At a time of recession, it is natural that there is a focus on the cost of energy and the impact of policies as well as gas prices on the amount that we pay for our fuel bills. At the same time, the record breaking low levels of Arctic sea ice recorded in August and September demonstrate more than ever the urgency with which we must shift our energy system away from fossil fuels and on to low carbon alternatives. Two of the expressed aims of the electricity market reform process currently underway are decarbonisation and affordability but opinion is divided on how to best achieve these twin aims.
Part of the problem comes from a gap between the neat neo-classical economic theory, according to which all we need in order to address climate change is a carbon price, and what actually happens in the real world. In the theoretical world, by pricing carbon and leaving the market to decide what kind of lower carbon generation capacity to invest in, we obtain the best of both worlds – carbon emission reductions but at the lowest possible cost. In this world, policies which provide targeted subsidies for specific technologies such as wind turbines, are accused of ‘picking winners’ and being inefficient. In the real world however, the simplicity of neo-classical theory gives way to a far more complex one.
We published a report today written by Dr Rob Gross of Imperial College which highlights the many weaknesses in the viewpoint that a carbon price alone is the most efficient way to tackle climate change and drive investment decisions towards low carbon. The reality is that providing targeted support for technologies which are not yet able to compete on a level playing field with more established ones (most of which have benefited from extensive subsidies in the past) is key to driving increased innovation and accelerating the reduction in costs of these new technologies. Otherwise, these technologies might never see the light of day.
Earlier stage technologies such as offshore wind, wave and tidal power all display great potential but are currently relatively expensive. There is every chance, however, that the cost of some or all of these technologies will substantially decrease as they mature to the point where they are sufficiently advanced to be able to compete on an equal basis with fossil fuel generators. In the meantime though, they require research and development funding but they also need to be deployed at a progressively larger scale in order to begin benefiting from economies of scale and increased learning.
It is at this point that in a world where carbon pricing is the sole mechanism to bring forward low carbon generation that we risk encountering what is sometimes known as the ‘valley of death’. This concept is loosely defined as the crucial stage of a technology’s development, where it is ready to move beyond simple R&D funding and to be deployed commercially at increasing scale, but has not yet managed to reduce its costs sufficiently to compete in the market even with a carbon price.
At this point, the neo-classical view point would essentially be that if the technology cost is still too high for the carbon price to act as an adequate incentive, then the best solution is to wait until the cost falls further and continue with a modest amount of research and development. This solution has one fundamental flaw – beyond a certain point in a technology’s development, cost savings and efficiency improvements will only be realised through progressively larger scale deployment, achieving learning and the economies of scale needed to drive the technology down the cost curve. Without the revenue certainty required to attract investment at a reasonable cost of capital, a “carry on researching it and see if the costs are any lower in five years time” approach will inevitably consign the technology to the backburner where it is likely to stay indefinitely, lacking the opportunity to further reduce costs or improve performance.
This is clearly not a desirable outcome. In the absence of a proportional, time limited and targeted mechanism which allows new technologies to continue along the road to cost competitiveness, we are essentially swapping what some might call a policy of ‘picking winners’ with a policy consigning all new renewable technologies to being inevitable losers.
Assuming that this is not our desired outcome, we then have two options to allow our offshore wind, tidal or wave turbines to continue along the path to maturity. We either increase the carbon price high enough to bring forward investment in the early stage technology, an idea which most would agree would be madness given that this would simply generate large windfall profits for existing low carbon generation capacity and push up bills unnecessarily. Alternatively, we provide targeted, stable and proportional support to renewable technologies, which complements a lower carbon price and decreases over time as a technology matures. I know which option I’d choose and it’s certainly the more efficient option.