energy

oil and natural gas supply 62% all energy consumed worldwide

how to transition to new sources?

use until mc of further use exceeds mc of substitute resources More abundant coal Or renewable solar

transition should be smooth

have allocations been efficient?

natural gas huge shortages on 1974-75. why?

rise of automobile rise of demand for gasoline search for new sources of crude oil uncovered large quantities of natural gas

in the 50’s gov’t put price ceilings

the effect of price controls

the effect of price controls price ceiling reduces MUC (higher future prices no

longer possible), decreasing total mc curve (supply)

consumers better off today (gained BC)

producers not better off: Overproducing giving up scarcity rent could have gotten without price

controls (area D only measures current profit)

the effect of price controls

consumers also lose in the future as resource depleted, supply curve shifts up (reflecting

higher extraction costs)

when mc reaches price ceiling, QS=0

but demand is not zero at that price: shortages

suppliers willing, demanders willing, but price control will not allow

overallocation to current consumers, underallocation to future consumers

losses to future consumers/producers are greater than gains to current consumers

oil similar price control problems

second source of misallocation: OPEC

restrict supply, raise prices

why OPEC so effective?1. price elasticity of demand for oil

• inelastic, substitutes exist but are expensive2. income elasticity of demand for oil

• income grows, demand grows3. supply responsiveness of non-OPEC members

• OPEC produces 2/3; only Mexico may have influence

oil: national security problem excessive dependence on imports

national security issue dependent on countries with unstable political

history actual price we pay is higher than world price

when national security is an issue market consumes too much oil domestic production is too small

the national security problem

vulnerability premium

market vs. efficient allocations vulnerability premium reflects additional national security

costs caused by imports

horizontal because each individual supplier has no effect on world price

market allocation demand Q5 Q1 domestically produced Q5-Q1 imported

efficient allocation demand Q4 Q2 domestically produced Q4-Q2 imported

the national security problem

vulnerability premium

what would happen during an embargo? consume Q1 at price of P2

supply curve assumes enough time to develop the resources

if embargo hits, not enough time – in short run supply curve becomes perfectly inelastic at Q1

price rises to P2 to equate supply & demand

huge loss in CS

the national security problem

vulnerability premium

self sufficiency? domestic supply = domestic demand

net benefits from Q3 < net benefits from Q4 (efficient allocation

w/imports)

Efficiency loss (shaded triangle): because foreign mc is lower than domestic mc (supply) loss between Q2 and Q4 (where domestic mc > foreign mc)

still better to import vulnerability premium lower than cost of

self sufficiency embargos not certain events possible to reduce vulnerability (strategic

reserves) using more domestically incurs user costs by

lowering amounts available for future

paying vulnerability premium creates more efficient balance btw present/future

the national security problem

vulnerability premium

how to achieve efficient consumption (Q4 instead of Q5)? energy conservation, e.g. gas tax

reduces consumption, but no affect on share of imports

subsidize domestic supply reduce imports, but not consumption

tariff on imports (P1-P0) or quota on imports (Q4-Q2) price rises to P1, consumption falls to Q4,

imports Q4-Q2

transition fuels how to transition to renewables?

fuels receiving most attention: coal, uranium coal: abundant uranium: not abundant with current reactors

technology is changing this

biggest issue btw these: environmental impact

transition fuels: environmental problems

coal: air pollution (sulfur, particulates, CO2)

uranium: nuclear accidents storage of radioactive waste

energy conservation significant role: defer capacity expansion

cost increases are substantial

by reducing demand for electricity, delay new plants, delay rate increases

current pricing systems rely on AC pricing, lower than true MC of new units

utilities invest in conservation when cheaper rebates for conservation measures in

homes

incentives for solar water heaters

energy audits

load management peak period imposes 2 costs on utilities

requires firing up special generators during those periods (higher MC)

growth in peak period demand => capacity expansion

peak load pricing

the long run: renewables hydro: flowing water

biomass: burning

solar energy: heat to drive turbines

solar into electricity: photovoltaics

wind energy: drive turbines

hydrogen: fuel cars / furnaces

geothermal: from deep in the earth