Energy policy is key at Davos

January 28, 2011

— Laurens de Vries and Emile Chappin are researchers at Delft University of Technology. Much of their research is funded by the Next Generation Infrastructures Foundation. The opinions expressed are their own. —

One of the key issues being debated at this year’s World Economic forum is energy policy, particularly how we best make the transition to clean energies of the future to mitigate global warming.

Nuclear power, like energies of the future — wind, solar, carbon capture — must rely on government subsidies to be economically viable. This is true of virtually all alternatives to fossil fuels, which is a consequence of the fact that the social costs of the pollution that they cause is not included in the price people pay for them.

As a result, governments deploy specific policies to foster renewables, nuclear energy and/or carbon capture. More often than not, these policies are made independently from each other, and are subject to frequent change. However, this lack of coherence and stability is harmful to the very goals that these policies are aimed to achieve:
•       Last month, the UK Government announced the biggest shake-up of the electricity market since privatisation 20 years ago.  The so-called ‘renewables obligation’, which has helped the country develop one of the world’s largest offshore wind industries, will be replaced in a move that is predicted to cause at least short-term investor uncertainty.

•       The German opposition, the SPD, have called for a referendum to block Angela Merkel’s decision to extend the lifespan of Germany’s nuclear power plants. The policy, which may yet be blocked in the upper house of the German parliament, the Bundesrat, would bring €6.4bn a year to the energy companies, part of which would be re-distributed to renewable technologies.

•       The Netherlands Government has recently reduced the country’s own target from 20percent to the EU target of 14percent renewable energy in 2020 and is in the middle of changing its renewable energy policy for the fourth time in twelve years, changing its financing and the technologies supported.

•       The Spanish government is cutting renewable energy subsidies drastically, wreaking havoc on the formerly blossoming Spanish renewable energy industry.

Most forms of renewable energy need subsidies to be viable in current markets. However, the cost of renewable energy can be reduced through innovation and economies of scale in the supplying industries, such as wind turbine manufacturers. The prerequisite for both innovation and economies of scale is security of demand — something which can only be delivered by a stable, long-term energy policy. Without a consistent government policy, large-scale, efficient renewable energy will not develop and costs will remain higher.

Nuclear energy and coal plants with carbon capture and storage are looked upon quite differently. They are built by different companies and have different supporters. However, whichever of these options one wants to support, they all require government support – as long as CO2 is not priced at its social cost — and therefore all depend on a stable energy policy.

For example, the construction period of a nuclear power station can easily exceed two government terms, while there is a risk that a new government could change the security rules or safety regulations, causing costs to increase unexpectedly. Moreover, government policy determines the liability in case of major accidents and the costs of waste storage. Carbon capture and storage is developing into a politically sensitive technology, while the cost of carbon storage is influenced by where the government allows it to be stored and how it is regulated.

Naturally, politicians need to be able to make choices, but the consequences of energy policy changes reach much further than the volume of investment in one technology or another. Every change in policy, every subsidy that is cut, and every unaccomplished goal reduces the credibility of future policy.

The more changes are made, the more investors will avoid policy-related risks. Since low-carbon and renewable technologies are considered to have higher risks than conventional technology, such policy changes can be expensive in the long run. This is especially true of the supply industry: if we want to have a large number of wind turbines or nuclear power stations by 2030, we will need to provide confidence to companies today, so that they can invest in factories that make the components of these power stations.

The price of capricious energy policy is therefore not only reduced effectiveness, but also higher technology costs — in the form of higher risk premiums for investors and smaller economies of scale. Can a balance be found between the advantages of stable government policies and the need for flexibility?

One solution may be for governments to limit themselves to slowing funding, or even introducing freezes, rather than, more harmfully, reducing it. Alternatively, low-carbon energy technologies could be less directly and heavily reliant on the public coffers.

The German feed-in tariff (and the current Dutch proposal), which are funded through a charge on electricity, are a good example of a secure policy. Similarly, taxes are more attractive than subsidies. Subsidies are always an attractive target for new governments or deficit-cutting finance ministers.

Eliminating taxes and charges, on the other hand, does not help the government budget, and are therefore rarely under threat. If the income transfers from such taxes are considered too high, the revenues can be returned to the industry. This is one reason why a hypothecated carbon tax is one of the most attractive ways to stimulate the energy transition.

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