Support of renewable energy: Prices versus quantities

1. Support of renewable energy: Prices versus quantities GIN 2006, Cardiff Jeroen De Paepe University of Ghent

2. Content • Need for support of renewable energy • Comparison of the different support mechanisms for renewable energy • Model • Flemish support system • Conlusions

3. Need for support of RE • Fossil fuel electricity production leads to environmental damage: external costs (static) • cfr. GHG, NOx, SO2 • Technologies are still immature (dynamic) • Also: -Reliability and diversity of energy supplies -Job creation at local level • Remark: importance of energy efficiency!

4. Support mechanisms for RE • Feed-in tariffs (price-based approach): obligation of electric utilities to purchase RES-E at a predetermined price • Tradable green certificates (quantity-based approach): -Suppliers obliged to supply a certain quota -Penalty for every missing certificate

5. Feed-in tariffs • Very effective (cfr. Spain, Germany, …) • Fixed prices provide stable investment climate • Risk reduction as a way of increasing the efficiency of a support system • Long term stability leads to innovation • Wind fall profits for RES-E producers can be avoided by stepped feed-in tarrifs

6. TGC • Quotas allacoted in an efficient way (cost efficiency) • Interesting in international context with more trading possibilities • BUT: -Volatility of certificate prices have negative effect on investments => less effective than feed-in tariffs -High windfall profits for incumbent RES-E generators

7. Model • Environmental economics: prices versus quantities when Marginal Reduction Costs are uncertain • Price mechanism: emission tax • Quantity mechanism: tradable permits • Proposition of Weitzman: “The preferred policy instrument depends on the relative steepness of the marginal damage and cost curves”.

8. Example • Treshold; very steep MD curve once a given level of emissions is reached • Under a situation of uncertainty, a price mechanism can lead to serious welfare losses when the resulting emission level is too high • Quantity mechanisms are better when the slope of the MD curve is higher than the slope of the MC curve

9. Model • MRC = cost difference between RES-E and fossil fuel electricity • MD = external costs of producing fossil fuel electricity • Price mechanisms: feed-in tariffs in stead of emission fees • Quantity mechanisms: TGC shemes in stead of tradable permits

10. MRCH MRC MD MRCL p* q* Emissions

11. Model • Weitzman: “Quantity regulations are preferred if MD of emissions are more steeply sloped than MRC; price mechanisms are preferred if MRC are more steeply sloped than MD” • Ass: MD of emissions are rather flat for the domain of variation considered • Static efficiency is higher for feed-in tariffs

12. Model results • Parameters: MD of emissions, MRCH, MRCL • Optimal values for feed-in tariff and quota • Calculation of the comparative welfare loss of an optimal quotum leads to the following results: • The expected comparative welfare loss increases as the marginal damage of emissions increases • The expected comparative welfare loss increases as the degree of uncertainty of the MRC increases

13. MRCH MRC MRCL p* q* Emissions

14. Model results • Adding a penalty to a quota system increases the efficiency: when MRC are high, emission reduction will stop earlier • Penalty choise is important • When an optimal penalty is added, the efficiency can be further increased by increasing the quota • Adding uncertainty to the MD of emissions does not influence the instrument choise but decreases the expected welfare gain

15. Flemish situation • Weighted average external cost of fossil fuel electricity in Flanders: 34.5 €/MWh • MRCL and MRCH determined by the current marginal costs and the potential of the different technologies (wind, biomass, PV) • Potential in Flanders is rather small which leads to higher values for the slopes of the MRC-curves (e.g. best sites are chosen first)

16. Optimal quotum: 7.2% • Optimal penalty: 24.5 €/MWh • Current system: - quotum: 3% - penalty: 125 €/MWh • Quotum increases every year and will amount to 6% in 2010 • However, according to our model, the penalty is set much too high => emission reduction/RES-E production at too high costs might occur

17. Conclusions • Effectivity: Feed-in systems are more effective than TGC shemes because of risk reduction • Distribution of profits: stepped feed-in tariffs can avoid windfall profits that occur when TGC shemes are used • Static efficiency: under the assumption of constant marginal damages of fossil fuel electricity production, feed-in tariffs lead to higher static efficiency

18. However: - there is not much experience with systems of TGC - systems of TGC can be very useful in an international context