Analysis of Interactions Between EU's RES Support and ETS by Pablo del Rio

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Analysis by Pablo del Rio from the Environmental Economics group at the Institute of Public Policies and Goods explores the interactions between the EU's renewable energy support and Emissions Trading System (ETS). The study presents contrasting mainstream and alternative economic views on the impact of Renewable Energy Sources (RES) policies on carbon pricing, mitigation alternatives, and efficiency. Del Rio argues for a balanced policy mix and dynamic efficiency considerations to achieve environmental and economic goals effectively.

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Are the interactions between the EU's RES support and ETS really so negative? Pablo del R o Environmental Economics group Institute of Public Policies and Goods, Consejo Superior de Investigaciones Cient ficas pablo.delrio@csic.es Ottawa, 2nd October 2015

Analysis based on Journal publications: DEL R O, P. (2009). Interactions between climate and energy policies: the case of Spain . Climate Policy 9(2), 119 138 DEL RIO, P. (2012). The dynamic efficiency of feed-in tariffs. The impact of different design elements. Energy Policy 41, 139-151. DEL R O, P., HOWLETT, M. (2013). Beyond the Tinbergen Rule in Policy Design: Matching Tools and Goals in Policy Portfolios. Annual Review of Policy Design 1, 1-16. DEL R O, P. (2014). On evaluating success in complex policy mixes: the case of renewable energy support schemes. Policy Sciences 47(3) , 267-287 HOWLETT, M., PUNG HOW, Y., DEL RIO, P. (2015). The parameters of policy portfolios: verticality and horizontality in design spaces and their consequences for policy mix formulation. Environmental and Planning C: Government and Policy (forthcoming). EU-funded projects: BEYOND2020 project. http://www.res-policy-beyond2020.eu/ TOWARDS2030 project. http://towards2030.eu/ AURES. http://aures.eu/

Index THE MAINSTREAM ECONOMIC VIEW: 1) RES targets crowd out cheap mitigation alternatives. 2) Conflicts due to the negative impact on the carbon price. THE ALTERNATIVE ECONOMIC VIEW: 3) A policy mix is needed for strictly economic reasons. Insights from innovation economics and SI. Insights from Public Choice and political economy. Model simulations. 4) Beyond a narrow and static perspective on efficiency. Dynamic efficiency. Different goals and assessment criteria. 5) The empirical evidence does not support a negative interaction. 6) The role of coordination, instrument choice and design elements. CONCLUSION.

THE MAINSTREAM ECONOMIC VIEW 1) RES targets crowd out cheap mitigation alternatives. Dedicated RES-E policy should not be added to an ETS. Such combination is: Ineffective. CO2 emissions covered under the cap. Inefficient. Higher compliance costs. Picking winners. Technology neutrality.

THE MAINSTREAM ECONOMIC VIEW 2) Conflicts due to the negative impact on the carbon price. Green promotes the dirtiest (B hringer and Rosendahl 2009) RES-E generation as a result of deployment policies results in lower CO2 prices which benefit the most carbon-intensive fossil-fuel generators. This lower price decreases investments and/or innovation efforts aimed at low emission technologies in sectors covered by the ETS.

THE ALTERNATIVE ECONOMIC VIEW 3) A policy mix is needed for strictly economic reasons. 3.1. Insights from innovation economics and SI. An environmental externality. An innovation externality. A diffusion externality. Multiple market failures require multiple instruments. A policy with a CO2 price could only internalize the environmental externality, not the other two. ETS: insufficient incentive for innovation. Supply-push and demand-pull.

THE ALTERNATIVE ECONOMIC VIEW 3) A policy mix is needed for strictly economic reasons. 3.2. Insights from Public Choice and political economy. Are credible carbon prices at sufficiently high levels politically feasible? Climate policy: temporal asymmetry of benefits and costs. Not-in-my-term-in-office syndrome. Lobbyism: influence of powerful interest groups (e.g., the incumbents in the energy sector).

THE ALTERNATIVE ECONOMIC VIEW 3) A policy mix is needed for strictly economic reasons. 3.3. Model simulations. Unless meaningful/binding emissions reductions are agreed at a global level, a second-best strategy based on strong support for RETs will lead to lower costs than in the case of a delayed climate agreement without early deployment of RETs (Bauer et al 2012). Strong RET deployment may provide a hedge against low stabilization targets (Lecuyer and Quirion 2013). if there is a risk that the carbon price drops to zero it can be socially beneficial to implement an additional instrument encouraging emissions reduction (RES support).

THE ALTERNATIVE ECONOMIC VIEW 4) Beyond a narrow and static perspective on efficiency. Dynamic efficiency. A cost-effective approach to achieve short-term targets: not necessarily the most cost-effective approach to achieve 2050 targets. Model simulations: promoting technological changes may be costly in the short term, but cheaper in the long-term (Huber et al 2007). Putting technologies on the shelf vs. taking technologies from the shelf (Azar and Sanden 2011).

THE ALTERNATIVE ECONOMIC VIEW 4) Beyond a narrow and static perspective on efficiency. Different goals and assessment criteria. Policy makers take several assessment criteria into account when implementing energy policies. Combinations may be justified if a less efficient instruent is more politically feasible. Policy-makers have other goals apart from CO2 mitigation. Combinations of instruments may be justified if they address different goals, which cannot be achieved with only one instrument. The combination : higher compliance costs with the CO2 target but not necessarily higher costs to reach all the goals jointly.

THE ALTERNATIVE ECONOMIC VIEW 5) The empirical evidence does not support a negative interaction The socioeconomic benefits of adding a RES target to an ETS might compensate the additional efficiency costs. Modest impact of RES on the CO2 emissions reductions and low ETS prices in the last decade with respect to other factors: Ellerman 2013, Ellerman and Buchner 2008, Spencer et al 2014, EC 2014.

THE ALTERNATIVE ECONOMIC VIEW 6) The role of coordination, instrument choice and design elements. Coordination. Ex-ante coordination: the problem of reducing CO2 emissions as a result of RES-E deployment would be mitigated and a lower carbon price would not result. Have the targets been coordinated in the EU?

THE ALTERNATIVE ECONOMIC VIEW 6) The role of coordination, instrument choice and design elements. Instrument choice. The results of the interactions depend on whether the instruments are quantity-based or price-based. RES-E support instruments: The negative interaction is due to an effective reduction of the stringency of the CO2 cap as a result of RES-E generation. TGCs have empirically shown to be less effective than FITs Coordination between the RES-E and CO2 targets are easier under a quantity-based RES-E instrument than under a price-based one. CO2 mitigation instruments: Negative interactions are mitigated with a carbon tax.

THE ALTERNATIVE ECONOMIC VIEW 6) The role of coordination, instrument choice and design elements. Design elements. The specific impacts of a RES-E support instrument are mediated by the design elements of the instruments: a remuneration cap in FIPs. ETS: a floor price.

CONCLUSIONS The coexistence of the RES target with the EU ETS has received considerable criticism in the past. Such criticism is flawed if different approaches in the economic literature and not only a narrow, short-term perspective of static efficiency are considered. Several implications at different levels.

CONCLUSIONS At the analytical and methodological level: A plea for methodological pluralism need to combine different economic perspectives. A broader, multidisciplinary economic analysis of the climate and energy policy mix. Insights from innovation studies and political economy approaches are crucial in understanding why different policies are combined.

CONCLUSIONS Regarding policy implications, 1) The policy mix of an ETS and RES targets is clearly justified. The existence of different market failures, goals and assessment criteria means that combinations are required. In contrast to the mainstream view: take into account the non-CO2 benefits of RES as the main goal of its deployment and consider the CO2 emissions reductions as its side effect, adapting the CO2 cap accordingly.

CONCLUSIONS Regarding policy implications 2) The mainstream view: RES deployment has a negative impact on carbon prices. However, since RES-E deployment has a depressing effect on the carbon price, RES-E support could make it more politically feasible to implement more stringent CO2 targets.

CONCLUSIONS Regarding policy recommendations, 3) Both types of policies (an ETS and dedicated RES support) could mutually reinforce each other, rather than conflict. The carbon price in an ETS would reduce the amount of funds devoted to RES promotion in a dedicated RES policy. And dedicated RES support would put currently expensive technologies on the shelf to achieve substantial l/t emissions reductions at low costs.

CONCLUSIONS Policy combinations: not a panacea. Combinations bring problems, including regulatory capture, overlaps and interactions (conflicts). However, rather than restricting the discussion to a uni- dimensional problem, this calls for an integrated approach to climate and energy policy. Therefore, the issue is not whether targets and instruments should be combined, but rather how the policy mix should look like The mix: Efficient, effective, socially acceptable and politically feasible. Appropriate balance between demand pull and technology push policies and, in particular, between support for R&D and deployment.