Changing Competitive Landscape Transition Policy’s Blind Spots

Discussion:

Using two well-known renewable energy transition case studies, potential transformations in the competitive landscape that are typically overlooked in policy design have been identified.

Germany’s energy transition journey exemplifies the complexities arising from trying to achieve local industry development targets and high penetration targets, simultaneously, within a tight timeframe. With hindsight, we can say that policy has overlooked the potential competitive pressures that could have arisen from global suppliers, inhibiting the achievement of local goals. Additionally, the German experience demonstrates how underestimating future cost reductions in the supported renewable technology can result in transmuting a reasonable financial incentive to a profligate one, and consequently causing political controversy while trying to agree on policy amendments. Scenario planning and asking ‘what-if’ questions are routes to mitigating the associated uncertainty. Equivalently, policies can be designed with flexibility attached to them to adapt for potential changing market conditions

In the US, regardless of the numerous federal and state policy instruments that were devised to support wind energy penetration, the natural gas value chain continued to improve its competitiveness in both the production of fuel and conversion to electric power – the supply cost curve moved downwards, even in the face of flat or growing demand levels. These improvements, which were not competitive reactions to wind industry growth, changed the landscape for all power generating technologies. We can imagine that this progress will continue, even assuming policy driven support for a new technology does not eat into the market share of the incumbent. It will therefore take longer than originally imagined by policy makers for the new entrant to become cost competitive in its own right. The high reliance of wind energy development on incentives for more than 20 years since the introduction of the wind PTC is an example. However, if the new entrant secures so great a penetration that demand for the incumbent begins to decline in absolute terms, the incumbent will move further down the supply curve to a lower marginal cost. This additional consequence of competition will further prolong the need for policy support for the new entrant.

The scale and duration of financial commitments by governments are undoubtedly an important aspect of any policy, and the case studies tell us that policy suppleness with respect to the finances can prevent creating political controversy at later stages of policy implementation. Two characteristics of a supple policy are of particular importance; the first is concerned with the ability to reduce or cease financial support dedicated to a specific technology if the technology costs fall for whatever reason. The German case-study (i.e. second blind-spot) reflects the value of this option in the face of technology costs falling faster than anticipated.

In the alternative case of renewable technology costs not falling as fast as those of incumbent fossil fuel supply chains, the danger is different. If the aim of policies supporting renewable energy is achieved – absolute reductions in consumption of fossil fuels – an economy may suffer higher energy prices than its competitors relying on fossil fuels. Renewables are only competitive with conventional fuels when their full cycle costs are comparable to the costs rather than the current market prices of fossil fuels. The continuing excess costs of renewables can only be borne by one of three stakeholders: investors (and their lenders), consumers, and taxpayers. There is no magical fourth source of funding. These higher energy costs are locked in once the capacity is installed, because of the high capital, low operating costs of wind and solar electricity. Furthermore, unless investors are coerced, there is a maximum contribution they will make based on their rate of return requirements. This leaves the balance to be shared between taxpayers and consumers, either directly or indirectly.

It is not hard to imagine that governments seeking to bolster their economies will succumb to the temptation to reduce the costs of support to their transition strategies. This may cause investors relying upon incentives to fill the cost gap in their economic comparisons of conventional and renewable energy to hold back or require levels of commitment that are politically difficult to provide. At least in the current economic climate, energy prices and taxes appear to exert more influence on an electorate, and thus their political leaders, than an appetite for a clean energy transition.