| Abstract: |
Read Georg Zachmann's Memos to the new Commissioner for Energy and the new
Commissioner for Climate Action
The issue: European Union energy policy is
guided by three objectives: sustainability, security of supply and
competitiveness. To meet its goals in these areas, the EU is updating its
energy strategy with new targets for 2030. The starting point for this is the
assessment of the previous EU climate and energy package, at the centre of
which were the 20-20-20 targets for 2020. Although the EU is largely on track
to meet these targets, EU energy policy is generally not perceived as a
success. Recent events have undermined some of the assumptions on which the
2020 package was built, and the policies for achieving the 2020 targets â??
although at first sight effective â?? are far from efficient.
Policy
challenge: ;To meet the EU's objectives for emissions, electricity supply and
gas security of supply, well-designed European markets could provide better
results at lower cost than uncoordinated national approaches. In other areas
â?? such as energy efficiency and supporting innovation â?? markets alone
might not be enough. Europe should thus rethink its quantitative headline
targets for 2030.The proposed 40 percent decarbonisationtarget is in line with
a stronger emission allowance market, but the target for renewables should be
defined in terms of innovation rather than deployment, and the
energy-efficiency target should be defined in terms of encouraged energy and
cost savings, not the amount of energy consumed in a certain period.
Introduction
The European Union is largely on track to meet the so-called
20-20-20 climate and energy targets1, which were seen as quite ambitious when
they were adopted in 2009. EU final energy consumption fell by 7 percent from
2005-11 (Figure 1), energy production from renewable sources increased by 4.2
percentage points from 2005-12 (Figure 1) and greenhouse gas emissions dropped
by 13 percent in the same period (Figure 2). By 2012, emissions were already
19.2 percent below the 1990 level, leaving just a small gap before the EU
meets the 20 percent reduction target for 20202.
However, EU energy policy
is generally not perceived as a success. Recent events have undermined some of
the assumptions on which the 2020 package was built, and the policies for
achieving the 2020 targets â?? although at first sight effective â?? are far
from efficient.
In terms of supply security, the Ukraine crisis has shown
that energy efficiency and increased deployment of renewables have been so far
insufficient to eliminate Europeâ??s reliance on Russian gas.
In terms of
sustainability, other major emitters have not wholeheartedly followed the EU
lead to cut emissions. New fossil energy resources make it more difficult to
believe that such a global agreement is feasible because it would imply not
using most of the fossil-fuel bounty. So the global impact of Europe's
emission reductions will be close to insignificant, while Europeâ??s
decarbonisation strategy turned out less ambitious than originally claimed,
because the recession (and some other factors) supplied much of the promised
emissions reduction.
In terms of competitiveness, various developments have
made the energy mix envisaged in 2008 relatively more expensive. The Fukushima
accident resulted in the closure of cheap nuclear plants while increasing the
already high cost of new nuclear. It also became clear that carbon capture and
storage technology3 is unlikely to become competitive any time soon relative
to other low-carbon electricity generation technologies. Consequently,
decarbonisation in Europe might have to rely even more on variable renewables,
which is likely to drive up the cost of the transition. Meanwhile, the US
shale gas boom caused a widening transatlantic energy price gap. All this
happened during the EUâ??s most severe economic crisis, and shifted the focus
of policymakers from long-term industrial policy projects such as developing
renewables, to defending the competitiveness of sectors such as
energy-intensive steel plants.
In addition, the 2020 climate and energy
policies have inherent problems. Decarbonisation has been mainly delivered by
a combination of economic downturn and renewables policy (CDC, 2014).
Consequently, the EU emissions trading system (ETS) â?? which would have been
able to identify much cheaper abatement options â?? was barely used.
Furthermore, most investments in power plants, networks and consumption have
been based on national remuneration schemes, undermining the internal energy
market and failing to deliver a well-balanced European energy system that
could support the climate and energy policy objectives.
Nevertheless, the EU
package for 2020 was a valid hedging strategy in a world of scarce and
expensive energy. It addressed the questions of its time, and could have been
quite effective in a scenario that saw renewable energy quickly become
indispensable in all parts of the world.
Now, European Commission proposals
for 2030 foresee an emissions reduction of 40 percent and a 27 percent share
of renewables (European Commission, 2014). There is also some momentum for a
binding energy efficiency target that could be set at 30 percent. The
differentiated increase in the three targets indicates a change in
priorities:
The 40 percent emissions reduction relative to 1990 is a
compromise. It is an ambitious unilateral target as long as there is no global
agreement. It provides a signal for low-carbon investment and allows the
political decarbonisation instruments â?? such as emission trading â?? to be
boosted without excessive cost. It therefore keeps the door to a more
aggressive decarbonisation policy open, should other major economies join the
battle. But the target is less than optimal to deliver Europe's share of the
global 2050 objective4.The 27 percent renewables target is essentially
insignificant5. Its main justification is to form the legal basis for national
renewable support schemes that might otherwise be challenged for undermining
the internal energy market.A 30 percent energy efficiency target would be an
acknowledgement of the importance of efficiency to achieve the energy policy
objectives. But the case for the chosen metric and the corresponding number is
weaker than that for the other two targets.
The proposed quantitative targets
testify to the prioritisation within EU energy policy â?? 40-30-27 instead of
20-20-20 â?? but are not a consistent strategy to respond to the changing
energy policy challenges6. The strategic task is to translate the
prioritisation of objectives and the interaction between instruments into a
consistent policy framework.
From a strategic perspective, it is important to
note that it is impossible to determine which menu of investments is most
conducive to achieve security of supply, sustainability and competitiveness of
energy supply. So the main role of policy is to develop reliable frameworks
that will encourage the investment that will enable stable energy services at
the lowest direct and external cost.
A well-functioning internal energy
market is the core of such a framework, complemented by an equally
well-functioning European market for emission allowances and a market for
supply security. Europe also needs an ambitious framework to speed up
low-carbon innovation. The final element is a system to make energy efficiency
policies at different levels of government comparable in order to come up with
the best mix.
Revamping the market
A functioning internal energy market in
which companies and technologies freely compete to provide the best services
at the lowest price, while respecting societal and environmental constraints,
could be hugely welfare enhancing. Despite three EU legal packages, neither
the provisioning of gas nor of electricity is organised in such markets. In
electricity, the attempt to create a European market by coupling national
day-ahead markets proved only partially successful. While national prices have
somewhat converged, no internal electricity market has developed because
important parts of the electricity sector are still subject to widely
differing national rules and arrangements7. Investment decisions in the
electricity sector are thus based on national policies, not European markets.
This non-cooperation is costly, and the corresponding welfare loss is set to
increase with the rising shares of renewables in the power system8.
A
European electricity market will not spontaneously evolve based on the
enforcement of some first principles. Functioning electricity markets need to
be designed: products need to be defined and schemes for their remuneration
need to be engineered. An efficient market design needs to include all parts
of the relevant system. It must ensure efficient incentives for trade-offs
such as demand response versus storage, transmission lines versus
decentralised generation or solar versus lignite. And to be efficient, this
design needs to be European.
The first step is to ensure that national energy
regulations are not used for domestic industrial or social policy. Regulated
final consumer tariffs in France below what the market would offer, the same
electricity price in south and north Germany despite a lack of
interconnection, or paying premiums to domestic plants â?? which is
essentially what capacity mechanisms and renewables support schemes do â?? are
all inconsistent with a functioning internal market.
This implies that the
fuel mix prerogative of the member states should be restricted to preferences
against certain technologies, such as â??no nuclear in Germanyâ?? or â??no
shale gas in Franceâ??. While restricting certain technologies, if done
transparently and predictably, would be consistent with a functioning European
market, there can be no European market if member states prescribe certain
fuel mixes, such as â??more than 40 percent of electricity from German
renewables in Germanyâ?? or â??more than 80 percent of Polish electricity from
Polish coalâ??.
Given the substantial distributive effects9, a European
energy market requires accountable governance. Market designs need to be
regularly adapted to changing circumstances, so the governance structure needs
to be institutionalised. But, the European Commission has neither been given
the authority to strike a deal between vested interests, nor does it possess
the manpower for such a complex task10. Consequently, the Commission relies on
selected stakeholders to negotiate compromises over individual issues11.
To
develop a truly functioning internal market, the Commission needs to prepare a
fourth legal package outlining the European energy market framework. This
should not shy away from curtailing the role of national energy policymaking.
It should propose one or several generic market designs. The European
Parliament and Council should then decide which of those generic designs
should be developed further. Because of the complexity, the substantial
information asymmetries between stakeholders and the significant
redistributive effects, this task of developing a market model should be
entrusted to a well-staffed and accountable institution that will also be
responsible for the ongoing implementation of the design12 â?? for example,
the Agency for the Cooperation of European Regulators (ACER). This would,
however, require resources matching its responsibility13 and an overhaul of
the decision-making process. The final design would then be ratified by the
European Parliament and Council.
Creating a functioning internal energy
market would be a major shift that will not be achieved through smooth
convergence of national markets. The alternative would be to return to a
system of more-or-less managed national electricity systems â?? with some
unreliable cross-border exchanges of energy. This would not only make the
systems less efficient. It will also make national security of supply more
costly, and deployment of renewables beyond a certain level prohibitively
expensive.
Re-establishing the ETS
The ETS covers most carbon-emitting
industries and will run indefinitely, with a shrinking annual supply of
allowances. It is an effective and efficient tool to mitigate emissions14.
But, the price of ETS allowances has collapsed because of an oversupply15 and
the undermining of the systemâ??s credibility. The risk in these developments
is that the ETS gets replaced by less-efficient national, sectoral and
time-inconsistent measures. A revamp is therefore important to incentivise the
use of current low-carbon alternatives (for example burning gas instead of
coal) and to ensure low-carbon investment.
The European Commission proposal
to revamp the ETS is (1) to increase the speed by which the annual allocation
of allowances are curtailed from 1.74 percent to 2.2 percent every year after
202017 and (2) to introduce a â??market stability reserveâ?? through which any
surplus of allowances above a certain level will be removed from the market,
and reintroduced when the surplus falls below a certain level.
Steeper
reduction of annual allowance allocations after 2020 is a sensible step to
ensure that Europe plays its part in the containment of global warming. There
is however a risk that the sectors covered by the ETS could fall out of step
with the emission reductions in sectors that do not fall under the ETS, such
as transport and heating. For example, electricity for electric vehicles and
heat pumps falls under the ETS, while combustion-engine cars and oil heating
do not. The most elegant solution to avoid different carbon prices for
different technologies would be to extend the scope of the ETS to all relevant
sectors18.
The Commission's proposed â??market stability reserveâ?? is
intended to avoid politically motivated intervention in the market. But the
use and workability of such a mechanism are highly disputed19.
A more
promising way to effectively shield the ETS from political interference would
be to ensure that future policymakers that decide to undermine the ETS have to
compensate companies that invested based on the claims made by policymakers
today that the ETS is stable.
This could be organised through private
contracts between low-carbon investors and the public sector. A public bank
could offer contracts that will pay in the future any positive difference
between the actual carbon price and a target level20. Low-carbon investors
would bid to acquire such contracts to hedge their investments. This would
produce three benefits. First, the public bank would be able to collect money
upfront (a sort of insurance premium) and make a profit if a sufficiently
tight climate policy is maintained. Second, the private investor significantly
reduces its exposure to the â?? political â?? carbon market and hence accepts
longer pay-back times for its investments. This would unlock long-term
investment that is currently too risky. Third and most importantly, public
budgets would be significantly exposed to the functioning of the ETS. If
future policymakers take decisions that increase the number of available
allowances, they might be called back by their treasuries because this would
activate the guarantees pledged to investors. This would serve as a much more
credible commitment to preserve the integrity of the ETS.
Supply security
The EU's perceived vulnerability to a reduction in gas (and oil) supplies from
Russia in the context of the Ukrainian crisis has put supply security back on
the agenda21.
Security of gas supply is not primarily about reducing import
dependency or increasing Europeâ??s negotiating power with foreign suppliers.
Rather, it is about maintaining unused alternatives that could be tapped into
for an indefinite period in case the most important supplier fails for
technical or political reasons.
There is a long-standing debate about whether
completing the internal market will deliver supply security. A functioning
internal market offers the most efficient rationing mechanism during crises
and market-based long-term prices in Europe ensure that suppliers have the
right incentives to develop new sources. On the other hand, the market â??
which typically goes for the cheapest available source â?? might fail to
sufficiently diversify. For example, the current market design will not
provide infrastructure to connect sources that are in normal circumstances
uncompetitive, but which serve as insurance in case the cheapest supplies
become unavailable.
But managed approaches, such as providing security via
public investment in certain infrastructure, could crowd out private
investment if not properly shielded from the market. If, for example, Europe
financially supports a pipeline from Turkmenistan, the business case for the
corresponding volume from the Levant region might disappear. Furthermore,
national managed approaches regularly fail to select the most efficient
options (eg demand curtailment, storage, LNG plants, pipelines, domestic
production, domestic fuels).
So neither the current market design nor ad-hoc
managed approaches appear well suited to efficiently ensure gas supply
security. We therefore propose a market for â??reserve suppliesâ??. Each
domestic gas supplier would be legally required to maintain a certain amount
of alternative supply, such as 20 percent of the contracted energy demand for
three years. Suppliers can meet their obligation through different options
such as (i) interruptible contracts with their consumers, (ii) volumes in
storage, or (iii) option contracts with other domestic and foreign suppliers.
Europe's suppliers would need to make sure that the transport capacities â??
pipelines and terminals â?? needed to deliver the corresponding volumes to
customers are available. Furthermore, â??reserve suppliesâ?? could not be met
by options involving pivotal suppliers/infrastructure. That is, holding an
option for additional supplies from Russia would not qualify as â??reserve
suppliesâ??. To ensure this, pivotal suppliers/infrastructure will have to be
identified. In case a supplier finds itself in a situation in which all
existing infrastructure is either already used or pivotal, it will have to
invest in new infrastructure. Suppliers would only be able to draw on these
â??reserve suppliesâ?? in security crises following an official declaration.
This system, the cost of which the domestic suppliers will largely pass
through to their customers, should ensure security of supply for all at lowest
cost and without undermining the internal market.
Such an approach would
obviously have distributive effects. Consumers in well-connected regions that
face a very limited risk of supply disruptions will have to pay for
â??theirâ?? share of reserves, which most likely only their less
well-connected neighbours might need. But this solidarity will not wash away
regional differences arising from different infrastructure endowments because
suppliers in areas with less-developed infrastructure will find it more costly
to ensure the level of supply security. This is efficient because it provides
an incentive against locating the most vulnerable sectors in vulnerable
markets. For example, a chemical plant in Cyprus will only get an
interruptible contract because no supplier could affordably secure the
required reserve capacities.
RES-innovation target
Since the EU 20 percent
target for renewables was decided, some of the reasons for investing in
renewables have become less urgent. There is less risk that fossil fuels will
run out quickly, more reliable suppliers are entering the global energy
market22 and a global agreement to mitigate greenhouse gases seems distant.
Nevertheless, in the longer-term, issues such as dependence on imports from
uncertain sources and rising hydrocarbon costs will return. Most importantly,
affordable decarbonisation of the energy sector will require competitive
renewable energy sources (RES).
Consequently, the focus of renewables support
should shift from a deployment target that encourages the quick roll-out of
the cheapest currently renewable technology, to an ambitious innovation target
that encourages investment to cut the cost of RES. If successful, an
innovation target will be the largest possible contribution of Europe (and its
partners) to saving the global climate, and might be instrumental in
developing a competitive edge in what will become a major global market23.
It
is difficult to establish the optimal size, selection, balance and timing of
'push' and 'pull' measures â?? for example, public R&D support, or feed-in
tariffs to create demand for a new technology. Zachmann et al (2014) indicate
that both public support to boost innovation and the timing of instruments
matters. It is not massive actual deployment24, but the prospect of deployment
that is the carrot for industry to commercialise the technologies developed
through publicly-supported R&D. A long-term deployment target â?? such as the
20 percent for 2020 â?? is helpful, not least because it incentivises
innovation and investment in complementary technologies such as storage or
networks. However, the deployment target should be broken down to
technology-specific targets and developed as part of an innovation policy that
optimally supports a broad portfolio of technologies at different stages of
maturity. A revised Strategic Energy Technology Plan25 could form the basis
for defining measures and allocating support to technologies.
The current and
envisaged renewables policies are not focused on innovation. Europe currently
spends on relevant R&D about a hundredth of what it spends on renewables
deployment (Figure 3)26. It does not integrate its deployment and R&D policies
into a strategic innovation policy and does not coordinate its deployment
policies across borders.
Energy efficiency
The key tool to ensure
efficient energy usage is confronting all users with market-based price
signals. Wasteful usage does not only refer to using more energy to produce a
certain good, but also artificially maintaining a specialisation in
energy-intensive goods. As Europe should not strive to subsidise labour costs
to make the European textile industry competitive with Asia, Europe should not
subsidise energy costs to make European aluminium production competitive with
the US, especially as defending energy-intensive sectors at all cost locks in
high energy consumption and implies that Europe needs to draw on more
expensive supplies for all other sectors.
Beyond the issue of prices, the
question is if energy efficiency needs to be regulated and if this should be
done at European level. The need for regulation is often deduced from the
finding that even efficiency measures with positive net present values are not
delivered by the market27. As energy efficiency is an issue in virtually all
sectors, there is a myriad of existing and proposed measures. So, energy
efficiency policies can be welfare enhancing, but their efficiency depends on
their design.
The same holds for the question of subsidiarity. The obvious
argument for a European energy efficiency policy is its interdependence with
the single market. National product energy-efficiency standards, national
energy-efficiency schemes for energy companies or even distorting energy taxes
could weigh on the single marketâ??s integrity. On the other hand, national
regulatory environments and structures for important energy consuming sectors
(eg buildings) differ markedly. This might make a one-size-fits-all European
energy efficiency policy very inefficient in these fields.
So the somewhat
generic conclusion on energy efficiency is that individual market failures
should be addressed by the most efficient measures at the right level of
government. For the broad portfolio of regional, national and European
policies that is necessary, a binding EU 2030 energy consumption target is not
well suited. It neither addresses who has to deliver nor does it properly take
economic developments into account. To benchmark energy-efficiency policies we
would suggest a bottom-up approach. Based on the ex-post evaluation of each
individual energy efficiency policy, the incentivised demand reduction and the
corresponding policy cost should be reported. For example, the
energy-efficiency loans in Germany in 2011 had an estimated cost of about â?¬1
billion and encouraged annual savings of 0.1 million tonnes of oil equivalent
(Mtoe).
Two targets would then serve to benchmark the success of the overall
policy framework up to 2030: one for total incentivised energy savings (eg
more than 400 Mtoe of induced energy savings between 2020 and 2030) and one
for total energy efficiency policy cost (eg less than â?¬100 billion). This
target might be broken down by member state (or even to sub-national level)
and even made binding.
Conclusion
Policy and market failures in the energy
sector are common. There is too little energy saving, too little investment in
security and innovation and emissions are too high. Governments tend to
over-invest in big supply projects and use energy-sector regulation for other
national policy purposes, preferring to solve the issues of the day instead of
addressing the structural problems.
The European 2030 framework should strive
to address the market failures without falling for the government failures.
Essential elements will be well-designed European markets for emissions,
electricity supply and gas security of supply. Better policy frameworks are
also needed to encourage energy efficiency and innovation in low-carbon energy
technologies.
This would be a radical step-change in European energy and
climate policy, but so were the 2020 targets. But in planning for 2030, Europe
cannot avoid substantially revising the governance of its energy sector,
without compromising on security of supply, sustainability and
competitiveness.
Research assistance from Marco Testoni is gratefully
acknowledged. The author would also like to thank those who provided valuable
comments on an earlier draft. The research underpinning this paper benefited
from support from the Simpatic project (EU Seventh Framework Programme, grant
agreement 290597, www.simpatic.eu). All notes and full references are
available in the .pdf. |