Interactions of Policies for Renewable Energy and Climate.pdf

7/27/2019 Interactions of Policies for Renewable Energy and Climate.pdf

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Interactions of Policiesfor Renewable Energy

and Climate

InternatIonal energy agency

cdrIc PhIlIbert

W O R K IN G PA PE R

2011


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Interactions of Policiesfor Renewable Energy

and Climate


cdrIc PhIlIbert

W O R K IN G PA PE R

2011

The views expressed in this working paper are those of

the author and do not necessarily reflect the views or policy of the

International Energy Agency (IEA) Secretariat or of its individual

member countries. This paper is a work in progress, designed to

elicit comments and further debate; thus, comments are welcome,

directed to the author at: [email protected]


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INTERNATIONAL ENERGY AGENCY

The International Energy Agency (IEA), an autonomous agency, was established in November 1974.Its primary mandate was and is two-fold: to promote energy security amongst its membercountries through collective response to physical disruptions in oil supply, and provide authoritative

research and analysis on ways to ensure reliable, affordable and clean energy for its 28 membercountries and beyond. The IEA carries out a comprehensive programme of energy co-operation amongits member countries, each of which is obliged to hold oil stocks equivalent to 90 days of its net imports.The Agencys aims include the following objectives:

Secure member countries access to reliable and ample supplies of all forms of energy; in particular,through maintaining effective emergency response capabilities in case of oil supply disruptions.

Promote sustainable energy policies that spur economic growth and environmental protectionin a global context particularly in terms of reducing greenhouse-gas emissions that contributeto climate change.

Improve transparency of international markets through collection and analysis ofenergy data.

Support global collaboration on energy technology to secure future energy supplies

and mitigate their environmental impact, including through improved energyefficiency and development and deployment of low-carbon technologies.

Find solutions to global energy challenges through engagement anddialogue with non-member countries, industry, international

organisations and other stakeholders.IEA member countries:

Australia

Austria

Belgium

Canada

Czech Republic

Denmark

Finland

France

Germany

Greece

Hungary

Ireland

Italy

Japan

Korea (Republic of)

Luxembourg

NetherlandsNew Zealand

Norway

Poland

Portugal

Slovak Republic

Spain

Sweden

Switzerland

Turkey

United Kingdom

United States

The European Commission

also participates in

the work of the IEA.

Please note that this publication

is subject to specic restrictions

that limit its use and distribution.

The terms and conditions are available

online atwww.iea.org/about/copyright.asp

OECD/IEA, 2011

International Energy Agency9 rue de la Fdration

75739 Paris Cedex 15, France

www.iea.org


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OECD/IEA2011 Interactionsofpoliciesforrenewableenergyandclimate

Page|3

TableofContents

Introduction.......................................................................................................................................5

CriticismofREincentives..................................................................................................................7

Theinteractionargument...........................................................................................................7

Thecosteffectivenessargument................................................................................................8

SupportingREincentives...................................................................................................................9

OtherdriversofREdeploymentpolicies...................................................................................9

Theneedforalongertermperspective.................................................................................10

Howarecostreductionsbestachieved?.................................................................................11

Discussion:lockingin,lockingout..................................................................................................16

Otherinteractioneffects.................................................................................................................17

Conclusion.......................................................................................................................................20

References.......................................................................................................................................21

Listoffigures

Figure1:Electricitygenerationbysourcesin2007,2030and2050underBaseline,

BLUEMap,BLUEHighNuclearandBLUEHighRenscenarios........................................................11

Figure2:Photovoltaiclearningcurve197692:linearandloglogrepresentations......................13

Figure3:PVlearningcurve.............................................................................................................14

Figure4:CorporateandpublicPVR&Dexpenses..........................................................................15

Figure5:Averagewholesaleelectricitypricesandrenewablesupportcost

byscenarioandmajorregion,201035..........................................................................................17

Figure6:Howwindpowerinfluencesthepowerspotpriceatdifferenttimesoftheday............18

Figure7:MeritorderandelectricitypriceincreasewithCO2price...............................................19

Listofboxes

Box1:Behindthelearningcurve....................................................................................................14


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Introduction

Morethan70governmentsaroundtheworld,andamongthemallIEAmembercountries,haveput

inplacetargetsandpoliciestosupportthedeploymentofrenewableenergy(RE)technologies.In

doingso,theypursueagreatvarietyofobjectives,includingimprovingenergysecurityandaccesstoenergyservices;reducingdependenceonenergyexportingcountries;environmentalprotection;

climatechangemitigation;provisionofemployment;and strengthening thecompetitiveedgeof

theirdomesticindustry.

Meanwhile,thenegotiationsintheframeworkoftheUnitedNationsFrameworkConventionon

Climate Change (UNFCCC) led, in 2005, to the entry into force, for ratifying countries, of the

KyotoProtocol.TheProtocolassignsbindingtargetsrelativetotheiremissionsofcarbondioxide

andothergreenhousegases (GHG), tocountries listed in itsAnnex I (industrialised countries).

Morerecently,the internationalcommunityformallyagreed (Cancun,Mexico,December2010)

tolimitglobalwarmingto2Cfrompreindustriallevel,andtoconsiderinonlyafewyearstime

possiblystrengtheningthisobjectivetolimitglobalwarmingto1.5C.

Renewableenergy(RE)technologieswillplayavery importantrole inreducingGHGemissions;

but they alone would not suffice to keep climate change manageable. Energy efficiency

improvements,inparticular,havebeenidentifiedasthelargestpotentialforenergyrelatedCO2

emissioncuts.TheIEAalsoincludesgreaternuclearpowerdeployment,aswellascarboncapture

andstorage(CCS)technologiesinitsclimatefriendlyscenarios.Thequestionisoftenraised:isit

necessaryor even useful to have two distinct types of policies and objectives, one series for

promotingREtechnologies,andanotheronedirectlyaddressingGHGemissions?

SomeeconomistsarguethatREincentivesarecounterproductivewhentheyinterferewithacap

andtradepolicysuchas theEuropeanUnionsEmissionsTradingSystem (EUETS).By lowering

thepriceofcarbon,policiesthatsupportREappeartofavourthemostpollutingformsoffossil

fuels. More importantly perhaps, it is argued that CO2 prices can singlehandedly drive theoptimal deployment of lowcarbon technologies, including renewables. According to these

scholars, specific renewable policies would not only be redundant but also raise the cost of

climatechangemitigation.

ProponentsofREpoliciesusuallyrespondbystatingthatREpolicieshavemultipleobjectives,as

mentionedabove.Whileessentiallycorrect,thisargumentmaynotbyitselfsuffice,asitsvalidity

issomewhatmitigatedbytheobservationthatotheroptionstoreduceCO2emissionscouldalso,

atleastinpart,satisfythesesameotherobjectives.

AnotherconsiderationbearsagreaterweightthatthecurrentinvestmentsinREtechnologiesare

essentialtoquicklyreducingtheircostandtomakeawideportfolioofREtechnologiesaffordable

andcompetitiveona largescalebeyondtheircurrentnichemarkets. IEAscenariosshowthatREtechnologieswillhavetoplayapivotalroleinthiscenturyifclimatechangeistobemitigated.Ifthe

overallcostsofmitigationduringthenextdecadesareconsidered,theeconomicassessmentmight

differsubstantially.ImmediateCO2reductionsdrivenbytheearlydeploymentofREmaycostmore

thanotheroptionstoday,butwillreducethecostsofmitigatingclimatechangeinthefuture.The

risk that some mitigation options may fall short should motivate policy makers to consider

highercostoptionsthateffectivelyprovideinsuranceagainstcatastrophicclimatechange.

Thispaperaims tocritically review theargumentsabout the interactionsbetweenREandCO2

policy instruments. It shows that developing new renewable resources (e.g. wind, solar and

others) from a very narrow basis today allows learning that will unlock their climatechange

mitigationpotential.Bycontrast,theassociatedminorchangeintherateofswitchingfuelfrom

coaltogasdoesnotlocktheenergysectorintomorepollutingtechnologies.


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Interactionsofpoliciesforrenewableenergyandclimate OECD/IEA2011

Page|6

Thepaperconcludesthat incentivesforthedeploymentofnotyetcompetitiveformsofREare

legitimateevenifCO2isappropriatelypriced,providedpolicyinstrumentsarewelldesignedand

relatedcostskeptundercontrol.CloserexaminationofpossibleinteractionsbetweenREandCO2

policyinstrumentsalsorevealsotherlittlenoticedaspects,relatingtohowbothpoliciestransfer

wealth fromutilitiesto (deregulated)customersorviceversa.Thisopensawholesetof issues

relating to the longterm financing of electricity systems, which could be subject to future

researchwork.


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CriticismofREincentives

Theinteractionargument

In a thoughtprovoking paper, Bhringer and Rosendahl (2009) claim that Green Serves theDirtiest, througha socalled interactioneffect.RE supportpolicies (quotas in theirmodel

tradable green certificate or TGC more generally) do, as a firstorder effect, reduce the

profitabilityofblackpower (i.e. from fossil fuels),and thus reduceoutput fromall fossilfuel

producers.However, inacountryorgroupofcountriessuchastheEuropeanUnion,wherean

emissions trading system (ETS) covers theCO2emissions fromelectricityproduction,emission

reductionsresultingfromthedeploymentofrenewablesleadtoreducedpricingofemissions.In

essence, they reduce the advantage given to efficient combined cycle gas turbines over coal

plants.EmissionsarenotreducedfurtherduetotheREincentives,aslongasthequantitativecap

issetonceandmaintained,insensitivetoCO2prices.

Meanwhile, policies that successfully increase the share of renewable, noncarbon emitting

electricityproductiontendtoreduceoverallemissionsanddisplaceelectricityproduction from

fossilfuels.Indoingso,theyrelativelyreducetheCO2price,therebydiminishingtheadvantage

givenbytheinstaurationoftheETStothelowercarbonemittingtechnologiesamongelectricity

productiontechnologiesfromfossilfuels.Thisbenefitsthemoreemissionintensivetechnologies.

Thereisatpresentnothingtoforcethefossilfuelproducerstoincreasetheiroutputandkeep

totalemissionsconstant.Theymightdo so foreconomic reasons,but theymightaswell save

allowancesandsellthemtootherentitieswhoseemissionsarecoveredbytheETSforexample

inotherindustrialsectors.Inanycase,thetotalemissionsarelikelytobethesameregardlessof

whetherapolicytospecificallypromoterenewableelectricityproduction is inplace,as longas

thequantitativecapisset,insensitivetoCO2prices.1TheETScreatesanabsolutecap:unlessthe

unabatedemission

trends

were

to

put

emissions

below

the

cap

and

the

carbon

price

were

to

fall

tozero,emissionswouldbeexactlyontarget,supposingfullcompliance.Carbonpricewithnull

valuemayresultfromanottoodemandingcaponemissions,a lowerthanexpectedeconomic

growth,averystringentrenewableenergytarget,oranycombinationofthese.

The interactionofbothpolicies reducesthedisadvantage thatETSalonewouldcreate forcoal

plants relative to gas plants.Onemust insist that Bhringer and Rosendahls result is only a

secondordereffect,forthismighthavebeenmisreadbysomereviewers.Forexample,Fischer

andPreonas(2010),reviewingBhringerandRosendahlspaper,writethatwhileoverallfossil

fuelproductionfallsasaresultofcombinedETSandTGCquotas,thedirtiestproducersactually

increaseoutput tokeep totalCO2emissionsat thebindingETSceiling.The readermight thus

believethatthis isanabsolute increaseoverthebaseline, i.e.thesituationwherenopolicyof

anykindwouldbeenacted.

ThemodelpresentedinBrhingerandRosendhalactuallyrevealssomethingquitedifferent.When

theemissionconstraint is imposed,powerproductionby lignitepower(thedirtiesttechnology)

decreasesby41%ifnoadditionalgreenquotaisinplace.Whenagreenquotaisintroducedat23%

oftotalelectricity,outputfromlignitepowerplantsalsodecreases,butbyonly31%.Thebenefit

forthedirtiestisnotabsolute,butclearlyrelativeanincreaseof17%overthescenariowiththe

ETSalone.Therefore,potentialinvestorsincoalplantsarestillconfrontedwithanegativeoutlook.

1Notethatifindependentpowerproducers(IPP)toosmalltobecoveredbytheETSturntoREtechnologies,totalCO2

emissionswillbereduced.Butif,asisoftenthecasewithwindorsolar,newIPPenterthemarketwithREelectricity,

althoughthisreducestheproductionfromETScoveredproducers,theoverallemissionswillstayontarget, i.e.their

levelisnotaffectedbytheREpolicy.


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Thecosteffectivenessargument

Many believe that the overlapping of CO2 and RE policy instruments increases the costs of

achievingtheCO2objective.Thisargumentfollowsastronglogic:themoreexpensivemitigation

achieved throughREdisplaces reductions that theETSwouldachieveata lowercost. In cases

where RE would be driven by the CO2 price alone and RE incentives were to persist, the

additionalsupportonlycreateswindfallprofits.

TheexactextentoftheadditionalcostofREsupportinachievingagivenCO2objectiveisdifficult

toevaluate.ItdependsonthecostofthepromotedREsourcesandontheamountofCO2they

avoid,andonthecostofavoidingsamequantitiesthroughothermeasuresthatwouldhavebeen

mobilised, had renewables not been promoted. Electricity generation from renewables is

particularlychallenging: itrequiresanassessmentoftheCO2contentofthekWhtheydisplace,

whichdependsonthemeritorder(i.e.thelastproductioncapacityrequiredtofulfilthedemand

ateverymoment).Theseelements typicallydiffer fromonecountry toanother.Thisdifficulty,

however,doesnotmakethepointanylessvalid.2

2A fuller investigationof theshorttermeffectsof these interactionswouldnecessitateassessing themacroeconomic

effectsofCO2pricesand changes inelectricityprices. IfREdeploymentwere required toachieve the shorttermCO2objectives(i.e.ifnocheaperoptionswereleftout),havingaspecificREincentivecouldhelpkeeptheCO2andelectricity

priceslower,andtheirmacroeconomiceffectlessimportant.AsthemodellingbyBhringenandRosendhalsuggests,this

isprobablynotthecasetoday.Butiftheirshorttermassessmentholdsinthecurrentcontext,itmaynotalwayshold.


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SupportingREincentives

Variousarguments canbemade in response to the criticismof specificRE incentiveswhen a

broaderCO2policyisinplace.Thispaperwillconsiderthefollowing:

1. Climatechangemitigationisonlyoneamongmanymotivesbehindthepromotionofrenewables.2. Climatechange isa longterm issue.Itmightbe importantto implementhighercostoptions

togetherwithlowercostoptions,ifthedeploymentoftheformerhasthepotentialtoreduce

thelongertermcostsofmitigation.

OtherdriversofREdeploymentpolicies

Thesupporttorenewablesmayhavevariousdriversotherthanclimatechangemitigation.These

include1)acontributiontoincreasedenergysecurity,reduceddependencefromimportedfossil

fuels; 2) hedging against price volatility and longterm price increase of fossil fuels; 3) a

contributiontothereductionofotherpollutantsandrelatedrisksarisingfromtheuseofother

energy sources;4)andawillingness todevelop localemployment, sometimes reinforcedbya

perceptionofthefirstmoversadvantage.

Whileauniquepolicyinstrumentmightworkwellwhenoneobjectiveispursued,itismorelikely

thatseveralobjectivespursuedtogetherwillrequireseveralpolicy instruments.When itcomes

tooverlappingCO2andREpolicies,theadditionalcost imposedontheachievementoftheCO2targetby theREpolicy instrumentmightbe simply considered the costof reaching theother

objectivespursuedbythispolicyinstrument.

Theseargumentsarevalid.Renewabletechnologydeploymentoffersmanybenefitsbeyond its

contributiontoclimatechangemitigation,whichneedtobeassessedandvalued.However,the

benefitsmayfallshort injustifyingtheextracost.Indeed,aswillbeshown,theenergyoptions

displacedbyREtechnologieswouldhavealsoprovided,atleastinpart,similarbenefits.

With respect to CO2 emissions from fossil fuel combustion, possible emission reductions all

belong to energy efficiency improvements, fuel switching to fuelswith lower carbon content

(usually from coal to natural gas in electricity production), nuclear or renewable, or carbon

capture and storage. It is important to consider how these options fare relative to theother

objectivespossiblyattributedtothepoliciessupportingREdeployment.

Energy efficiency improvements contribute as much or perhaps more than RE to all the

objectives assigned to RE policies. They reduce other pollution, increase energy security and

oftencreatelocaljobs(e.g.forhomeinsulation).

Fuel switching may or may not contribute to increased energy security, depending on the

resources of the country considered, and its relationships to exporting countries. It usuallyreducesotherpollutionalongwithCO2emissions, forburningnaturalgasusuallyentails lower

NOx,SOx,heavymetalsandparticulateemissionsthanburningcoal.

Carboncaptureandstorage increases fuelconsumption,andthusdoesnotprovideanyhedge

against price volatility and longterm price increase. It may, nevertheless, be considered to

increaseenergysecurityinacarbonconstrainedworldforcountrieswithcoalresources(oreven

without,consideringapossiblediversificationinfuelsandproviders).Itcapturesandstoresmost

atmosphericpollutantsaswellasCO2.

NuclearpowerdoesnotemitCO andtheotherpollutantsgenerallyassociatedwithfossil fuel

burning.Althoughnuclear raw fuelsmustoftenbe imported, their share in theoverall cost is

muchsmaller than inthecaseof fossil fuels. Inaddition,diversifying fuelsandbroadening theportfolioofprovidersreducesenergysecurityrisks.


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Anotheraspectoftenoverlookedinassessingpolicieswithmultipleobjectivesisthatothermeans

can be employed to achieve each objective individually. For example, while it is legitimate to

accountforthereductionofparticulate,SOxorNOxemissionswhenrenewableenergysubstitutes

for some fossil fuelburning,onemustalso considerotherpossibilities (andassociated costs) to

reduce the same emissions. This could be achieved through cleaning the fuel, using lowNOx

burnersorendofpipedevices(suchasfilters,scrubbers,fluegasdesulphurisationandothers).

Asaresult,themultiplicityofobjectivesortheexistenceofotherbenefitsmayfallshortoffully

justifying policy instruments specifically supporting the deployment of RE technologies

particularlyiftheanalysisremainsfocusedonshorttermeffectsandtheseinstrumentsdisplace

energyefficiencyimprovements.

Theneedforalongertermperspective

The interactions between RE and CO2 policy instruments are likely to increase the cost of

achievingtheCO2targetsetfortherelativelyshortterm.However,therequirementforclimate

changemitigationextendsfarbeyondtherelativelyshorttermperspectiveinwhichCO2targets

weresetatbest,15years inthecaseoftheKyotoProtocol,consideringthetime lagfrom its

adoptionattheendof1997andtheendofitsfirstcommitmentperiodattheendof2012.

Indeed climate change is a very longterm issue. The FourthAssessmentReport of the Inter

governmentalPanelonClimateChangehas shown that tokeep theglobal temperaturewithin

the rangeof2C to2.4Cabove thepreindustrial temperatureatequilibrium,using the best

estimateofclimatesensitivity,wouldrequireareductioninglobalCO2emissionsin2050of50%

to 85% of 2000 emissions. It further offers emissions ranges for categories of stabilisation

scenariosfrom2000to2100(IPCC,2007).Mitigationeffortswillneedtoextendoverthisentire

centuryandmaybebeyond.

It is widely acknowledged that these considerable emission reductions will require a broad

portfolioofmitigationoptions.The IEAWorldEnergyOutlook2010 (WEO2010), forexample,

suggests thatby2035 energyefficiency improvementsabove those adopted in theReference

Scenario would provide 47% of the CO2 emission reductions in the 450 Scenario; additional

emissionreductionswouldcomefrombroaderuseofrenewableandbiofuels(24%),CCS(19%),

andadditionalnuclearpowerplants(8%0(IEA,2010a).

The IEAEnergyTechnologyPerspectives2010(ETP2010)BLUEMapScenariochartsapathtoa

reductioninglobalenergyrelatedCO2emissionsby50%from2005levelsatthelowestpossible

overallcost(IEA,2010b).Itshowsthatby2050renewableenergysourceswillprovideabouthalf

ofglobalelectricity(Figure1).

TheHighRenewablevariantoftheBLUEMapScenariosuggeststhat, ifnuclear,CCSorenergyefficiencyimprovementscannotdeliverallthattheypromise,orifdeepercutsinCO2emissions

arewarranted,REsourcescouldprovideupto75%ofglobalelectricityby2050.Theincreasein

thecostofelectricitywouldbeabout10%.

Thenecessarylargescaledeploymentoflowcarbonenergytechnologiesinthecomingdecades

willresultfromsignificantcostreductionsoftheenergytheydeliver.ThecostsofdeployingCCS

technologiesorconcentratingsolarelectricityaredividedbyfourfromcurrentlevels;thecostof

photovoltaic(PV)modulesbysix;thecostoffuelcellforvehiclesbyanevengreaterfigure.The

costs of associated CO2 emissions reductions with respect to the baseline scenario can be

reducedevenmore.Forexample,whenREtechnologiesbecomefullycompetitive,themarginal

costofassociatedemissionreductionsfallstozero.


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Figure 1:Electricitygenerationby sources in2007,2030and2050underBaseline,BLUEMap,

BLUEHighNuclearandBLUEHighRenscenarios.

0

5

10

15

20

25

30

35

40

45

50

2007 B asel ine2050 B LUEMap

2050

BLUEHigh

Nuclear2050

BLUEHighRen

2050

PWh

Other

Solar

Wind

Biomass+CCS

Biomassandwaste

Hydro

Nuclear

Naturalgas+CCS

Naturalgas

Oil

Coal+CCS

Coal

Source:IEA,2010b.

Howarecostreductionsbestachieved?

These cost reductionsareexpected to come, in a largepart, from an earlydeploymentof these

technologies.This isthecruxofthe longertermperspective:even iftheearlydeploymentofsome

renewables now has higher costs of immediate emission reductions than other options, this

deployment must be undertaken if the cost reductions it drives are key to future largescale

deployment. The early deployment of RE technologies is a costeffective measure for longterm

climatechangemitigation,evenifitlookstoocostlywhenonlyshorttermreductionsareconsidered.

Thisargumentisoftenchallengedonthebasisthatresearchanddevelopment(R&D),insteadof

earlydeployment,would leadtothecostreductionsrequiredfor later, largescaledeployment.

Indeed,mostcriticsofearlymitigationefforts,includingthosechallengingthescienceofclimate

change,tendtodeferallpolicyneedstosupporttoR&Defforts.Theyarguethat ifthescience

confirmsthenecessityofmitigatingclimatechange,thenecessarycarbonleantechnologieswill

bemadeavailable(Lomborg,2001).

OthersrecognisetheneedforbothcarbonpolicyinstrumentsandgovernmentsupporttoR&D,

astheyrecogniseheretwodistinctmarketfailures.One isclimatechange,duetothenegative

externalityofGHGemissions:theotherisunderinvestmentofprivatefirmsinR&Dactivities.This

secondmarket failure isdue to the fact that firms investing inR&D activities cannot entirely

preventthediffusionoftheknowledgegainedthroughtheseactivitiestoothers,includingtheircompetitors.Although such knowledge spillovers are considered positive externalities (i.e.

theymakethesocialvalueofR&Dgreaterthanitsprivatevalue),theylegitimisethegovernment

supporttoR&Dactivitiesindependentlyofclimatepolicy.

OneinterestingexampleisprovidedbyFischerandNewell(2008).Theyhavedevelopedaunified

frameworktoassessthesixdifferentpolicyoptionsforreducingGHGemissionsandpromoting

the development and diffusion of renewable energy in the electricity sector. Although the

relativecostof individualpolicies inachievingreductionsdependsonparametervaluesandthe

emissionstarget,inanumericalapplicationtotheUSelectricitysector,FischerandNewellstate

thattheranking(bydecreasingefficiencies)isroughlyasfollows:1)emissionsprice;2)emissions

performance standards; 3) fossil power tax; 4) renewables share requirement; 5) renewables

subsidy;and6)R&Dsubsidy. Inanutshell,they findthatwhentheultimategoal istoreduce


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emissions, policies that create incentives for fossilfuelled generators to reduce emissions

intensity, and for consumers to conserve energy, perform better than those that rely on

incentivesforrenewableenergyproducersalone.

FischerandNewellnotethatanoptimalportfolioofpoliciesachievesemissionsreductionsata

significantlylowercostthananysinglepolicy:Given the presence of more than one market failure an emissions externality and

knowledge spillovers no single policy can correct both simultaneously; each poses

different tradeoffs. The presence of knowledge spillovers means that separate policy

instrumentsarenecessarytooptimallycorrecttheclimateexternalityandtheexternalities

forbothlearningandR&D.Infact,wefindthatanoptimalportfolioofpoliciescanachieve

emissions reductions at a significantly lower cost than any single policy, although the

emissionsreductionscontinuetobeattributedprimarilywiththeemissionsprice.

Some specificsof themodelused explain this result,which contradicts the costeffectiveness

argument.Themodelhastwoperiods.Thereisaknowledgestock,whichincreasesinperiod2as

afunction

of

both

R&D

expenditures

and

output

of

RE

technologies

in

period

1.

The

costs

of

RE

generation inperiod2are inverselyproportionaltotheknowledgestock.Themodeltakes into

accountincompleteappropriationofthebenefitsfromincreasedknowledge,whichjustifiesR&D

subsidiesorREdeploymentsubsidiesorboth. Inanycase,anemissionspricealone,although

theleastcostlyofthesinglepolicylevers,issignificantlymoreexpensivealonethanwhenusedin

combinationwithoptimalknowledgesubsidypolicies.Theoptimalmixhasthreedistinctpolicy

instruments:supporttoR&D,acarbonpriceandREdeploymentsupport.

Inthisway,FischerandNewellconfirmthatthecoexistenceofseveralpolicy instrumentsdoes

not increasebut reduces the costsofmitigating climate change,despite the limited temporal

perspectiveoftheirresearch,whichexploresrelativelymildemissionreductionobjectives.

One setofdifficultquestions remains:whatare

the

relative

weights

of

R&D

expenditure

and

learningbydoing?Which is themost important sourceof increasedknowledge?And,areboth

similarly appropriable by thefirms, or should one consider different spillover ratiosfor each?

According to FischerandNewell, if learning ismore firmspecificand less likely to spillover,

policiessubsidisingrenewablesare lessappropriatetocompensateforknowledgeexternalities.

Incontrast,iflearningismoredifficulttopatenttoappropriaterents,thenrenewablesubsidies

mayberelativelymorejustifiedthanR&Dsupport.

A classical perspective tends to describe the technical change as a linear process going from

invention to innovation todiffusion (Schumpeter,1942).Amoremodernandpossiblymore

realistic perspective instead sees technical change as a cyclical process, based on twoway

feedbacks between market experiences and technical developments. Not only are market

prospectsthemostvitalstimulantofindustryR&Defforts,butmoreimportantlythedeployment

of technologies inacompetitivemarketplace isakey sourceof informationon theirstrengths

andweaknesses,andthusonthedirectionsappliedR&Deffortsmighttake.Marketdevelopment

andtechnologydevelopmentgohandinhand(IEA,2003).

Thisperspectiveisborneoutbylessonsfrompasttechnologicaldevelopments,whichrevealthat

thecostsof technologiesdecreaseas totalunitvolumerises.Themetricofsuchchange is the

progressratio,definedasthereductionofcostasaconsequenceofthedoublingofcumulative

installedtechnology.Thisratiohasprovenroughlyconstantformosttechnologiesalthough it

differssignificantlyfromonetechnologytoanother.However,thefactthattheprogressratiois

usuallyconstantmeans that technology learningoccursmorequickly frommarketexperiences

when technologies are new than when they are mature. The same absolute increase incumulativeproductionhasamoredramaticeffectatthebeginningofatechnologysdeployment


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thanithaslater(IEA,2000).Thisiswhynewtechniques,althoughmorecostlyattheoutset,may

becomecosteffectiveovertime iftheybenefitfromsufficientdissemination.Socalled learning

curvesillustratethisphenomenonwithstraightlinesonlogloggraphs(Figure2).

Figure2:Photovoltaiclearningcurve197692:linearandloglogrepresentations

Note:Thetwofiguresrepresentthesamelearningcurve,thatofPVmodulesfrom1976to1992.Linearscalesareusedonthelefthandfigureforbothsalesandprices,whilebothscalesarelogarithmicontherighthandsidefigure.

Source:IEA,2000.

Still,itremainsdifficulttoclearlydistinguishbetweentheeffectsofR&Deffortsandthosearising

frommarketdeployment (Clarke andWeyant, 2003). Learningcurve literatureusually lacks a

detailed history of R&D expenditure, while R&D literature often ignores learning effects.

Moreover,thecoexistenceofincreasedmarketsharesanddecreasedcostsdoesnotnecessarily

demonstratethattheformercausedthelatter.Thecausalityrelationshipworksbothways:when

costsdecrease,marketsincrease.

TheEnergy

Technology

Perspectives(ETP2010)publication(IEA,2010b)extendstheanalysisfarbeyondthatofFisherandNewell.Itoffersacostoptimisationexercise,whichtakesintoaccount

currentandfuturecosts(witha10%discountrate)ofreducingenergyrelatedCO2emissionsto

half their 2005 levels by 2050. This IEA analysis shows that by 2050, RE technologies should

provide48%oftheglobalelectricityproductionandmore(57%)ifthediscountrateislowered

to3%.Toattaintheseleastcostsolutions,themodelprogressivelyincludesgrowingsharesofRE

technologiesintheelectricityandenergymixes,includingthosethatarenotyetcompetitiveand

needsupport.Formostofthem,thissupportisneededinthisdecadeandpossiblythenextone,

beyondthepricingofCO2.

AsETP2010states,Itwillnotbepossibletodecarbonisetheelectricity,withoutstrongpolicy

intervention. Today,many low carbon alternatives are considerablymore expensive than the

incumbenttechnologies.Governmentswillneedtocontinueandexpandtherangeoftransitionalincentives from RD&D support to market mechanisms to foster technological innovation and

movetechnologiestowardsmarketcompetitiveness.These incentivesshouldbetailoredtothe

maturityofthetechnologyandbedecreasingovertime.Thisshouldbeaccompaniedbypolicies

thatclosethedirtiestandleastefficientplantsattheearliestopportunity.

ETP2010makesextensiveuseof the learningcurve theory considered in itsbroader senseof

deploymentledcostreductions.Althoughthereliabilityofthistheoryasapredictivetoolcannot

beabsolute,analysesofactual sourcesof cost reduction (as in the IEATechnologyRoadmaps

publications)showthatitsfoundationsaresolid(Box1).


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Box1:Behindthelearningcurve

Somerecentstudiesattempttoshedlightonthedeterminantsofcostreductionsassociatedwiththe

learningcurve theory. For example,Nemet (2006) studied the cost reductions of electricity from

crystallinesiliconPVmodulesfrom1975to2001,andsoughttodisaggregatehistoriccostreductions

offactor20duringthisperiodintoobservabletechnicalfactors.Heidentifiedthreemajorfactorsofcostreductionsfrom1980to2001:manufacturingplantsize,moduleefficiencyandsiliconcost.

Fromitsacademicorigin(Arrow,1962),learningbydoingissometimesseenintheverynarrowsense

of increasedworkers productivity due to experience, other factors remaining constant.Nemet

suggeststhiswasa relativelyminor factorunderlying thedriversofcost reduction.The successof

somenewentrantswas insteaddue to theircapacity to raisecapitaland takeon the riskof large

investments. Ten out of the 16 major advances in module efficiency can be traced back to

government and university research and development programmes, while the other six were

accomplished incompaniesmanufacturingPVcells.Finally,reductions inthecostofpurifiedsilicon

wereaspilloverbenefitfrommanufacturingimprovementsinthemicroprocessorindustry.

It is interesting to extend the examination of the PV technology beyond the end of the period

considered byNemet.Up to that point,much of theprogress in PV growthhadbeen supported

throughnichemarkets in remoteplaceswherePVwasalready themostcosteffective solution.

Soonafter,largeincentiveprogrammesbeganinJapanandGermanyforgridconnectedPVmodules.

Inthe firstyears, itseemedthatthe learningcurvetheorywasprovingwrong:PVpricesremained

higher than expected. Analysts have attributed this to the bottleneck formed by the shortage of

appropriatepurifiedsiliconandsupplymarket.Since2008,however,priceshavefallendrasticallyand

joined almost exactly the level assigned to their cumulative development by the learningcurve

theory(Figure3).

Figure3:PVlearningcurve

Source:BreyerandGerlach,2010.

Increaseddeploymenthas thusbeen, throughvariouschannels, themost importantdriverofcost

reductions.Nemets analysis does not invalidate the policyprescription based on deploymentled

costreductionswhich is included in IEAETPprojectionsto2050.Theprojectionsarealsobasedon

analysesofthecostreductionpotentialstobemobilised in future learningphases,andmilestones

towardscompetitiveness inprogressivelybroaderelectricitymarkets(seeIEATechnologyRoadmaps,

inparticularIEA,2010c).

Detailed analyses would identify possible limits within the hidden drivers of cost reductions: for

example,limitstoPVcellefficiencyortoplantsize.Resourceexhaustionwhengoodsitesgetmore

scarceorremote,oriftheproportionofvariablesourcesinelectricgenerationpushesupintegration

costscanslowdeploymentandprogressalongthelearningcurve,butwouldnotmodifyitsslope.


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Figure4:CorporateandpublicPVR&Dexpenses

Source:Breyeretal.,2010.

Welldesigned incentives fordeploymentarealsoeffective in fostering research,development

anddemonstrationeffortsandinnovation;andthesecanbespecificallyencouragedbystillother

instruments,suchastheloanguaranteeprogrammeoftheAmericanEnergyActof2005.Recent

analysespointtoasignificanteffectof incentivesforearlydeploymentonprivateresearchand

developmentexpendituresinthecaseofphotovoltaics(Figure4).


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Discussion:lockingin,lockingout

ThesomewhatprovocativeexpressionGreenservesthedirtiestdesignatespoliciessupporting

renewableenergydeploymentas theonly culpritof theparadoxicaladvantage given to fossil

fuelswhichemithigherlevelsofCO.Theproblem,ifthereisone,arisesfromtheinteractionofthetwopolicies.ETSalonewouldcertainlygiveanadvantagetocleanerfossilfuels;REpolicies

alonewouldessentiallydisadvantagealltypesoffossilfuels.

Asnotedbyseveralotherauthors(seethereviewbyFischerandPreonas,2010),theadditionof

anREpolicytoanexistingETSisunlikelytoleadtoadditionalCO2emissionreductionsfromthe

entitiescoveredbytheETS.ThisdoesnotresultfromafailureoftheREpolicy:itisasimpleand

logicalconsequenceoftheverydesignoftheETS,whichisafixedquantitypolicy.Thingswould

be different, however, if the policy directly addressing CO2 emissionswas a price policy or a

hybridpolicy.Incaseofapricepolicysay,acarbontaxCO2reductionsdrivenbytheREpolicy

couldpossiblyaddtotheCO2reductionsdrivenbythecarbontax,dependingonthestrengthof

each.Incaseofahybridpolicy,suchasanETSwithapricefloor,areductionofthecarbonprice

resultingfromtheREpolicycouldpossiblyleadtoadditionalCO2emissionreductions,inasmuchthecarbonpriceweretofallbelowthelevelofthepricefloor.

The remaining question is whether the shortterm, relative advantage given to more CO2

intensivegenerationtechnologycouldtriggersomedetrimentallockinofsuchtechnology,atthe

expenseofeffortstocutemissions.

The feedback process from markets to technical improvements providing increasing returns

tends to create lockin and lockout phenomena: it is not (always) because a particular

technology is efficient that it is adopted, but (sometimes) because it is adopted that it will

become efficient (Arthur, 1989). Technological paths might very much depend on initial

conditions.Assuch,technologieshavingsmallshorttermadvantagesmaylockinthetechnical

basis of a society into technological choices thatmay have lesser longterm advantages thantechnologiesthatarelockedout.

The systemic and cumulative nature of technological change leads to clustering effects, or

technological interdependence, and possible phenomena of increasing returns: the more a

technology isapplied, themore it improvesandwidens itsmarketpotential.Changegoes ina

persistentdirectionbasedonanaccumulationofpastdecisions.AsnotedbyRoehrlandRiahi

(2000), technological change can go inmultiple directions, but once change is initiated in a

particulardirection,itbecomesincreasinglydifficulttochangeitscourse.Towhichtheyrightly

add: research,developmentanddemonstrationeffortsaswellas investmentdecisions in the

energy sectorover thenext two to threedecadesare critical indeterminingwhich longterm

technologicaloptionsintheenergysectormaybeopened,orwhichonesmaybeforeclosed.

Howdoesthisapplytotheissueoffuelshiftingvs.renewables?Fossilfueltechnologieshavehad

avery largeglobalmarketformorethanacentury.Theycanstill improve,butmarginally.Ifthe

combination of RE and CO2 policies reduces the shortterm use of the dirtier fossil fuel

technologieslessthanCO2policiesalonewoulddo,theconsequencesintechnologydevelopment

forbothdirtierandcleanerfossilfuelswouldbeminor.Theintroductionanddeploymentofnew

REtechnologiesfromaverynarrowbasisholdsthepossibilityofmoreconsiderableprogress.

Inotherwords,REpolicyinstrumentswillunlockthepotentialofrenewablesbutwillnotlikelylock

inthefossilfuelindustryintoitsdirtierforms.Itmustbenotedinthiscontext,thatwhileshifting

fromcoaltogasinelectricitygenerationdoesreduceGHGemissions,inclimatefriendlyscenarios

like the 450 Scenario of the WEO 2010 (IEA, 2010a) the global consumption of natural gas

decreasesafter2020whilerenewableenergyproductioncontinuestoexpand.Inthisscenario,the


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contributionofrenewabletoelectricityproductionreaches14500TWhby2035(from3800TWh

in2008),thecontributionofmodernrenewabletotheproductionofheat increasesfrom10% in

2008to16%,andtheproductionofbiofuelsfortransportationmultipliessevenfold.

Otherpossible formsof lockingindeserve greater consideration, inparticularwith respect to

energyefficiency improvements.Someenergyefficiencymeasuresneed tobeundertakenatagiventimeforexample,whennewplantsorbuildingsaredesignedandbuiltorriskcosting

muchmoreata laterstage.Acceptingtoo largean investment inrenewabletechnologieswhile

neglectingtimelyenergyefficiencyprogrammesclearlyrunstheriskof lockinginsocietiestoo

high energy consumption patterns, with detrimental longterm implications for both energy

securityandclimateprotection.

ThecosteffectivenessargumentagainstREpolicieshasmuchlessweightwhenthelongtermis

considered,anddoesnotleadtotheconclusionthatREincentivesshouldbeabandonedbutit

doesnotvanish.Policiesdesignedtosupportthedeploymentofrenewableenergiesmustbeas

costeffectiveaspossible,andtheirtotalcostsmustremainundercontrol.TheWEO2010(IEA,

2010a)hasassessed theglobalcumulativecostofsupport torenewables (i.e.thepricepaidto

renewableenergyproducersoverandabovetheprevailingmarketprice)atUSD4trillionfrom2010to2035initsNewPolicyScenarioofwhich63%forelectricityand37%forbiofuelsand

USD 5.2 trillion in its 450 Scenario.Although these numbers are to be seen in proportion to

wholesaleelectricityprices (Figure5), thesearenot smallsums;creating incentives tosupport

renewable energys deployment and costeffectiveness will be further examined in the IEA

publicationDeployingRenewables(IEA,forthcoming).

Figure5:Averagewholesaleelectricitypricesandrenewablesupportcostbyscenarioandmajor

region,201035

Source:IEA,2010a.

Otherinteractioneffects

Anotherpossibleaspectofthe interactionbetweenCO2andREpoliciesseemstohavereceived

very little attention so far. It relates to how both policies transfer wealth from utilities to

(deregulated)customersorviceversa.

Several studies show, from either theoreticalmodels or observations from existing electricity

markets, that the introductionofa large shareofREelectricity tends to reduce theelectricitypriceforderegulatedcustomers(forareview,seePyry,2010).


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Thiscanbestbeobservedwiththecaseofwindpower,whichhasrecentlybecomeasignificant

playerinsomeEuropeancountries.Ataboutthesametime,theirelectricitymarketsunderwent

deregulation. Inderegulatedmarkets, theprice is setwhere supplyanddemandcurvesmeet.

The demand for electricity is relatively inelastic it does not change much with the price.

Typically,thesupply ismadeupofvariouspowertechnologies:wind,hydro,nuclear,combined

heatandpowerplants, coalandnaturalgasplants,and gas turbines. Inapowermarket, the

supply curve is called the meritorder curveand goes from the least to themostexpensive

units, taking account only of the marginal variable costs (mostly fuel costs). Utilities bill all

kilowatthours soldonaderegulatedspotmarket,at theprice setby the lastandmostcostly

unit.Therefore,theygetthebenefitofsocalledinframarginalrents.

Thevariablemarginalcostofwind isvery low,andthuswindpowerentersnearthebottomof

thesupplycurve.Thisshiftsthesupplycurvetotheright(Figure6)andleads,ingeneral,tolower

powerspotprices.Thissocalledmeritordereffect is larger inpeakdemand times,where the

merit order curve is especially steep. With more wind into the mix, the size of the rents is

reduced,forthebenefitofderegulatedcustomersandtothedetrimentofutilities.

Figure6:Howwindpowerinfluencesthepowerspotpriceatdifferenttimesoftheday

Price

Capacities

Wind

Low High

Combined

CycleGas

Coal

Nuclear

Gas turbine

Inframarginalrents

Electricity demand

Market price (low wind)

Market price (high wind)

A few empirical analyses have attempted to estimate this meritorder effect. For example,

Sensfu et al. (2008) calculate that the volume of the meritorder effect would have been

EUR5billionin2006inGermanyiftheentireelectricitydemandofasinglehourwaspurchased

atthecorrespondingspotmarketprice.Meanwhile,thecostofincentivesforrenewablesinthat

sameyeartotalledEUR5.6billion.

Thesameauthorsestimatethevalueofthekilowatthourproducedbyrenewables(i.e.thecosts

avoided by substitution of electricity from other sources) at around EUR2.5 billion, leaving

EUR3.1billionas thetrueextracostofREsupport incentives.Ofthese,0.6billionaredirectly

paidbyfinalconsumers,whiletheremainderEUR2.5billionarebasicallypaidbyutilitiesthrough

adecreaseoftheirinframarginalrentsduetothemeritordereffect.Inthisway,themeritorder

effecttransferswealthfromutilitiestoderegulatedcustomers.

In reality, not all electricity is sold on the spot market in Germany, and bilateral contracts

mitigate this result. Furthermore, the lower price paid by deregulated customers does not

representalowercostforproducingelectricity.Theoverallcostofwindkilowatthoursremains

higher than some competitors,even if the gaphas considerablynarrowed in the lastdecade.Utilitiesmayultimatelyfindwaystopasspartofthesecoststocustomers.


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Amorerecentstudyonwindpower in Irelandprovidesevenmorestrikingresults.Cliffordand

Clancy (2011),usingadetailedmodelof theallIslandSingleElectricityMarket, show that the

windgenerationexpected in2011will reduce Irelandswholesalemarketcostofelectricityby

around EUR 74 million. This is approximately equivalent to the sum of the Public Service

Obligation (financing the feedin tariff for wind) cost, estimated as EUR 50 million, and the

increased constraint (or balancing) costs incurred due to wind in 2011. The reduction of

IrelandsdependenceonfossilfuelsandtheCO2emissioncutscostnothinginthiscase,despite

the persistence of the support scheme which ensures recovery of the longterm costs of

electricitygenerationfromthewindevenwhenthemarketpricesarelow.

Ithasalsobeenshown thattheelectricityproducersandutilitieshaveenjoyedwindfallprofits

from the implementationof theETS,because the resulting increase in themarginalelectricity

priceshas increasedtheir inframarginalrentsatthedetrimentoftheirderegulatedcustomers.

This isalsoaneffectofthemeritorder (Figure7).KepplerandCruciani (2010)haveestimated

thesewindfallprofits for theutilitysectorasawholeatmore thanEUR19billion for the first

phase of the EU ETS, and state that this phenomenonwill only be partiallymitigated by the

auctioningofemissionallowancesfrom2013on.Fromthisperspective,theinteractionbetweenRE andCO2 policy instruments,whichwork inopposite directions in transferringwealth from

utilitiestoindustrycustomersandviceversa,tendtooffseteachotherseffects,atleastinpart.

Figure7:MeritorderandelectricitypriceincreasewithCO2price

Price

Capacities

Wind

Combined

CycleGas

Coal

Nuclear

Gas turbine

Additional rents

Inframarginalrents

Market price (with CO2)

Market price (without CO2)

Electricity demand

CO2 cost

CO2 cost

CO2 cost

The quantitative assessment of the impacts of the meritorder effect and other interactionsneedsfurtherresearch.Thisassessmentwillbecrucialtodeterminetherealcostsofrenewable

energyincentivesforsociety.


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Conclusion

ThejuxtapositionofaCO2policyinstrumentofafixedquantitativeform(suchastheEUETS)and

ofpolicyinstrumentsspecificallypromotingtheearlydeploymentofREtechnologies,mayleadto

aCO2pricethatislowerthanitwouldhavebeenotherwise.Itmayalsoraisetheoverallcostsofachieving the shortterm CO2 reductions of the ETS, as this is attained through some costlier

emissionreductionsdrivenbyREtechnologydeployment.Meanwhile,bothpoliciesentailwealth

transfersbetweenutilitiesandderegulatedindustrycustomersthatworkinoppositedirections,

therebyoffsettingeachotherseffect.

However, as soon as technology improvements are factored in, even for a relatively limited

periodoftime,theoptimalportfoliominimisingthelongtermcostofsupportpoliciesbroadens

toat least three instruments:oneaddressing theCO externalitydirectly;one addressing the

spillovereffects fromR&Defforts; andoneaddressing the spillovereffects from learningby

doing. Various other policy instruments might be needed to address noneconomic barriers.

Lookingfartherintothefuture,theprominentroleofREtechnologiesinmitigatingclimatechange

becomesmore important.Currentpoliciespave theway formaking theirnecessary largescaledeploymentaffordable,thankstolearningbydoingprocessesinthebroadsenseoftheterm.

Apossiblepolicy recommendationwouldbe to takebetteraccountof the interactionsamong

policy instruments. IftheREpolicy istobedefinedfirstgiven its longertermroleandstrategic

importanceinaddressingclimatechange,thecarbonpolicyshouldthenbeadjustedtotakethe

REpolicyintoaccount.Thiscouldbedonewitheitherrelativelymoreambitioustargetsorwitha

moreflexibledesignincorporatingacarbonpricefloor.

This examination of the interactions between RE technology deployment and CO2 emission

reductionpolicyinstrumentsalsorevealsimportantareasforfutureinvestigation.Thereduction

of inframarginalrentsforutilitiesresultingfromthemeritordereffectraises issuesrelatingto

futureinvestmentsinnewcapacities,aswellasresearchrelatingtotheappropriatecalculationsof true benefits and costs of renewables in complex electric systems. The true cost of the

deploymentpolicyforratepayersisnotthesimplesumoftheincentives,butrathermuchless,as

renewablesprogressivelyreducethemarketcostsofelectricity through themeritordereffect.

Finally, how CO prices and RE deployment interact in wealth transfers between various

stakeholders,notablyelectricitycustomersandutilities,deservesfurtherscrutiny.


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