1. A Comprehensive Energy Policy
Chapter 17
A Comprehensive Energy Policy
The Big Picture
Peter Schwarz
Professor of Economics, Belk College of Business and
Associate, Energy Production and Infrastructure Center (EPIC)
UNC Charlotte

2. Introduction Piecemeal energy policy Holistic energy policy
Considers each energy source in isolation
Different policies for each energy source (or sometimes multiple policies for one energy source)
Unlikely to be socially efficient
Holistic energy policy
Recognizes inter-relationships among energy sources
More likely to minimize the social costs of meeting energy needs
How do these approaches differ?
Coal industry advocates may point to the decline in coal demand as evidence that environmental regulations are hurting the industry
However, the true reason for much of the declining demand for coal is the declining cost of natural gas, a close substitute for electricity generation
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3. Introduction: Cont.
Amory Lovins (1976) presented energy policy as the soft path vs. the hard path
The soft path is the one that focuses on energy efficiency and a switch to renewable fuels
The hard path continues to rely on oil, natural gas, and coal
A comprehensive energy policy will need to encompass both paths
Goal is to satisfy global energy requirements at the lowest social cost
Includes private costs of production and external costs to society due to negative by-products
Uses a holistic approach that considers inter-relationships across industries
Is an oil price of $26/bbl “too low?”
Is $200/bbl too high?
What is the “correct” price for a barrel of oil?
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4. First and Second-Best Policies
A first-best policy is one that gets prices right
Maximizes social welfare by equating price with the marginal social cost (MSC)
MSC = Marginal Private Cost + Marginal Damages
“Equimarginal Rule”
Use energy sources in way that equates their MSCs
Appropriate measurements need to be taken to determine accurate estimates for marginal damages
When first-best policies are not in place, a second-best policy is necessary to correct the market failure
Firms that produce unpriced externalities are implicitly subsidized
Coal generating power plants do not pay for their CO2 emissions
Subsidies for “carbon free” generation and energy efficiency programs are necessary to reach the efficient generation mix
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5. Arthur Cecil Pigou (1877-1959) Economics of Welfare, 1920
Made the case for corrective taxes to internalize externalities
Firms will reduce output of the offending externality so long as it is cheaper to do so than paying the tax
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6. Ronald Coase ( )
Identified the fundamental problem as transactions costs
Figured that involved parties have better knowledge of their costs
Parties would choose from a variety of solutions that would minimize costs
The efficient solution would come about regardless of initial assignment of property rights
Inspired Cap-and-Trade systems
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7. Equimarginal Principle
Both Pigou taxes and Coasian style trading rely on the equimarginal principle to achieve efficiency
Firms facing a Pigou tax will abate until the marginal cost of doing so equals the amount of the tax
Firms that operate in a trade based market will either purchase or sell permits until the market price of permits is equal to the firms’ marginal price of abatement
While theoretically equivalent, the two practices may create different incentives over time
Pigouvian tax may create more incentives for innovation
Approaches differ under uncertainty
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8. Transportation
Now the largest source of carbon emissions in the U.S.
Exceeding electricity generation for the first time since 1979
First-best option:
Put a price on CO2 emissions
Decrease in “gas-guzzling” vehicles
Incentivizes manufacturers to improve gas mileage or invest in hybrid technology
Internalizing the cost of CO2 emissions in transportation will increase price, but decrease quantity demanded
Reduced demand will have energy security benefits in addition to eliminating the DWL from the externality
What would you do to lower emissions from the transportation sector?
What kind of programs have been implemented already?
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9. Electric Utilities
SO2 had a successful permit trading program in the U.S.
Has dissolved since legislation required “scrubbers”
No federal program to limit CO2 emissions from power plants
Regional efforts have formed in the west and northeast
Efficiency gains are limited
Trading programs increase in effectiveness as cost heterogeneity increases between firms
Costs often vary more across regions than they do within a region
EU carbon cap-and-trade program
Greater than efficient number of permits issued
Necessary to garner industry support for the program
Permits trade for approximately €5, slightly above $5 as of 2017.
Social cost of carbon (SCC) estimated to be around $40
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10. Killing Two Stones with One Bird
Piecemeal approaches come in many shapes and sizes
Multiple programs aimed at the same objective are likely to reduce effectiveness
SO2 program largely hailed as a great success
Fell apart with the addition of CaC legislation
29 U.S. states have adopted renewable portfolio standards (RPSs)
Reduces the value of adding a cap-and-trade system
Second-best policies will result in a deadweight loss if there is a first- best approach already in place
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11. Industry Energy intensity has been decreasing since the 1980s
Less energy intensive manufacturing
Shift towards a service oriented economy
Not a response to government regulation
Profit-maximizing firms attempt to reduce reliance on energy as they face higher energy costs
Green Marketing
Advertising sustainable practices to attract more customers
“Warm Glow”
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12. Buildings and Commercial Users
Buildings account for 40% of primary energy consumption
About 60% goes towards heating, cooling, and lighting
Buildings are long-lived
Improvements to overall efficiency levels would require retrofitting existing structures as well as new construction standards
Voluntary government Programs:
LEED and ENERGY STAR
If energy efficiency saves money, why wouldn’t it be accomplished by the market?
McKinsey study showed that it is a case of imperfect information
Some question whether the study took opportunity costs into account
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13. Markets and Government
Comprehensive energy policy must be market oriented
Government has the potential to improve outcomes when markets over or under produce goods
Overproduction of electricity without a carbon price
Coasian trading or Pigou tax
Underproduction of research and development
Sponsor research to develop energy efficient technology
Private research resulting in a patent will result in a monopoly
Recall, monopolies underproduce when compared with the socially efficient output
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14. Takeaway Point
A comprehensive energy policy would be much easier if we had a carbon price
As long as we do not, we will have to evaluate second-best policies
Compare their cost per ton of carbon emissions reduced.
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