Supply constraints on rebound effects from increases in energy efficiency: the disinvestment effect

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1 Supply constraints on rebound effects from increases in energy efficiency: the disinvestment effect European Conference of the International Association of Energy Economists 7 10 September 2009, Vienna, Austria Karen Turner ESRC Climate Change Leadership Fellow Department of Economics, University of Strathclyde Co-authored with Kim Swales and Janine De Fence, Department of Economics, University of Strathclyde ESRC First Grants Programme, Ref: RES

2 The rebound effect Jevons (1865) confusion of ideas regarding productive use of fuel and diminished consumption increase utility, impact on implicit prices Increase (non-price induced) efficiency in use of energy, lower implicit energy price (reduced energy requirement per unit of consumption/production) If have local supply of energy, decreased energy requirement per unit of consumption/production puts downward pressure on actual energy prices also Rebound and backfire effects Khazzoom-Brookes Postulate Previous rebound analysis focus on demand response to falling effective and/or actual energy prices

3 General equilibrium analysis E.g. Semboja, 1994,; Dufournaud et al, 1994; Grepperud and Rasmussen, 2004; Glomsrød and Wei, 2005; Hanley et al, 2006, 2009; Allan et al, 2007 Rebound equates directly to general equilibrium price elasticity of demand for energy ESRC funded project: An empirical general equilibrium analysis of the factors that govern the extent of energy rebound effects in the UK economy, Oct 2008-Sept 2010 Main finding so far importance of supply-side response to changes in energy prices

4 A contradiction Allan et al (2007) initial analysis of increased energy efficiency in UK production rebound effects that are bigger in short-run that long-run Contrary to theoretical prediction of Wei (2007) and Saunders (2008) that rebound effects will be bigger in long-run due to increased productive capacity investment Key distinction Wei s model assumes return on capital exogenous Allan et al endogenous and impacted by any reduction in revenue as prices fall

5 The disinvestment effect Where actual energy prices affected (e.g. local energy supply, but may also affect imported energy) Price falls if quantity demanded does not rise sufficiently to offset decline in revenue, profitability falls (more inelastic demand larger drop in price) Return on capital decreases in energy supply Shedding of capital stock disinvestment Energy supply becomes more inelastic, energy prices rise Constrains size of rebound effect over time While not present in initial results for Scotland (Hanley et al, 2006, 2009), Turner (2008, 2009) shows may occur if reduce key parameters governing general equilibrium price elasticity of demand for energy

6 UKENVI and SCOTENVI 3 internal transactor groups (households, firms, government), plus Rest of World (and Rest of UK in Scotland) 25 commodities/sectors, including 5 energy sectors (coal, refined oil, gas, two electricity) Capital labour energy materials (KLEM) production structure using multi-level CES production functions. Assumes cost minimisation. Calibrated to 2000 UK SAM, 1999 Scottish SAM Recursive dynamic investment = depreciation plus proportion of difference actual and desired capital stock, where desired capital stock determined on cost minimisation criteria and reflects changing profitability at sectoral level (if return on capital rises above user cost, investment, and vice versa) Labour market wage bargaining (Scotland: migration in response to changes in relative wage and unemployment rates)

7 Energy efficiency shock Permanent, exogenous (and costless) 5% increase in energy augmenting technological progress Initially targeted at all 25 production sectors Rebound calculated as # E& R 1 T $ = & + ' % 100 (!" ) Starting point to work through basic drivers of and constraints on rebound introduce additional layers of complexity in stages

8 Figure 1. Impact on capital rental rates in the UK energy supply sectors of a 5% increase in energy efficiency in all production sectors (% change from base) - extracted from Turner (2009), Figure Coal (Extraction) Oil processing and nuclear refining Gas Electricity - Renewable (hydro and wind) Electricity - Non-renewable (coal, nuke and gas) Period/year

9 Figure 2. Impact on UK energy supply sector capital stocks of a 5% increase in energy efficiency in all production sectors (% change from base) - extracted from Turner (2009), Figure Coal (Extraction) Oil processing and nuclear refining Gas Electricity - Renewable (hydro and wind) Electricity - Non-renewable (coal, nuke and gas) Period/year

10 Figure 3 Percentage change in UK local energy supply prices in response to a 5% improvement in energy efficiency in all production sectors (applied to locally supplied energy) - (% change from base) - extracted from Turner (2009), Figure COA L (EXTRA CTION) OIL (REFINING & DISTR OIL A ND NUCLEA R) GA S Electricity - Renew able (hydro and w ind) Electricity - Non-renew able (coal, nuke and gas) Period/year

11 Disinvestment effects Wei (2007) and Saunders (2008) rebound bigger in long run than in short run because positive supply shock leads to expansion in set of production possibilities Here, true for non-energy supply sectors However, if profitability falls as actual energy prices fall, return on capital in energy supply falls, leading to contraction in capacity in these sectors (possibly also in external energy supply sectors where local energy demand impacts on external prices) However, if demand is sufficiently elastic, prices can fall without reducing profitability Use of UKENVI for analytical work to understand basic drivers of rebound vary key assumptions one at a time; here focus on elasticities of substitution in production and trade elasticities (imports and exports)

12 Figure 4. Qualitative non-electricity energy rebound and disinvestment results for Scotland Trade Production 0 (0.064) CD (0.064) CD ( ) A B C A. LR R > SR R Short run rebound dampened by weak competitiveness effects; long run rebound dampened by disinvestment B. SR R > LR R Long run rebound dampened by disinvestment C. LR R > SR R Long run rebound not constrained by disinvestment effects Extracted from Turner (2009), Figure 7

13 Conclusions and ongoing research Sector specific simulations reflect key questions: Will actual energy prices change? (Scottish commercial transport and refined oil) Will disinvestment adjustment process be smooth or lumpy? (Non-renewable electricity supply and coal) More generally, disinvestment results reflect importance of focussing on supply-side issues Wei (2009) Importance of determining key parameters governing general equilibrium price elasticity of demand for energy Current research - econometric estimations of KLEM production function (e.g. Kemfert 1998, Van der Werf 2008) Also different production structures energy as an intermediate or primary input? Other issues to focus on in CGE analysis: increased efficiency (total factor productivity) in energy production; increased efficiency in other factors of production (e.g. Turner et al, 2009); interregional analysis (e.g. Turner and Hanley, 2009); increases in energy efficiency in consumption

14 Thank you for your attention Questions?