International Handbook on the Economics of Energy

INTERNATIONAL HANDBOOK ON THE ECONOMICS OF ENERGY

International Handbook on the Economics of Energy

Edited by

Joanne EvansLecturer in Economics, Surrey Energy Economics Centre (SEEC), Department of Economics, University of Surrey, UK and

Lester C. HuntProfessor of Energy Economics, Surrey Energy Economics Centre (SEEC), Department of Economics, University of Surrey, UK

Edward ElgarCheltenham, UK Northampton, MA, USA

ContentsList of contributors Introduction Joanne Evans and Lester C. Hunt 1 A brief history of energy Roger Fouquet 2 The theory of energy economics: an overview Thomas Weyman-Jones 3 The economics of energy supply Kenneth B. Medlock III 4 The theory and practice of energy policy Richard L. Gordon 5 Energy demand theory Kenneth B. Medlock III 6 Empirical modelling of energy demand David L. Ryan and Andr Plourde 7 Economics of energy efficiency Grant Allan, Michelle Gilmartin, Peter McGregor, J. Kim Swales and Karen Turner 8 Theoretical foundations of the rebound effect Harry Saunders 9 The rebound effect: definition and estimation Steve Sorrell 10 Modelling energy savings and environmental benefits from energy policies and new technologies David L. Ryan and Denise Young 11 Bottom-up models of energy: across the spectrum Lorna A. Greening and Chris Bataille 12 The structure and use of the UK MARKAL model Ramachandran Kannan, Paul Ekins and Neil Strachan 13 Combining top down and bottom up in energy economy models Mark Jaccard 14 Computable general equilibrium models for the analysis of energy and climate policies Ian Sue Wing 15 Energyeconomyenvironment modelling: a survey Claudia Kemfert and Truong Truong 16 The oil security problem Hillard G. Huntington 17 Petroleum taxation Carole Nakhle v vii x

1 20 51 73 89 112 144

164 199

234 257 285 311

332 367 383 401

vi

International handbook on the economics of energy

18 The behavior of petroleum markets: fundamentals and psychologicals in price discovery and formation Dalton Garis 19 The prospects for coal in the twenty-first century Richard L. Gordon 20 Natural gas and electricity markets W.D. Walls 21 Incentive regulation of energy networks Thomas Weyman-Jones 22 The economics and regulation of power transmission and distribution: the developed world case Lullit Getachew and Mark N. Lowry 23 The market structure of the power transmission and distribution industry in the developed world Lullit Getachew 24 Mechanisms for the optimal expansion of electricity transmission networks Juan Roselln 25 Efficiency measurement in the electricity and gas distribution sectors Mehdi Farsi and Massimo Filippini 26 Wholesale electricity markets and generators incentives: an international review Dmitri Perekhodtsev and Seth Blumsack 27 Security of supply in large hydropower systems: the Brazilian case Luciano Losekann, Adilson de Oliveira and Getlio Borges da Silveira 28 Electricity retail competition and pricing: an international review Seth Blumsack and Dmitri Perekhodtsev 29 Emissions trading and the convergence of electricity and transport markets in Australia Luke J. Reedman and Paul W. Graham 30 International energy derivatives markets Ronald D. Ripple 31 The economics of energy in developing countries Reinhard Madlener 32 Energy visions to address energy security and climate change Christoph W. Frei 33 Current issues in the design of energy policy Thomas Weyman-Jones Index

420 441 456 471

499

541

582 598

624 650 663

685 705 740 759 770

791

List of contributorsGrant Allan is Research Fellow, funded through the EPSRC SuperGen Marine Energy Research Consortium, Fraser of Allander Institute and Department of Economics, University of Strathclyde, Glasgow, Scotland. Chris Bataille is Adjunct Professor, School of Resource and Environmental Management, Simon Fraser University and Director, MKJA Inc., Vancouver, Canada. Seth Blumsack is Assistant Professor of Energy Policy and Economics, Department of Energy and Mineral Engineering, Pennsylvania State University, University Park, PA, USA. Getlio Borges da Silveira is Associate Professor, Instituto de Economia Universidade Federal do Rio de Janeiro, Brazil. Adilson de Oliveira is Professor, Instituto de Economia Universidade Federal do Rio de Janeiro and Director of the High Studies Brazilian College, Universidade Federal do Rio de Janeiro, Brazil. Paul Ekins is Professor of Energy and Environment Policy, UCL Energy Institute, University College London, UK. Joanne Evans is Lecturer in Economics, Surrey Energy Economics Centre (SEEC), Department of Economics, University of Surrey, Guildford, UK. Mehdi Farsi is Senior Scientist and Lecturer, Centre for Energy Policy and Economics (CEPE), Department of Management, Technology and Economics, ETH Zurich, Switzerland and Lecturer at the Department of Economics, University of Lugano, Switzerland. Massimo Filippini is Professor of Economics/Energy Economics, Department of Management, Technology and Economics, ETH Zurich and Department of Economics, University of Lugano, Switzerland. He is also the Co-Director of the Centre for Energy Policy and Economics (CEPE), ETH Zurich, Switzerland. Roger Fouquet is Ikerbasque Research Professor, Basque Centre for Climate Change (BC3), Bilbao, Spain. Christoph W. Frei is Secretary General at the World Energy Council and Titulary Professor and Advisor to the President of the Swiss Federal Institute of Technology, Lausanne, Switzerland. Dalton Garis is Associate Professor of Economics and Petroleum Market Behaviour, The Petroleum Institute, Abu Dhabi, United Arab Emirates. Lullit Getachew is a Senior Economist, Pacific Economics Group, Madison, WI, USA. Michelle Gilmartin is a PhD student, funded through the EPSRC SuperGen Marine vii

viii


Energy Research Consortium, Fraser of Allander Institute and Department of Economics, University of Strathclyde, Glasgow, Scotland. Richard L. Gordon is Professor Emeritus of Mineral Economics, Pennsylvania State University, University Park, PA, USA. Paul W. Graham is Theme Leader, Energy Futures, Commonwealth Scientific and Industrial Research Organisation (CSIRO) Energy Technology, Newcastle, Australia. Lorna A. Greening is an Energy and Environmental Economics Consultant, Los Alamos, NM, USA. Lester C. Hunt is Professor of Energy Economics, Surrey Energy Economics Centre (SEEC), Department of Economics, University of Surrey, Guildford, UK. Hillard G. Huntington is Executive Director of the Energy Modeling Forum, Stanford University, Stanford, CA, USA. Mark Jaccard is Professor, School of Resource and Environmental Management, Simon Fraser University, Vancouver, Canada. Ramachandran Kannan is a Research Scientist, Paul Scherrer Institute, Switzerland. Claudia Kemfert is Professor and Head of the Department of Energy Transportation and Environment, Deutsches Institut fr Wirtschaftsforschung (DIW), Berlin and Humboldt University, Berlin, Germany. Luciano Losekann is Associate Professor, Faculdade de Economia Universidade Federal Fluminense, Rio de Janeiro, Brazil. Mark N. Lowry is a Partner, Pacific Economics Group, Madison, WI, USA. Reinhard Madlener is Full Professor of Energy Economics and Management and Director of the Institute for Future Energy Consumer Needs and Behavior (FCN), E.ON Energy Research Center, RWTH Aachen University, Aachen, Germany. Peter McGregor is Professor of Economics and Director of the Fraser of Allander Institute and a member of the Department of Economics, University of Strathclyde, Glasgow. Kenneth B. Medlock III is Fellow in Energy Studies, James A. Baker III Institute for Public Policy and Adjunct Professor, Department of Economics, Rice University, Houston, TX, USA. Carole Nakhle is Associate Lecturer, Surrey Energy Economics Centre (SEEC), Department of Economics, University of Surrey, Guildford, UK. Dmitri Perekhodtsev is Managing Consultant, LECG Consulting SAS, Paris, France. Andr Plourde is Professor of Economics, Department of Economics, University of Alberta, Edmonton, Canada. Luke J. Reedman is a Research Scientist, Energy Futures, Commonwealth Scientific and Industrial Research Organisation (CSIRO) Energy Technology, Newcastle, Australia.

Contributors

ix

Ronald D. Ripple is Professor of Energy Economics, Curtin Business School, Curtin University of Technology, Perth, Australia. Juan Roselln is Professor, Centro de Investigacin y Docencia Econmicas (CIDE), Divisin de Economia, Mexico and Research Associate, Dresden University of Technology (TU Dresden), Department of Business Management and Economics, Chair of Energy Economics and Public Sector Management, Germany. David L. Ryan is Professor of Economics, Director of the Canadian Building Energy End-Use Data and Analysis Centre (CBEEDAC) and Fellow of the Institute for Public Economics, Department of Economics, University of Alberta, Edmonton, Canada. Harry Saunders is Managing Director, Decision Processes Incorporated, Danville, CA, USA. Steve Sorrell is Senior Fellow in the Sussex Energy Group, SPRU (Science and Technology Policy Research), University of Sussex, Brighton, UK. Neil Strachan is Reader in Energy Economics and Modelling at the UCL Energy Institute, University College London, UK. Ian Sue Wing is Associate Professor, Department of Geography and Environment, Boston University, Boston, MA, USA. J. Kim Swales is Professor of Economics and Head of the Department of Economics, University of Strathclyde, Glasgow, Scotland. Truong Truong is Research Professor, Deutsches Institut fr Wirtschaftsforschung (DIW), Berlin, Germany and Honorary Professor in Sustainable Transport Systems, Institute of Transport and Logistics Studies (ITLS), Faculty of Economics and Business, The University of Sydney, NSW, Australia. Karen Turner is Senior Lecturer, Fraser of Allander Institute and Department of Economics, University of Strathclyde, Glasgow, Scotland. W.D. Walls is Professor of Economics, Department of Economics, University of Calgary, Alberta, Canada. Thomas Weyman-Jones is Professor of Industrial Economics, Department of Economics, Loughborough University, UK. Denise Young is Associate Professor, Department of Economics and Associate Director of the Canadian Building Energy End-Use Data and Analysis Centre (CBEEDAC), University of Alberta, Edmonton, Canada.

IntroductionJoanne Evans and Lester C. Hunt

Energy security, the impact of energy use on the environment, fuel prices and fuel poverty are all issues at the forefront of public attention. The economics of energy is a vital element which contributes to our understanding of these complex issues and influences policy makers thinking as energy policy is determined. This handbook reviews the key aspects and research issues in the economics of energy. It brings together a collection of contributions from international experts (both practitioners and academics) in the economics of energy, which synthesise the current literature and provide an analysis of the key issues. The handbook covers historical aspects of the economics of energy and the important topical research and policy issues of the day with the focus very much on the economics of energy and subsequent policy. Aiming to be accessible to final-year undergraduates and postgraduate students studying the economics of energy, as well as practitioners in industry and government, the handbook summarises the current state of knowledge and provides an insightful commentary. The handbook starts with a historical prospective of energy and associated public policy issues, followed by an overview of the economics of energy supply and demand. The economics of energy efficiency including the rebound effect are discussed, and then various energy economics modelling techniques are presented. Key issues associated with the various energy markets are addressed in turn: oil, coal, natural gas and electricity. The book concludes with a focus on contemporary energy policy issues. In Chapter 1, Fouquet considers the history of energy use and the global economy in starting from the evolution of agrarian economies and discussing the attempts in Europe to overcome the limits in organic energy systems and the first successful transition to a fossil-fuel economy in Britain. Fouquet also considers the long-term trends in the global energy system and different energy policies through time. In Chapter 2, Weyman-Jones provides an overview of the theory of energy economics, arguing that this is really just a phrase used for convenience given that there is no such commodity as energy; it is really the economics of fuel markets. Weyman-Jones analyses resource allocation in capital-intensive fuel industries covering the nature of short- and long-run marginal cost of energy supply, the process of investment decision making, the design of efficient price mechanisms, and the market conditions that are frequently found in the fuel industries. In Chapter 3, Medlock reviews the economics of energy supply considering the way in which energy sources are allocated through space and time. He outlines and develops the economists model of optimal extraction of depletable resources that is used to examine a range of energy economics issues; and assesses the worth of such models by analysing firm behaviour and peak oil. In Chapter 4, Gordon examines the theory and practice of energy policy, considering examples of energy programmes that he argues were ill advised, reviewing the errors in policies in search of energy security. For the US, Gordon considers policies that have attempted to alter energy choices and those with an x

Introduction

xi

environmental focus, whereas for Western Europe and Japan he considers the reluctance of governments to accept the uneconomic position of coal. In Chapter 5, Medlock turns his attention to the theory of energy demand, highlighting that energy is a derived demand, required in order to obtain energy services such as heating, lighting, automotive power and so on. He discusses energy accounting, the relationship between energy use and economic development and the issues of structural and technological change, before going on to consider the micro foundations of energy demand and the elasticity of energy demand. In Chapter 6, Ryan and Plourde focus on the empirical modelling of energy demand. They consider the historical development of empirical models of energy demand from single-equation models to systems approaches, the implications of non-stationarity of appropriate data series on empirical models of energy demand, and the issues associated with allowing for asymmetric price responses in empirical models of energy demand. The next few chapters focus on energy efficiency and the rebound effect (where an increase in energy efficiency reduces the price of the energy service, resulting in an increase in demand for energy that moderates any energy saving). In Chapter 7, Allan et al. analyse the economics of energy efficiency, given the arguments that improvements in energy efficiency are important for meeting sustainability and security of supply goals. Allan et al. adopt an analytical approach to investigate the impact of an improvement in energy efficiency in a stylised open economy, aiming to identify and clarify the nature of the various system-wide factors that can affect the change in energy use that accompanies improvements in energy efficiency. In Chapter 8, Saunders presents the theoretical foundations of the rebound effect in order to explore the subtle relationship between energy efficiency and energy consumption. He develops a simplified, but rigorous, theoretical framework for understanding the relationship, highlighting that the potential rebound impact is unknown but could be significant and have important policy impacts. In Chapter 9, Sorrell further examines the definitions and estimation of the rebound effect, highlighting that there are a range of mechanisms that may induce the rebound effect or even backfire (where the introduction of certain types of energy efficiency results in an overall increase in energy demand). He clarifies the definition of direct, indirect and economy-wide rebound effects, highlights the methodological challenges associated with quantifying such effects, and summarises the estimates of rebound that are currently available. Sorrell concludes that rebound effects are significant, but they need not make energy efficiency policies ineffective in reducing energy demand. In Chapter 10, Ryan and Young present an application of modelling the energy savings and environmental benefits from energy policies and new technologies. Drawing primarily on examples from the residential sector, they develop empirical microeconomic modelling approaches to evaluate the outcomes of policies that focus on the adoption of new technologies as a means of reducing energy demand and/or improving environmental quality, assessing the strengths and weaknesses of the various approaches. The following few chapters consider a range of energy economy models used by energy analysts and energy policy makers. In Chapter 11, Greening and Bataille provide an overview of technology-orientated bottom-up models of energy, focusing on the efforts to embed economic dynamics in bottom-up models by increasing their behavioural realism and macroeconomic completeness, as well as the possibility of including sufficiently large amounts of technological detail in existing macroeconometric or

xii


computable general equilibrium (CGE) frameworks. Greening and Bataille therefore discuss simulation models and hybridisation. They demonstrate that bottom-up models have become increasingly more detailed and sophisticated in the way they handle technology choice and represent the dynamics of the energy system, in addition to increasing their capabilities for simulating the relationship between the physical stock and the wider economy. One particular type of model reviewed by Greening and Bataille is the MARKAL model (MARKet ALlocation model), which is a bottom-up dynamic, linear programming optimisation model. MARKAL is a commonly used model for energy policy analysis and in Chapter 12, Kannan et al. consider MARKAL further by detailing the development of a UK MARKAL model. Kannan et al. present indicative results to demonstrate MARKALs strengths, range of outputs, and how MARKAL deals with uncertainties between alternative energy pathways. In Chapter 13, Jaccard investigates the combining of top-down and bottom-up energy economy models, exploring public policy efforts to influence the direction of technological evolution, known as induced technological change (ITC). He explores the ideal attributes of ITC policy models, noting the deficiencies and strengths of conventional approaches before explaining some recent modelling innovations that attempt to combine the best qualities of competing conventional models and parameter estimation. Jaccard then considers a specific ITC as an example of the challenge to provide a real-world empirical basis for estimating the response to ITC policies, and concludes that there remains considerable uncertainty concerning future responses of consumers and businesses to ITC policies. In Chapter 14, Sue Wing provides an exposition of CGE modelling for analysing energy and climate policies in order to de-mystify the CGE approach. By developing the general algebraic framework of a CGE model from microeconomic principles, Sue Wing demonstrates how such a model might be calibrated using actual data, solved for the equilibrium values of economic variables, and the equilibrium perturbed by introducing price and quantity distortions; hence demonstrating how the economy-wide impact of energy and climate policies might be analysed. In Chapter 15, Kemfert and Truong survey energyeconomyenvironment modelling. Recent modelling has attempted to integrate climate, ecosystem and economic impacts into a single framework of so-called integrated assessment modelling (IAM), and Kemfert and Truong provide an overview of such models covering the theoretical backgrounds, the methodologies and model designs. The following chapters focus on different fuels. In Chapter 16, Huntington evaluates the contributions of several strands in the energy security literature that emphasise the US oil security problem; however, the methodologies and basic principles also apply to many European and Asian countries. Huntington reviews and discusses three key economic issues central to the discussion of oil security: the oil import premium, the risk of oil supply interruptions, and the vulnerability of the economy to an oil disruption. In Chapter 17, Nakhle discusses the challenges inherent in designing and implementing an appropriate petroleum tax system aimed at achieving an appropriate balance between both government and industry interests. She recognises that there are no uniform solutions to these challenges; nevertheless, she argues that variety, flexibility and a readiness to adapt and evolve are the key requirements. In Chapter 18, Garis investigates the behaviour of petroleum markets beyond supplydemand fundamentals, arguing that there are circumstances where traders reject these in petroleum

Introduction

xiii

markets in favour of psychological characteristics and trader expectations. Garis conducts a behaviour analysis to show how petroleum market prices behave under various scenarios in order to try to understand why, at various times, the supplydemand fundamentals are ignored. In Chapter 19, Gordon plots the history of the coal industry and the world coal market, highlighting that in the twentieth century coal moved from being a general-use fuel to primarily being used for electricity generation with all the associated environmental implications. Following the historical review, Gordon examines coal trade patterns and US policy before concluding with a brief discussion of the uncertain future of coal. The opening up to markets, competition, alternate market structures, and incentives in electricity and gas industries is the focus of a number of following chapters. In Chapter 20, Walls provides an overview of the issues around the opening up of gas and electricity markets, as the industries are increasingly being regulated by market forces. Walls argues that the transition for natural gas to markets was easier in the US than it might have been; however, due to the complexity of balancing supply and demand, the introduction of market-based allocation mechanisms has proved to be far more difficult for electricity. In Chapter 21, Weyman-Jones presents a summary of the key theoretical ideas underpinning the incentive regulation of energy networks. He outlines the main regulatory principles and tools employed and the different regulatory models and mechanisms that are applied in the real world: price-cap, revenue-cap, sliding scale, and yardstick competition. In Chapter 22, Getachew and Lowry also explore the regulation of transmission and distribution in the developed world. Using the US as a case study, they demonstrate the importance of scale economies to illustrate the factors that affect the electricity industry in the developed world, going on to discuss the use of incentive-based regulation in the US, Canada, Europe, and the Pacific Region. In Chapter 23, Getachew explores the market structure of electricity networks in the developed world, presenting the various ways in which power industry restructuring by separating the natural monopoly activities of distribution and transmission from the competitive sectors has been instituted in the US, Canada, Western European countries, Japan, Australia and New Zealand. Getachew highlights the various transmission service arrangements that have been put in place across the developed world, concluding that the restructuring of the power industry is far from finished. In Chapter 24, Roselln reviews incentive mechanisms for electricity transmission expansion, arguing that the economic analysis of electricity markets has typically concentrated on short-term issues whereas investment in transmission capacity is long term in nature, as well as stochastic. He discusses the two main disparate analytical approaches to transmission investment (the incentive regulation hypothesis and the merchant approach) before offering insights into how to build a more comprehensive approach that combines both mechanisms. In Chapter 25, Farsi and Filippini review and discuss the empirical measurement of the productive efficiency of electricity and gas distribution. Following a review of production theory and the concepts of economies of scale and scope, they illustrate the different statistical approaches used to measure efficiency in the distribution sectors of electricity and gas (benchmarking), providing a selection of previous empirical studies. This is followed by a short discussion of actual benchmarking practice undertaken and a short case study of Switzerland. Farsi and Filippini conclude that the measurement of

xiv


efficiency is a contentious issue, so it is important to try to measure the efficiency from several angles, applying a number of models with different assumptions. Perekhodtsev and Blumsack review wholesale electricity markets and generators incentives in Chapter 26, outlining the critical properties of the markets applied in different wholesale electricity markets around the world. Highlighting the three design characteristics of market design rules, market power and resource adequacy and capacity mechanisms, Perekhodtsev and Blumsack conclude that the poor design of electricity markets may increase significantly the cost of electricity to customers and that no market has managed to overcome all the identified problems. In Chapter 27, Losekann et al. discuss security of supply in large hydropower systems. They use a simulation model to apply the missing money problem to Brazil and conclude that if the issue of energy storage incentive is not adequately addressed the system is likely to run into security of supply problems despite capacity payments to ensure an abundant supply of generation capacity. In Chapter 28, Blumsack and Perekhodtsev turn their attention to electricity retail competition, discussing the transition from regulated monopoly pricing to competition. By reviewing the various retail electricity market models across the world, they highlight that there is no widely accepted way to design such markets, and conclude by offering a set of policy prescriptions for successful retail electricity markets. In Chapter 29, Reedman and Graham consider emissions trading and the convergence of electricity and transport markets in Australia. Following an examination of the relative cost of greenhouse gas (GHG) abatement in the Australian electricity and transport sectors, they employ a partial equilibrium model to formulate three emission reduction scenarios. Some of their key findings include the need for emission permit prices to be significantly higher in order to achieve rapid and deep GHG emission abatement targets and that without further measures, the combined electricity and transport sectors will be unable to meet aggressive cuts in GHG emissions in the short term. The fundamental purpose for derivatives is to facilitate risk mitigation and to aid in price discovery of the underlying asset, and in Chapter 30 Ripple provides historical background on the introduction of derivatives, futures, forwards, options and other financial instruments into the energy markets, which assist market participants with their risk mitigation needs. Ripple outlines the underlying economics of these instruments and their markets with some examples of how such instruments might be employed, providing an analysis of the evolution of both price volatility and the relative roles of hedgers and investors/speculators in these markets. Some of the major themes and strands of research on the economics of energy supply and use in developing countries are presented by Madlener in Chapter 31, highlighting the literature on: the relationship between energy consumption and economic growth; the relationship between rapid fossil-fuel price rises on development; and interfuel substitution. Madlener concludes by predicting an increase in research activity on the impact of energy price rises on the sustainable development of developing countries, while indicating that the issues of equity and energy poverty should also be addressed. The final two chapters examine energy policy from very different perspectives. In Chapter 32, Frei presents an example of the use of energy visions analysis to consider alternative routes that energy policy might take in the future to address the twin problems of energy security and climate change. Using a combination of economics, and Webers

Introduction

xv

classifications of social behaviour, Frei builds energy visions that investigate different possible futures to aid the thinking of policy makers. In Chapter 33, Weyman-Jones takes a different perspective considering the current key issues in the design of energy policy.1 Recognising that energy policy is the attempt to correct the three market failures of asymmetric information, market power and externality, Weyman-Jones focuses on the positive economics of market power and externality (the normative economic policy towards asymmetric information being covered in Chapter 21). He therefore critically analyses a number of key contemporary energy policy issues including the social cost of carbon, carbon permits versus taxes, integrated assessment models, and the UK Stern Review of the economics of climate change. We hope that the wide spectrum of issues and techniques in this Handbook, as well as the depth of analysis, makes the economics of energy accessible to all those who are interested in understanding the current issues in energy economics. We would like thank all who contributed a chapter (or in some cases two or even three chapters) to this volume even the late ones that we had to chase the Handbook is the richer for each contribution. Finally, our thanks also to Matthew Pitman of Edward Elgar, who originally persuaded us to undertake this project, and also to the publishing team. Note1. In Chapter 4, Gordon considers the energy policy as previously designed, whereas in Chapter 33 WeymanJones considers the key energy policy issues currently faced by energy economists.

1

A brief history of energyRoger Fouquet1

1

The Importance of History

Energy has been fundamental to human survival and growth. At a basic level, the concentration of energy is the basis of life itself. For millions of years, animals have dedicated much of their lives to collecting sufficient energy in the form of food to survive. Success in this endeavour has enabled the human population to grow spectacularly over the last ten thousand years. The concentration of other (non-agricultural) forms of energy has allowed humankind to create increasingly elaborate surroundings and complex societies. More energy, more efficiently consumed provided greater amounts of heat, power, transport and light (Fouquet 2008). Most would agree that, overall, this has improved the populations quality of life. Human economies the production, exchange and consumption of goods and services are driven by refinements in ways of capturing and harnessing energetic resources. The growth of economies has been closely linked with the availability, extraction, distribution and use of energy. Indeed, there is a close relationship between energy consumption and economic development (see, for instance, Judson et al. 1999). Thus, to study this relationship is to partially investigate the processes of economic growth and development, to identify the likely changes in energy requirements and to consider the possible environmental implications of energy usage. Due to a lack of statistical information, many economists trying to study this relationship have focused at a point-in-time picture of energy and GDP, using cross-sectional data. However, there have been many attempts to identify the crucial steps in the history of energy (see, for instance, Cottrell 1955; Cipolla 1962; Wrigley 1988; Smil 1994 and Fouquet 2008). This is another briefer effort, benefiting from some of the latest research on the topic. First, this chapter looks at the evolution of agrarian economies, tied to the fruits of direct solar energy supplies. Then, there is a discussion of the limits that were faced in organic energy systems, with an emphasis on attempts to overcome them in Europe. The following section reviews the first successful transition to a fossil-fuel economy, in Britain. This then leads to an analysis of past and current trends in the global modern energy system. There is a brief discussion of the different energy policies through time, and a section on issues raised by environmental pollution related to energy. The final section tries to draw conclusions about the past ten thousand years of energy use in the global economy. 2 Energy in an Agricultural World

Life on Earth ultimately depends on solar energy. The sun provides on average 1366 watts (W) per square metre per second, which is roughly 170 000 terawatts (TW) on Earth, 1

2


equivalent to 128 000 000 million tonnes of oil equivalent (mtoe) per year (Ruddiman 2001). Plants capture and convert some of this energy through photosynthesis, providing the base for animal food chains. Early humans tended to live nomadic existences following the rhythm of seasonal plant growth. As gatherers of food, humans needed a large area of land within which to find sufficient food to meet their roughly 2000 kilocalories (kcal) daily requirement. The introduction of agriculture, as a way of directing the growth of plants, generally increased the amount of food yielded on a plot of land, allowing for an increase in population density. While there is great uncertainty and debate about the drivers for its permanent adoption, considerable evidence shows that agriculture in various forms co-existed with huntergatherer lifestyles for extended periods of time (Boserup 1965; Cowan and Watson 1992; Smil 1994, p. 23). Twelve thousand years ago, the human population on Earth numbered about four million. Most cultivations at the time were slash and burn. Burning the vegetation created a temporarily fertile soil, which could be cultivated for a few years. As the nutrients in the soil became depleted, the community moved on to the next settlement. By about 7000 years ago, the population had increased to five million. It is unclear which was cause and which was effect, yet, with the rise in population came a decline in slash and burn and an intensification of more permanent agricultural activities (Boserup 1965). In the next two thousand years, major innovations radically improved agricultural yields: irrigation, animals, the plough, the wheel and metals were introduced. These are likely to have helped support the 15 million inhabitants living 5000 years ago. Over the next three thousand years, the population rose between 170 and 250 million (Malanima 2003, p. 80). In many of the main centres of population, winters were mild, as humans lived sufficiently close to the equator. This reduced the need to protect from the cold and to create a warmer inner climate to survive. Thus, for many early communities fire, which was discovered more than 500 000 years ago, was used mainly for cooking heat provided the vital role of improving foods calorific and nutritional value (ibid., p. 80). Yet, the ability to use fire for warmth enabled settlements to gradually spread to more temperate climates. In pre-industrial Europe, where populations faced harsh winters, large quantities of crop residue, dung and especially wood were needed for domestic heating. This could reach 10 kg of wood or 30 000 kcal per day in the colder regions, which was at least three-quarters of a households energy requirements the majority of the rest was for animal fodder and food (ibid., p. 75). As well as cooking food and keeping humans warm, fire created light, which improved protection and safety. Heat enabled materials to be transformed, too, which was essential for many industrial activities. In other words, the gradual improvements in the taming and directing of fire enabled humans to generate more useful heat and light, increasing human populations and pushing the boundaries of human inhabitation away from the equator with better tools and greater protection. The expanding population had lived and their communities been bound by the flow of energy generated directly and indirectly from solar radiation. By the sixteenth century, about one-eighth of the worlds surface area was under continuous cultivation (ibid., p. 63). By that time, the population density was above 510 people per square kilometre. The main centres of continuous agriculture and, therefore, population were in Asia

A brief history of energy

3

(South, South-East and Far East), in the Middle East, Egypt and North Africa, in Europe and in Central America (ibid., p. 65). But the density of populations varied considerably according to the types of agriculture. For instance, in Japan, more than 850 inhabitants could live in 1 sq km; in China, nearly 500; in India, 270; and in Europe, only 60 people (ibid., p. 72). In Asia, more people cultivated the land, allowing for more-intensive farming and higher yields. Dense populations implied that labour was in large supply and wages low, encouraging intensification. In such concentrated activities, animals and machines could be harmful, and little incentive would have existed to develop animal- or machine-based innovations. Thus, the more-intensive farming led to little incentive for technical innovation and, therefore, the lowest standards of living (ibid., p. 74). In Europe, more land providing lower yields (and implying fewer people could survive) were more suited for animals. Although animals required considerable fodder, they were able to perform certain menial and hard tasks with more power. Oxen and later horses ploughed the earth for humanity also freeing up human effort for other activities and increasing crop yields by providing manure as a fertiliser. Their power was also being increasingly harnessed in commercial and industrial activities, and for transportation (Langdon 2003). 3 The Limits of the Organic Energy Economy

Evidence in England at the end of the eleventh century indicates that there was one animal (probably an ox) for every two people. In many locations across Europe, the horse replaced the ox as the source of power. A series of technological improvements in horse management during the Middle Ages led to a spectacular increase in draught horses (Langdon 1986, p. 19). The nailed horseshoe protected hooves, reducing splinters, and became common around the ninth century. The harness increased the animals productivity until its introduction, a metal bar was placed across the horses chest and windpipe, strangulating it, and reducing its efficiency by about 80 per cent (Mokyr 1990, p. 36). Another way in which humans helped generate more food was through the harnessing of other sources of energy. Water and wind power were directed towards the crushing of grains, in particular. The waterwheel was invented about 2500 years ago and, by the end of the Roman Empire, had made its way across Europe to become an established source of power for crushing grain, fulling cloth, tanning leather, smelting and shaping iron and sawing wood where sufficient demand existed for these goods (Reynolds 1983). The expansion of watermills and then windmills, which diffused through Europe in the twelfth century, drove down the cost of producing flour and bread (Langdon 2005). Yet, claims of an industrial power revolution in the medieval era (Carus-Wilson 1941) may have been exaggerated given that, certainly in Britain, work from animals provided considerably more power than water- or windmills (Fouquet 2008). Despite improvements in the ability to generate more power, the rapid growth in human population in Europe about one thousand years ago led to dramatic pressures on the land. Yields were dropping as less-fertile lands were being exploited. Forests were being encroached upon to provide more agricultural output. This tension between uses of land tended to favour agriculture, which could often generate faster returns, especially

4


when food prices were rising. The late medieval period in Europe saw the first examples of energy policy to address the problem of woodfuel supply (Hatcher 1993; Warde 2003, p. 585). While the pressures were relieved by the collapse of European populations in the middle of the fourteenth century as a result of the Black Death, they returned by the sixteenth century. Agricultural yields increased considerably in Western Europe from the fifteenth century (Smil 1994, p. 75). Wind power also provided a partial solution by reducing the costs of shipping crops from sources of supply to those of demand (Maddison 2003, p. 47). More food also led to a rise in the population, which put growing pressure on land both for agricultural and forestry products. Europe was caught in a tension between increasing supply of energy sources and growing demand. Holland provided a first (partial) success at extricating the economy from the limits of land and creating a modern and industrial economy. By the beginning of the sixteenth century, only one-quarter of the workforce was involved in agriculture, with another 12 per cent in fisheries and 3 per cent in peat digging; 38 per cent were in industrial activities, especially textiles, metalwork and brewing; the rest provided mostly trade and transport services (van Zanden 2003, p. 1016). A series of agricultural crises in the fourteenth and fifteenth centuries drove the populations towards the urban centres. This generated a large labour force able to work in fisheries and the brewing and textile industries, and to generate economies of scale (and possible learning effects) in production, making its products cheap. The Dutch maritime tradition and its improving ability to harness winds on its sailing ships meant that these products were competitive across much of Europe (ibid., p. 1019). A large trade developed with cities in the Baltic which could supply agricultural products in return, reducing land pressures in Holland (van Zanden 2003, p. 1022). Holland had managed to remove the land problem through importing grain and exporting high-value goods. The economy flourished in the sixteenth and seventeenth centuries. To manage this transition to an industrial economy it depended on a reliable fuel for heating. The damp countryside of parts of the Low Countries (that is, present Netherlands and Belgium) created large quantities of peat. The Flemish cities, such as Antwerp and Bruges, had already been exploiting these sources of energy in the thirteenth century. Given the slow rate of growth of peat in the soil, it was a non-renewable source of energy. The Flemish cities used up their local sources of peat and had to start importing from nearby areas, such as Brabant and even Holland. Similarly, during the sixteenth century, supplies of peat near Amsterdam were being heavily exploited (either for local uses or export) and started to dwindle. Especially after the crisis of the 1620s, large quantities of peat were available in other parts of the Netherlands that could be imported to Holland and the more urban areas along the wide network of canals of the Low Countries (ibid., p. 1025). An organic economy can only use energy at the rate at which direct and indirect solar energy can be converted into valuable services. The example of the Dutch Golden Age reflects that solutions could be found to the problem of organic energy supply, but that they were only temporary. The Dutch Golden Age was driven by wind (for transport) and peat (for heat). Peats supply was dependent on the availability of land, but was a reserve of more concentrated fuel than traditional biomass fuels. In other words, it

A brief history of energy600

5

(2000) per tonne of oil equivalent

500 Woodfuels 400

300

200

100

Coal

0 1400Source: Fouquet (2008).

1500

1600

1700

1800

1900

Figure 1.1

The price of coal and woodfuels in the United Kingdom ((2000) per toe), 14401900

was an intermediary between an organic and a mineral fuel. However, had the Dutch economy continued to grow so rapidly with such a large dependence on peat, it would have eventually faced land limits as the reserves were used up, and then its solution would have been to import a more concentrated form of energy with deeper reserves from abroad, which it eventually did by importing coal from Britain in the eighteenth century (van den Wouden 2003, p. 463). 4 The Transition to Fossil Fuels

In Britain, the solution to the tension was found through the use of mineral fuels (Cipolla 1962; Wrigley 1988; Warde 2007; Fouquet 2008). It has been argued that a woodfuel crisis imposed a heavy burden on the British economy in the sixteenth century, forcing an energy transition (Nef 1926). While there may have been localised shortages, the evidence available (Hatcher 2003 and Figure 1.1) puts in question a nationwide crisis at that time. It appears that the substitution towards coal was due to favourable prices of coal for heating, especially in urban centres (Fouquet 2008). While there may not have been a woodfuel crisis in the sixteenth century, the introduction of coal did reduce the burden imposed by a constrained land on a growing population. Later, between the 1650s and the 1740s, real woodfuel prices did rise substantially,

6


encouraging certain users and industries to make the transition to coal. It enabled the economy and especially industrial activity to expand to an extent impossible if limited to biomass. For instance, one estimate suggests that by 1800, had the British economy been dependent on woodfuel, a surface area of land equivalent to Britain would have had to be coppiced every year to meet the energy requirements (Wrigley 1988). Yet, in the same way that the production of biomass energy provided a flow of resources, the extraction of mineral resources created a flow. The stock of reserves was converted into a flow, through the carriage of coal vans and later trains full of coal. In other words, extraction rates and supply infrastructure determined the flow of energy. In medieval times, many of the British coal seams lay under Church land. Henry VIIIs (150947) Reformation meant that land owned by the Catholic Church was up for sale. An impetus for the expansion of the coal industry was the transfer of land ownership from the Bishop of Durham to the merchants of Newcastle in the sixteenth century. While the Church had mined coal, the land and what lay beneath it was exploited more vigorously in commercial hands (Hatcher 1993). The coal industry began to open many more mines and expand to meet the growing demands for heating. From the fifteenth to the end of the seventeenth century, the coalmining industry grew from a niche business to one of the major generators of wealth in the North-East of England. Around 1500, production was 27 000 toe (tonnes of oil equivalent), and increased to about 1.5 million toe in 1700 (ibid.). As demand grew in the seventeenth century, however, coal supplies were initially inadequate and fuel prices started to rise (see Figure 1.1). A series of transformations helped the coal industry adapt and become one of the pillars of the British economy. First, the development of pumps to remove water from mines enabled much greater depths to be achieved. In the eighteenth century, this was achieved most successfully by using the recently developed steam engines. At the time, steam engines were highly inefficient, burning large quantities of coal. Since coal was very cheap at the pit mouth, inefficiency was of little concern. Their great use for pumping water in coal mines enabled steam engine manufacturers to improve their efficiency and reduce both their operating and capital costs (Kanefsky 1979). Second, Britain discovered that its vast energy reserves were not limited to the NorthEast. A number of regions started to compete with the Newcastle trade. The coal industry transformed itself from a localised business to one of the leading sectors of the economy. Third, transport routes were dramatically improved. The improvements to rivers and building of canals enabled industrial regions to reduce the cost of heating services. Also, along the coast, economies of scale were achieved by increasing the size of ships carrying the goods (Hatcher 1993). However, the switch to coal was not a simple case of reacting to a lack of land and its products. The substitution towards coal had begun in the sixteenth century for certain industries and households. Instead of fossil fuels spectacularly resolving an energy crisis and driving an Industrial Revolution in Britain, the energy transition was a gradual process, lasting more than two hundred years. It depended on industries finding a solution and it being commercially viable. For instance, in the iron industry, the technological solution introduced by Abraham Darby in 1709 that enabled coal, in the form of coke, to be used was not adopted for over fifty years. It required substantial improvements in


7

the efficiency of coke-smelting before it became cheaper than traditional charcoal-based iron (Hyde 1973; King 2005). By the eighteenth century, many industries had found ways of using coal rather than woodfuels and had adopted them for heating purposes. The improvements in agricultural productivity in the eighteenth century had pushed much of the labour force to the urban centres, which expanded greatly (Campbell 2003). This population needed to keep warm and also use coal, as few had access to wood. In 1500, the British economy used roughly the same amount of energy for heating and power. By 1800, three-quarters of its energy requirements were for heating services in households, buildings and industry (Fouquet 2008). Heating services had made the transition from organic to fossil fuels by the beginning of the nineteenth century. Wind and water for power services, although significant, only provided one-tenth of the total power in 1800. Power and transport services (apart from at sea) depended mostly on food and fodder and were still stuck in the organic energy system at the beginning of the nineteenth century (Fouquet 2008). The means of making the transition to fossil fuels for both power and transport already existed and were used in niche markets. The steam engine and coal had been used to pump water out of mines since the early eighteenth century. During the nineteenth century, its adoption in the cotton industry began the transition for power services (von Tunzelmann 1978), and railways and steam ships enabled the switch for transport services (Harley 1988). By 1900, steam engines provided two-thirds of all power services. By then, railways carried more than 90 per cent of goods and steam ships provided about 80 per cent of all freight services at sea (Fouquet 2008). The growing demand for coal in the nineteenth century created new concerns about the scarcity of coal (see, for example, Jevons 1865) and the threat of higher prices (Church 1987). However, with only small technical improvements in production methods, coal supply in Britain again managed to expand to meet the growing demand, keeping prices stable throughout much of the nineteenth century (Figure 1.2). This was due to large and accessible reserves, a diversity of types and qualities of coal, a big labour force to draw from and improving means of transportation. For example, in 1830, there were around 100 000 miners, by 1870, nearly 400 000 and by 1913, over one million (Church 1989, p. 12). Taking a longer-run perspective, it is interesting to see the periods of abundance and scarcity. In the sixteenth and early seventeenth centuries, supply expanded and demand found new uses for coal. For the next hundred years, demand outstripped supply, which had to catch up. It did, ensuring resource abundance, driving down the price, and encouraging the creation of new demands for coal. Demand expanded to meet the large supply (Fouquet 2008). One of the problems associated with the production and supply of energy resources is that they often require long-term investments. For the British coal industry, there was, at times, a delay between the signal of scarcity and the change in flow of resources resulting from higher investment in extraction, hiring more miners and finding new seams. This created price volatility but no upward trend in the long run. As few economies had sufficient land and woodfuel resources to meet the large heating demands necessary to industrialise, in the nineteenth century, many countries discovered large coal reserves and followed Britains lead. Thus, coal provided the source of

8

International handbook on the economics of energy 4000 3500 (2000) per tonne of oil equivalent 3000 2500 2000 1500 1000 500 0 1800 Gas Electricity Oil

Coal 1850 1900 1950 2000

Source:

Fouquet (2008).

Figure 1.2

The price of energy sources in the United Kingdom ((2000) per toe), 18002000

transition from organic to fossil fuels for industrialising economies, especially in the USA, Germany and other European countries (Schurr and Netschert 1960; Sieferle 2001; Gales et al. 2007). For instance, in 1850, less than 10 per cent of the USAs energy requirements were met by coal. In 1910, fossil fuels provided 90 per cent of energy needs (Schurr and Netschert 1960, p. 145). The energy transition in the USA took about 60 years, whereas in Britain the same transition took two hundred years, between 1600 and 1800 (Fouquet and Pearson 2003, p. 103). This indicates that, as more of the new energy-using technology is available, the speed of the transition increases. Nevertheless, energy transitions will always be limited by the process of the scrapping of old technologies and the setting up of infrastructure associated with the new energy system. 5 Modern Energy Systems

Coal met energy requirements in many economies into the second half of the twentieth century (Schurr and Netschert 1960; Gales et al. 2007; Fouquet 2008). But, while coal production globally continued to grow into the twentieth century, the fragmentation of supply also reflected its jeopardy as the dominant energy source (Etemad et al. 1991). The introduction of new energy sources in the nineteenth century provided the next


9

phase in the history of energy. Town gas (derived from coal), petroleum and electricity all started as sources of energy in the emerging market of lighting (Fouquet and Pearson 2003). Their success in the lighting market and the dramatic decline in their prices (see Figure 1.2) encouraged use in other energy service markets where they increasingly ousted coal. The first oilfields to be exploited on a large scale were in Pennsylvania, in the NorthEast of the United States, in the 1860s. By the 1880s, one company, Standard Oil, emerged as the main refiner and supplier of petroleum products. It managed to control product quality and prices, providing stability to the oil lighting customer in a volatile market (Yergin 1991). The introduction and adoption of the internal combustion engine at the beginning of the twentieth century meant that petroleum products were to be used in the much larger market for transport services. The decline in the price of cars between the two world wars led to a huge growth in the demand for gasoline. As Standard Oil was broken up as a result of North American anti-trust laws and more suppliers entered the market, the price of petroleum products gradually fell between the 1930s and early 1970s (see Figure 1.2). Especially after the Second World War, global production and consumption of oil grew rapidly as the demand for private transport soared and oil began to be used for other services, such as heating and even electricity generation (Figure 1.3). By the early 1970s, despite being the largest oil producer in the world, the USAs consumption exceeded its supply for the first time. This implied that its companies no longer had the ability to increase output to control and stabilise oil prices. Instead, the Saudi Arabian oil industry had this privilege. As part of OPEC (the Organization of Petroleum Exporting Countries), and in response to North American and European policies in the Middle East, it began to limit supply and raise prices, which led to the oil shock of 1973. This was followed by other fears about supply from the Middle East in 1979 and 1980, triggered by the Revolution in Iran and its war with Iraq, driving the prices up further (Yergin 1991). The mid-1980s and 1990s saw a glut of oil as many countries drove up or began oil production (see Figure 1.3). With low prices and rapidly expanding developing economies, especially in Asia, consumption increased substantially. The beginning of the twenty-first century saw a return to higher oil prices, due to the growing world demand and the political instability in the Middle East, still the main oil exporting region. But, by the end of the first decade of the twenty-first century, as the global economy has entered a recession, oil prices have fallen again, allowing energy companies to expand their reserves and infrastructure. Concerns about security of energy supply in the 1960s and 1970s had generated a series of different reactions among importing governments. Some tried to forge strong political ties with countries that had reserves. Others searched and found oil. Many also focused on developing other energy sources. Gas had initially been produced from coal and used for lighting. It lit up the streets of industrialising nations in the middle of the nineteenth century. In the late nineteenth century, competition from electricity had forced lamp manufacturers to improve the efficiency of their products and gas suppliers to find alternative uses for theirs. The efficiency improvements delayed the uptake of electricity in many countries. The search for new uses also led to the adoption of gas as a smoke-free heating fuel (Thorsheim 2002).

10


4000 3500 3000 Million tonnes of oil 2500 Middle East 2000 1500 1000 500 Europe 0 1900Sources:

Africa

Asia-Pacific C. & S. America North America

1920

1940

1960

1980

2000

Mitchell (2003) and BP (2007).

Figure 1.3

World petroleum production by region (mtoe), 18502000

Natural gas (that is, not converted from coal) tended to be found during the extraction of oil. Often, the gas had been simply burnt at source as it had little market value. Threats relating to oil security of supply had encouraged consumers to start using gas for heating purposes and producers to pipe it to the growing sources of demand. After the oil shocks of the 1970s, the gas market increased rapidly, representing 21 per cent of the global energy market in 2000 (Figure 1.4). Electricity had been used predominantly for lighting at the end of the nineteenth century. Its use in urban transport services and for industrial power needs had enabled the price of electricity to fall. After all, a power station generating electricity for times of darkness had excess capacity during the day time. Thus, finding uses for electricity throughout the day spread the capital costs. The electrification of the global economy has radically altered many aspects of productive activities. While electricity could extend and replace human effort like steam engines did, it could provide the services in an easier, more flexible and safer environment. Machines had been driven by a single central steam engine, through a series of shafts and belts. The engine could stop, halting all work; a worker could stop working, implying wasted power; or a taught belt could snap, risking life and limb. An electrical machine allowed each worker to be in control of his or her equipment (Nye 1999). The


11

10 000

Nuclear power Hydro power

8000 Gas Million tonnes of oil 6000

4000

Petroleum

2000Coal

0 1800Sources:

Woodfuel 1850 1900 1950 2000

Etemad et al. (1991), Maddison (1995, 2003) and BP (2007).

Figure 1.4

World primary energy consumption by type (mtoe), 18002000

ease and flexibility of electricity in the provision of power and lighting encouraged the electrification of much of the worlds economies (Rosenberg 1998). Before the 1960s, much of the electricity was generated from coal. Oil increased its share of power generation, until the oil shocks of the 1970s. Where possible, many economies had sought to harness hydropower. After the Second World War, a desire for cheap electricity had led many governments along the path of supporting a civil nuclear power programme. While in a few countries, it has provided an important share of their electricity, higher expected costs and safety concerns have stunted nuclear powers growth. In 2000, hydro and nuclear power each provided nearly 6 per cent of global primary energy consumption (see Figure 1.4). 6 The Global Need for Energy

In the twenty-first century, changes in energy supply or demand in one region will have repercussions across the whole planet. Increasingly, the global economy consumes energy in a single and integrated market. Thus, it is worth considering global trends in energy consumption. From a global perspective, the slow energy transition from woodfuel to coal began in

12

International handbook on the economics of energy Total primary energy consumption (in mtoe) and annual growth rate (from year in previous column)1820 1870 397 1.1 1913 1214 2.6 1939 1713 1.17 1973 6417 4.0 2000 10 392 1.8 2006 12 029 2.5

Table 1.1

Consumption Growth rate (%)Source: See Figure 1.4.

225

the second half of the nineteenth century. In 1900, woodfuel was estimated to have still provided nearly 40 per cent of the global energy needs. By 1950, fossil fuels met 75 per cent of the total, and in 2000, they provided an estimated 78 per cent. Perhaps the most surprising information is the resilience of biomass fuels, still meeting an estimated 10 per cent of energy requirements around the world (see Figure 1.4). In 1870, the global economy consumed less than 400 mtoe. It had reached more than 1200 mtoe by 1913, reflecting the industrialisation of numerous Western economies and the growth in coal use. The annual rate of growth was 2.6 per cent (Table 1.1). In 1939, consumption had risen modestly to just over 1700 million. Then, the global economy expanded dramatically up to 1973, reaching nearly 6500 mtoe, rising at a spectacular 4.0 per cent per year. The oil crises slowed the global economys expansion, yet it is about 13 000 mtoe level at the end of the first decade of the twenty-first century. While a global picture hides much of the detail between countries and regions, to understand the dramatic growth in world energy consumption, it is worth observing per capita use and energy intensity. Per capita energy consumption has increased in two distinct phases: first, it rose from about 1850 up to 1913 and, then, between 1939 and 1979. Current global energy consumption per person has hardly changed since then (Figure 1.5). Energy intensity, however, shows a more complex path. It fell in the first half of the nineteenth century. This may have reflected the high value placed on manufactured products in the early phases of industrialisation so, early industrialisation, although using large quantities of energy, generated important increases in GDP. Then, between 1850 and 1913, the heat-intensive activities for heavy industries drove up energy intensity. It has been falling since then, especially after 1979. 7 The Evolution of Energy Policies

The role of government in influencing energy markets has changed dramatically over the last two hundred years. Historically, governments of agrarian and rural economies focused only marginally on modern forms of energy. Governments have had other priorities. Their principal objectives have been the maintenance of power and peace. Peace often was tied in with ensuring that the population had sufficient food to eat, so, attempts were made to stabilise agricultural markets. Ultimately, however, the state was a relatively small body with limited economic influence (Jupp 2006). In many cases, governments have introduced economic policies, such as new institutions or taxation schemes, with major implications for energy markets. These decisions were rarely concerned with the impact on the energy market, and were often modified

A brief history of energy 2.0 0.5 Tonnes of oil equivalent per thousand dollars (1990 Khamis-Geary dollar)

13

Tonnes of oil equivalent per person

1.5

Energy intensity

0.4

0.3 1.0 0.2 Energy consumption per capita

0.5

0.1

0.0 1800Sources:

0.0 1850 1900 1950 2000

Etemad (1991), Maddison (1995, 2003) and BP (2007).

Figure 1.5

World primary fossil fuel and biomass energy consumption per capita and energy intensity, 18202000

or revoked with abrupt changes in incentives for the markets. Apart from a few bans on using particular forests in times of concern about the availability of wood, energy markets tended to follow their own course, disturbed but not disrupted by government (Fouquet 2008). The transition away from biomass fuels, dependent on land for production, towards fossil fuels, gradually led to an increased involvement of the state in energy markets. The nineteenth and twentieth centuries saw the formation of a number of large energy supply companies, first, of coal and then, oil. During the nineteenth century, coal companies focused on the extraction and distribution process in the industrialising countries, and were subject to only minimal government influence. For instance, the main intervention of government upon the coal industry in the nineteenth century was to improve safety conditions and minimise the death toll relating to mining accidents (ibid.). In the first half of the twentieth century, cases of supply shortages and of poorly integrated systems (especially among electricity companies) highlighted some potential drawbacks of unregulated competition. Following the Second World War, and the experience of extreme dependence on energy in fuelling and powering the war effort, many countries chose to nationalise their oil and electricity companies. Much of the energy was supplied, therefore, through public monopolies (Chick 2007).

14


The 1980s saw the rebirth of energy market liberalisation, starting in the United Kingdom (Newbery 1996). This saw the dismantling of the monopolistic structure of energy production and supply. At the beginning of the twenty-first century economies are still involved in this process, such as efforts to promote competition in the Single European Market. Energy markets traditionally worked with little governance. Nation-states began to appreciate the importance of managing markets to avoid abuses and to promote specific objectives. Certain markets, such as the oil markets, are already fully integrated international markets. For natural gas and electricity, pipelines and interconnections have enabled much of the globe to be linked. Most main energy sources can be moved around to meet the short-term changes in supply and demand. Given the global reach of the energy markets, no organisation is in a position to oversee and potentially regulate them. Thus, they experienced a brief period of being managed, but have slipped the grasp of the policy maker and have become stronger than any individual countrys government. The question is whether there will be sufficient belief that the global energy market needs to be managed, and whether an international energy regulator, beyond the European Union, develops. 8 Energy and Its Environmental Effects

One example, which may be the precursor to other supra-national bodies dealing with energy issues, is the United Nations Framework Convention on Climate Change (UNFCCC). It has attempted to coordinate efforts to minimise the impact of greenhouse gas emissions on the climate. The Kyoto Protocol, the agreement on target emissions and mechanisms for potentially meeting them, acts as a modest step towards international cooperation and regulation of environment-related energy behaviour. The environmental problems of energy production and combustion have existed for hundreds of years. Local and national legislation on air pollution banning the burning of coal in certain areas was introduced as early as the thirteenth century (Brimblecombe 1987). Individual countries have suffered the burden of local energy-inflicted air pollution. For instance, one estimate of the health damage related to smoke placed it at onequarter of Britains GDP at the end of the nineteenth century (Fouquet 2008). There have been international organisations addressing transboundary effects of acid rain. Yet, the efforts of the Kyoto Protocol appear to be on a larger scale, because the perceived implications of inaction are greater and more irreversible. The Agricultural Revolution probably led to considerable deforestation, which meant that less carbon was absorbed by nature. While this effect on the global climate may have been relatively minor, as far more carbon is trapped in the oceans than in plant life, it was the beginning of an anthropogenic influence on climate (Ruddiman 2005). Since fossil fuels have been burnt and since the Industrial Revolution, the global economy has also been generating and adding to naturally occurring carbon dioxide emissions. The relatively rapid increase in the consumption of fossil fuels and, at the beginning of the twenty-first century, its addition of more than 7 billion tonnes of carbon dioxide each year is having an effect on greenhouse gas concentrations and, therefore, on the Earths climate (IPCC 2007). Having industrialised first, heavily dependent on coal, Europe has been the largest


15

polluter in history (Figure 1.6). Given that greenhouse gases act as stocks of pollutants, it is worth identifying the burden imposed by different regions. By 2000, Europe was responsible for about 115 000 billion tonnes of carbon accumulated. North America added 87 000 billion tonnes. It also surpassed Europe in annual contributions in 1999 and stood at more than 1.8 billion tonnes per year in 2004. Yet, the largest emitter (since 1994) is the Asia-Pacific region, responsible for 2.7 billion tonnes in 2004 (Marland et al. 2007). Since 1990, its annual growth rate has been 4.2 per cent. The Asia-Pacific regions historical addition of carbon to the atmosphere is just under 50 000 billion tonnes 42 per cent of it, after 1990. At the beginning of the nineteenth century, renewable energy sources met an estimated 95 per cent of all energy needs around the globe. At the beginning of the twentieth century, it fell to about 38 per cent and down to 16 per cent at the dawn of the twenty-first century. While the amount of annual solar radiation on Earth is 12 800 times greater than world energy consumption in 2000, without an abrupt transformation of the global energy system, this trend is likely to continue. Investments in renewable energy sources are growing rapidly. However, the incentives do not favour a reduction in the use of fossil fuels. There still exist large reserves of easily extracted fossil fuels. However, without a significant increase in renewable energy sources and a major decline in the use of fossil fuels, global emissions will continue to rise, perhaps faster than they have since 1950.

7000

Africa6000

Middle East

Million tonnes of carbon

5000

Asia-Pacific4000

C. & S. America3000

North America2000

1000

Europe

0 1800Source: Marland et al. (2007).

1850

1900

1950

2000

Figure 1.6

World carbon dioxide emissions by region, 18002000

16 9

International handbook on the economics of energy Concluding Remarks

This chapter has tried to provide a very broad perspective on the history of energy use. It focused on the economic forces at work driving trends in energy use, and some of the key technologies that altered these trends. It inevitably ignored many important developments in the history of energy (see Smil 1994 for more detail), yet, it tries to tie the past with the present condition and possible future paths. Humankind started its story as just another animal consuming the fruits of solar energy. Over the last ten thousand years, the human population has managed to achieve radical changes in its ability to harness energy sources, through a series of technological, managerial and institutional transformations. The Agricultural Revolution enabled humans to intensify agricultural productivity and, therefore, the quantity of energy in the form of food. Over thousands of years, a series of major refinements radically increased agricultural productivity and output, which coincided with step-jumps in the population level. The Industrial Revolution allowed humankind to remove the land constraints for non-agricultural energy sources. As a result of numerous technological innovations, the shift from an organic- to a fossil-fuel-based economy first led to a huge growth in the consumption of energy for heating purposes, such as iron and other metals, and then, in the generation of power, transport and light (Nordhaus 1997; Fouquet and Pearson 2006; Fouquet 2008). Central to these developments was the major transformations of the energy system and, in particular, the diversification of energy sources. The large-scale exploitation of coal, petroleum, natural gas, hydroelectricity and uranium and the vast networks of distribution, which began in the nineteenth century and extended to much of the human world in the twentieth century, has led to another leap in energy use. From the beginning of the nineteenth century to the end of the twentieth century, the global economy has managed to harness fifty times more (non-agricultural) primary energy. Given the rise in population, this implies that each person on earth is able to consume eight times more energy (see Figure 1.5). Naturally, there are large differences in per capita consumption, today. For instance, in 2006, the average person in North America consumed about 7 toe of primary energy; a person in India used around half of one tonne. And, despite substantial increases within developing economies lately in China, per capita consumption increased from 0.2 tonnes in 1965 to 1.5 in 2006 a large gap between countries and between regions remains (BP 2007). Yet, at the beginning of the twenty-first century, energy markets need to be considered not only at a local, national or even regional level, but also as a single global entity. As the overall world economy becomes more integrated, so do energy markets. Coal, petroleum and increasingly natural gas and even electricity markets are dependent on the dynamics of demand and supply around the world. It is probable that phases of abundance and scarcity of energy resources that have implied periods of wealth and of strife in individual cities, countries or continents of the past will now affect the whole world. To minimise these periods of strife as well as to address other issues, such as to contain abuses of market power as fewer, larger companies seek to control the global market a single world energy market regulator might be sought.


17

The focus on the world economy is even more pertinent in relation to environmental problems. Waste assimilation of atmospheric pollution acts at a global level. The global rate of pollution is beyond the planets assimilation capacity. This global scarcity is starting to signal the need for unified action. The Kyoto Protocol has begun a process of trading the rights to emit carbon dioxide, closely linking the world energy markets to international tradable permit schemes (Fischer 2005). Perhaps, in a not too distant future, the supply of permits will be dictated by the chairman of a global carbon reserve, whose role it is to manage naturally released and anthropogenic greenhouse gas emissions to stabilise the Earths climate. Since the Agricultural Revolution, the story of humankind has been transformed by its ability to harness energy. Economies and societies have faced a perpetual cycle of abundance and scarcity along a series of stages of rising consumption of energy and its services. Each new phase of scarcity leads to new pressures and outcomes. Today, scarcity in relation to energy acts on two fronts on resources and on pollution assimilation. The pressure (whether market prices or articles from climatologists appearing in newspapers) on the economy or politicians will lead to new outcomes and probably some solutions. These may well be the stepping-stones for the next stage in humankinds ability to harness energy. Note1. I would like to thank John Langdon for drawing my attention to the many papers on the history of energy in Cavaciocchi (2003).

ReferencesBoserup, E. (1965), The Conditions of Agricultural Growth: The Economics of Agrarian Change Under Population Pressure, Allen and Unwin, London. Brimblecombe, P. (1987), The Big Smoke: A History of Air Pollution in London Since Medieval Times, Methuen, London. British Petroleum (BP) (2007), BP Statistical Review of World Energy, available at: http://www.bp.com/productlanding.do?categoryId=6848&contentId=7033471 (accessed 12 July 2008). Campbell, B.M.S. (2003), The uses and exploitation of human power from the thirteenth to the eighteenth century, in Cavaciocchi (ed.), pp. 183212. Carus-Wilson, E.M. (1941), An industrial revolution of the thirteenth century, Economic History Review, 11, 118. Cavaciocchi, S. (ed.) (2003), Economia e Energia, Le Monnier, Florence. Chick, M. (2007), Electricity and Energy Policy in Britain, France and the United States since 1951, Edward Elgar, Cheltenham, UK and Northampton, MA, USA. Church, R. (1987), The History of the British Coal Industry, Vol. 3: 18301913, Clarendon Press, Oxford. Church, R. (1989), Production, employment and labour productivity in the British coalfields, 18301913: some reinterpretations, Business History, 31, 727. Cipolla, C.M (1962), The Economic History of World Population, Pelican Books, London. Cottrell, W.F. (1955), Energy and Society: The Relation Between Energy, Social Change, and Economic Development, McGraw-Hill, London. Cowan, C.W. and P.J. Watson (1992), The Origins of Agriculture, Smithsonian Institute Press, Washington, DC. Etemad, B., J. Luciani, P. Bairoch and J.-C. Toutain (1991), World Energy Production 18001985, Librairie Droz, Geneva. Fischer, C. (2005), Project-based mechanisms for emissions reductions: balancing trade-offs with baselines, Energy Policy, 33(14), 180723. Fouquet, R. (2008), Heat, Power and Light: Revolutions in Energy Services, Edward Elgar, Cheltenham, UK and Northampton, MA, USA.

18


Fouquet, R. and P.J.G. Pearson (2003), Five centuries of energy prices, World Economics, 4(3), 93119. Fouquet, R. and P.J.G. Pearson (2006), Seven centuries of energy services: the price and use of lighting in the United Kingdom (13002000), The Energy Journal, 27(1), 13977. Gales, B., A. Kander, P. Malanima and M. Rubio (2007), North versus South: energy transition and energy intensity in Europe over 200 years, European Review of Economic History, 11(2), 21953. Harley, C.K. (1988), Ocean freight rates and productivity, 17401913: the primacy of mechanical invention reaffirmed, Journal of Economic History, 48(4), 85176. Hatcher, J. (1993), The History of the British Coal Industry, Vol. I, Clarendon Press, Oxford. Hatcher, J. (2003), The emergence of a mineral-based energy economy in England, c.1550c.1850, in Cavaciocchi (ed.), pp. 483504. Hyde, C.K. (1973), The adoption of coke-smelting by the British iron industry, 17091790, Explorations in Economic History, 10, 400407. IPCC (2007), Climate Change 2007: The Physical Science Basis, Contribution of Working Group I to the Fourth Assessment Report of the Intergovernmental Panel on Climate Change, edited by S. Solomon, D. Qin, M. Manning, Z. Chen, M. Marquis, K.B. Averyt, M. Tignor and H.L. Miller (eds), Cambridge University Press, Cambridge, and New York. Jevons, W.S. (1865), The Coal Question, Macmillan, London. Jones, C.L. (1989), Coal, gas and electricity, in R. Pope (ed.), Atlas of British Economic and Social History since 1700, Routledge, London, pp. 6895. Judson, R., R. Schmalensee and T. Stoker (1999) Economic development and the structure of the demand for commercial energy, The Energy Journal, 20(2), 2958. Jupp, P. (2006), The Governing of Britain, 16881848, Routledge, London. Kanefsky, J.W. (1979), The diffusion of power technology in British industry, 17601870, PhD thesis, University of Exeter. King, P. (2005), The production and consumption of bar iron in early modern England and Wales, Economic History Review, 58(1), 133. Langdon, J. (1986), Horses, Oxen and Technological Innovation: The Use of Draught Animals in English Farming from 1066 to 1500, Cambridge University Press, Cambridge. Langdon, J. (2003), The use of animal power from 1200 to 1800, in Cavaciocchi (ed.), pp. 21322. Langdon, J. (2005), Mills in the Medieval Economy: England 13001540, Oxford University Press, Oxford. Maddison, A. (1995), Monitoring the World Economy, OECD Publications, Paris. Maddison, A. (2003), Growth accounts, technological change, and the role of energy in western growth, in Cavaciocchi (ed.), pp. 4360. Malanima, P. (2003), Energy system in agrarian societies: the European deviation, in Cavaciocchi (ed.), pp. 61100. Marland, G., T.A. Boden and R.J. Andres (2007), Global, regional, and national CO2 emissions, in Trends: A Compendium of Data on Global Change, Carbon Dioxide Information Analysis Center, Oak Ridge National Laboratory, US Department of Energy, Oak Ridge, TN. Mitchell, B.R (2003), International Historical Statistics (Volumes 13), 17501988, Macmillan, Basingstoke. Mokyr, J. (1990), Levers of Riches: Technological Creativity and Economic Progress, Oxford University Press, Oxford. Nef, J.U. (1926), The Rise of the British Coal Industry, Vols III, Routledge, London. Newbery, D. (1996), The restructuring of UK energy industries: what have we learned?, in G. MacKerron and P.J.G. Pearson (eds), The UK Energy Experience: A Model or a Warning?, Imperial College Press, London, pp. 130. Nordhaus, W.D. (1997), Do real output and real wage measures capture reality? The history of lighting suggests not, in T.F. Bresnahan and R. Gordon (eds), The Economics of New Goods, Chicago University Press, Chicago, IL. Nye, D.E. (1999), Consuming Power: A Social History of American Energies, MIT Press, Cambridge, MA and London. Reynolds, T.S. (1983), Stronger than A Hundred Men: A History of the Vertical Water Wheel, Johns Hopkins University Press, Baltimore, MD. Rosenberg, N. (1998), The role of electricity in industrial development, The Energy Journal, 19(2), 724. Ruddiman, W.F. (2001), Earths Climate: Past and Future, W.H. Freeman, London. Ruddiman, W.F. (2005), Plows, Plagues and Petroleum: How Humans Took Control of Climate, Princeton University Press, Princeton, NJ and Oxford. Schurr, S. and B. Netschert (1960), Energy in the American Economy, 18501975, Johns Hopkins University Press, Baltimore, MD. Sieferle, R.P. (2001), The Subterranean Forest: Energy Systems and the Industrial Revolution, White Horse Press, Cambridge. Smil, V. (1994), Energy in World History, Westview Press, Boulder, CO.


19

Thorsheim, P. (2002), The paradox of smokeless fuels: gas, coke and the environment in Britain, 18131949, Environment and History, 8, 381401. Unger, R. (1984), Energy sources for the Dutch Golden Age, Research in Economic History, 9, 22152. van den Wouden, A. (2003), Sources of energy in the Dutch Golden Age, in Cavaciocchi (ed.), pp. 44568. van Zanden, J.L. (2003), The ecological constraints of an early modern energy economy: the case of Holland 13501800, in Cavaciocchi (ed.), pp. 101130. von Tunzelmann, G.N. (1978), Steam Power and British Industrialisation until 1860, Clarendon Press, Oxford. Warde, P. (2003), Forests, energy and politics in the early-modern German states, in Cavaciocchi (ed.), pp. 58598. Warde, P. (2007), Energy Consumption in England and Wales (15602000), Consiglio Nazionele delle Ricerche, Istituto di studi sulle Societ del Mediterraneo, Napoli. Wrigley, E.A. (1988), Continuity, Chance and Change: The Character of the Industrial Revolution in England, Cambridge University Press, Cambridge. Yergin, D.H (1991), The Prize: The Epic Quest for Oil, Money and Power, Simon & Schuster, London.

2

The theory of energy economics: an overviewThomas Weyman-Jones

1

Introduction

In reality there is no such subject as energy economics, because energy, although a meaningful concept in the physics or engineering sense, is not a commodity that can be bought and sold in the marketplace. However, individual fuels (primary and secondary electricity, natural gas, oil, coal) can be bought and sold; in this context, primary electricity includes renewable sources and nuclear power. Therefore energy economics is really the economics of fuel markets, and the phrase: energy economics is used for convenience to represent all the useful economic concepts which arise in studying different fuels. The energy industries are organised in different ways in different countries; many are investor owned, especially in the USA and the UK, but state ownership is also common. Many are characterised by economies of scale and hence have considerable market power, which usually leads to them being regulated. Fuels are widely traded in solid, liquid and gaseous form, and are transported all over the world in tankers, pipes and wires. In some of these fuel markets we can see that it is cheaper to have one company do all the business rather than many. Examples are the national power and gas grid companies engaged in the activity of bulk transmission of electric power and natural gas. Such companies are traditionally referred to as public utilities (although there is no presumption that they are or should be owned by the state). Because these companies are believed to operate most cheaply or efficiently when there is only one of them in each market we call them natural monopolies (that is, the traditional public utilities: water, gas, electricity, telecommunications, have the characteristics known as natural monopoly even when they are not statutory monopolies). Consequently there is a wide public interest in the possibility of regulating their behaviour, and the economics of regulation becomes an intrinsic part of energy economics.1 The format of this chapter follows from these fundamental ideas. It begins by looking at the basic economic ideas of resource allocation in capital-intensive fuel industries with emphasis on the nature of costbenefit analysis of fuel investment decisions, and the consequent implications for efficient market pricing. The topics covered here include the nature of short- and long-run marginal cost of energy supply, the process of investment decision making, and the design of efficient price mechanisms in industries where storage of the product is very costly, and in industries where delivery of the product through a grid differs from the economic activity of creating the product. Both of these features are critical characteristics of the energy industries. When such characteristics stem from the fact that the industry delivers its output through a network of wires or pipes, analysts often use the alternative description: network industries. This is followed by a discussion of the market conditions that are frequently found in the fuel industries.

20

The theory of energy economics

21

pIndividual consumer surplus:p1

pq j ( p ) dpp0

Market demand curve aggregate consumer surplus:2 p1 p1 j =1 p0

q j ( p )dp = Q( p ) dpp0

p0p1

qjFigure 2.1

0

qj

1

qj

2

j=1

q j =Q

Individual and aggregate consumer surplus

2

CostBenefit Analysis and Marke

Date post:	16-Apr-2015
Category:	Documents
Upload:	kartheod
View:	778 times
Download:	6 times

International Handbook on the Economics of Energy

Documents