Question: If an effective carbon tax or cap-and-trade policy is in place to limit greenhouse gas emissions, is there any point in having a separate policy to promote renewable energy sources?

I have read several times recently that the answer is ‘No’.  Carlo Stagnaro states, correctly, that most economists advocate technology-neutral policies such as a carbon tax or cap-and-trade as the most cost-efficient way to reduce emissions (1).  Supporters of policies to encourage renewables, he suggests, are either being naïve (in failing to realise that such policies increase costs) or advancing vested interests (of industries supplying renewable technologies).  John Whitehead puts the cost-efficiency point in a slightly different way: a suitable carbon tax or cap-and-trade policy will provide the necessary incentives to use renewables to the extent that they are an efficient means of emissions reduction, without the need for a separate renewables policy (2).  Robert Stavins pursues in more detail the economic consequences of combining cap-and-trade with a renewables policy, correctly identifying three effects (3):

1. Any reductions in a company’s emissions due to the renewables policy will simply result in sales of emissions permits to other companies, enabling the latter to increase their emissions, so that total emissions will be the same as they would be with cap-and-trade alone.
2. The renewables policy will undermine the equalisation of marginal abatement costs which would result from cap-and-trade alone and so increase total abatement costs (another version of the point made by Stagnaro and Whitehead).
3. The renewables policy will reduce demand for emissions permits and so depress their price, and this will reduce the incentive for companies to invest in the development and installation of improved emissions-reduction technologies.

Let’s take a step back and review the objectives energy policy should address.  The list below would I suggest be widely acceptable: where energy policy becomes contentious is mainly in the choice of policy instruments to meet the objectives and in the priorities and trade-offs where objectives conflict.

1. Short- and medium-term security of energy supply.  Key requirements are a) adequate electricity generating capacity, b) adequate infrastructure relating to energy for transport, and c) diversity of supply to reduce the risks from over-reliance on any one source of imported energy.
2. Limiting energy costs to domestic and industrial users.  This includes a) limiting costs per unit of energy, and b) improving the effectiveness of energy use, eg via energy-efficient appliances and manufacturing techniques, and home insulation.
3. Limiting negative externalities from energy supply and use.  Such externalities include a) greenhouse gas emissions contributing to climate change, b) local and regional air pollution, and c) risks associated with nuclear energy.
4. Long-term sustainability of energy supply.  Key requirements are a) appropriate rates of depletion of finite sources, and b) improving technologies for exploiting both finite and renewable sources.

The problem I have with the positions of Stagnaro, Whitehead and Stavins is that their arguments only seem to address objectives 2 and 3a.  It also needs to be considered whether the encouragement of renewables might contribute to any of the other objectives.

It so happens that most renewable energy sources (hydro, solar, wind) do not emit greenhouse gases (or other atmospheric pollutants).  This is not entirely coincidence: if part of an energy source transfers to the atmosphere when it is used, that in itself indicates that the source is being depleted, and cannot be renewable unless what is transferred can be replaced (as with biofuels, which emit carbon when burnt but absorb it during growth).  Nevertheless, the essential characteristic of renewables is nothing to do with greenhouse gases or climate change: it is – to state the obvious – their renewability.  Either their use does not diminish their future availability, as with solar and wind, or they are replenished by natural processes, as with hydro via rainfall and biofuels via growth.  Although therefore renewables may have a contribution to make to the objective of reducing greenhouse gas emissions, the objective to which they most naturally relate is long-term sustainability of energy supply.

The fear that oil and other fossil fuels might one day become scarce used to loom large in debates on energy policy.  That fear has quite properly been eased by new technologies permitting the exploitation of previously inaccessible reserves of oil and gas, confounding earlier predictions of ‘peak oil’. Less rationally, the attention rightly given to climate change has perhaps tended to lower the profile of other scary visions of the future.  But the risk of future energy scarcity has not gone away.  A plausible scenario is that, in a few decades time, oil and gas might become so scarce as to be prohibitively expensive to most energy users. Future generations could be left to rely on some combination of coal (abundant but, unless carbon capture and storage can be made to work, highly polluting), nuclear (expensive and subject to well-known risks), and renewables.  Against that background, research and development in renewables can be seen as one of several prudent strategies that should be pursued to help improve the long-term sustainability of energy supply.

A market failure here that could justify a degree of subsidy is that the link between current research and profits that may be earned only after many decades may be subject to too much uncertainty to attract sufficient private investment. There could also be a need for policies to clarify or amend relevant property rights, both physical property associated with renewable installations, and intellectual property relating to new technologies (as with patents on new drugs, there may be a tension between providing incentives for development and allowing the results of development to be widely used).

For the long-term sustainability objective, what is important in respect of renewables is to find ways to improve efficiency and so reduce costs.  This is not best achieved by large-scale installation of current renewable technologies.  Admittedly, it is important that technologies are tested not only in ideal conditions but also in the range of real conditions in which they would have to operate if used on a large scale, and current technologies may offer scope for improvements via ‘learning by doing’. However, the main focus of a renewables policy with the aim of promoting long-term energy sustainability should be research and development in improved technologies for use if and when the need arises.

For some countries, there may also be a case for a policy encouraging investment in current renewable technologies to address the objective of short- and medium-term security of energy supply.  Consider this scenario.  A country has limited reserves of oil and gas.  It has large reserves of coal, but much of it is brown coal which, when burnt, can be even more polluting than ordinary bituminous coal.  Its public is strongly opposed to nuclear energy. It has opportunties to generate wind and solar energy within its territory, albeit at a cost which is too high to attract much private investment.  As a consequence it is heavily reliant on imported coal, oil and gas, of which a high proportion is from countries that are considered potentially unreliable.  Thus there is a risk of a serious energy shortage if, say, a severe winter were to coincide with an international crisis. Many of its energy users, if they had the option of paying a higher price for their energy in return for greater security of supply, would be willing to do so (just as they voluntarily pay for security in other aspects of their lives via insurance premiums and pension contributions). However, although the country’s electricity companies compete on price, the electricity is delivered through a single grid, and therefore it would be impracticable for any company to make a credible offer of secure supply in the event of a future shortage. Hence the workings of the energy market do not channel user demand for greater security in a way which creates incentives for electricity generators to become less reliant on imports.  There could then be a case for a policy encouraging domestic investment in current renewable technologies to address the failure of the market to respond to demand for greater energy security.

There are, therefore, at least two potentially legitimate arguments for policies to encourage the development or use of renewables.  How exactly such policies should be targeted, what policy instruments are most suitable, and the scale of any subsidy, are further issues.  I am certainly not offering a defence of the particular renewables policies of the European Union and its member countries.  What I am saying is that to reject any sort of renewables policy on grounds that have regard only to cost and greenhouse gas emissions would be a simplistic response to the complexities of energy supply.

References

1.  Stagnaro C (Institute of Economic Affairs) (13 Jan 2014) EU renewables target protects favoured industries at the expense of consumers  http://www.iea.org.uk/blog/eu-renewables-target-protects-favoured-industries-at-the-expense-of-consumers

2. Whitehead J (23 Jan 2014) No pain no gain?  http://www.env-econ.net/2014/01/europe-facing-economic-pain-may-ease-climate-rules-nytimescom.html

3. Stavins R (18 Jan 2014) Will Europe Scrap its Renewables Target? That Would Be Good News for the Economy and for the Environment  http://www.robertstavinsblog.org/2014/01/18/will-europe-scrap-its-renewables-target-that-would-be-good-news-for-the-economy-and-for-the-environment/