Energy demand - GEM-E3

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Model Documentation - GEM-E3

Corresponding documentation
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Model information
Model link
Institution Institute of Communication And Computer Systems (ICCS), Greece,
Solution concept General equilibrium (closed economy)
Solution method Optimization

The GEM-E3 model endogenously computes energy consumption, depending on energy prices, realised energy efficiency expenditures and autonomous energy efficiency improvements. Each agent decides how much energy it will consume in order to optimise its behaviour (i.e. to maximise profits for firms and utility for households) subject to technological constraints (i.e. a production function).

At a sectoral level, energy consumption is derived from profit maximization under a nested CES (Constant Elasticity of Substitution) specification. Energy enters the production function together with other production factors (capital, labour, materials). Substitution of energy and the rest of the production factors is imperfect (energy is considered an essential input to the production process) and it is induced by changes in the relative prices of each input.

Residential energy consumption is derived from the utility maximization problem of households. Households allocate their income between different consumption categories and savings to maximize their utility subject to their budget constraint. Consumption is split between durable (i.e. vehicles, electric appliances) and non-durable goods. For durable goods, stock accumulation depends on new purchases and scrapping. Durable goods consume (non-durable) goods and services, including energy products. The latter are endogenously determined depending on the stock of durable goods and on relative energy prices.

Energy efficiency

Energy efficiency in the GEM-E3 model can result from three factors:

• An increase in the amount agents spend to improve energy intensity in response to regulations, for example, by mirroring energy saving obligations or a minimum performance of energy efficiency (endogenous mechanism based on cost-potential curves for energy efficiency by sector).

• A change in energy prices that triggers the substitution of relatively less expensive inputs for more expensive energy, along the frontiers of substitution possibility.

• A change in the rate of energy-embodied technological progress (based on exogenous projections that reflect technological progress).

Expenditures in energy saving technology are treated as spending that economic agents undertake so as to reduce their energy consumption (e.g. purchases of more energy efficient appliances, insulation of buildings and retrofit etc.). For firms, expenditures in energy saving impact on their energy intensity and do not add to their capital stock (as opposed to investments). As energy saving expenditures do not add to the capital stock of firms, the productive capacity of the firms remains unchanged (i.e. energy saving expenditures of a firm reduce energy consumption per unit produced but they do not affect its productive capacity, that is the number of units that a factory can produce). Energy efficiency expenditures reduce energy consumption one period after they take place and continuously for a period of at least 20 years. Households’ expenditures in energy efficiency improvements do not have a direct impact on their utility. The impact is indirect through the reduced energy costs that households have to pay.

Expenditures in energy efficiency improvements generate additional demand for goods and services (ferrous and non-ferrous metals, non-metallic goods, chemical products, electrical goods, construction and market services) which provide inputs to energy efficiency projects (see Table 10).

Energy efficiency improvements exhibit decreasing marginal returns (saturation effect). Energy savings potential is inter-temporally limited (differently by sector) and higher energy saving entails an increase in marginal costs.

Calculating levels of energy efficiency expenditure

Expenditures in energy efficiency imply the accumulation of energy saving stock that is more energy efficient than the benchmark. Thus, specific rates of energy consumption (of equipment) and energy requirements are reduced, which contributes to savings of energy consumption following their installation. The higher upfront expenditures for energy efficiency imply funding requirements that need to be drawn from savings and from other borrowing. The additional funds are drawn from the entire economy (the sum of the economic agents’ savings and general financing from financial institutions), eventually stressing capital supply in the economy. Energy efficiency expenditures have no direct impact on the capital stock as they are used by the agents to purchase goods and services that reduce energy consumption and are not used to increase directly productive capacity. The sectors that provide the energy saving goods and services need to increase their productive capacity in order to meet the increased demand for their products and to this end compete for capital resources with all the other sectors in the economy. This leads to a crowding out effect, the magnitude of which depends on the assumptions about capital market flexibility worldwide and financial resources overall. Spending on energy efficiency stimulates demand for sectors that produce the required goods and services, such as construction, industrial materials, equipment and certain market services. The modelling takes into account that the demand for, and expenditure on, energy decreases permanently in the periods that follow energy efficiency expenditures. For the modelling of the energy saving expenditures the basic assumption is that institutional authorities at national, EU or World level define, by sector, obligations that target pre-specified rates of energy efficiency improvements. The amount of energy efficiency expenditure that is required to reach the pre-specified rate of reductions of energy intensity is determined by the energy efficiency cost curves.

Energy efficiency projects generate demand for inputs from several sectors. Technical coefficients are used to determine the share that each sector delivering inputs to the energy efficiency projects has on the final expenditure made, i.e. for every expenditure made on energy efficiency projects what percentage of it is spend on each of the different sectors providing inputs to energy efficiency projects. Table 10 shows which sectors contribute to the realisation of the energy savings projects and at what shares. These sectors then generate demand for the output of all other sectors through Leontief’s Input-Output system, based on technical coefficients that are endogenously projected by the model.

Table 10: Sectoral breakdown of expenditures on energy efficiency projects

Sector Share of expenditure (in equipment goods and services used to implement energy efficiency investment) as received by production sector, in % of overall expenditure in energy efficiency
Ferrous metals 4
Non-ferrous metals 4
Chemical Products 7
Non-metallic minerals 8
Electric Goods 2
Construction 60
Market Services 15