Technology substitution in the electricity sector - a top down approach with bottom up characteristics

The electricity sector in most CGE models is often highly aggregate lacking in the technology details that can describe the substitution between different energy inputs in the sector. To introduce these details into a CGE model, the first step is to disaggregate the total output of the electricity sector into outputs of different technologies, then ‘re-combining’ these back into the total output of the sector. Some issues arise during these processes: (1) how the cost structures of different technologies can be adequately represented, (2) how the substitution between these technologies can be explained. A conventional approach with regard to (1) is to assume that technology costs are represented simply by a ‘levelised’ cost index, but this masks the distinction between running costs and capacity utilization costs. With regard to (2) the conventional approach is to treat technology substitution as though competition between ‘intermediate inputs’ in an aggregate production function, but this ignores the fact that electricity outputs are homogenous and must be considered as near perfect substitutes. Near perfect substitutes, however, can lead to corner solutions, therefore to overcome this problem, capacity constraints such as in a mathematical programming approach must be introduced. In this paper, we propose an alternative method to the conventional approach which can be simpler and also more effective in handling capacity issues and technology output substitutions in the electricity generation sector. The proposed new method can be considered as though a hybrid between the top-down aggregate production function approach and a bottom-up mathematical programming approach but which can combine the important characteristics of both. The new approach is implemented to an existing CGE model (GTAP-E) to arrive at a new model called GTAP-E2. The new model in then applied in two simulation experiments to illustrate the usefulness of the new approach. The first experiment looks at the short run impacts of the Fukushima nuclear electricity accidents in Japan in 2011 and the second experiment looks at the long run impacts of the imposition of Japan's Post-Kyoto climate change and energy policies on the Japanese electricity sector for the period between 2013 and 2030.