The transition from fossil fuels to renewables is simple in theory, but the path can have some unexpected twists. In Europe, for example, some high-efficiency gas turbine (CCGT) power plants are being mothballed. It seems odd: natural gas is cleaner than coal and has lower carbon emissions, so what is going on?
It turns out that the profitability of natural gas plants has been undercut by decreased electricity demand, changing fuel prices and depressed carbon prices.
The depressed carbon prices are a result of the cap and trade system. When you have a recession – demand for power drops. That means that the number of permits needed falls. Since the authorities can’t adjust the number of permits, the price falls instead. The price of EU Emissions Trading Scheme (EU ETS) allowances fell from nearly €30 in July 2008 to near €4.50 in January 2014. This change is completely unconnected to the harm that CO2 does. Changing the price of permits when economy slows down is like adjusting the fine for speeding depending on the monthly labour force report.
Advocates of cap and trade see the variable price as a virtue – cheaper permits should give the economy a small macroeconomic boost. The problem is that cheaper permits makes coal-generation more attractive relative to natural gas, since coal generates more CO2 per megawatt of electricity.
As a result, the value of coal plants is higher than it would be, and the value of gas-generation plants decline as a result of the combination of policy and demand fluctuations. Modern gas-turbine plants are being mothballed. Utilities are forced to write down their investments. The write-downs are huge – in 2013 GDF SUEZ reported “impairments” of two billion Euros. In June 2013 Austrian utility Verbund reported that it would record impairment charges of €1.13bn on generation units. In July 2013 Vattenfall posted a €3.46bn write-down . No wonder utilities are unwilling to invest in new gas plants. A policy designed to shift to gas on the way to renewables has stopped working.
The cap and trade mechanism, in this case, damaged the price signals that serve as incentives for capacity investment. The cap and trade system, it turns out, is making the European electricity system less stable.
Notice that the cap is still in effect – there is no increase in total carbon emissions – just a failure to change the mix of fuels. Europe gets more pollution but not more CO2. It also gets a less flexible electricity generation system.
This would not have happened with a simple carbon tax. With a carbon tax the price of fossil fuels can fall, but the tax itself would not decline. As a result, the recession (or any other ‘exogenous’ decline in demand) would reduce carbon emissions. Furthermore A carbon tax would not favour carbon-based energy every time demand declines.
There is still a countercyclical macroeconomic effect with a carbon tax, but it would not be amplified by a reduction in the price of carbon permits.
The information I have used here comes from a report by the Stranded Assets Programme at the University of Oxford’s Smith School of Enterprise: “Stranded generation assets: Implications for European capacity mechanisms, energy markets and climate policy” Working Paper January 2014