ECO314 Review Notes

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University of Toronto St. George
Adonis Yatchew

ECO314 1 Energy Economics – Study Notes Lecture 1 In Canada, 75% of our energy is Hydrocarbons, 15% Renewables, and 10% Nuclear. In the World, 81% is Hydrocarbon, 13% Renewables, and 6% Nuclear. World consumption of oil is about 90 million barrels per day or about 30 billion barrels of oil per year. World consumption of natural gas is about 300 billion cubic feet per day or about 100 trillion cubic feet per year. FRACKING – involves applying high pressure water to break rocks, in order to extract shale gas, which is a natural gas that could replace oil. Challenge is horizontally drilling, since it is very deep. Shale is a sedimentary rock. Other Facts: Japan has the largest nuclear base, Canada has tar sands (thick liquids) Urban Heat Island effect – urban expansion will lead to higher temperature Why do we consume so much energy? Wealth, developed countries, long winters in Canada and Russia, population density (if dense, subway works. If sparse, then cars must be bought). Pearl Harbour – Japanese attacked US because of an oil embargo. It wanted to easily attack INodnesia for oil supply in 1941. Canada and Russia use the most natural gas, which is shipped through pipelines and have different markets depending on geography. Hydrocarbons can be in gas form (methane), liquid form (oil and tar sands), or solid form (coal). Coal produces 2x as much CO2 as natural gas, and Oil adds 1.5x as much CO2. Some argue that natural gas is a bridge fuel that will take us from one era to the next. Carbon Economy – where combustion of hydrocarbons produce CO2 and energy. Hydrogen Economy – burning hydrogen to produce water and energy. Our Atmosphere: - Nitrogen 78% • Oxygen 21% • Argon 0.9% • Carbon Dioxide 0.035% Fractional Distillation – how chemicals in a barrel of oil are separated. Different components of crude oil have different boiling points, and at first, you boil everything to 600 degrees Celcius. The vapour goes up a fractional distillation column, it cools and becomes a liquid. The trays collect various liquid fractions. It goes from residue, to diesel (260), kerosene (180), naphtha, petrol (40), and refined gas. Primary energy is a source of energy that has not been subject to a conversion or transformation process ECO314 2 Secondary energy involves conversion First law of thermodynamics: conservation of energy. changed from one form to another, but it cannot be created or destroyed. Second law of thermodynamics: law of entropy. system, the potential energy of the system is reduced and it results in losses primary energy  secondary energy  work Forms of Energy: Mechanical Chemical Thermal heat, vibration of molecules Radiant Nuclear Electric History: Biomass – people burned firewood. Waterwheels for grinding grain. Bronze age – burned a lot of copper and tin Iron Age – melting iron at 1500 degrees Sail ships and windmills were invented Inthstrial Revolution – External Combustion Engines (steam engines), Coal, Coke? 19thentury – internal combustion 20 century – turbines ECO314 3 Internal vs. External Combustion Engines: In an Internal Combustion Engine, the Fuel is burnt in the cylinder or vessel eg. Diesel or Petrol engine used in Cars. In an External Combustion Engine, the internal working fuel is not burnt. Here the fluid is being heated from an external source. The fuel is heated and expanded through the internal mechanism of the engine resulting in work. eg. Steam Turbine, Steam engine Trains. Internal engine has its energy ignited in the cylinder. like 99.9% of engines today. An external combustion example is a steam engine where the heating process is done in an boiler out side the engine. Rules of Thumb: 27% of carbon dioxide is carbon. The world consumers 90 million barrels of oil per day, or 30 billion in a year. Natural gas – 300 billion cubic feet per day, or 100 trillion a year. Coal adds 2x as much CO2 as natural gas Oil adds 1.5x as much CO2 as natural gas. Lecture 2 Conservation tillage is any method of soil cultivation that leaves the previous year's crop residue (such as corn stalks or wheat stubble) on fields before and after planting the next crop, to reduce soil erosion and runoff. To provide these conservation benefits, at least 30% of the soil surface must be covered with residue after planting the next crop. Some conservation tillage methods forego traditional tillage entirely and leave 70% residue or more.  Reduces soil erosion by as much as 60%-90% depending on the conservation tillage method; pieces of crop residue shield soil particles from rain and wind until new plants produce a protective canopy over the soil  Improves soil and water quality by adding organic matter as crop residue decomposes; this creates an open soil structure that lets water in more easily, reducing runoff  Conserves water by reducing evaporation at the soil surface  Conserves energy due to fewer tractor trips across the field  Reduces potential air pollution from dust and diesel emissions Demand for Energy is derived from need for heat, light, and mobility. Forms of energy such as natural gas, oil, and electricity are substitutes, but stoves last a long time so it is time consuming to change. Capital-energy substitution (home insulation, fuel-efficient cars) also take a long time due to the lives of such assets. Slowly, after the OPEC price shock, people started to switch. Supply for Energy can be renewable or depletable (oil, natural gas, coal). Renewable Energy can be storable (hydro, biomass), or non-storable (solar, wind, electricity). Consumer Theory: Maximize utility subject to budget constraints. Income elasticity of demand is the change in demand when income changes. Demand for energy increases as income increases. Own-price elasticity of demand is the change in demand for a good when its price changes. Increase in energy price = decrease in demand. Low in the short run because demand is inelastic, but change in the long run. Cross-price elasticity of demand is the change in demand for a good when the price of a related good changes. If it’s positive, then increase in price of one thing leads to an increased demand for another – meaning they’re substitutes. ECO314 4 E.g. Gasoline demand is based on price, income, number of cars, household, etc. In the short run, elasticity of demand was 0.25, but went up to 0.6 According to Yatchew, the long run price elasticity is -0.9, and income elasticity is 0.3 Producer Theory: minimize costs subject to producing a certain quantity of output (economies of scope and scale). E.g. electricity distribution – where the cost per customer is a function of customer density, load factor, PUC scope of operations, etc. However, as there are more customers, the cost may not be lowered (like a U shape). Competition: Perfect Competition – many firms, same products, many buyers with perfect information. Each firm is a price taker and has a perfectly elastic demand curve. MR = P = MC, and a close example is the coal industry. Monopoly – one supplier of product with no substitutes – high barriers to entry. Could be a legal BTE (government license, patent, etc.) or a natural BTE (due to economies of scale). MR = MC, never operates in the inelastic range of demand curve, has no supply curve since it’s a price maker, and make economic profits in the long run. However, it has deadweight loss, dynamic inefficiency, and regulatory market power is exercised. Dynamic Efficiency – the issue of innovation and technological change Static Efficiency – Are you using resources efficiently? Economies of Scale – reduced average costs through more output Economies of Scope – reduced average costs through increased range of goods E.g. electricity & natural gas distribution and transmission Cost Allocation Theory  If the initial cost is $60, but one firm is larger than others and need a joint cost of $70, then that firm can pay the difference of $10 and split the $60. Monopolistic Competition/Oligopoly – between PC and M Four Firm Concentration Ratio - % of industry sales by the four largest firms HHI – sum of squared market shares of 50 largest firms in industry Concentration Ratios are national, but some industries are local or international, has no indication of entry barriers, or recognition that firms operate in other industries too Monopolistic Competition – many firms compete through some differentiation, some monopoly power, and free entry and exit, firm can choose price and output. Profit max – choose Q where MC = MR. However, only short term profits are possible, long run = $0, with P = ATC Oligopoly – few firms compete and strategically interact. Kinked demand curve assumes if firm raises price, no one will follow, but if decrease price, all firms will follow – leading to sticky prices. It gives no indication about how P is determined or how DD curves change. Assumes one large firm with major cost advantage, with smaller firms. E.g. OIL markets, OPEC Game theory can be used to analyze oligopolistic markets, whether to enter an industry, and how to share costs. In a duopoly, firms can collude (form cartel) or cheat each other. In a one-time game, each firm has a dominant strategy of cheating. In a repeated game, they can take ‘tit for tat’ ECO314 5 strategy, where they take the other player’s last strategy, or trigger strategy, where they cooperate until someone else cheats. It has few firms and free entry, so they face competition from potential entrants. Thus, they may use entry-deterrence (competitive price), or limit pricing (lower price and higher q than monopoly, to deter entry). Externalities – an effect of an activity which is not limited to the parties involved, such as pollution/global warming, and new technology with multiple uses. Coase Theorem – as long as the rights to the externality can be appropriated, then bargaining will lead to efficient outcomes regardless of how the rights are set. Internalize the externality - How to deal with externalities in a socially efficient way. E.g. Cap n Trade Public Goods – can be consumed by everyone. Non-rivalry (one person’s consumption doesn’t affect another), Non-Excludability, Free Rider (someone can consume without paying),such as street lighting. Taxes – when taxes are paid, supply curve shifts upward, price goes up, q goes down, and deadweight loss is incurred. The more inelastic the demand, the lower deadweight loss. Carbon taxes have low deadweight loss in short run, but may increase in the long run. Hotelling’s Rule – as a resource is depleted, its price should rise by r, the rate of interest. It will rise exponentially. P1 = (1+r)P0. If P1 > (1+r)P0, then you’re better off extracting resources in the next period. If it’s smaller, then you’re better off selling more now. The optimal price is such that the next price next period is equal to the amount you receive this period x interest rate. Ehrlich-Simons Wager – Simons bet that prices will go down, and it did! Thus, Hotelling’s Rule has not prevailed, especially with shale gas. Surplus: Government intervention such as regulation, public ownership, and anti-combne law strive to influence surpluses. Consumer surplus is the value to consumers – price paid, and Producer surplus is the total revenue – opportunity cost Total surplus is maximized when deadweight loss is zero. In a monopoly, there is more producer surplus than consumer surplus. Economic Theory of Regulation – demand for regulation increases when consumer surplus, number of buyers, producer surplus per firm, and the number of firms increase. Supply of regulation increases when consumer surplus/buyer, producer surplus/firm, and number of people affected increases. In political equilibrium, interest groups and politicians accept existing regulations. Public Interest Theory – regulations supplied to maximize total surplus and eliminate deadweight loss. Government acts in public interest to achieve allocative efficiency. Capture Theory – regulations supplied maximizes producer surplus and economic profit. Governments ‘captured’ by the interests of producers (lobbyists) REGULATION (natural monopolies) ECO314 6 Governments set rates for natural gas and electricity, because of economies of scale for these natural monopolies. Rate of return regulation – set prices to achieve target return over its costs, similar to average cost pricing rule where P = ATC. However, there is an incentive for the firm to inflate cost to yield economic profits  AVERCH-JOHNSON EFFECT Thus, regulators moved to incentive regulation. There are three types of government intervention: First way is REGULATION Regulated monopolies seem to earn profits greater than average, supporting capture theory. Another way is PUBLIC OWNERSHIP Public firms have objectives of P=MC to maximize CS, but budget maximization and inflated costs are observed. Evidence shows that publicly owned firms overproduce and are less efficient than private firms. ANTI-COMBINE LAW Competition Act deals with conspiracy to fix prices, false advertising. Noncriminal actions dealt by Competition Tribunal, deals with mergers, abuse of market position, and exclusive dealing. The Competition Bureau says that the Commissioner will not challenge a merger when: the post merger market share accounted for by the four largest firms (Four Firm Concentration Ratio CR4) is less than 65%, or The most-merger market share of the merged entity would be less than 10%. Lecture 3 – Environmental Issues  Climate Change  Nuclear Accidents and Waste Disposal  Off-Shore Drilling and Oil Tanker Risks  Fracking Technologies and Water Supplies  Air Pollution o No fracking is allowed in France because they have a huge nuclear industry, and most of the shale is way below in the mines. Pennsylvanian frackers aren’t allowed to dump, while NYC allows dumping but no fracking. The world uses 81% hydrocarbons, 13% renewable, and 6% nuclear power. The atmosphere is composed of 78% nitrogen, 21% oxygen, 0.9% argon, and 0.035% carbon dioxide. Increased concentration of CO2 traps heat, and melts polar icecaps. Nordhaus Rule of Thumb: Doubling co2 from preindustrial level (280ppm) to 560ppm give a temperature increase of about 3 degrees Celsius above pre-industrial level. It gives a relationship between CO2 and climate change. It is around 430 ppm now. Stabilization Wedges: ECO314 7 A wedge is basically a strategy to reduce carbon emissions in 50 years, that grows at 1 GtC a year. It’s a framework to understand how we can cut carbon emissions to stop emitting the projected 200 billion tons of carbon in the next 50 years. The goal is to level off emissions in the next 50 years. There are around 15 wedges centred around energy efficiency/conservation, fossil-fuels, nuclear power, and renewable & biostorage. A solution should provide at least one wedge. Efficiency – Double efficiency (e.g. coal plant is 32% efficient today), double fuel efficiency of the world’s cars or halve miles traveled, and use best practices in residential and ECO314 8 commercial buildings (changing lightbulbs). These method affects all sectors  electricity, transport, and heart, and doesn’t require much $ to implement. Fuel Switching – substitute natural gas for coal because it’s usually cheaper. However, in Europe coal is cheaper… Carbon Capture & Storage – store carbon from electric or natural gas plants underneath the ground, but since it’s a gas, it takes a lot of volume. Can it be attached to a solid molecule? A bit costly. Nuclear Electricity – triple the world’s nuclear electricity…but not likely to happen because of radiation concerns. Denver Effect – plutonium and radioactive waste in the area that could be fatal to citizens. Wind Electricity – install 1 million windmills to replace coal, or u
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