Saturday, April 17, 2010

Energy Mix and Energy Intensity

The series continues:

Energy Quality and Shifts in Composition of Energy Input

In the course of economic development countries’ fuel mix tends to evolve as they move up the “energy ladder” (Hosier, 2004). Burke (2010) documents a similar progression for the power sources used in electricity generation. In the least developed economies and in today’s developed economies before the industrial revolution the use of biomass and animate prime movers dominates. The evolution of energy mix over the course of economic development and over history in the technologically leading countries depends on each country’s endowments of fossil energy and potential for renewables such as hydro-electricity but some regularities apply. The share of electricity in total energy use tends to rise. Low-income countries tend to generate electricity from hydropower and oil, while high-income countries have more diverse power sources including nuclear power. Direct use of coal tends to rise and then fall over time and income. Natural gas use has increased significantly in recent decades mostly in more developed economies. Finally electricity generated from solar- and wind-power and only now beginning to take off in more developed economies. The figure below illustrates this pattern for the United States.

Composition of US Primary Energy Input 1850-2008

Energy quality is the relative economic usefulness per heat equivalent unit of different fuels and electricity. Fuels have a number of physical attributes that will affect their relative qualities, including energy density (heat units per mass unit); power density (rate of heat units produced per unit are per unit time); ease of distribution; the need for a transfer medium; controllability (the ability to direct the position, direction and intensity of energy use); amenability to storage; safety, and environmental impacts (Berndt, 1978; Schurr, 1982; Zarnikau, 1996; Cleveland et al, 2000). Some fuels can be used for a larger number of activities and/or for more valuable activities. For example coal cannot be used to directly power a computer while electricity can. Some fuels, in particular electricity, can transform the workplace entirely and change work processes, thus contributing to productivity gains (Enflo et al., 2009).

Stern (in press) discusses alternative ways of measuring energy quality. The most relevant approach to understanding the impact of relatively small changes in the composition of the energy input on economic output is the marginal product of the fuel, which is the marginal increase in the quantity of a good or service produced by the use of one additional heat unit of fuel. The marginal product of a fuel is determined in part by the complex set of attributes described above that are unique to each fuel. It also varies according to what activities it is used in, how much and what form of capital, labor, and materials it is used in conjunction with, and how much energy is used in each application. More abundant fuels will be applied more widely and on the margin in less productive applications (Kaufmann, 1994). Therefore, energy qualities measured in this way are not fixed over time. However, it is generally believed that electricity is the highest quality type of energy followed by natural gas, oil, coal, and wood and biofuels in descending order of quality. This is supported by the typical prices of these fuels per unit of energy, which should be proportional to its marginal product. Under the assumption of optimizing behavior marginal products should be approximated by prices, which are usually readily available. Other indicators of energy quality must be estimated.

Surprisingly, relatively few studies evaluate the role of the change in energy mix on energy intensity. Schurr and Netschert (1960) were among the first to recognize the economic importance of energy quality in understanding trends in energy and output. Noting that the composition of energy use has changed significantly over time, Schurr and Netschert argued that the general shift to higher quality fuels reduces the amount of energy required to produce a dollar’s worth of GDP. Berndt (1990) also noted the key role played by the shifting composition of energy use towards higher quality energy inputs.

Cleveland et al. (1984), Kaufmann (1992, 2004) and OTA (US Congress, 1990) presented analyses that explain much of the decline in the US energy/GDP in terms of structural shifts in the economy and shifts from lower to higher quality fuels. Kaufmann (2004) estimates a vector autoregressive model of the energy/GDP ratio, household energy expenditures, energy mix variables, and energy price variables for the US. He finds that shifting away from coal use and in particular shifting towards the use of oil reduces energy intensity. This shift away from coal more than explains the decline energy intensity over the entire 1929-99 time period. If decoupling is mainly due to the shift to higher quality fuels then there appear to be limits to that substitution. In particular, exhaustion of low-cost oil supplies could mean that economies have to revert to lower quality fuels such as coal (Kaufmann, 1992).

U.S. GDP and Primary Energy Use and Quality Adjusted Final Energy

Notes: GDP is in constant dollars i.e. adjusted for inflation. Primary energy use is the sum of primary energy BTUs. Quality adjusted final energy use is a Divisia index of the principal final energy use categories – oil, natural gas, coal, primary electricity, wood and other biofuels. The different fuels are weighted according to their average prices. Sources: US Energy Information Administration and Bureau of Economic Analysis.

The figure above includes a quality-adjusted index of final energy use that accounts for differences in the productivity of different fuels by weighting them by their prices (see Stern, 2000). There is less evidence of decoupling of energy use and GDP in these data than indicated by the primary energy series especially up till 1973. The studies cited above and Stern (1993, 2000) used earlier GDP data that showed significantly less economic growth in the U.S.A. between 1960 and 1994 than more recent updated data. Using this data there was little decoupling of GDP from quality adjusted energy use even after 1973. This change in the GDP data indicates that structural change and technological change must also contribute to lowering the energy/GDP ratio in the last three decades assuming that prices reflect the relative marginal products of the fuels.

Other studies find, however, a much larger role for technological change than for changes in the composition of energy in the reductions in energy intensity seen around the world. For example, Ma and Stern (2008) find that interfuel substitution has negligible effects on the decline in energy intensity in China between 1994 and 2003. Technological change reduced energy intensity by more than the actual reduction in energy intensity due to the intensity increasing effects of structural change. Stern (2010) finds that between 1971 and 2007, changes in fuel mix within individual countries increased world energy use by 4%, while global energy intensity declined by 40%. Shifts in the distribution of economic activity towards countries with lower quality energy mixes such as China and India contributed further to increasing energy intensity globally.

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