# **5. The potential impact of energy price reform on household fuel choice**

The analysis of electricity price reforms so far has assumed that household choice of heating fuel does not change. However, evidence from other countries in the region suggests electricity tariff reforms can have a significant impact on household fuel choice. For example, in Armenia, more than 60 percent of households reported increasing use of fuelwood as a substitute when the price of electricity increased by about 50 percent.<sup>20</sup> The magnitude of proposed electricity price reforms in Montenegro therefore warrants at careful look at the potential impact of higher electricity prices on fuel substitution.

**_Approach to estimating household fuel choice_ .**<sup>**21**</sup> We estimate a multinomial logit model to investigate what factors determine household choice of a heating fuel. Since most households in Montenegro use electricity or fuelwood for heating, we specify a multinomial logit model with three choices: use only electricity for heating, use only fuelwood for heating, and use a mix of both electricity and fuelwood for heating.<sup>22</sup> Other types of heating fuel, such as gas, fuel oil, and diesel, are rather rare in Montenegro. A small percentage of households in the North use coal for heating as well, generally in conjunction with electricity and/or fuelwood. However, since the number of households using coal for heating amount to less than 5 percent of the sample, we do not include coal as a heating fuel choice in the analysis. We model household choice of heating fuel as a function of prices, income, household social and economic characteristics, housing characteristics, and location where the household lives.

Prices are clearly an important determinant of household heating fuel choice. Although the price of electricity does not vary across households, the price of fuelwood varies considerably across the country. Since the price of electricity does not vary, we cannot directly estimate its impact on heating fuel choice. We therefore examine the impact of the price of fuelwood _relative_ to the price electricity.<sup>23</sup> Household per capita expenditures are used instead of income, due to a large number of missing observations on reported income. The importance of income/expenditures in household fuel choice is well documented.<sup>24</sup> As income rises, household consumption of biomass fuels decreases and the uptake of modern fuels increases. However, one may be concerned that the inclusion of income and household characteristics which may partly determine

> 20 Lampietti, Julian, Anthony Kolb, Sumila Gulyani, and Vahram Avenesyan (2001). _Utility Pricing and the Poor: Lessons from Armenia._ World Bank Technical Paper No. 497.

> 21 The model used here follows Rasmus Heltberg’s analysis in _Fuel Switching: Evidence from Eight Developing Countries_ . Energy Economics (2004).

> 22 During the winter, households use fuelwood for heating as well as for cooking. This is simply because they typically have only one cooker in the house, mainly in the living and dining rooms (very often, those two rooms are connected).

> 23 We define the relative price as the ratio of the price of fuel wood to the price of electricity. The price of fuel wood is converted into kWh units, using the standard energy conversion factor of 2,610 kWh in one cubic meter of fuel wood. This assumes moisture content is one third of weight. The efficiency of using fuel wood is clearly determined by the type of wood stove used and the effective energy content of one cubic meter of fuel wood will be different for households using different types of wood stoves.

> 24 See Barnes, D.F., Krutilla, K., Hyde, W. (2004), _The Urban Energy Transition? Energy, Poverty, and the Environment._

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