Tag: energy demand

Navigating Environmental Policy Consistency Amidst Political Change

Posted on May 6, 2024 | Policy Brief

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Europe, like other parts of the world, currently grapples with the dual challenges of environmental change and democratic backsliding. In a context marked by rising populism, misinformation, and political manipulation, designing credible sustainable climate policies is more important than ever. The 2024 annual Energy Talk, organized by the Stockholm Institute of Transition Economics (SITE), gathered experts to bring insight into these challenges and explore potential solutions for enhancing green politics.

In the last decades, the EU has taken significant steps to tackle climate change. Yet, there is much to be done to achieve climate neutrality by 2050. The rise of right-wing populists in countries like Italy and Slovakia, and economic priorities that overshadow environmental concerns, such as the pause of environmental regulations in France and reduced gasoline taxes in Sweden, are significantly threatening the green transition. The current political landscape, characterized by democratic backsliding and widespread misinformation, poses severe challenges for maintaining green policy continuity in the EU. The discussions at SITEs Energy Talk 2024 highlighted the need to incorporate resilience into policy design to effectively manage political fluctuations and ensure the sustainability and popular support of environmental policies. This policy brief summarizes the main points from the presentations and discussions.

Policy Sustainability

In his presentation, Michaël Aklin, Associate Professor of Economics and Chair of Policy & Sustainability at the Swiss Federal Institute of Technology in Lausanne, emphasized the need for environmental, economic, and social sustainability into climate policy frameworks. This is particularly important, and challenging given that key sectors of the economy are difficult to decarbonize, such as energy production, transportation, and manufacturing. Additionally, the energy demand in Europe is expected to increase drastically (mainly due to electrification), with supply simultaneously declining (in part due to nuclear power phaseout in several member states, such as Germany). Increasing storage capacity, enhancing demand flexibility, and developing transmission infrastructure all require large, long-term investments, and uncompromising public policy. However, these crucial efforts are at risk due to ongoing political uncertainty. Aklin argued that a politics-resilient climate policy design is essential to avoid market fragmentation, decrease cooperation, and ensure the support for green policies.  Currently, industrial policy is seen as the silver bullet, in particular, because it can create economies of scale and ensure political commitment to major projects. However, as Aklin explained, it is not an invincible solution, as such projects may also be undermined by capacity constraints and labour shortages.

Energy Policy Dynamics

Building on Aklin’s insights, Thomas Tangerås, Associate Professor at the Research Institute of Industrial Economics, explored the evolution of Swedish energy policy. Tangerås focused on ongoing shifts in support for nuclear power and renewables, driven by changes in government coalitions. Driven by an ambition to ensure energy security, Sweden historically invested in both hydro and nuclear power stations. In the wake of the Three Mile Island accident, public opinion however shifted and following a referendum in 1980, a nuclear shutdown by 2010 was promised. In the new millennia, the first push for renewables in 2003, was followed by the right-wing government’s nuclear resurgence in 2010, allowing new reactors to replace old ones. In 2016 there was a second renewable push when the left-wing coalition set the goal of 100 percent renewable electricity by 2040 (although with no formal ban on nuclear). This target was however recently reformulated with the election of the right-wing coalition in 2022, which, supported by the far-right party, launched a nuclear renaissance. The revised objective is to achieve 100 percent fossil-free electricity by 2040, with nuclear power playing a crucial role in the clean energy mix.

The back-and-forth energy policy in Sweden has led to high uncertainty. A more consistent policy approach could increase stability and minimize investment risks in the energy sector. Three aspects should be considered to foster a stable and resilient investment climate while mitigating political risks, Tangerås concluded: First, a market-based support system should be established; second, investments must be legally protected, even in the event of policy changes; and third, financial and ownership arrangements must be in place to protect against political expropriation and to facilitate investments, for example, through contractual agreements for advance power sales.

The Path to Net-Zero: A Polish Perspective

Circling back to the need for climate policy to be socially sustainable, Paweł Wróbel, Energy and climate regulatory affairs professional, Founder of GateBrussels, and Managing Director of BalticWind.EU, gave an account of Poland’s recent steps towards the green transition.

Poland is currently on an ambitious path of reaching net-zero, with the new government promising to step up the effort, backing a 90 percent greenhouse gas reduction target for 2040 recently proposed by the EU However, the transition is framed by geopolitical tensions in the region and the subsequent energy security issues as well as high energy prices in the industrial sector. Poland’s green transition is further challenged by social issues given the large share of the population living in coal mining areas (one region, Silesia, accounts for 12 percent of the polish population alone). Still, by 2049, the coal mining is to be phased out and coal in the energy mix is to be phased out even by 2035/2040 – optimistic objectives set by the government in agreement with Polish trade unions.

In order to achieve this, and to facilitate its green transition, Poland has to make use of its large offshore wind potential. This is currently in an exploratory phase and is expected to generate 6 GW by 2030, with a support scheme in place for an addition 12 GW. In addition, progress has been achieved in the adoption of solar power, with prosumers driving the progress in this area. More generally, the private sectors’ share in the energy market is steadily increasing, furthering investments in green technology. However, further investments into storage capacity, transmission, and distribution are crucial as the majority of Polands’ green energy producing regions lie in the north while industries are mainly found in the south.

Paralleling the argument of Aklin, Wróbel also highlighted that Poland’s high industrialization (with about 6 percent of the EU’s industrial production) may slow down the green transition due to the challenges of greening the energy used by this sector. The latter also includes higher energy prices which undermines Poland’s competitiveness on the European market.

Conclusion

The SITE Energy Talk 2024 catalyzed discussions about developing lasting and impactful environmental policies in times of political and economic instability. It also raised questions about how to balance economic growth and climate targets. To achieve its 2050 climate neutrality goals, the EU must implement flexible and sustainable policies supported by strong regulatory and political frameworks – robust enough to withstand economic and political pressures. To ensure democratic processes, it is crucial to address the threat posed by centralised governments decisions, political lock-ins, and large projects (with potential subsequent backlashes). This requires the implementation of fair policies, clearly communicating the benefits of the green transition.

On behalf of the Stockholm Institute of Transition Economics, we would like to thank Michaël Aklin, Thomas Tangerås and Paweł Wróbel for participating in this year’s Energy Talk.

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.

Can the Baltic States Do Without Russian Electricity?

Posted on November 30, 2022 | Policy Brief

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Although much smaller than Russian exports of other energy commodities, Russian electricity exports to Europe have been a part of the European electricity systems. There are several connection points between the Russian and EU markets, but the Baltic States are the most exposed to Russian influence in the electricity sector. This brief discusses the Baltics’ dependency on Russian electricity, which currently accounts for 10 percent of the total Baltic electricity consumption. We argue that, while the Baltic states have some resilience (partly due to their connection to the Nordic countries), they are not immune to a complete halt to the Russian electricity trade, at least not in the short run.

The continuing military conflict in Ukraine and cut-offs of Russian gas to Europe are driving energy prices to unprecedented levels and creating concern about energy security all over Europe. The reliance on the Russian gas supply and the consequences of this has been profoundly discussed (for an overview, see e.g., Le Coq and Paltseva, 2022). At the same time, the topic of Russian electricity delivered to the EU has been largely left out of the current conversation.

Russia is exporting electricity directly to Europe, although at a much smaller scale than it has been exporting other energy commodities. There are several transmission connection points between the Russian and EU markets, but the situation of the Baltic States is the most precarious. They consume Russian electricity (about 10 percent of their needs) and their grids are still synchronised with Russia and Belarus. Therefore, they are exposed to some supply disruption and a desynchronization threat from Russia, potentially resulting in high market prices, severe congestion and even blackouts. Because the Baltics are connected to the leading power market in Europe, Nord Pool, any unexpected shocks may have consequences beyond the Baltic region.

Understanding how the Baltic States depend on Russia for their power consumption is an important element of the European energy security debate. This brief discusses the severity of the Baltics’ reliance on Russian electricity. We initially discuss the effect of a sudden halt to the Russian electricity trade in May 2022. We then address the potential consequences of the abrupt exclusion from the Russia-controlled transmission network. Finally, we discuss the future energy mix thought to replace Russian electricity in the Baltics.

The Baltic States’ Exposure to Indirect Imports of Russian Electricity

The Baltics’ exposure is analysed by examining the impact of a sudden stop of imports of Russian electricity to the EU in May 2022, which affected Nord Pool (https://www.nordpoolgroup.com/en/) prices as well as congestion in the Baltic States. This event cannot be qualified as an external shock, required for a rigorous empirical analysis. Nonetheless, it helps us assess the Baltics’ exposure.

On May 15th 2022, Russia broke off its electricity trade with Finland. This event is relevant to consider as Finland is increasingly a primary import source for the Baltic States. Any electricity supply disruption affecting Finland may therefore impact the Baltics’ energy system balance. To assess how the event impacted the Baltic electricity market, we compare the congestion occurrences in 2021 and 2022.

A standard way to assess the misfunctioning of a power market is to look at congestion episodes. The Nord Pool market, to which the Baltic states are connected, has several bidding areas. Prices between zones may differ in case of transmission bottlenecks. When transmission lines are saturated, no more electricity can, in that period, be transported from the cheap to the expensive areas to alleviate prices, referred to as congestion.

In the graphs below, we illustrate the congestion in the Baltics in 2021 as compared to 2022. Looking at the 2021 data for Estonia and Latvia, the countries belonged to the same price area most of the year; some price differences were observed in the summer months, but only 10 percent of the hours within those months were congested. In 2022 the price differences between the two countries grew substantially, since May reaching 20 percent, with more congested hours (Figure 1). In 2022 price differences also increased between Lithuania and Southern Sweden (region SE 4) as depicted in Figure 2.

Figure 1. Congestion between Estonia and Latvia (as percentage of congested hours out of all hours within a given month).

Source: Own calculations based on NordPool data.

Figure 2. Congestion between Lithuania and Sweden (SE4) (as percentage of congested hours out of all hours within a given month).

Source: Own calculations based on NordPool data.

Our aim is not to show a causal effect of the withdrawal of Russia from commercial electricity trading with the Baltic States region, but to describe some general, coincidental trends in congestion. Note that the congestion might be a result of the extreme prices observed in the Baltics – on August 17th 2022, prices reached the Nord Pool cap of 4000€/MW, the highest ever level in the region (Lazarczyk Carlson and Le Coq, 2022a).

To conclude, halting the electricity trade between Russia and Finland appears to have had some impact on the congestion in the Baltic States. Still, the consequences were not severe as the Baltics were already curtailing commercial exchanges with Russia and Belarus. Additionally, the Finnish yearly imports from Russia constituted at most 10 percent of the annual Finnish consumption.

The Baltic States’ Exposure to a Desynchronization Threat

The Baltics belong to the Moscow-controlled synchronous electrical power grid, BRELL, which connects power systems of Belarus, Russia, Estonia, Latvia and Lithuania. This grid dependency makes it virtually impossible for the Baltic States to completely stop Russian and Belarussian power from floating into the Baltics´ territory. A desynchronization from the BRELL network is currently not feasible. Although the Baltics have invested heavily in grid extensions and upgrade, the connection to the European grid is scheduled only for 2024/2025. Therefore, even though the Baltic States have been limiting commercial trading with Russia and Belarus on the Nordic electricity market, they are still receiving Russian/Belarusian electricity.

The Baltics’ dependency on the BRELL network creates a potential threat to the Baltic electricity supply security in case Russia should decide to weaponize its electricity supply further and disconnect the Baltic States from the network ahead of the planned exit in 2024/2025 (Lazarczyk Carlson and Le Coq, 2022a). Such premature disconnection could result in severe blackouts, and immediate reactions would be required to keep the system operational. In such scenario, strong support from the Nordic countries via Finland and/or Sweden would be needed. It is however important to keep in mind that a sudden disconnection from BRELL also could harm Kaliningrad – the Russian enclave between Lithuania and Poland, on the shores of the Baltic Sea. Although Russia has invested heavily in expanding Kaliningrad generation capacities and its energy self-sufficiency, it is not clear whether the region is to this day prepared to operate in island mode without the support of the BRELL and neighbouring countries. Up to date, three successful operating exercises in island mode have been conducted in Kaliningrad, the longest lasting for 72 hours. However, the two tests scheduled for 2022 have been cancelled.

The future re-initialization of electricity trading with Russia is uncertain at this point and the role of Russian electricity has diminished over the years. The Baltics are not planning to maintain any transmission connection with Russia and Belarus after synchronising with the European power grid. However, the Finnish standpoint needs to be clarified. If the Finnish-Russian electrical power trade exchange is re-established in the future, Russian electricity might once again flow into the Baltics´ transmission grid as imports from Finland are forecasted to increase in the coming years due to a third interconnector, which should become operational in 2035.

The Baltics’ (Future) Energy Mix Without Russian Electricity

The alternatives to Russian electricity depend on the Baltics’ energy mix and transmission system. In 2021 the demand for electric power in the Baltics was 27 TWh, with Latvia representing 26 percent, Estonia 30 percent, and Lithuania 44 percent of the total demand. Consumption is forecasted to grow by 60-65 percent by 2050, due to the electrification of the economy and increasing needs within industries, housing, transportation, etc. (Nordic Energy Research, 2022).

All Baltic States are today net importers of electricity. The main import sources are Finland and, to a lesser extent, Sweden, which have jointly exported 45 TWh of electric power to the region over the years 2016-2021. Finland is itself a net importer of electricity mainly importing power from Sweden. Until May 2022, Finland’s second import source was Russia.

The Baltics are heavily dependent on fossil fuels in their electricity mix as illustrated in Table 1.

Table 1. Energy mix for electricity production (MW) in the Baltics, 2022.

Source: ENTSO-E Transparency platform.

The region is now trying to limit the use of fossil-fuel energy and expand its green energy potential, as extensively discussed in Lazarczyk Carlson E. and Le Coq C. (2022b). The actual installed capacity for the onshore wind is however insufficient, with 326 MW in Estonia, 87 MW in Latvia, and 671 MW in Lithuania. The current offshore wind’s capacity is non-existent. There are some plans to develop 4.5 GW in Lithuania, 7 GW in Estonia, and 14.5 GW in Latvia by 2050, but this will require substantial investments (European Commission, 2019).

The region also plans to expand solar power production, especially in Latvia and Lithuania, where the current capacity is 14 and 259 MW respectively. There are also plans to expand Latvian hydro production for storage and balancing needs; currently, Latvia has 1588 MW of installed run-of-the-river hydro capacity, the highest among the Baltic States.

Investing in nuclear power is another possibility which is currently being considered. As part of the EU accession process, Lithuania shut down its Ignalina Nuclear Power Plant, the first unit in 2004 and the second in 2009, turning the country from a net exporter into a net importer of electric power (IEA, 2021). A project of replacing the Ignalina Nuclear Power Plant (NPP) by a new Polish-Lithuanian Plant, the Visaginas NPP, was discussed but later abandoned. The Estonian company Fermi Energy, in collaboration with the Swedish firm Vattenfall, are currently looking into small modular reactor (SMR) technology to develop nuclear energy. This project is however in the initial phases of development.

Renewables and nuclear power are credible alternatives to limit fossil-fuel energy usage and dependency on Russian electricity. The alternatives might however not be easily implemented in the short run.

Conclusion

The Baltic States’ dependency on the Russian electricity supply is limited. Nevertheless, discontinuing Russian electricity deliveries is not innocuous for at least two reasons.

First, the Baltics are still part of the BRELL network, so they are still physically dependent on Russia, although they plan to desynchronize from this network in the longer run. However, a sudden desynchronization initiated by Russia may have severe consequences in the short run (e.g. blackouts).

Second, considering the forecasted future increase in the demand for electrical power in the Baltics and the Nordic countries, the Baltics will remain dependent on power imports. Today, the Baltics rely on Finland and Sweden, as all three Baltic States are net electricity importers. To limit any future dependence on Russian/Belarussian electricity, the Baltics plan to sever any transmission connections with Russia and Belarus after desynchronization, thus cutting the potential for future electricity trade with both countries. If, however, the Nordic countries re-establish commercial exchanges with Russia via Finland, it is nevertheless possible that Russian electricity will be flowing in the Baltics transmission system again.

Acknowledgement

This policy brief is based on a project funded by the Energiforsk research program.

References

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 Energy and Climate Crisis Facing Europe: How to Strike the Right Balance

Posted on May 24, 2022 | Policy Brief

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Policymakers in Europe are currently faced with the difficult task of reducing our reliance on Russian oil and gas without worsening the situation for firms and households that are struggling with high energy prices. The two options available are either to substitute fossil fuel imports from Russia with imports from other countries and cut energy tax rates to reduce the impacts on firms and household budgets, or to reduce our reliance on fossil fuels entirely by investing heavily in low-carbon energy production. In this policy brief, we argue that policymakers need to also take the climate crisis into account, and avoid making short-term decisions that risk making the low-carbon transition more challenging. The current energy crisis and the climate crisis cannot be treated as two separate issues, as the decisions made today will impact future energy and climate policies. To exemplify how large-scale energy policy reforms may have long-term consequences, we look at historical examples from France, the UK, and Germany, and the lessons we can learn to help guide us in the current situation.

The war in Ukraine and the subsequent sanctions against Russia have led to a sharp increase in energy prices in the EU since the end of February 2022. This price increase came after a year when global energy prices had already surged. For instance, import prices for energy more than doubled in the EU during 2021 due to an unusually cold winter and hot summer, as well as the global economic recovery following the pandemic and multiple supply chain issues. Figure 1 shows that the price of natural gas traded in the European Union has increased steadily since the summer of 2021, with a strong hike in March 2022 following the beginning of the war.

Figure 1. Evolution of EU gas prices, July 2021-May 2022

Source: https://tradingeconomics.com/commodity/eu-natural-gas

Concerns about energy dependency, towards Russian gas in particular, are now high on national and EU political agendas. An embargo on imports of Russian oil and gas into the EU is currently discussed, but European governments are worried about the effects on domestic energy prices, and the economic impact and social unrest that could follow. Multiple economic analyses argue, however, that the economic effect in the EU of an embargo on Russian oil and gas would be far from catastrophic, with estimated reductions in GDP ranging from 1.2-2.2 percent. But a reduction in the supply of fossil fuels from Russia would need to be compensated with energy from other sources, and possibly supplemented with demand reductions.

In parallel, on April 4th, the Intergovernmental Panel on Climate Change (IPCC) released a new report on climate change. One chapter analyses different energy scenarios, and finds that all scenarios that are compatible with keeping the global temperature increase below 2°C involve a strong decrease in the use of all fossil fuels (Dhakal et al, 2022). This reduction in fossil fuel usage over the coming decades is illustrated in red in Figure 2.

It is thus important that, while EU countries try to decrease their dependency on Russian fossil fuels and cushion the effect of energy-related price increases, they also accelerate the transition to a low-carbon economy. And how they manage to balance these short- and long-run objectives will depend on the energy policy decisions they make. For instance, if policymakers substitute Russian oil and gas with increased coal usage and new import terminals for LNG, this can lead to a “carbon lock in” and make the low-carbon transition more challenging.  In this policy brief, we analyze what lessons can be drawn from past historical events that lead to large-scale structural changes in energy policy. Events that all shaped our current energy systems and conditions for climate policy.

Figure 2. Four energy scenarios compatible with a 2°C temperature increase by 2100.

Source: IPCC sixth assessment report on Mitigation of Climate Change, chapter 3, p23

Structural Changes in Energy Policy in France, the UK, and Germany

We focus on three “energy policy turning points” triggered by three geopolitical, political or environmental crises: the French nuclear plan triggered by the 1973 oil crisis; the UK early closure of coal mines and the subsequent dash for gas in the 1990s, influenced by the election of Margaret Thatcher in 1979; and the German nuclear phase-out triggered by the 2011 Fukushima catastrophe.

In response to the global oil price shock of 1973, France adopted the “Messmer plan”. The aim was to rapidly transition the country away from dependence on imported oil by building enough nuclear capacity to meet all the country’s electricity needs. Two slogans summarised its goals: “all electric, all nuclear”, and “in France, we may not have oil, but we have ideas” (Hecht 2009). The first commissioned plants came online in 1980, and between 1979-1988 the number of reactors in operation in France increased from 16 to 55. As a consequence, the share of nuclear power in the total electricity production rose from 8 to 80 percent, while the share of fossil fuels fell from 65 to 8 percent.

Figure 3. French electricity mix

Source: Data on electricity and heat production in France is provided by the IEA (2022).

In the UK, the election of Margaret Thatcher in 1979 opened the way for large market-based reform of the energy sector. Thatcher’s plan to close dozens of coal pits triggered a year-long coal miners’ strike in 1984-85. The ruling Conservative party eventually won against the miners’ unions and the coal industry was deeply restructured, with a decrease in domestic employment – not without social costs (Aragon et al, 2018) – and an increase in coal imports. At the same time, the electricity market’s liberalization in the 1990s facilitated the development of gas infrastructure. As an indirect and unintended consequence, when climate change became a prominent issue at the global level in the 2000s, there was no strong pro-coal coalition left in the UK (Rentier et al, 2019). Aided by a portfolio of policies making coal-fired electricity more expensive – a carbon tax in particular – the coal phase-out was relatively easy and fast (Wilson and Staffel, 2018, Leroutier 2022): between 2012 and 2020, the share of coal in the electricity production dropped from 40 to 2 percent.

In 2011, the Fukushima nuclear catastrophe in Japan triggered an early and unexpected phase-out of nuclear energy in Germany. The 2011 “Energiewende” (energy transition) mandated a phase-out of nuclear power plants by 2022, while including provisions to reduce the share of fossil fuel from over 80 percent in 2011 to 20 percent in 2050. The share of nuclear energy in the electricity production in Germany was halved in a decade, from 22 percent in 2010 to 11 percent in 2020. At the same time, the share of renewable energy increased from 13 to 36 percent, and that of natural gas from 14 to 17 percent.

In these three examples, climate objectives were never the main driver of the decision. Nevertheless, in the case of France and the UK, the crisis resulted in an energy sector that is arguably more low-carbon than it would have been without the crisis. Although the German nuclear phase-out was accompanied by large subsidies to renewable energies, its effect on the energy transition is ambiguous: some argue that the reduction in nuclear electricity production was primarily offset by an increase in coal-fired production (Jarvis et al, 2022).

The three crises also had different consequences in terms of dependence on fossil fuel imports. The French nuclear plan resulted in an arguably lower energy dependency on imported fossil fuels. The closure of coal mines in the UK had ambiguous effects on energy security, with an increase in coal imports and the use of domestic gas from the North Sea. Finally, Germany’s nuclear phase-out, combined with the objective of phasing out coal, has been associated with an increase in the use of fossil fuels from Russia: gas imports remained stable between 2011 and 2020, but the share coming from Russia increased by 60 percent over the period. In 2020, Russia stood for 66 percent of German gas imports (Source: Eurostat). Which brings us back to the current war in Ukraine.

The Current Crisis is Different

The context in which the current energy crisis is unfolding is different from the three above-mentioned events in two important ways.

First, scientific evidence on the relationship between fossil fuel use, CO2 emissions and climate damages has never been clearer: we know quite precisely where the planet is heading if we do not drastically reduce fossil fuel use in the coming decade. From recent research in economics, we also know that price signals work and that increased prices on fossil fuels result in lower demand and emission reductions (Andersson 2019; Colmer et al. 2020; Leroutier 2022). High fuel prices can also have long-term impacts on consumption patterns: US commuters that came of driving age during the oil prices of the 70s, when gasoline prices were high, still drive less today (Severen and van Benthem, 2022). The other way around, low fossil fuel prices have the potential to lock in energy-intensive production: plants that open when electricity and fossil fuel prices are low have been found to consume more energy throughout their lifetime, regardless of current prices (Hawkins-Pierot and Wagner, 2022).

Second, alternatives to fossil fuels have never been cheaper. It is most obvious in the case of electricity production, where technological progress and economies of scale have led to a sharp decrease in the cost of renewable compared to fossil fuel technologies. As shown in Figure 4, between 2010 and 2020 the cost of producing electricity from solar PV has decreased by 85 percent and that of producing electricity from wind by 68 percent. From being the most expensive technologies in 2010, solar PV and wind are now the cheapest. Given the intermittency of these technologies, managing the transition to renewables requires developing electricity storage technologies. Here too, prices are expected to decrease: total installed costs for battery electricity storage systems could decrease by 50 to 60 percent by 2030 according to the International Renewable Agency.

Finding alternatives to fossil fuels has historically been more challenging in the transport sector. However, recent reductions in battery costs, and an increase in the variety of electric vehicles available to customers, have led to EVs taking market share away from gasoline and diesel-powered cars in Europe and elsewhere. The costs of the battery packs that go into electric vehicles have fallen, on average, by 89 percent in real terms from 2010 to 2021.

Figure 4. Evolution of the Mean Levelised Cost of Energy by Technology in the US

Source: Lazard

Options for Policy-Makers

Faced with a strong increase in fossil fuel prices and an incentive to reduce our reliance on oil and gas from Russia, policy-makers have two options: increase the availability and decrease the price of low-carbon substitutes – by, for example, building more renewable energy capacity and subsidizing electric vehicles – or cut taxes on fossil fuels and increase their supply, both domestically and from other countries.

Governments have pursued both options so far. On the one hand, the Netherlands, the UK, and Italy announced an expansion of wind capacities compared to what was planned, in an attempt to reduce their dependence on Russian gas, and France ended gas heaters subsidies. On the other hand, half of EU member states have cut fuel taxes for a total cost of €9 billion by the end of March 2022, the UK plans to expand oil and gas drilling in the North Sea, and Italy might re-open coal-fired plants.

To guide policymakers faced with the current energy crisis, there are valuable lessons to draw from the experiences of energy policy reform in France, the UK and Germany. France’s push for nuclear energy in the 1970s shows that large-scale structural reform of electricity and heat production is possible and may lead to large drops in CO2 emissions and an economy less dependent on domestic or foreign supplies of fossil fuels. A similar “Messmer plan” could be implemented in the EU today, with the goal of replacing power plants using coal and natural gas with large-scale solar PV parks, wind farms and batteries for storage. Similarly, the German experience shows the potential danger of implementing a policy to alleviate one concern – the risk of nuclear accidents – with the consequence of facing a different concern later on – the dependence on fossil fuel imports.

One additional challenge is that the current energy crisis calls for a short-term response, while investments in low-carbon technologies made today will only deliver in a few years. Short-term energy demand reduction policies can help, on top of long-term energy efficiency measures. For example, a 1°C decrease in the temperature of buildings heated with gas would decrease gas use by 10 billion cubic meters a year in Europe, that is, 7 percent of imports from Russia. Similarly, demand-side policies could reduce oil demand by 6 percent in four months, according to the International Energy Agency.

Ending the reliance on Russian fossil fuels and alleviating energy costs for firms and households is clearly an important objective for policymakers. However, by signing new long-term supply agreements for natural gas and cutting energy taxes, policymakers in the EU may create a carbon lock-in and increase fossil fuel usage by households, thereby making the inevitable low-carbon transition even more difficult. The solutions thus need to take the looming climate crisis into account. For example, any tax relief or increased domestic fossil fuel generation should have a clear time limit; more generally, all policies decided today should be evaluated in terms of their contribution to domestic and European climate objectives. In this way, the current energy crisis is not only a challenge but also a historic opportunity to accelerate the low-carbon transition.

References

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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.

What does the Gas Crisis Reveal About European Energy Security?

Posted on January 24, 2022 | Policy Brief

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The recent record-high gas prices have triggered legitimate concerns regarding the EU’s energy security, especially with dependence on natural gas from Russia. This brief discusses the historical and current risks associated with Russian gas imports. We argue that decreasing the reliance on Russian gas may not be feasible in the short-to-mid-run, especially with the EU’s goals of green transition and the electrification of the economy. To ensure the security of natural gas supply from Russia, the EU has to adopt the (long-proclaimed) coordinated energy policy strategy.

In the last six months, Europe has been hit by a natural gas crisis with a severe surge in prices. Politicians, industry representatives, and end-energy users voiced their discontent after a more than seven-fold price increase between May and December 2021 (see Figure 1). Even if gas prices somewhat stabilized this month (partly due to unusually warm weather), today, gas is four times as expensive as it was a year ago. This has already translated into an increase in electricity prices, and as a result, is also likely to have dramatic consequences for the cost and price of manufacturing goods.

Figure 1. Evolution of EU gas prices since Oct 2020.

Source:  https://tradingeconomics.com/commodity/eu-natural-gas.

These ever-high gas prices have triggered legitimate concerns regarding the security of gas supply to Europe, specifically, driven by the dependency on Russian gas imports. Around 90% of EU natural gas is imported from outside the EU, and Russia is the largest supplier. In 2020, Russia provided nearly 44% of all EU gas imports, more than twice the second-largest supplier, Norway (19.9%, see Eurostat). The concern about Russian gas dependency was exacerbated by the new underwater gas route project connecting Russia and the EU – Nord Stream 2. The opponents to this new route argued that it will not only increase the EU’s gas dependency but also Russia’s political influence in the EU and its bargaining power against Ukraine (see, e.g., FT). Former President of the European Council Donald Tusk stated that “from the perspective of EU interests, Nord Stream 2 is a bad project.”.

However, neither dependency nor controversial gas route projects are a new phenomenon, and the EU has implemented some measures to tackle these issues in the past. This brief looks at the current security of Russian gas supply through the lens of these historical developments. We provide a snapshot of the risks associated with Russian gas imports faced by the EU a decade ago. We then discuss whether different factors affecting the EU gas supply security have changed since (and to which extent it may have contributed to the current situation) and if decreasing dependence on Russian gas is feasible and cost-effective. We conclude by addressing the policy implications.

Security of Russian Gas Supply to the EU, an Old Problem Difficult to Tackle

Russia has been the main gas provider to the EU for a few decades, and for a while, this dependency has triggered concerns about gas supply security (see, e.g., Stern, 2002 or Lewis, New York Times, 1982). However, the problem with the security of Russian gas supplies was extending beyond the dependency on Russian gas per se. It was driven by a range of risk factors such as insufficient diversification of gas suppliers, low fungibility of natural gas supplies with a prevalence of pipeline gas delivery, or use of gas exports/transit as means to solve geopolitical problems.

This last point became especially prominent in the mid-to-late-2000s, during the “gas wars” between Russia and the gas transit countries Ukraine and Belarus. These wars led to shortages and even a complete halt of Russian gas delivery to some EU countries, showing how weak the security of the Russian gas supply to the EU was at that time.

Reacting to these “gas wars”, the EU attempted to tackle the issue with a revival of the “common energy policy” based on the “solidarity” and “speaking in one voice” principles. The EU wanted to adopt a “coherent approach in the energy relations with third countries and an internal coordination so that the EU and its Member States act together” (see, e.g., EC, 2011). However, this idea turned out to be challenging to implement, primarily because of one crucial contributor to the problem with the security of Russian gas supply – the sizable disbalance in Russian gas supply risk among the individual EU Member States.

Indeed, EU Member States had a different share of natural gas in their total energy consumption, highly uneven diversification of gas suppliers, and varying exposure to Russian gas. Several Eastern-European EU states (such as Bulgaria, Estonia, or Czech Republic) were importing their gas almost entirely from Russia; other EU Member States (such as Germany, Italy, or Belgium) had a diversified gas import portfolio; and a few EU states (e.g., Spain or Portugal) were not consuming any Russian gas at all. Russian natural gas was delivered via several routes (see Figure 2), and member states were using different transit routes and facing different transit-associated risks. These differences naturally led to misalignment of energy policy preferences across EU states, creating policy tensions and making it difficult to implement a common energy policy with “speaking in one voice” (see more on this issue in Le Coq and Paltseva, 2009 and 2012).

Figure 2. Gas pipeline in Europe.

Source: S&G Platt. https://www.spglobal.com/platts/en/market-insights/blogs/natural-gas/010720-so-close-nord-stream-2-gas-link-completion-trips-at-last-hurdle

The introduction of Nord Stream 1 in 2011 is an excellent example of the problem’s complexity. This new gas transit route from Russia increased the reliability of Russian gas supply for EU countries connected to this route (like Germany or France), as they were able to better diversify the transit of their imports from Russia and be less exposed to transit risks. The “Nord Stream” countries (i.e., countries connected to this route) were then willing to push politically and economically for this new project. Le Coq and Paltseva (2012) show, however, that countries unconnected to this new route while simultaneously sharing existing, “older” routes with “Nord Stream” countries would experience a decrease in their gas supply security. The reason for this is that the “directly connected” countries would now be less interested in exerting “common” political pressure to secure gas supplies along the “old” routes.

This is not to say that the EU did not learn from the above lessons. While the “speaking in one voice” energy policy initiative was not entirely successful, the EU has implemented a range of actions to cope with the risks of the security of gas supply from Russia. The next section explains how the situation is has changed since, outlining both the progress made by the EU and the newly arising risk factors.

Security of Russian Gas Supply to the EU, a Current Problem Partially Addressed

Since the end of the 2000s, the EU implemented a few changes that have positively affected the security of gas supply from Russia.

First, the EU put a significant effort into developing the internal gas market, altering both the physical infrastructure and the gas market organization. The EU updated and extended the internal gas network and introduced the wide-scale possibility of utilizing reverse flow, effectively allowing gas pipelines to be bi- rather than uni-directional. These actions improved the gas interconnections between the EU states (and other countries), thereby making potential disruptions along a particular gas transit route less damaging and diminishing the asymmetry of exposure to route-specific gas transit risks among the EU members. Ukraine’s gas import situation is a good illustration of the effect of reverse flow. Ukraine does not directly import Russian gas since 2016, mainly from Slovakia (64%), Hungary (26%), and Poland (10%) (see https://www.enerdata.net/publications/daily-energy-news/ukraine-launches-virtual-gas-reverse-flow-slovakia.html). The transformation of the gas market organization brought about the implementation of a natural gas hub in Europe and change in the mechanism of gas price formation. It is now possible to buy and sell natural gas via long-term contracts and on the spot market. With the gas market becoming more liquid, it became easier to prevent the gas supply disruption threat.

Second, Europe has made certain progress in diversifying its gas exports. According to Komlev (2021), the concentration of EU gas imports from outside of the EU (excluding Norway), as measured by the Herfindahl-Hirschman index, has decreased by around 25% between 2016 and 2020. While the imports are still highly concentrated, with the HHI equal to 3120 in 2020, this is a significant achievement. A large part of this diversification effort is the dramatic increase in the share of liquified natural gas (i.e., LNG) in its gas imports – in 2020, a fair quarter of the EU gas imports came in the form of LNG. An expanded capacity for LNG liquefaction and better fungibility of LNG would facilitate backup opportunities in the case of Russian gas supply risks and improve the diversification of the EU gas imports, thereby increasing the security of natural gas supply.

However, the above developments also have certain disadvantages, which became especially prominent during the ongoing gas crisis. For example, the fungibility of LNG has a reverse side: LNG supplies respond to variations in gas market prices across the world. This change has intensified the competition on the demand side – Europe and Asia might now compete for the same LNG. This is likely to make a secure supply of LNG – e.g., as a backup in the case of a gas supply default or as a diversification device – a costly option.

In turn, new mechanisms of gas price formation in Europe included decoupling the oil and gas prices and changing the format of long-term gas contracts. The percentage of oil-linked contracts in gas imports to the EU dropped from 47% in 2016 to 26% in 2020. In particular, 87% of Gazprom’s long-term contracts in 2020 were linked to spot and forward gas prices and only around 13% to oil prices (Komlev, 2021). This gas-on-gas linking may have contributed to the current gas crisis: Indeed, it undermined the economic incentives of Gazprom to supply more gas to the EU spot market in the current high-price market. Shipping more gas would lower spot prices and prices of hub-linked longer-term contracts for Gazprom. In that sense, the ongoing decline in Russian gas supplies to the EU may reflect not (only) geopolitical considerations but economic optimization.

Similarly, this new mechanism also finds reflection in the ongoing situation with the EU gas storage. The current EU storage capacity is 117 bcm, or almost 20% of its yearly consumption, and thus, can in principle be effective in managing the short-term volume and price shocks. However, the current gas crisis has shown that this option might be far from sufficient in the case of a gas shortage (see, e.g., Zachmann et al., 2021).  One of the reasons for this insufficiency can be Gazprom controlling a sizable share of this storage capacity (see https://www.europarl.europa.eu/doceo/document/E-9-2021-004781_EN.html). For example, Gazprom owns (directly and indirectly) almost one-third of all gas storage in Germany, Austria, and the Netherlands.  Combining this storage market position with a long-term gas contract structure may also lead to strategic behavior for economic (on top of potential political) purposes.

Last but not least, the EU gas market is likely to be characterized by increased demand due to the green transition agenda (see Olofsgård and Strömberg, 2022). Being the least carbon-intensive fossil fuel, natural gas has an important role in facilitating green transition and increasing the electrification of the economy. For example, Le Coq et al. (2018) argues that gas capacity should be around 3 to 4 times the current capacity by 2050 for full electrification of transport and heating in France, Germany, or the Netherlands. In such circumstances, the EU is not likely to have the luxury to diminish reliance on Russian gas.

Conclusions and Policy Implications

Keeping the above discussion in mind, should the EU try to diminish its dependence on Russian gas to improve its energy security? This may be true in theory, but in practice, this might be too costly, at least in the short-to-medium run.

The current situation on the EU gas market suggests that simply cutting gas imports from Russia is likely to lead to high prices both in the energy sector and, later, in other sectors of the economy due to spillovers. Substituting gas imports from Russia with gas from other sources, such as LNG, is likely to be very costly and not necessarily very reliable. Alternative measures, e.g., improving interconnections between the EU Member States or controlling transit issues via the use of reverse flow technology, are effective but have limited impact. Simply cutting down gas demand is not a viable strategy. Indeed, with the EU pushing for a green transition and the electrification of the economy, the EU’s gas imports may have to increase. Russian gas may play an important role in this process.

As a result, we believe that the solution to keep the security issue of Russian gas supply at bay lies in the area of common energy policy. It is essential that the EU implements and effectively manages a coordinated approach in dealing with Russian gas supplies. The EU is the largest buyer of Russian gas, and given Russian dependency on hydrocarbon exports, such a synchronized approach would give the EU the possibility to exploit its “large buyer” power. While the asymmetry in exposure to Russian gas supply risks among the EU Member States is still sizable, the improvements in the functioning of the internal gas market and gas transportation within the EU make their preferences more aligned, and a common policy vector more feasible. Furthermore, recent EU initiatives on creating “strategic gas reserves” by making the Member States share their gas storage with one another would further facilitate such coordination. Implementing the “speaking in one voice” gas import policy will allow the EU to fully utilize its bargaining power vis-à-vis Gazprom and spread the benefits of new gas routes from Russia – such as Nord Stream 2 – across its Member States.

References

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.

Environmental Policy in Eastern Europe | SITE Development Day 2021

Posted on January 10, 2022 | Policy Brief

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The need for urgent climate action and energy transformation away from fossil fuels is widely acknowledged. Yet, current country plans for emission reductions do not reach the requirements to contain global warming under 2°C. What is worse, there is even reasonable doubt about the commitment to said plans given recent history and existing future investment plans into fossil fuel extraction and infrastructure development.  This policy brief shortly summarizes the presentations and discussions at the SITE Development Day Conference, held on December 8, 2021, focusing on climate change policies and the challenge of a green energy transition in Eastern Europe.

Climate Policy in Russia

The first section of the conference was devoted to environmental policy in Russia. As Russia is one of the largest exporters of fossil fuel in the world, its policies carry particular importance in the context of global warming.

The head of climate and green energy at the Center for Strategic Research in Moscow, Irina Pominova, gave an account of Russia’s current situation and trends. Similar to all former Soviet Union countries, as seen in Figure 1, Russia had a sharp decrease in greenhouse gas emissions (hereinafter referred to as GHG emissions) during the early 90s due to the dramatic drop in production following the collapse of the Soviet Union. Since then, the level has stabilized, and today Russia contributes to about 5% of the total GHG emissions globally. The primary source of GHG emissions in Russia comes from the energy sector, mainly natural gas but also oil and coal. The abundance of fossil fuels has also hampered investments in renewable resources, constituting only about 3% of the energy balance, compared to the global average of 10%

Figure 1. Annual greenhouse gas emissions per capita

Note: Greenhouse gas emissions are expressed in metric tons of CO2 equivalents. Source: Emissions Database for Global Atmospheric Research (EDGAR).

Pominova noted that it is a massive challenge for the country to reach global energy transformation targets since the energy sector accounts for over 20% of national GDP and 28% of the federal budget. Yet, on a positive note, the number of enacted climate policies has accelerated since Russia signed the Paris Agreement in 2019. One notable example is the federal law on the limitation of GHG emissions. This law will be enforced from the end of 2021 and will impose reporting requirements for the country’s largest emitters. The country’s current national climate target for 2030 is to decrease GHG emissions by 30% compared to the 1990 level. As shown in Figure 1, this would imply roughly a 10 percent reduction from today’s levels given the substantial drop in emissions in the 1990’s.

Natalya Volchkova, Policy Director at CEFIR in Moscow, discussed energy intensity and the vital role it fills in Russia’s environmental transition. Energy intensity measures an economy’s energy efficiency and is defined as units of energy per unit of GDP produced. Volchkova emphasized that to facilitate growth in an environmentally sustainable way it is key to invest in technology that improves energy efficiency. Several regulatory policy tools are in place to promote such improvements like bottom-line energy efficiency requirements, sectoral regulation, and bans on energy-inefficient technologies. Yet, more is needed, and a system for codification and certification of the most environmentally friendly technologies is among further reforms under consideration.

As a Senior Program Manager at SIDA, Jan Johansson provided insights on this issue from an international perspective. Johansson gave an overview of SIDA’s cooperation with Russia in supporting and promoting environmental and climate policies in the country. The main financial vehicle of Swedish support to Russia with respect to environmental policy has been a multilateral trust fund established in 2002 under the European Union (EU) Northern Dimension Environmental Partnership (NDEP). One of the primary objectives of the cooperation has been to improve the environment in the Baltic and Barents Seas Region of the Northern Dimension Area. Over 30 NDEP projects in Russia and Belarus have been approved for financing so far. Seventeen of those have been completed, and the vast majority have focused on improving the wastewater treatment sector.

Johansson also shed light on the differences that can exist between governments in their approach to environmental policy. For example, in the area of solid waste management, Russia prefers large-scale solutions such as landfills and ample sorting facilities. In Sweden and Western Europe, governments have a more holistic view founded on spreading awareness in the population, recycling, corporate responsibility, and sorting at the source.

Environmental Transition in Eastern Europe

In the second part of the conference environmental policies and energy transformation in several other countries in the region were discussed.

Norberto Pignatti, Associate Professor and Centre Director at ISET Policy Institute, talked about the potential for a sustainable energy sector and current environmental challenges in Georgia. The country is endowed with an abundance of rivers and sun exposure, making it a well-suited environment for establishing the production of renewable energy such as wind, solar, and hydro. As much as 95 % of domestic energy production comes from renewable sources. Yet, domestic energy production only accounts for 21% of the country’s total consumption, and 58% of imported energy comes from natural gas and 33% from coal. Furthermore, the capacity of renewable energy sources has declined over the last ten years, and particularly so for biofuel due to the mismanagement of forests. A notable obstacle Georgia faces in its environmental transition is attracting investors. Low transparency and inclusiveness from the government in discussions about environmental policy, along with inaccurate information from the media, has led to a low public willingness to pay for such projects. Apart from measures to overcome the challenges mentioned, the government is currently working on a plan to impose emission targets on specific sectors, invest in energy efficiency and infrastructure, and support the development of the renewable energy sector.

Like Georgia, Poland is a country where energy consumption is heavily reliant on imports and where coal, oil, and gas stand for most of the energy supply. On top of that, Poland faces significant challenges with air quality and smog and a carbon-intensive energy sector. On the positive end, Poland established a government-industry collaboration in September 2021, that recognizes offshore wind as the primary strategic direction of the energy transition in Poland. Pawel Wróbel, Founder and Managing Director of BalticWind.EU, explained that the impact of the partnership will be huge in terms of not only energy security but also job creation and smog mitigation. The plan implies the installation of 5.9 GW of offshore wind capacity by 2030 and 11GW by 2040. Wróbel also talked about the EU’s European Green Deal and its instrumental role in accelerating the energy transition in Poland. By combining EU-wide instruments with tailor-made approaches for each of the member states, the Deal targets a 55% reduction in GHG emissions by 2030 through decarbonization, energy efficiency, and expanding renewable energy generation. Michal Myck, Director of CenEA, highlighted the role of social acceptance in accelerating the much-needed energy transition in Poland. In particular, to build political support, there is a crucial need for designing carbon taxes in a way that ensures the protection of vulnerable households from high energy prices.

Adapting to the European Green Deal will also create challenges for countries outside of the EU, especially if a European Carbon Border Adjustment Mechanisms (CBAM) is put in place in 2026 as suggested. Two participants touched on this topic in the context of Belarus and Ukraine respectively. Yauheniya Shershunovic, researcher at BEROC, talked about her research on the economic implications of CBAM in Belarus. It is estimated that the introduction of CBAM can be equivalent to an additional import duty on Belarusian goods equal to 3.4-3.8% for inorganic chemicals and fertilizers, 6.7-13.7% for metals, and 6.5-6.6% for mineral products. Maxim Fedoseenko, Head of Strategic Projects at KSE, shared similar estimations for Ukraine, suggesting that the implementation of CBAM will lead to an annual loss of €396 million for Ukrainian businesses and a decrease in national GDP of 0.08% per year.

An example of Swedish support to strengthen environmental policies in Eastern Europe was presented by Bernardas Padegimas, Team Leader at the Environmental Policy and Strategy Team at the Stockholm Environment Institute. The BiH ESAP 2030+ project is supporting Bosnia and Herzegovina in preparing their environmental strategy. This task is made more challenging by the country’s unique political structure with two to some extent politically autonomous entities (and a district jointly administered by the two), and elites from the three different major ethnic groups having guaranteed a share of power. The project therefore aims to include a broad range of stakeholders in the process, organized into seven different working groups with 659 members on topics ranging from waste management to air quality, climate change and energy. The project also builds capacity in targeted government authorities, raises public awareness of environmental problems, and goes beyond just environmental objectives: mainstreaming gender equality, social equity and poverty reduction. The project is 80 percent finished and will produce a strategy and action plan for the different levels of governance in the country’s political system.  There is also a hope that this process can serve as a model for consensus building around important but at times contentious policy issues more generally in the country.

Public Opinion and Energy Security

Finally, Elena Paltseva, Associate Professor at SITE, and Chloé le Coq, Professor at the University of Paris II Panthéon-Asses (CRED), shared two joint studies relating to the green transition in Europe.

Recent research shows that individual behavioral change has a vital role to play in the fight against climate change, both directly and indirectly through changes in societal attitudes and policies motivated by role models. A precondition for this to happen is a broad public recognition of anthropogenic climate change and its consequences for the environment. The first presentation by Paltseva and Le Coq focused on public perceptions about climate change in Europe (see this FREE policy brief for a detailed account). Using survey data the study explores variation in climate risk perceptions between Western Europe, the non-EU part of Eastern Europe, and Eastern European countries that are EU members. The results show that those living in non-EU Eastern European countries are on average less concerned about climate change. The regional difference can partly be explained by low salience and informativeness of environmental issues in the public discourse in these countries. To support this explanation, they study the impact of extreme weather events on opinions on climate change with the rationale that people who are more aware of climate change risks are less likely to adjust their opinion after experiencing an extreme weather event. They find that the effect of extreme weather events is higher in countries with less independent media and fewer climate-related legislative efforts, suggesting that the political salience of the environment and the credibility of public messages affects individuals’ perceptions of climate change risks.

The second presentation concerned energy security in the EU, and the impact of the environmental transition. It was argued that natural gas will play an important role in Europe’s green transition for two reasons. First, since the transition implies a higher reliance on intermittent renewable energy sources, there will be an increased need for use of gas-fired power plants to strengthen the supply reliability. Second, the electrification of the economy along with the phasing out of coal, oil, and nuclear generation plants will increase the energy demand. Today, about 20% of EU’s electricity comes from natural gas and 90% of that gas comes from outside EU, with 43% coming from Russia. To emphasize what issues can arise when the EU relies heavily on external suppliers, the presentation discussed a Risky External Energy Supply Index (Le Coq and Paltseva, 2009) that considers the short-term impact of energy supply disruptions. This index assesses not only the importance of the energy type used by a country but also access to different energy suppliers (risk diversification). The index illustrates that natural gas is riskier than oil or coal since natural gas importers in the EU depend to a greater extent on a single or few suppliers. Another crucial component of the security of gas supplies arises from the fact that 77% of EU’s net gas imports arrive through pipelines, which creates an additional risk of transit. Here, the introduction of new gas transit routes (from already existing suppliers) may increase diversification and decrease risks to the countries having direct access to the new route. At the same time, countries that share other pipelines with countries that now have direct access may lose bargaining power vis-à-vis the gas supplier in question, as demand through those pipelines could fall. Le Coq illustrated this point applying the Transit Risk Index developed in Le Coq and Paltseva (2012) to the introduction of the North Stream 1 pipeline. She concluded that the green transition and associated increase in demand for natural gas is likely to be associated with higher reliance on large gas producers, such as Russia, and resulting in energy security risks and imbalance in the EU. One way to counteract this effect is to exercise EU’s buyer power vis-a-vis Russia within the EU common energy policy. While long discussed, this policy has not been fully implemented so far.

Concluding Remarks

This year’s SITE Development Day conference gave us an opportunity to highlight yet another key issue, not only for Eastern Europe, but for the whole world: global warming and energy transformation. Experts from across the region, and policymakers and scholars based in Sweden, offered their perspectives on the challenges that lie ahead, but also highlighted initiatives and investments hopefully leading the way towards a brighter future.

List of Participants

  • Chloé Le Coq, Professor of Economics at the University of Paris II Panthéon-Assas (CRED). Paris, France. Research Fellow at SITE.
  • Maxim Fedoseenko, Head of Strategic Projects at KSE Institute. Kyiv, Ukraine.
  • Jan Johansson, Senior Program Manager, SIDA. Stockholm, Sweden.
  • Michal Myck, Director of CenEA. Szczecin, Poland.
  • Bernardas Padegimas, Team Leader: Environmental Policy and Strategy, Stockholm Environmental Institute. Stockholm, Sweden.
  • Elena Paltseva, Associate Professor, SITE/SSE/NES. Stockholm, Sweden
  • Norberto Pignatti, Associate Professor of Policy at ISET-PI, and Head of the Energy and Environmental Policy Institute at ISET-PI. Tbisili, Georgia.
  • Irina Pominova, Head of Climatwe and Green Energy at the Center for Strategic Research. Moscow, Russia.
  • Yauheniya Shershunovic, Researcher at BEROC, Minsk, Belarus. PhD Candidate at the Center for Development Research (ZEF). Uni Bonn.
  • Natalya Volchkova, Policy Director at CEFIR, Assistant Professor at the New Economic School (NES). Moscow, Russia.
  • Pawel Wróbel, Founder and Managing Director of BalticWind.EU. Poland.
  • Julius Andersson, Researcher at SITE. Stockholm, Sweden.
  • Anders Olofsgård, Associate Professor and Deputy Director at SITE. Stockholm, Sweden.

Energy Demand Management: Insights from Behavioral Economics

Posted on October 22, 2018 | Policy Brief

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It has long been recognized that consumers fail to choose the cheapest and most efficient energy-consuming investments due to a range of market and non-market failures. This has become known as the ‘Energy Efficiency Gap’.  However, there is currently a growing interest in terms of understanding on how consumers make decisions that involve an energy consumption component, and whether the efficiency of their decisions can be improved by changing the market incentives and governmental regulation. Meeting this interest, the most recent SITE Energy Talk was devoted to Demand Side Management.  SITE invited Eleanor Denny, Associate Professor of Economics at Trinity College Dublin, and Natalya Volchkova, Assistant Professor at the New Economic School (NES) in Moscwo and Policy Director at the Center for Economic and Financial Research  (CEFIR) to discuss the Demand Side Management process. The aim of this brief is to present the principles of Demand Side Management and discuss a few implemented programs in Europe, based on the discussions  during this  SITE Energy Talk.

For the last two decades, climate change policies have mostly been focused on the energy supply side, constantly encouraging new investments in renewables. But reducing energy demand may be as effective. Indeed, Denny and O’Malley (2010) found that investing 100MW in wind power is equivalent, in terms of emissions, to a decrease in demand of 50MW. Hence, there is a clear benefit of promoting energy saving. This has been the central point of different Demand Side Management (DSM) programs that may diversely focus on building management systems, demand response programs, dynamic pricing, energy storage systems, interruptible load programs and temporary use of renewable energy. The goal of these programs is to lower energy demand or, at least, smoothen the electricity demand over the day (i.e. remove peak-hour segments of demand to off-peak hours) as illustrated in Figure 1.

Figure 1 – Smoothing electricity demand during the day

A behavioral framework

DSM encompasses initiatives, technologies and installations that encourage energy users to optimize their consumption. However, the task does not seem easy, given the well-documented energy efficiency gap problem (e.g. Allcott & Greenstone, 2012 or Frederiks et al., 2015): consumers do not always choose the most energy efficient investments, despite potential monetary saving. One reason why might be that energy savings per se are not enough to trigger investment in energy efficient solutions or products. As Denny mentioned in her presentation, consumers will invest when the total  private benefits are higher than the costs of investment. This trade-off can be summarized by the following equation:

This equation illustrates that any DSM design should take into account both non-monetary benefits and consumers’ time preferences. The non-monetary benefits, such as improved comfort, construction and installation time, but also warm glow (i.e. positive feeling of doing something good) or social comparison, may play a major role. Moreover, the consumers’ time preferences (reflected here by the discount rate ) are also crucial in the adoption of energy efficient products. In particular, if consumers have present biased preferences, they would rather choose a product with a lower cost today and greater future cost than the reverse (i.e. higher cost today with lower future cost). Since energy-efficient products often require higher upfront investment, consumers that are impatient for immediate gains, may never choose energy efficient products.

Ultimately, it is an empirical (and context specific) question when and why DSM programs can reduce the energy efficiency gap. We describe below some DSM programs that have been implemented and discuss their impact.

Smart meters, a powerful DSM tool

A common DSM program is the installation of smart meters, which measure consumption and can automatically regulate it. The adoption of smart meters allows real-time consumption measures, unlike traditional meters that only permitted load profiling (i.e. periodic information of the customer’s electricity use).

Figure 2 – Energy Intensity in Europe

As illustrated in Figure 2, many European countries have implemented smart meter deployment programs. Interestingly, most of those countries have a relatively high level of energy efficiency (proxied by the energy intensity indicator of final energy consumption). On the contrary, in the Balkans and non-EU Eastern Europe countries, which fare poorly on the energy intensity performance scale, no smart meter rollout programs seem to be implemented.

Following the European Commission (EC) directive of 2009 (Directive 2009/72/EC), twenty-two EU members will have smart meter deployment programs for electricity and gas by 2020 (see Figure 2).  These programs are targeting end-users of energy, e.g. households that represent 29% of the current EU-28’s energy consumption, industries (36.9%) and services (29.8%) (EEA). With this rollout plan, a reduction of 9% in households’ annual energy consumption is expected.

The situation across the member states is however very different. Spain was one of the first EU countries to implement meters in 1988 for industries with demand over 5MW. All the meters will be changed at the end of 2018. 27 million euros for a 30-year investment in smart meter installations is forecasted (EC, 2013). Sweden started to implement smart meter rollout in 2003 and 5.2 million monthly-reading meters were installed by 2009. Vattenfall, one of the major utilities in Sweden, assessed their savings up to 12 euros per installed smart meter (Söderbom, 2012). Similarly in the United Kingdom, the Smart Metering Implementation Programme (SMIP) is estimated to bring an overall £7.2 billion (8.2 billion euros) net benefit over 20 years, mainly from energy saving (OFGEM, 2010). In general, smart metering has been effective, but its effectiveness may diminish over time (Carroll et al, 2014).

From smart-meter to real-time pricing

The idea of real-time pricing for electricity consumers is not new. Borenstein and Holland (2005) and Joskow and Tirole (2006) argue that this price scheme would lead to a more efficient allocation, with lower deadweight loss than under invariant pricing.

By providing detailed information about real-time consumption, smart meters enable energy producers to adopt dynamic pricing strategies. The increasing adoption of smart meters across Europe will likely increase the share of real-time-pricing consumers, as well as the efficiency gains. With the digitalization of the economy, it is likely that smart metering will grow. Indeed, Erdinc (2014) calculates that the economic impact of smart homes on in-home appliances could result in a 33% energy-bill reduction, due to differences in shift potential of appliances.

In 2004, the UK adopted a time-of-use programme called Economy 10, which provides lower tariffs during 10 hours of off-peak periods – split between night, afternoon and evening – for electrically charged and thermal storage heaters. The smart time-of-use tariffs involving daily variation in prices were only introduced in 2017.

Likewise, France’s main electricity provider EDF, implemented Tempo tariff for 350,000 residential customers and more than 100,000 small business customers. Based on a colour system to indicate whether or not the hour is a peak period, customers can automatically or manually monitor their consumption by controlling connection and disconnection of separate water and space-heating circuits. With this program, users reduced their electricity bills by 10% on average.

In Russia, the “consumptions threshold” program discussed by Natalya Volchkova, gave different prices for different consumption thresholds. But it seems that the consumers’ behaviour did not change. This might be due to the thresholds being too low, and an adjusted program should be launched in 2019.

Joskow and Tirole (2007), argue that an optimal electricity demand response program should include some rationing of price-insensitive consumers. Indeed, voluntary interruptible load programs have been launched, mainly targeting energy intensive industries that are consuming energy on a 24/7 basis. These programs consist of rewarding users financially to voluntarily be on standby. For instance, interruptible programmes in Italy apply a lump-sum compensation of 150,000 euros/MWh/year for 10 interruptions and 3000 euros/MW for each additional interruption (Torriti et al., 2010).

Nudging with energy labelling

Energy labelling has been also part of DSM. Since the EC Directives on Ecodesign and Energy Labelling (Directives 2009/125/EC and 2010/30/EU), energy-consuming products should be labelled according to their level of energy efficiency. For Ireland, Eleanor Denny has tested how labelling electrical in-home appliances may affect consumers’ decisions, like purchasing electrical appliances or buying a house. First, Denny and co-authors have nudged buyers of appliances, providing different information regarding future energy bills saving. They find that highly educated people, middle income and landlords are more likely to be concerned with energy-efficiency rates, rather than high-income people.

In another randomized control trial, Denny and co-authors manipulate information on the energy efficiency label for a housing purchase. In Ireland, landlords are charged for energy bills even when they rent out their property. The preliminary findings are that landlords informed about the annual energy cost of their houses are willing to pay 2,608 euros for a one step improvement in the letter rating – the EU label rating for buildings ranges from A to G – compared to the landlords that do not receive the information (see CONSEED project).

Similar to the European Directive, the 2009 Russian Energy efficiency law includes compulsory energy efficiency labels for some goods and improvements of the building standards (EBRD, 2011). Volchkova and co-authors run a randomized controlled experiment on the monetary incentives to buy energy efficient products. In 2016, people in the Moscow region received a voucher with randomly assigned discounts (-30%, -50% or -70%- for the purchase of LED bulbs. Vouchers were used very little, irrespective of the income. It seems that consumption habits and not so much monetary rewards were the main driver of LED bulb purchase.

How can DSM be improved?

Any demand response program requires some demand elasticity. For example, smart meters and dynamic pricing only improve electricity consumption efficiency if demand is price elastic. As Jessoe and Rapson (2014) show, one should provide detailed information (e.g. insights on non-price attributes, real-time feedback on in-home displays) to try to increase demand elasticity. Hence it seems that  the low adoption of energy efficient goods is partly due to a lack of information or biased information received by the consumers. First, it is difficult for many to translate energy savings in kWh in monetary terms. Second, many consumers focus on the short-term purchase cost and discount heavily the long run energy saving. These information inefficiencies can, in principle, be diminished by private actors and/or governmental regulation. Denny mentioned the possibility of displaying monetary benefits on labels in consumers’ decision-making in order to improve energy cost salience. For instance, in the US or Japan, the usage cost information is also displayed in monetary terms. Moreover, lifetime usage cost (i.e. cost of ownership) should also be given to the customers since it has been shown that displaying lifetime energy consumption information has significantly higher effect than presenting annual information  (Hutton & Wilkie 1980; Kaenzig 2010).

Summing up, DSM programs, including those with a behavioral framework, are an important tool for regulators, households and industries helping to meet emissions reduction targets, significantly decrease demand for energy and use energy more efficiently.

References

  • Allcott, Hunt ; Greenstone, Michael. 2012. “Is There an Energy Efficiency Gap?”, Journal of Economic Perspectives, 26 (1): 3-28.
  • Borenstein, Severin; Holland, Stephen. 2005. “On The Efficiency Of Competitive Electricity Markets With Time-Invariant Retail Prices”, Rand Journal of Economics, 36(3), 469-493.
  • Carroll, James; Lyons, Seán; Denny, Eleanor. 2014. “Reducing household electricity demand through smart metering: The role of improved information about energy saving,” Energy Economics, 45(C), 234-243.
  • Denny, Eleanor; O’Malley, Mark. 2010. “Base-load cycling on a system with significant wind penetration”, IEEE Transactions on Power Systems 2.25, 1088-1097.
  • Erdinc, Ozan. 2014. “Economic impacts of small-scale own generating and storage units, and electric vehicles under different demand response strategies for smart households”, Applied Energy, 126(C), 142-150.
  • European Bank for Reconstruction and Development. “The low carbon transition”. Chapter 3 Effective policies to induce mitigation (2011).
  • European Commission. Electricity Directive 2009/92. Annex I.
  • European Commission. Ecodesign and Energy Labelling Framework directives 2009/125/EC and 2010/30/EU.
  • European Commission. “From Smart Meters to Smart Consumers”, Promoting best practices in innovative smart metering services to the European regions (2013).
  • European Commission. “Benchmarking smart metering deployment in the EU-27 with a focus on electricity” (2014).
  • European Environment Agency. Data on Final energy consumption of electricity by sector and Energy intensity.
  • Frederiks, Elisha R.; Stenner, Karen; Hobman, Elizabeth V. 2015. “Household energy use: Applying behavioural economics to understand consumer decision-making and behaviour”, Renewable and Sustainable Energy Reviews, 41(C), 1385-1394.
  • Hutton, Bruce R.; Wilkie, William L. 1980. “Life Cycle Cost: A New Form of Consumer Information.” Journal of Consumer Research, 6(4), 349-60.
  • Jessoe, Katrina; Rapson, David. 2014. “Knowledge is (less) power: experimental evidence from residential energy use”, American Economic Review, 104(4), 1417-1438.
  • Joskow, Paul; Tirole, Jean. 2006. “Retail Electricity Competition“, Rand Journal of Economics, 37(4), 799-815.
  • Joskow, Paul; Tirole, Jean. 2007. “Reliability and Competitive Electricity Markets”, Rand Journal of Economics, 38(1), 60-84.
  • Kaenzig, Josef; Wüstenhagen, Rolf. 2010. “The Effect of Life Cycle Cost Information on Consumer Investment Decisions Regarding Eco‐Innovation”, Journal of Industrial Ecology, 14(1), 121-136.
  • OFGEM. “Smart Metering Implementation Programme” (2010).
  • Söderbom, J. “Smart Meter roll out experiences”, Vattenfall (2012).
  • Torriti, Jacopo; Hassan, Mohamed G.; Leach, Matthew. 2010. “Demand response experience in Europe: Policies, programmes and implementation”, Energy, 35(4), 1575-1583.

Project links

Eleanor Denny and co-authors’ European research projects:

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.

Will New Technologies Change the Energy Markets?

Posted on October 24, 2016 | Policy Brief

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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

slide1Source: IEA, 2016.

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

slide2Source: IEA, 2016.

Energy producers

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

slide3Source: Calculations by Torbjörn Becker, October 13, 2016

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.

References

  • 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)

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