Firm-Level Estimates of Fuel Substitution: An Application to Carbon Pricing

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October 15, 2015 | ESRI Working Paper

Authors: Marie Hyland , Stefanie Haller

We estimate partial- and total-fuel substitution elasticities between electricity,
gas and oil, using firm-level data. We find that, based on the partial elasticity measure,
electricity is the least-responsive fuel to changes in its own price and in the price of other
fuels. The total elasticity measure, which adjusts the partial elasticity for changes in
aggregate energy demand induced by individual fuel price changes, reveals that the demand
for electricity is much more price responsive than the partial elasticity suggests. Our results
illustrate the importance of accounting for the feedback effect between interfactor and
interfuel substitution elasticities when considering the effectiveness of environmental
taxation. We use the estimated elasticities to simulate the impact of a €15/tCO2 carbon tax
on average energy-related CO2 emissions. The carbon tax results in a small reduction in CO2
emissions from oil and gas use, but this reduction is partially offset by an increase in
emissions due to increased electricity consumption by some firms.

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