Purchase or generate? An analysis of inter-fuel substitution and electricity generation in Japanese manufacturing plants

As the manufacturing industry is one of the largest contributors to global emissions, decarbonization of the production line is a key aspect in the fight against climate change. In this study, we examine the level of substitutability between fossil fuel and electricity. Using data on Japanese plants from 2004 to 2020, we estimate the elasticity of substitution between the two inputs and find that a 1 % increase in electricity prices results in a 6.55 % increase in fossil fuel consumption. Our paper also contributes to explaining mechanisms behind inter-fuel substitution, with a special focus on electricity and fossil fuel through cogeneration. We find that substitutability is highly sector-dependent, and identify the pulp & paper, iron & steel, chemicals and cement to be sectors with substitution capacity. These sectors see an increase in their electricity generation, the magnitude of which is estimated between 0.004 % (cement) to 0.23 % (iron & steel). Iron & steel and cement also increase their consumption of coal to power generators by 0.06 % and 0.005 %, respectively. Our findings suggest the need for taxation of both fuel and electricity together, to discourage further substitution attempts that would hinder decarbonization efforts.