E3G

Risk management, credible options and the future of European renewables policy

By Jonathan Gaventa and Nick Mabey

All long-term scenarios for Europe’s energy system involve considerable risks: the wrong decisions could jeopardise climate and energy security, damage human health and the environment, or lead to unacceptable costs for consumers. Recent events – including the sharp rises in fossil fuel prices accompanying the Arab spring, the nuclear crisis at Fukushima and the Deepwater Horizon oil spill – underline the profound unpredictability of future energy developments. At the same time, the opportunities associated with technological breakthroughs, such as distributed generation or thin film solar, could transform future energy outcomes.

When costs and potentials are not yet fully known, there is value in holding options open, to create a ‘policy hedge’ against future uncertainty. The European Union’s renewable energy policy has quickly become a key element of Europe’s strategy for managing the risks to the European economy associated with climate change and fossil fuel price swings. Though sometimes controversial, targets and subsidy mechanisms have served to drive development and deployment of key power technologies and widen the range of options available to deal with the challenges facing European energy systems. However, Europe is rapidly approaching the point where it must decide which potential energy pathways will be kept open and which will be foreclosed.

Renewables policy as risk management

The EU first adopted policies on renewable energy following the oil shocks of the 1970s. Since then, renewable energy policies have become increasingly sophisticated. All member-states now have financial support mechanisms in place, and the EU’s ‘renewable energy directive’, adopted in 2009, for the first time sets a binding target for 20 per cent of energy consumption to come from renewable sources by 2020. These policies have played two important roles.

First, renewables deployment has created an important buffer against the risk that the volatility of fossil fuel prices poses to Europe’s economy. Europe currently imports half of its primary energy and this figure is rising. Declining indigenous resources, combined with oil-linked pricing in the majority of Europe’s gas supply contracts, makes Europe increasingly vulnerable to shifts in international fossil fuel prices – often driven by political, economic and geological uncertainties over which Europe has little foresight or control.

When the 20 per cent renewables target was proposed in 2007, it was estimated that the policies to achieve it would add $26 billion per year to the cost of electricity by 2020 – under the baseline assumption of an average oil price of $48 a barrel.(See note 1 below) If the oil price averaged $78/bbl (the highest considered in the study), costs would drop to $0.2 billion per year. This suggests that if oil prices persist at current levels well above $100/bbl, the renewables targets may lead to net savings even without accounting for the carbon benefits.

The importance of this fuel price buffer is set to grow as Europe becomes more import-dependent and fossil fuel prices become more volatile. Analysis for the European Climate Foundation found that low-carbon technology pathways (involving significant levels of renewables) would prevent the loss of $300 billion in GDP in the event of a fossil fuel price spike lasting three years from 2020.(See note 2 below)

Second, renewables policies have allowed EU countries to gain experience of how low-carbon technologies operate at larger scale. From a very low base, renewable energy consumption has doubled in the last decade and, according to national plans, is on course to nearly double again by 2020 in order to meet the 20 per cent target.

The majority of existing power grids were built in an era in which electricity systems were predominately national, power generation was sited relatively close to the points of consumption, and power flows were uni-directional and more predictable.

Key technologies have moved from being theoretical possibilities to realistic options for the decarbonisation of Europe’s energy mix. As new technologies are deployed more widely, there is more solid evidence of their potentials and performance. In many cases the costs of technologies have also fallen. According to the European Commission, the costs of producing electricity from wind power have declined by 20 per cent over the nine years to 2006 and those of solar photovoltaic power by 57 per cent.(See note 3 below) Costs are expected to fall considerably further as installed capacity increases.

The experience generated by current policies has also made it easier to foresee the risks facing renewable energy in future. For example, the case of Spain shows that overly generous subsidies for certain technologies can create investment bubbles. These can just as quickly burst if policy is then changed and applied retroactively, as was the case in Spain where subsidies for already installed photovoltaic cells were cut considerably. The lesson is that drastic policy changes can damage the prospects for the whole sector. Another interesting example is the development of offshore wind farms in the UK. Large cost reductions were expected from installing such significant volumes of renewables. But experience showed that these cost reductions are difficult to predict far in advance and depend on a range of external factors, such as fluctuating exchange rates, the costs of steel and cement or the availability of cranes and ships.Greater understanding of these conditions will make risks easier to manage, but cannot remove them entirely.

The decision juncture

At low rates of penetration, renewable technologies can be incorporated into existing fossil based energy systems relatively easily. Existing grids can cope with the power flows; conventional generation can be ramped up or down to respond to intermittency. The key policies to facilitate the spread of renewables are subsidies for research and development and financial incentives for deployment.

To enable a move towards higher levels of renewables usage, however, the key policy challenge becomes one of adjusting the energy system as a whole rather than simply paying subsidies. Sufficient investment is unlikely to be forthcoming without confidence in the volume of future market opportunities; this in turn requires energy infrastructures, markets and longer-term policy frameworks conducive to renewable development. Europe faces key decisions in each of these areas over the next few years.