How can climate policies become more efficient and less costly? We must view climate policy as a process of long-term learning and restructuring, rather than a series of stand-alone measures in a static world.
The climate problem requires changes in every country and across almost all sectors. For us to have a realistic chance at limiting global warming to 2°C, emissions must be cut by around 60% between 2014 and 2050, and towards the end of this century, greenhouse gas emissions need to be close to zero.
At the same time, the global population is expected to grow by more than 40% towards the year 2100, and world production of goods and services may increase eightfold (given annual economic growth of 2.5%). Today’s economy is built on the use of fossil energy, which is also the biggest source of global warming. Future growth and prosperity need to be built on different energy solutions altogether.
In the European Commission’s Energy Roadmap 2050, the power sector has almost zero emissions in 2050. In order to reach such goals, pervasive restructuring of energy production and consumption is required. There is also a need for changes within transport, in parts of agriculture and manufacturing, and in how we plan and build the society of tomorrow. To efficiently promote changes such as these, we need new and better technologies, new ways of organising institutions and sectors, and not least, new ways of thinking.
Polluters must pay – and those who develop better climate solutions must be rewarded
There is widespread support for the principle that polluters should pay for the cost they impose on society. This is often highlighted as the cost-effective solution, and the thinking behind it is as follows:
By letting all polluters pay an equally high tax (or quota price), the result is emission cuts wherever cutting emissions is cheaper than paying the tax. If the tax is for instance €25 per tonne, all emission cuts that cost less than €25 per tonne will be implemented. This is cost-effective, since emissions are cut where it is cheapest.
The climate problem is a pollution problem. Therefore, it is tempting to conclude that the cost-effective solution is an equally high tax or quota price (hereafter referred to as a carbon price) for all greenhouse gas emissions, and that other measures are to be avoided. This would be wrong, however. Carbon pricing is important, but not sufficient to promote technology development and other knowledge development at the necessary pace. Carbon pricing also has other limitations.
High carbon prices give consumers and industry an incentive to reduce emissions when that is cheaper than paying the carbon price. It also makes goods and services that involve high emissions more expensive. Higher prices encourage customers to look for more climate- friendly alternatives. If markets are sufficiently confident that carbon prices will stay high in the future, carbon prices may also be an important instrument in long-term change. But carbon pricing will not encourage development of new technologies to a desired (optimal) degree. This is because companies and countries that develop new solutions, only reap a small share of the benefit offered by their solutions.
Developers of knowledge only reap some of the global benefit
Patent protection is an important driver for innovation, by giving developers the sole right to earn money on their solutions for a limited period (usually 20 years). Several types of learning cannot be patented effectively, but even when a new idea can be patented, much of its value (benefit) will still go to others. There are two reasons for this:
- During the patent period, the patent holder must give buyers a (significant) share of the benefit in order to make them buy the product (consumer surplus).
- After the patent period, anyone will be allowed to use the solution freely, without paying its developer. Since the climate problem will last for more than a century, good solutions could provide global benefits for many decades after the expiration of a patent. When it takes a long time to achieve widespread use of a product, most of its global benefit may in fact be realised after the expiration of the patent.
A lot of learning cannot be patented. This applies to informal learning and many general ideas. There is also value associated with discovering that certain solutions do not work.
Others can learn from these mistakes, avoid making them and be inspired to search for better solutions. Knowledge of possibilities and impossibilities also provides valuable information to all those planning long-term investments, even if they do not plan to use the (potential) solutions themselves.
Since the climate problem is global and here to stay, and since in the long-term, we need radical changes that will bring emissions down to zero, technology development and other types of learning will play a crucial role in our ability to reach these goals. We need policies and a set of measures, that encourage the necessary developments in knowledge, and that drive the costs of new solutions way down.
Learning curves: deployment lowers costs
Long-term, publically-financed research and programmes that encourage innovation, are very important when it comes to developing new solutions, but they frequently prove insufficient. In order to accelerate the development of new technologies and bring costs down to a competitive level, it is often necessary to stimulate greater deployment/production. Learning curves describe the drop in price that many products see as they become more widespread. The drop in price is driven by two factors:
- Learning through deployment and operation. Development and widespread use of new technologies, such as wind turbines, provide practical experience and therefore stimulate innovation. Furthermore, private companies often require a high rate of return on investments (e.g. 10%) and have little desire to invest in innovation which may find a market in the distant future. But when governments create a market for a new product, e.g. by providing funding the deployment of wind and solar power, innovation comes more easily. The industry is far more willing to go for a new idea when the road to realisation is short. Extensive deployment encourages innovation in every link of the value chain.
- Economies of scale. When investors have sufficient confidence in future sales, they are willing to invest in better and more specialised manufacturing equipment. Larger volumes also make it possible to exploit manufacturing facilities better. An example: In the event of extensive development of offshore wind power in an area such as the North Sea, investment could be made in special boats and cranes for installation of turbines, and the result would be better utilisation of boats and maintenance equipment. When a product, for instance a hydrogen car, is made in larger quantities, the costs of development can be spread among more units, and the logistics of delivering manufacturing materials and the finished product can be more efficient. When Tesla builds its gigantic battery factory, it is expected to bring battery costs down by at least 30%. The advantages of greater production can be seen throughout the value chain.
The cost of solar panels has dropped by 99% in 35 years, and the cost of wind power on land has fallen by 90% in 32 years. For LED lights, costs dropped by 85% from 2008 to 2012. During the same period, the cost of electric car batteries was halved, and there is solid hope that increased production and technology development may bring costs down to a quarter of 2012 prices by 2022. This would make electric cars cheaper than petrol cars. Such price drops are of crucial importance to climate policy, because they make more countries do more to reduce emissions. In those gratifying cases where climate-friendly solutions turn out cheaper than old, polluting alternatives, and any institutional barriers are removed, emission reductions will start to happen on their own.
Carbon pricing is insufficient for promoting immature technologies
A carbon price that is the same for all emissions will not distinguish between climate measures that could lead to large price drops in the future (through learning and economies of scale) and climate measures that offer no such effect. Since the cost reductions in question could be very large, this distinction is important.
The fact that development and deployment today contribute to lower costs in the future, must be taken into account when deciding what is cost-effective.
In order to stimulate learning effects and price drops through large scale manufacturing, we need designated and predictable funding for development and advancement of new solutions – in good interaction with research.
The development and deployment of solar panels, and the price drop that followed, could not have been brought about by a carbon price designed for all climate measures, or by a general funding that was equal for all renewable energy sources. To start with, immature technologies will typically have very high costs, and these costs will vary from one technology to another. In order to get development underway, funding needs to be adjusted to the cost level of each technology, and it should be reduced as the technology becomes cheaper.
Today, offshore wind power costs around €0.15–€0.18 per kWh. If this technology is to be developed further, the developers must be ensured income at this level.
When the goal is to develop specific technologies or solutions, instruments that directly target this goal will prove most effective. Instruments must be predictable and ensure the necessary profitability for investors.
More limitations of carbon pricing
One challenge of carbon pricing is that (private) companies often require high rates of return on investments. A high required rate of return means the companies place little emphasis on carbon prices in the distant future when considering emission-reducing measures. If there is also high uncertainty regarding future carbon prices, investors will be even less willing to stake their money on long-term emission-reducing measures. This applies to regular investments as well as investments in research and development (R&D).
Barriers that limit profitable energy efficiency must also be overcome using targeted measures.
A carbon price that only applies to some countries, could make industries with high emissions move to countries without carbon prices. This is called carbon leakage, and it might at worst lead to increased global emissions. When there is a need for a product (e.g. aluminium) in the future, policy instruments should be combined («carrot and stick») so that the industry is encouraged to stay, cut emissions where possible and develop more climate-friendly manufacturing technology. The latter is particularly important, as more climate-friendly technology may later help reduce emissions throughout the relevant industry in all countries.
We need to develop an energy system that is robust, emission-free and affordable
The energy sector represents approx. two thirds of global greenhouse gas emissions. It is possible to reduce the emissions in the energy sector significantly towards 2050. If nothing is done, however, emissions will see a steep increase as a result of large economic growth globally. It is therefore very important to succeed in radical emission reductions in the energy sector. Building coal power plants and other infrastructure that entail high CO2 emissions for many decades must be avoided, and it is important that we start developing solutions that can decarbonize our energy system completely.
Electricity will be a more important energy carrier in the future because we use electricity for more and more purposes, and because electricity will be put to use in new areas to reduce CO2 emissions throughout the energy sector. It is easier to bring down emissions from power generation than from many other types of energy use. In parallel with declining emissions in the power sector, electricity can increasingly be used for transportation and heating. The heating and transport sector can get rid of its CO2 emissions by using emission-free power and biomass/biofuels.
Traditionally, fossil power generation has ensured the necessary balance between consumption and generation. Now, fossil power will gradually be replaced by emission-free power, which is much harder to regulate, and which often varies depending on the weather. There will be hours when solar and wind facilities generate almost no power, and there will be times when they generate much more power than current consumption requires. The challenge is to develop an emission-free power system that provides enough power in every situation. Ideally, we should also utilise the large surpluses that will occur at certain times.
In order to bring emissions down to zero and also ensure supply in all situations, we need to develop new types of emission-free power that can cover consumption when the wind and sun have little to contribute. We will need new flexibility in generation and consumption, including technologies for storing energy. A stronger transmission grid must be built connecting areas and countries to alleviate local imbalances, and flexible heating solutions and intelligent control systems must be developed. The interaction of all these parts must be coordinated by suitable market solutions and regulations that exploit the benefits of trade between countries. This is a process of restructuring and learning where we know the general direction, but many of the solutions will have to be developed along the way.
Energy consumption is significant in the transport and heating sector. Heating (including the industrial use of heat) represents half of the energy end use in Europe. Using much more electricity in these two sectors will contribute to phasing out fossil fuels, better utilisation of renewable power and a more robust energy system:
Transportation. Vehicles with electric motors can be run on electricity from batteries or electricity generated from hydrogen in a fuel cell. Hydrogen can be made from electricity. The charging of batteries and the production of hydrogen could mainly take place during periods when the power system has plenty of capacity. Both batteries in electric cars (and elsewhere) and hydrogen solutions can give power back to the grid, when power becomes very scarce and prices are high. If the use of batteries and/or hydrogen becomes widespread, this contribution to flexibility could make a big difference.
Heating. In heating plants (e.g. district heating and smaller facilities), many countries use a lot of fossil energy. This could be replaced by electricity (in electric boilers) during periods with a surplus of renewable power (low prices) and by biomass or biofuel in other situations. Heat pumps will usually be in operation when there is a need for heat, but they may be turned off for a few hours if there is a scarcity of power (high prices). With a heat storage system (e.g. a large water tank), flexibility can be further increased.
Electrification of the transport and heating sector is an example of how we need to think in new ways and view investments in the various sectors in a larger context.
Various solutions and technologies will compete in contributing to an economical and secure supply. The usefulness of each technology will depend on which other solutions are developed and how much they cost. Making fundamental changes to the energy system leads to great uncertainty. In order to limit this uncertainty, it is important that authorities promote research, development and advancement of new, future-oriented solutions, to give us the clearest possible picture of the potential in different areas and the best possible platform for making long-term investment decisions.
Emissions in the power sector can be brought down a lot by replacing coal with gas, and by developing wind and solar power. But in order to reach our goal of zero emissions, we will have to develop many new zero emission solutions. Since it often takes several decades to develop new solutions and bring costs down, it is important that efforts in this area are intensified now.
Societal learning processes are important
A cost-effective and powerful climate policy requires development of laws and regulations, institutions, markets and attitudes. This involves learning processes that take time. An example of this is the deregulation of power markets in Europe. England and Wales deregulated their power market as early as 1989 and Norway followed in 1990. Other countries followed throughout the ‘90s. A well-functioning European power market is important in promoting efficient use of resources and security of supply. It will be even more important in the future, when more variable power generation increases the need for trade. For this reason, the EU has for many years been aiming to establish an efficient, common market for power in Europe, but has still not quite reached this goal. Developing suitable rules and organisations is difficult and can take a long time, in particular when several countries are involved.
Attitudes often change in interaction with changes to laws, institutions and policy. Prior to reforms, the public is often sceptical, even though the reforms offer great benefits when viewed as a whole. An example of this is the absence of congestion charges in most cities. The value of less time wasted in heavy traffic could in itself make congestion charges highly beneficial to society. In addition, the local environment would improve, CO2 emissions would decline and there would be better opportunities to develop public transport options on roads. Economists largely agree that congestion charges are a good solution for cities, but even so, few cities have actually introduced them. Often, reforms receive more support after implementation. In Stockholm, for instance, the population voted in favour of keeping congestion charges after a trial period.
Successful reforms in one place can make it easier to gain support for comparable reforms elsewhere. This is both because we can learn from what others have done and can be confident of good results, and because it is easier to argue for a model that has been proven to work in practice. Success breeds success. Those who lead the way contribute to increased cost-effectiveness globally.
Alliances of motivated countries can drive technology development forward
A number of countries may have significant self-interest in developing solutions that also result in lower CO2 emissions. For countries with big net imports of oil and gas, development of renewable energy and increased energy efficiency could encourage developments within industry and technology on a domestic level, lead to lower import bills, increase employment and reduce the risk of supply issues. In areas with serious pollution problems, the transition to emission-free power generation and electrification of transport could offer significant environmental rewards.
When several countries have a strong self-interest in developing new solutions and also have large industrial and research capacity, effective alliances can be formed. Together, these countries can obtain the desired developments in technology and industrialisation.
By coordinating efforts and sharing expenses, countries could be motivated to do more than they otherwise would have done to develop new climate solutions. This makes emission reductions cheaper.
When the cost of emission cuts goes down, it becomes easier to bring other countries on board with ambitious emission reductions.
Source: Energi Klim. Reproduced with permission.