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Scenario analysis as a background for important energy policy decisions
276
Scenario analysis as a background for important energy policy decisions David N U N N Department of Science and Technolog3,. The Chr. Michelsen Institute, N-5036 Fantofi. Bergen, Norway
This paper gives an example of how' scenario analysis can be used in a decision-making context in the sphere of public debate. The example chosen to illustrate the process is the Norwegian Smelting Industry, an industry which uses about 25% of Norway's primary energy consumption. The paper describes an attempt at rationalising the energy policy decis, ons which are interwoven with the smelting industry's future, fhe analysis used a 'Reference Group' comprising leading members of the relevant interest groups to identify the goals of the different parties, and strategies for reaching these goals. The long-terra consequences of following these paths were simulated and the results published in a popularised book [ 1].
1. Introduction
Researchers involved in work on energy policy in the public domain are faced with a variety of 1~~oblems. One of these problems is how to relate to the 'policy-maker' who can be quite an abstract character in questions of national policy, and by no means the clearly defined 'client" operations researchers are used to dealing with in matters of corporate planning. Matters concerning national energy policy are seldom decided overnight. In most countries, the government's energy policy is usually a compromise of the different views which are put forward by interest groups in the public debate on the issue. Politicians often speak of the need they feel for a systematic analysis of the consequences of following a given policy. Parliamentary committees which are '.he centre of intensive lobbying on hot issues do not usually have sufficiently thoroug~a knowledge of the subject matter to have the required overview. Without an analytical framework, evaluation of the proposals of the different interest groups against one another is difficult. North-Holland Pubfishing Company European Journal of Operational Research 11 (1982) 276-284
In this paper, we look at a specific topic in tht~ Norwegian energy debate and at a research pro-! ject ~ which tried to place this topic in a consistent analytical framework with the aim of 'rationaliz- i ing' the information on which ultimately the' government had to base its decision. The approach adopted in the study can be summarized as an application of the "what if...'" technique. In our case, the "what if...'" could be expanded to read "If interest group X's wishes were carried through, what would be the consequences for Y and Z?". Before we discuss the method in more detail, some background on the 'energy problem' under analysis would be of advantage. As in the case of most energy problems, this one is interwoven with several other policy areas: regional development, national industrial and economic policy and employment to mention the most important. The problem under consideration here is one of energy pricing; more specifically the pricing of electricity contracts to the Norwegian smelting industry as well as the size of future contracts. Some background on the Norwegian smelting industry The Norwegian smelting idustry encompasses 32 factories which produce aluminium, ferro-alloys, iron and steel, magnesium, zinc, nikkel and carbides (Fig. 1). A common feature for all these factories is that they consume large amounts of electricity. This industry consumes about 25% of Norway's total primary energy (expressed as theoretical energy content), including 40~ of the electricity. The smelting industry has long been the flagship of Norwegian industrialisation, so to shift the industrial emphasis away from this industry towards others has understandably aroused sharp reaction from many Norwegians. Historically, hydroelectricity provided Norway with a springboard t The project was a joint effort between the Resource Policy Group in Oslo and The Chr. Michelsen Institute.
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D. Nunn / Scenario analysis as a background for important energy policy decisions
into the industrial era. Just after the turn of the centu¢¢, the technology became available to build out its indigenous waterfalls and to utilise the power so generated in electro-thermal and later electro-chemical processes. In the 1920's Norway produced 12% of the world's aluminium, twice its present market share. The smelting industry was also established as a foreign-exchange earner. In 1975 it still accounted for 28% of Norway's industrial exports and 16% of the country's foreign currency income. Its percentage of total export earnings has been relatively constant during the past twenty-five years, but this will change in the future due to the boom in oil exports. The smelting industry's gross domestic product can be used as an indicator of its contribution to the generation of national wealth. The electro-industry's GNP has tripled between 1950 and 1975 from 1,2 to 3,5 thousand million kroner (constant 1978-kroner). It has maintained about a 10% share of total industrial GNP over the twenty-five year period. This can be seen in relation to a share of total industrial employment which has increased from 4~ to 5% and a share to total industrial electricity consumption which has increased from 33% to 60% over the same period. So far in the seventies, the electro-industry has contributed 2%3% to the total Norwegian GNP. The industry has in fact been actively used by earlier governments in their regional development policy. The industry's high growth rate during the p~st 25 years has meant that although productivity h;~s risen annually on an average 5,7%, employment has also been able to increase in absolute terms. This trend has, however, changed over the last 5 years because of lower industrial growth. Employment has now stagnated. Limitations in the technology for electricity transmission before the sixties meant that the smelting industry had mainly to be built up in company towns in regional Norway where the hydroelectric potential was located. Others have, however, questioned the logic of continuing to use such a large fraction of Norway's hydro-power (all electricity is produced by hydro-power in Norway) in this way. There are two main lines of argument against the present scale of the industry. Firstly, over 60% of Norway's economic hydro-power potential is developed or in the course of being developed, and pressure to
conserve the remaining river systems is large. Secondly, several economists have questioned the soundness of building new hydro-schemes before the market price of electricity reflec~ the average cost of construction. The reason for this is that according to economic theory, an investment will give a maximum present value return if it is ready to produce in the year that the market price for the product equals the average cost of production. This theory holds when prices increase over time. Because smelters only pay about 4,5 ~ r e / k W h (approx. 0,9 US cents/kWh) for their electricity at present and the cost of producing power from new hydro-schemes is calculated to be 10 erre/kWh, it is not difficult to see that adopting of such a pricing policy in the short term would have dire results for the industry's profitability. There are several possible future scenarios for the Norwegian smelting industry. The one that is actually realized will depend on which overall goals dominate the development of society as a whole - goals such as maintenance of a solid industrial base and the present pattern of employment and settlement, nature conservation, or maximum growth in the standard of living (GNP).
2. Method of analysis - The project reference group
The first rule for any research effort of this sort which hopes to be of use to decision-makers, is to involve the client at the earliest possible stage in the work and to continue the dialogue until the work is over - see [4]. The problem when dealing with macro-social systems is that there is no clearly defined client to converse with, just the spectrum of interest groups and decision makers described above. This problem was solved by defining as our user a reference group comprising 14 representatives of the different interest groups that affect or are affected by the development of the electro-industry. The group was drawn from persons of stature with long experience from practical life and included two former cabinet ministers. During the early stages of the project (the first six n~,onths) meetings were held once a month. These stages of the project covered problem definition, identification of the strategies to be explored and the primary s;tmulation of consequences, The agenda for the meetings was deliberately
D. Nunn / Scenario analysis as a background[or important enerlo, poll 0, decisions
wide ranging with the purpose of generating unprepared discussions with the following objectives: - T h e reference group discussions se1~,e to focus the simulation study on the main issues of relevance, on which possible strategies are the most interesting, and on which variables are the most important indicators of the success or failure of a proposed strategy - The reference group serves as a readily available and versatile information source supplying both quantitative and qualitative information about how the real world works. In addition, the group facilitates access to other information sources. - T h e reference group serves as a discriminating sounding board for the tentative hypotheses, syntheses, models and reports of the analysts. - The reference group members serve as an effective distribution channel for study results into their respective interest groups. - The reference group serves to give the results of the study enhanced credibility which is of help in the early dissemination stage.
2.1. Use of simulation modelling Parallel to the discussions in the reference group, a simulation model of the aggregate smelting industry was developed. The simulation model was not the primary focus of the research effort, but an aid to be used to check the consistency in assumptions on market price, profitability in the industry, the number or jobs in the industry as well as its power requirements, and the extent and cost of hydro-power development. It was used to follow the consequences of the strategies proposed by the reference group. The main elements in the model are outlined in Fig. 2. The model consisted of four sub-sectors: the world market for products, the Norwegian smelting industry, electricity supply and other electricity users. The most important variable simulated in the world market sector was product price. This calculation required assumptions to be made on: market growth rate, - technology (i.e. labor productivity and electricity productivity in the future), raw material costs, - electricity costs, wage rates. Given the product price, the smelting industry sector simulated Norwegian production, invest-
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ments, employment and electricity consumption. The assumptions on technology, raw materials costs, capital costs and wages were consistent with those made in the world market sector for foreign competitors. The price for new electricity contracts is given by the electricity supply sector and is dependent on the pricing policy adopted. The industry's investment plans can be modified in the model if new electricity contracts are limited. The electricity supply sector assures that enough electricity is produced to cover demar/d from both the smelting industry and other users. The price can be calculated on the basis of either marginal costs or average costs, or can be specified exogenously depending on the scenario one wishes to simulate. The fourth sector in the model, other electriciO' users, is simply modelled as the forecast from the Electricity Board modified with a price elasticity.
2.2. Choice of scenarios The aim of the research effort was to identify a set of scenarios each of which could be said to be representative for the goal of a particular interest group. A list of the scenarios which were finally included in the analysis is given in Table 1. We found the most difficult scenario to formulate to be that representing the wishes of the industry themselves. Their feeling was that Norway needed a strong industrial base with the ability to compete on export markets, and that the government should give them conditions which allowed the industry to maintain its competitive edge. Both labour interests and regional interests had a common goal; to maintain employment at the locations which today sited smelters. Conservation interests had as their overall goal a moratorium on future hydro-power schemes. This implies a stabilization of electricity consumption and was simulated in two scenarios which although they were not completely representative for this group main goal served to illustrate the extremes of following such a policy. These scenarios were limiting the amount of electricity granted to the industry in concessions, and a phased closure of the industry. After identifying the interest groups' main goals, the next stage was to identify the policies which could realize these goals. There are often several policy options available to achieve a stated aim.
D. Nunn / Scenario analysis as a background for important energy policy decisions
280
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The consequences of achieving this aim will differ according to which path is chosen. For example, the employees w i t ~ the smelting industry wish to m a i n ~ the n u m h ~ of industrial jobs in the areas in which the smel~iiag industry is already located; There are three w~ys of accomplishing this goal:
-increase primary metal production capacity at the same rate as productivity increases, -increase production of semi-finished or finished products, - diversify and begin production of other industrial products. It i,.; apparent that each of these strategy alter-
1). Nunn / Scenario analysis as a background for important energy policv decisions Table ! Outline of scenarios explored in the study Goal
,
Strategies
Changes in model
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I
Business as usual'
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A strong smelting industry, competitive o n world markets
III Maintain employment in regions with smelters today
-
Reduction of tax burden Increase primary production
- Tax on labour and investment eliminated - New power contracts to marginal pro" duction cost (7% interest rate) - Contracts renewed to original price on expiry, new contracts to marginal cost based on 5 % interest rate
Increase primary production
- All power priced to average production cost
Increase production of semifinished products Establish other industries IV Maximize value of the country's hydro-resources
Price electricity to marginal production cost
- Price all electricity consumed to marginal production cost by gradv.ally increasing electricity tax until 1990
V
Place ceiling o n amount of power available to smelters
- Ceiling on power availability: present level of power prices frozen
- Reduce power consumption in electro-industry to cover growth in other electricity users - Sell surplus power to other electricity users. Income is invested in alternative industry
- All remaining nondeveloped rivers conserved - No further investment in electro-industry - The industry maintains ownership of power contracts and sells surplus power to the grid
Stabilize electricity consumption
VI Protect remaining rivers from hydro-electricity development
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281
D, Nunn / Scenario analysis as a background for important energy policy decisions
282
natives will have a markedly different effect on future electricity requirements. Six variables were chosen as principal indicators of the consequences of following a given stratr - r~arn,,y metal production capacity, - number of jobs, -average electricity price paid by the smelting industry, - profitability (gross return on investment), - remaining fraction of hydro-electric potential, - installed thermal power generating capacity. The development of these variables was simulated until year 2020. The reason for choosing such a long time-span was the long-term contract structure which the industry has for supply of electricity. Historically, the industry has been able to obtain long-term electricity contracts, usually for a period between 20-40 years. Concessions which allowed companies to produce hydro-electricity themselves were often given for a 60-year period, although some of the first hydro-power schemes were built before the law requiring concessions for hydro-power production was passed. Few contracts expire before the middle of the 'nineties, and the industry is in fact guaranteed 20 T W h / y r in the year 2000 - 7670 of its consumption in 1976. By the year 2020, only the production rights which the industry itself owns will remain available to it unless contracts are renewed as they expire - see Fig. 3. The contract structure which the smelting industry has already secured can exert a very stabilizing influence on future dynamic behaviour unless measures are taken to adjust the price which the industry must pay for its power. Such a measure might be to increase the electricity duty which is levied on each kilowatt-hour used.
3.
Resu~s
As a reference scenario, it is tempting to run a "business as usual' case assuming that the same type of decision rules which have historically been applied, also are valid in the future. Our reference is based on the assumptions that t h e s m e l t i n g industry can obtain new electricity on 20-year contracts at the cost of producing power from a new electric;ty plant. The reference scenario (scenario I in Fig. 4) ghows a gentle increase in the
industry's production capacity until the middle of the first decade in the next century when capacity is drastically reduced. The buffer which existing power contracts afford the industry means that it is able to pay relatively high prices for marginal increases in its total power consumption in the short term. Although this development leads to gradually falling profits, margins are still high enough for a modest increase in production capacity to be attractive. After the turn of the century, many existing contracts expire and the industry loses much of its buffer against higher energy costs. The resulting lack of profitability causes the industry to close down. The reduction in the smelting industry's electricity demand comes too late to postpone the development of the remaining hydro-electric schemes or the construction of thermal power stations. This is because demand from other electricity users has grown in the meantime. Attempts to ameliorate the situation by reducing the taxes on labour and investments allow the industry to expand in the short term (scenario II in Fig. 4). The industry can easily afford to pay the relatively high prices for new power contracts and is able to continue along its historical pattern of expansion until the end of the century. The total abolition of labour and investment taxes cannot, however, from that point counter balance increased energy costs which result from so many power contracts expiring.
3.1. Electricity pricing is the crucial policy decision An analysis of the results of the different scenarios shows that the strategy which the government adopts as regards pricing of electricity to the smelters is of cardinal importance. Were the government to adopt a marginal pricing policy in which all the electricity which the industry consumed was continually priced to the average cost of producing more electricity from a new power station, the industry's international competitive edge would soon be eroded. (Scenario IV in Fig. 4.) The reason for this is that the remaining hydro-power projects which have not yet been constructed have increasing capital costs. As capital costs amount to between 80 and 90~ of all production costs, the cost to which hydro-power can be produced approaches the cost of thermal (oil)
D. Nunn / Scenario analysis as a background for important energy polity decisions 10
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the smelting industry at a rate reflecting the mean production cost in the whole electricity supply system, the industry would be able to continue to enjoy a strong comparative position (scenario II1 in Fig.4). The fundamental assumption in our model is that Norwegian smelters sell their products at a price fixed on the world market. The level of the Norwegian industry does not affect price fixation, but the ratio between the market price and production costs in Norway determines capacity utilization and, in the longer term, the level of investment. This last point brings us to the fundamental issue in the entire debate. The cost of producing power from eristing hydro-power plants falls over time because the decline in capital costs more than compensates for increasing variable costs. This means that although the marginal cost of producing electricity may be high in the year 2000, the average cost will be low. Compared with a country which produces electricity solely from oil-fired generating plants, the hydro cost advantage will annually amount to approx. $800 per capita in the year 2000 (1978 dollars). The crucial issue is thus who should reap the benefits of this cost advantage: the regions where the hydro-power is located, the smelting industry (which also provides substantial employment in these regions) or the country at large? The days when the only way of utilizing hydropower on a large scale was to smelt primary metals are gone. Advances in the technology of high-voltage electricity transmission have made it possible to sell electricity to other users in the cities or even abroad who are willing to pay more for their electricity than the smelting industry can possibly pay and remain solvent. 3.2. Jobs versus free-flowing rivers
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Fig. 4. E x t r a c t o f results f r o m scenario analysis. T h e scenario numbers r e f e r to T a b l e I.
power. The development in marginal production cost assuming that the cheapest hydro-schemes are constructed first, is shown in Fig. 5. In the scenario shown here, we have assumed that the alternative to producing hydro-power is to generate electricity in an oil-fired power station with oil priced at $20/bbl (1978 dollars). Were the government, however, to give highest priority to regional employment and sell power to
There is a clear conflict between the aims of both the unions and local interests of maintaining employment in the smelting industry, and the aims of environmentalists who wish to limit increases in future power consumption. The scenario involving maintaining employment levels in primary production leads to total development of the remaining hydro potential within the early nineties aod a comprehensive construction programme of thermal power plants if the project demand of other electricity (scenario Ill in Fig. 4) users is also to b~ met.
284
D. Nunn / Scenario analysis as a background for important energv policy decisions
Conservation can be achieved by stringent"use of marginal pricing which would cause the smelting industry to close down as well as reducing demand from other users. Conservation can also be achieved by freezing the smelter's electricity consumption and by a comprehensive programme of energy saving in other sectors. The aim for the other sectors should then be to limit the increase in their electricity consumption to 2~ annually until the year 2000 with no increase after that. We will not expound on the plausibility of following this last course of action now. 3.3. A summary of the different scenarios Some general comments on the different development paths shown in Fig. 4: The first point is that in all the scenarios involving development of the remaining hydro-potential, the need for investment in the electricity supply sector will rise from its present level of 2~ of G N P (6~ of total national investments), to around 4~ in 1990. This is clear from an inspection of the estimated capital costs of the remaining hydroschemes. After the introduction of thermal power plants, the combined yearly expenditure on plant investment and fuel costs will remain at this level. The smelting industry is relatively capital intensive itself, so any reduction in its growth would potentially liberate quite large amounts of capital which could then be productively employed in other less energy intensive sectors of the economy. The challenge which the country's industrial policy then has to face is to find growth sectors wifich can productively employ this capital and which ideally provide job opportunities in the regions where the contraction of the smelting industry will be felt most. As many of Norway's other traditional industries such as shipbuilding and manufacturing of pulp and paper are in economic difficulties at the present, the solution to this problem is by no means apparent. At present, the political consensus is centred around a scenario involving establishment of no new smelters, but providing existing firms with the electricity necessary to carry out modernization plans. This will necessitate a moderate reduction i;~ employment because productivity is expected to rise faster than capacity, but no greater than can be covered by natural wastage (scenario V in Fig. 4). To further accomodate environmental in-
terests, emphasis is being focused on saving electricity amongst other users.
4. Concluding remarks This paper has presented an example of how scenario analysis and simulation can be combined to form a basis for energy policy decision-making. Our starting point was the goals of the different patties with a stake in the future of the smelting industry. Our goal was to show what possible courses of action were open to the authorities to realize these parties' goals and what the consequences would be both for other groups and in the long-term. Many of the consequences of following a given strategy are difficult to quantify. It is an advantage to quantify a few key variables though so that one has some firm basis for comparison between scenarios. We limited analysis of other factors to a qualitative discussion. We desisted from making a ranking list of the different scenarios because it was in the nature of the matter that the scenario which won the day would have to be a compromise of considerations to the present pattern of employment, nature conservation and economics. The formulation of this compromise is dependent on who makes the decision. The interplay between the analyst and the reference group in which all the interested parties were represented, provided a forum for a broad discussion of these groups' strategies. The participants had another important function - to spread the insights from the strategy discussions to their respective interest group. The results of the scenarios and strategy discussions were finally published in a popularized book in order to reach a broader audience (see [1]).
References [i] L.K. Ervik, C. Tank-Nielsen, D. Nunn and J. Randers, Smelteoerkene i Smeltedigelen (Cappelens Forlag, Oslo, 1979). [2] D. Nunn, E. Moxnes and L.K. Ervik, Den kraftintensive industri i framtiden: Beskrivelse av gimuleringsmodellen SMELT, The Chr. Micheisen Institute, Bergen 0979). [3] J. Owens, Hydroelectric energy: The cost of conservation in Norway, GRS 121, Resource Policy Group, Oslo (1978). [4] J. Randers, The potential in simulation of macro-social processes, or how to be useful builder of simulation models, GRS I 1i, Resource Policy Group, Oslo 0977).
Scenario analysis as a background for important energy policy decisions David N U N N Department of Science and Technolog3,. The Chr. Michelsen Institute, N-5036 Fantofi. Bergen, Norway
This paper gives an example of how' scenario analysis can be used in a decision-making context in the sphere of public debate. The example chosen to illustrate the process is the Norwegian Smelting Industry, an industry which uses about 25% of Norway's primary energy consumption. The paper describes an attempt at rationalising the energy policy decis, ons which are interwoven with the smelting industry's future, fhe analysis used a 'Reference Group' comprising leading members of the relevant interest groups to identify the goals of the different parties, and strategies for reaching these goals. The long-terra consequences of following these paths were simulated and the results published in a popularised book [ 1].
1. Introduction
Researchers involved in work on energy policy in the public domain are faced with a variety of 1~~oblems. One of these problems is how to relate to the 'policy-maker' who can be quite an abstract character in questions of national policy, and by no means the clearly defined 'client" operations researchers are used to dealing with in matters of corporate planning. Matters concerning national energy policy are seldom decided overnight. In most countries, the government's energy policy is usually a compromise of the different views which are put forward by interest groups in the public debate on the issue. Politicians often speak of the need they feel for a systematic analysis of the consequences of following a given policy. Parliamentary committees which are '.he centre of intensive lobbying on hot issues do not usually have sufficiently thoroug~a knowledge of the subject matter to have the required overview. Without an analytical framework, evaluation of the proposals of the different interest groups against one another is difficult. North-Holland Pubfishing Company European Journal of Operational Research 11 (1982) 276-284
In this paper, we look at a specific topic in tht~ Norwegian energy debate and at a research pro-! ject ~ which tried to place this topic in a consistent analytical framework with the aim of 'rationaliz- i ing' the information on which ultimately the' government had to base its decision. The approach adopted in the study can be summarized as an application of the "what if...'" technique. In our case, the "what if...'" could be expanded to read "If interest group X's wishes were carried through, what would be the consequences for Y and Z?". Before we discuss the method in more detail, some background on the 'energy problem' under analysis would be of advantage. As in the case of most energy problems, this one is interwoven with several other policy areas: regional development, national industrial and economic policy and employment to mention the most important. The problem under consideration here is one of energy pricing; more specifically the pricing of electricity contracts to the Norwegian smelting industry as well as the size of future contracts. Some background on the Norwegian smelting industry The Norwegian smelting idustry encompasses 32 factories which produce aluminium, ferro-alloys, iron and steel, magnesium, zinc, nikkel and carbides (Fig. 1). A common feature for all these factories is that they consume large amounts of electricity. This industry consumes about 25% of Norway's total primary energy (expressed as theoretical energy content), including 40~ of the electricity. The smelting industry has long been the flagship of Norwegian industrialisation, so to shift the industrial emphasis away from this industry towards others has understandably aroused sharp reaction from many Norwegians. Historically, hydroelectricity provided Norway with a springboard t The project was a joint effort between the Resource Policy Group in Oslo and The Chr. Michelsen Institute.
0377-2217/82/0000-0000/$02.75 © 1982 North-Holland
/ Scenario analysis as a background for important energy policy decisions
D. Nunn
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~,a~'p)borg
(
A~Acee
L,sla Alummmumver~ (Ikem 5 ~oervefkel A.~
Fig. 1. Location of the Norwegian smelting industry. The area of the circles is proportional with the number of employees in 1977~
(Source [11.)
278
D. Nunn / Scenario analysis as a background for important energy policy decisions
into the industrial era. Just after the turn of the centu¢¢, the technology became available to build out its indigenous waterfalls and to utilise the power so generated in electro-thermal and later electro-chemical processes. In the 1920's Norway produced 12% of the world's aluminium, twice its present market share. The smelting industry was also established as a foreign-exchange earner. In 1975 it still accounted for 28% of Norway's industrial exports and 16% of the country's foreign currency income. Its percentage of total export earnings has been relatively constant during the past twenty-five years, but this will change in the future due to the boom in oil exports. The smelting industry's gross domestic product can be used as an indicator of its contribution to the generation of national wealth. The electro-industry's GNP has tripled between 1950 and 1975 from 1,2 to 3,5 thousand million kroner (constant 1978-kroner). It has maintained about a 10% share of total industrial GNP over the twenty-five year period. This can be seen in relation to a share of total industrial employment which has increased from 4~ to 5% and a share to total industrial electricity consumption which has increased from 33% to 60% over the same period. So far in the seventies, the electro-industry has contributed 2%3% to the total Norwegian GNP. The industry has in fact been actively used by earlier governments in their regional development policy. The industry's high growth rate during the p~st 25 years has meant that although productivity h;~s risen annually on an average 5,7%, employment has also been able to increase in absolute terms. This trend has, however, changed over the last 5 years because of lower industrial growth. Employment has now stagnated. Limitations in the technology for electricity transmission before the sixties meant that the smelting industry had mainly to be built up in company towns in regional Norway where the hydroelectric potential was located. Others have, however, questioned the logic of continuing to use such a large fraction of Norway's hydro-power (all electricity is produced by hydro-power in Norway) in this way. There are two main lines of argument against the present scale of the industry. Firstly, over 60% of Norway's economic hydro-power potential is developed or in the course of being developed, and pressure to
conserve the remaining river systems is large. Secondly, several economists have questioned the soundness of building new hydro-schemes before the market price of electricity reflec~ the average cost of construction. The reason for this is that according to economic theory, an investment will give a maximum present value return if it is ready to produce in the year that the market price for the product equals the average cost of production. This theory holds when prices increase over time. Because smelters only pay about 4,5 ~ r e / k W h (approx. 0,9 US cents/kWh) for their electricity at present and the cost of producing power from new hydro-schemes is calculated to be 10 erre/kWh, it is not difficult to see that adopting of such a pricing policy in the short term would have dire results for the industry's profitability. There are several possible future scenarios for the Norwegian smelting industry. The one that is actually realized will depend on which overall goals dominate the development of society as a whole - goals such as maintenance of a solid industrial base and the present pattern of employment and settlement, nature conservation, or maximum growth in the standard of living (GNP).
2. Method of analysis - The project reference group
The first rule for any research effort of this sort which hopes to be of use to decision-makers, is to involve the client at the earliest possible stage in the work and to continue the dialogue until the work is over - see [4]. The problem when dealing with macro-social systems is that there is no clearly defined client to converse with, just the spectrum of interest groups and decision makers described above. This problem was solved by defining as our user a reference group comprising 14 representatives of the different interest groups that affect or are affected by the development of the electro-industry. The group was drawn from persons of stature with long experience from practical life and included two former cabinet ministers. During the early stages of the project (the first six n~,onths) meetings were held once a month. These stages of the project covered problem definition, identification of the strategies to be explored and the primary s;tmulation of consequences, The agenda for the meetings was deliberately
D. Nunn / Scenario analysis as a background[or important enerlo, poll 0, decisions
wide ranging with the purpose of generating unprepared discussions with the following objectives: - T h e reference group discussions se1~,e to focus the simulation study on the main issues of relevance, on which possible strategies are the most interesting, and on which variables are the most important indicators of the success or failure of a proposed strategy - The reference group serves as a readily available and versatile information source supplying both quantitative and qualitative information about how the real world works. In addition, the group facilitates access to other information sources. - T h e reference group serves as a discriminating sounding board for the tentative hypotheses, syntheses, models and reports of the analysts. - The reference group members serve as an effective distribution channel for study results into their respective interest groups. - The reference group serves to give the results of the study enhanced credibility which is of help in the early dissemination stage.
2.1. Use of simulation modelling Parallel to the discussions in the reference group, a simulation model of the aggregate smelting industry was developed. The simulation model was not the primary focus of the research effort, but an aid to be used to check the consistency in assumptions on market price, profitability in the industry, the number or jobs in the industry as well as its power requirements, and the extent and cost of hydro-power development. It was used to follow the consequences of the strategies proposed by the reference group. The main elements in the model are outlined in Fig. 2. The model consisted of four sub-sectors: the world market for products, the Norwegian smelting industry, electricity supply and other electricity users. The most important variable simulated in the world market sector was product price. This calculation required assumptions to be made on: market growth rate, - technology (i.e. labor productivity and electricity productivity in the future), raw material costs, - electricity costs, wage rates. Given the product price, the smelting industry sector simulated Norwegian production, invest-
-
-
279
ments, employment and electricity consumption. The assumptions on technology, raw materials costs, capital costs and wages were consistent with those made in the world market sector for foreign competitors. The price for new electricity contracts is given by the electricity supply sector and is dependent on the pricing policy adopted. The industry's investment plans can be modified in the model if new electricity contracts are limited. The electricity supply sector assures that enough electricity is produced to cover demar/d from both the smelting industry and other users. The price can be calculated on the basis of either marginal costs or average costs, or can be specified exogenously depending on the scenario one wishes to simulate. The fourth sector in the model, other electriciO' users, is simply modelled as the forecast from the Electricity Board modified with a price elasticity.
2.2. Choice of scenarios The aim of the research effort was to identify a set of scenarios each of which could be said to be representative for the goal of a particular interest group. A list of the scenarios which were finally included in the analysis is given in Table 1. We found the most difficult scenario to formulate to be that representing the wishes of the industry themselves. Their feeling was that Norway needed a strong industrial base with the ability to compete on export markets, and that the government should give them conditions which allowed the industry to maintain its competitive edge. Both labour interests and regional interests had a common goal; to maintain employment at the locations which today sited smelters. Conservation interests had as their overall goal a moratorium on future hydro-power schemes. This implies a stabilization of electricity consumption and was simulated in two scenarios which although they were not completely representative for this group main goal served to illustrate the extremes of following such a policy. These scenarios were limiting the amount of electricity granted to the industry in concessions, and a phased closure of the industry. After identifying the interest groups' main goals, the next stage was to identify the policies which could realize these goals. There are often several policy options available to achieve a stated aim.
D. Nunn / Scenario analysis as a background for important energy policy decisions
280
Technology ~aw
Labour
FOREI~-~
Capital
COMPETITORS -
material
market
costs
costs costs
price
l l market growth
! l
I ! !
-|
I energy costs
i -- -- "~ 4-
NORWEGIAN
-- - -
Ceiling on available electricity
--
Taxes
ELECTRO-INDUSTRY -
Price
of
new
electricity contracts
productlon level ~investment employment energy requlremenl
( )
Demand
--
for
electricity
ELECTRICITY SUPPLY capital
costs
-
oil
production price investment
price
emand
growth trend
D
USERS demand
electri--------city tax
Fig. 2. Outline of the model structure. Dashed lines indicate exogenous input.
The consequences of achieving this aim will differ according to which path is chosen. For example, the employees w i t ~ the smelting industry wish to m a i n ~ the n u m h ~ of industrial jobs in the areas in which the smel~iiag industry is already located; There are three w~ys of accomplishing this goal:
-increase primary metal production capacity at the same rate as productivity increases, -increase production of semi-finished or finished products, - diversify and begin production of other industrial products. It i,.; apparent that each of these strategy alter-
1). Nunn / Scenario analysis as a background for important energy policv decisions Table ! Outline of scenarios explored in the study Goal
,
Strategies
Changes in model
i
I
Business as usual'
lI
A strong smelting industry, competitive o n world markets
III Maintain employment in regions with smelters today
-
Reduction of tax burden Increase primary production
- Tax on labour and investment eliminated - New power contracts to marginal pro" duction cost (7% interest rate) - Contracts renewed to original price on expiry, new contracts to marginal cost based on 5 % interest rate
Increase primary production
- All power priced to average production cost
Increase production of semifinished products Establish other industries IV Maximize value of the country's hydro-resources
Price electricity to marginal production cost
- Price all electricity consumed to marginal production cost by gradv.ally increasing electricity tax until 1990
V
Place ceiling o n amount of power available to smelters
- Ceiling on power availability: present level of power prices frozen
- Reduce power consumption in electro-industry to cover growth in other electricity users - Sell surplus power to other electricity users. Income is invested in alternative industry
- All remaining nondeveloped rivers conserved - No further investment in electro-industry - The industry maintains ownership of power contracts and sells surplus power to the grid
Stabilize electricity consumption
VI Protect remaining rivers from hydro-electricity development
PRICE BRE/KWH
30 ELECTRICTY AVAIALBLE ON EXIST- , ING ~ON-
~ ~VAILABLE ELECTRICITY
TRACTS
•~ ,_~ . . . . . .
(THH/YEAR)
PRICE
t t I t I0
t 1, X '%%%
I 1980
I 1990
I 2000
l 2010
2020
Fig. 3. Electricity available to the electro-industry on contracts signed before 1978. (Source [1].)
281
D, Nunn / Scenario analysis as a background for important energy policy decisions
282
natives will have a markedly different effect on future electricity requirements. Six variables were chosen as principal indicators of the consequences of following a given stratr - r~arn,,y metal production capacity, - number of jobs, -average electricity price paid by the smelting industry, - profitability (gross return on investment), - remaining fraction of hydro-electric potential, - installed thermal power generating capacity. The development of these variables was simulated until year 2020. The reason for choosing such a long time-span was the long-term contract structure which the industry has for supply of electricity. Historically, the industry has been able to obtain long-term electricity contracts, usually for a period between 20-40 years. Concessions which allowed companies to produce hydro-electricity themselves were often given for a 60-year period, although some of the first hydro-power schemes were built before the law requiring concessions for hydro-power production was passed. Few contracts expire before the middle of the 'nineties, and the industry is in fact guaranteed 20 T W h / y r in the year 2000 - 7670 of its consumption in 1976. By the year 2020, only the production rights which the industry itself owns will remain available to it unless contracts are renewed as they expire - see Fig. 3. The contract structure which the smelting industry has already secured can exert a very stabilizing influence on future dynamic behaviour unless measures are taken to adjust the price which the industry must pay for its power. Such a measure might be to increase the electricity duty which is levied on each kilowatt-hour used.
3.
Resu~s
As a reference scenario, it is tempting to run a "business as usual' case assuming that the same type of decision rules which have historically been applied, also are valid in the future. Our reference is based on the assumptions that t h e s m e l t i n g industry can obtain new electricity on 20-year contracts at the cost of producing power from a new electric;ty plant. The reference scenario (scenario I in Fig. 4) ghows a gentle increase in the
industry's production capacity until the middle of the first decade in the next century when capacity is drastically reduced. The buffer which existing power contracts afford the industry means that it is able to pay relatively high prices for marginal increases in its total power consumption in the short term. Although this development leads to gradually falling profits, margins are still high enough for a modest increase in production capacity to be attractive. After the turn of the century, many existing contracts expire and the industry loses much of its buffer against higher energy costs. The resulting lack of profitability causes the industry to close down. The reduction in the smelting industry's electricity demand comes too late to postpone the development of the remaining hydro-electric schemes or the construction of thermal power stations. This is because demand from other electricity users has grown in the meantime. Attempts to ameliorate the situation by reducing the taxes on labour and investments allow the industry to expand in the short term (scenario II in Fig. 4). The industry can easily afford to pay the relatively high prices for new power contracts and is able to continue along its historical pattern of expansion until the end of the century. The total abolition of labour and investment taxes cannot, however, from that point counter balance increased energy costs which result from so many power contracts expiring.
3.1. Electricity pricing is the crucial policy decision An analysis of the results of the different scenarios shows that the strategy which the government adopts as regards pricing of electricity to the smelters is of cardinal importance. Were the government to adopt a marginal pricing policy in which all the electricity which the industry consumed was continually priced to the average cost of producing more electricity from a new power station, the industry's international competitive edge would soon be eroded. (Scenario IV in Fig. 4.) The reason for this is that the remaining hydro-power projects which have not yet been constructed have increasing capital costs. As capital costs amount to between 80 and 90~ of all production costs, the cost to which hydro-power can be produced approaches the cost of thermal (oil)
D. Nunn / Scenario analysis as a background for important energy polity decisions 10
,,j
PRODUCTI ON APACl TY HIL~. TONN[ YEARJ
~
J 0 1960
J
a....
P
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\ B?5
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2006
2020
NUMBER OF
EflPLOYEES X
"\ \ 0 1960
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'.... 2005
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tO REMAINING HYDRGELECTRIC ~ESERVES FRACTION)
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.
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~
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......
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283
the smelting industry at a rate reflecting the mean production cost in the whole electricity supply system, the industry would be able to continue to enjoy a strong comparative position (scenario II1 in Fig.4). The fundamental assumption in our model is that Norwegian smelters sell their products at a price fixed on the world market. The level of the Norwegian industry does not affect price fixation, but the ratio between the market price and production costs in Norway determines capacity utilization and, in the longer term, the level of investment. This last point brings us to the fundamental issue in the entire debate. The cost of producing power from eristing hydro-power plants falls over time because the decline in capital costs more than compensates for increasing variable costs. This means that although the marginal cost of producing electricity may be high in the year 2000, the average cost will be low. Compared with a country which produces electricity solely from oil-fired generating plants, the hydro cost advantage will annually amount to approx. $800 per capita in the year 2000 (1978 dollars). The crucial issue is thus who should reap the benefits of this cost advantage: the regions where the hydro-power is located, the smelting industry (which also provides substantial employment in these regions) or the country at large? The days when the only way of utilizing hydropower on a large scale was to smelt primary metals are gone. Advances in the technology of high-voltage electricity transmission have made it possible to sell electricity to other users in the cities or even abroad who are willing to pay more for their electricity than the smelting industry can possibly pay and remain solvent. 3.2. Jobs versus free-flowing rivers
2OZ0
Fig. 4. E x t r a c t o f results f r o m scenario analysis. T h e scenario numbers r e f e r to T a b l e I.
power. The development in marginal production cost assuming that the cheapest hydro-schemes are constructed first, is shown in Fig. 5. In the scenario shown here, we have assumed that the alternative to producing hydro-power is to generate electricity in an oil-fired power station with oil priced at $20/bbl (1978 dollars). Were the government, however, to give highest priority to regional employment and sell power to
There is a clear conflict between the aims of both the unions and local interests of maintaining employment in the smelting industry, and the aims of environmentalists who wish to limit increases in future power consumption. The scenario involving maintaining employment levels in primary production leads to total development of the remaining hydro potential within the early nineties aod a comprehensive construction programme of thermal power plants if the project demand of other electricity (scenario Ill in Fig. 4) users is also to b~ met.
284
D. Nunn / Scenario analysis as a background for important energv policy decisions
Conservation can be achieved by stringent"use of marginal pricing which would cause the smelting industry to close down as well as reducing demand from other users. Conservation can also be achieved by freezing the smelter's electricity consumption and by a comprehensive programme of energy saving in other sectors. The aim for the other sectors should then be to limit the increase in their electricity consumption to 2~ annually until the year 2000 with no increase after that. We will not expound on the plausibility of following this last course of action now. 3.3. A summary of the different scenarios Some general comments on the different development paths shown in Fig. 4: The first point is that in all the scenarios involving development of the remaining hydro-potential, the need for investment in the electricity supply sector will rise from its present level of 2~ of G N P (6~ of total national investments), to around 4~ in 1990. This is clear from an inspection of the estimated capital costs of the remaining hydroschemes. After the introduction of thermal power plants, the combined yearly expenditure on plant investment and fuel costs will remain at this level. The smelting industry is relatively capital intensive itself, so any reduction in its growth would potentially liberate quite large amounts of capital which could then be productively employed in other less energy intensive sectors of the economy. The challenge which the country's industrial policy then has to face is to find growth sectors wifich can productively employ this capital and which ideally provide job opportunities in the regions where the contraction of the smelting industry will be felt most. As many of Norway's other traditional industries such as shipbuilding and manufacturing of pulp and paper are in economic difficulties at the present, the solution to this problem is by no means apparent. At present, the political consensus is centred around a scenario involving establishment of no new smelters, but providing existing firms with the electricity necessary to carry out modernization plans. This will necessitate a moderate reduction i;~ employment because productivity is expected to rise faster than capacity, but no greater than can be covered by natural wastage (scenario V in Fig. 4). To further accomodate environmental in-
terests, emphasis is being focused on saving electricity amongst other users.
4. Concluding remarks This paper has presented an example of how scenario analysis and simulation can be combined to form a basis for energy policy decision-making. Our starting point was the goals of the different patties with a stake in the future of the smelting industry. Our goal was to show what possible courses of action were open to the authorities to realize these parties' goals and what the consequences would be both for other groups and in the long-term. Many of the consequences of following a given strategy are difficult to quantify. It is an advantage to quantify a few key variables though so that one has some firm basis for comparison between scenarios. We limited analysis of other factors to a qualitative discussion. We desisted from making a ranking list of the different scenarios because it was in the nature of the matter that the scenario which won the day would have to be a compromise of considerations to the present pattern of employment, nature conservation and economics. The formulation of this compromise is dependent on who makes the decision. The interplay between the analyst and the reference group in which all the interested parties were represented, provided a forum for a broad discussion of these groups' strategies. The participants had another important function - to spread the insights from the strategy discussions to their respective interest group. The results of the scenarios and strategy discussions were finally published in a popularized book in order to reach a broader audience (see [1]).
References [i] L.K. Ervik, C. Tank-Nielsen, D. Nunn and J. Randers, Smelteoerkene i Smeltedigelen (Cappelens Forlag, Oslo, 1979). [2] D. Nunn, E. Moxnes and L.K. Ervik, Den kraftintensive industri i framtiden: Beskrivelse av gimuleringsmodellen SMELT, The Chr. Micheisen Institute, Bergen 0979). [3] J. Owens, Hydroelectric energy: The cost of conservation in Norway, GRS 121, Resource Policy Group, Oslo (1978). [4] J. Randers, The potential in simulation of macro-social processes, or how to be useful builder of simulation models, GRS I 1i, Resource Policy Group, Oslo 0977).