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Energy conservation and official UK energy forecasts
Communications on energy Energy conservation and official U K energy forecasts Behind the latest UK official forecasts of energy demand are implicit assumptions about future energy price elasticities. Here David Pearce examines the basis of the forecasts and finds that the long-term energy price elasticities which they imply are t w o or three times too low. The official forecasts substantially understate the responsiveness of demand to energy price rises. If more realistic price elasticities were assumed, the official forecasts would imply a zero primary energy demand growth to 2000. This raises the interesting possibility of a low energy future being brought about entirely by market forces. In 1978 the then Labour government published its Green Paper on UK energy policy to the year 2000.1 Before the publication of the Green Paper the broad outlines of the policy had been made available in the form of Energy Commission papers 2,3 but only the Green Paper had the full stamp of authority, although the earlier papers had the virtue of speculating about the 25 years after 2000. The Green Paper was quickly followed by an explanation of how the UK Department of Energy secures its forecasts of energy demand 4 while fairly late in 1979 revised forecasts were issued by the UK Department of Energy to the year 2000 in the light of some changed forecasts of iron and steel demand and of the balance between services and industrial production in the future composition of G D P ? The new Conservative administration in the UK has yet to release its own consultative document.
The official forecasts The actual forecasts made or implied in the 1978 and 1979 documents for the years 2000 and 2025 are shown in Table 1. The forecasting methodology, which is considered in outline later, forecasts the demand for useful energy - ie energy in terms of work done at the point of end use - since this is what consumers actually demand. Table 1 shows demand and supply in primary equivalent energy terms and therefore adjusts for losses in primary fuel
conversion, transmission, and end use losses. Obviously, the primary equivalent totals are the relevant ones when trying to forecast installed capacity requirements.
Implied coefficients A few immediate observations can be made. First, Table 1 gives a guesstimate of the conservation totals implicit in the forecasts. These absolute figures are reasonably explicitly stated in the Green Paper, although they are referred to as 'possible conservation' in the Energy Commission documents that preceded the 1978 Green Paper. There is a valuable exposition in the Department's document on forecasting. 6 The basic procedure in the UK Department of Energy forecasts is to adjust forecast energy demand downwards to allow for expected technological change - ie reduced energy intensities that will come about 'naturally' as capital stock is replaced with more energy efficient stock. Over and above this, however, there is a 15% saving in useful energy terms in 2000 which comes about through conservation directly, whether it is induced through policy or real price changes. It is worth making a guess at the absolute magnitude of these savings given the importance of the link between conservation and energy prices. In essence, the forecasts of primary demand are net of anticipated technicalchange-induced conservation and net of a further substantial conservation
ENERGY POLICY September 1980
component which appears to be almost entirely price induced. Second, the 1979 revisions reflect a change in expectations about the relative size of the service sector in the UK economy. Primarily, a reduction in the previous forecast for growth in the steel industry reflects a significant change of view. Clearly, there are political difficulties in forecasting a more pessimistic outlook for a nationalized industry than the industry itself would wish. It is perhaps no accident that the revised forecast for energy consumption in the steel industry therefore came at a time when the Labour administration had left office and when the British Steel Corporation was preparing some fairly drastic cuts in domestic capacity. Third, the 2025 figures tentatively put forward in 1977 and implied in 1979 are shown in Table 1 for illustration. They are not the result of the forecasting technique as such but rather an extrapolation of trends that appear to 'settle down' towards the end of the century. Thus, the implied primary energy coefficient7 is 0.43 for 19752000 and 0.55-1.01 for 2000-2025. The lower bound of the 2025 estimate is thus broadly consistent with a fairly stable coefficient which continues to reflect increased conservation. The upper end may be regarded as consistent with an 'exhausted' conservation scenario - ie one in which conservation potential has been largely taken up by 2000.
The policy gap Fourth, the 1979 forecasts set what, from the UK Department of Energy's point of view, are realistic capacities for coal and nuclear power in 2000. This still leaves an import requirement virtually identical with the 'policy gap' plus import requirement forecast in 1978. s The 'policy gap' was really an indication that coal and nuclear never would exceed the target supplies in the 1978 forecasts, so that the 'policy gap' has been simply a euphemism either for net imports or for an admission that forecast electricity demand simply would not be met. The problem in 1978 was that the 'gap' could not be cited as a net import requirement because it was a deficiency of supply with respect to demand and electricity could not be
245
Communications Table 1. UK primary fuel demand and supply (mtce).
1977 Demand and supply
"High' GDP case (3%/year GDP growth to 1990, 2.4%/year in the period 1990--2000)
GDP growth (for 1977 forecasts = 1.7%lyear, for 1979 forecasts, not stated).
2000 1977 forecast a
1978 forecast b
1979 forecast c
2025 1977 forecast d 1979 forecast e
Demand and supply
Demand
Supply
Demand
Supply Demand only
Coal Oil Gas Nuclear and hydro ('Policy gap') f
122 137 63 16
Not all ocated
165+ 130 50 95+
170 150 50 95
165 132 66 95
155 100 65 95
Total energy use
332
440--580
490
458
60--70
70
53
500--650
560
Non-energy and bunkers Total Demand--supply
50 28 360 0
Conservation assuredh
125--162
465
194 129 0 353 24
Demand
Supply 205
Not 15 allocated 195--295 50--75g
700 112
512
415
812
662--787 465--585 77--322
95
97
?
140
128
?
?
Note: Totals may not add because of rounding. a Department of Energy, Energy Policy Review, Energy Paper No 22, HMSO, London, 1977. b Energy Policy.'A Consultative Document, Cmnd 7101, HMSO, London, 1978, Annex 1, Tables 1-6. Reference to Chart 1 is necessary to allocate demand between fuels. c Department of Energy, Energy Projections 1979, Department of Energy, London, October 1979, p 3. d Energy Commission, Energy Forecasts: A Note by the Department of Energy, Energy Commission Paper No 5, Department of Energy, London, 1978. Referred to here as 1977 forecasts since they were computed then. See Chart 23. e No direct forecasts are given in the 1979 document but speculation about rates of growth are given. These have been used here to secure the overall estimate. f In pre-1979 forecasts this is electricity demand to be met from unknown sources. Imports are included in demand allocations. Thus the 50 mtce 'policy gap' would imply higher demand figures for coal and nuclear since oil fired generating plant would be uneconomic, hence the 'plus" signs on coal and nuclear. g These projections are for alternative energy sources. h The conservation element is taken to be 20% of what demand would have been in 2000. See Department of Energy, Energy Forecasting Methodology, Energy Paper No 29, HMSO, London, 1978.
imported other than through the use of oil in oil fired stations. The change in the forecast for electricity demand is therefore fortuitous indeed.
Forecasting methodology To secure any further insight into the forecasts of energy demand it is necessary to consider very briefly the forecasting methodology used by the Department of Energy. The basic approach is to look at regressions of demand in three sectors: the domestic sector; the 'other industry' sector (ie total industrial production minus iron and steel); and the commercial or 'other consumers' sector. The transport sector forecasts are taken independently from the UK Department of Transport, and the iron and steel forecasts are also obtained separately. For all sectors other than the iron and steel sector, some detail of the methodology is given in Energy Paper 29. 9
246
In those sectors where regressions are carried out, the time series cease at 1973. The Department's argument here is that price elasticities could be computed for the period up to 1973 but would be irrelevant to the current period in which energy prices have risen substantially. The claim is that price elasticities after 1973 are not easily computed. 1° Thus price does not enter into the equations in a direct manner. The equations for the three sectors internally forecast tend to be dominated by measures of income or variables closely correlated with income. This suggests that, contrary to general belief, a simple energy--GDP coefficient approach might suffice as a reasonable check on the actual forecasts. Table 2 shows primary energy demand in the period 1960-73, and the forecasts for 1977-2000. It also shows the annual growth rates in GDP. To allow for conservation in the forecasts, however, the 2000 energy
demand figure is increased to find out what it would have been without conservation (since the 1960-73 data does not contain a conservation policy element). The resulting energy coefficients are then calculated. Table 2 shows clearly the impact of the assumed conservation magnitudes. There can be a presumption that a good part of the conservation is assumed to be price induced, a presumption reinforced by policy measures in 1980 designed to downgrade 'active' conservation measures. In essence, the effect of conservation is to reduce the implied energy coefficient to well below its average for 1960-73, and, conversely, to raise it above the 1960-73 levels if conservation is excluded.
Importance of conservation While the Department of Energy emphasizes the crudeness and limited use of energy coefficients for forecasting
ENERGY
POLICY
September
1 980
Communications purposes, it is nonetheless the case that the high value of 0.88 is close to the value of the primary energy coefficient in the period 1965-73 (which, in turn, would be a coefficient largely unadjusted for policy induced or price induced conservation). That is, while the 'implied' coefficient is above that for 1960-73 as a whole, it is close to the value to which it was rising during that period." We can 'conflate' the forecasting equation into a single identity as follows: E2000 --E1977 (1 + GDP. ey + P.e~
where: E20o0 = energy demand in 2000; = percentage increase in GDP, 2000 on 1977; P = percentage increase in average energy prices, 2000 on 1977; ey = implied energy coefficient, 19772000; and ep = implied 'price' elasticity, 1977-2000. Note that this is categorically not a forecasting equation - it is an ex post statement of how the current forecasts can be 'simulated' in terms of G D P and price. 12 The 'implied price elasticity' (ep) and the price change need a little further explanation. The U K Department of Energy forecasts assume a $30/barrel (1977 prices) price of oil by 2000. The 'conservation adjustment' in Tables 1 and 2 is, as we have seen, primarily due to price-induced effects. This 'conservation elasticity' can be calculated as: (640 - 512) (14 + 30) = 0.31 (16)(640 + 512) where the measure of ep is an arc elasticity and is therefore, at best, an average elasticity for a very large price and quantity change. The 1977 price of oil is taken as $14/barrel and is used here as a surrogate for the price of energy. The actual increase in price is therefore some 115% for 1977-2000. Table 3. Price elasticities and UK energy demand in 2000. ep
E2000 (mtce)
0.6 0.7 0.8 0.9 1.0
392 351 310 269 228
ENERGY
POLICY
September
1960
GDP index (1975 = 100) Change Primary energy 1979 forecasts (mtce) Change Energy coefficient
1973
69.0 103.3 49.7%
270.9 354.2 30.7% 0.62
High GDP case With conservation 1977 2000
Without conservation 1977 2000
105.1
105.1
197.5
360
164.1 88%
88% 512 42% 0.48
360
640 78% 0.88
(1)
E1977 = energy demand in 1977; G D P
ep=
Table 2. Energy coefficient analysis of primary fuel demand.
The remaining data are taken from Table 1 (1979 forecasts). Now, despite its obvious lack of forecasting value Identity (1) does have some illustrative use in indicating the relative importance of income growth and price-induced conservation in the official forecasts. Roughly speaking, conservation nearly halves the absolute growth of demand (280 mtce) from 1977-2000, (reducing it to 152 mtce) and therefore underlines the crucial role played by the conservation adjustments in official policy, a role which seems widely misunderstood in commentaries on official policy.
Long-run pdce elasticities The value of 0.31 for ep is highly significant. It implies that a 1% rise in the real price of energy will reduce demand by 0.3%. This figure is close to the 'consensus' view of 0.25 for total energy price elasticities, as Pindyck notes. '3 But Pindyck's own work indicates long-term elasticities of greater than unity - in the range 1.05-1.15 - for residential demand, 0.8 for industrial demand, and above unity for transport, '4 and there are strong reasons for thinking other studies understate long-run elasticities. Not the least of these is that values of 0.25 characterize U K elasticities before 1973. '~ Given the much higher price now, elementary economic theory dictates that the elasticity will itself be higher unless energy demand curves have a specific functional form. The argument is strengthened further if we observe that a $30/barrel real price may itself be too low. If then we take a very conservative view and maintain the price assumption
1980
but use a price elasticity of 0.5 we immediately obtain drastic reductions in the forecasts of energy demand. In terms of Identity (1) we would have: E2000 = E1977 (1 + 88 x 0.88 - 114 x 0.5) 100 100 where 88 is the percentage rise in the G D P index (1977 = 100) assumed in the official forecasts, 114 is the percentage change in real energy prices, 0.88 is the energy coefficient, 0.5 is the assumed long-run price elasticity and E1977 is 360 mtce. The result is a value of E2000 of 433 mtce, some 15% lower than the official forecast and only 20% above the 1977 figure. Various other elasticity assumptions, up to Pindyck's suggested long-run elasticity of about unity, for total energy demand give the results shown in Table 3. Note that it requires a long-run price elasticity of 0.7 to achieve an energy demand level equal to the 1977 consumption level, combined with the 'official' assumptions of a 114% increase in the real price of energy and an 88% increase in GDP. Each 0.1 point rise in the price elasticity lowers primary energy demand by just over 40 mtce.
Conclusions Not surprisingly, it has been found that income growth 'dominates' the U K official forecasts but this tends to give a misleading impression of the role that energy price changes actually play. To this end it has been shown that, while 'explicit' price elasticities are not used in official forecasts, an 'implicit' price elasticity very close to the traditional 'consensus' view is in fact used. But is that consensus elasticity still a sensible
247
Communications construct for use in a long-term planning exercise? It was concluded that it is not and that long-run price elasticities may differ by a factor of between two and three from the value implied in the official forecasts. Making only a modest adjustment reduced energy demand in the year 2000 by 15% while raising the elasticity by a factor of just over two actually eliminated the growth in primary energy demand altogether. Quite simply, then, there is the interesting prospect of a 'low energy future' that requires no active policy measures to bring it about. Nonetheless, it seems likely that an active policy would ensure the adjustment which it has been argued would come about through price changes. One final word of caution. Like all prescriptions the one suggested here is not without dangers. It remains necessary to ask what happens if we are wrong. To that end the concept of 'insurance' technologies remains important, as does the retention of a skilled workforce which is able to respond to demand increases should they occur. Perhaps the general import is that there is far more flexibility in energy planning than has hitherto been thought to be the case for the next two decades. Thereafter one has to bear in mind that conservation, however brought about, has a 'once-for-all' characteristic. No doubt further conservation can and will occur beyond 2000 but at a decreasing rate. That places the onus on supply expansion in the period beyond 2000 and raises all the problems of how to sustain that supply capability before that period. D avid Pearce Department of Political Economy University of A berdeen Aberdeen, UK The views expressed here are entirely the author's and must in no way be taken to reflect opinions in any government department with which the author may be associated. 1 Department of Energy, Energy Policy: A Consultative Document, Cmnd 7101, HMSO, London, 1978. 2 Energy Commission, Working Document on Energy Policy, Energy Commission Paper No 1, Department of Energy, London, 1977. 3 Energy Commission, Energy Forecasts:
248
A Note by the Department of Energy, Energy Commission Paper No 5, Department of Energy, London, 1978. 4 Department of Energy, Energy Forecasting Methodology, Energy Paper No 29, HMSO, London, 1978. s Department of Energy, Energy Projections 1979, Department of Energy, London, October 1979. 6 Department of Energy, op cit, Ref 4. 7 The energy coefficient is defined as
e=~E/
AGDPGDP
ie it is the elasticity of energy demand with respect to GDP. 8 The 'policy gap' is the new name for the previous 'energy gap', the latter terminology being abandoned when it was recognized that, ex post, supply must equal demand. 9 Department of Energy, op cit, Ref 4. lo Department of Energy, Report of the
Working Group on Energy Elasticities, Energy Paper No 17, HMSO, London, 1977. Work by Michael Common at the University of Stirling suggests that this view is, in any event, incorrect. 11 For the Department of Energy view see
Department of Energy, op cit, Ref 4, paras 20-22. Note also that before the 1979 revisions to the forecasts, the average energy coefficient over 1960-73 was a surprisingly good estimator. 12The equation omits any negative feedback between energy prices and GDP which some commentators regard as important. See for example L.G. Brookes, 'Energy policy, the energy price fallacy and the role of nuclear energy in the UK', Energy Policy, Vol 6, No 2, June 1978, pp 94-106. However, Pindyck has suggested a model for measuring energy price impacts and shows that they cannot exceed the percentage share of energy expenditure in GDP. Using Pindyck's model my own calculations indicate a negligible impact on GDP of the Department of Energy's assumed energy price rises. See R.S. Pindyck, The Structure of World Energy Demand, MIT Press, Cambridge, MA, 1979. 13 R.S. Pindyck, op cit, Ref 12, p 118. 14Ibid, p 160 (for residential demand), p 181 (for the industrial demand estimate) and p 232 (for the transport estimate). 15 N.D. Uri, 'Energy substitution in the UK, 1948-64', Energy Economics, Vol 1, No 4, October 1979, pp 241-244.
Renewable energy sources for Egypt On the basis of present c o n s u m p t i o n p a t t e r n s and reserve estimates, S e l i m Estefan predicts t h a t Egypt and o t h e r d e v e l o p i n g countries will face severe fossil fuel s u p p l y p r o b l e m s unless t h e y invest n o w in rapid d e v e l o p m e n t of r e n e w a b l e sources. He o u t l i n e s s o m e of the Egyptian r e n e w a b l e e n e r g y projects currently u n d e r w a y or b e i n g studied, and argues t h a t the i m m e d i a t e e x p l o i t a t i o n of i n d i g e n o u s r e n e w a b l e sources is b o t h e c o n o m i c a l l y feasible and can be a c h i e v e d w i t h existing t e c h n o l o g y .
Total world reserves of oil are estimated at 500 billion (109) bbl, and world consumption of oil is 20 billion bbl/year, t Even at a constant rate of consumption, this oil reserve could last only 25 years. However, world consumption is increasing and the effect of this exponential growth is striking. There is one inevitable conclusion: if present trends continue the world will face severe oil supply problems sometime around the end of the century. The rivalry of the USA and the USSR over the world's remaining oil reserves could result in military conflict in the Middle East, the vital and chief source of energy for the Western World and the centre of the world's most intense ethnic conflicts. The development of renewable sources is urgently required. 2 A new
UN agency is required to initiate an i n t e r n a t i o n a l emergency energy programme. The aim of this programme should be to develop new supplies of reasonably priced energy using state of the art technology. The technology must also be compatible with the existing infrastructure.
Prospects for Egypt The consumption of fossil fuel in Egypt has increased considerably in the period 1952-77 and is likely to continue to grow in the future (see Table 1). Therefore Egypt, like many other developing countries, urgently requires the development of domestic energy sources, principally based upon simple technology. Renewable energy systems could be deployed on a massive scale at
E N E R G Y POLICY September 1980
The official forecasts The actual forecasts made or implied in the 1978 and 1979 documents for the years 2000 and 2025 are shown in Table 1. The forecasting methodology, which is considered in outline later, forecasts the demand for useful energy - ie energy in terms of work done at the point of end use - since this is what consumers actually demand. Table 1 shows demand and supply in primary equivalent energy terms and therefore adjusts for losses in primary fuel
conversion, transmission, and end use losses. Obviously, the primary equivalent totals are the relevant ones when trying to forecast installed capacity requirements.
Implied coefficients A few immediate observations can be made. First, Table 1 gives a guesstimate of the conservation totals implicit in the forecasts. These absolute figures are reasonably explicitly stated in the Green Paper, although they are referred to as 'possible conservation' in the Energy Commission documents that preceded the 1978 Green Paper. There is a valuable exposition in the Department's document on forecasting. 6 The basic procedure in the UK Department of Energy forecasts is to adjust forecast energy demand downwards to allow for expected technological change - ie reduced energy intensities that will come about 'naturally' as capital stock is replaced with more energy efficient stock. Over and above this, however, there is a 15% saving in useful energy terms in 2000 which comes about through conservation directly, whether it is induced through policy or real price changes. It is worth making a guess at the absolute magnitude of these savings given the importance of the link between conservation and energy prices. In essence, the forecasts of primary demand are net of anticipated technicalchange-induced conservation and net of a further substantial conservation
ENERGY POLICY September 1980
component which appears to be almost entirely price induced. Second, the 1979 revisions reflect a change in expectations about the relative size of the service sector in the UK economy. Primarily, a reduction in the previous forecast for growth in the steel industry reflects a significant change of view. Clearly, there are political difficulties in forecasting a more pessimistic outlook for a nationalized industry than the industry itself would wish. It is perhaps no accident that the revised forecast for energy consumption in the steel industry therefore came at a time when the Labour administration had left office and when the British Steel Corporation was preparing some fairly drastic cuts in domestic capacity. Third, the 2025 figures tentatively put forward in 1977 and implied in 1979 are shown in Table 1 for illustration. They are not the result of the forecasting technique as such but rather an extrapolation of trends that appear to 'settle down' towards the end of the century. Thus, the implied primary energy coefficient7 is 0.43 for 19752000 and 0.55-1.01 for 2000-2025. The lower bound of the 2025 estimate is thus broadly consistent with a fairly stable coefficient which continues to reflect increased conservation. The upper end may be regarded as consistent with an 'exhausted' conservation scenario - ie one in which conservation potential has been largely taken up by 2000.
The policy gap Fourth, the 1979 forecasts set what, from the UK Department of Energy's point of view, are realistic capacities for coal and nuclear power in 2000. This still leaves an import requirement virtually identical with the 'policy gap' plus import requirement forecast in 1978. s The 'policy gap' was really an indication that coal and nuclear never would exceed the target supplies in the 1978 forecasts, so that the 'policy gap' has been simply a euphemism either for net imports or for an admission that forecast electricity demand simply would not be met. The problem in 1978 was that the 'gap' could not be cited as a net import requirement because it was a deficiency of supply with respect to demand and electricity could not be
245
Communications Table 1. UK primary fuel demand and supply (mtce).
1977 Demand and supply
"High' GDP case (3%/year GDP growth to 1990, 2.4%/year in the period 1990--2000)
GDP growth (for 1977 forecasts = 1.7%lyear, for 1979 forecasts, not stated).
2000 1977 forecast a
1978 forecast b
1979 forecast c
2025 1977 forecast d 1979 forecast e
Demand and supply
Demand
Supply
Demand
Supply Demand only
Coal Oil Gas Nuclear and hydro ('Policy gap') f
122 137 63 16
Not all ocated
165+ 130 50 95+
170 150 50 95
165 132 66 95
155 100 65 95
Total energy use
332
440--580
490
458
60--70
70
53
500--650
560
Non-energy and bunkers Total Demand--supply
50 28 360 0
Conservation assuredh
125--162
465
194 129 0 353 24
Demand
Supply 205
Not 15 allocated 195--295 50--75g
700 112
512
415
812
662--787 465--585 77--322
95
97
?
140
128
?
?
Note: Totals may not add because of rounding. a Department of Energy, Energy Policy Review, Energy Paper No 22, HMSO, London, 1977. b Energy Policy.'A Consultative Document, Cmnd 7101, HMSO, London, 1978, Annex 1, Tables 1-6. Reference to Chart 1 is necessary to allocate demand between fuels. c Department of Energy, Energy Projections 1979, Department of Energy, London, October 1979, p 3. d Energy Commission, Energy Forecasts: A Note by the Department of Energy, Energy Commission Paper No 5, Department of Energy, London, 1978. Referred to here as 1977 forecasts since they were computed then. See Chart 23. e No direct forecasts are given in the 1979 document but speculation about rates of growth are given. These have been used here to secure the overall estimate. f In pre-1979 forecasts this is electricity demand to be met from unknown sources. Imports are included in demand allocations. Thus the 50 mtce 'policy gap' would imply higher demand figures for coal and nuclear since oil fired generating plant would be uneconomic, hence the 'plus" signs on coal and nuclear. g These projections are for alternative energy sources. h The conservation element is taken to be 20% of what demand would have been in 2000. See Department of Energy, Energy Forecasting Methodology, Energy Paper No 29, HMSO, London, 1978.
imported other than through the use of oil in oil fired stations. The change in the forecast for electricity demand is therefore fortuitous indeed.
Forecasting methodology To secure any further insight into the forecasts of energy demand it is necessary to consider very briefly the forecasting methodology used by the Department of Energy. The basic approach is to look at regressions of demand in three sectors: the domestic sector; the 'other industry' sector (ie total industrial production minus iron and steel); and the commercial or 'other consumers' sector. The transport sector forecasts are taken independently from the UK Department of Transport, and the iron and steel forecasts are also obtained separately. For all sectors other than the iron and steel sector, some detail of the methodology is given in Energy Paper 29. 9
246
In those sectors where regressions are carried out, the time series cease at 1973. The Department's argument here is that price elasticities could be computed for the period up to 1973 but would be irrelevant to the current period in which energy prices have risen substantially. The claim is that price elasticities after 1973 are not easily computed. 1° Thus price does not enter into the equations in a direct manner. The equations for the three sectors internally forecast tend to be dominated by measures of income or variables closely correlated with income. This suggests that, contrary to general belief, a simple energy--GDP coefficient approach might suffice as a reasonable check on the actual forecasts. Table 2 shows primary energy demand in the period 1960-73, and the forecasts for 1977-2000. It also shows the annual growth rates in GDP. To allow for conservation in the forecasts, however, the 2000 energy
demand figure is increased to find out what it would have been without conservation (since the 1960-73 data does not contain a conservation policy element). The resulting energy coefficients are then calculated. Table 2 shows clearly the impact of the assumed conservation magnitudes. There can be a presumption that a good part of the conservation is assumed to be price induced, a presumption reinforced by policy measures in 1980 designed to downgrade 'active' conservation measures. In essence, the effect of conservation is to reduce the implied energy coefficient to well below its average for 1960-73, and, conversely, to raise it above the 1960-73 levels if conservation is excluded.
Importance of conservation While the Department of Energy emphasizes the crudeness and limited use of energy coefficients for forecasting
ENERGY
POLICY
September
1 980
Communications purposes, it is nonetheless the case that the high value of 0.88 is close to the value of the primary energy coefficient in the period 1965-73 (which, in turn, would be a coefficient largely unadjusted for policy induced or price induced conservation). That is, while the 'implied' coefficient is above that for 1960-73 as a whole, it is close to the value to which it was rising during that period." We can 'conflate' the forecasting equation into a single identity as follows: E2000 --E1977 (1 + GDP. ey + P.e~
where: E20o0 = energy demand in 2000; = percentage increase in GDP, 2000 on 1977; P = percentage increase in average energy prices, 2000 on 1977; ey = implied energy coefficient, 19772000; and ep = implied 'price' elasticity, 1977-2000. Note that this is categorically not a forecasting equation - it is an ex post statement of how the current forecasts can be 'simulated' in terms of G D P and price. 12 The 'implied price elasticity' (ep) and the price change need a little further explanation. The U K Department of Energy forecasts assume a $30/barrel (1977 prices) price of oil by 2000. The 'conservation adjustment' in Tables 1 and 2 is, as we have seen, primarily due to price-induced effects. This 'conservation elasticity' can be calculated as: (640 - 512) (14 + 30) = 0.31 (16)(640 + 512) where the measure of ep is an arc elasticity and is therefore, at best, an average elasticity for a very large price and quantity change. The 1977 price of oil is taken as $14/barrel and is used here as a surrogate for the price of energy. The actual increase in price is therefore some 115% for 1977-2000. Table 3. Price elasticities and UK energy demand in 2000. ep
E2000 (mtce)
0.6 0.7 0.8 0.9 1.0
392 351 310 269 228
ENERGY
POLICY
September
1960
GDP index (1975 = 100) Change Primary energy 1979 forecasts (mtce) Change Energy coefficient
1973
69.0 103.3 49.7%
270.9 354.2 30.7% 0.62
High GDP case With conservation 1977 2000
Without conservation 1977 2000
105.1
105.1
197.5
360
164.1 88%
88% 512 42% 0.48
360
640 78% 0.88
(1)
E1977 = energy demand in 1977; G D P
ep=
Table 2. Energy coefficient analysis of primary fuel demand.
The remaining data are taken from Table 1 (1979 forecasts). Now, despite its obvious lack of forecasting value Identity (1) does have some illustrative use in indicating the relative importance of income growth and price-induced conservation in the official forecasts. Roughly speaking, conservation nearly halves the absolute growth of demand (280 mtce) from 1977-2000, (reducing it to 152 mtce) and therefore underlines the crucial role played by the conservation adjustments in official policy, a role which seems widely misunderstood in commentaries on official policy.
Long-run pdce elasticities The value of 0.31 for ep is highly significant. It implies that a 1% rise in the real price of energy will reduce demand by 0.3%. This figure is close to the 'consensus' view of 0.25 for total energy price elasticities, as Pindyck notes. '3 But Pindyck's own work indicates long-term elasticities of greater than unity - in the range 1.05-1.15 - for residential demand, 0.8 for industrial demand, and above unity for transport, '4 and there are strong reasons for thinking other studies understate long-run elasticities. Not the least of these is that values of 0.25 characterize U K elasticities before 1973. '~ Given the much higher price now, elementary economic theory dictates that the elasticity will itself be higher unless energy demand curves have a specific functional form. The argument is strengthened further if we observe that a $30/barrel real price may itself be too low. If then we take a very conservative view and maintain the price assumption
1980
but use a price elasticity of 0.5 we immediately obtain drastic reductions in the forecasts of energy demand. In terms of Identity (1) we would have: E2000 = E1977 (1 + 88 x 0.88 - 114 x 0.5) 100 100 where 88 is the percentage rise in the G D P index (1977 = 100) assumed in the official forecasts, 114 is the percentage change in real energy prices, 0.88 is the energy coefficient, 0.5 is the assumed long-run price elasticity and E1977 is 360 mtce. The result is a value of E2000 of 433 mtce, some 15% lower than the official forecast and only 20% above the 1977 figure. Various other elasticity assumptions, up to Pindyck's suggested long-run elasticity of about unity, for total energy demand give the results shown in Table 3. Note that it requires a long-run price elasticity of 0.7 to achieve an energy demand level equal to the 1977 consumption level, combined with the 'official' assumptions of a 114% increase in the real price of energy and an 88% increase in GDP. Each 0.1 point rise in the price elasticity lowers primary energy demand by just over 40 mtce.
Conclusions Not surprisingly, it has been found that income growth 'dominates' the U K official forecasts but this tends to give a misleading impression of the role that energy price changes actually play. To this end it has been shown that, while 'explicit' price elasticities are not used in official forecasts, an 'implicit' price elasticity very close to the traditional 'consensus' view is in fact used. But is that consensus elasticity still a sensible
247
Communications construct for use in a long-term planning exercise? It was concluded that it is not and that long-run price elasticities may differ by a factor of between two and three from the value implied in the official forecasts. Making only a modest adjustment reduced energy demand in the year 2000 by 15% while raising the elasticity by a factor of just over two actually eliminated the growth in primary energy demand altogether. Quite simply, then, there is the interesting prospect of a 'low energy future' that requires no active policy measures to bring it about. Nonetheless, it seems likely that an active policy would ensure the adjustment which it has been argued would come about through price changes. One final word of caution. Like all prescriptions the one suggested here is not without dangers. It remains necessary to ask what happens if we are wrong. To that end the concept of 'insurance' technologies remains important, as does the retention of a skilled workforce which is able to respond to demand increases should they occur. Perhaps the general import is that there is far more flexibility in energy planning than has hitherto been thought to be the case for the next two decades. Thereafter one has to bear in mind that conservation, however brought about, has a 'once-for-all' characteristic. No doubt further conservation can and will occur beyond 2000 but at a decreasing rate. That places the onus on supply expansion in the period beyond 2000 and raises all the problems of how to sustain that supply capability before that period. D avid Pearce Department of Political Economy University of A berdeen Aberdeen, UK The views expressed here are entirely the author's and must in no way be taken to reflect opinions in any government department with which the author may be associated. 1 Department of Energy, Energy Policy: A Consultative Document, Cmnd 7101, HMSO, London, 1978. 2 Energy Commission, Working Document on Energy Policy, Energy Commission Paper No 1, Department of Energy, London, 1977. 3 Energy Commission, Energy Forecasts:
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A Note by the Department of Energy, Energy Commission Paper No 5, Department of Energy, London, 1978. 4 Department of Energy, Energy Forecasting Methodology, Energy Paper No 29, HMSO, London, 1978. s Department of Energy, Energy Projections 1979, Department of Energy, London, October 1979. 6 Department of Energy, op cit, Ref 4. 7 The energy coefficient is defined as
e=~E/
AGDPGDP
ie it is the elasticity of energy demand with respect to GDP. 8 The 'policy gap' is the new name for the previous 'energy gap', the latter terminology being abandoned when it was recognized that, ex post, supply must equal demand. 9 Department of Energy, op cit, Ref 4. lo Department of Energy, Report of the
Working Group on Energy Elasticities, Energy Paper No 17, HMSO, London, 1977. Work by Michael Common at the University of Stirling suggests that this view is, in any event, incorrect. 11 For the Department of Energy view see
Department of Energy, op cit, Ref 4, paras 20-22. Note also that before the 1979 revisions to the forecasts, the average energy coefficient over 1960-73 was a surprisingly good estimator. 12The equation omits any negative feedback between energy prices and GDP which some commentators regard as important. See for example L.G. Brookes, 'Energy policy, the energy price fallacy and the role of nuclear energy in the UK', Energy Policy, Vol 6, No 2, June 1978, pp 94-106. However, Pindyck has suggested a model for measuring energy price impacts and shows that they cannot exceed the percentage share of energy expenditure in GDP. Using Pindyck's model my own calculations indicate a negligible impact on GDP of the Department of Energy's assumed energy price rises. See R.S. Pindyck, The Structure of World Energy Demand, MIT Press, Cambridge, MA, 1979. 13 R.S. Pindyck, op cit, Ref 12, p 118. 14Ibid, p 160 (for residential demand), p 181 (for the industrial demand estimate) and p 232 (for the transport estimate). 15 N.D. Uri, 'Energy substitution in the UK, 1948-64', Energy Economics, Vol 1, No 4, October 1979, pp 241-244.
Renewable energy sources for Egypt On the basis of present c o n s u m p t i o n p a t t e r n s and reserve estimates, S e l i m Estefan predicts t h a t Egypt and o t h e r d e v e l o p i n g countries will face severe fossil fuel s u p p l y p r o b l e m s unless t h e y invest n o w in rapid d e v e l o p m e n t of r e n e w a b l e sources. He o u t l i n e s s o m e of the Egyptian r e n e w a b l e e n e r g y projects currently u n d e r w a y or b e i n g studied, and argues t h a t the i m m e d i a t e e x p l o i t a t i o n of i n d i g e n o u s r e n e w a b l e sources is b o t h e c o n o m i c a l l y feasible and can be a c h i e v e d w i t h existing t e c h n o l o g y .
Total world reserves of oil are estimated at 500 billion (109) bbl, and world consumption of oil is 20 billion bbl/year, t Even at a constant rate of consumption, this oil reserve could last only 25 years. However, world consumption is increasing and the effect of this exponential growth is striking. There is one inevitable conclusion: if present trends continue the world will face severe oil supply problems sometime around the end of the century. The rivalry of the USA and the USSR over the world's remaining oil reserves could result in military conflict in the Middle East, the vital and chief source of energy for the Western World and the centre of the world's most intense ethnic conflicts. The development of renewable sources is urgently required. 2 A new
UN agency is required to initiate an i n t e r n a t i o n a l emergency energy programme. The aim of this programme should be to develop new supplies of reasonably priced energy using state of the art technology. The technology must also be compatible with the existing infrastructure.
Prospects for Egypt The consumption of fossil fuel in Egypt has increased considerably in the period 1952-77 and is likely to continue to grow in the future (see Table 1). Therefore Egypt, like many other developing countries, urgently requires the development of domestic energy sources, principally based upon simple technology. Renewable energy systems could be deployed on a massive scale at
E N E R G Y POLICY September 1980