Exploring the output effects on price-induced interfuel substitution and carbon dioxide emission

Abstract

This study explores how output effects influence price-induced interfuel substitution and examines its impact on CO2 emissions in the Korean industrial sector. Employing the differential fuel allocation model, which incorporates output supply decisions, we decompose the price response of energy demand to identify both substitution and output effects and simulate the resulting price-induced CO2 emissions. The results provide empirical evidence of substitutable relationships among coal, oil, and electricity, particularly showing that electrification helps substitute for coal and oil. In addition, the decomposition results reveal that the output effects strengthen own-price response but weaken cross-price response, reflecting the industrial sector's tendency to adjust output supply in response to cost pressures from rising energy prices, especially oil prices. Regarding price-induced CO2 emissions, the simulation results suggest the possibility of over- or under-estimating changes in net CO2 emissions if the output effects are not considered. Notably, they reveal that a rise in oil and gas prices can lead to a reduction in net CO2 emissions due to the output effects.