The Transition to Nondepletable Energy: Social Planning and Market Models of Capacity Expansion

As depletable energy becomes increasingly scarce and expensive, energy markets will turn to a multitude of nondepletable sources of energy. The rate at which this transition occurs will depend on the quantities of fuels available, production costs, government policies, and the choices of major producers. In this paper, we analyze the transition to nondepletable fuels, first in the context of a social planning model, then using a Stackelberg model to represent the dynamic game between owners of depletable and nondepletable fuels. We show that the pace of capacity expansion in the nondepletable sector has a strong influence on socially optimal energy prices and production rates. With the Stackelberg model, we characterize the strategy a market-dominating producer of depletable energy will use against the nondepletable sector. Numerical implementations of this model allow us to compare the socially optimal and market-determined outcomes. Our results show how a dominant depletable-energy producer can manipulate the nondepletable sector by pricing at the marginal cost of backstop output during an early phase of resource depletion.