Friday, January 30, 2009

The Impacts of Carbon Pricing on the Electricity Sector

It's time to look at the impacts of the coming carbon pricing on different parts of various energy chains. Let's start with the electricity sector. Electric utilities are responsible for a large part of CO2 emissions globally. In the U.S. the electricity sector accounts for 40 % of the country's CO2 emissions, and the twenty largest electric utilities alone account for about a quarter of the country's CO2 emissions. The share of total CO2 emissions from power generation is similar in China, and the Chinese sector now emits more in absolute terms than its U.S. counterpart. The growth in China's CO2 emissions has been unprecedented, although the economic crisis has slowed down the growth somewhat. A Berkeley study last year suggested that China's CO2 emissions will have grown by at least 11 % per year from 2004 to 2010. I'm hoping that will be true only for the period of 2004 to 2008. In any case, what will be the effect of a potential CO2 price on the operation and emissions of the electricity industry? I'll start with the economist's usual answer: it depends.

The answer depends on the elasticity of demand and supply of fossils fuel generated electricity,which in turn depend on the degree of electricity market deregulation (in particular, tariff setting mechanisms, demand response and the free choice of supplier by small and large customers), the age of current generation generation plants, the availability and price of clean electricity sources (and their supporting policies), the price of fossil fuels and carbon, and how new transmission investments will be managed. All of the previous determine not only the overall effectiveness of the CO2 price in mitigating emissions, but also whether it's the consumer or the producer who pays the additional cost.

In short, for the price of carbon to be effective in mitigating CO2 emissions, the electricity tariffs must be determined freely in the market to reflect true marginal costs. For that to really happen, there must also be demand response (e.g. smart grids with real time metering). Needless to say, all consumers should have the freedom to choose their supplier in order to give electric utilities the incentive to switch to cleaner energy sources. The age of current plants is important as newly built coal plants are unlikely to be bulldozed as Jim Hansen suggests. However, the possible grandfathering of old coal plants would be a huge mistake. The availability of economical renewable energy sources will also be crucial, and this is not only a question of local resources and support policies, but also one of efficient organizational and regulatory frameworks for new transmission investments. Transmission is a major stumbling block all over the world, and most of the current regulatory frameworks don't support the investments required to make carbon pricing effective and cost-efficient. In Europe, the issue is more severe and complicated when it comes to investments in cross-border transmission lines that benefit several member countries. On that more later.

Wednesday, January 28, 2009

The Internet and Open Society

I think Karl Popper would be pretty thrilled today, if he saw how the internet has enabled open intellectual debate on a global scale about various social issues. Vox's Global Crisis Debate, in partnership with the UK government has just been opened to allow all professional economists from around the world to share their views on how to fix the global economy and influence the G20 meeting in April at the same time. There are already top commentaries from people on the left, right, and centre. The floor is yours.

Tuesday, January 27, 2009

The Coming Climate Policies

There were a lot of news yesterday that signal aggressive climate change policies under President Obama's first year in office. He himself gave a speech where he stated that 'These urgent dangers to our national and economic security are compounded by the long-term threat of climate change, which, if left unchecked, could result in violent conflict, terrible storms, shrinking coastlines, and irreversible catastrophe.' He also said (talking about the economic crisis) that 'At a time of such great challenge for America, no single issue is as fundamental to our future as energy." (Full speech here). At the same time, Hillary Clinton appointed Todd Stern as the administration's chief climate negotiator. He'll be the one flying into Copenhagen this coming November with the intention, according to his own words, to "engage in vigorous, creative diplomacy to dramatically reduce emissions". Yesterday, NOAA also published a pretty shocking study that suggests that climate change would be largely irreversible for 1.000 years after CO2 emissions are completely stopped.

Now, since it looks like aggressive climate policies may finally become reality, I want to talk about how a carbon tax or a cap-and-trade system, which is more likely, would impact different parts of various energy chains. However, for now I want to get some sleep. It's late and I just came back from a trip to the Netherlands.

Saturday, January 24, 2009

Traveling for a few days.

Posting resumes on Tuesday, 27th of January.

Thursday, January 22, 2009

IEA's Principles for Effective Policies for Renewables

While browsing through IEA's books, I noticed two new titles: Deploying Renewables: Principles for Effective Policies for Renewables and Natural Gas Market Review 2008. Both have some interesting findings and deserve a paragraph or two in this blog. Let me begin with the former. IEA's review of the effectiveness of various policy schemes for renewables (summary) strengthens my previous views of the policy drivers and barriers for renewables, especially wind power. The book doesn't suggest that feed-in tariffs alone are superior to other forms of support mechanisms, but the message of their effectiveness is fairly clear: The countries with highest policy effectiveness (Germany, Denmark, Spain, and Portugal) all used FITs. What's more important, the average remuneration levels in these countries were lower (USD 0.09-0.11/kWh) than in countries that had quota obligations for renewables combined with tradable green certificates (USD 0.13-0.17 kWh). I think the UK versus Germany serve as good examples. The former has had used both a tender-based system and later, a quota system. I wrote a paper last year where I compared the overall policy frameworks of the two countries. The chart below tells a lot about policy effectiveness (sorry, I noticed it's hard to read. Blue line is Germany, red line UK. The timeline is 1990-2008e.)

IEA's book suggests, rightly so, that non-economic barriers, "such as administrative hurdles (including planning delays and restrictions, lack of co-ordination between different authorities, long lead times in obtaining authorisations), grid access, electricity market design, lack of information and training, and social acceptance, have a significant negative impact on the effectiveness of policies to develop wind power, irrespective of the type of incentive scheme." This is certainly true, but a quota system leaves full price, volume, and balancing risk on the investor's shoulder, making it much less effective in attracting new investments. At the same time, if the FIT-based system has involved lower tariffs than quota-based systems, it's naturally much more preferable to consumers and a more cost-effective policy for the tax payers. From the viewpoint of the utilities, it's also preferable, because it doesn't erode anybody's competitiveness in particular, and it allows a nationwide allocation of the tariff burden to all consumers. It's notable that UK actually has better wind resources than Germany, and so even a lower FIT than the ones in Germany could induce massive investments in new wind power capacity.

Tuesday, January 20, 2009

Our President's Inauguration

Thomas Jefferson said: "every man has two countries - his own and France." These words, as many have suggested, could well be applied to much of the world today with reference to the United States. I'm a Finn by nationality, but more than ever before my life is shaped more by U.S. policies than by Finnish policies. I just watched my new President's inauguration with great attention. Now, he's got to get to work. The list of things to do is endless. God bless America and us all.

Monday, January 19, 2009

Fear the N-Word No More

I admit I was a little afraid to use the word 'nationalization' myself outside the private dinner table. So far, there's been too little serious discussion about its merits versus its disadvantages. I thought I was missing something obvious by even seriously thinking about it. However, in the past few days at least Willem Buiter, Paul Krugman, and Felix Salmon are seriously considering the temporary nationalization of banks as possibly the only remaining option. Willem Buiter points out that the policies so far (governments providing liquidity with 'strings attached') have, in fact, created incentives against increasing lending. I strongly recommend at least reading Buiter's arguments. We'll just have to see how many policy makers in the U.S. and Europe have the balls to bring up the N-word, even if they saw its merits.

Sunday, January 18, 2009

Energy & Society on Alltop.com

Energy & Society is now listed under three categories on Alltop.com. The categories are Green, Oil, and Economics. So far, they unfortunately lack a general energy topic, but that could soon change. I thank the good people at Alltop.com for putting my blog up there. Thanks also to Santiago for the tip.

If you haven't heard of Alltop.com, it's a convenient tool to track the best blogs of a specific topic. According to their site, it's an "online magazine rack" of popular topics.

Saturday, January 17, 2009

American Recovery and Reinvestment Plan

This week the House Democrats released a summary of the coming American Recovery and Reinvestment Plan of 2009. The energy related provisions of the plan were neatly put into a chart by the think tank Center for American Progress. Let's look at the numbers. The plan is to invest about $ 66 billion in energy efficiency and renewable energy programs (I'm leaving out investments in public transit). Almost $ 30 billion of that total would go into building and appliance efficiency, and if you look more carefully at the $ 13.4 billion going into renewable energy, you notice that there's more money there being provided for efficiency. In fact, only $ 3.4 billion are provided for renewable energy as grants and loans. That's not much. On the other hand, there could potentially be much more allocated to interconnection and transmission upgrades for renewable energy under the $ 19 billion going into "grid/transmission". The section for clean cars has $ 2 billion going into advanced battery loans and grants out of a total of $ 3.5 billion, but so far the plan lacks any infrastructure spending for electric cars. Overall, the plan seems to focus mostly on efficiency. Perhaps the Obama administration is planning another type of federal policy to speed up transition to cleaner power generation. We'll find out soon.

Thursday, January 15, 2009

The Future of Banking

The Group of Thirty published a paper today (summary here) that deals with recommendations for banking regulation and supervision. The project was led by Paul Volcker, and it gives us some idea of what to expect from Barack Obama with regards to financial reform. The recommendations for strict government oversight make a lot of sense, but after reading the recommendations, I face two immediate questions. First, would a system with such a massive public regulatory and supervisory machinery be the most efficient one? Secondly, is the proposed regime sufficient to ensure that the financial sector does its duties? Well, what are those duties? Many would agree that those duties include the efficient allocation of capital, management of financial risks, and mobilization of savings. Probably all would agree that the main duty of the financial sector is to provide liquidity for the rest of the economy. Now, look at the current situation. Policy makers are pushing liquidity into banks in order to get credit flowing again. Where are banks putting that money? In government bonds. So again, what are banks for? I'm not the first person to ask this question.

I'm hopeful that the stimulus plan by President (elect) Obama will increase liquidity sufficiently in the U.S. economy, and that Paul Volcker's recommendations will be embraced to large extent. However, to ensure that we won't have to deal with this kind of crisis anytime soon, I think we should do more. Here's one suggestion: let's make all finance professionals study more economics, and have them go through some kind of "bar examination" to determine whether they qualify to practice finance. (I can hear the crowds roar - at least all investors who've lost their money during this crisis)

Tuesday, January 13, 2009

Oil Shocks Revisited

Why didn't the recent price hike in oil have nowhere nearly as devastating effects on the economy as the price hikes in the 1970s? Alan S. Blinder and Jeremy Rudd have the goods. Meanwhile, we're waiting for someone to write a coherent summary of the positive externalities of high oil prices on the demand of cleaner energy technologies, the environment (which is increasingly taken into account in economic growth models. See e.g. Prof. Dasgupta's work), traffic congestion (and the resulting wasted fuel and lost productivity), traffic related deaths, etc.

Sunday, January 11, 2009

I was wrong

firstly, about how soon the gas would flow through Ukraine again (I said latest by Friday), and secondly, about Ukraine giving up the game - they didn't. Reuters reports:

"A copy of the monitoring agreement, seen by Reuters, has the handwritten words "with declaration attached" next to the signature of the Ukrainian government's representative.

The declaration, a copy of which has also been seen by Reuters, stated that Ukraine had not siphoned off any transit gas and that it had no outstanding debts to Russian export monopoly Gazprom -- a central bone of contention between the two countries.

It said Russia must supply volumes of "technical" gas, at no cost, to Ukraine to maintain pressure in the pipeline system -- a demand Gazprom described as "an attempt to legalize the theft of gas."

Whither Ukraine?

Thursday, January 8, 2009

The Finals

Today, Gazprom rejected the agreement mediated by the EU to put independent monitors in Ukraine along the gas transit route. According to FT, Ukraine had no objections. It's starting to look more and more like the remaining players in the game are EU members and Russia (or Gazprom). Ukraine is dropping out.

Wednesday, January 7, 2009

Game Theory, Anyone?

If you put the current gas dispute between Ukraine and Gazprom into a game theoretic framework, who would be the players and what would be their options. Personally, I'm a bit puzzled in the midst of the numerous versions of what's going on. The only thing that is certain is that, if you had a two player game in mind, it's only a sub-game of a much larger game, if even that.

One of Gazprom's objectives is no doubt the speeding up of the Nordstream gas pipe line. According to the BBC, Gazprom's deputy chairman Alexander Medvedev said on Friday that they believe "it is necessary to develop, as soon as possible, alternative transit routes. We hope that Europe takes the necessary steps to support this".All in all, what the Russian counterparties, whether that's Gazprom or Kremlin, want to achieve from all this is less of a mystery. To me, the more relevant question is: what is going on in Ukraine and what are their options? It's obvious that Russia should compensate Ukraine for being able to pump gas through Ukraine, but the proposed price of $ 250 per thousand cubic meters may be the best deal Ukraine can get. Eventually, they might end up paying something close to the full market price. Of course, the gas will be flowing again in a day or two, because Russia must honor the bilateral agreements with its European customers. I'm looking forward to what the talks tomorrow between Gazprom, Ukraine and the EU will result in. However, history has taught me not to expect to fully undestand the game I'm watching. Is it purely commercial? Let's start by asking: to whom?