Wednesday, October 24, 2007

Elasticities everywhere: The green edition 

The cover story of this week's Business Week is titled Little Green Lies, about the on-the-job education of one Auden Schendler. After a few years of trying to get his company to make investments directly in reducing energy consumption, he was finally able to get them to make a commitment to purchase renewable wind energy credits. (They tout this on their environment page.) This gave the company a leadership position but Schendler a queasy feeling, because it wasn't really changing energy consumption, just buying a green plaque.

Any student of economics could have told you this would be true once they read the economics of these credits as described in the article.
Credits purchased at $2 a megawatt hour, the price Aspen Skiing and many other corporations pay, logically can't have much effect. Wind developers receive about $51 per megawatt hour for the electricity they sell to utilities. They get another $20 in federal tax breaks, and the equivalent of up to $20 more in accelerated depreciation of their capital equipment. Even many wind-power developers that stand to profit from RECs concede that producers making $91 a megawatt hour aren't going to expand production for another $2. "At this price, they're not very meaningful for the developer," says John Calaway, chief development officer for U.S. wind power at Babcock & Brown, an investment bank that funds new wind projects. "It doesn't support building something that wouldn't otherwise be built."
So the change in the price of electricity caused by the increase in demand for green energy generated by wind is less than 2.2%; what would be the elasticity of supply? In the short run you would expect it to be very, very small. What about in the longer run? Could it be greater than one? What would this due to the production of wind power generators?

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