In recent years several European countries alongside Canada and Israel have adopted the so-called Nordic model of prostitution legislation to try and reduce the risk of sexual exploitation. While the reforms directly affect the regulation of the domestic sex market, their effects may also spill over to other outcomes in nearby areas and internationally – for example affecting sex tourism flows. Making use of data on tourism flows and Google searches, a new study examines the causal effect from the implementation of the reform in four different countries on sex tourism in popular destinations. The findings indicate that domestic reforms increase sex tourism, calling for the design of policies to account also for these adverse effects.
Since 1999, when Sweden introduced the so-called Nordic model of prostitution legislation, similar legislation has been introduced in Canada, Iceland, Ireland, France, Norway, and most recently Israel. While the legislation design differs between countries (for an overview see Perrotta Berlin and Spagnolo, 2019), the common foundation is to effectively criminalize the purchase but not the selling of sexual services. The introduction of such reforms aims at battling human trafficking and reducing the risk of exploitation. While the effect from the asymmetric prostitution legislation has been found to increase rape incidence in Sweden (Ciacci, 2018), when it comes to the sex market the Nordic model is mainly thought to affect it in two contrasting ways. Firstly, it may suppress domestic supply, which could result in people travelling to destinations where prostitution is not criminalized. Secondly, it might affect the general view on prostitution (Kotsadam and Jakobsson, 2011), thus reducing domestic demand as well as international sex tourism.
Sex tourism is associated with human trafficking, child exploitation and increased spread of sexually transmitted diseases (Herold and Van Kerkwijk, 1992; Brooks and Heaslip, 2019; Newman et al. 2011). Despite this, few studies have explored the impact of prostitution laws on the practice – in part due to measurement difficulties.
This brief presents evidence from a forthcoming paper by Perrotta Berlin and Latour on sex tourism patterns following the implementation of the reform in four different countries.
Quantifying Sex Tourism
Perrotta Berlin and Latour use tourism patterns and Google searches to quantify sex tourism flows, in order to evaluate the effect from changes in prostitution legislation in Canada, France, Ireland and Norway. Specifically, they use data on the number of monthly tourist arrivals to Thailand and The Philippines, and weekly Google searches originating from the above-mentioned reform countries for popular sex-tourism and other tourism destinations, including attractions within cities. German tourism data and Google searches originating from France as well as Google searches originating in the US are used to estimate the effect on sex tourism to bordering countries (France to Germany and US to Canada, respectively). To evaluate the respective effects, they identify treated and control groups for each considered setting, and proceed to compare data between these groups before and after the reform (in line with the so-called difference-in-differences specification, as pioneered by Card and Krueger, 1994). In the following sections, each of these specifications and the subsequent results are discussed.
Evident Spillover Effects
Thailand and The Philippines
For Thailand and The Philippines, monthly data was available on tourist arrivals differentiated by country of origin from 2013 to 2020 and from 2008 to 2020, respectively. The underlying assumption is that, absent a prostitution legislation reform in the four considered countries (Canada, Ireland, France and Norway), the tourism flows from the country in question to Thailand and The Philippines would have remained the same over time. Thus, the change in the number of tourist inflow (out of which an unknown number are sex tourists) from the country in question – when compared to the number of tourists from other countries used as the control group – can be interpreted as a causal effect from the legislative reform on sex tourism.
The results show that, when compared to tourists arriving from other countries, the number of tourists arriving from one of the countries having recently implemented the Nordic model increased by 0.312 and 0.158 standard deviation points for The Philippines and Thailand respectively. Figure 1 below illustrates the results from an event study specification, in which the reform dates in the four different countries are aligned at 0, depicting how the increase is spread over the two years following the reform.
Figure 1. Number of tourists before and after the reform, The Philippines to the left and Thailand to the right.
In Germany, the legislative status of prostitution is determined at the level of municipality. For the analysis, German municipalities where prostitution is to some extent legal were considered to form the treatment group and municipalities where it is illegal constituted the control group. The outcomes of interest were i) tourists travelling to German municipalities of interest, and ii) Google searches from France for the same municipalities.
The analysis shows an increase in foreign tourism to the treatment municipalities following the implementation of the Nordic model of prostitution legislation in France. At the same time, no changes in domestic tourism was detected. The conclusion that the increase in foreign tourism is driven by an increase in French tourists, by which one could then argue the implemented reform to increase cross-border sex tourism, was validated by the analysis of French Google searches. In these data it can be seen that distant German municipalities where prostitution is legal become relatively more interesting in French Google searches after the reform compared to municipalities where prostitution is illegal.
Figure 2. Searches of German municipalities originated in France relative their distance from the French border.
Data on Google searches for Canadian municipalities from one year before to one year after the reform in Canada were considered for the analysis. Searches originate in different US states, which also differ in the extent to which purchase of sexual services is legally punishable. The length of imprisonment in each US state determines whether a state was considered treated – when the length of imprisonment equals or exceeds that in Canada following the reform – or control. Results show that after the introduction of the Canadian reform, Google searches for Canadian municipalities dropped, in particular, in US states with high punishments for purchase of sexual services – most likely those where sex tourism to Canada used to originate before the reform. The results from the event study is depicted in Figure 3 below.
Figure 3. Number of searches of Canadian cities before and after the reform, deseasoned.
Sex Tourism Destinations
Finally, Google Searches for sex tourism destinations were considered as the outcome variable with the underlying idea being that – in the absence of a legislative change in the four considered countries – the difference in number of searches for sex tourism vs tourism destinations would have been the same over time. Sex tourism destinations were defined in two alternative ways: first, a list of popular destinations was selected within countries where prostitution is legal; second, this list was augmented with information from websites that list popular destinations for sex tourism, regardless of the legal status of prostitution in that country.
The results from this analysis are less clear, varying with the definition of sex tourism destinations and with the country of origin. But by and large they showed, if anything, that the interest in sex tourism destination countries decreased after the reform. This might indicate a change in attitudes towards lower acceptance of sex trade in general in the countries where the reform was implemented.
Prostitution legislation reforms affect the domestic sex market and have potential cross-border and international spillover effects. One such impact from criminalizing the purchase of sexual services domestically is increased levels of sex tourism, which might in turn impose adverse effects on the destination countries.
Filling a research gap by studying the effect from introducing asymmetric prostitution laws on sex tourism, Perrotta Berlin and Latour find evidence suggesting that harsher domestic regulation, while potentially changing attitudes in the general population (as indicated by Google Searches) also, in specific cases, increases, the outflow of tourists to destinations with less stringent laws.
After the introduction of the Nordic model, Norway has imposed legislation prohibiting their citizens to purchase sexual services even in countries where it is legal and implemented awareness campaigns on the detrimental effects of sex tourism on local populations. Given that sex tourism is associated with human trafficking, child exploitation and increased spread of sexually transmitted diseases, the results call for other countries to follow suit with domestic prostitution legislation taking on a more global approach to achieve greater effectiveness.
- Brooks, A. and Heaslip, V. (2019). Sex trafficking and sex tourism in a globalised world. Tourism Review, 74(5): 1104-1115. https://doi.org/10.1108/TR-02-2017-0017
- Card, D. and Krueger, A. (1994). Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania. American Economic Review, 84(4): 772–793, September https://ideas.repec.org/a/aea/aecrev/v84y1994i4p772-93.html
- Ciacci, R. (2018). Banning the purchase of prostitution increases rape: evidence from Sweden. https://ideas.repec.org/p/pra/mprapa/100393.html
- Herold, E. S. and Van Kerkwijk, C. (1992). Aids and sex tourism. AIDS society, 4(1):1/8.
- Kotsadam, A. and Jakobsson, N. (2011). Do laws affect attitudes? an assessment of the norwegian prostitution law using longitudinal data. International Review of Law and Economics, 31(2):103–115. https://www.sciencedirect.com/science/article/pii/S0144818811000196
- Newman, W., Holt, B., Rabun, J., Phillips, G. and Scott, C. (2011). Child sex tourism: Extending the borders of sexual offender legislation. International journal of law and psychiatry, 34:116–21. doi: 10.1016/j.ijlp.2011.02.005
- Perrotta Berlin, M. and Spagnolo, G. (2019). The Nordic Model of Prostitution Legislation: Health, Violence and Spillover Effects. FREE Policy Brief. https://freepolicybriefs.org/2019/04/21/the-nordic-model-of-prostitution-legislation-health-violence-and-spillover-effects
- Perrotta Berlin, M. and Latour, C. (2023). Cross-Country Impacts of Prostitution Legislation: Evidence from Reforms in five Countries. Unpublished manuscript.
Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.
The Stockholm Institute of Transition Economics (SITE) in collaboration with the FREE Network is delighted to invite you to a webinar to share insights and knowledge on different strategies implemented in vaccination, opening up the borders and the socioeconomic aspects within Sweden, Eastern Europe and the Baltic Sea region, and the Caucasus region.
Since vaccination has started across all over the world, it is vital to reflect upon the road map different countries have chosen to open up societies and economies. How will countries in Eastern Europe and the Baltic Sea region, and the Caucasus region handle the opening of their respective borders and what lies next in line to go back to a pre-pandemic societal routine?
- RSVP: Monday, June 21, 2021, 23:59 (CET, Sweden).
- Location: Online. A link to the webinar will be sent to you 4-5 hours ahead of the start of the webinar.
- Registration: Please register via the Eventbrite platform (see here).
The webinar is part of a series of online discussions aiming to provide regional overview updates as well as in-depth analysis of specific topics related to the COVID-19 pandemic. Since the FREE Network includes research and policy institutes in Belarus (BEROC), Latvia (BICEPS), Russia (CEFIR at NES), Poland (CenEA), Georgia (ISET PI), Ukraine (KSE) and Sweden (SITE) the upcoming webinar will provide a comprehensive regional perspective on different strategies implemented in vaccination, opening up the borders and the socio-economic aspect. Learn more about the different strategies in FREE Network countries and ask questions directly to distinguished panelists and experts.
- Jesper Roine, Professor at the Stockholm Institute of Transition Economics (SITE/ Sweden)
- Iurii Ganychenko, Senior researcher at Kyiv School of Economics (KSE/Ukraine)
- Lev Lvovskiy, Senior Research Fellow at the Belarusian Economic Research and Outreach Center (BEROC/ Belarus)
- Michal Myck, Director of the Centre for Economic Analysis (CenEA/ Poland)
- Natalya Volchkova, Director of the Centre for Economic and Financial Research at New Economic School (CEFIR at NES/ Russia)
- Sergejs Gubins, Research Fellow at the Baltic International Centre for Economic Policy Studies (BICEPS/ Latvia)
- Giorgi Papava, Lead Economist at ISET Policy Institute (ISET PI/ Georgia)
- Anders Olofsgård, Deputy Director of the Stockholm Institute of Transition Economics (SITE) and Associate Professor at the Stockholm School of Economics (SSE)
Danske Bank has recently been accused of having laundered more than 200 billion Euros through its Estonian branch. The size of the scandal has reinvigorated the discussion over lax enforcement by regulators and poor bank compliance with anti-money laundering laws. In this brief, we concisely review some recent cases of poor regulatory and political behaviour with respect to these matters, focusing in particular on the UK, whose financial system seems to have become a main hub for this type of financial misconduct.
A widespread phenomenon
The size of the recent money laundering scandal at Danske Bank, involving more than 200 billion Euros, has surprised many. Money laundering is a widespread issue in an increasingly complex world where financial transactions are many and instantaneous, while oversight slow and limited (Radu 2016). According to the United Nations Office on Drugs and Crime, an estimated $800 – $2 trillion is laundered every year (United Nations Office on Drugs and Crime). The source of laundered money is often from corruption, crime and drug cartels (as with the HSBC scandal, see below). Attempts to blow the whistle on these illegal transactions have gotten several people killed, especially in Russia (The Daily Beast, October 2018).
Malta’s Pilatus bank recently had its license revoked by the European Central Bank after its chairman was charged with money laundering (Reuters, October 2018). The investigative reporter Daphne Caruana Galizia was killed in a car bomb in October of 2017 in Malta (The Guardian, October 2017). She was leading the Panama Papers investigation into corruption in the country and had accused Pilatus bank of processing corrupt payments (The Guardian, November 2018). In Sweden, some banks have recently been criticized for insufficient actions against money laundering. Experts at the regulator recommended extensive sanctions, but upper management stopped them (Svenska Dagbladet, December 2018). In November, Deutsche Bank’s headquarters in Frankfurt were raided by prosecutors in a money laundering investigation (BBC, November 2018).
Back to Danske Bank. Its Estonian branch was recently accused of having laundered money, amounting to over 200 billion Euros of suspicious transfers (Financial Times, November 2018). In 2011 the Estonian branch accounted for 0.5% of Danske Bank’s assets, while generating 12% of its total profits before taxes. In 2013, 99% of the profits in the branch came from non-residents. Many of the non-resident customers are believed to be from Russia and other ex-soviet states (Forbes, September 2018). The alleged money laundering came to light due to the whistleblower Howard Wilkinson, who headed Danske Bank’s market trading unit in the Baltics from 2007 to 2014. Surprisingly, his anger over these transactions was not primarily aimed at top management in Copenhagen, or failure of rank and file employees to follow protocol in customer acquisition, but against the UK, who he claimed is “the worst of all” when it comes to combating money laundering (Financial Times, November 2018). In fact, the UK institutions seem to have been at the very heart of the scandal (ibid):
“Mr Wilkinson’s emails to Danske executives in 2013 and 2014 highlighted how UK entities were “the preferred vehicle for non-resident clients” at the heart of the scandal.”
In an address to European Union Lawmakers, he said (Reuters, November 2018):
“The role of the United Kingdom is an absolute disgrace. Limited liability partnerships and Scottish liability partnerships have been abused for absolutely years”.
Regulatory or political capture?
The increasingly central role that the UK appears to be playing as a hub for financial crime is perhaps not new or surprising. The UK has indeed come to be widely recognized as one – though certainly not the only – main hub for these illegal transactions (see e.g. Radu 2016, p.15). The UK’s National Crime Agency estimates 93 billion GBP of tainted money is flowing into Britain annually (Financial Times, September 2018).
And according to the classic theory of regulatory capture (Stigler, 1970), it is to be expected that a large, wealthy and highly concentrated sector such as the UK financial industry, will be able to capture regulatory institutions and lead them to act more in its favour than in that of the (national or international) community. However, besides being a concentrated source of special interests, the financial sector also represents a large share of the UK economy. It could be the case, therefore, that the capture goes all the way up to the political system and the government (as in Becker 1983, and Laffont, 1996). So, is it the alleged crime-friendly environment in the UK financial system linked more to problems of regulatory capture, or to deeper political capture?
Already in 2004 there were worrying signs of possibly deep political capture. At the time, Paul Moore, a senior risk manager at Halifax Bank of Scotland (HBOS), raised concerns about the bank’s risk taking and was subsequently fired by the executive James Crosby. Crosby then proceeded to become Deputy Chairman at the Financial Services Authority (FSA). HBOS then collapsed during the financial crisis of 2008 and merged with Lloyds bank, leading to one of the most concentrated banking systems in the world (the top 5 banks have 85% of the UK banking market). Many took this to substantiate Moore’s claim that the bank had been taking excessive risks. During Prime Minister’s question time in the House of Commons, David Cameron commented on then Prime Minister Gordon Brown’s decision to appoint Crosby to the FSA:
“Sir James Crosby, the man who ran HBOS and whom the Prime Minister singled out to regulate our banks and to advise our Government, has resigned over allegations that he sacked the whistleblower who knew that his bank was taking unacceptable risks.” (cited in Dewing and Russell 2016, p.165)
A suggestive episode directly involving politicians and money laundering is the case of HSBC, with headquarters in London. HSBC avoided criminal prosecution in the US and entered into a deferred prosecution agreement with the DOJ in 2012 (Department of Justice, December 2012). HSBC was found to have violated U.S. Anti-Money Laundering and Sanctions Laws by laundering billions of dollars linked to Mexican drug cartels, groups in Iran and Syria, and groups linked to terrorism. While HSBC apparently had systems to flag suspicious transactions, employees were told to disregard red flags (Garrett 2014, p.201). The case led to a 2016 House Committee report entitled “too big to jail” that was extensively used against the Democrats by the Trump presidential campaign (Committee on Financial Services, 2016).
The report states that on the 10th of September 2012 UK Chancellor George Osborne (the UK’s chief financial minister) wrote a letter to Federal Reserve Chairman Ben Bernanke (with a copy transmitted to then Treasury Secretary Timothy Geithner). In the letter, Chancellor Osborne insinuated that the U.S. was unfairly targeting UK banks by seeking settlements that were higher than comparable settlements with U.S. banks. He also worried about what criminal sanctions against HSBC would imply for financial stability. Criminal charges could also lead to a revoked license, making the bank unable to do business in the US (Financial Times, July 2016). HSBC was eventually ordered to pay a 1.9 billion dollar fine, while another whistleblower claims that the money laundering still went on (Huffington Post, August 2013).
The FSA also appeared much more concerned about criminal sanctions against HSBC than with money laundering for the bloodiest drug cartel in history (estimated to be responsible for several tenths of thousands of murders). In fact, the house committee report states that “The FSA’s Involvement in the U.S. Government’s HSBC Investigations and Enforcement Actions Appears to Have Hampered the U.S. Government’s Investigations and Influenced DOJ’s Decision Not to Prosecute HSBC” (p.24).
Things have not improved more recently. In 2013 the FSA was split up into the Financial Conduct Authority and the Prudential Regulation Authority (FCA & PRA). In 2014 the FCA & PRA came out with a note requested by the British parliament on whether financial incentives for whistleblowers should be introduced in the UK. These financial incentives, or reward programs, are used extensively in the US in tax, procurement, and securities. The FCA & PRA came out strongly against rewards in their seven-page note, yet do not cite a single piece of evidence (PRA and FCA, 2014). Most importantly, the note contains important factual misstatements about available evidence on their effectiveness that were easy to check at the time of the report (Nyreröd & Spagnolo 2017, National Whistleblower Center 2018). Nor was the note amended when one of us repeatedly communicated the mistakes to the agencies. This suggests persistent and deep regulatory capture. Consistent with this interpretation is the sanctioning behavior of UK regulators.
A blatant recent example is the ridiculous fine against CEO of Barclays Bank Jes Staley. He ordered his security team to unveil the identity of an uncomfortable whistleblower, going so far as to request video footage of the person who bought the postage for the letter. Yet, the FCA & PRA decided to just fine him £642 000 – a small fraction of his pay package that year (Reuters, May 2018). When Moore was asked about the fine he replied that “it is a very clear sign to whistleblowers not to bother” (Reuters, April 2018).
Is this regulatory capture, or political capture? The impressive list of consistent cases of regulatory slack and of political complacency suggests both, at least in the case of the UK. But the problem of regulatory capture in the case of financial crimes goes way beyond the somewhat extreme case of the UK. In all jurisdictions financial misbehavior has recently only led to settlements between regulators and the infringing financial institution, with settlement payments way too low to generate (financial stability concerns, and) deterrence effects. Banking regulators appear mainly concerned about banks’ health and profitability, so that large financial institutions have not only become too big to fail, but also too big to jail, and now even too big to fine, at least to the appropriate extent (Spagnolo 2015). All this even though the financial crime has been that actively supporting through money laundering criminal organizations that killed tenths of thousands of innocent people.
- BBC, November 2018. “Deutsche Bank headquarters raided over money laundering“ Available at: https://www.bbc.com/news/business-46382722 (Accessed Dec. 7, 2018)
- Becker, G.S. (1983). ”A theory of Competition Among Pressure Groups for Political Influence”, The Quarterly Journal of Economics, 98: 371-400.
- The Daily Beast, October 2018. “Russian Whistleblower Assassinated After Uncovering $200 Billion Dirty-Money Scandal”. Available at: https://www.thedailybeast.com/russian-whistleblower-assassinated-after-uncovering-dollar200-billion-dirty-money-scandal (Accessed Dec. 5, 2018)
- Dewing, I. Russell, P. (2016). “Whistleblowing, Governance and Regulation Before the Financial Crisis: The Case of HBOS”, Journal of Business Ethics, 134: 155-169.
- Financial Times, November 2018. “Danske: anatomy of a money laundering scandal”. Available at: https://www.ft.com/content/519ad6ae-bcd8-11e8-94b2-17176fbf93f5 (Accessed Dec. 5, 2018)
- Financial Times, November 2018. “Danske whistleblower criticizes UK over money laundering”. Available at: https://www.ft.com/content/0bd94cfa-ed74-11e8-89c8-d36339d835c0 (Accessed Dec. 5, 2018)
- Financial Times, July 2016. “Osborne intervened in US HSBC money-laundering probe, report says”. Available at: https://www.ft.com/content/2be49f84-47c9-11e6-b387-64ab0a67014c (Accessed Dec. 5, 2018)
- Forbes, September 2018. “The Banks That Helped Danske Bank Estonia Launder Russian Money”. Available at: https://www.forbes.com/sites/francescoppola/2018/09/30/the-banks-that-helped-danske-bank-estonia-launder-russian-money/#7f17f8b47319 (Accessed Dec. 5, 2018)
- Garrett, B. (2014). Too Big to Jail: How Prosecutors Compromise with Corporations, The Belknap Press of Harvard University Press Cambridge, Massachusetts, London, England.
- The Guardian, October 2017. “Malta car bomb kills Panama Papers Journalist”. Available at: https://www.theguardian.com/world/2017/oct/16/malta-car-bomb-kills-panama-papers-journalist (Accessed Dec. 5, 2018)
- The Guardian, November 2018. “Malta’s Pilatus Bank has European licence withdrawn”. Available at: https://www.theguardian.com/world/2018/nov/05/pilatus-bank-malta-european-banking-licence-withdrawn (Accessed Dec. 5, 2018)
- Huffington Post, December 2013. “Is Anybody Listening? HSBC Continues to Launder Money for Terrorist Groups Says Whistleblower” Available at: https://www.huffingtonpost.com/marni-halasa/is-anybody-listening-hsbc_b_3831412.html?guccounter=1 (Accessed Dec. 5, 2018)
- Laffont, J.J. (1996). “Industrial Policy and Politics”, International Journal of Industrial Organization, Vol. 14 (1996), pp. 1-27.
- Nyreröd, T. Spagnolo, G. (2017). “Myths and evidence on whistleblower rewards”, SITE Working Paper No.44 Available at: https://swopec.hhs.se/hasite/papers/hasite0044.2.pdf (Accessed Dec. 5, 2018)
- National Whistleblower Center. (2018). “Creating an Effective Anti-Corruption Program: A Rebuttal to the Bank of England’s Findings on Whistleblower Incentives”. Available at: https://www.whistleblowers.org/storage/docs/boe%20report.pdf (Accessed Dec. 5, 2018)
- Reuters, April 2018. “HBOS whistleblower says Barclays case tells other ‘don’t bother’”. Available at: https://uk.reuters.com/article/us-barclays-ceo-whistleblowing/hbos-whistleblower-says-barclays-case-tells-others-dont-bother-idUKKBN1HR2N7 (Accessed Dec. 5, 2018)
- Reuters, May 2018. “Barclays CEO fined $1.5 million for trying to unmask whistleblower”. Available at: https://www.reuters.com/article/us-barclays-ceo/barclays-ceo-fined-870000-for-trying-to-identify-whistleblower-idUSKBN1IC119 (Accessed Dec. 5, 2018)
- Reuters, October 2018. “ECB moves to revoke license of Malta’s Pilatus Bank: sources”. Available at: https://www.reuters.com/article/us-eu-malta-pilatus/ecb-moves-to-revoke-license-of-maltas-pilatus-bank-sources-idUSKCN1MQ2OI (Accessed Dec. 5, 2018)
- Reuters, November 2018. “Danske money laundering whistleblower labels UK structures a ‘disgrace’.” Available at: https://www.reuters.com/article/us-danske-bank-moneylaundering/danske-money-laundering-whistleblower-calls-uk-structures-a-disgrace-idUSKCN1NQ0LK (Accessed Dec. 5, 2018)
- Spagnolo, G. (2015). “Saving the Banks but not Reckless Bankers.” Ch. 5.3 of J. Danielsson (Ed.), Post Crisis Banking Regulation, VoxEu.org eBook.
- Svenska Dagbladet, December 2018. “FI:s experter ville fälla bankerna – stoppades“. Available at: https://www.svd.se/fis-experter-ville-falla-bankerna–stoppades (Accessed Dec. 7, 2018).
- Stigler, G.J. (1971). “The Theory of Economic Regulation.” The Bell Journal of Economics, Vol. 2, pp.3-21.
- United Nations Office on Drug and Crime. “Money-Laundering and Globalization”. Available at: https://www.unodc.org/unodc/en/money-laundering/globalization.html (Accessed Dec. 5, 2018)
Disclaimer: Opinions expressed in policy briefs and other publications are those of the authors; they do not necessarily reflect those of the FREE Network and its research institutes.
With an increasing world demand for energy and a growing pressure to reduce carbon emissions to slow down global warming, there is a growing necessity to develop new technologies that would help addressing demand and carbon footprint issues. However, taking into account the world’s dependence on hydrocarbons the question remains – can new technologies actually change the energy markets? In this policy brief, we highlight challenges and opportunities that new technologies will bring for energy markets, in particular wind energy, smart grid technology, and electromobility, that were discussed during the 10th SITE Energy Day, held at the Stockholm School of Economics on October 13, 2016.
The expanding world population and economic growth are considered the main drivers of the global energy demand. Up to 2040, total energy use is estimated to grow by 71% in developing countries and by 18% in the more mature energy-consuming OECD economies (IEA, 2016). In parallel, many countries (including the world’s biggest economies and largest emitters: USA and China) have signed the Paris agreement – the first-ever universal, legally binding global climate deal that aims to reduce emissions and to keep the increase in global average temperature from exceeding 2°C above pre-industrial levels.
Meeting a growing global energy demand, and at the same time reducing CO2 emissions, cannot be achieved by practicing ‘business as usual’. It will require some fundamental changes in the way economic activity is organized. In this context, the development of new technologies and how it will affect the energy sector is a crucial element.
Wind power, smart grid, and electromobility
With technological progress and support schemes to decrease CO2 emissions, wind energy is now a credible and competing alternative to energy produced from coal, gas and oil. In 2015, wind accounted for 44% of all new power installations in the 28 EU member states, covering 11.4% of Europe’s electricity needs (see here).
This new technology has triggered a downward pressure on energy prices because of a “Merit order effect” (i.e. a displacement of expensive generation with cheaper wind). While consumers may appreciate this development, Ewa Lazarczyk Carlson, Assistant professor at the Reykjavik University (School of Business) and IFN, stressed that the increasing importance of wind energy challenges the functioning of electricity exchange. First, a lower price has reduced the incentives to invest in conventional power plants necessary when the wind is not blowing or when it is dark. Moreover, with the renewable energy intermittency, the probability of system imbalance and price volatility has increased. In turn, this has led to an increase of maintenance costs for conventional generators due to their dynamic generation costs (i.e. start-ups and shut-down costs).
Digital technology has gradually been used in the energy sector during the last decades, changing the way energy is produced and distributed. With smart grid (i.e. an electricity distribution system that uses digital information) energy companies can price their products based on real time costs while customers have access to better information, allowing them to optimize their energy consumptions. Sergey Syntulskiy, Visiting Professor at the New Economic School in Moscow, stressed that smart grids have had at least two effects. They have made the integration of renewable energy to the system easier and have allowed for prosumers, i.e. entities that both consume and produce energy. The next step is to develop new regulatory incentives to optimize energy systems as well as to provide a legal framework for the exchange of information in the energy sector.
One of the main pollutants has long been the transport sector that accounts for 26% energy-related of CO2 emission (IEA, 2016). Electromobility – that is, use of electric vehicles – is often considered the solution for this problem. When this technology is widely adopted, a major switch from oil to electricity is expected for the transportation sector. Mattias Goldmann, CEO of Fores, argued that even if electromobility will improve air quality and reduce noise levels in cities, its positive impact relies on smart grids and locally produced energy. Moreover, the environmental benefits will be ensured only if electric energy is produced from renewable and clean sources.
Toward a carbon-neutral energy system?
The Nordic countries are currently pushing for a near carbon-neutral energy system in 2050. Markus Wråke, CEO at the Swedish Energy Research Centre, emphasized that the Nordic Carbon-Neutral Scenario is only feasible if new technologies allow for a significant change of energy sources and a better interconnected market (see report by IEA 2016 b).
To cut emissions, a decrease in oil and gas consumption in energy production and within the transport sector is needed (see Figure 1). The adoption of electric vehicles (EVs) and hybrid cars is very likely to drastically increase in the next decades (EVs may have a share of 60% of the passenger vehicle stock in 2050, IEA 2016b).
Figure 1. Nordic CO2 emissions in the CNS
There are currently limited technology options to reduce emissions for big industrial energy consumers. Moreover, there is a concern that those industries may choose to relocate if the Nordic emission standards are too strict. It is therefore important to have low and stable electricity prices. This can only be achieved if cross-border exchanges are improved (which means that the electricity trade in the Nordic region will have to increase 4-5 times by 2050). It is unclear however how policy makers will create a regulation that incentivizes energy companies to build interconnections and increase trade both between the Nordic countries, and the Western and Eastern European countries.
Figure 2. Electricity trade 2015 and 2050
Another concern is that energy-exporting and energy-importing countries may have opposing attitudes towards investing and developing new energy technologies. Countries among the biggest energy producers and exporters depend on a stable demand and price for energy. For example, Russian GDP growth depends between 50-92% on the oil price, depending on the variables used for calculations, as mentioned by Torbjörn Becker, Director of SITE. For large exporters of hydrocarbon, new energy technologies may be seen as a threat because of a potentially reduced energy demand and an increased price volatility that will, in turn, create fundamental issues to balance state budgets and improve living standards.
Figure 3. The Relationship between Russian GDP and oil price
The challenge of security of supply
To summarize, new energy technologies will drive energy companies towards optimizations and cost cutting, bring previously unseen connectivity to energy markets and make energy markets more complex. Samuel Ciszuk, Principal Advisor at the Swedish Energy Agency, stressed that interconnected, more complex and interdependent energy systems might increase the vulnerability of energy systems to external threats and intimidates to decrease the security of supply. Technological change and increased competition with lower profit margins will force companies to minimize their expenditure on energy production, storage and transmission and to find cheaper financing options. Optimization and searches for cheaper financing instruments will push energy companies towards selling some of the company assets to financial investors. These changes will create a more decentralized energy market, with more players. Such energy systems will become harder to govern in times of an energy crisis and external threats. Policy makers will have to design new and more complex regulations to fit the needs of the transforming energy markets.
- Fogelberg, Sara and Ewa Lazarczyk, 2015. “Wind Power Volatility and the Impact on Failure Rates in the Nordic Electricity Market”, IFN Working Paper 1065.
- IEA, Annual Energy Outlook, 2016a.
- IEA/OECD/Norden, 2016b. “Nordic Energy Technology Perspectives” (see here)
- Speaker presentation from the 10th Energy day, 2016 (see here)