Integratation of Tradable Green Certificate Markets: What can be expected?

Transcription

1 MPR Munch Personal RePEc rchve Integrataton of Tradable Green Certfcate Markets: What can be expected? Erk. mundsen and Gjermund ese 6 Onlne at MPR Paper o. 168, posted 19. eptember 8 13:37 UTC

2 Integraton of Tradable Green Certfcate Markets: What can be expected? by Erk. mundsen 1 and Gjermund ese bstract: Recently, many countres have ntroduced systems of tradable green certfcates (TGCs) n order to ncrease the proporton of ther electrcty supply obtaned from renewable sources. The man objectve of ths paper s to nvestgate the analytcs of a TGC system of the ordc type when ntegrated wthn several countres and to determne what can be expected from the system when appled n a real world settng. oth an analytcal and a partal equlbrum verson of the model are appled. In partcular, we ask whether t s possble to derve analytcally clear cut results wth respect to how the system affects generaton of electrcty from renewable resources, and from carbon emttng resources, n the same way as t s possble for other known polcy nstruments such as an emsson permt system or a plan carbon emsson tax. key result s that TGCs may be an mprecse nstrument for regulatng the generaton of green electrcty and that the combnaton of TGCs wth a system of tradable emsson permts may yeld outcomes contrary to the ntended purpose. JEL classfcatons: C7; Q8; Q4; Q48 Key words: Renewable energy, electrcty, green certfcates, emssons tradng 1 Professor, Department of Food and Resource Economcs, Unversty of Copenhagen, Rolghedsvej 5, 1958, Frederksberg C, Denmark, tel: , fax.: , e-mal: esam@lfe.ku.dk enor dvsor, orwegan Competton uthorty, P.O. ox 439 entrum. O-585 ergen, orway tel.: , e-mal.: gjne@kt.no 1

3 1. Introducton 3 Many countres pursue polces to ncrease the share of renewable energy n ther total energy consumpton. For example, the EU has an explct target to ncrease ts share of "green" electrcty, generated from renewable energy sources, from ts current level of 14% to % by 1 (EU/COM, ). mlar targets exst for the U (e.g., see EP, 3). Untl recently, the generaton of green electrcty had been stmulated by varous subsdy schemes, ncludng subsed nvestments, tax relef, and drect subsdes per unt of green electrcty generated. However, wth the lberalzaton of electrcty markets, nterest has shfted towards other subsdy measures. One proposton that has become popular s to ntroduce systems of tradable green certfcates (TGCs). uch systems tend to have dfferent desgns n dfferent countres, but a common feature s that they seek to replace drect publc subsdes for renewable energy wth ncentve systems that use the market mechansm. More precsely, the objectve s to create a market where varous knds of green electrcty compete on equal terms to releve the government of the burden of drect nvolvement n the electrcty sector's nvestment decsons. nce 1998, the etherlands has appled a system of "green labelng", whch s a voluntary system of green certfcates. The UK and weden have compulsory systems that use the market mechansm more drectly for TGC tradng. These systems dffer sgnfcantly from the more establshed feed-n tarff subsdy schemes that exst n countres such as Germany (see utler and euhoff, 4). Many European countres partcpate n the Renewable Energy Certfcate ystem (REC) that, although not a support scheme tself, facltates many support schemes for green energy. 4 In addton, several countres outsde the EU have shown an nterest n ntroducng TGC systems, ncludng ustrala, U, Chna, and Inda (see Govnetto, 3). In, the UK ntroduced a TCG system called the UK Renewables Oblgaton Certfcate (ROC) Market. weden ntroduced ts system n 3. The orwegan Parlament has not yet decded but plans exst that orway and weden wll start 3 Fnancal support from F's Energy Research Program (fnanced by Gassco, tatkraft, tatnett and tatol), the orwegan Research Councl (REERGI), and the ordc Energy Research Program (EECI) s gratefully acknowledged. 4 REC s not restrcted by natonal boundares. It provdes a mechansm for representng producton of a MWh of renewable energy by a unque certfcate, whch can be transferred from owner to owner before beng used as proof of generaton, or exchanged for fnancal support (

4 tradng TGCs at some future date, thus creatng the frst ntegrated TGC market nvolvng several countres. 5 s well as analyzng the general functonng of a TGC market of the ordc type, 6 ths paper dscusses how a TGC market s expected to perform when t expands to nclude several countres. s n any other market, the markets for TGCs consst of supplers and buyers. upplers are the producers of green electrcty who receve an amount of TGCs correspondng to the amount of green electrcty they generate. The supplers may sell these TGCs on the TGC market. In ths way, the producers receve both the wholesale prce and the TGC prce per MWh of green electrcty generated. uyers of TGCs are the retalers or consumers, who are oblged by the government to keep a certan amount of TGCs n relaton to the total amount of electrcty they consume (.e., both green and "black" electrcty). Ths requrement s referred to as the "percentage requrement". Thus, the demand for TGCs s derved smply as a percentage of the total end use demand for electrcty. ased on supply and demand, a sngle TGC prce may then be establshed. The percentage requrement s the prmary polcy nstrument 7 that the government may use n order to attan the targets for green electrcty generaton and for the mx of black and green electrcty. oth weden and the UK have specfc plans for escalatng ther percentage requrements. long wth the development of the TGC markets n Europe, a more general and comprehensve system of emsson permts tradng (ET) 8 s about to emerge n the EU. The smple dea underlyng the ET s that the emsson permt prce wll add to 5 In 4, ord Pool began tradng TGCs on the wedsh market. TGC prces are posted on the ord Pool web page at 6 One partcular characterstc of the ordc system s that only small new hydro power plants qualfy for TGCs, whereas exstng large hydro power plants do not. Hence, even though electrcty generaton n a country lke orway s based on almost 1% waterpower, only electrcty generated by bomass, wnd, and new small hydro power plants' bomass wll count as green electrcty n the TGC system. For ths reason, t s lkely that the percentage requrement wll be set at a rather low level (.e., 5%). 7 s the UK system the ordc TGC system sanctons retalers/ consumers for not complyng wth the system. Hence, n the wedsh system the retalers have to pay a penalty for not havng suffcent TGCs. The penalty s set equal to 15% of the annual average prce for the perod n queston. One basc dfference between the UK system and the ordc system s that the former allows recyclng of revenues from the buy-out payments requred of electrcty companes that do not obtan suffcent ROCs. These buy-out payments are recycled to supplers that have presented ROCs. y contrast, the orwegan system does not nvolve any recyclng of the correspondng penalty payments. 8 The EU Emssons Tradng cheme (ET) s based on the EU Drectve of Emssons Tradng, whch was adopted n July 3 (European Commsson, 3) and was put nto effect n 5. t frst, t wll comprse only carbon emssons, but other greenhouse gases wll be ncluded later. The system covers emssons from several sectors, ncludng electrcty and dstrct heatng. 3

5 the cost of usng a carbon emttng resource, the cost ncrement beng n proporton to the emssons per unt of the resource used. s a result, nput substtuton n the long run s expected to take place n electrcty generaton, away from coal and gas power towards hydro, wnd, and nuclear power. 9 Hence, even though ths system s not drectly targeted at ncreasng the share of renewables n electrcty provson, clearly the system wll have an nfluence on the relatve cost of provdng green electrcty. In order to take account of ths nfluence we nvestgate how the TGC market and the electrcty market are affected by a carbon emsson permt prce or alternatvely a carbon tax. 1 The man objectve of ths paper s to nvestgate the analytcs of a TGC system of the ordc type when ntegrated wthn several countres and try to determne what can be expected from the system when appled n a real world settng. In partcular, we ask whether t s possble to derve analytcally clear cut results wth respect to how the system affects generaton of electrcty from renewable resources, and from carbon emttng resources, n the same way as t s possble for other known polcy nstruments such as an emsson permt system or a plan carbon emsson tax. To some extent smlar problems have been nvestgated earler. mundsen and Mortensen (1) nvestgated aspects of the percentage requrement for domestc TGC and electrcty markets. TGC prce volatlty and bankng were dealt wth by mundsen et al. (6). lso, numercal models of TGC and electrcty markets have been formulated and analyzed (e.g., ergman and Radetzk, 3; ye 3; ese, 3). Furthermore, the relatonshp between TGCs and carbon emsson permts have been addressed earler; e.g., n Fnon and Menanteau (3), Jensen and kytte (3), and Unger and hlgren (3). However, unlke these papers, our focus s on the ntegraton of domestc TGC markets nto a jont TGC market and on the analytcs of the effects of the major polcy measure, the percentage requrement, and of a carbon emsson permt prce/ carbon tax. 9 hort run nput substtuton wll be lmted by avalable technologcal possbltes. Therefore, the mmedate short run effect wll probably be substtuton from e.g. coal towards natural gas. 1 oth the ordc TGC market and the ordc electrcty market are too small to sgnfcantly mpact the ET system that covers all of Europe. Hence, we lmt our analyss to consder the effects of an exogenous shft of the emsson permt prce/emsson tax. 4

6 In the followng we formulate both an analytc model to derve general results and a numercal model to assess the functonng of the combned TGC and electrcty markets for orway and weden n partcular. The paper proceeds as follows. Frst, we consder the jont functonng of a TGC market and an electrcty market under autarky, focusng on questons such as how the generaton of green electrcty s affected by the percentage requrement, or by an emsson permt prce or an emsson tax. Then, we analyze the case where two countres trade n electrcty, but not n TGCs. Ths stuaton may be consdered an nterm case before a complete set of markets s n place. We then proceed to analyze cases nvolvng both a common TGC market and a common electrcty market. Thereafter, results from the numercal model are presented. Fnally, we dscuss the analytcal and numercal results obtaned and conclude the paper.. The model under autarky In order to analyze the nterplay between the electrcty market and the TGC market under autarky, we apply the followng symbols and functonal relatonshps. p = End-user prce of electrcty s = Prce of TGCs q = Wholesale prce of electrcty x = Total consumpton of electrcty y = Producton of "black" electrcty z = Producton of "green" electrcty α = Green electrcty requred as a proporton of total electrcty consumpton ("percentage requrement") τ = Parameter representng a carbon emsson permt prce or a carbon tax d g s g = Demand for TGCs = upply of TGCs p (x) : Inverse demand functon of electrcty, where ( p ( x) / x) = p' < 5

7 c = c( y; τ ) : Industry cost functon 11 for black electrcty wth emsson constrants. We c c c assume >,, and > y y y τ. 1 h h = h(z) : Industry cost functon for green electrcty, where > z Π = Π(.) : Proft functon h and > z.1. Frst-order condtons and the equlbrum In ths model, the electrcty producers supply a common wholesale market wthn whch a sngle wholesale electrcty prce s establshed. Retalers purchase electrcty on the wholesale market and TGCs on the TGC market. The electrcty s dstrbuted to end users and a sngle end-user prce s establshed. It s assumed that perfect competton prevals n all markets, wth many producers of both black and green electrcty, many retalers, and many end users. Hence, all agents treat the varous prces as gven by the market. The producers maxmze: [ ] Π ( y) = qy + q + s z c( y; τ ) h( z). The frst-order condtons for black, respectvely, green electrcty generaton are: c( y, τ) q = y, h( z) q + s =. z For each unt of electrcty (.e. MWh) purchased n the wholesale market and sold on to end users, retalers have to pay the wholesale prce plus a share α of the TGC prce. 11 The ndustry cost functon s derved by "horzontal addton" of the ndvdual cost functons;.e., the cost of aggregate market supply s mnmzed. Usng the ndustry cost functon avods usng messy notaton to descrbe ndvdual decsons and our prme nterest s n the equlbrum market soluton, not ndvdual decsons. However, lttle detal s lost by ths approach as ndvdual frst-order condtons for electrcty producers correspond drectly to those derved n the analyss; e.g., condtons 3) and 4) n the man text. 1 The cost functon for black electrcty condtonal on an emsson permt prce or an emsson tax may be derved from a standard cost mnmzaton problem, wth the addtonal constrant that a permt prce or a tax wll have to be pad per unt carbon emtted. 6

8 For smplcty, electrcty dstrbuton s assumed costless. 13 Wth a large number of retalers, the compettve equlbrum establshed by the market must be characterzed by: p = q + αs. Otherwse, we assume that the amount of TGCs s measured n the same unt as the amount of green electrcty. Thus, the demand for TGCs s gven by g d = αx and the supply by g s = z. Denotng equlbrum prces and quanttes by starred symbols, the equlbrum of the two markets s characterzed by: 1) ) 3) p( x αs ) = q + ; z x = y + z = ; α c( y, τ ) q = ; y 4) q + s = h( z). z Insertng ), 3), and 4) nto 1), we fnd that the end-user prce n equlbrum may be wrtten as a lnear combnaton of the margnal costs of black and green electrcty: 5) c( y, τ ) h( z) p( x ) = (1 α) + α. y z From ), we see that z αx = and y = ( 1 α) x... The effects of the percentage requrement In the TGC systems, the percentage requrement s perceved as a polcy nstrument to determne the amount of green electrcty n end-use consumpton. However, because the requrement s set as a percentage and not as a specfc quantty, t s not necessarly true that an ncrease of the percentage requrement leads to an ncrease of green electrcty generaton. The share of green electrcty generaton n total electrcty 13 Ths assumpton does not affect our qualtatve results. In the numercal model to follow we do, however, nclude dstrbuton costs. 7

9 consumpton may well ncrease even f green electrcty generaton declnes, f there s a suffcent reducton of electrcty consumpton and of black electrcty generaton. 14 In the followng secton, we study these effects n more detal. To examne the effect of an ncrease n the percentage requrement 15 (.e., ) on the z α ( 1 ) z generaton of green electrcty, we substtute x = and y = nto (5) and α α take the mplct dervates. Hence, omttng the starred symbols for the sake of smplcty, we obtan: p c αs + x ( 1 α) x y =,where D D p c h (1 α ) α. x y z = n nspecton of the sgns shows that the denomnator s negatve, whereas the numerator s ndetermnate. Hence, the effect on green electrcty generaton s ndetermnate. Wth respect to the effect on black electrcty generaton we obtan: h p ( 1 α) s + x α dy z x = D <. Inspecton of sgns shows that the numerator s postve, whereas the denomnator s negatve. The generaton of black electrcty s reduced as the percentage requrement ncreases. Wth respect to the total electrcty consumpton, we fnd: 14 In the wedsh system, however, there s no doubt that the ntenton of the TGC market s to stmulate an ncrease of capacty for generatng green electrcty. For ths reason, our focus throughout the paper wll be on how the absolute generaton of green electrcty s affected. 15 The results n ths paragraph represent a generalzaton of results n mundsen and Mortensen (1). 8

10 dx = h c s + x α ( 1 α) z y. D Inspecton of sgns shows that ths expresson s generally ndetermnate. However, f c the margnal cost of black electrcty s constant (.e., = ), we easly see that y dx <. Thus, an ncrease of the percentage requrement wll lead to a reducton of total electrcty consumpton. However, the mpact on green electrcty generaton remans ndetermnate. In addton, the effects depend on the level of the percentage requrement, α. 16 For example, f α =, then >, whereas dx s ndetermnate. Hence, n concluson, the ntroducton of a TGC system of the ordc type does not necessarly lead to greater green electrcty generaton, but t does lead to a reducton of black electrcty generaton. Furthermore, the effect on total electrcty generaton s ndetermnate..3. The effects of the emsson permt prce/emsson tax In order to nvestgate the equlbrum effects of ncreased emsson permt prce/emsson tax on green electrcty, we take the mplct dervate of 5) wth respect toτ and obtan: c α(1 α) y τ = <. dτ D Wth the assumed cross effects of the margnal cost functon of black electrcty t follows that the numerator s postve so that the total effect s negatve. Hence, ncreased emsson permt prce/emsson tax wll not lead to an ncrease n the generaton of green electrcty. On the contrary, generaton of green electrcty wll 16 y smplfyng the functonal forms of the model, for example by assumng lnear or constant elastc demand and lnear margnal cost functons, t s possble to study n more detal how the electrcty consumpton changes as the percentage requrement ncreases from to 1%; see ye (3). 9

11 declne. 17 s z α α α = x = ( 1 ) y, both the generaton of black electrcty and the total consumpton wll also declne. It may seem paradoxcal that an ncreased emsson prce can actually lead to a reducton n the generaton of green electrcty, as ths normally s supposed to advantage the producers of green electrcty. However, due to the nterplay of the emsson constrants wth the TGC market, ths wll not be the case despte the fact that, vewed n solaton, both systems work towards the same end of reducng carbon emssons. The reason for ths les n the specfc constructon of the TGC system. n ncrease of an emsson permt prce/ emsson tax mples an upward shft of the margnal cost functon for black electrcty. 18 Recallng that the margnal cost functon for electrcty generated n the requred proporton of green and black electrcty s a lnear combnaton of the margnal cost functons for green and black electrcty, respectvely, t follows mmedately that the margnal cost functon for electrcty n the requred proporton also must shft upwards. Consequently, n equlbrum, the end user prce must be hgher, consumpton must be lower, and so must the generaton of both green and black electrcty n order to preserve the proporton gven by the percentage requrement. 3. Trade n electrcty only In ths secton, we nvestgate how a TGC system functons n an open economy by expandng the model to nclude smultaneously functonng markets for electrcty and TGCs n two countres, country and country. The varables nvolved are the same as those under autarky, but there s one set of varables for each country, denoted by subscrpt, =,. In addton, we ntroduce the "trade varables", m and n, representng mports of electrcty and TGCs, respectvely. Demand may dffer between 17 In general, any postve shft of the margnal cost functon for black electrcty (e.g. resultng from an ncrease of nput prces of black electrcty generaton) wll nduce a reducton n the generaton of green electrcty. 18 Observe that, as the change of the emsson permt prce/ emsson tax s exogenous n ths model, there are no effects from the electrcty market back to the permt market. ascally, what s happenng s that the wholesale prce wll ncrease followng from the ncrease of the emsson permt prce/ emsson tax. However, due to substtuton/altered mx wthn technologes consdered black n the system, the wholesale prce wll not ncrease by as much as the permt prce/ tax. In part, the ncrease of the wholesale prce wll stmulate generaton of green electrcty. However, the reducton of the TGC prce more then offset the ncrease of the wholesale prce, wherefore green electrcty generaton s reduced. Observe also that the substtuton wthn the category of black technologes leaves black electrcty less black, but ths s not consdered green n the termnology of the system. 1

12 the two countres, but the demand functons have the same mathematcal characterstcs as the demand functon n the prevous secton. Furthermore, we assume that the technologes appled n generatng black and green electrcty may dffer between the two countres. Ths mples that comparatve advantages and dsadvantages may exst n the generaton of black and green electrcty of the countres. We assume that the cost functons for black and green electrcty have the same mathematcal characterstcs as above Frst-order condtons and the equlbrum Frst, we assume that cross-border trade takes place only for electrcty, not for TGCs. Furthermore, for smplcty, we assume that there are no transacton costs nvolved and that there are no transmsson constrants between the countres. 19 For these reasons, we can consder the electrcty markets of countres and to be a sngle market wth a common wholesale prce;.e., q = q = q. s there are only two countres nvolved, M one country's mports must equal the other country's exports. Therefore, n equlbrum, t must be the case that m =. The equlbrum condtons for each of the markets m n each of the countres can be expressed as follows: 6) p ( x ) q + α s = ; M 7) x z = y + z + m = ; α 8) q M + s h ( z ) = ; z 9) q c y τ (, ) M = y. Insertng 8) and 9) nto 6), we fnd as under autarky: c y τ h z p x = 1 +, =,. (, ) ( ) α y z 1) ( ) ( α ) 19 Ths assumpton s relaxed n the numercal model to follow. 11

13 3.. The effects of the percentage requrement In ths secton, we assume that the percentage requrement may be dfferent between the two countres and focus on the effects of an ncrease n the percentage requrement n one of the countres, e.g. country. Takng the mplct dervate of 1) wth respect to α, we fnd that the only sgns that can be determned wth certanty are those belongng to the effects on total combned black electrcty generaton for countres and, and the effects on country 's green electrcty generaton and electrcty consumpton. These effects follow from the expresson below: dy = h ( 1 α ) s + x α D E + D E z p x E, wherey y + y =, ( ) α D p = x c h α < and 1 y z E h p = α, for =, z x y c Inspecton of sgns shows that the numerator s postve and the denomnator negatve. Hence, the effect on the aggregate generaton of black electrcty n the two countres s negatve. Furthermore, t can be shown that: dy sgn dy sgn = = = =. dm sgn sgn dx sgn Y y s <, t follows that < α α y and <. Furthermore, t must be the case α dx that > and >. In other words, somewhat surprsngly, the ncrease of the percentage requrement n country leads to an ncrease n both electrcty Proofs may be obtaned from the authors upon request. 1

14 consumpton and green electrcty generaton n country whle these effects are ndetermnate for country. 1 In order to explan these effects, we frst recall that an ncrease n the percentage requrement wll necessarly lead to a reducton n the wholesale prce of electrcty. For country, the effects on electrcty generaton and consumpton are the same as those under autarky. However, n ths two-country model wth a common electrcty market, the reducton of the wholesale prce wll mply that electrcty becomes cheaper n country, thus leadng to ncreased demand n ths country. However, n order to satsfy the percentage requrement, the demand for TGCs wll have to ncrease n country. s there s no trade n TGCs, the ncrease n demand for TGCs can only be satsfed by a correspondng ncrease of the TGC supply n country. Hence, the generaton of green electrcty wll have to ncrease n country. Therefore, we arrve at the somewhat counterntutve result that an ncrease of the percentage requrement n country may lead to a reducton of green electrcty generaton n country, but wll defntely lead to an ncrease of green electrcty n country The effects of the emsson permt prce/emsson tax In ths case an ncrease of the carbon emsson permt prce/ carbon tax mples a reducton of green electrcty generaton n both countres,.e. dτ < and dτ <, a Y reducton of total generaton of black electrcty,.e. <, and a correspondng τ q ncrease of the wholesale prce,.e. M <. (Proof s gven n ppendx ). The τ ntuton behnd these results s the same as the ntuton for the autarky case. 4. Trade n both electrcty and TGCs In ths secton both electrcty and TGCs are traded. Ths mples that both the wholesale prce of electrcty and the prce of TGCs are common for the countres. 1 From a numercal model satsfyng the assumptons of ths paper, t can be shown that equlbra exst where the green electrcty generaton and electrcty consumpton n country may ether ncrease or decrease followng an ncrease n the percentage requrement n country. The detals of ths proof are not ncluded n the paper, but may be obtaned from the authors upon request. 13

15 Hence, s and s are replaced by s M n the objectve functons and frst-order condtons below. Otherwse, the model specfcaton s as n the prevous case Frst-order condtons and equlbrum TGCs wll be mported f the domestc demand for certfcates exceeds the domestc supply. In equlbrum, the mports of one country wll be equvalent to the exports of the other country;.e. n =. The trade n TGCs mples that the relatve share of n green electrcty generated n one country may be dfferent from the percentage requrement. The equlbrum can be expressed as follows: 11) p ( x ) q + α s = ; M M 1) x z + y + z + m = α n = ; 13) q M + s M h ( z ) = ; z 14) q c y τ (, ) M = y. Insertng 13) and 14) nto 11), we fnd agan. c y τ h z p x = 1 +, =,. (, ) ( ) α y z 15) ( ) ( α ) 4.. The effects of the percentage requrement The analyss shows that t s possble to determne only the effect on black electrcty generaton of an ncrease n the percentage requrement. gan, ths effect s negatve dy dy.e. <. To realze ths, assume the opposte.e.. Ths mples an ncrease n green electrcty generaton n order to fulfll the percentage requrement n both countres. Hence, n equlbrum, the consumpton of green electrcty must ncrease n both countres, as we now have a common market for both electrcty and TGCs. Constant or ncreased generaton of black electrcty mples that the wholesale prce, q M, s constant or ncreases, respectvely. Furthermore, for the generaton of 14

16 green electrcty to ncrease, the prce of green electrcty, q + s, must ncrease. From 11), ths mples an ncrease n the end-user prce of electrcty n both countres. Ths s not compatble wth an ncrease n the consumpton of electrcty. Thus, we have a dy contradcton, whch leads to the result that <. Furthermore, as n the case of M M dy trade n electrcty only, t can be shown that sgn dy = sgn. Hence, we must dy have < dy and <. Furthermore, the analyss shows that the effect on total green electrcty generaton of ncreasng the percentage requrement n country s ndetermnate. s we now have a common market for TGCs, t can be shown that: sgn sgn =. Thus, n contrast to the case of trade n electrcty only, an addtonal opportunty for tradng TGCs mples that we no longer obtan the unambguous result that an ncrease of leads to an ncrease n green electrcty generaton n country. The change n green electrcty generaton must now occur n the same drecton n both countres. Fnally, the results show that the effect on electrcty consumpton s ndetermnate n both countres. α 4.3. The effects of the emsson permt prce/ emsson tax In ths case, ncreased emsson permt prce/emsson tax mples a reducton of green electrcty generaton n both countres.e. dτ < and dτ <, a reducton of total Y generaton of black electrcty,.e. <, and a correspondng ncrease of the τ q wholesale prce,.e. M <. (Proof s gven n ppendx ). The ntuton behnd τ these results s the same as the ntuton for the autarky case. Proofs may be obtaned from the authors upon request. 15

17 5. umercal analyss and dscusson The results from the analytcal model nvestgated above are somewhat dscouragng. Indeed, as can be seen from Table 1 that summarzes the results, not very much can be sad about the effects of ncreasng the percentage requrement that s the man polcy nstrument of the TGC system. In fact, wth trade n both electrcty and TGCs the only clear cut result s that the generaton of black electrcty wll be reduced n the partcpatng countres, and there s no guarantee that generaton of green electrcty wll be stmulated. lso, nothng precse can be sad about the effect on total electrcty generaton. However, an ncrease of the emsson permt prce/emsson tax wll defntely reduce green electrcty generaton whch may seem somewhat surprsng. In vew of these results t may be of some nterest to nvestgate how the TGC system wll functon when appled to a real world case. For that purpose we apply a partal equlbrum model for orway and weden usng realstc parameter values. Table1. Effects of the percentage requrement (α ) and of the emsson permt prce/emsson tax (τ ) dy dy dx dx utarky? -? - dτ dτ Trade n electrcty only Trade n electrcty and TGCs? + - -? + - -?? - -?? - - The model s based on the prncples of the analytcal model developed above and s desgned to take care of trade n both electrcty and TGCs between the two countres n 1. 3 It determnes equlbrum prces and quanttes on, and cross border tarffs between, the electrcty markets as well as equlbrum prces and trade on the markets for TGCs n orway and weden. asc features of the model are descrbed n ppendx. 3 The basc model s developed by Lars ergman, tockholm chool of Economcs and appled n e.g. ndersson and ergman (1995) and mundsen and ergman (). The TGC part was ncluded n the model for weden by ergman and Radetzk (3) and further updated and expanded for the present purpose. Detaled nformaton on data can be obtaned from the authors upon request. 16

18 Frst we consder the effects of ntroducng a TGC system wth a percentage requrement of 5% for orway and 1.7% for weden. 4 Thereafter we consder the effects of changng the carbon emsson tax. We follow the general structure of the analytcal part of the paper and consder three scenaros for each of these two cases: ) utarky, ) Trade of electrcty only and ) Trade n electrcty and TGCs. 5.1 The effects of ntroducng a TGC system The effects of ntroducng a TGC system for orway are summarzed n Table. Techncally ths has been acheved by ncreasng the percentage requrement from zero to 5%. Table. Effects of ntroducng a TGC market for orway. Fgures n TWh and EUR 5 /MWh α z y x q s p s can be seen from Table, we have the expected effects of reduced wholesale prce of electrcty and reduced generaton of black electrcty. lso, there s an ncrease of green electrcty as well as of total electrcty generated and a reducton of the end user prce. ascally what s happenng n ths case s that revenues (hydro rents) are transferred from hydro power producers as subsdes to the producers usng new green generaton capacty. Hence, for ths numercal case, the ndetermnate effects on green electrcty generaton and total electrcty consumpton from the analytcal model have been determned. Table 3 dsplays the effects of ntroducng TGC markets n both countres but allowng for trade n electrcty only. The Table shows three features. Frstly, t shows that the effects of ntroducng a TGC market n weden are smlar to those n orway. 4 For weden ths percentage corresponds to the escalaton plan for 1. For orway a percentage requrement of 5% has been proposed but not decded. 5 wedsh kronor (EK) has been converted to Euro by usng the 5 average exchange rate of 9.9 per EUR. 17

19 α Table 3. Effects of ntroducng TGC markets for orway and weden wth trade n electrcty only. Fgures n TWh and EUR/MWh α z z y y x x q q s s p p econdly, Table 3 shows the effects of ntroducng a TGC market n orway n addton to that n weden. In ths case the generaton of green electrcty as well as total electrcty consumpton ncrease n both countres. Furthermore, the wholesale prces fall n both countres but due to the assumed stepwse lnear margnal cost functons the generaton of black electrcty s not affected n any of the countres. Thrdly, Table 3 shows what s happenng as the percentage requrement ncreases n orway (from 5 to 1 percent) but remans the same n weden. One effect of ths change s a reducton of black electrcty generated n each of the countres and a correspondng reducton of wholesale prces (that are not completely equalzed due to transmsson constrants). lso we see that the generaton of green electrcty ncreases. Ths s as expected for weden accordng to the analytcal model. However, even the green electrcty generaton n orway ncreases. Ths effect was ndetermnate n the analytcal model. Furthermore, t turns out that total electrcty consumpton falls n orway whle t ncreases n weden. lso, Table 3 shows that ths change has very strong effects on the TGC prces and end user prces n both countres. Table 4 dsplays the effects of ntroducng TGC markets n orway and weden and allowng for trade n both electrcty and TGCs. We observe that the generaton of green electrcty s ncreased n both countres. In orway the ncrease s larger n the case of a common TGC system between orway and weden, than n the case of separate TGC systems. In both the cases, the generaton of black electrcty s reduced. Ths reflects a compettve advantage for generaton of green electrcty n orway. Thus, TGCs are exported from orway to weden. s expected, orway and weden get dentcal TGC prces n the common TGC system. 18

20 Table 4. Effects of ntroducng TGC markets for orway and weden wth trade n both electrcty and TGCs. Fgures n TWh and EUR/MWh α α z z y y x x q q s s p p z , ,5, ,1, Ths varable reflects the net export of TGCs from orway to weden The last row of Table 4 llustrates a stuaton n whch orway ncreases ts percentage requrement from 5 to 1 per cent, whle weden contnues on 1.7 per cent. In accordance wth the theoretcal results we note that the postve effect on the generaton of green electrcty s sgnfcantly stronger n weden than n orway, even as the wedsh percentage requrement s unchanged, whle the orwegan percentage requrement s ncreased. In ths case, the consumpton of electrcty s, however, reduced n both countres. 5. The effects of the emsson permt prce/ emsson tax From Table 5 we see that the effects of ncreasng the emsson permt prce/ emsson tax for orway under autarky are rather small. The reason s that electrcty n orway s mostly generated from hydro whch causes no carbon emssons. However, as can be seen from Table 5, the wholesale prce of electrcty ncreases, thus leadng to a lttle less black electrcty generated. Otherwse, there s no notceable effect on green electrcty generaton, but the prce of TGCs falls n accordance wth the analytcal results. Table 5. Effects of changng the emsson permt prce/ emsson tax for orway under autarky. Fgures n TWh and EUR/MWh τ z y x q s p , ,

21 Table 6 dsplays the effects of ncreasng the emsson permt prce/ emsson tax for orway and weden wth trade n electrcty only. gan, the effects of changng the carbon tax are relatvely modest as both orway and weden have lttle emsson of carbon n electrcty generaton. weden does, however, have some generaton comng from combned heat and power plants. Ths appears to be the margnal technology for generaton of black electrcty n the smulatons. Thus, ths s the reason why the generaton of black electrcty n weden s reduced as the emsson permt prce/ emsson tax s ncreased, whle orway s not affected at all. Furthermore, we notce that rasng the emsson permt prce/ emsson tax leads to a hgher wholesale prce of electrcty and a lower TGC-prce. Our result from the theoretcal analyss thus seems to be confrmed by the numercal smulatons,.e. ncreasng the emsson permt prce/ emsson tax n a system whch also ncludes TGCs may have an adverse effect on the generaton of green electrcty; although, the effect s not very strong. Table 6. Effects of changng the emsson permt prce/ emsson tax for orway and weden wth trade n electrcty only. Fgures n TWh and EUR/MWh τ z z y y x x , , q q s s p p Fnally, Table 7 shows the effects of changng the emsson permt prce/ emsson tax for orway and weden wth trade both n electrcty and TGCs. We notce that openng of trade n TGCs does not affect the results, other than for the domestc generaton of green electrcty. The effects of changng the emsson permt prce/ emsson tax are smlar to the case n whch only electrcty s traded. τ Table 7. Effects of changng the emsson permt prce/ emsson tax for orway and weden wth trade both n electrcty and TGCs. Fgures n TWh and EUR/MWh z z y y x x q q s s p p z , ,

22 6. ummary and concludng remarks The man objectve of ths paper s to nvestgate the analytcs of a TGC system of the ordc type when ntegrated wthn several countres and try to determne what can be expected from the system when appled n a real world settng. In partcular, we ask whether t s possble to derve analytcally clear-cut results wth respect to how the system affects generaton of electrcty from renewable resources, and from carbon emttng resources, n the same way as t s possble for other known polcy nstruments such as an emsson permt system or a plan carbon emsson tax. In partcular, the paper addresses the role of polcy measures n TGC markets, the ntegraton of countryspecfc TGC markets, and compatblty ssues between TGC markets and an emsson permt system/ emsson tax system. oth an analytcal model and a partal equlbrum model for orway and weden are appled. One of the man conclusons of ths paper s that the percentage requrement s not a very precse polcy measure for stmulatng green electrcty generaton. Thus, an ncrease of the percentage requrement wll not necessarly lead to an ncrease of green electrcty generaton n the long run, though t wll lead to less generaton of black electrcty. It guarantees only an ncrease n green electrcty's share of total consumpton. These results are shown to be vald for all the cases nvestgated;.e., under autarky and when electrcty, or both electrcty and TGCs, are traded between two countres. However, t should be noted that a larger percentage requrement may be compatble wth more green electrcty generaton over tme f there s a general ncrease of demand. tll, the mmedate effect of a hgher percentage requrement on green electrcty generaton cannot be guaranteed. 6 Hence, f the objectve s to acheve a gven target of new green generaton capacty, a TGC system may not be the best system to use. Other systems, such as a tenderng or aucton system, or a system of plan subsdes, may work better n ths respect. On the other hand, the TGC system does provde a strong role for market forces and do take account of consumers' wllngness to pay for electrcty va the effects on demand and the end-user prce. In 6 Moreover, the percentage requrement for a sngle country s not a very potent measure f the country n queston s part of a large nternatonally ntegrated system of compettve markets for electrcty and TGCs. uch a crcumstance would mply that the prces of electrcty and TGCs are gven, and that the electrcty producers and the retalng companes n the economy wll adapt to these prces. However, ths n turn mples that nether the percentage requrement nor the TGC prce bounds for a gven country can be used to nfluence the green electrcty generaton or the composton of green and black electrcty n that country. 1

23 addton, the TGC system allows for voluntary purchases of TGCs by consumers who wsh to support green electrcty generaton. 7 Furthermore, as both the theoretcal and numercal analyss show, an ncrease of the percentage requrement wll have an ndetermnate effect on total electrcty consumpton under autarky. lso, n the case where one country mplements a TGC system and trades electrcty wth another country, the effect of an ncrease of the percentage requrement on total consumpton wll be ndetermnate n the country mplementng the TGC system. However, as confrmed n the numercal analyss, the other country wll experence an ncrease n both the total electrcty consumpton and green electrcty generaton. tll, allowng for trade of TGCs between the countres leads to an ndetermnate effect on both these varables n the country that does not mplement the TGC system. nother man concluson of the paper s that an ncrease of an emsson permt prce/ emsson tax wll push the prce of TGCs downwards, lowerng the profts of the green electrcty producers and thus lead to a reducton of green electrcty generaton. Ths result was shown to be vald n all specfed cases as well as n the partal equlbrum model. Ths also rases the queston as to why two polcy measures are needed to acheve what seems to be a common goal (.e. emsson reducton), as n the case of the European ET and TGC systems. Presumably, the answer s that the ams of the two systems are somewhat dfferent. The ET system s targeted at reducng global emssons of carbon and says nothng about that ths must be acheved through ncreased generaton of green electrcty. The TGC system, on the other hand, s targeted drectly at achevng an electrcty supply from renewable sources. Clearly, the TGC system may acheve a reducton of carbon emssons, but t also reduces the use of nonrenewable sources, notably crude ol and natural gas, that are n scarce supply and used at the expense of future generatons. ddtonal problems assocated wth the TGC systems need to be resolved. One problem relates to TGC prce volatlty. If the green generaton technologes n a country largely consst of wnd or water power, szable and erratc varatons of green 7 The opton of buyng green electrcty at a surcharge has been offered n many countres, for nstance Vattenfall n weden. However, demand has been low.

24 electrcty generaton may occur, owng to natural annual varatons of wnd or precptaton. Therefore, there may be smlar varatons n the numbers of TGCs for sale. Ths n turn wll gve rse to a hgh volatlty of TGCs prces. Hence, potental nvestors n green electrcty capacty face a hghly uncertan rate of return on ther nvestments and therefore requre hgh expected rates of return to be wllng to nvest. To some extent, however, the problem of prce volatlty may be resolved by the ntroducton of permt bankng (see mundsen et al., 6). nother problem related to the TGC market s the potentally hgh market power that a producer of green electrcty may possess. The reason for ths s that the percentage requrement mples that one TGC counts for a multple of MWh n consumpton. Hence, by wthholdng TGCs, a green producer may sgnfcantly reduce consumpton and ncrease the end-user prce, even though the producer's own power generaton s not that large. long wth the other potental problems dscussed above, the problems revealed n ths paper clearly call for cauton n the desgn and mplementaton of TGC systems, not least when they are put nto place on top of emsson tradng systems. References mundsen, E.. and J.. Mortensen (1): "The Dansh green certfcate system: ome smple analytcal results", Energy Economcs, 3, mundsen, E.., F. M. aldursson, and J.. Mortensen (6): "Prce Volatlty and ankng n Green Certfcate Markets", Envronmental and Resource Economcs,35:59-87 (DOI 1.17/s mundsen, E.. and L. ergman () Wll Cross-Ownershp Reestablsh Market Power n the ordc Power Market, The Energy Journal, 3 ():73-95 ndersson, and L. ergman (1995): Market tructure and the Prce of Electrcty: n ex nte nalyss of the Deregulated wedsh Electrcty Market, The Energy Journal, 16 (): ergman, L. and M. Radetzk (3): "Global klmatpoltk (Global clmate polcy)", Förlag, tockholm. utler, L. and K. euhoff (5): "Comparson of Feed n Tarff, Quota and ucton Mechansms to upport Wnd Power Development", Cambrdge Workng Papers n Economcs, 53, Faculty of Economcs, Unversty of Cambrdge, Cambrdge, UK. 3

25 ye, T.. (3): "On the prce and volume effects from green certfcates n the energy market", Dscusson paper 351/3, Research Department, tatstcs orway. European Commsson (3): "Greenhouse gas emssons tradng: Commssoner Wallstrøm hals fnal agreement on clmate change breakthrough", Press Release IP/3/931. EP, (3): EP trategc plan: Drecton for the future. U.. Envronmental Protecton gency. EU/Commsson, (): Drectve of the European Parlament and of the councl on the promoton of electrcty from renewable energy sources n the nternal electrcty market. Com() 79 fnal, russels. Fnon, D. and P. Menanteau (3) "The tatc and Dynamc Effcency of Instruments of Promoton of Renewables", Energy tudes Revew, 1(1): Govnetto, nna, (3). On the track of green certfcates. Envronmental Fnance, eptember 3. Jensen,.G. and K. kytte (3): "multaneous ttanment of Energy Goals by Means of Green Certfcates and Emsson Permts", Energy Polcy, 31(1), ese, G. (3): "Essays n Lberalzed Energy Markets", Doctoral dssertaton, Department of Economcs, The Unversty of ergen. Unger, T. and E.O. hlgren (3): "Impacts of a common green certfcate market on electrcty and carbon emsson markets n the ordc countres", Energy Polcy, 33(16), ppendx ) Proof of the effects of the emsson permt prce/emsson tax as there s trade n electrcty only To verfy that dτ < and dτ <, rearrange 1) to obtan: p ( x ) = ( 1 ) h ( z ) α qm + α. z whch upon dfferentaton gves: 1) p dx h dq = (1 ), =,. x d z d d M α α τ τ τ 4

26 From 7), we have z = α x. Therefore, we may wrte: ) 1 p 1 h dqm 1 p 1 h α = = α. 1 α x α z dτ dτ 1 α x α z dτ To prove the above clam by contradcton, assume dτ. Inspectng the sgns of ), we see that ths mples dτ, dx dτ, dx dτ, and dq M dτ. From 9), we see dq that M dτ mples dy dτ < and dy dτ <. Upon applyng 7) and elmnatng m, we fnd: dx dx dy dy + = +. dτ dτ dτ dτ 3) ( 1 α ) ( 1 α ) Inspecton of the sgns of 3) reveals that the left-hand sde s nonnegatve, whereas the rghthand sde s negatve. Hence, there s a contradcton. Therefore, t follows that the generaton of green electrcty and the consumpton of electrcty must fall n both countres. Furthermore, from 3), t s apparent that the total generaton of black electrcty must be reduced, whereas ) makes t clear that the wholesale prce of electrcty wll have to go up. ) Proof of the effects of the emsson permt prce/emsson tax as there s trade n both electrcty and TGCs To verfy that dτ < and dτ < frst observe from 1) that: 4) α dx dx + α = + and dτ dτ dτ dτ 5) (1 α ) dx + (1 α ) dx = dy + dy. dτ dτ dτ dτ To prove the above clam by contradcton, assume that the generaton of green electrcty n country s not reduced;.e. dτ. From 13), t follows that f one country does not reduce green electrcty generaton, ths mples that the other country wll not reduce ts green electrcty generaton ether. Ths must be the case as both countres are subject to the same 5

27 change n q + s. From 4), we observe that ths means that the consumpton of electrcty M M n at least one of the countres must ether ncrease or reman constant. ssume that country dx does not reduce ts consumpton of electrcty;.e., Dfferentatng 15) n the same dτ way that we found ), we fnd: 6) 1 p dx h dqm 1 p dx h α = = α. 1 α x dτ z dτ dβ 1 α x dτ z dτ s dτ and dx dτ, we observe from 6) that dq M dτ dy, whch mples dτ < and dy <. Therefore, the rght-hand sde of 5) s negatve, whereas the rght-hand sde of 4) dτ dx s nonnegatve. For ths to happen, we must have dτ < and n addton α > α. s we dq have assumed that green electrcty generaton does not declne and we have M dτ, t ds follows that M dτ. From ), we see that for green electrcty generaton to decrease n country, we must haveα < α. Ths contradcts thatα > α. Hence, the concluson s that green electrcty generaton wll be reduced n both countres. ppendx : ome basc features of the partal equlbrum model The model appled depcts the behavor of ndvdual power producng frms on the orwegan wedsh electrcty market. In addton there s an ndependent grd operator that owns and operates an nter-connector between the two countres. The flow of power across the natonal border s constraned by transmsson capacty. Each frm, f d has a country locaton, d and operates a set of generatng unts, all located n the home country. Frms may be of dfferent szes, and may have dfferent portfolos of generatng unts. These are dvded nto three categores,, j and g. Category conssts of exstng hydro-, exstng nuclear- and exstng wnd power plants. Category j conssts of condensng and combned heat (CHP) power plants and category g conssts of new hydro-, new wnd, and bo power plants. Categores, j are 6

28 consdered black, whereas g s consdered green 8. Quanttes produced n categores, j, g and total quantty produced n frm f d are denoted Y fd Y f d j Z fd g and X f d, respectvely. Hence, 3 3. X = Y + Y + Z fd fd fd j fd g Cost functons For each gven level of output the ndvdual frm allocates producton between the dfferent generatng unts n order to mnmze cost. The soluton of ths cost mnmzaton problem defnes the cost functon of the ndvdual frm. Hydro-, nuclear-, wnd- and bo power plants are assumed to be homogenous,.e., for each type of plant the margnal cost s ndependent of the level of capacty utlzaton and equal to c, (for exstng hydro-, exstng nuclear- and exstng wnd power), and h g, (for new hydro-, new wnd- and bo power). The total avalable capacty n plants of type, j and g n frm fd are denoted K, K fd fd j and K fd g, respectvely. Condensng and CHP generatng unts are assumed to be heterogeneous (due to dfferng fuel nput and thermal effcency). Heterogenety s reflected n the margnal cost functon of condensng and CHP plants, respectvely. These functons are wrtten Y fd j C fd j = a j + bj K fd j ρ Here, a j represents the margnal cost of the least expensve unt of type j, whle a j + b represents the margnal cost of operatng the most expensve generatng unt of type j j close to full capacty. Furthermore, ρ s a (postve) technologcal parameter. ll parameters are estmated on the bass of engneerng data, whereas capacty data are obtaned from publshed reports. The soluton to the cost mnmzaton problem s captured n the margnal cost functon denoted C = C ( X, K, K, K ). The functon ncludes a tax on carbon emsson and fd fd fd fd fd j fd g takes nto account that the net cost of generatng a unt of green electrcty s equal to h g s d, where sd s the TGC prce. 8 Ths s accordng to governmental decsons. Hence, for orway black electrcty generaton s almost exclusvely takng place n water power plants whereas black electrcty generaton n weden also ncludes electrcty from nuclear-, gas- and coal power plants. 7