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Conclusions: Whither Renewable


Generation?
Boaz Moselle, Jorge Padilla, and Richard Schmalensee

T he authors of this book have assessed the cur-


rent use and future potential of renewable
energy technologies for electricity generation.
this book, notably Germany (by Hannes Weigt
and Florian Leuthold in Chapter 14) and Spain
(by Luis Agosti and Jorge Padilla in Chapter 15), is
These are technologies that, as Godfrey Boyle consistent with this trend. The goal of the Euro-
puts it in Chapter 2, “enable constantly replen- pean Union is to achieve significant reduction in
ished renewable energy flows to be harnessed to carbon intensity by 2020, with renewable genera-
produce power in forms useful to humanity on a tion playing an important role. As explained by
sustainable basis.” In particular, the authors have Christopher Jones in Chapter 12, about 60% of
addressed the following two questions: What is the world’s wind capacity was installed in Europe
the case for promoting renewable energy? and at the end of 2007, and the EU is committed to a
What are the implications for power markets and 20% share for renewable energy in its total energy
systems of the widespread adoption of renewable mix by 2020, compared with about 8.5% in 2005.
generation? In this concluding chapter, we sum The growth in renewable generation is not—
up the answers provided in preceding chapters and, for the foreseeable future, is not likely to
and discuss some possible policy implications. be—driven by market forces, but is largely the
result of government intervention. As described
by Richard Schmalensee in Chapter 11, there are
four basic kinds of support schemes targeted spe-
The Case for Promoting cifically at renewable generation: feed-in tariffs,
Renewable Power output subsidies, investment subsidies, and output
quotas. Feed-in tariffs guarantee a predetermined,
Kenneth Gillingham and James Sweeney argue in above-market price for power over a period of
Chapter 5 that the transition from carbon-based years. They have been used widely within the EU,
technologies to renewable energy is inevitable in notably in Germany and Spain, and have proved
the very long run. As noted by Erin Mansur in to be a powerful mechanism to promote invest-
Chapter 3, we are likely to see a significant ment, minimize costs to consumers (for a given
increase in the role of renewables in meeting elec- level of output and mix of renewable technolo-
tricity demand in most developed countries in gies), and maximize production. Output subsidies
coming decades. Recent experience surveyed in paid on top of market price, though not as widely

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328 Boaz Moselle, Jorge Padilla, and Richard Schmalensee

employed, can be shown to be as effective as, and be an efficient response to those market-based
less distortionary than, feed-in tariffs. Investment interventions, but there is no guarantee that this is
subsidies are less efficient than feed-in tariffs or the case.
output subsidies yet are widely used all over the Market-based solutions would also affect all
world to promote the deployment of renewable CO2-emitting sectors in a similar way and would
power plants. Finally, output quotas typically not place the entire decarbonization burden on
require agents operating in power markets to gen- the electricity sector. Most of the jurisdictions
erate or procure a minimum fraction of energy analyzed in this book have committed to ambi-
from renewable sources. tious renewable generation targets even though
Renewable generation support schemes, they perhaps could have more easily and eco-
whether feed-in tariffs, output subsidies and quo- nomically achieved the decarbonization of their
tas, or investment subsidies, are commonly justi- economies through a properly designed carbon
fied as a means of curbing CO2 emissions and tax.
therefore as part of the overall response to global Governments almost universally have adopted
warming. Indeed, U.S. and especially EU energy specific policies to promote renewable generation
policies place renewables at the forefront of the rather than relying on market-based solutions,
fight against climate change (see Chapters 11 and however. This is so even though alternative tech-
12). Climate change is expected to adversely nologies may offer the same environmental ben-
affect many economic sectors and natural systems efits at lower cost. Of course, policy choices are
and increase human mortality and morbidity. The the outcome of political processes that are often
complex, and it would be naive to expect that
need to address this threat is beyond dispute. With
those outcomes generally coincide with the rec-
respect to renewable generation, the relevant and
ommendations of economics textbooks.
difficult question from an economic perspective is
Existing renewables policies and future policy
whether current and planned support schemes
proposals have been defended using both eco-
represent an efficient response to the challenges nomic and noneconomic arguments. The various
posed by climate change. chapter authors have a range of views regarding
From an economic viewpoint, the starting those justifications and the necessity or desirability
point for designing an efficient climate policy is a of specific support mechanisms for renewable
market-based mechanism to internalize the exter- generation. The view of the book editors is
nalities associated with emissions of greenhouse derived from three observations.
gases, such as a carbon tax or emissions trading First, it is plausible that the true size of the
(cap-and-trade) system. A properly designed car- negative externality associated with CO2
bon tax or cap-and-trade system can in theory emissions—the social cost of carbon—is higher
reduce emissions at least cost. than the current price of CO2 emissions (e.g., in
Those market-based instruments are by defi- the EU Emission Trading System, or ETS), and
nition technology-neutral.1 That is, they affect that, as Boyle argues in Chapter 2, the difference
different technologies in terms of their green- exceeds the incremental cost of renewable genera-
house emissions only, and therefore do not favor tion relative to conventional generation. This is a
one technology (e.g., renewable technologies) necessary condition for supporting renewable
over other low-carbon forms of generation (e.g., generation, though by no means sufficient (for
nuclear power or energy efficiency) on a priori example, one might be able simply to raise the
grounds. Under those mechanisms, technologies price of CO2 emissions).
compete on their merits and electricity is gener- Second, it is also plausible that other forms of
ated efficiently, using those technologies that are emissions reduction—such as nuclear, carbon
more economical on the basis of both their actual capture and storage (CCS), or energy efficiency
costs of production and the market cost of their policies2—are either more costly (at the relevant
emissions. Investment in renewable energy may margin) than renewables or constrained by

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Conclusions: Whither Renewable Generation? 329

noneconomic factors, such as the public accept- For example, investing in renewables to create
ability issues around nuclear power. jobs seems like poor economic policy. This is
The third observation is an empirical one, for because electricity generation is generally highly
which Part IV of this book provides ample sup- capital-intensive, the time frame for investment is
port: political processes do not easily deliver out- too long to allow for a temporary boost in
comes that resemble the first-best outcome of employment in the short run (during a recession),
technology-neutral, market-based mechanisms to and in the long run the level of employment
reduce greenhouse gas emissions. Why this is so depends on structural macroeconomic factors and
raises many interesting questions of political is unlikely to be affected by policies of this nature.
economy, but it is clear that governments face As an illustration, in Spain, the rapid growth of
great difficulty in credibly committing to a long- renewable generation before and after the Great
term carbon price that is close to the social cost of Recession has had, at most, a de minimis impact on
carbon or high enough to support significant its labor markets and has not offset in any mean-
investments in low-carbon technologies. Even the ingful way the growth of unemployment during
EU ETS, which is an impressive and unique the current crisis.
achievement, has to date given a level of carbon With regard to industrial policy, almost every
prices that induces switching from coal to gas- major government in the developed world seems
fired generation but is not high enough to support to believe that it will become a world leader in
such investments. new energy technologies, and that such leadership
Drawing these three observations together, will generate positive externalities on other com-
the editors therefore recognize that the need to panies within the energy sector as well as on other
respond to the challenges posed by global warm- industrial and services sectors. As yet, however,
ing, combined with real-world constraints on evidence is slim in support of that claim for any
policymaking processes, may provide a valid justi- nation. In particular, little evidence exists that
fication for specific support mechanisms for extensive deployment of renewables creates
renewables, especially for less costly forms. How- learning-by-doing (or knowledge) spillovers that
ever, no plausible combination of assumptions cannot be captured within firms (see, e.g., Chap-
justifies a “pay whatever it takes” approach. The ter 5). Moreover, as in other industries, it is likely
shadow value of investing in a given technology is that these positive externalities are much stronger
finite, limited, if by nothing else, at least by the at the R&D level. Subsidies for wide-scale
opportunity cost of investing more in lower-cost deployment of expensive renewable technologies
technologies. In particular, it is hard to justify are therefore unlikely to be justified on the basis
extensive investment in deploying extremely either that the cost is overestimated (because they
expensive forms of renewables, such as solar will bring down future costs) or that they will
photovoltaic in Spain, Germany, and parts of the stimulate an infant industry.
United States and offshore wind in the United An alternative justification for existing and
Kingdom. proposed support schemes for renewables con-
This logic for supporting some specific meas- cerns their impact on security of supply. In most
ures to promote renewable generation does not markets, individual participants deal effectively
depend on the kinds of market failure arguments and efficiently with uncertainty regarding demand
that are often cited in favor of such measures. and supply through price incentives, bilateral
Although it is possible in theory to identify many insurance contracts, and related devices. The con-
such market failures (see Chapter 5), in most cases clusion that supply insecurity justifies government
they appear unlikely to be material enough to action here must rest on the identification of one
justify the kind of large-scale interventions they or more specific externalities that can be cor-
are used to support. In general, the claimed “non- rected by nonmarket intervention.
climate-change externality” arguments for From a U.S. perspective, Gillingham and
renewables support appear rather weak. Sweeney point out in Chapter 5 that an important

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330 Boaz Moselle, Jorge Padilla, and Richard Schmalensee

externality may relate to the costs associated with second-best world.The editors would add that the
national security, but this concerns oil and has constraints that lead to second-best policy out-
little relevance to renewables other than biofuels. comes can change, and as the true cost of not
Looking at the EU, where security of supply is using technology-neutral, market-based mecha-
high on the political agenda and is routinely cited nisms becomes clearer over time, the opportunity
as a justification for renewables subsidies, Boaz may arise to move closer to first-best.
Moselle in Chapter 4 identifies significant exter-
nalities in the context of the key relevant security-
of-supply issue: dependence on Russia and Alge-
ria for natural gas. Although EU policymakers Renewable Generation and
often refer to generalized import dependence, few
security issues appear to exist around the use of Power Systems in Practice
imported coal, given that many diverse and his- Current policies toward greenhouse gas abate-
torically friendly countries have enormous coal ment in the electricity generation sector in the
reserves. Moselle discusses the extent to which EU, in many EU member states, in some U.S.
renewable generation in the EU, as opposed to states and regions, and under serious considera-
other energy sources, may replace Russian and tion at the federal level in the United States com-
Algerian gas. He concludes that dependence on bine a technology-neutral market-based mecha-
imported gas gives rise to real security-of-supply nism (e.g., the EU ETS and similar cap-and-trade
issues in the EU, especially in eastern Europe, and schemes in California and the U.S. Northeast)
that market outcomes may not provide an effi- with technology-specific interventions for
cient response to those risks because of “moral renewables, nuclear, and CCS. This mix of poli-
hazard” types of concerns that give rise to exter- cies has profound implications for wholesale
nalities. He argues, however, that these externali- power markets.
ties do not justify the specific promotion of Existing and planned policies may raise ques-
renewables, because it is not clear how much tions about the current model of liberalized
Russian or Algerian gas would be displaced by power markets. A large part of the benefits from
renewable generation, and because other forms of liberalization have come about through improved
low-carbon generation could have similar or investment decisions. In fact, dynamic efficiency
greater impact on security of supply. considerations underlay the move from regulated
In summary, then, although the environmen- to liberalized generation. However, current poli-
tal benefits of renewable generation are clear, the cies mean that market forces will have limited
editors are skeptical of economic and geostrategic impact on future investment decisions, as those
justifications for policies specifically aimed at pro- will be driven, to a large extent, by the environ-
moting renewables. They do, however, recognize mental and security-of-supply concerns of gov-
a political rationale for existing renewable support ernments. In the United Kingdom, for example,
schemes: subsidizing renewables may be politi- choices for new investment are affected by a very
cally more acceptable than taxing firms and con- large number of different environmental programs
sumers for polluting. As in many other instances, (as discussed by Michael Pollitt in Chapter 13),
first-best economic policy choices may not be whose cumulative effect is likely to be determina-
politically feasible. In such cases, we need to look tive.3
for second-best policy responses. Existing and At a more concrete level, existing and planned
planned support schemes can be rationalized only policies are bound to have a significant impact on
as second-best responses to the challenges posed the economics of conventional generation plants.
by climate change. Yet the authors widely agree As shown by James Bushnell in Chapter 9, the
that current and anticipated policies need consid- exploitation of wind resources will have a signifi-
erable fine-tuning before they can be properly cant impact on market prices. It will also affect the
regarded as the right policy instruments even in a net load shape, the difference between load and

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Conclusions: Whither Renewable Generation? 331

supply from intermittent sources. This is likely to In many (probably most, and perhaps all)
exhibit relatively higher spreads between peak and jurisdictions, however, governments lack the abil-
average demand for thermal production. As a con- ity to credibly commit not to intervene in energy
sequence, the equilibrium investment mix of markets when prices are high. Indeed many liber-
nonwind resources will shift toward less base load alized energy markets, including several in the
and more peaking capacity. The experiences in United States and in a number of EU member
Spain and Germany show that the widespread states, already have explicit price caps in place.
deployment of intermittent generation (wind) These caps in part reflect political sensitivities but
leads to increased price volatility, with very low are also a reaction to well-founded concerns that
(on occasions even zero or negative) prices when wholesale power markets are more susceptible
wind patterns make for high levels of output at than many others to market abuse.
In those circumstances, the second approach
times of low load (see Chapters 14 and 15).
to dealing with intermittency, price spikes, and
This combination of spot price volatility and
the need for backup is to provide a subsidy to
the need for large numbers of peaking plants with
investment in generation (and on efficiency
very low utilization is likely to significantly ex-
grounds, perhaps also to flexible load) in the form
acerbate the “missing money” problem that can
of “capacity payments”. A number of design
already arise in wholesale power markets, where a issues around the capacity markets determine
combination of the lack of real-time pricing for these payments, which have been widely explored
many consumers, transmission system operator (in theory and in practice) in the United States,
(TSO) behavior, explicit regulatory interventions much less so in the EU, where few jurisdictions
(price caps), and implicit regulation means that currently have any form of capacity payment in
markets do not provide the right signals to get place. Getting those payments at the right level
sufficient peaking capacity. appears to be key to ensuring that the move
Essentially three approaches can be taken to toward renewable energy does not compromise
this problem. The first is to observe that markets the reliability of electricity systems.
are quite capable of dealing with problems of this The third approach would be to conclude that
sort via the price mechanism, including for goods measures of this kind are ineffective, and that
that are not storable. For example, demand for competitive markets with a significant proportion
accommodation on or near a ski slope is highly of intermittent (and low-marginal-cost) renew-
weather related. High prices for that accommoda- able energy are not able to deliver the necessary
tion at times of peak demand (e.g., around Christ- rents to induce adequate investment in peaking
mas and during school holidays in winter) ensure capacity. From the discussion above, it should be
a high level of investment and the absence of lines clear that the editors do not share that conclusion.
outside ski chalets. Similarly, if there are no price The prospect of re-regulation of electricity aimed
caps and investors do not expect future govern- at ensuring generation adequacy, while at the
ment intervention, then they should be expected same time giving governments more direct con-
to build sufficient capacity to cope with demand, trol over technology choices, is nonetheless a real
investing in backup plants that would tend to run prospect,4 though in the editors’ view, it is prob-
infrequently, on the basis that the spot prices lematic and potentially worrisome.
when they did run would be high enough that That the shift to renewable energy may lead to
they could recover their fixed costs over time. At new market distortions and regulatory challenges
the same time, demand should become more does not justify giving up on markets. No doubt
responsive to short-term price signals as the regulators will have to adapt their tools to accom-
prevalence of price spikes makes it worthwhile to modate the environmental and security-of-supply
devote time and make necessary capital invest- concerns of governments, but they should do so
ments so as to be able more easily to reduce or without throwing off the discipline that a com-
shift demand at times of peak load. petitive market imposes not only on firms and

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332 Boaz Moselle, Jorge Padilla, and Richard Schmalensee

consumers, but also on policymakers. Bad poli- the effective deployment of renewables. If
cies, like poorly managed firms, tend to fail the renewables are to play a more important role,
market test quickly. policymakers must address these difficult prob-
Power markets that integrate large amounts of lems.
wind face several other policy issues. First, apart The location of large-scale renewable genera-
from the investment issue discussed above, tion will depend on a number of factors, includ-
increasing penetration of intermittent generation ing the location of appropriate resources, such as
gives rise to operational concerns because of the water, wind, sunshine, and sources of biomass; the
difficulty of predicting output ahead of time. relevant transportation costs for some of these
However, significant improvements have taken resources; issues around siting; and the costs of
place in forecasting wind generation output over developing the necessary distribution and trans-
time (see Chapter 2). Moselle argues in Chapter 4 mission systems. Efficient locational pricing, as
that as a result, the operational issue can in princi- discussed by William Hogan in Chapter 7, will
ple be made relatively straightforward and, subject help provide incentives for efficient decisions
to solving the problem of providing investment concerning the location of generation and trans-
incentives to ensure sufficient availability of peak- mission facilities, such as by ensuring higher
ing plants, the problem becomes simply a further prices in areas where transmission bottlenecks
cost element, albeit potentially a very material exist. However, it would be daunting even in
one, rather than a security-of-supply concern. theory to attempt to fully decentralize transmis-
Second, a subsidy per megawatt-hour of sion investment decisions via locational pricing, if
renewable generation distorts price signals and only because transmission investments are lumpy
can lead to inefficiencies. For example, the mas- and commonly eliminate the nodal price differ-
sive introduction of wind generation can lead to ences that justified the investments. In practice,
negative prices, reflecting an inefficient outcome therefore, more extensive work is needed on
where wind generators, which could stop run- developing and implementing appropriate meth-
ning at zero social cost but at the expense of losing odologies for transmission planning.
their feed-in tariff payments, pay others (e.g., Moreover, one effect of the need to locate
nuclear generators) to incur real costs to produce generation close to renewable resources, and far
less electricity (Schmalensee reports on negative from NIMBY-minded citizens, is likely to be a
spot prices in west Texas in Chapter 11). Other much greater mismatch between the locations of
inefficiencies may arise when the level of payment generation and load. New arrangements for trans-
is unrelated to the market price (e.g., the absence mission planning thus need to include arrange-
of an incentive to produce at peak hours or at ments to coordinate planning among multiple
peak times of the year). transmission owners. U.S. experience suggests
A third problem concerns the potential need that electricity systems operated by regional trans-
for new investment in transmission, as new pat- mission operators (RTOs) and independent sys-
terns of generation, reflecting different patterns of tem operators (ISOs) are more effective in inte-
location for new installed capacity, lead to chan- grating wind generation. Those systems leverage
ging flow patterns in transmission systems. Chris- their operational and transmission integration to
tian von Hirschhausen explains in Chapter 10 that facilitate deployment of renewable generation (see
the complexities of harnessing renewable energy Chapter 11). A new approach to infrastructure
to generate electricity are relatively simple in planning is foreseen in Europe. Under the third
comparison to transporting that electricity over internal market package, two new European
long distances to large demand centers. He also organizations, the Agency for the Cooperation of
describes the many market and institutional prob- Energy Regulators (ACER) and the European
lems, including regulatory and technological risks Network of Transmission System Operators for
and rent-sharing issues, which make it difficult to Electricity (ENTSO-E), will have to cooperate
overcome the transmission bottlenecks that limit and coordinate to put in place new infrastructure

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Conclusions: Whither Renewable Generation? 333

and grid access rules to ensure that the growth in on greenhouse gas emissions (or at least on CO2
renewable energy is sustainable and the available emissions), either directly via a tax or indirectly via
capacity is used efficiently (see Chapter 12). cap-and-trade. Under this definition, therefore, an
Finally, large-scale deployment of renewable instrument like tradable renewables certificates (or,
generation raises questions as to the nature of hypothetically, a tax on all nonrenewable genera-
regulation. Richard Green maintains in Chapter 8 tion) does not qualify as a market-based instru-
that energy regulation will need to adjust, for ment.
2. In industrialized countries, as explained by José
example by recognizing the need for new regu-
Goldemberg in Chapter 6), energy efficiency will
lated investments (e.g., in “smart grids” to com-
be an attractive, though limited, alternative to
plement distributed generation), but that there
renewable generation. In developing countries,
should be no step change in the fundamental energy efficiency programs are less likely to substi-
scope of energy regulation. He also suggests that tute for the promotion of carbon-free or low-
regulators should continue to focus on the pro- carbon technologies. In those latter countries,
motion of competition, and indeed that competi- energy demand is bound to grow and should be
tive models will have extra advantages in the con- met by deploying clean and efficient technologies
text of a transition to renewables because of their early in the process of development.
superior performance in stimulating innovation. 3. These programs include the EU ETS; the national
UK Emissions Trading Scheme; the Renewables
Obligation Certificates, which fund renewables
Conclusion deployment differentially by technology; invest-
ment subsidies for renewables, known as capital
Except possibly for nuclear terrorism, global grants; feed-in tariffs for new microrenewables;
warming is widely regarded as the most important support for cogeneration; new support measures
challenge to our globalized society. Policymakers currently being developed for nuclear and CCS;
are considering ways of confronting this challenge obligations on suppliers to install energy efficiency
and are also putting a substantial amount of measures to meet the Carbon Emissions Reduc-
money on the table. A significant share of that tion Target (CERT); as well as a number of other
money is being allocated to renewable generation measures.
support schemes. For a variety of reasons, a lot of 4. Recent proposals from the British energy regula-
that money will be spent inefficiently. Because the tor (formerly a leading advocate of liberalized
sums involved are very large, it is imperative that energy markets) include, at one extreme, the crea-
we discuss how to move toward a decarbonized tion of a single central buyer responsible for pro-
electricity system at the least possible cost. This curing wholesale power and contracting to pro-
requires moving away from generic and arcane cure new generation investment, which it would
debates about policy goals and toward analyzing secure against long-term contracts (see Ofgem
the design and implementation of renewable gen- 2010).
eration support schemes, as well as the relative
merits of renewable generation policies in com-
parison with other decarbonization policies. It is
hoped that this book represents a nontrivial step
forward in that direction.
Reference
Notes Ofgem. 2010. Project Discovery: Options for Delivering
1. A “market-based instrument” is defined in this Secure and Sustainable Energy Supplies, February 3.
context to refer to an instrument that puts a price London: Ofgem.

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