Construction of a fuel demand function portraying interfuel substitution, a system dynamics approach

Most of the recent numerical market partial equilibrium models of natural gas markets use imperfect competition assumptions. These models are typically embedded with a simple representation of the demand side, usually a single-variable, linear, inverse demand function, that does not capture any dynamic adjustment to past prices or energy substitution. To remedy this, we report an effort to construct an enhanced functional specification using the system dynamics-based model of [27,28]. This putty-clay model uses a vintage representation of capital stock to capture the effect of both past and current energy prices on fuel consumption. Using a re-calibrated version of this model, we first confirm the pertinence of this modeling framework to represent interfuel substitution at different fuel prices in the industrial sector. Building on these findings, a dynamic functional specification of the demand function for natural gas is then proposed and calibrated.