RETHINKING THE ECONOMICS OF GLOBAL WARMING AND RENEWABLE ENERGY

(Preview of a book in preparation)

James Plummer, President, Climate Economics Foundation

Robert Michaels, California State University at Fullerton

Richard Tol, Sussex University

John Constable, Renewable Energy Foundation

Fritz Varenholt, Hamburg University, German Wildlife Federation

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The purpose of this study This study is done from an economics perspective. Specifically, we are trying to determine what kinds of climate policies pass or don’t pass a benefit-cost test. That is the same as trying to determine what kinds of climate policies pass an economic efficiency test. That means that we are not dealing with issues of economic equity such as inequality of income or wealth distribution, or even effects on job creation. We focus on those climate policies that intend to reduce the levels of carbon dioxide emissions via aggressive promotion of renewable electricity generation We take a detailed look at three areas of the world where policies to promote renewable electricity have been aggressively pursued—California (now 20.9% renewables) , the United Kingdom and Germany (22% renewable in 2012). We conclude that the $ cost per tonne avoided via aggressive renewable electricity policies far exceed any reasonable $ benefit of avoiding a tonne of CO2 emissions

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How do economists measure the benefits of decarbonization?

The custom in the economics profession has been to call the monetary benefit of avoiding a tonne of CO2 emissions the “Social Cost of Carbon,” or SCC The SCC is the measure of the net economic damage caused by a tonne of CO2 Those damages include any damages caused by increases in temperature, or other types of “climate change” resulting from an extra tonne of CO2 emissions. The SCC concept must net out any positive economic effects of increased CO2 emissions, such as increased crop yields and positive impacts on forest growth Climatologists try to measure the “temperature sensitivity” of C02. Their convention is to measure that by the amount of temperature increase that will be caused by a doubling of the atmospheric concentration of CO2 As temperature sensitivity goes up or down, so does the SCC. If the temperature sensitivity were very small, then the positive effects of CO2 could be greater than the negative damages, resulting in a negative SCC. 3

Economists’ attempts to measure the SCC The many research studies on the SCC are described in a survey article by Richard Tol, “The Social Cost of Carbon: Trends, Outliers and Catastophes,” Journal of Economic Perspectives, 2009. Many of the estimates of the SCC have used “IAMs”—Integrated Assessment Models.

The use of IAMs is not confined to any one viewpoint in the field of climate economics. Here are some of the people that have used IAMs to produce estimates of the SCC: William Nordhaus (Yale University) is principal author of the DICE model Richard Tol (Sussex University) is the author of the FUND model Chris Hope is the principal author of the PAGE model and has collaborated

with Nicolas Stern N. Muller and R. Mendelsohn (Yale University) are principal authors of the

APEEP model With the exception of the PAGE model, most of these models produced SCC

estimates in the range of $5 to $20 per tonne.

Then, in 2011, USEPA and USOMB used three of the above models (DICE, FUND, PAGE), put in their own assumptions, and came up with an average SCC estimate of $36 per tonne. That number has been widely used. It is equivalent to about $38 in 2014 price levels. It may be biased high because the discount rate used is lower than what would conform to OMB’s own discount rate guidelines.

For purposes of our study, the level of SCC doesn’t matter much, because (as we will explain herein) the likely costs per tonne of CO2 avoided via renewable electricity are many times higher than any of these SCC estimates.

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4 levels of measurement of the cost of intermittent renewables

Level 1 estimate: The raw capital cost per installed megawatt Level 2 estimate: The cost per kwh, taking into account the lower availability of an intermittent source as compared with a “dispatchable” source. This is sometimes erroneously called “levelized cost comparisons” or “grid parity” comparisons; misnomers because they do not take into account the lower value of intermittent power in its hourly and weekly times. See Joskow, American Economic Review, 2011.

Level 3 estimate: The cost per kwh taking into account both the lower availability of the intermittent source and the lower value of the electricity in its typical hours of greatest supply (Joskow)

Level 4 estimate: The cost per kwh taking into account all the above factors plus the “indirect system costs” or “integration costs” that the presence of a “must take” intermittent source imposes on the rest of grid operation. See Apt and Jaramillo, Variable Renewable Energy and the Electricity Grid, Resources for the Future, 2014. 5

What are the “indirect system costs”?

The cost of installing and operating additional “backup” Combined Cycle Gas Turbines (CCGTs) The cost of installing and operating additional Open Cycle Gas Turbines (OCGTs). Most of these machines would not be present at all in the absence of “must take” intermittent sources. They are more costly and less energy efficient than CCGTs in normal operation, but they are more efficient at quick response “ramp up” and “ramp down” to accommodate the unpredictable intermittent sources. The extra fuel and other operating costs for the CCGTs and the OCGTs. The extra costs that an Independent System Operator (ISO) incurs in purchasing additional “backup” options to either buy or sell (in the case of “over generation”) electricity with neighboring power grids. The extra costs that the grid incurs and its members and customers incur in attempting to manage grid stability in the presence of “must buy” intermittent sources.

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The timeline of California renewables policies 2003 Energy Action Plan requires utilities to have 20% renewables by 2010 2006 AB32 requires reductions of overall CO2 emissions to 1990 levels by 2020 2011 law requires 33% renewables by 2020. That law does not include either nuclear power or large hydro facilities in the definition of renewables. As of 2014, by that definition of renewables, they were 20.9% of power generation In 2014, CA instituted a “cap and trade” system to complement the renewables policies and the state and federal auto emission reduction policies 2014, all the California utilities sponsored a study by E3 (Energy-Environmental Economics) which contained detailed power system modeling. In June 2014, Nancy Ryan, VP of E3 and ex-CPUC Commisioner, gave an address to the Western Conference of Public Service Commissioners that raised serious questions about the cost consequences of going beyond 33%. January 2015. Governor Brown announces that it is his goal to achieve 50% renewables by 2030. He said that it is “the kind of challenge that Californians enjoy.”

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From 2008 on it was clear that costs would be very high 2008. California Air Resources Board (CARB) published a “scoping study” which estimated that moving from 20% renewables to 33% renewables by 2020 would involve net cost increases of $133 per tonne of CO2 avoided ($149.40 in 2014 prices). Also in 2008, CARB commissioned a study supervised by Stanford University professors James Sweeney and John Weyant. Their estimates of the cost per tonne of CO2 avoided (in 2014 price levels) are as follows:

• Wind $90.15 per tonne of CO2 avoided• Biogas $36.50 per tonne of CO2 avoided• Biomass $203.90 per tonne of CO2 avoided• Small hydro $103.03 per tonne of CO2 avoided• Geothermal $75.12 per tonne of CO2 avoided

Sweeney and Weyant estimated that it would take 175 million tonnes of CO2 abatement to meet AB 32 goals, and that costs would rise to $160 per tonne avoided just to achieve a partial level of abatement of 16 million tonnes. Importantly, the above cost estimates were only “Level 2” estimates. They didn’t account for either time value of load or the “indirect system costs.”

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Potential methods of reducing “indirect system costs”

Grid storage (e.g. pumped water storage) Either through regulation or incentives, encouraging customers to do “demand shifting” from time periods of lesser intermittent supply to periods of greater intermittent supply Regulation or incentives for customer level “smart meters” or energy storage (e.g. batteries) Regulation or incentives for intermittent supplier “smart meters” or energy storage (e.g. batteries) Regulation or incentives for intermittent supplier dispatchability Modification of the “must take” features of intermittent supply in favor of “renewables curtailment” NOTE: Some studies incorporate the benefits of these kinds of strategies without also incorporating the costs of these strategies. 9

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Scan0001.jpg

Explaining the California “duck curve” The vertical axis is “net load.” What that means is the load left over after the “must take” renewables have been given their part of the likely electricity demand The horizontal axis numbers are the 24 hours in a typical March day As indicated by E3’s notes at the bottom, this graphic shows only the predicted situation at a 33% renewables level, the starting point toward Governor Brown’s goal of 50% renewable electricity by 2030. The most important part of the “duck curve” is where the “belly” of the duck is at its lowest point. That is where the renewable electricity is at its maximum in terms of “crowding out” the non-renewable electricity. If the 50% renewables goal is really pursued, one can contemplate a situation where there is a complete “crowd out” of non-renewables, and the Independent System Operatior (ISO) is required to export the high cost “overgeneration,” and all California electricity ratepayers are forced to pay for those very expensive exports.

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Estimated costs of going beyond 33% in California All 5 California utilities (3 investor-owned, 2 municipal) hired E3, to study Investigating a Higher Renewables Portfolio Standard in California, January 2014. They used the REFLEX model and studied many scenarios for going from a 2020 renewable standard in 2020 to higher standards by 2030 To go to a 40% renewable standard by 2030, the estimated cost was $340 per tonne of CO2 avoided To reach a 50% renewable standard by 2030, it would be necessary to use a diverse portfolio of large utility-scale resources, including some solar thermal (with new energy storage technology) and relying on some out-of-state wind; and the estimated cost would be $403 per tonne of CO2 avoided. They also ran a scenario for using more large scale solar along with paying renewables producers to engage in renewables curtailments, and the estimated cost was $637 per tonne of CO2 avoided. These renewables scenarios and the levels of estimated cost are the highest in the world, even higher than Germany.

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Conclusions about California Governor Brown was just re-elected for another four years. The new President of the California PUC is Brown’s former assistant for climate policy The legislature is behind the current 33% renewable electricity standard, and may go along with Brown’s goal of 50% renewables until Brown leaves office in 2019. In the next few years, any compromise in California climate policy would have to be some humble effort such as suggesting that California rely much more on its new “cap and trade” system, that hits all carbon industries, rather than further increase in renewables goals whose impacts hit electricity producers and their customers. California still has 11% of U.S. manufacturing activity. Most of that is light manufacturing that is not as electricity intensive as heavy industry. Unlike Illinois, Ohio, Pennsylvania, New York, Michigan and Indiana, California is still prosperous enough to endure the economic costs of high renewables goals. Perhaps the most useful role that California climate policy can play for the U.S. is to be an example of how costly the wrong policies can be. Regulators outside of California are often shocked when they learn how high the costs of California renewables are likely to go.

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Overview of EU environmental policy

By 2020, a 20% reduction of CO2 levels from 1990 levels; and a 20% renewables penetration of electricity supply. Called the “20-20-20 plan”The EU cap and trade system incorporated so many exemptions and special deals that the market price plunged. There is now consideration of fixing a minimum price in the cap and trade market. If that were done, it would in many ways be tantamount to converting it into a carbon tax. There are intra-EU tensions about renewables goals for 2030. Poland and other Eastern European countries do not wish to be committed to giving up coal. And they wish to keep their options open with regard to any future fossil and nuclear plants .There is growing support for the position that future EU policy should rely more on its cap and trade system and less on arbitrary renewables goals. For purposes of the negotiations with non-EU countries, leading to the December 2015 Paris conference, the EU wishes to posture a more united front on carbon policy than really exists within the EU.

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U.K. electricity policy Britain has important reliance on nuclear power and intends to build more Many offshore wind projects have failed to attract sufficient private financing Sunshine resources are limited enough that solar is not a big player British renewables policies have several prominent elements:

• A certificate based quota system (the Renewables Obligation, or RO), now aimed at larger installations (more than 5MW), due to close to new entrants in March 2017. 18 GW have so far been built under this program.

• A feed-in tariff , aimed at smaller installations. About 2.3 GW have been built

• A new feed-in tariff system will replace the old one after 2017• A Climate Change Levy on sales of fossil and also (bizarrely)

nuclear electricity to industrial customers.• The EU Emissions Trading System, which raises the cost of fossil

electricity and is a source of revenue to fund the above subsidies

• Production subsidies to renewable electricity are about 3 billion pounds per year

• There are not significant capital subsidies for the building of renewables plants

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Gordon Hughes studies of wind energy (Hughes is a professor of statistics and economics at the University of Edinburgh)

Why is Wind Power So Expensive? Global Warming Policy Foundation, 2013• For every GW of wind power, it is necessary to have roughly

36% of that in backup dispatchable capacity• If one adds up all the indirect system costs, the cost of

avoiding a tonne of CO2 is between $300 and $421.• A carbon tax would be a far less costly decarbonization policy.

The Performance of Wind Farms in the United Kingdom and Denmark, Renewable Energy Foundation, 2013

• There is a significant decline in average load factor of onshore wind farms (adjusted for wind availability) as they get older.

• Even more dramatic decline was observed for offshore wind farms in Denmark.

• For onshore UK farms, the normalized load factor declines from 24% at age 1 to 15% at age 10, and 11% at age 15.

• For Danish onshore farms, the decline is from 22% at age 1 to 18% at age 15

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Population density is part of the resistance to renewables in the UK. There are over 60 million people in a land area roughly the size of Minnesota, which means that land- hungry technologies like wind and solar are not popular There is more transparency in the U.K. political system, with the result that the failures and high costs of renewables plants are becoming more visible. Lord Lawson and the Global Warming Policy Foundation have been vocal about the high costs.There has not been the same aversion to nuclear power in the U.K. that there is in Germany, or even the U.S. Prime Minister Cameron promised in his last political campaign to have the “greenest government in British history.” He just fired his Secretary of Environment after he was critical of the “green blob.” Right now, Cameron is supportive of the overall EU position, leading up to the Paris conference. However, if he is re-elected in the spring of 2015, and then faces an up or down vote on British membership in the EU a year later, the “green” posture of the Cameron government may become a movable chess piece in British politics.

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Observations about the U.K.

Greater interconnection with the rest of Europe Its larger private utilities are “merchant” suppliers. They sell into an open market, with no guarantee of demand or price. They have lost half of their stock market equity value in the last five years. The mix of renewable supply has a much bigger representation of biomass and biogas technologies, and some of them are more economic than wind and solar The 2011 referendum that mandated the closure of some nuclear plants and the phase-out of others was a much more extreme step than other EU countries The recent ban on fracking, until at least 2021, and the greater dependence on natural gas imports from Russia forces Germany into a difficult “energy corner” Greater policy reliance on feed-in tariffs The whole mix of German policies is sometimes referred to as the “energiewende,” which translates roughly as “energy turnaround.”1

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Germany is different for many reasons

The January 25, 2014 issue of the Economist contained an article that quoted unnamed sources that the cost per tonne of CO2 avoided in Germany was in the range of 150 to 200 Euros, which would be about $205 to $274. That is roughly consistent with our other case studies (California and the U.K.) A recent study published in the Energy Journal by German author, Lion Hirth, explored the effects of indirect grid costs on the northwestern EU electricity grid:• The indirect backup costs that renewable plants impose on the

grid are substantial and greatly reduce the net value of their electricity output

• Without new cost reductions of 30% for wind plants and 60% for solar, his estimated “optimal” renewables penetration would be small (see figure).

• The presence of the EU carbon tax, even if its level is increased, does not substantially alter the degree of penetration of renewables

• The Hirth study does not add back the costs of the many forms of subsidies paid to renewables. So, its “optimum” is not an overall social welfare optimum.

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The costs of the “energiewende”

From Lion Hirth study: future % penetration depends on further cost reduction

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ESTIMATING GERMAN COSTS PER TONNE AVOIDED FROM THE “FEED-IN TARIFFS PAID (2010)

FIT tariffs paid 3,476 million Euros

-36% backup capacity cost-1,251 Ref. Gordon Hughes, “Why is Wind so Expensive?” Global Warming Policy Foundation 2012

-Eur ETS carbon payments - 402

Subtotal 4,325

Less 10% fossil power displacement-141 Consistent with German growth in kwh consumption

Mtonnes CO2 reduction 27

Cost per tonne abated by renewables 155 Euros (in 2010 prices)

In dollars, using 1.33 exchange (2010) $205 (in 2010 prices)

The data on FIT tariffs, ETS payments, and CO2 reduction come from Claudio Marcantonini and A. Denny Ellerman, “Cost of Abating CO2 Emissions by Renewable Energy Incentives in Germany. European University working papers, 2013. Those authors have their own assumptions for required backup capacity and displaced fossil power, and their results yield lower costs per tonne avoided. Our results are compatible with research results on California and the U.K.

Suppose the most favorable assumptions for renewable energy:• That the SCC is as high as the $36/tonne from the OMB/EPA

2011 study, which has some upward biases (such as a discount rate lower than OMB guidelines).

• That renewables are viewed as a “second best solution” behind carbon taxes or cap and trade systems, if those “first best” solutions are not available.

Even under those assumptions, the very high costs of decarbonization via renewable energy (above $200 per tonne avoided or higher), force the economic conclusion that investment in renewable energy is economic self-flagulation. This conclusion says nothing about whether other decarbonization options may pass benefit-cost tests. Those other options are outside the scope of this study.• Increased energy efficiency• Fuel switching among fossil fuels• Nuclear power• Mitigating Black Carbon. It is not a green house gas, but is a radiative forcing

pollutant that also has very widespread and deadly health effects in developing countries.

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Conclusions from case studies of CA, the UK and Germany

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Explanation of the “divergence graphic” The left side of the graphic shows how the SCC decreases as climatologists decrease their estimates of temperature to CO2 “sensitivity” Why are “sensitivity” estimates going down? Because, since 1998, temperatures have been relatively flat while the level of ambient CO2 has increased substantially The right side of the graphic shows what has happened to the $ cost/tonne of CO2 avoided in California, the U.K. and Germany. It is a classic example of economic “diminishing returns.” As the % penetration of renewables has gone up, they cause more and more disruption (indirect costs) to the power systems. The horizontal distance between the SCC and the $/tonne avoided via renewables measures the dollar amount of economic waste per tonne of CO2 avoided Some governments are doing all they can to hide the very high costs per tonne of CO2 reduction via renewables, but those costs will gradually become public knowledge, and those that have crusaded so hard for renewables will come under fire.

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Explanation of the “future potential reconvergence” graphic

Note that the horizontal axis of Figure 2 is not the same as in Figure 1. Figure 2 focuses just on those policy options whose cost is within or close to the range of SCCs The idea of Figure 2 is that, if we eliminate or greatly reduce the dollar investments in renewable electricity, we will have much more money to invest in those options that have lower costs per tonne of CO2 avoided. The green horizontal bars show some of those options. Don’t regard the size or placement of those green bar options too seriously. Those costs are outside the scope of our study. Among the options that deserve greater attention are:

• Planned adaptations, insurance reform and Black Carbon mitigation

• Fossil fuel switching and nuclear power• Promotion of increased energy efficiency 2

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Even within the EU, there is a recognition that it is more economic and politically acceptable to state decarbonization goals in terms of overall CO2 emissions than in terms of goals for use of renewable electricity. So, some small economic reality is slowly being recognized. Reading between the lines of the Lima communiques, there are certain broad emerging principles:• Outside the EU, there is little enthusiasm for binding

commitments by governments, or enforcement mechanisms, or penalties for non-compliance

• Instead, the new roadmap is for each government to submit periodic “aspirational” plans for future action, without binding targets or enforcement

• In Copenhagen, the U.S. and the EU made vague commitments for a $100 billion per year world climate fund to assist less developing countries in their decarbonization efforts. However, since the developing countries are very reluctant to make firm decarbonization commitments, the developed countries are understandably reluctant to make upfront commitments to the fund.

• We can expect renewable electricity to shrink in importance in international discussions.

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But what about the Lima and Paris conferences?

Sometimes those who are critical of some aspects of climate policy are branded as “deniers.” That word, reminiscent of the Holocaust, is an unfortunate rhetorical ploy. In climate analysis, a “denier” might be somebody that believes that carbon dioxide does not act at all to increase temperatures. In other words, a “temperature sensitivity” of zero. None of our authors take that position. Or there may be people that believe that the SCC is zero or negative. In other words the positive non-temperature dollar effects of CO2 are greater than the negative temperature dollar effects. None of our authors take that position. None of our authors take a position against investing in greater energy efficiency. None of our authors take a position against further R&D to find better and cheaper renewable energy technologies. None of our authors take the position that most or all of decarbonization should be pursued only or mainly by fuel switching from coal to gas turbines. Our position is just that most of the current renewable electricity plants are way too expensive relative to the decarbonization they achieve, especially when the share of these renewables is pushed to where it causes large indirect system costs.

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Reduction of renewables is NOT a “radical” policy position