Economics of Energy Markets

May 24, 2017
Supported by the U.S. Department of Energy and the National Science Foundation
Meredith Fowlie of the University of California at Berkeley, and Christopher R. Knittel of MIT, Organizers

Joseph E. Aldy, Harvard University and NBER

Evaluating a Discretionary Safety Valve: The Economic and Environmental Impacts of Waiving Fuel Content Regulations in Response to Supply Shocks

Given the uncertainty over compliance costs characterizing many public policies and regulations, economists have developed decision rules for choosing a price-based or quantity-based instrument – or a hybrid of the two approaches – to maximize net social benefits. Recent applications of quantity-price instruments include state renewable power mandates, federal renewable fuel mandates, and several carbon dioxide cap-and-trade programs. The evolution of fuel content regulations has resulted in quantity-based regulations in which the regulator retains discretionary authority to waive (temporarily) the stringent rules. Boutique fuel regulations dating to the 1990s – such as reformulated gasoline – established quantitative restrictions on pollutants in transportation fuels. Starting in 2005, the Environmental Protection Agency had the authority to issue a temporary waiver of these regulations in response to a fuel supply shock. In the first decade of this authority, EPA waived fuel content regulations 60 times, with nearly 90% of these waivers prompted by hurricane-related disruption of fuel supplies. This analysis examines the impacts of temporary waivers of regulations in response to shocks to production. Specifically, Aldy explores how shocks affect local fuel markets and how waivers mitigate these shocks through analysis of daily, city-level fuel price data. These markets experience large increases in response to hurricane shocks, then prices stabilize after a waiver, followed by fairly quick declines in fuel prices, although it is difficult to discern these impacts from markets that do not seek regulatory waivers. The nature of these shocks – affecting many local markets at the end of the pipeline far from the natural disaster – serves as the basis for statistically identifying the impacts of waivers on air pollutant concentrations. The researcher finds that waiving reformulated gasoline regulations does not meaningfully impact ozone concentrations, on average, but it does appear to have some city-specific impacts. Aldy also finds that fine particulate matter concentrations increase by about 20% in the two months after a waiver has been issued.

Christiane J.S. Baumeister,teh niversity of Notre Dame; Reinhard Ellwanger, Bank of Canada; and Lutz Kilian, the University of Michigan

Did the Renewable Fuel Standard Shift Market Expectations of the Price of Ethanol? (NBER Working Paper No. 23752)

It is commonly believed that the response of the price of corn ethanol (and hence of the price of corn) to shifts in biofuel policies operates in part through market expectations and shifts in storage demand, yet to date it has proved difficult to measure these expectations and to empirically evaluate this view. Baumeister, Ellwanger, and Kilian utilize a recently proposed methodology to estimate the market's expectations of the prices of ethanol, unfinished motor gasoline, and crude oil at horizons from three months to one year. The researchers quantify the extent to which price changes were anticipated by the market, the extent to which they were unanticipated, and how the risk premium in these markets has evolved. They show that the Renewable Fuel Standard (RFS) is likely to have increased ethanol price expectations by as much $1.45 in the year before and in the year after the implementation of the RFS had started. The researchers' analysis of the term structure of expectations provides support for the view that a shift in ethanol storage demand starting in 2005 caused an increase in the price of ethanol. There is no conclusive evidence that the tightening of the RFS in 2008 shifted market expectations, but the analysis suggests that policy uncertainty about how to deal with the blend wall raised the risk premium in the ethanol futures market in mid-2013 by as much as 50 cents at longer horizons. Finally, the researchers present evidence against a tight link from ethanol price expectations to corn price expectations and hence to storage demand for corn in 2005–06.

Gabriel E. Lade and Ivan J. Rudik, Iowa State University

Prices, Quantities, and Gas Capture Infrastructure: Reducing Flaring in North Dakota (NBER Working Paper No. 24139)

Oil wells often produce large volumes of lighter hydrocarbons such as natural gas. In regions that are primarily valued for their oil reserves, well operators often resort to flaring these gases. In 2015, the state of North Dakota implemented a regulation requiring operators to capture a minimum fraction of all gas produced across their wells. The regulation is enforced uniformly and does not allow for inter-firm trading. In this paper, Lade and Rudik estimate the effectiveness of this regulation and study its relative efficiency compared to a market-based approach. The researchers find that the regulation reduced flaring rates by 2 to 7 percentage points and that firms primarily complied by connected wells to gas capture infrastructure more quickly. They then exploit information on natural gas collection infrastructure costs to construct firm-specific marginal compliance cost curves, and construct counter-factual compliance scenarios that achieve the same flaring reductions but reallocate abatement from high- to low-cost firms. They find that allowing greater flexibility in the regulation would reduce aggregate compliance costs by tens of millions of dollars.

Sébastien Houde, the University of Maryland, and Erica Myers, the University of Illinois

Heterogeneous Misperceptions of Energy Costs: Implications for Measurement and Policy Design

A widely-used test of consumer misperception compares the demand response to potentially misperceived costs such as energy operating costs, sales tax, or shipping and handling, versus salient, correctly perceived purchase costs. The ratio of the responsiveness coefficients has been considered a sufficient statistic to determine the degree of consumer misperception. In this paper, Houde and Myers show that this statistic corresponds to a first-order approximation of the average degree of misperception, and this approximation can lead to an economically important bias. The direction of the bias depends on the sign of the correlation between the two responsiveness coefficients. Further, they show that even if measured correctly, the average amount of misperception in a market is not sufficient for optimal policy design, and can in fact be misleading. Using data for the U.S. refrigerator market, Houde and Myers quantify the bias of the first order approximation and demonstrate the importance of accounting for heterogeneity of misperception. They find substantial heterogeneity in perception of energy costs and show that this heterogeneity is not driven by income. In their context the first-order approach provides a downward bias of the average degree of misperception. The researchers use the estimated distribution the two responsiveness coefficients to simulate different optimal policies and show that heterogeneity in the degree of misperception can significantly impact optimal policy design and estimates of welfare effects.

Steven E. Sexton and Bryan Bollinger, Duke University, and Kenneth Gillingham, Yale University and NBER

Household Discount Rates and Net Energy Metering Incentives for Rooftop Solar Adoption

Net Energy Metering policies common to 41 U.S. states and parts of Europe subsidize distributed solar electricity generation by affording the generator displacement of grid electricity and export sales at retail electricity rates that value the electricity at greater than wholesale prices. This subsidy has engendered criticism on equity grounds because it affects cost shifting from relatively wealthy households who adopt solar photovoltaic capacity to poor households who bear greater shares of electric grid supply costs. This paper explores the efficiency implications of NEM policies that subsidize a future stream of electricity generation that may be highly discounted by households relative to market rates. Bollinger, Gillingham, and Sexton estimate an implied discount rate of NEM subsidies equal to 10.9-13.7% in preferred specifications, far greater than prevailing market rates, suggesting that planners could arbitrage discount rates to achieve greater solar generation per public dollar expenditure.

Sharat Ganapati, Yale University; Joseph S. Shapiro, Yale University and NBER; and Reed Walker, the University of California at Berkeley and NBER

The Incidence of Carbon Taxes in U.S. Manufacturing: Lessons from Energy Cost Pass-Through (NBER Working Paper No. 22281)

This paper studies how changes in energy input costs for U.S. manufacturers affect the relative welfare of manufacturing producers and consumers (i.e. incidence). In doing so, Ganapati, Shapiro, and Walker develop a partial equilibrium methodology to estimate the incidence of input taxes that can simultaneously account for three determinants of incidence that are typically studied in isolation: incomplete pass-through of input costs, differences in industry competitiveness, and factor substitution amongst inputs used for production. The researchers apply this methodology to a set of U.S. manufacturing industries for which they observe plant-level unit prices and input choices. They find that about 70 percent of energy price-driven changes in input costs are passed through to consumers. The researchers combine industry-specific pass-through rates with estimates of industry competitiveness to show that the share of welfare cost borne by consumers is 25-75 percent smaller (and the share borne by producers is correspondingly larger) than models featuring complete pass-through and perfect competition would suggest.

Frank A. Wolak, Stanford University and NBER, and Thomas P. Tangerås, Research Institute of Industrial Economics

Optimal Network Tariffs for Renewable Electricity Generation

The intermittency (variability) of solar and wind power imposes network costs associated with maintaining system stability. Wolak and Tangerås examine how the socially optimal deployment of intermittent renewable generation capacity depends on such ancillary services costs and demonstrate how network interconnection tariffs can be designed to implement the efficient outcome. They then apply our theory to obtain quantitative results for the California electricity market.

Richard G. Newell, Resources for the Future and NBER, and Brian C. Prest, Duke University

Informing SPR Policy Through Oil Futures and Inventory Dynamics (NBER Working Paper No. 23974)

This paper examines how information on the time pattern of expected future prices for crude oil, based on the term structure of futures contracts, can be used in determining whether to draw down, or contribute to the Strategic Petroleum Reserve (SPR). Such price information provides insight on expected changes in the supply-demand balance in the market and can also facilitate cost-effective transitions for SPR holdings. Backwardation in futures curves suggests that market participants expect shocks to be transitory, creating a stronger case for SPR releases. Newell and Prest use vector autoregression to analyze the relationship between the term structure of futures contracts, the management of private oil inventories, and other variables of interest. This relationship is used to estimate the magnitude of the impacts of SPR releases into the much larger global inventories system. Impulse response functions estimate that a strategic release of 10 million barrels will reduce spot prices by up to 4% and mitigate backwardation by approximately 1.5 percentage points. Historical simulations suggest that past releases reduced spot prices by 20% to 30% and prevented about 10 percentage points of backwardation in futures curves, relative to a no-release counterfactual. This research can help policymakers determine when to release SPR reserves based on economic principles informed by market prices. It also provides an econometric model that can help inform the amount of SPR releases needed to achieve given policy goals, such as reductions in prices or spreads.

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