Topic 9: Energy, water and agriculture

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Topic 9 Energy, water and agriculture

• Trade-offs between competing uses?

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Depletable Resources

• 1. Efficient intertemporal allocation
  (revisited)
• i.    Basic model
• ii.Change key parameters (e.g. DR, price
  backstop, etc)
• 2. Issues in Energy
• i.    Natural Gas price controls
• ii. Oil cartel, dependency imported oil
• iii.   Transition fuels coal, nuclear, etc
• iv.   Conservation aggregate demand, peak load,
  internalize envt cost
• v. Renewables hydro, biomass, solar, wind, etc
• 3. Water
• i.    Efficient allocation of surface and
  groundwater
• ii.Current market and policy failures
• iii.         Policy options
• 4. Agriculture
• i.    Global food scarcity
• ii.Current market and policy failures
• iii.         Policy options

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1. Efficient intertemporal allocation (revisited)

• i. Basic Model
• Private profit maximizing objective maximize the
  present value of economic rents from extracting
  the exhaustible resource
• ii. Conditions for achieving objective
• i) Flow condition The price of the resource in
  any period t (Pt ) is equal to the price of some
  initial stock (Po), compounded at rate r, the
  discount rate. Resource owner is is
• a. indifferent between a unit of resource at Pt
  and a unit at Poert
• b. indifferent between holding the reserve in the
  ground and investing in anoth asset.
• ii) Stock Constraint Cumulative extraction over
  time equals the total stock of resources, and the
  total stock of resources is depleted when
  extraction ceases. With a backstop technology
  (i.e. substitute), the stock goes to zero when
  the price of the exhaustible resource equals the
  'choke price' of the backstop technology and
  demand for the exhaustible resource goes to zero.
• iii) Terminal condition in the final period of
  extraction, the marginal rent equals the average
  rent and the average costs equals the marginal
  costs on the last unit extracted.
• When there are no extraction costs, prices rise
  at the rate of interest Pt Poert
• When there are extraction costs, rents (i.e.
  prices minus costs) rise at the rate of interest
  Rt Roert

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Determining the Optimal Extration Path

• To determine the optimal price path
  (graphically) we need to determine the inital
  price (Po) and how long it takes to exhaust the
  resource (T).
•  
• Assuming we know the choke price (from backstop
  technolgy or where demand curve intersects price
  axis), we know the price of the resource in the
  last period.
•  
• Given that prices rise at the rate of interest,
  we can work back to get the initial price and the
  time to depletion.

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Figure 1

•  
• Quadrant 1. Optimal price path of the resource
  against time with the price of backstop
  technology
•  
• Quadrant 2. Dummy quadrant (450 line) to
  transpose measure of time period
•  
• Quadrant 3. Relationship between quantity
  demanded, time, and cumulative extraction (area
  under curve)
•  
• Quadrant 4. Quantity demanded relative to price
  (in reverse of conventional form)

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ii. The Effects of Changing Parameters

• Discount rates - increase in discount rate leads
  to lower initial price and steeper price path.
  New price path initially beolw old price path,
  but rises quuicker and crosses over old price
  path. Time to exhauustion is reduced. 
• Price of backstop - fall in price of backstop
  technology leads to lower price but same slope of
  price path. The price path is everywhere below
  original price path and end price is lower. Time
  to exhaustion reduced.
• Resource stock - increase in resource stock leads
  to a reduction in initial price but same slope of
  price path. The price path is everywhere below
  the original price path. Time to exhaustion
  extended.
• Costs of extraction - fall in costs of extraction
  leads to fall in initial price and steeper price
  path. New price path initially below old price
  path, but rises quicker and crosses over old
  price path. Time to exhaustion reduced.
• Demand - increase in demand leads to increase in
  price path with same slope of price path. Time
  to depletion shortened.
• Other factors
• 1. Stock declining quality
• 2. Different quality of resource
• 3. Set-up costs
• 4. Uncertainty
• 5. Monoploy

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2. Issues in Energy

• i. Natural Gas price controls (i.e. price
  ceilings on natural gas) imposed during times of
  shortages inhibit the ability of the market
  economy to respond to changing conditions. Leads
  to an "overshoot and collapse" syndrome, due to
  government interference (i.e. government failure)
  which distorts allocation towards the present.
  The implication is inefficient intertemporal
  allocation, and a loss of consumer and producer
  surplus, especially in the future.
• ii. Oil OPEC cartel effectiveness depends on
• i.                 price elasticity of demand
  (i.e. low response of demand to change in price)
• ii.             income elasticity of demand (i.e.
  high increase in demand with increase in incomes)
• iii.         non-OPEC supply responsiveness (i.e.
  limited, as small suppliers)
• iv.          cohesion of OPEC (i.e. incentive to
  cheat and inability to agree price)
• iii. Oil - dependency imported oil policy
  options include import tax, domestic subsidy,
  decrease in demand

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• iv. Transition fuels coal, nuclear, etc. may
  have limited availability and/or environmental
  problems
• v. Conservation considered as an alternative
  investment option to reduce aggregate demand,
  reduce peak load. Internalize environmental
  costs changes relative energy resource prices.
• vi. Renewables hydro, biomass, solar, wind,
  hydrogen, geothermal. Often relatively high
  costs due to new technology, lower research and
  development subsidies, storage problems.

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3. Water

• i.    Efficient allocation of surface and
  groundwater
• Surface water is a renewable resource affecting
  current resource users. Efficient allocation
  requires that marginal net benefits are equal for
  all users.
• Groundwater is a depletable resource if
  extraction is greater than recharge over time.
  Efficient allocation requires that water is mined
  at a rate where the price of water increase at
  the rate of interest, and the point of exhaustion
  is reached when the demand drops to zero (i.e.
  due to high costs or substitute).
• ii.             Current market and policy
  failures
• -  restrictions on water transfers
• -  subsides to federal reclamation projects
• -  charging inefficiently low prices
• -  common property problems

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• i.                 Policy options
•  
• -  allowing transfers, e.g. conservers capture
  the value of water saved by selling it
• -  seperate fishing/recreational water rights
• -  water utilities use increasing block pricing
  (i.e. marginal cost pricing that reflects the
  scarcity value of water)
•  

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4.Agriculture

• i.    Global food scarcity 
• Rising demand for food with fixed supply of land.
  Leads to marginal land being brounght into
  production, and more intensive use of existing
  land (e.g. inputs, technical progress,
  environmental problems)
• ii.Current market and policy failures
• -  subsidies to specific farming inputs
• - -  guaranteed output prices
• -  protectionist trade barriers
• iii.         Policy options
• -  remove existing subsidies
• -  encourage sustainable farming
• -  remove trade barriers

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Dependency on imported resources the case of oil
Price (/barrel)
Supply of domestically produced oil (SD)
Supply of imported oil (SI)
PW
Domestic demand for oil (D)
Quantity of oil (Q)
Q1
Q2
Import dependency ratio (Q1 - Q2)/Q1
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Decreasing the import dependency ratio oil
(a) an import tax on foreign oil
(b) Increase domestic supply
P
P
SD
SD
SD
SI
PW PW(1t)
SI
SI
PW
PW
D
D
Q
Q2
Q1
Q
Q2
Q3
Q3
Q4
Q1
P
SD
(c) a fall in demand energy conservation or
recession
PW
SI
D
D
Q
Q2
Q3
Q1
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Global food scarcity optimism vs pessimism
Price of food (/ton)
Agricultural Supply (pessimistic)
P2
P1
Agricultural Supply (optimistic)
P0
Future demand
Current demand
Q0
Quantity of food (tons)
Q1
Q2