New research from the University of Alberta shows that price elasticities of demand, which reflect responsiveness of energy consumed to changes in price, have evolved in recent years. Energy consumers have become less sensitive to changes in the price of energy products. Understanding the reasons behind these trends and variations is crucial for predicting the success of a policy aimed at reducing emissions by adjusting the price of carbon. This Background Report presents the new elasticity figures, and discusses their implications for energy policy-makers.
- A carbon price can be imposed through a carbon tax or via an emissions trading system. In theory, carbon pricing shifts consumption away from carbon-intensive products by linking a good’s price to its carbon content. As a result, under carbon pricing, the more carbon-intensive a good, the higher its carbon premium. Energy products such as oil and natural gas have high carbon content and will be especially affected by carbon prices.
- The effectiveness of a carbon price in shifting consumption away from carbon-intensive goods depends on consumer responsiveness to price changes. This responsiveness is reflected in a statistic known as the price elasticity of demand.
- New research demonstrates that the price elasticities of demand for energy have been changing over time, especially as real energy prices have fallen.
- Natural gas and electricity are what is known as price inelastic commodities – i.e., their demand is not highly responsive to changes in price. This holds true for almost all regions and for both the residential and commercial sectors. As a result, higher prices for natural gas and electricity would have a relatively small impact on the quantity of energy consumed. Understanding these trends along with regional variations in the statistics is crucial for predicting the success of policies aimed at reducing carbon emissions via carbon pricing strategies. Policy-makers, as well as climate and economic modellers, require up-to-date information on how carbon prices impact consumer behaviour.
- Within the residential sector, oil demand has become less responsive to price changes in recent years. However, if the recent high oil prices are maintained, greater reductions in demand may occur over the long-run. As high prices persist, consumers are less likely to view the price level as temporary and will invest more in energy efficient equipment.
- In the industrial sector, increases in electricity and oil prices will have minimal effects on demand. However, the quantity demanded is more responsive to increases in natural gas prices. Natural gas is the dominant fuel in many energy-intensive industries.