Fuel switching and climate and energy policies in the European power generation sector: A generalized Leontief model

The purpose of this paper is to analyze: (a) the role and the nature of price-induced switching behavior between fossil fuels (i.e., coal, oil, and natural gas) in the western European power sector; as well as (b) the fuel choice impacts of a number of public policies implemented in this sector during the last 20years. The analysis is conducted within a Generalized Leontief cost function framework, and employs pooled data across eight countries over the time period 1978–2004. We present short-run own- and cross-price elasticities of fossil fuel demand, and assess the impacts of a set of government policies implemented over this time period. The empirical results show evidence of notable short-run interfuel substitution between oil and gas, and particularly in countries where fossil fuels are used extensively for both base and peak load purposes. These findings support the notion that ex post fossil fuel substitution takes place in dual- and multi-fired plants, by switching load between different single-fuel fired plants, as well as through the conversion of power plants to be able to burn alternate fuels. The results also illustrate that different public policies – i.e., removal of coal subsidies, electricity market liberalization etc. – have had profound impacts on fossil fuel choices and have in particular favored power generation gas use at the expense of coal. Finally, the paper makes use of the empirical results to simulate the fuel switching impacts of different carbon prices within the European Emissions Trading Scheme (EU ETS).