ECO314 Final Exam Preparation

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University of Toronto St. George
Adonis Yatchew

Lecture 4: Regulation and Government Intervention Types of Government Intervention  Command and control (e.g. safety standards on nuclear reactors)  Market intervention (e.g. cap-and-trade, regulation of electricity prices)  Public ownership (e.g. nationalization of oil reserves) Regulation of Monopoly  Cost of service regulation/Rate of return regulation o Regulator comes in and you report your costs. Regulator adjusts your rates to be at a level you can expect to recover your costs. Regulated companies have the incentive to persuade the regulator that their costs are reasonable. There is an asymmetry of information between the company and the regulator o Fair rate of return on capital Capital Asset Pricing Model (CAPM)  Incentive regulation o Using rewards and penalties to regulate the overall price level of utilities. o “Create competition where possible, regulation where necessary” o Firms compete in markets for goods/services/inputs, regulatory arenas, and political settings; the objective is to create productive incentives in each of these settings. o Examples:  Price-Cap Regulation  Sets a cap on the price that the utility provider can charge  % =RPI-X  Revenue-Cap Regulation  Limits the amount of total revenue received by a company operating  % =RPI-X+%  Benchmarking regulation (yardstick)  Regulator compares the performance (efficiency) of various monopoly companies and rewards/punishes those on the basis of their relative performance  Methodologies for benchmarking costs and production: o Cost and production function estimation o Index-based approaches (comparing unit cost indexes and productivity indexes) o Data envelopment analysis (if a given producer, A, is capable of producing Y(A) units of output with X(A) inputs, then the other producers should be able to do the same if they were to operate efficiently) o Stochastic cost frontier estimation (produces efficiency scores of producers)  Hybrid approaches  Combining forms of regulation  Menus of contracts  Regulated companies can choose Historical Context of Regulation  Early 20 century monopoly abuses o A lot of companies (e.g. Esso) became much bigger when they were able to accumulate much greater profits and political influence  Great Depression o Failure of markets to provide employment o From the 1930’s going forward, steady increase in regulation and government ownership or “nationalization”  1970s – period of stagflation (high inflation and high unemployment) o Stagflation due to overconfidence in government stimulation/printing money o Oil price shock (OPEC exercised cartel power) o People began to question about government’s power  1980s – period of privatization and deregulation o Expanding recognition of economic benefits and political implications of free markets and private ownership  2001 – collapse of Enron and California electricity market o Led us to recognize that “re-regulation” may be necessary in certain sectors  2008 – financial crisis o Government ownership increased again Private vs. Public Ownership -Private companies:  Owners: shareholders  Create incentives for cost minimization and profit maximization  If the company under-performs, mgmt. and even the Board can be replaced  If the company exceeds expectations, there is greater scope for rewarding mgmt./executives -Public companies:  Owners: government/taxpayers  Have different incentives from private companies and often have wider public mandates  Less flexibility in rewarding/punishing employees  More susceptible to government policies Lecture 5 Part 1: Renewable Energy in Ontario Ontario Renewable Energy Industry Overview -Ontario Hydro was divided into:  Ontario Power Generation (OPG) – inherited much of OH’s generation assets  Hydro One – inherited much of OH’s transmission and distribution -Key Agencies  Ontario Energy Board (OEB) – main regulatory body  Independent Electricity System Operator (IESO) – balances supply/demand  Ontario Power Authority (OPA) – assures a long-term supply of electricity in Ontario -Ontario Generation Capacity (37000 MW)  Hydro 21%  Nuclear 31%  Wind/Biomass/Solar 6%  Coal 17%  Oil/Gas 24% -Ontario Energy Generation (150 TWh/year)  Hydro 26%  Nuclear 55%  Wind/Biomass/Solar 3%  Coal 7%  Oil/Gas 10% FIT program vs. RESOP -FIT Program  Was enabled by the Green Energy Act 2009; was launched in October 2009  The objectives of the program are to increase the capacity of renewable energy supply, reduce emissions, introduce simpler method, to create green energy industry and jobs. Applicants receive guaranteed prices for new projects that generate electricity using certain renewable fuels to cover development costs. The prices are long-term fixed. Also, FIT projects are provided with a priority to connect to the existing transmission and distribution system. There are domestic content requirements for wind and solar PV projects in order to support manufacturers and job creation.  Divided into 2 streams: o FIT – projects over 10 kW o microFIT – projects less than 10 kW  Process: o Projects are first subject to Transmission Availability Test (TAT) to determine whether there is sufficient capacity already existing to accommodate the project’s expected generation volumes o Projects that are NOT approved under the TAT are then subject to an Economic Connection Test, under which the OPA determines whether suitable transmission upgrades to accommodate FIT projects are justifiable (assesses cost of connection)  There has been very strong response to the program o Applications totaled 15000 MW in its first year o Supply is dominated by wind (69%) and solar PV (28%) -RESOP  Launched in November 2006 and ended on October 1, 2009  Designed to encourage renewable supply connecting to distribution and not exceeding 10 MW  About 1000 MW of renewable was contracted during this period, mostly solar and wind  Challenges: o High concentration among developers o 10 MW limit: larger projects had to be broken up into smaller ones o Could not accommodate volume of applications o Program pricing does not reflect economies of scale Ontario FIT Program vs. Programs in Other Countries -Rates: o Ontario 11% o France 8% o Germany 5-7% o Spain 5-10% -Adjusting prices over time: o Germany: incorporates price degression under which projects that start up later receive lower payments to account for decreasing technology costs; subject to reviews every 4 years o Netherlands and Spain: prices adjusted through periodic review o Ontario: prices adjusted through periodic review -Prices for wind and solar o Ontario > Spain > Germany Political Sustainability of the FIT program -Electricity prices are expected to increase by 45% over the coming renewables -As shares of renewables grow in the generation mix, this will only put further upward pressure on prices, undermining the LT political sustainability of the program Lecture 5 Part 2: Support Schemes for Renewable Energy -Support Schemes: Support for renewable energy can be seen as a second-best policy to reduce emissions in the absence of direct measures (e.g. putting a price on carbon emissions); these support schemes are often more complex than the direct interventions and are more prone to government failure -3 categories of support policies: o Policies which require consumers or companies to pay for renewable power o FIT o Renewable portfolio standards (RPS) o Tradable green certificates (TGC) o Fiscal incentives o Taxes o Subsidies o Public financing o Public investments o Loans o Grants Effectiveness and Efficiency -The most important objective of a policy instrument is to promote dynamic efficiency -Measurements of effectiveness and efficiency in achieving dynamic efficiency objectives are difficult -Elements of instrument evaluation:  Narrower, but highly quantifiable effectiveness criterion: o Are prices for technology declining? o Does policy achieve targets? o Are generation prices consistent with costs? o Do prices paid for specific generation technologies create incentives for maximizing their benefits to the system?  Administrative cost, complexity, and regulatory burden -Major sources of inefficiency  Poorly designed markets: o Wide disparities in the marginal costs of meeting renewable targets would suggest the presence of substantial inefficiencies o Unnecessary segmentation reduces the liquidity of market-based instruments, inducing further inefficiencies.  Unstable and unpredictable government policies o Inefficiencies can be avoided by an institutional structure which creates an arms-length relationship b/w the regulator and the government  government can reduce distortionary political pressures -Support schemes that fix the price of renewable generation reduce risk for both generators and consumers Costs to Consumers and Taxpayers -Limiting rents -Technologies are picked and remunerated by the government Political Feasibility and Sustainability -Political feasibility of a policy instrument depends on:  Attributes of the instrument  Existing institutional structures, traditions, and political sensibilities -Sustainability depends on:  the ease with which it can be reversed  the rapidity with which the instrument includes an efficacious response  the magnitude and distribution of costs which may differ from those anticipated when the policy was introduced Evaluation of Instruments and Policies -Properly calibrated Pigouvian taxes on carbon would be a powerful and efficient tool for promoting renewable generation. -In the long term, this would be probably the best solution because of the importance of pricing externalities into production and consumption decisions. Using difference between risk and uncertainty to evaluate instruments & policies  Risk: we know roughly what the likelihood of an event is (can quantify the probabilities associated with outcomes)  Uncertainty: you can’t even assign probabilities -Uncertainties that a prospective provider of renewable power must face:  Uncertainties surrounding the future cost paths of renewable technologies, their integration into energy systems, and developments that could convert non-dispatchable sources into dispatchable ones through cost-effective storage -Risks that a prospective provider of renewable power must face:  Output price risk  Demand risk  Cost risk (e.g., capital costs)  Political and regulatory risk. Using Barriers to Entry to evaluate instruments & policies  Cost of producing energy from renewable sources  Ease of access to transmission and distribution grids  Need to build large facilities in order to be competitive Case Studies: Comparing Denmark, Germany, Spain, Great Britain, and the U.S. -Denmark, Spain, and Germany rely on FIT programs -Great Britain and the U.S. rely on TGC and RPS programs Denmark - Largest increase in renewable market share is exhibited (from 5 to 30%) - Denmark implemented its first FIT program in the early 1990’s - The primary renewable energy technology in Denmark is wind power (esp. onshore wind) - Bidders are competing for something close to a shovel-ready project Germany - Germany introduced a FIT program in the early 1990’s - The renewables share increased from about 4% to 16%. - Many parts of Germany have relatively poor wind conditions, and the FIT offers higher overall payments to generators at poorer sites Spain - FITs introduced in the 1990’s - The share of renewables in total electricity generation increased from 15% to 33% - Ratepayers were protected from increasing generation costs by regulated ceilings on rate increases - The “tariff deficit” was to be recovered through future rates. Note: Shares of renewables increased, but these countries have also experienced significant rate increases. UK - In the 1990s, the Non-Fossil Fuel Obligation required electricity retailers to pay for renewable power purchased through a series of tender rounds for new capacity Lecture 6: Oil The History of Oil -Early uses for street paving, medicine, water proofing, lighting, etc. -1848: first modern well dug near Baku -1859: Colonel Edwin drake strikes oil near Titusville, PA  Leads to Pennsylvania oil rush -1901: Anthony Lucas strikes oil on ‘Spindletop Hill’ in Texas  Launches the Texas oil industry  Texas became the birthplace of oil giants (Gulf Oil, Amoco, Humble Oil Company) -1911: Standard Oil broken up into 34 companies (e.g. Esso) -Until 1950s, US remained the world’s foremost producer -During Cold War:  The Soviet Union’s interests in the Middle East during the Cold War become the context for ‘resource nationalism.  OPEC tries to regulate oil prices but the cartel is unstable in the face of burgeoning non-OPEC supplies. Saudi Arabia then imposes “discipline,” and oil falls below $10/barrel in 1986 undermining longer term reserve development  The Soviet oil industry collapses under the price pressure and revenue losses hasten the collapse of the entire Soviet state -Post Cold War:  With the Asian Crisis of 1997, falling world aggregate demand conditions push oil downward toward $12/barrel, again undermining new capacity expansion.  In the Bust of 2001, oil collapses once again, climaxing with the 9/11 attack driving down consumption, but the US recovery in 2002 moves oil up again, this time over $50 - Suez canal crisis of 1956: President Nasser nationalized canal (66% of Europe’s oil passed through Suez) leading to Suez Canal crisis. -1973: OPEC embargo leads to energy crisis 1979: 2 oil crisis (Iranian Revolution) -Seven Sisters dominated the oil industry from 1940 to 1970: Socony, Socal, Standard Oil of New Jersey, Anglo- Persian Oil company, Royal Dutch Shell, Texaco, and Gulf -In 1979, President Carter declares access to oil a “vital national interest”, to be defended by “any means necessary” (Carter doctrine) Oil and Geopolitical Conflict (WWI & WWII) -Prior to WWI: Conversion of British fleet to oil, government financial support for opening of Persian oil fields, which had led to British Petroleum -WWII: Germany invades Russia to secure oilfields in the caucuses, invention of liquefaction by Germans, Japanese attack of Pearl Harbour to secure Indonesian oil fields Persian Gulf vs. Saudi Arabia vs. U.S. -Saudi Arabia:  23% of world’s conventional reserves of oil -Persian Gulf:  Contains about 2/3 of known world conventional oil reserves  Provides 28% of world supply -U.S.:  Consumption: 20m bbl per day  Production: 8m bbl/day  Imports 60% of oil Fractional Distillation -refer to the midterm notes Peak Oil -refer to the midterm notes Gasoline -Definition: a mixture of hydrocarbons usually containing between 4 to 12 carbon atoms (e.g. octane) End Uses of Oil  Transport 44%  Heating 19%  Propane 6%  Jet fuel 8%  Residual Fuel 5%  Asphalt 3%  Others 15%  Transport and heating: 2/3 World Oil Market -Oil demand is price inelastic and for fast growing economies, highly income elastic -Nationalization of oil reserves (governments own them) -New Sources of oil demand growth include China and India; these sources of new demand are likely to continue rising -Oil price shocks have impacts on macro side of business; 2 immediate impacts of oil price shocks:  Creates uncertainty in investments  Su
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