Is Europe’s Renewables Mandate Bad for the Environment?

Rob Stavins has a provocative post up at his (excellent) blog arguing that European renewables mandates are bad for the environment. Much of it makes good sense – but I suspect that it goes too far.

Stavins’s logic is simple. Since European stationary-source emissions are capped under the EU ETS, any renewables mandate simply shifts emissions around, rather than reducing them. And because carbon prices will be lower in the presence of a renewables mandate, less low-carbon innovation will be induced when a renewables mandate exists. (High carbon prices provoke investment in low-carbon innovation.) The net result is that adding a renewables mandate to a cap and trade system is bad not only for the economy but for the environment too.

Most of Stavins’s argument is persuasive – it is, among other things, a useful antidote to the oddly emphatic claim on the New York Times editorial page that Europe’s “ambitious [emissions] goals will not be met without continued incentives for renewable energy”. But his final judgment seems to have three potential holes.

The first hole has to do with technological change. Yes, as Stavins writes, lower carbon prices mean less incentive from a carbon price for low-carbon innovation. But the renewables mandate, depending on how it’s structured, means more incentive for renewables innovation! It’s going to be immensely difficult to determine how this one nets out. But it doesn’t make sense to pay attention only to the lower carbon price and not to the stronger renewables incentives when making a net assessment.

The second hole has to do with international spillovers. I can think of two relevant mechanisms.

First, higher domestic carbon prices raise demand for international carbon offsets. A corollary is that, with higher carbon prices, a larger fraction of a system’s mandated emissions cuts will come from outside. To the extent that international offsets are less credible than domestic emissions cuts, a higher carbon price for a given cap means higher global emissions.

Second, and perhaps most important, by altering the incidence of carbon abatement costs, renewables incentives should influence international carbon leakage. To see how this works, it’s useful to set renewables aside for a moment and think about complementary abatement policies in general. Imagine that one imposed a policy that forced all of the costs of the emissions cuts that Europe seeks to come only from sectors that can’t relocate. Then the carbon price would drop to zero – including in sectors that potentially could relocate. In this scenario, there should be no carbon leakage – which is less leakage than one would expect given a carbon price. Now imagine a scenario at the other extreme: the burden of emissions cuts is imposed entirely on sectors that could potentially relocate. These sectors now face much higher costs, and are more likely to relocate than they would have been under a simple carbon price. Emissions leakage is now higher than under a simple carbon price.

Now let’s get back to renewables: Which of these extremes is a renewables incentive closer to? It depends on the structure of the incentive. Some renewables incentives (such as broad-based feed-in tariffs) push electricity prices up even more than a carbon price does (for a given emissions reduction); if these increases are normally passed on to trade-exposed industries, they can increase carbon leakage and worsen environmental outcomes. Other renewables incentives (such as renewables subsidies paid for from the general budget) push electricity prices down, and hence should reduce carbon leakage (though a thorough analysis should include the effects of any second-order impacts on tax or interest rates too). Either way, if one wants to know the ultimate environmental impact of renewables incentives when combined with cap-and-trade, one needs to reckon with international leakage.

The last potential hole in Stavins’s argument is politics. Higher carbon prices presumably lead to greater political pushback against carbon pricing. In that case, if renewables mandates lower the carbon price for a given cap, they can make that cap more likely to stick, ultimately keeping emissions lower than they otherwise would be. To be fair, though, an astute commenter on Stavins’s blog makes a smart counterargument: the way that Europe has implemented its renewables incentives has raised electricity prices more than a straight carbon price would have, in the process provoking plenty of pushback against climate policy in general. It’s possible to imagine, then, that pairing renewables incentives with carbon pricing could undermine support for both. Ultimately, it’s tough to know what political dynamics ultimately mean for the net impact of a renewables mandate on European emissions.

Bottom line? Stavins is right that combining environmental policies can result in odd, and possibly perverse, environmental outcomes. Whether that’s the case for Europe’s renewables policies, though, is more complicated than meets the eye.