Instruments for the Energy Transition - Bruegelbruegel.org/wp-content/uploads/imported/events/14-02_Planetary... · Michael Grubb . With ... Instruments for the Energy Transition

www.eprg.group.cam.ac.uk

Michael Grubb With

Jean-Charles Hourcade and Karsten Neuhoff

Presentation to Bruegel Institute Brussels, 27th February

Instruments for the Energy Transition

Routledge/Taylor & Frances, Published 10 March 2014

Pre-publication insights from Planetary Economics: Energy, Climate Change and the Three Domains of Sustainable Development


• Nature of the energy challenge • The Three Domains and Three Pillars of Policy • System key components • Pillar I: Standards and Engagement • Pillar II: Markets and Pricing • Pillar III: Strategic investment • Growth theory and macroeconomic linkages • Policy Integration

• Joint Benefits • The Economics of Changing course

Instruments for the Energy Transition

- An integrated approach

www.eprg.group.cam.ac.uk Figure 1-5 Trends in energy productivity and decarbonisation, historically and potentially required trends to 2030 and 2050

0

0.5

1

1.5

2

2.5

3

0 2.5 5 7.5 10 12.5 15 17.5

Dec

arb

onis

atio

n (

CO

2/E

ner

gy

MtC

O2

/Mto

e)

Energy Productivity (GDP/Energy bn$2000/Mtoe)

HistoricalDecarbonisation/Energy…

20% by 2030

50% by 2050

Global emissions reduction below 1990 level

1980

1990

2010

Combination needed for percentage emissions reduction

Possible future paths

Historic average: 1.3%/yr

The energy challenge of decarbonisation


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5

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15

20

25

0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000

CO2 e

mis

sion

s to

nnes

per

cap

ita

(tCO

2) –

Wor

ld

Bank

GDP per capita PPP ($bn 2000)

USA

Australia

UK

Russian Federation

India Brazil

China

France

Germany

Japan Korean

Canada

Poland

Figure 1.7 Per-capita CO2 emission trends in relation to wealth - trends of major countries from1990-2008 Source: Authors. Data from World Bank (2011) and IEA (2010)

… largely stabilising per-capita emissions in industrialised countries with little sign of convergence


Australia Czech Republic

France

Germany

Hungary

Italy

Japan

Korea

Netherlands

Poland

Slovak Republic

Sweden

UK

USA

0

100

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300

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500

600

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0 0.05 0.1 0.15 0.2 0.25 0.3 0.35 0.4 0.45 0.5

Av

era

ge

en

erg

y p

rice

s ($

/t)

Average energy intensity (kg oil equivalent/$2005 GDP)

EU 15

Figure 6-1 The most important diagram in energy economics Note: The graph plots average energy intensity against average energy prices (1990-2005) for a range of prices. The dotted line shows the line of constant energy expenditure (intensity x price) per unit GDP over the period Source: After Newbery (2003), with updated data from International Energy Agency and EU KLEMS

National energy intensity approx inversely proportional to prices - across countries the % of GDP spent on energy is remarkably constant


• The proportion of national income spent on energy has remained surprisingly constant - for more than a century - for most countries

- Despite huge variations in energy prices (Bashmakov)

- This cannot be explained through the classical measures of in-country consumer price response (elasticities) but needs also to invoke: – Energy efficiency regulation and related policy responses – Innovation throughout energy supply and product chains

“Bashmakov’s Constant”


• Nature of the challenge • The Three Domains and Three Pillars of Policy • System key components • Pillar I: Standards and Engagement • Pillar II: Markets and Pricing • Pillar III: Strategic investment • Policy Integration • Joint Benefits • The Economics of Changing course

Three Domains and the

Three Pillars of Sustainable Development

An integrating approach to climate policy

www.eprg.group.cam.ac.uk Fig. 2 -3 b Resource trade-offs with the other two domains

Three Domains – an Economic Interpretation R

esou

rce

Use

/ En

ergy

& E

mis

sion

s

Economic Output / Consumption

3rd Domain

1. Real-world individual and organisational decision-making

“Transforming” behaviour

“Optimising” behaviour

1st Domain “Satisficing”

behaviour

2nd Domain

3. Innovation & evolution of

complex systems


The Three Domains rest on different fields of theory that apply at different scales

Behavioural and organisational

Neoclassical and welfare

Evolutionary and institutional

T I

M E

H O R I Z O N

S O C I A L

S C A L E


Cost

$U

SD/t

onne

of C

O2e

(in

Mill

ions

)

-100

-80

-60

-40

-20

0

20

40

60

80

100 Estimates of Global Mitigation Costs and Potential by 2030

Annual abatement in 2030 GtCO2e

Source: Planetary Economics, utising McKinsey data from Pathways to a Low Carbon Economy (2009)

Advanced Economies Emerging Asia Rest of the World

Smarter Choices (Pillar I)

5 10 15 20 25

Choosing cleaner products and processes

(Pillar II) Innovation and Infrastructure

(Pillar III)

Three realms of abatement opportunities - Global estimates for 2030 highlight first two ..


H

M

L

H Highest relevance M Medium relevance L Lowest relevance

Satisfice

Transform

Optimise

Domain Standards & Engagement

Markets & Prices

Strategic Investment

Smarter choices

Cleaner products & processes

Innovation & infrastructure

1 2 3

M

H

M

L

M

H

To deliver

Policy pillars

Solutions need to harness corresponding policy pillars based on the three domains, to transform energy systems

Source: M.Grubb, J.C.Hourcade, and K.Neuhoff, Planetary Economics,




First Pillar of Sustainable Development



ENDUSE

Buildings and appliances

Industry

Transport

CHANNELS

Direct fuels and heat

Electricity system

Refined fuels system

FUEL

Coal

Gas

Petroleum

Fig. 3.1 a

Agriculture Landuse , other gases

Process emissions

Emissions from fuel extraction

Energy and emission flows within the fossil fuel system Note: The lower panel gives the numeric breakdown at each stage illustrated in the upper panel. Numbers at each step in the Chart (fuel, channel, end-use) independently add to 100%.[ All data from the International Energy Agency, accessed through ESDS.


In transforming energy systems globally, all three domains are

• … approximately equally important – Cost curve data – Difference between in-country and international elasticities – Observed policies of the most successful countries – Suggestive evidence from economic Growth Accounting & individual pillar ‘bottom up’ evidence

• .. and interdependent

– The pillars are complementary, not competing – “Any pillar on its own will fail”

But the relative importance of different measures varies across sectors and nature of co-benefits are diverse


• Nature of the challenge • The Three Domains and Three Pillars of Policy • System key components • Pillar I: Standards and Engagement for Smarter

Choices • Pillar II: Markets and Pricing • Pillar III: Strategic investment • Policy Integration • Joint Benefits • The Economics of Changing course




www.eprg.group.cam.ac.uk Source: Authors, with data from McKinsey Pathways to a Low Carbon Economy (2009)

Evidence confirms potential exists across individuals and organisations and many sectors, and endless scope to argue about how ‘big and real’ it is …

Domestic buildings- electric

Commercial buildings - electric

Petroleum & Gas -General

Commercial buildings - thermal

Transport - Cars and vans (efficiency)

Waste - Landfill

Cement -Clinker substitution

Waste - Other

Chemicals - General

Iron & Steel - Energy efficiency and co-

generation

Other industry

Cement - Alternative fuels

Domestic buildings - thermal

-80

-70

-60

-50

-40

-30

-20

-10

0 5

10

Annual abatement in 2030 GtCO2e

Cost

$U

SD/t

onne

of C

O2e

Hidden & Implement -ation costs

A. ECONOMIC

SCEPTICISM

B. BUILDINGS EXPERTS

Default (inefficient) baselines &

holistic solutions

D. REBOUND

Warmer homes, more driving

with lower energy costs

C. CO- BENEFITS

Health, energy

subsidies, environmental benefits


• Nature of the challenge • The Three Domains and Three Pillars of Policy • System key components • Pillar I: Standards and Engagement • Pillar II: Markets and Pricing for cleaner products

and processes • Pillar III: Strategic investment • Policy Integration • Joint Benefits • The Economics of Changing course


Second Pillar of Sustainable Development



CO

2 P

rice

CO2 emissions

The price - where the lines cross- may be very sensitive to errors or changes in underlying demand curve

Emissions cap: supply of emission allowances in a given period is fixed

Figure 7-5 Source of price instability in an emissions trading system

Initial assumptions on emission trends and abatement costs tend to be conservative and to underestimate uncertainties

Economists have warned about the potential volatility of near-term caps …. with added real-world twists


CO

2 P

rice

Collapse of confidence – a short term view

Declining but unstable price based on future

expectations

Theoretical value on long term view

CO2 emissions

Emissions banking ‘flattens the demand curve’ (cf Fig 7.5) by

extending time horizon

Emissions banking supposed to be answer .. but is only stable within a certain range, otherwise amplifies risks


Price stabilisation mechanisms therefore essential for credibility – and also for linkages to other domains

Figure 7-8 Steadying mechanisms for emissions trading systems Note: The Figure illustrates mechanisms to help emissions cap-and-trade systems deal with deep uncertainties , so as to maintain a reasonable balance of price and quantity objectives. The mechanisms are most simply illustrated with respect to price floors and ceilings, in which case the shaded area indicates the likely region of price and quantity for a system with substantial surplus allowances. However the same principle could apply to other ‘threshold’ triggers, for example based on the level of cumulative surplus. Source: Authors

CO

2 P

rice

or

rela

ted

in

de

x

Emissions Volume

Withheld allowances

returned

Cap alleviated

Allowances withheld at floor

Additional allowances withdrawn


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60

Cos

ts /

GVA

%

41% of EU ‘value added’ (GDP) in manufacturing industry + utilities

Motor vehicles (0.6)

Other manufacturing (0.09%)

Construction (0.01%)

Mining and Quarrying (0.02%)

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10

20

30

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The Big Six

Lime

Cem

ent

Coke Oven

Fertilisers and Nitrogen

Refined petroleum

Basic Iron and Steel

Aluminium Production

Other inorganic basic chemicals

Paper

Most of manufacturing emissions are from c. 2 % ‘value added’ of EU GDP

Figure 8-4 Impact of carbon pricing on EU industry sectors and their share of the EU economy Data source: Eurostat and EU Commission


Cost pass through

Fre

e a

llo

cati

on

% o

f allo

wan

ces

rece

ived

for f

ree

Example of Blast Furnace Steel @ €30/tCO2

Increased profit

Reduced profit

20%

100%

% o

f allo

wan

ces

rece

ived

for f

ree

0%

90%

Prof

it M

argi

n

0%

5%

10%

15%

End user price increase

CURRENT PROFIT MARGIN

5% 10% 15%

0%

Figure 8-1 Profit and loss depend on the combination of free allocation and cost pass through to final products Note: the numbers on the graph correspond to one of the most carbon –intensive products, namely steel in Europe, at a carbon price of €20/tCO2, before international effects.

Distributional impacts 1: Up- or mid-stream, winners and losers depend on allocation and market structure


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Poorest20%

Middle Richest20%

Other Fuels

Gas

Electricity

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Poorest 20% Middle Richest 20%

OtherFuelsGas

Aver

age

hous

ehol

d £

per w

eek

% o

f hou

seho

ld in

com

e

Figure 8-7 Household expenditure on energy UK 2008 Source: Office of National Statistics 2009.

.. downstream the direct impacts are ‘all losers’ and regressive: ‘bills constancy’ hinges on the other Pillars


Pillar II Conclusions

• Economists have been ‘looking under the lamppost’ • The economics of carbon pricing are as much

about design and strategic credibility than level • The politics of carbon pricing are driven by

distributional impacts and the lack of clearly articulated positive narrative for either industry or consumers

• Links to the other two domains are central to any ‘tangible’ positive narrative, drawing on ‘Bashmakov’s Constant of Energy Expenditure’


• Nature of the challenge • The Three Domains and Three Pillars of Policy • System key components • Pillar I: Standards and Engagement • Pillar II: Markets and Pricing • Pillar III: Strategic investment for Innovation and

Infrastructure • Policy Integration • Joint Benefits • The Economics of Changing course


Third Pillar of Sustainable Development



Fig.9.1 Immediate costs and future benefits of low carbon technology

From II to III: Clean tech innovation and benefits


0

2

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6

8

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14

16

Fig.9.3 R&D expenditure by top companies in different sectors as % of sales, 2011 Data source: EU Joint Research Centre on Industrial Investment and Innovation, R&D Scoreboard 2012, http://iri.jrc.europa.eu/scoreboard12.html

We are seeking radical innovation in some of the least innovative sectors of our economies


Diffusion

POLICY ENVIRONMENT - tax incentives, subsidies, emissions pricing, regulations

Supply/

Research Demand/

Consumers

Framework Conditions – Macroeconomic Stability, Education & Skills, IP Protection Etc.

Market accumul

ation

Commercial -isation

Demon-stration

Applied R&D

Basic Research

Product/ Technology Push

Market Pull

Fig.9.5 The Innovation Chain

Source: Author

“Invention” “Innovation” “Diffusion”

Technologies have to traverse a long, expensive and risky chain of innovation to get from idea to market


INVENTION DIFFUSION

Highly innovating, close connection

consumers and innovators

- 1st & 3rd Domains –

R&D intensity 5-15% (eg. IT, drugs)

INNOVATION

Moderate innovation, mostly business to

business connection

- 2nd & 3rd Domains -

R&D intensity 1-5% (eg. industrial & product

engineering)

Low innovation, little connection between innovators and markets

R&D intensity < 1% (eg. energy & construction)

Market pull Technology push Market pull

Technology push

Market pull

Technology push

Technology Valley of Death

Market pull

Figure 9.7. Innovation intensity and the broken chain Source: Authors


Energy & related sectors are ‘complex sociotechnical systems’, with big evolutionary & lock-in characteristics

• Progress in clean energy industries impressive, but heavily dependent on public policy

• .. and so far outweighed by ‘carbon entanglement’ • Consider response to oil price rises • .. and study the policy implications of evolutionary

economics: – Niche accumulation – Hybridisation strategies

• Industrial strategy is unavoidable • … with the potential positive side being

macroeconomic version of “Porter’s kick”


The Three Domains also link to debates about macroeconomic growth

• Neoclassical economic growth models have consistently found a ‘residual’ accounting for typically half of observed economic growth that cannot be explained by resource and capital accumulation (Ch.11 the “Dark Matter” of growth)

• Economic research points two broad areas for attention: – Persistent suboptimal performance of many economic actors and structures – Inadequate education, infrastructure and suboptimal rates of innovation

• ie. First and Third domain processes recognised as important for macroeconomic growth. Yet these remain – largely absent in global (or national) modelling – poorly charted in policy

• Energy is a particularly strong candidate because – Pervasive input to numerous production sectors – Fossil fuel markets are intrinsically unstable – Exceptionally low rates of innovation particularly electricity &

construction







Experience and theoretical reasoning on each pillar shows …

• There are multiple lines of evidence that in context of transforming the global energy system over a few decades, all three domains are of comparable importance

• Only approaches that integrate across all three domains have potential to generate ‘Green Growth’

• The dominant neoclassical ‘Second Domain’ theories emphasise instrument (pricing) that maximises political opposition unless it is nested in the complementary triad

• First and Third pillar policies can (and have) delivered multiple benefits, but ….

www.eprg.group.cam.ac.uk Fig. 12.3 Public and private returns in the 3 domains

Res

ourc

e U

se /

Ener

gy &

Em

issi

ons

Economic Output / Consumption

Pillar III

1. Private returns (typically 10-25%+) >> public returns

=> Standards and

engagement

Innovation and infrastructure

Cleaner products and processes

Pillar I Smarter choices

Pillar II

3. Public returns (including innovation,

security & environment) >> private returns

=> Strategic investment

Different pillars have different structures of returns, good design can expand reach of the pricing pillar


But no pillar on its own can credibly solve the problem – nor offers a politically stable basis for policy

• Energy efficiency policy on its own limited by:

– Scale of intervention required – Growing scale satisficing behaviour – …. Leading to large Rebound effects

• Pricing on its own limited by:

– Blunt nature of impacts First and Third Domain impacts – Rising political resistance to rising fuel bills – .. and competiveness concerns

• Innovation on its own limited by:

– Lack of demand pull incentives – Scale & risks of investment costs – Political failures in absence of rising market feedbacks


Standards & Engagement

Markets & Prices

Strategic Investment

POLICY PILLARS

Technology options &

competitiveness

Changing course requires a sustained package - the key is to integrate and synergise across all three domains

Manage bills, increase

responsiveness

Revenues, revealed costs, strategic value

Values, pull & preferences

Attention, products &

finance

Education, access & control


Planetary Economics: Energy, Climate Change and the Three Domains of Sustainable Development

Pillar 1

• Standards and engagement for smarter choice • 3: Energy and Emissions – Technologies and Systems • 4: Why so wasteful? • 5: Tried and Tested – Four Decades of Energy Efficiency Policy

Pillar II

• Markets and pricing for cleaner products and processes • 6: Pricing Pollution – of Truth and Taxes • 7: Cap-and-trade & offsets: from idea to practice • 8: Who’s hit? Handling the distributional impacts of carbon pricing

Pillar III

• Investment and incentives for innovation and infrastructure • 9: Pushing further, pulling deeper • 10: Transforming systems • 11: The dark matter of economic growth

1. Introduction: Trapped? 2. The Three Domains

12. Conclusions: Changing Course

Routledge/Taylor & Frances, Published 10 March 2014

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Instruments for the Energy Transition - Bruegelbruegel.org/wp-content/uploads/imported/events/14-02_Planetary... · Michael Grubb . With ... Instruments for the Energy Transition