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2017

WP-2017-012

Black Carbon Problems in Transportation: Technological Solutions and Governmental Policy Solutions

The adverse effects of black carbon (BC) emissions from diverse sources are significant in human and economic terms. BC emissions are a public health problem, as they annually cause premature deaths on the order of millions worldwide. BC also has detrimental effects on food supplies, with crop production reduced by millions of tonnes per year. In addition, BC has significant climate change consequences, with a Global Warming Potential per tonne on the order of thousands of times greater than carbon dioxide’s over a 20-year period; in terms of total global warming impact, BC is second after carbon dioxide and thus greater than other greenhouse gases, including methane. Emissions mitigation technologies and government policies offer potential health, food and climate co-benefits. Within the transportation sector, there are many technologies and policies that can mitigate BC emissions; for example, inter-modal transfers of diesel particulate filter (DPF) technology from motor vehicles to maritime shipping offer a promising BC mitigation path. BC not only poses significant tangible technological issues; it also poses important political-economy conceptual issues with practical implications for industry and government policymaking. First, because of its short atmospheric lifetime average of about one week and concentrated localized depositions, BC poses “local-commons” and “regional-commons” problems as well as “global-commons” problems. Second, because of its localized and regionalized multiple negative externalities, BC challenges the economic efficiency rationale for one-policy-instrument-per-goal. The BC policy agenda thus extends over many levels of governance, and it entails a wide range of policy instruments. The multiplicity of policy instruments at multiple levels of governance are reflected in the assessment of existing policies and in the diversity of recommendations for further policymaking and research: (1) BC emission measurement deficiencies for motor vehicles and aviation need to be corrected, and a maritime shipping protocol in the International Maritime Organization should be finalized and adopted. (2) In addition to on-road motor vehicles, local BC emission reduction initiatives should be adopted, especially in large cities with seaports and airports. These programs should encompass all diesel engine sources of BC in maritime shipping and aviation port infrastructure areas, including off-road vehicles, loading/unloading equipment, and diesel locomotives. (3) Mitigating BC emissions should be an urgent objective in the International Civil Aviation Organization (ICAO) and International Maritime Organization (IMO). (4) Technology transfer issues, including transfers of diesel particulate filter technologies in motor vehicles and maritime shipping, should be included on the agenda of the Technology Mechanism of the UNFCCC. (5) All maritime shipping Emission Control Areas (ECAs) should include BC emission limits. (6) An Arctic Black Carbon Agreement in the form of a “carbon club” should be developed. (7) Annual COP meetings and other activities of the UNFCCC should expand recognition that BC mitigation can be included in countries’ Nationally Determined Contributions. (8) The prevailing climate change paradigm should be revised.

Key words: Black Carbon; Soot; Carbon Clubs; Paris Agreement.

JEL classification: F13; F18; O38; Q54; Q58.

WP-2017-011
Bruno Lanz, Jules-Daniel Wurlod, Luca Panzone, and Timothy Swanson, June 2017

The Behavioral Effect of Pigovian Regulation: Evidence from a Field Experiment

Pigovian regulation provides monetary penalties/rewards to incentivize prosocial behavior, and may thereby trigger behavioral effects beyond a more standard response associated with a change in relative prices. This paper quantifies the magnitude of these behavioral effects using data from an experiment on real product choices together with a structural model of consumer behavior. First, we show that information about external effects (products’ embodied carbon emissions) triggers voluntary substitution towards cleaner alternatives, and we estimate that this effect is equivalent to a change in relative prices of GBP30.69-165.15/tCO2. Second, comparing a Pigovian intervention (GBP19/tCO2) with a neutrally-framed price change of the same magnitude, we find a negative behavioral effect associated with regulation. Compensating this bias would require increasing the Pigovian price signal by up to 48.06/tCO2. Finally, based on a cross-product comparison, we show that the magnitude of behavioral effects declines with substitutability between clean and dirty product alternatives, a measure of effort to reduce emissions.

Keywords: Externalities; Pigovian regulation; Consumer behavior; Information; Field experiments; Environmental policy.

JEL Codes: C93; D03; D12; H23; Q58.


WP-2017-010

Modeling Unit Commitment in Political Context: Case of China’s Partially Restructured Electricity Sector

Restructuring an electricity sector entails a complex realignment of political and economic institutions, which may both delay and distort the achievement of satisfactorily competitive conditions. In research and planning for policy interventions in power systems under these varied regulatory environments, typical operational models may neglect important interactions between techno-economic criteria and political constraints, leading to poor understanding of underlying causes of inefficiency and to inappropriate recommendations. We develop tractable formulations of the unit commitment problem based on integer clustering of similar units that endogenize important political factors in the Northeast grid region of China. We demonstrate the importance of these interactions on operations and provide a set of options for researchers to explore further pathways for China’s ongoing power system reforms. For example, wind integration, a key policy priority, is inhibited by the interaction of institutions limiting short- and long-term sources of flexibilities in inter-provincial trade.

WP-2017-009

Early Nuclear Retirements in Deregulated U.S. Markets: Causes, Consequences and Policy Options

Electricity prices have fallen significantly since 2008, putting commercial nuclear reactors in the United States under substantial financial pressure. In this market environment driven by persistently low natural gas prices and stagnant electricity demand, we estimate that about two thirds of the 102 GW nuclear capacity are uncompetitive over the next few years under the current trajectory. Among those, 18 GW are retiring or are merchant plants at high risk of retiring prematurely.

The potential consequences of the hypothetical withdrawal of 20 GW of nuclear capacity include: 1) a ~3.2% increase in carbon emissions of the power sector if replaced by gas-fired units or 2) a significant increase in cost if replaced by renewables.

Without a carbon price, out-of-the-market payments would be needed to effectively maintain merchant nuclear capacity. Filling the revenue gap would come at a fleet-average cost of $3.5-5.5/ MWh for these plants, which is much lower than the cost of subsidizing wind power. The policy support could take the form of direct zero-emission credits, renewable portfolio standard expansion, or clean capacity market mechanisms. As a last resort, the exercise of a new mothballing status could prevent the irreversible retirement of nuclear power assets.

WP-2017-008

Are Consumers Poorly-Informed about Fuel Economy? Evidence from Two Experiments

It has long been argued that people are poorly-informed about and inattentive to fuel economy when buying cars, and that this causes us to buy low-fuel economy vehicles despite our own best interest. We test this assertion by running two experiments providing fuel economy information to people shopping for new vehicles. We find zero statistical or economic effect of information on average fuel economy of vehicles purchased. In the context of a simple optimal policy model, the estimates suggest that imperfect information and inattention are not valid as significant justifications for fuel economy standards at current or planned levels.

JEL Codes: D12, D83, L15, L91, Q41, Q48.

Keywords: Behavioral public economics, fuel economy standards, eld experiments, information provision.

WP-2017-007
Sergio L. Franklin Jr. and Robert S. Pindyck, March 2017

Tropical Forests, Tipping Points, and the Social Cost of Deforestation

Recent work has suggested that tropical forest and savanna represent alternative stable states, which are subject to drastic switches at tipping points, in response to changes in rainfall patterns and other drivers. Deforestation cost studies have ignored the likelihood and possible economic impact of a forest-savanna critical transition, therefore underestimating the true social cost of deforestation. We explore the implications of a forest-savanna critical transition and propose an alternative framework for calculating the economic value of a standing tropical forest. Our framework is based on an average incremental cost method, as opposed to currently used marginal cost methods, for the design of optimal land-use policy or payments for ecosystem services. We apply this framework to the calculation of the social cost of deforestation of the Amazon rainforest.

JEL Classification Numbers: Q5, Q57, C6

Keywords: Deforestation, critical transition, tipping points, social cost, incremental cost, catastrophic environment change, Amazon rainforest.

WP-2017-006

When Do States Disrupt Industries? Electric Cars in Germany and the United States

The literature on the developmental state suggests that state structure determines the ability of governments to drive technological change. This article argues that in mature industries systems of interest intermediation shape the state’s capacity for sectoral intervention. In corporatist developmental states, industry and government coordinate technological transformations in consensus-driven negotiations. Such coordination prioritizes the interests of incumbent firms, resulting in weak policy intervention. In pluralist developmental states, competition among interest groups and state agencies allows policymakers to organize coalitions of technology challengers in support of technological change, leading to strong policy intervention. We examine our argument in the context of electric vehicle policy in Germany and the United States. While Germany failed to disrupt its auto industry, the United States adopted comprehensive policy for the manufacturing and commercialization of electric cars. Our findings suggest that, counter to conventional wisdom, pluralist states can effectively engage in sectoral intervention in mature industries.

WP-2017-005

A Green Bargain? The Impact of an Energy Saving Program on Productivity Growth in China’s Iron and Steel Industry

The impact of environmental regulation on firm productivity has been long been debated, however, mainly for western economies and with limited firm-level evidence. We study the impact of a large-scale national energy saving program (the Top 1000 Energy-Consuming Enterprises Program, or T1000P, 2006-2010) in China on firm productivity in the iron and steel industry. The T1000P assigned targets for reducing the energy consumption of approximately 1000 most energy-consuming industrial firms. Using detailed data from the China Industrial Census on 5,340 firms for the period of 2003 to 2008, we estimate a positive effect of the T1000P on firms in the iron and steel industry. Specifically, we find T1000P firms are associated with significantly greater annualized TFP change (an increase of 3.1 percent on average), suggesting the competitiveness of treated firms increased. Effects on technical change and scale efficiency change are positive and statistically significant, and contribute about equally to the overall treatment effect. Results are robust to instrumenting for policy exposure and other alternative specifications. Private benefits to firms from the policy likely reflect the combination of incentives and targets applied under the program.

Keywords: Total factor productivity, China, Iron and steel industry, Environmental regulation, Policy evaluation

JEL classification: C23, C26, C51, D04, D22, D24, L50, L61, Q52

WP-2017-004
Katherine Rittenhouse and Matthew Zaragoza-Watkins, February 2017

Anticipation and Environmental Regulation

When agents expect a regulation to change the relative price of new equipment, they may shift purchases forward to avoid compliance costs. In the context of new-vehicle emission standards, prior analyses have not considered this adjustment margin. We model the effects of anticipation on freight-truck sales and retirements, and test our theory's predictions empirically. Consistent with our predictions, we find evidence that anticipation caused a sales spike just before new emission standards took effect and a sales slump after implementation. Our findings have important implications for analysis of markets where agents can shift purchases in anticipation of new regulation.

JEL: C41, D92, Q58

WP-2017-003
John Birge, Ali Hortaçsu, Ignacia Mercadal, and Michael Pavlin, January 2017

Limits to Arbitrage in Electricity Markets: A Case Study of MISO

As in most commodities markets, deregulated electricity markets allow the participation of purely financial traders to enhance informational and productive efficiency. The presence of financial players is expected, among other things, to help eliminate predictable pricing gaps between forward and spot prices, which may arise in the presence of market power and are linked to productive inefficiency. However, we find that the impact of financial players on reducing pricing gaps has been limited, even using credibly exogenous variation in financial activity to address potential endogeneity. A forward premium persists. We show that financial traders effect on the premium was limited by two barriers. First, arbitrageurs do not have unlimited access to capital. Trading was reduced during the financial crisis, when capital availability was restricted. The second is regulation, as high transaction costs imposed by the regulator restricted arbitrage. Moreover, during this period we observe that some financial players appear to be betting in exactly the opposite direction of the pricing gap, sustaining large losses while doing so. We find evidence consistent with participants using forward market bids to affect congestion and thus increase the value of their Financial Transmission Rights (FTR), i.e. these financial players incur losses with one financial instrument to make larger profits with another, introducing artificial congestion to the system.

WP-2017-002

Wind Capacity Investments: Inefficient Drivers and Long-Term Impacts

A pure energy-only market has been shown, under certain conditions, to create the optimal incentives for market entry and exit. This research extends these results to the case of potential entrants with variable and non-controllable production, such as wind generators. The research shows how the stochasticity of the wind resource implies a trade-off between sites with higher capacity factors and higher covariance with prices at the efficient frontier. The analysis suggests that the Production Tax Credit (PTC), along with some capacity mechanisms, bias wind investment towards high-producing sites but with lower covariance of their variable output with market prices. Furthermore, since wind production depresses prices, this bias is linked to covariance between wind sites. Fixed-price support mechanisms like the PTC lead to market equilibriums with higher levels of wind correlation. The long-run effiects of correlation in the wind investment portfolio in a theoretical market are somewhat nuanced, depending on the nature of the joint distribution of wind availability; they may be incorrectly interpreted in the usual discourse.

WP-2017-001

Estimating The Future Supply of Shale Oil: A Bakken Case Study

We propose a new way to estimate the remaining volume of recoverable shale oil resources in the U.S. Our method applies the principle of “successive sampling without replacement” to derive from historical drilling data maximum likelihood estimates of the number and productivity of remaining drilling sites. Unlike existing techniques, this approach identifies the portion of “technically recoverable” resources that can be developed economically at alternative price levels. For the Bakken, we estimate that 50% of remaining technically recoverable resources—roughly 8 billion barrels—could be developed if the oil price remains near $50/barrel.

JEL Codes: L71, Q35, Q41
Keywords: shale oil supply, MLE, drilling productivity, sequential sampling

2016

WP-2016-016
Lucas W. Davis and Christopher R. Knittel, December 2016
Abstract   |   Full Paper [PDF]

Are Fuel Economy Standards Regressive?

Despite widespread agreement that a carbon tax would be more efficient, many countries use fuel economy standards to reduce transportation-related carbon dioxide emissions. We pair a simple model of the automobile automakers' profit maximization problem with unusually-rich nationally representative data on vehicle registrations to estimate the distributional impact of U.S. fuel economy standards. The key insight from the model is that fuel economy standards impose a constraint on automakers which creates an implicit subsidy for fuel-efficient vehicles and an implicit tax for fuel-inefficient vehicles. Moreover, when these obligations are tradable, permit prices make it possible to quantify the exact magnitude of these implicit subsidies and taxes. We use the model to determine which U.S. vehicles are most subsidized and taxed, and we compare the pattern of ownership of these vehicles between high- and low-income census tracts. Finally, we compare these distributional impacts with existing estimates in the literature on the distributional impact of a carbon tax.

Key Words: CAFE Standards, Gasoline Tax, Carbon Tax, Distribution of Income
JEL: D31, D62, H23, Q38, Q41, Q48

WP-2016-015
Raina Gandhi, Christopher R. Knittel, Paula Pedro, and Catherine Wolfram, July 2016
Abstract   |   Full Paper [PDF]

Running Randomized Field Experiments for Energy Efficiency Programs: A Practitioner’s Guide

Researchers and professional evaluators are increasingly turning to randomized field experiments to evaluate energy efficiency programs and policies. This article provides a brief overview of several experimental methods and discusses their application to energy efficiency programs. We highlight experimental designs, such as randomized encouragement and recruit-and-deny, that are particularly well suited for situations where participation cannot be enforced. The article then discusses several implementation issues that can arise and characterizes applications that are a good fit for a randomized experiment. We also address the most common objections to field experiments, and share the best practices to consider when designing and implementing a field experiment in this space.

WP-2016-014
Christiane Baumeister and Lutz Kilian, October 2016

Lower Oil Prices and the U.S. Economy: Is This Time Different?

We explore the effect on U.S. real GDP growth of the sharp and sustained decline in the global price of crude oil and hence in the U.S. price of gasoline after June 2014. Our analysis suggests that this decline produced a cumulative stimulus of about 0.9 percentage points of real GDP growth by raising private real consumption and non-oil related business investment and an additional stimulus of 0.04 percentage points reflecting a shrinking petroleum trade deficit. This stimulating effect, however, has been largely offset by a large reduction in real investment by the oil sector. Hence, the net stimulus since June 2014 has been close to zero. We show that the response of the U.S. economy was not fundamentally different from that observed after the oil price decline of 1986. Then as now the response of the U.S. economy is consistent with standard economic models of the transmission of oil price shocks. We found no evidence of an additional role for frictions in reallocating labor across sectors or for increased uncertainty about the price of gasoline in explaining the sluggish response of U.S. real GDP growth. Nor did we find evidence of financial contagion, of spillovers from oil-related investment to non-oil related investment, of an increase in household savings, or of households deleveraging.

JEL codes: E32, Q43

Key Words: Stimulus; oil price decline; uncertainty; reallocation; savings; shale oil; oil loans.

WP-2016-013

Socialism for Red States in the Electric Utility Industry

TVA and the other federal electric utilities were created under Democratic administrations, and their service territories were initially bluer than average. These subsidized enterprises sell cheap power preferentially to non-investor-owned distributors, so such utilities are more prominent where the federal utilities are important sellers. The political map of the U.S. has changed dramatically since the federal utilities were created. The federal utilities and non-investor-owned distributors are now more important on average in red states than in blue ones. Interest has trumped ideology: Republican policy-makers strongly opposed to socialism in principle seem happy with the important role of government enterprises in the U.S. electric utility industry.

JEL: L32, L94, N72, Q48, H42

WP-2016-012
Robert L. Kleinberg, Sergey Paltsev, Charles K. Ebinger, David Hobbs, and Tim Boersma, August 2016
Abstract   |   Full Paper [PDF]

Tight Oil Development Economics: Benchmarks, Breakeven Points, and Inelasticities

When comparing oil and gas projects - their relative attractiveness, robustness, and contribution to markets - various dollar per barrel benchmarks are quoted in the literature and in public debates. Among these benchmarks are a variety of breakeven points (also called breakeven costs or breakeven prices), which are widely used, and widely misunderstood. Misunderstandings have three origins: (1) There is no broadly accepted agreement on definitions; (2) for any given resource there is no universally applicable benchmark; (3) various breakeven points and other benchmarks are applicable at various times in the development of a resource. In this paper we clarify the purposes of several benchmarks and propose standardized definitions of them. We show how and why breakeven points are partitioned, and when each of the partitioned elements is appropriate to consider. We discuss in general terms the geological, geographical, and temporal factors that affect the benchmarks. We describe some other factors that contribute to the inelasticity of tight oil production. Finally, we explore macroeconomic and policy implications of a broader, more rigorous, and more consistent application of the breakeven point concept, and the understanding of the inelasticities that accompany it.

Keywords: breakeven points, tight oil, cost of production, production decline profiles

WP-2016-011
Fitsum G. Tiche, Stefan E. Weishaar, and Oscar Couwenberg, August 2016
Abstract   |   Full Paper [PDF]

Carbon Market Stabilisation Measures: Implications for Linking

The persistently low allowance prices in the EU emissions trading scheme (EU ETS) – oscillating between €5/tCO2 and €17/tCO2 since 2008/9 – has reignited debates about the dynamic efficiency of cap-and-trade schemes. Within the context of the EU ETS, the debate has largely focused on the causes of the price slump, policy options to address the problem in the short- and long-run, and the efficiency, environmental effectiveness, and political feasibility of the various options. Despite the potentially significant risk that linking of emissions trading systems poses to market stability by facilitating contagion of localised price shocks and consequently eroding political support for domestic ETSs, studies analysing the linking implications of the proposed market stabilisation measures are largely absent. This paper fills that gap.

WP-2016-010
Julien Daubanes and Jean-Charles Rochet, July 2016
Abstract   |   Full Paper [PDF]

A Theory of NGO Activism

Now more than ever, activist NGOs oppose industrial projects/practices that have nevertheless been approved by public regulators. These NGOs are consumer associations, environmental groups, and stakeholders’ advocacy groups, and are particularly active in the energy, food, retailing and banking sectors. To understand this rise in NGO activism, we develop a theory of optimal regulation in which a regulated industry seeks to undertake a project that may be harmful to society. On the one hand, public regulation is vulnerable to the influence of industry, and may approve the project even though it is harmful. On the other hand, an NGO may oppose the project. We characterize the circumstances under which NGO opposition occurs and the circumstances under which this opposition is socially beneficial. The theory is used to explain the role that NGOs have assumed in the last decades, and has implications for the legal status of NGO activism and the appropriate degree of transparency.

JEL Codes: D02, D74, D82.
Keywords: NGO activism; Public regulation; Industry lobbying; Private politics; Transparency

WP-2016-009
Michael Mehling and Benjamin Görlach, May 2016
Abstract   |   Full Paper [PDF]

Multilateral Linking of Emissions Trading Systems

All things being equal, integration of emissions trading systems though linking increases their economic efficiency. With several greenhouse gas emissions trading systems already in operation and additional markets emerging at the subnational, national and regional level, their linkage has attracted considerable attention among researchers and decision makers. A provision in the recently adopted Paris Agreement facilitates voluntary cooperation between parties, including linking of emissions trading systems. To date, however, research has largely focused on bilateral links and linking between aligned trading systems. As linking expands beyond such default scenarios, it gives rise to numerous challenges that differ from those encountered at more limited scale and lower levels or complexity. This paper seeks to identify such challenges and describe different options for their successful management.

Key words: Emissions Trading, Carbon Pricing, Linking, Carbon Clubs, Paris Agreement

JEL classification: Q54

WP-2016-008

Absolute vs. Intensity-based Caps for Carbon Emissions Target Setting: An Obstacle to Linking the EU ETS to a Chinese National ETS?

Linking the European Union Emissions Trading System (EU ETS) to the Chinese national ETS promises considerable economic and political benefits. However, different policy choices regarding cap setting between the systems are likely to impede a potential linking. A striking distinction is that the EU ETS relies upon an absolute cap, while the Chinese national ETS appears to apply an "intensity-based cap" during the early stages. The current linking literature focuses on mapping legal barriers in general and has not yet focused on EU and China, let alone the intricacies of policy design. This paper seeks to fill this gap by concentrating on (static and dynamic) efficiency and environmental effectiveness implications of linking and cap design. From the analysis of the cap we derive policy implications for a hypothetical ETS linking between the EU and China.

Key words: carbon market, emissions trading, EU ETS, cap setting, linking

JEL classification: Q54

WP-2016-007

Energy Scenarios: The Value and Limits of Scenario Analysis

A need for a low-carbon world has added a new challenging dimension for the long-term energy scenarios development. In addition to the traditional factors like technological progress, demographic, economic, political and institutional considerations, there is another aspect of the modern energy forecasts related to the coverage, timing, and stringency of policies to mitigate greenhouse gas emissions and air pollutants. Modern tools for the energy scenario development provide a good basis for the estimates of the required changes in the energy system to achieve certain climate and environmental targets. While the current scenarios show that a move to a low-carbon energy future requires a drastic change in energy investment and the resulting mix in energy technologies, the exact technology mix, paths to the needed mix, price and cost projections should be treated with a great degree of caution. The scenarios are unlikely to be successful at producing precisely definitive estimates, but they can be used as a qualitative analysis of decision-making risks associated with different pathways. If history is any guide, energy scenarios overestimate the extent to which the future will look like the recent past. As future costs and the resulting technology mixes are uncertain, a wise government policy is to target emissions reductions from any source, rather than focus on boosting certain kinds of low-carbon energy.

WP-2016-006
Alberto Behar and Robert A. Ritz, March 2016
Abstract   |   Full Paper [PDF]

OPEC vs US shale: Analyzing the Shift to a Market-share Strategy

In November 2014, OPEC announced a new strategy geared towards improving its market share. Oil-market analysts interpreted this as an attempt to squeeze higher-cost producers, notably US shale oil, out of the market. Over the next year, crude oil prices crashed, with large repercussions for the global economy. We present a simple equilibrium model that explains the fundamental market factors that can rationalize such a regime switch by OPEC. These include: (i) the growth of US shale oil production; (ii) the slowdown of global oil demand; (iii) reduced cohesiveness of the OPEC cartel; (iv) production ramp-ups in other non-OPEC countries. We show that these qualitative predictions are broadly consistent with oil market developments during 2014-15. The model is calibrated to oil market data; it predicts accommodation up to 2014 and a market-share strategy thereafter, and explains large oil-price swings as well as realistically high levels of OPEC output.

Keywords: Crude oil, OPEC, price crash, shale oil, market share, limit pricing

JEL Classifications: L12, L71, Q41

WP-2016-005
Ignacio J. Pérez-Arriaga, Scott Burger, and Tomás Gómez, March 2016
Abstract   |   Full Paper [PDF]

Electricity Services in a More Distributed Energy System

The integration of significant volumes of intermittent renewable generation and distributed energy resources in electric power systems is forcing a debate on what electricity services are needed in a power system, how to price them and what agents are best suited for their provision. This paper defines and justifies the existence of a small set of primary electricity services that must exist in all power systems and regulatory contexts in order for the power system to operate satisfactorily. These services are determined by the placement of constraints on the planning and operation of power systems. As power system technologies evolve, new primary services may emerge, but will always be based on the placement of constraints on system operation and planning.

Keywords: electricity services; energy; operating reserves; black start; firm capacity; network connection; voltage control; power quality; constraint mitigation; loss reduction; regulation.

WP-2016-004

The Impact of Uncertainty on the Need and Design of Capacity Remuneration Mechanisms in Low-Carbon Power Systems

The case for or against capacity remuneration mechanisms (CRMs) is often made in a simple framework that takes the structure of the electric power system as a given and does not substantively consider uncertainty. This paper highlights the central role that uncertainty around the net load profile and net load growth plays in the case for a CRM and in determining its optimal design. Using a stylized example, the paper shows that uncertainty increases the risks investors take financing new generation so that a higher likelihood of near term profits is required. Existing alternative designs of CRMs have differing implications for how society can provide an efficient and effective signal about its demand for security of supply under uncertainty. In addition, different CRMs each present limitations in their ability to incorporate appropriate CRM design principles, which are also emphasized.

WP-2016-003
Thomas Covert, Michael Greenstone, and Christopher R. Knittel, February 2016
Abstract   |   Full Paper [PDF]

Will We Ever Stop Using Fossil Fuels?

Scientists believe significant climate change is unavoidable without a drastic reduction in the emissions of greenhouse gases from the combustion of fossil fuels. However, few countries have implemented comprehensive policies that price this externality or devote serious resources to developing low carbon energy sources. In many respects, the world is betting that we will greatly reduce the use of fossil fuels because we will run out of inexpensive fossil fuels (i.e., decreases in supply) and/or technological advances will lead to the discovery of less expensive low carbon technologies (i.e., decreases in demand). The historical record indicates that the supply of fossil fuels has consistently increased over time and that their relative price advantage over low carbon energy sources has not declined substantially over time. Without robust efforts to correct the market failures around greenhouse gases, relying on supply and/or demand forces to limit greenhouse gas emissions is relying heavily on hope.

JEL Codes: Q31, Q35, Q41, Q42, Q54

Keywords: Fossil fuels; alternative energy; renewables; climate change; fracking;
technological change

WP-2016-002
Alexander W. Bartik, Janet Curie, Michael Greenstone, and Christopher R. Knittel, February 2016
Abstract   |   Full Paper [PDF]

The Local Economic and Welfare Consequences of Hydraulic Fracturing

Exploiting geological variation within shale deposits and timing in the initiation of hydraulic fracturing, this paper finds that allowing fracing leads to sharp increases in oil and gas recovery and improvements in a wide set of economic indicators. At the same time, estimated willingness-to-pay (WTP) for the decrease in local amenities (e.g., crime and noise) is roughly equal to -$1000 to -$1,600 per household annually (-1.9% to -3.1% of mean household income). Overall, we estimate that WTP for allowing fracing equals about $1,300 to $1,900 per household annually (2.5% to 3.7%), although there is substantial heterogeneity across shale regions.

WP-2016-001
Scott Burger, Jose Pablo Chaves-Ávila, Carlos Batlle, Ignacio J. Pérez-Arriaga, January 2016
Abstract   |   Full Paper [PDF]

The Value of Aggregators in Electricity Systems

Distributed energy resources (“DERs”) are being adopted throughout the world. These technologies, if properly integrated, have the potential to not only deliver the valuable electricity services that have traditionally been provided by centralized generating units, but also new services enabled by their distributed nature. Aggregators may play a critical role in enabling these DERs to provide these valuable electricity services. This paper defines the factors that will determine the role of aggregators in power systems and describes the value that these aggregators can provide under different technological and regulatory scenarios. This document identifies three main categories of value: fundamental value, transitory value and opportunistic value. Fundamental value refers to value that is intrinsic to aggregation and is independent of the market or regulatory context. Transitory value exists today and may extend into the future, although certain technological or regulatory changes may diminish its magnitude. Finally, opportunistic value emerges as a result of regulatory or market design flaws that can be exploited by aggregation of DERs and that may endanger the economic efficiency of the power system. Identifying the value of aggregators is relevant in order to determine whether this activity should be regulated and how, or left open to market forces. Furthermore, in cases opportunistic value is identified, regulatory actions should to be taken to avoid endangering system economic efficiency.

Keywords: Value of Aggregators; Aggregation; Distributed Energy Resources; Fundamental Value; Transitory Value; Opportunistic Value; Regulation; Market Design.

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2015

WP-2015-016
Michael G. Pollitt, December 2015
Abstract   |   Full Paper [PDF]

A Global Carbon Market?

This paper explores the prospects for a global carbon market as the centrepiece of any serious attempt to reach the ambitious goal for greenhouse gas (GHG) reductions set by climate scientists. My aim is to clarify the extent to which we know what policy might best support global decarbonisation. I begin by discussing what we might mean by a global carbon market and its theoretical properties. I proceed to discuss the EU Emissions Trading System experience and the recent experience with the Australian carbon tax. Next, I assess the evolving carbon market initiatives in the US and in China. In the conclusion, I apply some principles of ‘good’ energy policy making to the prospects for a successful global carbon market.

Key words: carbon market, carbon tax, EU ETS

JEL classification: Q54

WP-2015-015
Richard Schmalensee and Robert N. Stavins, December 2015
Abstract   |   Full Paper [PDF]

Lessons Learned from Three Decades of Experience with Cap-and-Trade

Richard Schmalensee and Robert N. Stavins, December 2015

Thirty years ago, the notion of a government allocating tradable rights to emit pollution was controversial. Many environmental advocates felt this approach inappropriately legitimized environmental degradation, while others doubted its workability. At that time, virtually all pollution regulations took a more prescriptive, “command-and-control” approach, either specifying the type of pollution-control equipment to be installed or by setting uniform limits on emission levels or rates.

Today, it is broadly acknowledged that because emission reduction costs often vary greatly, aggregate abatement costs under command-and-control approaches can be much higher than they need to be. Instead, by establishing a price on emissions, either directly through taxes or indirectly through a market for tradable emissions rights (called permits or allowances) established under a cap-and-trade policy, market-based approaches tend to equate marginal abatement costs rather than emissions levels or rates across sources, and thereby can – in principle – achieve pollution-control targets at minimum cost.

Most early experience with market-based environmental policies was in the United States, starting with the Federal government’s attention to localized air pollution, and subsequently transboundary acid rain. More recently, with increased attention to the threat of global climate change, the locus of policy action using this approach has shifted from national to sub-national policies in the United States, and for national policies from this country to others.

We examine the design and performance of seven of the most prominent emissions trading systems that have been implemented over the past 30 years – systems that are particularly important environmentally and/or economically and the performance of which has been documented. We ask what lessons this experience offers for future applications. We focus on systems that involve trading emissions rights and exclude emission-reduction-credit (offset) systems, which offer credits for emissions reductions from some baseline. It is worth noting, however, that systems of the latter kind have been used in many countries, as well as internationally in the form of the Clean Development Mechanism under the Kyoto Protocol.

Key Words: market-based instruments, cap-and-trade, leaded gasoline phasedown, Clean Air Act amendments of 1990, sulfur dioxide, acid rain, carbon dioxide, global climate change, European Union Emissions Trading System

JEL Classification Codes: Q540, Q580, Q400, Q480

WP-2015-014

The Geoeconomics of Russian-EU Gas Trade: Drawing Lessons from the South Stream Pipeline Project

Antto Vihma and Umut Turksen, November 2015

Energy trade has developed into one of the most contentious and divisive issues between Russia and EU in the post-Cold War era. It reflects a broader geoeconomic struggle in which economic means are used to advocate geopolitical goals. This Working Paper argues that the case of the South Stream Pipeline Project (SSPP) – a grand project abruptly cancelled by President Putin in December 2014 – epitomizes these broader power politics involved in the energy relations between the two powers. In 2014 the Russian leadership advanced both traditional geopolitical and contemporary geoeconomic strategies, pursuing the former by conducting a military campaign in Crimea and Eastern Ukraine, and utilizing the latter by pushing the construction of South Stream in spite of the EU’s legal and political objections. The EU was able to harden its line on SSPP. The global energy context, including cheap coal prices, expansion of renewable energies, more liquefied natural gas and spot trading, cannot fully account for the assertiveness of the EU Commission and the allegiance of Member States in the SSPP case. The results of the process tracing conducted in this Working Paper confirm that in the case of the SSPP, Russian traditional geopolitics greatly hindered its geoeconomic power towards the EU. Furthermore, the Working Paper suggests that the strategic choices of geoeconomics vs. geopolitics may be more generally incompatible, even mutually exclusive. Russian geoeconomic activity has long been successful as a centrifugal, dividing power within the EU. The geopolitical campaign in Ukraine, in stark contrast, has been a centripetal force, causing increasing EU unity, eventually also seen in the SSPP case. It seems that claims of geoeconomics being a continuation of war by other means are potentially misleading. The means of geopolitical power projection and tools of geoeconomic power have notably different effects in the contemporary, interconnected world.

WP-2015-013
Christopher R. Knittel, Konstantinos Metaxoglou, and Andre Trindade, October 2015
Abstract   |   Full Paper [PDF]

Natural Gas Prices and Coal Displacement: Evidence from Electricity Markets

Christopher R. Knittel, Konstantinos Metaxoglou, and Andre Trindade, October 2015

We examine the environmental impact of the post-2005 natural gas glut in the United States due to the shale gas boom. Our focus is on quantifying short-term coal-to-gas switching decisions by different types of electric power plants in response to changes in the relative price of the two fuels. In particular, we study the following entities: investor-owned utilities (IOUs) and independent power producers (IPPs) in restructured markets coordinated by Independent System Operators, as well as IOUs in traditional vertically-integrated markets. Using alternative data aggregations and model specifications, we find that IOUs operating in traditional markets are more sensitive to changes in fuel prices than both IOUs and IPPs in restructured markets. We attribute our findings to differences in available gas-fired generating capacity with the most cost-efficient technology: electricity generators reduced their rate of investment in the restructured markets post restructuring. The heterogeneity in the response of fuel consumption to prices has implications for carbon dioxide (CO2) emissions for the entities considered. Using simple back-of-the-envelope calculations, the almost 70% drop in the price of natural gas between June 2008 and the end of 2012 translates to as much as 33% reduction in CO2 emissions for IOUs in traditional markets, but only up to 19% for IOUs in restructured markets.

JEL codes: L94, Q40, Q51.

Keywords: coal displacement, emissions, electricity markets, natural gas, utilities

WP-2015-012

Progress and Problems in Reforming the Swaps Marketplace

John E. Parsons, July 2015

US derivative markets, including commodity derivatives used in industries like energy, are undergoing dramatic reform following the financial crisis. This testimony to the US Congress surveys the current state of progress in implementing the reform. In particular, it identifies the ongoing failure to produce adequate reporting of trades. The problem is especially dramatic for commodity derivatives where the numbers reported by the US Commodities Future Trading Commission are demonstrably meaningless.

WP-2015-011
Hashmat Khan, Christopher R. Knittel, Konstantinos Metaxoglou, and Maya Papineau, August 2015
Abstract   |   Full Paper [PDF]

How do Carbon Emissions Respond to Business-Cycle Shocks?

Hashmat Khan, Christopher R. Knittel, Konstantinos Metaxoglou, and Maya Papineau, August 2015

Carbon dioxide emissions are highly correlated with cyclical fluctuations in the U.S. economy; they increase during booms and fall during busts. We examine this relationship focusing on the sources of business cycles identified using structural vector autoregression methodologies. Using data for 1973-2012, we find that emissions fall after unanticipated technology and investment shocks, as well as anticipated technology shocks. Emissions, however, increase after an anticipated investment shock. Our findings have two implications for the emerging literature that examines the optimality of environmental policy using dynamic stochastic general equilibrium models with unanticipated technology shocks. First, the assumption that unanticipated technology shocks cause carbon emissions to move with the business cycle has little support in the data both at the aggregate and the state-level. Second, identifying the shocks that explain procyclical carbon emissions is an important first step for crafting effective environmental policy over the business cycle

WP-2015-010
Christopher R. Knittel, Ben S. Meiselman, and James H. Stock, July 2015
Abstract   |   Full Paper [PDF]

The Pass-Through of RIN Prices to Wholesale and Retail Fuels under the Renewable Fuel Standard

Christopher R. Knittel, Ben S. Meiselman, and James H. Stock, July 2015

The U.S. Renewable Fuel Standard (RFS) requires blending increasing quantities of biofuels into the U.S. surface vehicle fuel supply. In 2013, the fraction of ethanol in the gasoline pool effectively reached 10%, the ethanol capacity of the dominant U.S. gasoline blend (the

WP-2015-009

The Simple Economics of Asymmetric Cost Pass-Through

Robert A. Ritz, June 2015

In response to cost changes, prices often rise more strongly or quickly than they fall. This phenomenon has attracted attention from economists, policymakers, and the general public for decades. Many assert that it cannot be explained by standard economic theory, and is evidence for “anti-competitive ”behavior by firms. This paper argues against this conventional wisdom; it shows that simple price theory can, in principle, account for such asymmetric pass-through— even with perfect competition. From a policy perspective, knowledge of cost pass-through patterns in a market does not allow for strong inferences on the intensity of competition.

Keywords: Asymmetric price transmission, cost pass-through, electricity markets, price theory, rockets and feathers

WP-2015-008
Jonathan Chemama, Maxime C. Cohen, Ruben Lobel, and Georgia Perakis, May 2015
Abstract   |   Full Paper [PDF]

Consumer Subsidies with a Strategic Supplier: Commitment vs. Flexibility

Jonathan Chemama, Maxime C. Cohen, Ruben Lobel, and Georgia Perakis, May 2015

Governments use consumer incentives to promote green technologies (e.g., solar panels and electric vehicles). Our goal in this paper is to study how policy adjustments over time will interact with production decisions from the industry. We model the interaction between a government and an industry player in a two-period game setting under uncertain demand. We show how the timing of decisions aff ects the risk-sharing between government and supplier, ultimately a ffecting the cost of the subsidy program. In particular, we show that when the government commits to a fixed policy, it encourages the supplier to produce more at the beginning of the horizon. Consequently, a flexible subsidy policy is on average more expensive, unless there is a signi ficant negative demand correlation across time periods. However, we show that the variance of the total sales is lower in the flexible setting, implying that the government

WP-2015-007
Maxime C. Cohen, Georgia Perakis, and Charles Thraves, May 2015
Abstract   |   Full Paper [PDF]

Competition and Externalities in Green Technology Adoption

Maxime C. Cohen, Georgia Perakis, and Charles Thraves, May 2015

In this paper, we study the e ffects of competition among multiple suppliers who sell green technology products, such as electric vehicles. The government o ffers consumer subsidies to encourage the product adoption. We consider a setting where suppliers adjust production and price depending on the level of subsidies o ffered by the government to the consumers. Our analysis expands the understanding of symmetric and asymmetric competition, incorporating the external influence from the government who is now an additional player in the system. We quantify how competition impacts the consumers, the suppliers as well as the government relative to the monopolistic setting where all the products are jointly produced from a single firm. In other words, we quantify who is bene fitting from the competition and under what conditions. Our model incorporates demand uncertainty as well as positive externalities. We fi rst compare di fferent government objectives and determine that the magnitude of the externalities plays a key role in selecting the right objective. We then show that the eff ects of competition may di ffer depending on the demand uncertainty, the supplier asymmetry and the magnitude of the externalities. When externalities are relatively small, we show that competition hurts the suppliers and benefi ts the government. However, it does not always benefi t all the consumers, as it is usually the case in classical competition settings. We also show that in a market with large externalities, consumers, unlike the government, are always better-off in a competitive environment. Finally, we test our model and validate our insights using actual data from the electric vehicle industry, which is becoming increasingly competitive.

Key words : Competition, Externalities, Government Subsidies, Green Technology Adoption, Newsvendor

WP-2015-006
Jeremy West, Mark Hoekstra, Jonathan Meer, and Steven L. Puller, May 2015
Abstract   |   Full Paper [PDF]

Vehicle Miles (Not) Traveled: Why Fuel Economy Requirements Don't Increase Household Driving

Jeremy West, Mark Hoekstra, Jonathan Meer, and Steven L. Puller, May 2015

A major concern with addressing the negative externalities of gasoline consumption by regulating fuel economy, rather than increasing fuel taxes, is that households respond by driving more. This paper exploits a discrete threshold in the eligibility for Cash for Clunkers to show that fuel economy restrictions lead households to purchase vehicles that have lower cost-per-mile, but are also smaller and lower-performance. Whereas the former effect can increase driving, the latter effect can reduce it. Results indicate these households do not drive more, suggesting that behavioral responses do not necessarily undermine the effectiveness of fuel economy restrictions at reducing gasoline consumption.

WP-2015-005
Mark Hoekstra, Steven L. Puller, and Jeremy West, April 2015
Abstract   |   Full Paper [PDF]

Cash for Corollas: When Stimulus Reduces Spending

Mark Hoekstra, Steven L. Puller, and Jeremy West, April 2015

The 2009 Cash for Clunkers program aimed to stimulate consumer spending in the new automobile industry, which was experiencing disproportionate reductions in demand and employment during the Great Recession. Exploiting program eligibility criteria in a regression discontinuity design, we show nearly 60 percent of the subsidies went to households who would have purchased during the two-month program anyway; the rest accelerated sales by no more than eight months. Moreover, the program

WP-2015-004
Saraly Andrade de Sá and Julien Daubanes, April 2015
Abstract   |   Full Paper [PDF]

Limit Pricing and the (In)Effectiveness of the Carbon Tax

The conventional analysis of policy-induced changes in resource extraction is inconsistent with the actual way OPEC is exerting its market power. We claim that OPEC is practicing limit pricing, and we extend to non-renewable resources the limit-pricing theory. Facing a very inelastic demand, an extractive cartel seeks to induce the highest price that does not destroy its demand, unlike the conventional Hotelling analysis: the cartel tolerates some ordinary substitutes to its oil but deters high-potential ones. With limit pricing, policy-induced extraction changes do not obey the usual logic. For example, oil taxes have no effect on current oil production. Extraction increases when high-potential substitutes are promoted, and may only be reduced by supporting its ordinary substitutes. The carbon tax not only applies to oil; it also penalizes its ordinary (carbon) substitutes, whose market shares are taken over by the cartel. Thus the carbon tax ambiguously affects current and long-term oil production.

JEL classification: Q30; L12; H21

Keywords: OPEC; Demand elasticity; Shale oil; Limit pricing; Carbon tax; Non-renewable resources; Monopoly power; Oil substitutes

WP-2015-003

The Use and Misuse of Models for Climate Policy

Robert S. Pindyck, April 2015

In recent articles, I have argued that integrated assessment models (IAMs) have flaws that make them close to useless as tools for policy analysis. IAM-based analyses of climate policy create a perception of knowledge and precision that is illusory, and can fool policy- makers into thinking that the forecasts the models generate have some kind of scientific legitimacy. But some have claimed that we need some kind of model, and that IAMs can be structured and used in ways that correct for their shortcomings. For example, it has been argued that although we know little or nothing about key relationships in the model, we can get around this problem by attaching probability distributions to various parameters and then simulating the model using Monte Carlo methods. I argue that this would buy us nothing, and that a simpler and more transparent approach to the design of climate change policy is preferable. I briefly outline what that approach would look like.

Keywords: Environmental policy, GHG abatement, uncertainty, outcome distributions, fat-tailed distributions, global warming, climate change, economic impact, catastrophic outcomes.

WP-2015-002
John E. Parsons, Cathleen Colbert, Jeremy Larrieu, Taylor Martin and Erin Mastrangelo, February 2015
Abstract   |   Full Paper [PDF]

Financial Arbitrage and Efficient Dispatch in Wholesale Electricity Markets

John E. Parsons, Cathleen Colbert, Jeremy Larrieu, Taylor Martin and Erin Mastrangelo, February 2015

Virtual bidding is a type of transaction introduced into wholesale electricity markets to improve competition and pricing. This paper analyzes the theory behind virtual bidding and describes circumstances under which it does not work as advertised. The case for virtual bidding is predicated on an oversimplified model of the multi-settlement market design. The complexity of the unit commitment and optimal power flow problems forces the actual market algorithms to make compromises with the theoretical model. These compromises create situations in which virtual bidders can pro fit without improving system performance. Indeed, in these situations, virtual bidding can add real costs to system operation. The paper illustrates this with a specific case study of virtual bidding in California, and with a matching numerical illustration. The paper explains the general nature of the problem with experiences in other regions and other situations. The fault with virtual bidding identified in this paper needs to be incorporated into any assessment of the costs and bene fits of virtual bidding.

WP-2015-001

Soft Cooperation in the Shadow of Distributional Conflict? A Model-Based Assessment of the Two-Level Game between International Climate Change Negotiations and Domestic Politics

Johannes Urpelainen and Antto Vihma, February 2015

In climate negotiations, negotiators frequently reject soft forms of cooperation that require no hard commitments and at best simple coordination. Why? We argue that in some cases negotiators reject these cooperative initiatives because they can thus signal their resolve to domestic audiences. If domestic audiences expect tough bargaining in the future, and therefore prefer a resolute negotiator, the incumbent negotiator may reject soft forms of cooperation to avoid losing the support of a hawkish domestic audience. In this paper, we develop a formal model to clarify the
relationship between domestic politics, distributional conflict, and the choice between "soft" and "hard"

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2014

WP-2014-009
James B. Bushnell, Stephen P. Holland, Jonathan E. Hughes, and Christopher R. Knittel, November 2014
Abstract   |   Summary [PDF]

Executive Summary: Strategic Policy Choice in State-Level Regulation: The EPA's Clean Power Plan

James B. Bushnell, Stephen P. Holland, Jonathan E. Hughes, and Christopher R. Knittel, November 2014

Flexibility in environmental regulations can lead to reduced costs if it allows additional abatement from lower cost sources or if policy tailoring and experimentation across states increases regulatory efficiency. The EPA's 2014 Clean Power Plan, which implements greenhouse gas regulation of power plants under the Clean Air Act, allows substantial regulatory flexibility. The Clean Power Plan sets state-level 2030 goals for emissions rates (in lbs CO2 per MWh) with substantial variation in the goals across states. The Clean Power Plan allows states considerable flexibility in attaining these goals. In particular, states can choose whether to implement the rate-based goals or equivalent mass-based goals (i.e., emissions caps). Moreover, states can choose whether or not to join with other states in implementing their goals. Using a model of electricity generation across states, we analyze incentives to adopt inefficient rate-based standards versus efficient mass-based standards. We show that adoption of inefficient rate-based standards is a dominant strategy for states from both a consumer's and a generator's perspective. We calibrate the model for electricity markets in the Western United States and calculate signi ficant inefficiencies from a failure to coordinate. In particular, state-by-state rate-based standards result in a substantial loss of welfare relative to business as usual. Even a harmonized West-wide rate-based standard dissipates a substantial proportion of the potential gains from regulation. Despite these large inefficiencies, the incentives for adoption of the inefficient policies are substantial particularly for generators.

WP-2014-009
James B. Bushnell, Stephen P. Holland, Jonathan E. Hughes, and Christopher R. Knittel, November 2014
Abstract   |   Appendix [PDF]

Appendix B: Strategic Policy Choice in State-Level Regulation: The EPAs Clean Power Plan

Appendix files for main paper WP-2014-009:

James B. Bushnell, Stephen P. Holland, Jonathan E. Hughes, and Christopher R. Knittel, November 2014

Flexibility in environmental regulations can lead to reduced costs if it allows additional abatement from lower cost sources or if policy tailoring and experimentation across states increases regulatory efficiency. The EPA's 2014 Clean Power Plan, which implements greenhouse gas regulation of power plants under the Clean Air Act, allows substantial regulatory flexibility. The Clean Power Plan sets state-level 2030 goals for emissions rates (in lbs CO2 per MWh) with substantial variation in the goals across states. The Clean Power Plan allows states considerable flexibility in attaining these goals. In particular, states can choose whether to implement the rate-based goals or equivalent mass-based goals (i.e., emissions caps). Moreover, states can choose whether or not to join with other states in implementing their goals. Using a model of electricity generation across states, we analyze incentives to adopt inefficient rate-based standards versus efficient mass-based standards. We show that adoption of inefficient rate-based standards is a dominant strategy for states from both a consumer's and a generator's perspective. We calibrate the model for electricity markets in the Western United States and calculate signi ficant inefficiencies from a failure to coordinate. In particular, state-by-state rate-based standards result in a substantial loss of welfare relative to business as usual. Even a harmonized West-wide rate-based standard dissipates a substantial proportion of the potential gains from regulation. Despite these large inefficiencies, the incentives for adoption of the inefficient policies are substantial particularly for generators.

WP-2014-009
James B. Bushnell, Stephen P. Holland, Jonathan E. Hughes, and Christopher R. Knittel, November 2014
Abstract   |   Full Paper [PDF]

Strategic Policy Choice in State-Level Regulation: The EPA's Clean Power Plan

James B. Bushnell, Stephen P. Holland, Jonathan E. Hughes, and Christopher R. Knittel, November 2014


Flexibility in environmental regulations can lead to reduced costs if it allows additional abatement from lower cost sources or if policy tailoring and experimentation across states increases regulatory efficiency. The EPA's 2014 Clean Power Plan, which implements greenhouse gas regulation of power plants under the Clean Air Act, allows substantial regulatory flexibility. The Clean Power Plan sets state-level 2030 goals for emissions rates (in lbs CO2 per MWh) with substantial variation in the goals across states. The Clean Power Plan allows states considerable flexibility in attaining these goals. In particular, states can choose whether to implement the rate-based goals or equivalent mass-based goals (i.e., emissions caps). Moreover, states can choose whether or not to join with other states in implementing their goals. Using a model of electricity generation across states, we analyze incentives to adopt inefficient rate-based standards versus efficient mass-based standards. We show that adoption of inefficient rate-based standards is a dominant strategy for states from both a consumer's and a generator's perspective. We calibrate the model for electricity markets in the Western United States and calculate signi ficant inefficiencies from a failure to coordinate. In particular, state-by-state rate-based standards result in a substantial loss of welfare relative to business as usual. Even a harmonized West-wide rate-based standard dissipates a substantial proportion of the potential gains from regulation. Despite these large inefficiencies, the incentives for adoption of the inefficient policies are substantial particularly for generators.

WP-2014-008

The Performance of U.S. Wind and Solar Generators: An Update

Richard Schmalensee, November 2014

Using data on hourly outputs and spot prices for a sample 25 wind and nine solar generating plants covering all seven U.S. ISOs for 2011 and up to 12 adjacent months, this study examines capacity factors, average output values, and several aspects of intermittency. Most performance measures studied vary substantially within and between ISOs, and some vary substantially over time. Implications for research, market design, and policies to support renewable generation are briefly discussed.

Keywords: wind, solar, renewable, VER, generation

WP-2014-007

Why is Spot Carbon so Cheap and Future Carbon so Dear? The Term Structure of Carbon Prices

Don Bredin and John Parsons, October 2014

This study examines carbon spot and futures price relationships and the dynamics of the carbon term structure in the European Union Emission Trading Scheme (ETS) between 2005-2012. Using spot and futures prices, we calculate an implied cost of carry. Using sequential futures prices, we calculate the implied forward cost of carry. Under the rules of the ETS, the cost of carry is

WP-2014-006

A Framework for Redesigning Distribution Network Use of System Charges Under High Penetration of Distributed Energy Resources: New Principles for New Problems

The growing potential for widespread integration of distributed energy resources (DER) presents the electric power sector with significant changes to technical operations, business models, and industry structure. Management of such changes to ensure the development and maintenance of well-adapted, reliable power systems requires updated regulations that keep pace with the evolution of technologies and end-user needs. Regulators are faced with the challenge of ensuring that a level playing eld exists for electricity service business models that align with a range of policy goals including the assurance of reliability and quality of electricity supply, affordability of electricity services, encouragement of innovation and economic growth, and the development of clean energy technologies for decarbonization. As the distribution system transitions from a passive network of consumers to a more actively managed system of network users with diverse consumption and production behaviors, price signals will play a crucial role in shaping the interactions between the physical components of the distribution system and network users. Distribution network use of system (DNUoS) charges, are the method by which distribution utilities cover network operation and maintenance costs and recover their infrastructure investments, and they signal to network users how their utilization of the distribution network impacts system costs and each user's share of those costs. This paper proposes a new framework for the design of DNUoS charges, calling for an overhaul of how distribution network cost allocation has been carried out thus far. The authors present a method for:

1) utilizing a reference network model (RNM) to identify the key drivers of distribution
system costs and
2) allocating those costs to network users according to network utilization profiles that capture each user's contribution to total system costs.

The resulting DNUoS charges are highly differentiated for network users according to the impact that network use behaviors have on system costs. This is a substantial departure from the convention of allocating distribution system costs across multiple users assumed to have similar network utilization behaviors and identical impacts on network cost drivers. Thus, regulators may choose to adjust the allocation of network costs to cost drivers in order to achieve varying regulatory objectives such as increased socialization and equity.

WP-2014-005

The Remuneration Challenge: New Solutions for the Regulation of Electricity Distribution Utilities Under High Penetrations of Distributed Energy Resources and Smart Grid Technologies

Ongoing changes in the delivery of electricity services and the use and management of electricity distribution systems – including the proliferation of distributed energy resources, smart grid technologies (i.e., advanced power electronics and information and communication technologies) and active system management techniques – present new challenges for the economic regulation of electricity distribution utilities. In particular, regulators are likely to face increased uncertainty regarding the evolution of network uses and the efficient cost of network investments and maintenance, as well as an increased informational disadvantage vis­‐à‐vis the regulated utility. These challenges are important for both cost of service (or rate of return) regulation and incentive regulation approaches (also known as revenue or price cap regulation, RPI­‐X, performance‐based regulation, or output‐based regulation). This paper proposes a novel process for establishing the allowed revenues of an electricity distribution utility and demonstrates its application as a practical solution to the imminent regulatory challenges discussed above. The proposed method is a new combination of three established regulatory tools: an engineering-­‐based reference network model (RNM) for forward-­‐looking benchmarking of efficient network expenditures; an incentive compatible menu of contracts to elicit accurate forecasts from the utility and establish profit-­‐sharing incentives for cost saving efficiency efforts; and ex post automatic adjustment mechanisms, or “delta factors,” to accommodate uncertainty in the evolution of network use and minimize forecast error. Simulation of a realistic, large-­‐scale urban distribution network is used to demonstrate, step-­‐by-­‐step, the practical implementation of this novel regulatory process and illustrate the advantages for the economic regulation of electricity distribution utilities under increasing penetration of distributed energy resources and smart grid technologies.

Keywords: Economic Regulation, Electricity Distribution, Network Utilities, Monopoly Regulation, Remuneration, Menu of Contracts, Reference Network Model

WP-2014-004
Karen Tapia-Ahumada, Claudia Octaviano, Sebastian Rausch, Ignacio Pérez-Arriaga, April 2014
Abstract   |   Full Paper [PDF]

Modeling Intermittent Renewable Energy: Can We Trust Top-Down Equilibrium Approaches?

Economy-wide top-down equilibrium (TD) models have traditionally proved to be valuable tools for assessing energy and climate policies. New modeling challenges brought about by intermittent renewable energy sources, however, require to carefully review existing tools. This paper provides an overview of and quantitatively assesses the suitability of TD modeling approaches to deal with intermittent renewables in the electricity sector. To this end, we develop a benchmark model that integrates a bottom-up electricity sector model—designed to analyze the expansion and operation of an electric power system with a large penetration of wind generation—within an economy-wide general equilibrium framework. We find that, if properly specified, a TD approach to modeling intermittent renewable energy is capable of roughly replicating the results from the benchmark model. We argue, however, that for practical purposes TD modelers do not possess the required information. This problem is further compounded by our finding that a TD approach is highly sensitive to key parameters which are a priori typically unknown or at least highly uncertain. While the integrated approach presented in this paper offers one possible alternative to overcome some of the issues that plague traditional TD models, our analysis suggests that traditional TD simulation tools have to be enhanced to avoid potentially misrepresenting the implications of future low-carbon policies.

Keywords: Renewable Energy, Electricity, Intermittency, General Equilibrium, Top-down
Modeling, Bottom-up Modeling

WP-2014-003

Explaining the Adoption of Diesel Fuel Passenger Cars in Europe

Joshua Linn, March 2014

Compared with gasoline engines, diesel fuel engines significantly reduce fuel consumption and greenhouse gas emissions from passenger vehicles, but they emit more nitrogen oxides and other pollutants. Across countries, the market share of diesel fuel engines in passenger vehicles varies from close to zero to more than 80 percent. Using a structural model of vehicle markets in seven European countries, I show that vehicle taxes and willingness to pay for fuel costs, rather than fuel prices or supply, explain adoption. The model is used to compare the environmental implications of fuel taxes and carbon dioxide emissions rate standards.

JEL Codes: L62, Q4, Q5
Keywords: Vehicle demand estimation, demand for fuel economy and performance, fuel taxes, vehicle taxes, carbon dioxide emissions rates

WP-2014-002

Technological Change, Vehicle Characteristics, and the Opportunity Costs of Fuel Economy Standards

Thomas Klier and Joshua Linn, December 2013

Many countries are tightening passenger vehicle fuel economy standards. In assessing the welfare effects of standards, the literature has not properly accounted either for their effects on the rate of technology adoption, or for improvements in vehicle characteristics in the absence of tightening standards. A dynamic model shows that accounting for both factors has ambiguous effects on estimated welfare costs. We find that recent U.S. and European standards have affected the rate of technology adoption as well as horsepower and torque. Estimated welfare losses from reduced horsepower and torque are of similar magnitude to the welfare gains from fuel savings.

JEL codes: L62, Q4, Q5

Keywords: passenger vehicles, U.S. greenhouse gas emissions rate standards, European carbon dioxide emissions rate standards, technology adoption

WP-2014-001

Risk Sharing in CO2 Delivery Contracts for the CCS-EOR Value Chain

Anna Agarwal

A key reason for poor performance in large capital projects is the weak incentives facing the involved entities to deliver optimal project outcomes. The weak incentives arise from misalignment of interests of the individual entities with the common interest of the project, thus resulting in sub-optimal decisions that do not maximize the overall project value. Contractual risk-sharing is key to aligning the interests of the individual entities and incentivizing them to make optimal decisions. We develop a framework to quantify the impact of the project contract terms on the financial value of large energy capital projects. We focus on a prototype carbon capture and storage (CCS) project wherein the power plant company (that captures the CO2) is linked to the oil field company (that stores the CO2 for enhanced oil recovery, EOR) through a long-term CO2 delivery contract. We evaluate alternate CO2 contract structures in terms of the incentives the contracts provide to the individual entities to respond to changes in the market risk factors (oil price, electricity price, and CO2 emission penalty). The results show that inappropriate risk allocation, as in fixed price CO2 contracts, leads to significant loss in project value. This loss under fixed price CO2 contracts is due to high contracting risks associated with ex post insolvencies and weak incentives for contingent decision-making. We find that risk sharing offered by oil-indexed price CO2 contracts significantly reduces the contracting risks and thus considerably increases the project value compared to a fixed price CO2 contract. Analyzing the weaknesses of alternate CO2 contract structures gives insights into the design of optimal CO2 contracts for the CCS-EOR value chain.

Keywords: risk management, contract design, risk sharing, capital projects, CCS

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2013

WP-2013-016

Investment Model for Renewable Electricity Systems (IMRES): an Electricity Generation Capacity Expansion Formulation with Unit Commitment Constraints

Fernando J. de Sisternes 

This paper describes the formulation of IMRES: an electricity generation capacity expansion model with unit commitment constraints in which decisions pertaining to investment, unit commitment and energy dispatch are taken jointly. The purpose of this model is to determine the minimum cost electricity generation capacity mix in systems with a high penetration of intermittent renewable energy resources, while accounting for the operational dynamics of thermal units and their impact on total system cost. The model is formulated as a 0-1 MILP, taking capacity decisions at the individual power plant level, and accounting for techno-economic considerations such as ramp constraints, startup costs, and minimum stable outputs of thermal plants, among others. Additionally, the model o ffers the possibility of introducing in the system other dynamic elements such as storage or demand side management, that facilitate renewable integration and reduce the total system cost.

WP-2013-015

Melting-pots and Salad Bowls: The Current Debate on Electricity Market Design for RES Integration

Jean-Michel Glachant and Arthur Henriot

This paper discusses a series of issues regarding the economic integration of intermittent renewables into European electricity markets. This debate has gained in importance following the large-scale deployment of wind farms and photovoltaic panels. As intermittent renewables constitute a significant share of the installed generation capacity, they cannot be kept isolated from the electricity markets.

We argue that RES integration is first and foremost an issue of economic efficiency, and we review the main debates and frameworks that have emerged in the literature. We first consider to what extent intermittent resources should be treated the same way as dispatchable resources. We then analyse the different tools that have been proposed to ensure the required flexibility will be delivered: finer temporal granularity and new price boundaries, integration of a complex set of balancing markets, and introduction of tailor-made capacity remuneration mechanisms. Finally we introduce the topic of space redistribution, confronting cross-continental markets integration to the emergence of a mosaic

WP-2013-014
Esther Duflo, Michael Greenstone, Rohini Pande, and Nicholas Ryan, May 2013
Abstract   |   Full Paper [PDF]

Truth-telling by Third-party Auditors and the Response of Polluting Firms: Experimental Evidence from India

Esther Duflo, Michael Greenstone, Rohini Pande, and Nicholas Ryan, May 2013

In many regulated markets, private, third-party auditors are chosen and paid by the firms that they audit, potentially creating a conflict of interest. This paper reports on a two-year field experiment in the Indian state of Gujarat that sought to curb such a conflict by altering the market structure for environmental audits of industrial plants to incentivize accurate reporting. There are three main results. First, the status quo system was largely corrupted, with auditors systematically reporting plant emissions just below the standard, although true emissions were typically higher. Second, the treatment caused auditors to report more truthfully and very significantly lowered the fraction of plants that were falsely reported as compliant with pollution standards. Third, treatment plants, in turn, reduced their pollution emissions. The results suggest reformed incentives for third-party auditors can improve their reporting and make regulation more effective.

WP-2013-013

Mapping and Measuring the Channels of Oil Price Exposure in the Economy and the Role of Oil Derivatives in Reshaping Them

John E. Parsons, October 2013

This paper provides a framework for understanding how the trade in oil derivatives relates to the physical production and use of oil in the economy. We use this framework to benchmark the scale of investment in exposure to oil prices made using futures, options and other derivatives. The paper reviews the available research on the valuation of oil reserves and on how companies use oil derivatives for hedging. We identify the inadequacy of the publicly available statistics on the OTC derivatives markets, and the limited research and statistics available on the financial channels of oil exposures.

WP-2013-012

The Performance of U.S. Wind and Solar Generating Plants

Richard Schmalensee, September 2013

Government subsidies have driven rapid growth in U.S. wind and solar generation. Using data on hourly outputs and prices for 25 wind and nine solar generating plants, some results of those subsidies are studied in detail: the value of these plants' outputs, the variability of output at plant and regional levels, and the variation in performance among plants and regions. Output from solar plants was about 32% more valuable on average than output from wind plants. Output variability differs substantially among plants and, on some dimensions, among regions. Policy implications of high generation when prices are negative and dramatic differences in capacity factors are discussed.

WP-2013-011
Christopher R. Knittel and Ryan Sandler, February 2013
Abstract   |   Full Paper [PDF]

The Welfare Impact of Indirect Pigouvian Taxation: Evidence from Transportation

Christopher R. Knittel and Ryan Sandler, February 2013

A basic tenet of economics posits that when consumers or firms don't face the true social cost of their actions, market outcomes are inefficient. In the case of negative externalities, Pigouvian taxes are one way to correct this market failure, where the optimal tax leads agents to internalize the true cost of their actions. A practical complication, however, is that the level of externality nearly always varies across economic agents and directly taxing the externality may be infeasible. In such cases, policy often taxes a product correlated with the externality.

For example, instead of taxing vehicle emissions directly, policy makers may tax gasoline even though per-gallon emissions vary across vehicles. This paper estimates the implications of this approach within the personal transportation market. We have three general empirical

WP-2013-010

The Origin of US Transportation Policy: Was There Ever Support for Gasoline Taxes?

Christopher R. Knittel, January 2013

From 1864 to 1972, the real price of oil fell by, on average, over one percent per year. This trend dramatically broke when prices for crude increased by over 650 percent from 1972 to 1980. Policy makers adopted several policies designed to keep oil prices in check and reduce consumption. Missing from these policies were taxes on either oil or gasoline, prompting a long economics literature documenting the inefficiencies of these alternative policies. In this paper, I review the policy discussion related to the transportation sector that occurred during the time through the lens of the printed press. In doing so, I pay particular attention to whether gasoline taxes were on the table, as well as how consumers viewed the inefficient set of policies that were ultimately adopted. The discussions at the time suggest that meaningful changes in gasoline taxes were on the table; the public discussion seemed to be much greater than it is today. Some in Congress and many presidential advisors in the Nixon, Ford, and, Carter administrations supported and proposed gasoline taxes. The main roadblocks for taxes were Congress and the American people. Polling evidence at the time suggests that consumers preferred price controls and rationing and vehicle taxes over higher gasoline taxes or letting gasoline prices clear the market. Given the saliency of rationing and vehicle taxes, it seems difficult to argue that these alternative polices were adopted because they hide their true costs.

WP-2013-009
Meghan R. Busse, Christopher R. Knittel, Jorge Silva-Risso, and Florian Zettelmeyer, November 2012
Abstract   |   Full Paper [PDF]

Did "Cash for Clunkers" Deliver? The Effects of the Car Allowance Rebate System

Meghan R. Busse, Christopher R. Knittel, Jorge Silva-Risso, and Florian Zettelmeyer, November 2012

In this paper we analyze whether the 2009 "Cash for Clunkers" program was indeed, as U.S. Transportation Secretary Ray LaHood suggested at the time, "good news for ... consumers' pocketbooks." To do so we investigate how much of the rebate benefited consumers as opposed to dealers, whether the rebate crowded out or stimulated manufacturer incentives, and whether the scrapping of a large number of vehicles affected prices in the used-vehicle market. We find that Cash for Clunkers was consistently positive for consumer welfare on all three dimensions that we measure: First, consumers received the full amount of the rebate; second, the program stimulated manufacturer rebates (thereby increasing the benefits to customers beyond the value of the Cash for Clunkers rebates alone); and third, the destruction of low-fuel-economy, old, high-mileage vehicles did not raise prices in the used-vehicle market.

WP-2013-008
Meghan R. Busse, Christopher R. Knittel, and Florian Zettelmeyer, November 2012
Abstract   |   Full Paper [PDF]

Who is Exposed to Gas Prices? How Gasoline Prices Affect Automobile Manufacturers and Dealerships

Meghan R. Busse, Christopher R. Knittel, and Florian Zettelmeyer, November 2012

Many consumers are keenly aware of gasoline prices, and consumer responses to gasoline prices have been well studied. In this paper, by contrast, we investigate how gasoline prices affect the automobile industry: manufacturers and dealerships. We estimate how changes in gasoline prices affect equilibrium prices and sales of both new and used vehicles of different fuel economies. We investigate the implications of these effects for individual auto manufacturers, taking into account differences in manufacturers' vehicle portfolios. We also investigate effects on manufacturers' affiliated dealership networks, including effects implied by the changes in used vehicle market outcomes.

WP-2013-007

Climate Change Policy: What do the Models Tell Us?

Robert S. Pindyck, July 2013

Very little. A plethora of integrated assessment models (IAMs) have been constructed and used to estimate the social cost of carbon (SCC) and evaluate alternative abatement policies. These models have crucial flaws that make them close to useless as tools for policy analysis: certain inputs (e.g. the discount rate) are arbitrary, but have huge effects on the SCC estimates the models produce; the models' descriptions of the impact of climate change are completely ad hoc, with no theoretical or empirical foundation; and the models can tell us nothing about the most important driver of the SCC, the possibility of a catastrophic climate outcome. IAM-based analyses of climate policy create a perception of knowledge and precision, but that perception is illusory and misleading.

JEL Classification Numbers: Q5, Q54, D81

Keywords: Environmental policy, climate change, integrated assessment models, climate impact, social cost of carbon, CO2 emissions abatement, damage functions, climate sensitivity.


WP-2013-006
Christopher R. Knittel and Robert S. Pindyck, April 2013
Abstract   |   Full Paper [PDF]

The Simple Economics of Commodity Price Speculation

Chris R. Knittel and Robert S. Pindyck

The price of crude oil in the U.S. had never exceeded $40 per barrel until mid-2004. By
2006 it reached $70 per barrel, and in July 2008 it reached a peak of $145. By the end
of 2008 it had plummeted to about $30 before increasing again, reaching about $110 in
2011. Are “speculators” to blame for at least part of the volatility and sharp run-ups
in price? We clarify the potential and actual effects of speculators, and investors in
general, on commodity prices. We focus on crude oil, but our approach can be applied
to other commodities. We first address the question of what is meant by “oil price
speculation,” and how it relates to investments in oil reserves, oil inventories, or oil
price derivatives (such as futures contracts). Next we outline the ways in which one
could speculate on oil prices. Finally, we turn to the data, and calculate counterfactual
prices that would have occurred from 1999 to 2012 in the absence of speculation. Our
framework is based on a simple and transparent model of supply and demand in the
cash and storage markets for a commodity. It lets us determine whether speculation
as the driver of price changes is consistent with the data on production, consumption,
inventory changes, and changes in convenience yields given reasonable elasticity
assumptions. We show speculation had little, if any, effect on prices and volatility.

WP-2013-005
Claudio Marcantonini and A. Denny Ellerman, February 2013
Abstract   |   Full Paper [PDF]

The Cost of Abating CO2 Emissions by Renewable Energy Incentives in Germany

Claudio Marcantonini and A. Denny Ellerman

Incentives for the development of renewable energy have increasingly become an instrument of climate policy, that is, as a means to reduce GHG emissions. This research analyzes the German experience in promoting renewable energy over the past decade to identify the ex post cost of reducing CO2 emissions through the promotion of renewable energy, specifically, wind and solar. To this propose, we calculated the annual CO2 abatement cost for the years 2006- 2010 as the ratio of the net cost over the CO2 emission reductions resulting from the use of renewable energy. The net cost is the sum of the costs and cost savings due to the injection of renewable energy into the electric power system. Results show that CO2 abatement cost of wind are relatively low, of the order of tens of Euro per tonne of CO2, while CO2 abatement cost of solar are very high, of the order of hundreds of Euro per tonne of CO2. CO2 abatement cost has changed considerably over the years due to variations of fossil fuels prices, carbon price and the amount of generated renewable energy.

WP-2013-004
Meredith Fowlie, Mar Reguant and Stephen P. Ryan, January 2013
Abstract   |   Full Paper [PDF]

Market-Based Emissions Regulation and Industry Dynamics

Meredith Fowlie, Mar Reguant and Stephen P. Ryan

We assess the long-run dynamic implications of market-based regulation of carbon dioxide emissions in the US Portland cement industry. We consider several alternative policy designs, including mechanisms that use production subsidies to partially offset compliance costs and border tax adjustments to penalize emissions associated with foreign imports. Our results highlight two general countervailing market distortions. First, following Buchanan (1969), reductions in product market surplus and allocative inefficiencies due to market power in the domestic cement market counteract the social benefits of carbon abatement. Second, trade exposure to unregulated foreign competitors leads to emissions leakage which offsets domestic emissions reductions. Taken together, these forces result in social welfare losses under policy regimes that fully internalize the emissions externality. In contrast, market-based policies that incorporate design features to mitigate the exercise of market power and emissions leakage can deliver welfare gains.

WP-2013-003

Adapting to Climate Change: The Remarkable Decline in the U.S. Temperature-Mortality Relationship over the 20th Century

Alan Barreca, Karen Clay, Olivier Desch

WP-2013-002

Hit or Miss: Regulating Derivative Markets to Reduce Hedging Costs at Non-Financial Companies

John E. Parsons

Derivative markets are an important tool enabling non?financial companies to reduce their risk and manage their financing. Effective regulation of these markets can lower companies hedging costs and help improve productivity. Ineffective regulation can raise costs and reduce productivity. In this testimony, I address what type of action is likely to be effective in reducing hedging costs at nonfinancial companies and what type of action is likely to be ineffective or counterproductive.

WP-2013-001

Do Housing Prices Reflect Environmental Health Risks? Evidence from More than 1600 Toxic Plant Openings and Closings

Janet Currie, Lucas Davis, Michael Greenstone and Reed Walker

A ubiquitous and largely unquestioned assumption in studies of housing markets is that there is perfect information about local amenities. This paper measures the housing market and health impacts of 1,600 openings and closings of industrial plants that emit toxic pollutants. We find that housing values within one mile decrease by 1.5 percent when plants open, and increase by 1.5 percent when plants close. This implies an aggregate loss in housing values per plant of about $1.5 million. While the housing value impacts are concentrated within one-half mile, we find statistically significant infant health impacts up to one mile away.

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2012

WP-2012-013
Michael Greenstone, John A. List and Chad Syverson, September 2012
Abstract   |   Full Paper [PDF]

The Effects of Environmental Regulation on the Competitiveness of U.S. Manufacturing

Michael Greenstone, John A. List and Chad Syverson, September 2012

The economic costs of environmental regulations have been widely debated since the U.S. began to restrict pollution emissions more than four decades ago. Using detailed production data from nearly 1.2 million plant observations drawn from the 1972-1993 Annual Survey of Manufactures, we estimate the effects of air quality regulations on manufacturing plants' total factor productivity (TFP) levels. We find that among surviving polluting plants, stricter air quality regulations are associated with a roughly 2.6 percent decline in TFP. The regulations governing ozone have particularly large negative effects on productivity, though effects are also evident among particulates and sulfur dioxide emitters. Carbon monoxide regulations, on the other hand, appear to increase measured TFP, especially among refineries. The application of corrections for the confounding of price increases and output declines and sample selection on survival produce a 4.8 percent estimated decline in TFP for polluting plants in regulated areas. This corresponds to an annual economic cost from the regulation of manufacturing plants of roughly $21 billion, which is about 8.8 percent of manufacturing sector profits in this period.

WP-2012-012

The SO2 Allowance Trading System: The Ironic History of a Grand Policy Experiment

Thomas Klier and Joshua Linn, August 2012

Two decades have passed since the Clean Air Act Amendments of 1990 launched a grand experiment in market-based environmental policy: the SO2 cap-and-trade system. That system performed well but created four striking ironies. First, by creating this system to reduce SO2 emissions to curb acid rain, the government did the right thing for the wrong reason. Second, a substantial source of this system's cost-effectiveness was an unanticipated consequence of earlier railroad deregulation. Third, it is ironic that cap-and-trade has come to be demonized by conservative politicians in recent years, since this market-based, cost-effective policy innovation was initially championed and implemented by Republican administrations. Fourth, court decisions and subsequent regulatory responses have led to the collapse of the SO2 market, demonstrating that what the government gives, the government can take away.

WP-2012-011

Using Vehicle Taxes to Reduce Carbon Dioxide Emissions Rates of New Passenger Vehicles: Evidence from France, Germany, and Sweden

Thomas Klier and Joshua Linn, August 2012

France, Germany, and Sweden link vehicle taxes to the carbon dioxide (CO2) emissions rates of passenger vehicles. Based on new vehicle registration data from 20052010, a vehicles tax is negatively correlated with its registrations. The effect is somewhat stronger in France than in Germany and Sweden. Taking advantage of the theoretical equivalence between an emissions rate standard and a CO2-based emissions rate tax, we estimate the effect on manufacturers profits of reducing emissions rates. For France, a decrease of 5 grams of CO2 per kilometer reduces profits by 24 euros per vehicle. We find considerable heterogeneity across manufactures and countries.

WP-2012-010
Robert S. Pindyck, July 2012
Abstract   |   Full Paper [PDF]

Risk and Return in Environmental Economics

Robert S. Pindyck, July 2012

I examine the risk/return tradeoff for environmental investments, and its implications for policy choice. Consider a policy to reduce carbon emissions. To what extent does the value of such a policy depend on the expected future damages from global warming versus uncertainty over those damages, i.e., on the expected benefits from the policy versus their riskiness? And to what extent should the policy objective be a reduction in the expected temperature increase versus a reduction in risk? Using a simple model of a stock externality (e.g., temperature) that evolves stochastically, I examine the "willingness to pay"

WP-2012-009
Robert S. Pindyck, July 2012
Abstract   |   Full Paper [PDF]

The Climate Policy Dilemma

Robert S. Pindyck, July 2012

Climate policy poses a dilemma for environmental economists. The economic argument for stringent GHG abatement is far from clear. There is disagreement among both climate scientists and economists over the likelihood of alternative climate outcomes, over the nature and extent of the uncertainty over those outcomes, and over the framework that should be used to evaluate potential benefits from GHG abatement, including key policy parameters. I argue that the case for stringent abatement

WP-2012-008

Up in Smoke: The Influence of Household Behavior on the Long-Run Impact of Improved Cooking Stoves

Rema Hanna, Esther Duflo and Michael Greenstone, July 2012

It is conventional wisdom that it is possible to reduce exposure to indoor air pollution, improve health outcomes, and decrease greenhouse gas emissions in the rural areas of developing countries through the adoption of improved cooking stoves. This belief is largely supported by observational field studies and engineering or laboratory experiments. However, we provide new evidence, from a randomized control trial conducted in rural Orissa, India (one of the poorest places in India), on the benefits of a commonly used improved stove that laboratory tests showed to reduce indoor air pollution and require less fuel. We track households for up to four years after they received the stove. While we find a meaningful reduction in smoke inhalation in the first year, there is no effect over longer time horizons. We find no evidence of improvements in lung functioning or health and there is no change in fuel consumption (and presumably greenhouse gas emissions). The difference between the laboratory and field findings appear to result from households' revealed low valuation of the stoves. Households failed to use the stoves regularly or appropriately, did not make the necessary investments to maintain them properly, and usage rates ultimately declined further over time. More broadly, this study underscores the need to test environmental and health technologies in real-world settings where behavior may temper impacts, and to test them over a long enough horizon to understand how this behavioral effect evolves over time.

WP-2012-007

Defensive Investments and the Demand for Air Quality: Evidence from the NOx Budget Program and Ozone Reductions

Olivier Desch

WP-2012-006
Christopher R. Knittel and Aaron Smith, July 2012
Abstract   |   Full Paper [PDF]

Ethanol Production and Gasoline Prices: A Spurious Correlation

Christopher R. Knittel and Aaron Smith, July 2012

Ethanol made from corn comprises 10% of US gasoline, up from 3% in 2003. This dramatic increase was spurred by recent policy initiatives such as the Renewable Fuel Standard and state-level blend mandates, and supported by direct subsidies such as the Volumetric Ethanol Excise Tax Credit. Some proponents of ethanol have argued that ethanol production greatly lowers gasoline prices, with one industry group claiming it reduced gasoline prices by 89 cents in 2010 and $1.09 in 2011. The estimates have been cited in numerous speeches by Secretary of Agriculture Thomas Vilsack. These estimates are based on a series of papers by Xiaodong Du and Dermot Hayes. We show that these results are driven by implausible economic assumptions and spurious statistical correlations. To support this last point, we use the same statistical models and find that ethanol production "decreases"natural gas prices, but "increases" unemployment in both the US and Europe. We even show that ethanol production "increases"

WP-2012-005
Antonio S. Mello and John E. Parsons, May 2012
Abstract   |   Full Paper [PDF]

Margins, Liquidity and the Cost of Hedging

Antonio S. Mello and John E. Parsons, May 2012

Recent financial reforms, such as the Dodd-Frank Act in the U.S. and the European Market Infrastructure Regulation, encourage greater use of clearing and therefore increased margining of derivative trades. They also impose margining requirements on OTC derivative dealers. One question arising out of the debates over these reforms is, does a margin mandate increases the cost of hedging by non-financial corporations—the so-called end-users of derivatives? Our answer is, No. We show that a non-margined derivative is equivalent to a package of:

(i) a margined derivative, and
(ii) a contingent line of credit.

A margin mandate merely requires that this package be marketed as two distinct products, but it does not change the total financing or capital that the non-financial corporation requires to back its hedging. Nor does it raise the cost to banks or other dealer of offering the package, at least not directly. There may be an indirect effect if the clearing mandate succeeds in lowering systemic risk, but indirect macro effects such as this are beyond the scope of this paper. We also explore how accounting rules and bank regulations may treat the implicit credit embedded in the nonmargined derivative differently from an explicit line of credit. This is important to understanding business and banker reaction to details of the proposal. Finally, we place the current debate in the context of the historical evolution of margin practices and regulations from the earliest trading of derivatives in the U.S. in the 1860’s to the present.

WP-2012-004

Local and Seasonal Effects in the U.S. of Global Climate Change

Richard S. Eckaus, May 2012

Though the facts of global climate change are beyond doubt, there has been relatively limited information about its local consequences. Global climate models and their derivatives have provided often differing and unspecific indications. This paper demonstrates an effective approach for the determination of local and seasonal effects of global climate change using data for the United States. Examples are given for specific weather station sites and for sites across the U.S. in five longitudinal strips divided into four latitudinal strips. Mean temperature and precipitation data are subjected to thirty year moving averaging and linear time trend lines are estimated, for which, in almost all instances, the estimated coefficients are highly significant.

While in some locations there have been significant weather effects of climate changes, in other locations the effects have been small and may even be perverse. Linear extrapolation into the future of the results for individual sites seems reliable, based on past experience.

Local weather patterns and local topographies modify the local effects of global climate change. An immediate implication of the results reported here is that there are significant local differences in the type and degree of adaptation to global climate change that should be considered.

WP-2012-003
Hannes Weigt, Erik Delarue and Denny Ellerman, April 2012
Abstract   |   Full Paper [PDF]

CO2 Abatement from Renewable Energy Injections in the German Electricity

Hannes Weigt, Erik Delarue and Denny Ellerman, April 2012

The overlapping impact of the Emission Trading System (ETS) and renewable energy (RE) deployment targets creates a classic case of interaction effects. Whereas the price interaction is widely recognized and has been thoroughly discussed, the effect of an overlapping instrument on the abatement attributable to an instrument has gained little attention. This paper estimates the actual reduction in demand for European Union Allowances that has occurred due to RE deployment focusing on the German electricity sector, for the five years 2006 through 2010. Based on a unit commitment model we estimate that CO2 emissions from the electricity sector are reduced by 33 to 57 Mtons, or 10% to 16% of what estimated emissions would have been without any RE policy. Furthermore, we find that the abatement attributable to RE injections is greater in the presence of an allowance price than otherwise. The same holds for the ETS effect in presence of RE injection. This interaction effect is consistently positive for the German electricity system, at least for these years, and on the order of 0.5% to 1.5% of emissions.

WP-2012-002
Michael Greenstone and Adam Looney, February 2012
Abstract   |   Full Paper [PDF]

Paying Too Much for Energy? The True Costs of Our Energy Choices

Michael Greenstone and Adam Looney, February 2012

Energy consumption is critical to economic growth and quality of life. America's energy system, however, is malfunctioning. The status quo is characterized by a tilted playing field, where energy choices are based on the visible costs that appear on utility bills and at gas pumps. This system masks the "external"

WP-2012-001
Paul L. Joskow and John E. Parsons, February 2012
Abstract   |   Full Paper [PDF]

The Future of Nuclear Power After Fukushima

Paul L. Joskow and John E. Parsons, February 2012

This paper analyzes the impact of the Fukushima accident on the future of nuclear power around the world. We begin with a discussion of the "but for" baseline and the much discussed "nuclear renaissance." Our pre-Fukushima benchmark for growth in nuclear generation in the U.S. and other developed countries is much more modest than many bullish forecasts of a big renaissance in new capacity may have suggested. For at least the next decade in developed countries, it is composed primarily of life extensions for many existing reactors, modest updates of existing reactors as their licenses are extended, and modest levels of new construction. The majority of forecasted new construction is centered in China, Russia and the former states of the FSU, India and South Korea. In analyzing the impact of Fukushima, we break the effect down into two categories: the impact on existing plants, and the impact on the construction of new units. In both cases, we argue that the accident at Fukushima will contribute to a reduction in future trends in the expansion of nuclear energy, but at this time these effects appear to be quite modest at the global level.

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As a benefit to our Associates, the latest Working Papers are embargoed for a period of up to six months before becoming accessible to the public. If you are interested in becoming an Associate or learning more about the benefits of sponsorship, please click here.

2011

WP-2011-021
Paul L. Joskow, October 2011
Abstract   |   Full Paper [PDF]

Creating a Smarter U.S. Electricity Grid

WP-2011-020
Christopher R. Knittel, December 2011
Abstract   |   Full Paper [PDF]

Reducing Petroleum Consumption from Transportation

Christopher R. Knittel, December 2011

The United States consumed more petroleum-based liquid fuel per capita than any other OECD- high-income country- 30 percent more than the second-highest country (Canada) and 40 percent more than the third-highest (Luxemburg). This paper examines the main channels through which reductions in U.S. oil consumption might take place: (a) increased fuel economy of existing vehicles, (b) increased use of non-petroleum-based low-carbon fuels, (c) alternatives to the internal combustion engine, and (d) reduced vehicles miles travelled. I then discuss how the policies for reducing petroleum consumption used in the US compare with the standard economics prescription for using a Pigouvian tax to deal with externalities. Taking into account that energy taxes are a political hot button in the United States, and also considering some evidence that consumers may not correctly value fuel economy, I offer some thoughts about the margins on which policy aimed at reducing petroleum consumption might usefully proceed.

WP-2011-019

Improving Regulatory Performance: Lessons from the United Kingdom

WP-2011-018
Mort Webster, Nidhi Santen and Panos Parpas, September 2011
Abstract   |   Full Paper [PDF]

An Approximate Dynamic Programming Framework for Modeling Global Climate

Mort Webster, Nidhi Santen and Panos Parpas, September 2011

Analyses of global climate policy as a sequential decision under uncertainty have been severely restricted by dimensionality and computational burdens. Therefore, they have limited the number of decision stages, discrete actions, or number and type of uncertainties considered. In particular, other formulations have difficulty modeling endogenous or decision-dependent uncertainties, in which the shock at time t+1 depends on the decision made at time t. In this paper, we present a stochastic dynamic programming formulation of the Dynamic Integrated Model of Climate and the Economy (DICE), and the application of approximate dynamic programming techniques to numerically solve for the optimal policy under uncertain and decision-dependent technological change. We compare numerical results using two alternative value function approximation approaches, one parametric and one non-parametric. Using the framework of dynamic programming, we show that an additional benefit to near-term emissions reductions comes from a probabilistic lowering of the costs of emissions reductions in future stages, which increases the optimal level of near-term actions.

WP-2011-017
Thomas Klier and Joshua Linn, August 2011
Abstract   |   Full Paper [PDF]

Fuel Prices and New Vehicle Fuel Economy in Europe

Thomas Klier and Joshua Linn, August 2011

This paper evaluates the effect of fuel prices on new vehicle fuel economy in the eight largest European markets. The analysis spans the years 20022007 and uses detailed vehicle registration and specification data to control for policies, consumer preferences, and other potentially confounding factors. Fuel prices have a statistically significant effect on new vehicle fuel economy in Europe, but this estimated effect is much smaller than that for the United States. Within Europe, fuel economy responds more in the United Kingdom and France than in the other large markets. Overall, substantial changes in fuel prices would have relatively small effects on the average fuel economy of new vehicles sold in Europe. We find no evidence that diesel fuel prices have a large effect on the market share of diesel vehicles.

WP-2011-016
Stephen P. Holland, Jonathan E. Hughes Christopher R. Knittel, Nathan C. Parker, August 2011
Abstract   |   Full Paper [PDF]

Some Inconvenient Truths About Climate Change Policy: The Distributional Impacts of Transportation Policies

Stephen P. Holland, Jonathan E. Hughes Christopher R. Knittel, Nathan C. Parker, August 2011

Instead of efficiently pricing greenhouse gases, policy makers have favored measures that implicitly or explicitly subsidize low carbon fuels. We simulate a transportation-sector cap & trade program (CAT) and three policies currently in use: ethanol subsidies, a renewable fuel standard (RFS), and a low carbon fuel standard (LCFS). Our simulations con rm that the alternatives to CAT are quite costly2.5 to 4 times more expensive. We provide evidence that the persistence of these alternatives in spite of their higher costs lies in the political economy of carbon policy. The alternatives to CAT exhibit a feature that make them amenable to adoption|a right skewed distribution of gains and losses where many counties have small losses, but a smaller share of counties gain considerablyas much as $6,800 per capita, per year. We correlate our estimates of gains from CAT and the RFS with Congressional voting on the Waxman-Markey cap & trade bill, H.R. 2454. Because Waxman-Markey (WM) would weaken the RFS, House members likely viewed the two policies as competitors. Conditional on a district's CAT gains, increases in a district's RFS gains are associated with decreases in the likelihood of voting for WM. Furthermore, we show that campaign contributions are correlated with a district's gains under each policy and that these contributions are correlated with a Member's vote on WM.

WP-2011-015

Cleaning the Bathwater with the Baby: The Health Co-Benefits of Carbon Pricing in Transportation

Christopher R. Knittel and Ryan Sandler, August 2011

Efforts to reduce greenhouse gas emissions in the US have relied on Corporate Average Fuel Economy (CAFE) Standards and Renewable Fuel Standards (RFS). Economists often argue that these policies are inefficient relative to carbon pricing because they ignore existing vehicles and do not adequately reduce the incentive to drive. This paper presents evidence that the net social costs of carbon pricing are significantly less than previous thought. The bias arises from the fact that the demand elasticity for miles travelled varies systematically with vehicle emissions; dirtier vehicles are more responsive to changes in gasoline prices. This is true for all four emissions for which we have data�nitrogen oxides, carbon monoxide, hydrocarbon, and greenhouse gases�as well as weight. This reduces the net social costs associated with carbon pricing through increasing the co-benefits. Accounting for this heterogeneity implies that the welfare losses from $1.00 gas tax, or a $110 per ton of CO2 tax, are negative over the period of 1998 to 2008 even when we ignore the climate change benefits from the tax. Co-benefits increase by over 60 percent relative to ignoring the heterogeneity that we document. In addition, accounting for this heterogeneity raises the optimal gas tax associated with local pollution, as calculated by Parry and Small (2005), by as much as 57 percent. While our empirical setting is California, we present evidence that the effects may be larger for the rest of the US.

WP-2011-014

Environmental Regulations, Air and Water Pollution, and Infant Mortality in India

Michael Greenstone and Rema Hanna, July 2011

Using the most comprehensive data file ever compiled on air pollution, water pollution, environmental regulations, and infant mortality from a developing country, the paper examines the effectiveness of Indias environmental regulations. The air pollution regulations were effective at reducing ambient concentrations of particulate matter, sulfur dioxide, and nitrogen dioxide. The most successful air pollution regulation is associated with a modest and statistically insignificant decline in infant mortality. However, the water pollution regulations had no observable effect. Overall, these results contradict the conventional wisdom that environmental quality is a deterministic function of income and underscore the role of institutions and politics.

WP-2011-013
Christopher R. Knittel, Douglas L. Miller, and Nicholas J. Sanders, July 2011
Abstract   |   Full Paper [PDF]

Caution, Drivers! Children Present: Traffic, Pollution, and Infant Health

Christopher R. Knittel, Douglas L. Miller, and Nicholas J. Sanders, July 2011

Since the Clean Air Act Amendments of 1990 (CAAA), atmospheric concentration of local pollutants has fallen drastically. A natural question is whether further reductions will yield additional health benefits. We further this research by addressing two related research questions: (1) what is the impact of automobile driving (and especially congestion) on ambient air pollution levels, and (2) what is the impact of modern air pollution levels on infant health? Our setting is California (with a focus on the Central Valley and Southern California) in the years 2002-2007. Using an instrumental variables approach that exploits the relationship between traffic, ambient weather conditions, and various pollutants, our findings suggest that ambient pollution levels, specifically particulate matter, still have large impacts on weekly infant mortality rates. Our results also illustrate the importance of weather controls in measuring pollutions impact on infant mortality.

WP-2011-012

Russia's Natural Gas Export Potential up to 2050

Sergey Paltsev, July 2011

Recent increases in natural gas reserve estimates and advances in shale gas technology make natural gas a fuel with good prospects to serve a bridge to a low-carbon world. Russia is an important energy supplier as it holds the world largest natural gas reserves and it is the world's largest exporter of natural gas. Energy was one of the driving forces of Russia's recent economic recovery from the economic collapse of 1990s. These prospects have changed drastically with a global recession and the collapse of oil and gas prices from their peaks of 2008. An additional factor is an ongoing surge in a liquefied natural gas (LNG) capacity and a development of Central Asia's and the Middle East gas supplies that can compete with Russian gas in its traditional (European) and potential (Asian) markets. To study the long-term prospects for Russian natural gas, we employ the MIT Emissions Prediction and Policy Analysis (EPPA) model, a computable general equilibrium model of the world economy. While we consider the updated reserve estimates for all world regions, in this paper we focus on the results for Russian natural gas trade. The role of natural gas is explored in the context of several policy assumptions: with no greenhouse gas mitigation policy and scenarios of emissions targets in developed countries. Scenarios where Europe takes on an even more restrictive target of 80 percent reduction of greenhouse gas emissions relative to 2005 by 2050 and reduces its nuclear-based generation are also considered. Asian markets become increasingly important for natural gas exports and several scenarios about their potential development are considered. We found that over the next 20-40 years natural gas can still play a substantial role in Russian exports and there are substantial reserves to support a development of the gas-oriented energy system both in Russia and in its current and potential gas importers. In the Reference scenario, exports of natural gas grow from Russia's current 7 Tcf to 10-12 Tcf in 2030 and 15-18 Tcf in 2050. Alternative scenarios provide a wider range of projections, with a share of Russian gas exports shipped to Asian markets rising to 30 percent by 2030 and more than 50 percent in 2050. Patterns of international gas trade show increased flows to the Asian region from the Middle East, Central Asia, Australia and Russia. Europe's reliance on LNG imports increases, while it still maintains sizable imports from Russia.

WP-2011-011
Carlos Batlle, Ignacio Perez-Arriaga, and P. Zambrano-Barragán, May 2011
Abstract   |   Full Paper [PDF]

Regulatory Design for RES-E Support Mechanisms: Learning Curves, Market Structure, and Burden-Sharing

Carlos Batlle, Ignacio Perez-Arriaga, and P. Zambrano-Barragán

Drawing from relevant experiences in power systems around the world, this paper offers a critical review of existing policy support mechanisms for RES-E (renewable energy sources for electricity), with a detailed analysis of their regulatory implications. While recent studies provide an account of current RES-E support systems, in this paper we focus on the impacts these mechanisms have on the overall energy market structure and its performance in the short and long term. Given the rising importance of RES-E in systems everywhere, these impacts can no longer be overlooked.

WP-2011-010

The Importance of Research and Development (R&D) for U.S. Competitiveness and a Clean Energy Future

WP-2011-009

Liability and Financial Responsibility for Oil Spills under the Oil Pollution Act of 1990 and Related Statutes

WP-2011-008

Evaluating Policies to Increase the Generation of Electricity from Renewable Energy

Richard Schmalensee, May 2011

Focusing on the U.S. and the E.U., this essay seeks to advance four main propositions. First, the incidence of the short-run costs of programs to subsidize the generation of electricity from renewable sources varies with the organization of the electric power industry, and this variation is may be a significant contributor to their political attractiveness in U.S. states. Second, despite the greater popularity of feed-in-tariff schemes worldwide, renewable portfolio standard (RPS) programs may involve less long-run social risk under plausible conditions. Third, in contrast to the E.U.'s approach to reducing carbon dioxide emissions, its renewables program is almost certain not to minimize the cost of achieving its goals. Fourth, the array of state RPS programs in the U.S. are also almost certain to cost more than necessary, even though most employ market mechanisms. To support this last point I provide a fairly detailed description of actual markets for renewable energy credits (RECs) and their shortcomings.

WP-2011-007

The Dynamic Effects of Hurricanes in the US: The Role of Non-Disaster Transfer Payments

Tatyana Deryugina, May 2011

We know little about the dynamic economic impacts of natural disasters. I examine the effect of hurricanes on US counties' economies 0-10 years after landfall. Overall, I find no substantial changes in county population, earnings, or the employment rate. The largest empirical effect of a hurricane is observed in large increases in government transfer payments to individuals, such as unemployment insurance. The estimated magnitude of the extra transfer payments is large. While per capita disaster aid averages $356 per hurricane in current dollars, I estimate that in the eleven years following a hurricane an affected county receives additional non-disaster government transfers of $67 per capita per year. Private insurance-related transfers over the same time period average only $2:4 per capita per year. These results suggest that a non-trivial portion of the negative impact of hurricanes is absorbed by existing social safety net programs. The fiscal costs of natural disasters are thus much larger than the cost of disaster aid alone. Because of the deadweight loss of taxation and moral hazard concerns, the benefits of policies that reduce disaster vulnerability, such as climate change mitigation and removal of insurance subsidies, are larger than previously thought. Finally, the substantial increase in non-disaster transfers suggests that the relative resilience of the United States to natural disasters may be in part due to various social safety nets.

WP-2011-006

Estimating the Social Cost of Carbon for Use in U.S. Federal Rulemakings: A Summary and Interpretation

Michael Greenstone, Elizabeth Kopits and Ann Wolverton, May 2011

The United States Government recently concluded a year-long process to develop a range of values representing the monetized damages associated with an incremental increase in carbon dioxide (CO2) emissions, commonly referred to as the social cost of carbon (SCC). These values are currently used in benefit-cost analyses to assess potential federal regulations. For 2010, the central value of the SCC is $21 per ton of CO2 emissions and sensitivity analyses are to be conducted at $5, $35, and $65 (2007$). This paper summarizes the methodology and process used to develop the SCC values, complemented with our own commentary about how the SCC can be used to inform regulatory decisions and areas where further research would be particularly useful.

WP-2011-004
Janet Currie, Michael Greenstone and Enrico Moretti, February 2011
Abstract   |   Full Paper [PDF]

Superfund Cleanups and Infant Health

Janet Currie, Michael Greenstone and Enrico Moretti, February 2011

We are the first to examine the effect of Superfund cleanups on infant health rather than focusing on proximity to a site. We study singleton births to mothers residing within 5km of a Superfund site between 1989-2003 in five large states. Our difference in differences approach compares birth outcomes before and after a site clean-up for mothers who live within 2,000 meters of the site and those who live between 2,000- 5,000 meters of a site. We find that proximity to a Superfund site before cleanup is associated with a 20 to 25% increase in the risk of congenital anomalies.

WP-2011-003
Bruno Lanz, Thomas F. Rutherford and John E. Tilton, February 2011
Abstract   |   Full Paper [PDF]

Subglobal Climate Agreements and Energy-Intensive Activities: Is there a Carbon Haven for Copper?

Bruno Lanz, Thomas F. Rutherford and John E. Tilton, February 2011

Subglobal climate policies induce changes in international competitiveness and favor a relocation of carbon-emitting activities. We argue that many energy-intensive activities are also capital-intensive, so that carbon policies could affect rents rather than abatement or location. Taking copper as an example, we formulate a plant-level spatial equilibrium model of the industry, and we estimate a set of elasticities to calibrate the behavioral parameters of the model. Given 2007 market conditions, Monte Carlo simulations suggest that a $50/tCO2 tax in industrialized countries induces emissions reductions of less than one percent in the copper industry, with a mean emission leakage rate of 25%. Our results conform with empirical findings on the pollution haven effect but challenge projections from computable general equilibrium models.

WP-2011-002

Stocks & Shocks: A Clarification in the Debate Over Price vs. Quantity Controls for Greenhouse Gases

John E. Parsons and Luca Taschini, March 2011

We construct two simple examples that help to clarify the role of a key assumption in the analysis of price or quantity controls of greenhouse gases in the presence of uncertain costs. Traditionally much has been made of the fact that greenhouse gases are a stock pollutant, and that therefore the marginal benefit curve must be relatively flat. This fact is said to establish the preference of a price control over a quantity control. The stock pollutant argument is considered dispositive, so that the preference for price controls is categorical. We show that this argument can only be true if the uncertainty about cost is a special form: all shocks are transitory. We show that in the case of permanent shocks, the traditional comparison of marginal benefits vs. marginal costs is mis-measured. The choice between quantity and price controls becomes ambiguous again and depends upon a more difficult measurement of marginal costs and benefits. The simplicity of the examples and the solutions is a major element of the contribution here. The examples are readily accessible and the comparison of results under the alternative assumptions of transitory and permanent shocks is stark.

WP-2011-001

Review of Support Schemes for Renewable Energy Sources in South America

C. Batlle and L.A. Barroso, February 2011

This article reviews the current experiences implemented to date in the South American region to promote non-conventional renewable energy sources. We briefly describe first the particular characteristics of the territory which make it so appealing for the RES deployment. Then we scour the continent examining the mechanisms implemented to date. We conclude by just pointing out what should be expected for the years to come. The authors aim to contribute to fill in the current lack of state of the art, not only for South American audience, but also for those seeking for new "green business" opportunities."

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2010

WP-2010-017
David J. Ramberg and John E. Parsons, November 2010
Abstract   |   Full Paper [PDF]

The Weak Tie Between Natural Gas and Oil Prices

David J. Ramberg and John E. Parsons, November 2010, revised June 2011

Several recent studies establish that crude oil and natural gas prices are cointegrated. Yet at times in the past, and very powerfully in the last two years, many voices have noted that the two price series appear to have decoupled. We explore the apparent contradiction between these two views. We find that recognition of the statistical fact of cointegration needs to be tempered with two additional points. First, there is an enormous amount of unexplained volatility in natural gas prices at short horizons. Hence, any simple formulaic relationship between the prices will leave a large portion of the natural gas price unexplained. Second, the cointegrating relationship does not appear to be stable through time. The prices may be tied, but the relationship can shift dramatically over time. Therefore, although the two price series may be cointegrated, the confidence intervals for both short and long time horizons are large.

WP-2010-016
Yangbo Du and John E. Parsons, November 2010
Abstract   |   Full Paper [PDF]

Capacity Factor Risk At Nuclear Power Plants

Yangbo Du and John E. Parsons, November 2010

We develop a model of the dynamic structure of capacity factor risk. It incorporates the risk that the capacity factor may vary widely from year-to-year, and also the risk that the reactor may be permanently shutdown prior to the end of its anticipated useful life. We then fit the parameters of the model to the IAEA's PRIS dataset of historical capacity factors on reactors across the globe. The estimated capacity factor risk is greatest in the first year of operation. It then quickly declines over the next couple of years, after which it is approximately constant. Whether risk is constant or increasing in later years depends significantly on the probability of a premature permanent shutdown of the reactor. Because these should be very rare events, the probability is difficult to estimate reliably from the small historical sample of observations. Our base case is parameterized with a conservatively low probability of a premature permanent shutdown which yields the approximately constant variance. Our model, combined with the global historical dataset, also yields relatively low estimates for the expected level of the capacity factor through the life of the plant. Our base case estimate is approximately 74%. Focusing on alternative subsets of the data raises the estimated mean capacity factor marginally, but not significantly, unless the sample chosen is restricted to selected countries over select years. This emphasizes the need for judgment in exploiting the historical data to project future probabilities.

WP-2010-015

Financing a National Transmission Grid: What Are the Issues?

Gilbert E. Metcalf, October 2010

The United States requires a substantial investment in transmission capacity over the next several decades. This investment is needed to ensure system reliability, to accommodate growth in demand for electricity, and to allow the integration of significant amounts of renewable generating capacity. In this paper I survey the need for new transmission capacity and consider the financial and regulatory obstacles that stand in the way of this new investment.

This paper makes three points. First, the historical pace of transmission investments will not be adequate to enhance grid reliability or to allow largescale penetration of renewable generating capacity. Second, the replacement of a vertically integrated electric utility industry in many parts of the country by a more disaggregated one composed of merchant generators has added to the challenge of transmission planning and investment. Third, the focus on federal funding for grid improvements is misplaced. There is no evidence that the private sector is incapable of raising the funds needed for critical investment, provided a rationalized regulatory structure is put into place.

Making changes to our regulatory and political systems that facilitate transmission investment and siting will not be easy. But the costs of underinvesting in an improved and enlarged national transmission grid are high. Moving to a largely carbon-free economy by the middle of the century will require a transformation of the power system in this country, one that cannot be successful without a strong interstate high-voltage transmission backbone.

WP-2010-014

Gas Balancing Rules Must Take into account the Trade-off between Offering Pipeline Transport and Pipeline Flexibility in Liberalized Gas Markets

Nico Keyaerts, Michelle Hallack, Jean-Michel Glachant and William D'haeseleer, September 2010

This paper analyses the value and cost of line-pack flexibility in liberalized gas markets through the examination of the techno-economic characteristics of gas transport pipelines and the trade-offs between the different ways to use the infrastructure: transport and flexibility. Line-pack flexibility is becoming increasingly important as a tool to balance gas supply and demand over different periods. In the European liberalized market context, a monopolist unbundled network operator offers regulated transport services and flexibility (balancing) services according to the network code and the balancing rules. Therefore, gas policy makers should understand the role and consequences of line-pack regulation. The analysis shows that the line-pack flexibility service has an important economic value for the shippers and the TSO. Furthermore, the analysis identifies distorting effects in the gas market due to inadequate regulation of line-pack flexibility: by disregarding the fixed cost of the flexibility in the balancing rules, the overall efficiency of the gas system is decreased. Because a full market based approach to line-pack pricing is unlikely, a framework is presented to calculate a cost reflective price for pipeline flexibility based on the trade-offs and opportunity costs between the right to use the line-pack flexibility and the provision of transport services.

WP-2010-013

Comparing the Costs of Intermittent and Dispatchable Electricity Generating Technologies

Paul L. Joskow, September 2010

Economic evaluations of alternative electric generating technologies typically rely on comparisons between their expected life-cycle production costs per unit of electricity supplied. The standard life-cycle cost metric utilized is the "levelized cost" per MWh supplied. This paper demonstrates that this metric is inappropriate for comparing intermittent generating technologies like wind and solar with dispatchable generating technologies like nuclear, gas combined cycle, and coal. Levelized cost comparisons are a misleading metric for comparing intermittent and dispatchable generating technologies because they fail to take into account differences in the production profiles of intermittent and dispatchable generating technologies and the associated large variations in the market value of the electricity they supply. Levelized cost comparisons overvalue intermittent generating technologies compared to dispatchable base load generating technologies. They also overvalue wind generating technologies compared to solar generating technologies. Integrating differences in production profiles, the associated variations in the market value of the electricity supplied, and life-cycle costs associated with different generating technologies is necessary to provide meaningful comparisons between them. This market-based framework also has implications for the appropriate design of procurement auctions created to implement renewable energy procurement mandates, the efficient structure of production tax credits for renewable energy, and the evaluation of the additional costs of integrating intermittent generation into electric power networks.

WP-2010-012
Robert S. Pindyck, September 2010
Abstract   |   Full Paper [PDF]

Fat Tails, Thin Tails, and Climate Change Policy

Robert S. Pindyck, September 2010

Climate policy is complicated by the considerable compounded uncertainties over the costs and benefits of abatement. We dont even know the probability distributions for future temperatures and impacts, making cost-benefit analysis based on expected values challenging to say the least. There are good reasons to think that those probability distributions are fat-tailed, which implies that if social welfare is based on the expectation of a CRRA utility function, we should be willing to sacrifice close to 100% of GDP to reduce GHG emissions. I argue that unbounded marginal utility makes little sense, and once we put a bound on marginal utility, this implication of fat tails goes away: Expected marginal utility will be finite even if the distribution for outcomes is fat-tailed. Furthermore, depending on the bound on marginal utility, the index of risk aversion, and the damage function, a thin-tailed distribution can yield a higher expected marginal utility (and thus a greater willingness to pay for abatement) than a fat-tailed one.

WP-2010-011
Esther Duflo, Michael Greenstone, Rohini Pande and Nicholas Ryan, August 2010
Abstract   |   Full Paper [PDF]

Towards an Emissions Trading Scheme for Air Pollutants in India

Esther Duflo, Michael Greenstone, Rohini Pande and Nicholas Ryan, August 2010

Emissions trading schemes have great potential to lower pollution while minimizing compliance costs for firms in many areas now subject to traditional command-and-control regulation. This paper connects experience with emissions trading, from programs like the U.S. Acid Rain program, to lessons for implementation of a Trading Pilot Scheme in India. This experience suggests that four areas are especially important for successful implementation of an emissions trading scheme: setting the cap, allocating permits, monitoring and compliance. The introduction of emissions trading would position India as a clear leader in environmental regulation amongst emerging economies.

WP-2010-010

On The Portents of Peak Oil (And Other Indicators of Resource Scarcity)

James L. Smith, August 2010

Although economists have studied various indicators of resource scarcity (e.g., unit cost, resource rent, and market price), the phenomenon of peaking has largely been ignored due to its connection to non-economic theories of resource exhaustion (the Hubbert Curve). I take a somewhat different view, one that interprets peaking as a reflection of fundamental economic determinants of an intertemporal equilibrium. From that perspective, it is reasonable to ask whether the occurrence and timing of the peak reveals anything useful regarding the state of resource exhaustion. Accordingly, I examine peaking as an indicator of resource scarcity and compare its performance to the traditional economic indicators. I find the phenomenon of peaking to be an ambiguous indicator, at best. If someone announced that the peak would arrive earlier than expected, and you believed them, you would not know whether the news was good or bad. Unfortunately, the traditional economic indicators fare no better. Their movements are driven partially by long-term trends unrelated to changes in scarcity, and partially but inconsistently driven by actual changes in scarcity. Thus, the traditional indicators provide a signal that is garbled and unreliable.

WP-2010-009
Maria Lykidi, Jean-Michel Glachant and Pascal Gourdel, July 2010
Abstract   |   Full Paper [PDF]

Modelling the Effects of Nuclear Fuel Reservoir Operation in a Competitive Electricity Market

Maria Lykidi, Jean-Michel Glachant and Pascal Gourdel, July 2010

In many countries, the electricity systems are quitting the vertically integrated monopoly organization for an operation framed by competitive markets. In such a competitive regime one can ask what the optimal management of the nuclear generation set is. We place ourselves in a medium-term horizon of the management in order to take into account the seasonal variation of the demand level between winter (high demand) and summer (low demand). A flexible nuclear set is operated to follow a part of the demand variations. In this context, nuclear fuel stock can be analyzed like a reservoir since nuclear plants stop periodically (every 12 or 18 months) to reload their fuel. The operation of the reservoir allows different profiles of nuclear fuel uses during the different seasons of the year. We analyze it within a general deterministic dynamic framework with two types of generation: nuclear and non-nuclear thermal. We study the optimal management of the production in a perfectly competitive market. Then, we build a very simple numerical model (based on data from the French market) with nuclear plants being not operated strictly as base load power plants but within a flexible dispatch frame (like the French nuclear set).

Our simulations explain why we must anticipate future demand to manage the current production of the nuclear set (myopia can not be total). Moreover, it is necessary in order to ensure the equilibrium supply-demand, to take into account the non-nuclear thermal capacities in the management of the nuclear set. They also suggest that non-nuclear thermal could stay marginal during most of the year including the months of low demand.

WP-2010-008

Electricity Network Tariff Architectures: A Comparison of Four OECD Countries

Vivek Sakhrani and John E. Parsons, July 2010

The study is motivated by the question what is the optimal tariff design? While we do not offer an answer to this question, we use the different designs in four select countries to illuminate the issues involved in designing electricity network tariffs. Electricity networks are a resource shared by all network users. A tariff design that is clear to network users and well understood by them can help them make efficient decisions. A design that sets up conflicting or perverse incentives results in economic distortions. We find that there are a variety of choices and trade-offs while designing the electricity network tariffs for any electricity system. The tariff design must not only be influenced by the technical and economic characteristics of the system, but also the secondary policy objectives that policy makers wish to achieve, while allowing network companies to recover the costs of building and maintaining the network.

WP-2010-007

Risk and Responsibility Sharing in Nuclear Spent Fuel Management

Guillaume De Roo, June 2010

With the Nuclear Waste Policy Act of 1982, the responsibility of American utilities in the long-term management of spent nuclear fuel was limited to the payment of a fee. This narrow involvement did not result in faster or safer development of a solution for commercial nuclear waste. In most other countries, the financial liability and practical involvement of utilities appear more extensive. This paper highlights how such differences in institutional frameworks affect risk sharing and economic incentives. It argues that a greater allocation of risk and responsibility to the utilities should reenter the debate over nuclear waste in the US.

WP-2010-006

Taxation and the Extraction of Exhaustible Resources: Evidence From California Oil Production

Nirupama S. Rao, April 2010

Rapid increases in oil prices in 2008 led some to call for special taxes on the oil industry. Because oil is an exhaustible resource, however, the effects of excise taxes on production or on reported producer profits may be more complex than in many other markets. This paper uses well-level production data on California oil wells for the period 1977-2008, along with the rich variation in producer prices induced by federal oil taxes and pre-1980 price controls, to estimate how temporary taxes affect oil production decisions. Theory suggests that temporary taxes could lead producers to shut wells, and more generally that they create strong incentives for retiming production to minimize tax burdens. The empirical estimates suggest small estimates of extensive responses to after-tax prices, meaning that wells are rarely shut, but they also suggest substantial retiming of production for operating wells. While the estimates vary with specifications, the elasticity of oil production with respect to the after-tax price is estimated to fall between 0.208 and 0.261. The estimates are used to calibrate a simple model of the efficiency cost of tax-induced distortions relative to the no-tax optimal extraction path. These calculations suggest that a 15 percent temporary excise tax on California oil producers reduces the present value of producer surplus by between one and five percent of the no-tax surplus or between 113 and 166 percent of the government revenue raised, depending on the original life of the well and the duration of the temporary tax.

WP-2010-005
Matti Liski and Pauli Murto, March 2010
Abstract   |   Full Paper [PDF]

Uncertainty and Energy Saving Investments

Matti Liski and Pauli Murto, March 2010

Energy costs are notoriously uncertain but what is the effect of this on energysaving investments? We find that real-option frictions imply a novel equilibrium response to increasing but uncertain energy costs: early investments are cautious but ultimately real-option frictions endogenously vanish, and the activity affected by higher energy costs fully recovers. We use electricity market data for counterfactual analysis of the real-option mark-ups and policy experiments. Uncertainty alone implies that the early compensation to new technologies exceeds entry costs by multiple factors, and that uncertainty-reducing subsidies to green energy can benefit the consumer side at the expense of the old capital rents, even in the absence of externalities from energy use.

WP-2010-004

Speculation without Oil Stockpiling as a Signature: A Dynamic Perspective

Axel Pierru and Denis Babusiaux, April 2010

According to the standard analysis of commodity prices, stockpiling is a necessary signature of speculation. This paper develops an approach suggesting that speculation may temporarily push crude oil prices above the level justified by physical-market fundamentals, without necessarily resulting in a significant increase in oil inventories. Looking beyond debate on the value of oil-demand price-elasticity, showing a demand curve makes sense only if we consider a fixed time horizon (e.g. short-run). The scenario of oil demand slowly but continuously adjusting to a price fuelled by speculation implies that price elasticity of demand is an increasing function of the time horizon considered. Short- and long-run elasticities can then be used to calibrate this function. A very low very-short-run price elasticity suggests that an exogenously-driven rise in crude oil price has a very slight impact on demand in the very short run and therefore, with supply constant, leads to a minimal increase in inventories. This interpretation differs from the traditional view, according to which storage of just a few barrels is enough to raise prices when elasticity is very low. We present several analytical and numerical illustrations (with oil-demand adjustment following Gompertz, logistic and exponential paths). The role that speculation may have played in recent movements in oil prices is also discussed.

 

WP-2010-002

Why and How the European Union Can Get a (Near To) Carbon-Free Energy System in 2050?

Christopher Jones and Jean-Michel Glachant, March 2010

Reducing the European Union GHG emissions by at least 80% by 2050 will require a near zero carbon electricity, road and rail transport industry, and heating and cooling in buildings. As compared to "business as usual" the amount of energy required will basically vary according to the level of energy efficiency: it is the "system scale". Then it is the "system design" which will provide the needed carbon-free technologies consisting of renewable, nuclear and fossil fuels with carbon capture and storage.
A zero carbon energy system by 2050 is then demonstrated to be feasible. However it is far from easy and requires immediate and substantial policy action. The main policy implications are addressed in this paper. The 5 years 2010-2015 will be decisive in establishing a regulatory environment whereby the EU will be in a position, by 2020, to take the next steps to achieve the 2050 goal.

WP-2010-001

Modeling the Impact of Warming in Climate Change Economics

Robert S. Pindyck, January 2010

Any economic analysis of climate change policy requires some model that describes the impact of warming on future GDP and consumption. Most integrated assessment models (IAMs) relate temperature to the level of real GDP and consumption, but there are theoretical and empirical reasons to expect temperature to affect the growth rate rather than level of GDP. Does this distinction matter in terms of implications for policy? And how does the answer depend on the nature and extent of uncertainty over future temperature change and its impact? I address these questions by estimating the fraction of consumption society would be willing to sacrifice to limit future increases in temperature, using probability distributions for temperature and impact inferred from studies assembled by the IPCC, and comparing estimates based on a direct versus growth rate impact of temperature on GDP.

 

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As a benefit to our Associates, the latest Working Papers are embargoed for a period of up to six months before becoming accessible to the public. If you are interested in becoming an Associate or learning more about the benefits of sponsorship, please click here.

2009

WP-2009-020

Investment in Energy Infrastructure and the Tax Code

Gilbert E. Metcalf, October 2009

Federal tax policy provides a broad array of incentives for energy investment. I review those policies and construct estimates of marginal effective tax rates for different energy capital investments as of 2007. Effective tax rates vary widely across investment classes. I then consider investment in wind generation capital and regress investment against a user cost of capital measure along with other controls. I find that wind investment is strongly responsive to changes in tax policy. Based on the coefficient estimates the elasticity of investment with respect to the user cost of capital is in the range of -1 to -2. I also demonstrate that the federal production tax credit plays a key role in driving wind investment over the past eighteen years.

 

 

WP-2009-019
Georg Grüll and Luca Taschini, November 2009
Abstract   |   Full Paper [PDF]

Cap-and-Trade Properties under Different Scheme Designs

Georg Grüll and Luca Taschini, November 2009

This paper examines the key design mechanisms of existing and proposed cap-and-trade markets. First, it is shown that the hybrid systems under investigation (safety-valve with offsets, price floor using a subsidy, price collar, allowance reserve, and options offered by the regulator) can be decomposed into a combination of an ordinary cap-and-trade scheme with European- or American-style call and put options. Then, we quantify and discuss the advantages and disadvantages of the proposed hybrid schemes by investigating whether pre-set objectives (enforcement of permit price bounds and reduction of potential costs for relevant companies) can be accomplished while maintaining the original environmental targets.

 

 

 

WP-2009-018

A Comparison of Reduced-Form Permit Price Models and their Empirical Performances

Georg Grüll and Luca Taschini, September 2009

Equilibrium models have been proposed in literature with the aim of describing the evolution of the price of emission permits. This paper derives _rst estimation methods for the calibration of three competing equilibrium models. Second, it demonstrates how their reduced-form versions are inter-related. Third, by means of calibration to historical data, it is shown how these reduced-form models perform in the current price-evolution framework also with respect to standard continuous time stochastic models.

 

 

 

 

WP-2009-017
Richard Schmalensee, November 2009
Abstract   |   Full Paper [PDF]

Renewable Electricity Generation in the United States

Richard Schmalensee, November 2009

This paper provides an overview of the use of renewable energy sources to generate electricity in the United States and a critical analysis of the federal and state policies that have supported the deployment of renewable generation. Particular attention is paid to the use of wind energy and to the contrasting experiences in Texas and California.

 

 

 

 

WP-2009-016
Denny Ellerman, November 2009
Abstract   |   Full Paper [PDF]

Allocation in Air Emissions Markets

 

 

 

WP-2009-015
Hunt Allcott, October 2009
Abstract   |   Full Paper [PDF]

Rethinking Real Time Electricity Pricing

Hunt Allcott, October 2009

Most US consumers are charged a near-constant retail price for electricity, despite substantial hourly variation in the wholesale market price. This paper evaluates the .rst program to expose residential consumers to hourly real time pricing (RTP). I .nd that enrolled households are statistically signi.cantly price elastic and that consumers responded by conserving energy during peak hours, but remarkably did not increase average consumption during o-peak times. Welfare analysis suggests that program households were not su ciently price elastic to generate efficiency gains that substantially outweigh the estimated costs of the advanced electricity meters required to observe hourly consumption. Although in electricity pricing, congestion pricing, and many other settings, economists.intuition is that prices should be aligned with marginal costs, residential RTP may provide an important real-world example of a situation where this is not currently welfare-enhancing given contracting or information costs.

WP-2009-014
Hunt Allcott, October 2009
Abstract   |   Full Paper [PDF]

Social Norms and Energy Conservation

Hunt Allcott, October 2009

This paper evaluates a pilot program run by a company called OPOWER, previously known as Positive Energy, to mail home energy reports to residential utility consumers. The reports compare a households energy use to that of its neighbors and provide energy conservation tips. Using data from randomized natural field experiment at 80,000 treatment and control households in Minnesota, I estimate that the monthly program reduces energy consumption by 1.9 to 2.0 percent relative to baseline. In a treatment arm receiving reports each quarter, the effects decay in the months between letters and again increase upon receipt of the next letter. This suggests either that the energy conservation information is not useful across seasons or, perhaps more interestingly, that consumers motivation or attention is malleable and non-durable. I show that profiling, or using a statistical decision rule to target the program at households whose observable characteristics suggest larger treatment effects, could substantially improve cost effectiveness in future programs. The effects of this program provide additional evidence that non-price nudges can substantially affect consumer behavior.

WP-2009-013

Black Gold & Fool's Gold: Speculation in the Oil Futures Market

John E. Parsons, September 2009

This paper addresses the question of whether the oil price spike of 2003-2008 was a bubble. We document and discuss what is known about the level of speculation in the paper oil market. We then analyze the dynamics of the term structure of futures prices, both during the earlier period of 1985-2002 and during the spike. The dynamics of the term structure changed in important ways during this latter period, and we explain how this may have contributed to generating a bubble. We also explain how this answers the puzzle of the lack of accumulating above-ground inventories. Finally, we discuss the implications for regulatory reform of the paper oil markets.

WP-2009-012
Robert S. Pindyck, September 2009
Abstract   |   Full Paper [PDF]

The Economic and Policy Consequences of Catastrophes

Robert S. Pindyck, September 2009

What is the likelihood that the U.S. will experience a devastating catastrophic event over the next few decades something that would substantially reduce the capital stock, GDP and wealth? What does the possibility of such an event imply for the behavior of economic variables such as investment, interest rates, and equity prices? And how much should society be willing to pay to reduce the probability or likely impact of such an event? We address these questions using a general equilibrium model that describes production, capital accumulation, and household preferences, and includes as an integral part the possible arrival of catastrophic shocks. Calibrating the model to average values of economic and financial variables yields estimates of the implied expected mean arrival rate and impact distribution of catastrophic shocks. We also use the model to calculate the tax on consumption society would accept to reduce the probability or impact of a shock.

WP-2009-011
Maria Mendiluce, Ignacio Perez-Arriaga and Carlos Ocana, August 2009
Abstract   |   Full Paper [PDF]

Comparison of the Evolution of Energy Intensity in Spain and in the EU15. Why is Spain Different?

Maria Mendiluce, Ignacio Perez-Arriaga and Carlos Ocana, August 2009

Energy intensity in Spain has increased since 1990, while the opposite has happened in the EU15. Decomposition analysis of primary energy intensity ratios has been used to identify which are the key sectors driving the Spanish evolution and those responsible for most of the difference with the EU15 energy intensity levels. It is also a useful tool to quantify which countries and economic sectors have had most influence in the EU15 evolution. The analysis shows that the Spanish economic structure is driving the divergence in energy intensity ratios with the EU15, mainly due to the strong transport growth, but also because of the increase of activities linked to the construction boom, and the convergence to EU levels of household energy demand. The results can be used to pinpoint successful EU strategies for energy efficiency that could be used to improve the Spanish metric.

WP-2009-010

A Comprehensive Approach for Computation and Implementation of Efficient Electricity Transmission Network Charges

Luis Olmos and Ignacio J. Perez-Arriaga, July 2009

This paper presents a comprehensive design of electricity transmission charges that are meant to recover regulated network costs. In addition, these charges must be able to meet a set of inter-related objectives. Most importantly, they should encourage potential network users to internalize transmission costs in their location decisions, while interfering as least as possible with the short-term behaviour of the agents in the power system, since this should be left to regulatory instruments in the operation time range. The paper also addresses all those implementation issues that are essential for the sound design of a system of transmission network charges: stability and predictability of the charges; fair and efficient split between generation and demand charges; temporary measures to account for the low loading of most new lines; number and definition of the scenarios to be employed for the calculation and format of the final charges to be adopted: capacity, energy or per customer charges. The application of the proposed method is illustrated with a realistic numerical example that is based on a single scenario of the 2006 winter peak in the Spanish power system.

WP-2009-009

Regulatory Instruments for Deployment of Clean Energy Technologies

Ignacio J. Pérez-Arriaga, July 2009

Answering to the formidable challenge of climate change calls for a quick transition to a future economy with a drastic reduction in GHG emissions. And this in turn requires the development and massive deployment of new low-carbon energy technologies as soon as possible. Although many of these technologies have been identified, the critical issue is how to make them happen at the global level, possibly by integrating this effort into a global climate regime. This paper discusses the preferred approaches to foster low-carbon energy technologies from a regulatory point of view. Specific promotion policies for energy efficiency and conservation, renewable energy, carbon capture and sequestration, and nuclear power are examined, but the focus is on the regulatory instruments that will be needed for the deployment of enhancements to electricity grids and the associated control systems so that they are able to integrate intelligent demand response, distributed generation and storage in an efficient, reliable & environmentally responsible manner. The paper also comments on the interactions between technology and climate change policies and provides recommendations for policy makers.

WP-2009-008

Nuclear Fuel Recycling - the Value of the Separated Transuranics and the Levelized Cost of Electricity

Guillaume De Roo and John E. Parsons, September 2009

We analyze the levelized cost of electricity (LCOE) for three different fuel cycles: a Once-Through Cycle, in which the spent fuel is sent for disposal after one use in a reactor, a Twice-Through Cycle, in which the spent fuel is recycled for a second use in a light water reactor after which the spent fuel is sent for disposal, and a Fast Reactor Recycle in which all of the transuranics are repeatedly recycled in fast reactors. We carefully define the LCOE and provide a simple solution method that involves simultaneously calculating the value of the recycled materials, whether plutonium or the transuranics. We parameterize our formulas and calculate the LCOEs. Earlier reports do not provide general formulas and solution methods for calculating the LCOE. We contrast our methodology with the definitions and solution methods employed in various prior reports, and we compare our parameter inputs and resulting LCOEs. For example, we show that the "equilibrium cost" of fast reactor systems as calculated in other studies exaggerates the LCOE. Our calculations show that, based on current estimates of the costs for the various activities, recycling increases the LCOE by between 1.7 and 2.8 mills/kWh. This is an approximately 20-34% increase in the fuel cycle cost of the Once-Through Cycle, which we estimate at 8.28 mill/kWh. This is an approximately 2-4% increase in the total LCOE of the Once-Through Cycle, which we estimate at 75.32 mill/kWh. For the Twice- Through Cycle, the separated plutonium has a negative value, meaning that a reactor will have to be paid to take the recycled plutonium. For the Fast Reactor Cycle, the separated transuranics have a negative value, meaning that a fast reactor will have to be paid to take the transuranics.

WP-2009-007
Robert S. Pindyck, August 2009
Abstract   |   Full Paper [PDF]

Uncertain Outcomes and Climate Change Policy

Robert S. Pindyck, August 2009

Focusing on tail effects, I incorporate distributions for temperature change and its economic impact in an analysis of climate change policy. I estimate the fraction of consumption ?*(?) that society would be willing to sacrifice to ensure that any increase in temperature at a future point is limited to ?. Using information on the distributions for temperature change and economic impact from studies assembled by the IPCC and from integrated assessment models (IAMs), I fit displaced gamma distributions for these variables. Unlike existing IAMs, I model economic impact as a relationship between temperature change and the growth rate of GDP as opposed to its level, so that warming has a permanent impact on future GDP. The fitted distributions for temperature change and economic impact generally yield values of ?*(?) below 2%, even for small values of ?, unless one assumes extreme parameter values and/or substantial shifts in the temperature distribution. These results are consistent with moderate abatement policies.

WP-2009-006
Juan-Pablo Montero, July 2009
Abstract   |   Full Paper [PDF]

Market Power in Pollution Permit Markets

Juan-Pablo Montero, July 2009

As with other commodity markets, markets for trading pollution permits have not been immune to market power concerns. In this paper, I survey the existing literature on market power in permit trading but also contribute with some new results and ideas. I start the survey with Hahns (1984) dominant-firm (static) model that I then extend to the case in which there are two or more strategic firms that may also strategically interact in the output market, to the case in which current permits can be stored for future use (as in most existing and proposed market designs), to the possibility of collusive behavior, and to the case in which permits are auctioned off instead of allocated for free to firms. I finish the paper with a review of empirical evidence on market power, if any, with particular attention to the U.S. sulfur market and the Southern California NOx market.

 

WP-2009-005
Sergey Paltsev, John M. Reilly, Henry D. Jacoby and Jennifer F. Morris, April 2009
Abstract   |   Full Paper [PDF]

The Cost of Climate Policy in the United States

Sergey Paltsev, John M. Reilly, Henry D. Jacoby and Jennifer F. Morris, April 2009

We consider the cost of meeting emissions reduction targets consistent with a G8 proposal of a 50 percent global reduction in emissions by 2050, and an Obama Administration proposal of an 80 percent reduction over this period. We apply the MIT Emissions Prediction and Policy Analysis (EPPA), modeling these two policy scenarios if met by applying a national cap-and-trade system, and compare results with an earlier EPPA analysis of reductions of this stringency. We also test results to alternative assumptions about program coverage, banking behavior, and cost of technology in the electric power sector. Two main messages emerge from the exercise. First, technology uncertainties have a huge effect on the generation mix but only a moderate effect on the emissions price and welfare cost of achieving the assumed targets. Measured in terms of changes in economic welfare, the economic cost of 80 percent reduction by 2050 is in the range of 2 to 3% by 2050, with CO2 prices between $48 and $67 in 2015 rising to between $190 and $266 by 2050. Second, implementation matters. When an idealized economy-wide cap-and-trade is replaced by coverage omitting some sectors, or if the credibility of long-term target is weak (limiting banking behavior) prices and welfare costs change substantially.

 

 

WP-2009-004
Yangbo Du and John E. Parsons, May 2009
Abstract   |   Full Paper [PDF]

Update on the Cost of Nuclear Power

Yangbo Du and John E. Parsons, May 2009

We update the cost of nuclear power as calculated in the MIT (2003) Future of Nuclear Power study. Our main focus is on the changing cost of construction of new plants. The MIT (2003) study provided useful data on the cost of then recent builds in Japan and the Republic of Korea. We provide similar data on later builds in Japan and the Republic of Korea as well as a careful analysis of the forecasted costs on some recently proposed plants in the US. Using the updated cost of construction, we calculate a levelized cost of electricity from nuclear power. We also update the cost of electricity from coal- and gas-fired power plants and compare the levelized costs of nuclear, coal and gas. The results show that the cost of constructing a nuclear plant have approximately doubled. The cost of constructing coal-fired plants has also increased, although perhaps just as importantly, the cost of the coal itself spiked dramatically, too. Capital costs are a much smaller fraction of the cost of electricity from gas, so it is the recent spike in the price of natural gas that have contributed to the increased cost of electricity. These results document changing prices leading up to the current economic and financial crisis, and do not incorporate how this crisis may be currently affecting prices.

 

WP-2009-003
Matti Liski and Juan-Pablo Montero, April 2009
Abstract   |   Full Paper [PDF]

On Coase and Hotelling

Matti Liski and Juan-Pablo Montero, April 2009

It has been long recognized that an exhaustible-resource monopsonist faces a commitment problem similar to that of a durable-good monopolist. Indeed, Hrner and Kamien (2004) demonstrate that the two problems are formally equivalent under full commitment. We show that there is no such equivalence in the absence of commitment. The existence of a choke price at which the monopsonist adopts the substitute (backstop) supply divides the surplus between the buyer and the sellers in a way that is unique to the resource model. Sellers receive a surplus share independently of their cost heterogeneity; a result in sharp contrast with the durable-good monopoly logic. The resource buyer can distort the equilibrium through delayed purchases, but the Coase conjecture arises under extreme patience (zero discount rate).

 

 

WP-2009-002

Multi-Factor Model of Correlated Commodity - Forward Curves for Crude Oil and Shipping Markets

Paul D. Sclavounos and Per Einar Ellefsen, March 2009

An arbitrage free multi-factor model is developed of the correlated forward curves of the crude oil, gasoline, heating oil and tanker shipping markets. Futures contracts trading on public exchanges are used as the primary underlying securities for the development of a multi-factor Gaussian Heath-Jarrow-Morton (HJM) model for the dynamic evolution of the correlated forward curves. An intra- and inter-commodity Principal Component Analysis (PCA) is carried out in order to isolate seasonality and identify a small number of independent factors driving each commodity market. The cross-commodity correlation of the factors is estimated by a two step PCA. The factor volatilities and cross-commodity factor correlations are studied in order to identify stable parametric models, heteroskedasticity and seasonality in the factor volatilities and correlations. The model leads to explicit stochastic differential equations governing the short term and long term factors driving the price of the spot commodity under the risk neutral measure. Risk premia are absent, consistently with HJM arbitrage free framework, as they are imbedded in the factor volatilities and correlations estimated by the PCA. The use of the model is described for the pricing of derivatives written on inter- and intra-commodity futures spreads, Asian options, the valuation and hedging of energy and shipping assets, the fuel efficient navigation of shipping fleets and use in corporate risk management.

 

 

WP-2009-001
John E. Parsons, A. Denny Ellerman and Stephan Feilhauer, January 2009
Abstract   |   Full Paper [PDF]

Designing a US Market for CO2

John E. Parsons, A. Denny Ellerman and Stephan Feilhauer, January 2009

In this paper we focus on one component of the cap-and-trade system: the markets that arise for trading allowances after they have been allocated or auctioned. The efficient functioning of the market is key to the success of cap-and-trade as a system. We review the performance of the EU CO2 market and the US SO2 market and examine how the flexibility afforded by banking and borrowing and the limitations on banking and borrowing have impacted the evolution of price in both markets. While both markets have generally functioned well, certain episodes illustrate the importance of designing the rules to encourage liquidity in the market.

 

 

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2008

WP-2008-019

Challenges for Creating a Comprehensive National Electricity Policy

Paul L. Joskow, September 2008

This is a speech given to the National Press Club, September 26, 2008 outlining the need for comprehensive reform of the electric power sector in the U.S. It outlines the centrality of the electricity sector to the economy and to any national energy and climate policies. The U.S. electric power sector is the last energy sector in the U.S. to be brought into the 21st century with organization and regulatory governance institutions that are compatible with modern technology, future technological opportunities, reliability and environmental goals. The speech details the elements needed in a comprehensive national policy for the electric power sector.

 

 

WP-2008-018

Grandfathering and the Endowment Effect An Assessment in the context of the Spanish National Allocation Plan

Mar Reguant and A. Denny Ellerman, November 2008

In this paper, we test the Coase theorem in the context of carbon emissions trading. We investigate whether generating firms were influenced in their operational decisions by the initial amount of grandfathered emissions in the trial period of the European Union Emission Trading Scheme (EU-ETS). Theory suggests that under certain assumptions, the initial allocation should not affect production outcomes. We exploit a non-linearity in the allocation rule of CO2 allowances across coal plants in Spain to test for the relevance of the initial allocation to abatement outcomes. The evidence suggests no systematic relationship between the initial endowment and production decisions at the unit level.

 

 

WP-2008-017

A Top-down and Bottom-up look at Emissions Abatement in Germany in response to the EU ETS

A. Denny Ellerman and Stephan Feilhauer, November 2008

This paper uses top-down trend analysis and a bottom-up power sector model to define upper and lower boundaries on abatement in Germany in the first phase of the EU Emissions Trading Scheme (2005-2007). Long-term trend analysis reveals the decoupling of economic activity and carbon emissions in Germany that has occurred since 1996 and has accelerated since 2005, in response to rising commodities prices, the introduction of a carbon trading, and other measures undertaken in Germany. Differing emission intensity trends and emissions counterfactuals are constructed using emissions, power generation, and macroeconomic data. Resulting top-down estimates set the upper bound of abatement in Phase I at 121.9 mn tons for all EU-ETS sectors and 56.7 mn tons for the power sector only. Using the tuned version of the model E-simulate a lower boundary of Phase I abatement is established at 13.2 million tons, based only on fuel switching in the power sector, which constitutes 61% of German ETS sector emissions. The paper characterizes abatement, critically discusses the underlying assumptions of the outcomes, and examines the impact of two main factors on power sector abatement, namely price and load.

 

 

 

WP-2008-016
Adrien de Hauteclocque and Jean-Michel Glachant, November 2008
Abstract   |   Full Paper [PDF]

Long-term Energy Supply Contracts in European Competition Policy: Fuzzy not Crazy

Adrien de Hauteclocque and Jean-Michel Glachant, November 2008

Long-term supply contracts often have ambiguous effects on the competitive structure, investment and consumer welfare in the long term. In a context of market building, these effects are likely to be worsened and thus even harder to assess. Since liberalization and especially since the release of the Energy Sector Enquiry in early 2007, the portfolio of long-term supply contracts of the former incumbents have become a priority for review by the European Commission and the national competition authorities. It is widely believed that European Competition authorities take a dogmatic view on these contracts and systemically emphasize the risk of foreclosure over their positive effects on investment and operation. This paper depicts the methodology that has emerged in the recent line of cases and argues that this interpretation is largely misguided. It shows that a multiple-step approach is used to reduce regulation costs and balance anti-competitive effects with potential efficiency gains. However, if an economic approach is now clearly implemented, competition policy is constrained by the procedural aspect of the legal process and the remedies imposed remain open for discussion.

 

 

 

WP-2008-015
James L. Smith, September 2008
Abstract   |   Full Paper [PDF]

World Oil: Market or Mayhem?

James L. Smith, September 2008

The world oil market is regarded by many as a puzzle. Why are oil prices so volatile? What is OPEC and what does OPEC do? Where are oil prices headed in the long run? Is peak oil a genuine concern? Why did oil prices spike in the summer of 2008, and what role did speculators play? Any attempt to answer these questions must be informed and disciplined by economics. Such is the purpose of this essay: to illuminate recent developments in the world oil market from the perspective of economic theory.

 

 

 

WP-2008-014

Do Trading and Power Operations Mix? The Case of Constellation Energy Group 2008

John E. Parsons, November 2008

Constellation Energy has been a leading performer in the merchant power business since 2001. In addition to its legacy utility, Baltimore Gas and Electric, Constellation is a merchant generator and a wholesale power marketer serving the load of utilities as well as industrial, commercial and retail customers. Constellation has developed sophisticated risk management capabilities and a large trading operation in electric power and related commodities. In a recent reorganization, Constellation gave its trading operations greater organizational independence and prominence. It also increased the scale of its proprietary trading, and used its trading operation as the tool for expanded investments into upstream natural gas and coal and international freight. In August and September of 2008, Constellation experienced a major liquidity crisis that saw its stock price fall by nearly three-quarters. In an emergency search for cash, it was forced to agree to sell itself at the low price. This paper reviews Constellations history and the specific events precipitating its liquidity crisis. It then places Constellations strategy vis--vis its commodity trading operations in the context of the larger history of commodity trading operations and discusses the key financial and strategic questions posed by Constellations crisis.

 

 

WP-2008-013

The EU's Emissions Trading Scheme: A Proto-Type Global System?

A. Denny Ellerman, September 2008

The European Union's Emission Trading Scheme (EU ETS) is the world's first multinational cap-and-trade system for greenhouse gases. As an agreement between sovereign nations with diverse historical, institutional, and economic circumstances, it can be seen as a prototype for an eventual global climate regime. Interestingly, the problems that are often seen as dooming a global trading system international financial flows and institutional readiness haven't appeared in the EU ETS, at least not yet. The more serious problems that emerge from the brief experience of the EU ETS are those of (1) developing a central coordinating organization, (2) devising side benefits to encourage participation, and (3) dealing with the interrelated issues of harmonization, differentiation, and stringency. The pre-existing organizational structure and membership benefits of the European Union provided convenient and almost accidental solutions to the need for a central institution and side benefits, but these solutions will not work on a global scale and there are no obvious substitutes. Furthermore, the EU ETS is only beginning to test the practicality of harmonizing allocations within the trading system, differentiating responsibilities among participants, and increasing the stringency of emissions caps. The trial period of the EU ETS punted on these problems, as was appropriate for a trial period, but they are now being addressed seriously. From a global perspective, the answers that are being worked out in Europe will say a great deal about what will be feasible on a broader, global scale.

 

 

WP-2008-011

An Empirical Model of Imperfect Dynamic Competition and Application to Hydroelectricity Storage

Olli Kauppi and Matti Liski, September 2008

The Nordic power market presents a unique opportunity for testing the nature and degree of market power in storage behavior due to preciseness of data on market fundamentals determining hydro resource use. We develop an explicit model of dynamic imperfect competition mapping the primitive distributions to market outcomes as a function of the market structure. We estimate the market structure that best explains the main behavioral patterns in pricing, storage, and production in years 2000-05. Exceptional events in the data allow us to identify a pattern for market power. We simulate the expected effiency loss from the pattern and limited scope for social losses. Market power however increases expected reservoir and price levels, and also implies an increase in price risk.

WP-2008-010
Meghan McGuinness and A. Denny Ellerman, September 2008
Abstract   |   Full Paper [PDF]

CO2 Abatement in the UK Power Sector: Evidence from the EU ETS Trial Period

Meghan McGuinness and A. Denny Ellerman, September 2008

This paper provides an empirical assessment of CO2emissions abatement in the UK power sector during the trial period of the EU ETS. Using an econometrically estimated model of fuel switching, it separates the impacts of changes in relative fuel prices and changes in the EUA price on the utilization and emissions of coal and natural gas-fired generating units. We find clear statistical evidence that the CO2price did impact dispatch decisions, resulting in natural gas utilization that was from 19% to 24% higher and coal utilization that was 16% to 18% lower than would have otherwise occurred in 2005 and 2006. Abatement as a result of fuel switching in the power sector is estimated to have been between 13 million and 21 million tons of CO2in 2005 and 14 and 21 million tons in 2006.

WP-2008-009

The Effect of Power Plants on Local Housing Values and Rents: Evidence from Restricted Census Microdata

Lucas W. Davis, June 2008

Current trends in electricity consumption imply that hundreds of new fossil-fuel power plants will be built in the United States over the next several decades. Power plant siting has become increasingly contentious, in part because power plants are a source of numerous negative local externalities including elevated levels of air pollution, haze, noise and traffic. Policymakers attempt to take these local disamenities into account when siting facilities, but little reliable evidence is available about their quantitative importance. This paper examines neighborhoods in the United States where power plants were opened during the 1990s using household-level data from a restricted version of the U.S. decennial census. Compared to neighborhoods farther away,housing values and rents decreased by 3-5% between 1990 and 2000 in neighborhoods near sites. Estimates of household marginal willingness-to-pay to avoid power plants are reported separately for natural gas and other types of plants, large plants and small plants, base load plants and peaker plants, and upwind and downwind households.

WP-2008-008
Erik D. Delarue, A. Denny Ellerman and William D. D, June 2008
Abstract   |   Full Paper [PDF]

Short-Term CO2 Abatement in the European Power Sector

Erik D. Delarue, A. Denny Ellerman and William D. Dhaeseleer, June 2008

This paper focuses on the possibilities for short term abatement in response to a CO2price through fuel switching in the European power sector. The model E-Simulate is used to simulate the electricity generation in Europe as a means of both gaining insight into the process of fuel switching and estimating the abatement in the power sector during the first trading period of the European Union Emission Trading Scheme. Abatement is shown to depend not only on the price of allowances, but also and more importantly on the load level of the system and the ratio between natural gas and coal prices. Estimates of the amount of abatement through fuel switching are provided with a lower limit of 35 million metric tons in 2005 and 19 Mtons in 2006.

WP-2008-006
Matti Liski and Juan-Pablo Montero, June 2008
Abstract   |   Full Paper [PDF]

Forward Trading in Exhaustible-Resource Oligopoly

Matti Liski and Juan-Pablo Montero, June 2008

We analyze oligopolistic exhaustible-resource depletion when ?rms can trade forward contracts on deliveries, a market structure prevalent in many resource commodity markets. We ?nd that this organization of trade has substantial implications for resource depletion. As ?rms interactions become in?nitely frequent, resource stocks become fully contracted and the symmetric oligopolistic equilibrium converges to the perfectly competitive Hotelling (1931) outcome. Asymmetries in stock holdings allow ?rms to partially escape the procompetitive effect of contracting: a large stock provides commitment to leave a fraction of the stock uncontracted. In contrast, a small stock provides commitment to sell early, during the most pro?table part of the equilibrium.

 

WP-2008-005
Vincent Rious, Jean-Michel Glachant, Yannick Perez and Philippe Dessante, May 2008
Abstract   |   Full Paper [PDF]

The Diversity of Design of TSOs

Vincent Rious, Jean-Michel Glachant, Yannick Perez and Philippe Dessante, May 2008

It is puzzling today to explain diversity and imperfection of actual transmission monopoly designs in competitive electricity markets. We argue that transmission monopoly in competitive electricity markets has to be analysed within a Wilson (2002) modular framework. Applied to the management of electricity flows, at least three modules make the core of transmission design: 1 the short run management of network externalities; 2 the long run management of network investment; and 3 the coordination of neighboring Transmission System Operators for cross border trade. In order to tackle this diversity of designs of TSOs, we show that for each of these modules, three different basic ways of managing them are possible. Among the identified twenty seven options of organisation, we define an Ideal TSO. Second, we demonstrate that 1monopoly design differs from this Ideal TSO and cannot handle these three modules irrespective of the institutional definition and allocation of property rights on transmission; while 2definition and allocation of property rights on transmission cannot ignore the existing electrical industry and transmission network structure: they have to complement each other to be efficient. Some conclusions for regulatory issues of transmission systems operators are derived from this analysis of network monopoly organisation.

 

WP-2008-004
Meghan McGuinness and A. Denny Ellerman, May 2008
Abstract   |   Full Paper [PDF]

The Effects of Interactions between Federal and State Climate Policies

Meghan McGuinness and A. Denny Ellerman, May 2008

In the absence of a federal policy to cap carbon emissions many states are moving forward with their own initiatives, which currently range from announcements of commitments to reduce greenhouse gases to a regional multi-state cap-and-trade program slated to begin in 2009. While federal legislation is expected in the next few years, it is unclear how such legislation will define the relationship between a federal cap and trade program and other state regulations. Assuming the introduction of a cap-and-trade program at the federal level, this paper analyzes the economic and environmental impacts of the range of possible interactions between the federal program and state programs. We find that the impacts of interaction depend on relative stringency of the federal and state program and overlap in source coverage. Where state programs are both duplicative of and more demanding than the federal cap, the effect is entirely redistributive of costs and emissions, with in-state sources facing higher marginal abatement costs. Also, differing marginal abatement costs among states create economic inefficiencies that make achievement of the climate goal more costly than it need be. These redistributive effects and the associated economic inefficiency are avoided under either federal preemption of duplicative state programs or a carve out of state programs from the federal cap with linkage to the federal allowance market.

WP-2008-001
Xiaochun Zhang and John E. Parsons, January 2008
Abstract   |   Full Paper [PDF]

Market Power and Electricity Market Reform in Northeast China

Xiaochun Zhang and John E. Parsons, January 2008

The Northeast region of China has been used as a testing ground for creation of a functioning wholesale electric power market. We describe the ownership structure of the generation assets for those plants participating in the trial operation of the Northeast China Regional Electricity Market and also for the region as a whole and for each of the provinces making up the region. We calculate the 4-firm Concentration Ratio (CR4) and the Hirschman-Herfindahl Index (HHI). In general, we find that the current ownership structure is relatively concentrated. Arguably, this is a troublesome obstacle to instituting some form of competitive bidding in the wholesale power market, and this may be one factor in the poor outcome of the trial operation.

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As a benefit to our Associates, the latest Working Papers are embargoed for a period of up to six months before becoming accessible to the public. If you are interested in becoming an Associate or learning more about the benefits of sponsorship, please click here.

2007

WP-2007-013
Michael Greenstone and Ted Gayer, December 2007
Abstract   |   Full Paper [PDF]

Quasi-Experimental and Experimental Approaches to Environmental Economics

Michael Greenstone and Ted Gayer, December 2007

This paper argues that an increased application of quasi-experimental and experimental techniques will improve understanding about core environmental economics questions. This argument is supported by a review of the limitations of associational evidence in assessing causal hypotheses. The paper also discusses the benefits of experiments and quasi-experiments, outlines some quasi-experimental methods, and highlights threats to their validity. It then illustrates the quasi-experimental method by assessing the validity of a quasi-experiment that aims to estimate the impact of the Endangered Species Act on property markets in North Carolina. The papers larger argument is that greater application of experimental and quasi-experimental techniques can identify efficient policies that increase social welfare.

 

WP-2007-012

Technical Memorandum on Analysis of the EU ETS Using the Community Independent Transaction Log

Meghan McGuinness and Raphael Trotignon, December 2007

This memorandum provides an overview of three deficiencies within the current presentation of the Community Independent Transaction Log (CITL) data that have implications for researchers ability to accurately analyze the impacts of the EU ETS. It evaluates the impact of these deficiencies on analyses of the UK, Spain, and France, three Member States with readily available installation-level data that can be compared against the CITL.

 

WP-2007-011

The Macroeconomic Effects of Oil Price Shocks: Why are the 2000s so different from the 1970s?

Olivier J. Blanchard and Jordi Gal, August 2007

We characterize the macroeconomic performance of a set of industrialized economies in the aftermath of the oil price shocks of the 1970s and of the last decade, focusing on the differences across episodes. We examine four different hypotheses for the mild effects on inflation and economic activity of the recent increase in the price of oil: (a) good luck (i.e. lack of concurrent adverse shocks), (b) smaller share of oil in production, (c) more flexible labor markets, and (d) improvements in monetary policy. We conclude that all four have played an important role.

 

WP-2007-010

First Evidence of Asymmetric Cost Pass-Through of EU Emissions Allowances: Examining Wholesale Electricity Prices in Germany

Georg Zachmann and Christian von Hirschhausen, September 2007

This paper applies the literature on asymmetric price transmission to the emerging commodity market for EU emissions allowances (EUA). We utilize an error correction model and an autoregressive distributed lag model to measure the relationship between CO2 price changes and the development of wholesale electricity prices. Using data from the German market for electricity and EUAs, we find that the rising prices of EUAs have a stronger impact on wholesale electricity prices than falling prices -- the first empirical evidence of asymmetric cost pass-through for these new allowances.

 

WP-2007-009
Junsang Nam, Mort Webster, Yosuke Kimura, Harvey Jeffries, William Vizuete and David T. Allen, August 2007
Abstract   |   Full Paper [PDF]

Reductions in Ozone Concentrations Due to Controls on Variability in Industrial Flare Emissions in Houston, Texas

Junsang Nam, Mort Webster, Yosuke Kimura, Harvey Jeffries, William Vizuete and David T. Allen, August 2007

High concentrations of ozone in the Houston/Galveston area are associated with industrial plumes of highly reactive hydrocarbons, mixed with NOx. The emissions leading to these plumes can have significant temporal variability, and photochemical modeling indicates that the emissions variability can lead to increases and decreases of 10-50 ppb, or more, in ozone concentrations. Therefore, in regions with extensive industrial emissions, accounting for emission variability can be important in accurately predicting peak ozone concentrations, and in assessing the effectiveness of emission control strategies. This work compares the changes in ozone concentrations associated with two strategies for reducing flare emissions in Houston, Texas. One strategy eliminates the highest emission flow rates, that occur relatively infrequently, and a second strategy reduces emissions that occur at a nearly constant level. If emission variability is accounted for in air quality modeling, these control scenarios are predicted to be much more effective in reducing the expected value of daily maximum ozone concentrations than if similar reductions in the mass of emissions are made and constant emissions are assumed. The change in the expected value of daily maximum ozone concentration per ton of emissions reduced, when emissions variability is accounted for, is 5-10 times the change predicted when constant (deterministic) inventories are used.

 

 

WP-2007-008
Mort Webster, Junsang Nam, Yosuke Kimura, Harvey Jeffries, William Vizuete and David T. Allen, August 2007
Abstract   |   Full Paper [PDF]

The Effect of Variability in Industrial Emissions on Ozone Formation in Houston, Texas

Mort Webster, Junsang Nam, Yosuke Kimura, Harvey Jeffries, William Vizuete and David T. Allen, August 2007

Ambient observations have indicated that high concentrations of ozone observed in the Houston/Galveston area are associated with plumes of highly reactive hydrocarbons, mixed with NOBxB, from industrial facilities. Ambient observations and industrial process data, such as mass flow rates for industrial flares, indicate that the VOCs associated with these industrial emissions can have significant temporal variability. To characterize the effect of this variability in emissions on ozone formation in Houston, data were collected on the temporal variability of industrial emissions or emission surrogates (e.g., mass flow rates to flares). The observed emissions variability was then used to construct region-wide emission inventories with variable industrial emissions, and the impacts of the variability on ozone formation were examined for two types of meteorological conditions, both of which lead to high ozone concentrations in Houston. The air quality simulations indicate that variability in industrial emissions has the potential to cause increases and decreases of 10-52 ppb (13-316%), or more, in ozone concentration. The largest of these differences are restricted to regions of 10-20 kmP2P, but the variability also has the potential to increase region wide maxima in ozone concentrations by up to 12 ppb.

 

 

WP-2007-006

Technologies, Markets and Challenges for Development of the Canadian Oil Sands Industry

Romaine H. Lacombe and John E. Parsons, June 2007

This paper provides an overview of the current status of development of the Canadian oil sands industry, and considers possible paths of further development. We outline the key technology alternatives, critical resource inputs and environmental challenges and stgrategic options both at the company and government level. We develop a model to calculate the supply cost of bitumen and synthetic crude oil using the key technologies. Using the model we evaluate the sensitivity of the supply costs to the critical model inputs.

 

 

WP-2007-004

Time and Location Differentiated NOX Control in Competitive Electricity Markets Using Cap-and-Trade Mechanisms

Katherine C. Martin, Paul L. Joskow, and A. Denny Ellerman, April 2007

Due to variations in weather and atmospheric chemistry, the timing and location of nitrogen oxide (NOX) reductions determine their effectiveness in reducing ground-level ozone, which adversely impacts human health. Electric generating plants are the primary stationary sources of NOX in most regions of the United States. In the Eastern U.S. they are subject to a summertime NOX cap and trade program that is not well matched to the time and locational impacts of NOX on ozone formation. We hypothesize that the integration of weather and atmospheric chemistry forecasting, a cap and trade system in which the exchange rates for permits can be varied by time and location based on these forecasts, and its application to a competitive wholesale electricity market, can achieve ozone standards more efficiently. To demonstrate the potential for reductions in NOX emissions in the short run, we simulate the magnitude of NOX reductions that can be achieved at various locations and times as a consequence of redispatch of generating units in the classic PJM region taking supply-demand balance constraints and network congestion into account. We report simulations using both a zonal model and an optimal power flow model. We also estimate the relationship between the level NOX emission prices, competitive market responses to different levels of NOX prices, and the associated reductions in NOx emissions. The estimated maximum potential reductions, which occur at NOX prices of about $125,000/ton, are about 8 tons (20%) hourly in peak electricity demand hours and about 10 tons (50%) in average demand hours. We find that network constraints have little effect on the magnitude of the reductions in NOX emissions.

 

WP-2007-003
M.A. de Figueiredo, H.J. Herzog, P.L. Joskow, K.A. Oye, and D.M. Reiner, April 2007
Abstract   |   Full Paper [PDF]

Regulating Carbon Dioxide Capture and Storage

M.A. de Figueiredo, H.J. Herzog, P.L. Joskow, K.A. Oye, and D.M. Reiner, April 2007

This essay examines several legal, regulatory and organizational issues that need to be addressed to create an effective regulatory regime for carbon dioxide capture and storage (CCS). Legal, regulatory, and organizational issues will need to be resolved for the industrial organization of CO2 transportation and storage, storage safety and integrity issues, and liability. Although there are some gaps in the current regulatory system as applied to CCS, we find that many of the currently identifiable issues have been successfully resolved in other contexts.

WP-2007-002

Public Attitudes Toward America's Energy Options - Report of the 2007 MIT Energy Survey

Stephen Ansolabehere, March 2007

The prospects of global warming and potential shortages of oil have brought energy back to the forefront of the list of national, indeed, global, problems that governments, corporations and society must address. In 2002, as part the MIT study on The Future of Nuclear Power, the first MIT Energy survey considered public attitudes toward nuclear power in light of other sources of electric power. That survey found that the two key drivers behind public preferences about energy sources are general environmental harm and cost of electricity.

In February, 2007, I replicated the energy survey. What has changed over the last five years is a noticeable decline in the popularity of oil and a noticeable but quite modest increase in support for nuclear power. Oil has lost much of its luster. Americans now strongly wish to reduce the use of oil, and they view this energy source less favorably than any other source of power. Coal, seen as moderately priced but very harmful to the environment, also remains quite unpopular. Nuclear power, five years ago, was viewed similarly badly. It now seems to have gained support and is approaching natural gas in terms of favorability.

WP-2007-001

An Institutional Frame to Compare Alternative Market Designs in EU Electricity Balancing

Jean Michel Glachant and Marcelo Saguan, January 2007

The so-called "electricity wholesale market" is, in fact, a sequence of several markets. The chain is closed with a provision for "balancing," in which energy from all wholesale markets is balanced under the authority of the Transmission Grid Manager (TSO in Europe, ISO in the United States). In selecting the market design, engineers in the European Union have traditionally preferred the technical role of balancing mechanisms as "security mechanisms." They favour using penalties to restrict the use of balancing energy by market actors.

While our paper in no way disputes the importance of grid security, nor the competency of engineers to elaborate the technical rules, we wish to attract attention to the real economic consequences of alternative balancing designs. We propose a numerical simulation in the framework of a two-stage equilibrium model. This simulation allows us to compare the economic properties of designs currently existing within the European Union and to measure their fallout. It reveals that balancing designs, which are typically presented as simple variants on technical security, are in actuality alternative institutional frameworks having at least four potential economic consequences: a distortion of the forward price; an asymmetric shift in the participants' profits; an increase in the System Operator's revenues; and inefficiencies.

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2006

WP-2006-020

Does Hazardous Waste Matter? Evidence from the Housing Market and the Superfund Program

Michael Greenstone and Justin Gallagher, September 2006

This paper uses the housing market to develop estimates of the local welfare impacts of Superfund sponsored clean-ups of hazardous waste sites. We show that if consumers value the clean-ups, then the hedonic model predicts that they will lead to increases in local housing prices and new home construction, as well as the migration of individuals that place a high value on environmental quality to the areas near the improved sites. We compare housing market outcomes in the areas surrounding the first 400 hazardous waste sites chosen for Superfund clean-ups to the areas surrounding the 290 sites that narrowly missed qualifying for these clean-ups. We find that Superfund clean-ups are associated with economically small and statistically indistinguishable from zero local changes in residential property values, property rental rates, housing supply, total population, and the types of individuals living near the sites. These findings are robust to a series of specification checks, including the application of a quasi-experimental regression discontinuity design based on knowledge of the selection rule. Overall, the preferred estimates suggest that the local benefits of Superfund clean-ups are small and appear to be substantially lower than the $43 million mean cost of Superfund clean-ups.

 

WP-2006-019

The Future of Nuclear Power in the United States: Economic and Regulatory Challenges

Paul L. Joskow, December 2006

This paper examines the economic and regulatory challenges that must be faced by potential investors in new nuclear power plants in the United States. The historical development of the existing fleet of over 100 nuclear plants and their recent performance history are discussed. The pattern of re-licensing of existing plants and the implications for the role of the extended operation of the existing fleet in the overall electricity supply portfolio over the next 50 years is examined. The economic competitiveness of investments in new nuclear power plants compared to investments in alternative base load technologies is discussed under a variety of assumptions about construction costs, fuel costs, competitive and economic regulatory environments and various levels of carbon emissions prices affected competing fossil-fueled technologies. Federal government efforts to facilitate investment in new nuclear power plants, including streamlined licensing procedures and financial incentive provided by the Energy Policy Act of 2005 are discussed. These regulatory changes and financial incentives improve the economic competitiveness of nuclear power. First mover plants that can benefit from federal financial incentives are most likely to be built in states that continue to regulate generating plants based on cost-of-service principles, transferring construction cost and operating performance risks to consumers, and where there is room on existing sites to build additional nuclear capacity. Once federal financial incentives come to an end lower and more stable construction costs combined with carbon emissions charges are likely to be necessary to make investments in new nuclear plants significantly more attractive than investments in pulverized coal plants. Unresolved waste disposal policies and local opposition to new nuclear plants are likely to represent barriers to investment in new nuclear power plants in some areas of the country.

 

WP-2006-018

Infrastructure Investments and Resource Adequacy in the Restructured US Natural Gas Market - Is Supply Security at Risk?

Christian von Hirschhausen, December 2006

The objective of this paper is to analyze the development of US natural gas infrastructure over the last two decades and to discuss its perspectives. In particular, we focus on the relationship between the regulatory framework for the natural gas sector and the development of investment in LNG terminals, interstate pipelines, and storage facilities. We also discuss some cross-sectional investment issues related to financing (cost of capital, financial markets) and regulation (price caps, siting). We conclude that while some improvements in the regulatory framework might enhance investments in the US natural gas sector, there is no reason to be overly concerned about infrastructure investments, resource adequacy, or supply security.

WP-2006-017
Robert S. Pindyck, November 2006
Abstract   |   Full Paper [PDF]

Uncertainty in Environmental Economics

Robert S. Pindyck, November 2006

In a world of certainty, the design of environmental policy is relatively straightforward, and boils down to maximizing the present value of the flow of social benefits minus costs. But the real world is one of considerable uncertainty over the physical and ecological impact of pollution, over the economic costs and benefits of reducing it, and over the discount rates that should be used to compute present values. The implications of uncertainty are complicated by the fact that most environmental policy problems involve highly nonlinear damage functions, important irreversibilities, and long time horizons. Correctly incorporating uncertainty in policy design is therefore one of the more interesting and important research areas in environmental economics. This paper offers no easy formulas or solutions for treating uncertainty to my knowledge, none exist. Instead, I try to clarify the ways in which various kinds of uncertainties will affect optimal policy design, and summarize what we know and dont know about the problem.

 

WP-2006-016

Over-Allocation or Abatement? A Preliminary Analysis of the EU ETS Based on the 2005 Emissions Data

A. Denny Ellerman and Barbara Buchner, November 2006

This paper provides an initial analysis of the EU ETS based on the installation-level data for verified emissions and allowance allocations in the first trading year. Those data, released on May 15, 2006, and subsequent updates revealed that CO2 emissions were about 4% lower than the allocated allowances. The main objective of the paper is to shed light on the extent to which over-allocation and abatement have taken place in 2005. We propose a measure by which over-allocation can be judged and provide estimates of abatement based on emissions data and indicators of economic activity as well as trends in energy and carbon intensity. Finally, we discuss the insights and implications that emerge from this tentative assessment.

 

 

WP-2006-015
Barbara Buchner, Carlo Carraro and A. Denny Ellerman, September 2006
Abstract   |   Full Paper [PDF]

The Allocation of European Union Allowances: Lessons, Unifying Themes and General Principles

Barbara Buchner, Carlo Carraro and A. Denny Ellerman, September 2006

On January 1st, 2005, the EU Emissions Trading Scheme (EU ETS) scheme was officially launched, only two years after the European Council adopted the EU Emissions Trading Directive (European Community 2003). As a consequence of this formal start, the worlds largest ever market in emissions has been established, and European companies now face a carbon-constrained reality in form of legally binding emission targets. Within essentially one year, 2004, the international carbon market has gained momentum through major policy developments and quick market responses, which among others have enabled the establishment of a framework for the EU carbon market.

 

 

 

WP-2006-014
John V. Mitchell, August 2006
Abstract   |   Full Paper [PDF]

A New Era for Oil Prices

John V. Mitchell, August 2006

Since 2003 the international oil market has been moving away from the previous 20-year equilibrium in which prices fluctuated around $25/bbl (in todays dollars). The single most important reason is that growing demand has eliminated the structural surplus of crude production capacity which had existed since the oil price shock of 1979-83.

So far, the higher oil prices since 2003, and even higher since 2005, have not induced economic recession in oil-importing countries so that oil demand has not fallen as it did in the 1980s after the second oil shock. Unless this occurs, a structural surplus will not be recreated, and prices are likely to remain high above $50/bbl until longer-term reactions take effect. If the political situation in the Middle East deteriorates further prices could reach new levels, but the reaction would be quicker and stronger.

Meanwhile, supply and demand are set to expand roughly in balance over the next five years, though there are many uncertainties which will lead to short-term fluctuations. With so little controllable flexibility in supply or demand, prices will remain volatile in the short term.

Five or more years of oil and related energy prices averaging double (or more) their previous long-term average cannot fail to create a new long-term situation both in terms of economic behaviour and government policy. This will bring new competition which will simultaneously reduce the demand for energy, increase the supply of oil, and increase the substitution of other fuels for oil outside the transport sector. As these forces develop, oil prices will be unstable through the long term.

For the transport sector, there is a very large range of possibilities which do not depend on the development of new technology. Examples are a shift in US vehicle demand to vehicles with typical Japanese or European fuel efficiency (which would reduce world transport fuel demand by nearly 10%) and the opening of US and European markets to competition from Brazilian and other developing country ethanol supplies. A period of high oil prices will also lead to investment to increase the production of liquid fuels from oil sands or natural gas. Once these investments are made, they are likely to continue producing as long as their operating costs remain lower than the price of oil.

 

 

 

 

WP-2006-013

New Entrant and Closure Provisions: How do they distort?

A. Denny Ellerman, June 2006

As a person whose life began in England and ended in North America and who maintained academic affiliations in the United Kingdom, Canada and the U.S., Campbell Watkins had a fine appreciation for the subtle differences that mark the two sides of the North Atlantic. He embodied the cross-fertilization that trans-Atlantic exchanges imply and I have no doubt that that was one of the reasons the IAEE received so much of his attention and benefited so grandly from it. This essay concerns one of those trans-Atlantic exchanges and one of which Campbell would have enjoyed the irony: An American innovation that goes to Europe and becomes bigger than anything yet seen in North America. The transplant is the cap-and-trade form of emissions trading and the European application is the European Union CO2 Emissions Trading Scheme (EU ETS). More specifically, this paper focuses on a particular feature of the allocation process in the European variant, the endowment of new entrants with allowances and the forfeiture of allowances when facilities are closed.

 

 

WP-2006-012

Energy Prices and the Adoption of Energy-Saving Technology

Joshua Linn, April 2006

This paper investigates the link between factor prices, technology and factor demands. I estimate the effect of price-induced technology adoption on energy demand in the U.S. manufacturing sector, using plant data from the Census of Manufactures, 1963-1997. I compare the energy efficiency of entrants and incumbents to measure the effect of technology adoption on the demand for energy. A 10 percent increase in the price of energy causes technology adoption that reduces the energy demand of entrants by 1 percent. This elasticity has two implications: first, technology adoption explains a statistically significant but relatively small fraction of changes in energy demand in the 1970s and 1980s; and second, technology adoption can reduce the long run effect of energy prices on growth, but by less than previous research has found.

 

WP-2006-010

Long-Term contracts and Asset Specificity Revisited - An Empirical Analysis of Producer-Importer Relations in the Natural Gas Industry

Anne Neumann and Christian von Hirschhausen, May 2006

In this paper, we analyze structural changes in long-term contracts in the international trade of natural gas. Using a unique data set of 262 long-term contracts between natural gas producers and importers, we estimate the impact of different institutional, structural and technical variables on the duration of contracts. We find that contract duration decreases as the market structure of the industry develops to more competitive regimes. Our main finding is that contracts that are linked to an asset specific investment are on average four years longer than those who are not.

 

WP-2006-009

Competitive Electricity Markets and Investment in New Generating Capacity

Paul L. Joskow, May 2006

Evidence from the U.S. and some other countries indicates that organized wholesale markets for electrical energy and operating reserves do not provide adequate incentives to stimulate the proper quantity or mix of generating capacity consistent with mandatory reliability criteria. A large part of the problem can be associated with the failure of wholesale spot market prices for energy and operating reserves to rise to high enough levels during periods when generating capacity is fully utilized. Reforms to wholesale energy markets, the introduction of well-design forward capacity markets, and symmetrical treatment of demand response and generating capacity resources to respond to market and institutional imperfections are discussed. This policy reform program is compatible with improving the efficiency of spot wholesale electricity markets, the continued evolution of competitive retail markets, and restores incentives for efficient investment in generating capacity consistent with operating reliability criteria applied by system operators. It also responds to investment disincentives that have been associated with volatility in wholesale energy prices, limited hedging opportunities and to concerns about regulatory opportunism.

WP-2006-007

The Convergence of Market Designs for Adequate Generating Capacity with Special Attention to the CAISOs Resource Adequacy Problem

Peter Cramton and Steven Stoft, April 2006

This paper compares market designs intended to solve the resource adequacy (RA) problem, and finds that, in spite of rivalrous claims, the most advanced designs have nearly converged. The original dichotomy between approaches based on long-term energy contracts and those based on short-term capacity markets spawned two design tracks. Long-term energy contracts led to call-option obligations which provide marketpower control and the ability to strengthen performance incentives, but this approach fails to replace the missing money at the root of the adequacy problem. Hogans (2005) energy-only market fills this gap.

On the other track, the short-term capacity markets (ICAP) spawned long-term capacity market designs. In 2004, ISO New England proposed a short-term market with hedged performance incentives essentially based on high spot prices. In 2005, we developed for New England a forward capacity market, with load obligated to purchase a target level of capacity covered by an energy call option.

The two tracks have now converged on two conclusions: (1) High real-time energy prices should provide performance incentives. (2) High energy prices should be hedged with call options. We argue that two more conclusions are needed: (3) Capacity targets rather than high and volatile spot prices should guide investment, and (4) Long-term physically based options should be purchased in a forward market for capacity. The result will be that adequacy is maintained, performance incentives are restored, market power and risks are reduced from present levels, and prices are hedged down to a level below the present price cap.

 

WP-2006-006

Energy Prices and Energy Intensity in China: A Structural Decomposition Analysis and Econometrics Study

Xiaoyu Shi and Karen R. Polenske, May 2005

Since the start of its economic reforms in 1978, China's energy prices relative to other prices have increased. At the same time, its energy intensity, i.e., energy consumption per unit of Gross Domestic Product (GDP), has declined dramatically, by about 70%, in spite of increases in energy consumption. Is this just a coincidence? Or does a systematic relationship exist between energy prices and energy intensity?

In this study, we examine whether and how Chinas energy price changes affect its energy intensity trend during 1980-2002 at a macro level. We conduct the research by using two complementary economic models: the input-output-based structural decomposition analysis (SDA) and econometric regression models and by using a decomposition method of own-price elasticity of energy intensity. Findings include a negative own-price elasticity of energy intensity, a price-inducement effect on energyefficiency improvement, and a greater sensitivity (in terms of the reaction of energy intensity towards changes in energy prices) of the industry sector, compared to the overall economy.

Analysts can use these results as a starting point for China's energy and carbon emission forecasts, which they traditionally conduct in China without accounting for energy-intensity changes. In addition, policy implications may initiate new thinking about energy policies that are needed to conserve China's energy resources and reduce carbon emissions.

WP-2006-005

Using Futures Prices to Filter Short-term Volatility and Recover a Latent, Long-term Price Series for Oil

Miguel Herce, John E. Parsons and Robert C. Ready, April 2006

Oil prices are very volatile. But much of this volatility seems to reflect short-term,transitory factors that may have little or no influence on the price in the long run. Many major investment decisions should be guided by a model of the long-term price of oil and its dynamics. Data on futures prices can be used to filter out the short-term volatility and recover a time series of the latent, long-term price of oil. We test a leading model known as the 2-factor or short-term, long-term model. While the generated latent price variable is clearly an improvement over the raw spot oil price series, we also find that (1) the generated long-term price series still contains some of the short-term volatility, and (2) a nave use of a long-maturity futures price as a proxy for the long-term price successfully filters out a large majority of the short-term volatility and so may be convenient alternative to the more cumbersome model.

WP-2006-004

Short & Long Run Transmission Incentives for Generation Location

Ralph Turvey, March 2006

This paper is about one aspect of Britain's electricity trading system, its advantages and its weaknesses concerning the incentives it provides or fails to provide for the location of generation. (Similar considerations apply to the location of loads, though these are less responsive to locational influences exerted by the trading system). The optimal location of generation in the short-run is a matter of determining the unit commitment and dispatch of the existing generation park so as to minimise the cost of generation hour by hour, subject to security constraints and taking account of transmission losses. In the long-run, choices of the locational pattern of new plant construction and of the decommissioning of old plant should be influenced by their effects upon the cost of the transmission investment that they entail. In systems with a gross pool, such as in New York, Ireland and New Zealand, there is a central dispatch. This, taking account of transmission losses and constraints, can produce locational marginal prices. Expectations concerning their future levels provide signals relevant to the location of new generation. Thus both in the short-run and in the long-run these systems provide locational incentives. In some of them, where the long-run incentives to investment provided by the uncertain prospect of future price spikes are deemed insufficient, capacity requirements are imposed upon (what in Britain are called) "suppliers". These too can embody a locational element, as in the LICAP arrangements in New York and proposed for New England.

In the British system, there is a net pool, and two cashout prices rather than one emerge from the Balancing Mechanism. This is Britain's version of what is elsewhere called the spot market, regulation market or real time market. Unit commitment is left to the generators, while National Grid, as system operator re-dispatches so as to preserve balance and to deal with transmission constraints. For the latter purpose, it constrains on here and constrains off there (though such actions may serve other purposes too). This costs it money, providing the occasion for it to weigh up the operating cost of dealing with constraints against the capital cost of removing them. But locational prices do not emerge from this process and no account is taken of locational differences in marginal losses. These are two defects of the short-run locational incentives provided by the British system. On the other hand, the British system scores highly with respect to long-run locational incentives. Instead of providing these by participants' expectations of future locational differences in energy prices, and maybe capacity prices, Britain provides them through locational differences in the transmission costs borne by generators. National Grid's Transmission Use of System Charges vary locationally to reflect the results of an "Incremental Cost" analysis. But although these may be roughly right, National Grid's approach is imperfect, even though it has evolved to meet some past criticism1. This paper points to its remaining defects after first tackling the short-run issue of the treatment of losses.

 

WP-2006-003

Efficient bidding for hydro power plants in markets for energy and ancillary services

Dmitri Perekhodtsev and Lester Lave, January 2006

In order to preserve stability of electricity supply generators must provide ancillary services in addition to energy production. Hydroelectric resources have significant ancillary service capability because of their dynamic flexibility. This paper suggests a solution for optimal bidding for hydro units operating in simultaneous markets for energy and ancillary services by estimating water shadow price from operating parameters of the hydro unit, expectations on prices of energy and ancillary services, and water availability. The model implications are illustrated on a numerical example of a hydro unit operating in markets of New York Independent System Operator.

Participation in ancillary services market increases or decreases water shadow price depending on water availability. As a result of participation in ancillary services markets, a unit with water availability given by a capacity factor of 0.6 increases the value of existing generating capacity by 25% and nearly doubles the value of incremental generating capacity.

 

WP-2006-002

Rational Plunging and the Option Value of Sequential Investment: The Case of Petroleum Exploration

James L. Smith and Rex Thompson, February 2006

Any investor in assets that can be exploited sequentially faces a tradeoff between diversification and concentration. Loading a portfolio with correlated assets has the potential to inflate variance, but also creates information spillovers and real options that may augment total return and mitigate variance. The task of optimal portfolio design is therefore to strike an appropriate balance between diversification and concentration. We examine this tradeoff in the context of petroleum exploration. Using a simple model of geological dependence, we show that the value of learning options creates incentives for explorationists to plunge into dependence; i.e., to assemble portfolios of highly correlated exploration prospects. Risk-neutral and risk-averse investors are distinguished not by the plunging phenomenon, but by the threshold level of dependence that triggers such behavior. Aversion to risk does not imply aversion to dependence. Indeed the potential to plunge may be larger for risk-averse investors than for risk-neutral investors. To test the empirical validity of our theory, we examine the concentration of bids tendered in petroleum lease sales. We find that higher levels of risk aversion are associated with a revealed preference for more highly concentrated (i.e., less diversified) portfolios.

 

 

WP-2006-001

The Economic Impacts of Climate Change: Evidence from Agricultural Profits and Random Fluctuations in Weather

Olivier Deschenes and Michael Greenstone, January 2006

This paper measures the economic impact of climate change on US agricultural land by estimating the effect of the presumably random year-to-year variation in temperature and precipitation on agricultural profits. Using long-run climate change predictions from the Hadley 2 Model, the preferred estimates indicate that climate change will lead to a $1.1 billion (2002$) or 3.4% increase in annual profits. The 95% confidence interval ranges from -$1.8 billion to $4.0 billion and the impact is robust to a wide variety of specification checks, so large negative or positive effects are unlikely. There is considerable heterogeneity in the effect across the country with Californias predicted impact equal to -$2.4 billion (or nearly 50% of state agricultural profits). Further, the analysis indicates that the predicted increases in temperature and precipitation will have virtually no effect on yields among the most important crops. These crop yield findings suggest that the small effect on profits is not due to short-run price increases. The paper also implements the hedonic approach that is predominant in the previous literature. We conclude that this approach may be unreliable, because it produces estimates of the effect of climate change that are very sensitive to seemingly minor decisions about the appropriate control variables, sample and weighting. Overall, the findings contradict the popular view that climate change will have substantial negative welfare consequences for the US agricultural sector.

 

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2005

WP-2005-017
Joseph J. Doyle Jr., and Krislert Samphantharak, December 2005
Abstract   |   Full Paper [PDF]

$2.00 Gas! Studying the Effects of Gas Tax Moratorium

Joseph J. Doyle Jr., and Krislert Samphantharak, December 2005

Despite the considerable attention paid to the theory of tax incidence, there are surprisingly few estimates of the pass-through rate of sales taxes on retail prices. This paper estimates the effect of a suspension and subsequent reinstatement of the gasoline sales tax in Illinois and Indiana on retail prices. Earlier laws set the timing of the reinstatements, providing plausibly exogenous changes in the tax rates. Using a unique dataset of daily gasoline prices at the station level, retail gas prices are found to drop by 3% following the elimination of the 5% sales tax, and increase by 4% following the reinstatements, compared to neighboring states. Some evidence also suggests that the tax reinstatements are associated with higher prices up to an hour into neighboring states, which provides some evidence on the size of the geographic market for gasoline. Effects across different competitive environments are considered as well.

WP-2005-016

Market power in a storable-good market: Theory and applications to carbon and sulfur trading

Matti Liski and Juan-Pablo Montero, November 2005

We consider a market for storable pollution permits in which a large agent and a fringe of small agents gradually consume a stock of permits until they reach a long-run emissions limit. The subgame-perfect equilibrium exhibits no market power unless the large agents share of the initial stock of permits exceeds a critical level. We then apply our theoretical results to a global market for carbon dioxide emissions and the existing US market for sulfur dioxide emissions. We characterize competitive permit allocation profiles for the carbon market and find no evidence of market power in the sulfur market.

WP-2005-015
Jean-Michel Glachant and Fran??ois L??v?, September 2005
Abstract   |   Full Paper [PDF]

Electricity Internal Market in the European Union: What to do next?

Jean-Michel Glachant and Franois Lvque, September 2005

The European Unions internal energy market remains a work in progress. It is even possible its construction were to stall. Given current political, institutional and business conditions in Europe, there are no guarantees that the dynamics of this construction will not dissipate, as in the United States, or that the internal market will not fracture into national blocks that may be permanent or persist for a long time. This is exactly what this paper seeks to avoid. It suggests priority actions and secondary improvements to sustain the dynamics of construction of the internal market, from today to the few coming years. It tries too to explain the underlying rationale for these recommendations by describing several aspects of the present state of the construction of the internal market and what factors are blocking or unblocking its progress.

A main constraint has guided our thinking and writing of this paper. We have excluded the issuance of a new package of European directives and regulations to push for stronger convergence in the construction of the EU internal energy market. In fact, such an event is low likely. By contrast, we have counted on two levers: the conscientious applying of the provisions of the second directive and companion regulations, and the promoting of reinforced regional cooperation agreements that will lead to the voluntary opening of some domestic markets to regional mini internal markets. We believe and try to demonstrate that thank to these levers a minimal but sufficient dynamics of construction can be fostered.

The identified priority actions will allow to progress without precluding further policy changes at a later date. Then the length of the phase is defined by the expected life of the current College of European Union Commissioners, that is until 20091.

The paper is divided into 5 sections. Each section corresponds to priorities to improve a critical factor: 1- national market designs, 2- EU internal market design, 3- industry structure, 4- TSOs, and 5- regulators. Each section will indicate what makes this factor a key for the building of the internal market and what are the priority or secondary actions which could be useful to keep constructing an EU electricity single market from 2005 to 2009.

Note that this paper does not cover all the areas of the European energy policy. Other topics representing core interests of the European Union and the 25 Member States, such as Security of Supply and Sustainability of European Energy Regime, have not been treated in this paper. They deserve further investigation and analysis.

 

WP-2005-014

Incentive Regulation in Theory and Practice: Electricity Distribution and Transmission Networks

Paul L. Joskow, September 2005

Modern theoretical principles to govern the design of incentive regulation mechanisms are reviewed and discussed. General issues associated with applying these principles in practice are identified. Examples of the actual application of incentive regulation mechanisms to the regulation of prices and service quality for unbundled transmission and distribution networks are presented and discussed. Evidence regarding the performance of incentive regulation in practice for electric distribution and transmission networks is reviewed. Issues for future research are identified.

WP-2005-013

Oil and Natural Gas Reserve Prices: Addendum to CEEPR WP 03-016: Including Results for 2003 and Revisions to 2001

M. A. Adelman and G. C. Watkins, March 2005

Introduction. A working paper entitled Oil and Natural Gas Reserve Prices 1982-2002: Implications for Depletion and Investment Cost was published in October 2003 (cited hereafter as Adelman & Watkins [2003]). Since then we have obtained data for 2003 and estimated oil and natural gas reserve prices for that year. We have also revised our previous estimates of reserve prices for 2001.

This addendum paper reports on the nature and significance of the results for 2003 and the revisions to 2001. We have also extended the analysis by adding two new features. First is the expression of reserve prices in real terms previously we had only reported nominal prices. Second, we have estimated levelized or constant field prices that appear to underlie reserve prices, for each year. We refer to these as planning prices.

Previously we had only published estimated growth rates in field prices from levels prevailing for a given year, congruent with our estimates of reserve prices. Section 1 of this Addendum paper highlights the 2003 results. Section 2 discusses the revisions for year 2001. Section 3 outlines the nature of the analytical extensions, presents the results, and discusses what they show. Concluding remarks are in Section 4. Adelman & Watkins [2003] included an extensive set of tables in Appendices. The revisions to all these tables to include 2003 and revised 2001 data are attached here as Appendices.

This paper is to be read in conjunction with, not as a substitute for, Adelman & Watkins [2003]: analysis and description in the 2003 paper is not repeated here.

WP-2005-012

Markets for Power in the United States: An Interim Assessment

Paul L. Joskow, August 2005

The transition to competitive wholesale and retail markets for electricity in the U.S. has been a difficult and contentious process. This paper examines the progress that has been made in the evolution of wholesale and retail electricity market institutions. Various indicia of the performance of these market institutions are presented and discussed. Significant progress has been made on the wholesale competition front but major challenges must still be confronted. The framework for supporting retail competition has been less successful, especially for small customers. Empirical evidence suggests that well-designed competitive market reforms have led to performance improvements in a number of dimensions and have benefited customers through lower retail prices.

WP-2005-011
Juan-Pablo Montero and Juan Ignacio Guzman, August 2005
Abstract   |   Full Paper [PDF]

Welfare-enhancing collusion in the presence of a competitive fringe

Juan-Pablo Montero and Juan Ignacio Guzman, August 2005

Following the structure of many commodity markets, we consider a reduced number of large firms and a competitive fringe of many small suppliers choosing quantities in an infinite horizon setting subject to demand shocks. We show that a collusive agreement among the large firms may not only bring an output contraction but also an output expansion (relative to the non-collusive output level). The latter occurs during booms, when the fringes market share is more important, and is due to the strategic substitutability of quantities (we will never observe an output-expanding collusion in a price-setting game). In addition and depending on the fringes market share the time at which collusion is most difficult to sustain can be either at booms or recessions.

WP-2005-009

What should the government do to encourage technical change in the energy sector?

John Deutch, March, 2005

Government support of innovation both technology creation and technology demonstration is desirable to encourage private investors to adopt new technology. In this paper, I review the government role in encouraging technology innovation and the success of the Department of Energy (DOE) and its predecessor agencies in advancing technology in the energy sector. The DOE has had better success in the first stage of innovation (sponsoring R&D to create new technology options) than in the second stage (demonstrating technologies with the objective of encouraging adoption by the private sector). I argue that the DOE does not have the expertise, policy instruments, or contracting flexibility to manage successfully technology demonstration, and that consideration should be given to establishing a new mechanism for this purpose. The ill-fated 1980 Synthetic Fuels Corporation offers an interesting model for such a mechanism.

 

WP-2005-008
Paul L. Joskow, April 2005
Abstract   |   Full Paper [PDF]

Regulation of Natural Monopolies

Paul L. Joskow, April, 2005

This chapter provides a comprehensive overview of the theoretical and empirical literature on the regulation of natural monopolies. It covers alternative definitions of natural monopoly, regulatory goals, alternative regulatory institutions, price regulation with full information, regulation with imperfect and asymmetric information, and topics on the measurement of the effects of price and entry regulation in practice. The chapter also discusses the literature on network access and pricing to support the introduction of competition into previously regulated monopoly industries.

 

WP-2005-007
James L. Smith and Rex Thompson, April 2005
Abstract   |   Full Paper [PDF]

Diversification and the Value of Exploration Portfolios

James L. Smith and Rex Thompson, April, 2005

Conventional wisdom holds that dependence among geological prospects increases exploration risk. However, dependence also creates the option to truncate exploration if early results are discouraging. We show that the value of this option creates incentives for explorationists to plunge into dependence; i.e., to assemble portfolios of highly correlated exploration prospects. Risk-neutral and risk-averse investors are distinguished not by the plunging phenomenon, but by the threshold level of dependence that triggers such behavior. Aversion to risk does not imply aversion to dependence. Indeed the potential to plunge may be larger for risk-averse investors than for risk-neutral investors.

 

WP-2005-006
Matti Liski and Juan-Pablo Montero, March 2005
Abstract   |   Full Paper [PDF]

Forward trading and collusion in oligopoly

Matti Liski and Juan-Pablo Montero, March, 2005

We consider an infinitely-repeated oligopoly in which at each period firms not only serve the spot market by either competing in prices or quantities but also have the opportunity to trade forward contracts. Contrary to the pro-competitive results of finite-horizon models, we find that the possibility of forward trading allows firms to sustain collusive profits that otherwise would not be possible. The result holds both for price and quantity competition and follows because (collusive) contracting of future sales is more effective in deterring deviations from the collusive plan than in inducing the previously identified pro-competitive effects.

WP-2005-005
A. Denny Ellerman and Juan-Pablo Montero, March 2005
Abstract   |   Full Paper [PDF]

The Efficiency and Robustness of Allowance Banking in the U.S. Acid Rain Program

A. Denny Ellerman and Juan-Pablo Montero, March, 2005

This paper provides an empirical evaluation of the efficiency of allowance banking (i.e., abating more in early periods in order to abate less in later periods) in the nationwide market for sulfur dioxide (SO2) emission allowances that was created by the U.S. Acid Rain Program. We develop a model of efficient banking, select appropriate parameter values, and evaluate the efficiency of observed temporal pattern of abatement based on aggregate data from the first eight years of the Acid Rain Program. Contrary to the general opinion that banking in this program has been excessive, we find that it has been reasonably efficient. We also show that this optimal banking program is robust to the errors in expectation that characterized the early years of this program; however, this property is due to design features that are unique to the U.S. Acid Rain Program.

 

WP-2005-004
Paul L. Joskow, March 2005
Abstract   |   Full Paper [PDF]

Patterns of Transmission Investment

Paul L. Joskow, March, 2005

This paper examines a number of issues associated with alternative analytical approaches for evaluating investments in electricity transmission infrastructure and alternative institutional arrangements to govern network operation, maintenance and investment. The economic and physical attributes of different types of transmission investments are identified and discussed. Alternative organizational and regulatory structures and their attributes are presented. The relationships between transmission investments driven by opportunities to reduce congestion and loss costs and transmission investment driven by traditional engineering reliability criteria are discussed. Reliability rules play a much more important role in transmission investment decisions today than do economic investment criteria as depicted in standard economic models of transmission networks. These models fail to capture key aspects of transmission operating and investment behavior that are heavily influenced by uncertainty, contingency criteria and associated engineering reliability rules. I illustrate how the wholesale market and transmission investment frameworks have addressed these issues in England and Wales (E&W) since 1990 and in the PJM Regional Transmission Organization (RTO) in the U.S. since 2000. I argue that economic and reliability-based criteria for transmission investment are fundamentally interdependent. Ignoring these interdependencies will have adverse effects on the efficiency of investment in transmission infrastructure and undermine the success of electricity market liberalization.

WP-2005-003

Electricity Market Reform in the European Union: Review of Progress toward Liberalization & Integration

Tooraj Jamasb and Michael Pollitt, March, 2005

The energy market liberalisation process in Europe is increasingly focused on electricity market integration and related cross border issues. This signals that the liberalisation of national electricity markets is now closer to the long-term objective of a single European energy market. The interface between the national electricity markets requires physical interconnections and technical arrangements. However, further progress towards this objective also raises important issues regarding the framework within which the integrated market is implemented. This paper reviews the progress towards a single European electricity market. We then discuss the emerging issues of market concentration, investments, and security of supply as well as some aspects of market design and regulation that are crucial for dynamic performance of a single European market.

WP-2005-002

A Review of the Monitoring of Market Power: The Possible Roles of TSOs in Monitoring for Market Power Issues in Congested Transmission Systems

Paul Twomey, Richard Green, Karsten Neuhoff, and David Newbery, March, 2005

The paper surveys the literature and publicly available information on market power monitoring in electricity wholesale markets. After briefly reviewing definitions, strategies and methods of mitigating market power we examine the various methods of detecting market power that have been employed by academics and market monitors/regulators. These techniques include structural and behavioural indices and analysis as well as various simulation approaches. The applications of these tools range from spot market mitigation and congestion management through to long-term market design assessment and merger decisions. Various market-power monitoring units already track market behaviour and produce indices. Our survey shows that these units collect a large amount of data from various market participants and we identify the crucial role of the transmission system operators with their access to dispatch and system information. Easily accessible and comprehensive data supports effective market power monitoring and facilitates market design evaluation. The discretion required for effective market monitoring is facilitated by institutional independence.

WP-2005-001
Xavier Labandeira, Jos?? M. Labeaga, and Miguel Rodriguez, February 2005
Abstract   |   Full Paper [PDF]

A Residential Energy Demand System for Spain

Xavier Labandeira, Jos M. Labeaga, and Miguel Rodriguez, February, 2005

Sharp price fluctuations and increasing environmental and distributional concerns, among other issues, have led to a renewed academic interest in energy demand. In this paper we estimate, for the first time in Spain, an energy demand system with household microdata. In doing so, we tackle several econometric and data problems that are generally recognized to bias parameter estimates. This is obviously relevant, as obtaining correct price and income responses is essential if they may be used for assessing the economic consequences of hypothetical or real changes. With this objective, we combine data sources for a long time period and choose a demand system with flexible income and price responses. We also estimate the model in different sub-samples to capture varying responses to energy price changes by households living in rural, intermediate and urban areas. This constitutes a first attempt in the literature and it proved to be a very successful choice.

 

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2004

WP-2004-022
R.S. Eckaus, December 2004
Abstract   |   Full Paper [PDF]

Unraveling the Chinese Oil Puzzle

WP-2004-021

Gasoline Price Spikes and Regional Gasoline Content Regulations: A Structural Approach

Erich J. Muehlegger,November 2004

Since 1999, gasoline prices in California, Illinois and Wisconsin have spiked occasionally well above gasoline prices in nearby states. In May and June 2000, for example, gasoline prices in Chicago rose twenty eight cents per gallon to $2.13, while prices nationally rose only nine to $1.73. Several qualitative studies identify unique gasoline formulations in California, Illinois and Wisconsin as crucial factors related to regional price spikes. This paper provides the first quantitative estimates of two distinct effects of state-level gasoline content regulations in California, Illinois and Wisconsin: (i) the effect of increased production costs associated with additional refining necessary to meet content criteria, and (ii) the effect of incompatibility between these blends and gasoline meeting federal reformulated gasoline (RFG) standards. Using a structural model based on the production optimization problem of refiners, I simulate wholesale prices for jet fuel, diesel and four blends of gasoline in each geographic market. I then specify a counterfactual in which gasoline in the three states only met federal RFG requirements. Using a constructed dataset of refinery outages, I am able to separately identify each effect. Using a similar methodology, I also estimate the effect of two other factors thought to increase gasoline prices, (i) changes in refinery ownership and (ii) limited expansion of domestic refining capacity. Point estimates for the effect of increased refining costs are 4.5, 3.0 and 2.9 cents per gallon in California, Illinois and Wisconsin. The effect of incompatibility with federal RFG criteria, conditional on an in-state refinery outage, is 4.8, 6.6 and 7.1 cents per gallon in California, Illinois and Wisconsin. Controlling for the magnitude of local outages in these areas, I estimate that 72, 92 and 91 percent of price spikes created by local refinery outages could be mitigated by compatibility with federal RFG standards. I find that changes in refinery ownership in the late 1990s increase prices by 1.4 to 1.5 cpg in Illinois and Wisconsin and by 0.73 cents per gallon in California. A five-percent increase in domestic refining capacity reduces prices 3.7 to 3.8 cents per gallon in Illinois and Wisconsin and 4.3 cents per gallon in California.

WP-2004-020

Electricity Transmission Pricing: How much does it cost to get it wrong?

Richard Green,September 2004

Economists know how to calculate optimal prices for electricity transmission. These are rarely applied in practice. This paper develops a thirteen node model of the transmission system in England and Wales, incorporating losses and transmission constraints. It is solved with optimal prices, and with uniform prices for demand and for generation, re-dispatching when needed to take account of transmission constraints. Moving from uniform prices to optimal nodal prices could raise welfare by 1.5% of the generators revenues, and would be less vulnerable to market power. It would also send better investment signals, but create politically sensitive regional gains and losses.

 

WP-2004-019
R.F. Kosobud, H.H. Stokes, C.D. Tallarico, and B.L. Scott, November 2004
Abstract   |   Full Paper [PDF]

The Chicago VOC Trading System: The Consequences of Market Design for Performance

R.F. Kosobud, H.H. Stokes, C.D. Tallarico, and B.L. Scott,November 2004

The Chicago cap-and-trade approach to regulating stationary source VOC emissions in the Chicago ozone non-attainment area is a pioneering program that could set a precedent for other urban areas troubled by high ozone concentrations. It holds out the promise of cost-effectiveness, innovation stimulation, and flexibility compared with traditional regulation. To appraise this program design and evaluate these objectives, this study analyzes four years of data since the inception of the program in 2000. The data reveal that while emissions are far below the cap, there are unexpectedly large banks, startling expirations, and low prices of tradable permits, all inconsistent with an effective market. We find that the market as designed has been constrained from reaching its objectives by the continuance and extension of an underlying layer of traditional regulation, and to a lesser extent by over-allotment of tradable permits. That is, traditional regulation and over-allotment, combined with a market design calling for a small reduction in emissions from baseline and a one-year limit on banking, explain the incongruous outcomes recorded in the market. This study explores the evolution of this particular market design and presents statistical evidence in support of the hypothesis that the performance of a cap-and-trade market is very sensitive to design features when combined with other regulatory measures. The study concludes that the market as presently designed falls far short of achieving cost effectiveness, innovation stimulation, and flexibility. The policy recommendations include that the cap be significantly tightened, perhaps in a series of steps, and the banking horizon be extended to three years or more. Such redesign should enable the cap-and-trade approach to assume its proper role in helping to achieve the new eight-hour standard for ozone concentrations.

WP-2004-018

Does Competition Reduce Costs? Assessing the Impact of Regulatory Restructuring on U.S. Electric Generation Efficiency

Nancy L. Rose, Kira Markiewicz, and Catherine Wolfram,November 2004

Although the allocative efficiency benefits of competition are a tenet of microeconomic theory, the relation between competition and technical efficiency is less well understood. Neoclassical models of profit-maximization subsume static cost-minimizing behavior regardless of market competitiveness, but agency models of managerial behavior suggest possible scope for competition to influence cost-reducing effort choices. This paper explores the empirical effects of competition on technical efficiency in the context of electricity industry restructuring. Restructuring programs adopted by many U.S. states made utilities residual claimants to cost savings and increased their exposure to competitive markets. We estimate the impact of these changes on annual generating plant-level input demand for non-fuel operating expenses, the number of employees and fuel use. We find that municipally-owned plants, whose owners were for the most part unaffected by restructuring, experienced the smallest efficiency gains over the past decade. Investor-owned utility plants in states that restructured their wholesale electricity markets had the largest reductions in nonfuel operating expenses and employment, while investor-owned plants in nonrestructuring states fell between these extremes. The analysis also highlights the substantive importance of treating the simultaneity of input and output decisions, which we do through an instrumental variables approach.

WP-2004-017
Paul L. Joskow, October 2004
Abstract   |   Full Paper [PDF]

Transmission Policy in the United States

Paul L. Joskow,October 2004

This paper provides an overview of the development of electric power transmission access, pricing and investment policies in the U.S. over the last 15 years and evaluates the current state of those policies. Pre-liberalization transmission access and pricing policies are reviewed since more recent policies have evolved from them. FERCs efforts to ensure that transmission owning utilities provide non-discriminatory access and pricing to wholesale transmission customers, culminating in Order 888 and 889 are discussed. These rules did not respond to problems created by a highly balkanized transmission system and only partially responded to problems caused by common ownership and operation of transmission networks with generating and marketing businesses in the same regions. These problems motivated FERC to seek to create Regional Transmission Organizations (RTO) meeting a long list of criteria related to governance, network consolidation, network operations, transmission pricing and investment as reflected in Order 2000. The slow pace of voluntary reform following Order 2000 led FERC to issue a proposed Standard Market Design Rule (SMD) which provided more detailed prescriptions for wholesale market design, network operations, regional planning, resource adequacy, and transmission investment. The SMD rule confronted enormous resistance from groups of utilities and states that have not embraced an electricity sector liberalization agenda. However, many of the provisions of the SMD are being implemented by the RTOs and ISOs in the Northeast and Midwest. PJMs market rules and transmission pricing, planning and investment policies are reviewed as an articulation of FERCs RTO and SMD visions.

WP-2004-016

Electricity Reform in Chile: Lessons for Developing Countries

Michael Pollitt,September 2004

Chile was the first country in the world to implement a comprehensive reform of its electricity sector in the recent period. Among developing countries only Argentina has had a comparably comprehensive and successful reform. This paper traces the history of the Chilean reform, which began in 1982, and assesses its progress and its lessons. We conclude that the reform has been very successful. We suggest lessons for the generation, transmission and distribution sectors, as well as the economic regulation of electricity and the general institutional environment favourable to reform. We note that while the initial market structure and regulatory arrangements did give rise to certain problems, the overall experience argues strongly for the private ownership and operation of the electricity industry.

 

WP-2004-014
Juan Pablo Montero, September 2004
Abstract   |   Full Paper [PDF]

Pollution Markets with Imperfectly Observed Emissions

Juan Pablo Montero,September 2004

I study the advantages of pollution permit markets over traditional standard regulations when the regulator has incomplete information on firms emissions and costs of production and abatement (e.g., air pollution in large cities). Because the regulator only observes each firms abatement technology but neither its emissions nor its output, there are cases in which standards can lead to lower emissions and, hence, welfare dominate permits. If permits are optimally combined with standards, in many cases this hybrid policy converges to the permits-alone policy but (almost) never to the standards-alone policy.

WP-2004-013

Market Power in the England and Wales Wholesale Electricity

Andrew Sweeting,August 2004

This paper shows that generators exercised increasing market power in the England and Wales wholesale electricity market in the second half of the 1990s despite declining market concentration. It examines whether this was consistent with static, non-cooperative oligopoly models, which are widely used to model electricity markets, by testing the static Nash equilibrium assumption that each generator chose its bids to maximize its current profits taking the bids of other generators as given. It finds a significant change in behavior in late 1996. In 1995 and 1996 generator behavior was consistent with the static Nash equilibrium assumption if the majority of their output was covered by financial contracts which hedged prices. After 1996 their behavior was inconsistent with the static Nash equilibrium assumption given their contract cover but it was consistent with tacit collusion.

 

WP-2004-012
Mattie Liski and Juan-Pablo Montero, May 2004
Abstract   |   Full Paper [PDF]

Forward Trading and Collusion in Oligopoly

Mattie Liski and Juan-Pablo Montero,May 2004

We consider an infinitely-repeated oligopoly in which at each period firms not only serve the spot market by either competing in prices or quantities but also have the opportunity to trade forward contracts. Contrary to the pro-competitive results of finite-horizon models, we find that the possibility of forward trading allows firms to sustain collusive profits that otherwise would not be possible. The result holds both for price and quantity competition and follows because (collusive) contracting of future sales is more effective in deterring deviations from the collusive plan than in inducing the previously identified pro-competitive effects.

WP-2004-010

Did English Generators Play Cournot? Capacity withholding in the Electricity Pool

Richard Green,March 2004

Electricity generators can raise the price of power by withholding their plant from the market. We discuss two ways in which this could have affected prices in the England and Wales Pool. Withholding low-cost capacity which should be generating will raise energy prices but make the pattern of generation less efficient. This pattern improved significantly after privatisation. Withholding capacity that was not expected to generate would raise the Capacity Payments based on spare capacity. On a multi-year basis, these did not usually exceed competitive levels, the cost of keeping stations open. The evidence for large-scale capacity withholding is weak

WP-2004-009
Paul L. Joskow and Jean Tirole, March 2004
Abstract   |   Full Paper [PDF]

Retail Electricity Competition

Paul L. Joskow and Jean Tirole,March 2004

We analyze a number of unstudied aspects of retail electricity competition. We first explore the implications of load profiling of consumers whose traditional meters do not allow for measurement of their real time consumption, when consumers are homogeneous up to a scaling factor. In general, the combination of retail competition and load profiling does not yield the second best prices given the non price responsiveness of consumers. Specifically, the competitive equilibrium does not support the Ramsey two-part tariff. By contrast, when consumers have real time meters and are billed based on real time prices and consumption, retail competition yields the Ramsey prices even when consumers can only partially respond to variations in real time prices. More complex consumer heterogeneity does not lead to adverse se1ection and competitive screening behavior unless consumers have real time meters and are not rational. We then examine the incentives competitive retailers have to install one of two types of advanced metering equipment. Competing retailers overinvest in real time meters compared to the Ramsey optimum, but the investment incentives are constrained optimal given load-profiling and retail competition. Finally, we consider the effects of physical limitations on the ability of system operators to cut off individual customers. Competing retailers have no incentive to determine the aggregate value of non-interruption of consumers in the zones they serve, preferring instead to free ride on other retailers serving consumers in the same zones.

 

WP-2004-008
Paul L. Joskow and Jean Tirole, March 2004
Abstract   |   Full Paper [PDF]

Reliability and Competitive Electricity Markets

Paul Joskow and Jean Tirole,March 2004

Despite all of the talk about deregulation of the electricity sector, a large number of non-market mechanisms have been imposed on emerging competitive wholesale and retail markets. These mechanisms include spot market price caps, operating reserve requirements, non-price rationing protocols, and administrative protocols for managing system emergencies. Many of these mechanisms have been carried over from the old regime of regulated monopoly and continue to be justified as necessary responses to market imperfections of various kinds and engineering requirements dictated by the special physical attributes of electric power networks. This paper seeks to bridge the gap between economists focused on designing competitive market mechanisms and engineers focused on the physical attributes and engineering requirements they perceive as being needed for operating a reliable electric power system. The paper starts by deriving the optimal prices and investment program when there are price-insensitive retail consumers, and their load serving entities can choose any level of rationing they prefer contingent on real time prices. It then examines the assumptions required for a competitive wholesale and retail market to achieve this optimal price and investment program. The paper analyses the implications of relaxing several of these assumptions. First, it analyzes the interrelationships between regulator-imposed price caps, capacity obligations, and system operator procurement, dispatch and compensation arrangements. It goes on to explore the implications of potential network collapses, the concomitant need for operating reserve requirements and whether market prices will provide incentives for investments consistent with these reserve requirements.

 

WP-2004-007

Did the Clean Air Act Cause the Remarkable Decline in Sulfur Dioxide Concentrations?

Michael Greenstone,October 2003

Over the last three decades, ambient concentrations of sulfur dioxide (SO2) air pollution have declined by approximately 80%. This paper tests whether the 1970 Clean Air Act and its subsequent amendments caused this decline. The centerpiece of this legislation is the annual assignment of all counties to SO2 nonattainment or attainment categories. Polluters face stricter regulations in nonattainment counties. There are two primary findings. First, regulators pay little attention to the statutory selection rule in their assignment of the SO2 nonattainment designations. Second, SO2 nonattainment status is associated with modest reductions in SO2 air pollution, but a null hypothesis of zero effect generally cannot be rejected. This finding holds whether the estimated effect is obtained with linear adjustment or propensity score matching. Overall, the evidence suggests that the nonattainment designation played a minor role in the dramatic reduction of SO2 concentrations over the last 30 years.

WP-2004-006
Kenneth Y. Chay and Michael Greenestone, August 2003
Abstract   |   Full Paper [PDF]

Air Quality, Infant Mortality, and the Clean Air Act of 1970

Kenneth Y. Chay and Michael Greenestone,August 2003

We examine the effects of total suspended particulates (TSPs) air pollution on infant health using the air quality improvements induced by the 1970 Clean Air Act Amendments (CAAA). This legislation imposed strict regulations on industrial polluters in nonattainment counties with TSPs concentrations exceeding the federal ceiling. We use nonattainment status as an instrumental variable for TSPs changes to estimate their impact on infant mortality changes in the first year that the 1970 CAAA was in force.

TSPs nonattainment status is associated with sharp reductions in both TSPs pollution and infant mortality from 1971 to 1972. The greater reductions in nonattainment counties near the federal ceiling relative to the attainment counties narrowly below the ceiling suggest that the regulations are the cause. We estimate that a one percent decline in TSPs results in a 0.5 percent decline in the infant mortality rate. Most of these effects are driven by a reduction in deaths occurring within one month of birth, suggesting that fetal exposure is a potential biological pathway. The results imply that roughly 1,300 fewer infants died in 1972 than would have in the absence of the Clean Air Act.

WP-2004-005
Matti Liski and Juan-Pablo Montero, February 2004
Abstract   |   Full Paper [PDF]

A Note on Market Power in an Emission Permits Market with Banking

Matti Liski and Juan-Pablo Montero,February 2004

In this paper, we investigate the effect of market power on the equilibrium path of an emission permits market in which firms can bank current permits for use in later periods. In particular, we study the market equilibrium for a large (potentially dominant) firm and a competitive fringe with rational expectations. We characterize the equilibrium solution for different permits allocations. We find, for example, that if the large firm enjoys a dominant position in the after-banking market, this position gets extended to the market during the banking period regardless of the allocation of the stock (bank) of permits.

WP-2004-004

The Option to Try Again: Valuing a Sequence of Dependent Trials

James L. Smith,January 2004

In various fields of economic endeavor, agents enjoy the option to try, try again. Failure in a particular pursuit often brings renewed effort to finally succeed. Many areas of R&D could be characterized in this fashion. Our purpose is to define and measure the value of this option to try again. The value of repeated trials is closely related to the extent of statistical dependence among them. We describe the solution to this valuation problem, examine the behavior of the option premium, and characterize potential errors that are inherent in two ad hoc procedures that are often used to obtain bounds on the true value of the prospect. To be concrete, the problem is framed in terms of petroleum exploration, but the methods we employ are general and could be applied to various forms of R&D and other types of risky investments.

 

WP-2004-003

Managing a Portfolio of Real Options: Sequential Exploration of Dependent Prospects

James L. Smith and Rex Thompson,January 2004

We consider the impact of sequential investment and active management on the value of a portfolio of real options. The options are assumed to be interdependent, in that exercise of any one is assumed to produce, in addition to some intrinsic value based on an underlying asset, further information regarding the values of other options based on related assets. We couch the problem in terms of oil exploration, where a discrete number of related geological prospects are available for drilling, and managements objective is to maximize the expected value of the combined exploration campaign. Managements task is complex because the expected value of the investment sequence depends on the order in which options are exercised. A basic conclusions is that, although dependence increases the variance of potential outcomes, it also increases the expected value of the embedded portfolio of options and magnifies the value of optimal management. Stochastic dynamic programming techniques may be used to establish the optimal sequence. Given certain restrictions on the risk structure, however, we demonstrate that the optimal dynamic program can be implemented by policies that are relatively simple to execute. In other words, we provide sufficient conditions for the optimality of intuitive decision rules, like biggest first, most likely first, or greatest intrinsic value first, and we develop exact analytic expressions for the implied value of the portfolio. This permits the value of active management to be assessed directly. Finally, the sufficient conditions we identify are shown to be consistent with plausible exploration risk structures.

WP-2004-002
Guillaume L'Hegaret, Boriss Siliverstovs, and Christian von Hirschhausen, January 2004
Abstract   |   Full Paper [PDF]

International Market Intergration for Natural Gas? A Cointergration Analysis of Prices in Europe, North America, and Japan

Guillaume L'Hegaret, Boriss Siliverstovs, and Christian von Hirschhausen,January 2004

We examine the degree of natural gas market integration in Europe, North America and Japan, between the mid 1990s and 2002. Our hypothesis is that there was a certain split of prices between Europe and North America. The relationship between the international gas marker prices and their relation to the oil price, are investigated through principal component analysis and Johansen likelihood-based procedures. Both of them show a high level of integration within the European/Japanese and North American markets and that the European/ Japanese and the North American markets are connected to a much lesser extent.

 

WP-2004-001

The Sources of Emission Reductions: Evidence from U.S. SO2 Emissions from 1985 through 2002

A. Denny Ellerman & Florence Dubroeucq,January 2004

An enduring issue in environmental regulation is whether to clean up existing old plants or in some manner to bring in new clean plants to replace the old. In this paper, a unit-level data base of emissions by nearly 2000 electric generating units from 1985 through 2002 is used to analyze the contribution of these two factors in accomplishing the significant reduction of sulfur dioxide emissions from these sources in the United States. The effect on SO2 emissions of the new natural-gas-fired, combined-cycle capacity that has been introduced since 1998 is also examined. The results indicate that cleaning up the old plants has made by far the greatest contribution to reducing SO2 emissions, and that this contribution has been especially large since the introduction of the SO2 cap-and-trade program in 1995. The new natural-gas-fired, combined cycle units have displaced conventional generation that would have emitted about 800,000 tons of SO2; however, the effect has not been to reduce total SO2 emissions since the 9.0 million ton cap is unchanged, but to reduce the quantity of abatement required of other units in meeting the cap and thereby the cost of doing so.

 

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2003

WP-2003-016

Oil and Natural Gas Reserve Prices 1982-2002: Implications for Depletion and Investment Cost

M.A. Adelman and G.C. Watkins,November 2003

A time series is estimated of in-ground prices - as distinct from wellhead prices of US oil and natural gas reserves for the period 1982-2002, using market purchase and sale transaction information. The prices are a measure of the unit investment cost (long-run marginal cost) of creating new oil and gas reserves. The data are also used to examine the impact of reserves status (producing or not), the rate of production (R/P ratios) and of wellhead prices on reserve prices, and to reveal oil and natural gas price expectations embedded in reserve prices. Noticeable differences are disclosed between oil price expectations (ambiguous) and natural gas (positive). Estimates are made of current market values of US oil and gas reserves.

Over the 21 year time span studied the trend in oil reserve prices is zero to mildly negative, that in natural gas is zero to mildly positive. All of these results -- the reserve prices themselves, their trends, and estimates of one year returns on holding reserve assets-- are incompatible with Hotelling doctrines. All these estimates refute the assumption of a fixed stock of hydrocarbons whose incessant decrease by production makes the still unproduced remainder constantly more valuable. The results are compatible with a process whereby investment adds to reserves even as production depletes them.

 

WP-2003-014

Electricity Sector Restructuring and Competition: Lessons Learned

Paul L. Joskow,August 2003

We now have over a decade of experience with the privatization, restructuring, regulatory reform, and wholesale and retail competition in electricity sectors around the world. The objectives and design attributes of these reform programs are reviewed. The improvements in sector performance that have been achieved are discussed. The nature and sources of performance problems are also reviewed. Several lessons learned from this experience are identified and their implications for successful ongoing electricity reform initiatives presented. Electricity sector restructuring, regulatory reform and competition initiatives can yield significant consumer benefits when these reforms are designed and implemented well. Applying the lessons learned from recent experience can yield larger consumer benefits in the future.

WP-2003-013

Energy Policies and their Consequences After 25 Years

Paul L. Joskow,July 2003

Hans Landsberg and Sam Schurr each led research teams that produced two important energy futures policy studies that were published in 1979. The conclusions, policy recommendations, and energy demand, supply, and price forecasts contained in these studies are reviewed. Developments in U.S. energy policy over the last 25 years are discussed and compared with the recommendations contained in the two studies. The projections of energy demand, supply, and prices for 2000 contained in the studies is presented and compared to actual realizations. The nature, magnitudes, and reasons for the differences between the studies forecasts and what actually emerged 25 years later are discussed. All things considered, the Landsberg and Schurr studies have stood the test of time very well.

WP-2003-012
Robert S. Pindyck, June 2003
Abstract   |   Full Paper [PDF]

Volatility in Natural Gas and Oil Markets

Robert S. Pindyck,June 2003

Using daily futures price data, I examine the behavior of natural gas and crude oil price volatility since 1990. I test whether there has been a significant trend in volatility, whether there was a short-term increase in volatility during the time of the Enron collapse, and whether natural gas and crude oil price volatilities are interrelated. I also measure the persistence of shocks to volatility and discuss its implications for gas-and oil-related contingent claims.

WP-2003-010

Diagnosing and Mitigating Market Power in Chile's Electricity Industry

M. Soledad Arellano,May 2003

This paper examines the incentives to exercise market power that generators would face and the different strategies that they would follow if all electricity supplies in Chile were traded in an hourly-unregulated spot market. The industry is modeled as a Cournot duopoly with a competitive fringe; particular care is given to the hydro scheduling decision. Quantitative simulations of the strategic behavior of generators indicate that the largest generator (Endesa) would have the incentive and ability to exercise market power unilaterally. It would do so by scheduling its hydro resources, which are shown to be the real source of its market power, in order to take advantage of differences in price elasticity: too little supply to high demand periods and too much to low demand periods. The following market power mitigation measures are also analyzed: (a) requiring Endesa to divest some of its generating capacity to create more competitors and (b) requiring the dominant generators to enter into fixed price forward contracts for power covering a large share of their generating capacity. Splitting the largest producer in two or more smaller firms turns the market equilibrium closer to the competitive equilibrium as divested plants are more intensely used. Contracting practices proved to be an effective tool to prevent large producers from exercising market power in the spot market. In addition, a more effcient hydro scheduling resulted. Conditions for the development of a voluntary contract market are analyzed, as it is not practical to rely permanently on vesting contracts imposed for the transition period.

 

WP-2003-009

Lessons from Phase 2 Compliance with the U.S. Acid Rain Program

A. Denny Ellerman,May 2003

This paper provides preliminary answers to four questions concerning the behavior of agents operating under the SO2 Allowance Trading Program that could not be adequately answered until several years' data on compliance behavior in the final Phase II could be observed. The four questions are:


  1. How is abatement distributed geographically when all fossil-fuel-fired electricity generating units are included?

  2. Will agents draw down the accumulated Phase I bank, as expected and more or less efficiently, during Phase II?

  3. Is there any evidence that the failure to endow new generating units with allowances constitutes a barrier to entry?

  4. What can be said about the cost of the SO2 Allowance Trading Program in Phase II when all units are included and when it is fully phased in?

WP-2003-008

The Difficult Transition to Competitive Electricity Markets in the U.S.

Paul L. Joskow,May 2003

This paper provides a comprehensive discussion of the causes and consequences of state and federal initiatives to introduce wholesale and retail competition into the U.S. electricity sector between 1995 and the present. Information about the development of wholesale market institutions, the expansion of wholesale power trade, the performance of wholesale market institutions, the entry of merchant generating capacity, and the financial collapse of the trading and merchant generating sector is presented and discussed. Issues regarding the ability of evolving spot wholesale energy market institutions and market power mitigation mechanisms to provide adequate incentives for investment in new generating capacity in the absence of some form of peak capacity obligation are discussed theoretically and evaluated empirically. The diffusion of retail competition and the performance of retail competition programs in eight states is examined empirically. Imperfections in transmission governance arrangements and barriers to efficient expansion of the transmission network are identified. The analysis leads to the overall conclusion that the development of efficient competitive wholesale and retail electricity markets continues to be a work in progress and faces many technical, institutional and political challenges in the U.S. Suggestions for successfully confronting, or at least better understanding, these challenges are presented.

 

WP-2003-007
Joanne Evans and Richard Green, January 2003
Abstract   |   Full Paper [PDF]

Why did British Electricity Prices Fall After 1998?

Joanne Evans and Richard Green (revised version 2005),January 2003

In an attempt to reduce high electricity prices in England and Wales, the government and regulator forced the largest generators to divest some plant in the late 1990s, and introduced New Electricity Trading Arrangements in March 2001. We use a supply function model to simulate prices from April 1997 to March 2004, and find no change in the relationship between our simulations and actual prices over this period. This implies that while the reduction in concentration has had a significant impact on short-term wholesale electricity prices, the switch from a centralised to a decentralised market has not.

 

WP-2003-006

Distinguishable Patterns of Competition, Collusion and Parallel Action

James L. Smith,May 2003

Alternative market structures are distinguishable by the degree of parallel action exhibited by producers. We show that the correlation between output levels varies systematically with the degree of interdependence among firms, and establish an ordering among alternative behavioral hypotheses (Cournot, Stackelberg, Edgeworth/Bertrand, collusion, and perfect competition). Because the ordering is invariant to the values of background parameters, statistical tests of market conduct may be possible even when the slopes of the demand curve and marginal cost curves are unknown. An application to the world oil market finds strong evidence of collusive behavior among OPEC members, but not elsewhere.

WP-2003-005

Inscrutable OPEC? Behavioral Tests of the Cartel Hypothesis

James L. Smith,May 2003

We show that standard statistical tests of OPEC behavior have very low power across a wide range of alternative hypotheses regarding market structure. Consequently, it is difficult, given the current availability and precision of data on demand and costs, to distinguish collusive from competitive behavior in the world oil market. This, along with other factors, may account for the largely inconclusive nature of findings so far reported in the empirical literature on OPEC. We apply a new approach for examining alternative hypotheses and find strong evidence of cooperative behavior among OPEC members. Our results also suggest that OPECs formal quota mechanism, introduced in 1982 to replace a system based on posted prices, increased transactions costs within the organization. We do not find strong evidence to support the view that Saudi Arabia has played the role of dominant producer within the cartel.

WP-2003-004
Paul L. Joskow and Jean Tirole, February 2003
Abstract   |   Full Paper [PDF]

Merchant Transmission Investment

Paul L. Joskow and Jean Tirole,February 2003

We examine the performance attributes of a merchant transmission investment framework that relies on market driven transmission investment to provide the infrastructure to support competitive wholesale markets for electricity. Under a stringent set of assumptions, the merchant investment model has a remarkable set of attributes that appear to solve the natural monopoly problem and the associated need for regulating transmission companies traditionally associated with electric transmission networks. We expand the merchant model upon which these conclusions are based to incorporate imperfections in wholesale electricity markets, lumpiness in transmission investment opportunities, stochastic attributes of transmission networks and associated property rights definition issues, the effects of the behavior of system operators and transmission owners on transmission capacity and reliability, coordination and bargaining considerations, forward contract, commitment and asset specificity issues. Incorporating these more realistic attributes of transmission networks and the behavior of transmission owners and system operators significantly undermines the attractive properties of the merchant investment model. Relying primarily on a market driven investment framework to govern investment in electric transmission networks is likely to lead to inefficient investment decisions and undermine the performance of competitive markets for electricity. A significant research challenge is to design regulatory mechanisms for system operators and incumbent transmission owners and a better framework for defining transmission property rights that will stimulate efficient investments by regulated incumbent transmission owners and by merchant entrants responding to market opportunities when they are the most efficient suppliers.

WP-2003-003

Ex Post Evaluation of Tradable Permits: The U.S. SO2 Cap-and-Trade Program

A. Denny Ellerman,January 2003

The U.S. SO2 cap-and-trade program was established as a result of the enactment of the 1990 Clean Air Act Amendments (1990 CAAA) under the authority granted by Title IV, which included several measures to reduce precursor emissions of acid deposition.2 The SO2 component consisted of a two-phase, cap-and-trade program for reducing SO2 emissions from fossil-fuel burning power plants located in the continental forty-eight states of the United States. During Phase I, lasting from 1995 through 1999, electric generating units larger than 100 MWe in generating capacity with an annual average emission rate in 1985 greater than 2.5 pounds of SO2 per million Btu of heat input in 1985 (hereafter, #SO2/mmBtu) were required to reduce emissions to a level that would be, on average, no greater than 2.5 #SO2/mmBtu. In Phase II, beginning in 2000 and continuing indefinitely, the program was expanded to include fossil-fuel electricity generating units greater than 25 MWe, or virtually all fossil-fuel power plants in the United States. Emissions from these affected units are limited, after accounting for any allowances banked from Phase I, to an annual cap of 8.9 million tons, or about half of total electric utility SO2 emissions in the early 1980s. The Phase II cap is equivalent to an Ex Post Evaluation: US SO2 Program 2 average emission rate of 1.2 #SO2/mmBtu, when divided by the mid-1980s level of heat input at fossil-fuel burning power plants.

WP-2003-002

Trends and Breaks in Per-Capita Carbon Dioxide Emissions, 1870-2028

Markku Lanne and Matti Liski,January 2003

We consider per-capita carbon dioxide emission trends in 16 early developed countries over the period 1870-2028. Using a multiple-break time series method we find more evidence for very early downturns in per-capita trends than for late downturns, during the oil price shocks of the 1970s. Only for two countries do downturns in trends imply downward sloping stable trends. We also consider trends in emission composition and find little evidence for in-sample peaks for emissions from liquid and gaseous fuel uses. These results lead us to reject the oil price shocks as events causing permanent breaks in the structure and level of emissions, a conclusion often made in analyses using shorter postwar data.

 

WP-2003-001

UNITED STATES OF AMERICA Before the FEDERAL ENERGY REGULATORY COMISSION - Comments of Professor Paul L. Joskow

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2002

WP-2002-012

Transmission Pricing of Distributed Multilateral Energy Transactions to Ensure System Security and Guide Economic Dispatch

Maria Ilic, Eric Hsieh, and Prasad Ramanan,December 2002

In this paper we provide a simulations-based demonstration of a hybrid electricity market that combines the distributed competitive advantages of decentralized markets with the system security guarantees of centralized markets. In this market, the transmission service provider (TSP) guides an electricity market towards the optimal power flow (OPF) solution, even when maximizing its own revenue. End users negotiate with each other to determine an energy price and then submit separate bids for transmission to the TSP. The TSP returns with prices for transmission, allowing end users to respond. In simulations, this hybrid-decentralized market approaches the near-optimal results of fully coordinated and constrained markets. Additionally, this market exhibits properties that remove incentives for the TSP to withhold capacity. This hybrid market leads a market towards the optimum while allowing the TSP and the end users to act out of self-interest. Index TermsElectricity markets, transmission, optimum power flow.

WP-2002-011
M.A. Adelman & G.C. Watkins, December 2002
Abstract   |   Full Paper [PDF]

Costs of Aggregate Hydrocarbon Reserve Additions

M.A. Adelman & G.C. Watkins,December 2002

In what follows, we highlight problems created by aggregation using fixed conversion coefficients (Section 1). We then offer an economic index approach as an alternative, one that recognizes changing relative values of oil and gas over time (Section 2). This aggregation technique - the Divisia index - is applied to US reserve and in situ price data from 1982 to year 2001 to derive implicit shifts in unit costs of aggregated oil and gas reserve additions; these results are compared with those from the traditional fixed coefficient measures (Section 3). Concluding remarks are in Section 4.

WP-2002-010

Statement of Professor Paul L. Joskow Before The Committee on Govermental Affairs - THE UNITED STATES SENATE

WP-2002-009

Introducing Competition in the French Electricity Supply Industry: The Destabilisation of a Public Hierarchy in an Open Institutional Environment

Dominique Finon,November 2002

The introduction of market rules in a electricity supply industry characterized by a vertically integrated monopoly and public ownership is not inherently doomed to failure if characteristics of the reform or other elements of industrial structures give room for enforcing market-rules. The organisation of the French ESI in a public monopoly was deeply rooted in French institutional peculiarities. Therefore the initial reform, which was adopted in February 2000 under the prescription of the European law of electricity market liberalization, introduced only a provision of regulated third party access to the grid, without legal separation of the transmission system operator and creation of a power exchange. But this created a dynamics of regulatory change which allows the development of an effective competition on the wholesale market and the industrial customers segment. The paper analyses how the governmental goal of preserving the national champion EDF have had two paradoxical effects in favour of competition development and the building of safeguards for the entrants:


  1. the creation of a credible regulatory governance structure with effective power of control on the network access, and which promoted market-rules and the creation of a power exchange for balancing the incumbents dominant position,

  2. the enforcement of the credibility of the regulatory framework by the self control of the incumbent on the use of its dominant position and on the capture of the regulator, This two effects results from the influence of the European institutional environment which is superposed to the national one, in particular under the intensive scrutiny of the European Commission, on a model far behind the competitive model. The paper concludes to the originality of such an institutional model : a permanent regulatory threat on the incumbent for balancing the effects of public property and integration of industrial structures. In other words it would not only be the industrial structures which determine the market players behaviour but also the credibility of market rules and their enforcement by the regulatory threat and the self control of the incumbent.


This paper has been presented at the 2002 annual Conference of the International Society for New Institutional Economics (ISNIE) held in Cambridge (Mass.) on September 27-29. The author thanks Paul Joskow and Jean- Michel Glachant for their useful comments on the draft version.

WP-2002-008

The Role of Content Regulation On Pricing and Market Power in Regional Retail and Wholesale Gasoline Markets

Erich Muehlegger,November 2002

Since 1999, regional retail and wholesale gasoline markets in the United States have experienced significant price volatility, both intertemporally and across geographic markets. This paper focuses on one potential explanation for regional variations in price levels and volatility, gasoline content regulation. Implemented regionally to address local mobile-source emissions, gasoline content regulations increase cost to refiners, transporters and distributors of gasoline, in addition to reducing the fungibility of gasoline across different regions. This paper first provides a summary of the regional gasoline content regulations and a primer on the refining industry. In addition, this paper specifies the costs regional content regulation imposes on refiners, transporters and distributors of gasoline and the role increasing heterogeneity of gasoline may play in regional price volatility. Finally, this paper surveys the previous literature looking at the effect of gasoline content regulation on prices and price volatility and suggests directions for future research.

WP-2002-007
Tanga McDaniel and Karsten Neuhoff, October 2002
Abstract   |   Full Paper [PDF]

Auctions to gas transmission access: The British experience

Tanga McDaniel and Karsten Neuhoff,October 2002

When access to monopoly owned networks is constrained auctioning access rights can increase the efficiency of allocations relative to negotiation and grandfathering when there is sufficient competition among network users. Historically, access rights to entry capacity on the British gas network were granted by the monopoly network owner via negotiation; rights were later based on regulated tariffs with an increasing reliance on market based constraint resolution by the system operator. In 1999 an auction mechanism for allocating rights was introduced. Comparing the different allocation methods we conclude that where there is competition at entry terminals auctions have been successful with respect to anticipating spot prices, capturing producer rents and reducing the costs of alleviating network constraints. Moreover, auctions are more transparent and better facilitate entry.

WP-2002-005

Enviornmental Benefits and Cost Savings Through Market-Based Instruments: An Application Using State-Level Data from India

Shreekant Gupta,September 2002

This paper develops a methodology for estimating potential cost savings from the use of market-based instruments (MBIs) when local emissions and abatement cost data are not available. The paper provides estimates of the cost savings for a 50% reduction of particulate emissions in Indias five main industrial states, as well as estimates of the benefits from doing so. The estimates are developed by applying World Bank particulate intensity and abatement cost factors to sectoral output data. The estimated costs savings range from 26% to 169% and the benefits are many times greater than the costs even without the use of MBIs. The paper concludes by commenting on the relative difficulty of implementing reductions by market-based instruments and conventional command-and-control regulations.

WP-2002-004
Juan-Pablo Montero, September 2002
Abstract   |   Full Paper [PDF]

Testing the Efficiency of a Tradeable Permits Market

Juan-Pablo Montero,September 2002

A tradeable permits market is said to be efficient when all affected firms trade permits until their marginal costs equal the market price. Detailed firm-level data are generally required to perform such an efficiency test, yet such information is rarely available. If firms face a declining target, however, and are allowed to bank permits, as has occured recently, aggregated data such as the evolution of the permits bank is sufficient to test for either less than optimal market participation or the exercise of market power. An application to the U.S. sulfur dioxide emission permits market is provided.

 

WP-2002-003
A. Denny Ellerman & Juan-Pablo Montero, September 2002
Abstract   |   Full Paper [PDF]

The Temporal Efficiency of SO2 Emissions Trading

A. Denny Ellerman & Juan-Pablo Montero,September 2002

This paper provides an empirical evaluation of the temporal efficiency of the U.S. Acid Rain Program, which implemented a nationwide market for trading and banking sulfur dioxide (SO2) emission allowances. We first develop a model of efficient banking and select appropriate parameter values. Then, we use aggregate data from the first seven years of the Acid Rain Program, to assess the temporal efficiency of the observed banking behavior. We find that banking has been surprisingly efficient and we discuss why this finding disagrees with the common perception of excessive banking in this program.

WP-2002-002
A. Denny Ellerman, February 2002
Abstract   |   Full Paper [PDF]

Analysis of the Bush Proposal to Reduce the SO2 Cap

A. Denny Ellerman,February 2002

This paper evaluates President Bush's recent proposal to reduce the cap on total SO2emissions using a model of emissions banking that fits the experience so far under Title IV. It provides a brief introduction to emissions banking and reports results concerning the effect of a the proposed reduction of the cap on emissions, abatement costs, and the value of the existing SO2allowance endowment.

WP-2002-001
Juan-Pablo Montero, January 2002
Abstract   |   Full Paper [PDF]

Trading quasi-emission permits

Juan-Pablo Montero,January 2002

I study the design of environmental policies for a regulator that has incomplete information on firms' emissions and costs of production and abatement (e.g., air pollution in cities with numerous small polluting sources). Because of incomplete information on emissions, there is no policy that can implement the first-best. Since the regulator can observe firms' abatement technologies, however, it is possible to design a quasi-emissions trading program based on this information and show that it can provide higher welfare than command-and-control regulation such as technology or emission standards. I then empirically examine this claim using evidence from a particulate quasi-emissions trading program in Santiago, Chile.

 

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2001

WP-2001-009

Considerations For Designing A Tradable Permit System To Control SO2 Emissions in China

Denny Ellerman,October, 2001

As China's economy has grown, atmospheric pollution has become a greater problem and a matter of increasing concern to policymakers at all levels of government. One of the principal pollutants has been sulfur dioxide (SO2), which is emitted in varying intensity when coal, China's most abundant fossil energy resource, is burned. Excessive SO2emissions can cause serious health problems locally from high ambient concentrations, as well as non-health-related damages that can occur from acidification at some distance from the source of emissions.

 

WP-2001-008
Juan-Pablo Montero, July 2001
Abstract   |   Full Paper [PDF]

Multipollutant Markets

Juan-Pablo Montero,July 2001

I study the optimal design of marketable permit systems to regulate various pollutants (e.g. air pollution in urban areas) when the regulator lives in a real world of imperfect information and incomplete enforcement. I show that the regulator should have pollution markets integrated through optimal exchange rates when the marginal abatement cost curves in the different markets are steeper than the marginal benefit curves; otherwise he should keep markets separated. I also find that incomplete enforcement reduces the advantage of market integration.

 

WP-2001-007
Robert S. Pindyck, August 2001
Abstract   |   Full Paper [PDF]

Volitility and Commodity Price Dynamics

Robert S. Pindyck,August 2001

Commodity prices tend to be volatile, and volatility itself varies over time. changes in volatility can affect market variables by directly affecting the marginal value of storage, and by affecting a component of the total marginal cost of productions: the opportunity cost of exercising the option to produce the commodity now rather than waiting for more price information. I examine the role of volatility in short-run commodity market dynamics, as well as the determinants of volatility itself. Specifically, I develop a model describing the joint dynamics of inventories, spot and futures prices, and volatility, and estimate it using daily and weekly data for the petroleum complex: crude oil, heating oil, and gasoline.

WP-2001-006
Paul L. Joskow, September 2001
Abstract   |   Full Paper [PDF]

California's Electricity Crisis

Paul L. Joskow,September 2001

The collapse of Californias electricity restructuring and competition program has attracted attention around the world. Prices in Californias competitive wholesale electricity market increased by 500% between the second half of 1999 and the second half of 2000. For the first four months of 2001, wholesale spot prices averaged over $300/Mwh, ten times what they were is 1998 and 1999. Some customers have been required involuntarily to curtail electricity consumption in response to supply shortages. While wholesale prices rose dramatically, retail prices were fixed until early in 2001. 2 As a result, Californias two largest utilities --- Pacific Gas & Electric (PG&E) and Southern California Edison (SCE) --- were paying far more for wholesale power than they were able to resell it for at retail. Both effectively became insolvent in January 2001 and stopped paying their bills for power and certain other financial obligations. PG&E declared bankruptcy on April 6, 2001 and its reorganization is now before a federal bankruptcy court.

WP-2001-005

Creating the Wholesale Market for Electricity in Japan: What Should Japan Learn from Major Markets in the United States and Europe?

Takahide Hori,July 2001

The movement of deregulation in Japan's electric power industry started in 1995 with the revision of the Electric Utility Industry Law. During these past over five years, levels of various discussions have been made in Japan, but remarkable changes of market structure have not appeared except for so far little utilized provision allowing large industrial customers to be supplied by suppliers other than 10 incumbent Electric Power Companies (EPCOs). The big problem confronting deregulation in Japan is the potential market power of these vertically integrated, regionally franchised utilities. This paper proposes the first step to deregulate Japan's electric power industry at the wholesale level in Japan and of policy lessons from four major deregulated markets: California, PJM, England and Wales, and Norway.

WP-2001-004
Paul L. Joskow, July 2001
Abstract   |   Full Paper [PDF]

U.S. Energy Policy During the 1990's

Paul L. Joskow,July 2001

This essay discusses U.S. energy policy and the associated evolution of energy supply, energy demand, energy prices and the industrial organization of the domestic energy industries during the period 1991 through 2000. This period covers the last two years of the George H. W. Bush administration and the entire Clinton administration. It begins with an energy crisis stimulated by the invasion of Kuwait and the subsequent Gulf War and ends with an energy crisis caused by significant increases in oil and, especially, natural gas prices, the collapse of Californias new competitive electricity markets and the threat of electricity shortages throughout the Western U.S. Both energy crises led the sitting Presidents administrations to develop national energy strategies and to try to convince Congress to enact comprehensive energy legislation to implement them. Neither energy crisis had the severe economic impact or led to the kinds of dramatic, and often ill-conceived, policy responses observed following the two oil shocks of the 1970s. The 1990-91 energy crisis was short-lived and interest in energy policy soon faded. It would not be surprising if the latest energy crisis follows a similar course.

WP-2001-003

The Effect of Falling Market Concentration on Prices, Generator Behaviour and Productive Efficiency in the England and Wales Electricity Market

Andrew Sweeting,May 2001

A universal prediction of the various oligopoly models used to predict and explain behaviour in the England and Wales (E&W) electricity wholesale market is that divestiture of plants by the two large incumbent generators and new entry should have led to lower prices and mark-ups. However, even though the market has become significantly less concentrated over the 1990s through both of these mechanisms the regulator (OFGEM, formerly OFFER) has continued to complain about high prices and generator manipulation of prices. This led to OFGEM taking two generators (AES and British Energy) to the Competition Commission in a (failed) attempt to have market abuse conditions inserted in their licences, and has led to the Pool being replaced by a new set of arrangements (NETA) in Spring 2001. These new arrangements are controversial (see Sweeting (2000) for a discussion), and their success is likely to be partly determined by how much market power the generators still have. This paper gathers evidence on what happened to prices and mark-ups during the last five years of the Pool, which have been studied relatively little compared to the first five years, and also seeks to make several more original contributions.

 

WP-2001-002

The Dynamics of Commodity Spot and Futures Markets: A Primer

Robert S. Pindyck,May 2001

I discuss the short-run dynamics of commodity prices, production, and inventories, as well as the sources and effects of market volatility. I explain how prices, rates of production, and inventory levels are interrelated, and are determined via equilibrium in two interconnected markets: a cash market for spot purchases and sales of the commodity, and a market for storage. I show how equilibrium in these markets affects and is affected by changes in the level of price volatility. I also explain the role and behavior of commodity futures markets, and the relationship between spot pries, futures prices , and inventory behavior. I illustrate these ideas with data for the petroleum complex--crude oil, heating oil, and gasoline--over the past two decades.

 

WP-2001-001

Optimal Timing Problems in Environmental Economics

Robert S. Pindyck,March 2001

Because of the uncertainties and irreversibilities that are often inherent in envi-ronmental degradation, its prevention, and its economic consequences, environmental policy design can involve important problems of timing. I use a simple two-period model to il-lustrate these optimal timing problems and their implications for environmental policy. I then lay out and solve a continuous-time model of policy adoption in which the policy itself entails sunk costs, and environmental damage is irreversible. The model has two stochastic state variables; one captures uncertainty over environmental change, and the other captures uncertainty over the social costs of environmental damage. Solutions of the model are used to show the implications of these two types of uncertainty for the timing of policy adoption.

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2000

WP-2000-008

Characteristics of North Sea Oil Reserve Appreciation

G.C. Watkins,December 2000

In many petroleum basins, and especially in more mature areas, most reserve additions consist of the growth over time of prior discoveries, a phenomenon termed reserve appreciation. This paper concerns crude oil reserve appreciation in both the UK and Norwegian sectors of the North Sea. It examines the change in reserves attributed to North Sea fields over time, seeking to reveal patterns of reserve appreciation both for individual fields and for groups of fields classified by potentially relevant common elements. These include field size, year of production start-up, geological age, gravity, depth and depletion rate. The paper emphasises the statistical analysis of reserve appreciation. It contrasts the Norwegian and UK experience. An important distinction is drawn between appreciation of oil-in-place and changes in recovery factors. North Sea oil reserve appreciation between production start-up and the last observation year (usually 1996) is found to be substantial, but it generally lacks a consistent profile. Appreciation recorded for the Norwegian fields on average is considerably greater than for the UK. Most UK appreciation is seemingly accounted for by oil-in-place; in Norway, from increases in recovery factors. However, UK recovery factors commence at much higher levels than those for Norway.

WP-2000-007

The Wholesale Market for Electricity in England and Wales: Recent Developments and Future Reforms

Andrew Sweeting,September 2000

The England and Wales wholesale electricity market is about to undergo major reform (NETA). I describe and analyse the proposed arrangements, contrasting them with those currently in operation. I argue that while NETA will remove one or two of the Pools problems, particularly by eliminating capacity payments, there is no reason to expect that it will significantly improve outcomes. Market power could continue to be a problem and, despite NETAs attempt to decentralise the market, the complex rules of the centralised phase operating close to real time are likely determine the level of wholesale electricity prices. Future arrangements for transmission are also considered. I argue that, if generators have local market power, these may exacerbate rather than reduce current problems.

WP-2000-006

Tax Effects upon Oil Field Development in Venezuela

Osmel Manzano,May 2000

Important reforms have been made to the oil sector tax code in Venezuela. Given its diversity of oil resources,there was a concern that some resources were not being exploited because of the structure of the tax code. This paper uses traditional theoretical models to review these reforms. Then, a panel of 821 Venezuelan oil fields was used to estimate the effects of the reforms. The major conclusion reached is that reforms based on the development of marginal fields that will not produce because of the tax structure-may overlook the distortions generated by the tax system in non-marginal fields, distortions that can be greater than is the case in marginal fields.

WP-2000-005
Juan-Pablo Montero, Jos?? Miguel S?, July 2000
Abstract   |   Full Paper [PDF]

A Market-Based Environmental Policy Experiment in Chile

Juan-Pablo Montero, Jos Miguel Snchez, and Ricardo Katz,July 2000

Despite growing interest in the use of emissions trading for pollution control, empirical evidence for this regulatory instrument has been confined to a few experiences in the United States. This paper broadens the empirical base by examining the Emission-Offsets Trading Program that has been in place since 1992 to control airborne particulate emissions in Santiago, Chile. While the program is doing well from an environmental perspective, due in part to the price-based introduction of natural gas, the market is performing poorly because of high transaction costs, uncertainty, and poor enforcement. However, the scarcity rents created by allocating grandfathered emission rights to incumbents have proved to be a very effective tool for completing the emissions inventory.

WP-2000-004
Thomas M. Stoker, Ernst. R. Berndt, A. Denny Ellerman, Susanne M. Schennach, March 2000
Abstract   |   Full Paper [PDF]

Panel Data Analysis of U. S. Coal Productivity

Thomas M. Stoker, Ernst. R. Berndt, A. Denny Ellerman, Susanne M. Schennach,March 2000

We analyze labor productivity in coal mining in the United States using indices of productivity change associated with the concepts of panel data modeling. This approach is valuable when there is extensive heterogeneity in production units, as with coal mines. We find substantial returns to scale for coal mining in all geographical regions, and find that smooth technical progress is exhibited by estimates of the fixed effects for coal mining. We carry out a variety of diagnostic analyses of our basic model and primary modeling assumptions, using recently proposed methods for addressing 'errors-in-variable' and 'weak instrument bias' problems, as well a new method for studying errors-in-variables in nonlinear contexts.150. Optimal Design of a Phase-in Emissions Trading Program , Juan Pablo Montero, Public Economics 75: 27391 (2000).

This paper studies a phase-in emissions trading program with voluntary opt-in possibilities for non-affected firms and derives optimal permits allocation to affected and opt-in firms when the environmental regulator has incomplete information on individual unrestricited emissions and control costs. The regulator faces a trade-off between production efficiency (minimiztion of control costs) and information rent extraction (reduction of excess permits allocated to opt-in firms). The first-best equilibrium can be attained if the regulator can freely allocated permits to affected and opt-in firms; otherwise a second-best equilibrium is implemented. The latter is sensitive to uncertainty in control costs and benefits.

WP-2000-003

Deregulation and Regulatory Reform in the U.S. Electric Power Sector

Paul L. Joskow,February 2000

This paper discusses the evolution of wholesale and retail competition in the U.S electricity sector and associated industry restructuring and regulatory reforms. It begins with a discussion of the industry structure and regulatory framework that characterized the U.S. electric power industry during most of the 20 th century and reviews the initial efforts to open the electricity industry to competitive suppliers of generating services during the 1980s and early 1990s. The economic and political pressures that emerged in the early 1990s for more fundamental reforms are discussed, including the stranded cost issue and its resolution. The architecture of the basic reform model that supports both wholesale and retail competition in the supply of generation services adopted by a number of pioneer states is developed. Recent trends in generation divestiture, mergers between electric utilities, and between electric and gas pipeline and distribution companies, and entry of unregulated merchant generating plants are then reviewed. The new institutional arrangements necessary to govern access to and the operations of electric transmission networks to support competition among competing decentralized generators of electricity are examined. Transmission pricing, market organization, congestion management and market power issues are included in this analysis. The structure and performance of California's competitive electricity markets are discussed in detail as an example of the applications of these principles and the challenges that electricity sector restructuring must confront. Early experience with retail competition in California, Massachusetts, and Pennsylvania is reviewed. The paper concludes with an initial assessment of the benefits and costs of electricity sector restructuring to date in the U.S. and some thoughts regarding future challenges and trends.

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1999

WP-99010

Comments in Response to FERC Rulemaking on Regional Transmission Organizations

Paul L. Joskow,October 1999

On May 13, 1999, the Federal Energy Regulatory Commission (FERC) issued a Notice of Proposed Rulemaking (NOPR) on Regional Transmission Organizations (RTO). The purpose of the NOPR is to solicit comments on proposed FERC regulatory rules that would encourage transmission system owners to participate in regional transmission organizations. Such organizations would manage various aspects of the operation and expansion of the nation's high-voltage electricity transmission system to support developing competitive wholesale and retail electric generation service markets that rely on these transmission networks. Regional integration of transmission systems is thought to be required in order to manage more effectively transmission network operations, to internalize various network externalities, and to facilitate the development of competitive electricity markets. The FERC initiative aims to speed the development of such regional organizations. I prepared the attached comments in response to FERC's RTO NOPR. My comments focus primarily on the future structure of the regulatory framework that governs how transmission system owners and operators will be compensated for providing transmission service. I also present a framework for evaluating the benefits and costs of not-for-profit ISOs that operate transmission facilities owned and maintained by others vs. for-profit Independent Transmission Companies (Transcos) that own, maintain, and operate their own transmission facilities.

WP-99008

The Portfolio of Generation Facilities in Japan's Electric Power Sector, Past and Future

Naoto Nishimura, June 1999

Japan consumes a considerable amount of the world's energy, and it occupies an even more important position in the markets for internationally traded energy. Because sufficient domestic fossil-fuel reserves are not economically available to sustain the nation, Japan currently imports:

5.7 million bbl/day (329 million kl in 1994) of petroleum, one-eighth of the total traded internationally
56 billion cubic meters of natural gas annually (43 million tons in liquefied form in 1994), one-fifth of the total natural gas traded internationally (and 65% of the total traded in the form of liquefied natural gas, LNG)
120 million tons of hard coal annually (in 1994), one-quarter of the total amount traded internationally
Japan's electric power sector is a major consumer of these natural resources, burning 30 million kl of petroleum, 35 million tons of LNG, and 47 million tons of bituminous coal in 1997. The sector generated more than 300 million MWh of electricity from nuclear power in 1996, equivalent to 74 million tons of crude oil.

The Japanese electric utility sector faces conflicting pressures, which will affect international energy markets. On the one hand, the sector is beginning a process of deregulation that will make portfolio choices less subject to what is widely perceived to be strong government guidance on energy choices. On the other hand and in response to the Kyoto Protocol, the Japanese government has indicated its intention to achieve a major part of the required greenhouse gas emission reduction by a significant increase in the amount of nuclear power capacity (25 GWe by 2010). In addition, the significant decline in the growth rate of demand for electricity resulting from the stagnating national economy further complicates the outlook.

This paper proceeds in two parts. In the first part, the evolution of the current portfolio of generation facilities is examined. Particular focus is given to the role of the frequently stated policy goal of energy diversification. Although Japanese government policy was an important element in shaping generation facilities, the choices made by Japanese electric utilities are not notably different from those made by electric utilities in other countries. Moreover, diversification of energy sources was as much a result of other policy goals, such as environmental control in urban areas and the development of nuclear power, as an explicit policy of diversifying energy sources.

The second part of the paper examines the prospects for further changes in the portfolio of generation facilities over the next decade based on an analysis of current conditions. Forecasts for a significant increase in nuclear power capacity do not appear realistic, and the prospective capacity additions do not appear likely to change the current portfolio mix significantly.

WP-99007

Storage and Capacity Rights Markets in the Natural Gas Industry

Luis A. Paz-Galindo,June 1999

This dissertation presents a different approach at looking at market power in capacity rights markets that goes beyond the functional aspects of capacity rights markets as access to transportation services. In particular, this dissertation analyzes the role of storage in limiting the ability of pipelines to extract monopoly rents. The first two chapters present a model that show storage, by intertemporally linking markets, as introducing the pipeline in the valley as a competitor to the pipeline in the peak. As such, storage limits the ability of the pipeline to price monopolistically. This competitive effect is present although the pipeline retains 100% market share. It is thus important that regulators understand that focusing on concentration indices as a measure of market power overestimates the extent to which pipeline can extract monopoly rents. This dissertation also focuses on the role of contracts in capacity rights markets. Contracts play a dual role. They not only allow for a stronger competitive effect of storage but they can also lead to more efficient levels of pipeline investments as they can allocate risks more efficiently and can solve the information asymmetry problems. In this sense, contracts and storage should be seen as substitutes to market mechanisms when markets fail. In some instances, this dual role of contracts can be conflicting. Regulators need to understand this dual role of contracts in order to use it as a tool for achieving efficiency in capacity rights markets.

 

WP-99006

Environmental Policy in Transition Economies: The Effectiveness of Pollution Charges

Patrik Sderholm,May, 1999

Most economists and analysts claim that extended use of pollution charges in environmental policy will have substantial efficiency advantages in countries undergoing transition to market economies. Essentially this paper challenges this view and argues that the proposed policy presumes the existence of an already functioning institutional framework. By focusing on the Russian case, the paper identifies and discusses a number of reasons why it has become hard to implement pollution charges in an economic system where behavioral patterns and jurisdictions established in the past are still prevalent. Institutional obstacles both at the firm level and within Russian regulatory agencies are discussed. The paper concludes that it is probably more appropriate to view environmental problems in transition economies not as market imperfections per se, but as results of institutional inertia in the economic and political systems. As a consequence the choice of pollution control strategy becomes much more complex than is implied by economic theory. The paper ends with a discussion of command and control regulation and input taxes as alternative ways to control pollution in Russia.

Key words: Russia, Transition economies, Environmental policy, Pollution charges, Institutional impediments

 

WP-99004

Transmission Rights and Market Power on Electric Power Networks II: Physical Rights

 

 

WP-99003

Transmission Rights and Market Power on Electric Power Networks I: Financial Rights

 

 

WP-99001
Robert S. Pindyck, January 1999
Abstract   |   Full Paper [PDF]

The Long-Run Evolution of Energy Prices

Robert S. Pindyck,January 1999

I examine the long-run behavior of oil, coal, and natural gas prices, using up to 127 years of data, and address the following questions: What does over a century of data tell us about the stochastic dynamics of price evolution, and how it should be modeled? Can models of reversion to stochastically fluctuating trend lines help us forecast prices over horizons of 20 years or more? And what do the answers to these questions tell us about investment decisions that are dependent on prices and their stochastic evolution?

 

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1998

WP-98012
Jasmin Gunnarshaug, November 1998
Abstract   |   Full Paper [PDF]

Natural Gas Pricing in the Northeastern U.S.

Jasmin Gunnarshaug,November 1998

This paper examines natural gas pricing at five citygate locations in the northeastern United States using daily and weekly price series for the years 1994-97. In particular, the effects of the natural gas price at Henry Hub, weather, and the natural gas inventory levels in the region are examined. The results indicate that natural gas spot citygate prices in the Northeastern U.S. are influenced mainly by the Henry Hub spot price and local heating degree-days. The storage-inventory level supplying the Northeast appears to have little influence.

 

WP-98011

Explaining Low Sulfur Dioxide Allowance Prices: The Effect of Expectation Errors and Irreversibility

Juan-Pablo Montero and A. Denny Ellerman,September 1998

The low price of allowances has been a frequently noted featured of the implementation of the sulfur dioxide emissions market of the U.S. Acid Rain Program. This paper presents theoretical and numerical analyses that explain the gap between expected and observed allowance prices. The main contributing factors appear to be expectation errors augmented by the presence of irreversible investments.

 

WP-98009

Electric Utility Response to Allowances: From Autarkic to Market-Based Compliance

WP-98008
M. A. Adelman, June 1998
Abstract   |   Full Paper [PDF]

Crude Oil Supply Curve

M. A. Adelman,June 1998

Short-run cost curves shift over time as depletion counters increasing knowledge. Under competition, a rightward (leftward) shift indicates lower (higher) cost and greater (lesser) productivity. A simple coefficient captures the slope, and its changes. USA crude oil productivity rose for many years, declined after 1972. In natural gas it can only be discerned since 1984, but has if anything increased. OPEC productivity rose greatly before 1970, reflecting greater plenty not scarcity; later years are not measurable. Non-OPEC productivity increased greatly after 1980.

WP-98007

The Economics of Pollution Permit Banking in the Context of Title IV of the 1990 Clean Air Act Amendments

Susanne M. Schennach,March 1998

Tradable pollution permits are the basis of a new market-based approach to environmental control. The Acid Rain Program, established under Title IV of the Clean Air Act Amendments of 1990, and aimed at drastically reducing the SO2 emissions of electricity generating units in the US, is the world's first large-scale implementation of such a program.

An important feature of this program is that pollution permits, called allowances under Title IV, can be banked for future use. This thesis introduces a model of the collective banking behavior of affected units in the context of Title IV. The present theoretical investigation differs from previous work by its rigorous treatment of the constraint that allowances can only be banked, but never borrowed from future allocations, a consideration which has important consequences. The model presented captures the effects of the changes in electricity demand, the number of affected units, environmental regulations and technological innovations on the utilities' banking behavior and on the allowance price. The effect of uncertainty on the banking behavior is explored, and an analysis of how the allowance market would react in a world of uncertainty to various circumstances is then presented.

WP-98006

Intertemporal Pricing of Sulfur Dioxide Allowances

Elizabeth M. Bailey,March 1998

The Clean Air Act Amendments of 1990 initiated the first large-scale use of the tradable permit approach to pollution control. The theoretical case for this approach rests on the assumption of an efficient market for emission rights. This paper presents the inter-temporal pattern of allowance prices that should be observed in the market for sulfur dioxide allowances in world of certainty with no transaction costs, and demonstrates that this pattern is roughly consistent with what is observed. Where there are deviations, these deviations can be explained using the theory that is applied to other well established, well functioning markets. The empirical analysis in this paper suggests that the forward market for emission rights has become reasonably efficient.

WP-98005

Allowance Trading Activity and State Regulatory Rulings: Evidence From The U. S. Acid Rain Program

Elizabeth M. Bailey,March 1998

The U.S. Acid Rain Program is one of the first, and by far the most extensive, applications of a market based approach to pollution control. From the beginning, there has been concern whether utilities would participate in allowance trading, and whether regulatory activity at the state level would further complicate utilities' decision to trade allowances. This paper finds that public utility commission regulation has encouraged allowance trading activity in states with regulatory rulings, but that allowance trading activity has not been limited to states issuing regulations. Until there is evidence suggesting that significant additional cost savings could have been obtained if additional allowance trading activity had occurred in states without regulations or that utilities in states with regulations are still not taking advantage of all cost saving trading opportunities, this analysis suggests that there is little reason to believe that allowance trading activity is impeded by public utility commission regulations.

WP-98004
A. Denny Ellerman, Thomas M. Stoker, and Ernst R. Berndt, March 1998
Abstract   |   Full Paper [PDF]

Sources of Productivity Growth in the American Coal Industry

A. Denny Ellerman, Thomas M. Stoker, and Ernst R. Berndt,March 1998

This paper exploits a large mine-level database to contribute to our understanding of the micro-sources of productivity growth. The database contains observations for labor input and coal output at every mine in the United States from 1972 through 1995, as well as a number of characteristics pertaining to technology, location and ownership. The research proceeds in two stages. Because of the pronounced heterogeneity of this industry, we divide the national data into eleven sub-aggregates, according to geography and mining technology, and calculate indices of national coal mining productivity growth that are corrected for heterogeneity. The second stage of the research is the application of panel regression techniques to each of the eleven relatively homogeneous sub-aggregates. By this process, we are able to identify and to quantify four sources of productivity change: the level of annual output, the price of output relative to labor, mine-specific fixed effects and residual time effects. The last effect accounts for only a small part of the remarkable improvement in coal mining labor productivity that has been observed since the late 1970s.

WP-98003

The Geographic Expanse of the Market for Wholesale Electricity

Elizabeth M. Bailey,February 1998

This paper develops new techniques to assess the expanse of the geographic market under varying supply and demand conditions and applies these techniques to the current wholesale electricity market in the western United States. This paper finds that, by and large, the expanse of the geographic market extends across most of the western United States, but that conditions which create congestion along transmission lines, such as high hydroelectric flows in the Pacific Northwest, transmission line outages and deratings, and high demand for wholesale electricity, cause the expanse of the geographic market to narrow at certain times.

WP-98002
Ruth A. Judson, Richard Schmalensee, and Thomas M. Stoker, January 1998
Abstract   |   Full Paper [PDF]

Economic Development and the Structure of the Demand for Commercial Energy

Ruth A. Judson, Richard Schmalensee, and Thomas M. Stoker,January, 1998

To deepen the understanding of the relation between economic development and energy demand, this study estimates the Engel curves that relate per-capita energy consumption in major economic sectors to per-capita GDP. Panel data covering up to 123 nations are employed, and measurement problems are treated both in dataset construction and in estimation. Time and country fixed effects are assumed, and flexible forms for income effect are employed. There are substantial differences among sectors in the structure of country, time, and income effects. In particular, the household sector's share of aggregate energy consumption tends to fall with income, the share of transportation tends to rise, and the share of industry follows an inverse-U pattern.

WP-98001

Voluntary Compliance with Market-Based Environment Policy: Evidence from the U.S. Acid Rain Program

Juan-Pablo Montero,January 1998

The U.S. acid rain program, Title IV of the 1990 Clean Air Act Amendments, is a pioneering experience in environmental regulation by setting a market for electric utility emissions of sulfur dioxide (SO2) and by including a voluntary compliance provision. Under the Substitution provision, non-affected electric utility units can voluntarily become subject to all compliance requirements of affected units and receive SO2 tradeable permits (allowances). This paper studies the welfare implications of this voluntary provision and tests the adverse selection hypothesis of voluntary programs. The results indicate that although this provision has had a rather small effect on the overall performance of the SO2 market, there has been a significant participation, mostly from units with counterfactual emissions (i.e. emissions in the absence of regulation) well below their allowance allocations, which suggests that SO2 emissions have been higher than otherwise. An ex post cost-benefit analysis shows that this adverse selection effect tend to dominate the flexibility effect of permitting shifts in emissions reductions from high-cost affected units to low-cost non-affected units. On the other hand, participation with the Substitution provision confirms that electric utilities are choosing cost-effective strategies to comply with SO2 limits and that transaction costs have been low.

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1997

WP-97006
Avinash K. Dixit and Robert S. Pindyck, December 1997

Expandability, Reversibility, and Optimal Capacity Choice

Avinash K. Dixit and Robert S. Pindyck,December 1997

We develop continuous-time models of capacity choice when demand fluctuates stochastically, and the firm's opportunities to expand or contract are limited. Specifically, we consider costs of investing or disinvesting that vary with time, or with the amount of capacity already installed. The firm's limited opportunities to expand or contract create call and put options on incremental units of capital; we show how the values of these options affect the firm's investment decisions.

 

WP-97004

Optimal Design of a Phase-in Emissions Trading Program with Voluntary Compliance Options

Juan-Pablo Montero,July 1997

In this paper we explore the welfare implications of voluntary compliance within an emissions trading program and derive optimal permits allocations to affected and opti-in sources when the environmental regulator has incomplete information on individual unrestricted emissions and control costs. The regulator faces a trade-off between production efficiency (minimization of control costs) and information rent extraction (reduction of excess permits allocated to opt-in sources). The first-best equilibrium can be attained if the regulator can freely allocate permits to affected and opt-in sources; otherwise a second-best equilibrium is implemented. The latter is sensitive to uncertainty in control costs and benefits.

 

WP-97002
Avinash Dixit, Robert S. Pindyck and Sigb??rn S??dal, February 1997

A Markup Interpretation of Optimal Rules for Irreversible Investment

Avinash Dixit, Robert S. Pindyck and Sigbrn Sdal,February 1997

We re-examine the basic investment problem of deciding when to incur a sunk cost to obtain a stochastically fluctuating benefit. The optimal investment rule satisfies a trade-off between a larger versus a later net benefit; we show that this trade-off is closely analogous to the standard trade-off for the pricing decision of a firm that faces a downward sloping demand curve. We reinterpret the optimal investment rule as a markup formula involving an elasticity that has exactly the same form as the formula for a firm's optimal markup of price over marginal cost. This is illustrated with several examples.

 

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1996

WP-96009
Andrew B. Bernard, September 1996

Race, Waste and Long-Run Outcomes

Andrew B. Bernard,September 1996

We examine the hypothesis that hazardous waste facilities are disproportionately located in minority neighborhoods. We also ask whether such facilities provide observable economic benefits to the surrounding community. the results are disturbing. as found by other researchers, neighborhoods with large minority populations are more likely to have one or more hazardous waste facilities. we find some evidence that, even controlling for economic and political factors, race still remains associated with site location. Economic outcomes over long horizons are worse for locations that start with a hazardous waste site and for those that acquire one. Areas with sites have lowr income growth, increases rather than drops in poverty rates, and sharper increases in unemployment. In addition, the minority share of the population in such areas rises increasing the exposure.

 

WP-96008
Richard Schmalensee, September 1996

Greenhouse Policy Architectures and Institutions

 

 

WP-96007
Paul L. Joskow, Richard Schmalensee, and Elizabeth M. Bailey, August 1996
Abstract   |   Full Paper [PDF]

Auction Design and the Market for Sulfur Dioxide Emissions

Paul L. Joskow, Richard Schmalensee, and Elizabeth M. Bailey,August 1996

Title IV of the Clean Air Act Amendments of 1990 created a market for electric utility emissions of sulfur dioxide (SO2). Recent papers have argued that flaws in the design of the auctions that are part of this market have adversely affected its performance. These papers incorrectly assume that trade can only occur at auctions, however. Our empirical analysis of the SO2 emissions market shows that the auctions have become a small part of a relatively efficient market and that the auction design problems that have attracted the most attention have had no effect on actual market prices.

WP-96006

A Review of Oil Production Capacity Expansion Costs for the Persian Gulf

M.A. Adelman,August 1996

The U.S. Energy Information Agency has recently published a report prepared by Petroconsultants, Inc. that addresses the cost of expanding crude oil production capacity in the Persian Gulf. A study on this subject is much needed in view of the dwindling supply of data on such costs from this region; however, this report does not provide any data and does little more than present the consultants' assumptions. Where those assumptions can be checked against plausible extrapolations of costs elsewhere, the investment per well is too high and productivity per well is too low. The result is an overstatement of the needed investment per unit of output.

 

WP-96005

The Competition Between Coal and Natural Gas: The Importance of Sunk Costs

A. Denny Ellerman,July 1996

This paper explores the seeming paradox between the predominant choice of natural gas for capacity additions to generate electricity in the United States and the continuing large share of coal in meeting incremental generation, despite little new coal capacity and the aging of existing plants. The explanation offered here relies upon a consideration of the factors which affect fuel choice in new and existing plants, and decisions about retirement and the expansion of capacity to meet load growth. The sunk costs of past investment are an important unifying theme in the explanation.

 

WP-96004
M.A. Adelman and G.C. Watkins, May 1996

The Value of United States Oil and Gas Reserves

M.A. Adelman and G.C. Watkins,May 1996

The object of this research is to estimate a time series, starting in 1979, for the value of in-ground oil reserves and natural gas reserves in the United States. Relatively good statistics exist for the physical quantities. (Regrettably, they will now be compiled only in alternate years.) Our task is to estimate the unit values. We focus mainly on data from the mid 1980s to the end of 1994.

 

WP-96002

Allowance Trading Activity and State Regulatory Rulings: Evidence from the U.S. Acid Rain Program

Elizabeth M. Bailey,March 1996

Please see the update to this paper:WP-98005 - Allowance Trading Activity and State Regulatory Rulings: Evidence from the U.S. Acid Rain Program

The U.S. Acid Rain Program is one of the first, and by far the most extensive, applications of a market based approach to pollution control. From the beginning, there has been concern whether utilities would participate in allowance trading, and whether regulatory activity at the state level would further complicate utilities' decision to trade allowances. This paper finds that public utility commission regulation has encouraged allowance trading activity in states with regulatory rulings, but that allowance trading activity has not been limited to states issuing regulations. Until there is evidence suggesting that significant additional cost savings could have been obtained if additional allowance trading activity had occurred in states without regulations or that utilities in states with regulations are still not taking advantage of all cost saving trading opportunities, this analysis suggests that there is little reason to believe that allowance trading activity is impeded by public utility commission regulations.

WP-96001

Why Are Allowance Prices So Low? An Analysis of the SO2 Emissions Trading Program

A. Denny Ellerman and Juan Pablo Montero,February 1996

This paper presents an analysis of the reduction in SO2 emissions by electric utilities between 1985 and 1993. We find that emissions have been reduced for reasons largely unrelated to the emission reduction mandate incorporated in Title IV of the 1990 Clean Air Act Amendments. The principal reason appears to be the change in the economics of coal choice that has resulted from the remarkable decline in rail rates for low sulfur western coal delivered to higher sulfur coal-fired plants in the Midwest. We conclude that allowance prices are lower than expected because less sulfur must be removed to meet the Title IV caps on aggregate SO2 emissions.

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1995

WP-95007
Richard Schmalensee and Thomas M. Stoker, August 1995
Abstract   |   Full Paper [PDF]

Household Gasoline Demand in the United States

Richard Schmalensee and Thomas M. Stoker,August 1995

Continuing rapid growth in U.S. gasoline consumption threatens to exacerbate environmental and congestion problems. We use flexible semiparametric and nonparametric methods to guide analysis of household gasoline consumption, and including this variable cuts the estimated income elasticity in half. Slower projected future growth in licensed drivers points to slower growth in gasoline consumption. A parsimonious representation of age, income, lifecycle and location effects is developed and tested. We show how flexible methods also helped reveal fundamental problems with the available price data.

WP-95006
Andrew B. Abel, Avinash K. Dixit, Janice C. Eberly, and Robert S. Pindyck, June 1995

Options, the Value of Capital, and Investment

Andrew B. Abel, Avinash K. Dixit, Janice C. Eberly, and Robert S. Pindyck,June 1995

Capital investment decisions must recognize the limitations on the firm's ability to later sell off or expand capacity. This paper shows how opportunities for future expansion or contraction can be valued as options, how this valuation relates to the q-theory of investment, and how these options affect the incentive to invest. Generally, the option to expand reduces the incentive to invest, while the option to disinvest raises it. We show how these options interact to determine the effect of uncertainty on investment, how these option values change in response to shifts of the distribution of future profitability, and how the q-theory and option pricing approaches to investment are related.

WP-95002
Avinash K. Dixit and Robert S. Pindyck, February 1995

The New Option View of Investment

Avinash K. Dixit and Robert S. Pindyck,February 1995

This paper provides a simple introduction to the new option view of investment. We explain the shortcomings of the orthodox theory, and then outline the basic ideas behind the option framework. Several industry examples are briefly discussed.

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1994

WP-94009
A. Denny Ellerman, November 1994

The World Price of Coal

A. Denny Ellerman,November 1994

A significant increase in the seaborne trade for coal over the past twenty years has unified formerly separate coal markets into a world market in which prices move in tandem. Due to its large domestic market, the United States has become the residual supplier and price setter in the world coal market. Changes in multifactor productivity have been the primary cause of the long-term fluctuations in coal prices that have been observed in the United States since the end of the Second World War and in the world coal market.

WP-94006

Implementing Environmental Taxes on Intermediate Goods in Open Economies

James M. Poterba and Julio J. Rotemberg,June 1994

Many proposed and actual environmental taxes are taxes on intermediate goods. These goods, such as fossil fuels, are typically tradable, and they are also used in the production of many tradable final goods. How should imports of intermediate and final goods be taxed if the government does not want environmental tax policy to alter the competitive positions of domestic and foreign producers? Not surprisingly, imports of the intermediate goods itself can be taxed at the same rate as domestic intermediate goods. Imports of final goods that are produced using these intermediate goods can be taxed based on their intermediate good intensity, provided there is no joint production. Under conditions of joint production, however, such as those that characterize the petroleum refining and petrochemical industries, it is difficult to define the intermediate goods intensity of any single product. Arbitrary assignments of intermediate good content, for example on the basis of output weight or value, are unlikely to preserve the competitive positions of domestic and foreign producers.

WP-94005

Evaluation of Capacity Release Transactions in the Natural Gas Industry

Stephen Lautzenhiser and Scott McDonald,June 1994

The purpose of this thesis is to analyze capacity release transactions in the natural gas industry and to state some preliminary conclusions about how the capacity release market is functioning. Given FERC's attempt to enhance market efficiency through the capacity release mechanism, we analyze the development of capacity release from approximately April 1993 through the middle of February 1994. We examine the prices for released capacity and their corresponding terms on two natural gas pipelines, Tennessee Gas Pipeline and El Paso Natural Gas Pipeline.

After we explain the capacity release market and identify the factors influencing capacity release prices, we attempt to quantify the importance of these factors through cross-section regression analysis. We perform separate regression analyses for each of the pipelines recognizing the differences in the California and Northeast markets. We then pool the data to test the hypothesis that the markets are operating in a sufficiently similar manner to validate an integrated-markets understanding of capacity release. Finally we suggest some areas of future study and ways to improve upon our analysis if given sufficient time and resources.

The results of our analysis suggest that the market for released capacity that is subject to bidding (i.e. capacity that is posted on electronic bulletin boards for prospective replacement shippers to bid on), is thin. For the two pipelines we analyzed, there appears to be limited competition for capacity release. The price is therefore not being bid up beyond the minimum rate specified by the releasing shipper. Thus, the relevant question in the bidding market segment is how releasing shippers are determining the minimum rate. Our results suggest a trial-and-error method on the part of firm shippers in the concentrated California market, where firm shippers have lowered their required minimum rates over time. Nonetheless, there are prearranged deals that earn the maximum rate. This suggests that when capacity is scarce, parties are prearranging for capacity release at the maximum value, leaving the residual capacity, with little demand, open to bidding.

 

WP-94004
Andrew B. Bernard and Pamela H. Chang, June 1994

Trade in Waste Among Developed Countries: Evidence and Origins

Andrew B. Bernard and Pamela H. Chang,June 1994

In this paper, we examine the determinants of the international trade in waste between developed countries. Data from the 1980s suggest that while the trade in waste between developed and less developed countries has garnered the most attention, the preponderance of waste flows have been among the developed countries. We examine both economic and institutional factors governing incentives to export and import waste. In particular, we find that countries with high cost of disposal tend to export but that low urban-rural population ratios, industry share in GDP, and population densities are also relevant for explaining the amount of waste that crosses national borders.

 

WP-94003

Deregulation in Japanese Gas Industries

Masayuki Inoue,March 1994

In recent years, the circumstances surrounding Japanese City gas industries have been changing drastically. On one hand, as energy suppliers, natural gas which has become major fuel resource for city gas, as public utilities, a new theory of economics and the economic reform process are requesting the new regulatory framework instead of traditional one. Under such recognition, this study has three major purposes. The first purpose is to consider the significance of city gas deregulation in the context of drastic change in energy policy and in public utility regulation. The second is to discuss the expected advantages and noted point of rate deregulation for large industrial customers. The third purpose is to think about the implications from the US experience of deregulation in natural gas industry since 1970's.

WP-94002

Option Valuation of Flexible Investments: The Case of a Coal Gasifier

Olivier Herbelot,March 1994

This paper examines the use of contingent claim analysis to evaluate the option of retrofitting a coal gasifier on an existing gas-fired power plant in order to take advantage of changes in the relative prices of natural gas and coal. Commodity price changes over time were modeled by binomial stochastic processes, and the price of natural gas is first assumed to follow a Wiener process over time. The option to wait before retrofitting the gasifier was found to be very valuable to the utility. The volatility and convenience yield of natural gas prices were shown to have a strong influence on the exact option value. Uncertainties surrounding future gasifier capital costs proved to be less critical. The paper also examined the case where the price of natural gas follows a mean-reverting process over time, and found that the option value can be substantially affected.

WP-94001

Option Valuation of Flexible Investments: The Case of a Scrubber for Coal-Fired Power Plant

Olivier Herbelot,March 1994

Standard discounted cash flow methods are not well suited to the valuation of investments whose characteristics can be modified by the decision-maker after the initial investment decision has been made (multistage decision investments). For some problems of this type the theory of financial options offers a better alternative.

The theory is applied here to an existing coal-fired power plant that is required to comply with the new SO2 emission limits introduced by the Clean Air Act Amendments of 1990. By assumption, the power plant operator can either purchase emission allowances from other utilities, or switch fuels to a lower-sulfur coal, or install an SO2 emission reduction system (scrubber). The two main sources of uncertainties (future price of SO2 allowances, and future difference between the price of high-sulfur and low-sulfur coals) are assumed to follow Wiener stochastic processes over time. A binomial model is developed to calculate the present value of the options to install the scrubber and/or switch coals. It is shown that the possibility of switching coal has little value to the utility in the case considered, but that the possibility of installing a scrubber reduces the net present cost of complying with the Clean Air Act SO2 requirements. A parametric study is performed to estimate the influence of various model variables on the option present values. Also, the effect of future scrubber technology improvements is investigated. Finally, the model is used to obtain an investment criterion that specifies, ex-ante, the future conditions under which the scrubber should be installed or the fuel switched.

The investment case considered shows how contingent claim analysis can be applied in practice to evaluate realistic flexible investments. The results underline the need to take investment flexibility into account and the practical advantages of option valuation. They show that investment criteria can be substantially modified by the value of flexibility. Also, the binomial model for two underlying variables developed here is found to be quite intuitive and easy to apply numerically. It can also be used to determine investment criteria.

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1993

WP-93016

Fuel Costs and the Retirement of Capital Goods

Austan Goolsbee,December 1993

This paper explores the effect that energy prices and market conditions have on the retirement rates of capital goods using new micro data on aircraft lifetimes and fuel costs. The oil shocks of the 1970s made fuel intensive capital like the Boeing 707 a prime target for retirement. The results, based on retirements of 707s from the fleets of the major airline carriers from 1972-1984 are quite robust and show that the oil shock of 1979-1981 made the probability of retirement for a 707 between 5 and 15 times higher. The estimated probability that a 15 year old 707-300C in 1981 would retire before 1982 was 96%. If the oil shock had not occurred this probability of retirement would have been between 8 and 14%. The potentially large effect of energy taxes on capital retirement has important implications for their usefulness and for their potential impact on current airline fleets.

WP-93015
Richard Schmalensee, October 1993

The Costs of Environmental Protection

Richard Schmalensee,October 1993

Recently, some have argued that tougher environmental policies can create jobs, stimulate innovation, and enhance competitiveness. On this view, economic side effects make environmental protection a sort of green free lunch. This essay provides an overview of the level and industrial incidence of environmental protection costs in the U.S. and shows why attempts to transmute these substantial costs into benefits are invalid. Environmental policies shift patterns of employment and R&D, but there is no reason at all to think that they create jobs or enhance economy-wide innovation on balance except, perhaps, in the very short run.

WP-93014
Jerry A. Hausman and Whitney K. Newey, September 1993

Nonparametric Estimation of Exact Consumers Surplus and Deadweight Loss

Jerry A. Hausman and Whitney K. Newey,September 1993

We apply nonparametric regression models to estimation of demand curves of the type most often used in applied research. From the demand curve estimators we derive estimates of exact consumers surplus and deadweight loss, that are the most widely used welfare and economic efficiency measures in areas of economics such as public finance. We also develop tests of the symmetry and downward sloping properties of compensated demand. We work out asymptotic normal sampling theory for kernel and series nonparametric estimators, as well as for the parametric case.

The paper includes an application to gasoline demand. Empirical questions of interest here are the shape of the demand curve and the average magnitude of welfare loss from a tax on gasoline. In this application we compare parametric and nonparametric estimates of the demand curve, calculate exact and approximate measures of consumers surplus and deadweight loss, and give standard error estimates. We also analyze the sensitivity of the welfare measures to components of nonparametric regression estimators such as the number of terms in a series approximation.

WP-93013

BOOK REVIEW: Three Books on Global Climate Change

WP-93012

Climate Change and Agriculture: Global and Regional Effects Using an Economic Model of International Trade

John Reilly, Neil Hohmann, and Sally Kane,August 1993

Empirical estimates of the economic welfare implications of the impact of climate change on global agricultural production are made. Agricultural yield changes resulting from climate scenarios associated with a doubling of atmospheric trace gases are used as an input into a global model of agricultural supply and demand. The agricultural production, price and economic welfare implications for 32 separate geographic regions are computed for 9 scenarios. The 9 scenarios reported are based on 3 different general circulation models (GCMs), estimated with and without the direct effects of carbon dioxide on plant growth, and with different levels of adaptation. The major conclusions are that economic welfare losses tend to be more severe in developing countries, major agricultural exporters can gain significantly if world agricultural prices rise, and the carbon dioxide fertilization effect substantially offsets losses dut to climate change alone. In one scenario, the combination of carbon dioxide fertilization and adaptation led to net global welfare increases. Policy implications of the potential changes and uncertainty in the magnitude, direction , and timing of change are discussed.

WP-93010

Global Warming: A Public Finance Perspective

WP-93009

Toward Economic Evaluation of Climate Change Impacts: A Review and Evaluation of Studies of the Impact of Climate Change

John Reilly and Chris Thomas,June 1993

Efforts to access climate change have generally been unsuccessful in describing the economic damages (or benefits) associated with climate change or the functional relationship of damage (or benefits) to climate. Existing integrated economic studies have developed an aggregate damage estimate for the United States associated with equilibrium doubled trace gas climate that is unlikely to occur for 100 years or more. These estimates are used to extrapolate damages to other regions and over time. There is little or no basis for such extrapolation. It is possible to introduce climate explicitly into standard economic models but such models have generally not been estimated. Potentially affected sectors include 1) forestry and ecosystems, 2) agriculture, 3) coast, 4) fishers, 5) water resources, and 6) communities and households. An impact classification system is developed that considers short and long run flexibility to adapt to climate change, the existing knowledge or capacity to adapt, and the degree to which climate matters after adaptation (i.e., the degree to which damages can be avoided).

WP-93008
Diego Rodriguez and Thomas M. Stoker, June 1993

Semiparametric Measurement of Environmental Effects

Diego Rodriguez and Thomas M. Stoker,June 1993

This paper gives the results of a semiparametric analysis of pollution effects on housing prices using the Boston Housing Data. The exposition introduces the basic ideas of modeling pollution impacts with hedonic price methods, discusses the standard log-linear model, and then introduces nonparametric estimation and semiparametric index models. We focus on the intuitive content and substantive results of the semiparametric analysis. We find that the impact of pollution is smaller than that previously estimated, and varies dramatically depending on the status level of the community. We give various interpretations of the findings, and contrast our methods with those used in previous analysis of the Boston Housing Data.

WP-93007
Paul L. Joskow and Donald B. Marron, May 1993

What Does a Negawatt Really Cost? Further Thoughts and Evidence

WP-93006
Paul L. Joskow, Nancy Rose, and Andrea Shepard, March 1993

Regulatory Constraints on Executive Compensation

Paul L. Joskow, Nancy Rose, and Andrea Shepard,March 1993

This paper explores the influence of economic regulation on the level and structure of executive compensation. We find substantial and persistent differences in CEO compensation between firms subject to economic regulation and those in unregulated industries. CEOs of regulated firms are paid substantially less, on average, than their counterparts in the unregulated sector. In particular, in the electric utility industry, the sector which is most tightly regulated and for which we have the most data, CEOs average only 30% to 50% of the compensation earned by the CEO of a comparable firm in the unregulated sector. Compensation in the regulated sector tends to be more heavily weighted toward salary and cash and away from incentive-based forms of pay (such as stock options), and tends to be less responsive to variations in firm financial performance. The pattern of compensation discounts across industries, over time, and between firms in the electric utility industry is broadly consistent with the presence of binding political constraints on executive pay, as medicated through the regulatory process.

WP-93004

Comparing Greenhouse Gases for Policy Purposes

Richard Schmalensee,March 1993

In order to derive optimal policies for greenhouse gas emissions control, the discounted marginal damages of emissions of different gases must be compared. The greenhouse warming potential (GWP) index, which is most often used to compare greenhouse gases, is not based on such a damage comparison. This essay presents assumptions under which ratios of gas-specific discounted marginal damages reduce to ratios of discounted marginal contributions to radiative forcing, where the discount rate is the difference between the discount rate relevant to climate-related damages and the rate of growth of marginal climate-related damages over time. If there are important gas-specific costs or benefits not tied to radiative forcing, however, such as direct effects of carbon dioxide on plant growth, there is in general no shortcut around explicit comparison of discounted net marginal damages.

 

WP-93003
Robert S. Pindyck and Andr??s Solimano, January 1993

Economic Instability and Aggregate Investment

Robert S. Pindyck and Andrs Solimano,March 1993

A recent literature suggests that because investment expenditures are irreversible and can be delayed, they may be highly sensitive to uncertainty. We briefly summarize the theory, stressing its empirical implications. We then use cross-section and time-series data for a set of developing and industrialized countries to explore the relevance of the theory for aggregate investment. We find that the volatility of the marginal profitability of capital -- a summary measure of uncertainty -- affects investment as the theory suggests, but the size of the effect is moderate, and is greatest for developing countries. We also find that this volatility has little correlation with indicia of political instability used in recent studies of growth, as well as several indicia of economic instability. Only inflation is highly correlated with this volatility, and is also a robust explanator of investment.

WP-93001
Stewart C. Myers and Richard S. Ruback, January 1993

Discounting Rules for Risky Assets

Stewart C. Myers and Richard S. Ruback,Revised January 1993

This paper develops a new rule for calculating the discount rate to value risky projects. The rule works under any linear asset pricing model and any equilibrium theory of debt and taxes. If securities are priced by the standard capital asset pricing model, the discount rate is a weighted average of the after-tax Treasury rate and the expected rate of return on the market portfolio, where the weight on the market portfolio is the project beta. We prove that this discount rate gives the correct project value and explain why it works. We also recast the rule in certainty equivalent form, restate it for multifactor capital asset pricing or arbitrage pricing models, and derive implications for the valuation of real options.

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1992

WP-92013

The Effects of Hazardous Waste Taxes on Generation and Disposal of Chlorinated Solvent Waste

Hilary Sigman,October 1992

In 1989, 30 states levied taxes on e generation or management of hazardous waste. These taxes constitute one of the broadest applications of an emissions tax in U.S. environmental policy and provide a natural experiment for studying the effects of such taxes. This paper examines the impacts on chlorinated solvent waste from metal cleaning, using plant-level data from EPA's 1987-89 Toxic Release Inventories. The results suggest that the taxes have an observable, but small, impact on total generation of solvent wastes. The taxes also reduce the frequency with which land disposal is used relative to incineration or other treatment.

WP-92011
Robert M. Margolis, October 1992

Interpreting the IPCC Emissions Scenarios

Robert M. Margolis,October 1992

This paper discusses how two sets of emissions scenarios, generated using the Atmospheric Stabilization Framework, were used by the United Nations Intergovernmental Panel on Climate Change (IPCC). In particular it discusses how the scenarios were specified, what roles models played in developing the scenarios, and how the scenarios were interpreted by participants in the IPCC process. It draws on the results of interviews conducted with 14 participants in the IPCC process.

After looking at how both sets of IPCC emissions scenarios were defined and interpreted it is clear that analysts need to explore the effects of policies in the context of uncertainty. Thus, instead of testing policy options on a single future and/or generating a range of possible futures in the absence of policy intervention, analysts need to investigate the effectiveness of various policy options across an entire set of possible futures. Conducting this sort of analysis would be an important step beyond the IPCC emissions scenarios.

WP-92010

Statistical Issues in the Assessment of Undiscovered Oil and Gas Resources

Gordon M. Kaufman,September 1992

Prior to his untimely death, my friend Dave Wood gave me wise counsel about how best to organize a paper describing uses of statistics in oil and gas exploration. A preliminary reconnaissance of the literature alerted me to the enormous range of topics that might be covered. Geology, geophysics with particular attention to seismology, geochemistry, petroleum engineering and petroleum economics--each of these disciplines plays an important role in petroleum exploration and each weaves statistical thinking into its fabric in a distinctive way. An exhaustive review would be book length. Dave and I agreed that a timely review paper of reasonable length would:


  1. Illustrate the range of statistical thinking of oil and gas exploratists.

  2. Concentrate on topics with statistical novelty, show how statistical thinking can lead to better decision making and let the reader now about important controversies that might be resolved by better use of statistical methods.

  3. Focus on topics that are directly relevant to exploration decision making and resource estimation.


In response to Dave's sensible suggestions, the Department of Interior's 1989 assessment of U.S. undiscovered oil and gas will be a tour map for a short trip through a large territory of statistical methods and applications. Were he here to review this review, I know that it would be better than it is.

WP-92009
Ricardo J. Caballero and Robert S. Pindyck, August 1992

Uncertainty, Investment, and Industry Evolution

Ricardo J. Caballero and Robert S. Pindyck,August 1992

We study the effects of aggregate and idiosyncratic uncertainty on the entry of firms, total investment, and prices in a competitive industry with irreversible investment. We first use standard dynamic programming methods to determine firms' entry decisions, and we describe the resulting industry equilibrium and its characteristics, emphasizing the effects of different sources of uncertainty. We then show how the conditional distribution of prices can be used as an alternative means of determining and understanding the behavior of firms and the resulting industry equilibrium. Finally, we use four-digit U.S. manufacturing data to examine some implications of the model.

WP-92008

Energy and Environmental Policy and Electric Utilities' Choice under Uncertain Global Warming

Masaki Takahashi, August 1992

The paper reviews and discusses uncertainty about global warming science, impact on society. It also discusses what assumptions have been made and how appropriate the assumptions in scenarios have been for estimating global warming and its impacts. It then reviews energy consumption and supply trends and past environmental issues and countermeasures, and discusses energy and environmental policy including: regulations, taxes and emission rights, as well as how global environmental policy should be formed and how technology transfer helps developing countries. Finally it discusses issues in energy resource and technologies for fossil fuels, nuclear energy, renewable energy, efficiency improvements and suggest the choice for utility industries under uncertain global warming. It concludes that global warming is not an issue of high priority and CO2 emission rate is not an appropriate index to form energy and environmental policy, and that an appropriate population and economic growth rate, energy consumption rate reduction should be sought through efficiency improvement and technology transfer.

WP-92007

A Comparison of Public Policies for Lead Recycling

Hilary Sigman,June 1992

Policies that encourage recycling may be used to reduce environmental costs from waste disposal when direct restrictions on disposal are difficult to enforce. Four recycling policies have been advanced: (i) taxes on the use of virgin materials; (ii) deposit/refund programs; (iii) subsidies to recycled material production; and (iv) recycled content standards. This study analyzes the structure of these policies and ranks them in terms of the private costs necessary to achieve a given reduction in disposal. the policies are then examined in the empirical context of the recycling of lead from automobile batteries. Elasticities for primary and secondary lead supply and demand are estimated in order to simulate the effects of lead recycling programs. The results suggest that price-based policy mechanisms can be successful in increasing lead recovery and that the difference in efficiency between the four approaches is substantial.

WP-92006
Diego Rodriguez and Thomas M. Stoker, June 1992

A Regression Test of Semiparametric Index Model Specification

Diego Rodriguez and Thomas M. Stoker,June 1992

This paper presents a simple regression test of parametric and semiparametric index models against more general semiparametric and nonparametric alternative models. The test is based on the regression coefficient of the restricted model residuals on the fitted values of the more general model. A goodness-of-fit interpretation is given to the regression coefficient, where the variance of the coefficient is adjusted for the use of nonparametric estimators. An asymptotic theory is developed for the situation where kernel estimators are used to estimate unknown regression functions, and the variance adjustment terms are given for this case. The methods are applied to the empirical problem of characterizing environmental effects on housing prices in the Boston Housing data, where a partial index model is found to be preferable to a standard log-linear equation, yet not rejected against general nonparametric regression. Various issues in the asymptotic theory and other features of the test are discussed.

 

WP-92005
Robert S. Pindyck, March 1992

Investments of Uncertain Cost

Robert S. Pindyck,March 1992

I study irreversible investment decisions when projects take time to complete, and are subject to two types of uncertainty over the cost of completion. The first is technical uncertainty, i.e., uncertainty over the amount of time, effort, and materials that will ultimately be required to complete the project, and that is only resolved as the investment takes place. The second is input cost uncertainty, i.e., uncertainty over the prices and quantities of labor and materials that are expected to be required, and which is external to the firm's investment activity. This paper derives simple decision rules that maximize the firm's value, and that are easy to implement. I show how these two types of uncertainty have very different effects on the decision to invest, and how they affect the value of the opportunity to invest.

WP-92004

Reserve Asset Values and the "Hotelling Valuation Principle"""

M.A. Adelman and G.C. Watkins,March 1992

The Hotelling Valuation Principle, that the in-situ value of a mineral unit equals the current net price, is a special case of a more general relation. Tested against a set of recent Canadian sales of oil and gas reserves, the HVP is strongly rejected. The method permits also a demonstration that price expectations were quite different in oil and in gas, confirming industry opinion.

WP-92003
M.A. Adelman, February 1992

OPEC at High Noon 1974-1981

M.A. Adelman,February 1992

After 1973, oil consumption stagnated worldwide. Non-OPEC output increased, mostly in Alaska, Mexico, and the North Sea, but not because of the price rise.

The cartel nations had to assume the whole burden of cutting back output to maintain price. The demand for OPEC oil, the difference between total demand and non-OPEC supply, declined accordingly. From early 1974, current producing capacity much exceeded current output.

The oil companies were expropriated from production. They were no longer a buffer between the OPEC nations and the market, and no longer equated the amount of crude supplied with the amount demanded.

Thus it was more difficult for the cartel nations to cope with their two objectives: (1) A price and total cartel output to keep or improve total cartel revenues. (2) A division of the market acceptable to the members, at least for the time being. Each objective is difficult, both together much more so. All solutions are temporary. What is right today is wrong tomorrow. The optimal price/output combination may change, or its perception may change. Members may cheat, or the burden of restriction may become intolerably great for one or more sellers.

Despite shrinking demand the loss of the oil companies as agents, the OPEC nations raised the price through 1974, and raised it more moderately through 1978. There was much dissension, which never broke unity.

More price increases were expected in 1978. The demand for oil was misperceived as almost completely unresponsive to price. OPEC decision-making was further biased by the OPEC nations' chronic financial problems as their spending rose even faster than their revenues. By 1978, Saudi Arabia was in budget and current-account deficit.

The Iranian Revolution led to a temporary loss of all Iranian supply, and a permanent loss of some. There was little if any shortfall in production, and beyond production there was enough excess capacity to have maintained output without price increases. But two output cuts by Saudi Arabia, and refusal to indicate when they would be restored, generated waves of precautionary and then speculative demand which made spot prices explode.

Official or contract prices were ratcheted up to make the increases permanent, roughly from 12.50 to $34 in 1981. We are compelled to go past this date in describing the upward movement because of the general market disarray. One cannot date with precision when it became apparent that the OPEC nations had raised the price too far for their own good. But there was no willingness to retreat on price, and the line was held for the time being.

 

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1991

WP-91015
John S. Carroll, Constance Perin, and Alfred A. Marcus, December 1991

Organizational Learning at Nuclear Power Plants

John S. Carroll, Constance Perin, and Alfred A. Marcus, December 1991

The Nuclear Power Plant Advisory Panel on Organizational Learning provides channels of communications between the management and organization research projects of the MIT International Program for Enhanced Nuclear Power Plant Safety and plant personnel actively concerned with important operational issues, inside and outside the control room, relevant to safety. The Panel is conceived as an opportunity for plants to share their knowledge and concerns about aspects of management and organization, with a particular emphasis on self-assessment, learning, and the management of change. Further, the Panel seeks to identify opportunities for collaborative research with practical benefits.

At the first Panel meeting, 20 representatives from U.S. nuclear power plants and utilities and 14 MIT faculty, research staff, and students explored mutual interests and priorities in order to guide future research efforts. Professor John Carroll introduced the overall MIT research project. Three MIT researchers discussed their proposed research: Professor Alfred Marcus discussed quantitative analyses of improvements in U.S. nuclear power plant safety during the 1980s, and the need to conduct detailed studies of plant improvements and of utility strategies; Dr. Constance Perin discussed how work requires bridging across functions, levels, technical groups, and shifts within a social and cultural system, and proposed to study various plant programs in terms of their vertical relationships and institutional context; Professor John Carroll focused on the analysis of safety-relevant incidents through the application of knowledge distributed among various professional groups in the plant, and the need for research to characterize this knowledge and its relationship to performance enhancement. In addition, Professor Michael Golay discussed the organization and management implications of new reactor technology, and Professor Thomas Kochan summarized research on contractor training and safety in the petrochemical industry.

Roundtable groups discussed three topics of their own choosing: configuration control, proactivity and communication with management, and event trending (including root cause analysis and corrective action tracking). A wide-ranging discussion explored topics of mutual interest, their connections to safe operations and their potential for research. A variety of research opportunities were raised and discussed, along with next steps for continued communication between the Panel and MIT.

WP-91013
Ann F. Friedlaender, Ernst R. Berndt, Judy Shaw-Er Wang Chiang, Mark Showalter, and Christopher A. Vellturo, September 1991

Rail Costs and Capital Adjustments in a Quasi Regulated Environment

Ann F. Friedlaender, Ernst R. Berndt, Judy Shaw-Er Wang Chiang, Mark Showalter, and Christopher A. Vellturo,September 1991

This paper reports on results obtained from the estimation of a rail cost function using a pooled-time series, cross section of Class I railroads for the period 1974-1986. An analysis is performed of short-run and long-run returns to scale, the extent of capital disequilibrium, and adjustments to way and structures capital in the heavily regulated and quasi-regulated environments before and after the passage of the Staggers Act in 1980. In general, it is found that there is considerable overcapitalization in the rail industry and that this has persisted in spite of the regulatory freedom provided by the Staggers Act.

WP-91012
Charles R. Blitzer, Richard S. Eckaus, Supriya Lahiri, and Alexander Meeraus, June 1990

A General Equilibrium Analysis of the Effects of Carbon Emission Restrictions on Economic Growth in a Developing Country

Charles R. Blitzer, Richard S. Eckaus, Supriya Lahiri, and Alexander Meeraus,June 1990

A general equilibrium approach, in the form of a multisector, intertemporal programming model, is used to analyze the effects on the growth of the Egyptian economy of carbon emissions constraints that differ across sectors and over time. The model embodies significant substitution possibilities among factors, including fuels.
It is found that any substantial reduction in the rate of emissions has correspondingly important impacts on economic growth. The abatement of carbon emissions would, therefore, create major economic problems. Economy-wide constraints are, however, less restrictive than the same level of constraints imposed on particular sectors.

 

WP-91011
Charles R. Blitzer, Richard S. Eckaus, Supriya Lahiri, and Alexander Meeraus, May 1990

The Potential for Reducing Carbon Emissions from Increased Efficiency: A General Equilibrium Methodology

Charles R. Blitzer, Richard S. Eckaus, Supriya Lahiri, and Alexander Meeraus,May 1990

This paper presents a methodology for analyzing the potential for reduction in carbon emissions through increased fuel efficiency and provides an illustration of the method. The methodology employed is a multisectoral, intertemporal, programming model embodying significant non-linearities in production and consumption.

The first set of experiments embody the analysis of the potential resulting from completely costless improvements in efficiency in the use of fuels in several sectors. Because of the improvements in fuel efficiency, the required reductions in carbon emissions always have a less depressing effect on economic performance than would otherwise be the case. Nonetheless, as the carbon emissions constraints become more restrictive, economic performance declines substantially.

The next set of experiments show the effects of fuel efficiency improvements in the adjustments to carbon emissions constraints, where such improvements now require additional capital. It is clear that exploitation of the option of retrofitting capital in adjusting to carbon emissions constraints improves the overall economic performance of the economy.

The demonstration of nonlinearity in the economic impact of carbon emission constraints appears to be a robust outcome.

WP-91010

USA Oil/Gas Production Cost: Recent Changes

M.A. Adelman,February 1991

During 1984-1989, oil development investment cost in the USA fell, but only because of lower activity. The whole cost curve shifted unfavorably (leftward). In contrast, natural gas cost substantially decreased, the curve shifting rightward. This is an additional reason why measures of cost or value "per barrel of oil equivalent"" should be avoided."

WP-91009

A Note on Competitive Investment under Uncertainty

Robert S. Pindyck,August 1991

This paper clarifies how uncertainty affects irreversible investment in a competitive market equilibrium. With free entry, irreversibility affects the distribution of future prices, and thereby creates an opportunity cost of investing now rather than waiting. As with an imperfectly competitive firm, uncertainty can also increase the value of a marginal unit of capital. I show that with an infinite horizon, the opportunity cost is larger than this increase in value, so that uncertainty reduces investment.

 

WP-91008

The Present Value Model of Rational Commodity Pricing

Robert S. Pindyck,July 1991

The present value model says that an asset's price equals the sum of current and future discounted expected future payoffs from ownership of the asset. I explore the limits of the present value model by testing its ability to explain the pricing of storable commodities. For commodities the payoff stream is the convenience yield that accrues from holding inventories, and it can be measured directly from spot and future prices. The present value model imposes restrictions on the joint dynamics of spot and future prices, which I test for four commodities. I find a close conformance to the model for heating oil, but not for copper or lumber, and especially not for gold. The pattern is the same when one looks at the serial dependence of excess returns. These results suggest that for three of the four commodities, prices at least temporarily deviate from fundamentals.

 

WP-91007

Energy Conservation Policy in Developing Countries: The Case for Market Solutions

R.W. Bates,July 1991

Interest in energy conservation, although to some degree cyclical, has been stimulated during the last twenty years by the rising cost of energy in a wide range of developing and developed countries, especially following the oil price shocks of 1973-1974 and 1979-1980; by environmental concerns, notably due to the impact of increasing energy consumption on global warming, pollution, forests and natural habitats; and by national security considerations, as domestic energy supplies continue to be vulnerable to political events in the Middle East. An active debate has ensued, in which it is alleged that the existence of a variety of market failures, imperfections and distortions justifies government intervention in energy markets to promote expenditures on energy conservation.

It is the purpose of this paper to evaluate the validity and relevance of that debate to developing countries, in terms of demand-side management, mainly where the public sector exerts control over a significant portion of energy supply; and where that supply is sold predominantly in markets subject to consumers acting competitively. The central tenet of the paper is that confusion in the debate can only be avoided if a careful distinction is maintained between arguments related to the proper functioning of energy markets, on the hone hand; and externalities, on the other.

On the basis of a review of the literature on the sources of possible market failures and the proposed remedies, much of which was inspired by circumstances in the U.S.A., the paper finds that evidence of significant market failures sufficient to justify government intervention in energy markets is not convincing; and that the proposed remedies in any case are inappropriate. The paper concludes that, while environmental externalities may provide grounds for carefully-targeted public sector intervention in energy markets, the national security argument is hard to sustain in developing countries; and market imperfections and distortions generally do not justify non-price intervention, with the possible exception of information provision and support for basic research and development.

WP-91006

Testimony on Electricity Policy Issues Before the Subcommittee on Energy and Power, House Committee on Energy and Commerce

Paul L. Joskow,March 1991

This testimony discusses the changing structure of the electricity industry and some of the public policy issues that are associated with these changes. Professor Joskow also discusses his perspective on a selected set of structural and regulatory changes and answers questions from the Subcommittee on policy issues related to these and other changes in the electricity industry.

WP-91005

The Potential Role of New Technology for Enhanced Safety and Performance of Nuclear Power Plants Through Improved Service Maintenance

Ted Glen Achorn, May 1991

Refinements in the safety and performance of nuclear power plants must be made to maintain public confidence and ensure competitiveness with other power sources. The aircraft industry, US Navy, and other programs have proven many advanced service maintenance methods that may improve commercial nuclear plants.

This thesis is concerned with how new technologies in sensing and monitoring can be used to reduce the potential for hardware failures. The specific components with the greatest impacts upon safety and performance were determined using historical data from the experience of the nuclear industry. Failure modes associated with selected components are used to indicate the most important monitoring needs and these requirements help focus a technology survey for potential improvements. The thesis concludes with a discussion of possible applications which may enhance monitoring needs. Proposals for focusing future research to further develop appropriate technologies are presented.

Nuclear facility managers are provided a means to self-analyze the status of onsite efforts to improve vital safety and performance related equipment in this thesis. Many of the monitoring needs and potential improvements indicated have general application to most plants. The process discussed in this report can be used to further tailor technology to plant specific needs.

WP-91003

Tax Policy To Combat Global Warming: On Designing a Carbon Tax

James M. Poterba,March 1991

This paper develops several points concerning the design and implementation of a carbon tax. First, if implemented without any offsetting changes in transfer programs, the carbon tax would be regressive. This regressivity could be offset with changes in either the direct tax system or transfers. Second, the production and consumption distortions associated with small carbon taxes, on the order of $5/ton of carbon, are relatively small: less than $1 billion per year for the United States. Stabilizing carbon dioxide emissions at their 1988 levels for the year 2000, however, would require a carbon tax ten to twenty times this size. It would more than triple the producer price of coal and nearly double the producer prices of petroleum and natural gas, would have much more significant private efficiency effects. Third, a central issue of carbon tax design is harmonization with other fiscal instruments designed to reduce greenhouse warming. Ensuring comparability between taxes rates on chlorofluorocarbons and fossil fuels is particularly important to avoid unnecessary distortions in production or consumption decisions.

WP-91002

Contractual Form, Retail Price and Asset Characteristics

Andrea Shepard,Revised January 1992

Predictions derived from a principal-agent analysis of the manufacturer-retailer relationship are derived and tested using microdata on contractual form, outlet characteristics and retail prices for gasoline stations in Eastern Massachusetts. The empirical results are consistent with upstream firms choosing contracts that have strong incentive characteristics but less direct control when asset characteristics make unobservable effort by downstream agents important. Manufacturers trade off incentive power for more direct control when observable effort is relatively more important. Retail prices are affected by the identity of the decisionmaker and are slightly lower when the upstream firm is allowed to directly control the retail price.

WP-91001

Planning for Future Uncertainties in Electric Power Generation: An Analysis of Transitional Strategies for Reduction of Carbon and Sulfur Emissions

R.D. Tabors and Burt L. Monroe,January 1991

The object of this paper is to identify strategies for the U.S. electric utility industry for reduction of both acid rain producing and global warming gases. The research used the EPRI Electric Generation Expansion Analysis System (EGEAS) utility optimization/simulation modeling structure and the EPRI developed regional utilities. It focuses on the North East and East Central region of the U.S. Strategies identified were fuel switching -- predominantly between coal and natural gas, mandated emission limits, and a carbon tax.
The overall conclusions of the study are that using less (conservation) will always benefit Carbon Emissions but may or may not benefit Acid Rain emissions by the offsetting forces of improved performance of new plant as opposed to reduced overall consumption of final product. Results of the study are highly utility and regional demand specific. The study showed, however, that significant reductions in both acid rain and global warming gas production could be achieved with relatively small increases in the overall cost of production of electricity and that the current dispatch logics available to the utility control rooms were adequate to reschedule dispatch to meet these objectives.

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1990

Please note: Working Papers published prior to 1990 have only been digitized and uploaded to the website in exceptional cases. If you are interested in a specific working paper from this period, please contact us.

WP-90023

A Two-Method Solution to the Investment Timing Option

Henry Jacoby,December 1990

Within the realm of derivative asset valuation, two types of methods are available for solving the investment timing option, each with a serious limitation for practical projects. Methods that use Monte Carlo simulation of risk-adjusted probability measures allow consideration of the complicated cash flow models typical of real projects, in the face of prespecified operating policies, but they do not provide an adequate way to determine what the optimal policy is. Formulation of the problem as an American option in the vein of Black-Scholes and Merton permits calculation of an optimal start policy, but only in situations with drastically simplified cash flow models.

The solution to this dilemma is the development of an approach which applies the two methods in tandem. The rights to explore and develop an oil field are used as an example, and Monte Carlo simulation is used to calculate the value of these rights as a function of start time and contemporaneous oil price. This payoff function is then input to a Black-Scholes-Merton option calculation. The resulting optimal start policy is then reinserted to the Monte Carlo model for further analysis of project and individual cash-flow magnitudes and risks. Also, possible bias because of numerical-analysis errors are checked by direct search of start policies in the vicinity of the calculated optimum.

WP-90022

Comparing the Effects of Greenhouse Gas Emissions on Global Warming

Richard S. Eckaus,November 1990

Policies dealing with global warming require a measure of the effects of the emissions of greenhouse gases that create different magnitudes of instantaneous radiative forcing and have different lifetimes. The Global Warming Potential (GWP), a physical index of the total radiative forcing due to an emission of a unit amount of a particular greenhouse gas has been proposed by the Intergovernmental Panel on Climate Change as a such a policy tool. In general, no such physical index will serve this purpose. Adding up physical measures of radiative forcing in different periods resulting from emissions at different times and places is, in an economic and policy sense, like adding apples and oranges. Discounting of radiative forcing in successive periods, as in done in some versions of the GWP, is only an arbitrary weighting.

Reduction of radiative forcing effects in different future periods of greenhouse gas emissions that occur at different times and places can be expected to impose different economic costs. These opportunity cost valuations must be used to weight the effects of a greenhouse gas emission over its lifetime. That leads to the concept of the Emissions Opportunity Cost (EOC) of a greenhouse gas emission. While this is more difficult to measure, it is the essential guide to policy.

WP-90021
James M. Poterba, October 1990

Is the Gasoline Tax Regressive?

James M. Poterba,October 1990

Claims of the regressivity of gasoline taxes typically rely on annual surveys of consumer income and expenditures which show that gasoline expenditures are a larger fraction of income for very low income households than for middle or high-income households. This paper argues that annual expenditure provides a more reliable indicator of household well-being than annual income. It uses data from the Consumer Expenditure Survey to re-assess the claim that gasoline taxes are regressive by computing the share of total expenditures which high-spending and low-spending households devote to retail gasoline purchases. This alternative approach shows that low-expenditure households devote a smaller share of their budget to gasoline than do their counterparts in the middle of the expenditure distribution. Although households in the top five percent of the total spending distribution spend less on gasoline than those who are less well-off, the share of expenditure devoted to gasoline is much more stable across the population than the ratio of gasoline outlays to current income. The gasoline tax thus appears far less regressive than conventional analyses suggest.

 

WP-90020
M.A. Adelman, October 1990

User Cost in Oil Production

M.A. Adelman,October 1990

The assumption of an initial fixed mineral stock is superfluous and wrong. User cost (resource rent) in mineral production is the present value of expected increases in development cost. It can be measured as the difference between in-ground market value and development cost, or estimated approximately from current development cost. For private or national-income accounting, mineral reserves should be treated as a renewable inventory. Adjustment for change in inventory may increase or decrease the income of a mineral producer, but an increase is more likely.

 

WP-90018
Anne F. Friedlaender, Ernst R. Berndt, Judy Shaw-Er Wang Chiang, and Christopher A. Vellturo, June 1990

Rail Costs and Capital Adjustments in a Quasi-Regulated Environment

Anne F. Friedlaender, Ernst R. Berndt, Judy Shaw-Er Wang Chiang, and Christopher A. Vellturo,June 1990

This paper reports on results obtained from estimation of a rail cost function using a pooled time-series cross section of Class I U.S. railroads for the period 1973-1986. Based on the results of this cost function, an analysis is performed of short-run and long-run returns to scale, and adjustments in way and structure capital in the heavily regulated and quasi regulated environments. In general, it is found that there is considerable overcapitalization in the rail industry, and that this has persisted in spite of the regulatory freedom to abandon track and service provided by the Staggers Act.

WP-90017
Antonio Mello and John Parsons, June 1990

The Agency Cost of Alternative Debt Instruments

Antonio Mello and John Parsons,Revised June 1990

In this paper we show how to adapt the traditional contingent claims valuation techniques to correctly value the firm and its liabilities in the presence of agency costs. This enables us to measure the significance of the agency costs as a function of the quantity of debt outstanding and as a function of the design of the debt contract: with this we can determine the relative benefits of alternative contract design. Our work makes a contribution to the recent database about how much debt a corporation can prudently assume. It is possible to measure the agency advantages of the new debt instruments for a given firm, and therefore to determine for which firms the advantages are significant and for which firms they are not.

WP-90014
Timothy Besley, Stephen Coate, and Glenn Loury, May 1990

The Economics of Rotating Savings and Credit Associations

Timothy Besley, Stephen Coate, and Glenn Loury,May 1990

This paper examines the role and performance of an institution for allocating savings which is observed world wide - rotating savings and credit associations. We develop a general equilibrium model of an economy with an indivisible durable consumption good and compare and contrast these informal institutions with credit markets and autarkic saving in terms of the properties of their allocations and the expected utility which they obtain. We also characterize Pareto efficient and expected utility maximizing allocations for our economy, which serve as useful benchmarks for the analysis. Among our results is the striking finding that rotating savings and credit associations which allocate funds randomly may sometimes yield a higher level of expected utility to prospective participants than would a perfect credit market.

WP-90012
Jean-Jacques Laffont and Jean Tirole, December 1989

Auction Design and Favoritism

Jean-Jacques Laffont and Jean Tirole,December 1989

The theory of auctions has ignored the fact that often auction designers, not the principal, design auctions. In a multi attribute auction, the auction designer may bias his subjective evaluation of quality or distort the relative weights of the various attributes to favor a specific bidder, an ancient concern in the procurement of weapons, in the auctioning of government contracts and in the purchase of electricity by regulated power companies. The paper analyzes the steps to be taken to reduce the possibility of favoritism.

It is first shown that in the absence of favoritism, quality differentials among firms are more likely to be ignored if the auction designer has imperfect information about the firm's costs. Second, if the auction designer may collude with only one bidder, the other bidders should be chosen if they are as least as efficient as the former bidder, and no hard information about quality differentials is released by the auction designer that would justify fair discrimination in favor of the former bidder. Last, if the auction designer can collude with any bidder, the optimal auction tends to a symmetric auction in which quality differentials are ignored. The possibility of favoritism reduces the auction designer's discretion and makes the selection process focus on non-manipulable (monetary) dimensions of bids.

 

WP-90011
Jean-Jacques Laffont and Jean Tirole, September 1989

The Politics of Government Decision Making: Regulatory Institutions

Jean-Jacques Laffont and Jean Tirole,September 1989

Public decision makers are given a vague mandate to regulate industries. Restrictions on their instruments or scope of regulation affect their incentives to identify with interest groups and the effectiveness of supervision by watchdogs.

This idea is illustrated in the context of the regulation of a natural monopoly. Much of the theoretical literature has assumed that a benevolent regulator is prohibited from operating transfers to the firm and maximizes social welfare subject to the firm's budget constraint. The tension between the assumptions of benevolence and of restrictions on instruments in such models leads us to investigate the role played by the mistrust of regulators in the development of this institution. We compare two mandates: average cost pricing (associated with the possibility of transfers). The regulator may identify with the industry, but a regulatory hearing offers the advocacy groups (watchdogs) an opportunity to alter the proposed rule making. The comparison between the two mandates hinges on the dead-weight loss associated with collusion and on the effectiveness of watchdog supervision.

WP-90010
Oliver Hart and Jean Tirole, April 1990

Vertical Integration and Market Foreclosure

Oliver Hart and Jean Tirole,April 1990

Few people would disagree with the proposition that horizontal mergers have the potential to restrict output and raise consumer prices. In contrast, there is much less agreement about the anti-competitive effects of vertical mergers. The purpose of this paper is to develop a theoretical model showing how vertical integration changes the nature of competition in upstream and downstream markets and identifying conditions under which market foreclosure will be a consequence or even a purpose of such integration. In contrast to much of the literature, we do not restrict upstream and downstream firms to particular contractual arrangements, but instead allow firms to choose from a full set of contractual arrangements both when integrated and when not. We also allow non-integrated firms to respond optimally to the integration decisions of other firms, either by remaining nonintegrated, exiting the industry or integrating too (i.e. bandwagoning). In a final section we use our analysis to shed some light on a number of prominent vertical merger cases, involving computer reservation systems for airlines, the cement industry and the St. Louis Terminal Railroad.

WP-90009

Pricing Behavior and Vertical Contracts in Retail Markets

WP-90008
Robert S. Pindyck and Julio Rotemberg, April 1990

Do Stock Prices Move Together Too Much?

Robert S. Pindyck and Julio Rotemberg,April 1990

We show that comovements of individual stock prices cannot be justified by economic fundamentals. This finding is a rejection of the present value model of security valuation. Unlike other tests of this model, ours is robust in that it allows for volatility in ex ante rates of return. The only constraint we impose is that investors' utilities are functions of a single consumption index. This implies that changes in discount rates must be related to changes in macroeconomic variables, and hence stock prices of companies in unrelated lines of business should move together in response to changes in current or expected future macroeconomic conditions. We also show that this constraint implies that any priced factors in the APT model must be related to macroeconomic variables. Hence our results are also a rejection of the APT, so constrained.

WP-90007

Irreversibility, Uncertainty, and Investment

Robert S. Pindyck,March 1990

Most investment expenditures have two important characteristics. First, they are largely irreversible; the firm cannot disinvest, so the expenditures are sunk costs. Second, they can be delayed, allowing the firm to wait for new information about prices, costs, and other marketing conditions before committing resources. An emerging literature has shown that this has important implications for investment decisions, and for the determinants of investment spending. Irreversible investment is especially sensitive to risk, whether with respect to future cash flows, interest rates, or the ultimate cost of the investment. Thus if a policy goal is to stimulate investment, stability and credibility may be more important than tax incentives or interest rates.

This paper presents some simple models of irreversible investment, and shows how optimal investment rules and the valuation of projects and firms can be obtained from contingent claims analysis, or alternatively from dynamic programming. It demonstrates some strengths and limitations of the methodology, and shows how the resulting investment rules depend on various parameters that come from the market environment. It also reviews a number of results and insights that have appeared in the literature recently, and discusses possible policy implications.

 

WP-90006

Energy Use, Technical Progress and Productivity Growth: A Survey of Economic Issues

Ernst R. Berndt,March 1990

This is a survey paper for non-specialists on interactions between energy and productivity growth. The first half of the paper surveys the general economic literature linking technical progress to realized gains in productivity growth. The second half of the survey focuses in particular on the important role of energy in linking technical progress to productivity growth, and contains an overview of a great deal of literature, both classic and recent.

WP-90005

Inventories and the Short-Run Dynamics of Commodity Prices

Robert S. Pindyck,March 1990

I examine the behavior of inventories and their role in the short-run dynamics of commodity production and price. Competitive producers of a storable commodity react to price changes by balancing costs of changing production with costs of changing inventory holdings. To determine these costs, I estimate a structural model of production, sales, and storage for copper, heating oil, and lumber. I then examine the implications of these costs for inventory behavior, and for the behavior of spot and futures prices. I find that inventories may serve to smooth production during periods of low or normal prices, but during periods of temporarily high prices inventories have a more important role in facilitating production and deliver scheduling and avoiding stockouts.

This paper differs from earlier studies of inventory behavior in three respects. First, I focus on homogeneous and highly fungible commodities. This helps avoid aggregation problems, simplifies the meaning of marginal convenience yield, and allows the use of direct measures of units produced, rather than inferences from dollar sales. Second, I estimate Euler equations, and allow marginal convenience yield to be a convex function of inventories. This is more realistic, and better explains the value of storage and its role in the dynamics of price. Third, I use futures prices to directly measure marginal convenience yield. This produces tighter estimates of the parameters of the convenience yield function.

WP-90004
John S. Carroll and Peter B. Cebon, February 1990

The Organization and Management of Nuclear Power Plants

John S. Carroll and Peter B. Cebon, February 1990

Nuclear power plants are a controversial technology. The future of the industry depends on the ability to manage efficiently and safely, and to effectively manage organizational change as new technologies and practices are introduced and disseminated. This paper provides a conceptual framework and discussion of the management and organization of nuclear power plants around three questions: (1) How should nuclear power plants be organized and managed to ensure that they are operated most safely and efficiently? (2) What does an understanding of the organization and management of nuclear power plants tell us about how they change or resist change? and (3) What indicators or measures of various characteristics and processes of nuclear power plants are needed in order to address the above questions? We review existing literature on the organization and management of nuclear power plants, and suggest how we would structure a research project to address the above questions.

WP-90003

Irreversibility and the Explanation of Investment Behavior

Robert S. Pindyck,January 1990

The explanation of aggregate and sectoral investment behavior has been one of the less successful endeavors in empirical economics. Existing econometric models have had little success in explaining or predicting investment spending. This may be because most such models fail to account for the irreversibility of most investment spending. With irreversibility, changes in the riskiness of future cash flows or interest rates should in theory dramatically affect the decision to invest - more so than, say, a change in the levels of interest rates. Here I survey some of the empirical support for this proposition, and discuss the implications for investment modelling.

 

WP-90001

One for You, Three for Me...or... The Design of Optimal Production Sharing Rules for a Petroleum Exploration Venture

Philip Hampson, John Parsons, and Charles Blitzer,Revised July 1990

This is a case study in the design of the production sharing rule used in an oil exploration partnership contract. The contract was negotiated in mid-1986 when a state-owned oil resources authority hired a U.S. oil company to explore and develop a defined territory owned by the authority. The company was given a share in production so that it would have a financial incentive to pursue an exploration and development program that maximizes the net return to the authority. We use the Grossman and Hart (1983) principal-agent model to improve on the shape and calibration of the sharing rule. In comparison with the actual contract, the optimal rule assigns the company a larger share of the small discoveries and the company's share decreases significantly as the size of the discoveries increases. The optimal sharing rule increases the expected return on the project to the authority by $7.8 million, or 6% of the $129 million net present value that the authority would enjoy under the actual contract. The increased NPV is a result of improving incentives for the choice of an optimal exploration program on the part of the company, and ensuring that the company enjoys an interest in completing marginally profitable wells.

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1986

Mar-1986
International Natural Gas Trade Project, Center for Energy Policy Research, Energy Lab, MIT, March 1986
Abstract   |   Full Paper [PDF]

East Asia/Pacific Natural Gas Trade

Dec-1986
International Natural Gas Trade Project, Center for Energy Policy Research, Energy Lab, MIT, December 1986
Abstract   |   Full Paper [PDF]

Western Europe Natural Gas Trade

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1985

Oct-1985
International Natural Gas Trade Project, Center for Energy Policy Research, Energy Lab, MIT, October 1985
Abstract   |   Full Paper [PDF]

Canadian-U.S. Natural Gas Trade

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