of capital ignores the short-run complementarity between energy and capital inputs for a given production technology. In reality, capital stocks tend to be highly idiosyncratic, and very few types of energy-using technologies can utilize multiple fuels (Steinbuks, 2012).<sup>2</sup> That is, the relationship between capital technologies and corresponding fuels is fixed, at least in the short term. This implies that firms do not pick a particular fuel, but rather a particular technology bundle that combines capital with a specific type of energy input. The second potential limitation of the approach is that the capital adjustment process is not properly accounted for. The economic and econometric models of interfuel substitution are either static, where capital adjustment is ignored, or recursive dynamic, where capital adjustment costs are implicitly estimated using lagged values of output or prices as a proxy for capital. This implicit estimation largely ignores asymmetries in capital adjustment due to irreversibilities of capital, and is prone to measurement error as non-capital inputs to production tend to adjust faster. Failing to account for the capital adjustment process and its associated costs contradicts the economic literature that finds these costs non-trivial; see, for example, Caballero (1999), Caballero and Engel (1999), and Caballero and Engel (2003). Furthermore, the more specific role of adjustment costs in the transition to low-carbon and energy-efficient technologies has been highlighted by Jacoby and Wing (1999), Wing (2008), and Steinbuks and Neuhoff (2014).

Our paper proposes a novel approach to analyze interfuel substitution that explicitly incorporates heterogeneous energy-using capital stocks in the estimation of optimal fuel choice. We model the capital and energy use decisions jointly, implying that firms choose capital and energy inputs concurrently. The fundamental choice that firms make is among different competing fuelusing technologies; this contrasts with the two-step approach in which firms first choose which fuels to use and then choose the other factor inputs.

Our analysis draws on two previous studies; one that is concerned with energy and capital utilization (Atkeson and Kehoe, 1999), and another that deals with the adjustment dynamics of heterogeneous capital goods (Goolsbee and Gross, 2000). Following Atkeson and Kehoe (1999), we assume that energy inputs and capital stocks are complements in the short run as, for a given level of capital stocks, a fixed quantity of energy inputs is needed. In the long run capital and energy will be substitutable as firms can respond to rising energy prices by investing in new, presumably less energy-intensive, capital stocks. We incorporate this “putty-clay” structure of Atkeson and Kehoe (1999) in the modeling framework of Goolsbee and Gross (2000) to estimate the form of adjustment costs for heterogeneous capital stocks. Specifically, we develop a structural model of the demand for different types of fuel-using technologies, which we estimate in two stages. In our model, the “types” of energy-using capital refer to the specific fuels used to run the capital stocks. In the first stage, we estimate the frictionless stock of each type of capital for firms in our data. The frictionless stock of capital is the optimal amount of each type of capital that firms would employ in the absence of any adjustment costs. In the second stage we estimate non-parametrically the relationship between frictionless and actual capital stocks to

> 2One example of such technologies is a combined cycle turbine for electricity generation.

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