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Economics of Energy & Environmental Policy
Volume 7, Number 2


The Coupled Cycles of Geopolitics and Oil Prices

Mahmoud A. El-Gamal and Amy Myers Jaffe

DOI: 10.5547/2160-5890.7.2.melg
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We analyze the coupled cycles of Middle-East geopolitical violence and oil prices. Building on earlier work that shows that low oil prices are regularly followed by geopolitical strife, and that the latter is usually followed by higher oil prices, due to actual or feared disruption in oil supply, we focus in this paper on one particular factor: Which geopolitical events are most likely to lead to sustained supply disruptions? Using discrete wavelet analysis of oil production at the country level, we find that military conflicts that destroy production installations or disrupt oil transportation networks are the most significant antecedents of sustained, long term, disruptions in oil supply; whereas nonviolent regime change, internal political strife, and low level geopolitical tensions have more limited sustained impact. We discuss a framework to analyze whether conflict-related disruptions to oil supply could be endogenous to the oil cycle and offer some policy considerations for ameliorating that cycle's impacts.

The Importance of Penalties and Pre-qualifications: A Model-based Assessment of the UK Renewables Auction Scheme

Marijke Welisch

DOI: 10.5547/2160-5890.7.2.mwel
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This paper assesses the multi-technology auctions for Contracts for Difference (CfDs) in the UK, with a special focus on how pre-qualifications and penalties affect bidders' behaviour, risk aversion and bidding strategies and thus the auction outcomes in terms of prices and project implementation probability. The auctions are modelled to closely represent the auction design foreseen by the implementing agency, the Department for Business, Energy and Industrial Strategy (BEIS). Two alternative designs are presented: In the first one, bidders bid their true costs as a drop-out after being awarded would be penalised. The second one does not include a penalty. In that case, bidders are modelled with a cost function that includes a higher level of uncertainty. The model results show that low pre-qualifications and low or no penalties lead to an increased drop-out of agents after being awarded. For the policy-maker this implies a lower realisation rate for the auctions. Furthermore, the non-penalty case does not yield lower prices compared to a case with a stricter penalty/pre-qualification system in place.Keywords: Renewable Energy, Auction Theory, Agent-Based-Simulation, Energy Policy

How Renewable Energy is Reshaping Europe’s Electricity Market Design

L.J. De Vries and R.A. Verzijlbergh

DOI: 10.5547/2160-5890.7.2.ldev
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We present a systematic review of the challenges to the regulation of electricity markets that are posed by the integration of variable renewable energy sources. System integration is the key to developing the required flexibility, because flexibility options exist at all system levels and within the competitive as well as in the regulated (network) domains. The fluctuating nature of variable renewable energy changes the dynamics of investment decisions. We develop a framework for analysing relations between aspects of the regulation of the power sector that need to be coordinated in order to achieve (or at least improve) economic efficiency. We base the framework on the technical functionalities of the electricity infrastructure, which we group along three dimensions: system level (from retail/distribution to transmission/wholesale), geographic scope (the connection between electricity systems) and time scales (from real-time operations and balancing markets to the investment time scale). The framework helps identify regulatory challenges - potential inefficiencies due to a lack of coordination - and to place them into context. The picture that emerges from this approach is that the institutional fragmentation of the European electricity sector will become increasingly burdensome as the development variable renewable energy requires ever closer coordination between countries, between the different levels of the electricity system and between markets that serve different time scales. Interactions between elements of market design and regulation such as congestion management, renewable energy policy and system adequacy policy affect each other and are an additional reason for a system integration approach to regulation. Keywords: Electricity market design, renewable energy, flexibility, system integration

How Do Low Gas Prices Affect Costs and Benefits of US New Vehicle Fuel Economy Standards?

Joshua Linn, Virginia McConnell, and Benjamin Leard

DOI: 10.5547/2160-5890.7.2.jlin
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In their initial benefit-cost analysis of the 2012-2016 passenger vehicle fuel economy standards, the U.S. regulatory agencies estimated that the benefits of the standards would be three times greater than the costs. However, their analysis was based on the high gasoline prices forecasted at the time; after their analysis, expected gasoline prices fell by 25 percent. We augment the agencies' benefit-cost framework and use recent evidence on behavioral responses to gasoline prices to estimate the effects of low gasoline prices on benefits and costs. Accounting for consumer changes in miles traveled and vehicle choice, we find that the 25 percent reduction in future gasoline prices reduces the value of fuel savings by 22 percent. Because of consumer changes in vehicle choice, lower gasoline prices raise compliance costs by about $0.5 billion per year, or about 9 percent of the total net benefits of the program. Accounting for these responses does not overturn the agencies' initial conclusions that benefits exceed costs. Keywords: Corporate average fuel economy standards, CAFE, attribute-based standards, greenhouse gas standards, consumer behavior

From COP21 pledges to a fair 2°C pathway

F. Babonneau, A. Haurie, and M. Vielle

DOI: 10.5547/2160-5890.7.2.fbab
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At the COP21, about 160 countries proposed the so-called INDCs that define GHG abatement objectives by 2030. While encouraging, these commitments are not ambitious enough to achieve the 2�C threshold by 2100, and further negotiations are needed. There is, therefore, a necessity to assess the economic consequence of a pathway to 2�C and the fair sharing of this burden. In this paper, we use a game theoretic approach for the design of fair agreements concerning additional abatements up to 2050. The simulations performed with our model confirm the weakness of INDC pledges but show that, with political determination, an equitable burden-sharing agreement can be achieved with very reasonable costs for all nations of approximately 0.8% of total discounted household consumption. With a more ambitious 1.5�C target, global cost is multiplied by a factor of four revealing the stringency of such an objective. Numerical results also show that the implementation of an international carbon market and participation of all countries in the game are crucial elements for reaching equitable burden-sharing among countries. For example, considering a reduced G20 coalition, welfare losses are multiplied by a factor of three for coalition members. Our simulations also permit a first evaluation of the possible impacts of the recently announced USA withdrawal from the Paris agreement. Keywords: Climate negotiations, Burden sharing, COP21, Meta-game, Fair agreement, Computable general equilibrium, USA withdrawal

Winners and Losers of EU Emissions Trading: Insights from the EUTL Transfer Dataset

Johanna Cludius

DOI: 10.5547/2160-5890.7.2.jclu
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This paper analyses distributional effects between participants of the EU Emissions Trading System (EU ETS) during its first trading period. To this end, a selection model is formulated and applied to a dataset based on account information and transfer data from the EU Transaction Log (EUTL). Four different ways of adding carbon prices to the dataset are explored. Findings confirm that whether a company made a gain during the first period of EU emissions trading is highly dependent on the level of free allocation it received. Consequently, large industrial companies, especially in the iron and steel and cement sectors emerge as the biggest 'winners' as they were the companies with the highest allocation surplus. This also applies to a number of electricity generators located in Central and Eastern Europe. Policy makers therefore have to be mindful about decisions regarding the level of free allocation to individual sectors and companies, as those design choices have a large influence on the way in which gains and costs are distributed under the system, which in turn has repercussions on its political acceptability. Rules for free allocation are harmonised at EU-level since the beginning of the third trading period, but relatively generous free allocation to industrial sectors and additional sources of unequal treatment remain. The analysis also confirms that small companies were less likely to participate, which points to the existence of significant transaction costs preventing many small companies from realising potential gains on the market (as well as jeopardising the efficiency of the system). It is therefore important to reduce transaction costs for small companies, in particular at the beginning of an ETS, in order to incentivise market entry.

Carbon Pricing and Cross-Border Electricity Trading for Climate Change Mitigation in South Asia

Govinda R Timilsina and Mike Toman

DOI: 10.5547/2160-5890.7.2.gtim
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South Asia's electricity supply system is quite carbon-intensive, particularly due to extensive use of coal. Under "business as usual," that situation is expected to continue for several decades. Using an electricity system planning model, this study investigates two complementary strategies to reduce CO2 emission intensity of the power sector in South Asia: carbon pricing, and expansion of cross-border electricity trade to exploit clean energy resources, especially hydropower. The study finds that with a carbon tax imposed on fossil fuels used for power generation, CO2 emissions from the power sector would be 10% lower than that in the baseline over 20152040 even if the cross-border electricity transmission capacity is not expanded from the current level. On the other hand, if the cross-border transmission capacity is expanded to facilitate unlimited power trading across countries, the carbon tax would cause 16% reduction of regional power sector CO2 emissions from the baseline. The regional electricity trade is not only beneficial economically as it saves almost US$100 billion electricity supply cost in the region over 20152040, but also an attractive option for climate change mitigation. The carbon tax would, however, increase the power supply cost and could adversely impact consumers unless the carbon tax revenue is used as a safeguard measure.Keywords: South Asia, carbon pricing, cross-border electricity trade, power sector

An Extended Analysis on the Remuneration of Capacity under Scarcity Conditions

Anthony Papavasiliou, Yves Smeers, and Gilles Bertrand

DOI: 10.5547/2160-5890.7.2.apap
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This paper extends a recent analysis which investigated the impact of scarcity adders produced by operating reserve demand curves on the financial viability of generation units in the Belgian market. Our paper is inspired by practical considerations related to the implementation of the mechanism in European electricity markets. We are specifically interested in: (i) the extent to which the mechanism rewards flexible resources for being available 'when and where' needed, as required by European competition law; (ii) the sensitivity of the mechanism to certain parameters that require regulatory judgment; (iii) the interaction of the mechanism with indirect capacity mechanisms; and (iv) the ability of the mechanism to provide long-term investment signals. We find that the restoration of nuclear capacity in the Belgian market would suppress scarcity adders to near-zero values. We show that the increase in value of lost load would have a minor impact on scarcity adders when capacity shortages are negligible. We find that the removal of strategic reserve from the Belgian market would have a significant impact on scarcity adders. We find strong positive correlation in consecutive imbalance increments, and show that this correlation can result in noticeable impact on the computation of scarcity adders. We demonstrate that the back-propagation of scarcity adders is essential for providing a long-term investment signal to flexible resources.Keywords: Flexibility, energy-only markets, renewable integration, operating reserves

Book Reviews

Book Reviews

The Reform of Network Industries: Evaluating privatisation, regulation and liberalisation in the EU, edited by Massimo Florio - Book Review by: David Newbery

Confronting the Climate Challenge: U.S. Policy Options, by Lawrence Goulder and Marc Hafstead - Book Review by: Mark Jaccard

Ethical Asset Valuation and the Good Society, by Christian Gollier - Book Review by: John Parsons

The Economics of Environmental Policy. Behavioral and Political Dimensions, edited by Thomas Sterner and Jessica Coria - Book Review by: Juan-Pablo Montero

Doughnut Economics: Seven Ways to Think Like a 21st-Century Economist, by Kate Raworth - Book Review by: Hanna Brauers and Christian von Hirschhausen

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