ENVIR &RESOURC ECON
ENVIR &RESOURC ECON ECON 380
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Date Created: 09/26/15
CHAPTER 11 STATIONARY SOURCES LOCAL AIR POLLUTION Introduction A There are approximately 27000 major stationary sources of air pollution in the U S B In this section we will look at the evolution of efforts to control these pollutant sources focusmg on the cost effectiveness of the alternative policy tools that have been used Phase I Pre 1970 A Prior to 1970 there was little in the way of federal laws dealing with these sources of air pollution B The laws that were passed during this period were focused on 1 Providing funds for research into the problem 2 State grants for personnel training and technical assistance C At the same time the states were reluctant to move on the issue because it would put them at a competitive disadvantage in keeping and attracting industry D The Air Pollution Control Act of 1955 1 This was the first attempt to deal with the air pollution problem at the federal level 2 The law mai111y subsidized research into air pollution problems E Three addition pieces of legislation of importance 1 The Clean Air Act of 1963 the original clean air act a Created a mechanism for permanent federal support of environmental research b Allowed for federal assistance for the development of state control agencies c Introduced federal involvement in transboundary pollution problems 2 The 1965 Motor Vehicle Air Pollution Control Act Allowed HEW Health Education and Welfare to set emission standards for new motor vehicles 3 The 1967 Air Quality Act a Required states to establish air quality control regions AQCR s 15 1 111 b Required states to establish ambient airquality standards for the criteria pollutants F The transition piece of legislation between this and the next period was the National Environmental Policy Act of 1969 signed 1170 NEPA 1 Prior to NEPA environmental responsibilities were divided among 20 federal departments and agencies The agencies claimed to have no mandate to consider environmental problems NEPA b Created the Council of Environmental Quality a temporary precursor of EPA to quotprovide a consistent and expert source of review of national policies environmental problems and trends both longterm and short term Such a council would act entirely independently of the executive mission oriented agenciesquot Introduced the notion of the environmental impact statement This legislation represented the first tentative efforts of the federal government into the realm of direct involvement in pollution control Phase II 1970 1990 This second phase of pollution control efforts emerged from a frustration on the part of the federal government in terms of the lack of progress by states This phase is characterized by very direct intervention on the part of the federal government with extensive use of command and control forms of pollution control Four major developments occurred during this period including two pieces of legislation A The Clean Air Act Amendments of 1970 1 This act put the federal government in the position of a major player in pollution control for the first time The U S Environmental Protection Agency EPA was established to oversee and implement pollution control strategies The primary focus of the 1970 Clean Air Act was on criteria pollutants a DEFINITION Criteria Pollutants are ones that are I relatively common substances 2 found in almost all parts of the country and 3 presumed dangerous only in high concentration It is also called conventional pollutants in contrast to hazardous pollutants ones that pose a localized risk of severe harm to human health 152 The name comes from the language of the act requiring that the EPA develop quotcriteria documentsquot to be used in setting acceptable standards for these pollutants The criteria pollutants include i Sulfur dioxide ii Total suspended particulates iii Carbon Monoxide iv Nitrogen Oxides V Ozone vi Lead The Command and Control Policy Framework i The primary approach to air pollution has been to use emissions standards ie the command and control policy CAC ii Recall from the previous section that this approach is not ef cient iii For each criteria pollutant the EPA has established ambient air quality standards 0 These standards are legally binding everywhere but for practical purposes are only monitored at speci c locations iv The standards may specify a 0 short term eg three hour average concentration level typically can be exceeded no more than once a year and o A longterm standard eg annual concentration levels v Two standards are used 0 The primary standard is designed to protect human life and is used for all pollutants o The secondary standard is designed to protect other aspects of human welfare 7 Aesthetics 153 ltgt TSP and Sulfur dioxide impair visibility 7 Physical objects 0 Ozone corrodes rubber and paint 0 Sulfur Dioxide and TSP also corrode meta 7 Vegetation ltgt Nitrogen Oxides are toxic to plant life If there is a secondary standard it is the legally dominant standard e The ambient standards are required to be set by statute without any consideration given to the costs of meeting them f While EPA established the standards the states are primarily responsible for enacting the laws i iii States must establish a quotState Implementation Planquot SIP to be approved by the EPA The SIP divides the state into so called quotair quality control regionsquot The SIPs then spells out for each control region procedures and timetables for 0 Meeting local standards and o For the abatement of the effects on other regions 4 A Secondary focus was placed on Hazardous Pollutants a DEFINITION Hazardous gollutants are ones that pose a localized risk of severe harm to human health They are distinguished from criteria pollutants both by the degree of harm they pose and by the fact that emissions usually occur only at a few key locations b The EPA follows a separate control policy for this category i First the EPA identi es the substance as being within this categorization Once the substance is listed the EPA has to move within 180 days to either regulate the substance or remove it from the list 154 Typically it is acknowledged that there is no safe level for airborne carcinogens so that they should be banned entirely according to some readings of the Clean Air Act However this would be prohibitively expensive Question What would you expect to be the EPA39s approach in this case A The EPA has moved slowly to list pollutants By 1980 only 7 pollutants were on the list i asbestos ii beryllium iii mercury iv vinyl chloride v benzene vi radionuclides vii inorganic arsenic Despite the 180 day deadline only four were regulated by 1980 i Asbestos ii beryllium iii mercury iv vinyl chloride Subsequent court action led to addition standards by 1984 By 1989 only 7 of the 86 pollutants were controlled The EPA has incorporated bene t cost analysis and risk assessment into its decision making process unlike in the case of criteria pollutants It has created a list of substances on an quotintention to listquot list in order to buy time The 1977 Amendments to the Clean Air Act 155 1 By 1975 it was apparent that many regions would not meet the statutory deadlines 2 In 1977 congress passed the 1977 Amendments to the Clean Air Act a The carrot extending the deadline for attainment to i 1982 for all primary standards ii 1987 for ozone and carbon monoxide b The stick designating all areas not expected to reach the original deadlines as quotnonattainment regionsquot These regions were subjected to stringent controls i These regions had to have precise plans for attainment with the EPA now having the power to o Halt construction on new or modi ed pollution sources 0 Deny federal sewage and transportation grants to the offending state ii Nonattainments regions were forced to have a permit program for large new construction and major modi cations technology based effluent standards TBES are introduced 0 Permits could not be issued if it jeopardized attainment 0 New sources had to control emissions to the quotlowest achievable emissions ratequot LAER DEFINITION LAER is the lowest emissions rate included in any SIP plan whether or not any source is currently achieving that rate Note LAER is set by the state 0 Existing Sources in nonattainment regions had to install RACT39s reasonably available control technologies 3 Another major development during this period was the establishment of the Prevention of Signi cant Deterioration Policy PSD a Standards merely set upper bounds they do not lead to improvements everywhere or prevent deterioration of existing attainment regions b The PSD program speci es the maximum increase in pollution from a speci ed baseline with the increase depending upon a region s classi cation 1 5 6 i Class I Consisted primarily of national parks and wilderness areas Almost no allowable increment ii Class 11 Moderate increments allowed iii Class 111 Largest increments allowed unless increments to violation of ambient standards c Permits were required for new pollution sources within a region i The new sources must employ the best available control technology BACT ii BACT39s were determined by the state on a casebycase basis iii No technologybased effluent standards for existing sources EPA also established national uniform emissions standards for new sources known as the New Source Performance Standards NSPS a These were instituted as a oor to BACT and LAER standards b The idea is that the EPA should control the standards for new sources and the states control standards for existing sources NSPS speci es the oor for new sources c Empirically if the EPA has decided a NSPS it is usually considered as LAER in nonattainment areas and BACT in PSD areas Newsource bias stricter standards for new sources Justi cation a economic more costly to incorporate new control equipments to existing plants than to new plants b political owners of existing plants have more political power than those of new plants i This policy helps deter competition c administrative there are more existing plants than new plants cost saving Question What are going to be problems with the above policies a It takes time to establish all of the standards including LAERs and BACTs b It also takes money Enforcement is required 1 5 7 C c In 1977 the federal government established that noncompliance penalties be based upon the economic value of delay to the source d The standards do not take into account differences in meteorological conditions Therefore they must be stringent enough to work under the most adverse conditions Evaluating the Command and Control Approach 1 Efficiency of the Command and Control Approach Efficiency requires that the ambient standards be set at an efficient level There are four aspects of current procedures which suggest that this is not done a The Threshold concept i The Clean Air Act prohibits the balancing of costs and benefits of pollution ii Instead it uses the quothealth criterion thresholdquot the quotstandard has to be set with a margin of safety high enough so that no adverse health effects would be suffered by any member of the population as long as the air quality met the standardquot iii Question What is wrong with this standard besides the fact that it ignores costs and benefit trade offs o It presumes that such a threshold exists 0 In all likelihood this threshold is zero or near zero b The Level of the Standard i Costbene t analysis is precluded ii The resulting standard is likely to be inefficient iii That is not to say that controls are unjusti ed just that they may be inefficiently set c Uniformity the standards usually take no account of i The number of people exposed ii The sensitivity of the local ecology iii The cost of emissions control in various areas iv The Timing of emissions ows 158 o The timing of emissions can be as important as the locational considerations 0 Stagnant air can make normally acceptable pollution level problematic 0 Since bene ts depend upon meteorological conditions so should emissions standards The CostEffectiveness of the CAC Approach a In general it is hard to say how bad the CAC approach is b Several studies however suggest that the problem may be severe c These studies typically compare the CAC approach to the least cost method of ach1ev1ng the same object1ve d In general the costs are 2 to 22 times higher under CAC than under the least cost method Table 162 e The CAC approach did relatively well only where the pollution problem was so bad e g LA in the Hahn and Noll article that everyone had to control as much as possible In these cases there was no room for exibility Emissions Trading Program 1 The Clean Air Act focused on the speci cation of emissions standards imposed upon speci c emissions sources e g stacks vents storage tanks The Emissions Trading Program was developed not as the result of a single law but through a series of rulings and statutes from late 1975 through present The trading program tries to inject a degree of exibility into the system Components a The Emissions Reduction Credit i This is the currency of the system ii Sources controlling emissions to a point higher than the degree necessary to ful ll its obligations can apply for a certi cation of excess control 159 iii They then receive a reduction credit which can be quotbankedquot or used in one of the following policies iv In order to receive the credit the source must prove that the reduction is o a surplus o enforceable o permanent not that the trade must be permanent Only that the emission reductions giving rise to the ERC is permanent o quanti able The Offset Policy for newexpanding sources in nonattainment regions i This policy attempts to resolve the con ict between economic grth and ambient standards in nonattainment regions ii The policy allows a new or expanding source to commence operation in a nonattainment area provided they acquire sufficient emissions reduction credits from existing sources Typically they must acquire 20 more credit than the added emission of the new facility iii In essence the new sources are nancing the additional emissions control by existing sources iv The new sources must still meet the LAER requirement by itself and for all existing sources owned and operated by the applicant The Bubble Policy for existing firms mame intrame i The bubble policy allows existing sources to use emissions reduction credits to satisfy their SIP responsibility ii The sum of emission reduction credits plus actual emissions reductions must equal assigned emissions reductions iii The name comes from the image of treating all sites as being within a bubble and the goal being to reduce the total pollution within the bubble Netting for modi cation of existing sources intrafirm i Netting allows sources undergoing modi cation or expansion to escape the burden of new source review so long as the net 15 10 increase in plantwide emissions is insigni cant including emissions reductions credits ii Typically new source review occurs when the increased emissions resulting from modernization or expansion exceeded a speci ed threshold iii Netting allows the company to o avoid the review process 0 The need to acquire permits as well as meeting the associated permit requirements such as 7 the need to install BACT or LAER control technologies iv However netting cannot be used to avoid NSPS standards Banking i Banking allows the firm to store emission reduction credits for future use ii Emission credit reductions are the currency of this bank iii States are responsible for designing their own banking systems The Effectiveness of the reform Example Narraganset Electric Company i The company had two generators ii Originally both plants had to burn 1 sulfur oil in order to meet the standard iii The trading program allows them to run one plant with high sulfur coal 22 while running the second plant using natural gas or not at all iv This saved an estimated 3 million reduced imported oil by 600000 barrelsyear and reduced sulfur emissions by 30 Achievements i Worked well mai111y for unifome mixed pollutants ii Mame involved large polluting sources close to each other 1511 Table 15 8 of Field c Question What can go wrong with this system i Potential Imperfect Competition 0 If monopolies or oligopolies arise in the market for permits inef ciencies can result 0 Initial allocation of permits becomes imp01tant for ef ciency 0 While this is a potential problem the data suggest that it is not currently a signi cant problem and is far outweighed by the bene ts of the problem ii Property Rights and Permit Banking 0 Emissions reduction credits are not always vested in the supplier o In San Francisco and LA communities have resisted vesting ownership of credits with the original sources 7 The credits are viewed as a public resource to be used for other purposes 7 San Francisco allows these credits to be con scated if more stringent standards are set later Question What impact will this have on the trading program and its ef cacy It will eliminate the rm s incentive to reduce emissions and obtain marketable permits Progress to Date 1 There has been some signi cant progress in the control of the criteria pollutants particularly a Lead b Particular matter c Carbon monoxide Portney Figures 1512 2 However signi cant problems persist in terms of a Ozone b The number of nonattainment regions Portney Table 3 3 3 It is dif cult to determine the reason for these changes a The Clean Air Act Amendments may have contributed to the changes b However there is evidence to suggest the change in pollution control was more rapid prior to 1970 than in the years after 1970 IV Phase III 1990 Present The 1990 Clean Air Act A There is additional recognition of the region diversity of needs in terms of pollution control Severe Moderate Serious etc divisions B Transferable emission permit plan for controlling S02 emissions from power plants 1 EPA issues quantity of emission permits to designated power plants a Each permit allows 1 ton of S02 2 Phase I 1995 2000 a covers 110 electric utility large coalburning plants in 21 eastern and Midwestern states b number of permits of each plant average BTUs of fuel used 19851987 in million 25 pounds of 302 per million BTUs c about 55 million permits were allocated initially d EPA also has 35 million reserve permits 3 Phase 11 program to be expanded to cover power plants throughout the country a Formula change 12 pounds of S02 instead of 25 b Overall cap of 895 million permits given out by the EPA 1513 CHAPTER 7 DEPLETABLENONRECYCLABLE ENERGY RESOURCES I Introduction A In this chapter we will review the use of alternative energy resources and their use Speci cally we will look at 1 2 II Energy Usage A The dependency of the U S energy 1 on Overview of Energy Resources Natural Gas the impact of price controls Oil a Price Controls and Cartels b The Impact of OPEC on resource allocation c Oil as a national security concern Alternative Energy Resources a Transition fuels Coal Uranium b Renewable resources Solar Power Wind Power Hydroelectric Power Current Conservation Efforts resources IAII III r has grown signi cantly over time Changes in U S Energy Sources a 1850 1900 1950 1989 Current Energy Usage Patterns 1 US US Energy Sources 5 4 EB i am ass 2 World World Energy Sources 4 l7 EBiomass 32 Oil and natural gas should be transition fuels eventually replaced by with smooth transition 1 other transition fuels coal and uranium 2 renewable resources solar power wind power hydroelectric power D We will focus primarily upon the use of oil and natural gas Speci cally we will be asking the question Given current property rights and market conditions are these resources likely to be optimally allocated III Natural Gas A Historical Background 1 Natural gas was discovered in the search for oil 2 Discovered principally in Texas Oklahoma Louisiana California and West Virginia as well subsequently in Alaska and offshore 3 Prior to WWII the usefulness of natural gas was limited due to transportation costs a It was not found in traditionally industrialized areas of the country b In the 1920 s and 30 s it was primarily burned off as a wasted product 4 Following WWII a long distance pipeline system was developed increasing the availability of gas allowing natural gas to become a major source of energy for the United States a Currently Natural gas comprises about 25 of the energy consumer in the U S b About 50 of residential homes and buildings rely upon gas for heating B Question Has natural gas been ef ciently allocated in the past and is it likely to be in the future 1 Historically the answer to this question appears to be no a During the winter of 197475 serious shortages occurred in the natural gas industry with shortages of approximately 10 of the total gas production in 1975 b The likely cause of this shortage was price controls set by federal regulation 2 The Origins of Price Controls a The Natural Gas Act of 1938 i This act empowered the Federal Power Commission FPC later the Federal Energy Regulatory Commission FERC to regulate 73 the price pipeline companies could charge for gas shipped over state line ie interstate ii The 1938 Act did not allow the FPC to regulate wellhead prices However the companies that owned the elds often also owned the pipelines If they did not this helped to encourage vertical integration iii Average Cost pricing was used to determine prices with an allowable rate of return built in b The Supreme Court 1954 Phillips vs Wisconsin gave the FPC powers to regulate back to the wellhead i Owners of the fields were perceived to have monopoly powers and to be charging too high a price However the evidence does not support this conclusion ii Primarily the regulation was an attempt to shift rents from the producers to the consumers rents from the increased cost of discovering and extracting new reserves That is the problem of new versus old wells arose iii The pipeline owners that did not own elds were in part behind this regulatory push as were final consumers c Regulatory havoc ensued The task of regulation proved cumbersome i There were thousands of natural gas wells at the time and thousands of individual producers ii In early years FPC was overwhelmed 0 Between 1955 and 1960 over 3500 producers applied for rate increases Only 10 of these applications were processed 0 Finally the FPC decided upon quotarea ratesquot with differences between quotoldquot and quotnewquot gas Question What are the consequences of price controls 1 Short Run a Static analysis the shortage is qdqs pgtxlt Pc i l E D gtxlt Q qs q qd b Average Cost Pricing new gas vs old gas rent distribution Price MEC2 Pavg MEC1 Dem and Q0 Q Qd Quantity c The lack of intrastate regulation caused wide disparities between states ie those with natural gas reserves and those without i higher price within the production state ii producers commit reserve addition to intrastate instead of interstate markets iii shortage becomes more intensi ed in states relying on pipeline Long Run intertemporal Misallocation i Price lower at the beginning and jumps at the end p MCsub PC J 0 p0 time ii Price control has impacts even when pc is not binding if the price control is effective permanently S3 82 S0MECMUC pc Sl h 12 qo ql q 0 Even if pcgtp0 MUC decreases as price control is imposed 0 Total MCMECMUC thus S1 is lower than S0 more is produced at a lower price initially iii 0 As stock decreases MEC increases and eventually shortage happens at Sgyshortage is qzqg In summary two impacts of the pricecontrol policy 0 Demand will increase due to lower prices 0 Supply will decrease current reserves will decline as long as the price controls are permanent Two differences between this allocation and the efficient one o The time of transition to a substitute is earlier with price contro s o The transition is abrupt with prices suddenly jumping to a higher level Question Why would the government do this Consider the impact of these controls on the current time period PU TMCMUCMC1 MC1 RR B MC1 A C E D H G Demand Qi Quantity 0 Question What impact would these changes have on TNB ACS ABCE ABDE BCD APS ABDE DCHG ATNB ACS APS BCD DCHG gt 0 Politically attractive current voters gain Question What is the problem with this solution Answer It ignores future generations V Substitution Bias The use of average cost pricing led to the use of expensive blending agents eg liquid and synthetic gas to ll the gaps created by shortages This increased the reliance upon imports at a time when official policy was to discourage imports It also led to a reliance upon expensive energy substitutes that could be blended with gas and away from substitutes which could not be blended solar power etc Conversions to natural gas continued due to artificially low prices further increasing the demand for gas The low price of natural gas leads to additional investment in equipment that relies on natural gas However the market for the equipment will dry up when the gas is not available vi Intertemporal guessing Real Impact Up until now we have assumed that the pricecontrols are permanent The additional uncertainty regarding price controls leads to additional uncertainty and inef ciency i Early in the 1970 s residential customers were getting all the gas they wanted but gas companies were refusing to sign new contracts with industrial customers 78 OPEC oil embargo and subsequent oil price shocks By mid1970 s gas supplies to existing customers were curtailed All curtailments were occurring in the interstate markets Between 1976 and 1979 gas was being cut off during the peak period winter and schools were being shut down Recall we also have oil crisis during this period Public outcries for change in regulatory process This did lead to some changes 0 Rationing was instituted which has its own problems 0 FPC raised prices for new contracts allowing for quotnew newquot gas The price for new new gas was set at intrastate market level Retained vintages for gas and average cost pricing 3 The Natural Gas Policy Act November 1978 This act allowed for the eventual phase out of some price controls a b The House wanted broader control The Senate wanted decontrol Compromise i Only 3 out of 30 categories of gas were decontrolled Creates substitution bias Deepwells deregulated while some other types of wells were not This encouraged the move to deep wells In 1977 there were 50 deepwells This rose to 350 by 1980 All old contracts Alaskan and offshore gas would still be regulated even after 1985 Movement away from average cost pricing Institution of the intrastate gas price control until decontrol was completed This was not a complete fix but a temporary one i Eventually supplies could again be short IV Oil ii Recession of 1981 saved the day to some extent along with the oil glut that followed and continues today On July 27 1989 Bush signed a bill removing in stages all of the remaining controls on natural gas By January 1993 no sources of natural gas were subject to price controls Major issue cartel and price control A History 1 Phase 1 The emergence of the majors a Prior to WWI there were 4 international rms i Standard Oil ii Shell Oil iii Nobel iv Rothschild The last two rms were Russian and died out with the Russian Revolution During W W I AngloPersian emerged later renamed British Petroleum During the 1920 s and 30 s four more international rms emerged i Gulf ii Texaco iii Standard Oil of California iv Mobil These intemational oil companies formed what was know as the quotseven sistersquot of the oil industry alluding to the extensive collusion that took place between these firms During the early period the majors with the help of their governments eg the U S State Department established concessions with countries later found to have substantial oil reserves Both parties benefited i The Host Countries gained 710 0 Capital and technical expertise to develop their resources The majors were taking a risk While the rst Saudi wells were drilled in 1934 the first successful wells were not found until 1938 and the size of the Saudi reserves were not appreciated until after WWII o Revenues in the form of xed royalty payments ii The Majors gained 0 Access to large geographical areas with potentially large oil reserves for a large number of years 0 Almost total control over production and pricing Phase 2 The Decline of the Power of the Majors WWII to 1960 a Things changed after WWII with i Increased oil demand which led to the entrance of hundreds of smaller new entrants into the market and consequently the majors losing market power Some governments actively encouraged new entrants including Libya ii In ation which reduced the real value of the xed royalty payments to the host countries iii The rise of nationalism in the host countries iv The uncovering of large reserves in the host countries These countries began to realize their true wealth and potential market power The majors had almost done too good a job of discovering oil b The Collapse of the Major s power i 19431948 Venezuela established the principle of profit sharing ii 1957 American rms raised prices to thwart independents The host countries liked this move because it increased their pro ts iii 1959 Realizing that the increased prices were not working the majors pushed for a reduction in oil prices This created friction between the host countries and the majors which in turn led to the formation of OPEC by 711 0 Saudi Arabia 0 Iran 0 Iraq 0 Kuwait 0 Venezuela These countries gured everyone was winning but them 0 Gas stood at 30 barrel from which the Saudis got 20 30 barrel 0 Oil prices were dropping iv Despite the formation of OPEC not much changed initially o The companies had three major advantages Technical expertise Control of the distribution and marketing of oil The majors could work together 0 In addition there was still excess capacity in the system Phase 3 Rise of OPEC 1960 1981 a The boom of the 196039s increased the demand for oil b Other countries were using up their reserves Figure 81 c OPEC Countries started using the threat of nationalization d ArabIsraeli War 1973 i The Suez Canal was closed ii OPEC ceased bargaining with the oil companies iii OPEC tied the supply of oil to perceived support for Arab countries in the ArabIsraeli war cutting off oil to the U S 712 iv OPEC countries started the nationalization process of oil reserves 4 Phase IV The Decline of OPEC s Power a Iran Revolution and the IranIraq war While oil price increased internal disharmony increased within OPEC b Demand started to fall due to high oil prices and long run adjustments to oil demand began i fuel ef cient cars ii fuel ef cient houses etc c The recession of 1981 induced an additional reduction in the demand for oil with prices dropping from 40barrel to 28barrel by 1983 d With the oil glut came a loss of power and incentives to cheat by individual countries e OPEC remains a formidable force controlling roughly 75 of the world s proven oil reserves What factors made OPEC possible 1 The price elasticity of demand DEFINITION The griee elastiei of demand the percentage change in usage that results from a 1 change in the price 713 Inelastic Demand 77 0 Elastic Demand 77 gt Price Demand Price MEC MEC P1 P1 PU PU Demand Quantity Quantity a The price elasticity determines the change in revenues that can result from forming a caitel Caitel is more pro table when demand elasticity is lower Low Elasticity of High Elasticity of Demand l lt 7 lt 0 Demand 77 lt 1 Price Demand Demand Quantity b The elasticity of demand depends upon the availability of substitutes and conservation opportunities i Substitutes place an upper limit on the degree to which prices can be raised by the oil cartel Examples natural gas cartel controls much of this as well solar power currently competitive in many parts of the country for space and water heating wind power developed extensively in the west esp hydroelectric power a growing part of U S electricity supply due transportation improvements ie wheeling coal ii Conservation more important in the long run Thus longrun elasticity of demand is typically much higher than shortrun elasticity Examples storm windows fuel ef cient cars water heater wraps A high income elasticity of demand improves OPEC s position over time OPEC will be effective only if it controls a major portion of the oil Currently only Mexico has large enough reserves to individually Other major players include Great Britain and Norway with the North 2 The income elasticity of demand a 3 NonOPEC suppliers a reserves b in uence the market c Sea oil d The strategy of OPEC Salant s 1976 competitive fringe model 715 i The fringe makes a difference if it controls as little as 13 of the market ii The residual demand facing the Cartel has a higher demand elasticity Sf q iii The cartel initially sells at a lower price with the fringe than without the fringe forcing the fringe to produce more in response to higher demand and use up its reserves Then the Cartel can charge a much higher price 1979 OPEC accounted for 50 of world oil production 1986 OPEC accounted for only 30 of world oil production iv The competitive fringe bene ts from the existence of the Cartel they do not have to cut production to enjoy the high price Compatibility of Member Interests a The internal cohesion of the cartel is critical b This cohesion was highest during the ArabIsraeli war c Each member has an intrinsic economic incentive to cheat i While other members cut their production to raise the price you can earn a high pro t by producing more cheating 716 d But if everybudy ehests pnce wtu deereese humng all cartel members d thuut edhesmn manba39s WAllbemure temptedte cheatdunng hard dmes Questinn What are the cnnseqllmczs at having 2 when 1 The market Will smteh prematurely td mef mmt Energy resuurces z Cunsuma Surplus mu he lust Quantity There Will he a sxgm cznt Ted smbuhun ufwurld medme an inef cient redistributh OPEC 15 hdtthe unly pmhlem wtth the ml market Qnem39tm What isanmhu39 pmhlexm Pnce eedmgs 1 Pnce eedmgs un ml stated with the wageghee cuntxuls uf Nxxun The handhele fur these cuntxuls ms m anun guhng Nmem wmted te ehmmate m anunary Expectauuns h A seeemd ranunale fur pnce cuntxuls was te pmteet cunsumErs 39nm munupuly puwer z The Ema39gmcy Fetxuleum Aet uf1973 extended cuntxulstu ddmesde ml 7717 shortage resulted 3 Decontrol began during the Carter Administration in 1979 4 What are the problems with price controls a We have the same problems as with natural gas b The OPEC problem makes this problem even worse by encouraging the U S to use up its own reserves E Oil as a National Security Problem 1 From an economic point of view vulnerable strategic imports have added public costs to society which are not re ected in the marketplace Price A SUPPIYdomestic T T SforeignMCsec 13 Sforeign Q Demand lt gt Qd QT Quantity QT 2 Basic Case without premium draw black part of graph a Demand QT b Domestic Supply Qd c Foreign Supply QT Qd 3 Adding in national security consideration draw new line a Demand QT 718 V b Domestic Supply increases to QT c Foreign Supply is reduced to zero Without the security issue considered too little is produced domestically and too much is imported Question What happens in the event oftrade embargo a In the short run only QT is supplied at price P2 Eventually domestic supply rises Question Is self suf ciency optimal a No It lowers overall consumer surplus b Embargoes are not certain events c Strategic petroleum reserves and other government actions can be used to mitigate the impact of an embargo d Current consumption of domestic reserves increases the vulnerability of future generations Possible solutions a Oil consumption tax encourages conservation but cannot achieve the ef cient importdomestic production ratio b Subsidization of domestic supply achieves ef cient ratio but cannot reduce consumption c Tariffs on oil imports setting the tariff P1 P0 i The higher price will achieve ef cient ratio and discourage consumption ii Provide some revenues for the federal government iii Transfer some of the rents from OPEC to the U S Transition Fuels A Coal 2 U S Reserves of Coal are 22 times greater than its reserves of oil and gas combined The environmental impacts of coal burning however are high 719 a Acid rain b Increase amounts of carbon dioxide in the air the greenhouse effect B Uranium 1 Domestic uranium reserves are 42 times higher than gas and oil reserves 2 With the use of breeder reactors uranium reserves are 252 times oil and gas reserves 3 There are signi cant potential and actual environmental problems with nuclear power a Nuclear Accidents i Three Mile Island March 28 1979 ii Chernobyl s core meltdown April 25 1986 b Political problems Sweden is dropping all of its nuclear plant due to political pressures with dif cult transitional problems in their future c Recent problems with Pentagon nuclear plants CBO 1994 estimated that it may cost 1 trillion to bring the facilities into compliance d The problem of disposing of radioactive waste i Waste has an extremely long life 1000 to 250000 years Thus decisions today have impacts on many future generations ii One could tax those who consume nuclear power today in order to compensate those living near nuclear plants or disposal sites e Question Will the market make the right decisions here Probably not VI Conservation and Load Management A Conservation has naturally occurred with the higher oil and gas prices B PUC s chose responsibilities include regulating production transmission and sale of electricity have been encouraging conservation C Conservation approaches a Utilities invest in conservation not in new plants subsidize conservation measures 720 peakload pricing charge higher price at peak time winter or certain time of a day at the MC of peaking units internalizing environmental costs environment tax on electricity 72 1
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