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Government intervention in the micro-economy: Modeling the interventions

About the workshop 

The workshop, held in March 2014 with some 40 participants to discuss energy systems modeling.

Background to the workshop 

The workshop was held in Riyadh, Saudi Arabia at the King Abdullah Petroleum Studies and Research Center (KAPSARC) on March 18 - 19, 2014. The focus was on government intervention in the micro-economy, including regulation of energy markets, sustainable technologies, case studies quantifying the impact of energy policy implementation, and climate policy.

Summary for policymakers

The challenges of energy policy are multiplying, particularly as climate change has become a feature of the discourse around the world. There is no single policy tool that addresses all elements of the energy trilemma – securing affordable, reliable, and environmentally sustainable energy. The resulting collage of often overlapping policies may yield unexpected, and potentially undesirable, results without a proper ex-ante analysis of their interactions.

Government intervention is ubiquitous in the energy landscape, including taxation, subsidization, and directly regulating market operations among others. These interventions are aimed at:

Achieving social or political objectives, such as alleviating financial burdens on low-income households or incentivizing growth in a particular economic sector by regulating input prices. 

- Mitigating the effects of externalities, such as by adopting a carbon tax or cap-and-trade system. 

- Reducing the real or perceived risks of market failure. 

- Controlling the presence of market power and inducing competition.

In some countries, market intervention represents the status quo leading to consideration of policies focused on transition from a centrally planned economy to more competitive markets. But such market deregulation may impact end consumers and the social compact of a nation to the point of precipitating further interventions to restore a politically acceptable balance. 

Policies can achieve their intended outcomes or result in unintended consequences. For example, Independent Systems Operators in the US power market upgraded their optimization technology for clearing day-ahead electricity markets, saving millions of dollars for consumers. By contrast, US biofuel policies ran into unanticipated market conditions – declining demand for gasoline – and had to be reframed to remain viable.

The application, in a holistic, integrated framework of a range of analytical techniques may lead to better coordination among policy instruments and a better understanding of their interactions in producing policy outcomes. An example of the alternative is the uncoordinated planning and implementation of policies in the EU, which targeted a combination of carbon trading, climate, renewables and power market integration. The resulting undesirable interactions led to a rise in carbon emissions, a fall in carbon prices, which depressed “low carbon” investment, and an increase in the costs of renewable subsidies that distorted incentives to invest in capacity. 

Could policy misalignments be prevented by engaging in better modeling and analysis to understand how different policies might interact? In the increasingly multidimensional policy environment, individual stakeholders that focus on only one aspect of the problem may generate misleading conclusions.

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