Markets for the Environment and Renewable Energy

MIT CEEEPR

Markets for the Environmentand Renewable Energy

A. Denny EllermanCenter for Energy and Environmental Policy Research

Massachusetts Institute of Technologyhttp://web.mit.edu/ceepr/www/

Perspectives from Abroad ColloquiaSustainable Energy Ireland

Dublin, IrelandMay 21, 2003

Massachusetts Institute of TechnologyCenter for Energy and Environmental Policy

Research

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Outline

• Introducing environmental & renewable markets

• The US Experience with Emissions Trading

• The UK Experience with Renewable Energy

• Interactions among markets

• Concluding Comments

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Some Preliminaries

• Societies, governments, and markets– From Locke’s social contract to Lincoln’s “of

the people, by the people, and for the people”

• Natural markets, banned markets, and constructed markets– Decisions reflect societal values

• Non-appropriability as the underpinning for constructed markets

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An Environmental Market:U.S. Cap and Trade Programs

• Basic requirement: one ton = one allowance– Demand has been created, but non-specific– Radical refocusing of the government role: from

specific mandate to accounting– Measuring instead of inspecting

• Simultaneous recognition and issuance of tradable “rights to emit”

• Simplicity, strict accountability, & flexibility

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A Renewable Energy Market:Renewable Obligation Certificates

• Basic requirement: ROCs = % obligation– Creates demand for certificates (ROCs)– Producers of renewable energy earn ROCs– Specific mandate abandoned, market will take care of

supply

• Unbundling of electricity and “renewability”– Like in environmental markets– Allows separate markets to operate– No build requirements for utilities – Also, subtle shift from capacity to generation

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Outline

• Introducing environmental & renewable markets

• The US Experience with Emissions Trading

• The UK Experience with Renewable Energy

• Interactions among markets

• Concluding Comments

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U.S. Cap-and-Trade Programs

• The Acid Rain (SO2 allowance trading) Program– Nationwide, single source beginning in 1995

• RECLAIM Programs for NOx and SO2 in the Los Angeles Basin – Multi-source, local program starting in 1994

• The Northeastern NOx Budget Program– Seasonal program (May-Sept) enacted by coordinated

individual state action beginning in 1999– Expanded by federal action to include all eastern U.S. in

2003

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What are the Results?• Cost savings have been achieved

– 50% savings in the Acid Rain Program– Markets have emerged in all programs and

significant trading has been observed

• Better environmental performance than conventional regulatory alternatives– 1st year effect with & without banking– Big, dirty units reduce the most – 100% (real) compliance because of treatment

of high abatement cost facilities

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First Year Effect in “Big Dirties”

0

2

4

6

8

10

12

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

Millio

n t

on

s S

O2

Program starts

ALLOWANCES

EMISSIONS

COUNTERFACTUAL EMISSIONS

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First Year Effect in Other Units

0

2

4

6

8

10

12

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009

Mill

ion

to

ns

SO

2

PROGRAM STARTS

ALLOWANCESEMISSIONS

COUNTERFACTUAL EMISSIONS

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Why Did the “Big, Dirties” Reduce the Most?

• Deep abatement technology is capital intensive

• Economics depends on units of output over which the (large) fixed costs can be spread

• Cap & Trade Programs pay per unit of abatement, while conventional regulatory programs do not

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Why 100% Compliance?Exception and Equity

• Cost heterogeneity implies C & C rule will not fit all…imposes unique hardship on some

• Leads to administrative appeal and equitable exception that relaxes or delays requirement

• One-sided process…those facing less cost than others never offer to do more

• Fine line between equity and special pleading

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Special Pleading Has Been Made Uneconomic

• Cheaper to buy an offset than seek exception

• Trading provides for automatic off-setting

• Also, harder to claim unique hardship in a market with many buyers… highest cost is price of an allowance

• Easier to enforce allowance-emissions matching than prescriptive rules

• Flexibility, simplicity & strict accountability

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Outline

• Introducing environmental & renewable markets

• The US Experience with Emissions Trading

• The UK Experience with Renewable Energy

• Interactions among markets

• Concluding Comments

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How has Renewable Energy Procurement Fared?

Contracted (MWe)

On stream

(EOY 2002)

% “Live”

NFFO 1 (1990) 152 141 93%

NFFO 2 (1991) 472 172 36%

NFFO 3 (1994) 627 293 47%

NFFO 4 (1997) 843 195 23%

NFFO 5 (1998) 1,177 119 10%

TOTAL 3,271 920 28%

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NFFO and RO Capacity(England & Wales)

NFFO Contracts (1990-98) 3,271 MWe

NFFO Completed (12/31/02) 920 MWe

RO Accredited Effective 4/1/02 1,215 MWe

RO Accredited since 4/1/02 717 MWe

Total RO Accredited as of 1/31/03 1,932 MWe

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ROC Performance to date(England, Wales, & Scotland)

(% Share) Capacity

(MWe)

ROCs (GWh)

(Apr 02-Jan03)

Capacity Factor

Biomass 1,038 (48%) 818 (18%) 11%

Landfill & sewage gas

547 (24%) 2,375 (53%) 59%

Hydro 201 (9%) 428 (10%) 29%

Wind 507 (22%) 870 (19%) 23%

TOTAL 2,293 4,490 27%

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Another Similarity:Markets Supplant Regulation?

• Emissions Trading– RECLAIM and NOx programs superseded conventional

programs with ample authority• Too complicated to implement by regulation

– Acid Rain Program was “de novo”

• Renewables: Market replaces direct procurement • Separability, decentralization & specialization• Avoiding pitfalls of informational asymmetries and

the political uses of administrative discretion• More general than environment and renewables

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Outline

• Introducing environmental & renewable markets

• The US Experience with Emissions Trading

• The UK Experience with Renewable Energy

• Interactions among markets

• Concluding Comments

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Market Interactions

• Many markets interact– Substitution and budget constraints

• Environmental markets are similar– Caps are independent & costs are additive

– But sometimes, abatement of one pollutant reduces/increases another pollutant

– If both capped, markets are interdependent

• Renewable energy markets will interact with CO2 markets, for instance the EU Trading Scheme

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The ROC/CO2 Interaction

• Renewable energy emits no CO2 and is often seen as an instrument of climate policy

• Any CO2 market will provide some impetus to renewable energy production

• If CO2 and ROC markets co-exist– Tighter CO2 caps will reduce ROC prices, and– Larger ROs will reduce CO2 prices– Potentially one could drive the other price to

zero

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Is There Something Wrong with this Interaction?

• Something unique and non-appropriable about renewables? – Set the RO at the right level – Don’t worry about interactions

• If the RO is a surrogate carbon policy,– Justified only as a 2nd best instrument

• Interaction is appropriate if CO2 price is rising

– Otherwise, an RO is superfluous or inefficient

MIT CEEEPR

Outline

• Introducing environmental & renewable markets

• The US Experience with Emissions Trading

• The UK Experience with Renewable Energy

• Interactions among markets

• Concluding Comments

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Why Markets Now?

• Technological Trends– Information revolution has greatly reduced cost

of monitoring, reporting and processing

• Societal Trends– Greater willingness to rely on “markets” and less

faith in “government” and “experts”

• Environmental Problems are Different– Blunt tools work only on big obvious problems

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Some Concluding Thoughts

• Exciting new world of constructed markets– Reflecting broad underlying trends– Not besotted market ideology

• More intelligent use of government– Sorting out government and market roles by

equal application of market and public failure– Adapting to diminishing supply of civil

servants

• The right attitude for policy…

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“If it is feasible to establish a market

to implement a policy,

no policy-maker can afford

to do without one.”

Pollution, Property and Prices

J. H. Dales (1968)