Transcript WP3 Energy Supply Security - Needsproject

Some macro-economic estimates of
Energy Security Externalities
Alistair Hunt
University of Bath
NEEDS FORUM 2
Energy Supply Security – Present and Future
Issues
Krakow, July 5th, 2007.
1
Structure of Presentation

Taxonomy of energy security




Definitions
Welfare effects
Measurement of macroeconomic impacts:
method & results
Outline of Method for measuring impacts on
individuals e.g. risk aversion
2
Definition of Energy Insecurity
Lack of “availability of regular supply of
energy at a reasonable price” (IEA)


Physical availability dimension and price dimension
Long term and short term dimensions



Longer term: will there be enough energy available at an
affordable price in the future?
Shorter term: an unanticipated cut in supply and
corresponding increase in price (sustained or not)
We focus here on short term effects of (supply shock)
insecurity (i.e. 1-2 years after shock).
3
Empirical Evidence: Dimensions of past shocks
Typologies of oil disruptions
• Quantity shocks, related to physical constraints (political and military conflicts, strikes)
• Price shocks, related to producers decision (OPEC) or economic factors (Asian crisis)
• Technology shocks, related to new concepts and ideas, or to new constraints (i.e., an
unanticipated technical advantage of nuclear over oil with the discovery of the climate
change problem) (rare)
Dimensions oil disruptions looking at the past
• Magnitude of supply shortfall: absolute value (4
mb/d limit value of main shocks, 3.2 mb/d IEA
reference value for Emergency Response
System)
• Magnitude of supply shortfall: relative value
(7% reduction in oil supply, as IEA reference
value for Emergency Response System). 2002
world consumption was 76 mb/day
• Variation of oil price (increase of 50%)
• Duration of shocks (maximum 9 months)
Dec 2002
Jun- Jul 2001
Aug 1990- Jan 1991
Oct 1980- Jan 1981
Nov 1978- Apr 1979
Oct 1973- Mar 1974
May 1970- Jan 1971
Jun 1967- Aug 1967
Nov 1956 - Mar 1957
Supply shortfall
0.0
(mb/d)
Venezuelan Strike
Iraqi Oil Export Suspension
Gulf Crisis
Iran-Iraq War
Iranian Revolution
Arab-Israeli War
Lybian Price Controversy
Six-Day War
Suez Crisis
1.0
2.0
3.0
4.0
5.0
4 6.0
Energy Security and Its Impacts
Security
Events
Cuts in
foreign supply
Accidents at
domestic
sources of
supply
Terrorism
Increased
uncertainty in
world
markets
Loss of
Earnings
Employment
Rationing
X
X
Increase
in price
of
energy
XX
X
X
XX
X
X
X
X indicates an effect is likely but could be small
XX indicate effects that are likely to be dominant
Variance
in
Energy
Costs
X
X
XX
Morbidity
Mortality
Main
Sectors
Affected
X
Oil, Gas
X
Hydro,
Nuclear
XX
All
Oil, gas
5
Theoretical Justification for
Public Policy on ES

Individual decisions on production,
consumption and import of energy do not take
account of full social costs (externality)



Disruption of supply has macroeconomic impacts that
individual do not take into account
Producers and importers cannot accommodate the
risks for competitive reasons (e.g. holding of stocks)
Individuals may underestimate the risks of disruption
6
Characterisation of Energy Insecurity
Impacts
Impacts on economy (derived from international
macro models)
Effects of supply shocks to energy markets (price
changes) and indirect / induced effects on other markets
That is … Pecuniary externality – when the actions of one
economic agent affects the welfare of a 3rd party through
changes in price(s).
SR only: assume in LR adjustments take place in amount
of energy related investment & rate of innovation
7
Military Expenditure Associated with
Stabilizing Oil Exporting Areas
Military Expenditures? – we exclude this because:

1.
2.
3.
Military expenditures are cost of mitigating energy
insecurity, not cost of insecurity itself.
Securing oil flows/stabilizing prices is one of a number of
security interests targeted by expenditure. Problem with
apportionment.
Benefits accrue to a large number of countries. Again,
problem with apportionment.
8
Developing Unit Costs
General Methodology



Metric of welfare loss: GDP …. Assess importance of macroeconomic
costs of energy price shocks and, if possible, draw inferences about
potential empirical significance of externality component. These costs
constitute upper bound (After Sanchez (1995)).
Review of empirical literature relating to estimates of macro-economic
costs of energy security (mainly oil import dependence, sustained price
increases).
Convert ‘externality’ to unit value (€ / kWh).
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Empirical Evidence:
Dimensions of past shocks (I)
Some estimates of main direct economic impacts of oil disruptions
 Reduction of GDP growth rate with 1-2 years lag
 Negative balance of payments with maximum 1 year lag
 Reduction of negative effects (especially for GDP growth rate) after 1973 oil
shock due to:
Balance of
Payments
(current
bilUS$)
• More appropriate policy responses
Years
• Consistent reduction of oil consumption
(demand restraint policies)
1973
24.8
6.29
-1.8
1974
217.14
2.2
-7.02
80
8
1975
…
-8.74
-0.11
5.74
70
6
60
1979
98.41
3.58
-27.33
50
1980
4.69
1.97
-35.71
5
-13
0.19
26.03
4
40
3
30
2
20
1989
1990
1991
16.09
24.12
-19.18
4.27
2.73
1.56
-19.41
0.21
-32.43
1
10
1999
36.22
3.8
-66.49
0
2000
62.63
4.42
-52.4
-10
2001
-14.25
1.85
49.13
Real oil price
0
-1
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
US$ barrel
GDP growth rate
7
GDP growth rate (%)
% change of
GDP growth
real price of
rate
imported crude
1981
…
…
…
…
…
…
…
…
…
…
…
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Empirical Evidence:
Dimensions of past shocks (II): EU impacts
Some estimates of main indirect impacts of oil disruptions
 Increase of inflation rate with 1 year lag
 Increase of unemployment rate with 1-3 years lag
 Gradual reduction of negative effects for inflation rate
 Small gradual increase of unemployment rate due to structural conditions of
European labour market
18
7.07
Crude Oil Price
70
11.67
8.11
1983
-12.22
9.78
9.1
EU Unemployment rate
60
1989
16.09
5.7
7.69
1990
24.12
6.53
7.2
1991
-19.18
5.71
7.63
1992
-6.24
4.66
8.51
1993
-14.44
4.02
9.99
8
30
6
20
4
2
10
0
0
1984
5.45
12.93
40
1981
-
13.13
-13
10
1978
10.38
4.69
-12.75
50
1975
98.41
1980
Unempl.
rate
1982
12
1972
1979
Inflation
rate
1981
1987
1990
1993
1996
1999
2002
Oil Price (US$2002 per barrel)
Unemployment/Inflation rate (%)
14
% change
price of
imported crude
80
EU Inflation rate
16
Years
…
1999
…
…
…
36.22
7.54
7.21
11
2000
62.63
1.48
2.8
2001
-14.25
2.97
-
Empirical Evidence: Dimensions of past
shocks (III)
Factors that affect the magnitude of economic costs
 Capacity to anticipate shocks
 Level and duration of the shortfall (and price increase)
 Response of the oil markets (increase of production elsewhere, price volatility)
 Internal oil production and dimensions of strategic stocks
 Specific characteristics at macroeconomic level for immediate impacts:
• Oil intensity of industrial sectors or transport sector (relative
importance to economy)
• Degree of flexibility of the energy sector (fuel-switching capacity)
 Specific characteristics at macroeconomic level for indirect impacts:
• Monetary and fiscal policies (in order to reduce inflation)
• Level of petroleum products taxation
• Degree of flexibility of labour market
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Modelled Estimates of Macro-economic Losses
Source
Year Driver
Barell and Pomerantz (2004)
EU Commission (2004)
Andre et al 2001
World Bank (2000)
Hunt et al 2001
Dieppe and Henry (2004)
2004
2004
2001
2000
2001
2004
50% increase in oil prices
50% increase in oil prices
50% increase in oil prices
50% increase in oil prices
50% increase of oil prices
50% increase of oil prices
Estimate (%)
-0.8
-0.5
-0.4
-0.3
-0.1
-0.1
Units
Devn. from baseline GDP after 1 year
Devn. from baseline GDP after 1 year
Devn. from baseline GDP after 1 year
Devn. from baseline GDP after 1 year
Devn. from baseline GDP after 1 year
Devn. from baseline GDP after 1 year
Country /
Region
Eurozone
Eurozone
Eurozone
World
Eurozone
Eurozone
13
Inter-EU country differences
14
Inter-EU country differences

The role of fiscal and monetary policy responses.

Level and duration of the oil price increase - effects are greater the
more sudden and pronounced the increase in price;

Response of oil market. Whether other suppliers can and do act to
alleviate the impact;

Amount of oil reserves available at the national level

Import dependence

Features of the individual national economy e.g. weight of energy costs
in GDP,

Flexibility of energy sector i.e. capacity to shift from one fuel to another15
Conversion to Unit Costs
Distribution of %
change in GDP
Mean %
reduction in
GDP
Annual World / EU25 GDP averaged
over corresponding
period
Modelling studies
Mean € per kWh
Mean barrels
per day
Corresponding
distribution of
physical supply
shock
Loss in annual
World / EU-25
GDP
Mean kWh per
annum
Conversion
factors
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Approximate ‘Externality’ Unit Value
EU27
GDP loss over 1 year (€)
43,798,143,600
GDP loss over 4 years
175,192,574,400
Original oil consumption (mb/day)
Fall in oil consumption (mb/day)
82.5
3
New oil consumption (mb/day)
79.5
Change in GDP per barrel consumed (1 year loss) (€)
1.5
Change in GDP per barrel consumed (4 year loss) (€)
6.0
Each Barrel is equal to 1648.8 kWhs
Thermal Efficiency
40%
Likelihood of shock
0.2
Cost estimate per kWh - 1year loss (€)
0.002289
Cost estimate per kWh - 4 year loss (€)
0.009154
cost (€/kWh) 1 year loss
0.000458
Cost (€/kWh) 4 year loss
0.001831
Cost proportional to electricity generation (€/kWh)
0.000004
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Possible model refinements




Simplified model of economy that asks ‘what is cost
of event, and what is likelihood of event?’. 
estimates an upper bound to external pecuniary
effects of fall in supply of oil to EU’s electricity
generating sector.
A dynamic model would look at effect of oil supply
shock over time how economy would adjust
Precautionary expenditure e.g. on stockpiling and
using the futures market. Currently exogenous to
model, but models could be developed to capture the
effect of these policies.
Inclusion of risk aversion factors
18
Measurement of value of actions that
result in change in energy security
Two elements of Willingness to Pay
 value economic losses using direct valuation methods

value individual aversion to risk using Contingent
Valuation (i.e. questionnaire).
 e.g. loss due to an act of terrorism


value economic losses from earnings, employment etc.
for each loss, an individual will be WTP something more
than the value of the loss times the probability of the
loss, because s/he is averse to the risk of the event.
This WTP element needs use of CVM methods
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Energy Security and Its Impacts
Security
Events
Cuts in
foreign supply
Accidents at
domestic
sources of
supply
Terrorism
Increased
uncertainty in
world
markets
Loss of
Earnings
Employment
Rationing
X
X
Increase
in price
of
energy
XX
X
X
XX
X
X
X
X indicates an effect is likely but could be small
XX indicate effects that are likely to be dominant
Variance
in
Energy
Costs
X
X
XX
Morbidity
Mortality
Main
Sectors
Affected
X
Oil, Gas
X
Hydro,
Nuclear
XX
All
Oil, gas
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Methods of Estimating Benefits of
Different Energy Security Impacts
Impacts
Direct Valuation
Valuation of Risk Factor
Loss of Earnings
Labour market data
CVM
Rationing
Loss of output
CVM
Increase in Price of Energy Loss of Consumer Surplus
CVM
Variance in Energy Costs
N/A
CVM
Morbidity/Mortality
Value of health endpoints
CVM
N/A: Not available
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Sample of CVM Question
“Suppose a terrorist act has a probability of 1:1000 of occurring, which damages a
hydro plant in the country. The effect of this act in terms of increases in the price of
energy, rationing etc are as follows (list impacts quantitatively). How much would
you be WTP to reduce this risk by 25%, 50%?”
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CVM- Issues

How to make risk change understandable?




Use historic frequencies if possible/relevant?
Increase to e.g. 1:100 risk change and assume
linearity? Maybe realistic if consider more than one
security event together.
Issue of fear/dread distorting rationality -limit
by questionnaire design
Other CVM biases - e.g. free riding - limit
through testing
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Future research directions



Develop macroeconomic externality
estimates from PDF of event sizes
Exploration and derivation of
individuals’ risk aversion to aspects of
energy insecurity
CBA of macro- and micro-policy
responses
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