Essay: Energy Economics Cost and Benefit

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[. . .] The capital cost associated with energy economics are; sunk, site specific, site non-specific and fixed. (Rothschild 2008)[footnoteRef:16] [16: Bob Rothschild, "Cost Benefit Analysis." (unpublished lecture., Lancaster University, 2008), Lancaster University, http://www.engineering.lancs.ac.uk/lureg/nwhrm/project/Joule Centre conf 08/rothschild.pdf.]

[footnoteRef:17] [17: Bob Rothschild, "Cost Benefit Analysis." (unpublished lecture., Lancaster University, 2008), Lancaster University, http://www.engineering.lancs.ac.uk/lureg/nwhrm/project/Joule Centre conf 08/rothschild.pdf.]

The above diagram shows the share of various costs in energy economics projects.

Cost and Benefit Applied to Energy Products

Cost and benefit applied to the energy economics can be defined as an appraisal of all the costs and benefits associated with a particular energy project or policy. This project might be marketable or non-marketable. This type of cost includes both the present and future costs and benefits. And both the costs and the benefits are represented in the common unit of value. (Clinch 2003)[footnoteRef:18] [18: Peter Clinch, Cost-Benefit Analysis Applied To Energy, (University College Dublin: Dublin, 2003)http://www.ucd.ie/gpep/publications/archivedworkingpapers/2003/03-04.pdf (accessed May 25, 2013), 4-16. ]

As discussed in the above definition, all the costs and benefits associated with a project must be included in the cost and benefit analysis regardless of the fact that whether these costs and benefits are marketed or not. This point enables the cost and benefit analysis related to the energy economics to include some wider social and environmental issues in it. The common unit of value, which is being used in the above discussed cost and benefit analysis, is money. As the social and environmental issues are non-monetary, therefore, the costs and benefits associated with them are also non-monetary. These costs and benefits are then converted into monetary value so that they can be compared to other costs and benefits easily. (Clinch 2003)[footnoteRef:19] [19: Peter Clinch, Cost-Benefit Analysis Applied To Energy, (University College Dublin: Dublin, 2003)http://www.ucd.ie/gpep/publications/archivedworkingpapers/2003/03-04.pdf (accessed May 25, 2013), 4-16.]

In most of the cases related to energy economics, the costs and benefits occur at different points in time. This happens, especially, in such projects, where all the consequences are unpredictable and environmental factors may have an influential impact of the policies and projects. In such cases various costs and benefits occur at different points in time. To compare the future costs and benefits with the present costs and benefits, the technique of discounting is used. This technique discounts the costs and benefits of future to the present and determines the present value of such costs and benefits. After the determination of the present, the comparison is done between the present values. (Clinch 2003)[footnoteRef:20] [20: Peter Clinch, Cost-Benefit Analysis Applied To Energy, (University College Dublin: Dublin, 2003)http://www.ucd.ie/gpep/publications/archivedworkingpapers/2003/03-04.pdf (accessed May 25, 2013), 4-16.]

In addition to that costs and benefit analysis is also used to determine and analyze various environmental costs associated with different energy economic projects. It analyses the net benefits of using various sources of energy, the benefits of using renewable modes of energy, the benefits of using alternate modes of transports, the benefits of employing different energy efficiency policies etcetera. (Clinch 2003)[footnoteRef:21] [21: Peter Clinch, Cost-Benefit Analysis Applied To Energy, (University College Dublin: Dublin, 2003)http://www.ucd.ie/gpep/publications/archivedworkingpapers/2003/03-04.pdf (accessed May 25, 2013), 4-16.]

Uses of Cost and Benefit Analysis in Energy Economics

The basic reason behind the use of cost and benefit analysis in the energy economics is market failure. If there would not have been any market failures and all the energy economic institutions would have been privately owned then there would not have been any need of the cost and benefit analysis. The cost and benefit analysis is used in the following areas in the field of energy economics. (Clinch 2003)[footnoteRef:22] [22: Peter Clinch, Cost-Benefit Analysis Applied To Energy, (University College Dublin: Dublin, 2003)http://www.ucd.ie/gpep/publications/archivedworkingpapers/2003/03-04.pdf (accessed May 25, 2013), 4-16.]

Energy Externalities

One of the major environmental problems persisting today is the environmental hazards associated with the fossil fuels that generate energy, especially greenhouse gasses. Many of the damaging gasses are emitted by the energy economic sector and transport sector. These gasses have negative impacts on the local, national and international environments. (Clinch 2003)[footnoteRef:23] [23: Peter Clinch, Cost-Benefit Analysis Applied To Energy, (University College Dublin: Dublin, 2003)http://www.ucd.ie/gpep/publications/archivedworkingpapers/2003/03-04.pdf (accessed May 25, 2013), 4-16.]

The energy externalities can be defined by a simple example, if an organization is producing products that emit SO2 in the environment and this SO2 leads to acid rain and deteriorates buildings and forests then, in the free market, such costs are not reflected in the price of the product and hence the price prevailing in the energy market does not represent the total cost of the product. The costs that do not impact the organization or people who incur it are known as external costs. By the use of cost and benefit analysis and the environmental valuation associated with it, the organizations can include such costs in their overall price. (Clinch 2003)[footnoteRef:24] [24: Peter Clinch, Cost-Benefit Analysis Applied To Energy, (University College Dublin: Dublin, 2003)http://www.ucd.ie/gpep/publications/archivedworkingpapers/2003/03-04.pdf (accessed May 25, 2013), 4-16.]

Formation of Policies Related to Externalities

Unless these external costs are converted into internal costs, the organizations will continue to exploit and over use the scarce economic resources. This calls for the intervention of government and the formulation of policies. The cost and benefit analysis provides the tools which are required for the tradeoff between policies and externalities. (Clinch 2003)[footnoteRef:25] [25: Peter Clinch, Cost-Benefit Analysis Applied To Energy, (University College Dublin: Dublin, 2003)http://www.ucd.ie/gpep/publications/archivedworkingpapers/2003/03-04.pdf (accessed May 25, 2013), 4-16.]

Sustainability Assessment and Green National Accounting

Cost and benefit analysis enables the organization to assess its sustainability. By using this tool the organization can answer the questions such as, 'what is the current value of our resources?' 'Are our resources being used productively and efficiently?' And 'Is the man made capital that is replacing the resources, equal to the resources?' etcetera. The green house accounting on the other hand enables the organizations and the government to adjust various environmental and social costs in the Net Income, Gross Domestic Product (GDP) and Gross National Product (GNP) etcetera. (Clinch 2003)[footnoteRef:26] [26: Peter Clinch, Cost-Benefit Analysis Applied To Energy, (University College Dublin: Dublin, 2003)http://www.ucd.ie/gpep/publications/archivedworkingpapers/2003/03-04.pdf (accessed May 25, 2013), 4-16.]

Issues in the Application of Cost and Benefit Analysis on Energy

While using cost and benefit analysis for measuring the benefits and costs of energy projects, it should be kept in the mind that this tool is not free of criticism and controversies. The first controversy that this tool faces is the fact that it uses money as the unit of valuation for all the costs and benefits. In addition to that, while assessing the welfare change the use of willingness to pay (WTP) is a valid theoretical concept if, the income is equally distributed in the society but if the income is not equally distributed and there are high income variances then this is not a valid or accurate option. As poor people in the society will be willing to pay less, whereas, the rich ones will be willing to pay more. Moreover, the prices used in the cost and benefit analysis of an energy product or policy, are a part of the current income distribution, so if there is a change in the income distribution there would be a change in the prices, the market values and the non-market values. In addition to that, all economists do not agree with the concept of tying the environmental costs and benefits with money. (Clinch 2003)[footnoteRef:27] [27: Peter Clinch, Cost-Benefit Analysis Applied To Energy, (University College Dublin: Dublin, 2003)http://www.ucd.ie/gpep/publications/archivedworkingpapers/2003/03-04.pdf (accessed May 25, 2013), 4-16.]

Apart from that, the environmental valuation methods are not efficient measures of the valuation of the environmental issues. These valuation methods are limited and do not measure the environmental costs with complete accuracy. (Clinch 2003)[footnoteRef:28] [28: Peter Clinch, Cost-Benefit Analysis Applied To Energy, (University College Dublin: Dublin, 2003)http://www.ucd.ie/gpep/publications/archivedworkingpapers/2003/03-04.pdf (accessed May 25, 2013), 4-16.]

Economists have mentioned various measures via which the accuracy of environmental valuation can be evaluated. These measures include, validity ( the extent to which the valuation measures the economic value of an environmental change), Reliability ( it is the degree to which the changes in the non-marketable values are a result of random variation), Applicability ( it is the degree to which it determines where the techniques fit best), Cost ( the degree to which the valuation is practical and viable). These valuation techniques are limited and only estimate how the values should be used. They do not form any proper relation between marketable goods and environmental needs. (Clinch 2003)[footnoteRef:29] [29: Peter Clinch, Cost-Benefit Analysis Applied To Energy, (University College Dublin: Dublin, 2003)http://www.ucd.ie/gpep/publications/archivedworkingpapers/2003/03-04.pdf (accessed May 25, 2013), 4-16. ]

To solve the problem of environmental valuation, simpler and less complex valuation systems shall be used. In addition to that, much attention shall be paid on achieving high degrees of reliability. (Clinch 2003)[footnoteRef:30] [30: Peter Clinch, Cost-Benefit Analysis Applied To Energy, (University College Dublin: Dublin, 2003)http://www.ucd.ie/gpep/publications/archivedworkingpapers/2003/03-04.pdf (accessed May 25, 2013), 4-16.]

Conclusion

Cost and benefit analysis provides us with an assessment of efficiency, productivity and… [END OF PREVIEW]

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