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Energy Journal Issue

The Energy Journal
Volume15, Number 3

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The Hotelling Principle and In-Ground Values of Oil Reserves: Why the Principle Over-Predicts Actual Values

Stephen L. McDonald

DOI: 10.5547/ISSN0195-6574-EJ-Vol15-No3-1
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Two articles previously published in this Journal (Watkins 1992 and Adelman 1993) reported that the valuation version of the Hotelling Principle over-predicts in-ground values of oil and gas reserves by a factor of approximately two. This paper shows these results are to be expected once it is understood that: (1) the Principle assumes individual operators have the effective freedom to schedule extraction rates so as to make net prices rise at the rate of discount, regardless of the course of gross (wellhead) prices; and (2) the long-prevailing system of regulating oil well spacing and extraction rates in the United States and Canada, designed to deal with the common pool problem, effectively denies operators that freedom. The discrepancy between actual in-ground values and those predicted by the Hotelling Principle suggests the benefits to be had by substituting compulsory reservoir unitization cum manager freedom for the current system of regulation.

The Impact of Sulfur Limits on Fuel Demand and Electricity Prices in Britain

David M. Newbery

DOI: 10.5547/ISSN0195-6574-EJ-Vol15-No3-2
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By the year 1996, about one-quarter of Britain's electricity will be generated from gas, compared to zero in 1992, displacing coal. This switch is required by 2000 to meet the EC and UN mandated sulfur emissions limits, but was advanced by the imperfect market created by privatisation. This paper examines the economics of Flue Gas Desulfurisation, and argues that without the right to trade emissions permits, FGD may run at only 17% load because of premature investment in gas generation. Tradable permits have a large impact on profits for the generators and British Coal. At present the pool fails to schedule plant on avoidable cost, and electricity prices are likely to be set by the price of gas, not the emissions limits, though gas prices may rise with tighter future limits.

Emission Costs, Consumer Bypass and Efficient Pricing of Electricity

Chi-Keung Woo, Benjamin Hobbs, Ren Orans, Roger Pupp and Brian Horii

DOI: 10.5547/ISSN0195-6574-EJ-Vol15-No3-3
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Electricity generation causes external costs because of the emission of air pollutants. Pricing an electric utility's service at the sum of the utility's marginal generation cost and marginal emission cost, however, is inefficient due to "bypass" by large industrial customers and the need to maintain the utility's financial viability. This paper derives the optimal tax on emission and efficient prices for retail service to two customer classes, one of which has the option to self-generate. These rules are used to evaluate the pricing proposals made in a recent rate case in California. These proposals are shown to be inefficient, in that they encourage over-consumption by residential customers who do not have access to alternative sources of electricity supply.

Incentive Effects of Environmental Adders in Electric Power Auctions

James B. Bushnell and Shmuel S. Oren

DOI: 10.5547/ISSN0195-6574-EJ-Vol15-No3-4
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We make a systematic examination of the options for incorporating environmental adders into auctions for non-utility generation. To date, adders have been a popular tool of some regulators for the planning process, but have not been embraced as a tool for operations. We argue that any rational implementation of adders into a competitive acquisition process will have at least an indirect effect on the operations of the resulting electric system. If adders are to be employed, regulators must therefore be comfortable enough with them to use them explicitly in both the operation and selection of generation resources.

Emerging Environmental Markets: Improving the Competitiveness of Natural Gas

Janie M. Chermak

DOI: 10.5547/ISSN0195-6574-EJ-Vol15-No3-5
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Current U.S. regulations focus on market approaches to reduce SO2, NOx, and CO2 pollution, allowing affected firms to choose the least-cost compliance alternative. Natural gas, a relatively benign fuel from an environmental perspective, could realize a substantial increase in demand if it is competitive. The viability of gas as an alternative has been questioned due to high forecast price and unstable supply. This paper assesses potential efficiency gains in the completion and production of natural gas wells which may lower production costs and increase recoverable reserves. Coupled with the premium that can be paid for its environmentally desirable qualities, gas can potentially be a feasible alternative. However, the window of opportunity is limited, because many industries, such as electric power generation, require decisions involving up-front capital expenditures that lock the firm into a specific compliance mechanism and fuel.

Integrated Resource Planning with Environmental Costs in Developing Countries

Chitru S. Fernando, Paul R. Kleindorfer and Mohan Munasinghe

DOI: 10.5547/ISSN0195-6574-EJ-Vol15-No3-6
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This paper presents an integrated approach to dealing with the twin problems of environmental degradation and capital costs associated with the rapid expansion of electric power in developing countries. The integrated resource planning framework developed here calls for a careful balancing of supply and demand side options. Interruptible technologies are an important option in those developing countries where capital is scarcer and shortage costs are higher. When environmental costs of conventional generating technologies are included, the balance shifts even further in favor of demand side measures. This integrated perspective at the planning phase must be complemented by pricing policies that accurately reflect the cost of providing electric power, and organization structures that provide strong incentives for efficient operation.

Import Policy Effects on the Optimal Oil Price

Steven M. Suranovic

DOI: 10.5547/ISSN0195-6574-EJ-Vol15-No3-7
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A steady increase in oil imports leaves oil importing countries increasingly vulnerable to future oil price shocks. Using a variation of the U.S. EIA's oil market simulation model, equilibria displaying multiple price shocks is derived endogenously as a result of optimizing behavior on the part of OPEC Here we investigate the effects that an oil import tariff and a petroleum stock release policy may have on an OPEC optimal price path. It is shown that while both policies can reduce the magnitude of future price shocks neither may be politically or technically feasible.

Who Pays Broad-Based Energy Taxes? Computing Lifetime and Regional Incidence

Nicholas Bull, Kevin A. Hassett, and Gilbert E. Metcalf

DOI: 10.5547/ISSN0195-6574-EJ-Vol15-No3-8
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This paper measures the incidence of energy taxes using a lifetime framework to study both a Btu tax and a carbon tax. It takes into account two key facts. First, because energy taxes have different incidence effects across the life cycle, it is important to measure the burden of taxes in terms of lifetime incidence, not just their burden in a given year. To take account of lifetime incidence, we introduce an estimation methodology for lifetime-correction as well as showing current consumption measures. Second, energy taxes have a total effect that combines both direct and indirect effects: in addition to directly increasing the price of energy goods, energy taxes also indirectly increase the price of all other goods in proportion to the energy used to produce them. We provide incidence estimates by income group and by geographical region.

Structural Changes and Energy Consumption in the Japanese Economy 1975-95: An Input-Output Analysis

Xiaoli Han and TK. Lakshmanan

DOI: 10.5547/ISSN0195-6574-EJ-Vol15-No3-9
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This paper analyzes the effects of the pervasive structural changes in the Japanese economy on its energy intensity in the decade 1975-85. It advances the energy input-output (I-O) structural decomposition analysis (SDA) in two ways. First, it introduces a double denominator method to relax the assumption that all electricity is derived from fossil fuels in energy I-O analysis. Second, it develops a model which identifies explicitly the effect of energy imports. The application of our model to the Japanese experience suggested that changes in final demand structure contributed more to reducing the energy intensity of the economy than the much discussed effects of changes in technology. The overall decline in the energy intensity of the economy was accompanied by drastic shifts in the fuel mix of its energy supply, in particular, a substitution of oil by natural gas.