Technology’s the answer! (but what was the question?) Analytic and Transatlantic divisions in responding to climate cha

1. Technology’s the answer! (but what was the question?) Analytic and Transatlantic divisions in responding to climate change Presentation to HGDC seminar, 19 November 2003 Michael Grubb Associated Director of Policy, the Carbon Trust Visiting Professor, Climate Change and Energy Policy, Imperial College London Senior Research Associate, Department of Applied Economics, Cambridge

2. Overview • The basic issue of technology-push vs demand-pull: - examples and significance • Economic theory and technology innovation • The different conceptions – evidence, strengths and weaknesses • Integrated perspectives • Practical problems arising from incomplete theories of innovation • Some implications for UK strategy • Technology perspectives and Kyoto strategies • Some additional observations on energy policy and technology • Conclusions

3. The basic issue • Technology is the answer! • All studies agree that low carbon technology is central to addressing long-term climate change • Technologies adequate to stabilise the atmosphere are not yet commercially available • But what was the question? • Is this a question of R&D investment by governments to develop the technologies that can solve the problem (‘technology push’ / exogenous technical change)? • Or a question of market incentives to promote private sector investment in emerging technologies and learning-by-doing (‘demand pull’ / induced technical change)

4. Global Development of Wind Power capacity Source: Morthurst, Riso national laboratory

5. Cost trends in wind energy, historic and projections compared to conventional power production Source: Morthurst, Riso national laboratory

6. Induced technical change can revolutionalise the long term view… results of IIASA studies with induced innovation Source: Gritzevski & Nakicenovic, in Energy Policy, 1999

7. .. And fundamentally affect international strategy … Induced technology & policy spillovers determine long-run effect of Kyoto-style agreement FirstCommitment Period Zero Spillover Scenario 14,000 12,000 Developing Country Emissions 10,000 Intermediate Spillover Scenario 8,000 Carbon Emissions (MTCpa) 6,000 Maximum Spillover Scenario 4,000 2,000 Industrialised Country Emissions (Kyoto -1% pa) Source: Grubb, Hope and Fouquet, in Climatic Change, 2003

8. Overall, different conceptions of technical change can radically affect the policy conclusions Source: Grubb, Koehler and Anderson, in Ann.Rev.Energy, 2002

9. Economic theory and environmental innovation policies

10. Technology-R&D push – the track record is not encouraging.. • The theoretical basis • Classic R&D market failures • The impact of liberalisation • Some classic energy examples: • Nuclear fission • Coal-based synthetic fuels • Nuclear fusion • Basic problems of: • ‘picking winners’ • Cooperation vs competition • Policy displacement • Theoretical paradox of the ‘classical’ view • the giant leap • the ‘valley of death’

11. Demand-led induced technical change – if only markets were so perfect .. • Some classic energy examples: • North sea oil • CCGTs • Wind energy …? • Basic problems of: • Classic R&D failures • Policy stability for environmental innovation • The real world is ‘second best’ • Theoretical paradox of the ‘classical’ demand-led view • the need for perfect R&D markets • The need for long term certainty • The need for perfect communication between government, research, and industry

12. Integrated perspectives: technologies have to traverse a long, expensive and risky chain of innovation to get from idea to market Government Policy Interventions Basic R&D Applied R&D Demon-stration Commercial-isation Market accumulation Diffusion Market Pull Research Consumers Product/ Technology Push Investments Business and finance community Source: Foxon (2003) adapted by the author

13. There are extensive barriers to investment that differ along the innovation chain Basic R&D Applied R&D Demon-stration Commercialisation Market accumulation Diffusion Social n Political Technical Economic High Medium Low

14. Market theory is blind to the innovation process – innovationassumed to emerge out of R&D and market pull, with government no-go zone in between Government Carbon trading / taxation Policy Interventions C,C,C Univ funding Cofunding, tax breaks Basic R&D Applied R&D Demon-stration Commercial-isation Market accumulation Diffusion Market Pull Research Consumers Product/Tech Push Investments Business and finance community C,C,C: Contentious, constrained, confused …

15. Consequently we lack integration across the innovation chain • New entrants (technology and corporate) • require €/$ billions, and years, of development • Compete against established incumbants and rules • Rely upon regulation to embody external costs of incumbants • political signals of future regulation are not ‘bankable’ • (‘White paper reactions’) • fierce market competition and regulatory change in electricity has left: • Financial community extremely risk averse • companies without financial resources for longer term investment • (‘CMI reactions’)

16. Some elements of integrated strategies - application for the UK

17. Offshore Wave Energy Crops Offshore Wind Onshore Wind A range of policy measures are needed to help technologies traverse the innovation chain Illustrative Appropriate economic support for specific technologies will vary as costs decline Technology specific support RD&D Grants Capital Grants/ Loans ROC (Buyout) General support CCL Exemption Wholesale Price Note: ROC excludes recycling; Capital grant based on maximum of 40% of typical capital costs Source: PIU Working Papers (OXERA II Base case cost decline)

18. Support needs to target advantaged technology groups and build upon comparative advantages- whilst market used to identify winning solutions Assessment Criteria Funding Prioritisation Co-operate Internationally Invest Aggressively • High Domestic Resource • High Materiality • Early mover advantage • Value added potential Technology Groups Estimated impact Watching brief BuildOptions UK comparative advantage

19. Carbon Trust: Low Carbon Technology Assessment seeks to classify main technologies on these bases High • Monitor • Buildings (Controls) • Waste to energy • Nuclear fission • Ultra-high efficiency CCGT • Smart metering • Wind • Fuel Cells (Transport, Baseload power • Biomass for Transport • Industry (Alternative Equipment) • CO2 sequestration • Focus • Buildings (Fabric, Ventilation, Cooling, • Integrated Design) • Industry (Combustion technologies, Materials, • Process control, Process intensification, • Separation technologies); • Hydrogen (Infrastructure, Production, • Storage and Distribution); • Fuel cells (Domestic CHP, Industrial • and Commercial) • CHP (Domestic micro, Advanced macro) • Biomass for local heat generation Estimated impact on carbon emissions • Limited • Intermediate energy vectors • HVDC Transmission • High Efficiency Automotive • Power Systems • Nuclear fusion • Cleaner coal combustion • Solar thermal electric • Low head hydro • Tidal (Lagoons, Barrages) • Geothermal • Consider • Solar Photovoltaics • Solar water heating collectors • Photoconversion • Wave (Offshore, Near shore devices and • shoreline) • Biomass for local electricity generation • Tidal stream • Coal-bed methane • Electricity storage technologies • Buildings (Lighting, Existing building fabric, • Existing building services) • Industry (Waste heat recovery). Low Low High Materiality of potential Carbon Trust investments

20. Some implications for Kyoto implementation and strategy

21. Kyoto commitments and trading potential- a low or zero price will not aid technology development! Gap between present (yr 2000) emissions and Kyoto target,and managed forest allowances (MtC/yr)

22. Analogies with the oil markets? The oil market: • International traded price far greater than marginal cost • Major ‘swing’ suppliers have big influence but not monopoly power • Price instability has forced restructuring of markets and relationships • International collaboration to maintain oil price at ‘reasonable’ levels • Strong government-industry interrelationships Kyoto CP1 carbon market could have all these features (Russia as the Saudi Arabia; EITs as the OPEC; DCs as non-OPEC) But important differences: • Constructed commodity, depends upon institutional credibility (compliance, etc) • Heirarchy of ‘environmental and political legitimacy’ • Sequentially negotiated allocations • CP1 massive supply-demand imbalance created by US pullout

23. Implications for the Kyoto mechanisms- projects Heirarchy of value led by project mechanisms: • CDM, small projects • renewable energy may be highest value • Potential for early start (Delhi, COP8) • Other CDM • JI – ‘track two’ dependent upon Supervisory Cttee • JI – mainstream, forward trading contingent on meeting eligibility, probably looser project governance • Removal Units (Annex I sink projects): variable domestic price, low international price • Total volume from international project credits limited

24. Implications for the Kyoto mechanisms – emissions trading Heirarchy within AAU trading: • ‘Greened’ trading: revenues linked to environmental reinvestment (Russian Green Investment Scheme) • OECD countries that exceed their targets due to domestic action (eg. UK?) • EIT exports governed through non-GIS-type routes (eg. through domestic trading with ‘acceptable’ allocation). • wholesale transfers of AAUs without any linkages or constraints (will this happen at all?)

25. Some broad conclusions on innovation • ‘Supply push’ vs ‘demand pull’ conceptions lead to radically different perceptions and policy prescriptions • An important obstacle to effective policies is inadequate economic combined theories of industrial innovation (and especially environmental innovation): • ‘standard’ theories yield policies that are limited in their feasibility, effectiveness and dynamic efficiency • We have no goods tools to design the most dynamically efficient mix of policies • But it is clear that effective policies are impeded by ‘one size fits all’ application of core policies, such as: • New Electricity Trading Arrangements (NETA) • European State Aids • Coherent policies need to work across the innovation chain and be clear about strategic priorities and comparative advantages • Kyoto commitments and Kyoto-style structure is a foundational element to give incentives and develop global markets

26. Supplementary thoughts: On UK energy prospects and energy diversity

27. Imports Oil UK electricity mix – under ‘business as usual’ gas dominates UK supply – “reference” scenarioElectricity Supply - MtOe Renewables Nuclear Gas Coal Note: Assumes no new nuclear build Sources: DTI - IAG, DUKES, EP68

28. Greater effort on variety of renewables would lead to a more diverse set of energy sources UK supply – “Renewable Energy” scenarioElectricity Supply - MtOe Imports Nuclear Renewables Oil Coal Gas Source: CT Strategic framework analysis

29. Diversity can be quantified and is enhanced under an increased renewables scenario UK electricity supply mix scenariosDiversity index Renewables Scenario Business as Usual scenario Source: CT Strategic framework analysis

30. Diversity – index and concentration charge • Diversity index for portfolio of I options = -ipi . ln[pi] • where • pi = the proportional reliance on the ith technology / fuel source • To encourage diversity, could levy a concentration charge, eg. • (exp[pi] – 1) cents /kWh • Would • increase marginal cost of given source as it starts to dominate • give modest boost for new entrants • UK at present relatively diverse –politically palatable starting point!

31. Conclusions 1: Implications of technology innovation analysis • Modern understanding of the economics of industrial innovation (and especially environmental innovation) need to be codified and applied to inform policy: • A mix of policies is required for different stages of the innovation chain through from research to market • Core established policies need to be adapted to avoid being impediments • International economic studies need to incorporate technology (and political) spillovers as well as economic substitution effects • The debate on ‘targets’ vs ‘technology’ is false: • Technology policies without targets (cap & trade) are ineffective • Targets without technology policies are inefficient • Kyoto provides a bedrock of credibility and carbon markets – but much more needs to be done on technology to enable deeper and wider cuts in subsequent negotiating rounds

32. Conclusions 2: supplementary observations on climate-technology policy • The challenge is not adding abatement costs to ‘do nothing’ future, but is to reorient €/$ trillions of investment over coming decades • IEA World Investment Outlook • This will not happen without active intervention domestically and internationally • Innovation is too risky, the ‘bankable’ signals of political declarations and agreements are too weak, and the obstacles to new entrants are too big • Low carbon sources can generally support security objectives, but need appropriate tools to support new entrants rather than protect high carbon existing options • A ‘concentration charge’ to foster system diversity could be considered