Prices Versus Policy: An Analysis of the Drivers of the Fossil Fuel Energy Mix

About the Project

The KAPSARC Energy Vulnerability project looks at analyzing energy shocks and disruptions from the perspective of both exporting and importing economies. The project’s objective is to understand what are the macroeconomic fundamentals that increase the resilience of a country to energy shocks and, in particular, the role of the energy mix in reducing vulnerability. The research will be complemented by an analysis of policies that enhance the resilience of economies to energy shocks.

Key Points

Understanding how the composition of a country’s energy mix is formed in an environment where greater government involvement is anticipated due to climate change obligations is critical. This paper is part of a project analyzing drivers of the mix and the transition to a future energy mix where renewables will have a key role. This initial study considers the fossil fuel mix in the U.S., Germany and the U.K. by undertaking a macroeconomic analysis of the importance of prices relative to policy in shaping the mix for these economies over the last 35 years.

• U.S. fossil fuel mix has been primarily driven by market forces and relative prices since the early 1980s. In Germany and the U.K., on the other hand, the mix was primarily shaped by policy until the 1990s; and by relative prices thereafter as structural changes initiated a move toward liberalizing power generation markets.

• The transition from coal to gas in Germany and the U.K. increased macroeconomic volatility since the price of natural gas is more volatile than that of coal and, thus, transfered this higher volatility to economic activity.

• German and U.K. policies have resulted in a ‘cleaner’ fuel mix, but this transition was not initiated by a climate change agenda, it was the result of pro-market policies. However, Europe is now in a new energy transition’ era with a move to increase significantly the proportion of renewables via command policies and financial incentives–thus, moving the evolution of the energy mix away from a pure market equilibrium.