REM 350: Sustainable Energy & Materials Management

1. REM 350:Sustainable Energy & Materials Management Economics & Pricing Mark Jaccard Energy and Materials Research Group School of Resource and Environmental Management Simon Fraser University Jaccard-Simon Fraser University

2. Coverage Pricing of energy & commodities – differential rent, scarcity rent, monopoly rent Natural monopoly market failure – economies-of-scale, economic regulation and non-linear pricing Externality market failure – pricing environmental damages & risks Public good market failure and common property resources Costing energy efficiency (dematerialization) – LCC, rebound effect Costing renewables (transmaterialization) – non-dispatchable energy Jaccard-Simon Fraser University

3. Pricing of energy & commodities Competitive markets and price determination – supply and demand Economic rent – returns above the level necessary to invest. Three types are differential, scarcity and monopoly rent. Differential rent (Ricardian rent) – economic rent earned by the producer of a resource because of lower production costs relative to the highest cost producer in the market Scarcity rent (Hotelling rent) – economic rent earned by the producer of a non-renewable resource if the market price reflects anticipation of future high prices caused by scarcity Monopoly rent – economic rent earned by an unregulated monopoly producer (usually only a short-run phenomena) What determines the price of oil? Copper? Phosphate? Water? Food? Jaccard-Simon Fraser University

4. Market price and differential / scarcity rent If market price here ( rent=D+S) S = scarcity rent D = differential rent S If market price here (rent=only D) D Marginal producer $/unit Inframarginal producers If quantity demanded is here Quantity (units) Jaccard-Simon Fraser University

5. Oil price: real and nominal Jaccard-Simon Fraser University

6. Natural gas price by region Jaccard-Simon Fraser University

7. Competitive markets and human welfare Assumption that competitive markets enable consumers to allocate consumption to maximize their welfare and force producers to be economically efficient – getting the most out of productive inputs. These conditions may not occur for various reasons: * Consumer choice restricted by government * Monopoly or oligopoly in production * Government subsidies to production or consumption * Market failures – natural monopoly, negative externality, public good Focus in this course on market failures: cases where markets will not maximize welfare without government intervention. Jaccard-Simon Fraser University

8. $110 billion in FF subsidies in 2012 Jaccard-Simon Fraser University

9. Market failure: natural monopoly Natural monopoly – cost of production in an industry is lowest with only one firm, so it is in society’s interest to establish a monopoly (due to extreme economies-of-scale, one large firm can serve the entire market at lower average costs than two competing firms) Policy solution – create either a private monopoly and regulate it or create a publicly-owned monopoly (and perhaps regulate). The monopoly is called a utility and its regulator a utilities commission. Jaccard-Simon Fraser University

10. Setting regulated prices with a natural monopoly Non-linear pricing – charging different prices for consumption of different quantities and at different times (includes time-of-use pricing and block pricing), but setting average prices to prevent monopoly rents (regulated monopoly only earns normal returns) Time-of-use pricing – different prices at different times of day or different seasons to reflect cost of providing energy and capacity at specific times Block pricing (stepped rates) – charging block prices that rise or fall to reflect rising or falling costs with increases in supply Jaccard-Simon Fraser University

11. Load duration curve and time-of-use pricing Peaking plants Load-following plants MW of capacity Baseload plants 8763 hours Hours Jaccard-Simon Fraser University

12. Fossil fuels Jaccard-Simon Fraser University

13. California residential electricity rate: PG&E 2014 Jaccard-Simon Fraser University

14. Technical change & natural monopoly conditions Technical change can undermine natural monopoly conditions. Policy-makers need to decide if a regulated natural monopoly is the best market structure. Are telephone land-lines a natural monopoly? Is the electricity sector a natural monopoly? Is the provision of space heating to groups of buildings or a city centre a natural monopoly? Jaccard-Simon Fraser University

15. Electricity sector reform? vertically-integrated monopoly reformed market structure competing producers generation transmission transmission monopoly distribution distribution customers customers Jaccard-Simon Fraser University

16. Market failure: negative externality Negative environmental externality – a harm or risk from production or consumption of a good that is not included in its price * usually occurs where property rights are not well-defined, as with common property resources like air, ocean, atmosphere; * result is to under-price the good Policy solution – charge producer the monetary value of the harm (taxes, tradable permits), which will increase the market price. Sometimes regulations can produce a similar outcome. How do we estimate a monetary value for the externality? Jaccard-Simon Fraser University

17. Pricing a negative externality Sm = market supply Ss = social supply Ss P Sm Ps Pm Externality D Qs Qm Q Jaccard-Simon Fraser University

18. Estimated externality damage costsfor electricity Source: Zycher c/kWh Jaccard-Simon Fraser University

19. Social cost of carbon Estimate of incremental damages of an extra unit of carbon pollution in future time periods, or the discounted sum of incremental damages. Zycher’s estimate for electricity includes a value for carbon pollution (something like $10-$20 / t CO2) Nordhaus (Yale) has made estimates like this, but his latest estimates are rising significantly over time. US Environmental Protection Agency estimates $40-$60. Chris Hope (Cambridge) estimates $110 today. British Columbia carbon tax is $30 Cdn / to CO2. Why? Jaccard-Simon Fraser University

20. BC Carbon tax rates by fuel 2012 Jaccard-Simon Fraser University

21. Demand for taxed fuels Jaccard-Simon Fraser University

22. GHG / capita from taxed fuels Source: GHG emissions data from Environment Canada, National Inventory Report; population data from Statistics Canada. Years beginning Jan. 1. *Excludes aviation, fugitive emissions, and electricity & heat generation GHG emissions Jaccard-Simon Fraser University

23. Ontario bans electricity from coal: % Jaccard-Simon Fraser University

24. Ontario % electricity generation in 2012 Jaccard-Simon Fraser University

25. Cal renewable mix: past & forecast Jaccard-Simon Fraser University

26. US energy consumption Jaccard-Simon Fraser University

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29. Market failure: public goods Public good – good or service of value to society, characterized by non-exclusivity and non-rivalry – hence underprovided by private markets (eg, lighthouse, national defense, pristine nature park, information) (public goods characterized by positive externalities) Common property resource – natural resource that is characterized by non-exclusivity and rivalry (eg, ocean fishery, air, atmosphere) (common property resources characterized by negative externalities) Policy solution – governments manage / regulate common property resource use or create enforceable property rights; governments must provide public goods, collecting the necessary funds from society or obligating participation by all (no free riders) Is the climate change risk a common property resource or public good? Jaccard-Simon Fraser University

30. Market failure: public goods Jaccard-Simon Fraser University

31. Energy efficiency:market failure or normal competitive market? Must energy use track economic output? Does improvement in energy efficiency increase welfare? How do we answer these questions? Jaccard-Simon Fraser University

32. US GDP and elec growth rates Jaccard-Simon Fraser University

33. Regulation and ave. fridge in California Jaccard-Simon Fraser University

34. Costing energy efficiency(dematerialization) Dematerialization – reducing E&M throughput for a given level of energy services; “energy efficiency” is simply “energy dematerialization,” (a strange-sounding term) Calculation Method • Compare a conventional technology with a higher efficiency alternative providing the same service. • Divide extra capital cost of efficient technology by its discounted energy savings = life-cycle-cost (LCC) of efficiency (¢/kwh). • Graph estimated total energy savings (each service) in ascending order of cost to produce steps of dematerialization (efficiency) cost curve. • Initial steps could have negative costs; all steps costing less than utility rates are privately profitable; all steps costing less than new energy supply are socially profitable. Jaccard-Simon Fraser University

35. Cost of electricity: Life-cycle-cost of a dam Cost = Inv Annual production Lifespan = n Dam $1 million 2000 MWh/yr 50 years Interest / discount rate (i) = 10% (.1) CRF = capital recovery factor CCR = capital charge rate (annualized capital cost) = 0.1 CCR = INV * CRF = $1 mill * .1 = $100,000/yr. ($100,000/yr.) / (2000 Mwh/yr.) = 5 ¢ / kWh Jaccard-Simon Fraser University

36. Life-cycle-cost of efficiency: choice of fridge Discount rate = 10% Cost Annual consumption Lifespan Fridge A $1,100 840 kWh 10 years Fridge B $1,000 1,380 kWh 10 years = 0.163 CCR = INV * CRF = $100 * 0.163 = $16.30/yr. ($16.30/yr.) / (540 kwh/yr.) = 3 ¢ / kWh To know if we should invest in the fridge or in new supply, we can compare the life cycle costs of new electricity with improved efficiency. Jaccard-Simon Fraser University

37. Financial least-cost curvefor energy efficiency $ / kWh delivered cost from new generation 5¢ / kWh electricity rates efficient building shell 4¢ / kWh 3¢ / kWh cost of efficient fridge electricity savings efficient motors efficient light bulbs 0 electricity saved Jaccard-Simon Fraser University

38. Integrated resource planning & demand-side management Integrated resource planning (IRP) – comparing, on an equal basis, investments and actions to produce more of a commodity (energy in this case) or consume it more efficiently to meet a given service Demand-side management (DSM) – measures to influence the timing or amount of demand for a commodity (energy in this case) Can the IRP / DSM approach apply to dematerialization of materials and other services? (eg, personal transportation, information services, use of paper, electronic hardware, other?) Jaccard-Simon Fraser University

39. Integrated resource planning curve $ / kWh large hydropower supply 5 biomass supply efficient lightbulbs 3 cogeneration supply efficient fridges small hydropower supply efficient motors electricity generated or saved Jaccard-Simon Fraser University

40. Least-cost method to estimate GHG abatement cost curves Compare a conventional technology with a lower emission alternative for the same service. Calculate present value of capital and operating costs of both technologies. Take the difference in these costs and divide by the difference between emissions = cost of abatement ($/tonne of CO2). Graph estimated total emissions reductions (each service) in ascending order of cost to produce abatement cost curve. Initial steps could have negative costs, meaning profits + GHG abatement (“win-win”, “no regrets”) Jaccard-Simon Fraser University

41. GHG abatement cost curve: McKinsey energy efficiency dominant Jaccard-Simon Fraser University

42. Issues with efficiency cost curves Efficiency cost curves were popular 30 years ago and GHG abatement cost curves already 20 years ago. They fell out of favor with most energy-economy analysts, who argued these curves mislead about costs and are unhelpful with policy. Yet these cost curves have recently re-emerged in GHG abatement policy discussions. The McKinsey consulting company has produced these for the US and other countries. Important to remember that the curves fell out of favor because they do not include: (1) the full costs of the more efficient option, which is rarely a perfect substitute, and (2) estimate of rebound effect after efficiency occurs Jaccard-Simon Fraser University

43. Estimating the full cost of the efficient option Quality of service assumed identical. But some technologies provide (or are perceived to provide) lower quality service – a concern with new technologies especially (e.g., efficient light bulbs, transit vs personal vehicles) Risk assumed identical. But: (1) long payback investments usually higher investment risk, and (2) new technologies usually higher failure risk. Incorporating this risk usually causes higher “expected cost” for high efficiency / low emissions technologies. Jaccard-Simon Fraser University

44. Correction for expected cost $ / kWh ordering could also change expected cost higher 0 electricity saved Jaccard-Simon Fraser University

45. McKinsey vs “corrected” estimate 300 Corrected abatement cost curve 200 $/tCO2 McKinsey abatement cost curve 100 0 1 2 3 4 Gigatonnes CO2 abated -100 Jaccard-Simon Fraser University

46. Estimating the rebound effect Standard energy efficiency analysis ignores rebound effects. direct rebound – increased efficiency that lowers the operating cost of an energy service (car travel) stimulates an increased demand indirect rebound – profitable energy efficiency increases consumer income (and if occurring also in industry) lowers the costs of goods and services – both of which increase demand for goods and services, with associated increased energy use productivity and innovation rebound – energy efficiency fosters innovations in related products and new services (e.g., fridge efficiency => wine cooler, beer cooler, water cooler, desk-top fridge, mini-freezer, etc.) Jaccard-Simon Fraser University

47. Service cost and service demand:UK lighting (1800 – 2000) Energy service demand = f (GDP, service cost, other?) Source: Fouquet and Pearson, The Energy Journal, 2006 Jaccard-Simon Fraser University

48. Trends in human preferences Efficiency policies have produced important improvements in energy efficiency of major durable goods (major appliances, vehicles, industrial equipment), but the rate of development of new devices is accelerating which collectively (and sometimes individually) use a lot of energy This demand for energy from the energy service, often called “other,” is driven by (1) rising incomes, (2) shifting consumer preferences, and (3) innovations that in part benefit from efficiency gains (hence partially a rebound effect) Jaccard-Simon Fraser University

49. US data for “other” household devices - number Steve Groves, SFU – 2009 Jaccard-Simon Fraser University

50. “Other” household devices – electricity consumption Steve Groves, SFU – 2009 Jaccard-Simon Fraser University