When US presidential hopeful Senator John McCain told the US public: “We need to drill here and we need to drill now,” the idea that America should begin drilling off its own shore to secure its oil supply and bring down fuel prices (then at $4 a gallon) proved popular with disgruntled voters.
Senator McCain was also striking a populist note that many other politicians would like to follow. The runaway cost of energy, coupled with the notion of energy security, is at the top of everyone’s agenda.
The world is facing an energy crunch. Supplies of conventional fossil fuels are dwindling and competition for those supplies is becoming ever more acute, pitting the needs of one country against another. With other forms of energy not yet able to take up the slack, price spikes are inevitable and painful.
Many countries reliant on external sources for their energy needs have failed to factor in growing appetite from developing economies or rocketing prices, and have dithered over policy. They have failed to diversify their energy sources or to develop alternative technologies. They now face a growing energy gap and perilously little energy security.
The energy crunch is putting pressure on the free market approach to energy supply. In the face of massive price hikes and the threat of rolling blackouts in some of the world’s most developed economies, some argue that market-based structures pursued through deregulation have failed to deliver in terms of increased capacity, greater efficiency, security of supply or consumer choice. In the US, the champion of the free market, some states are ‘re-regulating’ energy.
Furthermore, the fact that prices at the fuel pump may help to clinch the forthcoming US presidential election is evidence that the new energy reality is reshaping the broader political agenda. As competition for energy has intensified, the political requirement for energy security is pushing other issues such as climate change back down the agenda. Coal-fired electricity – the dirtiest fuel – is back in vogue.
This may come as no surprise in thirsty developing countries such as China, where every week at least one new coal-fired plant is built, but the effect can also be seen across the EU, where several governments have backtracked on commitments to use more, cleaner alternatives.
The resurgence of coal bodes ill for attempts to slow climate change, and it is happening despite the stringent targets in place to reduce carbon emissions and the fact that policymakers have argued for energy security and climate security to be addressed in tandem.
So, while governments around the world have failed to secure energy (or energy price) security, they may also fail to meet even the most conservative promises to cut emissions. Despite years of debate about alternative energy and energy efficiency, why have policymakers failed their constituents and what options do they have?
Energy poor
Around the world, the threat of power shortages is rising – and not just in developing nations with immature or less sophisticated infrastructure. In June, the New Zealand government asked the public to turn off appliances for the third time in seven years and major commercial electricity users said they were cutting back production to help save power.
In response to shortages, many European countries are turning back to coal as a fast and dirty solution.
Even in Germany, which has hitherto had one of the strongest political commitments to developing renewable energies, 20 coal-fired power plants are now in the pipeline. In the UK, almost a dozen new coal-fired power stations are currently in planning, and in last year’s energy White Paper, the government promised to secure the future of coal-fired power generation, albeit with a pledge to stimulate investment in clean coal technologies. In Italy, Enel is converting its power plant in Civitavecchia from oil to coal over the next five years, and Italy plans to increase its reliance on coal from 14% to 33%. E.ON, the largest energy producer in Europe, has just revealed plans to build a new coal-fired power plant in the Czech Republic.
Reasons vary for the coal volte face. A key driver is fear about security of supply. In March this year, memories of Gazprom turning off the tap to Ukraine in 2006 were revived when the Russian gas giant again reduced supplies to Ukraine by 50% during a three-day dispute.
A resurgent Russia with a virtual stranglehold on gas supply carries a lot of emotional power in countries such as Poland and Germany.
Italy, too, feels vulnerable; the 2006 dispute between Ukraine and Russia also affected Italy’s supplies and it was forced to dip into precious gas stores to make up the shortfall. The mere possibility of power shortages as a result of such action has gone some way to overturning consensus in a country which had been blazing an alternative energy trail by championing wind and solar power, and generates almost 15% of its electricity from renewables.
In the UK, most blame rocketing prices and the country’s lack of energy self-sufficiency on dithering by this and previous governments. Despite relatively rich natural reserves and one-time leadership in nuclear power, electricity prices have risen by 40% and gas by 60% since 2004. It is using more and more imported gas: this year the proportion will to rise to 40% from 27% in 2007, and by 2015 it is expected to rise to 75%. Yet the UK has much less gas storage space than other countries in north-west Europe (13 days, compared with 99 days in France and 122 days in Germany). The UK is therefore less able to buy cheaper gas in the summer and has to pay higher prices for gas imports in the winter.
Bad planning, the failure to commit to energy plans and an inability to grapple with the environmental opposition to nuclear power and the use of coal has left the UK with a yawning energy gap, wrote Jill Kirby, director of the UK’s Centre for Policy Studies, in a recent article. With the UK’s own gas reserves in decline and nearly half of the country’s nuclear and coal-fired power stations being phased out over the next six to eight years, what will be the energy solution then, asked Ms Kirby?
This question has particular relevance following the collapse in August of the nuclear power plant deal between French supplier EDF and British Energy, which had formed a central plank of the UK government’s attempt to increase the country’s energy security. Blaming global factors and promising a tax on energy profits (Ms Kirby attributes the collapse of the EDF deal to the latter) will do little to close any gaps in energy policy.
The not-so-free market
In the US, things don’t look much better. They look so bad, in fact, that the home of the free market is calling into question the free market in energy.
The debate about the weaknesses of energy deregulation is not new in the US. Following partial deregulation in California begun in the mid-1990s, the competitive system failed to work as planned and throughout 2000 and 2001 the state suffered from rolling blackouts and high prices. A system of energy price regulation encouraged suppliers to ration their electricity supply rather than expand production and created opportunities for market manipulation by energy speculators such as Enron and Reliant Energy.
Last year, with electricity and natural gas prices rising, the issue returned. In Ohio, which was scheduled to move from partial deregulation to market-based electricity rates by the end of this year, state governor Ted Strickland said that instead of creating a competitive market and lowering prices, Ohio’s deregulation had given utilities there a monopoly and pushed rates higher.
“There must be a sensible balance between regulation and competition,” said Mr Strickland in a speech in August 2007. “We must develop a market that serves the needs of Ohio, not a system that offers utilities both the benefits of deregulation and the protections of regulation.”
The same debate is under way in other states, including Delaware and Maryland. In an address to the Maryland Association of Counties in August, state governor Martin O’Malley said that a “hands-off, pro-business approach has failed”. No new power plants have been built in the state for decades and, despite growth in the state’s electricity demand, “the market did not respond as promised”, he said, warning that the state faces brownouts and blackouts as early as 2011.
In Ohio and Virginia, the result has been ‘re-regulation’. Ohio’s electric energy policy, Senate Bill 221, came into force on July 31, and sets out to expand the state’s green energy industry and stabilise electricity prices using a system under which rates would be set by the Public Utilities Commission of Ohio.
Market failure
The fundamental problem is that if deregulation achieves one aim – to increase competition and reduce prices for consumers – lower prices and slimmer margins cause it to fail in another, by reducing the incentive for operators to invest in improving the system’s attributes or increasing energy efficiency.
Several factors make it difficult to apply normal competitive structures to electricity supply. First, it is difficult and costly to store. More importantly, a shortfall or surplus does not just endanger a few customers, it threatens the entire grid. Meanwhile, hardly any customers have the opportunity to respond to real-time prices, meaning that there is little or no demand management.
This combination makes electricity markets particularly vulnerable to the exercise of market power: a producer can ask for an extremely high price to deliver the power, and consumers (or the local entity that represents them in the wholesale market) have to pay it.
Similarly, neither new entry nor demand management are likely to inject competition. Legal and environmental hurdles mean it can take a newcomer years to enter the market, and the technology that would enable consumers to manage demand, such as smart meters, is not readily available.
Price caps are equally tricky to manage: set too low, they discourage production from high-marginal-cost plants in the short term and lead to disinvestment in the long term as producers are unable to cover their cost of capital; set too high, and the exercise of market power means price hikes.
Nor is it easy to rebalance the equation in the transmission stage. If it is easier for market participants to ‘import’ electricity from another supplier (whether that is a country or a neighbouring state) than for new producers to enter the market, imports are limited by the capacity of transmission lines between regions: once a line reaches its capacity, it cannot import any more energy. Power grids, though vulnerable to shortfalls, are generally not flexible enough to be able to take power from multiple sources such as microgeneration by solar panels.
In the US, the question has become: are the costs of sustaining competition lower than those of sustaining regulation?
When the state of Virginia re-regulated last year, returning to a ‘cost-of-service’ regulation under which the state has the authority to set rates and review the records and costs of utilities, it hoped to overcome some of the weaknesses of deregulated markets.
Its two energy bills incorporate provisions aimed at improving energy efficiency, encouraging the installation of environmental equipment at power stations and the use of renewable energy. A central aim is also to provide incentives for operators to increase capacity, so the bills include room to establish a floor for return on equity and higher authorised returns for major new generation projects that will enable operators to attract the necessary new capital. The bills also provide incentives for entities to invest demand-side management and conservation programmes.
Efficiency is crucial
By only paying lip-service to increasing energy efficiency, governments are missing out on the single most powerful way to increase energy security. Nick Mabey, founder and CEO of UK-based E3G, a not-for-profit sustainable development consultancy, says that the failure of governments to put greater energy efficiency at the core of energy policy is a major part of the energy problem.
“Increasing energy efficiency immediately reduces pressure on energy demand, and thereby increases energy security. But if energy efficiency targets are not built into the market structure, then market participants cannot not respond to them,” says Mr Mabey, who, until December 2005, was a senior advisor in the UK prime minister’s Strategy Unit.
In many instances, governments have put the onus on the wrong part of the value chain or have put the wrong incentives in place, which target the wrong people.
For example, in April, the UK government launched the Carbon Emission Reduction Target, a home insulation programme to be funded by energy companies under which they must offer grants to householders to make their homes more energy-efficient. Many argue that instead of making energy suppliers largely responsible for energy efficiency, it would be better to place responsibility with firms such as house builders, large-scale property managers and appliance manufacturers.
Evidence suggests that regulation-led efforts, such as mandating minimum energy standards on new buildings, public programmes to refurbish existing housing stock and mandatory efficiency standards on appliances, can have a big effect.
According to a study by Boston-based energy and utility consulting practice NBrockway & Associates, the aggressive application of these regulatory levers has enabled the state of California to keep energy consumption per capita at the same level as it was in the early 1970s. The study, which was commissioned in 2007 by the State of Delaware Legislation in response to state-wide price rises, says this has enabled California to avoid the equivalent of 22 nuclear power plants.
The lack of correctly targeted incentives also means there has been no widespread development of technology that would enable consumers to monitor or manage their energy consumption. Smart meters that are able to communicate with the power grid, combined with varied price tariffs, for example, would enable households to see when they were using the most electricity, at what price, and offer them the opportunity to cut consumption or use appliances differently.
Old-fashioned national power grids are another critical weakness. Today’s alternating current power grid was created in the 19th century and is still based on analogue principals. The migration to a ‘smart’ grid which uses micro-electronics and two-way communication would enable grids to make use of distributed and highly adaptive control systems and make them more resilient, more efficient and more flexible. It would enable decentralised power generation, making it easier to feed in power from a wider variety of sources. This would mean that all homes and businesses could become both energy client and supplier, for example, by selling back excess energy generated by solar panels and wind turbines.
Despite this potential, smart grid technology is only operational at the fringes. In the US, for example, California has flirted with elements of it and in March this year, US energy company Xcel Energy announced a $100m project to make Boulder, Colorado, the first integrated smart grid city in the US over the next few years. Only Italy’s Enel has a full-blown project under way: 27 million Enel customers have already been fitted with smart meters and, last year, it launched the ‘Address’ project, which will encourage distributed generation, increase network efficiency and enable consumption optimisation.
No room for uncertainty
Mr Mabey believes that in many instances, governments are creating the sort of uncertain policy or short-term investment environment that make it difficult for markets to respond. Governments that take bold policy decisions are having greater success in building renewable and sustainable energy markets than those countries which do not have a clear policy; uncertainty has a cost, says Mr Mabey.
Germany is a case in point. Among other provisions, its Renewable Energy Sources Act set a national target for renewable energy of 20% by 2020 and requires energy companies to purchase power generated from renewable sources at a price that is set above the market price, over 20 years. This kind of certainty has spawned massive interest in the purchase of renewable energy products and has helped to create a market.
By July this year, Germany had already exceeded its 2010 target of 12.5%; the UK generates about 4.6% of its energy from renewables.
“Germany succeeded because it established a market by setting a national target and guaranteeing high prices. This meant Germany got the renewables investment it wanted; it will be able to reduce costs over time,” says Mr Mabey. “The UK, by contrast, has tried to encourage development of renewables ‘cost-efficiently’, putting all the risk onto the private sector; but the market wasn’t interested in this model and has not responded. In the end, per-unit public subsidy for comparable renewables, Germany was a more cost-efficient way of achieving the same end. It gave the private sector the certainty it needed.”
Ohio’s re-regulation framework is taking Germany’s decisive approach. It requires a 22% reduction in energy demand by 2025 and includes benchmarks and penalties. By 2025, 25% of electricity sold in Ohio must be generated from alternative energy sources such as clean coal, nuclear energy, fuel cells and cogeneration. Half of this must be met with renewable sources, including a 0.5% solar set-aside. In addition, half of the advanced energy and renewable energy must be located in Ohio.
Government sponsorship
Germany’s success in renewable energy is underpinned by government support through legislation and subsidies. This has not been without controversy, or market peculiarities. For one thing, instead of reducing unit costs and therefore making solar energy more competitive, the rush for solar panels has created a shortage of high-grade silicon used to make the photovoltaic cells: prices have soared from $25 per kilogram in 2003 to about $400 today.
Moreover, the ruling CDU party had proposed that subsidy levels be cut more aggressively than the planned reduction over time that was already agreed. In the end, the cuts of 9% to 10% a year until 2011, announced in July, were less than the 30% proposed by the CDU.
But Germany stands as proof that government policy and sponsorship can be critical. By investing in infrastructure and providing policy certainty, governments can create markets, and these can become international industries.
Here Germany’s boldness is being repaid. It may still have 10 of Europe’s most highly polluting coal-fired power stations, but it now harnesses a huge amount of solar and wind energy and in 2007, sales in the German renewable energy sector reached €24.6bn (four times higher than in 2000), of which more than €8bn were from exports. Investment has surpassed €9bn, and the clean tech industry employs more than 235,000 people.
Germany’s clean tech industry is not yet self-sustaining, but it will be, says the government. Anyway, defenders argue, support for solar energy, for example, still doesn’t match subsidies to the dirty and declining coal industry.
And until then, it preserves Germany’s position in emerging technologies. More importantly, its push has created jobs in formerly blighted industrial parts of the country and has lured investors from Canada, Norway and the US.
Public financing in the early stages of development created most of the technologies that are now taken for granted, such as computers and the internet; investing for the future created the national railways, post offices and national airlines.
Governments, more than corporations, have the ability to invest in ‘the public good’. Smart grids, for example, have never been implemented on a large scale by a power utility even though most of the hardware behind it is relatively proven. Proponents argue that this is because building the intelligent grid is less to do with technical innovation than with strategic innovation. Utilities tend to focus their business strategies on lumpy capital investments such as power plants and high-voltage transmission lines because those investments have prioritised mature technologies with well-proven benefits – and that’s attractive to their investors. The smart grid, however, is more difficult to define, and offers different benefits for utilities depending on their operational systems, market structures, and load profiles; this is much more difficult to sell to the private sector.
Others can only dream of German-type support. According to the most recent figures from the International Energy Agency, in 2006, the US government invested $3bn in energy research and development. This equates to one and a half days of US defence spending. US government annual funding on renewable energy technologies was $239m – or just three hours of defence spending.
Perhaps with one eye on Germany’s success, UK prime minister Gordon Brown laid out in June his vision of a low-carbon manufacturing sector building renewable energy equipment, electric and hybrid cars and low-carbon aircraft. The underlying aim is to ensure that as many as possible of these jobs stayed in the UK. His vision of a manufacturing sector focusing on green technology will require £100bn ($179bn) of investment from the private sector. There is little talk of government sponsorship.
According to Jeffrey Sachs, director of The Earth Institute at Columbia University, New York and special advisor to United Nations secretary-general Ban Ki-moon, the world has no choice but to link energy security with climate security. The demand for energy will keep rising, and it will become increasingly difficult for global resources of fossil fuels to keep up, he says.
Climate and energy security
In an article for the UK’s Guardian newspaper in April, Mr Sachs argued that for developing economies to continue enjoying rapid economic growth and for rich countries to avoid a slump, it will be necessary to develop new energy technologies. This means technology to make dirty fuel cleaner and energy use more efficient, as well as low-cost alternatives to fossil fuels.
Moreover, he argues that for all the promising technologies, such as carbon capture and sequestration or hybrid technology for cars, governments need to invest to help move the technology from blueprint to product.
But in light of coal’s recent resurgence in even the greenest of countries, it seems more likely that energy price spikes and geopolitical insecurity will lure governments down the path of least resistance: a return to dirty fuels.
In July 2006, the European Commission stated: “Climate security and energy security are inextricably linked. Energy efficiency and diversification of energy sources are key responses to both.” Few subsequent policy choices within the EU reflect this realisation.
The possibility of achieving both is amply demonstrated by France’s nuclear power industry. Putting aside the fact that the country produces enough plutonium to make about 10 nuclear bombs a week, France’s 30-year-long determination to eliminate its dependence on oil from the Middle East has resulted in a nuclear industry which now generates more than 87.5% of France’s electrical power generation – and it is carbon free.
What France clearly illustrates, however, is the importance of clear long-term policies. Proponents argue that with sufficient policy support, there are plenty of renewable alternatives that could achieve the same effect. Moreover, many argue that now is the ideal time to put the right kinds of long-term policies in place, because the much-needed replacement of ageing infrastructure offers a unique opportunity for clean energy investment in Europe, the US and elsewhere.
Emerging economy
The link between energy and climate security is increasingly recognised in developing economies, too. In an interview in August, Indian prime minister Dr Manmohan Singh acknowledged that emerging economies must increase their use of renewable energy both to maintain current growth trends and cut emissions.
“If India does not wish energy to become a constraint on its ability to deliver high levels of growth… then it must make a deliberate and graduated shift to renewable energy,” he said. “In the meantime, it must conserve energy and increase efficiency in energy-intensive sectors. Thus, promoting energy security will, as a consequence, deliver climate change benefits as well. This is the strategy which underlies India’s National Action Plan on climate change.”
E3G’s Mr Mabey says that if governments don’t identify climate security as a threat to their country at the same level as energy security, then they end up prioritising energy over climate. He argues that countries have to move towards co-operation and away from competition.
“Prioritising energy security means that you end up competing for resources with countries like China. You realise that you can’t achieve energy security at the expense of other people’s climate security and that you can’t get agreement on climate security unless you get agreement on everybody’s energy security. Then your energy policy becomes: how do I co-operate with China to decarbonise it, and between us manage the transfer of economies dependent on fossil fuel revenues to a non-fossil fuel base? Why should we help China to decarbonise when it has $1500bn in foreign exchange reserves? Because if we don’t, we all go down. This is realpolitik.”GLOBAL SOLUTIONSThere is no silver bullet: A portfolio of technologies, solutions and energies is needed.Get the incentives right: wrong incentives mean no market or too much pricing power.Create certainty with targets and long-term policiesImprove appliance efficiency: the UK spends almost £1bn a year on standby energy. Mandate standards for energy efficiency in new buildings and buildings refurbishment.Disseminate data: decisions must be informed by accurate and comparable information.Develop technologies such as smart meters to monitor and manage energy demand.Co-operation, not competition: global solutions for global problems.POLICY CHOICES
- France: up-front emission tax on gas-guzzlers has led to a 50% drop in SUV purchases.n Italy: deployment of smart meters by Enel to 27 million customers over five-year period.
- US: deployment of the first, integrated smart grid planned for Boulder, Colorado.
- Germany: feed-in-tariff as an incentive to encourage the adoption of renewable energy.
- Netherlands: from 2010, use-of-road (per km) tariff will replace car tax.
- Sweden: eNyckeln: a database for collection and comparison of official energy statistics.
- Canada: ecoENERGY Retrofit provides federal grants and incentives to homeowners, business and public institutions.
