Topic 2: Fossil Fuel Supply and Demand: Effect of Subsidies and Taxation. () Global Energy Issues, Industries and Markets 1 / 53

Transcription

1 Topic 2: Fossil Fuel Supply and Demand: Effect of Subsidies and Taxation () Global Energy Issues, Industries and Markets 1 / 53

2 Introduction This topic follows strategy I plan in using in this course A bit of economic theory in the context of a particular energy market plus a case study Here Supply + Demand for fossil fuels But we will also use Supply+Demand ideas useful in other energy markets Effect of taxes and subsidies Case study: effect of fossil fuel subsidies (general theory plus focus on a few specific countries) () Global Energy Issues, Industries and Markets 2 / 53

3 Supply and Demand Supply and demand graphs are a basic tool for many economic problems Involves Q = quantity bought and sold (produced and consumed) P = price Supply = what is produced/sold by companies/firms Demand = what is consumed/bought by consumers The quantity firms supply increases with price E.g. price of coal goes up, miners produce more coal Quantity consumed decreases with price E.g. price of coal goes up, electricity generators buy less coal (switch to gas) Next slide illustrates this in Supply-Demand graph () Global Energy Issues, Industries and Markets 3 / 53

4 Price Demand Curve Supply Curve Quantity () Global Energy Issues, Industries and Markets 4 / 53

5 Supply Equals Demand in Equilibrium Demand curve: for each price, how much will consumers buy? Supply curve: for each price, how much will producers produce? Equilibrium price: quantity demanded equals quantity supplied Why? If price too low, then producers will not produce enough to meet demand Excess demand means price will be driven up If price too high, the consumers won t buy as much as producers want to produce Excess supply means price will be driven down () Global Energy Issues, Industries and Markets 5 / 53

6 Price Demand Curve Supply Curve P equilibrium P low Q supplied Q demanded Quantity () Global Energy Issues, Industries and Markets 6 / 53

7 Example: What Influences Supply for Coal? Supply depends on price of coal (movement along the supply curve) Other factors will shift entire supply curve Factor influencing costs of production (e.g. wages, etc.) In longer run, technology and geology influence supply curve E.g. mine cheapest seams of coal first before digging deeper for more expensive () Global Energy Issues, Industries and Markets 7 / 53

8 Example: What Influences Demand for Coal? Depends on price of coal (movement along the demand curve) Other factors shift entire demand curve Coal is heavily used for electricity generation Anything that influences demand for electricity will also affect coal Weather (home heating, electricity for air conditioners, etc.) State of the economy: industry uses a fair degree of coal directly or indirectly as electricity Price of alternative fuels In relation to alternative fuel prices, introduce some terminology on next slide () Global Energy Issues, Industries and Markets 8 / 53

9 Electricity generating companies often own both gas and coal generating plants These depend on prices of fuels and influence demand curve Spark spread = profit margin per unit of electricity produced using gas Dark spread = profit margin per unit of electricity produced using coal Switch production depend on so-called spreads Also including price of CO 2 emissions leads to clean dark/spark spreads Hot issue: in US natural gas price very low, electricity generation switching to gas, hurting coal miners Glut of cheap US coal bought by German electricity generators () Global Energy Issues, Industries and Markets 9 / 53

10 Government Actions Can Influence Supply and Demand Example: EU-ETS requires electricity generating companies to buy carbon permits Electricity generation from coal releases more CO 2 than generation from other sources Carbon price rises implies coal generation becomes more costly How would this appear in a supply-demand graph? Shift demand curve down Why? Electricity generators are demanders of coal At any price level demand less (the effective price of coal they pay has increased since higher carbon price) Result: equilibrium price and quantity of coal falls Note: this is what is happening in US to coal industry now due to fall in natural gas price () Global Energy Issues, Industries and Markets 10 / 53

11 Price Original Demand Curve Supply Curve Original P New P New Demand Curve New Q Original Q Quantity () Global Energy Issues, Industries and Markets 11 / 53

12 Government Intervention: Price Supports Price support: Set minimum price for coal. If market price above price support, no effect If market price below, the government must intervene buying coal to force price up to price support Alternatively, governments sometimes set maximum price for fossil fuels (to protect consumers) If market price above minimum price, excess demand (black market, corruption) Supply-demand graphs can be used to show these () Global Energy Issues, Industries and Markets 12 / 53

13 Government Intervention: Subsidies Subsidies: E.g. for each ton of coal produced the government will pay 10 Euros Or for each 1 Euro of coal you sell, the government will pay an extra 10% Subsidies are the opposite of energy taxes so I will defer graphs until taxes discussed Price supports/subsidies common in Europe in the past (particularly in the coal industry) Declining slowly (but even in 2001 Germany was spending almost $5 billion on coal subsidies) Protect coal industry and jobs Hot issue: economic consequences of energy subsidies in developing world Return to this issue shortly () Global Energy Issues, Industries and Markets 13 / 53

14 Government Intervention: Taxation Fossil fuels are typically heavily taxed in various ways, including: Corporation tax (tax on profits as paid by any company) Severance taxes (popular in US, sometimes called ad valorem taxes) E.g. percentage of value of coal produced. Royalties VAT and other taxes paid by consumers, etc. Many other taxes To give a flavour of the types of tax regimes, faced by fossil fuel companies I will give a few examples () Global Energy Issues, Industries and Markets 14 / 53

15 Hot Issue: UK Taxation of North Sea Oil From budget statement on 23 March 2011: Chancellor of the Exchequer announced increase in the supplementary charge paid by companies involved in North Sea oil & gas production. North Sea companies pay corporation tax on their profits from oil and gas extraction in the UK and the UK Continental Shelf. In its 2002 Budget the Labour Government introduced a supplementary charge on profits set at 10%, and this was increased to 20% in January In his Budget speech Mr Osborne argued that the rise in oil prices since this reform had provided unexpected profits for the oil companies, and that it was fair to set the supplementary charge at a new rate of 32%. () Global Energy Issues, Industries and Markets 15 / 53

16 But one year later and after sharp fall in North Sea Oil exploration... From the Financial Times (22 March 2012) North Sea groups welcome Budget s change of tax: A year on from a 2bn raid on North Sea profits, industry operators, suppliers and advisers have expressed satisfaction with changes made in this week s Budget to the taxing of those involved in UK oil and gas production. That raid, used in part to finance a 1p a litre reduction in fuel duty, raised the marginal tax rate facing operators of fields to between 62 per cent and 81 per cent... Note: this tax change related to relief for decommissioning (dismantling rigs and wells once oil and gas fields run dry) () Global Energy Issues, Industries and Markets 16 / 53

17 Russian Taxation of Foreign Oil and Gas Companies () Global Energy Issues, Industries and Markets 17 / 53

18 Angola Treatment of Foreign Oil and Gas Companies () Global Energy Issues, Industries and Markets 18 / 53

19 Other Types of Taxes But it is not just fossil fuel companies which pay taxes Companies which use fossil fuels (e.g. electric utility companies) pay taxes Consumers also pay taxes Rich countries tend to tax petrol (see next slide) But many poor countries do the opposite subsidizing consumption of fossil fuels In sum, variety of taxes/subsidies which impact in various ways () Global Energy Issues, Industries and Markets 19 / 53

20 Example: Petrol Taxes in OECD Countries () Global Energy Issues, Industries and Markets 20 / 53

21 Taxation in a Model of Supply and Demand Taxes on producers will shift the supply curve Taxes on consumers will shift the demand curve Remember: subsidy is the opposite of a tax so shifts in opposite direction for subsidies But, before showing effects of tax, I will show how supply-demand graphs can be used to measure profits and welfare: Producer surplus and consumer surplus () Global Energy Issues, Industries and Markets 21 / 53

22 Consumer Surplus Consumer surplus is the total benefit consumers get from consuming a product It is the area above the price charged in the market and below the demand curve (a triangle) Why? Economists think marginally (one unit at a time) Demand curve plots marginal benefit to consumers of each unit consumed What are consumers willing to pay for first unit? Point on demand curve above quantity=1 What are consumers willing to pay for second unit? Point on demand curve above quantity = 2, etc. Add up all these marginal benefits to get total benefit = consumer surplus See next slide () Global Energy Issues, Industries and Markets 22 / 53

23 A Demand Curve Price Consumer Surplus is Triangle ABC B C Quantity () Global Energy Issues, Industries and Markets 23 / 53

24 Producer Surplus Producer surplus is the total benefit producers get from producing a product (rent) It is the area below the price in the market and above the supply curve (a triangle) Why? Similar reasoning to consumer surplus Supply curve reflects marginal cost What does producer get for producing 1st unit? Price (=B in graph) What does it cost producer? Point on supply curve for Q=1 Difference between these two is profit for producer Adding up for 1st unit, 2nd unit, etc. get producer surplus triangle See next slide () Global Energy Issues, Industries and Markets 24 / 53

25 Price B C Supply Curve Producers Surplus is Triangle BCD D Quantity () Global Energy Issues, Industries and Markets 25 / 53

26 Consumer and Producer Surplus in Equilibrium Now let s put it all together in a supply-demand graph Equilibrium price and quantity determined where supply and demand intersect Total benefit = producer plus consumer surplus See next slide () Global Energy Issues, Industries and Markets 26 / 53

27 Price A Demand Curve Total Benefit = Cons + Prod Surplus = Triangle ACD Supply Curve B C D Q Quantity () Global Energy Issues, Industries and Markets 27 / 53

28 The Effect of a Tax on Demand, Supply and Consumer and Producer Surplus Now let us return to the effect of a tax In previous example (EU ETS) considered a tax on consumers of coal (electricity generating plants) Now consider a tax on suppliers This will shift supply curve up Why? Supply curve reflects marginal costs, if taxes go up costs will go up Next slide illustrates this Tax will cause price to rise from B to B* Quantity produced will fall from Q to Q* () Global Energy Issues, Industries and Markets 28 / 53

29 Price A Demand Curve Supply Curve With Tax B* B C* C Supply Curve D* D Q* Q Quantity () Global Energy Issues, Industries and Markets 29 / 53

30 The Effect of a Tax on Demand, Supply and Consumer and Producer Surplus But what will happen to consumer and producer surplus? In preceding slide, they both shrink Consumer surplus falls from ABC to AB*C* Producer surplus falls from BCD to B*C*D* Government gains tax revenue which partly balance these losses But can show (count areas in graph) that there is still a deadweight loss from taxation () Global Energy Issues, Industries and Markets 30 / 53

31 Who Bears Burden of a Tax? Burden of taxation depends crucially on shape of supply/demand curves Elasticity is usual way of talking of shape of these curves Elasticity of supply = percentage change in supply caused by one percent change in price Elasticity of demand = percentage change in demand caused by one percent change in price Inelastic if elasticities are near zero Think of elastic as sensitive so inelastic = insensitive to changes in price Note: obtaining estimates of this is important, useful for forecasting () Global Energy Issues, Industries and Markets 31 / 53

32 Who Bears Burden of a Tax if Demand is Inelastic? What if demand is insensitive to price? Always need oil for cars, etc. IMF report claims very low price elasticities of oil 10 percent permanent increase in oil prices reduces oil demand by about 0.7 percent after 20 years Suppose oil production is less inelastic (e.g. Saudi Arabia has excess production capacity so can adjust production easily to changes in oil prices) Effect of tax: price rises much more than before Output falls very little and producer s surplus falls only a little. In case of perfectly inelastic demand, tax is simply passed on for consumers to pay with no effect on producers Consumers bear burden of tax () Global Energy Issues, Industries and Markets 32 / 53

33 Price A Inelastic Demand Curve Supply Curve With Tax B* C* Supply Curve B C D* D Q* Q Quantity () Global Energy Issues, Industries and Markets 33 / 53

34 Who Bears Burden of a Tax if Supply is Inelastic? What if supply is insensitive to price? E.g. coal producers have large fixed costs and diffi cult to adjust production when prices change Suppose demand for coal by consumers is less inelastic E.g. Electric utility companies consumers of coal and can switch to gas easily Effect of tax: price rises less than before Output falls more than before and consumer surplus falls only a little. In case of perfectly inelastic supply, full burden of tax borne by producers () Global Energy Issues, Industries and Markets 34 / 53

35 Price Supply Curve With Tax A Demand Curve B* B C* C Inelastic Supply Curve Q* Q Quantity () Global Energy Issues, Industries and Markets 35 / 53

36 Case Study: Fossil Fuel Subsidies In their 2010 World Energy Outlook, the IEA says: Fossil-fuel subsidies result in an economically ineffi cient allocation of resources and market distortions, while often failing to meet their intended objectives In this case study, we will examine the IEA s case From our supply-demand graphs have shown deadweight loss of taxes/subsidies This leads to ineffi cient allocation of resources and market distortions, but IEA makes some additional points... () Global Energy Issues, Industries and Markets 36 / 53

37 Common Types of Subsidies There are many types of subsidies to fossil fuels. A few examples: Price controls E.g. Venezuela law: petrol must be sold for equivalent of 3 cents per litre Tariffs of import of competing fuels Laws which say, e.g., domestic coal must be used for electricity generation Implicit subsidies to producers (e.g. favourable tax deductions for oil and gas fields, government taking on risk for accidents, decommissioning, etc.) etc. () Global Energy Issues, Industries and Markets 37 / 53

38 Why Do Governments Subsidize Fuels? Alleviating energy poverty Security of energy supply Redistribute nation s resource wealth widely Protecting employment in energy industries Protect the environment (more relevant for renewables, such as UK s subsidy of wind power, will discuss in detail later in course) () Global Energy Issues, Industries and Markets 38 / 53

39 Why Does IEA Not Like Fossil Fuel Subsidies? Encourage wasteful consumption Hasten the decline of exports (for producer nations) Encourage fuel adulteration, smuggling and corruption Discourage investment in energy infrastucture Disproportionately benefit middle class and rich Drain state budgets Distort markets (and, in case of fossil fuel subsidies, discourage development of clean energy) Increase CO 2 emissions and pollution Encourage volatility in world energy prices by dampening price signals () Global Energy Issues, Industries and Markets 39 / 53

40 IEA s Justification? Most are self-evident, but I will elaborate on a few Note first, that economists would argue: If you want to help the poor, more direct methods better Type of claim in countries with cheap energy: If we have lots of oil, costing $5 per barrel to produce, why should our consumers be paying more for our oil? Economists argue: Better to sell your oil for $50 per barrel on the international market. Can show your country will be better off as a whole if you do this. Note: students of economics will know the economic theory underlying this (gains from trade, comparative advantage, markets are effi cient, etc.), but I will not explain in detail () Global Energy Issues, Industries and Markets 40 / 53

41 Why Might Price Controls Lead to Corruption and Related Problems? This can be shown in our initial supply-demand graph Setting too low a price leads to excess demand Can make money by trying to satisfy this excess demand Black market in fuel Smuggling of cheap fuel to neighbouring country without fuel subsidies Recent issue: Argentinian nationalization of YPF (previously owned by Spanish company Repsol) Repsol accused of lack of investment/development of resources Repsol said Argentinian price controls made it uneconomic to invest () Global Energy Issues, Industries and Markets 41 / 53

42 Why Is Volatility of Energy Prices Affected by Subsidies? E.g. what if price of oil (on international market) very different from price of oil paid by consumers? Demand for oil then becomes inelastic Consumers of oil protected from changes in world oil price and, thus, do not change their demand with world oil price increases But look back at our graph with the inelastic demand curve In it, small shifts in the supply curve cause big changes in world oil price increased volatility Prices can signal useful information (e.g. to resolve a shortage, conservation is useful), but dampening price signal to consumers useful information is lost In early 2008, petrol prices were rising, 2/3 of 131 countries did not fully pass this price rise on to consumers () Global Energy Issues, Industries and Markets 42 / 53

43 How Big are Energy Subsidies and Where are They Most Prevalent? See next three slides Short answer: They are BIG and mostly in the poor countries which can least afford them. () Global Energy Issues, Industries and Markets 43 / 53

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47 How Much Fuel Could be Saved by Eliminating Subsidies? IEA estimates that removing fuel subsidies would: Lead to many benefits including: Saving of oil (particularly in transportation) Reduction in CO 2 emissions (almost halfway to reaching the 450 Scenario) See next three slides () Global Energy Issues, Industries and Markets 47 / 53

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51 Fossil Fuel Subsidies Still in the News E.g. Financial Times, September 16, 2014 Growth and fighting global climate change not incompatible New Climate Economy Report (commissioned by UK, South Korea and five other countries including Ethiopia and Indonesia). Recommendations: wealthy countries immediately stop building new coal power plants and all countries phase out fossil fuel subsidies now valued at about $600bn a year, compared with $100bn for clean energy subsidies. () Global Energy Issues, Industries and Markets 51 / 53

52 Case Study Topic In this course, you are asked to do two essays/case studies/projects The first one will be on a specific country, second one on a specific policy/issue The IEA s World Energy Outlook for 2010 has much more on energy subsidies, including Country subsidy profiles for Iran, Russia, India and Indonesia Case study: detailed study of energy subsidies in these countries Discussion of themes in this lecture with detailed facts/experience of one country Have things changed since 2010? The IEA s World Energy Outlook for 2014 has a section on subsidies Focus on particular aspect (e.g. impact of energy subsidies on CO 2 emissions) Or broaden beyond subsidies only for general discussion of energy policy in one country () Global Energy Issues, Industries and Markets 52 / 53

53 Summary This lecture introduced some basic economic theory: supply+demand (consumer/producer surplus and elasticities) Focussed on supply and demand for fossil fuels Taxation/subsidies are very important in international energy markets Factors which determine the impact of taxes/subsidies Possible case study topic: world energy subsidies () Global Energy Issues, Industries and Markets 53 / 53