Abstract
There are two good reasons for government intervention in the electricity sector: the monopolistic bottleneck formed by the electricity grid and the environmental impact of many power generation technologies. The monopolistic bottleneck is first characterised as a natural monopoly with sunk costs. Among the various alternatives for government intervention, the focus is laid on non-discriminatory grid access, unbundling and price regulation. Regarding incentive (or performance-based) regulation, both the theoretical benefits and major practical challenges are highlighted. Also, principles of network pricing are reviewed, contrasting the theoretical concept of Ramsey pricing with practical network tariffs including base, capacity and energy charges. In an application example, the implications of the concepts are illustrated. Environmental damage is first related to the economic concept of externalities. The link of specific emissions like CO2 and nitrogen oxides (NOx) to environmental impacts like climate change and acidification is then established. Emissions may be reduced through pre-, post- and in-combustion technologies. In the context of climate change mitigation, these are relevant for carbon capture and sequestration (CCS). Life cycle assessment as a tool for a comprehensive environmental analysis is shortly introduced. Subsequently, the focus is on policy instruments for combating climate change. Emission taxes as price-based instruments and certificate-trading systems as quantity-based instruments are introduced as first-best instruments as opposed to command and control or incentive-based instruments. Detail is then provided on the EU emissions trading system (EU ETS) and its practical challenges as well as on renewable support mechanisms that may take various forms.
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Notes
- 1.
Note that economies of scale, defined through: \(C\left(\lambda \cdot q\right)<\lambda \cdot C\left(q\right)\) for λ > 1, are a sufficient condition for subadditive costs, but not a necessary one over the whole output range. Similarly, marginal costs below average costs over the entire output range are another sufficient but not necessary condition for subadditive costs.
- 2.
More precisely, this should be qualified as a (monetary) willingness to accept service interruptions (cf. e.g. Horowitz and McConnell 2003 for the distinction between willingness to accept and willingness to pay).
- 3.
- 4.
We use hourly values to keep the numbers simple. Those can easily be transformed into annual numbers by multiplying with the number of hours of a year, i.e. 8760. As the basis of our calculations is an average hour, we also disregard the distinction between capacity, energy and other grid price components as usual in simple models of Ramsey pricing.
- 5.
Note that we have considered wholesale market prices to be exogenously given, independent of generator decisions. This is obviously not true in reality. Yet an endogenous treatment of market equilibrium would require a substantial extension of the classical Ramsey pricing model, making use of the market equilibrium models introduced in Sect. 7.1.
- 6.
Grids with high air-conditioning and cooling loads may be an exception to the rule, if the load peak coincides with periods of high solar radiation and hence high PV infeed. The so-called duck curve observed in California (cf. e.g. IEA 2019) yet suggests that even in such grids the coincidence is far from being perfect: in California, the peak in electricity consumption occurs in the early evening, when people return from work and turn on air-conditioning and other appliances at home.
- 7.
The “tragedy of the commons”, i.e. the overgrazing of common land, is described in a seminal paper by Hardin (1968).
- 8.
These preferences will differ from person to person and may vary over time.
- 9.
Besides, regional effects on climate are known (e.g. due to local reduction of wind speeds), while global impacts are not (yet) identified.
- 10.
Natural activities causing changes of the climate are, e.g., variations of solar cycles.
- 11.
Again a conflicting effect is observable here: SO2 reduction via limestone scrubbing leads to an increase of CO2 emissions.
- 12.
Especially enhanced oil recovery (EOR) and enhanced gas recovery (EGR).
- 13.
Another possibility to produce negative emissions is the use of direct air capture (DAC).
- 14.
Only parts of the whole life cycle are considered in so-called cradle-to-gate or gate-to-gate analyses.
- 15.
Note that transaction costs is used in the broad economic sense of costs related to a market transaction. These include here among others the cost for negotiating an agreement, for measuring pollution quantities and for enforcing the pollution limits.
- 16.
In principle such a trading approach can be used for all kinds of environmental goods, e.g. for land use (cf. Walz et al. 2009).
- 17.
It has to be mentioned here that in reality these targets are often the result of intense political negotiations.
- 18.
There is a broad discussion in environmental economics about the relative benefits of price- versus quantity-based instruments under uncertainty starting with Weitzman (1974).
- 19.
Factors of production are inputs needed to be able to produce the output of the company. In Economics usually the three factors of production land, capital and labor are differentiated, in Business Administration much more detailed classifications exist (cf. e.g. Dyckhoff and Spengler 2010, p. 16-19).
- 20.
This does not hold true for contingent allocation rules. A scarce production factor will not necessarily be fully priced in by a company if the allocation in future trading periods depends on the actions of the company still to be taken, e.g. if the reference period of a later allocation period is updated and incorporates the current year the production today might influence the allocation in future (cf. Weber and Vogel 2014).
- 21.
As the environmental problem that this emission trading system is aiming at is a global one, limitations regarding participating countries should rather be avoided.
- 22.
Temporarily the scope regarding the aviation sector was reduced to flights between airports in Europe.
- 23.
To fulfil the national targets, the ESR provides different flexibility mechanisms, e.g. it is allowed that member states buy “surplus emission reductions” from other member states.
- 24.
This renewable levy covers the gap between electricity wholesale market prices and the renumeration paid.
- 25.
If the target with regard to renewable energies is given for all renewables together, the support scheme is called technology-neutral, which can lead to high profits for the producers of renewables if the renewable cost curve is rather steep (cf. e.g. Haas et al. 2011).
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Weber, C., Möst, D., Fichtner, W. (2022). Regulation: Grids and Environment. In: Economics of Power Systems. Springer Texts in Business and Economics. Springer, Cham. https://doi.org/10.1007/978-3-030-97770-2_6
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