Energy saving investments: simple analytics and an application to electricity

We consider a simple model of energy saving investments under uncertainty of energy costs. Adjustment delays in replacing energy-intensive capital follow from two natural elements: uncertainty and heterogeneity of the existing capital structure. They imply a simple dichotomy where short-run output contracts, but the long-run output recovers and increases above the initial output, despite the increasing energy costs. To provide a quantitative assessment of the consumer price increase needed for the investments, adjustment delays, and policies expediting the change, the elements of the model are estimated using electricity market data. Counterfactual simulations show that large scale entry of green energy requires unprecedented energy cost and consumer price increases mainly due to rents of the existing capital. Subsidies to green energy can greatly benefit the consumer side at the expense of the old capital rents. JEL Classification: D00; D40; L00 Q30.