1) Introduction energy
Left: oil continues to hold the largest share of the energy mix. Coal is the 2 nd largest fuel.
Renewable energy has surpassed nuclear power in the energy mix. Right: oil is mostly
consumed in Asia Pacific and North America (together they account for 60% of global
consumption).
Left: North America is the region with the highest consumption/capita, followed by CIS and
the Middle East. Africa remains the region with the lowest average consumption. Belgium is
at 189 mainly because of its energy intensive sectors and its high usage of cars. Right: energy
use/capita is now (green) more evenly distributed.
Key energy issues
Historically (adjusted for inflation), energy prices have not increased:
Effects on the planet: climate change, coal ash spills, oil spills, fracking, nuclear waste, hydro
dams etc.
1
,Economic Approach
Government regulation:
• Command-and-control (CAC) = policies that prescribe technology and performance
standards. CAC should be reserved for situations such as toxic wastes.
Incentive-(market-) based approach (IB, see p54)
• Differences:
o IB approaches make use of markets, whereas CAC replaces them.
o IB policies encourage a variety of approaches to achieve the goal, whereas CAC
mandates 1 approach with no assurance that it is the least-cost approach.
Market failure = the market fails to produce an efficient outcome
Government failure = the government fails to remedy market inefficiency.
E.g., the US only allows corn-based ethanol, and bans imports of sugar-based ethanol,
which is cheaper to produce. Plus, the subsidy for corn-based ethanol pushes up the
price of not only food where corn is a basic ingredient, but almost all foods given the
prevalence of corn syrup and corn oil in processed foods.)
Economics = the allocation of scarce resources
Economic efficiency = maximizing output (the size of the pie) from scarce resources
• Private efficiency: the best outcome for direct participants of the market exchange.
• Social efficiency: the best outcome for all affected parties of the market exchange.
Equity = income distribution (how the pie is sliced)
Social welfare = maximizing the societal well-being, including efficiency and equity.
Sustainable development = development that meets the needs of the present without
compromising the ability of future generations to meet their own needs.
(In)efficiency
Pareto improvement (it’s possible to make someone better off without making someone else
worse off) >< Pareto efficient point (it’s impossible to make someone better off without
making someone else worse off)
An outcome is Hicks–Kaldor efficient if the winners could compensate the losers for accepting
a change, even if compensation does not take place. If compensation does take place, it would
then be a Pareto improvement.
Market failure due to:
1. Monopoly
There is only 1 producer in the market, and that producer determines the industry price. The
objection to the Organization of Petroleum Exporting Countries (OPEC) is not that they earn
more profit than they did in the years before their formation, but rather that the world would
be better off if energy were produced competitively.
2
,When P = MC, there is an incentive to produce the efficient output. Monopolists charge a P >
MC (what OPEC does). While OPEC gains, there is a social welfare loss (DWL) to society.
Natural monopoly = a situation where monopoly is potentially more efficient than
competition. The lowest-cost method of production is to have a single firm in the industry.
2. Externalities/third-party effects/spillover effects
Externalities are usually negative. They occur when 2 parties make a decision that affects
others, and those 2 parties don’t internalize those externalities into their decision.
3. Public goods characteristics
= extreme case of positive externalities; the provision of a good has external benefits
Non-rival: my use of a good in no way diminishes the amount available to you
Non-excludable: no one can be prevented from using a good
E.g., clean air: the benefits of cleaner fuel go to everyone, and no one can be excluded
from them. Other example: less global warming, GHG reductions etc.
Markets will not provide non-rival goods efficiently, whether they are nonexcludable. Where
the good is also nonexcludable, markets will not only fail but fail miserably, as free riders will
recognize that they can obtain the benefits of the good without paying.
4. Imperfect information
Asymmetric information: consumers may be unaware of the connection between energy use
and climate change. One party has superior information.
E.g., you buy a compact fluorescent bulb that is predicted to last 20x longer. The seller knows
that it won’t last that long if you turn the lights on and off frequently. Also, you may not be
aware of mercury content or of the difficulty of disposing of burned-out bulbs.
5. Second-best considerations
In a second-best world, our starting point is that there is an existing market failure in one or
more other markets.
If the use of fossil fuels is contributing to global warming but carbon emissions go unpriced,
there may be a justification to subsidize cleaner alternative fuels. In the world of the 2nd best
where one market (fossil fuels) has a distortion, it may be more efficient to introduce a
distortion in a second market for renewable fuels rather than to price them at MC.
FITs and RPS are second-best policies to accelerate the use of renewables, if you rule out
carbon tax and cap-and-trade:
3
, • Feed-In-Tariffs (FIT) which is price based
It requires utilities to pay an above market price to their suppliers thus accelerates the
use of renewables (it can make electricity more expensive)
• Renewable Portfolio Standard (RPS) which is quantity based
It requires utilities to generate a given percentage of electricity using alternative fuels,
including renewables and in some cases energy efficiency.
6. Macroeconomic instability
Due to inflation or unemployment. These failures cause inefficiency insofar as the economy
performs below its potential GDP.
Sustainability
Triple bottom line/3 P’s: planet, people, and profit
Strong sustainability: leave the future as much of a specific resource as we have today. It
assumes that there are no substitutes for a particular resource.
Weak sustainability: leave the future as much production capacity as we have today.
Robert Solow: “We have an obligation to conduct ourselves so that we leave to the
future the option or the capacity to be as well off as we are.”
Examples:
• Norway: oil revenues go into a pension system for future citizens = WEAK
• Texas: oil revenues go towards a university system = WEAK
• Alaska: oil revenues pay dividends to current citizens = NOT sustainable
Future trends
There are 3 scenarios to explore the energy transition: rapid transition, net zero transition,
business-as-usual.
How might oil demand be affected by the mobility revolution?
4
Left: oil continues to hold the largest share of the energy mix. Coal is the 2 nd largest fuel.
Renewable energy has surpassed nuclear power in the energy mix. Right: oil is mostly
consumed in Asia Pacific and North America (together they account for 60% of global
consumption).
Left: North America is the region with the highest consumption/capita, followed by CIS and
the Middle East. Africa remains the region with the lowest average consumption. Belgium is
at 189 mainly because of its energy intensive sectors and its high usage of cars. Right: energy
use/capita is now (green) more evenly distributed.
Key energy issues
Historically (adjusted for inflation), energy prices have not increased:
Effects on the planet: climate change, coal ash spills, oil spills, fracking, nuclear waste, hydro
dams etc.
1
,Economic Approach
Government regulation:
• Command-and-control (CAC) = policies that prescribe technology and performance
standards. CAC should be reserved for situations such as toxic wastes.
Incentive-(market-) based approach (IB, see p54)
• Differences:
o IB approaches make use of markets, whereas CAC replaces them.
o IB policies encourage a variety of approaches to achieve the goal, whereas CAC
mandates 1 approach with no assurance that it is the least-cost approach.
Market failure = the market fails to produce an efficient outcome
Government failure = the government fails to remedy market inefficiency.
E.g., the US only allows corn-based ethanol, and bans imports of sugar-based ethanol,
which is cheaper to produce. Plus, the subsidy for corn-based ethanol pushes up the
price of not only food where corn is a basic ingredient, but almost all foods given the
prevalence of corn syrup and corn oil in processed foods.)
Economics = the allocation of scarce resources
Economic efficiency = maximizing output (the size of the pie) from scarce resources
• Private efficiency: the best outcome for direct participants of the market exchange.
• Social efficiency: the best outcome for all affected parties of the market exchange.
Equity = income distribution (how the pie is sliced)
Social welfare = maximizing the societal well-being, including efficiency and equity.
Sustainable development = development that meets the needs of the present without
compromising the ability of future generations to meet their own needs.
(In)efficiency
Pareto improvement (it’s possible to make someone better off without making someone else
worse off) >< Pareto efficient point (it’s impossible to make someone better off without
making someone else worse off)
An outcome is Hicks–Kaldor efficient if the winners could compensate the losers for accepting
a change, even if compensation does not take place. If compensation does take place, it would
then be a Pareto improvement.
Market failure due to:
1. Monopoly
There is only 1 producer in the market, and that producer determines the industry price. The
objection to the Organization of Petroleum Exporting Countries (OPEC) is not that they earn
more profit than they did in the years before their formation, but rather that the world would
be better off if energy were produced competitively.
2
,When P = MC, there is an incentive to produce the efficient output. Monopolists charge a P >
MC (what OPEC does). While OPEC gains, there is a social welfare loss (DWL) to society.
Natural monopoly = a situation where monopoly is potentially more efficient than
competition. The lowest-cost method of production is to have a single firm in the industry.
2. Externalities/third-party effects/spillover effects
Externalities are usually negative. They occur when 2 parties make a decision that affects
others, and those 2 parties don’t internalize those externalities into their decision.
3. Public goods characteristics
= extreme case of positive externalities; the provision of a good has external benefits
Non-rival: my use of a good in no way diminishes the amount available to you
Non-excludable: no one can be prevented from using a good
E.g., clean air: the benefits of cleaner fuel go to everyone, and no one can be excluded
from them. Other example: less global warming, GHG reductions etc.
Markets will not provide non-rival goods efficiently, whether they are nonexcludable. Where
the good is also nonexcludable, markets will not only fail but fail miserably, as free riders will
recognize that they can obtain the benefits of the good without paying.
4. Imperfect information
Asymmetric information: consumers may be unaware of the connection between energy use
and climate change. One party has superior information.
E.g., you buy a compact fluorescent bulb that is predicted to last 20x longer. The seller knows
that it won’t last that long if you turn the lights on and off frequently. Also, you may not be
aware of mercury content or of the difficulty of disposing of burned-out bulbs.
5. Second-best considerations
In a second-best world, our starting point is that there is an existing market failure in one or
more other markets.
If the use of fossil fuels is contributing to global warming but carbon emissions go unpriced,
there may be a justification to subsidize cleaner alternative fuels. In the world of the 2nd best
where one market (fossil fuels) has a distortion, it may be more efficient to introduce a
distortion in a second market for renewable fuels rather than to price them at MC.
FITs and RPS are second-best policies to accelerate the use of renewables, if you rule out
carbon tax and cap-and-trade:
3
, • Feed-In-Tariffs (FIT) which is price based
It requires utilities to pay an above market price to their suppliers thus accelerates the
use of renewables (it can make electricity more expensive)
• Renewable Portfolio Standard (RPS) which is quantity based
It requires utilities to generate a given percentage of electricity using alternative fuels,
including renewables and in some cases energy efficiency.
6. Macroeconomic instability
Due to inflation or unemployment. These failures cause inefficiency insofar as the economy
performs below its potential GDP.
Sustainability
Triple bottom line/3 P’s: planet, people, and profit
Strong sustainability: leave the future as much of a specific resource as we have today. It
assumes that there are no substitutes for a particular resource.
Weak sustainability: leave the future as much production capacity as we have today.
Robert Solow: “We have an obligation to conduct ourselves so that we leave to the
future the option or the capacity to be as well off as we are.”
Examples:
• Norway: oil revenues go into a pension system for future citizens = WEAK
• Texas: oil revenues go towards a university system = WEAK
• Alaska: oil revenues pay dividends to current citizens = NOT sustainable
Future trends
There are 3 scenarios to explore the energy transition: rapid transition, net zero transition,
business-as-usual.
How might oil demand be affected by the mobility revolution?
4
