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Innovation and the Evolution of Energy SystemsPolicy and Modelling

Michael GrubbProfessor of Energy and Climate Change

University College London

International Seminar on Climate System and Climate Change (ISCS) Nanjing University,

July 2018

• The nature of Innovation in energy and industrial technologies• Innovation at system level – a 3 pillar process• Examples from Europe – Germany and the UK• A novel approach to ‘integrated assessment’ modelling – pliability and inertia

• Invention – the creation of something new (ideas, technologies, products, business models, etc.)

• Innovation – development and improvement associated with introduction of novelty into economic realm

• Diffusion – widespread dissemination / adoption

Basic concepts

Technology usually means a product + knowledge, with the product itself embodying technical knowledge

The economics of these processes – especially the innovation stage – still a subject of much theoretical dispute and uncertainty

Economics has traditionally distinguished three stages

Learning by doing• Both codified knowledge

and intangible ‘know-how’; often tacit

• In technologies, implies “experience curves” as a function of deployment

Learning by searching• Codified, explicit knowledge• Depends on investments in

education, R&D etc.

There is also ‘learning by interacting’; ‘learning by using’, etc.

Knowledge can be • codified (explicit, e.g. from writing and formal education) • or tacit (assumed, acquired through experience, implicit)

On Knowledge and Learning

Knowledge is acquired from Learning, through

Technology push view• The theoretical basis

– Technologies are ideas-led– Multiple uncertainties and market failures

impede any economic incentives– Governments identify public needs, fund

exploration & develop potentials• Some classic energy examples:

– Nuclear fission– Coal-based synthetic fuels– Nuclear fusion

• Basic problems of:– Governments ‘picking winners’– Cooperation vs competition

• Theoretical paradox– giant leap from innovation to diffusion,

absence of innovation ‘learning by doing’– Seamless transition from public (innovation) to

private (diffusion) money

Views on Innovation: Polar Opposites?Market pull view

• Theoretical basis– Innovation is driven by economic incentive– Role of government restricted to basic R&D &

correcting specific ‘market failures’• Some classic energy examples (assumed):

– Oil industry development – Combined cycle gas turbines

• Basic problems of:– Classic R&D failures / spillovers – Inadequate Policy direction / internalisation– Real world is ‘second (or third or fourth..)- best’

• Theoretical paradox– Absence of curiosity or public-good learning-by-

searching / or – seamless transition from public (R&D) to private

(innovation), perfect research-industry communication– Idealised Intellectual Property (i.e monopoly) markets– Long term certainty including government-market– Unlimited ‘deep pockets’ and risk neutrality

Different conceptions of innovation ..

Issue Technology-push: Govt R&D-led technical change

Market pull: Demand-led technical change

Implications for long-run economics of big problems (e.g. climate change)

Atmospheric stabilisation likely to be very costly unless big R&D breakthroughs

Atmospheric stabilisation may be quite cheap as incremental innovations accumulate

Policy instruments and cost distribution

Efficient instrument is government R&D, complemented if necessary by ‘externality price’ (eg. Pigouvian tax) phased in.

Efficient response may involve wide mix of instruments targeted to reoriented industrial R&D and spur market-based innovation in relevant sectors. Potentially with diverse marginal costs

Timing implications Defer abatement to await technology cost reductions

Accelerate abatement to induce technology cost reductions

Carbon cost profile over time Carbon cost starts small and rises slowly

Big investment in early decades, cost declines as learning-by-doing accumulates

‘First mover’ economics of emissions control

Costs with little benefits Up-front investment with potentially large benefits

Nature of international spillover / leakage effects arising from emission constraints in leading countries

Spillovers generally negative (positive leakage) due to economic substitution effects in non-participants

Positive spillovers may dominate (leakage negative over time) due to international diffusion of cleaner technologies

… can radically affect the policy conclusions

…. Of the many stages and interactions & feedbacks between them

Real innovation is complex because ….

Diffusion

…. also because it spans the transition between technology push and market pull, and associated public vs private incentives/funding

Novel technology

Mature technology

Market accumul

ation

Commercial-isation

Demon-stration

Applied R&D

Basic Research

Formation and Product/ Technology Push

Market Pull and Growth

Fig.9.5 The Innovation Chain

Note: there is no single “right” structure for the innovation chain … merely different degrees of disaggregation of the various stages

“Invention”“Innovation”

“Diffusion”

Feedback

Real innovation is complex ….

So the ‘polar opposites’ are unhelpful

Overall, innovation involves complex multi-domain journeys

Basic R&D

Technology RD&D Demonstration Commerciali-

zation Market

accumulation Wide

diffusionTechnology

journey

Organisation & supply chain

1 or 2 individuals

Venture or new unit

First outsiders

Recruit specialists,

Develop supply chain

Grow operational

staff

Maturecompany or independent

division

FinancingPublic orInternal funding

Internal fundsor projectgrants

Internal funds, Project grants,

angel or VCinvestors

First sales, internal or

external fundsstill needed

First profits

Financing through private equity,

banks, etc.

Market Regulation

Neutral or negative regulation

Neutral or negative

regulation

Neutral regulation

Specific positive

regulation

Positivegeneral

regulation

Fully adapted regulatory

environment

Institutional Research institutions

Bespoke

tech institutions

First sector associations

Eg. first IPO, licence

acquisitions

Lobbying, corporate expansion

Stable role of associationsin negotiatingsector policy

Customers and standards

No marketdefined

first targeting of

possible markets

ChoosingMarket of

commercial-ization

Early adopters and niches, basic standards

Expanding range of

customers

Well defined Customer profile,

trusted brand

1st

2nd

3rd

Infrastructure Research infrastructure

Test centres Negative

or neutral

‘Piggybacking’/First enablinginfrastructure

Barriers from existing

infrastructure

Adapted or Dedicated

infrastructure

Grow

ing social scale and role of higher domains

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July 2018


Countries with higher energy prices did not end up spending more on energy- In fact they spend less

Eastern Europe had prices lower than any OECD- And ended up spending more on energy

Not consistent with classical measures of in-country

consumer price elasticities), evidence for:

Energy efficiency regulation and related

policy responsesInnovation throughout

energy supply and product chains

Challenge is to accelerate such trends for decades without politically untenable policy-

driven price shocks

Energy systems adjusted in the decades after oil price shocks - to keep energy expenditure to an economically manageable level

Innovation far wider than just supply technologies ..

But no pillar on its own can credibly transform global energy systems– nor offers a politically stable basis for policy

• Energy efficiency policy on its own limited by: – Scale of intervention required– Growing scale satisficing behaviour – …. Leading to large Rebound effects

• Pricing on its own limited by:– Blunt nature of impacts First and Third Domain impacts– Rising political resistance to rising fuel bills – .. and competiveness concerns

• Innovation on its own limited by:– Lack of demand pull incentives– Scale & risks of investment costs– Political failures in absence of rising market feedbacks

Figure 12‑ 4 Potential joint benefits in energy and climate policy

Pillar

Standards & engagement for Smarter Choices

Enhance efficiency,Indoor and Local health

subsidy removal ..

Prices and markets for Cleaner products and

processes

Stabilise investor confidence, revenues,

air pollution & energy security

Strategic investment for Innovation & Infrastructure

Accelerate Innovation in weak sectors, coordinate supply

chain & infrastructure

Co-Benefits Integration

Climate Policy potential to

MotivateStabiliseCoordinateFinance

forlong-run security

efficiency growth

innovation

Whilst the underpinning evidence and theory of Planetary Economics suggests several routes to ‘co-benefits’

Fig. 12.3 Public and private returns in the 3 domains

Res

ourc

e U

se /

Ener

gy &

Em

issi

ons

Economic Output / Consumption

Pillar III

1. Private returns >> public returns but not realised

=> Standards and engagement

Innovation and infrastructure

Cleaner products and processes

Pillar ISmarter choices

Pillar II

3. Public returns (including innovation, security &

environment) >> private returns

=> Strategic investment

Essential to understand the complementary economic roles of the different pillars in Asia?

Experience and theoretical reasoning on each pillar shows..• There are multiple lines of evidence that in context of transforming the

global energy system over a few decades, all three domains are of comparable importance

• Only approaches that integrate across all three domains have potential to generate ‘Green Growth’

• The dominant neoclassical ‘Second Domain’ theories emphasise instrument (pricing) that maximises political opposition unless it is nested in the complementary triad

• First and Third pillar policies can (and have) delivered multiple benefits, but ….





July 2018


2020-20%

Greenhouse Gas Emissions

20%Renewable

Energy (national targets)

20%Energy Efficiency

10%Interconnection

2030≤ -40%

Greenhouse Gas Emissions

≥ 32%Renewable

Energy

≥ 32.5%*Energy Efficiency

15%Interconnection

*to be reviewed by 2020, having in mind an EU level of 30%

New Governance System and Indicators

UK Germany

Energy Efficiency

EU Product Standards (high economic & environmental value)

Emphasis on cost-effectiveness, quasi-market approaches

Emphasis on strategic imperative (eg. deep retrofits)

Carbon Pricing

Carbon pricing - EU ETSKey instrument: shored up by carbon floor price since 2014

Peripheral instrument

Low-carbon power

(since 2010, EU renewables directive)Diverse options, Second-mover renewables

Renewables central, Prime mover

Both UK and Germany have in practice pursued 3-pillar policies, but with different emphasis

0

50000

100000

150000

200000

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

Cumulative PV installedcapacity, MW

Germany Japan China others

From 1996 to 2006, German plus Japanese PV deployment > 70% of total global deployment. By 2006, their cumulative share accounted for 82% of global PV capacity.

Japan dominated until 2003, Germany 2004 to 2012.

…. And cost

The decline and collapse of UK coal power generation – 20 year view

Falling electricity demand, with Coal displaced by gas & Renewables

UK electricity – an ‘island of coal’ no more

UK power sector emissions halved since 1990, coal now below 10% of generation.

C price drives operation and closure not new investment or efficiency. Impact since 2014 much bigger than before due to price+ and :• Lower gas – coal price

differential • energy efficiency policies,

demand declining since c. 2010

• Rapidly rising share of renewables

UK electricity – an ‘island of coal’ no more

UK Germany

Energy Efficiency

EU Product Standards (high economic & environmental value)

Emphasis on cost-effectiveness, quasi-market approaches

Emphasis on strategic imperative (eg. deep retrofits)

Carbon Pricing

EU ETSKey instrument: shored up by floor price since 2014

Peripheral instrument

Low-carbon power

(since 2010, EU directive)Diverse options, Second-mover renewables

Renewables central, Prime mover

Result

Far more cost-effective over-delivery of 2020 GHG target

More costly and under-delivery of 2020 GHG target, but huge innovation

Progress to 2030 and beyond may be more costly (esp heating)

Deeper future reductions now clear, cost-effective, & embedded

UK and Germany: both models have value





July 2018


Illustrative model

Adaptive energy system

The ‘global optimal trajectory’ is radically different for an adaptive / pliable energy system, given ‘typical’* damage & discounting assumptions

Default (reference) trajectory

Standard (non-adaptive)

Emissions: if emissions system adaptive/pliable, steady decline: sustained almost linear if fully adaptive

‘Ambition’: with these parameters, cumulative emissions c. +350GtC, if high damages, or if system highly pliable (in which case, stabilises atmosphere)

Blue range: with semi-pliable (‘A&B cost’: � = 0.5) emission system, shows emissions range for damage sensitivities x 2 & 0.5 respectively



Adaptive / fully pliable system


Default (reference) trajectory Standard (non-

adaptive)

* See Annex for assumptions: many parameters reflect typical DICE parameters

Semi-pliable (50:50) system(shown with range of climate damages)

Semi-pliable (50:50) system

Source: https://www.eprg.group.cam.ac.uk/eprg-working-paper-1808/

‘Optimal’ effort

Effort: If adaptive / pliable system, much bigger early efforts because they have much higher benefit

Measures which steadily adjust the pathway are optimal at much higher effort / ‘cost of carbon’




Timely investment: Optimal global investment < $1trn/yr can cut annual costs (abatement + damage) towards end of century by at least 5 times as much





Source: https://www.eprg.group.cam.ac.uk/eprg-working-paper-1808/

Key policy implication of some numerical analysis

• The value of measures which adjust the pathway is several times that of measures which just save CO2

• Useful to think of a ’base’ carbon price as that which can be implemented today to reflect the assumed damage of CO2 emissions

• Measures in the First and Third Domains may well justify a “cost of carbon” well above this base carbon price, because these measure endure

• A rising base carbon price can also enhance in particular strategic investments & leverage long term institutional finance

• .. When the Three Domains & associated Pillars of Policy designed as a mutually reinforcing package

• 21st Century energy systems will be radically different from 20th Century

• Transition is already under way, so far driven far more by the non-pure-market policies

• We need the full and balanced package – including fresh consideration of carbon pricing:– Stability and direction?– Use of revenues for energy innovation and infrastructure? – Direct consumer access to zero-carbon energy

• Clear policy direction with all three pillars can shift risk, lower finance costs, and increase the gains to innovation and infrastructure

Standards & Engagement

Markets & Prices

Strategic Investment

POLICY PILLARS

Technology options &

competitiveness

Manage bills, increase

responsiveness

Revenues, revealed costs, strategic value

Values, pull & preferences

Attention, products &

finance

Education, access & control

“Only Connect”

Conclusions• Overwhelming evidence of induced learning and capacity of energy technologies and systems to adapt in

response to policies and external forces (“pliability”)• But coupled with high inertia – several decades for major transitions• Consider Dynamics

– ‘Optimal’ response does not just depend on assumed scale and non-linearity of impacts and discount rate! Also depends on responsiveness and inertia and adaptive capacity (pliability) of emitting systems

– Standard frameworks imply sharply rising costs – both damages and mitigation costs - over the century– Adaptability / pliability is a major driver of the net benefits of early action – will vary by specific options and would justify

diversity in apparent mitigation costs

• The combination can lead to ‘cost benefit’ effort levels similar to a risk-averse strategy dominated by non-linearly / threshold assumptions, may almost stabilise gross costs

• Annex: Some background to model & parameter assumptions

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