Energy Economics

ANIL KUMAR

WHAT IS ECONOMICS?
Economics can be defined as a social science that deals with the production, distribution and consumption of scarce resources in an Economy

WHAT IS ENERGY ECONOMICS?

In the light of the definition of economics, Energy Economics can be defined as a subject that deals with various aspects relating to Production, Distribution and Consumption Of Energy related resources

Issues related to Energy production

Production Planning /Assessment of Production Possibilities [harnessing/generation of different forms of energy] Investment allocation for meeting the targets of energy generation Identification/Assessment of Costs & benefits of production Alternative choices of production techniques/methods Optimization of production etc.

Issues related to Energy distribution

Distribution costs assessment of financial costs and T&D losses Options for efficient distribution Managerial options for containing T&D losses/wastages etc.

Issues related to Energy Consumption

Understanding energy consumption pattern/consumer behaviour Estimating Demand and Supply situations Demand and Supply side management etc.

STEPS IN ECONOMIC APPRAISAL OF THE ENERGY PROJECTS Sequential steps that are normally followed for the economic evaluation of the projects are; Establish the socio-economic boundaries of the project Identify the flows of resource inputs and outputs with in and across the boundary Quantify the flows of resources and outputs with in and across the boundary

Identify the benefits and costs associated with and with out the proposed project
Quantify the benefits and costs Compare benefits and costs

Establish the socio-economic boundaries of the project This is a very critical step in economic appraisal

The approach followed in establishing the socioeconomic boundaries is primarily descriptive & qualitative rather than quantitative All possible consequences that will occur with and without the project are considered
The possible consequences are weighed from several perspectives and then this information is used to judge whether the perspectives included in the boundary

Establish the socio-economic boundaries of the project (Contd.) While studying the economic viability of Energy Projects, a variety of aspects must be considered which include; Energy Technology

Physical & Energy resources required & delivered

End use(s) of Energy Social development consideration Geo-political considerations etc.

Identifying the flows of Important Resources, Inputs and Outputs with in and across the Boundary The resources and inputs required for any energy project may either be -internal to the project or -obtained from out side the boundary Similarly, the output(s) of energy projects may either be -used internally [with in the boundary] or -traded out side the boundary Thus, the respective inputs and outputs can be identified as internal or external to the boundary

Identifying the flows of Important Resources, Inputs and Outputs with in and across the Boundary (Contd.)

For most of the energy projects the input(s) and output(s) can be grouped in to following categories:

[i] Materials and fossil fuels Raw & Processed

materials and fossil fuels [to drive machines & equipment] are required in any projects. Therefore, it is necessary to identify their sources with in or out side the boundary [ii] Equipment: For construction and generation

Identifying the flows of Important Resources, Inputs and Outputs with in and across the Boundary (Contd.) [iii] Human skills: Labour & Management skills for construction of the projects [unskilled (may be locally available) & skilled (may have to be imported from out side the boundary] Land & Energy Sources: Land area, water, coal, gas, biomass, fossil fuels etc.

[iv]

[v] Output(s) of Energy System/project: Specific output of energy system needs to be identified. These include the energy flow and any residual products from the process. The residuals may be useful products or may need disposal

Quantifying the flows of Physical Resources and outputs

Materials, Equipment, Land and Energy Resources needed in the energy project should be quantified in such a manner that the contribution of the energy system/project can be directly linked with the values quantified. The Human Resources must be quantified in such a manner that the contribution of each person involved in the establishment and operation of the project is explicitly specified. Similarly, the gain in return accrued to each of the manpower from the energy project must be quantified the gains may be in monetary terms or in terms of the useful output of the energy system. All the outputs of the project also must be quantified to provide the information on both the energy flows as well as the residuals in meaningful terms.

Identifying the benefits and Costs

An attempt is made to identify and value the costs and benefits that will arise with the proposed project and compare them with the situation as it would have been without the project.

The approach is not to compare the situations before andafter the project but to quantify and evaluate all the resources, input and out put flows from the perspective of with and with out the project.

Identifying the benefits and Costs [contd.] Values are associated with the flows of resources inputs & outputs. This is due to the fact that the resources and inputs invested in the project could be used in a different project and therefore have value to that other project. If the resources and inputs are thus a cost which must be incurred to obtain energy ( and other useful residuals) from the energy project. These opportunity costs of resources and inputs can be expressed in monetary or physical terms.

Identifying the benefits and Costs

[COSTS]

[contd.]
The direct costs to a project normally include: (i) Physical goods: materials, energy, equipment etc.

(ii) Labour and Management: (iii) Land (iv) Contingency allowances: Physical : an incraes in physical inputs above those originally anticipated Price : an increase in prices of inputs above those anticipated because of specific of specific input proce changes and general inflation.

Identifying the benefits and Costs

[COSTS]

[contd.] (v) Taxes : Payment of taxes including duties and tariffs is customarily treated as transfer payments in economic analysis. (vi) Payment of interest and repayment of capital: both these items are also often considered as transfer payment. (vii) Sunk costs: These are the costs incurred in the past upon which proposed new investmebnt will be based. Usually, the expenditures incurred in the past (i.e. sunk costs) are not considered in economic analysis.

Identifying the benefits and Costs [Benefits] [contd.] The outputs obtained from the energy system have corresponding values. The value of each output depends upon its use and the opportunity cost of the output being used for a specific purpose should be taken in to account. In some cases, the value is a monetary value while in others the value may have a monetary value or be consumed by the project proponents/owners directly (like in case of RE projects). In either case the benefits stemming from the output of the project is considered as tangible

Identifying the benefits and Costs [Benefits] [contd.]

Tangible Benefits: i] Energy and residual products for other productive activities: Ex: Biogas project: 1. Energy (methane as an energy source) 2. Effluent/slurry (as fertiliser / manure, leading to increase in Agricultural. Production or decrease in fertiliser costs ii] Energy for direct consumer use: Ex: An energy project leads to 1. the production of fuel which replaces higher cost fuels or 2. provides fuel that has not been available before. iii] Energy to be marketed: An energy project could produce a fuel or energy that has an already established market and be sold for cash. For ex: Electric power produced by a grid connected wind form can be sold to the consumers/distributors
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Identifying the benefits and Costs [secondary costs and benefits] [contd.]
Energy/RE projects can also lead to benefits created or costs incurred out side the boundary of the project itself.

Economic analysis also takes in to account of these secondary costs and benefits so that they can be properly attributed to the project investment.
In certain cases the costs and benefits are intangible in the sense that the cannot be readily quantified. Intangible benefits: For Ex: -the inactivation of pathogenic bacteria of the human faeces fed in to a biogas digester is an intangible benefit. -the primary purpose of the project is to produce methane gas and organic fertiliser for agriculture. However, an additional benefit of the project is reduced diseases.

Other intangible considerations

i] Economic consideration such as

-income distribution, -regional development and -employment generation (no. of jobs created) ii] National consideration such as -national integration, -national security and -national self-reliance. iii] Environmental considerations such as -preservation of environment

Quantifying costs and benefits

Determination of the level of costs and benefits of the energy projects may be a complex and difficult task. The important issues to be considered in the process are: i) Market Prices : i) market prices are a good reflection of the values of the inputs and outputs, if the markets for inputs and outputs of the project are well established. ii) in such a case the market prices and the quantities of inputs and outputs can be used to find out the total costs and benefits associated with the project. ii) Export and Import parity prices: in case the energy projects make use of imported/exported goods, the prices are often based on projections of prices at some distant foreign point.

Quantifying costs and benefits

(contd.)
Export and Import parity prices - Appropriate prices must then be calculated for use in the economic analysis - All relevant factors such as freight loading and unloading, insurance, brokerage, storage, duties, local transportation and other associated costs need to be estimated. Future prices of inputs and outputs: The prices of inputs and outputs of an energy project change with the time as, -market forces may cause price changes -general inflation causes all prices to rise relative to their base level values at the beginning of the project. Therefore, the future prices of all inputs and outputs must be predicted and adjusted in to monetary units which help in the assessment of the initial investment.

iii)

Quantifying costs and benefits

(contd.)

iv) Shadow prices, opportunity costs: In many situations representative market prices for some of the projects or outputs of energy projects may not be available. Thus, to undertake the economic evaluation of the project prior to investment, suitable estimates for the values of inputs and outputs are required. The next best use of the inputs if it were not used for the energy project establishes its opportunity cost. Which is also referred to as shadow price. Once determined the shadow price can be used in the same way as market established price(s).
For ex: Natural resources, land, labour and management can be difficult to value Example: in the case of valuation of labour, if there is substantial unemployment in an area ( i.e. it is not contributing to output) the opportunity value of the labour in that area shall be rather low. Thus, in the economic analysis of such cases, labour should be

Quantifying costs and benefits

(contd.)

v)

Valuation of intangible costs and benefits: Efforts should be made to identify all intangible costs and benefits associated with the project. If possible, these costs and benefits associated can be quantified in terms of physical units.

For ex: the effects of using improved cook-stove on air quality indoors can be quantified in terms of the reduction in the indoor concentration of pollutants.
in some cases it may be possible to convert these figures expressed in physical units in to monetary figures with recent advancements in the field of natural resource economics and energy and environment interaction studies.

Quantifying costs and benefits

(contd.)

vi) Comparing benefits and costs: Once, the costs and benefits associated with the project have been -identified -priced and -valued the same may be compared to assess the economic viability of the project.

A variety of measures to evaluate and compare project worths of investment are available [like Cost-Benefit analysis, NPV method, IRR method etc.] which can be used for economic evaluation

Thank You!