This post originally appeared on Robert Stavins’s blog, An Economic View of the Environment.
The European Union is considering scrapping the use of binding renewable energy targets as part of its global climate change policy mix that will extend action from 2020 to 2030. The Financial Times reported that this move – presumably due to concerns over high European energy costs during the ongoing economic turndown – will “please big utility companies but infuriate environmental groups.” The International New York Times framed the story in similar ways.
The press coverage has missed the very important reality that this potential decision by the European Commission will be good news both for the economy and for the environment. The fundamental reason is that in the presence of the European Union’s Emissions Trading Scheme (EU ETS) – its pioneering, regional cap-and-trade system that covers electricity generators and large-scale manufacturing – the “complementary” renewables mandate conflicts with, rather than complements other policies. Without the renewables mandate, the cap being planned for the EU ETS will be achieved at lower cost and will foster greater incentives for climate-friendly technological change.
Some Background
In 2007, the European Union established three sets of targets and related policies: (1) a 20% reduction in greenhouse gas (GHG) emissions below 1990 by 2020, to be achieved by the cap-and-trade system; (2) a 20% target for 2020 for the share of Europe’s electricity consumption coming from renewable resources; and (3) a 20% improvement in energy efficiency by 2020. These are the so-called “20-20-20 targets” for the year 2020. A wonderful slogan, but a flawed policy, because of perverse interactions among the three elements.
Europe is well on its way to achieving the first goal, with emissions now reduced by about 18%, and it is now looking to establish targets for the subsequent decade. At the same time, Europe is continuing to experience its greatest economic downturn since the Great Depression, while European electricity prices have risen by some 40% since 2005 (while the U.S. economy rebounds, with electricity prices actually having fallen – mainly because of low natural gas prices). Therefore, there is great concern in European capitals and at EU headquarters in Brussels about high energy prices damaging the international competitiveness of European industry.
Plans for 2030
Although the planned, new emissions targets for 2030 may increase stringency from the currently mandated 20% cut by 2020 to perhaps a 35% or even 40% cut by 2030, it now appears that the European Commission may drop specific binding constraints on the share of electricity generated from renewables. Why would this elimination of the renewables target be good news not only economically, but environmentally as well?
Perverse Policy Interactions
Under the umbrella of a cap-and-trade scheme, unless a complementary policy addresses some other market failure that is not addressed by the price signals of the cap-and-trade mechanism (such as the principal-agent problem thought to retard energy-efficiency adoption decisions in renter-occupied properties), these complementary policies that are under the cap will either be irrelevant or counter-productive. Here is the basic logic.
- Under the umbrella of the EU ETS, the cap will be achieved cost-effectively (at minimum aggregate cost) if the cap is binding, which it surely will be with the new 2030 targets. (Cost effectiveness is achieved because the CO2 cap-and-trade mechanism – like a carbon tax – provides incentives for all sources to control at the same marginal abatement cost.)
- A “complementary policy” under the cap, such as a renewables target, will either be irrelevant (if it is not binding) or, if it is binding, any additional emissions reductions achieved in the electricity sector under the complementary measure (the renewables program) will cause electricity generators to have additional allowances they do not need. And they will not tear up those allowances, but will sell them to other sources, such as those in other sectors. Hence, emissions in those other sectors will be greater than they otherwise would have been, completely neutralizing the emissions-reduction impact of the renewables policy.
- So, in the presence of the over-arching EU ETS, the renewables target has no incremental impact on CO2 emissions. On net, the emissions reduction due to the renewables policy is zero. But the bad news does not stop there.
- With more emissions reductions in the electricity sector and less in other sectors than under the cost-effective allocation of control achieved by the cap-and-trade system on its own, aggregate abatement costs are actually increased. Marginal abatement costs are no longer equated, and the allocation of control responsibility is no longer cost-effective. There is too much abatement in the electricity sector, and not enough in some other sector or sectors. Costs are driven up.
- Hence, nothing is being accomplished in terms of CO2 emissions with the renewables policy, and costs have been driven up! Wait, there is more.
- If some emissions reductions are being achieved by the binding renewables policy, then there is less demand overall for tradable allowances. Since the supply of allowances has not changed, this means that allowance prices are inevitably suppressed; and low allowance prices mean less induced climate-friendly technological change over time.
The Path Ahead
That is the perverse trifecta of a complementary renewables policy under the umbrella of a cap-and-trade scheme, such as the EU ETS: no additional emissions reductions are achieved; but costs are driven up; and technological change is retarded.
If the European Commission decides to eliminate its renewables targets as it proceeds with more stringent emissions targets for 2030 under the EU ETS, it will be good news both for the economy and the environment.
