Integrating energy and climate policy for low-carbon growth in Europe

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Europe’s efforts to control emissions are failing, yet the necessary technologies are already here – decarbonising the power system and then using it to run more of our economy is the key, say Johannes Meier, CEO of the European Climate Foundation, and Arne Mogren, Director of the European Climate Foundation’s Power Programme and Member of the Energy Roadmap 2050 ad hoc Advisory Group.

Photo: Avedøre power plant, Denmark (by Martin Nicolaj Bech via Flickr)

It made grim headline news when newspapers reported this spring that the average CO2 reading in the atmosphere over a 24-hour period passed 400 parts per million at Mauna Loa in Hawaii, where observations have been recorded since 1958.

The best available evidence suggests that the amount of CO2 in the air hasn’t been so high for at least three million years. The reading from Mauna Loa is a sobering reminder that our efforts to bring human-produced emissions under control are failing so far. In the period since the Industrial Revolution, the burning of fossil fuels has caused a 40% increase in atmospheric CO2.

Decarbonisation is among the greatest challenges of our time. What’s needed is clear: we must reduce emissions substantially. But the question remains: how are we going to do this before it’s too late? Specifically, how can we factor the decarbonisation goal into Europe’s ongoing efforts to create an effective internal energy market for gas and electricity? This article summarises current developments and lays out three “must-haves” for structuring the internal energy market in the run-up to 2030.

Europe has committed to bring greenhouse gas (GHG) emissions down by 80-95% by 2050, consistent with the internationally agreed target to limit global warming to below 2°C. A number of studies by the European Commission, Eurelectric, the European Climate Foundation and others point in the same direction: far-reaching decarbonisation in the run-up to 2050 is feasible building on known technologies. Higher shares of renewable energy, substantial energy efficiency improvements and better and smarter energy infrastructure are no-regrets options for transforming the European energy system. The role of gas with Carbon Capture and Storage (CCS) and nuclear power not only depends on acceptance by the general public but also on the extent to which these alternatives make economic sense.

“Electrification and decarbonisation of the power system are at the very heart of a decarbonisation strategy for our economies. That implies a major build-out of renewables in most parts of Europe.”

Decarbonisation will obviously not happen overnight. To drive the process, we need a step-wise approach, with clear targets and milestones. The EU already has a framework for steering energy and climate policies up to 2020, so the logical next step is to create a framework for 2030 that will give investors the confidence they need for funding over the long haul.

With or without decarbonisation, significant investments are needed to modernise Europe’s energy system, and these investments will have an impact on energy prices up to 2030. A decarbonised energy system doesn’t of itself lead to higher costs, but the cost mix will be different because capital expenditure will be up while operational expenditure will be down. Against this background, we face the big challenge of building confidence among investors that the decoupling of growth from traditional ways of using fossil fuels can and will happen. Well-functioning trade mechanisms, transparency and transaction efficiency are crucial to building investor confidence. In short, competitive markets must be at the core of the decarbonisation process.

But markets won’t achieve decarbonisation on their own. We need clarity on the overall architecture, aligning the energy and climate agendas. Power systems in Europe are already becoming more integrated thanks to a process that started a long time ago. Its main drivers are economies of scale because the sharing of resources and trading can lower the total system cost substantially.

“With or without decarbonisation, significant investments are needed to modernise Europe’s energy system, and these investments will have an impact on energy prices up to 2030.”

Electricity is becoming integrated with gas and heat. In the long run, we will also see the electrification of transport. With decarbonisation as a major driver, electricity is a tool for efficiency gains, and higher volumes of variable power supply mean that different forms of demand response can add value. The ongoing internationalisation of the economy at large and its effect on users, especially energy-intensive companies, is also binding power markets closer together.

So market integration is already happening, but the effects are uneven and the EU’s capacity to handle the challenges of the decades ahead at European level is weak. The key will be setting a clear pathway for the no-regrets options while also leaving room for new technologies and market developments.

When the single market was established 20 years ago, electricity and gas were still viewed as national interests. All-inclusive monopolies and cartels dominated, while various forms of direct intervention – such as state ownership, subsidised capital and detailed price regulation – were governments’ main instruments for influencing these sectors, along with extensive cross-subsidies. The real market value of electricity was unknown – to the utilities, to the users and to the public. Outwardly, society appeared to have a firm grip on the utilities, but in reality the power sector to a large extent governed itself.

But, market innovation was on the way, beginning in the UK and in Norway. The approach to opening up the Nordic region was twofold – a shift from controlling details to using more general instruments such as taxes accompanied by the opening up of rigid market structures to competition and innovation. From the start, transparent market-based price creation was at the core of this shift. Unbundling, along with some additional measures, meant that control of physical flows in the system no longer led to dominance over economic transactions.

“Without this opening up of the power sector, it is hard to imagine the progress so far on increasing renewables and reducing emissions would ever had taken place. There’s still a long way to go, but the basic principles are in place, and the decarbonisation agenda makes them more essential than ever. Without correct price signals, it is very hard for resources to be used efficiently.”

We are still at only the initial stages of building more sustainable energy systems. There are critical challenges associated with large-scale deployment, such as fully integrating renewables into the EU’s electricity system in a way that deals with intermittency and improving co-operation among member states in meeting targets.

What’s needed, then, to make the EU’s internal energy market the centrepiece of a successful European decarbonisation drive? We should focus on three “must-haves”. First, European governments need to focus on integrating the internal energy market and other policy instruments into a powerful 2030 package. The complexity of the dependencies, inconsistencies and higher order and side effects of the interventions and initiatives at different levels of governance is such that we see a lack of orientation and direction across actors. Support schemes like feed-in tariffs deliver, but they are costly and can have unforeseen consequences on market integration and on wholesale markets. The internal energy market and the deployment of renewables should be seen as correlated rather than in isolation. We need to move faster on integration to ensure that we have a European-wide market in place beyond 2020.

Second, we need a robust carbon price to drive the long-term, low-carbon investments that will enable us to decouple growth from fossil fuel consumption, and also to decarbonise the power sector. Emissions need to come with real costs.

The internal energy market and the Emissions Trading System (ETS) are, in a way, two sides of the same coin. The current carbon price doesn’t provide the signals to investors needed to trigger massive low-carbon investments. A structural reform of the ETS so that investors can expect a robust and “de-politicised” carbon price would be a major step forward. Just using the carbon price as a backstop won’t drive change; the price needs to be sufficient, and complemented by policies targeting the parts of the abatement mix that the ETS doesn’t reach.

Third, we need a more forceful way of achieving physical integration of national markets. Plans and dialogues have been strengthened, but shared efforts to build infrastructure are still insufficient. We must view infrastructure as an enabler of decarbonisation and more efficient use of existing resources-generation as well as demand response. We also must do more to integrate our power, gas and heat systems. Grids and grid connections must be seen with a long-term perspective.

A powerful 2030 package combining market integration, a robust carbon price and strengthened infrastructure are prerequisites for European decarbonisation. All three ingredients are essential if we are to avoid the costs that will follow from a lost decade.

Once again, markets alone will not drive decarbonisation. We need to set targets – starting with decarbonisation – and transform those targets into market-relevant instruments. It’s worth repeating the insight from the Roadmap 2050 analyses that a 2030 GHG reduction target of less than 40% would over the longer term increase the costs of decarbonising the economy.

Complementary measures will be needed to scale up efficiency investments and to drive down costs for renewable technologies. One lesson learned from the 2020 package is the importance of avoiding a compromise motivated by political calculations. Complementary measures should be viewed systemically, not on a stand-alone basis, and there has to be a clear hierarchy and a comprehensive view of what should be achieved by when and how that can happen.

“A powerful 2030 package combining market integration, a robust carbon price and strengthened infrastructure are prerequisites for European decarbonisation. All three ingredients are essential if we are to avoid the costs that will follow from a lost decade.”

The internal energy market is a valuable resource for driving innovation and change in the EU, but we need to think much bigger than that, in terms of 2030. We believe that the internal energy market agenda should therefore be seen as an integrated element in the architecture of a new growth model for Europe, a growth model based on a low-carbon economy.

To help achieve this vision, we need a European “industrial policy” that tests new market solutions through step-by-step exposure to market risks. So far, this has happened mainly at national level, but now the time has come to consider new solutions from a European perspective. If those issues aren’t handled effectively, there’s a risk that the combination of integrated systems, open markets and national policies will trigger growing tensions and perhaps protectionist moves by some member states.

Without widespread support, and demand from member states for common solutions, it will be hard to pursue a low-carbon growth model. The economic crisis has fundamentally changed priorities for the time being. It may be tempting to use all resources to solve the immediate problems and provide local solutions, but is such a “balkanisation” of energy and climate issues really an attractive alternative for anyone? The fact is that European markets already depend on each other, and decarbonisation increases that dependency.

We need an ambitious idea for Europe, so a vision of low-carbon economic growth is exactly that. The internal energy market aligned with a robust carbon price and complementary measures to drive energy efficiency and renewable solutions, can and should play a crucial role in achieving the synergies needed for competitiveness, security of supply and sustainability. Hanging onto existing structures in business-as-usual scenarios isn’t a sufficient basis for a viable European future. A more positively forward-looking view of European energy is a growing imperative.

This is the fourth of a series of short essays that first appeared in the discussion paper EU’s Internal Energy Market: Tough Decisions and a Daunting Agenda published by Friends of Europe on 4 June 2013. We are grateful for the author’s and Friends of Europe’s permission to reprint it here.

In the first article in this series, Jorge Vasconcelos, founder of the Council of European Energy Regulators and Member of the Energy Roadmap 2050 ad hoc Advisory Group, argued that we need to “rethink the single energy market”. In the second articleFernand Felzinger, President of the International Federation of Industrial Energy Consumers (IFIEC) Europe, expounded the view that the internal energy market should be much more closely linked to Europe’s global competitiveness position. In the third article, David Buchan, Senior Research Fellow at the Oxford Institute for Energy Studies, warned that the internal energy market is being undermined by member states’ reluctance to align their national renewable energy strategies or to depend on one another for back-up.

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