Transcript 20.Non_renewables

Non-renewable resources &
energy
Economics, management, and
policy
Motivating Group Project
California Renewable Energy
Requirement for Electricity: Legislation
requires that 20% of generation be
from renewables by 2020. How can
this best be achieved?
2003-4 Bren Group Project
Key Characterisics of Nonrenewables
Fixed endowment of given quality
Stock declines over time
For minerals
Costly process of discovery
Costly process of extraction
Technical change decreases costs of exploration and
extraction over time
Key Results
Physical Stocks Decline over time
Price eventually increases with time
Technical change may cause prices to decrease
initially
Time paths
Production ceases;
Substitutes enter
p
tc dominates
exhuast dom
t
Stock
t
Scarcity value of non-renewables
Since limited supply, non-renewable
resource command a “scarcity value”
Problem: You own a barrel of oil. Can
sell today for $30. Should you sell
today, or wait for next year? (r=.05)
Intertemporal Arbitrage: Hotelling’s Rule
Price today: p0
Price tomorrow: p1
If p1>$31.5, wait
If p1<$31.5, sell today
In equilibrium:
p1=p0(1+r)
Hotelling “rent”
Prices should rise at rate of interest. If think
they won’t, firms would deplete reserves
today.
What about extraction costs?
Rt = Pt – MCt implies Rt+1 = Rt(1+r)
Also called “user cost”, “royalty”, “rent”
Hotelling: It is actually rent which rises at rate
of interest
Present value of rents equal through time.
Indifferent between selling barrel today or any
point in future.
What about quantity extracted?
Recall demand curve:
If price increases through time,
quantity must decrease.
$
D
Barrels of oil
Confounding factors:
1. Shifts in demand
2. New discoveries
3. New extraction technology
4. Backstop technology
Prices and quantities over time
Seek: Price path that follows Hotelling Rule, such that stock is
just exhausted when quantity demanded drops to zero
Price
Quantity
Produced
time
time
Switching to a “backstop”
Backstop technology: a perfect
substitute for non-renewable resource
that can be produced in any amount at
constant (usually high) price.
When price of non-renewable = price of
backstop, we’ll switch.
The effect of a backstop technology
$
Question: If you know backstop price
And stock of resource, how do you
Find initial price?
MCb
Price path with
backstop
time
Other factors that affect price
path: with a backstop technology
Decreasing extraction cost:
Lower price initially, then rises more quickly
Sudden increase in demand:
Price jumps suddenly
Monopoly:
Price higher but rises more slowly, but extraction
is slower so extends life of the resource.
The monopoly case
Price
Quantity
Monopoly
MCb
Time
Time
What do they mean when they say “A monopolist is a conservationist’s best friend”?
Are we running out of resources?
Physical measures of “scarcity”
Reserves: known amount that can be profitably
extracted.
Changes with tech, discoveries, cost, price.
Inventory ~ constant through time
Reserves/Production:
Assumes constant demand
Crustal abundance: total amt in crust.
Ignores cost of extraction
Ultimately recoverable: total to 1 km depth
Arbitrary, different for all resources, no new tech.
Economic measures of “scarcity”
Marginal cost of extraction:
likely to increase as stock decreases, but ignore price
Price:
Ignores extraction cost.
Hotelling rent:
Difficult to observe, but probably best measure of scarcity.
Confounding factor:
Technology of extraction continues to improve
Studies of Scarcity
Barnett and Morse (Scarcity and Growth)
Looked at natural resource prices over 100 yrs
Nearly all resources getting less scarce
Timber only exceptin
Slade
Extraction tends to drive price up
Technological change tends to drive price down
Eventually exhaustion overcomes tech change
Simon-Ehrlich Bet
Question: If we made the same bet today, who
would be on Ehrlich’s side and who on Simon’s?
Subsidizing renewable energy
Remember our model: Price of non-
renewable rises until it reaches price of
backstop.
If extraction cost = 0, extract all nonrenewable before switching (more likely,
won’t extract all of it).
If MCb decreases from subsidy, current price
of oil will decrease, and consumption of oil
will increase.
The effect of decreasing MCb
Price path with
high backstop price
MCb0
MCb1
Price path with
low backstop price
time
Comparing the two policies
Taxing the thing that causes damage (oil
consumption) can internalize externality.
Subsidizing renewables may have
unintended consequence of pushing
consumption of fossil fuels to the
present!
Principle of targeting: design regulation
or policy to target (internalize) the
externality.
OPEC
Organization of petroleum exporting
countries
Algeria, Indonesia, Iran, Iraq, Kuwait, Libya,
Nigeria, Qatar, Saudi Arabia, United Arab
Emirates, Venezuela
Controls most of world oil production.
Maintain low production to keep prices
(profits) high.
Why would prices ever drop?
The “Prisoner’s Dilemma”
Saudi Arabia
cooperate
cooperate
defect
30
30
40
5
Kuwait
5
defect
40
10
10
Maintaining cooperation
An example of a “Nash Equilibrium” –
both countries do what is in their best
interest given what the other does.
Defecting from the original agreement is a
dominant strategy for both countries.
Intuitively, incentive to cheat (by
overproducing) is very high.
Because other countries restrict output to
keep prices high.