Efficiency
and Sustainability in Restructured
Electricity Markets:
The Renewables Portfolio Standard
[As published in the July 1996 edition of
The Electricity Journal.]
The
debate over social and environmental policy in restructured
electricity markets has suffered from unclear policy
objectives and incorrect economic reasoning. The common
misconception that efficiency must be sacrificed for
other objectives to be attained is wrong. The correct
use of economics can fashion policies to structure
the market so that social goals of reliability, environmental
quality and equity are attained most efficiently.
By
Nancy A. Rader and Richard B. Norgaard
In
light of the consistent public support[1]
for the benefits renewable resources bring to electricity
production, many now advocate that policies to promote
renewable energy should be integral to electric industry
restructuring. To this end, several policy options
have been proposed, including green pricing programs,
funding renewables through system benefits charges,
and adopting renewables portfolio standards.
Others,
however, are arguing that renewables should be subject
to the "discipline of the market" as other
energy sources will be. They argue that the whole
idea of restructuring is to let markets determine
what is best and that policies supporting renewables
would reduce economic efficiency.
To
help clarify this debate, we define the relevant questions
as they relate to renewable energy: Is policy necessary
to improve economic efficiency? Is policy necessary
to achieve other objectives that derive from societal
preferences? If the answer to either or both questions
is yes, what policies would best achieve those objectives?
We
discuss how market imperfections will hinder the commercial
advance of renewables in competitive markets and show
why policy is necessary to promote economic efficiency.
We then argue, while recognizing that this is an area
of legitimate public debate, that policy to advance
renewables in the market is also warranted to respond
to strong public concern for the sustainability of
development. Finally, we explain why setting market
standards for renewables in electricity production
is the most promising policy approach for addressing
these concerns. Specifically, we discuss why a "renewables
portfolio standard" is the most efficient means
of correcting market imperfections and for moving
toward sustainability.
Restructuring
electricity markets to promote renewable energy resources
can be entirely consistent with making markets competitive
and efficient. To understand how questions of market
efficiency relate to policy questions relating to
equity -- and renewables policy involves both -- we
must review some basic economic theory that is too
often misunderstood or long forgotten.
A.
Economic Theory
Two
distinct issues arise within the broader question
of whether policy to advance renewable energy is justified.
The first is whether market imperfections exist. This
is an issue of economic efficiency that can, at least
in theory, be addressed by economists. The second
has to do with equity, or how as a society we choose
to distribute resources such as finite fossil fuels,
environmental quality and a stable climate between
current and future generations. The efficiency logic
of economics is insufficient to determine how these
distributional choices should be made.[2]
For choices about equity and sustainability, we must
rely on democratic processes, including commissions
to whom public authority has been delegated.
Economic
efficiency is typically, but mistakenly, referred
to as an objective which must be compromised if other
objectives are sought. For example, the Montana Public
Service Commission asks in its restructuring docket,
"To what extent should efforts to increase economic
efficiency be balanced by equity and other public
interest concerns?"[3]
But equity and efficiency are not traded off. It is
not "inefficient" to ensure that all homes
are heated on the coldest winter day, nor is it "inefficient"
to preserve environmental quality, though these goals
can be achieved in efficient or inefficient ways.
There
are multiple efficient market allocations of goods
and services, depending on how rights to resources
are initially distributed. Conserving finite fossil
fuel resources and preserving the earth's atmospheric
balance are essentially matters of distributing rights
to future generations.[4]
To understand the implications of redistributing rights
to resources to different people, economists use general
equilibrium analysis. Energy and environmental economists
have been trained to think in partial equilibrium
analysis, with the efficient solution being where
the supply and demand curves cross when these curves
represent social costs and benefits. While this form
of analysis is extremely useful, it assumes that the
distribution of rights is constant and that sustainability
is simply a matter of correcting environmental market
failures to make markets work efficiently. General
equilibrium analysis shows that achieving sustainability
entails making markets work *differently*, but still
efficiently, and that criteria beyond economics are
necessary to determine whether a sustainable economy
is better.
The
economics of sustainability using a general equilibrium
framework is illustrated in Figure 1. This diagram
shows the trade-off between the well-being of the
current and future generations. The "utility",
or well- being, of the present generation is on the
x-axis and the utility of each future generation is
on the y-axis. The utility frontier, U, represents
the highest levels of well- being possible for future
generations given any level of well-being of current
generations. Every point on U is efficient, since
no generation can be made better off without other
generations being made worse off. Points B and C illustrate
two efficient market solutions that are associated
with different distributions of resource rights among
the current generation and each future generation.
B.
Economic Efficiency
Energy
and environmental economists have typically been concerned
with market failures that prevent the economy from
working efficiently. An obvious example is the external
cost of environmental pollutants. If polluters had
to buy the right to pollute from those they harm,
there would be less pollution. Policies that correct
for market failures can be illustrated in the figure
as a move from Point A toward Point B. Point A on
the graph is inefficient because both current and
future generations can be made better off. Economic
efficiency reasoning makes it clear that a move from
Point A to Point B improves well-being for all.
Imperfections
in competitive markets ought to be corrected through
policies that affect how the market works, if the
cost of correction is reasonable. If they are not
corrected, inefficient outcomes will occur, which
means that we are attaining both less energy and fewer
environmental benefits than we could. Yet, the problems
of market imperfections are seldom acknowledged in
discussions about restructuring electricity markets.
On the contrary, faced with market imperfections,
free marketers simply declare "let the market
work." In this journal, for example, guest editorialist
Ken Maize wrote, "Clearly, consumerists and environmentalists
believe they cannot win in a competitive environment
. . . What's needed is economic democracy.[5]
Similarly, it is argued that, through the marketing
of electricity from renewable energy, those who want
cleaner air will have the opportunity to buy it.
Responding
to these arguments in human terms, when Connie Consumer
ponders whether to pay a little more for electricity
from renewable energy, she rightly considers that
all her neighbors would benefit as much as she would
from the resulting cleaner air, and she is rightfully
concerned that her neighbors may not reciprocate.
Maize's charge that the policies called for by environmentalists
presume "stupid customers" and that these
environmentalists "lack confidence in their ability
to survive in a free market" ignores Connie's
economically rational decision not to pay for other
people's benefits. Her reasoning, when she does receive
the benefits of her choice, is the same economically
rational calculation that makes markets work so well.
Her concern that others will "free ride"
on her socially preferred choice is well-recognized
in economic theory as a reason for market failure.
The result for renewables is that their true value
is not likely to be reflected in individual choices,
and an inefficient outcome results.
Connie
Consumer, however, probably does not recognize an
important systemic benefit in the form of risk reduction
provided by a larger share of renewables in the system.
Nor are competitive electricity producers likely to
fully recognize these risk reduction benefits. Two
types of risk are reduced. First, overall electricity
price volatility is reduced when the diversity of
energy sources used to produce electricity is greater.
Second, renewables face fewer regulatory risks such
as the risk that a carbon tax will be levied on fossil
fuels in the future to reduce net carbon emissions.
Risk reduction is systemic in that it reduces shocks
to the economy as a whole. This benefit of renewables
is best thought of as a "public good." National
defense is the classic example: despite its clear
benefits, it would not be provided by the market.
The defining quality of a public good is that additional
people cannot be prevented from enjoying the benefits
of the good that is provided by those who buy it,
and the additional cost of providing the benefit to
other people is zero. Markets do not provide public
goods since individuals will not volunteer to pay
for benefits that accrue to everyone.
Obtaining
the optimum amount of a public good requires that
all contribute. Electricity producers do not have
sufficient incentives to diversify adequately to avoid
the above risks because their profits depend on their
diversity relative to other producers and because
most of the costs of the shock reverberate throughout
the economy rather than being concentrated among electricity
producers. The price and regulatory risks associated
with fossil fuel use will easily be passed on to consumers
because electricity producers manage risks to ensure
that their own exposure is limited *relative to that
of their competitors*, the vast majority of whom will
also be using fossil fuels. Private risk mitigation
measures will tend to center around controlling the
price fluctuations of the investor's own investments
through financial hedges, such as futures markets.
Private actors are less concerned with major fossil
fuel price disruptions, whose likelihoods are unknown,
because such disruptions will affect all actors in
the market and will not change their own *relative*
standing.
Renewables
are also faced with market barriers, another category
of market imperfection. For example, the risk premiums
placed on capital in more competitive markets will
have a disproportionate impact on renewables, because
they are capital-intensive. Further, in retail competition,
the marketing costs that renewable energy suppliers
will have to absorb to inform Connie Consumer about
their product and convince her to switch -- and stay
switched -- will be formidable. If competition for
the long distance phone market is an indicator, advertising
will be the primary means of gaining market share.[6]
Competing with multi- billion dollar competitors will
not be an easy task for the relatively small renewable
energy industries.[7]
The
market barriers facing renewables could be addressed
through renewables policy if society has an interest
in continuing the very substantial technological advancements
and cost declines that have occurred over the past
decade. The costs of wind and solar technologies are
likely to decline significantly as a result of "economies
of production" (increased number of units manufactured).
A predictable and growing market for renewables will
facilitate the establishment of streamlined, state-of-the-
art manufacturing facilities and drive costs down.
We have an interest in developing the renewable energy
industries that, if healthy, can compete for large
export markets and aid the U.S. economy. If we do
not develop them, in the future we may be importing
all of our renewable technologies. In addition, a
renewable energy industry infrastructure must be maintained
to preserve our readiness to respond to market conditions.
Of
course, correcting all of these market imperfections,
while theoretically a technical economic question,
is not easily done by economists. Absent the problems
of market imperfections, how *would* consumers act?
If investors internalized all risks to consumers,
how would their decisions change? How high do we believe
the cost of pollution to be? On this question, a recent
OTA study concluded that
"no
clear consensus exists on quantitative estimates of
environmental costs of electricity, or on methodologies
for making those estimates . . . Some critical disagreements
over methodology . . . mask deeper disputes over values,
basic policy goals, and the intended role of environmental
cost studies. It is unlikely that these disputes can
be resolved by technical analysis or scientific research.
Instead, these disagreements are more likely to be
successfully addressed through public debates in the
policy arena."[8]
As
this statement indicates, these questions are somewhat
amenable to technical analysis, but also require public
discussion and collective judgment because they relate
not only to questions of efficiency, but also to questions
of equity.
C.
Equity
Resolving
market imperfections is only half of the job of policymaking.
In Figure 1, the utility frontier U between current
and future generations clearly illustrates that there
are many efficient market solutions, and that, therefore,
some other criterion than economic efficiency is needed
for public decisionmaking. Sustainability -- a matter
of equity between generations -- is now a well-recognized
criterion that is increasingly being used by many
public agencies, from city governments to the World
Bank.
Sustainability
is not a matter of correcting environmental market
failures to achieve existing ends more efficiently.
Sustainability entails directing markets to achieve
different ends.
Sustainability
means that future generations have equal or higher
levels of well-being than the current generation.
This is represented by any position above the 45 degree
line in the figure. While both points B and C are
efficient, only point C is sustainable. Since these
two points, and all other possibilities along the
U curve, represent efficient allocations of resources,
efficiency criteria cannot be used to select between
them.[9] Picking
one point over another is a distributional issue which
must be decided politically. Indeed, economic theorists
have long argued that a criterion outside economics,
some value system beyond economic valuation such as
illustrated by the curve W in the figure, is necessary
for deciding how an economy should best operate.[10]
The figure clearly shows that sustainability is an
issue of the distribution of resource rights between
generations, not a question of the efficient use of
resources per se.
There
is, of course, broad concern about sustainability.
The likelihood that climate change is a serious problem
is central to this concern. Deliberately making a
transition to renewable energy sources is a well-
recognized component of every proposal to avert, or
at least ameliorate, climate change in an effort to
protect our future and that of our children. Promoting
renewables for the purpose of protecting future generations
is not something we *should* do by economic reasoning.
It's a matter of whether we *want* to do it, based
on our beliefs about how the future will unfold and
moral concern for future generations. And, indeed,
the public has shown such concern, including strong
and consistent support for renewable resources in
polls over the past 15 years.[11]
D.
The Task for Policy Makers
State
regulators are clearly empowered to address questions
of market failures -- moving from point A to point
B, improving economic efficiency but not deliberately
affecting inter-generational distribution. But some
commissioners may feel it is inappropriate for them
to make value judgments on behalf of society with
respect to sustainability. In several states, however,
regulatory commissions have been implicitly or explicitly
directed by their legislatures to consider future
generations. For example, an Oregon statute states:
"It
is essential that future generations not be left a
legacy of vanished or depleted resources, resulting
in massive environmental, social and financial impact.
. . . It is therefore the policy of Oregon that .
. . development and use of a diverse array of permanently
sustainable energy resources be encouraged."[12]
Whether
regulators assume this task or not, most state legislatures
will be addressing at least some aspects of restructuring,
and many will debate the merits of renewable energy
policies, as they should.
The
task for policy makers, then, is to sort out the rhetoric,
separating questions of efficiency from questions
of equity. Those who advocate policies to meet environmental
or social objectives are often accused of wanting
to "distort" markets and of being distrustful
of the "discipline" of the market to achieve
economic efficiency. Such political rhetoric appeals
to, but has no basis in, economic theory; they amount
to econom*ism*[13]
-- common beliefs which too often pass for proper
economic logic. The critical point here is that markets
are not "distorted," "uncompetitive,"
or "inefficient" simply because society
makes a decision to protect future generations. A
deliberate move toward point C through transferring
rights to future generations, achieving the goals
of a consensus with respect to the rights of future
generations, is compatible with economic efficiency.
A policy of maintaining and strengthening the share
of renewables in the energy portfolios of electricity
suppliers can be entirely consistent with an efficient
electricity sector.
With
a proper understanding of the relationship between
questions of economic efficiency and sustainability,
policy makers may consider their objectives and develop
mechanisms appropriate for meeting those objectives.
As discussed above, the possible objectives are as
follows:
1.
If we are interested in economic efficiency, then
policy makers should seek to correct market failures.
2.
If we are interested in accelerating the development
of technologies with substantial public benefits,
then policy makers should seek to correct the market
barriers facing these technologies.
3.
If we are interested in sustainability and leaving
future generations with an environment resembling
what we have today, policy makers should set the market
on such a course. Once agreement over these policy
objectives is achieved, policy mechanisms can be considered,
which should meet two additional objectives:
4.
Mechanisms should be the most efficient means of meeting
intended policy objectives.
5.
Mechanisms should be "competitively neutral"
by applying to all competitors equally.
Until
discussion of restructuring rocked the regulatory
landscape, integrated resource planning (IRP), including
planned portfolio diversity, provided a mechanism
to address market imperfections and, in some states,
the sustainability issue. In states that firmly limit
competition to the wholesale market, IRP practices
can continue. But where retail competition is being
considered, we need mechanisms to serve as a market-friendly
proxy for IRP.
A
single mechanism could potentially meet all of the
above objectives, though the magnitude of the intervention
may vary according to the objective. Three types of
mechanisms relating directly to the electric industry
have been discussed for promoting renewables: green
pricing/marketing, programs funded through system
benefits charges, and portfolio standards. For the
reasons discussed next, we believe that portfolio
standards are the most effective and efficient means
of meeting the above objectives.
At
the outset, it should be pointed out that general
environmental policies can complement but are not
a substitute for policies directly supporting renewables.
Pollution taxes, emissions adders and clean air standards
will not necessarily result in development of renewable
resources,[14] and
could result simply in greater reliance on gas. Environmental
policies do not recognize the non- environmental benefits
of renewables or the economic benefits of creating
sustained markets for these technologies which can
be expected to significantly lower costs in the long
run.
A.
Renewables Portfolio Standards
The
"Renewables Portfolio Standard" (RPS) has
been advocated by the American Wind Energy Association
and the Union of Concerned Scientists and was adopted
by the California Public Utilities Commission as part
of its recent restructuring decision.[15]
The distinctive feature of the RPS is that it would
rely on competitive markets to achieve policy objectives,
whether the objective is to correct market failures,
overcome market barriers, or set the electricity sector
on a sustainable path.
1.
Description
Under
the RPS,[16] every
retail power supplier would be required to purchase
renewable-energy credits (RECs) equivalent to some
percentage of its total annual kWh energy sales. A
REC would be created when a qualifying renewable-
energy resource is used to generate one kWh of electricity.
Retail suppliers could own renewable facilities and
certify their own RECs, purchase RECs bundled with
renewable power, or purchase RECs separately either
directly from a renewables generator or from a REC
broker. Retail suppliers and renewables developers
would conduct business privately to bring the supplier
into compliance with the standard most cost-effectively,
making all decisions about how to comply - - whether
to own, purchase power, or buy credits; which technologies
to use; how to value an intermittent resource; what
the contract terms should be; whether to use a central,
niche or distributed application; and so forth.
Government
involvement would be limited to certifying RECs (though
this could be contracted out to the private sector)
and monitoring compliance. Thus, there would be two
separate reporting requirements: the REC certification
process, which would apply to generators who wish
to certify their renewables output; and the demonstration
of ownership of sufficient RECs compared to electricity
sales, which would apply to every retail seller.
Setting
the Standard. The percentage requirement would be
determined by the state legislature or utility commission
after considering their policy objectives, market
conditions, and the renewable resource supply curve
-- in essence conducting a "one-time IRP"
that could be reviewed periodically. The standard
would be set at different levels, depending on the
policy objectives. If the objective is to correct
market failures and overcome market barriers, the
standard might be set, for example, at one or two
percent in a state that currently has few renewables,
and rise slowly over time. If the objective were to
achieve sustainability, the percentage might increase
more rapidly over time.
Compliance.
To ensure compliance and to create an automatic incentive
to comply and self-monitor, suppliers would be charged
a per REC fee for any REC shortfall for the year,
allowing a three-month "true-up" period
(also, excess generation in one year could be "banked"
for use or sale during the next). The fee should plainly
exceed the marginal compliance cost, e.g., three cents
per REC shortfall. (Under the Clean Air Act amendments
of 1990, which is analogous to the RPS, utilities
are charged $2,000 per ton for excess sulfur dioxide
emissions -- several times the compliance cost, and
compliance has not been a problem.) The filing of
misinformation would constitute fraud, subject to
normal state penalties.
Cost
Containment. A cost cap would not be necessary if
the RPS is developed with a good understanding of
the costs and availability of renewable resources
in the region. Standards (such as efficiency standards
for buildings and consumer products) are normally
set at a level that is considered justified given
expected costs; there are generally no conditions
under which standards can be avoided. However, if
it is politically necessary to guarantee that costs
will not exceed some level, there are at least two
possible ways of achieving cost containment. One way
would be to specify a cents/REC price cap, wherein
the standard could be reduced if the price of RECs
on the market exceeds some level. Alternatively, the
standard could be reduced if it is shown that retail
suppliers cannot comply with the requirement without
increasing their overall costs by some specified percentage.
In either case, retail suppliers would need to demonstrate
in administrative proceedings the lack of availability
of renewable generation or credits at the prescribed
cost containment level. Obvious drawbacks to creating
such cost caps are that they could create loopholes,
encourage resistance, and increase administrative
involvement. A penalty that is too close to the marginal
cost of renewables could undermine the REC market.
Emerging
Renewables. To encourage renewable technologies that
are not yet commercialized, a portion of R&D funds
could be used to leverage these emerging renewable
technologies into the RPS market. Alternatively, or
in addition, a kWh produced from such technologies
could count for more than one kWh credit.
2.
Advantages
Because
the RPS is linked directly with a state's policy objectives
-- whether the objectives are to correct market failures,
overcome market barriers, or achieve sustainability
goals -- it ensures that those policy goals will be
met by achieving the intended minimum level of renewables.
The flexible, market-based implementation of the standard
would ensure achievement of policy goals at least
cost. Thus, the RPS meets the fourth objective of
efficiency. And, because it would apply equally to
all retail suppliers, the RPS is competitively neutral.
Because the standard could apply to vertically integrated
utilities (the only retail suppliers today) and expand
to cover the retail suppliers of tomorrow (distribution
utilities, direct access suppliers and power aggregators),
it could be easily adapted as market structures evolve.
This adaptability would also be facilitated by the
ability to trade renewable energy credits.
Perhaps
the most important reason to favor the RPS as a mechanism
is that it would foster a productive dynamic as compared
to other approaches. Under an RPS, suppliers would
look to maximize the value of the required renewables
in order to minimize the impact on their competitive
position, and perhaps gain an advantage. Suppliers
would seek out technological applications and combinations
which have the greatest system value, and utilize
their own financial resources to drive costs down.
Thus, by "mainstreaming" renewables into
the market, the resources and creativity of the entire
electric industry are brought to bear on the cost
and system integration of renewables. This dynamic
is not fully achieved by programs that require renewables
industries to fight their way into the market or rely
on bureaucratic administration. In short, for all
the reasons that the monopoly utility industry is
giving way to competition, so should we rely on competitive
markets to implement renewables policy.
Finally,
the standard would be a floor, not a ceiling, so "green"
marketers could still sell additional renewable energy
to consumers who wish to exceed the standard.
3.
Meeting Other Policy Goals Through Portfolio Standards
For
the same reasons that the portfolio standard concept
is attractive for meeting renewable energy policy
objectives, standards might also be attractive for
meeting other policy objectives. To provide for universal
service, for example, all retail suppliers could be
required to serve a fraction of the rural market proportionate
to their total market share. Similarly, it might be
feasible to require retail providers to serve a proportionate
fraction of low- income customers with a prescribed
service package. Suppliers could be allowed to trade
these obligations among each other. It is also possible
to conceive of ways that DSM standards could be applied
to all retail suppliers. However, methods would have
to avoid the obvious conflict of interest inherent
in having sellers of electricity seeking to conserve
electricity. In addition, economies of scope and the
difficulty of monitoring program effectiveness for
multiple providers could justify supporting these
programs through central programs funded by system-benefits
charges. While we have not given these subjects as
much thought as we have renewables, it is worth considering
how market standards might be applied to them.
B.
Green Marketing
It
is frequently argued in the restructuring debates
that once consumers have the ability to choose from
among many electric service providers, including those
offering electricity from renewables, there will be
no need for policies to promote renewables in the
electric marketplace, because consumers can "vote"
with their dollars. Providing customers with a choice
of electric service, whether as an option provided
by the utility or in a retail access world, is not
undesirable (assuming one accepts the desirability
of retail competition). Green pricing alone, however,
is insufficient for meeting environmental and sustainability
objectives.
While
retail competition would allow companies to market
renewables directly to consumers, it would not achieve
any of the three policy objectives stated earlier.
Green marketing programs administered by utilities
(perhaps distribution-only utilities) could help overcome
market barriers, particularly the transactions costs
associated with marketing and perhaps facilitating
financing. If successful, these programs could create
a market that is large enough to sustain at least
some segments of the renewable resource industries.
But this is not assured. To date, such utility-sponsored
programs have not been very successful, supporting
very small installations that would not sustain existing
renewable energy producers, even if repeated by many
utilities. Several green marketing programs have been
abandoned altogether. If program administration costs
are charged to all consumers, green marketing would
be competitively neutral, though the cost of administration
imposes an efficiency penalty as compared to a market
standard approach.[17]
No
forms of green marketing, whether simple retail competition
or utility-administered programs, will adequately
correct market failures or set the electric industry
on a sustainable path. To argue that providing individual
customer choice is enough to satisfy public objectives
is to assume that individual choice is the same as
societal choice. The very nature of market failure
assures us that this is not the case.
As
a real-world example, consider Salem Electric in Oregon,
whose customers were recently asked whether they would
be willing to pay more for renewable power, and, if
so, which of two methods they would prefer.[18]
The first method would offer each customer the opportunity
to raise his or her own rates for the amount of green
power desired. The second would raise everyone's rates
"somewhere in the 4- 8 percent" range to
make Salem Electric 20-40 percent green. Though this
was not a scientific survey, nearly 100 of the utility's
14,000 customers responded -- an unprecedented response
rate on any issue for this utility.
Over
75 percent of the responses supported paying more
for renewables. Of those who expressed a preference
for a particular method, only two preferred the individual
choice approach while 28 supported the collective
decision. Salem Director Steve Weiss said, "It
convinced the board that our customers want us to
make a collective choice to green our system rather
than leave it to individual choice where the outcome
would be uncertain."[19]
If other regulators were to engage in public discussions
of "greening" the resource base, no doubt
similar decisions would result.
If
the "individual choice is enough" argument
is accepted, one would also have to accept that repealing
the Clean Air Act is justified, because customers
have a choice between dirty and cleaner sources of
power generation. Similarly, green marketing advocates
often point to the availability of organic produce
markets as an indication of the power of consumer
demand, but the existence of these markets does not
justify repealing minimum state and federal standards
that govern pesticide residuals on foods.
In
the same vein, we should develop electric industry
policy that, at a minimum, corrects for market failures,
and, if we so choose, offsets market barriers and
begins to put the electric industry on a sustainable
course. Individual consumers with strong preferences
can then opt for greater reliance on renewables through
green pricing or green marketing programs.
C.
System Benefits Charges
The
most common proposal for maintaining so-called "stranded
benefits" (which include low-income programs,
research and development, energy efficiency and renewables)
in a restructured industry is the "non-bypassable
system benefits charge" (SBC). This is a competitively
neutral method of creating a pool of funds to support
various policy ends. While this mechanism may be appropriate
for some of these ends, it is not optimal for supporting
commercial renewable energy projects.
SBC-funded
programs are appropriate if centrally collecting and
spending funds is the most efficient way to accomplish
the relevant policy objective. To support R&D
with public goods benefits,[20]
for example, it makes sense to collect funds so they
can be concentrated at a few research institutions
to gain economies of scale and scope rather than duplicating
efforts across the entire industry. SBC-funded programs
for supporting commercial renewable projects can be
aimed at a level sufficient to correct market failures
and overcome market barriers. And some see SBC-funded
programs as advantageous because their costs can be
known precisely, as compared to setting a standard
without a cost cap. However, market standards would
be a more efficient mechanism for achieving public
policy objectives because SBC programs require public
administration.
Publicly
administered programs are not likely to foster the
kind of "ingenuity dynamic" that is created
with a market standard, and they risk pitfalls of
various sorts. The kinds of programs that have been
envisioned for dispersing funds involve either contract
administration by utilities or the auctioning of per-kWh
production subsidies. It is not hard to imagine the
potential pitfalls of such programs, such as conflicts
of interest if the funds are administered by vertically
integrated utilities or paying out "subsidies"
to projects that are already cost-effective and may
have been undertaken anyway (after all, some renewables
are cost-effective now and many more are cost- effective
when a broader, long-term view is taken). These are
the kinds of problems that restructuring is intended
to move us away from by relying on markets wherever
possible.
At
the heart of restructuring is the notion that we should
rely on competitive markets to deliver what they are
capable of delivering because, once imperfections
are corrected, markets are the most efficient way
of achieving the ends we desire. Therefore, if we
want markets to deliver renewables (and, by accepting
the need for an SBC to support commercial renewable
energy projects, one accepts this proposition), then
markets need only be instructed to do so, as with
a market standard.
The
SBC clearly is not aimed at creating a sustainable
energy future, because it would make no sense at all
to accomplish that goal as an aside to the market,
rather than directly through the market. This is most
clear in California, where the SBC being discussed
by some is envisioned at a level of $100 million per
year to pay for the "above-market" costs
of new renewables projects. If successfully administered,
this would fund an estimated 440 megawatts over five
years. Such an SBC policy would not prevent significant
erosion of the 3,600 MW of existing renewables capacity
(geothermal, biomass, small hydro, wind, and solar),
which supplies about 10 percent of California's total
electric consumption. The state's substantial existing
resource diversity could disappear and it wouldn't
matter under this policy, because the policy is aimed
at providing funds to new renewable energy projects
and not at achieving diversity.
III. Conclusion
The
debate over social and environmental policy in restructured
electricity markets has suffered from unclear policy
objectives and incorrect economic reasoning. A common
misconception is that efficiency must be sacrificed
for other objectives to be attained. The correct use
of economics, however, addresses which policies will
structure the electricity market so that the social
goals of reliability, environmental quality and equity
are attained most efficiently. The continued public
concern with the sustainability of development in
general and energy use in particular indicates that
a sustainable energy system is also an important social
objective. Energy and environmental economists too
often have assumed that sustainability is simply a
matter of making the market work more efficiently.
We have shown that sustainability is a distributional
decision that cannot be made using efficiency criteria;
it must be a political choice.
The
existence of market imperfections clearly justifies
renewables policy. Beyond that, we recognize that
there is debate over whether the electric industry
should be put on a sustainable course (despite international
scientific consensus about serious global warming
risks). We should have that debate, and invoke the
"discipline of democracy," by informing
and involving the public and soliciting their opinions
directly. Educating the public could be done through
polling, as Salem Electric did, through an approach
more akin to a grand jury process, as was recently
used successfully by TU Electric,[21]
through legislative hearings directed at the question
of sustainable energy policy, or by direct vote.
As
with any environmental policy, the public and its
policy makers will have to weigh the extent to which
they put themselves at a short-term competitive disadvantage
(real or perceived) with states (and other nations)
that choose to sacrifice long-term economic and environmental
health for short-term economic gain. To promote regional
consistency, states can work with their neighbors
to develop regional policies, such as a regional RPS
that would allow credits to be traded regionally.
Working with Congress to develop a national RPS with
a national trading system is another option.
In
this country, markets operate within a democracy.
Good economics works within what society deems to
be good social and environmental policy. Economism
is bad economics used against democracy. All available
evidence indicates that most people want environmental
safeguards and support renewables. The only question
is whether and how public preferences will figure
in electric industry policy as it evolves. The renewables
portfolio standard is simply a means of reflecting
public values within a more competitive market, relying
on the market to efficiently deliver the goods people
want. Yes, it "picks winners," but the "winner"
is the broad category of resources that the public
wants to promote because they know it facilitates
their goals. Within the renewables category, the specific
technologies and companies that win will do so because
their merits have been sorted out in the merciless
market.
Endnotes
1.
Barbara Farhar, Trends in Public Perceptions and
Preferences on Energy and Environmental Policy
(Nat'l Renewable Energy Laboratory, NREL/TP-461-4857,
Feb. 1993).
2.
The distributional choice can be informed by economic
analysis, however, in the sense that the public can
make a better decision if it knows the trade-off between
current and future well-being.
3.
Montana PSC, "Notice of Issues and Amended Schedule,"
Question #I.7, Docket No. D95.7.96. October 6, 1995.
4.
Richard B. Howarth and Richard B. Norgaard, "Intergenerational
Choices Under Global Environmental Change", Handbook
of Environmental Economics (Daniel W. Bromley
(ed), Oxford, 1995); see also Howarth and Norgaard,
"Environmental Valuation Under Sustainable Development",
82 AM. ECON. REV 473-77 (1992).
5.
Kennedy P. Maize, "`It's the Customer, Stupid'
Not 'The Stupid Customer,'" ELEC. J., June 1995,
at 85 (guest editorial).
6.
The long distance competitors spend about $800 million
in advertising annually. The New York Times,
May 19, 1994, at C4 (cited in "Affected with
the Public Interest", NARUC, Sept. 1994).
7.
One could argue that the major competitors will acquire
renewables in order to gain a marketing edge, but
whether renewables would be used as window dressing
or to significantly diversify the resource base is
an open question.
8.
U.S. Congress, Office of Technology Assessment, "Studies
of the Environmental Costs of Electricity", OTA-ETI-134
Washington, D.C. U.S. Government Printing Office,
September 1994.
9.
Economic reasoning can help inform the political process
with respect to the likely increases in well-being
possible for future generations given different reductions
in well- being of present generations through, for
example, avoiding climate change, but economic reasoning
cannot determine whether point B or C is "best."
10.
For a review of the history and properties of the
social welfare function, see Paul A. Samuelson, Foundations
of Economic Analysis, 219-28 (Harvard U. Press,
Cambridge, 1947).
11.
Supra, note 1.
12.
ORS 469.010.
13.
Richard B. Norgaard and Richard B. Howarth, "Economism,
Economic Logic, and the Assessment of Renewable Energy
Technologies", ECOLOGICAL ECON. (forthcoming).
(Paper commissioned in 1993 by the Office of Technology
Assessment project on the Assessment of Renewable
Energy Technologies.)
14.
Indeed, state efforts to incorporate environmental
externalities as "adders" have not had much
impact on resource selection. See ENERGY INFORMATION
ADMINISTRATION, ELECTRICITY GENERATION AND ENVIRONMENTAL
EXTERNALITIES: CASE STUDIES (DOE/EIA-0598, Sept. 1995);
and GENERAL ACCOUNTING OFFICE, ELECTRICITY SUPPLY:
CONSIDERATION OF ENVIRONMENTAL COSTS IN SELECTING
FUEL SOURCES (GAO/RCED-95-187, May 1995).
15.
See Calif. PUC, Order Instituting Rulemaking on the
Commission's Proposed Policies Governing Restructuring
California's Electric Services Industry and Reforming
Regulation, D.95-12-063 (Dec. 20, 1995) as modified
by D.96-01-009, and "Comments of the American
Wind Energy Association and the Union of Concerned
Scientists on the Alternative Proposals Issued May
24, 1995, to Restructure California's Electric Services
Industry and Reform Regulation," Docket No. 94-04-031,
July 24, 1995.
16.
Portfolio standards implemented by states would not
be in conflict with the Commerce Clause or the Federal
Power Act. See Scott Hempling and Nancy Rader, State
Implementation of Renewables Portfolio Standards:
A Review of Federal Law Issues, prepared for the American
Wind Energy Association under contract to the U.S.
Department of Energy (Jan 1996); and Richard A. Rosen
et al., PROMOTING ENVIRONMENTAL QUALITY IN A RESTRUCTURED
ELECTRIC INDUSTRY ch. 6 (Prepared for the National
Association of Regulatory Utility Commissioners by
Tellus Inst., Dec. 15, 1995).
17.
Developing green marketing programs and setting a
portfolio standard would both entail a public process.
However, green marketing programs would entail ongoing
program administration and funding decisions, which
are avoided with a standard.
18.
Compilation of responses received from Salem Electric
customers regarding their interest in renewable energy.
(Provided by Robert J. Speckman, Assistant General
Manager, Salem Electric, June/July 1995).
19.
"Salem, Ore., Residents to Get What They Want
-- Renewables", Wind Energy Weekly, Nov.
13, 1995.
20.
For a discussion of the need for public goods R&D,
see CALIF. ENERGY COMM'N, RESEARCH, DEVELOPMENT AND
DEMONSTRATION AND ELECTRIC INDUSTRY RESTRUCTURING
(June 1995).
21.
TU ELECTRIC, TU E PLAN 2004: AN ENERGY GUIDE TO THE
FUTURE. (TU's 1995 IRP plan was created by 30 representatives
of its customer base, including residential, commercial
and industrial customers, assisted by TU's technical
staff. The group used quantitative data and qualitative
information to guide the judgments it ultimately made.
It decided on a portfolio of resources that included
340 MW of renewable resources, or seven percent of
total new resources to be acquired in the next decade.)
