Energy Pricing And Demand Management

Mohan Munasinghe

• Publisher: Taylor & Francis
• Year: 2019
• Print ISBN: 9780367017156
• eBook ISBN: 9780429716386
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: Politics
• Index: Politics & International Relations

Dr. Munasinghe emphasizes the importance of coordinated energy planning and pricing in less developed countries with particular reference to the interrelationships among the pricing policies adopted in various energy subsectors--electric power, petroleum, natural gas, coal, and traditional fuels (e.g., firewood, crop residues, and dung). In less developed countries the already complex problems typically faced by energy planners are exacerbated by high levels of market distortion, shortages of foreign exchange and resources for development, large numbers of poor households whose basic needs must be met, reliance on traditional fuels, and a relative paucity of energy data. The principal investment issues surrounding energy planning and the extent to which they influence pricing policy are also discussed.

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Energy Pricing Framework

Introduction to Integrated National Energy Planning and Demand Management

In recent years, decision-makers in an increasing number of countries have realized that energy sector investment planning and pricing should be carried out on an integrated basis within the framework of a national energy master plan that determines energy policy, ranging from short-run supply-demand management to long-run planning. In practice, however, investment planning and pricing are still carried out on an ad hoc and at best partial or sub-sector basis. Thus typically, electricity and oil sub-sector planning have traditionally been carried out independently of each other as well as of other energy sub-sectors. As long as energy was cheap, such partial approaches and the resulting economic losses were acceptable. Lately, however, with rising energy costs (especially of oil), changes in relative fuel prices, and substitution possibilities, the advantages of an integrated energy policy have become evident.

This study will emphasize the importance of coordinated energy planning and pricing, with particular reference to the inter-relationships among the pricing policies adopted in various energy sub-sectors such as electric power, petroleum, natural gas, coal, and traditional fuels (e.g., firewood, crop residues, and dung). Non-conventional sources can also be fitted into this framework. The focus will be on the less developed countries where the problems faced by energy planners are exacerbated by higher levels of market distortion, shortages of foreign exchange and resources for development, larger numbers of poor households whose basic needs must be met, greater reliance on traditional fuels, and a relative paucity of energy data. Investment issues will also be studied insofar as they affect pricing policy.

Before developing an integrated framework for energy pricing, it is necessary to discuss briefly what is meant by national energy planning. The broad underlying rationale is to make the best use of energy resources to promote socio-economic development and improve the welfare and quality of life of citizens. Therefore, energy planning is an essential part of overall national economic planning and should be carried out in close coordination with it. However, in energy planning the principal emphasis is on the comprehensive and disaggregate analysis of the energy sector, with due regard for the main interactions with the rest of the economy. In a strictly technical sense, the energy planner's role might be confined to seeking the least-cost method of meeting future energy requirements. However, energy planning also includes a variety of other objectives such as reducing dependence on foreign sources, supplying basic energy needs of the poor, reducing the trade and foreign exchange deficit, priority development of special regions or sectors of the economy, raising sufficient revenues to finance energy sector development (at least partially), ensuring continuity of supply and price stability, and preservation of the environment.

In general, energy planning requires analysis at the following three hierarchical levels in relation to fundamental national objectives; (a) links between the energy sector and the rest of the economy, (b) interactions between different sub-sectors within the energy sector, and (c) activities within each individual energy sub-sector. The steps involved in the planning procedure usually include energy supply and demand analyses and forecasting, energy balancing, policy formulation, and impact analysis to meet short-, medium-, and long-range goals.¹ Initially, these activities may be carried out at a relatively simple level and later, as data and local analytical capabilities improve, more sophisticated techniques including computer modelling could be implemented. The institutional structure should also be rationalized by setting up a central energy authority or ministry of energy, with its principal focus on energy planning and policy-making. The execution of policy and day-to-day operations would remain the responsibility of line agencies like the electric utilities or petroleum corporations already in existence in practically all countries.

Supply and demand management make it easier for the energy policy-maker to forecast shortages and achieve energy supply-demand balance, thus preventing major economic disruptions and consequent reductions in national welfare. Supply management includes identification and optimal exploitation of all energy resources, investment planning, transformation, refining, and distribution of energy. Demand management includes all means of influencing the magnitudes and patterns of energy consumption. As discussed below, the so-called hard tools of demand management such as physical controls and rationing, mandatory regulations relating to the pattern of energy production and use, and technological options such as energy-saving retrofits, are most effective in the shorter term. The "soft" tools of demand management such as pricing, taxation, financial incentives and subsidies, education and propaganda, are more useful in the medium- and long-run.

Scope and Objectives of Energy Pricing

To put pricing in proper context, we note that it is only one of the policy instruments available for optimal supply-demand management and planning; others include physical controls, technical methods (including research and development), education and propaganda. Since these tools are inter-related, their use should be well coordinated. Physical controls are most effective in the short-run when there are unforeseen shortages of energy. All methods of physically limiting consumption such as load-shedding and rotating power cuts in the electricity sub-sector, as well as reducing the supply of gasoline or banning the use of motor cars during some periods, are included in this category. Technical means include, on the supply side, the least-cost means of producing a given form of energy, the best mix of fuels, research and development of substitute fuels such as wood-alcohol for gasoline and, on the demand side, introducing higher efficiency energy conversion devices such as better stoves for woodfuel. Education and propaganda include, on the supply side, efforts to make citizens aware of external diseconomies such as pollution and supportive of re-afforestation schemes to preserve the environment and, on the demand side, public education for energy conservation.

Pricing is a very important tool, especially in the long-run. As discussed below, pricing and investment decisions should be closely related. However, energy supply systems -- electricity generation, transmission, and distribution, oil and gas wells and pipelines, coal mines, forests -- usually require large capital investments with long lead times and lifetimes. Therefore, once the investments decision is made -- usually on the basis of the conventional least-cost method of meeting demand by sub-sector, with due regard for interfuel substitution possibilities -- there is a lock-in effect with respect to supply. Thus prices should be related to the long-run horizon of planning. On the demand side also, energy conversion devices, such as motor cars, gas stoves, electric appliances, and machines, are expensive relative to average income levels and have relatively long lifetimes, thus limiting the ability of consumers to respond to changes in relative fuel prices in the short-run.

The objectives of energy pricing are closely related to the goals of energy planning, but are more specific. First, the economic growth objective requires that pricing policy should promote economically efficient allocation of resources both within the energy sector and between it and the rest of the economy. In general terms, this implies that future energy use would be at optimal levels, with the price (or willingness-to-pay of the consumer) for the marginal unit of energy used reflecting the incremental resource cost of supply to the national economy. Relative fuel prices should also influence the pattern of consumption in the direction of the optimal or least-cost mix of energy sources required to meet future demand. Distortions and constraints in the economy necessitate the use of shadow prices and economic second-best adjustments, as described in the next section.

Second, the social objective recognizes the basic right of all citizens to be supplied with certain minimum energy needs. Given the existence of significant numbers of poor consumers and wide disparities of income, this implies subsidized prices, at least for low-income consumers.

Third, the government would be concerned with financial objectives relating to the viability and autonomy of the energy sector. This would usually be reflected by pricing policies that permitted institutions (typically government-owned) in the different energy sub-sectors to earn a fair rate of return on assets and to self-finance an acceptable portion of the investments required to develop future energy resources.

Fourth, energy conservation is also an objective of pricing policy. While prevention of unnecessary waste is an important goal, there often are other reasons underlying the desire to conserve certain fuels. These include the desire for greater independence from foreign sources (for example, oil imports) and the need to reduce the consumption of woodfuel due to deforestation and erosion problems.

Fifth, we recognize a number of additional objectives, such as the need for price stability to prevent shocks to consumers from large price fluctuations and the need for simplicity in energy pricing structures to avoid confusing the public and to simplify metering and billing.

Finally, there are other specific objectives, such as promoting regional development (e.g., rural electrification) or specific sectors (e.g., export oriented industries), as well as other socio-political, legal, and environmental constraints.

In summary, price is most effective as a long-run policy tool. From the viewpoint of economic efficiency, the price indicates to the suppliers the consumers' willingness-to-pay and use-value of energy while, to the consumers, it signals the present and future opportunity costs of supply based on various energy sources. We conclude this section with a brief review of the pervasive role that most governments play in the pricing of commercial energy resources and the relative neglect of issues relating to traditional forms of energy. Governments exercise direct influence, usually through the ownership of energy sources or price controls. Indirect influences occur through such means as taxes, import duties, subsidies, market quotas, taxes on energy-using equipment, and government-guided investments in energy resources.

In practically all developing countries, the electric utility is government-owned. In oil and gas production, refining, and distribution as well as in coal mining, both public and private organizations operate, often side-by-side. However, irrespective of the form of ownership, all governments exercise some form of price control, usually at several levels including the production stage, refinery, transport or transmission, and wholesale or retail marketing. Income and excise taxes are also levied from both public and private energy sector companies.

Generally, certain fuels for specific uses tend to be subsidized, although leakages and abuses of subsidies by non-targeted consumer groups also occur. Kerosene for lighting and cooking, rural electricity for lighting and agricultural pumping, and diesel fuel for transportation commonly qualify for subsidies. Cross-subsidies between different fuels, user groups, and geographic regions exist. Thus highly priced gasoline may finance the subsidy on kerosene, industrial electricity users may subsidize household consumers, and a uniform national pricing policy usually implies subsidization of energy users in remote areas by those living in urban centers. The principal problem associated with subsidies is that the energy producer may not be able to raise sufficient revenues for financing investment to meet expanding demand, or even to maintain existing facilities, eventually leading to shortages. Furthermore, cross-subsidies give consumers the wrong price signals with consequent misallocation of investments.

Import and export duties, excise and sales taxes are levied, often by several levels of government, from federal to municipal, at various stages in the production, processing, distribution, and retailing chain. In many developing countries, the combined levies are several hundred percent of the original product price for some items, and negative or close to zero for others. Several less obvious methods such as property taxes, water rights, user charges, and franchise fees are also used to influence energy use. Energy prices are also affected by the wide range of royalty charges, profit-sharing schemes, and exploration agreements between governments and multinational companies for the development of oil and gas resources.

Other policy instruments are often used to reinforce pricing policies, such as quotas on imported or scarce forms of energy coupled with high prices. Conservation regulations may affect maximum depletion rates for oil and gas, while the availability of hydropower from some multipurpose dams may be subordinate to use of water for irrigation or river navigation. Many special policies involving tax holidays and concessions, import subsidies, export bonuses, government loans or grants, and high taxes on large automobiles are also used to affect energy use.

The traditional fuels sub-sector has been relatively neglected because transactions involving these forms of energy are usually of a non-commercial nature. However, there is growing acceptance of the coordinated use of indirect methods such as displacement of fuelwood used in cooking by subsidizing kerosene and LPG, increasing the supply of fuelwood by re-afforestation programs and effective distribution of charcoal, enforcing stiffer penalties for illegal felling of trees, and proper watershed management.

Economic Framework

Because the objectives mentioned above are often mutually inconsistent, a realistic integrated energy pricing structure must be flexible enough to permit trade-offs among them. To achie...

Table of contents

• Cover
• Half Title
• Series Page
• Title
• Copyright
• About the Series
• Contents
• List of Tables and Figures
• Preface
• 1 Energy Pricing Framework
• 2 Energy Efficiency and Conservation
• 3 Electric Power Tariffs
• 4 Case Study I: Electricity Tariffs in Burma
• 5 Case Study II: Inter-Fuel Substitution for Cooking in Sri Lanka
• 6 Case Study III: Industrial Inter-Fuel Substitution Issues in Thailand
• Bibliography
• Appendix A: Model for Optimal Energy Pricing Using Shadow Prices
• Appendix B: Allocation of Capacity and Energy Costs Among Peak and Off-Peak Users
• Index