Class 11: Wed Oct 10. Energy: Tech, Econ, and Environment

Stern Review on the Economics of Climate Change

[For a shorter (and probably better but not as detailed) explanation please see the summary Stern provides. See above ]

I. The innovation process: a review of previous lectures on innovation.

1. Freeman:

· incremental innovations: continuous improvements of existing products

· radical innovation: new inventions what lead to significant departure from previous production methods (hybrid cars).

· cluster of radical inventions impact on several branches of economy

· changes of techno-economic paradigm when technology change impacts on every other branch of economy.

2. Schumpeter:

· invention (first practical demonstration of idea)→innovation (first commercial application)→diffusion (spreading of technology throughout the market) [think S curve]

· high profits and risk of being left behind drive firms to invest in innovation.

3. experience curves:

· Marginal cost of production decreases with increase in cumulative output.

· New technologies may not become cost effective until significant investment has been made—may reduce incentive of investing. Therefore lock-ins of existing technologies.

4. information spillovers: innovation produces benefits beyond that of individual firm.

· Policy responses:

i. enforce private property rights through patents. However rigid patent protection can slow process of innovation by preventing competing firms from building on each others’ progress. Hard to enforce international patent arrangements.

ii. Direct government funding.

II. innovation for low-emission technologies: additional barriers to innovation?

· lack of certainty over the future pricing of carbon emissions will reduce incentive to innovate.

· Failure to take account of environmental externality ensures there will be under-provision or slower innovation.

· Power-generation sector: Public energy R&D as share of GDP (R&D intensity) declined since 1980s.

· Explanations:

1. learning process: takes several decades before they become commercially viable. niche market in power sector very limited in absence of government policy. Cost reduction takes several decades to fill→financing gap that capital markets unable to fill.

2. infrastructure: national grids favor centralized power plants. Large-scale renewables may encounter problems if they are sited in areas far from existing grads.

3. many policies distort market in favor of existing fossil fuel technologies.

4. nature of competition within market not conducive to innovation: electricity monopoly and government regulation reduces incentive to invest is regulator prevent firms from reaping full benefits.

*historically driven by economies of scale the electricity system is easily locked into technological trajectory—resistant to technical change that will be necessary in a shift to a low-carbon economy.

· Radical change may not be delivered by the markets: hybrids are penetrating markets with limited government support, but markets alone can’t deliver more radical changes such as plug-in hybrids or alternative fuels.

III. Policy implications for Climate change technologies:

· Policies to encourage low-emission technologies can be seen as a hedge against the risk of high abatement costs.

· Greater diversity in sources of energy tend to provide benefits to security of supply.

· Requires a combo of government interventions including: carbon pricing (reduce learning cost), R&D support, technology-specific early state deployment support. Complemented by policies to address non-market barriers.

· Stable framework of incentives for the private sector: most development and deployment undertaken by private sector.

· Benefits of R&D and deployment support in the past:

-public sector R&D can play vital role in stimulating private spending up to the potential point of crowding out as well as preserving public good.

IV. R&D policies:

· Likely greater emphasis on private research but still role for public funding.

· Education and training of scientists. Spur wider interest in science as challenge of climate change becomes more prominent.

· Research with clear objects with without over-commitment can eliminate wasteful expenditures.

· Priorities of publicly funded institutions reflect those of society.

· Demonstration funding to prove viability and reduce risk.

· Failure to develop energy-storage technologies will increase cost of mitigation once low-emission potions are exploited. Allow low-emission resources to provide energies in other sectors (such as transport).

· Public R&D should complement, not compete with private R&D.

V. deployment policies:

· Examples: reduced taxes, demonstrator projects, feed-in tariffs (fixed price), quotas, subsidy, procurement of public monopoly.

· Global energy R&D is at a low level and should rise.

· Important that funding is spread across wide range of ideas.

VI. Conclusions:

1. Environmental externalities exacerbate existing market imperfections, limiting incentive to develop low-carbon tech.

Energy Crisis and Transition-Nye

• Energy crisis in 1970s
• Seemed to be an aberration that came from abroad
• Median family real income sank

• Energy crisis played itself out in five stages:
• Stage 1: 1971
• Nixon imposed price controls on gasoline as demand increased while supplies were diminishing à actually encouraged use of gasoline
• Policy of “keeping it cheap”: implemented through regulatory distortion of free-market relationships
• Businessmen perceived problem as one of government interference
• Free market could solve problem
• Stage 2: 1972
• Oil prices began to climb as result of shortages/price hikes by OPEC
• Oil embargo imposed on US in retaliation for helping Israel during Yom Kippur War à artificially high prices
• Nixon’s response: “Project Independence” – R&D program for more energy sources à discipline public to use more fuel-efficient tech and adjust consumption patterns
• Stage 3: mid ‘70s
• Embargo’s effects subsided, energy supplies increased
• No coherent energy policy emerged: focused entirely on supply, not demand
• Wanted US to dominate world’s energy markets à can’t happen
• Stage 4: 1979
• Iran cut off its oil
• Public angry and bitter; economy suffered inflation and stagnation (together)
• Stage 5: early 80s
• OPEC unable to keep some members from overproducing à prices dropped
• Americans believed oil sheiks/Iranian revolutionaries were responsible for crisis
• Longer perspective of energy crisis:
• Result of rising domestic demands for energy and failure of US government to devise coherent long-term policies
• Throughout 1970s, energy use increased
• Electricity consumption increased by 50% (even with “cutbacks”)
• Sunbelt experienced rapid development in 1970s
• With urban concentration, Americans did little to adjust behavior during crisis—only short-tern concessions were made
• Great unease with nuclear reactors after accident at Three Mile Island (1979) made nuclear energy unattractive as new source of energy
• Before the crisis:
• Environmental activists attacked use of coal as fuel because it caused acid rain à delayed construction of Alaskan oil pipeline
• Later, embargo undermined their support
• Public later led to believe there existed a connection between the oil embargo and illegal campaign contributions by oil companies (Watergate) à confusion
• Fatalistic views of futures developed if world were to continue consuming pattern
• Called for fundamental changes in values and behavior to achieve equilibrium and to avoid overloading world’s finite ecology
• Innovative measures to control energy crisis: use “soft energy paths” (e.g. recycling and renewable power, solar, wind, water power)
• Lower energy consumption à reduce US imports of oil à improve balance of payments à enhace overall economic performance
• Reagan campaigned that Carter implemented policies that prevented US from finding more energy sources
• Reagan said US had abundance of energy that just needed to be tapped
• He won election
• At the same time, OPEC’s efforts to control prices broke down à prices dropped
• Benefited from conservation measures of 1970s
• Energy was so integrated into consumer lifestyle that few people were willing to make adjustments
• The poor, who consumed little energy, had to change lifestyles
• When prices dropped, most returned to old consumption pattern

Nuclear Energy-Pool

Nuclear Power: American problems in scaling up nuclear power generation and how the French avoided those problems.

Rickover – oversaw the construction of more than a hundred nuclear reactors and described the differences between “paper reactors” (plans for reactors) versus real ones:

Paper Reactors:

• Simple

• Small

• Cheap

• Lightweight

• Easily/quickly built

• Doesn’t require much development

• Is not being built

Real Reactors:

• Complicated

• Large

• Heavy

• Is being built

• Is behind schedule

• Requires tons of development on seemingly trivial items

By 1963, people were no longer intimidated by the idea of nuclear power. A certain degree of arrogance led some to believe that nuclear power generation could be scaled up. Unfortunately, the learning phase for this particular branch was not over. When you scale nuclear operations up by just a little bit, they get a lot more complex.

People thought that nuclear reactors would develop more smoothly than their coal counterparts. They were kind of right about this specifically, but forgot that the reactor is only a small part of a nuclear power plant.

There were huge problems with suppliers and construction workers: Suppliers underestimated the task and workers thought that the same techniques they’d used in coal-fire plants should be good enough for the nuclear ones, too.

Security also was a much bigger concern. In coal-fire plants, when something goes wrong, nobody dies. It’s the opposite with nuclear plants: Everybody dies. Everybody. Dies. Even people outside the plant boundaries.

The difference between the American nuclear industry and the French nuclear industry that makes all the difference: The US industry refused to standardize. The standardization of the French nuclear industry led to increased learning and economies of scale.

Why didn’t the US pursue standardization techniques? Firstly, there wasn’t anything obviously wrong with the way they were doing things as was. Secondly, Individual companies weren’t really conscious of the huge costs they were taking on… The utilities were regulated monopolies, and as such, they could charge however much they wanted and get paid for their expenses.