World Bank Reprint Series: Number 255 Mohan Munasinghe Third World Energy Policies Demand Management and Conservation Reprinted with permission from Energy Policy, vol. 11, no. 1 (March 1983), pp. 4-18. Published by Butterworth Scientific Ltd., Guilford, U.K. World Bank Reprints No. 220. Gershon Feder and Knud Ross, "Risk Assessments and Risk Premiums in the Eurodollar Market," Journal of Finance No. 221. Bela Balassa, "Policy Responses to External Shocks in Selected Latin American Countries," Quarterly Review of Economics and Business No. 222. Choong Yong Ahn, Inderjit Singh, and Lyn Squire, "A Model of an Agricultural Household in a Multi-crop Economy: The Case of Korea," Review of Economics and Statistics No. 223. Emmanuel Jimenez, "The Economics of Self-help Housing: Theory and Some Evidence from a Developing Country," Journal of Urban Economics No. 224. Thawat Watanatada and Clell G. Harral, "Determination of Economi- cally Balanced Highway Expenditure Programs under Budget Con- straints: A Practical Approach," Transport Research for Social and Economic Progress No. 225. George Psacharopoulos, "The Economics of Higher Education in Developing Countries," Comparative Education Review No. 226. Katrine Anderson Saito and Delano P. Villanueva, "Transaction Costs of Credit to the Small-scale Sector in the Philippines," Economic Development and Cultural Change No. 227. Johannes F. Linn, "The Costs of Urbanization in Developing Coun- tries," Economic Development and Cultural Change No. 228. Guy P. Pfeffermann, "Latin America and the Caribbean: Economic Performance and Policies," Southwestern Review of Management and Economics No. 229. Avishay Braverman and Joseph E. Stiglitz, "Sharecropping and the Interlinking of Agrarian Markets," American Economic Review No. 230. Abdun Noor, "Managing Adult Literacy Training," Prospects No. 231. Bela Balassa, "Shifting Patterns of World Trade and Competition," Growth and Entrepreneurship: Opportunities and Challenges in a Changing World No. 232. Johannes Bisschop, Wilfred Candler, John H. Duloy, and Gerald T. O'Mara, "The Indus Basin Model: A Special Application of Two-Level Linear Programming," Mathematical Programming Study No. 233. Keith Bradley and Alan Gelb, "Motivation and Control in the Mondragon Experiment," and "The Replication and Sustainability of the Mondragon Experiment," British Journal of Industrial Relations No. 234. Gary P. Kutcher and Roger D. Norton, "Operations Research Methods in Agri,ldtural Policy Analysis," European Journal of Operational Resparn A No. 235. Bela Balassa, "Economic Reform in China," Banca Nazionale del Lavoro Quarterly Review No. 236. S. van Wijnbergen, "Stagflationary Effects of Monetary Stabilization Policies: A Quantitative Analysis of South Korea," Journal of Develop- inent Economics No. 237. Gershon Feder, Richard Just, and Knud Ross, "Projecting Debt Servicing Capacity of Developing Countries," Journal of Financial and Quantitative Analysis Third World energy policies Demand management and conservation Mohan Munasinghe Increasing energy costs underline Today's societies require increasing amounts of energy for domestic, the need for more efficient man- industrial, commercial, agricultural, and transport uses. These energy agement of energy supply and needs are met by the commercial energy sources including the short- demand to maintain economic term, depletable fossil fuel supplies - petroleum, coal, and natural gas - growth, especially in the resource as well as the longer-run, renewable sources such as hydroelectric, scarce developing countries. Com- b bining policy tools for demand bIomass," solar, geothermal, wind, and tidal power. management and conservation In18,wrd:mecaenrycnupinaslot14mlin (inclucing pricing, physical con- barrels per day of oil equivalent. Only 20% of this was used by the trols, technical methods, and developing countries although they contained over 75% of the world's education) yields the best results. population. The almost six-fold increase in the real price of oil between Pricing policy takes into account 1972 and 1980, and the general rise in costs of supplying all forms of the efficiency costs of energy energy have placed enormous financial strains on most nations. The supply required to meet economic resource scarce Third World countries will need over US$600 billion (in objectives. This is then adjusted to 1980 constant terms) for energy investments in the 1980s.2 To ensure that satisfy other objectives of pricing energy is economically and efficiently used, policy makers in many such as social-subsidy considera- countries are beginning to realize that energy investment and pricing tions, financial viability, conserva- decisions should be carred out on an integrated basis, eg within the tion, price stability, etc. Energy framework of a national energy master plan that addresses both supply conservation programmes should be implemented only after deter- and demand issues. mining whether their economic benefits exceed the corresponding National energy planning costs. The broad rationale underlying national energy planning3 is to make the Keywords: Energy; Third World; best use of energy resources to promote socio-economic development Demand management and improve standards of living. As an essential part of overall national economic planning, the principal emphasis of energy planning, is on the The author is Senior Energy Advisor to comprehensive and disaggregate analysis of the energy sector and its the President of Sri Lanka, Ministry of interactions within the economy. The energy planner's role might be Power and Energy, Colombo, Sri confined to seeking the least-cost method of meeting future energy Lanka; on leave of absence from The requirements, although a variety of other objectives might be included.4 World Bank, Washington, DC 2G433, Energy planning requires analysis at three levels: USA. 0 links between the energy sector and the rest of the economy; 4 031'1-4215/83/010004-15$03.00 � 1983 Butterworth & Co (Publishers) Ltd Third World energy policies The views and opinions expressed in this * interactions between different subsectors within the energy sector; paper are the author's and do not neces- and sarily reflect those of the Govemment of Sri Lanka or the World Bank. The author is * activities in each individual energy subsector. grateful to Gunter Schramm, Lyndon Driscoll and an anonymous referee for The steps involved in the planning procedure usually include energy helpful comments. supply and demand analysis and forecasting, energy balancing, policy formulation, and impact analysis, to meet short-, medium- and long- range goals. These activities are first carried out at a relatively simple level and later (as data and local analytical capabilities improve) more sophisticated techniques including computer modelling may be imple- mented. The institutional structure should be rationalized by setting up a central energy authority (CEA), or ministry of energy, with its principal focus on energy planning and policy making. The execution of policy, and day-to-day operations, would remain the responsibility of line agencies such as the electricity utilities or petroleum corporations that already exist in practically all countries. Demand and supply management permit the energy policy maker to maintain the energy supply-demand balance, thus avoiding major economic disruptions and reductions in national welfare.5 Policy tools The policy tools available for energy planning and management include pricing, physical controls, technical methods (including research and development), and education and propaganda, Since these tools are 'Biomass consists of traditional and non- interrelated, their use should be well coordinated. Price is most effective commercial fuels such as wood, vegetable in the medium- and long-term. In terms of economic efficiency, price residue and animal waste. These traditional fuels are particularly important in develop- indicates the consumer's willingness-to-pay and use-value of energy to ing countries. See for example Mohan the supplier; while to the consumers, it signals the present and future Munasinghe and Gunter Schramm, Energy opportunity costs of supply based on various energy sources. Economics, Demand Management and Conservation Policy, Van Nostrand, New Physical controls are most effective in the short-run when there are York, NY, USA, forthcoming 1983. unforeseen shortages of energy. All methods of physically limiting con- 2World Bank, Energy in the Developing s Countries, Washington, DC, USA, 1980. umption are Included i this category.6 Techncal means iclude, on the 'For further details see Mohan Munasinghe, supply side, the cheapest means of producing a given form of energy, the 'Integrated national energy planning best fuel mix, research and development of substitute fuels such as (INEP) in developing countries', Natural wood-alcohol for petrol; and on the demand side, introducing higher Resources Forum, Vol 4,1980, pp 359-73. 4For example reducing dependence on efficiency energy conversion devices such as better wood burning stoves foreign sources, supplying basic energy etc. Education and propaganda include, on the supply side, efforts to needs of the poor, reducing the trade and foreign exchange deficit, priority develop- make people aware of exteral dis-economies such as pollution, and ment of special regions or sectors of the supportive of re-afforestation schemes to preserve the environment; and economy, raising sufficient revenues to on the demand side public education for energy conservation. finance energy sector development (at least partially), ensuring continuity of supply and price stability, preservation of Objectives and integrated pricing framework the environment. betvsaditgae rcn rmwr sDemand management includes all .. . .. means of influencing and controlling the ricing and Investment decisions should be closely related. However, magnitude and pattern of energy consump- energy supply systems7 usually require large capital investments with tion. Supply management includes identifi- long lead- and life-times. Once the investment decision is made (usually cation and optimal exploitation of all energy * t resources, investment planning, trans- on the basis of the conventional least-cost method of meeting demand by formation, refining and distribution of sub-sector, with due regard for interfuel substitution possibilities) there is energy and so on. a lock-in effect with respect to supply. TSherefore prices should be related 6For example load shedding and rotating power cuts in the electricity subsector and to the long-term plannig horizon. On the demand side, energy conver- reducing the supply of petrol or banning the sion devices (eg cars, gas cookers, electric appliances, machines and so use of cars during some periods. on) are expensive relative to average income and have relatively long 'For example electricity generation, trans- life-times, thus limiting the ability of consumers to respond to changes in mission and distribution, oil and gas wells and pipelines, coal mines, forests. relative fuel prices in the short run. ENERGY POLICY March 1983 5 Third World energy policies Economic efficiency The objectives of energy pricing are closely related to the goals of energy planning, but are more specific. The economic growth objective requires that pricing policy should promote economically efficient allocation of resources both within the energy sector and when integrated with the economy in general. This implies, generally, that energy use would be at optimal levels, with the price (or consumer's willingness-to-pay) for the marginal unit of energy used reflecting the incremental resource cost of supply to the national economy. Relative fuel prices should also influence the pattern of consumption in the direction of the optimal or least-cost mix of energy sources required to meet future demand. Distortions and constraints in the economy necessitate the use of shadow prices and economic second-best adjustments. Social-basic needs The social objective recognizes the basic right of all citizens to be supplied with certain minimum energy needs. Given the existence of significant numbers of poor consumers and also wide disparities of income, this implies subsidized prices, at least for low income consumers. Financial viability The government is concerned with financial objectives relating to the viability and autonomy of the energy sector. This implies pricing policies which permit institutions (typically, government-owned) in energy sub- sectors to earn a fair rate of return on assets and to self-finance an acceptable portion of the investments required to develop future energy resources. Conservation Energy conservation is also an objective of pricing policy. While pre- vention of unnecessary waste is important, there are often other reasons underlying the desire to conserve certain fuels. These include the desire for greater independence from foreign sources (eg oil imports), the need to reduce the consumption of woodfuel due to deforestation and erosion problems, etc. Other There are a number of additional objectives, such as the need for price stability to protect consumers from large price fluctuations, the need for simplicity in pricing structures to avoid public confusion and for simplicity of metering and billing, and so on. Finally, there are other specific objectives such as promoting regional development (eg rural electrification) or specific sectors (eg export- oriented industries), as well as other socio-political, legal and environ- mental constraints. Two stage pricing policy The objectives mentioned above are often not mutually consistent, and so a realistic integrated energy pricing structure must be flexible enough to permit trade-offs among them. To achieve this, pricing policy formulation must be carried out in two stages. In the first stage, a set of prices which strictly meets the economic efficiency objective is deter- 6 ENERGY POLICY March 1983 Third World energy policies F mined, based on a consistent and rigorous framework. The second stage \ consists of adjusting these efficient prices to meet all other objectives. The latter procedure is more ad hoc with adjustments being determined \G by the relative importance attached to each objective. ' Da Shadow pricing and economic efficiency p i Shadow pricing theory has been developed mainly for use in the cost- 01 0min 02 benefit analysis of projects.8 However, since investment decisions in the Ouantity energy sector are closely related to the pricing of energy outputs, for consistency the same shadow pricing framework should be used in both Figure 1. Income distributional argu- instances.9 ment for the social or lifeline rate. Given perfect competition the interaction of atomistic'0 profit maxi- mizing producers and atomistic utility maximizing consumers yield market prices which reflect the correct economic opportunity costs, and 8For more general use of shadow pricing in thus scarce resources will be efficiently allocated. However, in the real developing countries see Lyn Squire and world, a variety of distortions" lead to market prices, which may diverge PronectJns HderTopak,nsoUniveArityPressof substantially from their shadow prices or true economic opportunity Baltimore, MD, USA, 1975; and for more costs. Therefore, 'efficiency' shadow prices must be used in investment specificapplicationtotheenergysectorsee and output pricing decisions, to ensure proper allocation of resources Mohan Munasinghe, The Economics of Power System Reliability and Planning, (see Appendix 1). Moreover, if there are large income disparities, even Johns Hopkins University Press, Baltimore, these efficient shadow prices must be further adjusted, especially to MD, USA, 1979, Chapter 9. achieve socially equitable energy pricing policies for serving poor 9Shadow prices are used instead of market prices (or private financial costs) to repre- households.12 To clarify the basic concepts involved in optimal energy sent the true economic opportunity costs of pricing we have analysed a relatively simple model using a two step resources (from the national viewpoint), procedure (see Appendix 2). 10Atomistic competition comprises a market structure in which the number of firms is very large and hence each firm competes Adjustments to efficient energy prices independently. "For example monopoly practices, exter- nal economies and diseconomies (which Once efficient energy prices have been determined, the second stage of are not internalized in the private market), pricing to meet social, financial, political and other constraints, must be interventions in the market process through carried out. taxes, import duties and subsidies etc. "2Lack of data, time and manpower resources, particularly in the LDC context, Social-lifelines prices will generally preclude the analysis of a full Socio-political or equity arguments are often advanced in favour of economy-wide model when making energy-related decisions. Instead a partial subsidized prices or 'lifeline' rates for energy, especially where the costs approach may be used where key linkages of energy consumption are high relative to incomes of poor households. and resource flows between the energy B sector and the rest of the economy, as well conomic reasoning based on externality effects may also be used to as interactions among differeht energy sub- support subsidies, eg cheap kerosene to reduce excessive firewood use sectors are selectively identified and ana- and prevent deforestation, erosion, etc. To prevent leakages and abuse of lysed, using appropriate shadow prices such as the opportunity cost of capital, such subsidies, energy suppliers must act as discriminating monopolists. shadow wage rate, marginal opportunity Targeting specific consumer classes (for example, poor households), and costs for different fuels and so on. This limiting the cheap price only to a minimum block of consumption is holistic approach or general equilibrium analysis is conceptually important. For comparatively easy to arhieve for metered forms of energy like gas or example the efficiency shadow price of a electricity. Other means of discrimination may also be required such as given resource may be represented by the rationing, licensing, etc.13 change in value of aggregate national con- . ' . '. sumption or output, due to a small change The icome distrbution arguments for a subsidized energy price are in the availability of that resource. A more illustrated in Figure 1. This shows the respective demand curves for detailed discussion of general versus par- energy (CD and FG) of low (I,) and average (I,) income domestic users, tial equilibrium in relation to eneg sector analysis is given in Munasinghe, Op cit the social tariff p, over the minimum consumption block Q to Qmin, and Ref 8. the efficient price level Pe. All tariff levels are in domestic market prices. "3For example, a minimum ration of cheap If the actual pricep = Pe then the average household will be consuming at kerosene for households, or a special licence for trucks using subsidized diesel oil the 'optimal' level Q,, but the poor household will not be able to afford and ban on diesel-a,ien passenger cars. the service. ENERGY POLICY March 1983 7 Third World energy policies If increased benefits accruing to the poor have a high social value, then the consumer surplus portion CDE should be multiplied by an appro- priate 'low income social weight' (W>1).14 Thus, although in nominal domestic prices the point A lies below Pe, the weighted consumer surplus could be greater than the shadow price of supply. The adoption of the block tariff shown in Figure 1, consisting of the lifeline rate ps, followed by the full tariff Pe, helps to capture the consumer surplus of the poor user, with minimum effect on the optimum consumption pattern of the average consumer. 15 In practice, the magnitude Qmin has to be carefully determined, to avoid subsidizing relatively well-off consumers; it should be based on acceptable criteria for identifying 'low income' groups, and reasonable estimates of their basic energy needs (eg for poor electricity consumers, in most developing countries Qmin would be less than 50 kWh per month, whereas the corresponding value in inidustrialized countries might be several hundred kVVh). The level of Ps relative to the efficient price may be determined on the basis of the poor consumer's income level relative to some critical consumption level. 16 The financial requirements of the energy sector would also be con- sidered in determining Ps and Qmin. This approach may be reinforced by an appropriate supply policy (eg subsidized house connections for elec- tricity, special supply points for kerosene, etc). Financial viability The financial constraints most often encountered relate to meeting the revenue requirements of the sector; most often some target financial rate of return on assets, or an acceptable rate of contribution towards the 14These social weights, that give greater future investment programme. Acceptable revenue levels have to be importance to benefits and costs affecting poorer consumers, forrn the basis for a achieved by adjusting efficient prices.17 'social' shadow pricing framework. By con- Theoretically one can discriminate between the various consumer cate- toruaslty tdhesceffiencyshadlow pnrices incoe gories so that the greatest divergence from the marginal opportunity cost distributional issues. based price occurs for the consumer group with the lowest price elasticity '51gnoring the income eiZect due to of demand, and vice versa. This will result in the smallest deviations from reduced expenditure of the average con- the 'optimal' levels of consumption consistent with a strict efficiency sumer for the first block of consumption, ie up to Qmin' pncing regime. In many countries the necessary data for the analysis of 16For details see Mohan Munasinghe and demand by consumer categories is rarely available, so rule-of-thumb Jeremy Warford, Electricity Pricing, Johns methods of determining the appropriate tariff structure have to be Hopkins University Press, Baltimore, MD, aotd USA, 1982. adopted. "In principle, for state-owned energy sup- However, if an energy subsector exhibits increasing costs (eg marginal pliers, the most efficient solution would be electricity costs greater than average costs), this constitutes a practical to set prices at the eff icient level and rely on government to subsidize losses or tax sur- means of raising public revenues in a manner which is generally consistent pluses exceeding sector financial needs. In with the economic efficiency objective, at least for the bulk of the con- practice, because of the drain on public sumers who are not subsidized, while at the same time helping to supply fails to achieve minimum financial targets basic energy needs to low income groups. Similarly in the oil subsector. for continued operation of the sector, would high prices for petrol, based on efficiency, externality and conservation rarely be acceptable. Conversely, when arguments, may be used to cross-subsidize the 'poor-man's' fuel- efficient pricing results in financial sur- krsn rdee sdfrtasot1 pluses well in excess of traditional revenue kerosene, or diesel used for transport. targets, this may be politically unpopular, especially for an electric utility. Other considerations 18However, a number of undesirable side effects may follow such as the practice of There are additional considerations that may justify departing from a mixing petrol with kerosene, and so on. The strictly efficient pricing policy. The decision to provide commercial income distribution effects may also beenergy such as kerosene or electricity in. a remote rural area, which often perverse, with the relatively wealthy divert- ing cheap kerosene or diesel for use in entails subsidies because the beneficiaries are not able to pay the full price vehicles or in industry. based on high unit costs, could be made on non-economic grounds, eg for 8 ENERGY POLICY March 1983 Third World energy policies general socio-political reasons such as maintaining a viable regional industrial or agricultural base, stemming rural to urban migration, or alleviating local political discontent. Similarly, uniform nationwide energy prices are a political necessity in many countries, although this policy often implies cross-subsidization eg urban consumers subsidizing those consumers in remote rural areas where distribution costs are higher. However, the full economic benefits of such a course of action may be much greater than the apparent efficiency costs which arise from any divergence betweer. actual and efficient price levels. Again this possibi- lity is likely to be much more significant in a developing country than in a developed one, not only because of the high cost of energy relative to incomes in the former, but also because the available administrative or fiscal machinery to redistribute incomes or achieve regional or industrial development objectives by other means is frequently ineffective. The conservation objective (to reduce dependence on imported energy, improve the trade balance, and so on) usually runs counter to subsidy arguments. Therefore it may be necessary to restrict cheap energy to productive economic sectors which need to be protected and strengthened, while in the case of basic energy needs of households, the energy price could be sharply increased for consumption beyond appro- priate minimum levels.19 In other cases conservation and subsidized energy prices may be consistent. For example, cheap kerosene might be required, especially in rural areas, to reduce excessive woodfuel con- sumption, thus preventing deforestation and erosion. Finally, owing to the practical difficulties of metering, price discri- mination, and billing, and the need to avoid confusing consumers, the pricing structure may have to be simplified, thus limiting the number of customer categories, consumption blocks, etc. Electricity and gas offer the greatest possibilities for structuring. The degree of sophistication of metering depends on the net benefits of metering, problems of instal- lation and maintenance, and so on. However, for liquid fuels like kero- sene, subsidized or discrirninatory pricing would usually require schemes involving rationing and coupons, and could lead to leakage and abuses. Energy conservation Using both price and non-price policy tools, demand management techniques help establish economically efficient or optirnal pattems and levels of energy consumption. This may involve reducing the consump- tion of some forms of energy and increasing the use of others that are cheaper or more suitable. Energy conservation is an important element 191t may be particularly difficult to raise prices to anywhere near the optimal efficient of demand management and involves measures that specifically seek a levels where low incomes and a tradition of deliberate reduction in the use of energy below some level that would subsidized energy have increased con- otherwise prevail. Such reduction involves elimination of outright waste, sumer resistance. In practice, price changes have to be gradual, in view of the reduction of energy using activity, substitution of one form of energy for costs which may be imposed on those who another, or substitution of other productive factors like capital and have already incurred expenditures on labour for energy. energy using equipment and made other decisions, while expecting little or no changes in traditional energy pricing poli- Conservation economics cies. At the same time, a steady price rise will prepare consumers for future high Some conservation is achieved simply by reducing or eliminating certain energy prices. The efficiency costs of a energy-using activities. Foregoing Sunday pleasure driving, using lower gradual instead of a sharp price rise can be t hermostat settings and shutting off appliances and lighting fixtures when seen as an implicit shadow value placed on the social benefits that result from this not directly needed are typical examples. Other conservation measures policy. may require the substitution by either capital or labour. Examples are ENERGY POLICY March 1983 9 Third World energy policies re-using heat in industrial processing, the energy-saving reductions in the weight of vehicles by better engineering or lighter materials, or the use of improved insulation. The substitution of some form of costly, or scarce energy resource by some other that is more readily available is an important conservation measure. Examples are the use of coal instead of fuel oil in heat pro- cesses, the use of natural gas instead of petroleum products for power plants where gas is plentiful compared to oil, or the use of gasohol instead of petrol for transport. In a physical sense, (as measured by Btu con- sumed) such substitution may not 'save' energy. In an econoinic sense, however, such substitution may be quite sensible, given the economic scarcity values of the altemative fuels. The pursuit of energy conservation as a goal raises the issue of up to what point the reduction of energy consumption is socially beneficial or desirable. Common sense indicates that 'wasteful' energy use should be discouraged, but there is a limit beyond which conservation becomes too costly in terms of foregoing other resources or useful outputs, thereby causing more harm than good. The principle objective of a given policy should be the maximization of the welfare of a society over time.20 Economic criterion In simple terms, the adoption of a given conservation measure is eco- nomically justified if AB>AC, + AC2, where AB, AC, and AC2 are the economic values of marginal energy saving benefits, marginal additional input costs and marginal ieductions in consumption benefits respectively. This condition should be achieved over the life expectancy of the activity,21 implying use of expected lifetime costs, not just presently prevailing cost relationships. For example, if energy costs are expected to increase relative to other input costs or the value of output over time, greater substitution by non-energy inputs (ie higher levels of energy conservation) is called for. If we introduce the time element the conser- vation criterion becomes: nb 1 (c,tn tI b, (1+r) > t2] (C1,1 + C2,t)(lr where bt, c1 t and c,, t are the respective annual energy savings, additional input costs and losses in consumption benefits in year t and r is the discount rate, all defined in terms of appropriate shadow prices. Application of the criterion Let us consider a particular end use for energy such as home lighting, and assume there is a choice of two distinct types of light bulbs, incandescent and fluorescent. For simplicity, we begin by assuming that both have the 201f aggregate consumpton or production (eg same economic cost, same life-time, and provide light output of the same gross domestic product or GDP) is taken as quality. If the fluorescent bulb uses less electrical energy than the incan- a proxy for aggregate welfare, then welfare maximization implies the use of scarce descent one, then replacing the latter by the former is a conservation resources such as energy, capital, labour measure that results in an unambiguous inprovement in economic as well and land in such awaythatoutputismaxi- as technical efficiency. In this case, using fluorescent bulb instead of contribute to this goal, provided that ten e incandescent lamps reduces the economic resources expended to provide added costs of such conservation mea- the desired output, ie lighting. Electrical energy has been conserved, with sures or process changes do not outweigh no change in other economic costs and benefits. the value of the energy savings achieved. 21More accurately, over the life expectancy Next, assume that the fluorescent bulb is more costly to install. There is of the fixed input components of the activity. a trade-off between the higher capital cost of the fluorescent lamp and the 10 ENERGY POLICY March 1983 Third World energy policies greater consumption of kWh by the incandescent bulb. The relevant data to determine whether substitution of incandescent by fluorescent bulbs is economically justified are summarized in Table 1. At this stage we distinguish between the economic value (or opportunity cost or shadow price, as discussed earlier) of a good or service, and its market price. The former is revelant cO decision making from a national perspective and the latter is more appropriate from a consumer's viewpoint. The national eost (based on economic values) of using the incandescent and fluorescent bulbs over their two year lifetimes are respectively:22 EC, = 10.5 + 16 + 16/(1 + r) (1) ECF = 32 + 4.4 + 4.4/(1 + r) (2) Assuming an economic discount rate of r = 0.1, we find EC, = 41.0 > ECF= 40.4. We have compared the energy cost saving of (16 - 4.4) = 11.6 dineros per year for two years against the increase in capital costs (32 - 10.5) = 21.5 dineros. We find that (16 - 4.4) + (16 - 4.4)/(1 + r) > (32 - 10.5). Therefore using fluorescent lightbulbs, with their associated reduction in energy consumption, will improve economic as well as technical efficiency. Note, however, that if we use r = 0.2, EC, = 39.8 < ECF = 40.1; and the conservation measure is no longer beneficial. This reduction in the relative value of conservation will always occur with increases in the discount rate, because increases in initial investment costs are traded off against the future cost-savings realized by conservation. This finding has 22As discussed earlier, the term economic important policy implications. Energy users who confront high value is used synonymously with oppor- opportunity costs of capital (eg those in many developing countries) will tunity costs or efficiency shadow prices, find costly capital-intensive energy conservation measures relatively less and tllese may differ from actual market prices. attractive than users who have access to low-cost sources of capital. This 23Legal barriers, capital rationing or lack of means that economically 'optimal' conservation measures may differ credit facilities, inappropriate foreign ex- significantly among different countries. change rates, price controls, extemalities and many other factors interfere in the nor- mal functioning of the energy market. Other Market imperfections and privare consumers complications arise from a lack of know- So far the analysis has been based on the national viewpoint, using values ledge of available altematives as well as future costs and prices, and the lock-in for all inputs and outputs (including those for energy) reflecting economic effects of long-lived facilities and equip- opportunity or shadow costs. However, market prices may differ from ment. All of these factors tend to distort rational choice pattems, with the result that shadow values because market imperfections, particularly in the pricing private energy use and conservation pat- and availability of energy, abound in most countries.23 terns diverge substantially from those To illustrate the effects of these divergences, let us return to the simple found to be optimal from a rational view- l e point (ie based on economic efficiency light-bulb example. Phe private costs (based on market prices) of using criteria). incandescent or fluorescent lighting respectively are as follows: Table 1. Data to assess the economic efficiency of energy conservation for lighting. Incandescent bulb Fluorescent bulb Installation cost (dineros) Economic value (opportunity cost) 10.5 32 Market price 18 35 Physical energy consumption (kWh per year during 2 year lifetime) 40 11 Value of energy consumption (dineros per year during 2 year lifetime) Econorriic value (marginal opportunity cost)a 16 4.4 ao.4 dineros/kWh Market priceb 12 3.3 bo.3 dineros/kWh ENERGY POLICY March 1983 11 Third World energy policies PCI = 18 + 12 + 12/(1 + r) PCF = 36 + 3.3 + 3.3/(l + r) At a discount rate of r = 0.1 (eg the market interest rate based on private bank rates): PC, = 40.9 < PCF = 42.3. This means that a rational consumer would prefer to use incandescent light bulbs, because this is the cheaper option. At any higher dis,'ount rate the advantages of the incan- descent system over the fluorescent one increases further. Thus, since market prices diverge from real economic costs, consumers would make economically inefficient energy-use decisions. Developing country issues24 In the commercial energy using sectors of developing countries, essenti- ally the same demand management and conservation arguments apply, as for industrialized nations. However, particular policies and their imple- mentation should be adapted in a country-specific manner.25 Dissemi- nating up-to-date information is a critical element in convincing con- sumners to follow desirable policies. Energy conservation in transport, which tends to be highly oil-intensive, implies changing from more to less energy consuming transport modes, increasing the technical efficiency of given modes of transport, and changing lifestyles, behaviour and patterns of urban dwelling. Similarly, energy consumption for lighting and space conditioning of buildings may be reduced by improving the conservation awareness and changing the behavioural characteristics of occupants, installing more efficient energy using equipment, and altering the archi- tectural design practices and building materials used. In the industrial sector, conservation efforts should focus on waste heat recovery and cogeneration, other retrofits and improvements in existing operations, major changes in manufacturing processes and production methods, and recycling and recovery of waste materials. Finally, in electric power supply, energy savings may be realized through increasing the efficiency of generation, reducing loss in transmission and distri- bution systems, and improving the patterns and efficiency of end use. A recent estimate indicates26 that by 1990, the developing counties can save over 4 million bbl/day oil equivalent or about 15% of total commer- cial energy consumption if effective conservation policies are adopted in the four key sectors outlined, although this will not be easy. Thus, inappropriate pricing of energy resources is not the only reason for inefficient energy conservation decisions. In many developing countries the lack of foreign exchange resources forces governments to maintain strict import controls. Thus, it is often impossible for large energy users to import new, more energy-efficient equipment to replace the existing, even though they are usually able to secure their share of high-cost imported fuel supplies to keep their existing fuel-inefficient equipment operating. In countries in which fuel prices are subsidized at the same time, there is little incentive for such equipment owners to press for 24For more details see Munasinghe and appropriate changes in import policies. Schramm, op cit, Ref 1. Conservation issues unique to the developing countries arise in the case 25lndustrialized country conservation pro- of households that depend on traditional fuel resources such as firewood, grammes are discussed in Energy Conser- charcoal and dung. They often employ primitive cooking appliances like vation, Intemational Energy Agency, OECD, Paris, 1981. open fires that are highly inefficient, using only about 55 of the inherent 26World Bank, op cit, Ref 2. heat energy of the fuel. Heavy population pressures, dwindling firewood 12 ENERGY POLICY March 1983 Third World energy policies resources resulting in sharply increased costs of fuelwood gathering as well as increased soil erosion, reduced availability of crop residues from new short-term, high yield crop varieties, all combine to make this one of the foremost and serious energy problems in the majority of developing countries. The use of simple cooking stoves constructed of locally available materials at out-of-pocket costs barely exceeding $5 to $10 could improve energy efficiency by a factor of 4 to 5 in laboratory tests and perhaps by a factor of 2 or better in actual day-to-day household use. Price and non-price policy interactions and complications In addition to appropriate pricing there are a wide variety of direct and indirect policy measures that can be tak-en to bring about desirable levels of energy conservation. Among them are direct regulation of energy uses, regulation of the use of energy con1suming equipment and appli- ances, mandatory standards, mandatory information requirements about energy consumption rates, taxes and subsidies, appropriate infra- structure investments for energy saving facilities (eg better roads, rail- roads, marine shipping facilities) education and propaganda, and others. To analyse some of the effects of such conservation-oriented policies let us first return to the lightbulb example. As we have found, existing market prices have made it more attractive for users to opt for the incandescent lightbulb system. To resolve this difference between optimal economic and private market choices, the first option policy makers might consider could be to raise the market price of electricity from 0.3 dineros per kWh to its economic value of 0.4 dineros per kWh. We now have: PC, = 48.5 > PCF = 44.4 and rational electricity con- sumers will make the correct decision in favour of fluorescent lighting. In addition, setting the electricity price equal to its marginal opportunity cost will also establish electricity consumption for non-lighting purposes at optimal levels. Suppose that public resistance or other social pressures make it impos- sible to raise electricity prices. Let the ecow.)mic value of an incandescent bulb be its cost of production or producer price, while the imposition of a government tax of 7.5 dineros determines the market price, Similarly, assume that an import duty of 4.0 dineros represents the difference in the cif import cost (32 dineros) and the market price of fluorescent bulbs. Instead of raising electricity prices, an alternative policy option might be to raise the tax on incandescent lightbulbs to 9.5 dineros, making the market price 20 dineros. In this case, PC, = 42.9 > PCF = 42.3, which encourages the desirable consumer decision. Reducing the duty on fluo- rescent bulbs to 2 dineros and lowering the retail price to 34 dineros would also yield a favourable result, since now: PC, = 40.9 > PCF= 40.3. Some combination of the tax increase and lowering of duty could also be used prom a strictly economic viewpoint, and ignoring effects outside the lightbulb market, reducing the import duty would be preferable to raising the producer tax because the former action reduces the divergence between market price and economic opportunity cost of fluorescent bulbs whereas the latter has the opposite effect and increases the market distortion in the price of incandescent lightbulbs. Next, assume that the tax on incandescent lightbulbs cannot be increased because the legislation affects a much larger class of related products. Sirnilarly, suppose that the import duty on fluorescent bulbs ENERGY POLICY March 1983 13 Third World energy policies cannot be reduced because it would undercut the price of a high-cost local producer and drive him out of business. In this instance, some final options left to the energy policy maker might be to legislate that all incandescent lightbulbs be replaced by fluorescent ones, or to give a direct cash subsidy to consumers who adopt the measure, or to mount a major public education and propaganda campaign to bring about the required change.27 Complications If the useful lifetimes of technological alternatives are different, then economic comparisons become somewhat more complicated. This would be the case in our earlier example if the lifetime of incandescent bulbs were to be only one year while that of fluorescent lamps might be three years. Two alternative approaches could be used to overcome this diffi- culty. In the first, the investment costs of each alternative would have to be annuitized over its lifetime at the appropriate discount rate and the associated energy consumption and other recurrent costs for one year would be added on. Then the total costs for each option would be compared. The second method would compare the full costs of each alternative over a much longer period, say 20 years, including the costs of periodic replacement of worn-out equipment. 28 The two methods should give consistent results, assuming the same values are used for parameters such as the discount rate. Another difficulty associated with changes in the benefits of consump- tion arises if either the quality of the end-product of energy use is different for the two alternatives. Consider a comparison of electric versus kerosene lamps for lighting. In addition to the differences in equipment and fuel costs, the cost-benefit assessment of the two options should also include a tenn to recognize that electricity is likely to provide lighting of a superior quality.29 While the quantification, in monetary terms, of this qualitative superiority will be difficult, one measure might be the willingness-to-pay of the consumers for the different forms of 7The evidence concerning the effective- lighting, usually represented by the area under the relevant demand ness of education and propaganda as an curve. energy conservation tool is mixed. See Specific conservation measures such as rationing have a quality effect James M. Walker, 'Voluntary responses to that raust be taken into account. For example, with the physical rationing energy conservation appeals', Joumal of o Consumer Research, Vol 7, June 1980, pp of petrol, the cost, or welfare loss to the consumer due to the reduction in 88-92; and A.E. Peck and O.C. Doering, the miles he can travel in his car must be added to the cost of implement- 'Voluntarism and price response: con- ing the rationing scheme and then compared with the benefits of reduced The Bell Journal of Economics, Volr , petrol supply. Once again, the willingness-to-pay of petrol users would be Spring 1976, pp 287-292. the appropriate measure of the foregone consumption benefit. However 28Strictly speaking the discounted scrap in the long-run petrol consumption could also be reduced by the intro- value of equipment left at the end of the 20 year period should also be deducted from duction of a more fuel efficient car engine without (perhaps) requiring a the costs stream associated with the cor- reduction in the miles travelled. This shows that a reduction in energy responding alternative, consumption does not always imply a reduction in consumption benefits. the danger from its use, its social accept- a major focus of the appropriateness of conservation policies should be ability, and so on, are all factors that may the service derived from the energy use. affect the consumer choice. Finally, the costs and benefits associated witt externalities should be recognized.thus, if an oil-bumin enerat- included in the economic cost-benefit comparison of alternatives. For ing plant already exists, the initial compari- example, improvements in technical efficiency or fuel substitution son must allow for the fact that the system's measures may give rise to pollution, as in the case of conversions from oil costs of the oil option has no associated capital costs until the plant is physically fully burning to coal-fired electric power plants. These additional 'external' depreciated. costs should be explicitly evaluated in the analysis.30 14 ENERGY POLICY March 1983 Third World energy policies Summary As energy costs rise, more efficient planning and management of energy supply and demand is essential to meet multiple national objectives including the maintenance of economic growth and welfare, especially in the resource scarce developing countries. The policy tools available for managing energy demand and reducing wasteful use are pricing, physical controls, technical methods, and education and propaganda. Co- ordinated use of these instruments provides the best results. The policy analysis should be disaggregated as far as possible by energy source, type of consumption, etc. Energy pricing policy is more effective in the medium and long-run, and is usually implemented in two stages. First, the strict efficiency costs of energy supply are estimated to satisfy the objective of efficient alloca- tion of economic resources. Next, those strict efficiency costs are system- atically adjusted to yield a realistic set of prices that also meet other pricing objectives such as meeting the basic needs of poor consumers by subsidizing energy, ensuring the financial viability of energy producing institutions, maintaining price stability, and so on. Non-price policy measures such as direct controls are useful to deal with short-run crises, but are also more likely to disrupt the economy. A package of price and non-price policies may be used to implement energy conservation measures and eliminate wastage. An energy policy maker should carry out the following analysis to evaluate any given conservation measure before adopting and implementing it. First, using economic opportunity costs consistent with the national viewpoint, it should be established whether the benefits of such an action exceed the costs. If this is the case, then the same test should be repeated, using market prices relevant to the appropriate consumer group, to establish whether a rational consumer would adopt the conservation measure. If this is not the case, changes in energy prices, taxes or import duties on equipment, subsidies to consumers, legislation, and other policy options may have to be used to implement the conservation technique. In general, price changes that reduce the divergence between market prices and oppor- tunity costs should be preferred, However, care should be exercised to ensure that these policy actions do not have adverse repercusions in other energy as well as non-energy markets. Appendix 1 Relevant issues in shadow pricing To derive a consistent set of economic pressed in terms of units of local on the international market. opportunity costs or shadow prices for currency converted at the official goods and services, a common yard- exchange rate. The discussion below is stick or numeraire to measure value is developed in relation to this particul Applying shadow prices necessary. A most appropriate yardstick of value. The border-priced The estimation and use of shadow numeraire in many instances is a unit of numeraire is particularly relevant for prices is facilitated by dividing econo- uncommitted public income at border the foreign exchange-scarce develop- mic resources into tradable and non- prices. Essentially, this unit is the same ing countries because it represents the tradable items. The values of directly as freely disposable foreign exchange set of opportunities available to a imported or exported goods and ser- available to the government, but ex- country to purchase goods and services vices are already known in border ENERGY POLICY March 1983 15 Third World energy policies prices, that is, their foreign exchange where m and u are the forgone that are not important enough to merit costs converted at the official exchange marginal output and overhead costs of individual attention or lack sufficient rate. Locally purchased items whose labour in market prices, and a and c are data. The SCF is equal to the official values are known only in terms of corresponding conversion factors to exchange rate (OER) divided by the doriestic market prices, however, must convert these values into border prices. more familiar shadow exchange rate be converted to border prices, by mul- In most developing countries the (SER), appropriately defined. Con- tiplying the former prices by appro- labour conversion factor (LCF) or ratio verting domestic market priced values priate conversion factors (CF). There- of ESWR to the market wage rate into border price equivalents by apply- fore, tradables and non-tradables are ranges from 0.5 to 1 for unskilled ing the SCF to the value, is concep- treated differently. labour, and is close to 1 for skilled tually the inverse of the traditional The most important tradable inputs workers. practice of multiplying foreign currency used in the energy sector are capital The appropriate shadow value costs by the SER (instead of the OER), goods and petroleum-based fuels. placed on land depends on its location. to convert to the domestic price equiva- Some counties may have other fuels Usually, the market price of urban land lent. The standard conversion factor is available, such as natural gas or coal is a good indicator of its economic usually less than unity in most Third deposits. If no clear-cut export market value in domestic prices, and the appli- World countries. It may be approxi- exists for these indigenous energy cation of an appropriate conversion mated by the ratio of the OER to the resources, then they cannot be treated factor, such as the SCF (see below), to free trade exchange rate (FTER), when like tradables. In addition, if there is no this domestic price will yield the the country is moving toward a freer alternative domestic use for the fuels, border-priced cost of urban land trade regime: an appropriate economic value is the inputs. Rural land that can be used in MSC of production, that is, of agriculture may be valued at its oppor- OER eX + nM extracting gas or coal plus a markup for tunity cost, the net benefit of foregone SCF =- = the discounted value of future agricultural output. The marginal cost FTER eX(l-t5) + nM(l+tm) consumption foregone, or 'user cost'.1 of other rural land is usually assumed to Where X = fob value of exports; M = If another high value use exists for this be negligible, unless there is a specific cif value of imports; e = elasticity of fuel, the opportunity cost of not using reason to the contrary. Examples might export supply; n = elasticity of import the resource in the alternative use be the flooding of virgin jungle because demand; t, = average tax on exports should be considered the economic of a hydroelectric dam that would (negative for subsidy); and tm = aver- value of the fuel. involve the loss of valuable timber, or age tax rate on imports. The most important non-tradable spoilage of a recreational area that has Usually the estirnation of shadow primary factor inputs are labour and commercial potential. prices on a rigorous basis is a long and land. Consider a typical case of un- The shadow price of capital is usually complex task. Therefore, the energy skilled labour in a labour surplus reflected in the discount rate which is sector analyst is best advised to use country - for example, rural workers defined as the rate of decline in the whatever shadow prices have already employed for dam construction. The value of the numeraire over time. been calculated. Alternatively, the forgone output of workers used in the Although there has been much discus- analyst would estimate a tzw important electric power sector is the dominant sion concerning the choice of an items such as the standard conversion component of the efficiency shadow appropriate discount rate, in practice factor, opportunity cost of capital, and wage rate (ESWR). Complications the opportunity cost of capital (OCC) shadow wage rate. When the data are arise because the original rural income may be used in the pure efficiency price not precise enough, sensitivity studies earned may not reflect the marginal regime. The OCC is defined as the may be made over a range of values of product of agricultural labour and, expected value of the annual stream of such key national parameters. furthermore, for every new job consumption (in border prices) net of created, more than one rural worker replacement, which is yielded by the may give up former employment. investment of one unit of public income 'For a review of practical energy pricing Allowance must also be made for the at the margin. In the developing rules, especially with respect to nonrenew- seasonality of employment. countries, usually 12%g0>CC�8%. able energy sources see Mohan The standard conversion factor energy pricing in developing countries', The ESWR = a.m. + c.u. (SCF) mav be used with non-tradables Energy Journal, Vol 3, July 1980, pp 1-30. Appendix 2 Modelling optimal energy prices First, the marginal opportunity cost to be further adjusted to compensate including other energy substitutes.2 (MOC) or shadow price of supply must for demand side effects rising from dis- Suppose that the marginal oppor- be determined. Second, this value has tortions in the prices of other goods, tunity cost of supply in a given energy 16 ENERGY POLICY March 1983 Third World energy policies sub-sector is the curve MOC(Q) shown under consideration is given by the basket of goods. If the consumer is a in Figure A1.3 For a typical non-traded curve PD(Q), whiclh is the willingness- residential one, b would be the ratio of item like electricity, MOC which is to-pay (WTP) of consumers. Consider the shadow price to the market price of generally upward sloping is calculated a small increment of consumption AQ the household's market basket (here, b by first shadow pricing the inputs to the at the market price level p. Since MOC is also called the consumption conver- power sector and then estimating both is shadow priced, PD must also be sion factor). The most general case the level and structure of marginal transformed into a shadow priced would be when the consumer was supply costs (MSC) based on a long- curve before comparing it with MOC. unspecified, or detailed information on run system expansion programme.4 This is done by taking the increment of consumer categories was unavailable, For tradable items like crude oil and for expenditure p.AQ and asking the so that b would be the ratio of the fuels which are substitutes for tradables question: 'what is the shadow priced official exchange rate (OER) to the at the margin, the intemational or marginal cost of resources used up else- shadow exchange rate (SER), also border prices of the tradables (ie cif where in the economy if the amount called the standard conversion factor price of imports of fob price of exports, p. AQ (in market prices) was devoted to (SCF).9 This represents a global with adjustments for intemal transport alternative consumption (and/or second-best correction for the and handling costs) are appropriate investment)?' divergence between market and indicators of MOC.5 For most Third Suppose that the shadow cost of this shadow prices averaged throughout the World countries, such import or export alternative pattem of expenditure is economy.'� MOC curves will generally be flat or b(p.AQ), where b is called a conver- perfectly elastic. Other fuels such as sion factor (see Appendix 1). Then the 2From a practical, viewpoint, an optimal coal and natural gas could be treated transformed PD curve which repre- pricing procedure which begins with MOC either way depending on whether they sents the shadow costs of alternative is easier to implement because supply costs are generally well defined (from are tradables or non-traded.6 consumption forgone is given by technological-economic considerations), The MOC of non-renewabik, non- b.PD(Q); where in Figure Al, it is whereas data on the demand curve are traded energy sources will generally assumed that b<l. The optimal con- relatively poor. The same model is modified include a 'user cost' or economic rent sumption level is Q,pt, where the MOC in the text to establish socially equitable component, in addition to the marginal and b. PD curves cross, or equivalently submsedrs.ze prces for low income con costs of production.7 The economic where a new pseudo-supply curve 3Q actually represents a disaggregated value of traditional fuels are the most MOC/b, and the market demand curve energy type, eg a particular oil product like difficult to determine because in many PD intersect. The optimal or efficient petrol or electricity consumed during the cases there is no established market. selling price to be charged to con- peak period. 4For a detailed discussion ofthe procedures However, as discussed later, they may sumers (because they react only along used in the electric power subsector see be valued indirectly on the basis of the the market demand curve PD, rather Mohan Munasinghe, 'Principles of modem savings on altemative fuels such as than the shadow priced curve b.PD) electricity pricing'Proceedings ofthe IEEE, kerosene, the opportunity costs of will be: Pe MOC/b, at the actual Vol 69, March 1981, pp 332-48. In this sub- labour for gathering firewood, and/or market clearing point B. At this level of sector MSC is also called the long-run marginal cost (LRMC). the external costs of deforestation and consumption, the shadow costs and 'We not" that the use of border prices erosion. benefits of marginal consumption are does ri .equire the assumption of free Thus, for a non-traded form of equal ie MOC = b. PD. Since b trade, but implies that the numeraire or unit energy, MOC is the opportunity cost of depends on user specific consumption of value for shadow pricing is essentially uncommitted foreign exchange (but con- inputs used to produce it plus a user patterns, different values of the effi- verted into local currency at the official cost where relevant, while for a niade- cient price Pe may be derived for exchange rate). For details see Lyn Squire able fuel or a substitute, MOC repre- various consumer categories, all based and Herman Van der Tak, Economic Ana- sents the marginal foreign exchange on the same value of MOC. We clarify lysis of Projects, Johns Hopkins University cost of imports or the marginal export the foregoing by considering several 6A non-traded item is generally character- earnings foregone. In each case, MOC specific practical examples. ized by a domestic supply price that lies measures the shadow priced economic First, suppose that all the expendi- above the fob price of exports, but below value of alternative output foregone, ture (p.AQ) is used to purchase a sub- the cif price of imports. because of increased consumption of a stitute fuel, ie complete substitution. given form of energy. After identifying Then the conversion factor b is the rela- MOC/b the correct supply curve, we next exam- tive distortion or ratio of the shadow P -. - - MOC(OC ine demand-side effects, especially price to market price of this other fuel. a. Pv - second best corrections which capture Therefore Pe = MOC/b, represents a a: 101 interactions between different energy specific second-best adjustment to the b. PD sub-sectors. This second step is just as MOC of the first fuel, to compensate � L important as the first one, and there- for the fixed distortion in the price of �Pt fore it will be examined in some detail. the substitute fuel.' Next, consider a Ouantilty In Figure Al, the market priced less specific case in which the amount Figure Al. Efficient pricing with demand curve for the form of energy (p.AQ) is used to buy an average shadowprices. ENERGY POLICY March 1983 17 Third World energy policies 7For details see Mohan Munasinghe and equipment such as lightbulbs, kerosene application of the SCFto the former, is con- Gunter Schramm, Energy Economics, lamps, partial substitution effects etc: a ceptually the inverse of the traditional prac- Demand Management and Conservation more refined analysis of substitution possi- tice of multiplying foreign currency costs by Policy, Van Nostrand, New York, forth- bilities would have to incorporate these the SER (instead of the OER) to convert to coming 1983. additional considerations). It would be mis- the domestic price equivalent. 8For example MOCEL could represent the leading however to then use circular "For example, suppose the border price of long run marginal cost of rural electricity (for reasoning and attempt to justify the sub- imported diesel is 4 Pesos per litre (ie lighting) and the substitute fuel could be sidized kerosene price on the basis of com- US�20 per litre, converted at the OER, of 20 imported kerosene. Suppose that the (sub- parison with the newly calculated low price Pesos per US$). Let the appropriate SER sidized) domestic market price of kerosene of electricity. We note that all these energy which reflects the average level of import is set at 50% of its import (border) price, for sector subsidies must be carefully targeted duties and export subsidies be 25 Pesos socio-political reasons. Then b = 2, and the to avoid leakages and abuses. per US$. Therefore SCF = OER/SER = efficient selling price of electricity Pe = 9Note that with the foreign exchange 0.8, and the appropriate strictly efficient MOCEL/2 (ignoring differences in quality of numeraire, conversion of domestic price selling price of diesel: Pe = 4/0.8 = 5 Pesos the two fuels, capital costs of conversion values into shadow price equivalents by per litre. 18 ENERGY POLICY March 1983 No. 238. Richard H. Goldman and Lyn Squire, "Technical Change, Labor Use, and Income Distribution in the Muda Irrigation Project," Economic Development and Cultural Change No. 239. J. Michael Finger, "Trade and the Structure of American Industry," Annals of the American Academy of Political and Social Science No. 240. David M.G. Newbery and Joseph E. Stiglitz, "Optimal Commodity Stock-piling Rules," Oxford Economic Papers No. 241. Bela Balassa, "Disequilibrium Analysis in Developing Economies: An Overview," World Development No. 242. T.N. 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Nancy Birdsall and Susan Hill Cochrane. "Education and Parental Decision Making: A Two-Generation Approach," Education and Devel- opnment No. 248. Kemal Dervis, Jaime de Melo, and Sherman Robinson, "A General Equilibrium Analysis of Foreign Exchange Shortages in a Developing Economy," The Economic Journal No. 249. Kyu Sik Lee, "A Model of Intraurban Employment Location: An Application to Bogota, Colombia," Journal of Urban Economics No. 250. J. B. Knight and R. H. Sabot, "From Migrants to Proletarians: Employment Experience, Mobility, and Wages in Tanzania," Oxford Bulletin of Economics and Statistics No. 251. M. Louise Fox, "Income Distribution in Post-1964 Brazil: New Results," Journal of Economic History No. 252. Nizar Jetha, "The Welfare Cost of Taxation: Its Meaning and Measure- ment," Bulletin for International Fiscal Documentation No. 253. Larry E. Westphal, "Fostering Technological Mastery by Means of Selective Infant-Industry Protection," Trade, Stability, Technology, and Equity in Latin America No. 254. Gershon Feder, "On Exports and Economic Growth," Journal of Development Economics Issues of the World Bank Reprint Series are available free of charge from the address on the bottom of the back cover. THE WORLD BANK Headquarters: U 1818 H Street, N.W., Washington, D.C. 20433, U.S.A. Telephone: (202) 477-1234 Telex: WUI 64145 WORLDBANK RCA 248423 WORLDBK Cable address: INTBAFRAD WASHINGTONDC European Office: 66, avenue d'1ena 75116 Paris, France Telephone: (1) 723-54.21 Telex: 842-620628 Tokyo Office: Kokusai Building 1-1, Marunouchi 3-chome Chiyoda-ku, Tokyo 100, Japan Telephone: (03) 214-5001 Telex: 781-26838 The full range of World Bank publications, both free and for sale, is described in the Catalog of Publications; the continuing research program is outlined in Abstracts of Current Studies. 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