Moulay El Mehdi Falloul Energy and environmental economics 1 2 Introduction Energy economics is a broad scientific subject area which includes topics related to supply and use of energy in societies. Due to diversity of issues and methods applied and shared with a number of academic disciplines, energy economics does not present itself as a self-contained academic discipline, but it is an applied subdiscipline of economics. From the list of main topics of economics, some relate strongly to energy economics: econometrics, environmental economics, finance, industrial organization, microeconomics, macroeconomics, resource economics. Energy economics also draws heavily on results of energy engineering, geology, political sciences, ecology etc. Recent focus of energy economics includes the following issues: Climate change and climate policy risk analysis and security of supply sustainability, energy markets and electricity markets, demand response, energy and economic growth, economics of energy infrastructure environmental policy, Energy derivatives, forecasting energy demand. Environmental Economics is a sub-field of economics that is concerned with environmental issues. Quoting from the National Bureau of Economic Research Environmental Economics program. According to the National Bureau of Economic Research: ”Environmental Economics undertakes theoretical or empirical studies of the economic effects of national or local environmental policies around the world”. Particular issues include the costs and benefits of alternative environmental policies to deal with air pollution, water quality, toxic substances, solid waste, and global warming. This text provides an overview and a clear introduction to the fields of 3 energy and environmental economics. The volume’s audience is broad- gauged, academics and students seeking foundations for learning and research, and practitioners seeking guidance for informing their critical decisions in energy and environmental economics. Both newcomers to study of the field and those with a deeper knowledge base will find the material informative and stimulating. In order to establish boundaries and facilitate learning, I have divided this book into two parts: the first part deal with energy economics and the second part deal with environmental economics. 4 Part I Energy Economics 5 6 Chapter 1 Introduction to Energy Economics and its related fields 1. Introduction Energy economics or more precisely the economics of energy is a branch of applied economics where economic principles and tools are applied to “ask the right questions”, and to analyse them logically and systematically to develop a well-informed understanding of the issues. The energy sector is complex because of a number of factors: • The constituent industries tend to be highly technical in nature, requiring some understanding of the underlying processes and techniques for a good grasp o the economic issues. • Each industry of the sector has its own specific features which require special attention. • Energy being an ingredient for any economic activity, its availability or lack of it affects the society and consequently, there are greater societal concerns and influences affecting the sector. • The sector is influenced by interactions at different levels (international, regional, national and even local), most of which go beyond the subject of one discipline. Consequently, analyses of energy problems have attracted inter- disciplinary interests and researchers from various fields have left their impressions on these studies. The influence of engineering, operations research and other decision support systems in the field of energy 7 economics has been profound. Energy issues have been analysed from an economic perspective for more than a century now. But energy economics did not develop as a specialised branch until the first oil shock in the 1970s. The dramatic increase in oil prices in the 1973–1974 highlighted the importance of energy in economic development of countries. Since then, researchers, academics and even policymakers have taken a keen interest in energy studies and today energy economics has emerged as a recognised branch on its own. Like any branch of economics, energy economics is concerned with the basic economic issue of allocating scarce resources in the economy. Thus the microeconomic concerns of energy supply and demand and the macro- economic concerns of investment, financing and economic linkages with the rest of the economy form an essential part of the subject. However, the issues facing the energy industry change, bringing new issues to the fore. For example, in the 1970s, the focus was on understanding the energy industry (especially the oil industry), energy substitution and to some extent on renewable energies. Moreover, there was some focus on integrated planning for energy systems with a major emphasis on developing countries. The scope of the work expanded in the 1980s. Environmental concerns of energy use and economic development became a major concern and the environmental dimension dominated the policy debate. This brought a major shift in the focus of energy studies as well-the issue of local, regional and global environmental effects of energy use became an integral part of the analysis. In the 1990s, liberalisation of energy markets and restructuring swept through the entire world although climate change and other global and local environmental issues also continued. These changes brought new issues and challenges to the limelight and by the end of the decade, it became evident that unless the fundamental design is not well thought through, reforms cannot succeed. In recent years, the focus has shifted to high oil prices, energy scarcity and the debate over state intervention as opposed to market-led energy supply. This swing of the pendulum in the policy debate is attributed to the 8 concerns about security of supply in a carbon-constrained world. Accordingly, the objective of this book is to present in a single volume basic economic tools and concepts that can be used to understand and analyse the issues facing the energy sector. The aim is to provide an overall understanding of the energy sector and to equip readers with the analytical tools that can be used to understand demand, supply, investments, energy- economy interactions and relate policy aspects. 2. Energy and Multidimensional Interactions The multidimensional nature of the energy-related interactions is indicated in Figure 1. At the global level, three influences can be easily identified: (a) Energy trade-All transactions involving energy commodities (especially that of oil and to a lesser extent that of coal and gas) are due to the differences in the natural endowments of energy resources across countries and the gaps in domestic supply and demands; similarly flow of technologies, human resources, financial and other resources as well as pollutants generated from energy and other material use can also be considered at this level. (b) International institutional influences-Various influences through international institutions affect interactions among countries and govern transactions. These include the legal frameworks, treaties and conventions, international organisations such as the United Nations (UN), the World Bank and the International Monetary Fund (IMF), the judicial system and the like. (c) Other interaction-Other interactions among countries (co-operation, competition and conflicts) involving their governments or other entities (such as the firms) also influence the energy sector. These influences are neither mutually exclusive nor static in nature. Consequently, the relative importance of one or more of these influences on a particular country would vary and changes in the importance of one or the other over time could modify the relationships extensively. The key role of the energy sector in the economic activities of any economy arises because of the mutual interdependence between economic activities and energy. For example, the energy sector uses inputs from 9 various other sectors (industry, transport, households, etc.) and is also a key input for most of the sectors. These interrelations influence the demand for energy, possibilities of substitution within the energy and with other resources (capital, land, labour and material), supply of energy and other goods and services, investment decisions, and the macro-economic variables of a country (economic output, balance of payment situations, foreign trade, inflation, interest rate, etc.). Once again, the national level institutions (including the rules and organisations like government, judiciary, etc.) both influence and get influenced by these interactions. Figure1 Multidimensional interaction of the energy sector 10