The allocation of energy resources in the very long run

This paper investigates the Nordhaus (1973) model developed to understand how markets allocate energy resources. In particular, the model proposes that royalties earned by non-renewable energy producers are closely related to the cost of the backstop energy source, the interest rate and the switching date to the backstop energy source. Here, the paper presents the prices of the main and backstop energy sources, extraction costs and royalties, as well as transport costs, taxes and interest rates, over more than five hundred years in Britain to test the model’s ability to explain very long run market behavior. While the model needs a more rigorous analysis, the very long run data and this crude test suggests that certain episodes might be explained by the model and that others do not appear to be. Also, each of the three explanatory variables do appear to be relevant in these explained episodes. In general, though, energy markets appear to be myopic, unaware of the limits of the non-renewable resource being traded, and only in moments of crisis do they consider the finiteness of the resource and, then, perhaps too dramatically, triggering major new technological, infrastructure and R&D investments.