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Carbon Taxes Help The Environment . . . But May Not Help Renewables

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POST WRITTEN BY
Sam Aflaki and Serguei Netessine
This article is more than 6 years old.

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The policy of taxing carbon enjoys the support of a broad coalition of unlikely political bedfellows, from most U.S. Democrats to nearly half of all Republicans (bar the president himself). You can also throw in a majority of American environmentalists and economists, 1,200-plus multinational corporations and over 140 global companies, including Microsoft and Cummins. The latter already embed a carbon price within their business strategies and operations even though there is no legal mandate to do so.

Of course, a carbon tax is not any old tax. It is designed to make renewable, or “green” sources of energy more competitive against traditional, often more polluting, ways to generate power. Putting a price on carbon emission often aims not to raise government revenue but to reduce gas emissions. The worldwide increase in capacity installations for renewables, such as wind and solar power, is accelerating. In the last decade, wind capacity installations have increased by 1,000%. China has the greatest installed capacity in the world, followed by the United States, Germany, India and Spain. Despite these facts, the Trump Administration has repeatedly denied it will consider a carbon tax as part of its tax reform agenda.

But our research reveals an important, largely overlooked factor for policymakers when they deal with one of the great challenges of our time. Indeed, we conclude that such a tax may actually have a negative rather than positive impact on the drive to increase the share of renewable energy sources in the electricity generation portfolio. Yet this is one of the key demands for advocates of greener energy.

How can this be?

Counterproductive Link Between Renewables And Liberalization

The problem stems from two landmark developments reshaping electricity generation, transmission, distribution, and retailing: the introduction of renewables and market liberalization. Renewables are handicapped by what is called their intermittency. In its present form, many renewable energy sources cannot be turned on and off with a switch because wind still stubbornly refuses to blow when we want it to, while access to sunlight can be interrupted by the weather and air pollution or simply be switched off by an inconvenient phenomenon called night-time.

This means there is still significant uncertainty associated with the outputs of some (but not all) renewable technologies. To compensate for renewable intermittency, energy suppliers resort to backup generators that range from clean hydropower to carbon-intensive and inefficient gas-fired turbines; these backup technologies must have the capacity to be “ramped up” in a relatively short amount of time. So, while a rise in carbon price is designed to directly incentivize the use of renewables, it may reduce their competitive advantage if they require emission intensive backup.

Coupled with market liberalization, this effect becomes more pronounced. Indeed, the liberalization of electricity markets over the last two decades has created an environment that has the potential to amplify the intermittency problem because of the way spot prices are determined.

Long-term Contracts Are No Panacea

To make renewable technologies more competitive in a liberalized market, public policy experts propose long-term fixed-price contracts with generators. They hope that investment in new generating capacity will be protected from the risk of volatile spot prices. For instance, long-term contracts involving wind developers, electricity suppliers, and large customers are used in the United States and Europe to promote investment in renewable capacity despite their ever-increasing cost competitiveness.

Almost all electricity markets resort to bilateral forward contracts between suppliers and generators to guarantee spot price stability. These forward contracts can cover periods ranging from a single day to 20 years. In the United States, long-term forward contracts are promoted as a means to encourage investment in renewable generation capacity and to “spur the growth of renewable generation.” A number of states such as Massachusetts, Rhode Island, New Jersey, and Delaware), are using legal instruments to sign long-term power purchase agreements with fixed prices and with contracting horizons of 10-25 years. The two European countries with highest installed capacity for renewable energy, Germany and Spain, also use long-term fixed-price contracts to promote renewable energy investments.

These contracts are a viable means of compensating for the disadvantages of market liberalization from the standpoints of total cost and greenness. Yet they could also lead to dramatic overinvestment in renewables and underinvestment in non-intermittent generation for high enough carbon prices. The likely result would be an overreliance on the (potentially) emission-heavy backup generators since researchers have yet to find adaptable solutions for unused renewable energy.

So what can be done?

Making Renewables Less Intermittent

Clearly, the intermittency of renewable energy sources handicaps investment decisions in these technologies. Fortunately, there are several viable options to disentangle the links between carbon taxation and backup power generation. And, by reducing intermittency, you increase the effectiveness of carbon pricing as a renewable-promoting strategy.

To start with, renewable energy sources can be your backup power source. By combining negatively correlated sources of energy such as solar and wind energy, for example, you reduce the need for expensive, emission intensive backup. There is also relatively new technologies available: for example, pumped-storage hydropower which stores electricity in the form of potential energy, and pumped-heat electricity storage which uses argon gas to store power in the form of heat. Recently, Tesla has developed the first potentially scalable form of renewable energy storage in the form of a battery that retains excess solar power for use in individual homes.

Authorities Need Holistic Vision

But these technologies have a long way to go. They require significant investment before they can begin to noticeably reduce the intermittency prevalent in the status quo. To encourage this, policymakers should adopt a holistic approach to the question of cost, based on the following questions: what is the price of renewables, intermittency and backup? How can we tailor the backup power options to individual energy supply scenarios?

Government can help expand renewables with additional monetary incentives and research financing. By investing in new ways of reducing renewables intermittency – better battery technology, electricity storage, pairing wind and solar sources, etc. – the potentially pernicious interaction between intermittency and market pricing could be severed.