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International Evidence on Sectoral Interfuel Substitution

Abstract:
This paper estimates interfuel substitution elasticities in selected devel�oping and industrialized economies at the sector level. In doing so, it employs state-of-the-art techniques in microeconometrics, particularly the locally .exible normalized quadratic functional form, and provides evidence consistent with neo�classical microeconomic theory. The results indicate that the interfuel substitution elasticities are consistently below unity, revealing the limited ability to substitute between major energy commodities (i.e., coal, oil, gas, and electricity). We .nd that on average, industrial and residential sectors tend to exhibit higher potential for substitution between energy inputs as compared to the electricity generation and transportation sectors in all countries, with the United States being the only exception. In addition, we .nd that developed countries demonstrate higher po�tential for interfuel substitution in their industrial and transportation sectors as compared to the developing economies. The implication is that interfuel substi�tution depends on the structure of the economy, not the level of economic devel�opment. Moreover, higher changes in relative prices are needed than what we have already experienced to induce switching toward a lower carbon economy.

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Energy Specializations: Petroleum – Markets and Prices for Crude Oil and Products; Energy Modeling – Energy Data, Modeling, and Policy Analysis; Natural Gas – Markets and Prices; Electricity – Markets and Prices

JEL Codes:
L13 - Oligopoly and Other Imperfect Markets
E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination
D42 - Market Structure, Pricing, and Design: Monopoly

Keywords: Interfuel substitution, Flexible functional forms, Normalized quadratic (NQ) cost function, Theoretical regularity

DOI: 10.5547/ISSN0195-6574-EJ-Vol31-No4-1


Published in Volume 31, Number 4 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.