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Capital Adjustment and the Optimal Fuel Choice

Abstract:
We propose a novel approach to analyze interfuel substitution that explicitly incorporates heterogenous fuel-using capital stocks in the estimation of the optimal fuel choice. Our econometric framework structurally estimates the frictionless level of fuel-using capital stocks and employs non-parametric analysis to reveal information on the form of adjustment costs facing firms. To illustrate this approach we use a large panel of Irish manufacturing firms over the period 2004-2009. The econometric estimates show a large variation in the optimal response of capital to changing fuel prices across different fuel-using technologies and imply substantial costs to capital adjustment. These results underscore the significance of the frequently ignored link between capital adjustment and the choice of fuels used by manufacturing firms.

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Keywords: Capital adjustment, Fuel choice

DOI: 10.5547/01956574.40.5.mhyl

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Published in Volume 40, Number 5 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.