Economic growth with coal, oil and renewable energy consumption in China: Prospects for fuel substitution

Highlights

• Long-run bi-directional causality between energy use of each type and economic growth

• Uni-directional causality found running from only coal to pollutant emission

• Long-run impact on emissions positive for coal but negative for renewable energy

• Negative own-price and positive cross-price elasticity for each energy source

• Good prospects for price-led substitution from coal and oil to renewable energy

Abstract

We examine the relationship between Chinese aggregate production and consumption of three main energy commodities: coal, oil and renewable energy. Both autoregressive distributed lag (ARDL) and vector error correction modeling (VECM) show that Chinese growth is led by all three energy sources. Economic growth also causes coal, oil and renewables consumption, but with negative own-price effects for coal and oil and a strong possibility of fuel substitution through positive cross-price effects. The results further show coal consumption causing pollution, while renewable energy consumption reduces emissions. No significant causation on emissions is found for oil. Hence, making coal both absolutely and relatively expensive compared to oil and renewable energy encourages shifting from coal to oil and renewable energy, thereby improving economic and environmental sustainability.

Introduction

Climate change, geopolitical tensions and recent nuclear accidents have increased concerns about energy supply security and environmental impacts associated with energy production and consumption. As a result, several countries are currently proposing strong energy substitution policies and radical energy conservation measures. In this setting, it is important to assess the prospects for the success of those policies, including potential impacts on economic growth (Goldemberg and Lucon, 2010).

Despite the emergence of a bourgeoning literature on the nexus between energy consumption and economic growth, consensus remains elusive. Some of the probable reasons for not having any consensus in this area are using different data sets, alternative econometric methodologies and different countries' diverse characteristics (Ozturk, 2010).

Studies identifying the relationship between energy consumption (both at aggregate and disaggregate levels) and output primarily take two different approaches. The supply-side approach analyzes the contribution of energy consumption in economic activities within the traditional production function framework (see, Oh and Lee, 2004, Stern, 2000). The demand-side approach analyses the relationship between energy consumption, gross domestic product (GDP) and energy prices in a tri-variate energy demand model (see, Asafu-Adjaye, 2000, Rafiq and Salim, 2009). All previous studies in this field follow one or the other of these two approaches and, on that basis, devise energy conservation policies. Application of both models concurrently potentially provides more robust estimates and more meaningful policy implications.

Fuel substitution is an energy policy instrument that can enhance sustainable development. To reduce global warming many countries are considering substituting oil, natural gas or renewable energy for coal, as coal exerts the most detrimental impact on environment. Hence, an empirical study analyzing this substitution prospect is warranted. To undertake meaningful policy insights in this regard this paper includes coal, oil and renewable energy in applying a combined supply-side and demand-side approach to Chinese data. We then discuss the possibilities for energy conservation and fuel substitution between coal, oil and renewable energy. Coal and oil have been selected as they are two major energy sources for the Chinese economy right at this moment and both have good price data available. Although prices of renewables are not available, we have included renewables consumption data and endeavor to infer the substitution possibilities.

Why is China a suitable case study? China has been on the ‘news’ for its spectacular GDP growth as well as high energy demand (particularly crude oil and coal) in recent years. China is the largest producer and consumer of coal in the world, and accounts for almost half of the world's coal consumption. Oil consumption in China is growing very fast in recent years and China is the second-largest consumer of oil behind the United States (EIA, 2014). Also China is widely blamed for its high pollutant emission by media and civil societies all around the world. Based on the amount and growth potential of demand for energy in the Chinese economy, it is now time to search for causal relationships between various forms of energy consumption and national output (GDP) in China and also for possible substitutability among the three major energy sources for environmental sustainability, coal, oil and renewables.

This paper adds two distinctive contributions to the existing literature. First, this is one of the very first papers to investigate the growth, energy and emission linkage in China by including oil, coal and renewable energy consumption to reach to robust energy conservation policy implications. Second, we examine fuel substitution relationships in China using advances in time-series methodology.

The rest of the paper is structured as follows. The next section presents an overview of the energy consumption profile of China. The third section provides a summary of findings on the relationship between energy consumption and economic growth in the last decade, Section 4 introduces the theoretical framework used in this paper, while a description of data sources and methodologies is presented in Section 5. Section 6 presents the empirical results. Conclusions and policy implications are given in the final section.