Mechanisms of EU climate and energy policies Compatibility

Mechanisms of EU climate and energy policies: Compatibility of green, white and black certificates by Eirik S. Amundsen University of Copenhagen, University of Bergen The Danish Economic Councils Talk prepared for the S. CO. RE. seminar , Loyola de Palacio Chair, RSCAS, European University Institute, San Domenico, April 18, 2015

Contents • EU-targets on climate and energy • A critical view • Measures and instruments designed to attain the targets: TGCs, TWCs, TEPs • Compatibility of instruments on the electrcicity market • Comparison of RES measures • Conclusions

EU-targets on climate and energy

EU climate and energy targets Targets for 2020 • a 20% cut in greenhouse gas emissions (GHG) compared with 1990 levels • at least a 20% share of renewable energy consumption • at least 20% energy savings compared with the business-as-usual scenario Targets for 2030 • a 40% cut in GHG emissions compared with 1990 levels • at least a 27% share of renewable energy • at least 27% energy savings compared with the business-as-usual scenario Target for 2050 • Low carbon society with (a 80% - 95% cut in GHG emissions compared with 1990 levels)

Framework for climate and energy policies (2020), (1) Regulated by EU CO 2: Nonquota area -Common total constraint of CO 2 emission within EU - Issue of quotas to countries and sectors - Administration relating to assignment of quotas free of charge (“grandfathering”) or by sale (“auctioning”) - Determine and fix national targets CO 2: Quota area (EU ETS) Regulated by MS -National choice of economic and administrative measures

Framework for climate and energy policies (2020), (2) Regulated by EU Regulated by MS Renewable energy - Determine and fix national targets relating to share of renewables out of gross energy consumption - Implementation of common measures (e. g. Coop Mex) - Choice of national economic and administrative measures Energy savings/ more efficient use of energy - Common targets on energy saving/ efficiency to be implemented? (3% annual energy saving in public buildings, 1. 5% savings by energy distribution companies/ retailers) - Determine and fix of national targets - Economic and administrative measures

A critical view on EU climate and energy targets

Economic arguments for regulation Regulation called for if market failures are present. For example: • External effects (negative and positive) • ”Public goods” (in Samuelson sense) • Natural monopolies • ”Missing markets” (e. g. due to lack of assignment of property rights)

Why targets on CO 2 emission in EU? Emission of greenhouse gases gives a negative external effect on a public good (i. e. a stable and predictable climate) “Climate change is the biggest market failure the world has ever seen. ” Stern Review on the Economics of Climate Change (political report by Sir Nicholas Stern (and co-authors) to British government): 2007

Why targets on shares of renewables? Four common arguments • Will reduce CO 2 -emission, but … • Will increase the degree of security of supply, but… • Will create green jobs, but… • Will give the MSs ”First mover advantage” in production and exports of RES-tecknologies and capital equipment, but …

Why targets on energy saving? • Some of the arguments put forward are the same as for the renewable target (e. g. reduction of CO 2 -emission). • Increasing energy prices will by itself lead to energy saving and to stimulation of research and deployment of new technology (“smart grids” etc. ) • Why then specific targets on energy saving? (Is there some kind of information failure? )

Measures and instruments designed to attain the targets

Some measures and instruments for CO 2 emission and energy saving CO 2 -emission: • EU ETS (Tradable Emission Permits) • CO 2 taxes (in the non-quota sector) • Command control measures Energy saving: • White certificates (TWCs) • Energy taxes • Command control measures

Measures and instruments for renewable energy in EU • Coop-Mex (The EU RES-Directive, 2009/28/EC) • Statistical transfers (involve trade between MSs) • Joint projects between MSs (may involve private companies) • Joint support schemes • Feed-in tariffs • Green certificates (TGCs)/ Renewables Obligation Certificates

Green certificates (TGCs) • System in operation in many countries (e. g. Sweden, UK, Italy, Belgium) • Sweden and Norway connected with a joint TGC market from January 1. , 2012 • System intended to stimulate new REScapacity based on water, wind, biomass, peat, sun, waves, geothermic power (however, only small water power plants qualify for TGCs) • System is technology neutral (all kinds of green electricity get the same support) • System to be in operation until 2035

The basic ideas of a TGCsystem • The TGC system is a market based subsidy system for renewables in electricity provision (i. e. “green electricity”) It relieves the government from making direct subsidies as in a feed-in system • Sellers of TGCs are the producers of green electricity • For each MWh they load into the network they get a TGC to be sold on the TGC-market • Buyers are the consumers/retailing companies that are required to hold at least a certain percentage (e. g. 20%) of TGCs corresponding to total consumption/ end-use deliveries • Hence, for each MWh green electricity the producers get the wholesale price plus the certificate price • In general, the system puts a constraint on energy consumption

The TWC-system • Many different systems in use (e. g. UK, Italy, USA) with different names ( e. g. USA “Energy Efficiency Portfolio Standards”, Energy Efficiency Certificates) • Typical for such systems is that producers, suppliers or distributors of electricity, gas and oil are required to achieve energy efficiency measures according to predefined percentages • The certificates issued for attaining the targets are typically also tradable • Here, we consider a system similar to the TGC system i. e. where the producers/distributors of energy undertake the energy saving and are issued TWCs for sale in the TWC market. Buyers are the suppliers/retailing companies that are required to hold at least a certain percentage of TWCs corresponding to total consumption/ end-use deliveries. Like the TGC system, the TWC system puts a constraint on energy consumption.

A simple model (Amundsen og Mortensen, 2001: Amundsen and Bye, 2012) Symbols og functional forms y: quantity ”black” electricity z: quantity ”green” electricity w: quantity electricity saving x: total quantity electricity equivalents, x=y+z+w p(x): demand for electricity equivalents, p(x)’<0 q: wholesale price s: price of green certificates r: price of white certificates α: percentage requirement for TGCs, β: percentage requirement for TWCs, c(y): Black industry cost function, c’(y, τ)>0, c’’(y)≥ 0 h(z): Green industry cost function, h’(z)>0, h’’(z)>0 k(w): Industry cost function for saving, k’(w)>0, k’’(w)>0

A simple model (continued) Assume perfect competition «all over» Optimization problem for producers: max Ω=q(y+z+w)+sz+rw-c(y)-h(z)-k(w) F. O. C. c’(y)=q, h’(z)=q+s, k’(w)=q+r Optimization problem for retailers: max Π=(p(x)-q-s(α/(1+β))-r(β/(1+β)x F. O. C. in equilibrium: p(x)=q+s(α/(1+β))+r(β/(1+β))

A simple model (continued) The equilibrium is characterized by: p(x)=q+s(α/(1+β))+r(β/(1+β)) z=α(y+z) w=β(y+z) x=y+z+w c’(y)=q h’(z)= q+s k’(w)=q+r Observe: a) p(x)=((1 -(α/(1+β))-(β/(1+β))c’(y) +(α/(1+β))h’(z) +(β/(1+β)k’(w) The end user price is equal to a convex combination of marginal costs b) TGCs: sz=(α/(1+β))sx: subsidies = taxes c) TWCs: sz=(β/(1+β))rx: subsidies = taxes

A simpel model: Illustration (only TGCs)

A simple model: some results

A simpel model: Some conclusions Amundsen and Mortensen (2001), Amundsen, Baldursson and Mortensen (2006), Amundsen and Nese (2009), Amundsen and Bergman (2012) Some conclusions: Introduction of a TGC system and a TWC system will: - achieve the percentage targets (in theory) - be «financially self-contained in the market» (i. e. no external finance) - imply a reduced (or constant) wholesale price of electricity - reduce the generation of black electricity But: - an increase of the percentage requirement for TGCs may lead to less green electricity - an increase of the percentage requirement for TWCs may lead to less energy saving - an increase of the percentage requirements for TGCs and/or TWCs may lead to a lower end user price of electricity and an increase of electricity consumption - an increase of the carbon price may lead to less green electricity

A simpel model: Some conclusions (cont. ) Amundsen og Mortensen (2001), Amundsen, Baldursson og Mortensen (2006), Amundsen og Nese (2009), Amundsen og Bergman (2012) Some conclusions: - if there is no market for TGCs, an increase of the percentage requirement for TWCs would lead to less generation of electricity (both black and green) i. e. there are compatibility problems - Producers of green electricity may possess strong market power - TGC- prices may be highly volatile if the system is primarily based on wind power

Conclusions on international cooperation on renewables • The cap on EU ETS should be lowered and the system expanded. This would give rise to RES expansion and energy saving • There may be large benefits from separating which country is actually constructing new capacity for renewables and which countries are paying for it. • Such a separation will equilibrate the marginal costs of installing new capacity for renewables, lower the customer prices and give benefits from trade • Therefore, an institutional set up such as the EU-ETS is called for • Hence, one should promote the initiatives of cooperation that is included in the EU RES-directive, 2009/28/EC under Coop-Mex • If a MS has a comparative advantage in constructing new capacities for renewables and a TGC market is established that MS could profit from selling TGCs to other MSs.