Cost of Carbon Emissions Abatement in the Ontario Electricity Market 2006 to 2011

COST OF CARBON EMISSIONS ABATEMENT IN THE ONTARIO ELECTRICITY MARKET 2006 TO 2011 Derek E. H. Olmstead Alberta Market Surveillance Administrator & Carleton University 1.403.402.9168 (Canada) [email protected] & [email protected]

Overview In 2006, in response to growing concerns about the negative effects of carbon emissions and other environmental considerations, the Ontario government directed a government-sponsored agency to induce the entry of significant amounts of renewable energy generation capacity into Ontario’s electricity market by use of long-term, fixed-price contracts. This paper reports results of economic modelling and econometric analysis of the cost of carbon emissions abatement obtained by direct intervention in this market over the period 2006 to 2011. Numerous alternative policies have been employed in other electricity markets to induce such outcomes. This analysis is important because, without a comprehensive understanding of the cost of Ontario’s policy, comparative policy analysis is not possible and there is no theoretically sound way to assess the cost efficiency of Ontario’a approach. Methods A six-equation structural model of the Ontario wholesale electricity market is specified. The equations correspond to Ontario-based (1) supply and (2) demand, (3) imports, (4) exports, (5) the government-sponsored agency’s budget constraint, and (6) the quantity equilibrium. The first four equations are estimated using a generalised method of moments instrumental variables estimator. This sustem of equations, fitted with the econometrics results, is used to construct a base case equilibrium against which a counter-factual can be compared. The relevant counter-factual is defined to be a case where the renewable energy contracted by the government- sponsored agency is not installed. Using the structural model, the cost of carbon emissions abatement is then estimated, by use of a bootstrap method, as the ratio of the change in the total cost of electricity and the change in carbon emissions between the two cases. While the renewable energy policy was introduced in 2006, monthly data over the period 2002 to 2011 are used to estimate each component of the analysis described above with the period 2002 to 2005 being unaffected by the counter-factual. Results

Estimates of the cost of carbon emissions abatement range from C$93/tCO2e to C$207/ tCO2e, depending on the assumptions made about the type of fuel consumed by generation displaced from the market as a result of the entry of contracted renewable energy generation capacity. Lower estimates are associated with coal-fired generation being displaced while higher estimates are associated with natural gas-fired generation being displaced. These estimates are consistent with those reported by others in the context of the Ontario market at this time using much simplier methods, e.g., Dewees (2010). Gross of the positive effects of carbon emissions abatement, consideration of particular aspects of the market reveals that Ontario-based consumers, non-contracted generation, and importers were negatively affected by the implementation of the renewable energy generation capacity program, while contracted firms and exporters were positively affected. Conclusions There are important implications to this analysis. First, in comparison to carbon prices associated with the EU Emissions Trading Scheme and the US Regional Greenhouse Gas Initiative (typically an order of magnitude less at this time), the cost of carbon abatement achieved in the Ontario electricity market is well in excess of that obtainable in other markets, sectors, and jurisdictions. Second, as a corollary given limitations on the availability of economic resources, far less emissions abatement was achieved than was possible per dollar of economic resources. Finally, the effects of the policy are likely to persist due to the long-term nature of the contractual arrangements. More generally, the analysis supports the proposition that direct policy intervention in the market is likely to be both more costly and less effective than application of a market-oriented approach such as a carbon tax or a cap-and-trade scheme. 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