1. What is the first-best policy instrument to mitigate climate change in the energy industry? How...

1. What is the first-best policy instrument to mitigate climate change in the energy industry? How does the performance of subsidies for renewable energy compare with the first-best policy? (Response can be in list form here.)

2. What is the first-best time-varying pricing solution and why? With the growth of renewable energy, what does it additionally aim to address?

Expert Solution

Four main criteria are used to evaluate policies and instruments: environmental effectiveness, cost effectiveness, distributional effects, including equity, and institutional feasibility
All instruments can be designed well or poorly, and be stringent or lax. In addition, monitoring to improve implementation is an important issue for all instruments. General findings about the performance of policies are:

Integrating climate policies in broader development policies makes implementation and overcoming barriers easier.
Regulations and standards generally provide some certainty about emission levels. They may be preferable to other instruments when information or other barriers prevent producers and consumers from responding to price signals. However, they may not induce innovations and more advanced technologies.

stabilization.
Some corporations, local and regional authorities, NGOs and civil groups are adopting a wide variety of voluntary actions. These voluntary actions may limit GHG emissions, stimulate innovative policies, and encourage the deployment of new technologies. On their own, they generally have limited impact on the national or regional level emissions

For a wide range of parameters, using permanently renewable energy subsidies instead of carbon prices to achieve mitigation implies disastrous welfare losses: they are multiple times higher than first-best mitigation costs under a carbon price policy.15 Although renewable energy becomes cheaper due to subsidies and learning-by-doing, it is difficult to crowd out fossil energy supply. Resource prices decrease due to the supply-side dynamics of fossil resource extraction. And the good – but not perfect – substitutability between energy technologies requires to maintain a high price differential between renewable and fossil energy. Achieving the cost break-through is therefore not sufficient. If the substitutability between fossil and renewable energy is high, the second-best costs decrease. Hence, a sectoral policy approach with renewable energy subsidies in the electricity sector (where technologies are almost perfect substitutes) and carbon taxes in the industry sector may decrease the second best-costs.

An extensive sensitivity analysis revealed that these high costs are not accidentally due to the chosen parametrization but prevail for a wide rage of parameter. It further shows that mitigation costs are correlated with the second-best costs of the renewable energy subsidy. For example, a low fossil resource base and low renewable energy generation costs reduce the second-best costs – though the mitigation costs fall dramatically in these cases and a carbon pricing policy has thus a marginal impact on the economy. The political economy concerns due to carbon pricing may therefore be low for these parameter settings.

Permanent renewable energy subsidies are not only an expensive choice to reduce emissions. They are also a very risky instrument because small deviations from the second-best optimum lead to strong responses in emissions and welfare. If the subsidy was set 2% below its optimal value, emissions would increase by 18%. In contrast, if the subsidy was set 2% above its optimal value, welfare would decrease by an additional 3% due to an over-ambitious emission reduction.

There are, however, attractive alternatives to a pure carbon pricing policy. The feed-in-tariff and the carbon trust policy cause only small additional costs (0.8% and 0.6%, respectively) while they limit energy price increases – as side effect – to 60%. Relaxing the income-neutrality constraint of feed-in tariffs and the carbon trust policy, a freely adjustable renewable energy subsidy (that complements a carbon price) can reduce energy price increases to any desired level at even lower costs: A 50% maximum energy price increase can be achieved at 0.1% BGE losses and a 0% maximum price increase at 1.1% BGE losses.

Renewable energy subsidies are an efficient policy instrument when they address market failures directly associated with renewable energy technologies or markets.16 This article emphasized that beside this aspect, renewable energy subsidies might be an important additional instrument to address the serious political concerns of carbon pricing regarding energy price impacts. However, if renewable energy subsidies aim to reduce carbon emissions because carbon prices are entirely missing, welfare losses can be substantial. In particular, if mitigation imposes a severe constraint on the economy – i.e. if fossil resources are abundant and cheaply available compared to renewable energy generation – a subsidy policy creates high additional consumption losses. The results of this paper show that without some form of carbon pricing, pragmatic renewable energy policies may turn out to be a fatal aberration for mitigating global warming as costs explode. In order to achieve mitigation targets at low costs, there seems to be no way around direct or indirect carbon pricing – at least in the long run.

2)

At most times of the year, much of the electricity generating capacity in the United States stands idle. In fact, on average we use less than half of the available capacity. That’s because the electric power system is built to handle demand at its peak – those few sweltering summer days when everyone’s AC is running full blast. What utilities pay for power at those times of peak demand drives up the price we pay for electricity around the clock and all year long. One way to reduce spikes in demand is with rates that vary by time of use. By pricing electricity higher at times when demand typically peaks, consumers large and small have an incentive to reduce their electricity use when it matters most to the power grid – reducing the costs of the system overall.

Time varying rates (TVR) come in four general categories: Time-of-Use (TOU), Critical Peak Pricing (CPP), Peak Time Rebate (PTR) and Real Time Pricing (RTP). TOU is the most basic pricing scheme which consists of pre-defined peak and off-peak time periods with a tiered pricing structure for each. RTP is the most sophisticated and most variable, with hourly prices determined by day-ahead market prices or real-time spot market prices for electricity. In between are CPP, in which fixed rates are punctuated by higher rates charged during peak demand events (announced in advance), and PTR, which is essentially the reverse – customers receive a rebate when they reduce their usage during a peak demand event.

TVR is not a new concept. Many large commercial and industrial customers are already on TVR. But it is less common for residential customers. According to the EIA, less than 3% of residential customers participate in TVR programs.

In the late 1980s and 1990s, there was a wave of TVR experiments run across the country with promising results, but they never caught on. There was some customer backlash, and furthermore, utilities had little incentive to offer TVR: they feared losing revenue. Also, at the time TOU metering was relatively expensive and the difference in cost between baseload and peaking plants was not as significant.

Since then, peak demand has grown much faster than overall demand, and the cost of meeting demand peaks has driven up costs overall. Now, with enabling technologies like advanced metering, and advanced energy companies developing energy management products and services that give customer the information and tools to respond to price signals, more states are beginning to implement TVR.

In AEE’s PowerPortal database we have almost 500 TVR rates, for residential and small and medium commercial customers, of which almost 85% are TOU, under 10% are CPP, under 5% are PTR and around 3% are RTP. Arizona leads the nation in TVR participation, accounting for 30% of overall TVR participation. Here are some examples of recent actions, as TVR seems poised for takeoff:

As part of a broader grid modernization effort, the Massachusetts Department of Public Utilities adopted a new default time varying rate structure, with utilities required to file new rate plans by August 5, 2015. All residential customers on basic service would be placed on Time-of-Use (TOU) pricing as the default: a tiered rate with special higher pricing during specified peak demand times, and lower pricing during the rest of the day. Customers will have the ability to opt-out and choose a flat rate instead, though with a Peak Time Rebate (PTR), so even flat-rate customers have an incentive to curb peak time use.

The Tennessee Valley Authority, the nation’s largest federally owned electric utility, is also considering adding TVR options for their nine million customers in Tennessee and portions of Alabama, Mississippi, Kentucky, Georgia, North Carolina and Virginia. The TVA board will vote in August on the new rates and, if approved, they could go into effect as soon as this October. TVA President and CEO Bill Johnson said, “Overall, we must be able to efficiently match power supply to changing demands over the long term and from day to day.”

The California Public Utilities Commission (CPUC) also has an open proceeding to examine the state of TVR and to establish potential pathways from the existing fixed tiered residential rate structure towards one that utilizes TVR. CPUC Staff have proposed a transition to default TOU rates starting in 2018, once statutory restrictions are lifted. The CPUC is expected to issue a proposed decision on the rate design portion of the proceeding sometime this month.

In Illinois, the Citizens Utility Board (CUB) and the Environmental Defense Fund (EDF) are asking the Illinois Commerce Commission to require the state’s two largest investor-owned utilities to offer TOU rates. In the filing, they propose a three block structure that would look like the chart below.