European Industrial Energy Intensity: Innovation, Environmental Regulation, and Price Effects.

• Author: Ajayi, Victor

1. INTRODUCTION

   Energy efficiency is often seen as perhaps the most straightforward 'no-regrets' means of delivering energy security, greenhouse gas emissions reductions and decoupling economic growth from rising energy use (Jaffe, Newell & Stavins, 2004). Moreover, energy efficiency can act as a bulwark against ever-increasing pressure on energy-intensive industries to reduce emissions and energy use in a carbon-constrained world. Rising fuel prices and their impact on industrial competitiveness have made energy efficiency improvements a central focus of EU energy policy. The oil crises of 1973-1974 and 1979 brought energy prices (and hence energy efficiency) to the fore as a crucial concern in national policy-making. More recently, external pressures such as the US shale gas 'revolution' and China's burgeoning steel exports have highlighted the challenges Europe faces in terms of global competitiveness if it is to retain its domestic manufacturing base. In response to the mandate received from the European Council, the European Commission issued a report on energy-intensive industries (like steel, ceramic, chemicals, glass) and documents that the competitiveness of these industries may be at risk as a result of increasing energy prices and transmission costs (CEPS, 2014).

   Faced with the slow recovery of industrial output against the challenge of growing competitive pressures from emerging economies following the Global Financial Crisis, most countries in the EU continue to witness a falling share of their manufacturing sectors (Bernard et al., 2016; Stollinger, 2016). Given that the manufacturing sector is viewed as a key element in industrial strategy and employment in traditional industries in the European Union, many European policymakers seek to avert (or at least attenuate) the decline in manufacturing associated with the wider structural shift towards the service sector, which is becoming more important in all developed countries (Schettkat and Yocarini, 2006; Hofer et at., 2015). This belief hinges on the supposition that a strong industrial base is fundamental to Europe's economic recovery and competitiveness. To remain profitable in a globally competitive environment, in the presence of stringent environmental policies and regulation, European manufacturing firms must constantly increase their productivity performance. Becoming more innovative in term of production and process is one promising way to open new paths in this context. Since the launch of the EU ETS in 2005, there has been considerable debate over leakage, i.e., the extent to which firms would move operations of higher-carbon activities abroad versus inducing European manufacturing firms to develop new emission reducing technological innovation without a corresponding reduction in output (e.g. Sato et al., 2015; Demailly and Quirion, 2006).

   Meanwhile, research into energy intensity has tended to focus on the contributions of energy efficiency improvements towards reducing global energy consumption and greenhouse emissions. Evidence of technological efficiency effect in decreasing aggregate energy intensity is documented in a number of studies, including Welsch and Ochsen (2005), Metcalf (2008), Zhang (2013), Voigt et al. (2014), Parker and Liddle (2016), and Karimu et al. (2017). Moreover, several previous studies also allude to the fact that structural effects can have an impact on the energy intensity change (see Unander, 2007; Lescaroux, 2008; Huntington, 2010; Mulder and de Groot, 2012; Mulder et al., 2014). This has necessitated using other perspectives beyond the traditional approach of technological and structural effects to further investigate the factors influencing energy intensity. Investigating the factors contributing to declining energy intensity is usually based on regression analysis following decomposition of the total energy intensity into efficiency and structural effects. However, while the technological efficiency effect and the structural effect separately affect aggregate energy intensity change, the existing literature reveals an obvious neglect of the direct role of technological innovation on energy intensity. (1) Furthermore, even though technological efficiency change is adjudged to be an important driver of the change in energy intensity, the index number approach does not account for the contribution coming from this source (Ma et al., 2009). To the extent that decomposition analyses provide important insights regarding the overall intensity of energy consumption, as well as the structure of the economy, subsectoral energy intensity is directly linked with production which tends to be impacted more specifically by policy actions.

   Subsectors also differ in terms of energy required relative to other inputs like capital and labour (Mulder and Groot, 2012). Therefore, gaining a comprehensive understanding of the factors influencing energy intensity (i.e., energy consumption per unit of output) at the industrial level is crucial. Moreover, this analysis is all the more important considering the high degree of variation in energy intensity across industries, ranging from 40.70 TJ/ $million PPP (1995$) in chemical industry to 1.87 TJ/ $million PPP in electrical and optical equipment industry. (2) For example, evidence of varying impact of technological innovation on energy intensity in different industries could indicate that certain industries possess greater or lesser ability to undertake more ambitious decarbonization efforts and might require tailored intervention. This could provide useful information for policymakers on the design and implementation of fiscal incentives for enhancing further energy conservation and targeting new emission-reducing technologies.

   We offer four main contributions in this study. First, we have developed a unique industry-level patent dataset to investigate the determinants of industrial energy intensity across European manufacturing industries. As such, patent stock provides insight into the interplay of energy prices and technological innovation on energy intensity. Second, building on the existing energy demand literature, we consider asymmetric response of industrial energy intensity to price by decomposing energy price into three components/ Third, we explore heterogeneities across industry categories, with special focus on energy-intensive industries and less energy-intensive industries. Taking into account that subsectors of manufacturing differ in important respects from each other in term of intensity of energy use, hence their reasonable classification as energy-intensive and less energy-intensive industries. Finally, we compare regional industrial energy intensity analysis by accounting for inter-regional differences, notably the presence or absence of a carbon tax.

   The remainder of the paper is structured as follows. In the next section, we provide a brief literature review of previous studies that examine the determinants of energy intensity. We describe our methodological approach in greater detail in Section 3. The data used are presented and discussed in Section 4. In Section 5 we present the results, while Section 6 offers some conclusions and points to some important policy implications.

2. RELATED LITERATURE

   Our study draws on two different strands of the academic literature that have each been well studied in their own right, but which have not intersected much - aggregate energy intensity found in single or multi-country context and asymmetric price response, usually employed in energy demand literature. Indeed, there is now a large body of work on energy intensity and its determinants, usually using a two-stage approach comprising index decomposition analysis technique and econometric techniques to examine on the relationship between energy intensity indices and their determinants (3). These studies span a wide range of countries and time periods over the last three decades, including both multiple and single-country studies. The change in energy intensity at the aggregate level is found to occur through two basic sources. The change in sectoral energy productivity due to technological improvements, and structural change which involves shifting production between sub-sectors, especially from energy-intensive manufacturing industries towards less energy-intensive service sectors.

   Many of the multi-country studies on economy-wide aggregate change in energy intensity analysis, for example, Oseni (2009); Zhang (2013); Jimenez and Mercado (2014); Mulder et al. (2014) and Atalla and Bean (2017), identify energy prices and per capita income as the main determinants of energy intensity. Examining energy determinants for 16 Organisation of Economic Cooperation and Development (OECD) countries, Oseni (2009) concludes that long-run reduction in energy intensity as a result of energy prices and income is largely due to movement away from energy-intensives activities and toward the less energy-intensive service sector. Drawing on 75 countries, Jimenez and Mercado (2014) show that per capita income, petroleum prices, fuel-energy mix, and GDP growth are the factors contributing to energy intensity with clear correlation with structural economic shift. They conclude that Latin American countries experience decline in energy intensity around 20% during the sample period which was regarded as underperformance. Atalla and Bean (2017) estimate the determinants of energy productivity in 39 countries and confirm that higher levels of income per capita and higher energy prices are associated with greater energy productivity, while a greater share of output from industry is associated with lower energy productivity levels.

   Single-country studies on aggregate energy intensities include those of Metcalf (2008), Song and Zheng (2012) and Wu (2012), all of which find a marked reduction in energy intensity during the sample period and identify efficiency as the major...