s u s t a i n a b l e de v e l o p m e n t Insights Green Revolution 2.0: A Sustainable Energy Path

Nalin Kulatilaka A b o u t t h e au t h o r The Green Agricultural Revolution Role of Energy in Nalin Kulatilaka is the Wing Tat Lee greatly increased crop yields and Sustainable Development Family Professor of Management and averted mass starvation, but it also Co-Director of the Clean Energy & Economic development depends on turned small farms into factory farms Environmental Sustainability Initiative factors of production that are often that concentrated production in few (CEESI) at Boston University. His research in scarce supply, and energy is often locations and reduced the diversity of is in real options, energy intermediaries, the most critical factor. Having access and financial contracting. He is the author of the widely acclaimed book, Real Options (1999), and over 75 scholarly papers.

The author has benefited from valuable suggestions from many friends and colleagues. Special thanks go to members of the Clean Energy & Environmental Sustainability Initiative (CEESI), to a reliable and cost-effective supply which engages university-wide resources crops. In this paper I propose a strategy to help prepare for a world where of energy is a vital ingredient for for a Green Energy Revolution, centered increasing demand for energy resources economically sustainable development. on a smart electricity network, that must be balanced with environmental, But development often also comes takes a different path: By enabling economic and social sustainability. with negative spillovers in the form rich information flows, it allows of congestion and environmental for diversity of energy sources. By externalities that can have far-reaching conveying more accurate cost signals, Sustainable Development Insights is a impact on quality of life, and ultimately it creates incentives to reduce levels of series of short policy essays supporting impose a heavy drag on development the Sustainable Development consumption and shifts consumption itself. The challenge is to devise an energy Knowledge Partnership (SDKP) and patterns to reduce the peak capacity strategy that is both economically and edited by Boston University’s Frederick needs. By bringing energy farms closer environmentally sustainable. S. Pardee Center for the Study of the to demand centers, it reduces losses. Longer-Range Future. The series seeks And by improving the quality of power, to promote a broad interdisciplinary Transitioning from our fossil fuel driven it enables the creation of valuable new dialogue on how to accelerate economy will be a slow and costly process services. sustainable development at all levels. that requires careful management. Most www.un.org/esa/dsd http://tinyurl.com/susdevkp www.bu.edu/pardee 006 october 2010 Green Revolution 2.0: A Sustainable Energy Path Energy Green Revolution A Sustainable 2.0: of the world’s current capital stock higher standards of living lead to Weaning an economy from and social systems are designed more energy-consuming human dependency on fossil fuels and to function with fossil fuels that activities that also rely on more substituting a portfolio of renewable are in limited supply. Even with refined energy forms like electricity. energy sources positions a country improvements in exploration and The development challenge then is to strongly against scarcity and negative extraction technologies, the scarcity raise standards of living while keeping environmental spillovers. A prudent of fossil fuels will act as a drag on energy intensity low (Corless 2005). and sustainable growth strategy, growth and add to global insecurities therefore, must recognize the and exacerbate wealth imbalances. As The energy mix (the type and form realities of scarcity, spillovers, and the “peak oil” literature argues, it is of the energy) to a large extent also equity. In other words, a sustainable not a question of if, but when and at determines the spillover effects. The development strategy must include what levels the production levels peak complicated inter-dependencies a sustainable energy future — one that and begin to decline. The resulting between energy use in human systems harnesses a diverse mix of plentiful uncertainty is sufficient reason to base and natural systems can have harmful energy sources in ways that are long-range growth plans on renewable side effects on human health and economically sustainable, minimizes sources of energy. A diversified natural ecosystems. Most complex environmentally harmful side energy portfolio will have significant and far-reaching spillovers are due effects, and addresses distributional short-run benefits as well. Reducing to greenhouse gas emissions from concerns across nations and disruptions arising from geopolitically burning fossil fuels and its impacts populations within nations. driven supply uncertainty and on the global climate. This climate improving trade imbalances due to externality increases the urgency The challenge for the 21st century heavy dependence on foreign energy to wean our economies from fossil is to find a path to such an energy sources further strengthens the case fuels. Although there is significant future. I argue doing so calls for for seeking energy independence. uncertainty about the exact levels of addressing a wider complementary climate change, there is mounting system for “green energy” that includes not only less-polluting energy sources, but also more “Weaning an economy from dependency on fossil fuels and efficient ways to transport, store, substituting a portfolio of renewable energy sources positions and use energy. Transitioning from a country strongly against scarcity and negative environmental an oil dependent, carbon-emitting, legacy capital stock to one that spillovers. A prudent and sustainable growth strategy, therefore, depends on renewable sources is must recognize the realities of scarcity, spillovers, and equity.” a costly and time-consuming task. This paper takes a complementary network view of the energy challenge. With supply constrained, improving scientific evidence that anthropogenic In complementary systems the efficiency becomes a natural path climate change will occur over the proliferation of one component to a sustainable energy future. A next century. The resulting global (hardware) leads to innovation and large fraction of primary energy is warming, rise in sea level, and variety in other complementary lost before its final use. According extreme weather events will lower the components (software) in to the U.S. Department of Energy/ value of existing capital that is well subsequent time periods. Hence, Energy Information Administration’s adapted to the present climate and the transition away from a fossil estimates, more than 55 percent destroy wealth (IPCC 2007). As the fuel-based ecosystem must consider is lost in the various steps involved global political community unites changes to the traditional energy in harnessing, transporting, and around this problem, it is inevitable sector as well as complementary converting processes. As economies that the social costs of the climate sectors including energy-using work their way up the development externality will be internalized in appliances; incentives that affect ladder, industrial sectors tend the price of carbon emissions and individual habits and business to improve in energy efficiency. reflected in cost of fossil fuels. practices; and reforms to regulations Unfortunately, the accompanying and institutions. For instance, small

2 sustainable development insights | 006 | october 2010 investments can induce efficiency The First Green Revolution Meanwhile, the International Rice improvements in the short run. During the middle part of the 20th Research Institute (IRRI) in the Philippines developed hybrid Larger infrastructure investments century, countries around the world varieties of rice that had shorter and behavior changes are needed to were grappling with the challenges crop cycles (allowing more crop sustain these efficiency gains and to of feeding their rapidly growing seasons); grew in submerged facilitate the inclusion of clean energy populations. In his best seller The conditions (opening flood-prone sources. But the value from the Population Bomb, Paul Ehrlich (1968) land for rice cultivation); and were complementary system grows non- predicted that programs aimed at disease and pest resistant (better linearly with the size of the network increasing food production would suited for tropical climates). The (Amram and Kulatikika 2009). be unable to avoid mass starvation. hybrid rice IR8, which became the Such arguments leading to limits poster child of this innovation, more I argue that the heart of transforming to growth do not take into account than doubled the per acre yields. the energy sector will be a modern price responses and hinge on the electricity network. With its growing assumption that technological Much else, however, was needed to pervasiveness in modern society, change would be slower than realize high crop yields. The new seeds the “smart” electricity network is a population growth. The Green had to be made available to farmers central asset to growth. By building Revolution debunked this notion. in developing countries; new farming ubiquitous measurement, monitoring, and communication capabilities to complement the energy generation Table 1: Green Agricultural Platform and distribution infrastructure, Technology Infrastructure Markets and Public such a smart electricity network can Financial Policy catalyze a Green Energy Revolution. Institutions It will increase system efficiency by Seeds Roads/Railway Commodity Price driving down waste and lead to networks markets supports superior cost economics. Pervasive (e.g., eChoupal) information will endow consumers Fertilizer and Irrigation Insurance Land with situational awareness and adjust Pesticides reform their behavior to be more prudent Farm Logistical Credit Crop users. Distributed energy sources can equipment systems markets Insurance be more readily integrated into the network. Restructured regulations Food processing Agricultural/ and storage Development and public policy will create an technologies Banks environment where businesses can flourish through innovation of new products and services. What results techniques ranging from better could be a resilient network consisting The term “Green Revolution” is most often associated with the irrigation, fertilizing, and the use of of “Islands of Power” where electricity development of high yielding pesticides needed to be demonstrated; would be produced closer to where grains that were produced through risk had to be managed through it is consumed and is consumed scientific research. Norman Borlaug, crop insurance and agricultural price more efficiently, in a system that is who was awarded the 1970 Nobel supports; and capital had to be less vulnerable to cascading failures. Peace Prize and considered the provided through agricultural banks Such a distributed system forms a father of the revolution, headed and futures markets. platform for introducing a diverse mix a team at Mexico’s International of generation sources (Woolsey et al Maize and Wheat Improvement Center In addition, getting the crops from 2010). (CIMMYT) that developed dwarf the farms to consumers required varieties of wheat that flourished fundamental changes to various For ideas and insights, let’s look in a wide range of climates and complementary services. Countries at another Green Revolution from produced four-fold yield increases. that experienced true Green recent history.

sustainable development insights | 006 | october 2010 3 Green Revolution 2.0: A Sustainable Energy Path Energy Green Revolution A Sustainable 2.0: Figure 1: Electricity Network Transformation Reaches Far and Wide

Current Electricity Network vision of the smart energy grid

Micro Micro Solar Heat Efficient Micro Commerical Domestic wind CHP water pumps boilers Biomass heating Commerical Domestic Industrial

Industrial Smart metering Storage

One-way One-way Two-way Two-way Two-way energy financial energy information financial flows flows flows flows flows

Storage Static infrastructure

Small range of Solar conventional CCs plant technologies Large scale Hydro- Nuclear Large scale Gas solar onshore and electric power (coal/gas) CHP and Production offshore wind power station biomass

CO2 transport and storage

Revolutions saw parallel investments prevented consuming more land for population centers; markets had to and innovations in agricultural farms but it also created more oil be developed where farmers could markets, transportation infrastructure, fields. A case can also be made that not only get a fair price for their and logistics (Mann 1997; Evenson the primary beneficiaries were large crops but also could get access to and Gollin 2003). Good harvests didn’t commercial farms with ready access financing through rural banking always mean piles of rotting produce or to fertilizer, pesticides, and modern networks. In other words, success even rock bottom prices. Storage and equipment, thus rendering smaller came through the creation of a food processing technologies allowed farms uneconomical and worsening business platform that connected the the crops to be efficiently distributed inequities in income and asset consumers with producers and the over not only geographic distances but distribution. network of stakeholders in the wider also over time. complementary system. What relevant lessons can we glean The Green Revolution is not without from this discussion of the first Green Before applying these insights to the its critics. Some point out that the Revolution as we prepare for the energy sector, I will frame the energy heavy use of fertilizer and irrigation Second Green (Energy) Revolution? challenge and highlight the central role caused long-term degradation of the First, success wasn’t based simply on played by the electricity sector. The soil. The use of chemical fertilizers the development of new technologies parallelism comes from the dependent contributes to increased dependency — hybrid seeds and modern farming variables. Whereas a well-executed on oil and adds the problem of green techniques. A much broader set of Green Agricultural Revolution provided house gas emissions. In fact, some capabilities had to be built around food security and self-sufficiency, estimates claim that the modern these technologies: dramatic changes a Green Energy Revolution has the farming techniques have resulted were needed in the transportation potential to bring about energy in a tenfold increase in the amount infrastructure and storage systems independence, reduced carbon of energy used in food production. that moved food from farms to emissions, and higher power quality The Green Revolution may have needed for growth in the 21st century.

4 sustainable development insights | 006 | october 2010 Designing a Smart As with high-yielding varieties of corn Table 2 (see page 6) summarizes the Electricity Network and rice, there are many challenges components of the Green Energy to overcome. Vested interests, old Platform and draws parallels to “The Smart Grid”, used as a proper habits and work practices, and the Green Agricultural Platform. It noun, refers to a particular vision for legacy capital makes disrupting the also offers opportunities to a broad the technical design configuration status quo a difficult task even when ecosystem of firms and institutions. — a smart technical grid comprised a superior system is available. The of a cyber-physical system that challenges for implementation of the overlays intelligence (sensing, Who Will Build the Smart smart electricity network include: communication, information Electric Network? processing) on the physical electric 1. Integrating the existing energy An important characteristic of power system. My notion of a “smart technologies and innovations network economics is that creating electricity network” takes a broader in new information and value requires large up-front view. It includes the institutional communication technologies investments. Since network effects and governance structures to build including the Internet. increase with the network’s size, capabilities and launch new services. 2. Providing incentives for behavior benefits begin accruing at a slow, changes in key actors (individuals Much like the folk tale of the low rate but accelerate more-or- and organizations) needed to best elephant and the six blind men, the less exponentially. These immense use the newly enabled capabilities. impact of the smart grid depends opportunities come with equally large 3. Developing decision support on your vantage point. But the most uncertainties for value capture and and control systems to manage salient feature of the smart grid for depend on evolution of technical end user appliances and realize this discussion is that it bridges the standards, regulatory policies, and synergies between intermittent information gap between various business models. Thus, private capital generating resources and stakeholders in the system. The cyber markets are ill equipped to navigate system will enable information to interruptible loads. flow in both directions — to and from customers. Figure 1 compares the current electricity network with the vision for a smart electricity network.

Realizing the full potential of the smart grid needs more than technology. It calls for parallel changes to markets, business models, and public policy. Only then will the smart grid be able to provide the 4. Developing new markets that the risks of platform building. Yet, the requisite power quality for the digital signal timely price information social value potential and the strategy economy; enable efficient operation to the various participants urgency make this an appropriate leading to lower cost structures; (including end users) of the target for public investment. build resiliency by anticipating and widely distributed network. responding to disturbances; and 5. Creating new financing vehicles History is rife with examples of accommodate environmentally- and contracts to facilitate industries where public-private friendly generation and storage investments in distributed energy partnerships successfully developed options. Such a smart electricity resources (environmentally friendly new platforms and “tipped” network becomes a business platform loads, storage, and generation). systems away from inefficient to innovate and launch a wide variety 6. Restructuring policies and the legacy network systems. Besides of end-user services. Consequently, regulatory environment to facilitate creating the necessary regulatory the challenges and opportunities the transition and value capture. policies, public funds and leadership offered by the smart grid affects a 7. Developing new services and revenue through R&D for seed technology, much broader set of institutions. models to deliver them to end-users. educational and awareness programs

sustainable development insights | 006 | october 2010 5 Green Revolution 2.0: A Sustainable Energy Path Energy Green Revolution A Sustainable 2.0: Table 2: The Green Energy Platform

Technologies Infrastructure Markets and Financial Public Policy Institutions

Sensors, smart Wholesale power markets Building codes meters, and other grid Appliance standards technologies Transportation fleet standards Smart Technical Grid — incorporating ubiquitous Emissions limits, carbon connectivity, sensory prices, renewable portfolio capabilities, and standards (RPS) and Control and decision intelligence in electricity other incentives for clean support tools distribution network Ancillary service markets generation

Renewable generation (PV, Restructured utility wind) and storage (fuel regulation: e.g., cells, flywheels, batteries) Cost reflective rates and “decoupling”, net metering, technologies retail power markets and feed-in tariffs

Smart appliances Performance contracts Direct subsidies or tax incentives

for new farming technologies, and established, end-user equipment and Co-evolution: I argue that a more building the physical distribution applications introduced, new services apt strategy for sustainable energy infrastructure was crucial for success offered. Customers came, but is to seek changes in a modular in the Green Agricultural Revolution. innovation was slow and gradual. fashion where technologies and Public investment in the highway institutions co-evolve. The installed system formed a platform for The challenge in sustainable energy base of capital, business practices, private investment in trucking and is different. Innovation is drastic. behavior, institutional arrangements, transportation services to evolve. In Technology choices are vast and and existing ecosystems of firms both cases, the public intervention existing systems rapidly become can be used to earn short-term catalyzed private investment. obsolete. Applications and services benefits, while innovating new are uncertain and may need changes modules, and keeping alive valuable Build It and They Will Come: to behavior. Competition is fierce and growth options. Under such a Investing in infrastructure ahead global. Much social value, economic strategy, government investment of determining the uses of the competitiveness, and security is at seeds innovation and thereby allows infrastructure is an effective stake. Exacerbating the problem for exploration of many potential transformation strategy when a are time dynamics of network technologies in various parts of the single entity controls most aspects systems evolution. Individuals and value network. Then public policy of the complementary network, institutions make decisions about can create a regulatory climate that when new technology is incremental, energy using capital goods based on would induce commercialization and choices are few. There is little available information at the time of and wide-spread adoption. It takes uncertainty about how value is the decision, with less than perfect advantage of design principles of created and captured. Cases in point foresight. Early decisions can lock modularity (Baldwin and Clarke are phone companies that were patterns of usage and lead to a 2000). An example would be the either state-owned or functioned as “tipping tendency” where sometimes development of mobile navigation regulated natural monopolies, like inferior technologies may be chosen. services. It required public the AT&T of old. Operating within The resulting path dependency is akin investments in the Global Positioning a “walled garden”, there was little to the extreme sensitivity to initial System, private investments in uncertainty about how to capture conditions found in chaos theory and digitized maps, and a proprietary value: networks were built, standards to evolutionary paths in biology. interface for the service provider.

6 sustainable development insights | 006 | october 2010 Towards a Green Introduction of smart rates, either The performance levels of appliances Energy Revolution through markets or institutional fall and their lifetime shrinks as the proxies, must provide opportunities voltage and frequency move outside In this paper I advance the notion for consumers to recognize and allowable ranges. Quality must also of a smarter electricity network receive rewards for shifting risk take into account the resiliency of as a central building block of a through demand response and the power system to ensure reliable sustainable growth strategy. Such scheduling smart loads. Smart delivery in the face of extreme a network will reduce the need for technologies and smart rates weather events, demand spikes, and investments in polluting power create opportunities. But it takes various supply interruptions. A smart generation plants. However, large informed consumers/agents to grid not only enables the provision investments will be required in make smart decisions and harness of higher quality power but also complementary cyber infrastructure. the value of those opportunities. measures and conveys the quality We can think of this strategy as A well-functioning system must and cost to consumers so that new substituting polluting (brown) capital have smart organizations with a services based on quality can be with clean (green) capital investments. governance structure that changes offered. The notion of quality extends relationships between utilities, beyond the technical characteristics At the network’s core is a smart customers and regulators and into risk management and other grid business platform that calls for induces broader changes to business/ financial attributes. One can even coordinated actions through a public- work practices, behavior and habits. imagine developing services around private partnership. Investments Such an environment will spawn “packets” of energy that can be in smart technologies creating a smart services that can differentiate valuable in serving interruptible loads robust cyber-physical infrastructure quality of service at a granular level such electric vehicles. will form the backbone. Also key is

It is important to note that smart Figure 3: Smart Grid Business Platform Substitutes grid business models can foster “Brown” Capital with “Green” Capital significant network effects. The real time information flow created Distributed End-User Resources by intelligent systems that span

pe (renewable generation, responsive loads, storage)

a both the transfer and distribution c

s Business Infrastructure (T&D) infrastructure and the (cost reflective rates, incentive contracts, energy services) user communities will enable nd

a new workflow designs, spawn L Cyber Infrastructure y highly distributed service-based (smart grid technologies, sensors, smart meters, etc.) ic

l organizations, sustain innovation at

o the product level, and perhaps most

P Physical Electricity Network (centralized generation, T&D resources) critically, give rise to new market structures that use price signals to facilitate more efficient behavior. The of segmentation. For instance, combination of the new products, a modern distribution system that demand-side response will smooth services and related markets will turns the grid into a resilient dynamic out peak loads and reduce the need lead to a significant transformation system capable of delivering the for investments in expensive and across the entire energy value chain. power quality needed for modern environmentally harmful generation The resulting ecosystem will adopt industry and a rapidly modernizing plants. Leading the energy strategy clean energy technologies while society. In parallel, consumer-side with a smarter electricity network has fostering new businesses, creating technologies that can respond to other benefits too. new jobs and ultimately empowering information about energy prices and society to reach new heights in energy grid conditions by adjusting energy Modern industry and sophisticated consumption will increase efficiency conservation and sustainability. consumers place a high premium on • and lower customer bills. But realizing “quality of power” (Cleveland 2010). value needs much more.

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Woolsey, J., R. Klienfeld, and C. Sexton. (2010). “No Strings Attached: The The views expressed in Sustainable Case for a Distributed Grid and a Low-Oil Future.” World Affairs, September/ Development Insights are strictly those October. of the author(s) and should not be assumed to represent the position of their own institutions, of Boston University, of the Frederick S. Pardee Center for the Study www.un.org/esa/dsd http://tinyurl.com/susdevkp www.bu.edu/pardee of the Longer-Range Future, or the United Nations.