Concepts, Issues, Markets and
Governance
Second Edition
Energy Economics
Subhes C. Bhattacharyya
Energy Economics
Concepts, Issues, Markets and Governance
2nd ed. 2019
Subhes C. Bhattacharyya
Institute of Energy and Sustainable
Development
De Montfort University
Leicester, Leicestershire, UK
ISBN 978-1-4471-7467-7 ISBN 978-1-4471-7468-4 (eBook)
https://doi.org/10.1007/978-1-4471-7468-4
1st edition: © Springer-Verlag London Limited 2011
2nd edition: © Springer-Verlag London Ltd., part of Springer Nature 2019
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V
Preface
The first edition of Energy Economics: Concepts, Issues, Markets and Gov-
ernance was well received by the academic community. Readers have pro-
vided positive feedback on the book and it has trained a generation of young
energy economists, who have appreciated the wide range of topics covered by
the book. Since the book was published in 2011, a lot of changes have taken
place in the energy sector. The emergence of the US as an energy exporter has
wiped out the peak oil debate and hardly anyone is talking about the concerns
of energy security these days. Instead, the launch of the Sustainable Develop-
ment Goals has galvanised the attention on global energy access, sustainable
energy and green growth. In addition, the Paris Agreement has revived the
global climate change agenda and made a breakthrough by adopting a com-
mon agenda for all countries. All these developments made a revision to the
book essential and at the suggestion of the publisher, Springer, I agreed to
revise and update the book more than 2 years ago.
However, the revision task appeared to be a never-ending process and I con-
tinued to miss deadline after deadline. Increased workload at the University
meant that the book project had to be moved to personal working time—in
the evenings, weekends and holidays. However, the work pressure started to
encroach on these personal times, making the project completion a major
challenge. I have managed to complete this during the summer when I was
supposed to go on a family vacation but this had to be sacrificed to complete
the manuscript.
The revised version retains the same features of the first edition. Most of the
content of the book is accessible to persons of non-mathematical background.
The economic concepts have also been explained in simple terms, often using
graphical presentations. However, for those who cannot imagine an energy
economics book without mathematics, I have added some materials and have
provided references for further reading. Essentially, mathematics has been
used as an aid and not for the sake of it.
The organisation of the book has been updated. This now reflects closely the
title of the book. Accordingly, the book is divided into four parts instead of six
parts found in the first edition. The content has also been thoroughly revised
to reflect the changes in the industry and the business environment.
I am grateful to the readers who provided valuable feedback and encouraging
comments on most of the materials of this book. Their suggestions and criti-
cisms have always have helped me in improving my work.
VI Preface
A book of this size always takes special personal efforts. I am grateful to
Mr. Anthony Doyle of Springer Nature for his understanding and agreeing to
my requests for extension. Above all, I could not have realised this work with-
out the support and sacrifice of my family members—my spouse Debjani and
my daughter Saloni. I have no words to express my gratitude for their altru-
istic gesture of letting me work during the entire summer holidays of 2019,
without any complaint. This summer will never return and the loss of oppor-
tunity to recharge the battery for the next year will be dearly felt. Perhaps it
is high time to assess the external costs academics impose on their near and
dear ones, but that is outside the scope of this book.
Subhes C. Bhattacharyya
Leicester, UK
August 2019
VII
Contents
1 Introduction to Energy Economics ............................... 1
1.1 Introduction ......................................................... 2
1.2 Organisation and Content of the Book ................................ 4
Reference ............................................................ 4
I Economic Concepts Applied to the Energy Sector
2 Energy Data and Energy Balance ................................. 7
2.1 Introduction ......................................................... 9
2.2 Energy Basics ......................................................... 9
2.2.1 Energy Defined ....................................................... 9
2.2.2 Alternative Classifications of Energy .................................... 10
2.3 Introduction to the Energy System .................................... 12
2.4 Energy Accounting Framework ....................................... 14
2.4.1 Components of the Energy Account. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
2.4.2 Commodity Accounts and Overall Energy Balance ...................... 17
2.4.3 Units, Conversion Factors and Aggregation of Energy Flows ............. 20
2.5 Accounting of Traditional Energies .................................... 25
2.6 Special Treatments of Some Entries in the Energy Balance ............. 27
2.6.1 Treatment of Primary Electricity Production ............................ 27
2.6.2 Treatment of Electricity in Final Consumption .......................... 28
2.6.3 Self Generation ....................................................... 29
2.7 Analysis of Energy Balance Information ............................... 29
2.8 Alternative Presentation of Energy Accounting Information ........... 31
2.8.1 Energy Flow Diagrams ................................................ 31
2.8.2 Reference Energy Systems (RES) ....................................... 32
2.9 Common Energy Data Issues .......................................... 34
2.10 Conclusion ........................................................... 36
Annex 2.1: Worked Out Examples ..................................... 36
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39
3 Energy Demand Analysis .......................................... 41
3.1 Introduction ......................................................... 43
3.2 Basic Rational Choice Model of Energy Demand ....................... 44
3.2.1 Consumer Demand for Energy: Utility Maximization Problem ............ 44
3.2.2 Cost Minimization Problem of the Producer ............................ 48
3.3 Energy Demand Decisions from a Behavioural Economics Perspective .... 50
3.4 Overview of Energy Demand Decisions ............................... 51
3.5 Simple Indicators for Energy Demand Analysis ........................ 53
3.5.1 Visualisation of Demand Trend ........................................ 53
3.5.2 Growth Rates ......................................................... 55
VIII Contents
3.5.3 Demand Elasticities ................................................... 56
3.5.4 Energy Intensities ..................................................... 57
3.6 Decomposition Analysis .............................................. 61
3.6.1 Analysis of Changes in Total Energy Demand ........................... 62
3.6.2 Analysis of Changes in Energy Intensity ................................ 65
3.6.3 Analysis Using Physical Indicators ...................................... 69
3.7 Energy Demand Analysis Using the Econometric Approach ............ 70
3.7.1 Single Equation Regression Models .................................... 70
3.7.2 Other Econometric Approaches ........................................ 73
3.8 Big Data and Energy Demand Analysis ................................ 77
3.9 Conclusion ........................................................... 78
Annex 3.1: Consumer Demand for Energy—The Constrained
Optimization Problem ................................................ 79
Annex 3.2: Cost Minimization Problem of Producers ................... 80
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80
4 Sectoral Energy Demand Analysis. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
4.1 Introduction ......................................................... 84
4.2 Energy Demand at the Sector Level ................................... 84
4.3 Sectoral Energy Accounting .......................................... 87
4.4 Analysis at the Sectoral Level ......................................... 88
4.4.1 Industrial Energy Demand Analysis ..................................... 89
4.4.2 Energy Demand Analysis in the Transport Sector ........................ 102
4.4.3 Energy of Energy Demand in the Residential and Commercial Sectors .... 108
4.5 Conclusion ........................................................... 113
Annex 4.1: Hierarchical Decomposition ................................ 113
Annex 4.2: Translog Cost Function ..................................... 115
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118
5 Energy Demand Forecasting ...................................... 121
5.1 Introduction ......................................................... 122
5.1.1 Simple Approaches ................................................... 122
5.1.2 Advanced or Sophisticated Techniques ................................ 127
5.2 Review of Some Common Energy Demand Analysis Models ........... 137
5.2.1 MAED Model .......................................................... 138
5.2.2 LEAP Model ........................................................... 138
5.3 Conclusion ........................................................... 140
Annex 5.1: Mathematical Representation of Demand Forecasting
Using the Input–Output Model ........................................ 142
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144
6 Economic Analysis of Energy Investments ...................... 147
6.1 Introduction ......................................................... 148
6.1.1 Main Characteristics of Energy Projects ................................. 148
6.2 Essentials of the Economic Analysis of Projects ........................ 150
6.2.1 Identification of Costs ................................................. 151
IX
Contents
6.2.2 Identification of Benefits .............................................. 152
6.2.3 Valuation of Costs and Benefits ........................................ 153
6.3 Economic Versus Financial Investment Analysis ....................... 159
6.4 Indicators of Cost-Benefit Comparison ................................ 160
6.4.1 Methods Without Time Value .......................................... 160
6.4.2 Methods Employing Time Value ....................................... 161
6.5 Uncertainty and Risk in Projects ...................................... 165
6.6 Conclusion ........................................................... 167
Annex 6.1: Example of a Project Evaluation Exercise ................... 168
Annex 6.2: Some Commonly Used Interest Formulae ................... 171
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174
7 Economics of Non-renewable Energy Supply ................... 175
7.1 Introduction ......................................................... 177
7.1.1 Exploration ........................................................... 179
7.1.2 The Economics of Exploration Activities ................................ 181
7.1.3 Investment Decision .................................................. 182
7.1.4 Risks in Exploration Projects ........................................... 183
7.2 Field Development ................................................... 187
7.2.1 Investment Decision .................................................. 188
7.2.2 Resource Classification ................................................ 190
7.2.3 Classification of Crude Oil, Natural Gas and Coal ........................ 192
7.3 Production ........................................................... 192
7.3.1 Conventional Oil Production ........................................... 193
7.3.2 Production Decline and Initial Production Rate ......................... 195
7.3.3 Conventional Gas Production .......................................... 196
7.3.4 Coal Production ....................................................... 197
7.3.5 Unconventional Oil and Gas Production ................................ 197
7.4 Economics of Fossil Fuel Production .................................. 198
7.4.1 Field Level Economics ................................................. 198
7.4.2 Industry Level Economics .............................................. 199
7.5 Resource Rent ........................................................ 201
7.6 Depletion of Resources ............................................... 204
7.6.1 Depletion Dimension: Now or Later .................................... 205
7.7 Supply Forecasting ................................................... 206
7.7.1 Relation Between Discoveries and Production .......................... 206
7.7.2 Supply Forecasting Methods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 207
7.8 Conclusion ........................................................... 208
Annex 7.1: Mathematical Treatment of Depletion ...................... 209
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 214
8 The Economics of Renewable Energy Supply .................... 217
8.1 Introduction: Renewable and Alternative Energy Background ......... 218
8.1.1 Status of Renewable Energies at Present ............................... 218
8.2 Renewable Electricity Generation ..................................... 222
8.3 Bio-Fuels ............................................................. 223
X Contents
8.4 Renewable Energy for Heating and Cooling ........................... 227
8.5 Drivers of Renewable Energy ......................................... 229
8.6 The Economics of Renewable Energy Supply .......................... 231
8.6.1 The Economics of Renewable Electricity Supply ......................... 231
8.7 The Economics of Bio-Fuels ........................................... 242
8.7.1 Bio-Ethanol Cost Features ............................................. 242
8.7.2 Bio-Diesel Costs ....................................................... 243
8.7.3 Support Mechanisms for Biofuels ...................................... 244
8.8 Conclusion ........................................................... 246
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 246
9 Energy Pricing and Taxation ...................................... 249
9.1 Perfectly Competitive Market Model .................................. 251
9.2 Extension of the Basic Model ......................................... 254
9.2.1 Indivisibility of Capital ................................................. 254
9.2.2 Depletion of Exhaustible Resources .................................... 257
9.2.3 Asset Specificity and Capital Intensiveness ............................. 257
9.3 Market Failures ....................................................... 259
9.3.1 Monopoly Problems ................................................... 259
9.3.2 Natural Monopoly ..................................................... 261
9.3.3 Existence of Rent ...................................................... 267
9.3.4 Externality and Public Goods .......................................... 267
9.4 Tradability of Energy Products and Opportunity Cost .................. 268
9.5 Peak and Off-peak Pricing ............................................ 271
9.6 Short-Run Versus Long-Run Debate ................................... 273
9.7 Government Intervention and Role of Government in the Sector ...... 274
9.8 Energy Taxes and Subsidies ........................................... 277
9.8.1 Principles of Optimal Indirect Taxation ................................. 280
9.8.2 Equity Considerations ................................................. 282
9.8.3 Issues Related to Numerical Determination of an Optimal Tax ........... 283
9.8.4 Who Bears the Tax Burden? ............................................ 284
9.8.5 Subsidies ............................................................. 284
9.8.6 Subsidy Dilemma in Developing Countries with High Dependence
on Traditional Energies and Informal Sectors ............................ 287
9.9 Conclusion ........................................................... 288
Annex 9.1: Peak Load Pricing Principle ................................ 289
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291
10 The Economics of Environment Protection ...................... 293
10.1 Introduction ......................................................... 295
10.2 Energy–Environment Interactions .................................... 295
10.2.1 Energy–Environment Interaction at the Household Level ................ 296
10.2.2 Community Level Impacts ............................................. 300
10.2.3 Impacts at the Regional Level .......................................... 301
10.2.4 Global Level Problems: Climate Change ................................ 302