The European Union is considering scrapping the use of binding renewable energy targets as part of its global climate change policy mix that will extend action from 2020 to 2030. The Financial Times reported that this move – presumably due to concerns over high European energy costs during the ongoing economic turndown – will “please big utility companies but infuriate environmental groups.” The International New York Times framed the story in similar ways.
The press coverage has missed the very important reality that this potential decision by the European Commission will be good news both for the economy and for the environment. The fundamental reason is that in the presence of the European Union’s Emissions Trading Scheme (EU ETS) – its pioneering, regional cap-and-trade system that covers electricity generators and large-scale manufacturing – the “complementary” renewables mandate conflicts with, rather than complements other policies. Without the renewables mandate, the cap being planned for the EU ETS will be achieved at lower cost and will foster greater incentives for climate-friendly technological change.
Some Background
In 2007, the European Union established three sets of targets and related policies: (1) a 20% reduction in greenhouse gas (GHG) emissions below 1990 by 2020, to be achieved by the cap-and-trade system; (2) a 20% target for 2020 for the share of Europe’s electricity consumption coming from renewable resources; and (3) a 20% improvement in energy efficiency by 2020. These are the so-called “20-20-20 targets” for the year 2020. A wonderful slogan, but a flawed policy, because of perverse interactions among the three elements.
Europe is well on its way to achieving the first goal, with emissions now reduced by about 18%, and it is now looking to establish targets for the subsequent decade. At the same time, Europe is continuing to experience its greatest economic downturn since the Great Depression, while European electricity prices have risen by some 40% since 2005 (while the U.S. economy rebounds, with electricity prices actually having fallen – mainly because of low natural gas prices). Therefore, there is great concern in European capitals and at EU headquarters in Brussels about high energy prices damaging the international competitiveness of European industry.
Plans for 2030
Although the planned, new emissions targets for 2030 may increase stringency from the currently mandated 20% cut by 2020 to perhaps a 35% or even 40% cut by 2030, it now appears that the European Commission may drop specific binding constraints on the share of electricity generated from renewables. Why would this elimination of the renewables target be good news not only economically, but environmentally as well?
Perverse Policy Interactions
Under the umbrella of a binding cap-and-trade scheme, unless a complementary policy addresses some other market failure that is not addressed by the price signals of the cap-and-trade mechanism (such as the principal-agent problem thought to retard energy-efficiency adoption decisions in renter-occupied properties), these complementary policies that are under the cap will either be irrelevant or counter-productive. Here is the basic logic.
- Under the umbrella of the EU ETS, the cap will be achieved cost-effectively (at minimum aggregate cost) if the cap is binding, which it will be with the new 2030 targets. (Cost effectiveness is achieved because the CO2 cap-and-trade mechanism – like a carbon tax – provides incentives for all sources to control at the same marginal abatement cost.)
- A “complementary policy” under the cap, such as a renewables target, will either be irrelevant (if it is not binding) or, if it is binding, any additional emissions reductions achieved in the electricity sector under the complementary measure (the renewables program) will cause electricity generators to have additional allowances they do not need. And they will not tear up those allowances, but will sell them to other sources, such as those in other sectors. Hence, emissions in those other sectors will be greater than they otherwise would have been, completely neutralizing the emissions-reduction impact of the renewables policy.
- So, in the presence of the over-arching EU ETS, the renewables target has no incremental impact on CO2 emissions. On net, the emissions reduction due to the renewables policy is zero. But the bad news does not stop there.
- With more emissions reductions in the electricity sector and less in other sectors than under the cost-effective allocation of control achieved by the cap-and-trade system on its own, aggregate abatement costs are actually increased. Marginal abatement costs are no longer equated, and the allocation of control responsibility is no longer cost-effective. There is too much abatement in the electricity sector, and not enough in some other sector or sectors. Costs are driven up.
- Hence, nothing is being accomplished in terms of CO2 emissions with the renewables policy, and costs have been driven up! Wait, there is more.
- If some emissions reductions are being achieved by the binding renewables policy, then there is less demand overall for tradable allowances. Since the supply of allowances has not changed, this means that allowance prices are inevitably suppressed; and low allowance prices mean less induced climate-friendly technological change over time.
The Path Ahead
That is the perverse trifecta of a complementary renewables policy under the umbrella of a cap-and-trade scheme, such as the EU ETS: no additional emissions reductions are achieved; but costs are driven up; and technological change is retarded.
If the European Commission decides to eliminate its renewables targets as it proceeds with more stringent emissions targets for 2030 under the EU ETS, it will be good news both for the economy and the environment.
Yes, it raises costs but results in a more politically acceptable carbon price. Without the renewable target there may have been instead pressure to abolish the ETS as you documented in the case of US sulfur emissions trading. John Quiggin has a paper on this the interaction of the Australian RET and ETS:
http://ageconsearch.umn.edu/handle/152099
OTOH this didn’t work so well in Australia as the increased electricity prices partly due to the RET got blamed on the carbon price by the Liberal Party who now are abolishing the ETS….
Hi Robert,
as usual, your argumentation is sound and logical and I agree with your predicted effects of a renewables target, if we assume that the ETS system actually works as intended (I think the jury is out on that).
But you could be missing an angle of the argument which is not captured on the traditional MACC curve: As you know abatement options do not just have different (net) costs and carbon abatement potential. They have additional effects not captured in traditional MACC assessments, such as impacts on human health, habitat, job creation and, most importantly, systemic interactions with other options.
Could including these factors make a renewables target more defendable? I don’t know, but we should agree that it’s *possible* that these effects, like the landlord tenant problem, could represent additional considerations which a simple market based instrument may not address.
As a thought experiment, I think the systems point is actually the most interesting one: Given that we know that we have to decarbonise our electricity system in the medium-term and that this means we need a paradigm shift in how we design, build and operate electricity transmission and distribution systems, maybe an early shift to renewables is helpful in getting us to get the power system ready. Maybe, if we left it up to the cap and trade system, by the time the carbon price was high enough for us to implement PV in Europe, we would have built so much ‘traditional’ power infrastructure that that transition would then be even more expensive than it is now?
I don’t know what the answer is, but we should remember to include these other factors when making policy, which may warrant a ‘steering’ of the abatement options, at the expense of higher cost of abatement and / or lower carbon prices.
Good Morning Prof. Stavins,
Your point of view is definitely interesting. My question is if a regular “backloading” could eliminate the perverse effect of having more emissions under complementary renewables policies. Another questions relates to the green jobs: do you share the view that a change of the energy paradigm (due to the one single target option without a mandatory ren target …) can create more jobs, whereas an increase of ren generation can only bring to more efficiency and consolidation in the market for renewables, then less jobs (at an higher cost) ?
Dear Prof. Stavins, I’m sorry to say I’m not convinced, and the argument seems to me narrow and short-sighted. Cost-effectiveness in reducing emissions in the short term is not the issue – unlocking considerable potential for reducing emissions in the long term is the issue. Carbon price is welcome, but hard to put in place, and will hardly do more than incentivise a shift from coal to gas in existing plants. This would be nice but has little long term effects. Deploying renewables has – and already had in the last five years, mostly in Europe. The price of PV modules was divided by five in five years, that of PV systems by two, wind power and other technologies have seen significant improvements as well. This will have long lasting effects, and would not have happened without binding renewable targets. I would suggest couple of readings:
– this excellent paper by authors at the Imperial college: http://assets.wwf.org.uk/downloads/on_picking_winners_oct_2012.pdf
– this one from my colleague at the IEA: http://www.iea.org/publications/freepublications/publication/Summing_Up.pdf
– maybe this one by myself:
http://www.iea.org/publications/freepublications/publication/interactions_policies.pdf
And for those who prefer a shorter piece (and like Yogi Berra), this note on my blog:
http://cedricphilibert.net/one-two-three/
Thanks and cheers
– a note on my blog here: http://cedricphilibert.net/
Two points worth emphasizing as well. First, there may be a conflict between EU’s renewable energy target and the emissions trading scheme to the extent that they both make use of market price mechanisms to produce changes in how energy is produced. However, energy supply and demand in some sectors may display low price responsiveness (e.g. the transport and buildings sectors), and as such, depending on how the renewables target is implemented in practice, this may not necessarily conflict but complement the ETS. Second, in order for emissions reductions to be significantly reduced and for a low-carbon society to be achieved, the ETS is a necessary but not sufficient step. A low-carbon economy would involve structural and systemic changes in our production and consumption patterns, and market-based instruments will be important but not suffice in order to make this a reality and spur the technological innovation required, in its broadest social and institutional sense.
The EU’s climate and energy policy is not obeying a logic of economic theory as politics gets in the way. The first point in Rob’s reasoning actually includes an assumption: the assumption that increasingly stringent targets in the ETS – leading to the price pressure that makes renewable energy targets obsolete and even counterproductive – are politically feasible.
The past has already shown that they probably are not. Emission targets are highly vulnerable to industry pressure – justified or not; we are working under conditions of lack of information.
Under conditions of an imperfect emissions trading scheme, environmental safeguards may not lead to the theoretically most efficient outcome, but are needed nevertheless.
Robert,
Thanks for highlighting a problem that has long frustrated industry in europe, i.e. the conflicts between the RES and CO2 targets. Having worked many years in the electricity sector here I can confirm that the issue is real and important.
That said I have a couple of counterarguments to make (arguments I frequently tried to advance with my lobbyist colleagues at Vattenfall!). One relates narrowly to the stimulation of low-carbon technology development that you reference. Yes, a sufficiently high carbon price is essential to the development and deployment of some abatement technologies (especially CCS, biomass co-combustion, and mature renewables), but (as I’m sure you’re aware), the RES targets can also stimulate new technologies quite effectively, as evidenced by the advances in wind and solar in recent years. The problem is the problem of merit order and efficiency: solar and wind are ‘jumping the queue’ and delivering abatement at a higher cost than an efficient CO2 market would. But it is wrong to argue that they are lowering the overall abatement or the overall abatement potential: A cap is a cap is a cap, and as long as the ETS is in place, the politically-determined abatement will be achieved. The difference is cost.
More important is to remember that the Renewables policy in Europe is not only a climate policy. Renewable energy is politically (and perhaps societally) desirable in and of itself, on the basis of lowering resource consumption, other pollution, import dependency etc. So the idea of arguing against renewable targets based on their impact on the CO2 market has always been a bit of a dodge: the Renewable targets have their own purpose. So a positive way of viewing their impact is that, rather than raising the cost of CO2 abatement, they are delivering ‘extra’ CO2 abatement as a side effect of delivering desirable renewable energy to the market. Of course, if we want to advance this view, we have to simultaneously argue for a tighter emissions target, based on the idea that the ‘baseline’ emissions are being reduced by the RES transition anyway. That lower cap would lead to a higher CO2 price and a future for CCS, etc.
It all comes down to finding politically acceptable cost levels: in the end, the consumer is paying either way, and they have rightly started to object to the over-generous RES subsidies. (The RES targets have been unpopular with industry, btw, because the incumbents are not large deployers of wind and solar, and feed-in tariffs don’t have the lovely effect on the electricity price that CO2 permits do.) But political acceptability probably requires both some RES promotion (to support citizens’ preferred energy sources) and tougher CO2 pricing (to push incumbent utilities towards action).
I am not sure if this would change your overall argument, but the Renewable Energy Directive is not ‘under the umbrella’ of the EU ETS because the cap-and-trade system only handles around 40-45% of EU GHG emissions. The other 55-60% of emissions are covered by the Effort Sharing Decision, which does not involve a cap-and-trade market.
Your basic assumption that the EU-ETS must be the leading tool for reducing emissions in Europe is also up for discussion. See the latest CEO report which shows that burying the dead corpse of the EU-ETS could create opportunities for much swifter action towards decarbonizing high-carbon Europe (remember our per capita emissions? where would minus 40% be getting us then?): http://corporateeurope.org/climate-and-energy/2014/01/life-beyond-emissions-trading
In any case, thanks for pointing to some counter-intuitive results of policy options. This is much needed. There are so many people out there trying to save the climate by pushing forward offsets such as REDD+, not realizing the impacts running counter to their own intentions. A more systemic view can help avoid such pitfalls.
Professor Stavins is right…except for one important point: Technology does not follow smooth, predictable cost curves.
Technologies requiring lots of development or with specialized capital requirements or living in closed or imperfect markets often require custom policies. If everything is allocated according to marginal costs, than technologies with higher current prices but lower ultimate prices will likely get stranded. In Germany, on-shore wind would have dominated the renewable energy program had it not been a separate price for solar. This custom policy was a principal force in driving down the price of solar by 80% in five years–which is a huge benefit for the whole world. (There are more cost-effective ways of achieving this goal than the German plan, but the ETS would have failed altogether.). You can love or hate nuclear, or CCS, but the ETS would not engender the technology development of either. Monopoly utilities pass on energy prices to customers, so they are impervious to marginal pricing schemes. Building owners don’t generally pay energy costs, so do not make capital investments in insulation and good windows. And so forth.
The punchline is that performance standards (fuel economy standards, appliance equipment standards, building codes, RPS), if well-designed, are crucial complements to pricing.
For more on how to get the design right, go to http://energyinnovation.org/wp-content/uploads/2012/01/Policies-That-Work_Overview-Report.pdf
Hal
Heleen,
“Environmental safeguards may not lead to the theoretically most efficient outcome, but are needed nevertheless.” Actually they may lead to efficient outcomes, it’s proved in: Lecuyer, Quirion 2013, Can uncertainty justify overlapping policy instruments to mitigate emissions? Ecological Economics 93, 177-191
Also, in the absence of complementary policies, power producer will focus on the cheapest ways to reduce emissions (eg switch from coal to gas). This may actually be bad: in the long term, we want carbon emission to be almost null. This will require renewable power, which cannot be implemented overnight. Hence, complementary policies are useful to ensure that long-term options receive the short term attention they need.
Vogt-Schilb, Hallegatte, 2014: Marginal Abatement Cost Curves and the Optimal Timing of Mitigation Measures, Energy Policy 66, 645–653
Cheers
Amazed that The Economist made the same argument below:
http://www.economist.com/news/leaders/21595002-current-policies-are-mess-heres-how-fix-them-worse-useless
Dear Pr. Stavins,
Sorry, but I am really not convinced. You propose to drop renewables support, a set of policies which is admittedly highly imperfect in their current form, but which has delivered significant CO2 abatement and cost decrease through learning-by-doing. I see several reasons not to drop them, all of which being sufficient:
– the EU ETS cap is not binding. This is due to several reasons, the main one being the economic crisis. The CO2 price does not drop to zero but stays at a miserable 5 € because some market participants hope for a policy intervention to sustain the price. The allowance surplus is higher than one year of emissions and still growing, and there is no prospect of a cut in this surplus. The approved “backloading” of 900 mn allowances does not solve the problem, as recognised by the European Commission, who proposes a market stability mechanism… from 2021 onward. Even if this proposal were backed by the Parliament and Council, it would be too little, too late. This means that CO2 abated by additional renewables (by the way, the same argument goes for nuclear, CCS or electricity savings) does not increase emissions covered by the ETS through a drop in the CO2 price: since the cap is not binding, they just make it further away from being binding, which does not impact emissions.
– the fact that the EU ETS cap is not binding may be seen as an accident. In fact the same has happened in many ETS around the world, at some point in their history (including the US SO2 ETS, cf. your JEP paper with R. Schmalensee), for different reasons. Hence, ex ante, it would be presumptuous to assume a proposed cap to be binding whatever happens. In a situation in which you do not know in advance whether the cap would be binding or not, a subsidy to renewables overlapping the ETS raises the expected welfare even without considering the other externalities than climate change (which are important, as pointed out in other comments). cf. Lecuyer, Quirion, 2013. Can Uncertainty Justify Overlapping Policy Instruments to Mitigate Emissions? Ecological Economics. 93: 177–191. Doi:10.1016/j.ecolecon.2013.05.009
– Without the renewables support policies, in particular in Denmark, Germany and Spain, the massive cost decreases in PV and wind during the last decades would not have taken place. These cost decreases have generated positive spillovers in the form of renewables deployment in third countries, especially China which has been the #1 market in the world for PV in 2013 (12 GW) and for wind for the last years. Cf. http://about.bnef.com/press-releases/chinas-12gw-solar-market-outstripped-all-expectations-in-2013/
– As pointed out by my colleague Adrien Vogt-Schilb in his own comment, with just an ETS, we would at best cut emission through fuel switch and substitution between plants of slightly different energy efficiencies, but we would not be prepared to go for the necessary more ambitious emission cuts, which require a massive switch to zero-carbon technologies. Given the cost and risks of new nuclear and CCS, this means a massive deployment of renewables, which require specific policies. On the cost of new nuclear compared to that of PV and wind, cf.
http://www.renewablesinternational.net/cost-of-new-nuclear-and-new-renewables/150/537/74119/
Sincerely yours,
Philippe Quirion