International Evidence on Sectoral Interfuel Substitution

This paper estimates interfuel substitution elasticities in selected devel­oping and industrialized economies at the sector level. In doing so, it employs state-of-the-art techniques in microeconometrics, particularly the locally .exible normalized quadratic functional form, and provides evidence consistent with neo­classical microeconomic theory. The results indicate that the interfuel substitution elasticities are consistently below unity, revealing the limited ability to substitute between major energy commodities (i.e., coal, oil, gas, and electricity). We .nd that on average, industrial and residential sectors tend to exhibit higher potential for substitution between energy inputs as compared to the electricity generation and transportation sectors in all countries, with the United States being the only exception. In addition, we .nd that developed countries demonstrate higher po­tential for interfuel substitution in their industrial and transportation sectors as compared to the developing economies. The implication is that interfuel substi­tution depends on the structure of the economy, not the level of economic devel­opment. Moreover, higher changes in relative prices are needed than what we have already experienced to induce switching toward a lower carbon economy.