Question

1. In terms of efficiency, what justifies subsidies for R&D in renewable energy? What justifies subsidies for electricity generation from renewable energy? (Response can be in list form here.)

2. 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.)

3. How does emissions trading (cap-and-trade) work and what is the benefit of its approach?

4. Explain the reason for revenue decoupling and how it works. (Hint: Explain how revenue decoupling is a deviation from traditional rate-of-return/cost-of-service regulation).

5. Deregulation of electricity markets leads to different electricity prices on different days and at different times of a day. Using a supply-demand diagram, explain why electricity prices tend to be volatile under such pricing. (Hint: how would you characterize the price elasticity of supply and demand at peak periods?)

Answer 1

1) What justifies subsidies for R&D in renewable energy? What justifies subsidies for electricity generation from renewable energy?

1. Without subsidies renewable energy the price for the electricity produced via these technologies would not be competitive versus the electricity produced using fossil fuel.

2. Given the instability of oil price, governments that are not oil-producing might be better off minimizing or even eliminating their dependency on fossil fuels which can help them plan their economic policy with less unpredictable factors.

3. In order for the green energy price to become competitive there has to be funding for research and development. Thus the renewable energy subsidies are essentially a way to invest in the R&D of efficient renewable energy production methods that will eventually be in parity or even cost less than fossil fuel om the future.

4. We always tend to forget that fossil fuel supply is finite and at some point the earth’s reserves will be depleted. Some estimate that we will reach this point within the next 40 to 50 years. Therefore we should get prepared well ahead In order not to find ourselves in the same position again down the road. Thus the wise thing to do is to invest into energy sources that are not finite and are sustainable such as solar, wind, hydro power and biomass.

5. Another significant variable into our decision of going after for a sustainable energy model for our economies is the pollution that the usage of fossil fuels is causing. The destruction of the environment has an impact on our quality of lives as well as on our health for the current and the future generation. This sort of impact carries inevitably also an economic cost that we either deal with in the short run or in the long run, personally or as country.

II. How does emissions trading (cap-and-trade) work and what is the benefit of its approach?

Cap and trade reduces emissions, such as those from power plants, by setting a limit on pollution and creating a market. Cap and trade is a powerful approach to reducing pollution in our atmosphere.

The cap on greenhouse gas emissions is a limit backed by science. Companies pay penalties if they exceed the cap, which gets stricter over time.

The trade part is a market for companies to buy and sell allowances that permit them to emit only a certain amount. Trading gives companies a strong incentive to save money by cutting emissions.

Benefits:

1. Emissions trading achieves the environmental objective – reduced emissions – at the lowest cost.

2.Emissions trading is better able to respond to economic fluctuations than other policy tools.

3. Emissions trading incentivizes innovation and identifies lowest-cost solutions to make businesses more sustainable

4. Cap and trade has proven to be an effective policy choice.

5. Emissions trading can provide a global response to a global challenge

6. As emissions trading spreads around the world, there are a number of opportunities to link systems, which enhances their effectiveness and reduces costs.

III.Revenue Decoupling:

– Severing the link between profits of service providers (LDC in gas, local service provider

in electric) from sales.

– Separating the collection of required revenues to cover the cost of fixed infrastructure from sales by the utility.

– Does not discriminate between the reasons(weather, economic growth, energy efficiency) for which required revenues where over- or under-collected.

-Revenue decoupling implicitly imposes a revenue cap on the utility for the provision of fixed infrastructure services

– Separate from the commodity gas or electric power

– Cap on total revenue to cover the entire fixed infrastructure service which assume changes in customer base do not lead to changes in required infrastructure

– Cap revenue per customer acknowledging changes in customer base require changes to the infrastructure base and hence required revenue