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An intertemporal theory of

renewable energy development

Darko JusCenter for Economic Studies

Ludwig-Maximilians University of Munich

July 30th, 2013

32nd USAEE/IAEE North American Conference, Anchorage

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Motivation I

In the theoretical literature, fossil resources are usually considered within dynamic models (resource extraction literature, e.g., Hotelling (1931), Solow (1974), Stiglitz (1974), Sinn (2008))

Renewable resources are often modeled as a (static) ‘backstop technology’ (e.g., Dasgupta and Heal (1979), Gerlagh (2011) and van der Ploeg and Withagen (2012))

Result from these models: Society should immediately fully switch to renewable energy once it becomes cheaper than fossil energy

In reality: Simultaneous use of renewable and fossil energy Two questions:

How can we explain the simultaneous use of both? Is this optimal for society?

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Motivation II

Why do we model fossil energy within dynamic frameworks?

Non-renewable resource

Owners must decide when to extract the resource

Solve an intertemporal problem (Hotelling 1931)

Hotelling rule (for constant extraction costs):

Is renewable energy really a static problem since it does not involve the use of a non-renewable resource?

Static production problems: choices at one point in time do not affect the set of possible choices at a later point, e.g. daily production of milk

I consider here the problem of society, focussing on electricity generation

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Why renewable energy is an inter-temporal problem

1) Locations for the use of renewable energy differ in quality

Favorability of wind energy (average wind speed, left diagram) and photovoltaic (yearly sum of solar irradiation, right diagram)

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Why renewable energy is an inter-temporal problem

Also holds for Europe as a whole

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Why renewable energy is an inter-temporal problem

2) Improving profitability of renewable energy as a natural process

This is the time component of the argument

The social profitability of renewable energy generally improves over time, due to increasing social cost of fossil resources (relevant as fossil resources are a substitute for renewable energy in the electricity generation)

Increasing social costs of fossil resources because of

their increasing scarcity

rising extraction costs as increasingly unfavorable deposits need to be accessed

the marginal cost of adding carbon dioxide to the atmosphere increasing because of climate change

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Why renewable energy is an inter-temporal problem

To summarize:

the available renewable energy projects differ in quality

the profitability of renewable energy generally improves over time

Thus, if renewable energy is initially not profitable, at some point the high quality technology-location combinations first become profitable

However, low quality combinations need more time, and some may never become profitable for society

Hence, alternative locations/technologies imply different social profits at any instant in time, with each changing as time progresses

An inter-temporally optimizing society must decide when to start using renewable energy, at which location, and with which renewable energy technology

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Society’s optimality rule

Intertemporal efficiency condition of the society

 

 

 

 

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𝑡𝛼 𝑡𝛼𝑖

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Difference to the problem of extracting a fossil resource

When extracting a non-renewable (fossil) resource, the intertemporal problem is usually based on the resource being finite

In the case of renewable energy, no absolute finiteness of renewable energy locations is required

It is a relative scarcity that renders it a dynamic problem, namely involving a scarcity of locations of the same good quality

Suppose each quality of location for the use of renewable energy exists only once

Then, once a location with a certain quality has been used, this quality of location is no longer available for future projects

Each locational quality can be interpreted as a finite and non-renewable stock, although the total space for renewable energy is practically infinite.

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Results from the simple dynamic model

Society should go through three phases of electricity generation

First phase is characterized by a high degree of abundance of fossil energy, and consequently its low social cost

Over time, renewable energy becomes more favorable and the social cost of fossil electricity eventually rises sufficiently high to make the best available renewable energy project socially profitable

This project is characterized by having the best location and technology, in terms of yield and costs; society should realize this project once the dynamic efficiency condition is fulfilled

Renewable energy begins being used when this occurs, but does not fully replace fossil energy immediately

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Results from a simple dynamic model

As time progresses, increasingly more renewable energy projects become profitable, thus representing the second phase with a simultaneous use of fossil and renewable energy

The second phase might eventually flow into a third phase, in which only renewable energy should be used

This may become optimal as time goes to infinity, or even before, depending on how well renewable energy alone can satisfy society’s need for electricity

Moreover, it also depends on whether the fossil resources will be used up in finite time.

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Comparing the model results with reality

If renewable energy can be used in different regions sharing a common electricity market, a renewable energy technology should first be employed in the region offering the best conditions

In Europe, countries including Spain, Greece, Italy and also France are substantially more favorable than Germany on average (measured by the geographic distribution of the solar irradiation)

However, three of the four countries with the highest per capita solar power capacity in Europe – Germany, the Czech Republic and Belgium – are not very favorable

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Comparing the model results with reality

Installed solar power capacity as of 2010 in W per capita

Ireland

Sweden

Denmark

France

Cyprus

Portugal

Italy

Belgium

Czech Rep.

0 20 40 60 80 100 120 140 160 180 200 220

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Thank you for your comments and questions!

darko.jus@econ.lmu.de

Center for Economic Studies

University of Munich