Ebook: Interfuel Substitution

The effects of output growth and changing fuel prices on the demand for
energy depend on interfuel substitution and the substitutability of energy
and other factors of production. Over the years, these issues have attracted
a great deal of attention in a large number of energy demand studies, with
most of these studies taking the approach of using a flexible functional form
for the underlying aggregator function, following Diewert’s (1971) influential paper. In fact, this approach to empirical energy demand analysis was
pioneered by Berndt and Wood (1975), Fuss (1977), and Pindyck (1979).
It involves specifying a differentiable form for the cost function, and applying Shephard’s lemma to derive the resulting cost share (or input-output)
equations. Using these equations and relevant data, one then could estimate the parameters and produce inferences about the demand for fuels
(including those about the own- and cross-price elasticities as well as the
elasticities of substitution).
Although the role of energy in the structure of production has been the
focus of a large number of econometric studies, the evidence on interfactor
and interfuel substitutability is mixed. For example, the early studies by
Berndt and Wood (1975), Fuss (1977) and Magnus (1979) all used time
series data for a single country and found substitutability between energy
and labor, but complementarity between energy and capital. Also, Fuss
(1977), using Canadian data, found oil, gas, and coal to be substitutes, but
found no substitutability between each of these energy inputs and electricity. Moreover, Pindyck (1979), taking a similar approach to that used by
Fuss (1977), used pooled time-series data for a cross section of countries
and found energy and labor to be substitutes and also energy and capital
to be substitutes, and not complements as earlier studies had indicated.
Such variability in results can be partly explained by significant inherent
differences between short- and long-run adjustments.

Contents
Preface vii
1. Empirical Energy Demand Analysis 1
1.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.2 The Econometric Approach . . . . . . . . . . . . . . . . . 2
1.3 Theoretical Regularity . . . . . . . . . . . . . . . . . . . . 3
1.4 Flexible Functional Forms . . . . . . . . . . . . . . . . . . 4
1.4.1 The Generalized Leontief . . . . . . . . . . . . . . 5
1.4.2 The Translog . . . . . . . . . . . . . . . . . . . . . 7
1.5 Estimation Issues . . . . . . . . . . . . . . . . . . . . . . . 8
1.6 Concluding Comments . . . . . . . . . . . . . . . . . . . . 10
2. Interfuel Substitution in the United States 11
2.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . 11
2.2 Theoretical Foundations . . . . . . . . . . . . . . . . . . . 12
2.2.1 The Energy Submodel . . . . . . . . . . . . . . . 12
2.2.2 The Translog Energy Price Aggregator Function . 13
2.2.3 Theoretical Regularity . . . . . . . . . . . . . . . 15
2.3 Empirical Modelling . . . . . . . . . . . . . . . . . . . . . 16
2.3.1 Elasticities . . . . . . . . . . . . . . . . . . . . . . 18
2.3.2 Separability Testing . . . . . . . . . . . . . . . . . 19
2.4 The United States Data . . . . . . . . . . . . . . . . . . . 20
2.5 Empirical Evidence . . . . . . . . . . . . . . . . . . . . . . 21
2.6 Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . 35
3. International Evidence on Sectoral Interfuel Substitution 37
3.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . 37
3.2 Theoretical Foundations and the NQ Cost Function . . . 38
3.3 Econometric Methodology . . . . . . . . . . . . . . . . . . 41
3.4 The International Sectoral Data . . . . . . . . . . . . . . . 43
3.5 Estimation Strategy . . . . . . . . . . . . . . . . . . . . . 44
3.6 Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
3.6.1 Industrial Sector . . . . . . . . . . . . . . . . . . . 52
3.6.2 Residential Sector . . . . . . . . . . . . . . . . . . 55
3.6.3 Electricity Generation Sector . . . . . . . . . . . . 60
3.6.4 Transportation Sector . . . . . . . . . . . . . . . . 61
3.7 Summary and Conclusions . . . . . . . . . . . . . . . . . . 63
4. Short- and Long-Run Aggregate Interfuel Substitution 67
4.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . 67
4.2 Estimation of the NQ System . . . . . . . . . . . . . . . . 67
4.3 The International Aggregate Data . . . . . . . . . . . . . 70
4.4 Empirical Evidence . . . . . . . . . . . . . . . . . . . . . . 71
4.4.1 Short-Run Estimates . . . . . . . . . . . . . . . . 71
4.4.2 Long-Run Estimates . . . . . . . . . . . . . . . . . 81
4.5 Concluding Comment . . . . . . . . . . . . . . . . . . . . 107
Bibliography 109
General Index 113
Author Index 117