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Debate: subsidies versus carbon pricing in European renewables

By JP Casey and  By Yoana Cholteeva 08 Apr 2021 (Last Updated April 7th, 2021 22:21)

Renewable power subsidies and carbon pricing schemes are among the most popular projects to encourage clean energy investment, but which is more effective? Our writers debate both sides of the issue.

Debate: subsidies versus carbon pricing in European renewables
Renewable power subsidies and carbon pricing schemes are among the most popular projects to encourage clean energy investment, but which is more effective? Credit: David McNew and Getty Images

Energy subsidies have long formed a key component of Europe’s push towards a green economy, with it understood that government subsidies for new renewable power projects help overcome the prohibitive costs that often accompany such projects. 

This approach has translated to significant investment in renewable power in Europe, with figures from the EU showing that total energy subsidies in the bloc reached $189.7bn in 2018, vast financial support that forms the backbone of renewable power funding across the continent. 

Yet despite the financial backing for such projects, new research has suggested that putting the burden of renewable funding on national governments may not be the most financially efficient means of operating. 

A paper published by the Vienna University of Economics and Business has suggested that carbon pricing schemes could be more economically sound, as they encourage private innovation in the sector, and could help offset the cost of clean power through lucrative private investment, rather than relying on more static government support. 

With Europe aiming to hit ambitious climate targets in both the near and long term, getting the economics of clean power right is a key issue, and one up for considerable debate.

Yoana Cholteeva: renewable subsidies could drive Europe towards complete decarbonisation

While both renewable subsidies and carbon prices could be considered as two sides of the same coin, renewable capital injections appear as the more proactive and encouraging approach to an accelerated renewable energy transition.

Indeed, research from the Potsdam Institute For Advanced Sustainability Studies has found that while the introduction of carbon pricing systems has led to emission reductions in some countries, they have not significantly stimulated technological change. 

The research was based on empirical knowledge in academic expost analyses of the effectiveness of existing, comparatively highprice carbon pricing schemes in the EU, New Zealand, British Columbia, and the Nordic region.

A central argument to the study suggests that there may be limits to carbon pricing’s value as the objectives of the Paris Agreement do not just require a reduction in emissions of carbon dioxide, but rather its complete elimination from the energy sector by 2050.

In order to achieve this, a complete reconfiguration of the energy system, mobility, and of carbon-emitting industry is necessary as a complete decarbonisation requires development and deployment, up to full market penetration of zero-carbon technologies and systems.

Technological transition knowledge explored as part of the report also suggests that the factors influencing the direction and pace of technological change go well beyond differences in costs. Through their existing systems of infrastructure and institutions, societies can be “locked in” using high-carbon technologies. 

This lock-in phenomenon can then be exacerbated by economic mechanisms such as decreasing costs and increasing returns, which put new technologies at a competitive disadvantage. Such spillover effects could also mean that markets tend to achieve suboptimal levels of innovation, suggesting that state interventions to increase the rate of innovation are necessary to support an effective transition at pace

While renewables are often criticised for receiving numerous subsidies, fossil fuels and nuclear power continue to benefit from more financial support compared to renewables, which is counter-intuitive to the outlined Paris Agreement goals.

For example, coal, oil, and gas receive more than $370bn a year in support, compared with $100bn for renewables, the 2019 International Institute for Sustainable Development report found.

Moreover, a policy insight paper by the Energy Futures Lab and the Grantham Institute – Climate Change and the Environment at Imperial College London, found that the use of renewable subsidies is motivated by the need to address market failures. Included among these are the price disparity with fossil fuels as the cost of power generated by fossil fuels does not reflect the environmental costs they generate in the form of climate change and local air pollution.

Defending a similar theory, Matt Goodwin, sales director at waste pellet plant company Waste Knot Energy, suggests that “the alternatives to fossil fuel use need to be simpler, less open to interpretation, and easily measured”.

“Investments in long-lived, carbon-intensive infrastructures, such as natural gas, are ongoing due to the amount of capital already invested and tied-up. It is not realistic to expect certain industries to shut-up-shop because of their carbon footprint – the economics and regulatory frameworks need to be changed so that some businesses are no longer viable.

“For example, while locally produced fuel pellets are available to produce electricity in our power stations, power stations are importing wood pellets from forests being felled over 4,000 miles away in North America.” 

In a scenario where the energy sector needs a complete reinvention, including the way the industry is regulated, increased government and organisational investment support can prove to be the backbone of a systemic transformation.

JP Casey: subsidies are limited in scope, while carbon pricing offers continent-scale solutions

There are potentially vast, and oftentimes imbalanced, economic costs associated with renewable subsidies. The majority of European subsidies are drawn from tax funds, with the EU reporting that around 70% of fossil fuel subsidies were drawn from tax expenditures. 

This creates an unsustainable economic model where taxpayers are made responsible for the financial requirements of the energy transition, while not being involved in the economic benefits, such as the investment opportunities provided by carbon pricing.

“Renewable subsidies would only make renewables cheaper, replacing a mix of coal and gas in the short run,” explains Professor Klaus Gugler, one of the authors of a report published in March this year that highlighted the strengths of carbon pricing over renewable subsidies.

“In the longer run, it may be – if coal stays cheaper than gas – that gas is replaced, but not coal,” continues Gugler.So subsidies and winner-picked technologies partly solve the environmental problem – you emit less carbon dioxide – but at a very high cost. There are studies [that show] subsidies cost three to five times as much as a carbon tax [scheme].”

This is not to say that renewable subsidies are entirely without merit, only that their high costs make them an unwieldy solution on a large scale. Gugler notes that Europe will struggle to meet its environmental targets relying on a subsidies-driven approach, saying that, “we will tinker around with regulations here and there, and subsidies here and there, [but] I think without the carbon tax we will not do it”.

Gugler goes on to describe key drawbacks with renewable subsidies on an international scale: “Coal and gas prices may fall due [to] the reduced demand necessitating ever higher subsidies to decarbonise.” 

He explains: “[And second] subsidies are not technology neutral, thus the state decides who is the winner. We know that the state is very bad in winner-picking [and] it could well be that another form of decarbonised energy is best in, say, 10-20 years, [and] a technology neutral carbon price would incentivise research in that direction.”

Beyond these limitations of renewable subsidies, carbon pricing offers a number of advantages, most notably the lucrative financial benefits associated with such a system. The Vienna University report drew comparisons between the carbon pricing-led approach of the UK and the subsidy-heavy method of Germany, and concludes that the market-driven nature of the former leads to greater innovation.

For instance, in the UK, coal-fired power plants have been phased out of the energy mix almost entirely, while in Germany, natural gas has been pushed out of the market, leaving coal-fired power stations in place. The researchers noted that Germany’s emissions declined only “modestly” in recent years, while Britain’s emissions fell by an “astonishing” 55% in the five years since the implementation of a unilateral carbon tax. 

The tax was first set at $6.84 per tonne of carbon dioxide in 2013, before being capped at $24.93 per tonne between 2016 and 2020 to “limit the competitive disadvantage faced by businesses and to reduce energy bills by consumers”, as the academics put it.

This combination of free market innovation and government limitation could create the ideal economic and innovative conditions for an energy transition that is both environmentally effective and financially viable. 

The report concluded that, in Germany, a spend of €1bn on a low carbon price would lead to an annual reduction in carbon dioxide emissions of around 20 million tons, four times the reduction from the same spend on wind power subsidies and 20 times the fall in emissions resulting from that spend on solar subsidies.

Gugler is eager to see these financial benefits reinvested into solutions that can benefit European energy, and power infrastructure, as a whole.

“The revenues from the carbon price [and] tax should be used [firstly] to support poorer people to alleviate distributional concerns and [secondly] to finance R&D in decarbonisation technologies, [creating a] double dividend.”