An intertemporal theory of renewable energy development Darko Jus Center for Economic Studies Ludwig-Maximilians U

1. An intertemporal theory of renewable energy development Darko Jus Center forEconomicStudies Ludwig-Maximilians University ofMunich July 30th, 2013 32nd USAEE/IAEE North American Conference, Anchorage

2. Motivation I • In the theoretical literature, fossil resources are usually considered within dynamic models (resource extraction literature, e.g., Hotelling (1931), Solow (1974), Stiglitz (1974), Sinn (2008)) • Renewableresourcesareoftenmodeledas a (static) ‘backstop technology’ (e.g., Dasgupta and Heal (1979), Gerlagh (2011) and van der Ploeg and Withagen (2012)) • Result from these models: Society should immediately fully switch to renewable energy once it becomes cheaper than fossil energy • In reality: Simultaneous use of renewable and fossil energy • Two questions: • How can we explain the simultaneous use of both? • Is this optimal for society? 2

3. Motivation II • Why do wemodel fossil energywithindynamicframeworks? • Non-renewableresource • Owners must decidewhentoextracttheresource • Solve an intertemporal problem (Hotelling 1931) • Hotellingrule (forconstantextractioncosts): • Isrenewableenergyreally a staticproblemsinceitdoes not involvetheuseof a non-renewableresource? • Staticproductionproblems: choices at one point in time do not affect the set of possible choices at a later point, e.g. daily production of milk • I considerheretheproblemofsociety, focussing on electricitygeneration 3

4. Why renewable energy is an inter-temporal problem • Locations for the use of renewable energy differ in quality • Favorability of wind energy (average wind speed, left diagram) and photovoltaic (yearly sum of solar irradiation, right diagram) 4

5. Why renewable energy is an inter-temporal problem • Also holds for Europe as a whole 5

6. Why renewable energy is an inter-temporal problem • Improving profitability of renewable energy as a natural process • This is the time component of the argument • The social profitability of renewable energy generally improves over time, due to increasing social cost of fossil resources (relevant as fossil resources are a substitute for renewable energy in the electricity generation) • Increasing social costs of fossil resources because of • their increasing scarcity • rising extraction costs as increasingly unfavorable deposits need to be accessed • the marginal cost of adding carbon dioxide to the atmosphere increasing because of climate change 6

7. Why renewable energy is an inter-temporal problem • To summarize: • the available renewable energy projects differ in quality • the profitability of renewable energy generally improves over time • Thus, if renewable energy is initially not profitable, at some point the high quality technology-location combinations first become profitable • However, low quality combinations need more time, and some may never become profitable for society • Hence, alternative locations/technologies imply different social profits at any instant in time, with each changing as time progresses • An inter-temporally optimizing society must decide when to start using renewable energy, at which location, and with which renewable energy technology 7

8. Society’soptimalityrule • Intertemporal efficiency condition of the society 8

9. Differencetotheproblemofextracting a fossil resource • When extracting a non-renewable (fossil) resource, the intertemporal problem is usually based on the resource being finite • In the case of renewable energy, no absolute finiteness of renewable energy locations is required • It is a relative scarcity that renders it a dynamic problem, namely involving a scarcity of locations of the same good quality • Suppose each quality of location for the use of renewable energy exists only once • Then, once a location with a certain quality has been used, this quality of location is no longer available for future projects • Each locational quality can be interpreted as a finite and non-renewable stock, although the total space for renewable energy is practically infinite. 9

10. Resultsfromthe simple dynamicmodel • Society should go through three phases of electricity generation • First phase is characterized by a high degree of abundance of fossil energy, and consequently its low social cost • Over time, renewable energy becomes more favorable and the social cost of fossil electricity eventually rises sufficiently high to make the best available renewable energy project socially profitable • This project is characterized by having the best location and technology, in terms of yield and costs; society should realize this project once the dynamic efficiency condition is fulfilled • Renewable energy begins being used when this occurs, but does not fully replace fossil energy immediately 10

11. Resultsfrom a simple dynamicmodel • As time progresses, increasingly more renewable energy projects become profitable, thus representing the second phase with a simultaneous use of fossil and renewable energy • The second phase might eventually flow into a third phase, in which only renewable energy should be used • This may become optimal as time goes to infinity, or even before, depending on how well renewable energy alone can satisfy society’s need for electricity • Moreover, it also depends on whether the fossil resources will be used up in finite time. 11

12. Comparingthemodelresultswithreality • If renewable energy can be used in different regions sharing a common electricity market, a renewable energy technology should first be employed in the region offering the best conditions • In Europe, countries including Spain, Greece, Italy and also France are substantially more favorable than Germany on average (measured by the geographic distribution of the solar irradiation) • However, three of the four countries with the highest per capita solar power capacity in Europe – Germany, the Czech Republic and Belgium – are not very favorable 12

13. Comparingthemodelresultswithreality • Installed solar power capacity as of 2010 in W per capita 13

14. Thankyouforyour commentsandquestions! darko.jus@econ.lmu.de Center forEconomicStudies University ofMunich