Energy substitution in Italy: an economic evaluation

In the light of the implementation of the Kyoto Protocol, understanding the underlying pattern of energy sources substitution in Italy is of key importance for shaping medium term energy policy. In addition to the flexible mechanisms envisaged by the agreement itself, additional interventions will need to be carried out in the medium term to reduce CO2 emissions, particularly concerning those sectors of the economy not considered by the agreement, i.e. transport, households and small business, and agriculture. The effectiveness of fiscal measures to force the use of energy sources with the lowest or no carbon content, and increase energy efficiency, depends critically on the price reactivity of energy sources demand. Moreover, policy interventions require to be differently tailored depending on whether a desired substitution process among energy sources is already at work or, differently, has still to be started. The two main conclusions of the study are as follows. Firstly, the evidence points to price rigidity of the energy inputs demand and a low rate of substitutability across sources, with natural gas being a substitute for all of the other primary energy sources, electricity a substitute for oil, and coal a complement for oil and electricity. For instance, an increase of 30% in the oil price would lead to a reduction of 2.1% in the demand for oil, and to an increase of 1.8% in the demand for natural gas and of 0.6% in the demand for non fossil fuels. Hence, it is likely that environmental policy will have to seek alternative or complementary approaches to the fiscal instrument to CO2 emissions abatement. Secondly, evidence of a favourable ongoing substitution process among energy sources is found. Since the 1960s oil would have been saved at a constant yearly rate of -1.1%, while electricity, natural gas and coal used at the constant rates of +0.44%, +0.55%, and +0.11%, respectively. Policies aiming to decouple economic activity from CO2 emissions are currently needed to reinforce such pattern, favouring the use of sources with the smallest or no carbon content.