Energy Economics

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ENERGY ECONOMICS

Energy economics is the application of economics to energy issues. Central concerns in energy economics include the supply and demand for each of the main fuels in widespread use, competition among those fuels, the role of public policy, and environmental impacts. Given its worldwide importance as a fuel and the upheavals in its markets, oil economics is a particularly critical element of energy economics. Other efforts have treated natural gas, coal, and uranium. Energy transforming and distributing industries, notably electric power, also receive great attention. Energy economics addresses, simultaneously as well as separately, both the underlying market forces and public policies affecting the markets.

Economic concerns differ sharply from those of natural scientists and engineers. The most critical difference is in the outlook towards supply development. Many economists argue that market forces allow smooth adjustments to whatever happens to the physical stock of resources. Potentially, these market forces can produce resources cheaper than other methods presently employed to cause adjustments. At worst, the cost rises will be gradual and manageable. In contrast, these economists stress the harmful effects of governments on energy.

A major influence on this optimism in market forces is observation that, historically, technical progress has promoted energy market development. However, the processes by which this progress emerges have not been conducive to formal economic analysis. Rather than wait for a satisfactory model, economists must treat new technology as an unexplained but vital element of energy markets. A related consequence is that established energy sources get almost all the attention. Economics can say little about products that have not emerged.

RESEARCH IN ENERGY ECONOMICS

Scholarly study of the issues in energy economics ranges from massive tomes to short articles. Government and international agencies, consulting firms, industrial corporations, and trade associations also produce a vast body of research in energy economics.

THE PRACTITIONERS

The practitioners of energy economics variously identify themselves as energy economists, mineral economists, natural resource economists, and industrial organization economists. Separate professional societies exist to represent each of three specialties: resource and environmental economics, mineral economics, and energy. These associations do not interact with one another In addition, academic programs exist in each of these areas.

SPECIALTIES AND SUBDISCIPLINES

In each case, quite different bases created the specialties. Energy economics as a separate field emerged with the energy turmoil of the 1970s. Many people were suddenly drawn into dealing with energy issues and felt a strong need for organizations exclusively dealing with their concerns. In contrast, mineral economics emerged in the 1930s from interactions among mineral engineers, geologists, and economists on how the insights of their individual fields could be combined to deal with the problems of all forms of mineral extraction. Mineral economists took a broad view of minerals that gave a prominent role to energy, but many energy economists viewed mineral economists as concerned only with rocks. A more critical problem with mineral economics was that its reach was and remains limited to specialized academic programs and long-established mineral agencies such as those in the U.S. Department of the Interior, and that it was dominantly North American. The energy economists attained greater breadth in the identity and nationality of participants.

Resource economics has at least two bases. Many natural scientists raise widely accepted broad concerns over natural resource availability. A massive federal government study of the problem was instituted during the Truman administration. One result of the effort was the Ford Foundation endowment that established Resources for the Future, a Washington, D.C., research institute, devoted to the study of all natural resource problems. The institute has attracted leading figures in all areas of resource economics, including the environment. Academic programs in resource economics grew mainly from efforts to broaden the scope of agricultural economics, a discipline long practiced principally at the land-grant colleges of major U.S. agricultural states. The scope went on to encompass consideration of environmental problems.

WHY SUBFIELDS EXIST

As is standard in the development of subdisciplines, these fields arose from an intuitive perceived need. Nothing more than the ability to maintain a critical mass of participants adequately justifies the separations. Although the areas deal with different bodies of fact, this distinction is insufficient to justify a field. If it were, we might also have automotive economics or baseball economics. All involve application of economic principles to particular problems. Finding unifying analytic bases for separation is problematic.

Similar arguments, however, can be made about the formal justifications made for even the largest, longest-established branches of economics. The line between pure theory and industrial economics is fuzzy; international trade economics is largely a demonstration that nationality should be economically irrelevant. Given the vast expansion of modern economics, it is necessary to subdivide into convenient sectors. The energy and related realms reflect, on a considerably smaller scale, the value of such segmentation in uniting people with similar interests. Thus, the argument that special analytic issues arise does not justify the existence of special fields; a community of interests is what dominates.

MINERAL DEPLETION AND ITS POLICY IMPLICATIONS

A perennial subject of concern is the long-term availability of energy resources. Natural scientists and even many economists not specializing in natural resources stress the importance of the physical limits to the amount of available energy and to the thermodynamic forces through which initial use precludes economic reuse. Natural resource economists counter that this approach provides an incomplete and misleading vision of the "natural" resource sector. While the physical endowment is limited by definition, its usability is not. Existence does not guarantee economic value. First, a use for the "resources" must be found. Then techniques must be designed and profitably implemented for finding ("exploration"), converting the finds to producing properties ("development"), processing the output to a useable form, and moving the production to customers.

Resource economics stresses that, to date, experience is that the conversion of unutilized resources to profitable ones has moved ahead of demand growth and resource commodity prices have fallen over time. Moreover, M. A. Adelman's classic studies of petroleum supply development have shown that exploration is an ongoing effort to expand the potential for supply expansion. A backlog of developable prospects always exists. When profitable, the much more expensive development stage is undertaken.

Resource pessimists counter that this process cannot proceed forever because the eternal persistence of demand for any given commodity that is destroyed by use must inevitably lead to its depletion. However, the eternal persistence assumption is not necessarily correct. The life of a solar system apparently is long but finite. Energy sources such as nuclear fusion and solar energy in time could replace more limited resources such as oil and natural gas. Already, oil, gas, nuclear power, and coal from better sources have displaced traditional sources of coal in, for example, Britain, Germany, Japan, and France.

Alarms about depletion arose long before massive energy consumption emerged. Experience suggests that the fear is premature. Acting politically to save energy resources may prove more wasteful than allowing consumption. Indeed, the exhaustion problem already is extensively abused to justify undesirable policies. Every local energy producer that reaches the end of its economic life argues that it should be preserved as a hedge against exhaustion (or whatever other evil that can be thought up).

Markets themselves are structured to be very responsive to whatever problems arise with resource supply. Depletion is an economic problem, and markets are capable of reacting to it. Economic limits necessarily are greater than physical ones. That is, much that is physically present will never be economical to employ. Total depletion, if it occurs, will repeat on a large scale what has already occurred for specific suppliers. Costs will become prohibitive, output will start declining, and a steady, recognizable move to extinction will follow.

Elaborate economic theories of exhaustible resources shows that the cost and price pressures associated with such resource depletion provide incentives for slowing depletion. Prudent investors are rewarded doubly. The impending decline in supply pushes up prices and thus the gross income from sales. The restraint slows the depletion of low cost resources, lowers production costs, and thus the net payoff to delayed sales. The theory also indicates that the distribution of payoffs between the two sources can differ greatly. Thus, while we can expect to observe steady upward pressures on energy prices, many different patterns are possible. Price rises will be persistent but not necessarily at a constant rate. The absence of evidence of such price pressures is strong evidence that exhaustion is not an immediate threat. Whatever pattern proves optimal can emerge in the marketplace, and the skepticism among many economists about government foresight are amply proved by prior energy experience. Appraisals of prospects will change with improved knowledge and whatever else permanently alters the situation. Competition among specialized private investors is more adaptable than public policy.

To complicate matters, a government program to assist investment in minerals will not necessarily slow depletion. Investment aid, to be sure, encourages depletion-reducing investment in delaying production. However, the aid also stimulates depletion-increasing investments in production facilities. Which effect predominates depends on the circumstances. Depletion retardation is more likely for producers with presently large excesses of price over cost. Depletion stimulation is more likely when prices are close to costs.

ECONOMIC EFFICIENCY VERSUS SUSTAINABLE DEVELOPMENT

Since the 1980s, the persistence of concerns over both the maintenance of natural resource commodity supply and environmental quality has become restated as a search for sustainable development. The concern is that unregulated markets will produce a pattern of natural resource commodity production that unduly favors the present and near-term future over the longer-term, and generates too much pollution.

Some resource economists fervently support the concept of sustainability. Others argue that the principle is less coherent, comprehensible, and compelling than prior concepts, particularly the core economics principle of efficiency. For economists, the choice of terminology is secondary. The primary concern is resolving the underlying problems of possible market inefficiencies and the ability of governments to cure them.

Richard L. Gordon

BIBLIOGRAPHY

Adelman, M. A. (1995). The Genie out of the Bottle: World Oil since 1970. Cambridge, MA: MIT Press.

Barnett, H. J., and Morse, C. (1963). Scarcity and Growth: The Economics of Natural Resource Availability. Baltimore: Johns Hopkins Press for Resources for the Future.

Brennan, T. J.; Palmer, K. L.; Koop, R. J.; Krupnick, A. J.; Stagliano, V.; and Burtraw, D. (1996). A Shock to the System: Restructuring America's Electricity Industry. Washington, DC: Resources for the Future.

Gilbert, R. J., and Kahn, E. P., eds. (1996). International Comparisons of Electricity Regulation. Cambridge, Eng.: Cambridge University Press.

Simon, J. L. (1996). The Ultimate Resource 2. Princeton, NJ: Princeton University Press.