Thursday, April 27, 2017

How Accurate are Projections of Energy Intensity?

A new short working paper about how accurate projections of future energy intensity are. It's an extension of comments I made at Energy Update 2016 here at the ANU.

Energy intensity is one of the four factors in the Kaya Identity, which is often used to understand changes in greenhouse gas emissions. It is one of the two most important factors together with the rate of economic growth. The 2014 IPCC Assessment Report shows that less than 5% of models included in the assessment project that energy intensity will decline slower than the historic rate under business as usual:*

Is this likely? In the paper, I evaluate the past performance of the projections implied by the World Energy Outlook (WEO) published annually (except in 1997) by the International Energy Agency (IEA). The following graph shows the average annual difference between the projected and actual rate of change in energy intensity in subsequent years** for each WEO since 1994:

Positive errors mean that energy intensity declined slower than projected in the following years while negative errors mean it declined faster. So, for example, the error of -0.4% for 2000 means that over the years 2001-2015, on average energy intensity declined by 0.4% a year faster than was projected in the 2000 WEO.

It turns out that these errors are strongly negatively correlated (r = -0.8) with the error in projecting the rate of economic growth, which IEA outsources. Csereklyei et al. (2016), similarly, find that reductions in energy intensity tend to only occur in countries with growing economies. If we divide and multiply the growth rate of energy intensity g(E/Y) by the growth rate of GDP g(Y) we get the following identity:

The first term on the right hand side can be seen as the elasticity of energy intensity with respect to GDP.*** The following graph plots the elasticity as projected and as subsequently realized for each WEO:

The two seem to have tracked each other quite well. But there is a complication. The 1994 to 96 WEOs only projected future energy use up to 2010. 2010 is the only recent year when global energy intensity actually increased. This end point reduces (in absolute value) the actual elasticities for these three WEOs. From 1998 on, the difference between the projected and actual rate of change in energy intensity is calculated up to 2015. But through the 2011 WEO, 2010 is one of the years in the projection period. From 2012, 2010 is no longer include in the projection period and there is a sharp step down in the actual elasticity over the projection period. I think that the elasticities for 2012-16 probably under-estimate the true long-run elasticities and that the relatively stable values from 1998-2011 are more representative of what the future elasticities will be over the full projection horizon to 2030 or 2040.

If that is the case, then the projected elasticity of -0.6 in the 2016 WEO probably over-estimates the the elasticity that will be realized in the long run. Why would this be the case?

Early WEOs largely modeled energy intensity trends based on historical trends. This is not the case for recent WEOs. Over time, the IEA has endogenized more variables in their model of the world energy system and included more and more explicit energy policies. It is likely that the model under-estimates the economy-wide rebound effect. It's also possible that energy efficiency policies are not implemented as effectively as expected.

As part of our ARC funded DP16 project, we hope to contribute to improving future projections of energy intensity by empirically estimating the economy-wide rebound effect.

* The light grey area indicates the projections between the 95th and 100th percentile of the range for the default scenario.
** The base year for each WEO is 2-3 years before the publication date. Therefore, we can already assess the 2015 and 2016 WEO's.
*** We can use the identity to decompose the projection errors:

Over time the contribution of errors in the projected growth rate has increased relative to the contribution from errors in the elasticity. But I think that if we revisit this experiment in 2030 we will find a larger contribution from errors in the elasticity for what are currently recent issues of the WEO.

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