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Renewable Energy Deployment: The Role of Government in Driving Technological Innovation

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John Papaspanos Seton Hall University Honors Department Honors Thesis Dr. Peter Ahr 21 December 2009

Renewable Energy Deployment: The Role of Government in Driving Technological Innovation
“Substantive, mass promotion of renewable energy sources, combined with energy savings, is the only realistic, effective and viable solution for dealing with climate change and ensuring adequate energy supplies.” European Environment Commissioner Stavros Dimas 1.1 Introduction In recent years, the upward trend of fossil fuel prices and mounting evidence of anthropogenic global warming have compelled policymakers in the European Union (E.U.) to confront a burgeoning global crisis at the intersection of energy security and climate change. With the adoption of Directive 2001/77/EC in 2001, the European

Commission has acknowledged the centrality of renewable energy sources (RES) to meeting its long term energy objectives and fulfilling its Kyoto obligations. In 2008, the E.U. Parliament adopted a climate package which included a RES directive with the political aim of generating 20% of the E.U.’s total electricity generation from RES by setting specific RES targets for each member state (MS).1 Due to the presence of several market and institutional obstacles, such an ambitious objective can be fulfilled only with the enactment of national support schemes that can stimulate the nascent RES market. In the E.U., the two predominant RES support schemes used among MS are the green

certificate system (GCS) and the feed-in tariff (FIT). Even though both support schemes have demonstrated some degree of success, I will outline the success of Germany’s Renewable Energy Sources Act (EEG)—which is centered on a well-designed FIT—to argue that the FIT is a more effective policy instrument in expanding the RES market on the basis of two overarching criteria: economic effectiveness and ecological efficiency. In this paper, I have examined the following research objectives: 1) Why is government intervention necessary for the development and deployment of RES technologies? What is the most effective national support scheme that can be employed in the E.U.? What is the central problem concerning the widespread diffusion of green technologies to the developing world and how can this be resolved? 1.2 The Role of Green Technology in Combating Climate Change The E.U. cannot pursue a low-carbon, economic growth trajectory without the development, deployment, and diffusion of RES-based technologies (green technologies) that enable producers to efficiently harness the power of wind, solar, geothermal, and other RES for the generation of low-carbon electricity (green electricity). However, such green technologies cannot be widely adopted in the short term under current market conditions due to the various obstacles that hinder the long term and complex process of technological innovation.

1.3 The Technological Innovation Process Joseph Schumpeter recognized the three distinct stages of the innovation process: “innovation as the first practical demonstration of an idea; innovation as the first commercial application and diffusion as the spreading of the technology or process throughout the market.”4 Nevertheless, this process is not linear but follows an iterative path that is “linked by learning and feedback that flow both ‘downstream’ from research to design and develop, and ‘upstream’ from the development process to fundamental

research.”5 This perspective illuminates the learning that takes place by the innovators of a technology and its end users through periods of trial-and-error. With this conceptualization of the innovation process, radical scientific or technological breakthroughs are not as economically significant as the long term series of incremental improvements that are undertaken to reach a cost-effective product that can attract consumers and investors.6 Historical examples of this observation are the transistor and the gas turbine, in which both technologies were developed over the course of many years—initially with the support of the public sector, and then, further enhanced by the private sector. 1.4 Four Obstacles to Market Entry Technological innovation largely occurs within the private sector. Market participants are responsible for driving the innovation process of conducting research and development (R&D), applying this knowledge to the development of a commercial product, and deploying this technology in domestic and international markets. If there is difficulty in any stage of the innovation process, investors will be very reluctant in providing the necessary funding for the R&D activities due to the high associated risk. In the energy sector, market actors encounter several market and institutional barriers which hinder the acceleration of the innovation process. These obstacles mainly revolve around the difficulties in penetrating the electricity generation market: 1) high initial costs, 2) inadequate infrastructure, 3) distorted markets, and 4) oligopolistic market structure.7 The first obstacle encompasses the inherent difficulties in accelerating the learning process in production for new entrants in the electricity market. Since electricity is a homogenous good, potential producers in this industry cannot penetrate through a niche market and then expand to the broader market of end-users. Therefore, the RESharnessing technologies must directly compete against the more cost-competitive and

reliable incumbent technologies. Historical experience has shown that infant RES technologies cannot compete in such an environment during the initial phase of market entry and that decades are required before dynamic increasing returns emerge such as “economies of scale and learning effects, which can lead to costs falling as production increases.”8 The second obstacle lies with the nature of national electricity grids. Since the electrical grids of MS are designed for the accommodation of conventional power plants, investors confront severe difficulties in attracting capital funds for RES electrical systems. First, if the proposed construction sites of RES electrical systems are located far away from the electrical grid, then the utilities cannot provide access to RES producers. In addition, the current electrical grids are usually not equipped to receive electricity from multiple independent producers. Unless the electrical grids are restructured to absorb green electricity from RES producers, the current status quo in electric power distribution cannot be changed. The third obstacle is centered on the current market distortions due to government subsidies on existing fossil fuel technologies. The estimated subsidy for fossil fuels is $150-250 billion per year globally.9 With such considerable support from the government, utilities hold a competitive advantage in the energy sector and strive to deter the entry of any potential competition. In the absence of government regulation (e.g. cap and trade scheme or carbon tax), utilities hold a strong position because they are not obligated to internalize the environmental externality of greenhouse gas (GHG) emissions into their cost structures. Given the fact that conventional power is more costcompetitive, RES technologies cannot become a viable option in the short term, and thus, the incentive to invest in the RES sector is negligible. The fourth obstacle focuses on the market structure of the energy sector. Generally, the electricity market is highly regulated and there is a limited number of

competing firms. For example, the French firm Électricité de France is the world’s largest utility company, the dominant electricity provider of France, and the supplier of 22% of the E.U.’s electricity. The large utilities within this oligarchic structure tend to be risk averse and predominantly use conventional fuels to generate electricity because adopting new technologies may prove to be more costly or less reliable. Therefore, the drive to innovate is negligible and there is a tendency for the status quo to remain. 1.5 Public-Sector R&D Investment Even though the private sector is the principle agent in technological innovation, the public sector can play an essential role in driving private spending until a certain threshold is reached—to the point at which public funding begins to “crowd out” the entry of private investment. If there are sufficient flows of private capital to the development of a specific technology, then the government can withdraw its support because the private sector can further advance the technology to maturity without the use of public funds. The role of public-sector R&D is also very important in maintaining the “public good nature of major scientific advances1”. The government has historically been successful in spearheading innovative activities that offered unexpected benefits for other applications. For instance, the diffusion of knowledge from military R&D to civilian applications occurred in the airframe industry when Boeing exploited knowledge obtained in constructing World War II bombers and tankers for the U.S. Air Force in its commercial designs and tooling for the 707.11 Specifically, the energy sector has benefited from military R&D, the U.S. space program, and other sources of knowledge such as the development of the gas turbine. Originally designed to propel a military jet aircraft, the gas turbine is also used to power many electric power plants. These examples “highlight the spillover effect that occurs between sectors and the need to avoid too narrow an R&D focus”12

Last, the government is instrumental in the development of human capital, which is a necessary step towards the aim of building a strong technological research base that can stimulate the RES market. If the government expects scientific institutions and laboratories to continue attracting young scientists and engineers, there needs to be an adequate allocation of public funds for their education and to the R&D firms that employ them. To this purpose, the government will strongly contribute to the stimulation of the RES sector by deterring any potential volatility that may discourage private investment. 1.6 The Role of RES Support Schemes As evidenced above, market actors do not only respond to price signals in the market in order to maximize profits, but also adjust their market behavior to signals from the government13. Without the presence of a national support scheme to support the development and deployment of green technology, the current market dynamic and regulatory framework does not provide the sufficient economic incentives for market actors to undertake such innovative activities, especially with the urgency and scale necessary to meet the E.U.’s indicative targets by the year 2020. The following diagram demonstrates the role of government intervention in advancing this process by internalizing the costs of carbon as an environmental externality and providing subsidies as compensation to offset the cost disadvantages of green technology. Since the E.U. did not prescribe a specific support scheme to achieve its RES directive, each MS has selected a national support scheme that can overcome the aforesaid barriers in order to promote their respective renewable energy sectors. Presently, two major support schemes have emerged: “the older and more widely used feed-in tariff (FIT) schemes on the one hand and the newer but increasingly popular tradable quota models, referred to ‘green certificates’ (GC), on the other hand.”14 Generally, the FIT mechanism involves the obligation of a utility or energy company to purchase electricity generated by RES producers in its service area at a

politically determined price and guaranteed for an established time horizon.15 The tariff component of the law refers to the fixed price received by the producer for any kWh of green electricity. In addition, modern FITs provide technology-specific tariffs

determined by the consideration of several factors such as manufacturing and operating costs, resource endowments, and industry lobbying. With regard to financing the legislation, the FIT applies the costs of the tariffs to the end users of the utility companies. In contrast, the GC system generally obliges “producers, distributors or consumers to either produce or buy a certain amount of green electricity (in absolute values or quota).”16 In its simplest form, the GC system the government imposes the need to produce a politically determined share of their total electricity generation in a certain time period (usually 1 year). In addition, the GC systems are usually accompanied by a trading mechanism in which producers are given an option in fulfilling their quota obligation: either to produce the green electricity themselves or to purchase “credits”17 of green electricity generation from other producers.

1.7 Criteria of Effectiveness The two criteria that will be employed in the comparison analysis between these two support schemes are economic efficiency and ecological effectiveness. Economic efficiency will be defined as the relative cost of this policy option as compared to other support schemes and the absence of government intervention. The greatest level of economic efficiency will entail the lowest possible cost of the support scheme to the body politic. The complimentary criterion is ecological effectiveness, which constitutes the amount of installed capacity of electricity from green electricity generation. An examination of Germany’s regulatory framework as a case study will focus on the

strengths and weaknesses of a model FIT and will be followed by a comparison to the next leading E.U. support scheme—the GC system.

1.8 Case Study: The Support Scheme of Germany (EEG) Among the industrialized countries, Germany is at the forefront of RES deployment—ranked first in terms of installed capacity for wind energy and second for photovoltaics (PV).18 Even though other countries have more favorable resource endowments such as Italy, Spain, and Greece for solar energy and Scandinavia and the UK for wind energy, Germany has exceeded the rest of Europe in RES deployment due to its superior regulatory framework. Since 1979, in the wake of the first oil crisis in 1974, Germany has been enhancing its FIT legislation at the behest of the German Bundestag and the German people at large. Introduced in 1990, the first fully formed modern feed-in law in Germany was the Stromeinspeisungsgesetz (StrEG), which was designed to assist electricity producers from small hydropower stations and wind energy installations. After several modifications, the German government adopted the Erneuerbare EnergienGesetz (EEG and also known as the 2000 Renewable Energy Sources Act), which “represented an update, refinement, and replacement of German renewable energy policy.”19 The EEG was instrumental in the success of Germany’s FIT mechanism because, unlike its predecessor, it included “a differentiation in tariff rates—depending on the renewable energy type, size, and site.”2 Furthermore, the EEG expanded the range of technologies that were supported by tariffs and the StrEG’s tariff percentage-based rates were replaced with fixed rates over a set period of twenty years of operation for each new RES electrical system. In 2004, the EEG was amended and its new provisions called for the increase of the contribution of green electricity in the total electricity supply to 12.5% by 2010 and catalyzed a boom in the solar industry by raising its respective

tariff. Last, a new concept of tariff rate digression was introduced for the different RESbased technologies.

1.9 Practical Solutions in Overcoming the Market Obstacles The features of the EEG and its attendant amendment have far-reaching implications in achieving the aim of encouraging the development of a nascent RES sector by resolving the inherent difficulties represented by the four aforementioned obstacles. The problems associated with the learning process are overcome with the implementation of the EEG because the tariff is fixed and guaranteed over a specific period of time (20 years) which ensures the profitability of the investment for producers and a stable investment environment for manufacturers, financers, and suppliers. With the guarantee that household and industrial producers are guaranteed a premium and sustained price for green electricity, market demand is created and industry responds with the increased production of RES-based technologies. Another implication of this dynamic is that lenders are inspired to offer favorable loans to consumers willing to purchase the RES-based equipment and to invest in the capacity expansion of manufacturers in order to meet rising demand. Therefore, the establishment of stable expectations and the guarantee of concrete incentives create the conditions that are necessary for market creation. Consequently, the increase of production leads to the creation of economies of scale and the acceleration of the learning process. In the case of Germany, the price of photovoltaic systems has decreased by more than 20% since 1999 because new products are facilitating the mounting of such systems, economies of scale are reducing the manufacturing costs of equipment, and the growing experience of dealers and craftsmen are further reducing costs.21

The EEG addresses the second obstacle when the authorities impose an obligation upon the utilities to connect RES producers to the electrical grid and to transmit the green electricity to consumers. This requirement leads to the restructuring of the grid in order to accommodate the influx of multiple RES electrical systems as compared to the current model of centralized production units in the form of conventional power plants. In addition, the transmittance of the green electricity through the grid will increase the total supply of electricity and thereby reduce the demand for electricity produced by conventional power plants. The third obstacle of market distortion can be cleared with the shifting of electricity production subsidies by the government from conventional sources to RES. Traditionally, governments have offered subsidies to domestic energy industries to ensure adequate domestic supply, to reduce energy prices, and to promote job creation. In fact, the history of coal, oil, natural gas, and nuclear power demonstrates that no energy sector was developed without the use of subsidies.22 In the case of the U.S., the government has distributed $74 billion to fund the R&D for conventional and nuclear power from 1973 to 2003 whereas only $26 billion was spent on RES technologies and energy efficiency.23 Specifically, recent research has shown that even though the U.S. nuclear and wind technology produced roughly the same amount of energy, the subsidy to nuclear outweighed that to wind by a factor of over forty24. But in the case of the E.U., a lower proportion of generation capacity has been in the private sector. Hence, a different form of support has been granted to the formerly state-owned firms that are still benefitting to the present-day, which includes infrastructure, R&D, capital investment, and subsidized operating costs.25 Therefore, the EEG has succeeded in leveling the playing field by facilitating the penetration of RES technologies into the market in order to compete against incumbent technologies. The fourth obstacle is resolved by the EEG indirectly by the measures mentioned above. Essentially, the government establishes the framework in which RES deployment

can occur. In doing so, the broader interest of society supersedes the narrow interest of the utilities. 2.0 Economic efficiency As stated in Section 1.7, economic efficiency is defined as the relative cost of this policy option as compared to other support schemes and the absence of government intervention. The policy option with the highest level of economic efficiency compared to the alternative policies will carry the lowest costs to society. The societal costs can be differentiated between the costs to consumers and producers, whereas the environmental externality is encompassed in the ecological effectiveness criterion. The costs to producers will be grouped with the investment risk of investors because the majority of the economic burden in both support schemes is passed onto the end user. In the literature reviewed for this thesis, there have been no findings of data that attempted to measure the costs incurred by the utilities, the transmission operators, and the capital investors. For this reason, I have adopted the standard used by the Climate Change Advisory Group of Deutsche Bank in order to assess the attractiveness of each support scheme to producers and investors. Investors are attracted to the quality of incentives provided by a renewable energy policy framework that is considered in light of three key considerations: transparency, longevity, and certainty. Transparency is defined as the ease in which investors can circumnavigate the bureaucracy and policy structure. Longevity represents the

correspondence between the investment horizon and the policy timetable. Investors seek the confidence that a RES support scheme will retain the support of the government and the public to remain operational. And last, the notion of certainty involves the capability to precisely calculate the future cash flows of an investment given the market and institutional conditions.

The costs to consumers will be accounted for by an analytical approach and the use of statistics drawn by several reports conducted by multinational corporations and university research studies. Although there are different technology-specific tariff rates that could have been employed in this comparison, I mainly focused on wind and solar because these RES have seen the highest rates of growth. The major statistic that is used in this comparison is the cost of the tariff per household for a given RES-based technology.

2.1 Economic Efficiency: Green Certificate System The green certificate system creates a quota requirement of property rights to the environmental benefits derived from generating green electricity26. A certifying agency established by the government oversees the purchasing, selling, and trading of these unique rights (certificates) on a certificate market. The price of a certificate is determined by the costs associated with the generation of green electricity. When the producer generates electricity from RES instead of the less costly conventional sources, the certificate’s value on the market should cover the producer’s incurred loss—in accordance with theory. The GC system separates the market for electricity (commodity) from the market for certificates (rights to environmental benefits). Economic efficiency is maximized because producers are allowed to make rational decisions in how they will fulfill the predetermined quota, which represents an artificially-induced market demand. The producers are given the option of either generating green electricity through their own means or they can purchase the certificates from other producers. However, in reality, the producers and investors are faced with uncertainty in determining the best course of action due to the fluctuation of the price of the certificates, which depends on different factors such as the location of the facility producing the green electricity and the type of RES electrical system.27 The empirical data provides evidence that even though the GC system has seen considerable success in MS at the beginning of

the decade, it currently encounters severe difficulties due to the high level of investment uncertainty in the long term. Furthermore, with regard to producers and investors, the rules of the certificate market call for the drafting of bi-lateral contracts to settle the terms of the purchasing and selling of certificates28. Such agreements are conducted on a case-by-case basis and the price of the certificates is determined by laws of supply and demand. However, the drafting of these bilateral agreements, in accordance with free market principles, creates an environment of uncertainty—in addition to the incurred transaction and administrative costs. Therefore, there is “very little transparency or certainty going into the negotiation”29. The following diagram demonstrates the suite of external factors that

increase the uncertainty of the underlying value of the certificate. Last, the nature of electricity does not permit its storage. In order to respond to price signals, utilities need to install new generation capacity that may take from one to five years to commission. This feature of the industry produces further uncertainty in both the electricity and the certificate markets in the form of volatile prices and illiquid capital assets, respectively. With regard to consumer costs, the findings of the International Energy Agency (IEA) have demonstrated new evidence that contradicts the prevalent claim that GC systems are less costly than FIT mechanisms. The IEA research revealed that the GC systems are more costly to consumers than the FIT. In the portion of the report focusing on on-shore wind power, the research team suggested that only fixed tariffs above a specified price can catalyze a specific RES market: “a minimum level of remuneration appears necessary to encourage wind power deployment…none of the countries that provide overall levels of remuneration below USD 0.07/kWh witnessed significant deployment effectiveness”3. The report proceeded to reveal that the leading countries in wind power deployment—Germany, Spain, Demark, and recently, Portugal—used FIT with lower

average remuneration levels in 2005 (USD .09-.11/kWh) than those in countries that used GC systems (USD .13-.17/kWh). This blaring discrepancy can be explained by the fact that beyond a certain price ceiling, the degree of policy effectiveness is not necessarily enhanced even with the continued increase of remuneration levels. The cases of Italy, Belgium, and the United Kingdom and their use of GC systems provide further evidence of this theory because even though these countries provide the highest level of remuneration for wind power, none of these countries scored high levels of deployment effectiveness. Therefore, the appropriate question is why did these countries fail to promote their respective RES sectors? The report identifies two leading factors that discouraged the use of green technologies: “non-economic barriers and intrinsic problems with the design of the GC systems31”.

2.2 Economic Efficiency: Feed-In Tariff

In the case of the EEG and its feed-in tariff mechanism, the German regional or national transmission system operators are obligated to feed in the full generation of green electricity by independent producers at politically fixed prices according to the RES technology. The price of the fixed tariff rates are agreed upon using a transparent equation, and thus, are less vulnerable to fraud, manipulation, and volatility. The costs of this support scheme are also borne by the end users; however, the economic burden for the consumer under the conditions of a FIT mechanism is more predictable than the GC system.

The German government has set a fixed tariff rate for each eligible green technology. Every two years, regulators assess the capacity installation of each technology and calibrate its respective tariff rate in accordance with a specified growth trajectory. For example, the yearly energy produced by the German wind power sector is approximately 40,000 GW h with an average tariff rate of about .07 Euros for every kilowatt per hour. If the objective is to generate 50,000 GW h by the year 2030, the German government will assess the expansion of wind power generation every two years and calibrate the tariff rates to achieve moderate and sustained growth. In this way, an accurate prediction of the total costs to the end user can be determined. For instance, the monthly cost per household to fund the FIT for solar energy only averages about 3 Euros in 2008.32 Albeit the higher relative costs of the FIT mechanism (e.g. up to .65/kWh for solar photovoltaic systems), the economic burden of the support scheme can be easily determined every year and an accurate prediction of future costs can be determined. However, the most important implication of the FIT is that its transparent price calculation provides a higher quality bundle of incentives for investors. The effect of providing stable expectations for the investment period is evident in the remarkable performance of the FIT mechanism as compared to other support schemes. In a comparative analysis conducted by the University of Palermo, the FIT mechanisms in the countries of Germany, France, Spain, and Italy have led to pay-back-periods of under 19 years. In the case of Germany, the EEG has provided the following statistics that guide investors in making their decisions: · · · · Average pay-back period of photovoltaic systems: 16 years Average pay-back period of wind systems: 15 years Average internal rate of return for photovoltaic systems: 3% Average internal rate of return for wind systems: 3.5%

The pay-back period designates the cost of the project divided by the annual cash flows, which will equal the total amount of time that is required in order to cover the initial investment. In the German RES market, a household or utility is guaranteed that the installation of a RES electrical system will pay for itself no later than 19 years. In addition, the internal rate of return represents the discount rate that is used in capital budgeting that will set the net present value of a project’s cash flows equal to zero. In the case of Germany, the internal rate of return indicates that an investor covers the costs of the initial capital investment, and also earns a premium bonus of approximately 3%. In the cumulative cash flows comparison for non-integrated photovoltaic systems33, the EEG provided the best stimulus for growth among the four leading countries. This figure represents the category of RES energy projects that are funded in part by local landowners and community members in the rural areas of Germany. A growing social acceptance of community energy projects called “energy cooperatives” has democratized the local supply of electricity for many German towns and has highly contributed to the expansion of the RES sector. Furthermore, the FIT has an economic advantage over the GC system because it enables the economic burden of its implementation to be reversed by the consumer. If the consumer decides to take out a low-interest rate loan and to install an independent RES power generator, then the rate of return the RES electrical system will accrue can cover the annual costs of the FIT. It may be the case that under a FIT mechanism, the total economic costs to the consumer are greater than the GC system, but even so, the economic burden under a FIT is not only more predictable, but also it can be mitigated more readily if the consumer proceeds in purchasing a RES electrical system. One of the major weaknesses in the FIT, with regard to consumer costs, has been corrected during the initial phase of its implementation. Ringel identified this flaw in design by observing that no “differentiation had to be made between network operators with a high share of renewable in their operation area and operators with having

practically no green power producers to deal with, consumers were caught and simply had to pay the additional costs34”. For instance, northern Germany operators were mandated to feed in a large portion of wind power whereas the operators in southern Germany had considerably less green electricity generation. However, the German government solved this problem by implementing a compensation scheme that distributed the economic costs of the FIT equally between the operating areas and their respective consumers. 2.3 Ecological Effectiveness: Feed-In Tariff With regard to ecological effectiveness, the GC system should theoretically promote the greater amount of installed capacity of green electricity over the FIT mechanism. However, consulting the empirical evidence of recent years will reveal the multiple counterexamples that clearly signify an overriding trend that FIT tariffs are, in fact, more effective in expanding RES generation capacity (Appendix 1). For example, the “surge of wind energy in the E.U. has clearly taken place within countries that selected the FIT as their national support scheme35”. The countries of Germany, Denmark, and Spain surpass the E.U. 15 average by at least 2,000 GWh; however, the country of Netherlands—which implements both a FIT and a GC system—is much closer to the E.U. 15 average. The only difference between the Netherlands and the other three countries is that the Netherlands does not obligate transmission operators to take green electricity generated by RES producers. This observation suggests the importance of each feature of a well-designed FIT because the other factors would most likely not override the potential benefits of an effective FIT. In the case of solar energy, Germany is dominant in the area of photovoltaic generation, accounting for 47% of the world’s new PV generation capacity in 200736. In terms of generation capacity, Germany installed 1.1 GWp in 2007, which elevates the total photovoltaic capacity to 3.8 GWp. Accordingly, economists are predicting that this

growth rate will have a high impact on other major markets such as Spain, Italy, France, Greece, Japan, and the US, particularly because the PV industry is expecting manufacturing costs to continue decreasing.37 2.4 Ecological Effectiveness: Green Certificate System A. Failure to Achieve E.U. Energy Objectives

The greatest disadvantage of the GC system in promoting the use of RES generation is its inherent tendency to concentrate on a select few green technologies within its country of jurisdiction. If the E.U. does not promote a high level of diversity among RES technologies within the energy sector, then it will fail to achieve its long term energy objectives—namely, to achieve energy supply security and to reach its indicative RES targets. The objective of energy security will not be reached with the implantation of a GC system because of its inherent design. Since the price of the certificates is dependent on supply and demand only, the purchasing party will seek out the certificates that have been earned with the least cost. As a result, only the most efficient producers will be better equipped to sell certificates at a more competitive price than less efficient producers. This element of the GC system appears beneficial on the surface; however, wind power, hydro, and biomass energy are the only green technologies in the energy sector that reach efficiency levels that enable producers to competitively sell their earned certificates and to continue producing green electricity. Under these market conditions, technologies such as solar photovoltaic will not be able to compete, and thus, will not be deployed. The objective of energy security is particularly important for the E.U. because it is highly reliant on foreign imports of fossil fuels. If the price of fossil fuels fluctuates, then the E.U. will experience price hikes, possible supply disruptions, and grave economic losses. In addition, Ringel cites the example of the Brazilian blackouts in 2003 to

demonstrate the danger of generation fluctuations in the case of natural catastrophe. The series of black-outs occurred because a heat wave hindered the production of hydroelectricity, which is a source of power generation that contributes a large share of Brazil’s total capacity Furthermore, the objective of reaching the E.U. indicative RES targets will not be fulfilled unless a diverse portfolio of RES is stimulated. Many MS have specialized in one or two RES in accordance with their respective resource endowments. For example, the country of Austria has exploited its mountainous geography to harness the potential of hydroelectric power, whereas Spain has extensively developed its solar power generation capacity. Since the further deployment of such RES technologies will incur rising marginal costs and other difficulties, it will become necessary for the MS to stimulate the use of additional RES technologies in order to reach their indicative RES targets. If a GC system cannot stimulate the more costly RES-based technologies, it cannot be the support scheme of choice for many MS.

B.

False Claim of Timeliness

Proponents of the GC system claim that, unlike the FIT and its reliance on voluntary market participation, the imposition of volume quotas ensures that a RES target is fulfilled in a timely manner. However, the caveats of this claim are numerous to the extent that it does not hold true in practice. First, the binding volume target can be avoided by utilities by accepting the compliance penalties for the failure to generate green electricity or to purchase green certificates. Second, both support schemes are the result of political negotiations whose incentives are not guaranteed beyond the provisions of the legislation. The long term continuation of such programs is of the utmost importance in inspiring confidence among producers and investors. Therefore, the support scheme with the greatest and most sustained support from the body politic will have the highest likelihood of continuation.

Given this proposition, the utilities of an energy sector would be more in favor of a GC system because it is the least costly and it is more advantageous for large firms with the resources and leverage to negotiate the bilateral contracts needed for the exchange of certificates. In contrast, the FIT extends the incentives of the support scheme to any independent producer—from the residents of a city apartment building to the farmers of a small community. The FIT mechanism can enable any citizen to install a RES electrical system and generate green electricity, and thus, the FIT is a more democratic and open policy instrument. This feature of the FIT increases the likelihood that it can garner greater public support and political backing.

C.

Potential Reduction of the Volume Targets

Furthermore, government authorities are “sensitive to the impact that the binding targets may have on electricity rates and some policies have clauses that explicitly exempt the utility from compliance if the rate reaches a certain threshold38. Given this fact, the indicated target may not be definitively binding for the energy sector; but nevertheless, the costs are borne by the end users in exchange for minimal accrued benefits. The overall aim of generating 20% of the E.U.’s total electricity generation from RES has been “split up into indicative targets for its member states due to different levels of nationally available RES.”39 If the economic burden on the consumer becomes overbearing and the countries with GC systems ease their generation obligations, then every MS will be negatively affected because the integrity of the indicative RES targets will be compromised. For this reason, the FIT mechanism is the most ecologically effective support scheme because it creates a framework of incentives without establishing a cap that may hamper RES growth rates. The primary example of this proposition is the collapse of the solar market in Spain. Since the feed-in tariff was stimulating the RES market to the degree that the Spanish government could not

sufficiently fund the program, the authorities imposed a cap. This restriction flooded the market with participants who did not want to lose the opportunity. This created a further strain on the Spanish government, and once the cap was reached, the solar tariff ended and the market imploded soon after. This case is a useful lesson in the importance of proper FIT design and implementation. Unlike the German FIT, Spain did not pass the costs on to the consumer and they imposed a cap on the market, which led to drastically counterproductive results. 2.5 Intellectual Property Rights and Technology Transfer Without the deployment of emissions-reducing, energy-saving technologies, countries cannot exploit the agricultural, industrial, and residential products and software necessary to pursue a low-carbon economic growth trajectory. Such climate-related technologies are central to the international effort to mitigate and adapt to climate change. Historically, most of the world’s technological innovation has originated in the industrialized “North” whereas the developing “South” confronts several obstacles to accessing such technologies, which include: inadequate foreign direct investment flows and minimal indigenous research and development (R&D). Since the developing countries’ total greenhouse gas emissions are exceeding the level emitted by the industrialized countries, the objective of bridging this technological disparity becomes increasingly important. A major obstacle that hinders technological transfer and a stumbling block for current negotiations in Copenhagen is the issue of intellectual property rights (IPR). On the one side of the debate, U.S., Europe, and Japan are entrenched in the policy position that IPR protection is not an obstacle, but imperative in encouraging innovation. Since innovative activities are both costly and risky, market actors must be ensured of temporary monopolistic power in order to appropriate the benefits accrued from their innovation. In addition, the dissemination of knowledge is

promoted because information from the patent claims is available to other inventors and entrepreneurs, which can serve as a substrate for further innovation. Proponents of IPR protect claim that in the absence of IPR protection, the threat of imitation damages the incentive for any potential R&D. In contrast, the diplomatic coalition of developing countries, the G-77, represents the antithetical view that the current IPR regime is an obstacle to technology transfer because it stifles innovation and knowledge diffusion. Proponents of this view generally believe that profiteering multinational corporations withhold proprietary knowledge to the detriment of the welfare of the South. For this reason, India, Brazil, and China have led efforts to demand compulsory licensing, especially in the wake of the precedent-setting Doha Declaration and the concession of the pharmaceutical companies in the Africa HIV/AIDS epidemic. These two views correspond to either extreme of the spectrum of policy options. The optimal course of action is a balancing act between maintaining a strong incentive for firms to engage in R&D while keeping costs low for new technologies, especially for their use in developing countries. For this purpose, measures should be taken to uphold the minimum standards of IPR protection established by international treaties such as the World Trade Organization’s Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS). If IPR protection is effectively enforced, inventors and entrepreneurs will have the confidence to challenge the status quo by experimenting and creating new innovations. Policymakers must be cautious of providing excessive IPR protection because then proprietors of knowledge can reserve their patents that may lower output and increase costs of the new technology, which will hinder its deployment. But in the interest of the developing world, mature technologies should be transferred as readily as possible in order to enhance the social and economic welfare among the most vulnerable populations. To avert damaging

the incentive for future R&D, the transferred technologies can constitute information and products that are behind the technological frontier by at least five years. 2.6 Resolution to the Debate Unfortunately, both parties of the debate are entrenched in rigid positions and the only viable solution may lie with the idea of cooperative international R&D agencies. Since the majority of innovative activities occur within the private sector, national governments can contribute funding to an international clean technology institution that can allow countries to tap into its knowledge stock and to exploit its technological solutions. This compromise will be mutually advantageous for the producers of the North and the end users in the South. The most cutting edge technologies will continue to be developed by free market firms and their profit margins will not be reduced. In addition, the global clean technology institution can direct its efforts in meeting the technological needs that are either non-existent in the private sector or inaccessible. In addition, this source of knowledge and know-how can stimulate a learning process that can enable firms in developing countries to accelerate their transition from imitation to innovation. In the wake of the failed Copenhagen negotiations, policymakers must reach a consensus in this essential, but highly under-reported issue in the global climate change debate. The balance between incentivization of R&D and the fulfillment of social, economic, and ecological objectives should be struck in a manner conducive to the spirit of multilateralism and cooperation. For this reason, the best resolution to this debate is to establish an international clean technology R&D institution that can provide useful environmentally sound technologies to those who stand to benefit the most from them—the developing countries of the world. 2.7 Conclusion

This paper started its analysis with an examination of the role of RES-based technologies in the effort to combat global climate change. In order to answer the first research question, I provided a background of the technological process and the obstacles that hinder its advancement. Then, I established that government

intervention is the only means in which these obstacles can be overcome by market actors. The research conducted for this paper has determined that public sector R&D coupled with RES support schemes constitute the only way to achieve widespread deployment of green technologies. I chose two leading support schemes to compare in order to answer the second research question. The GS system and the FIT mechanism represent my dependent variables because they affect the independent variable of RES deployment. To determine which support scheme is the most effective, I employed two criteria: economic efficiency and ecological effectiveness. The results of my analysis are that GC systems should theoretically be less costly to society (economic efficiency); however, the empirical record coupled with additional factors of uncertainty has led to different conclusions. In addition, GS systems should also perform better in pursuant to the ecological criterion, however, the FIT has proven to be the better policy instrument in creating green electricity generation capacity. In conclusion, this analysis has demonstrated that the FIT is the superior support scheme in light of the two defined criteria that were used in the qualitative approach. Last, the issue of intellectual property rights is raised in the context of technology transfer. If the green technologies are imperative to the international strategy of mitigating and adapting to climate change, then the developing world is entitled to assistance in advancing their technological innovation and adopting the use of RES electrical systems (especially in light of the fact that the industrialized nations have historically contributed the majority of greenhouse gas emissions into the

atmosphere). The final resolution to this dilemma between incentivizing innovative activities and keeping costs low is the establishment of an international research institution that can be tapped for knowledge and funding.

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Nicolosi and Fuersch pg. 25

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Energy industries is a generic term for all of the industries involved the production and sale of energy, including fuel extraction, manufacturing, refining and distribution
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Pew Center on Global Climate Change pg. 7 Stern pg. 349 Pew Center on Global Climate Change pg. 7 Pew Center on Global Climate Change pg. 8 The four obstacles are derived from the analysis of the Stern Report Stern pg. 350 Stern pg. 355 Stern pg. 361 Pew Center on Global Climate Change pg. 35 Stern pg. 361 Slater and Tonkiss pg. 124 Ringel pg. 6 Campoccia, Dusonchet, Telaretti, Zizzo pg. 289 Ringel pg. 8 Analogous to the notion of emissions allowances in a cap and trade scheme Lauber and Mez pg. 105 E-Parliament memorandum pg. 3

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E-Parliament memorandum pg. 3 Stryi-Hipp pg. 4 Pernick, Ron and Wilder, Clint Pernick, Ron and Wilder, Clint

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Goldberg European Environment Agency pg. 16 Campoccia, Dusonchet, Telaretti, and Zizzo pg. 288 Campoccia, Dusonchet, Telaretti, and Zizzo pg. 289

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The GC system favors large electricity generators with the resources to engage in negotiations. This feature also increases transaction costs which are passed on to the consumer.
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Deutsche Bank Advisory Report pg. 50

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Gipe pg. 2 Gipe pg. 2 Martin pg. 2

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The term non-integrated photovoltaic systems refers to generators that are not integrated into the exterior structures of buildings.
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Ringel pg. 6 Ringel pg. 10 Modern Power System Magazine pg. 32

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The experience of recent decades has shown that the cost of PV electricity is reduced by 20% with each doubling of the total installed volume.
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Deutsche Bank Advisory Report pg. 52 Ringel Pg. 2

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