Energy Analysis and Policy: Selected Works

volume.

INTRODUCTION¹

Writing an introduction to the works of a great author is similiar perhaps to introducing a distinguished speaker to an audience eager to listen to the star of the evening and not one bit interested in the drabness of the introduction. In preparing this short text, therefore, I feel uncomfortably sandwiched between a lucid and effective Foreword by a distinguished economist -- Professor Robert Pindyck -- and the rich creation of Professor Mohan Munasinghe based on years of thought, analysis and insightful probing into the energy problems facing the world. However, since I have the honor of contributing the introduction to this admirable piece of work, I shall attempt to do full justice to my task.

Before I get into the substance of the enormous range of subjects covered by Mohan, I must pay adequate tribute to the professional par excellence in him. Each one of us has memories of that one great teacher who, through his brilliance and mastery of the subject, could explain the most complex of ideas and analyses in the simplest terms. Professor Munasinghe’s writings are typically those of that great teacher -- covering the most intricate and difficult issues with the facility and ease of a master.

The other general impression which I have gathered from the valuable material contained in this volume relates to the great industry, zeal, and dedication of the man. Most of us hold talks and lectures at many training programs and workshops, but I have run into very few who do not follow the general practice of putting a few things together at the last minute and presenting a rehash of what they have been saying for the past several years. Often the applause that one receives at the end of such a talk lulls one into a feeling of false accomplishment, tempting one to repeat the process at the next opportunity. One gains a facility with words and delivery, which over time becomes a substitute for profound analysis and original thinking. It is apparent from the lectures delivered by Professor Munasinghe, some of which are included in this book, that he treats each such event as a professsional challenge and as an opportunity to produce a work of original scholarship and rigorous analysis. Herein lies his strength, which undoubtedly is evidence of his dedication to perfection.

The material presented in this volume has general relevance to energy analysts and policymakers throughout the world, but has a special appeal for those dealing with this area in the developing countries. This Third World emphasis reflects not only the author’s own interests and concerns, but has merit of its own, since the developing countries face unprecedented challenges in the energy sector, which can only be met through analysis and innovation of the highest order.

The most difficult challenge facing Third World countries lies in the growing demand for finance that those dealing with energy sector decisions have to contend with. This challenge results not only from a rapid increase in demand for energy, and therefore, for supply capacity, but also from the growing capital intensity of the energy supply industry. The problems to be solved are, therefore, manifold.

Firstly, energy sector organizations in the developing countries must achieve economic efficiency in their investment decisions and operations through the practice of rational economic priniciples. Secondly, supply capacity enhancement must be integrated with approaches for management of demand, so that overall resources for development are utilized in an optimal fashion with explicit inclusion of efficiency objectives. Thirdly, the imperatives of growth require that the development of the energy sector must take place in a manner such that the welfare of society is maximized, particularly in respect of economic disparities that exist between rich and poor in the Third World.

The chapters of this volume address these questions and provide a framework whereby analysts and policymakers can pursue integrated energy planning and policymaking in accordance with the overall objectives of growth and equity.

The first chapter in the book deals with energy economics in developing countries, and examines the complex problem of adapting economic theory to practice in an environment where market forces and mechanisms often do not operate at all, or function under distortions which are not easy to remove in view of various social, political and organizational constraints. The value of this chapter (which is an edited version of Munasinghe’s acceptance speech on the occasion of receiving the annual IAEE Award for Excellence in 1987), lies in the fact that policymakers often dismiss sound economic theory for being too far removed from reality. On the other hand, many theorists denigrate institutional arrangements in such situations as totally unsuitable for the implementation of rational economic principles, and contend that unless existing institutions and organizations are dismantled, sound economic theory cannot be applied. Mohan bridges the gap between these two extremes and one emerges with a greater understanding after reading his analysis irrespective of whether the reader prefers one or the other viewpoint.

The second and third chapters are classic works published concurrently in 1980, in which Munasinghe brought together his research of the late 1970’s, to develop an original and comprehensive framework for energy pricing, planning, policy analysis, and implementation in the developing countries. In the second chapter, the principles of integrated national energy planning are set out, clearly. Here, not only are non-conventional forms of energy included in the exposition, but also traditional fuels -- a vital part of energy consumption in many developing countries. This chapter is particularly valuable, because planning for different forms of energy remains oftentimes fragmented in most countries, both developed and developing.

The concept of integrated energy planning is relatively new and came into focus only when substitution possibilities became more attractive economically, in the wake of the first oil price shock of 1973–74. Earlier, electric utilities, oil companies, coal suppliers, and the nuclear power establishment generally followed their own isolated attempts at energy planning. Notwithstanding the inclusion of a few variables such as the price of substitute fuels that entered into their demand functions, very little was done to evaluate fuel choices within an integrated framework.

In those countries where energy planning is based on the free interplay of market forces, there is still no integrated energy planning, even though governments may have prepared documents and future scenarios utilizing an integrated approach. In the developing countries, where a large share of energy sector decisions is still centralized in the hands of the government, the integration of different energy forms within an overall framework is essential not only for ensuring balanced economic growth, but also for minimizing overall costs of energy and use.

Munasinghe has done valuable work in the field of energy pricing. His writings are not only quoted frequently, but several of his arguments are utilized extensively by researchers, policymakers and analysts. I find his 1980 paper on Energy Pricing: An Integrated Framework perhaps the most valuable contribution in this volume, difficult as it is to separate out one from so many excellent chapters. It is really in this chapter that, through a simple but rigorous approach, the author presented a novel framework linking energy prices with other economic variables, and analyzed the structure of energy prices and their influence on economic activities and vice versa.

Perhaps greater harm has been done in the long run by policymakers round the world who deviate from an integrated energy pricing framework than from any other set of energy related decisions. Unfortunately, a regime of irrational prices is very difficult to alter. Even more difficult is the prospect of changing opinions and positions on energy pricing when they have been developed over time through a restricted view of the role of prices in an economic system. Munasinghe’s chapter in this book presents an excellent picture of how pricing decisions should be promulgated, if economic welfare is to be maximized. He has adopted a framework that is concurrently logical, easily understood and yet rigorous.

The fourth chapter dealing with integrated national energy planning using microcomputers is an interesting exposition of how he successfully implemented, while serving as the Senior Energy Advisor to the President of Sri Lanka, many of the principles and analytical techniques he had developed earlier. I recall the presentation of this paper in a one week workshop dealing with this subject in September 1985, at which I had the pleasure of being the Technical Chairman of the workshop organized by the the UN DTCD. Mohan’s was one of the few papers that addressed the challenges of applying the use of models within a Third World organizational and institutional milieu which may not be entirely conducive to energy modelling. Often, researchers who have developed energy models get carried away in their presentations by the technical excitement of the model itself, divorced from the environment within which these models are to be used.

Of course, 1985 was a period when interest in microcomputers and the development of microcomputer-based software was not as widely prevalent as it is today. The subsequent four years witnessed an enormous explosion of energy modelling activities and applications of models dealing with energy and other forms of natural resource use. Nevertheless, Munasinghe’s presentation contains benefits for all those interested in the subject at this time, particularly since the organizational problems in the use of energy models and many of the questions dealing with the decisionmaking process are as valid today as they were when he carried out his work.

The next five essays dealing with energy strategies for oil importing developing countries (1984), energy demand management and conservation (1978), national energy policy implementation in Sri Lanka (1983), energy demand analysis and forecasting (1983), and energy project evaluation and planning (1982), are all subjects that form an essential part of the energy planning and analysis process. The merit of the material presented again lies in a very practical approach based on rational economic principles. Typically, there is widespread interest in energy conservation possibilities in several developing countries, but little is known on how energy conservation goals and objectives can be built into overall planning strategies. Mohan’s analysis is illuminating because it deals with particular energy using sectors, specific types of end uses, and problems of behavioral change. As exemplified in Chapter 6, he had made key contributions over a decade ago, towards establishing a sound analytical and practical basis for the energy efficiency, demand management and conservation programmes that have become the accepted practice in the environmentally-conscious 1980s. The references to the situation in Sri Lanka and other countries add a case study dimension and practical flavour to energy management strategies and approaches.

The chapter on energy demand analysis and forecasting is an extremely useful summary and can be used essentially as a manual by anyone who wishes to analyze energy demand and make projections for the future. The simplicity and clarity of presentation of methodologies is refreshing. While it does not examine in detail, some sophisticated econometric techniques that have been employed widely in recent years -- such as the translog production function -- it is a very useful guide for anyone who wishes to study energy demand for simple and direct application, especially in an operating environment where data is scarce.

Of the remaining chapters in the book that I have not specifically mentioned, I would like to single out the chapters dealing with non-conventional energy project analysis (1983), rural energy issues and supply options (1986) and bioenergy management policy (1979). These three chapters have particular relevance to the developing countries, and their strength lies in the consideration that the author has provided to non-conventional subjects within a conventional framework. Generally, this is where the gap lies in the process of policy formulation and energy planning for renewables in most developing countries.

Unfortunately, even in those nations where vigorous non-conventional energy programs are being pursued, the path followed is one of isolation from conventional energy development. There is as much a gap between organizations and institutions in this regard as there is in methodologies of planning. Conventional energy projects are often pursued on the basis of routine accounting and financial principles; whereas advocates of non-conventional energy pursue a technology-driven approach where economic questions are often wished away as inconvenient and irrelevant. Yet, within a national planning framework, economic rationality has to govern the development of non-conventional energy use, just as conventional energy forms have to contend with questions of resource depletion, environmental costs and other social costs which are either hidden or minimized by analysts pushing thermal power plants, refineries or large hydro projects. Munasinghe provides a valuable framework to bridge this gap.

The final two chapters dealing with energy issues in Thailand (1979) and energy research and development in the developing countries (1983), once again demonstrate the breadth of the author’s coverage and interests in the energy field. In the same spirit, I wish to end this introduction by suggesting that Munasinghe direct his energies even more widely -- to some of the environmental implications of energy policy analysis and planning -- not because it is currently fashionable to do so, but in the interests of ensuring that energy choices in the future fully account for environmental costs and benefits. In my own experience I have found that a whole range of issues such as the setting of environmental standards, the estimation of environmental costs and benefits, and environmental impact analysis are still dealt with in an arbitrary manner. Yet the environmental implications of energy supply and use are immense and continue to grow in magnitude and implication.

Knowing Mohan Munasinghe’s ability and wide interests as a researcher, I am certain that some of these questions are already receiving his attention. Regardless of what Munasinghe writes in the coming months and years, I eagerly await his upcoming works and know that the many thousands of his readers share this feeling. It has been an education and pleasure to read this present volume, and an honour to write the introduction for it. No monopolist can derive a higher economic rent.

Rajendra K. Pachauri

President, International Association for Energy Economics and Director, Tata Energy Research Institute

Delhi, India

¹The opinions expressed herein are those of the author, and do not necessarily represent the views of any organization or institution.

Chapter 1

ENERGY ECONOMICS IN DEVELOPING COUNTRIES: ANALYTICAL FRAMEWORK AND PROBLEMS OF APPLICATION¹

Publisher Summary

Central to the success of the energy economics approach has been the concept of economic value of scarce resources. The economic numeraire has provided the basis on which alternative uses of various resources might be evaluated, facilitating the trade-off between energy and other more traditional inputs, such as capital and labor, and different forms of energy. The complexity of energy-economic interactions indicates that energy sector investment planning, pricing, and management should be carried out on an integrated basis. In energy planning and policy analysis, the principal emphasis is on the detailed and comprehensive analysis of the energy sector, its linkages with the rest of the economy, and the main interactions within the various energy subsectors themselves. The purely financial goals most often encountered relate to meeting the revenue requirements of the sector, and are often embodied in criteria, such as some target financial rate of return on assets, or an acceptable contribution toward the future investment program. The central concepts of opportunity costs and economic value have provided the numeraire on the basis of which integrated national energy policies can be developed, and alternative options concerning the use of scarce resources can be traded off. The economic efficiency objective provides a practical benchmark against which other goals and objectives are conveniently evaluated.

1.1 Introduction

The pervasive and vital role of energy in national economies indicates that the identification of energy issues, and energy policy analysis and implementation are important areas of study. While the softening of world oil prices which began in 1986 has provided some relief to the economies of oil importing nations, energy related problems still preoccupy the minds of decisionmakers in most developing countries. Thus, the availability of adequate energy resources at a reasonable cost remains a vital precondition for continued economic growth, while most of the key energy issues identified during the past decade persist. Typically, developing country energy investments still account for about 25 percent of total public capital expenditures, while this figure is around 50% in some nations -- particularly in Latin America. Furthermore, oil importers are spending an average of 15–20 percent of export earnings on petroleum imports, and serious fuelwood shortages and deforestation problems continue unabated -- especially in Africa and Asia.

Following the first international oil crisis of 1973, the rapidly increasing costs of all forms of energy, led by the world oil price, stimulated the development of new analytical tools and policies. Indeed, much of this success may be attributed to the discipline of energy economics, and the increasing recognition received by our profession reflects the valuable contributions made by many distinguished researchers and colleagues in the field. It is a privilege to briefly set out in this paper, my views on the progress made in recent years, and its impact on energy decisionmaking and implementation in the developing countries. Unfortunately, limitations of space and time prevent full justice being done to the considerable literature available.

Central to the success of the energy economics approach has been the concept of economic value of scarce resources. The economic numeraire has provided the basis on which alternative uses of various resources might be evaluated, facilitating the tradeoff between energy and other more traditional inputs such as capital and labour, as well as among the different forms of energy themselves. Furthermore, economic efficiency in both energy supply and use is a practical benchmark. Thus, the economic costs of deviating from efficient policies, to meet sociopolitical and other goals, may be used to assess the desirability of such options.

Several important lessons have been learned by both energy analysts and policymakers, during the last 10–15 years. First the importance of an integrated approach to energy analysis, and more systematic exploration of energy-macroeconomic links, emerged. Furthermore, while policy analysis and formulation at the national level might be centralised, the effective implementation of policy requires the maximum use of decentralised market forces and institutions. Second, the need became apparent, for greater coordination between energy supply and demand options, and better use of demand management and conservation. Third, the more disaggregate analysis of both supply and demand within the energy sector offered greater opportunities for inter-fuel substitution in specific uses. Fourth, the analytical and modelling tools for energy subsector planning became more sophisticated, particularly in their treatment of uncertainty, reliability and supply quality. Fifth, greater practical reliance was placed on economic principles, such as marginal costing and shadow pricing in the developing countries, rather than relying on engineering and financial analysis alone.

1.2 Framework for Integrated National Energy Planning (INEP), Policy Analysis and Implementation

Energy decisions cannot be made in isolation. The complexity of energy-economic interactions indicate that energy sector investment planning, pricing and management should be carried out on an integrated basis, e.g., within a integrated national energy planning (INEP) framework which helps analyse the whole range of energy issues and policy options over a long period of time.

Energy planning, broadly interpreted, denotes a series of steps or procedures by which the myriad of interactions involved in the production and use of all forms of energy may be studied and understood within an explicit analytical framework. Planning techniques range from simple manual methods to sophisticated computer modelling. The complexity of energy problems and the enhanced capability of low cost microcomputers, has led to increasing reliance on the latter approach. Energy policy analysis is the systematic investigation of the impact of specific energy policies or policy packages on the economy and society, at all levels. Energy supply and demand management involves the use of a selected set of policies and policy instruments, to achieve desirable national objectives.

An important goal of developing countries must be to upgrade the quality of energy planning, policy analysis and management. However, the word planning, whether applied to the national economy or the energy sector in particular, need not imply some rigid framework along the lines of centralized or fully planned economies. Planning, whether by design or neglect, takes place even in the so-called market economies. Furthermore, while the energy planning, policy analysis and formulation may require centralised coordination, policy implementation is most effectively carried out using decentralised mechanisms and market forces, as discussed later in this paper.

In energy planning and policy analysis, the principal emphasis is on the detailed and comprehensive analysis of the energy sector, its linkages with the rest of the economy, and the main interactions within the various energy subsectors themselves. In the industrialised nations, the complex and intricate relationships between the various economic sectors, and the prevalence of private market decisions, make policy analysis a difficult task. In the developing countries, substantial levels of market distortions, shortages of foreign exchange as well as human and financial resources, larger numbers of poor households whose basic needs have to be met, greater emphasis on rural energy problems, and relative paucity of energy and other data, add to the already complicated problems faced by energy analysts