The Interfuel Substitutability in China’s Energy Transition: A National and Sectoral Level Analyses Using Normalized Quadratic Function

Abstract

The substitutability between traditional fuels and modern fuels is essential for examine the possibility of energy transition. The existing literature on China’s interfuel substitution is mainly based on the translog function form and often the global curvature is not imposed. There is also a lack of a comprehensive analysis encompassing both the national and sectoral levels. This study fills the gap by estimating the Normalized Quadratic (NQ) cost and expenditure functions with global curvatures imposed. We analyse China’s provincial panel data from 2000 to 2012 both at national and sectoral levels: agriculture, industry, service and residential. Our analysis follows a two-stage process: first we estimate a nonlinear system of energy share equations using the Iterative Feasible Generalized Nonlinear Least Square (IFGNLS) method, and second, we calculate the Allen-Uzawa and Morishima elasticities of substitution. We have three main findings. First, the four main types of energy - coal, oil, gas and electricity - are overall substitutable, suggesting that China’s energy transition towards modern fuels is possible. Second, with the nation ascending the energy ladder from traditional to modern energy, the Morishima elasticities of substitution become more elastic, suggesting that a decrease in difficulty of energy transition in China. Third, the Morishima elasticities of substitution in the direction of modern energy price changes usually are greater than that in the direction of traditional energy price changes, suggesting that consumer behaviour change is more sensitive to the modern energy price fluctuations other than that of traditional energy. Overall, we conclude by providing a prospect of energy transitions in China, especially when the relative prices of modern energy are falling.