Innovation for Sustainable Electricity Systems -Exploring the Dynamics Of

Sustainability and Innovation

Coordinating Editor: Jens Horbach

Series Editors: Eberhard Feess Jens Hemmelskamp Joseph Huber René Kemp Marco Lehmann-Waffenschmidt Arthur P.J. Mol Fred Steward Sustainability and Innovation

Published Volumes:

Jens Horbach (Ed.) Indicator Systems for Sustainable Innovation 2005. ISBN 978-3-7908-1553-5 Bernd Wagner, Stefan Enzler (Eds.) Material Flow Management 2006. ISBN 978-3-7908-1591-7 A. Ahrens, A. Braun, A.v. Gleich, K. Heitmann, L. Lißner Hazardous Chemicals in Products and Processes 2006. ISBN 978-3-7908-1642-6 Ulrike Grote, Arnab K. Basu, Nancy H. Chau (Eds.) New Frontiers in Enviromental and Social Labeling 2007. ISBN 978-3-7908-1755-3 Marco Lehmann-Waffenschmidt (Ed.) Innovations Towards Sustainability 2007. ISBN 978-3-7908-1649-5 Tobias Wittmann Agent-Based Models of Energy Investment Decisions 2008. ISBN 978-3-7908-2003-4 R. Walz, J. Schleich The Economics of Climate Change Policies 2009. ISBN 978-3-7908-2077-5 Barbara Praetorius • Dierk Bauknecht Martin Cames • Corinna Fischer Martin Pehnt • Katja Schumacher Jan-Peter Voß

Innovation for Sustainable Electricity Systems

Exploring the Dynamics of Energy Transitions

Physica-Verlag A Springer Company Dr. Barbara Praetorius Dr. Corinna Fischer

DIW Berlin - German Institute Verbraucherzentrale for Economic Research Bundesverband e.V. (vzbv) Energy & Environment Division Markgrafenstr. 66 Mohrenstraße 58 10969 Berlin 10117 Berlin Germany Germany [email protected] [email protected] Dr. Martin Pehnt Dierk Bauknecht IFEU Institut für Energie-und Öko-Institut e.V. - Institute for Applied Ecology Umweltforschung Energy & Climate Division Wilckensstr. 3 Merzhauser Straße 173 69120 Heidelberg 79100 Freiburg Germany Germany [email protected] [email protected] Martin Cames Dr. Katja Schumacher Dr. Jan-Peter Voß Öko-Institut e.V. - Institute for Applied Ecology Energy & Climate Division Novalisstr. 10 10115 Berlin Germany [email protected] [email protected] [email protected]

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9 8 7 6 5 4 3 2 1 springer.com Contents

Preface...... ix

1 Introduction...... 1 1.1 Electricity Systems under Transformation ...... 2 1.2 Shaping Innovation Towards Sustainability...... 3 1.3 Empirical Foci of the Book...... 4 1.4 Structure of the Book...... 6 References ...... 7

2 Transformation and Innovation in Power Systems ...... 9 2.1 Systems in Flux: An Everlasting Path of Electricity Innovation ...... 9 2.2 Are we Locked in a Carbon (and Nuclear) Trap?...... 13 2.3 Current Stimuli for Change ...... 17 2.3.1 Impacts of Liberalization ...... 17 2.3.2 Increasing Climate Change Concerns ...... 20 2.3.3 Impulses from Technological Change ...... 21 2.4 Actors and Institutions of Change ...... 23 References ...... 24

3 Towards a Systemic Understanding of Innovation...... 29 3.1 Conceptualizing Innovation...... 29 3.2 Sustainability ...... 34 3.3 Systemic Perspectives on Innovation in Literature...... 37 3.4 Design of the Innovation Case Studies...... 39 References ...... 41

4 Micro Cogeneration...... 45 4.1 Micro Cogeneration as an Innovation Cluster ...... 45 4.2 Design Options and Sustainability Potential ...... 48 4.2.1 Technological Variations...... 48 4.2.2 Operating Schemes...... 49 4.2.3 System Level Impacts ...... 51 4.2.4 Ecological Performance...... 51 vi Contents

4.2.5 Economic Performance...... 53 4.2.6 Micro Cogeneration Scenarios...... 55 4.3 The Innovation Process of Micro Cogeneration...... 56 4.3.1 Evolution of the Innovation System...... 57 4.3.2 Market Setting and Situation to Date...... 59 4.3.3 General Reasons for Slow Diffusion in Germany...... 61 4.3.4 Actors and Coalitions ...... 62 4.4 Shaping the Innovation Process...... 67 4.5 Conclusions ...... 71 References ...... 74

5 Carbon Capture and Storage...... 77 5.1 CCS as an Innovation to the Electricity System...... 77 5.2 Design Options and Sustainability Potential ...... 78 5.2.1 Technological Variations...... 78 5.2.2 Ecological Performance...... 84 5.2.3 Economic Performance...... 88 5.2.4 CO2 Mitigation Scenarios for the Electricity System ...... 91 5.3 The Innovation Process of CCS...... 93 5.3.1 Research and Development Activities...... 93 5.3.2 CCS Actors and Constellations in Germany ...... 96 5.3.3 Development of the Institutional Framework...... 101 5.4 Shaping the Innovation Process...... 103 5.5 The Future of CCS in a Sustainable Electricity System ...... 106 References ...... 109

6 Consumer Feedback through Informative Electricity Bills...... 115 6.1 Introduction ...... 115 6.2 Description of Innovation and Design Options ...... 116 6.2.1 General Design Options ...... 116 6.2.2 Example: Design Options for Electricity Bills in Germany ..118 6.3 Effects and Sustainability Potential of Consumer Feedback ...... 123 6.3.1 Electricity Conservation ...... 124 6.3.2 Satisfying Consumer needs ...... 126 6.3.3 Case study: Informative Energy Bills in Heidelberg ...... 126 6.3.4 Some Conclusions for Feedback Design...... 130 6.4 Process of Innovation and Factors Influencing It ...... 131 6.4.1 Origin and Transfer of the Innovation ...... 131 6.4.2 Implementation in Germany...... 134 6.5 Possibilities for Shaping ...... 140 Contents vii

6.5.1 Short-term and Long-term Options...... 140 6.5.2 Introducing the Informative Electricity Bill: Problems...... 141 6.5.3 The Role of Actors Other than Politics and Utilities ...... 143 6.6 Conclusions ...... 144 References ...... 147

7 Emissions Trading ...... 151 7.1 Introduction ...... 151 7.2 Design Options ...... 152 7.2.1 Scope and Coverage: What Sources Shall be Included?...... 152 7.2.2 Cap: How Much is Allowed?...... 153 7.2.3 Allocation: Who Gets what and how?...... 153 7.2.4 Banking: When can Allowances be Used?...... 158 7.2.5 Commitment Periods: What is the Planning Horizon? ...... 159 7.2.6 The Interplay of Design and Sustainability...... 161 7.3 Process of Innovation: Networks, Politics, Institutions...... 164 7.3.1 The Innovation Journey of Emissions Trading ...... 164 7.3.2 Gestation: Emerging Practices of Flexible Regulation and New Options in Economic Theory ...... 165 7.3.3 Proof of Principle: Creating Spaces for First Developments at US EPA in the Shadow of the Old Regime ...... 166 7.3.4 Embedding a Prototype: Project 88 and the Transformation of US Clean Air Policy ...... 168 7.3.5 Regime Formation: Linkage with International Climate Policy, the Carbon Industry and EU Emissions Trading ...... 170 7.3.6 The Allocation Process ...... 173 7.3.7 Possible Future Developments ...... 178 7.4 Shaping the Innovation Process for the Sustainable Development of Electricity Systems...... 179 7.5 Conclusions ...... 181 References ...... 185

8 Network Regulation...... 191 8.1 Introduction ...... 191 8.2 Design Options and Sustainability...... 192 8.2.1 Design Options ...... 192 8.2.2 Sustainability ...... 197 8.3 Process of Innovation ...... 201 8.3.1 Development of the ‘Standard Model’ of Network Regulation...... 202 8.3.2 Reopening the ‘Standard Model’: Drivers of Change and the British Case...... 205 viii Contents

8.4 Possibilities for Shaping ...... 214 8.4.1 Room for Change in the Standard Model...... 214 8.4.2 Developing Alternatives ...... 215 8.4.3 Broadening the Actor Arena...... 216 8.5 Conclusions ...... 218 References ...... 221

9 Innovation Dynamics in the Electricity System: Progressing Towards a Sustainable Path? ...... 227 9.1 Overview and Summary ...... 227 9.2 Explaining the Innovation Dynamics ...... 232 9.2.1 The Dynamic role of Institutions, Actors and Networks...... 232 9.2.2 The Role of Blocking, Competing and Matching Innovations ...... 236 9.3 Shaping the Environment for Innovation Dynamics ...... 239 9.4 Some Final Remarks...... 243 References ...... 245 Preface

Innovation is a complex issue. It involves much more than a new idea to be realized, sometimes even the reconfiguration of reality. Successful innovations involve ‘creative destruction’ of existing patterns and the formation of new configurations that work. Such reconfigurations comprise cognitive, institutional, technical and behavioral elements. They also involve the collective action of concerned actors, organizations and networks in order to be successful. The focus of this book is on the conditions and implications of sustainable innovation in the electricity system. Our interest is to better understand the conditions and opportunities for innovation that could bring about a more sustainable situation than the current fossil and nuclear fuel-based electricity system in Germany. We look at various innovation processes that are ongoing and continuously shape the system of the future. Our intention is to analyze and assess these processes with a view to identifying possibilities to shape innovation in the electricity system for sustainable development. To this end, we assess the potential of selected technological, societal, and institutional innovations, among others. This book is the final publication of more than five years of research in the interdisciplinary project “Transformation and Innovation in Power Sys- tems” (TIPS). It is also the result of collective action. The authors would like to thank Markus Duscha and Johannes Henkel for their contributions. The book benefited immensely from proofreading by Vanessa Cook. We also appreciate the helping hands of our team assistant Cornelia Wolter, our student assistants, Alexandra Börner, Nadine Braun, Katherina Grashof, Sebastian Knab, Anke Mönnig, and Christoph von Stechow. We grate- fully acknowledge funding of the TIPS research team (2002–2008) by the German Ministry for Education and Research within its Social-Ecological Research Framework.

Barbara Praetorius, Dierk Bauknecht, Martin Cames, Corinna Fischer, Martin Pehnt, Katja Schumacher, Jan-Peter Voß

Berlin and Heidelberg, May 2008 1 Introduction

Innovation is key to achieving a sustainable electricity system. New technologies and behavioral change are needed to bring about radical reductions in carbon emissions, and to enhance energy security for today and the future generations. Also, innovation is a continuous process: it happens every day and builds a future in which coming generations will live. Inno- vation not only comprises new technology, but also new forms of organization, new practices, new discourses and new insights on global and local concerns. Innovation is therefore deeply entwined with sustainable development. This is especially important in electricity where fundamental changes are ongoing while some great challenges lie ahead. There is climate change and there is still ongoing restructuring from liberalization. Classic issues like security of supply and affordability become reframed with geopolitical changes and a stronger role for market competition. What are the processes driving these changes? How is the future of electricity being shaped? What will this future look like? Will it be in line with various societal aspirations grouped together under the heading of “sustainable development”? If not, what are the options to change course, to shape ongoing processes of innovation so as to bring about a sustainable transformation of electricity systems? In this book we make an attempt at answering these questions by digging deeper at some selected points, aiming at laying bare some crucial processes of renewal which are beneath the overwhelming impression of system transformation in electricity. These processes comprise the creation of novelty in areas as diverse as small distributed generation technology, large scale carbon clean-up technology, consumer information and feedback methods, innovative forms of electricity market regulation and public policies for reducing the environmental burden of electricity production by issuing tradable emission certificates. We maintain that the future of electricity is brought about through these (and other) ongoing innovation processes and their interaction. We understand electricity transformation as the result of such diverse innovation processes. If we want to shape the future of electricity, we need to understand the dynamics and identify the specific potential for sustainable development in each specific process of innovation, 2 1 Introduction and to mirror it against the evolving future electricity system as a whole. This is what we are going to embark on with this book.

1.1 Electricity Systems under Transformation

Electricity brings the pulse and rhythm to modern societies. It fuels industrial development and public administration and energizes private comfort. This has legitimized a policy of protection for the electricity industry for more than a century. Governments all over the world sheltered their emerging national electricity infrastructure from any competition, supported it with generous grants and provoked (over-)investment by price regulation based on guaranteed returns to investment. Innovation activities focused on introducing new, large scale, capital-intensive technologies, such as nuclear power. With the exception of distinct environmental crises (such as health impacts from local air pollutants, acid rain, risks of nuclear catas- trophes or landscape destruction), the sustainability of the electricity system was not an issue. This picture and the perception of the electricity industry have changed substantially over the last few decades. The economic paradigm of liberalization pervaded the system, and topics such as market restructuring, institutional and regulatory reform, reorientation of business strategies, technology emergence and diffusion, customer reinvention are now on the agenda, possibly provoking a reconfiguration of the entire socio-technical architecture of electricity generation and consumption. At the same time, the awareness of environmental problems, particularly the risks associated to climate change, has increased. In response to the new economic and environmental challenges, the electricity sector has been substantially restructured, having been de- and re-regulated in many countries. New players emerged and disappeared, and new formal and informal constellations of actors formed, including major mergers and acquisitions among electricity suppliers – on both national and international levels. One decade later, the process is still ongoing; however, most markets are not as competitive as originally hoped for, and the incumbent actors and technological structures are still persisting and dominating in many countries. This is one reason why electricity systems are still being associated with notions like inertia and resistance towards sustainable change – be it with respect to economic efficiency, environmental integrity, or societal justice. The electricity system is a complex system, consisting of much more than just the technical infrastructure for the generation, transmission and 1.2 Shaping Innovation Towards Sustainability 3 distribution of electricity. Electricity is an invisible and indirect consumption good, providing energy services such as light, heat, and power. A manifold system is responsible for transforming physical energy sources for human purposes and delivering those fundamental energy services to business, public bodies and private households. Its material aspects (resources extraction and use, technical infrastructure for generation, distribution and consumption) and symbolic aspects (values, ideas, knowledge, institutions) are closely interwoven. The electricity system is the intermediate structure between multiple forms of individual actions and their aggregated material and social effects. It involves a multitude of actors, networks and institutions equally interlinked with the other system components. They include organizations such as appliance manufacturers, electricity utilities, financial institutions and consumers, and also rules and rule-setting bodies such as governments, regulators and the related politics. Electricity systems are thus a typical case of large technological systems (Hughes 1983, 1987), characterized by high capital intensities of parts of the system, and a high degree of techno- economic interlinks. The complexity of the system structure and its inherent dynamics make it difficult to determine the influence of individual factors and to estimate future development paths. It is clear, however, that for the maintenance and development of such complex systems, powerful and effective forms of societal organization are a fundamental precondition. This points to the crucial role of actors, networks and institutions in initiating change: without the flexibility of the actors and institutions, combined with pushes through (external) crises and challenges, change will rarely take place, and the electricity system may run into the risk of being a major source of societal destabilization, due to its non-sustainable character.

1.2 Shaping Innovation Towards Sustainability

Today’s electricity systems are not sustainable. Global electricity generation is responsible for some 41% of greenhouse gas emissions worldwide, and is expected to increase further: The IEA expects global electricity generation from fossil fuels to double until 2030 as compared to today levels (IEA 2006, 2007). Most of the non-renewable fuels burned in electricity generation end up as lost heat, due to poor conversion efficiencies and the absence of excess heat usage, such as district heating systems. The release of pollutants and radioactive waste, the use of finite resources, the impacts of fuel mining, and manifold other environmental and social impacts present 4 1 Introduction challenges of our current energy system. On the other end of its life cycle, electricity is being consumed lavishly. Most ecological consequences of electricity generation and consumption become evident only a long time after they have been caused. Innovation, the process of generating and – even more importantly – of disseminating novelties can be considered an integral part of a transformation towards sustainable development. A sustainable electricity system requires significant energy savings, improvements in energy efficiency and the substitution of fossil fuels by less problematic energy carriers such as renewable technologies. The technical and theoretical potential for improved efficiency and sustainable generation has been analyzed in a number of scenario studies (Voß and Fischer 2006). Its translation into reality, however, is difficult. Shaping the transformation path towards a sustainable electricity system remains a major challenge today. The successful diffusion of innovation depends on many interlinked factors and elements. For understanding innovation-led transformation processes, it is necessary to understand the heterogeneity of the underlying innovation processes, the factors that influence them and the way they interact with each other. On the one hand, innovations involve uncertainty and risk for pioneers and for society as a whole. On the other hand, path dependencies may pre-determine certain innovation paths and impede a flexible adaptation of the system to new knowledge and new developments. The societal and policy challenge is therefore to provide for a setting that motivates change towards the “right” direction, while accounting for the risk of failures. Developing such a strategic approach for shaping innovation is an ambitious task. The challenge starts with the definition of appropriate targets and criteria for appraisal and continues with a wide range of complexity and momentum of the diffusion of innovations. The desire to tackle these challenges and better understand the dynamics of and the conditions for shaping the transformation process towards a sustainable electricity system is the starting point for this book.

1.3 Empirical Foci of the Book

As innovation in the electricity system is a large research field, we decided to focus our investigations on certain topics and questions. We strived to select innovation cases which each represents a specific kind of innovation category (in order to grasp the full spectrum of innovation) in the ongoing transformation of the electricity system. 1.3 Empirical Foci of the Book 5

On the supply side, one trend in the electricity sector is the increasing share of distributed power generation, particularly in terms of small cogeneration plants, including fuel cells in the more remote future, and also small renewable energy technologies. Cogeneration allows heat and power to be produced on site or close to consumption with much higher efficiencies than their separate generation. When produced in small and micro units on the level of households and buildings, such distributed generation may transform the whole electricity system structure, blurring the traditional roles of consumers and producers. This affects a broad set of stakeholders (consumers, electricity supply companies, etc.) and presumes technological innovation, in particular with regard to grid regulation and information technologies and small-scale cogeneration technologies themselves. The other supply-side trend points towards promises of central “clean coal” electricity generation technologies by means of carbon capture and storage (CCS) which have lately gained increasing attention in the energy policy debate. There are still many open questions regarding the technology, its economics and the risks related to underground storage, but the network of researchers, politicians and industry involved in CCS development activities has been ever increasing during recent years. One possible reason behind this dynamic is that it would allow for conservation of the incumbent architecture with large fossil power plants of most electricity systems worldwide. At the other end of the chain, the evolution of the electricity sector is also influenced by developments on the demand side. Demand side energy efficiency and electricity saving are potentially important building blocks for a sustainable electricity system. In liberalized markets, consumer information is crucial for influencing consumer behavior and allowing them to better control their consumption. Therefore, we studied innovative ways of improving feedback on electricity consumption with a special focus on more informative electricity bills. The policy framework is another vital component of the system and a possible lever for enhancing its sustainability. This is particularly true for the international climate change policy framework. The European carbon emissions trading scheme (EU ETS) is considered one of the most important instruments for mitigating climate change. The EU ETS was introduced in 2005. It is supposed to stimulate innovations towards a sustainable electricity system, and also trigger structural change within the system, for example towards more distributed and more highly efficient energy supply technologies. If designed inappropriately, however, it may also lead to adverse effects and an undue preference of certain fuels or technologies. 6 1 Introduction

A major link between the supply and the demand side is the electricity grid, an often underestimated yet essential element of the electricity system. The related network regulation is an innovative by-product of liberalization and unbundling of the former vertically integrated electricity industry. It also forms an important framework for any innovation activity in the electricity system. We looked at the role of network regulation in shaping and enabling innovation diffusion, and at the process of designing and implementing grid regulation. An issue of overall relevance is the behavior of actors, in particular with regard to the process of decision making, in the liberalized electricity market. With liberalization, we can observe changes in the composition of the actor network and the terms for individual actors’ decisions. New actors emerged and disappeared again, like electricity traders and small production firms. Existing actors confront changing opportunities, like consumers facing greater choice, and companies having to deal with the risks and chances of heightened competition. In all case studies, we explored how different actors deal with these changes and in what respect they influence their innovation activities. Most case studies presented in this book focus on the German electricity system. Nevertheless, they are embedded in an international perspective, as experience abroad is always an important angle for framing national case studies. Evidently, the German electricity system is part of the larger European electricity system and experiences similar external influences as other countries. As in many other European countries and beyond, the German electricity system experienced substantial changes during the last decade or so, partly caused by the liberalization directive of the EU commission and the subsequent liberalization of the German electricity market in 1998. Also, Germany has been participating in technological trends and advances that developed across many industrialized countries. The intention of profoundly assessing innovation dynamics, however, needs a focus on selected components of the electricity system, either with a national focus or a thematic focus. Otherwise the complexity is simply too high. In our case studies we therefore chose to focus on the German electricity system. Where helpful, however, we compare experiences in Germany with those in other European countries and beyond.

1.4 Structure of the Book

The book is organized as follows. In Chap. 2, we prepare the empirical and conceptual ground for the innovation cases. The current and most recent References 7 trends in transformation and innovation processes in the electricity sector in Germany are sketched. In Chap. 3, our approach to understanding innovation dynamics is positioned within the range of concepts offered from technology and innovation diffusion studies. This is followed by five innovation cases. In Chap. 4, the potential contribution of micro cogeneration in Germany is analyzed as an example of distributed generation. Chapter 5 focuses on carbon capture and storage (CCS) as potential climate mitigation option on the central level of generation. The third case study in Chap. 6 looks at the consumer side and at the potential role which more informative electricity bills may play in changing consumer attitudes and thus improving electricity efficiency on the consumer side. We continue with an assessment of two innovative policy instruments, first the development of the European emissions trading scheme (EU ETS) and its effects on innovation in the electricity industry (Chap. 7), and then of network regulation as a governance innovation in the UK and Denmark (Chap. 8). In the final chapter (Chap. 9), we compare and discuss the case studies and our approach, and draw some conclusions regarding the possibilities and needs for shaping sustainable innovation in the electricity system. This book is the result and the synthesis of both individual and collective contributions from the interdisciplinary research team “Transformation and Innovation in Power Systems” (TIPS). All chapters were prepared by 2–3 main authors indicated in the first footnote of each chapter and then went through a thorough review process by other members of the research team and a revision by the main authors.

References

Hughes TP (1983) Networks of power: electrification in western society 1880- 1930. The Johns Hopkins University Press, Baltimore Hughes TP (1987) The evolution of large technological systems. In: Bijker WE, Hughes TP, Pinch T (eds) The social construction of technological systems. The MIT Press, Cambridge, MA, pp 51–82 IEA (2006) World Energy Outlook 2006. OECD/IEA (International Energy Agency), Paris IEA (2007) World Energy Outlook 2007 – China and India Insights. OECD/IEA (International Energy Agency), Paris Voß J-P, Fischer C (2006) Dynamics of socio-technical change: micro cogeneration in energy system transformation scenarios. In: Pehnt M, Cames M, Fischer C, Praetorius B, Schneider L, Schumacher K, Voß J-P (eds) Micro cogeneration. Towards decentralized energy systems. Springer, Berlin, Heidelberg, pp 19–47 2 Transformation and Innovation in Power Systems

The electricity system has been innovating itself from the beginning onwards – albeit with a long period of stabilization and incremental growth in between. It is with upcoming crises and impulses from inside and outside that the incumbent system is challenged and that marginal and innovative options (such as renewable technologies, or Combined Cycle Gas Turbines) have made their way into the system up to now. In this chapter, we provide a brief sketch of the transformation process in electricity systems as a context of our more focused case studies. We outline the development of electricity systems in the last one and a half centuries, look at the related innovation cycles and the outcome in terms of the current electricity system.

2.1 Systems in Flux: An Everlasting Path of Electricity Innovation

Today’s electricity system is the result of more than 100 years of innovation in progression. In the early days of electricity generation at the beginning of the nineteenth century, electricity was produced by steam engines, fuelled with coal. At first, electricity was only used for a few industrial purposes and for the lighting of public streets and buildings. In Germany, electric light started to enter private households between 1900 and 1910. The process was rather one of supply push than demand pull: Electricity utilities provided customers with free electric lamps and installations and with subsidized tariffs, especially for industry, in order to create connections and increase demand. Early micro grids were linked up with other isles of electricity generation and supply. Later on, large companies protected by government built up the eventual grid architecture dominated by large power stations and the long-distance transport of electricity. Eventually, by 1920, electricity replaced steam as the major source of motive power in industry, and in 1929, electric motors represented 78% of total capacity for driving machines (Ruttan 2001). 10 2 Transformation and Innovation in Power Systems

On the demand side, the corresponding trend was an ever increasing demand through a variety of novel appliances and applications, a trend that was actively promoted by the electricity supply industry. One important building block of demand was industry motors, another the electrification of railways. In private households, innovations like electric razors, refrigerators, and vacuum cleaners had been promoted since the 1920s. The use of electricity for cooking and heating purposes was heavily advanced from 1925 onwards, and until the end of the 1950s, electric stoves, refrigerators, water heaters and washing machines had arrived in most households (Zängl 1989). The electrical age had arrived. Since the early twentieth century, the dominating patterns of electricity generation and supply, made up of centralized power plants of an increasing size, did not change in principle until the second half of the twentieth century (Ruttan 2001). The standard boiler-turbogenerator process was only developed with respect to its scale and improved in terms of thermal efficiency. New advances in material research allowed for shifts towards higher temperatures and to reheat cycles in the period of 1948–1957, and higher pressure until the late 1960s. R&D activities have focused on so- called supercritical high temperature thermal processes, with the aim of reaching efficiencies of more than 50% and steam temperatures of up to 700°C, for which new special metals are required. Fig. 2.1 visualizes the

Gross electricity generation divided by primary energy consumption for electricity generation 45%

West Germany Germany

40% Hard coal: y = 0,0594Ln(x) + 0,1757 R2 = 0,9663

35%

Lignite: y = 0,0533Ln(x) + 0,1638 R2 = 0,9644 30%

25%

Lignite 20% Hard coal Logarithmisch (Hard coal) Logarithmisch (Lignite)

15% 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Fig. 2.1 Development of average electrical generation efficiencies in Germany (VIK 1991; AGEB 2007a, b). The vertical line in 1990 marks German reunifica- tion, which is the reason for the temporary drop of average lignite efficiencies in Germany 2.1 Systems in Flux: An Everlasting Path of Electricity Innovation 11 continuous increase of average electrical generation efficiencies in West Germany between 1950 and the mid-1970s. Since then, it has remained more or less constant, with hard coal technologies continuously showing higher efficiencies than lignite. Since the level of 40% electrical efficiency was approached, technical and economic barriers hindered further advances in efficiency. To date, the coal and lignite industry has been making major efforts to improve the generation efficiency of their central power plants, targeting at supercritical thermal processes.

Net Efficiency 65%

CCGT: 60% y = -0,0001x2 + 0,4782x - 481,5 R2 = 0,9133 55%

50%

45% Coal: y = 0,0024x - 4,3478 R2 = 0,7002 40%

Lignite: 35% y = 0,0026x - 4,79 R2 = 0,7676 30%

Lignite 25% Coal CCGT

20% 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Fig. 2.2 Development of generation efficiency of new thermal power plants (authors’ own compilation)

The numbers in Fig. 2.1 reflect the efficiency of the average mix of existing coal and lignite power plants respectively. Figure 2.2 provides an idea of the state of the art of new power plant efficiency, which is some 5% points above the average existing mix of plants. The figure also shows the impressive increase in generation efficiencies of gas-based power generation, which have recently reached almost 60%. Gas turbines are innovative to the electricity sector, as they only entered the market in the 1990s when combined cycle gas turbines (CCGT) became commercially available. Box 2.1 discusses the usefulness of other innovation indicators to understand innovation dynamics. 12 2 Transformation and Innovation in Power Systems

Box 2.1 What can we learn from innovation indicators?

Typical innovation indicators are R&D resource inputs, the number of patents granted to a firm, patent applications, and bibliometric data on patterns of scientific publication and citations, in which the data stem from surveys, company accounts and intellectual property rights statistics. Simple input and output indicators, however, have restricted explanatory power. R&D expenses measure the input into innovation, but not the outcome. Patents do not say much about the actual deployment or diffusion of an innovation, and even less about non-technological innovations. And bibliometric analyses of publications on research outcomes do not say much about innovation dynamics and outcomes either. All of these indicators tend to overemphasize invention of new scientific or technical principles as the point of departure of a linear innovation process (Smith 2001). Moreover, they are indicators for product or process innovations with a technical focus rather than for other forms of innovation, such as organizational or policy innovations, consumer-side advances and the like. More recent conceptual and empirical approaches also try to capture the environment for technical innovations, both inside a company (environmental management systems, changes in corporate strategy, advanced management techniques, new marketing strategies) and with regard to its environment (quality of educa- tional systems, university-industry collaborations, or availability of venture capital). Other indicators include market research related to new product development, and capital investment related to, for example, new product development. The methodological and empirical problems associated with quantifying such indicators and forming composite indicators form the subject of numerous research projects on innovation indicators, and surveys such as the European Innovation Monitoring Initiative, the European Innovation Scoreboard, or the Community Innovation Survey (CIS) – both under the auspices of the European Commission, just as the most recent initiative “Pro-Inno Europe” (www.proinno-europe.eu). The results of CIS, for example, demonstrate that R&D is but one component of innovation expenditures, and by no means the largest (Smith 2001). Innovation, however, has also taken place on the demand side. Unfortunately, things are even more complex in this regard, and useful indicators are hard to define. For example, some indication of innovation could be drawn from market penetration rates of efficient appliances, such as efficient refrigerators or washing machines. Here, however, a major problem on the consumer side becomes apparent: Not every innovation is sustainable as it may create new electricity consumption. Also, besides market penetration rates of efficient appliances, indicators for measuring innovative behavior are difficult to define and identify. Similarly, the assessment of indicators for institutional, policy and other societal innovation denotes a considerable research challenge with a questionable outcome. In all of these cases, it seems more fruitful to take an in-depth look at the evolution dynamics of exem- plary innovations such as emissions trading in the case of an innovative energy and climate policy tool, and network regulation in the case of governing the electricity grid. 2.2 Are we Locked in a Carbon (and Nuclear) Trap? 13

One single major innovation – which fitted well into the prevailing system architecture – was the development of nuclear energy from the 1950s onwards. The first nuclear power plant started operating in 1961. The vision emerged that nuclear energy could be the solution to any energy supply problem. Yet the economics of scale and related cost reductions were not realized as anticipated, and the technology needed to be bolstered by massive subsidies from government and financing institutions. Also, due to the related nuclear risks for society, nuclear energy triggered massive political conflicts from the mid-1970s onwards.

2.2 Are we Locked in a Carbon (and Nuclear) Trap?

Innovation depends on previous historical development steps. Many improvements in efficiencies are based on advances in materials and other technological or organizational elements. Thus, innovation is, among other factors, also a result of experience. From the beginning onwards, increasing economics of scale seemed to be a natural law in electricity generation. Belief in the advantages of ever-larger power stations integrated in the electricity network, dominated the perception and institutional design of the electricity system until the 1980s. Consequently, most electricity systems worldwide were completely protected from competition. Highly concentrated markets of state-owned monopolies, public–private partnerships or private companies were established and protected, all in similar ways. In Germany, for example, the Federal Energy Management Act of 1935 set the seal on this structure for more than 60 years – until its revision in 1998. The related phenomenon of decreasing specific investment costs for ever-larger electricity generating technologies and companies, and the consequences of learning and experience for technology choice, have been extensively investigated in the last few decades, both theoretically and empirically. Learning is a cumulative process on both the level of the firm and of the sector (or industry, or country). It is a phenomenon that benefits society, but that also contributes to explaining the existence of path dependencies and lock-in, for example in a carbon (and nuclear) based electricity system. Therefore the question is: What role does learning then play in explaining the current system structure, and what does that mean for the future development and innovation opportunities? Does it mean that the likelihood to switch to a more sustainable low carbon society is smallest? In his theoretical assessment of competition between alternative technologies, Arthur (1989) prepared the theoretical ground for this phenomenon 14 2 Transformation and Innovation in Power Systems by highlighting the incidence of increasing returns to adoption (IRA), or falling specific cost of technology deployment. Arthur (1989) proposes a positive feedback between adoption and competitiveness. The more a technology is adopted, the more likely it is to be further adopted. This is due to increasing returns to adoption, which in turn can be traced back to four factors: scale economies (declining unit costs), learning effects (experience, learning by doing), adaptive expectations (adoption reduces uncertainty), and network economics (the more users, the more useful a technology is). Together with other driving factors such as R&D, knowledge spillovers, and exogenous market dynamics, cumulative learning or experience is a major factor for IRA (Ibenholt 2002; Nemet 2006; Papineau 2006). As a consequence, once a technology has gained an advance compared to alternatives, this leads to self-reinforcing and self-stabilizing dynamics of technology adaptation. In short, these dynamics may lead to path dependencies and even to a situation of technological lock-in, as has been shown by David (1985) for the QUERTY keyboard design, and by Cowan (1990) for the light water nuclear reactor in the case of the electricity system. As a matter of fact, power generation in Germany in the early twenty-first century is still dominated by large scale coal, lignite and nuclear power plants, which is also an example of system lock-in (Unruh 2000, 2002; Unruh and Carrillo-Hermosilla 2006). Another indicator for the dominant technology choice and priorities on national and international levels can be found in the composition of R&D expenses. Table 2.1 demonstrates the major strategic relevance still allocated to research in both nuclear fission and fusion. Considerably more research funds are flowing into these technologies than into future ones such as small-scale renewable technologies. But the numbers also show the increasing relevance of alternatives: Renewable energy sources, for example, enjoy a rising share, amounting to 24% in 2005. Research in energy efficiency, by comparison, has been neglected ever since. Yet these numbers already indicate that path dependency does not necessarily lead to an everlasting carbon lock-in. In fact, the prevailing paradigm of ever increasing sizes of power generation slowly became obsolete in the 1980s. The case of conventional steam turbine power plants shows that learning rates can decrease or even stagnate over time (Helden and Muysken 1983). At around the same time, the dominating setting of large generation plants increasingly became complemented by smaller and more distributed technologies. Combined Cycle Gas Turbines (CCGT), for example, allowed for smaller investment capital needs (and thus risks), shorter building periods and higher flexibility in reacting to fluctuations in electricity demand, as they can more easily 2.2 Are we Locked in a Carbon (and Nuclear) Trap? 15

Table 2.1 Composition of German federal R&D costs regarding energy (IEA 2007) 1995 2000 2005 Mill € % Mill € % Mill € % Energy efficiency 15.2 3.6 9.5 2.3 19.6 4.7 Fossil fuels 13.6 3.3 9.6 2.4 11.5 2.8 Renewable energy sources 74.9 17.9 76.9 19.0 99.4 24.1 of which – Photovoltaics 31.5 7.5 38.9 9.6 41.0 9.9 – Solar thermal power 3.5 0.8 1.5 0.4 5.0 1.2 Nuclear fission and fusion 166.7 39.9 153.0 37.7 137.2 33.2 Hydrogen and fuel cells – n.a. – n.a. 21.5 5.2 of which – Stationary fuel cells – n.a. – n.a. 19.3 4.7 Other power and storage technologies 0.0 0.0 22.1 5.4 3.3 0.8 Total other R&D 12.8 3.1 11.5 2.8 120.6 29.2 Total Energy R&D 417.4 100.0 405.8 100.0 413.2 100.0 adapt their output. Also, renewable energies gained increasing attention from politicians and, as a result of advantageous framework conditions, also a rising share of electricity generation. In consequence, continuous learning effects were reported for most renewable energy technologies, allowing for a sustained decrease in generation costs (except for fuel-based systems such as biomass). Impressive examples of the decline in cost with increasing cumulative production of innovative technologies are renewable energies such as wind and photovoltaic. In a recent survey, the IEA (2006) reports learning rates1 of between 4 and 8% for the production of wind turbines in Denmark and Germany, with slightly higher rates for the complete process including installation. For PV modules, the decrease in price has been steady for more than three decades now, with a learning rate of about 20%. Nevertheless, PV is still not competitive. Germany is a good example when studying the effects of public support for an innovation on deployment numbers in the case of renewable energy. Guaranteed feed-in tariffs and other subsidies have attracted investment capital for production sites in Germany. As a result of these incentives, electricity generation from renewable energies more than doubled between

1 A learning rate of 10% reflects a 10% cost reduction with each doubling of installed capacity. 16 2 Transformation and Innovation in Power Systems

1999 and 2006 (from 30.5 to 70.4 TWh). This was mostly accounted for by hydro- and wind power, despite the growing number of small-scale installations. The cumulative capacity of PV cells, for example, grew from 2 MW in 1990 to 2,740 MW in 2006, but PV still accounted for only 0.4% of total electricity generation, or 2,220 GWh, in 2006 (Fig. 2.3). And despite its geographical and climatical disadvantages, Germany ranks among the leading countries in the world in terms of both the construction and use of solar cells (modules) and wind turbines. Also, distribution and marketing structures are well developed, with numerous information sites and services, and large amounts being continuously invested in new production sites.

2500

2000

1500

GWh 1000

500

0 1990 1992 1994 1996 1998 2000 2002 2004 2006

Fig. 2.3 Electricity generation from PV in Germany, 1990–2006 (BMU 2007)

New technologies can also begin their market penetration in a process of hybridization, that is, starting from a rather complementary relationship of established and new technologies. In the UK, for example, CCGT developed its potential in such a process of hybridization with incumbent technologies, first offering peak load capacities and then taking over due to its economic advantages, as its only economic risk was (and is) the gas price (Islas 1997). The technology led to a “dash for gas” (Winskel 2002), increasing its share from 0 to some 30% of generation capacity within a decade and changing the structure of electricity supply substantially. Also, despite the increase in gas prices, 33.5% of total generation in the UK still stems from CCGT in 2006 (BERR 2007). 2.3 Current Stimuli for Change 17

Thus, change is indeed happening, and alternative technologies are entering the scene. These rather optimistic examples, however, should not distract from the fact that the incumbent system of fossil fired and nuclear plants is still dominating the supply side of the electricity system, which supports the idea of inertia in large technological systems. In many cases, such as renewable technologies and CCGT, the technology or idea as such already existed for a while before it was able to enter a broader market. The question therefore arises as to what exactly pushed them into broader deployment.

2.3 Current Stimuli for Change

Major impulses for change in the dominating system design can be expected to arise from frictions or bottlenecks in the existing architecture of such large technological systems. Such “reverse salients”, as Hughes (1983) calls them, form a limitation to the development of the system. Substantial or disruptive challenges to an everlasting linear development of the system could originate from, for example, technological or demand-side factors, or from changes in the external setting. Two major changes on the macro-level became relevant for the electricity sector in the 1990s: market liberalization on the one hand, and the international climate protection regime on the other hand. Both macro-processes – liberalization and climate change concerns – add to the enduring impulse stemming from the oil crises of the 1970s, which raised awareness of supply security and resource depletion issues. These macro-level events are both accompanied and accommodated by a third component, which are technological developments that are relevant to the electricity sector.

2.3.1 Impacts of Liberalization

In the 1990s, a spate of liberalization processes made their way across Europe and the rest of the world, changing the institutional setting for electricity generation and consumption. While the designs differ substantially with the country contexts, the underlying economic paradigm is the same: After decades of protected monopolies, based on an understanding of the vertically integrated electricity system as a “natural monopoly”, competition on the generation and distribution levels are now expected to create more choice, more diverse supplier structures, and thus less expensive electricity for consumers. Germany formally liberalized its electricity sector in April 1998 on all levels, including final customers, in one fell swoop. Box 2.2 provides an overview of today’s electricity system in Germany. 18 2 Transformation and Innovation in Power Systems

Box 2.2 Structural characteristics of the German electricity system

The German electricity system is carbon intensive, with coal and lignite as major inputs into generation; 43% of German CO2 emissions are related to electricity overwhelmingly generated in large fossil fired plants. Germany has committed itself to a CO2 reduction of 40% by 2020 compared to 2005 levels. Stringent policy targets for renewable energies and an accommodating Renewable Energy Sources Act are one means to reach this target; others are efficiency improvements and clean coal technologies as well as – recently – the development of CCS. Electricity reform in Germany took place in several steps. In April 1998, full competition on all levels was introduced in the formerly protected market. In 2005, an electricity regulator was installed to formulate and implement an incentive based regulation of grid access and grid use. Legal unbundling of generation, transmission and distribution/sales activities was compulsory by 1 July 2007. The development of key indicators for the state of competition is disappointing. Prior to liberalization, the electricity system consisted of about 900 local utilities, some 60 regional distributors and about nine large generation and transmission companies. Now a wave of major mergers reduced the number of large players to four, E.ON, RWE, Vattenfall, and Energie Baden-Württemberg (EnBW), plus some large municipalities and regional suppliers. The big four own the long-distance electricity grid. In 2006, E.ON and RWE supplied 53%, and all big four together supplied 80% of total electricity generated in Germany; they have at their disposal 286 shareholdings (>10%) in regional and local utilities (Monopolkommission 2007). Both horizontal and vertical concentration increased after liberalization (Brunekreeft and Twelemann 2005; Öko-Institut 2005; London Economics 2007). Investigations into factual market power based on the Lerner Index 2 estimated a mark-up on marginal cost pricing of about 20% for 2005 (Hirschhausen et al. 2007; Zimmer et al. 2007). One reason is the poor regulation of network access after liberalization. Grid access was initially organized by self-regulation (so- called “negotiated grid access”), which was an effective means of restraining competition and newcomers. In 2005, motivated by an intervention by the European Commission, an independent regulator (Bundesnetzagentur, Federal Network Agency) was established, which went on to implement an incentive oriented regulation. On the consumer side, despite increasing debate about exaggerated electricity price rises, the supplier change rate of household electricity customers is much below those in, for example, the UK. Depending on the data source, 7–12% changed their supplier, with an increasing trend. The numbers are higher in the case of commercial customers. Also, independent power producers, energy traders, Third Party Financing institutions and the like started entering the markets in 1998. However, the number of newcomers decreased again after 2000.

2 The Lerner Index relates the difference between market prices and marginal cost to the market price. It has a value between 0 and 1, where 0 indicates that no market power is exercised. 2.3 Current Stimuli for Change 19

In the real world context, the outcome of the different liberalization experiments worldwide has been mostly disillusioning to date. In his review of liberalization processes and results, Thomas (2006) lists a large number of failures and deviations from the competitive model when re-regulation is introduced in order to balance the desire for a secure and reliable electricity system with the investment risks related to competitive markets, or network access for newcomers in vertically integrated systems as in Germany. Thomas concludes that “all that is left of the competitive element of the model is the free market rhetoric” (Thomas 2006). There are several signs underlining this pessimistic perception: electricity prices are as high as they used to be under monopoly conditions; market actors now play oli- gopoly or duopoly rather than a free competition game; and vertical integration is still pervasive. Yet investment is indeed more risk related than it used to be under monopoly conditions, and with liberalization, this risk has been increasing. With regard to innovation, market liberalization can be expected to transform the selection environment for search and innovation decisions and changes, and may thereby weaken prevailing technological regimes (Markard and Truffer 2006). This is due to two effects: First, new market entrants may pursue new technology paths and thus cause technological competition, and second, competition theoretically also creates a need for more diversified, trendy products and services offered on the market in order to survive in competition, as is the case with many goods and services. It thus has the potential to increase innovation activities and variation on the firm level. On the other hand, competitive pressures may also reduce the efforts to risky and costly innovation. Pollitt and Jamasb (2005) review a broad body of literature on the effects of deregulation, unbundling, privatization and general restructuring of electricity systems on innovation and find that they are linked to a significant decline in R&D expenses, while R&D productivity increased with electricity reforms. Among the factors responsible for the decrease are smaller firm sizes, organizational diseconomies of vertical disintegration, and a decreasing propensity of private firms to take risks in an environment of increased uncertainty and a competitive market environment. On the other hand, a price cap regulation tends to increase technical progress, at least compared to rate of return regulation. Despite this rather pessimistic account, a number of indirect innovation incentives can be observed and related to national electricity market reforms, and at the same time show the differences between countries. One example is the generous provisions for cogeneration plants in Germany, which are unique in Europe. Germany introduced a bonus for electricity from cogeneration in order to protect it from too much competition. Another 20 2 Transformation and Innovation in Power Systems example is the rise of CCGT in the UK which is also a result of liberalization, which sees newcomers succeeding on the market with an innovative technology. In Germany, by comparison, structural dynamics and the coalition of actors in coal mining and coal-based electricity generation were powerful in holding back CCGT, namely in the conflict relating to the taxation of gas for power generation. Neither coal nor lignite has ever been subject to input taxation, but in the case of gas, such taxes existed and were relieved only for highly efficient plants. The underlying political negotiation process created considerable uncertainty for investors and thus troubled the early CCGT investors (Stadthaus 2001). In both countries, CCGT has suffered from high gas prices since 2005, which caused the window of economic opportunit ies for CCGT to be closed again.

2.3.2 Increasing Climate Change Concerns

Parallel to market liberalization, a second major – or macro – impact developed momentum: societal awareness of the risks of climate change increased continuously and thus also started impacting on the course and focus of innovation activities. Concerns about the environment are raising new heights with the upcoming awareness of human-made climate change. Up to now the increasing concern about the climate and the environment has led to a number of institutional innovations and a changing framework for technological and organizational innovations. A whole new business stream for environmental improvements developed. Building on the impulses from the oil shocks in the 1970s, an intense debate about the future of our energy supply started in the 1990s. Environmental concerns activated the use of more or less the whole environmental policy toolbox, with all possible instruments seeing their realization in one form or another: Ecological taxes and voluntary agreements, efficiency labeling, labeling of electricity, “green” electricity, funding of R&D in new technologies, emissions trading, feed-in remunerations for renewable energies and cogeneration, and all forms of market information and introduction programs and so forth were introduced. Governments set themselves targets for renewable technologies and for efficiency. This gave a major impulse for renewable energies and energy efficiency, and is likely to continue doing so, inspiring innovative actors to become dynamic innovators. The United Nations Framework Convention on Climate Change (UNFCCC) and its 1997 Kyoto Protocol formed the first international institutional framework for global climate change mitigation. International reports, such as the four IPCC assessment reports as well as a number of national reports (e.g. the Stern report on the economics of climate change) 2.3 Current Stimuli for Change 21 raised awareness and called for immediate action. The 2005 implementation of an EU-wide emissions trading system is a direct offspring of this process. The main impact of the EU ETS is to give CO2 emissions a price, thereby altering the setting for investment decisions. This, in turn, is a premise for technological innovations such as distributed generation or CCS. With the continuous growth of global emissions and growing concerns about global climate change, the European Union initiated a number of processes to keep the global temperature increase below 2qC. These include specific mid-term targets for emissions reductions, renewable energy shares, biofuels, and improvements in energy efficiency. An integrated energy and climate program, including a directive for the continuation of the EU ETS, for renewable energy, for CCS etc., is under development to ensure that these targets will be fulfilled. Similarly, the German government initiated an integrated energy and climate policy package to ensure that these targets and additional more stringent national targets are met. In the field of energy efficiency, the EU directive on energy efficiency and energy services (Directive 2006/32/EC) has been a major policy initiative. It is currently triggering, among other things, innovations in consumer feedback on their electricity consumption via improved electricity bills and other means. In the wake of these developments, interest in renewable energy sources and energy efficiency grew. “New” renewable energies beyond the established hydropower started developing momentum in terms of technological development, learning curves and related cost reduction, and market penetration. Supported by governmental programs and legislation, they entered into commercial electricity generation, albeit with different shares in total electricity supply in different countries, depending on the respective form and level of support. In Germany, for example, renewable energy took off with the Federal Feed-in Law in 1990 and even more with the Federal Renewable Energy Sources Act of 2000, which guarantees operators of renewable electricity generation technologies preferential treatment for their electricity feed-in as well as a fixed feed-in remuneration for usually 20 years. The share of renewable technologies rose to around 14% by the end of 2007 (BMU 2007), and Germany now ranks among the leading innovator and producer countries in the world in terms of the development and construction of solar cells (modules) and wind turbines.

2.3.3 Impulses from Technological Change

A third major factor impacting on transition processes in the electricity sector is technological change. New technological developments can be 22 2 Transformation and Innovation in Power Systems specific to the electricity sector, such as new or improved power generation technologies. They can also be of a rather generic type (e.g. information and communication technologies (ICT)) or progress in materials research and other fundamental science. Generic technological advances are flexible in their deployment and may, for example, enable improvements in generation and related technologies (such as high temperature conventional coal or gas plants) or increase the options available for consumer feedback (e.g. via smart metering, or smart houses). Technological change can interact with and even stimulate institutional change and influence the societal setting for innovation (Werle 2003; Rohracher 2007; Dolata and Werle 2007). In particular, modern ICT can be considered a prerequisite or even be core to stimulating regulatory and organizational reform in the electricity system. The operation of electricity exchanges, for example, is unimaginable without ICT. Liberalization of the electricity markets, in particular the unbundling of electricity generation, transport and distribution, and the implementation of electricity exchanges, presumes the existence of technological solutions for handling the enormous amount of information involved – which again is unthinkable without ICT. In fact, the universal character and impact of ICT can even be interpreted as a change in the ruling techno-economic paradigm (Freeman and Perez 1988; Dolata 2007), which – in the case of electricity – has the possible (or even unavoidable) consequence of major amendments in the institutional and technical architecture of the system. Similarly, the discovery and development of new material allows for better and more efficient generation and transmission technologies. The commercial development of inventions – such as the fuel cell or small-scale Stirling motors, renewable technologies as well as the development of more efficient fossil-based power plants (with or without integrated carbon capture) – is based on and entails further advancements in materials and mechanics. Technological change also has the potential of triggering change in the current generation structure of the electricity system. An example is the interplay of new technological developments on the level of generation. After decades of increasing returns to scale (with the result of ever increasing sizes of power stations), new generation technologies are rather smaller scaled or even of a distributed nature, such as small or micro cogeneration units and small or medium-size renewable energies. These technologies are often fluctuating in their provision of electricity to the grid and – so far – need to be balanced by other, quickly and permanently available, generation technologies. In this context, new technology developments and ICT solutions are important for integrating such sustainable technologies into a reliable overall electricity system. 2.4 Actors and Institutions of Change 23

It was also with liberalization in the 1990s that a comparatively new and highly efficient generation technology managed to spread successfully into the market and disarrange the incumbent system of large-scale electric power plants. The combined cycle gas turbine (CCGT), fired with natural gas, allowed electrical efficiencies of 56% and more to be reached, coupled with much lower investment costs of about 450–550€/kW, compared to 1,100–1,300€/kW for lignite or coal plants (Erdmann and Zweifel 2008). In the absence of advanced electricity storage technology, CCGT offered the “missing link” to fluctuating energy generation technologies. However, despite its comparatively low specific investment costs and its high efficiency, CCGT suffered more and more from increasing prices for natural gas. Its competitive advantage now lies in the peak load segment of electricity generation. In consequence, after an initial “dash for gas” (Winskel 2002) in the UK in the 1990s, followed by announcements of increasing numbers of CCGT in Germany, the number of actually commissioned and newly planned gas plants decreased in Germany, and also in the UK. Interestingly, in the UK, the advantages of CCGT were not attractive to the incumbent actors; it was newcomers to the market who realized its enormous potential in a mix of coincidence and contingence (Winskel 2002: 585). This highlights the role of both liberalization as a setting to change, and of actors taking their chances in such a changing environment, in successful transition processes – an aspect to which we shall now turn.

2.4 Actors and Institutions of Change

All of the above “macro” impact factors are interlinked. Also, the coevolution of technological advancements and institutional change as stipulated by Hughes (1987) or Nelson (1994), and its relevance to sector transitions, are already at hand. Transition, moreover, needs action, and the role of actors and actor networks in realizing possible changes deserves more attention than it receives in many cases. The institutional setting forms a framework for innovation, but is also subject to change and innovation itself. It is both external and internal to the electricity system and its components. It consists of the regulation and administration of grid access, standards and technical norms, plus the setting of political regulation such as feed-in remuneration, priority grid access, policy instruments such as ecological taxes or emissions trading, and fiscal law, for example with respect to energy taxes and exemptions or subsidies in general. In addition, new institutions like power exchanges or independent system operators (in, for example, the UK but not in Germany) 24 2 Transformation and Innovation in Power Systems are also relevant framework factors. Institutions impact on the administrative, technological and economic feasibility and viability of innovations and their implementation. It seems superfluous to point to the fact that actors are core to any change, be it of institutions or by introducing new artifacts to the electricity system. Actors are responsible for inventing and for spreading novelties. Actors are equally accountable for blocking unwanted innovation. What is more, actors tend to form networks, and networks are usually more powerful and more successful in pushing their ideas through than individual actors. They are even stronger when they manage to integrate complementary or even competing forces such as research actors, politicians and industrial stakeholders. In the case of innovation policy and politics, this insight led to governmental support for the formation of knowledge networks, as can be found in the fields of renewable energy and CCS, for example. Also, ministerial or interministerial “working groups” on energy legislation and policy formulation, with invitees from industry, NGOs and inputs from the research community, are a popular means to advance innovation and innovation policy. The system of actors in electricity and innovation is complex to grasp and varies, depending on the specific innovation. It includes the whole product and process chain, starting from the manufacturers of generation and transmission technologies, the electricity utilities themselves, the appliance and engineering equipment industry, and eventually the commercial, industrial and household consumers. These actors are surrounded by regulating and stimulating institutional and policy actors, and by a research community as diverse in their focus and interest as the other different elements of this large technological system. Also, many of the concrete impulses for changes on the national level stem from international sources and the European Commission, a prominent example being the EU ETS or CCS. All in all, there are multiple forms of potential linkages and networks and their innovation impacts; assessments of the respective sub-networks or settings of actors will be presented in the innovation cases that follow.

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So far we have discussed selected aspects of the electricity system and its transition over time. We surveyed the evolution of the technological, institutional and structural components of today’s electricity system in Germany, and assessed indicators for the diffusion and success of innovation as well as for its path dependency. All of these aspects are a necessary background for our research. However, both statistics and standardized indicators miss explanatory power with regard to the dynamics of innovation. While they are an important ingredient in capturing the innovation history and technological developments, they fail to capture the coevolutionary dynamics within the process of innovation and the interactive relation between the different elements of the electricity system in the innovation process, and they fail to indicate possible drivers and driven, and barriers to innovation in the electricity system. As we are interested in identifying options and the need for shaping the innovation and transformation path towards a sustainable future electricity system, we need a more complex conception of innovation and a more systemic understanding of the processes involved. For this purpose, we first clarify the concept of innovation used in this book, and also the definition of sustainability as applied in analyzing the innovation cases. We then discuss suggestions for systemic perspectives on innovation dynamics with regard to their usefulness for the purpose of the innovation cases analyzed in this book. From this basis we derive the research design applied to the innovation case studies in this book.

3.1 Conceptualizing Innovation

A sustainable transformation of electricity systems can be thought of as the aggregate result of appropriate innovations at the level – or on various levels – of the elements that make up its overall structure. In our understanding, innovation is not restricted to technological advances of products and processes. It also includes changes in the organizational and conceptual dimension of electricity provision. Innovations in 30 3 Towards a Systemic Understanding of Innovation electricity are of a very diverse nature. They comprise new generation, transmission and end-use technologies, new management concepts, product offers, industrial processes and forms of business organization, new user routines, imageries and attitudes, new roles and identities of electricity customers, new policy problems, regulatory concepts, institutions and governance arrangements. Hence, for understanding the transformation of electricity systems, it is necessary to understand the heterogeneity of the underlying innovation processes, the factors that influence them and the way that they interact with each other. Starting from these thoughts, and based on a literature review and intensive discussion, we defined a concept of innovation as common frame of reference and guide of our research: We understand innovation to be the intentional, goal-oriented invention, development and implementation of socio-technical novelty in the electricity sector that is seen to solve a problem or is perceived as an improvement by a social group or actor (TIPS 2003). Intentional, goal-oriented. To qualify as an innovation, a novelty must be promoted by intentional, goal-oriented human action. A discovery may be made by chance, but to count as an innovation, there must be conscious considerations on how to develop and implement it. However, the qualifi- cation of innovative action as intentional and goal-oriented does not imply that the process and its final outcome are fully under control. On the contrary, innovation is a complex process full of unintended side effects that may turn in completely unexpected directions. New actors may join the process and lend it a new twist, new properties of the innovation may be discovered, political or economic factors may change the course of the process, or interactions between all of these factors may take place. The actual innovation journey can therefore be understood as a “trans-intentional” result of goal oriented interaction. Invention, development and implementation. An innovation process has different phases. The innovation is not completed with the invention (cognitive construction or discovery) of a novelty. The invention needs to be developed into a model or prototype which is adapted to the actual conditions of its practical realization. These conditions include availability and physical features of materials, requirements of the production process, organizational procedures, needs and routines of users, aesthetical pre- dispositions, institutional framework conditions, etc. In order to actually contribute to the solution of a perceived problem, however, the innovation also has to set into effect (i.e. be implemented) within real world contexts. In our case, this means that the model or prototype needs to become effective as part of the operational working of the electricity system. For a product innovation, this means market introduction and diffusion; for a 3.1 Conceptualizing Innovation 31 policy innovation, it refers to the actual implementation and enforcement of measures, for a social innovation it means the diffusion and stabilization of social attitudes and norms of behavior among relevant parts of society. For the selection of innovation cases, this meant that we did not only consider “new” inventions, but also looked at ideas or prototypes of technologies, or innovative behavior or policies that have been known for some time, but have not yet completed their respective “innovation process”, as its implementation (either market introduction, diffusion or policy enforcement) is still under way. In conceptualizing innovation by a phase heuristic of invention, development and implementation, some implications need to be clarified. First, it is important to realize that the heuristic distinction of phases is not always as clear in empirical reality. Phases may be temporally or spatially detached: an invention may be made at a specific point of time in a certain country, and only be implemented much later or in a different country. Moreover, the phases may not appear in a linear order but include iterative cycles and feedback between the different phases. Such is the case when changing conditions of implementation require adaptations of a prototype or when development capacities (e.g. laboratory infrastructure or political alliances) guide increased efforts in search of new inventions. Another problem is to determine at which point of implementation an innovation process is completed. Certainly, there is a point in time when a (former) novelty is so firmly established that effects from further diffusion or improved implementation are only marginal, meaning that they cannot count as part of the innovation process any more. But where exactly is this point? A helpful guideline is to consider the point at which an innovation starts having effects that are relevant to the operation of the electricity system. Naturally, the definition of this point depends on the type of innovation. A new product may become effective when it has reached a certain market share, when its potential market is saturated, or when market penetration has reached its climax and starts to slow down. Behavioral change may be defined as effective when it is firmly established among a sufficient number of people to have an effect on markets or on the environment. A policy becomes effective through guiding social interaction processes. Social, technical and socio-technical. Our concept of innovation comprises both social and technical novelties. Technical novelties may be new materials, product components, products or production processes. Social novelties comprise new lifestyles, habits, attitudes and values, social relationships, routines, organizational processes, institutions, political regulations, organizations and the like. In modern societies, many innovations are of a socio- technical nature, necessarily combining social and technical elements. To 32 3 Towards a Systemic Understanding of Innovation have an effect, technological developments on the one hand depend on their social context (for example, appropriate legal frameworks or a reorganiza- tion of the work flow). On the other hand, they influence and re-shape the social world (for example, by generating new patterns of use). In complex innovations like the World Wide Web or mobile phones, technological solutions interact and coevolve with behavioral changes, new habits, reorgani- zation of work processes, the development of adequate legal frameworks, operating arrangements and more. Novelty. To qualify as a novelty, we require that something is new to the context to which it is being introduced. It need not be new to the world. Since the conditions for adaptation, development and implementation differ, the process of innovation needs to be studied separately for varying contexts. Solving a problem or being perceived as an improvement by a social group or actor. Many theorists define innovation normatively, claiming that they lead to more effectiveness or efficiency, improve living conditions or make society more humane. In our research, however, we stress that the expectation of improvement or problem solving is the core motivation for delib- erately undertaking innovation activities. That means innovation can be triggered by a problem that cannot be solved in the context of the existing system architecture (similar to the notion of reverse salients by Hughes 1983). However, there is no such thing as “objective” improvement or problem solving. Improvement is always improvement for a certain actor; a problem is somebody’s problem. One group’s solution may be another’s problem; one group’s improvement another’s impairment. In the electricity sector. To identify an innovation, it is important to specify the system of reference which is supposed to be affected. In our research, we concentrated on innovations that have an effect on the sector level in the electricity sector. Thus, we exclude certain novelties from scrutiny which may usually count as innovations. For example, we do not deal with the restructuring of the production process in an individual power plant if it is not potentially relevant for the whole sector or has little or no potential effect on sector processes and structures. In practice, these different components make up a seamless web of innovations. But for analytical purposes, it is helpful to distinguish a cluster of core innovations from impacting innovations and induced innovations (Fig. 3.1). The core innovation is the product, technology, institution or policy strategy that forms the focus of a particular study. Impacting innovations are innovations that influence the core innovation’s functioning or development process. Induced innovations are further innovations that are influenced by the core innovation. 3.1 Conceptualizing Innovation 33

Fig. 3.1 Innovation cluster as analytical framework

However, there is no unidirectional cause-effect relation between the core innovation on the one hand and the promoting (or enabling) and induced innovations on the other hand. Innovations mutually influence each other in the sense of coevolution. The above distinction between “core”, “promoting” and “induced” innovation is therefore rather analytical, intended to depict the dominating direction of influence. If, for example, we focus on micro cogeneration as a core innovation, we find that a combination of technological change, such as the development of a new energy converter (fuel cell, Stirling engine), and changing user and producer patterns and practices (on-site power production, third- party services, etc.) are necessary to bring it into effect. Innovations in the institutional framework, retail and service infrastructure, social image, housing patterns, etc. can be considered inducing or enabling innovations in so far as they facilitate the development of the core innovation. Its effective implementation, on the other hand, may influence further innovations such as integrated facility management, building standards or new business models of service provision. If we choose informative energy bills as a core innovation, we can identify smart meters and internet-based information and billing techniques as enabling innovations and the diffusion of new energy saving devices as induced innovations. 34 3 Towards a Systemic Understanding of Innovation

3.2 Sustainability

The fundamental definition of sustainability as applied in most concepts can be traced back to three constitutive elements: an inter- and intragenera- tional justice, a global and an anthropocentric perspective (Brandl et al. 2001). A general scientific definition would refer to the long-term viability of social systems within an ecological context. However, the transformation of this concept into concrete targets, rules derived from these targets or even indicators describing the state and the dynamics of our society with respect to these targets has since been con- troversially discussed. For instance, the discussion of the substitution of natural by human made capital (strong and weak sustainability), of the relative importance of the environmental, social and economic dimension, of the manner in which the integration of these dimensions is accom- plished and of ways how to deal with conflicts between the dimensions is still ongoing. In all of these discussions, a compromise between explanatory power and dilution, between universality and applicability, and between transparency and complexity of the sustainability concept has to be found. For the purpose of this book, in which innovation and transformation processes were identified, described, assessed and anticipated, thus combining descriptive and normative elements, the sustainability concept can serve to: x exclude certain aberrations and assess what Bossel calls the accessibi- lity space (Bossel 1999): a space of possible future developments as constrained by physical conditions (carrying capacity, laws of nature, etc.), by social conditions (ethics, institutions, actor constellations, etc.), and by the dynamics of the system. For this purpose, sustainability helps to provide “guardrails” for development trajectories under the conditions of profound scientific uncertainty, e.g. to define “safe minimum standards” for certain problem areas to avoid developments which otherwise would turn out ex post to be unsustainable. x assess the dynamic viability of societies and their constitutional parts to characterize the ability – under the condition of profound uncertainty and changing social values – to cope with internal transformation and with different developments of the environment (“a sustainable society must allow and sustain change” (Bossel 1999: 4)). This means that for the purpose of this book, a balance of two objectives must be achieved: 3.2 Sustainability 35 x To allow for change, sustainability has “to build on an ongoing process of defining objectives” (Minsch et al. 2000), i.e. sustainability cannot provide a defined set of instructions for our actions, but rather has to give us the direction for possible solutions and guarantee that the search process of society and the required flexibility and adaptability are present. Therefore sustainable development is rather “a regulative idea that should be able to lead the political discussion into the right direction without determining it” (Minsch et al. 2000). x To provide the necessary guardrails, however, the concept needs to be substantiated to make available a framework for analysis. Numerous attempts to define sustainability and its underlying rules as well as sets of indicators, both generally and for the energy sector, have been undertaken. The notion of sustainability referred to in this book is based on the guidelines for a sustainable energy system developed by the HGF project on sustainable development in Germany (Nitsch et al. 2001) and further elaborated by the German Enquête Commission “Sustain- able Energy System” (Enquête 2002). These two long-term research and consultation processes represent probably the most comprehensive review and discourse of defining sustainability for electricity in Germany. A summary of the criteria and guidelines is provided in Box 3.1. Defining and agreeing upon such guidelines is not as straightforward as it may seem. To go one step further, i.e. to delineate precise preconditions for electricity to be sustainable, is almost impossible. Trade-off effects between material wealth, security and environmental protection are subject to societal and economic value assessments. Knowledge and values may develop over time (Walker and Shove 2007). Also, the effects of a particular innovation within the context of the electricity system as a whole cannot be easily predicted (Grunwald 2007). Any assessment is based on planned designs which, however, may change significantly until the innovation is actually implemented on a large scale. Sustainability effects also depend on the interaction with many other innovations. Therefore, although we used advanced methods to evaluate the sustainability impact of innovations and tried to take these aspects into account, our assessment must remain preliminary and probably also incomplete. 36 3 Towards a Systemic Understanding of Innovation

Box 3.1 Guidelines for a sustainable energy system. Source: adapted from Nitsch et al. (2001) and Enquête (2002) Distributional justice: Access to energy resources/services for basic needs, such as heat, light, sanitation and cooking, but also to information, for all people. Needs-oriented use and stable security of supply. The energy required for satisfying sustainability-compatible needs must be supplied permanently, in adequate amounts and according to the geographic and temporal demand. This implies a geographic and fuel diversification and security margins to allow adaptability to unforeseen crises and sustain or enlarge the future window of opportunity. Resource protection. This is essential for future generations. It implies increased energy productivity, the use of renewable energy resources and closed material flows. The use of biotic resources should not exceed their growth rate. Environmental, climate and health compatibility. The capacity of nature to adapt and regenerate should not be stressed. Climate gas and other emissions must be drastically reduced, water quality be secured and radioactive waste be ceased. Risk reduction and fault tolerance. Unavoidable risks and hazards of energy conversion and distribution have to be minimized principally and constrained in terms of geographic and temporal range. Mistaken conduct, improper handling and will- ful demolition have to be taken into account. Social compatibility. Concerning the design of future energy systems, participation of all concerned people in decision making must be guaranteed. This implies democratic, decentralized decision structures as well as know-how building. Mino- rity rights must be protected. Social compatibility also means a socially acceptable transition towards future energy systems. Adaptability. Any shaping of the energy system must leave scope for flexible adaptation to unpredictable future developments. In order to increase societal learning capacities, sustainable energy generation and use must become an integrated topic in higher education. Comprehensive economic efficiency. Energy services – in relation to other economic activities – must be supplied at acceptable total costs, where “acceptable” means both the preservation of microeconomic viability, and reflection of total societal costs, including external social and ecological costs. International cooperation. On an international level, future energy systems must be designed in such a way that they do not destabilize the world due to, for example, unfair distribution of resources, and promote peaceful cooperation. Leapfrogging of modern technologies shall help emerging countries to grow energy efficiently. 3.3 Systemic Perspectives on Innovation in Literature 37

3.3 Systemic Perspectives on Innovation in Literature

We now turn to concepts of innovation and its dynamics that have been recently put forward by other authors. These approaches partly form the background for the case study design and therefore require a short description and discussion. Among them, perhaps the most influential approach in conceptualizing innovation is the evolutionary economics perspective as advanced by Nelson and Winter (1982). In combining a system perspective with a micro perspective on the actors of innovation, they show that innovation is a process of coevolution on different levels. Decision making on the level of the individual and of the firm is restricted by bounded rationality (Simon 1957; Williamson 1985). Information is costly and sometimes not available. Decision makers are hence confronted with significant uncertainty and risk. The resulting challenge for the firm is to use decision-making rules to deal with information deficits and minimize the related risk, and adjust these rules when they turn out to be inappropriate. The evolutionary perspective also introduces notions such as path dependency, learning and irreversibility to the analysis. On the system level, the established technological paradigm and trajectory (Dosi 1982) form a stable frame which tends to be reluctant to substantial change. In addition, the specific characteristics of large technological systems such as the electricity system, in particular the size and interlinks of the system elements, imply a certain inertia to change (Hughes 1983, 1987) and thus a considerable risk of lock-in in the well-established structures. The idea to conceptualize innovation dynamics in more complex systems of innovation can be traced back to Lundvall (1985), followed by a number of authors such as Nelson (1993), Freeman (1987, 1991) and Edquist (1997). Innovation systems can be categorized by geographical terms (e.g. national, regional, local) or by focus (technological or geographical). For example, the concept of national innovation systems has increasingly been operationalized by governmental and related bodies in order to frame innovation processes on geographical levels (OECD 1997, 2001). Compared to this, technological innovation systems are an analytical category for understanding the underlying dynamics and identifying starting points for forming innovation processes. Carlsson and Stankiewicz (1991) define technological innovation systems (TIS) as “network(s) of agents interacting in a specific technology area under a particular institutional infrastructure for the purpose of generating, diffusing, and utilizing technology” (Carlsson and Stankiewicz 1991), thereby not restricting a TIS to a specific technology but to a set of contextual factors around a technological core. Innova- tion system studies capture the elements and the structure of technological 38 3 Towards a Systemic Understanding of Innovation innovations. However, for the analysis of change and its determinants, such a static approach is not sufficient. The multilevel perspective put forward by Rip and Kemp (1998) and further developed by Geels (2002, 2005) goes one step further, following on from the idea of technological regimes of Nelson and Winter (1982). They conceptualize innovation as a dynamic, multilayer transformation or transition process. In their perception, the start and breeding point for any innovation are niches of deployment. From there, a successful innovation may succeed to diffuse into the broader regime and trigger adjustments on the “socio-technical regime” level which are required for its broader diffusion. The regime level captures the prevailing technological regime and related actors networks and thus captures the incumbent, well-established elements and inertia of (large) socio-technical systems. In fact, technologies become innovations only when they are actually deployed in more than a niche, and for this they need to be embedded in existing socio-technical contexts. The top layer or “landscape” level is even more resilient to change: it describes the societal setting of values, general or macro trends and other, rather persistent factors. This heuristic framework has been applied to many innovation studies (Elzen et al. 2004; Mahapatra et al. 2007; Raven 2007). In fact, the concept is so open and flexible that it allows integration of different streams of thinking, such as actor network theory, social constructivist approaches, or LTS concepts, to explain the emergence and stabilization of technology on the one hand, and economic, sociologi- cal and socio-technical diffusion analyses to explain successful diffusion dynamics on the other. Even the idea of long waves of technology regimes may be combined with describing developments on the landscape level (Geels 2004: 40). Both the multilevel heuristic and Hughes’ large technological systems framework are descriptive in their nature and were mainly developed using historical case studies. In contrast, the innovation functions approach put forward by Jacobsson and Bergek (Jacobsson and Bergek 2004; Bergek et al. 2008) focuses on a set of functions required for the creation and success of a new technological innovation system whose assessment forms the starting point for strategic or policy considerations. They suggest that the performance of the TIS is assessed with the help a set of functions, capturing core preconditions and dynamic features of a successful TIS. One such important precondition (and thus function) for a successful TIS is a proper level of legitimacy, which may find its expression as public concern, social acceptance, interest groups and, in the best case, as governmental state- ments and actions such as a policy target. Other functions include the need for the development and diffusion of knowledge, the availability and mobi- lization of financial and other resources for fostering the innovation, or 3.4 Design of the Innovation Case Studies 39 the emergence and development of entrepreneurial experience in the new technology, which goes hand in hand with market formation (Jacobsson and Lauber 2006). Methodologically, the mapping of these functions can lead to a storyline of the different functions and their evolution over time. Based on this, drivers and barriers of the innovation can be traced and patterns of the innovation be identified. Insights into these patterns can then help to formulate policy recommendations for shaping the course of innovation dynamics (Hekkert et al. 2007).

3.4 Design of the Innovation Case Studies

The above literature overview shows that the academic discourse on the sources and dynamics of sustainable innovation processes in the electricity system is far from offering a one-off, single, path-breaking concept. The overall dynamics and direction of transformation of the electricity system are too difficult to grasp. Drivers of innovation can be multifold and interdependent, and so is the perception of drivers and driven by scholars. Focusing a research project on only one perspective – be it ecological, economical, technical, or political – runs the risk of producing answers which ignore important influences on the remaining parts of the system. Integra- ting the different perspectives, therefore, appears to be crucial for producing research results which address real world interdependencies and offer answers relevant to societal problem-solving. The research challenges increase even further in terms of complexity when the idea of an assessment of the sustainability of an innovation becomes an integral part of the analysis. To this end, an interdisciplinary approach to integrate social and natural science perspectives is required. There have been a few attempts to integrate or combine different disci- plines. One line is the attempt to conceptualize and compile the conditions of long-term change in large technical systems like electricity provision (Mayntz and Hughes 1988; Kemp 1994), or the above-mentioned multilevel and multiactor heuristic of socio-technical change as developed by Rip and Kemp (1998) and Geels (2002). Other approaches are more directly based on the idea of path dependency and lock-in, and thus also at the idea of a self-sustaining process of cumulative causation (Jacobsson and Bergek 2004) once an innovation is successfully initialized or implemented in a niche. However, many of these (and other) approaches are rather multi- than interdisciplinary, and it is no surprise that disciplinary backgrounds continue to be formative for the perception of the world and the relevant analytical variables, even in the case of interdisciplinary researchers. The 40 3 Towards a Systemic Understanding of Innovation result is that the employed conceptual setting and the related analytical outcome varies with the discipline (Geels 2006). The approach followed in this book borrows from several of the above conceptions and integrates the idea of a detailed sustainability assessment into the analysis. In five case studies, we study the sustainability impact and potential of innovations on the level of governance, technology and consumers. The aim is to learn about common features and differences in order to better understand the overall dynamics of innovation processes in the electricity system. We analyze the potential contribution of our innovation examples to a sustainable electricity system transformation and point out the challenges and the unexpected, tricky aspects. We study the course of the innovation and assessed the potential of shaping the implementation process with regard to a sustainable electricity transformation path. We try to understand success and failures as a basis for deriving starting points for strategic action by government. An important level of analysis is to understand the role and influence of actors and networks, and of politics. Innovations may also compete or even conflict with each other. Such areas of conflict are identified and conclusions for possible paths to the future be depicted with reference to the conditions under which they would be likely to unfold. The cases represent examples of innovation processes from different areas of the electricity system, namely technology, user practices, and governance. Empirically, we look at innovations in the areas of distributed generation, central clean-up technology, consumption practices, environmental regulation and electricity network regulation. Despite evidently fundamental differences in the characteristics of the considered innovations, a comparable analytical structure for the innovation cases was designed, so that all case studies follow the same structure. We first describe and assess the innovation with regard to its sustainability or contribution to a more sustainable electricity system. We then trace the innovation process and eventually analyze the potential for shaping the respective innovation process. The main components of each case study are thus: (1) a description of the respective novelty, its innovativeness and its different design options, (2) an assessment of its expected sustainability and electricity system impact, (3) an analysis of the innovation process, with the aim to describe the origin, the factors and structures forming the process of innovation development and diffusion, and to identify the inducing and blocking mechanisms, and (4) an essay on the options of shaping the respective innovation, given its sustainability potential and the existing dynamics and barriers to its diffusion. Major descriptors of the innovation dynamics are the origin and transfer mechanisms of the innovation, context factors, and the setting of actors. We look at inducing and impeding factors, and conclude with suggestions References 41 for shaping the underlying dynamics. A brief summary of these aspects is presented in a table at the end of each case study. A comparison and discussion of these cases with respect to the lessons learned on innovation dynamics in the electricity sector is provided in the last chapter of this book.

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4.1 Micro Cogeneration as an Innovation Cluster

Micro combined heat and power (micro cogeneration) is the simultaneous generation of heat (or cold) and power on the level of individual buildings, based on small energy conversion units (below 15 kWel ) which are usually fuelled by natural gas or heating oil. The heat is used for space and water heating inside the building, whilst electricity is used within the building or fed into the public electricity grid (Fig. 4.1). With the help of modern communication technologies, micro cogeneration could also be controlled centrally and integrated into an ensemble of other generation or load management technologies, forming a so called “virtual power plant”.

Energy converter Energy converter Energy converter Communication Data technology

Electricity

Energy Fuel supply Grid access Fuel converter

Heat Energy management

Energy service to customer

Fig. 4.1 Technological components of a micro cogeneration system

Micro cogeneration could contribute to the transition of the traditionally centralized energy supply system towards a more sustainable system. It has the potential to enhance overall efficiency, to reduce carbon dioxide (CO2) emissions and to contribute to a more reliable energy system and a more competitive energy market. The generation of power close to the point of

* By Martin Pehnt and Barbara Praetorius. This chapter is a summary and update of Pehnt et al. (2006). We would like to thank Katja Schumacher for comments on an earlier version. 46 4 Micro Cogeneration use in individual homes and the subsequent decentralized structure of supply reduces the need to transport power over long distances and could increase the reliability of power supply. Micro cogeneration increases consumers’ choice with regard to their energy provision and has the potential to increase competition depending on the mode of deployment (e.g. by the introduction of energy service contracts for micro cogeneration). Despite these expected benefits, deployment of cogeneration has been slow to date. This chapter looks at the dynamics of micro cogeneration diffusion, with a particular focus on the German market. We explore structural and functional elements of the related innovation system and analyze the functions and factors that promote or prevent the emergence of such an innovative technology within the existing German energy system. Micro cogeneration was chosen as the subject of the case study because it offers a rewarding opportunity for studying the conditions facing innovations in potentially unfavorable regime contexts (Pehnt et al. 2006; Praetorius et al. 2008). The innovativeness of micro cogeneration goes beyond the conversion unit as a technical artifact. It may rather be conceptualized as a socio- technical innovation cluster and not as a technological innovation alone, even more so since the technologies it builds upon have been available for a long time (Pehnt et al. 2006). Within this cluster, the development and diffusion of conversion technologies for micro cogeneration interact with other innovations which may promote or inhibit the application of micro cogeneration. Vice versa, these innovations may be promoted or inhibited by developments in the conversion technology for micro cogeneration. The cluster comprises various interdependent innovation processes, of a social as well as technical nature. Figure 4.2 provides a schematic sketch of the micro cogeneration innovation cluster. The technical artifact “micro cogeneration”, i.e. the energy conversion unit, is the focal innovation at the core of the cluster. In a first step, other technological, institutional, or cultural innovations which are linked to the focal innovation can be divided into three types, according to the dominant kind of relational influence they have with respect to the focal innovation. Promoting innovations such as Third Party financing schemes, maintenance and service networks, remuneration of avoided transmission costs by network regulation, or heat storage technologies, provide favorable conditions for the focal innovation. Micro cogeneration technologies may also act as a driver for and induce other innovations, such as virtual power plants, integrated facility-management services, or adaptive networks. At the bottom of the figure, a number of competing innovations are listed, such as district heating, thermal solar collectors, long-distance import of solar electricity. They belong to rival socio-technical configurations and 4.1 Micro Cogeneration as an Innovation Cluster 47

Fig. 4.2 Micro cogeneration innovation cluster may impede micro cogeneration development – or become inhibited by it themselves, depending on which innovation is leading the technological competition for deployment or for resources. The remaining chapter is organized as follows. In the next section, we introduce technological design options and sustainability potentials for micro cogeneration. This includes a discussion of operation schemes and system level impacts of an increased introduction of micro cogeneration. An analysis of the environmental impacts and economic viability of technological design options highlights differences between the distributed supply of electricity and heat, i.e. micro cogeneration, and the centralized supply of electricity and heat. The results are reflected in scenario analyses of the potential contribution of micro cogeneration to a more sustainable electricity system. Against this background, we then outline the innovation process and the inducing and blocking mechanisms inherent to this process, and thereby explain the (slow) diffusion of micro cogeneration in Germany. We draw conclusions for shaping the innovation process in order to improve the prospects of micro cogeneration. We end with a summary of the state and perspectives of the innovation system micro cogeneration in Germany. 48 4 Micro Cogeneration

4.2 Design Options and Sustainability Potential

4.2.1 Technological Variations

The technological roots of micro cogeneration date back to the early development of steam and Stirling engines in the eighteenth and nineteenth century, respectively. Today, there are several technologies which are capable of providing cogeneration services. The conversion process can be based on combustion and subsequent conversion of heat into mechanical energy, which then drives a generator to produce electricity (e.g. internal combustion reciprocating engines, Stirling engines, gas turbines, steam engines). Alternatively, it can be based on direct electrochemical conversion from chemical energy to electrical energy (i.e. fuel cells). Other processes include photovoltaic conversion of radiation (e.g. thermo photovoltaic devices) or thermoelectric systems (see Pehnt 2006 for a detailed review of available technologies). The various technological micro cogeneration systems are at a differ ent development stage today (Fig. 4.3). Reciprocating engines are well- developded technologies; based on products from the car or appliance industry, they have been adapted to the requirements of micro cogeneration. Reciprocating engines are mostly conventional piston-driven internal combustion engines. For micro cogeneration applications, spark ignition (Otto-cycle) engines are typically used, comparable to those used in auto- mobiles. Stirling engines are currently entering the market. Unlike spark-ignition engines, for which combustion takes place inside the engine, Stirling engines generate heat externally. Owing to continuous combustion, Stirling engines offer lower emissions, and, due to the fact that fuel combustion is carried out in a separate burner, high fuel flexibility. This makes them suitable for bio-fuels, and, in principle, for other heat sources, such as concentrated solar irradiation. Fuel cells are still in the R&D phase, with a variety of designs being developed, and a number of pilot plants currently being tested. A fuel cell converts the chemical energy of a fuel and oxygen continuously into electrical energy. In the case of hydrogen, the energy incorporated in the reaction of hydrogen and oxygen to water will be partially transformed into electrical energy (Pehnt 2002). Fuel cell micro cogeneration units are either based on Polymer Electrolyte Fuel Cells (PEFC; also Proton Exchange Membrane Fuel Cell, PEMFC), using a thin membrane as an electrolyte and operating at about 80°C, or Solid Oxide Fuel Cells (SOFC), which are high-temperature fuel cells operating at 800°C. As hydrogen is not yet broadly available, fuel cells in stationary (micro cogeneration) applications are typically fuelled by natural gas which is converted into hydrogen in a 4.2 Design Options and Sustainability Potential 49 so called reforming reaction. This takes place either in a separate device, the reformer, or, as in the case of high-temperature fuel cells, inside the stack (internal reforming). In the last decade, considerable efforts have been made to further develop the fuel cell technology, mainly by research institutions and small firms, partly supported by larger boiler manufacturers or energy utilities. Challenged by long development times and capital costs that were still high, a number of companies had to stop their development or drastically shift their anticipated market entry date. Currently, the PEFC appears to become the dominant design for small-scale (residential) applications. A number of other technologies for micro cogeneration energy conversion are currently under development (such as steam expansion or Rankine steam cycle engines, or thermo-photovoltaics), but they will not be discussed here in more detail.

Research and Demonstration Commercialisation Market diffusion development

Development of a new Scale-up to commercial First introduction into Technology mature idea size commercial market (e. g. Lab-scale development Prototypes, field tests in niches)

Reciprocating engine

Stirling engine

Fuel cell

Steam expansion engine

Further technologies e. g. Thermophotovoltaics Time to market introduction

10 years or more 5 years1 year 0 years

Fig. 4.3 Status of market development of micro cogeneration technologies (Pehnt 2006)

4.2.2 Operating Schemes

Micro cogeneration may potentially change the traditional roles attributed to the private consumer. Typically, households purchase and consume electricity from the grid and produce heat with a heating unit owned by 50 4 Micro Cogeneration them (or the house owner). With a micro cogeneration unit installed in their house, they become electricity producers and may sell electricity to the grid. Micro cogeneration systems can be run in two different modes, either electricity-driven or heat-driven. In the first case, the unit is designed to satisfy the electricity needs of a customer, and the heat is used to contribute to water and space heating. In this case, a supplemental peak boiler may be required to meet total heat demand. In the second case, the micro cogeneration unit is sized to meet the heat demand while electricity is either used internally or exported to the public grid. The decision for either mode depends on the economics. The last few years have witnessed an increasing variety of ownership and deployment models for any form of energy supply in buildings, such as contracting and third party financing schemes. Similar to energy efficiency investments, such schemes aim at sharing financial risks (and potential gains) and at appropriating the economics of experience and of scale incorporated in professional external operators. Depending on their accu- mulated know-how and the number of establishments they contracted, professional external operators are able to negotiate better conditions for the initial investment (e.g. by purchasing larger numbers of machines), and they benefit from experience in related administrative and operational maintenance issues. In Germany, this has been the typical model for micro cogeneration up to now, involving local energy agencies or contracting sub-units of the electricity or gas industry; they usually own and operate the micro cogeneration unit. The availability of such external operator schemes obviously depends on the margin they are able to realize when offering their services. Given the economic features of micro cogeneration today, this model is mostly not (yet) viable for smaller-scale micro cogeneration units. Some other operating schemes and variations of this model are also thinkable. To give an example, Sauter et al. (2006) suggest a “Plug and Play” model in which the micro-generation unit is owned and financed by the homeowner. They also discuss a “Community Microgrid” model in which consumers choose to set up a local network of micro cogeneration units. In addition, either operation scheme could be combined with leasing concepts and with different operation modes. For example, the units may either be operated to serve households needs, with some surplus electricity sold to the grid occasionally, or – as a “virtual power plant” – according to the needs of an energy company so as to help balance supply and demand, and to avoid buying electricity from other sources. The latter would presume that the heat generated by the micro cogeneration unit can be used 4.2 Design Options and Sustainability Potential 51 by the customer or stored within a suitable medium, such as water heat reservoirs.

4.2.3 System Level Impacts

Whether or not micro cogeneration can contribute to a sustainable system depends – among other factors – on its impacts on the system level, and on its environmental and economic features. On the system level, a broader diffusion of micro cogeneration would have major technical impacts which need to be considered. The distributed nature of micro cogeneration systems influences the various technical systems involved in its deployment (e.g. electricity network) and markets (e.g. heat market). The impact of micro cogeneration on the electricity network is mostly beneficial. As generated power is mainly consumed on site, congestion of the distribution and transmission system is lowered. As a consequence, distribution and transmission losses are decreased and upgrades of the system may be deferred if micro cogeneration plants are properly sited. However, increased market penetration of micro cogeneration could also raise several challenges for network operators. The capacity of equipment (transformers, power lines, fuses, switches, etc.) may not be suitable due to changed or reversed power flows. With many dispersed generators, the voltage could vary beyond established limits and, in some cases, protection of the distribution network – e.g. in cases of maintenance work – may become more difficult with distributed generators (Jenkins et al. 2000). These restrictions can in some instances be overcome by improvements to the power plants, such as filters, current limiters and, in the case of fuel cells, smart AC/DC converters. In other cases, the restrictions may necessi- tate modifications of the grid (Schneider and Pehnt 2006). For energy supply security, the broad diffusion of micro cogeneration will primarily have positive effects, both in terms of fuel supply security and in terms of the reliability of electricity networks. Micro cogeneration may reduce the dependence on fossil fuels by enhancing energy efficiency. Nevertheless, with natural gas being the preferred fuel at present, risks associated with gas dependency must be kept in mind and reduced in terms of importance by means of fuel diversification and development of renewable fuel micro cogeneration.

4.2.4 Ecological Performance

The ecological performance of micro cogeneration units is assessed using the life cycle analysis (LCA) method. It leads to somewhat ambiguous 52 4 Micro Cogeneration results (Pehnt and Fischer 2006): Compared to separate generation and supply, the combined production of electricity and heat in micro cogeneration units clearly results in primary energy savings and greenhouse gas (GHG) benefits. Based on natural gas as a fuel, GHG emissions per kWh electricity and heat produced are typically 20% – and under certain circumstances up to 45% – lower in comparison to a combination of condensing boilers in the household, and electricity generated in modern gas fuelled combined cycle power plants. The emission reduction is even more obvious if compared to the total generation mix in Germany. In some cases, however, only a small amount – if any – of GHG mitigation can be achieved, compared to separate heat and power production with state-of-the-art technologies (Fig. 4.4). This is, for example, the case with regard to technologies with low electrical and total efficiency such as for small Stirling engines. Compared to district heating systems, micro cogeneration does not offer significant energy and GHG emissions advantages. District heating systems have the disadvantage of potentially high heat distribution losses

District Electricity 800 Micro CHP heating w/o CHP )

el 700 1030 600 eq./kWh 2 500

400

300

200

100 Climate Gases (g CO (g Gases Climate PEMFC SOFC lambda = 1 Lean Lean, cond. Lean LowNOx 0,85 kW 3 kW 9 kW 0 1 kW lean 3 kW 9 kW Fuel cell 1 kW Reciprocat. engine Stirling 2010 SOFC Lignite Lignite PEMFC 0,85 kW lamda=1 Reciproc. Engine CC w/CHP Mix Germany Mix CC (600 MW) (600 CC lean, LowNOX lean, CC w/o CHPCC w/o CC with CHPCC with Mix Germany lean, condensor lean, Reciproc. 50 Reciproc. kW Fig. 4.4 Life cycle GHG emissions of micro cogeneration technologies compared to large cogeneration and conventional electricity production in 2010; functional unit 1 kWh electricity at low voltage level; co-produced heat is credited (Pehnt and Fischer 2006). Cond: Heat condenser available. LowNOx: system optimized for low NOx emissions. Lean: lean burn engine operating with air access. Lambda = 1: engine operating at air-fuel ratio 1. 4.2 Design Options and Sustainability Potential 53

(depending on the quality of the heat grid and the density of the customers); but these are offset by significantly higher electrical efficiencies compared to micro cogeneration. Therefore, we regard micro cogeneration not as a competing, but rather as a supplementary technology to district heating, meaning that it should optimally be applied in cases where larger district heating is not viable for infrastructural or economic reasons. In rural areas, for instance, building density is often low, causing long transport distances and thus high investment costs and large distribution losses for district heating networks. Another relevant parameter for ecological performance is the fuel on which a micro cogeneration system runs. Heating oil, liquefied petroleum gas (LPG), and renewable fuels (such as vegetable oil, biogas, gases produced from solid biomass), and other primary energy sources may also be used. Reciprocating engines based on heating oil are widespread and exhi- bit similar GHG advantages as natural gas based engines when compared to conventional modern oil heating systems. However, the nitrogen oxide (NOx ) emissions of these systems are significantly higher than in the case of other micro cogeneration technologies (see Pehnt 2006). The most flexible technology regarding the choice of fuels is the Stirling engine. It could also run on biomass; the first Stirling engine fuelled by wood pellets has been available since 2006. However, the use of biomass (e.g. wood) is more complex in micro cogeneration than in larger plants because the required process components (e.g. gasification, gas clean-up, biomass burner) are more difficult to realize on a small scale. Integration of renewable energy carriers into micro cogeneration systems will, therefore, be less straightforward unless it takes place via an increased feed-in of renewable gases (biogas, wood gas, etc.) into the natural gas grid.

4.2.5 Economic Performance

Compared to conventional heating systems and external electricity supply, the economic performance of micro cogeneration is characterized by higher upfront investment costs. These are compensated by continuous energy cost savings over time. In addition, micro cogeneration in Germany benefits from regulations in the 2002 Combined Heat and Power (CHP) law. For small-scale cogeneration, the CHP law provides that electricity fed into the grid receives at least a “usual price” based on the average base load electricity price traded at the European Energy Exchange (some 3–5 cents), plus a bonus payment of 5.11€ cent per kWh fed into the grid and a 54 4 Micro Cogeneration bonus for avoided grid losses. Furthermore, electricity1 and natural gas2 tax exemptions are granted. This, however, does not cover full generation costs which are in the range of 8–12.5€ct/kWh. As a result, micro cogeneration plants are only economically attractive if most of the electricity is used on site and not primarily fed into the grid.

140% Reference scenario Micro cogeneration scenario (best plant) 130% Small DH scenario 120% 110% 100% 90% 80% 70% 60% Single-family Single-family Apartment Apartment Hotel house house building building (low heat (avg. heat (low heat (avg. heat demand) demand) demand) demand)

Fig. 4.5 Heat and electricity supply costs for the reference buildings from the independent operators’ perspective (DH = district heating) (Schneider 2006)

Schneider (2006) set up a detailed economic model and showed that under German conditions, micro cogeneration could be an economically interesting option for operators. For a single family household with low heat demand, a micro cogeneration unit would be economically attractive if suitably small systems were available on the market (Fig. 4.5). Similarly, larger units in apartment buildings show net cost reductions. In the case of apartment buildings, however, given the rules of the liberalized electricity market, tenants may choose to be supplied by an external energy company and thus jeopardize the economic viability of the cogeneration unit. Currently, micro cogeneration is best suited to serve apartment buildings or hotels rather than single family homes. However, smaller systems of about 1 kWel are about to break through. They could fully substitute boilers in single family houses. Therefore, single family houses are a particularly promising market segment.

1 For plants below 2 MW capacity. 2 Only for CHP plants with an average energy efficiency of over 70%. 4.2 Design Options and Sustainability Potential 55

The economic viability of micro cogeneration also depends on the attractiveness of competing heat and electricity supply options. In urban areas with high heat densities, district heat is often an economically (and ecologically) more attractive option, whereas micro cogeneration is more promising in areas with low heat densities. Currently, however, none of the micro cogeneration technologies assessed here would be economically viable without the regulatory support schemes applied in Germany. Also, the above calculations do not yet include the transaction costs which add to the conventional costs. These additional costs include search and evaluation costs, authorization and reporting demands, contract negotiations, and other legal aspects. Complicated rules and lack of access to information give rise to relatively high transactions costs and reduce the economic attractiveness of micro cogeneration plants (Meixner 2006). The operating schemes discussed here are a means to overcoming these barriers. Also, learning and experience processes, together with improvements in the institutional framework setting, may further reduce transaction costs over time. Furthermore, with state-of-the-art micro cogeneration technologies, a trade-off between environmental and economic performance must be acknowledged. In particular, small Stirling engines designed for single family houses have a rather good economic performance, but a relatively low electrical efficiency. Reaching the highest electrical and total efficiencies possible is crucial for achieving emission reductions at a reasonable cost.

4.2.6 Micro Cogeneration Scenarios

Given the above analysis, what might the future of micro cogeneration look like? There are only few scenario analyses which explicitly include micro cogeneration, showing that it could indeed contribute to a sustainable future energy system (Voß and Fischer 2006). The potential depends on demand drivers such as population development, building stock and structure, heat demand, and the structure of heating systems. Most scenarios expect a future decrease in overall heat demand, thereby reducing the potential for micro cogeneration. As stated above, micro cogeneration also faces competing and ecologically attractive supply options such as larger CHP, biomass technologies, or solar heat and power. To give an example, in a sustainability scenario developed by Krewitt et al. (2004), some 3.3 GWel of micro cogeneration systems would be installed in Germany by the year 2050. This corresponds to one million systems, assuming an average system size of 3.3 kWel. If an increase to a 56 4 Micro Cogeneration yearly production rate of 50,000 systems within 10 years were assumed for the German market, this market size would be reached in 2030. Thus, by 2030 the share of micro cogeneration would be about 50 times larger than today. Assuming average full-load hours of 4,000 h/a, 3.3 GWel would correspond to an electricity production rate of 13 TWh/a. This represents almost 3% of the electricity demand expected for 2050 in the sustainability scenario (Table 4.1).

Table 4.1 Installed power of decentralized cogeneration systems (<10 MWel) in Germany, in 2000 and in two scenarios in 2050 (Krewitt et al. 2004)

GWel 2000 2050 Reference Sustainability scenario scenario Micro cogeneration | 0 0.6 3.3 District heating 1.2 2.8 7.9 Decentralized commer- 2.7 8.1 10.3 cial and industrial CHP Total 3.9 11.5 21.5 All in all, the scenario concludes that micro cogeneration will contribute one small but nevertheless relevant building block to the overall sustainable transformation of the electricity system. Its future market share is likely to remain small when compared to other CHP options, such as district heating and larger commercial or industrial CHP applications. The picture may change, however, when district heating is not as successful as assumed in the example scenario. In that case, part of its potential may be transferred to micro cogeneration and thereby increase its share significantly. Also, new and ongoing developments like small reciprocating engines and small Stirling engines are entering or will sooner or later enter the market for heating appliances. Thus, in the longer term, technological improvements in combination with cost decreases on the one hand, and changes in fuel prices on the other hand, combined with a shift in consumer awareness may well change the picture in favor of micro cogeneration. Such a conclusion may also be derived from the assessment of trends in the innovation diffusion of micro cogeneration presented in the following section.

4.3 The Innovation Process of Micro Cogeneration

In this section we ask whether micro cogeneration is on its way to unfold- ing its potential, and what barrier and incentive structures are involved 4.3 The Innovation Process of Micro Cogeneration 57 in the processes of diffusion and forming a market. According to Bergek et al. (2006), three key processes are relevant in the formative phase, which is the focus of this analysis. These include (1) the entry of new firms and other organizations, (2) institutional alignment, and (3) the formation of networks. The entry of new firms is important for providing resources for production of the technology. The emergence of new firms may also impact on political networks and advocacy coalitions in support of the new technology, which in turn is crucial for societal acceptance and institutional alignment in favor of the new technology. Existing institutions were often built around incumbent technologies and changes are therefore critical for new technologies to be installed. A well-functioning innovation system must address these (and other) issues successfully. In our analysis, we first trace the evolution of structural components of the emerging micro cogeneration technological innovation system (TIS). Then, with reference to Bergek et al. (2006), a brief analysis of the functions of the innovation system for micro cogeneration is conducted. Special attention is given to the analysis of the current market situation in Germany and to the actors and networks involved in the diffusion of micro cogeneration in Germany as well as to the institutional setting.

4.3.1 Evolution of the Innovation System

The innovation process of micro cogeneration consists of a number of separate but interlinked developments, and it is only recently that they have been perceived and discussed under a common header “micro cogeneration” (or sometimes, even more broadly, as part of micro generation in general) (Praetorius et al. 2008). In fact, the individual conversion technologies have followed quite different development paths, and neither technology was originally invented with the purpose of serving as a micro- size cogeneration unit in single family houses (Box 4.1). Fuel cells and the Stirling engine were invented earlier than Otto and Diesel motors, but the latter succeeded, not only in terms of motor vehi- cles, but also with regard to local electricity generation. The earliest motivation for such “distributed” electricity generation (as early as 1882) was the replacement of gas for street lighting and the supply of electricity to public buildings by public power plants, starting in Manhattan, USA. At that time, the development of small-scale so called dynamo generators for electricity generation was mainly motivated by technical constraints of long-distance power transport and fuel supply. 58 4 Micro Cogeneration

Box 4.1 Milestones of micro cogeneration development 1816 Robert Stirling obtains a patent for inventing a “heat economizer”. 1838 Principle of fuel cells discovered by Christian Friedrich Schönbein. 1876 Patent for the Otto engine, invented by Nikolaus A. Otto in 1862. 1882 Pearl Street station (Lower Manhattan), first public power plant operated by Thomas Edison, starts operating and delivers electric lighting. 1892 Robert Diesel invents the Diesel motor. 1996 The company Senertec (later belonging to British Baxi Group) is founded as a spin-off of Fichtel & Sachs and starts producing and marketing the “Dachs” reciprocating machine. 1999 Power Plus (now a Vaillant subsidiary) starts marketing the “Ecopower” reciprocating machine – the first micro cogeneration unit worldwide for individual houses, developed in 1995 by a group of automotive engineers which also created the famous “Smart” car. 1999 efc (european fuel cell, since 2002 part of the British Baxi group) is founded by a gas consultant and E.ON, whilst developing a PEM fuel cell for detached houses. 2000 Other boiler manufacturers (Vaillant, Viessmann, Buderus…) start developing stationary fuel cell systems for residential houses. 2002 The “Initiative Brennstoffzelle”, an information and marketing alliance of manufacturers and utilities, is founded. 2003 Honda’s 1 kW reciprocating cogeneration unit enters the Japanese market; >15,000 detached homes have since been equipped with it. 2004 British energy supply company Powergen (E.ON UK) announces the installation of 80.000 Whisper Tech Stirling units in the UK by 2020. 2006 Senertec produces the 15,000th “Dachs” cogeneration system; PowerPlus sells its 2000th Ecopower. 2006 The Swiss company Sulzer announces that it is to stop the development of SOFC micro cogeneration devices. 2007 Sunmachine announces series production of the first wood pellet Stirling, but experiences a delay in market entry. 2007 Closure of Microgen and Solo Stirling, major technology developers. 2008 Whisper Tech announces a series production of Stirling engines in cooperation with MCC, a Spanish group of companies.

In the following decades, advances in power plant development and electricity transport put the development of local or micro generators to one side. It was not until the 1970s and early 1980s that the idea of decentralized structures (“small is beautiful”) – and thus the development of smaller generation units, and more specifically cogeneration – gathered speed again, and local utilities started setting up district heating grids. In 2004, with an installed capacity of 20.8 GW, cogeneration contributed 57 GWh or 9.3% to total electricity generation in Germany (Ziesing et al. 2006). 4.3 The Innovation Process of Micro Cogeneration 59

Particular momentum for this phenomenon stems from the first “oil crisis” which put energy savings and thus the cogeneration of heat and electricity on the agenda. This fuelled the development of small-to-medium size cogeneration units, so called Blockheizkraftwerke (BHKW) suitable for building complexes such as several apartment buildings or industrial factories. Again, it was not until the mid 1990s that smaller – or micro – cogeneration units, designed for single houses, entered the market. Not only historically, but also recently, common to most micro cogeneration technologies is that the product itself was developed as a spin-off of, or at least in close collaboration with, other product groups. The reciprocating engine was developed for automotive purposes, and then for refrigerators or other applications. The Senertec “Dachs” engine, for instance, was developed by Fichtel & Sachs, originally an automotive supply company, for the purpose of an air-water heat pump. When this development was stopped, a group of engineers left Fichtel & Sachs and founded Senertec, a new company which developed the “Dachs” as micro cogeneration unit for use in households and buildings. Similar synergies between the development of consumer products and appliances and micro cogeneration applications occur for Stirling engines (e.g. chillers), steam engines and fuel cells (power trains for transport applications, auxiliary power units in automotive applications; emergency power supplies).

4.3.2 Market Setting and Situation to Date

Micro cogeneration has to succeed in different sub-markets simultaneously, notably the electricity, gas, and heat market. Since the late 1990s, these markets have been changing rapidly. The structure of the energy market, which traditionally had a technical architecture based on large central power stations and an institutional structure based on regulated monopoly, has been undergoing a fundamental transformation – a situation which potentially offers new opportunities, but also new risks for distributed generation. In April 1998, the German electricity market was fully liberalized. Subsequently, due to a substantial decline in electricity prices, energy efficient cogeneration plants, as located in many cities and managed by local utilities, struggled to survive. As a consequence, a strong advocacy coalition around cogeneration3 formed and put pressure on policy.

3 The advocacy coalitions comprise, among a number of politicians and researchers, industry and local utility associations like AGFW, B.KWK, VKU, as well as BUND, an environmental NGO, and – for reasons of their personal contacts – the trade union ver.di. On the international level, COGEN Europe is a very active advocate. 60 4 Micro Cogeneration

This resulted in the first (2000) and second (2002) CHP law, which obliges network operators to connect all CHP installations and to buy the electricity provided by these installations, and guarantees a remuneration for electricity fed into the grid as described above. In Germany, the market for micro cogeneration technologies has been characterized by a handful of small- and medium size manufacturers. Micro cogeneration represents a rather insignificant part of the German power generation portfolio. The number of installed units is in the range of 20,000, which is marginal given that there are almost 40 million households in Germany. Globally, the consultancy Delta Energy & Environment reports some 21,600 units (38 MW) being sold in 2006, which is 23% up on the number sold in 2005 (Delta 2007). While the market for reciprocating engines is in a phase of slow but steady growth, both the developers of Stirling and fuel cell machines are undergoing a phase of uncertainty and delay. In the case of fuel cells, this is mainly due to the unresolved technological and cost issues, which lead to further R&D being required prior to market entry. In the case of Stirling engines, this development came somewhat as a surprise. The closure of Microgen and Solo Stirling, both being leading European developers, are partly owing to the inability to find larger companies manufacturing their components at appropriate costs, but also due to an uncertainty of investors regarding the market volume of micro cogeneration. All in all, however, the trend seems generally positive. The number of small micro cogeneration units installed in Germany has been growing steadily. Since liberalization of the electricity market in 1998, there has been a steady increase in installed units in Germany, with 50% more plants being installed in 2004 compared to 2002. The Senertec “Dachs”, the most successful technology, produced 15,000 units, the “Ecopower” from Power Plus some 2000 units up to late 2006. Both technology producers have experienced increasing annual sales to date. In Fig. 4.6, the installation of new micro cogeneration plants (<15 kWel) in Germany is estimated for the years 1990–1998 and 2002–2006. It shows that only very few micro cogeneration plants were installed during the 1990s, whilst many more micro cogeneration units have been installed in recent years. In other countries, in particular in the UK and in Japan, the picture looks different with regard to successful technologies and framework conditions. In Japan, despite the absence of feed-in tariffs and connection standards, a 1 kW Honda reciprocating machine has been particularly successful; some 15,000 units have been sold within some 4 years (Osenga 2005); the technology is still not available in Germany. Similarly, the 1 kW Whisper Tech Stirling unit is on the verge of entering the UK market in large 4.3 The Innovation Process of Micro Cogeneration 61

20 * Forecast

Annual capacity additions (MW) capacity additions Annual 5

0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 *

Fig. 4.6 Total annual capacity additions of micro cogeneration plants (<15 kWel) in Germany from 1990 to 1998 and 2002 to 2006 (Pehnt and Schneider 2006: updated) numbers; in Germany, it is in a testing phase. One could expect global spill-over effects. In general, though, country-specific characteristics such as institutional frameworks, energy system qualities, heating requirements, building standards and the setting of the market players are responsible for the comparatively different market result, as country studies for the UK, Japan, the USA and the Netherlands show (Pehnt et al. 2006).

4.3.3 General Reasons for Slow Diffusion in Germany Since the late 1970s, the awareness of scarce energy resources and of environmental damages related to burning fossil fuels has been increasing and helped to push cogeneration technologies into the energy market. How- ever, micro cogeneration is still situated in a niche and is far from being a major element of transforming the electricity system towards more sustainability. We will now focus on the barriers to the diffusion of micro cogeneration. For this purpose, we briefly discuss some of the functions a technological innovation system of micro cogeneration should have at its disposal for successful diffusion. We then outline the related actors’ network, with the ultimate aim of assessing the potential and expectations in the market. On the technological level, a major reason for the limited success of micro cogeneration is competing technologies, in particular large-scale cogeneration. Micro cogeneration also competes with renewable micro 62 4 Micro Cogeneration generation technologies, such as PV, solar thermal plants, and wood pellet boilers. In all cases, micro cogeneration (with the exception of fuel cells) suffers not only from economic or technological disadvantages, but also with respect to public attention. In Germany, the social and political attention to and acceptance (and hence societal legitimation) of renewables and also for fuel cells is significantly higher than for other micro cogeneration technologies. Related to this, there is a low level of information on the customer side; technologies other than fuel cells are hardly known and elicit little enthusiasm. Fuel cells, by contrast, are perceived as a sustainable and potentially clean technology – albeit probably only available in the remote future. Renewables, particularly renewable electricity generation, enjoy even more attention and explicit policy targets – and corresponding levels of support for their development and diffusion. As a matter of fact, successful innovation diffusion presumes such support for the development and diffusion of novelty. Usually, public R&D funding acts as a significant driver in this context (Jacobsson and Lauber 2006). Again, R&D funding for micro cogeneration is overwhelmingly devoted to the development of fuel cell technologies and, to a lesser extent, to virtual power plants. For example, a fuel cell and hydrogen programme was recently announced which devoted some 500 million Euro to this technology line, a significant part of which is attributed to small stationary systems. Micro cogeneration as such, or technological variations such as reciprocating or Stirling engines or micro turbines, do not constitute a funding area eligible for public R&D support (Cames et al. 2006). Apart from within the feed-in regulations of the CHP law, a comprehensive and consistent federal policy towards micro cogeneration does not yet exist. Recently, however, representatives of the German government announced a micro cogeneration program which provides investment subsidies specifically targeted at micro cogeneration. This also finds expression in the related level of transaction costs for small-scale generators. A review of connection requirements by the ELEP research group in the EU-15 found a general lack of transparency regarding processes and procedures; procedures seem confusing and many adminis- trators are involved – in many cases with a lack of competence on the issues. The natural consequence of this is the time required to get through the administrative process: sometimes several months, often more than a year (ELEP 2005, 2007).

4.3.4 Actors and Coalitions

All of the above aspects impact on business expectations, thus on the direction of search and investment behavior of firms, and also on consumer 4.3 The Innovation Process of Micro Cogeneration 63 or household behavior. In the next section we discuss the relevant actors and their cooperation structures in order to better understand the (dis-) function of the network. To date, small-scale reciprocating engines are the only technology commercially available in a niche market. Two technology developers are predominant: Senertec which has promoted its “Dachs” since 1996, and Power Plus, which developed its “Ecopower” reciprocating machine in 1995 and has been marketing it since 1999. Foreign Stirling technology developers, like Whisper Tech, are investigating the German market, but such technology was not available on that market in late 2007 (so far, it has only been made available for testing purposes). Commercial production of fuel cells is still far off. It is interesting to note that originally independent technology developers like Senertec and Power Plus, along with a number of fuel cell developers, have been purchased by other boiler or CHP technology manufacturers. In the case of Senertec, the British Baxi Group – also a fuel cell developer – was interested in the elaborated German distribution network of Senertec and speculates for a future market. In general, international investors are interested in the future German fuel cell market and engage in fuel cell development (Brown et al. 2007). The cooperation between traditional boiler companies and micro cogeneration manufacturers appears promising, as a micro cogeneration plant could be marketed as a “better” boiler which also produces electricity. Such a marketing strategy, which is particularly practiced by the Stirling companies entering the British markets, may simplify the diffusion of micro cogeneration for various reasons. Consumers are mostly unaware of CHP and do not properly understand it. Nevertheless, they could easily be given information on micro cogeneration when they need to replace a boiler. In addition, micro cogeneration is economically more promising, and easier to install when it fully replaces the traditional boiler. The gas supply industry is a “natural ally” of micro cogeneration, because micro cogeneration is primarily fuelled by natural gas. However, ownership structures may deter the gas industry from investing in micro cogeneration. Integrated gas and electricity companies will compare the potential advantages of increased gas sales with the losses through decreasing electricity sales. In the German market, the electricity company E.ON, for example, acquired the natural gas importer and long-distance transport company Ruhrgas and pursues a strategy to gain access to the gas grid and the local heating market. The electricity market is not part of this focus, as it is supplied by other E.ON subsidiaries. Consequently, Ruhrgas would not much engage in micro cogeneration, as the electricity generated competes with the electricity generated and distributed by E.ON. Other gas supply units 64 4 Micro Cogeneration owned by electricity companies are likely to face similar strategic decisions. On the municipal level, the picture is more mixed, again depending on the respective business concept. Traditionally, the focus of the established large-scale electricity industry has been on centralized supply structures. A certain path dependency in strategic decision management in favor of large power stations may thus be presumed, fuelled by economies of scale of large-scale power plants. However, micro cogeneration has several advantages including lower incremental and strategic risks because the initial investment is small compared to large power stations. It also has competitive benefits on the customer side related to energy cost reductions, full-service packages and added value services (if offered), but also branding, and diverse tools for consumer retention. This argumentative route was followed by E.ON UK – formerly PowerGen and the UK’s second largest energy retailer – which ordered 80,000 Stirling machines with the ultimate objective of equipping (and thus binding) up to 30% of the UK households with micro cogeneration in the year 2020 (Whisper Tech 2004). However, in early 2008, the order and the related target are still waiting for realization. The recent cooperation of Whisper Tech with the Spanish MCC, a group of companies, could eventually give rise to a series production line, thus helping to meet the target. It should be noted, however, that the features of the UK retail market differ substantially from the German market, in particular with respect to heating needs – German houses are much better insulated – and to the quality of maintenance services – in Germany, the service network functions well, so a full-service package from an energy company is not as attractive to private households in Germany as it is to those in the UK. This is a major reason for E.ON Germany not to follow the UK example. Other potential allies for micro cogeneration could be expected among the large number of local energy companies in Germany. Competition with the large, cross-regional energy companies is an explicit challenge for them. Hence, customer retention activities are an important objective on the local level, in particular with respect to medium sized customers like hotels, public swimming pools, or small businesses. Local energy companies that own both a power and a natural gas grid, but have few self-generation capacities, should thus have good reasons to promote micro cogeneration in order to increase their sales in natural gas, as gas offers a higher margin. However, the margin is still comparatively small, so that the economic incentives are low for engaging in such a “new” technology. Some local energy companies invest for customer retention reasons. Altogether, however, only a small share is active in the area of micro cogeneration. 4.3 The Innovation Process of Micro Cogeneration 65

In terms of diffusion of micro cogeneration, energy Third Party Financ- ing or energy contracting and service companies (ESCOs) play a crucial role. Indeed, their business models may even represent the most advantageous way of introducing micro cogeneration to the market. ESCOs – in the denotation used here – are companies that offer energy services to final customers by means of implementing a technology on site and acting as a link to the original energy supplier (mostly gas or electricity). While most of the actors assessed above gain few economic advantages from introducing micro cogeneration, ESCOs can find a number of additional commercial opportunities in operating micro cogeneration units. They are able to overcome typical problems, such as information and skill shortages, delivery or operation and maintenance risks, and the like. They benefit from bundling knowledge and from established contacts to relevant administrative and financing institutions, they apply standard contracts and are able to negotiate quantity rebates with both the technology and the energy industry. All in all, they are able to realize higher margins than individuals in implementing micro cogeneration. It is therefore likely that ESCOs will not only be initial market entrants, but also the principle long-term players. This may also be an underlying reason for medium and large sized energy companies to have subsidiary ESCOs. Distribution network operators (DNOs) do not currently have much motivation to foster distributed generation, even less so as they are all owned by large electricity generation companies. The existing economic (dis)incentives and ownership structures do not provide attractive terms for connecting distributed generators. DNOs may receive new incentives to facilitate the connection of micro cogeneration, depending on the evolution of an incentive-based regulatory scheme by the new German energy regulatory body (see Chap. 8 in this book). Technology advocacy coalitions and other collective actors are rare in the context of micro cogeneration. Liberalization prompted the emergence of a strong advocacy coalition for cogeneration which resulted in the CHP laws, albeit focusing on large-scale CHP. Initiatives to form a network or association specifically focusing on micro cogeneration, for example the idea of forming a “Micro Cogeneration” Working Group in 2005, did not succeed. Cooperation among developers is difficult: with currently two manufacturers dominating the market, there is little interest in joint marketing or lobbying. 66 4 Micro Cogeneration

Table 4.2 Micro cogeneration: incentives and disincentives for actors

Actors Incentives Disincentives Technology Expected market growth High transaction costs developers First mover advantages Dismissive attitude of DNOs Developing a service and marketing infrastructure Gas industry Increase in gas sales Often ownership by electric- Customer retention ity companies First mover advantages Existing cogeneration/local Improved perception of company heating grids Large elec- Low investment risks Losses in electricity sales tricity com- Short lead time panies Customer retention Improved perception of company, increased reputation Local energy Customer retention High transaction costs companies Low investment risk Losses in electricity sales vs. Short lead time gains in gas sales Improved perception of company, Existing local heating grids increased reputation Increased natural gas sales volume and local self-generation ESCOs Business opportunities High transaction costs/small Improved perception of company, margin in the case of micro increased reputation cogeneration First mover advantages DNOs Disburdening of local network Ownership structures Reduced demand peaks (vertically) Loss of revenue (reduced transmission) Customers Electricity generation at home High transaction costs Environmental benefits Small or no economic Large customers: economic advantages benefits

Customers, although fascinated by the novelty or “high tech” fuel cell, are not yet much interested in small cogeneration. Supplier change rates (which are an indicator for active consumers) are still low; only about 10% switched to another supplier, compared to 40% or more in the UK. Also, full-service packages, as offered successfully in the UK, are not as appealing to German households. Users are usually not interested in installing a new technology as long as the old technology is still running well, especially when economic advantages of the replacement do not exist. Only a comparatively small number of consumers who are environmentally 4.4 Shaping the Innovation Process 67 conscious and critical about the market power of large energy companies may value micro cogeneration as a contribution to a decentralized and environmentally sound energy supply (Fischer 2006). Such pioneer users, however, play an important role in the diffusion of new technologies by testing them and giving feedback to manufacturers and by spreading the word and acting as multipliers. Given the high investment costs of today’s micro cogeneration units, it is no surprise that its diffusion is still rather slow. This picture may however change with a changing institutional setting as well as new technologies like the Stirling engine, learning effects, and with new technology suppliers entering the market. An overview of the role and incentive structure of these major actors is shown in Table 4.2. To summarize at this stage, technology manufacturers themselves and energy service companies, together with a handful of gas companies, represent the main drivers for micro cogeneration.

4.4 Shaping the Innovation Process

Our assessment shows that the conditions for micro cogeneration in Germany would need to be improved if its future potential is to be exploited or increased. Some of the issues are common to other innovative and distributed generation technologies. Strategies to improve the setting for one of them could simultaneously improve the setting for other small-scale generation technologies. In this section, we look at what would need to happen when its share in a future electricity system is to be increased, and to reveal starting points for shaping and thus improving the process of innovation diffusion for micro cogeneration. Four major areas for shaping can be distinguished (Cames et al. 2006): First, institutional alignment with respect to admission and grid connection of small-scale cogeneration units; second, creation of financial incentives; third, intensified R&D and pilot plant activities; and fourth, information campaigns and training activities. Institutional alignment. As it shapes the market and thus the prospects for micro cogeneration, the regulatory and institutional framework plays an important role in its development and diffusion. The regulatory framework in Germany is characterized by financial incentives on the one hand and discontinuity and non-transparency in the overall policy towards CHP on the other. Clear mid- and long-term perspectives, as could be provided by a modified, reliable CHP law, are a key prerequisite for decision- making by manufacturers, energy utilities and consumers. An amendment of the CHP law from 2008 considerably improves the conditions for micro cogeneration and sets a long-term target of a 25% cogeneration share of total German electricity generation. Compulsory and transparent network 68 4 Micro Cogeneration connection standards and procedures, possibly on a European level, would reduce transaction costs and allow for a further standardization of micro cogeneration systems and installation procedures, such as full service packages. Moreover, the administrative requirements for the installation of micro cogeneration plants could be simplified. This refers, for example, to the registration fees for micro cogeneration and the procedures to receive tax reimbursements. Most importantly, a clear legal framework for third-party operation of micro cogeneration needs to be created. This concerns particularly two areas of civil law. First, there is the German civil law for tenants and land- lords, which, for instance, does not clarify whether the supplemental capital cost of micro cogeneration units can be shifted to the tenant. Also, the regulation for heating costs is unclear with respect to the rules for passing on the operation and fuel costs for the heating system to tenants in larger apartment houses. There are suggestions for a clear procedure (Meixner 2006); however the compatibility with existing regulation has yet to be assessed. The question as to whether tenants can be obliged to purchase electricity from a cogeneration system is also open. The second legal question concerns the electricity law, particularly the question of the legal form of electricity grids within an apartment building. This has various legal consequences for a potential third party company (Meixner 2006). Here, a clear legal framework for third-party (contracting) companies is required to open a long-term perspective for time-efficient and standardized micro cogeneration installations. With respect to grid-use tariffs, a consistent regulation is needed to provide sufficient incentives to distribution network operators to support the connection of distributed generators. For example, grid regulation could include a certain target for connecting high-efficiency cogeneration plants, which would then be rewarded in the approval of future grid use tariff adjustments. Furthermore, more active network structures, with enhanced interaction between distribution network operators and micro cogeneration operators by means of communication technologies or spatially/temporally resolved feed-in tariffs could help to provide ancillary services, such as relief of grid congestion and peak load shaving (see Chap. 8 in this book). An important institutional barrier for micro cogeneration is the ownership structure of the distribution network operators. They all belong to established electricity supply companies, which are likely to make use of their market power. Legal unbundling is not sufficient; a complete ownership unbundling and the establishment of an independent system operator for the transmission grid would be required to create a level playing field. Experience in other countries, particularly the UK, shows that in a competitive environment, a significant supply-side push can come about when large utilities engage in distributed technologies. 4.4 Shaping the Innovation Process 69

Creation of financial incentives. Financial incentives are an effective means of stimulating the market, as demonstrated by the example of renewable energies. Here, both investment subsidies and financial incentives for energy generation supported their broader diffusion into the market. However, any financial support scheme – also for micro cogeneration – should be designed carefully in order to avoid counterproductive effects. First of all, the economic incentives for micro cogeneration in Germany are considerable. However, to become interesting for the building industry and energy service companies, decentralized cogeneration would need a support scheme that gives sufficient incentives, regardless of whether electricity is consumed on site or fed into the grid. The provisions of the cogeneration law are a good starting point, but they do not encourage investment in micro cogeneration with electricity being fed into the grid, with the result that often electricity-driven systems would be installed and a supplemental peak boiler would be needed. However, some of the current proposals of the CHP law envisage extending the range of the CHP bonus from fed-in electricity to the total amount of electricity generated in the CHP unit. Secondly, any further increase in feed-in remuneration and other support schemes for micro cogeneration should consider effects on and benefits from alternative technologies. It would not make sense to foster micro cogeneration at the expense of other energy technologies which are equally or more sustainable, such as district heating or thermal solar collectors, when the latter are more suitable from both an economic and an ecological perspective. The ultimate aim should be to provide a consistent framework, to offer equal financial support for technologies with similar environmental benefits, and to reward low pollutant emission levels, or even to demand a certain emission level, such as that required by the German environmental label “Blauer Engel” (blue angel). Only highly efficient cogeneration should, for example, then benefit from natural gas tax exemptions. Scope and Focus of R&D Policy. To date, German R&D policy has strongly focused on selected technologies such as fuel cells. However, several other technologies appear promising for stationary applications. We recommend that R&D policies broaden their scope – and focus not only on the technology itself, but on the innovation cluster. There is still scope for technological and material improvements in terms of cost and efficiency. For example, burner technologies for biomass, such as wood pellet burners, enhance the use of renewable fuels in micro cogeneration Stirling or steam engines. Given the substantial need for climate change mitigation and the relevance of renewable energies in the long term, this seems an important strategy element for making micro cogeneration fit into a long-term perspective. 70 4 Micro Cogeneration

Also, as a step towards an intelligent and cheap grid access, innovative control and metering technology are required which reduce costs and increase the acceptance of micro cogeneration by distribution network operators. Standardized electronic equipment for micro cogeneration plants may help in grouping them to larger packages, ultimately to virtual power plants. Advanced IT applications for micro cogeneration could also be a first step toward smart home energy management and simplify formal procedures such as notification, tax declaration, automated maintenance, etc. In addition, advanced heat storage technologies would make micro cogeneration technologies more flexible and compatible with different operation strategies. Also, combinations of micro cogeneration with other innovative conversion technologies, such as heat pumps and refrigeration engines, in this small capacity regime require further R&D. This would also open up new markets for micro cogeneration, such as the provision of cooling, if successfully implemented. Awareness Raising and Innovative Financing & Operation Concepts. For broader market diffusion, and in order to reduce information and search costs, authoritative and independent information about products and systems needs to be disseminated more broadly. Currently, very few potential operators and intermediaries, such as boiler installation firms, know about the different micro cogeneration technologies, as they usually focus on either heating systems or electricity, not on their combined production. Also, the cogeneration benefit could be maximized by prioritizing and deferring loads (demand response) and by employing time-resolved metering of electricity feed-in. Feedback (e.g. displays) on current consumption and generation of electricity and heat would make micro cogeneration more economical. It could also induce secondary effects, such as enhanced awareness of energy consumption (see Chap. 6). Probably the most successful way in which to market micro cogeneration is to promote it as innovative heating systems with an integrated supply of electricity. Thus, building owners who have to replace an old heating system would take cogeneration systems into consideration. For this to happen, boiler manufacturers, plumbers and heating installers are important strategic partners for micro cogeneration developers, because they are usually consulted when the heating system needs to be replaced. An information campaign for craftsmen and architects would greatly facilitate this marketing approach. Finally, innovative financing concepts may bridge financial gaps for initial investment. An alternative approach, realized in the UK, would be to market micro cogeneration via the electricity market. This has the advantage that large electricity supply companies provide technical and financial back-up and thus guarantee reliability of heat and electricity supply. These approaches 4.5 Conclusions 71 are complementary. Which one is more realistic depends greatly on the motives and commitment of the actors in the heat and electricity market in the respective countries. In Germany, however, for reasons explained in Sect. 4.3, the established electricity industry is not yet interested in decentralization.

4.5 Conclusions

This chapter looked at the state and perspectives of the innovation system or cluster for micro cogeneration with a focus on Germany. Our assessment has illustrated that micro cogeneration, albeit to a small extent, has the potential to contribute to a sustainable transformation of the electricity system in Germany (and abroad). Table 4.3 summarizes key characteristics of this innovation cluster. Micro cogeneration can contribute to sustainability in many ways; its positive effects include reduced distribution losses, relief of grid congestion, peak load shaving, emissions reduction, greater consumer awareness, efficiency increases, improved reliability of the electricity system, competitiveness effects and – last but not least – potential economic benefits, depending on the oil price development. Micro cogeneration is also increasingly being used in other countries. The future potential of micro cogeneration further increases when renewable fuels (i.e. biofuels, or hydrogen from renewable primary energy sources) are used instead of natural gas, which is the dominating fuel today. As the economic and ecological analyses have shown, the performance of micro cogeneration varies between technologies and also depends on the implementation context. Also, its use should be balanced with competing sustainable energy options, such as district heating in areas with high heat densities and the use of renewable energy carriers where they are available at reasonable costs. When these aspects are taken into consideration, micro cogeneration can be regarded as a sustainable innovation. Our analysis has also shown that significant blocking mechanisms for a broader diffusion exist in Germany. These include economic uncertainty for consumers, the regulation of grid access and remuneration, but also high transaction costs associated with searching for information, negotiation and administration for all actors. The analysis of actors’ interests and actor networks involved in the diffusion of micro cogeneration shows that it has had little advocacy backing it up or driving it to date. While large cogeneration benefits from a formed advocacy coalition, micro-cogeneration 72 4 Micro Cogeneration

Table 4.3 Micro cogeneration: dynamic characteristics of the innovation cluster Descriptors Characteristics of micro cogeneration Purpose of Highly efficient, decentralized generation of heat and electricity innovation on household level Relevant 1973 oil crisis shifts focus to efficiency and security of supply context factors 1998 liberalization of German electricity market 2005–2006 implementation of regulator (Federal Grid Agency) Phases Origin and transfer: Invention of motors in early nineteenth century; focus on automotive and backup/remote area electricity supply. Development and diffusion as medium-sized stationary cogeneration starting in mid 1970s. Niche market formation in late 1990s with liberalization of German electricity market. Increasing installation numbers, but marginal total share of power generation. Only reciprocating engines commercially available today, Stirling to enter the market, fuel cells as future option Actors Mostly individual actors or small groups, little advocacy, no “helping interests”. Formed coalitions around larger CHP and fuel cells, with positive spill-over effects for micro CHP (feed-in remuneration, bonus), but also adverse or retarding effects. Competing Local district heating systems with larger CHP units may have innovations economic and environmental advantages, depending on specific characteristics of location, and on fuel used. Renewable technologies (e.g. solar thermal heat generation) and increasing building standards lower the range of use for micro cogeneration systems Matching Virtual power plants, smart home technologies. innovations Other distributed generation (e.g. renewables) with spill-over as regards institutional setting (e.g. grid connection, feed-in). Inducement CHP laws, market liberalization, general trend towards resource mechanisms efficiency and climate protection International developments: UK utilities or Japanese companies with active micro cogeneration strategy Blocking High upfront investment factors Information/transaction cost, especially administrative efforts Sustainable Scenario analyses expect a minor share of total electricity in 2050 vision from micro cogeneration. Balance with other (renewable) DG options & district heating (level playing field) Possibilities Clear mid- and long-term perspective (CHP law), network con- for shaping nection standards, legal framework for third party financing, grid- use tariffs, ownership unbundling. Revision of financial incentives for market introduction; feed-in framework consistent with alternative technologies. Intensified R&D for micro cogeneration, heat storage, control and metering, IT technologies, etc. Information campaigns and training activities, marketing programs, feedback systems, formation of advocacy coalitions 4.5 Conclusions 73 activities tend to be undertaken by individual actors, not networks. Micro cogeneration is mostly treated as the “little brother” of CHP in general and fuel cells in particular, which is an advantage as CHP has a formed and successful lobby, but also a disadvantage, as small cogeneration has not been a focus of this lobby until recently. Within the large-scale German electricity industry, there is currently little interest in micro cogeneration. Competition is not powerful, and for customer retention, there is not (yet) a need to consider binding energy service packages (as in the UK), as most customers do not change suppliers anyway. Grids are owned by large utility companies, and grid regulation has been weak so far. Also, transaction costs for micro cogeneration for the electricity industry are expected to be high in comparison to those for large (co)generation units. These structural components do not provide any incentives for a move towards decentralization. Given the existing framework conditions, the focus of most actors is on other technologies and issues, and there is little motivation to refocus these activities yet. The incentives for new firms to move into small cogeneration are small, with the result that there is little drive in the market. The resulting market for micro cogeneration in Germany thus appears to be small and is dominated by reciprocating engines. However, the market is likely to continue its slow but steady development, just as it did in the past. Further technologies, in particular small Stirling and reciprocating engines, are proximate to market entry and will stimulate price competition and demand. Also, consumer awareness with regard to electricity prices, the electricity market structure and climate change has been increasing substantially in the recent past. The trend of increasing numbers for distributed generation units is still unbroken and gives an idea of a future market. The diffusion of micro cogeneration has some challenges to meet in Germany. In the absence of policies shaping the framework conditions, the diffusion of micro cogeneration is likely to stagnate at the rather insignificant level it is at today. Also, micro cogeneration is unlikely to leave its market niche as long as no powerful driver or advocacy coalition has been formed. This rather bleak prediction may, however, become invalid upon the emergence of a wise change in institutional incentives, changing fuel and carbon prices, improved availability of renewable fuels, and cost decreases along a process of technological learning and related economies of scale. Therefore, to sum up, micro cogeneration can be expected to provide valuable input in a transformation towards a sustainable electricity system in Germany, and possibly also abroad. Policy action is demanded in order to shape the innovation process. A number of possibilities for shaping exist. Depending on their realization, it remains open as to whether micro cogeneration provides a larger scale option for the German electricity system. 74 4 Micro Cogeneration

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Pehnt M (2002) Energierevolution Brennstoffzelle? Perpektiven, Fakten, Anwendungen. Wiley VCH, Weinheim Pehnt M (2006) Micro cogeneration technology. In: Pehnt M, Cames M, Fischer C, Praetorius B, Schneider L, Schumacher K, Voß J-P (eds) Micro cogeneration. Towards decentralized energy systems. Springer, Berlin, Heidelberg, pp 1–18 Pehnt M, Cames M, Fischer C, Praetorius B, Schneider L, Schumacher K, Voß J-P (eds) (2006) Micro cogeneration. Towards decentralized energy systems, Springer, Berlin, Heidelberg Pehnt M, Fischer C (2006) Environmental impacts of micro cogeneration. In: Pehnt M, Cames M, Fischer C, Praetorius B, Schneider L, Schumacher K, Voß J-P (eds) Micro cogeneration. Towards decentralized energy systems. Springer, Berlin, Heidelberg, pp 87–116 Pehnt M, Schneider L (2006) The future heating market and the potential for micro cogeneration. In: Pehnt M, Cames M, Fischer C, Praetorius B, Schneider L, Schumacher K, Voß J-P (eds) Micro cogeneration. Towards decentralized energy systems. Springer, Berlin, Heidelberg, pp 48–65 Praetorius B, Sauter R, Watson J (2008) On the dynamics of microgeneration diffusion in the UK and Germany. In: Foxon T, Köhler J, Oughton C (eds) Inno- vation for a low carbon economy: economic, institutional and management approaches. Edward Elgar, Cheltenham, UK, pp 142–174 Sauter R, Watson J, James P, Myers L, Bahaj B (2006) Economic Analysis of Microgeneration Deployment Models, Working Paper Series 2006/1 Schneider L (2006) Economics of micro cogeneration. In: Pehnt M, Cames M, Fischer C, Praetorius B, Schneider L, Schumacher K, Voß J-P (eds) Micro cogeneration. Towards decentralized energy systems. Springer, Berlin, Heidelberg, pp 67–86 Schneider L, Pehnt M (2006) Embedding micro cogeneration in the energy-supply system. In: Pehnt M, Cames M, Fischer C, Praetorius B, Schneider L, Schumacher K, Voß J-P (eds) Micro cogeneration. Towards decentralized energy systems. Springer, Berlin, Heidelberg, pp 197–218 Voß J-P, Fischer C (2006) Dynamics of socio-technical change: micro cogeneration in energy system transformation scenarios. In: Pehnt M, Cames M, Fischer C, Praetorius B, Schneider L, Schumacher K, Voß J-P (eds) Micro cogeneration. Towards decentralized energy systems. Springer, Berlin, Heidelberg, pp 19–47 Whisper Tech (2004) Whisper Tech signs $300 million agreement. Whisper Tech Media Release Ziesing H-J, Matthes FC, Horn M, Harthan R (2006) Ermittlung der Potenziale für die Anwendung der Kraft-Wärme-Kopplung und der erzielbaren Minderung der CO2-Emissionen einschließlich Bewertung der Kosten (Verstärkte Nutzung der Kraft-Wärme-Kopplung). Öko-Institut und DIW Berlin. Forschungsvorhaben Nr. 202 41 182 des Umweltbundesamtes, Berlin 5 Carbon Capture and Storage*

5.1 CCS as an Innovation to the Electricity System

Coal is a major pillar of electricity generation worldwide, providing around 40% of total electricity generation (IEA 2006b). Emerging countries like China or India are continuously commissioning new large coal plants in order to meet their massive increases in electricity demand. In Germany, coal and lignite are major domestic energy resources and also dominating inputs to electricity generation. Prospects for escaping this “carbon lock-in” and the related environmental and climate impacts are unfavorable at present (Unruh 2000; 2002; Perkins 2003; Unruh and Carrillo-Hermosilla 2006). Carbon Capture and Storage (CCS) promises to enable the low-emissions coal power station. CCS is an incremental innovation, representing a change within the existing system that does not endanger its overall structure. CCS allows for the continued use of fossil fuels, can be combined with the existing infrastructure (that is, mostly large-scale centralized power plants) and implemented by existing actors. Opponents therefore fear that CCS may further delay the urgent transition to a carbon-free electricity system. How- ever, CCS may also be considered as an innovation that “buys time” for radical restructuring and may serve as a bridging technology towards a sustainable energy future. CCS could then be an innovation that paves the way out of the current carbon focus of electricity generation. In combination with electricity generation from fossil fuels, CCS is at an early stage of development and market formation, leaving several decisions to be made and a number of questions to be asked. Moreover, with regard to sustainability, CCS in combination with the extraction and combustion

* By Katja Schumacher, Martin Pehnt and Barbara Praetorius, with contributions from Johannes Henkel, ifeu Institute for Energy and Environmental Research, Heidelberg, now Technical University Berlin. This chapter is a summary and update of a collective research project by the TIPS research team (Fischer et al. 2006; Fischer and Praetorius 2008). We would like to thank Corinna Fischer for her comments on an earlier version of the chapter. 78 5 Carbon Capture and Storage of hard coal and lignite for electricity generation is a heatedly debated issue. On the one hand, CCS involves an “energy penalty”, i.e. a significant loss of generation efficiency, which leads to a higher level of primary energy needs for electricity generation. On the other hand, coal is believed to ensure security of energy supply at a low cost, e.g. under the conditions of nuclear phase-out in Germany. Moreover, decisions have to be taken regarding the share of research and development (R&D) expenditures spent on CCS vis-à-vis other sustainable technologies such as renewable technologies, or energy efficiency. In turn, CCS, renewable energy technologies and energy efficiency may also be considered to belong to one and the same trajectory of a sustainable energy system: Given a sufficiently high price level of CO2 emissions, energy utilities are induced to choose a portfolio of options to reduce emissions, including CCS, energy efficiency measures and renewable energy. This chapter sets out to explore these issues in more detail. We ask whether CCS could contribute to a sustainable future electricity system, and whether it is likely to be available in terms of time, costs, and regulatory and institutional framework so that the challenges of climate change mitigation currently under discussion can be met. We start with an overview of the current state of CCS technology, its economics and environmental performance, and discuss the challenges facing the technology and its deployment. From this, we portray the process of innovation in Germany and the factors influencing it. As CCS is at an early stage of development, and as its diffusion dynamics are strongly dependent on the engagement of actors, specific attention is given to the setting of the actors and actor constellations in Germany. We then discuss the possibilities and needs for shaping the framework conditions for innovation in such a way that CCS may contribute to a sustainable electricity system to a suitable extent. We conclude with an overview of our findings.

5.2 Design Options and Sustainability Potential

5.2.1 Technological Variations

In principle, any large point source of CO2 emissions such as coal and gas fired power stations, cement or steel plants or oil refineries can be equipped with the option of carbon capture and storage (CCS) and can thus be converted into a low-emissions production site. Implementing carbon capture and storage in an electricity or industrial plant requires a number of different steps: (1) the removal of the carbon dioxide from the industrial process, 5.2 Design Options and Sustainability Potential 79

Pulverized NGCC IGCC O2/Coal fired PP Fuel Cells Power Plant type Coal PP (Combustion with CO2/O2)

Absorption: Adsorption: Cryogenics Membrane Systems: x Chemical x PSA x Gas separation membranes x Physical x TSA x Gas absorption membranes Capture Methods

Compression/ Liquefaction

Transportation Pipelines Tankers/Railway

Underground In solid form Ocean Industrial and Commercial use: (carbonates) x Beverages x Chemicals x Food Processing Storage Utilization

Lake Scenario Deep Exhausted gas Enhanced Oil In coal Salt CO2 Dispersion Aquifers reservoirs Recovery beds/seams caverns (CO2 isolation) in deep waters PP: Power Plant

Fig. 5.1 Elements of CCS technical systems. Source: Authors’ own presentation, based on IPCC (2005) (2) its transport to an adequate storage site, and (3) the storage in long-term storage sites. Each of these steps can be realized in a variety of technological sub-options which will be outlined in terms of application in power generation in the sections below. An extensive overview is provided in IPCC (2005).

Removal Technologies. Removal of CO2 can be integrated into power production at several stages of the power plant process: either end-of-pipe by cleaning the flue gas, or upfront by removing CO2 from the fuel before the actual combustion process takes place. Currently, a number of separation options are being investigated today (Fig. 5.1), of which the three most promising approaches are:

1. Post-combustion capture: Separation of CO2 from the flue gas. The concept of post-combustion capture can be applied to conventional steam turbine cycle power plants. In this type of power plant, a fossil fuel is combusted with air. The flue gases leave the plant at atmospheric pressure through the stack. CO2 is then captured, preferably through a chemical absorption process. 80 5 Carbon Capture and Storage

2. Pre-combustion capture: Here, the fuel is directly converted to CO2 and a carbon-free combustible (e.g. hydrogen) followed by separating CO2 from hydrogen. This is particularly relevant for Integrated Gasification Combined Cycle (IGCC) power plants where coal is gasified, resulting in a so called synthesis gas that mainly consists of carbon monoxide (CO), hydrogen (H2), and CO2. This gas passes several gas cleaning steps, especially particulate removal and sulfur removal, before it is burned in a combined cycle process. IGCC technology is expected to be the technology that is best suited to integrating CO2 capture in the power plant process, as the synthesis gas leaves the gasifier with high pressure and CO2 can be absorbed through physical processes. 3. The oxyfuel combustion process obtains a highly concentrated CO2 stream by burning the fuel with a mixture of oxygen and recycled CO2 instead of air. The resulting flue gas consists of highly concentrated CO2, together with water vapor and small amounts of pollutants. Thus, a nearly pure CO2 stream can be produced relatively easily. Also, the theoretical minimum efficiency loss is only 0.5 percentage points (Göttlicher 1999), although this has not yet been realized in practice. Thus, in the long term, oxyfuel technology appears to have good prospects, compared to the other options. Commercial availability. The individual components of CCS are at different stages of market development. CO2 capture based on post-combustion pathways, for example, is already widely practiced, e.g. in the chemical industry. However, the combination of more components of the CCS process chain has rarely been realized, except in the case of Enhanced Oil Recovery (EOR), since the early 1970s. For power plants, however, estimations are that larger systems will not be commercially available before 2020 (Fig. 5.2). For today’s generation of power plants and those planned for the next decade, CCS may thus come too late for an optimal integration. Retrofit is only possible for post combustion or oxyfuel technologies. Both options lead to significant changes in the process layout and require large additional space (e.g. for solvent regeneration or oxygen supply) which is often not available at concrete power plant locations. Alternatively, capture-ready plants may be set up which would anticipate ex post installation of capture equipment with regard to both space requirements and technological adjustments. Both the retrofit of plants and capture-ready set-ups have pronounced effects on capital investment and cost recovery. This again relates to the important question of the timing of CCS strategies. 5.2 Design Options and Sustainability Potential 81

Fig. 5.2 Expected development of CCS (de Coninck and Groenenberg 2007)

Transport. Theoretically, CO2 can be transported via pipelines, by tank wagons and by ship. However, as power plants produce huge flows of CO2, pipeline transport will be the only cost-effective option onshore if large-scale use of CCS takes place. Initially, pipeline transport will be most likely the main means of CO2 transport (BMWA 2003; Donner and Lübbert 2006). In the long term, with the exhaustion of local storage opportunities, ship transport may also become relevant, as more remote potential storage locations, for example in the Middle East and the former Soviet Union, will have to be used. Costs for transportation obviously depend on quantities involved and distances, but also on local geographical conditions. However, the transport costs are generally considered low compared to the costs of capture (Gielen and Podkanski 2004). Storage. For CCS to be an effective means of mitigating global climate change and its high costs to be justified, the captured CO2 must be stored for a long time period. Additionally, storage must be in accordance with existing national and international law. Among the main options for storage are oil and gas reservoirs, deep saline aquifers, unminable coal seams and the deep ocean. For all these storage options the density of the stored CO2 must be as high as possible in order to use the storage space efficiently, which in practice results in a minimum depth of typically about 800–1,000 m. Storage in the form of mineralization (mineral sequestration) is also investigated, but not discussed here because the necessary huge mass flows are regarded as prohibitive (IPCC 2005). The basic principle associated with all underground methods of storing CO2 is that it is stored in a geological structure which contains the gas and 82 5 Carbon Capture and Storage prevents its release into the atmosphere in the long run. The structure must consist of a permeable layer to allow injection of CO2 and an impermeable or low-permeable layer to prevent escape of CO2 into the atmosphere. Oil and gas reservoirs as well as deep saline aquifers consist of porous rock that is covered by an impermeable cap rock layer. As the geological structure of depleted oil and gas reservoirs is well investigated, further exploration costs would be small and capacity estimations are relatively accurate. Additionally, the reservoirs have proven to be leak-proof for millions of years (IPCC 2005). However, drilled wells are potential leakage pathways, and it will require cautious engineering to seal them for hundreds or even thousands of years. Another possibility related to CO2 injection into oil reservoirs, namely in the case of reservoirs at a mature state but still in use, is enhanced oil recovery (EOR). These potential storage targets are dispersed worldwide. Together, they represent a capacity for storing hundreds to thousands of gigatons of carbon (GtC). Deep aquifers are usually not well characterized in terms of size, geological structure and physical characteristics. Injected CO2 must push out the brine, which in the case of low permeability may cause an increase in pore pressure, resulting in mechanical stress for the structure and more energy being required for injection. Over the years, the CO2 could dissolve (at least partly) in the brine, which on the one hand could result in safer storage. On the other hand, formation of water circulation is not well understood yet and could be stimulated by CO2 dissolution. Thus, the dissolved CO2 could be transported if the aquifer is open, for example to the deep sea (Radgen et al. 2006). In the very long term (about thousands of years), CO2 is also expected to react with minerals to form carbonates so that it would be locked up essentially permanently. What makes aquifer storage especially attractive is the fact that aquifers exist in every part of the world and capacities are, with high uncertainty, estimated one order of magnitude higher than all other options put together. However, many research areas remain open: site selection criteria, long-term leakage rates and monitoring of retention and migration of the stored CO2 (Clarke et al. 2004). Unminable coal seams are coal deposits from which coal production is not economically attractive. The coal would absorb the injected CO2, which would at the same time replace methane that normally exists in the coal, increasing the pit gas yield from such deposits. If methane can be produced, this technology is called enhanced coal bed methane (ECBM) (Clarke et al. 2004). One potential advantage could be the low distance between CO2 source and storage site as many coal power plants are built near coal deposits. However, in the case of open cast lignite mining in Germany, this is not an option. 5.2 Design Options and Sustainability Potential 83

Ocean storage involves the injection of liquid CO2 deeply below sea level or the insertion of solid CO2 blocks into the sea. The disposal of CO2 in deep oceans is currently not regarded as an option in Europe, including Germany.2 Its risks, particularly in terms of the time of storage and effects on the marine environment, are considered to be too high (WBGU 2003). Total storage capacity. The total theoretical storage capacity in Germany is estimated to be in the range of some 80–150 years if all CO2 from power plants (about 320 Mt/a) is to be stored (COORETEC 2003; GESTCO 2004). Actual technical and economical capacities are lower, depending on geological restrictions, cost and the location of the storage sites. Moreover, as many storage sites are cross-national, the distribution of rights and responsibilities requires clarification. A basic estimation of worldwide storage potential is shown in Table 5.1. The values for storage potential in oil and gas reservoirs are relatively accurate as these are well characterized and the amount of produced oil or gas is known. A remaining uncertainty is the percentage of the space available for CO2 storage since some of the space that was originally filled with hydrocarbons may have been filled by water from the surrounding rock in the meantime.

Table 5.1 Storage capacity for several geological storage options (IPCC 2005)

Reservoir type Storage capacity (Gt CO2) Lower estimate Upper estimate Oil and gas fields 675a 900a Unminable coal seems 3–15 200 Deep saline formations 1000 Uncertain, but possibly 104 aThese numbers would increase by 25% if estimations for undiscovered oil and gas fields are included in the assessment.

For the capacity of aquifers, estimations differ by one order of magnitude. The reasons are different assumptions as to which aquifers are suitable for CO2 storage: Some studies only consider closed aquifers as the probability of leakage in these is lower. Another point of discussion is which of the different storage mechanisms (e.g. physical trapping, dissolution, adsorption, etc.) dominates. From the presented values it can be concluded that large-scale application of CCS should be possible for some decades with utilization of oil

2 However, the US and Japan are considering ocean storage, and international legal barriers have recently been removed. The London Convention on the Prevention of Marine Pollu- tion by Dumping of Wastes and Other Matter has been changed so that CO2 no longer counts as a pollutant (IEA 2006c; Point Carbon 2006). 84 5 Carbon Capture and Storage and gas fields and aquifers only. However, for reasons of transport costs, the distance between CO2 source and storage site should be minimized. In countries where geologic storage options are not available within an acceptable distance (e.g. Japan), other storage options would therefore have to be considered.

5.2.2 Ecological Performance

Along the process chain, various environmental consequences could result from a widespread application of CCS (Fig. 5.3). The potential impacts can be broadly distinguished between local and global environmental issues. The most pronounced issues are leakage (e.g. losses of CO2 from storage and transport processes) and the increase in resource depletion resulting from the supplemental energy need for the separation of CO2. In fact, a major drawback of CCS is its negative impact on power plant efficiency. With post combustion in conventional hard coal plants, the conversion efficiency decreases between 8 and 12 percentage points, for IGCC between 6 and 8 percentage points (Schumacher and Sands 2006), and for the oxyfuel technology around 10 percentage points. Both – leakage and conversion efficiency – are significant parameters for the global warming balance of CCS. Efficiency losses increase resource use, fuel extraction and amounts of CO2 to be stored as well as associated environmental damage such as landscape destruction and pollutant emissions. All of this gives rise to substantial debate.

Leakage of CO2 along the CCS process chain (non-permanence of CO2 storage and transport losses) is probably amongst the most important issues. Such diffusion of CO2 via various pathways cannot be fully ruled out. Bore holes, diffusion through overlaying rocks, or through natural fractures and faults present possible leakage paths. Moreover, accidental releases as a result of high-pressure transportation via pipelines should also be taken into consideration. The likelihood of these dangers is not yet sufficiently known. A number of studies have been carried out to address this issue (Hepple and Benson 2003; Chalaturnyk and Gunter 2004). Model calculations and natural analogies suggest that in many geological formations, leakage rates below 1% over 1,000 years are possible. Exhausted gas and oil fields and, to a lesser extent, salt caverns have been regarded as safe permanent storage sites to date. However, any leakage rate greater than zero means that most of the CO2 stored will have escaped some day. Therefore, liability for expected or unexpected leakage is an issue to be debated. Doubts about storage safety have been fuelled by a recent US study showing that stored CO2 can dissolve minerals in the ground and, in this way, 5.2 Design Options and Sustainability Potential 85

CO Removal/ Power 2 Transport Storage Plant

Reduced CO2 emissions Leakage climate change dito Energy penalty mobilise contaminants in increased resource surrounding rocks consumption acidification of ground water, increased upstream soils impacts danger to health Reduced direct pollutant emissions, partially offset by Rapid CO2 release higher amounts of combusted danger to human health dito fuel climate change dito Increased consumption of chemicals Increased transport services Structural changes microseismic activity Increased amounts of solid waste Area requirements (mineralisation)

Change of the marine ecosystem (ocean storage)

Fig. 5.3 Environmental impacts along the process chain cause leakage (Kharaka et al. 2006). Overall, however, the IPCC 2005 report optimistically states that “the fraction retained in appropriately selected and managed reservoirs is very likely to exceed 99% over 100 years, and is likely to exceed 99% over 1,000 years” (IPCC 2005). Leakage leads to impacts both on local and global levels. At global scales, slow leakage of large amounts of CO2 into the atmosphere might impede future generations to return to a “safe” level of greenhouse gas emissions. Thus, CCS might fail to achieve its purpose of avoiding dangerous climate change. Locally, leaking CO2 might endanger shallow drinking water supplies by mobilizing contaminants from the surrounding rock. Acidification of ground water at large depths in oil and gas fields and/or aquifers due to CO2 injection may occur if the containment of those formations is breached. In the direct vicinity of leaking reservoirs or pipelines, CO2 may also reach toxic concentrations in extreme cases, where a geographic depression permits an accumulation. The associated health, safety and environmental risks depends not only on the profile of CO2 release (sudden vs. slow), but also on the location of the CO2 storage (vegetation, population density, meteorological circumstances) and the design of security and monitoring equipment. 86 5 Carbon Capture and Storage

In the case of leakage, the question arises as to whether postponing the emission of CO2 has a value in itself (Pehnt and Henkel submitted). Switch- ing from a sudden release of CO2 to a low-dose, but long-term emission profile results not only in a change of absolute emission quantities, but also in changes of the specific damage that is caused by a given quantity of CO2. These changes of the environmental damage caused are a result of the fact that the kinetics and thermodynamics of slow vs. sudden CO2 release lead to different CO2 concentrations in the atmosphere; or that the (slower) changes in concentration have less damage (because, for instance, animals and plants can adapt to this process); or that even though the consequences of the concentrations are the same (e.g. a temperature increase), they are counteracted by other processes (e.g. historical climate cycles) and thus do not have the same damage effect. In addition, delaying CO2 emissions could buy time for capital turnover and for developing new ways of mitigating greenhouse gas emissions (technical progress). Other potential environmental impacts have a more local range. Under- ground CO2 storage might cause structural changes in geological formations and thermodynamic properties could be altered, thus leading to microseismic activity. Also the build-up of high pressure in those reservoirs could affect the stability of geological layers above them and generate soil collapses. To consider all up- and downstream processes such as installation of the CCS equipment, transport and storage of the CO2, and altered operation characteristics of power plants, life cycle analyses (LCA) are required. Only few studies have attempted this exercise. The LCA model developed by Idrissova (2004) and Henkel (2006) was applied to a conventional lignite power plant (LPP), a lignite power plant with CO2 recovery by chemical absorption, an integrated gasification combined cycle (IGCC) power plant without CO2 recovery and an IGCC with CO2 separation by physical absorption (see Pehnt and Henkel (submitted) for detailed input data). The results of the impact analysis are summarized in Fig. 5.4 below. In this figure, three values are shown for every power plant and impact category, representing a reference case, a slow development (SD) case with pessimistic assumptions with respect to power plant and capture efficiencies, auxiliary power demands and emission factors, and a dynamic development (DD) case with optimistic values. The time frame of the analysis includes a horizon of 100 years, implying an essentially zero leakage of CO2. Not surprisingly, CCS leads to a substantial decline in global warming impacts from electricity generation. With regard to the supplemental energy demand, the increase is less pronounced for IGCC than for the post-combustion capture and oxyfuel cases as the energy penalty is lower. For the other impact categories, the effects are less predictable. Generally, 5.2 Design Options and Sustainability Potential 87

absorbing CO2 capture with monoethanolamine as a chemical solvent leads to a significant increase of the impacts in most categories, especially in the SD case. This is found to be caused by the high energy penalty and the chemical solvent process. Impacts of the IGCC power plants with and without CO2 capture are low compared to the conventional power plant because of the inherently lower pollutant emissions from this power plant process. For the oxyfuel power plant, impacts depend extremely on the assumptions underlying the analysis, particularly on the assumed energy demand for oxygen production and even more so on whether co-capture of other

Cumulated Energy Demand Global Warming

16 1000

14 800 12

10 600 8 MJ MJ 400 6 g CO2 equivalent CO2 g g CO2 equivalent CO2 g 4 200 2

0 0 PC PC+CCS IGCC IGCC+CCS Oxyfuel CCS PC PC+CCS IGCC IGCC+CCS Oxyfuel CCS

Acidification Summer smog

1,4 30

1,2 25

1 20 0,8 15 equivalent equivalent 2 2 0,6 10 g SO g SO 0,4 g ethene equivalent ethene g g ethene equivalent ethene g 5 0,2

0 0 P C PC+ CCS IGCC IGCC+CCS Ox y fuel CCS PC PC+CCS IGCC IGCC+CCS Ox y fuel CCS

Eutrophication Health impacts

250 0,1 0,09 200 0,08 0,07 150 0,06 0,05 equivalent equivalent YOLL 3- 3- 4 4 100 0,04 0,03 g PO g PO 50 0,02 0,01 0 0 PC PC+CCS IGCC IGCC+CCS Oxyfuel CCS PC PC+CCS IGCC IGCC+CCS Oxyfuel CCS

Slow Development (SD) Reference Dynamic Development (DD)

Fig. 5.4 Life cycle assessment results (without CO2 leakage) per kWhel (Pehnt and Henkel submitted). PC Pulverized Coal; IGCC Integrated Gasification Com- bined Cycle; NGCC Natural Gas Combined Cycle 88 5 Carbon Capture and Storage pollutants is possible or not.3 In the case of DD, the resulting impacts are extremely low, while in the case of SD the impacts are nearly as high as for post-combustion capture. To summarize, the energy penalty due to the actual process of CCS – and potentially also leakage – are the most significant environmental parameters, while the effect of other life cycle stages (e.g. compression along the pipeline) and system components (e.g. construction of the pipeline) are of only minor importance.

5.2.3 Economic Performance

The market potential for CCS depends mainly on how economical the process is compared to other CO2 reduction strategies. Carbon capture increases the cost of electricity generation because of the additional plant equipment and the decrease in conversion efficiency. The latter is smaller for pre- than for post-combustion processes, with corresponding economic effects. CCS is therefore more likely to be implemented in new power plants once it has become commercially available than by retrofitting existing plants. Retrofit requires large additional capital investment which is usually not anticipated in the upfront investment decision and may thus render some plants uneconomic before the end of their lifetime. In addition, because of its negative impact on conversion efficiency, it is only suitable for highly efficient plants. Alternatively, capture-ready plants may be set up which would anticipate ex post installation of capture equipment. Capture-ready plants have higher upfront capital costs which would be part of the initial investment decision. However, this might defer some investment because the higher upfront costs increase investment uncertainty. The acceptance of higher initial costs depends on the expectation as to whether CCS will be implemented or not, which in turn depends on climate and energy policies and the costs and availability of CCS vs. alternative mitigation options. CCS imposes additional capital, operation and maintenance and fuel costs for the capture plant as well as for transport and storage of the captured CO2. In the relevant literature, the range of estimated costs for electricity generation is great, depending on the underlying assumptions, in particular those on investment costs, conversion efficiencies, future interest rates, fuel prices and the cost of CO2 emission certificates. Table 5.2 provides a summary of cost and performance measures compiled from various studies (Ecofys

3 There is still insufficient knowledge to determine the interaction between co-pollutants and the storage formation. Thus, the allowed pollutant levels in the captured CO2 are still uncertain. 5.2 Design Options and Sustainability Potential 89

2004; IEA 2003; WI et al. 2007). The table shows levelized costs for each technology in accordance with WI et al. (2007), based on common assumptions with respect to interest rates (10%), depreciation period (25 years), plant use (7,000 h/a) and fuel prices (5.7 €/GJ for gas, 2.3 €/GJ for coal in 2020).

Table 5.2 Expected cost and performance measures of new electricity generation technologies with and without CO2 capture and storage in the year 2020 Pulverized IGCC NGCC Coal Plant Plant Plant IEA Ecofys WI IEA Ecofys WI IEA Ecofys WI 2003 2004 2007 2003 2004 2007 2003 2004 2007 Without CO2 capture Conversion efficiency 44% 42% 49% 46% 47% 50% 59% 58% 60% 1,086 1,085 950 1,335 1,685 1,300 424 480 400 Investment cost (€/kW) Operation & mainte- 33.0 50.0 48.3 37.1 575.5 53.0 14.8 37.3 34.1 nance cost (€/kW) Cost of power genera- 4.15 4.39 3.87 4.48 5.18 4.46 4.35 4.71 4.44 tion (€-cent/kWh)

With CO2 capture Conversion efficiency 36% 33.7% 40% 40% 42.2% 42% 51% 52% 51% Emission reduction 85.3% 85.0% 85.3% 86.2% 86.6% 85.7% 86.1% 86.6% 85.9% 1,823 1,880 1750 1,733 2,3752,000 850 890 900 Investment cost (€/kW) Operation & mainte- 78.0 79.7 80.0 55.0 87.5 85.0 35.0 51.7 54.0 nance cost (€/kW) Cost of electricity 6.29 6.48 5.95 5.57 6.95 6.28 5.77 5.99 6.08 generation (€cent/kWh) Cost penalty for CCS 2.14 2.09 2.08 1.09 1.77 1.82 1.42 1.72 1.64 (€-cent/kWh)

With CO2 capture, transport and storage Cost of power genera- 6.35 6.68 6.28 tion (€-cent/kWh) Total cost penalty for 2.48 2.22 1.84 CCS (€-cent/kWh) Mitigation cost 43.2 39.2 63.7 (€/t CO2) Note: Calculations are based on common assumptions with respect to interest rate (10%), depreciation period (25 years), plant factor (7,000 h/a) and fuel prices for 2020 (5.7 €/GJ for natural gas and 2.3 €/GJ for coal). Transportation costs are not included, except for WI et al. (2007). Costs and prices are in real values with a base year of 2000. 90 5 Carbon Capture and Storage

The range of transport and storage cost estimates is wide. WI et al. (2007) estimate transport distances in Germany to be around 200km, resulting in additional costs for transport and storage of about 0.20 €-cent/kWh for gas based power plants and 0.40 €-cent/kWh for coal based plants. The cost differential between plants with and without CCS would thus be about 2.48 €-cents/kWh for a pulverized coal combustion plant, 2.2 €-cents/kWh for an IGCC plant, and 1.8 €-cents/kWh for a NGCC plant, thus raising electricity generation costs by more than 60% for coal plants, by 50% for IGCC plants and by 40% for NGCC. The additional costs caused by CCS can also be expressed as costs of mitigating a ton of CO2 and thus provide an indication of the level of the CO2 price that would allow these costs to be offset. The respective range of estimates given by IPCC (2005) is substantial and varies from 31 to 73 €/t CO2 for conventional coal technology, 21–73 €/t CO2 for IGCC and 41– 94 €/t CO2 for NGCC. WI et al. (2007) estimate CCS costs to be around 40–45 €/t CO2 for coal plants and around 60 €/t CO2 for NGCC plants in 2020. This includes transport and storage which together account for about 10–13 €/t CO2. These values approximately represent the average in the range of IPCC estimates. Other estimates, provided by for example Vatten- fall for their Oxyfuel demonstration plant in Germany, are around 20 €/t CO2 for carbon capture upon completion of their plant, excluding transport and storage. In a world of uncertain energy supply, prices and policies, it may be of interest to take a closer look at the interaction of natural gas prices and CO2 prices and their impact on the choice of energy source and generation technology. Low natural gas prices provide a comparative advantage for gas-to-electricity plants to the extent that new capacity may primarily be based on natural gas. With a climate policy and a resulting sufficiently high CO2 price, CCS would come to play a role and NGCC + CCS would be the least cost option for new investment. The picture changes with regard to high natural gas prices. Variable costs of natural gas based power generation would increase with an impact on the merit order and capacity utilization, which in turn would further reduce the competitiveness of those plants (Rubin et al. 2007). At a high natural gas price, new investment may completely shift towards coal-to-electricity generation. CCS in combination with coal-to-electricity would come to play a role at a specific CO2 price level, which would, however, be significantly lower than in the natural gas based case because of the higher carbon intensity of coal. Fig. 5.5 illustrates these interactions, exemplified for NGCC, PC and IGCC technologies. 5.2 Design Options and Sustainability Potential 91

In consequence, whether CCS will make sense economically depends first and foremost on the existence and level of carbon prices and the respective climate policy goals. The degree to which it will be able to compete with other energy sources such as renewable energy remains an open issue. In any case, CCS will be most competitive for large, centralized power plants, ideally located close to the storage location. Correspondingly, the economic potential of CCS to contribute to climate change mitigation remains limited to the share of generated centrally electricity.

Fig. 5.5 Economics of CCS and Security of Supply, exemplified for Natural Gas (NGCC), Pulverized Coal (PC) and Integrated Gasification (IGCC) technologies (Damen 2007)

5.2.4 CO2 Mitigation Scenarios for the Electricity System A number of scenarios include CCS as an option within the future generation mix in Germany. They all conclude that ambitious emission reduction targets can be achieved at lower cost when CCS is included in the possible set of mitigation options. They also agree that a CO2 price of at least 30 €/t CO2 would be a prerequisite for CCS to be included in investment decisions. For example, in their general equilibrium model analysis with the Sec- ond Generation Model (SGM Germany) based on bottom-up engineering descriptions of electricity generation technologies, Schumacher and Sands 92 5 Carbon Capture and Storage

(2006) show that both coal based and natural gas based combined cycle plants (IGCC and NGCC) would supply generation shares at a carbon price of at least 30 €/t CO2 and increasingly supply these shares with CCS at higher carbon prices. The authors conclude that an emissions reduction target can be achieved at equal or lower marginal costs when CCS is included. Via the price mechanism, the model also includes endogenous shifts towards renewable energy sources and efficiency improvements: as the carbon price increases, renewable electricity generation takes up an increasing share in electricity supply independent of additional policy support. At the same time electricity demand decreases. Martinsen et al. (2007) assess the role of CCS within a national mitigation strategy and use a bottom-up optimization model (IKARUS). As in Schumacher and Sands (2006), energy demand is a function of economic activity and energy prices, while no active energy efficiency policies are modeled. The model shows that CCS can represent an interesting mitigation option in view of stringent CO2 reduction goals. CCS would be competitive, and all newly built power stations would include CCS at a CO2 price of 30 € or above. However, CCS can at best represent one element in an overall strategy. The model shows that according to cost-efficiency criteria a large number of measures in all energy sectors would need to be taken in order to reach a given goal. In the IPCC Special Report on Carbon Capture and Storage, Dadhich et al. (2005) compare a large number of modeling experiences with a wide span of resulting energy and carbon futures. They conclude that “technological developments are at least as important a driving force as demo- graphic change and economic development”. For CCS, they consider the “choice of the technology path” as an impact factor that is more important for the pace of deployment than other factors (ibid.). Both global integrated assessment models (MiniCAM and MESSAGE) referred to by Dadhich et al. (2005) show that there is no single mitigation measure suited to achieving a stable concentration of CO2, but rather a portfolio of technologies in addition to other social, behavioral and structural changes. In both models, the level needed for an increased deployment of CCS (30 €/t CO2) is reached in the middle of the century only, with the consequence that CCS mainly contributes to emissions reductions in the second half of the century along with the implementation of renewable energy, energy efficiency improvements and fuel switching. In fact, the literature body shows a wide span of estimations for the starting point of a commercial operation of CCS, ranging from somewhere between around 2020 to beyond 2050. The assessment up to now indicates that CCS may well contribute to the transition of the electricity system. The emergence and the implementation 5.3 The Innovation Process of CCS 93 of CCS in combination with modern coal-to-electricity (Integrated Coal Gasification Combined Cycle, IGCC) and gas-to-electricity (Natural Gas Combined Cycle, NGCC) technologies would considerably affect the absolute and relative shares of lignite and hard coal and of natural gas in electricity generation, depending on the development of relative prices and climate policies. The eventual structure of the electricity system hence depends on the price of CO2 emissions and on the success of further developing capture and storage technologies. Coal may then benefit from the “reconciliation” of coal combustion and climate protection that CCS promises. The degree of CCS deployment also affects the degree of centralization of the future electricity system. As CCS is only feasible for large point sources of emissions, CCS deployment runs somewhat contrary to decentralized energy generation technologies. Consequently, the future system will be more centralized, the more widely CCS is deployed. This also has consequences for the deployment of combined heat and power generation. Centralized coal power plants have a significantly lower CHP potential because the distribution of very large amounts of heat via district heating requires ample heat sinks and sites of power plants, which may not coincide with power plant sites of possible carbon storages. In the end, a reasonable CO2 price creates a level playing field for a number of possible mitigation approaches such as energy efficiency and renewable electricity technologies. The determination of an “optimal” mix of these options and the degree of centralized vs. distributed supply structures compatible with the ideal of a sustainable electricity system remains a continuous challenge for future research in this area.

5.3 The Innovation Process of CCS

In this section, we assess the evolution of CCS as an option for climate gas mitigation in the last few decades. We look at this process with a specific focus on actors and networks building up alongside the technology development. For this purpose, we portray the actor constellation in the German coal-to-electricity system and identify the setting, interests and views of the actors, networks and coalitions. We analyze the role, involvement and changes in attitude or involvement of various sets of actors in the discourse on CCS. The section starts with a description of milestones of the evolving technological concept of CCS, followed by an assessment of actors and networks, based on written documents and on 29 semi-structured interviews conducted in 2005 and 2006 (Fischer and Praetorius 2008). 94 5 Carbon Capture and Storage

5.3.1 Research and Development Activities

CCS as such is not a new technological concept. The technologies and practices associated with carbon capture and geologic storage have been in commercial operation within various industries for 10–50 years (Curry 2004). The oil industry has been injecting CO2 into oil formations to recover additional oil since the 1970s. A network of pipelines was built in the Western USA in order to connect CO2emission points and oil drilling places. In Norway, the company Statoil started injecting CO2 in the Sleipner Field in 1996 (approx. 1 mill. t CO2 per year). Other examples are storage in the Weyburn oil field, Canada, and in the gas exploration field of In Salah, Algeria, in 2004. One of the main differences between EOR and CCS is that the former is not concerned about the long-term fate of the injected CO2. Leakage is, therefore, not an issue and neither is liability. CCS with a focus on CO2 emissions in the energy industry, however, is still in an early stage of development. Some first implementations of IGCC technology exist, however without CCS to date. Neither capture nor storage technologies are ready for deployment yet, with the result that the key focus is still on its development. This is reflected in the structure of actors involved in this area: globally, more than 60% of actors involved in CCS are situated in research institutes and universities. In Germany, about two thirds belong to R&D institutions, and one third to industry (Radgen et al. 2006). The last few years have witnessed a growing level of activities around CCS both nationally and internationally (European Commission 2004; Linßen et al. 2006; Radgen et al. 2006). Given the nascent status of the technology, most activities focus on R&D rather than on commercial deployment. An increasing number of pilot and demonstration plants as well as storage projects are in the process of planning and design worldwide. The IEA set up a database on CO2 Capture and Storage projects which, by the end of 2007, identified 133 projects on capture, transport and storage (IEA 2007). On the level of actors and networks, platforms and forums have been set up in the last few years. One example is the Carbon Sequestration Leader- ship Forum (CSLF), an international ministerial-level initiative for CCS development set up in 2003, which focuses on technology development through coordinated research and development with international partners and private industry. Germany is a partner of the CSLF. In parallel, CCS enjoys increasing attention and R&D support on the European level (Dimas 2006a; Levefre 2006). By the end of 2005, the “Technology Platform for Zero Emissions Fossil Fuel Power Plants” (ZEP) was launched by the European Commission; it brings together actors from industry, research, NGOs and the EU in an effort to develop a strategic research agenda and 5.3 The Innovation Process of CCS 95 deployment plan for CCS. A large number of research projects, consortia and networks followed, involving industry and research and sometimes national ministries (see Table 5.3).

Table 5.3 Overview of recent CCS activities (own compilation) Name Type and time Description, actors involved of activity International level CSLF International forum, Interministerial platform to foster the since 2003 deployment of CCS EU level

CO2STORE Research project, Storage of CO2 in aquifers. 19 industry 2003–2006 & research partners. EU FP5. CO2NET Knowledge Transfer To develop CCS as a “safe, technically Network; resource and feasible, socially acceptable option”. technical portal, 2002– Network of 65 stakeholders from 18 2005; follow-up activi- countries. Initially under EU FP5, now ties self-funded by members. CASTOR Strategic project, Focus on post combustion (65% of 2004–2008 budget) and storage (25%). 30 industry & research organizations from 11 countries. EU FP6. ENCAP Research consortium, Technology development. 6 large fos- 2004–2009 sil fuel users, 11 technology providers, 16 R&T institutions. EU FP6. Co2GeoNet Research network of Research & training/dissemination excellence, network on storage-related issues. 2004–2009 13 scientific institutes. EU FP6. ZEP Technology Platform, Strategic research agenda for low- since 2005 emission power plants, involving industry, NGO, scientists, EU, etc. Funded by EU and industry. ACCSEPT Research consortium, Assessment of acceptability. Research 2006–2007 institutes & consultants. EU FP6. CO2SINK Pilot plant research In-situ R&D Laboratory for Geologi- consortium, cal Storage in Ketzin (GER). Industry 2004–2009 & research institutes. EU FP 6. National level (Germany)

GEOTECHNO- Special research Projects on CO2 storage. 62 research LOGIEN program, since 2000 institutes, 38 industry partners. Funding by BMBF, BGR and DFG. COORETEC Research consortium, Economics ministry, research, industry 2003– today Oxyfuel Pilot plant Vattenfall, 30 MW, launch in 2008 IGCC+CCS Demonstration plant RWE, 450 MW, in 2014 96 5 Carbon Capture and Storage

These European and international initiatives are an important framework for national activities. In Germany, a first 30 MW oxyfuel pilot plant – operated by the major energy utility Vattenfall – was completed in 2008 and will be followed by a demonstration station of 250-350 MW. RWE, another major utility, announced that it will build an IGCC plant of 450 MW by 2014. Other industry actors such as other utilities, the power plant technology industry, and many research institutions are increasingly involved in European level projects but also in various national research and industry policy programs as supported by the Federal Ministry for Economics and Technology (BMWI), the Federal Agency for Geosciences and Raw Materials (Bundesanstalt für Geowissenschaften und Rohstoffe, BGR) and the Federal Ministry of Education and Research (BMBF). One result is that the German federal government included CCS in its 2007 outline for an integrated energy and climate program (Bundesregierung 2007), announcing its intention to install 2–3 demonstration plants of the 12 CCS plants aimed at on the EU level. In contrast, the Federal Ministry for the Environment (BMU) pursues a scrutinizing and policy-oriented approach to evaluating CCS. Their research programs include comparisons to scenarios with renewable energy technologies, fostering the dialogue between different actors (WI et al. 2007), and assessing the public perception of CCS (WI 2008). Similarly, the Fed- eral Environment Agency (Umweltbundesamt, UBA) assessed CCS technologies, concluding that CCS could, at the utmost, be considered a bridging technology (Radgen et al. 2006; UBA 2006). Recently, an increasing number of studies on CCS from a technology assessment perspective can be noted, which reflect upon CCS with regard to its systemic impacts, its coherence with societal and other developments, and sustainability (de Coninck et al. 2007; Viebahn et al. 2007; WI et al. 2007; Gibbins and Chalmers 2008).

5.3.2 CCS Actors and Constellations in Germany

For a long time, CCS was not much of a political issue in Germany; most of the activities have developed rather recently. Initially, the debate took place almost exclusively in expert circles, involving a relatively limited set of actors. The main drivers were research organizations, the oil and gas industry and a few political bodies such as the economics ministry and the German Council for Sustainable Development. More recently, the debate has gained new momentum. Climate policy is a re-emerging issue: the negotiations for the second commitment period of the Kyoto Protocol are taking off, climate change has been a topic at G8 5.3 The Innovation Process of CCS 97 summits and recent flood events and heat spells have heightened public attention. In parallel, CCS technology is being recognized on an international level by the climate policy community, as shown by the IPCC report on CCS (IPCC 2005) and the increasing number of technology platforms and research initiatives described above. In this vein, political interest in CCS is beginning to increase. Substantial differences between actors arise in their perception of risks and problems. Environmentalists point to issues of storage safety, long-term CO2 mitigation and possible impacts on eco- systems as outlined above, while the electricity and power plant industry is concerned with cost and public acceptance. The latter do not reject climate policy outright but rather demand climate protection goals to be predictable and internationally harmonized in order to prevent market distortion. The oil and gas industry, albeit not directly involved in electricity generation, has longstanding expertise in using CO2 for enhanced oil recovery and could benefit from CCS with a double dividend: first, by receiving CO2 from the electricity industry which they need for EOR and second, by offering and selling off the related CO2 emission reductions to participants of the emissions trading system. At first glance, the coal mining industry has surprisingly remained rather passive up to now. Associations which represent the traditional coal and lignite mining industry as well as electricity generators that rely on coal have not been strong in terms of promoting CCS. Aside from a few information sheets, they have not yet appeared as a driver or discussant in the actors’ network. One possible reason in the case of hard coal is the “task sharing” between coal miners and traders on the one hand and electricity industry on the other. The mining industry leaves it up to the power industry to deal with an issue which is ultimately closely related to power generation. Moreover, climate protection has never been much of an issue for the mining industry as they consider coal to be indispensable in any case for the time being. Finally, CCS creates additional costs for power generation from coal which threatens to undermine its competitiveness compared to other technologies and fuels, e.g. renewable energy. On the other hand, CCS would open up a future for coal mining which may otherwise dis- appear in the case of stricter emission reduction targets. All in all, the rather passive position of coal miners may thus be explained by the cost and benefit relation expected of CCS still being unclear. The involvement of the electricity and power plant industry was (and still is) dominated by a strategic pattern which they share with the coal mining industry, called the “Three-Step” or “Three Horizons” concept. It stipulates that fossil fuels should be made more climate friendly in three steps: first, by applying existing “best practice” technology (and exporting it worldwide); second, by developing new power plants with increased 98 5 Carbon Capture and Storage conversion efficiency; and third, by exploring possibilities for CCS. CCS is thus presented as a technology for the rather remote future. One major reason behind this reluctance to assign higher levels of importance to CCS is the expected loss in conversion efficiency and the increase in cost. In any case, the level of engagement neatly corresponds to the share of coal based generation in electricity companies’ German portfolio, i.e. those companies with high coal and lignite shares are more dynamically involved in CCS activities (Table 5.4).

Table 5.4 Shares of coal and lignite in electricity generation 2006. Sources: EnBW 2006; E.on 2007; RWE 2007; Vattenfall 2007. in % Vattenfall RWE E.on EnBW Hard coal 4.8 27.9 27.6 n.a. Lignite 74.3 37.3 7.1 n.a. Total share 79.1 65.3 34.7 19.3a Total Generation, in TWh 70.6 181.8 120.8 74.9 aEnBW does not disclose its coal shares; the share is for fossil fuels, incl. oil/gas. Yet there is a change in strategy that can be observed. Until recently, most industry players were involved in R&D activities in order to keep up-to-date with state of the art or future technologies. However, they kept their engagement rather low key, calling for public funding as a condition for their own investment. At the outset of the debate on CCS, they were not very active in publicly promoting the technology. This picture recently changed with rising natural gas prices and the likelihood of carbon prices also rising in the medium and long term – with the result that CCS is becoming more attractive. The three biggest electricity companies, E.ON, RWE and Vattenfall, along with the power plant constructor Siemens PG now hold key roles in the EU Technology Platform ZEP and are all involved in a number of projects on both national and EU levels aimed at the technological and commercial development of CCS. The “Three-Step” concept is still used in public communication but is increasingly being modified to endorse CCS in a more committed fashion (RWE 2006). One might expect that prospects for international markets stimulate the activities of the power plant industry. This was also voiced by some interview partners, who pointed, for example, to China’s future energy need and the expected rise in its use of coal. However, the factual level of commitment is rather dominated by national considerations. International markets seem to be more of a theoretical argument, even more so given that the biggest 5.3 The Innovation Process of CCS 99 future coal users (like China) have not taken on climate commitments to date. It also remains an open question the degree to which they will be interested in climate mitigation technology and whether they have suitable storage opportunities. That might change by 2020, and if CCS is accepted under CDM, the picture will change even sooner. Environmental NGOs and the Green Party have recently joined together to develop critical momentum. They demand a clear legal framework and registration rules for CCS, similar to the “Gold Standard” for projects in the Clean Development Mechanism. They also point to the fact that CCS does not make much sense as retrofit given that most of the coal based power plants currently being planned will not be equipped with carbon capture. In their view, in other words, CCS would come too late anyway, regardless of the eventual options and related risks of storing the captured CO2. Meanwhile, both environmentalists and renewable energy lobbyists are confident that cost reductions in renewable energies and a reasonable price for CO2 will make them competitive with coal and CCS. On the other hand, they fear that CCS might deduct funds from R&D on renewables and that it could be an excuse for investment in large centralized power plants which cement supply structures that are unconducive to energy saving, decentralized renewable energies and CHP. Between these actors, we can find two closer-knit networks linked by a looser net of communication and dialogue. The first network is formed among the electricity and power plant industry, the oil and gas industry, mostly technology-oriented researchers, the BMWI and the BMBF. They cooperate mainly in developing, funding and executing R&D programs and projects. The coal mining and trading industry is connected to this network, mainly via organizational links with electricity industry: miners and power producers are part of the same corporations and are grouped under the same umbrella organizations. The trade union “Industriegewerkschaft Bergbau, Chemie, Energie” (IGBCE) also comprises both sectors. The coal industry is also becoming engaged, for example within the GEOTECHNOLOGIES Program. The second network is formed by environmental NGOs, BMU, the renewable energy lobby, and another part of the scientific community, mostly focusing on a socio-political, economic, and/or socio-ecological approach. The network is mainly held together by information and consultation flows. These two networks are connected via a looser network of communication. Ministries, the electricity and power plant industry, researchers and NGOs at least know each other’s positions from organized communication – for example, within the Zero Emissions Platform ZEP, in CCS workshops or in the context of stakeholder oriented research projects. By contrast, the coal mining industry, political parties and trade unions have taken part to a lesser degree in such forums to date. 100 5 Carbon Capture and Storage

Last but not least, the public perception of CCS by the general and local public is a white spot in the actor constellations as portrayed so far, yet it is an essential component of and prerequisite for any successful deployment of CCS. Unfortunately, little valuable information about public acceptance of – or opposition to – CCS is available to date, and no analysis has been published with regard to Germany yet. Only a handful of international studies on public perception and acceptability have been conducted (see Curry 2004; IEA 2005; Peteves et al. 2005 for a comprehensive discussion). Most studies show very low levels of recognition of the technology and related issues. This deficiency has increasingly been recognized by policy, industry and other drivers of CCS. An assessment of social and acceptability issues in Germany, including an analysis of public risk perception as well as the perception of CCS more generally is now underway, with the ultimate aim of designing an information campaign (WI 2008). Similarly, pilot plant operators like Vattenfall are investigating local and regional attitudes towards their pilot plant (Daniels and Heiskanen 2006). On the EU level, technology platforms and industry/research consortia (Table 5.3) are increasingly including public awareness raising in research plans and dissemination strategies. The EU level project ACCSEPT (“Acceptance of CO2 Capture and Storage Economics, Policy and Technology”) points to the same direction. Still, the eventual public perception remains the great unknown. To summarize our assessment of actors and coalitions with regard to issues of debate and consensus, three main points can be stated. First, there is a considerable degree of consensus on many topics amongst actors. Most remarkably, there is little fierce opposition towards CCS – though little enthusiastic support, either. The technology seems to promise interesting options for climate protection but the remaining uncertainties are substantial so that all actors agree on the need for further scientific exploration and public discussion. CCS is conceived as an international issue that cannot be decided upon at national level. Future worldwide energy demand, the needs of newly industrializing countries, export options, foreign storage potential and international climate regimes will influence CCS and the development of coal. Second, actors agree that CCS is not a “magic bullet” that will solve the climate issue without further changes in the energy system. Actors acknowledge in principle that, on the one hand, fossil fuels (and specifically coal) will continue to be important in Germany for some time. On the other, though, CCS is only a temporary solution. The debate revolves around the exact time span for fossil fuel and CCS use and around the nature of the future energy system. Environmental NGOs tend to adopt a wider time horizon, discussing energy futures up to the year 2050–2100. Industry, coal organizations and the BMWI (with few exceptions) prefer to restrict 5.3 The Innovation Process of CCS 101 their goals and visions to a shorter term, pointing out that every statement concerning the time beyond about 2030 is highly speculative.

5.3.3 Development of the Institutional Framework

The implementation of a suitable institutional setting for CCS is currently an issue in its infancy. Apart from some R&D programs, no elaborated policy exists at the moment with respect to CCS. However, given the economic, technological and geological risks of CCS, a clear and reliable framework seems a precondition for its eventual deployment, and also for its development as well. It is against this background that all involved actors have been underlining the necessity of a reliable and stable long-term energy policy framework in order to provide security of investment (Fischer and Praetorius 2008). Such an institutional framework needs to regulate at least two major issues: First, a predictable and high CO2 price is in any case necessary for making CCS competitive with conventional fossil power plants. This points to the relevance of future international climate regimes and the development of the EU emissions trading system for the future of CCS. Second, clear legal regulations of technology and liability issues are required. The latter could also include a “capture ready” standard as suggested by the EU Commission (European Commission 2007a). A third aspect of institutional relevance is the regulation of financial support for the development and deployment which needs proper institutional treatment. This includes regulations to prohibit unjustified technology subsidies, as included in the European competition law. Related to this, suggestions to remunerate electricity fed into the grid from “clean coal power stations” with CCS in ana- logy to the Renewable Energy Law in Germany would also require accurate legal rules. On an international level, activities to develop the necessary regulatory framework have been underway for a couple of years now, but they have only recently started to be recognized in the German debate. This includes guidelines for including CCS in national greenhouse gas inventories as suggested by the IPCC (Eggleston 2006; IPCC 2006) and early IEA activities on legal aspects (IEA 2006a). In parallel, the EU Commission started the process of developing legislation for the topics of risk, liability, legal barriers and incentives including embedment in the EU emissions trading scheme (Dimas 2006b; Levefre 2006; Working Group on CCS 2006). Any legal framework for CCS involves a number of detail related problems to be solved. In fact, legal conditions need to be tackled individually for each process step: Capture, transport and storage. Capture is primarily 102 5 Carbon Capture and Storage a national issue, while storage safety standards, long-term monitoring, reporting and liability need to be addressed on both national and international levels (Öko-Institut 2007). A substantial number of details require clarification: is the captured product (CO2) to be considered as a waste product, a by-product or an emission? For each category different rules apply. The same holds true for the regulation of transport activity which will additionally depend on whether CO2 is transported nationally or internationally. Moreover, for all storage options a consistent policy framework is needed that takes into account the potential risk of long-term CO2 leakage. One possible way towards this end could be to establish a market based risk management system that addresses liability and internalizes the uncertainty and danger of CO2 leakage – in particular in the longer run. Edenhofer et al. (2004) suggest the introduction of Carbon Sequestration Bonds to provide monetary incentives for the selection of safe, permanent storage sites and to ensure liability and compensation in the case of leakage and climate impacts. As in many other areas of climate and energy policy, major institutional impulses for CCS are increasingly coming from the EU Commission. In a Communication from January 2007 (European Commission 2007b), the EU Commission identified two major tasks for the deployment of CCS: To develop an enabling legal framework and economic incentives for CCS within the EU and to encourage a network of demonstration plants across Europe and in key third countries. On 23 January 2008 the EU Commission proposed a Directive on CO2 storage as part of a major legislative package on climate protection policy (European Commission 2008b). The Commission’s proposal intends to enable CCS by providing a framework to manage environmental risks and remove barriers in existing legislation. It also suggests its integration into the EU Emissions Trading Scheme, proposing consideration of CO2 captured and safely stored according to the EU legal framework as not emitted under the ETS. In Phase II of the ETS (2008–12) CCS installations can be opted in. For Phase III (2013 onwards), under the proposal to amend the Emissions Trading Directive, capture, transport and storage installations would be explicitly included in Annex I of the ETS. With regard to capture ready plants, the EU Commission currently rejects suggestions to make CCS mandatory (European Commission 2008c; 2008a). It considers the related cost to be high and without clear advantages – neither in stimulating technological development and improving air quality nor in promoting the earlier uptake of CCS by non-EU countries. In fact, it would implicate mandating a technology that has not yet been demonstrated on a commercial scale. In summary, the Commission follows economic arguments, pointing to the fact that mandatory CCS would run counter to the market based approach of the European Trading System: “Whether CCS is 5.4 Shaping the Innovation Process 103 taken up in practice will be determined by the carbon price and the cost of the technology. It will be up to each operator to decide whether it makes commercial sense to deploy CCS” (European Commission 2008c). In the end, however, the EU Commission does not completely rule out such a mandatory approach to CCS and suggests that if commercial take-up of CCS is slow, the idea of compulsory CCS would be reconsidered.

5.4 Shaping the Innovation Process

Carbon capture and storage is currently at a stage of development and simultaneously at a point of departure. This section first looks at probable visions for a sustainable deployment of CCS and then derives the need for shaping the path for the development of CCS. Theoretically, carbon capture and storage promises a low-emission, fossil based electricity generation option that may contribute to a sustainable transformation of the electricity system. It would allow keeping the existing system structures in terms of fossil fuel use and large scale electricity generation. Thus, not surprisingly, interest and activities on the side of the incumbent electricity system actors are increasing. Both research and advocacy networks and platforms are sprouting, and the necessary regulatory framework for its implementation is in. From a practical perspective, however, any sustainability evaluation of CCS is ambivalent at present, and many open issues remain. Knowl- edge about CCS is far from complete: Substantial uncertainties and risks exist which are related to the disadvantageous economics as well as to the required further technological development, and – last, but not least – to the security and reliability of transporting and storing CO2. In particular, many geological issues such as the impact of underground CO2 storage are still unknown. Also, as a result of the decrease in generation efficiency, CCS causes comparatively increased resource and landscape depletion related to coal mining. Moreover, the existence of sufficient societal acceptance for CCS is still an open question. In the light of climate policies, the economics of CCS compared to alternative mitigation options play an important role. At a sufficiently high carbon price, CCS will be cost competitive with conventional technologies, but probably also with other options, such as new and advanced renewable energy technologies like cogeneration. This also implies a decision about the future character of the system, i.e. towards a more distributed generation structure, or rather a continuation of the present centralized structure with large power stations. For example, as CCS is only economically viable for large power plants, it is not thus compatible with decentralized combined 104 5 Carbon Capture and Storage heat and power generation, which needs to be located close to heat sinks, and is of a smaller size. One question therefore is to what extent both trends are complementary or contradictory, and whether one will become dominant and exclusive at some point. Uncertainty also includes the timing of large scale and commercial availability of CCS. Given the increasing risks of climate change, CCS may simply come too late for large scale application, for example in Germany where much of the addition in generation capacity needs to be available before 2020. For this reason, an obligation for capture-ready implementation of new coal generation plants, as pursued by the European Commission, is currently regarded as an option. However, given the higher investment cost related to both CCS and capture-ready plants, the need for recovering capital cost may unintentionally add to the carbon lock-in and path dependency phenomena. Once a CCS plant is built, companies are likely to operate it with the aim of recovering their costs rather than switching to less dam- aging technologies before the end of its lifetime is reached. However, there is no “window of opportunity” that strictly closes in 2020, the year often mentioned as the end of a period of necessary massive rein- vestment in Germany. It is rather a continuous replacement process that would still allow for a step-by-step implementation of both retrofit and integrated CCS technologies after 2020, followed by a slow but steady decom- missioning of CCS plants towards the depletion of CO2 storage capacities. The need for shaping. All in all, CCS features both the chance for a smooth transition towards a sustainable electricity system, and the risk of prolong- ing the current carbon path unnecessarily and at the expense of society. The eventual outcome is still unknown. The major governance challenge therefore is to frame the future development of CCS in such a way that it will only be implemented when it proves its sustainability. First and foremost, a clear and reliable climate policy framework needs to be in place to develop the portfolio of technologies and allow for a transition towards a low-carbon or even carbon-free future. This includes creating a continuous and appropriate price for CO2 emissions, for example by means of an international emissions trading regime. Power generation cost must reflect environmental cost. For this, clear and stringent climate targets are needed so that CO2 has a price and CO2 emissions become a relevant cost factor in electricity generation. This stimulates the development of efficiency and renewable technologies as well as of CCS. Such an emissions price is the precondition for the economic viability of CCS (and of other mitigation options). All relevant actors accept or support long-term climate goals and policies as long as they are stable, predictable and internationally harmonized. Policy makers should hence build on this consensus and offer 5.4 Shaping the Innovation Process 105 a reliable framework. Moreover, the integration of CCS into climate policy regimes as a mitigation option is likely to increase the motivation of countries such as the USA to join a post-Kyoto international agreement on climate protection. Second, a precondition for CCS is a well developed regulatory and institutional system in order to ensure secure operation and the monitoring of storage sites, to prevent leakage and to regulate liability issues. Secure operation needs to be made a precondition for CCS implementation. A clear and conducive framework would need to cover site selection and licensing procedures, environmental and safety standards, risk assessment and management, monitoring and reporting, liability rules, the regulation of international cooperation and the compatibility of national and international legal frameworks. The EU Commission proposal for a CCS Directive (European Commission 2008b) suggests that a monitoring plan must be set up to verify that the injected CO2 is behaving as expected, otherwise corrective measures will be required to return the site to a safe state. Analogously, Emissions Trading Allowances must be surrendered for any leaked CO2 to compensate for the fact that the stored emissions were credited under the ETS as not emitted when they left the source. With regard to monitoring, national authorities are to ensure that inspections are carried out to verify that the provisions of the proposed directive are observed. Routine inspections must be carried out at least once a year, involving examination of the injection and monitoring facilities and the full range of environmental effects from the storage complex. Under the proposed directive a storage site shall be transferred to the state when all available evidence indicates that the CO2 will be completely contained for the indefinite future. We expect that, as the devil is in the details, concrete implementation of those issues will be a major source of conflict. Third, with regard to an appropriate research strategy, there are still many uncertainties and risks that need careful investigation and clarification. This includes the development of the different CCS technology elements and options as well as transport and storage related issues, and also the economics which are currently rather unfavorable compared to other mitigation options. In this area, one of the most-debated issues is the direction, level and intensity of public R&D funding for CCS as compared to other (renewable or efficiency-oriented) energy or climate change mitigation technologies. Up to now, CCS is not dominating research budgets, yet the increasing level of attention that CCS is attracting is already reflected in increasing research and funding sources. One of the key issues here is that in a first phase of CCS development, it can be demonstrated that suitable storage sites exist, and that the potential risks associated with CCS are at acceptable levels. 106 5 Carbon Capture and Storage

In fact, given the speculative nature of the technology forecasts, a sensitive research and mitigation policy strategy must include all other options. The idea of CCS is to contribute to a CO2 mitigation strategy. However, most experts expect CCS to be commercially available no earlier than 2020. Until this – tentative – point of time of market introduction, other means of mitigation need to be explored in parallel. Therefore, CCS should not crowd out research on renewable energies or energy efficiency. A sensible decision could be to focus public involvement on basic research and on issues of public interest like storage safety while leaving commercial development of capture technologies as a task for industry R&D. Last but not least, the implementation of a new and major technology such as CCS also presumes social acceptance. Without a broad acceptance among stakeholders and also by the broad public, transport and storage activities risk being held back by protest activities organized by NGOs. Thus, any successful strategy to implement CCS needs active and open public outreach activities combined with a well developed regulatory framework, which must adequately be balanced with gold standard criteria as put forward by major NGOs. To summarize, given the risks and uncertainties still related to CCS, any political shaping of the innovation process should start by setting a proper framework which includes, first, a stringent climate protection framework with rules for integrating CCS projects under the Emissions Trading Scheme, and under the CDM; and second a strong regulatory and monitoring framework with clear and adequate rules for storage site selection, transparent monitoring and reporting, clear liability rules and a binding international framework. With such a setting, a level playing field for the different options for mitigation would be prepared on which CCS may compete for its appropriate share.

5.5 The Future of CCS in a Sustainable Electricity System

CCS is increasingly being seen as a potentially attractive option within a portfolio of options to mitigate climate change and is therefore moving from the fringes to the centre stage of climate policy and related innovation discourses. Our assessment has shown that there is no final answer to the question as to whether CCS is beneficial to a sustainable transformation of the electricity in Germany and abroad. In this last section, we draw some conclusions for the future development and deployment of CCS in the context of the national and global electricity system. Table 5.5 summarizes our findings. 5.5 The Future of CCS in a Sustainable Electricity System 107

Table 5.5. Dynamic characteristics of the innovation process of CCS Descriptors Characteristics of CCS

Purpose of Low CO2 fossil fuel based power station by means of carbon innovation capture and storage. Relevant 1997 Kyoto Protocol context 2005 European Emissions Trading System factors IPCC reports and an increasing public perception of climate change make post-Kyoto emission reduction schemes likely. Path dependency: Coal dominant in German power generation. Phases Origin and transfer: Technology used by chemical industry since the 1970s to produce CO2 as input to EOR and EGR. Development and diffusion ongoing. Niche market formation starts in early twenty first century with some first implementation of IGCC technology, however without CCS; no installation of IGCC with CCS yet. Demonstration and pilot plants for CCS now in progress. Commercial availability expected for 2015–2020. Actors Active drivers: Scientific community, oil and gas industry, electricity industry and the Federal Ministry of Economics. Positive impulses for CCS from EU and international development. Relevant critical actors: Most environmental NGOs, Green party. Passive/undecided: Other parties, coal industry, trade unions, parliament. Potential for consensus amongst actors on CCS as bridging technology; public acceptance as open issue. Competing Renewable technologies (no CO2) innovations Energy efficiency and energy reduction efforts and technologies (crowding out of support measures); Decentralized electricity generation (CCS for large point sources) Complementary IGCC, NGCC, biomass to electricity innovations EU ETS, Post Kyoto climate regimes, complementary policies Inducing Increasing public perception of climate change and mitigation. mechanisms Expected continuation of EU ETS and Post Kyoto regimes. Accountability through Kyoto flexible mechanisms. Expected cost reduction of CO2 capture (learning). Blocking Timing and availability, high cost, energy penalty factors Risk of leakage of CO2, potential public resistance, uncertainty about information, liability, and transaction cost. Sustainable CCS may be considered as one option for CO2 mitigation among vision others, but a careful assessment, more R&D efforts and a reliable regulatory framework are needed beforehand to clarify the risks of technology and storage. Possibilities Reliable climate policy (nationally and internationally). for shaping Creation of regulatory and incentive system, in particular with respect to storage security. Public and private R&D and pilot plant activities. Awareness raising and public acceptance. 108 5 Carbon Capture and Storage

On the one hand, there are various reasons why CCS could be seen as a bridging technology that allows for a smooth transition away from the current carbon focus of electricity generation towards a more sustainable future. CCS could indeed reconcile fossil fuel use with climate targets, but this presumes storage capacity to be available, and safety to be guaranteed. In this case, it may buy time to advance with renewable and alternative carbon free technologies. Also, CCS is more compatible with the prevailing electricity system structures than other mitigation strategies as it allows for the postponement or reconsideration of radical changes in these system structures and it serves vested interests of existing actors. Second, it allows for continuation of the exploitation of domestic lignite resources in Germany and thus fits well with considerations of energy security and national employment. Third, national deployment of CCS allows German companies to be pioneers with regard to pilot and demonstration projects and may lead to first mover advantages. CCS may thus open up space for the concept of fossil fuels as “transitional” fuels. On the other hand, CCS may prolong the dominance of the current coal- to-electricity path to some 100 years instead of about 40 years in Germany. As carbon separation is only viable for large point emissions, the current structure of centralized coal-fired power plants would be partly conserved. Not all investment, however, is likely to flow into such plants. Rather, a mix of central and decentralized options based on different fuels is likely to result. Such a trajectory seems reasonable as long as it is compatible with climate protection and other sustainability demands, and as long as the transition period is used to develop alternatives to the fossil system that may ultimately result in a low-carbon future electricity system. The most important precondition for any further engagement with CCS is thus to create a reliable and stringent regulatory and climate policy framework, considering all relevant aspects of security and liability, thereby creating a level playing field. A responsible future technology and climate policy needs to consider all the different mitigation options. Aside from this, CCS is relevant not only for Germany. CCS will be a prominent discussion in the post-Kyoto process, particularly if Parties see it as an easy way forward for reducing industrial emissions without having to make major structural changes in the current energy infrastructure. This “advantage” may also attract countries like the USA to join an international climate protection regime. Whether CCS will take off in emerging economies ultimately depends on the climate regime. Countries like China and India (and other emerging countries) have some potential as addressees for the deployment of CCS, as Stern (2006: 368) points out: “…CCS is a technology expected to deliver a significant portion of the emission reductions. The forecast growth in emissions from coal, especially in China and References 109

India, means CCS technology has particular importance. Failure to develop viable CCS technology, while traditional fossil fuel generation is deployed across the globe, risks locking-in a high emissions trajectory.”At the same time, this presumes a technological leadership role for developed countries: No emerging country will invest in mitigation technology that was developed but is not deployed in industrialized countries. Any idea of a “global rollout” of CCS must presume such a step-by-step development and diffusion process (Gibbins and Chalmers 2008). Simultaneously, this opens up new perspectives for power plant industries – a new export market can be developed. To this end, technology development and implementation in Germany is an important step. To summarize, CCS is not a panacea. It is one option within a broad portfolio of climate protection measures that compete for implementation. Such a broad portfolio allows for those options with the lowest CO2 mitigation cost to be chosen. CCS can assume a specific role within that portfolio as a bridging technology during a transition from a carbon based towards a carbon-free electricity system. CCS is an incremental innovation that has a certain potential to smoothen a transition towards a less carbon- intensive energy future, provided that the related uncertainties are resolved, in particular with respect to leakage and liability. The actor constellation in Germany currently opens up such possible trajectories for using CCS as one bridging technology among others towards a more sustainable electricity system.

References

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6.1 Introduction

In Germany, the household sector is currently the one with the fastest growing end energy consumption. Electricity consumption is rising especially fast. Having a 27% share of total national electricity consumption in 2005, households are now the second biggest electricity consumer after industry. This poses problems for a sustainable energy future: due to high generation and distribution losses, electricity consumption puts a special strain on total primary energy demand. And the latter must come down if renewable energy sources are to contribute substantially to energy supply (Enquête- Kommission 2002; DLR et al. 2004; Velte 2004; DIW et al. 2005, Green- peace and EREC 2007). Therefore, electricity conservation in the household sector is an important building block for a sustainable energy future. One possible innovation that could support conservation is improved feedback on electricity consumption. Knowing how much one consumes and what it costs, being aware of the environmental impacts, and being able to link this information to individual activities, could increase households’ control over their consumption, allow them to single out electricity-intensive activities, and also motivate them to try methods for bringing down consumption and cost. International experience shows that improved feedback can produce electricity savings of upto 20% and usually lie between 5 and 12% (Fischer 2007). Furthermore, price incentives such as time of use pricing can be combined with real-time feedback on the current tariff, thus stimulating load shifting (Martinez and Geltz 2005). This way, feedback can help to adapt load profiles to the production

* By Corinna Fischer and Markus Duscha, ifeu Institute for Energy and Environmental Research, Heidelberg. We would like to thank Martin Cames and Barbara Praetorius for comments on an earlier version. 116 6 Consumer Feedback Through Informative Electricity Bills profile and thus support the increased use of intermittent sources like wind or solar power. Today, feedback on electricity consumption is far from what it could be. In Germany, the two existing sources of information are the meter and the annual bill. In owner-occupied houses, the meter is usually hidden in the cellar. In rented flats, it may be installed in the apartment or stairwell, but is usually enclosed in a locker. Reading the meter therefore requires active interest. It does not easily allow for the effect of an individual appliance to be seen, and its continuous operation makes it difficult to compare consumption from one period of time to the other. The annual bill presents an aggregate figure on electricity consumption which is impossible to link to individual activities and difficult to benchmark due to a lack of comparative standards. Kempton and Layne (1994) equate this situation to shopping in a grocery store in which no individual item has a price tag, and the consumer receives an annual bill on an aggregate price for “food consumption”, making it impossible to control consumption or cost. Environmental impact information is given only on the average electricity mix of a certain supplier, but not on the impact of individual electricity consumption. This chapter explores innovative approaches for improving feedback on electricity consumption. It combines a more general discussion based on a literature review with the analysis of an example case, the introduction of informative electricity bills in Germany, specifically by the utility Stadtwerke Heidelberg. The case study builds on evaluation research that has been carried out by the ifeu research institute for the Stadtwerke Heidelberg, which includes a customer survey, and on interviews with utilities. In section 6.2, different design options and their potential impact are discussed. In section 6.3, experience with improved feedback is reviewed in order to assess its sustainability effect. Section 6.4 analyzes the process of implementation of innovative feedback forms. Section 6.5 discusses possibilities for shaping such an innovation and its implementation, using the example of the informative bill.

6.2 Description of Innovation and Design Options

6.2.1 General Design Options

There are various design options for optimizing feedback on electricity consumption. Feedback may be improved with respect to the following characteristics (for an overview of international projects, see Fischer 2007): 6.2 Description of Innovation and Design Options 117

Medium and mode of presentation. It has long been clear from communication sciences and learning theory that the way information is presented is crucial for its adoption (Roberts and Baker 2003). Two basic media may be used for feedback: electronic media and written material. An electronic, maybe interactive, meter may show the total consumption of a household as well as time-specific breakdown or cost. Another approach is to use computer and internet as interactive tools. A computer program is supplied with data that may stem from user input (e.g. on household size, appliance stock) and/or from metering of actual consumption, and can provide the user upon request with a broad range of information, e.g. load curves, appliance- specific breakdown, comparative standards, or energy-saving tips. Written material may come on its own in the form of direct mailings, brochures, etc. Or else, the electricity bill may be used as an information carrier. Equally important is the comprehensibility and appeal of the design. The most common variants are text, load curves, bar or pie charts (for presenting an appliance-specific breakdown or comparisons in time and with other households), and horizontal lines or bell curves (for presenting comparisons with other households). Frequency. Giving feedback more often can improve control over electricity consumption because it allows for link electricity-consuming activities to be linked more directly to their consequences. One extreme is continuous feedback, e.g. via a running meter or a computer program displaying load curves. Feedback may also be given monthly or bimonthly, e.g. via more frequent bills. Content. Feedback may be improved by combining information on physical consumption (i.e. kWh) with information on other associated aspects, such as cost or environmental impacts. This way, different motives and norms, such as cost savings or environmental protection, can be activated. Breakdown. Feedback becomes more informative if a breakdown, e.g. for specific rooms, appliances or times of the day is provided. This is almost the only way of establishing consciousness of the relevance of individual activities. It can be provided by, for example, a computer program showing room- or appliance-specific load curves for various periods, or by feedback devices attached to individual appliances. Benchmarks for comparison. Comparisons are said to stimulate energy conservation, first, by stimulating competition and ambition, and secondly, by making transparent whether consumption is “out of the norm”, activat- ing the search for reasons and redress. Historic comparison relates actual to prior consumption. Normative comparison compares one household’s 118 6 Consumer Feedback Through Informative Electricity Bills consumption to others’ (e.g. to a national or regional average, to households in the neighborhood, or to households that are in some way similar). Additional information and other instruments. Feedback can be combined with other instruments. From a theoretical point of view, feedback on consumption will not work without a motivation to conserve, and without practical information on how to do it. The motivation may be provided by instruments like financial incentives, goal setting or personal commitment. Information on how to save energy is ideally closely connected to the appliance or situation on which feedback is given. Many of these options are in fact already being used in Germany, but have little effect because other important features of feedback are lacking. The electricity meter gives continuous feedback, but is barely used as a tool for controlling consumption – partly because of invisibility and bad presentation, partly because other important information like aggregate consumption, cost, or a link to individual activities or appliances is not provided. The annual bill provides some of this information. However, it arrives too seldom to make the information relevant and allow real control. The environmental information given on the bill describes only the fuel mix and the resulting per kWh emissions of the supplier. No direct connection is made between the amount of electricity consumed by the household and the resulting environmental burden. These examples show that improvements of individual aspects of feedback are of little use as long as an integrated concept is missing. In the following section, we explore a practical example for improved feedback: attempts in Germany to create a more informative electricity bill. That is, we have chosen an example that does not touch upon theissues of frequency, breakdown, or media, but tries to optimize aspects like understandability, visual design or benchmarks for comparison within the established format of the annual bill. The main reason for this choice is political feasibility. Compared to other forms of feedback, improved bills are relatively easy to implement because they use established institutional structures and procedures and do require much additional technical infrastructure. Furthermore, they can be designed as long-term projects, forming energy- conscious habits over time.

6.2.2 Example: Design Options for Electricity Bills in Germany

Private households in Germany have an electricity contract directly with their supplier (often the local public utility company). The network operator is responsible for the power meter. In the majority of cases, it is identical with the power supplier. Customers normally receive a written electricity 6.2 Description of Innovation and Design Options 119 bill once a year, but pay (bi-) monthly flat estimated rates based on previous year’s consumption or on averaged values. Other payment systems, such as cash or chip card meters, are only used in exceptional cases and mainly for customers who have had problems with the retroactive payment system. Due to this system and the applicable legal requirements (Regulation for Basic Power Supply1, StromGVV), a variety of information must be indicated on the electricity bill: x Meter readings upon which the bills are based, and resulting power consumption; x The base tariff, including base price, measuring price (monthly rates for connection and meter) and working price (for kWh consumed), as well as any changes to electricity prices during the accounting year, x The actual electricity costs; x Previously paid installments and the resulting amount due or to be re- funded; x Installment rates based on the current bill and resulting future monthly rates; x Tax payments (value-added tax, power tax); x Electricity consumption levels of the previous year for comparison; x Source of the electricity and resulting emissions; x And finally, customer number and meter numbers. Since, along with electricity, communal energy supply companies are usually also responsible for gas, district heating, and water supply, there is often an integrated bill for all these services. The electricity bill alone often covers more than two standard DIN A4 pages. Together with gas and water bills, it can easily exceed more than four closely typed sheets of paper. Due to this enormous amount of information, it is not always easy for the customer to extract relevant information, such as yearly electricity consumption or comparison to the previous years. Some energy suppliers are trying to help their customers by improving the bill structure or placing important summaries on the first page. However, this normally results in a simplified representation of the electricity cost and only rarely concerns the electricity consumption. Additional information on power consumption (such as comparison of power consumption with other households, breakdown on different end-uses) or on saving electricity (savings tips, information sources) have normally not been included in the bills.

1 Regulations for general requirements for basic supply of private customers and alternative supply with electricity from the low voltage network, 26.10.2006. 120 6 Consumer Feedback Through Informative Electricity Bills

Generally, the comprehensibility of electricity bills in Germany is considered as poor: in a study on customer satisfaction in the private sector conducted in 2005, power supply companies achieved the next-to-last position of all industries polled. Besides the price-performance ratio, customers were mainly dissatisfied with the understandability and design of the bills (ZfK 2005). We will now present a selection of different bill designs in order to highlight the variety of options. Since, up to now, the data and mode of communication (written, yearly) have not varied greatly among German energy suppliers, we will focus on differences in presentation. The first example shows how the comparison with consumption in previous years could be presented. The second one concerns the different representations of the source of electricity.

Example 1: Historic Comparison

Example 1.1: Most common format of German electricity bills (Source: Stadtwerke Georgsmarienhütte GmbH, 2006)

For your point of consumption, we supplied or removed the following between 01.01.06 and 31.12.06:

Consumption Previous year’s consumption Amount € Electricity 2,306 kWh 1,837 kWh 437.00

Total 437.00 Minus advance payments until 05 January 07 -360.00

Total due 77.89

Example 1.2: Calculation of daily averages (Source: Greenpeace Energy, 2006)

Overview of consumption Information on our gross prices Total No. of Consumption / As from Base price Price per kWh days day (kWh) (date) /month kWh (ct) Current bill 1,012 372 2.7 01/01/05 7.85 18.40 Previous bill 932 357 2.6 01/01/06 7.85 18.90

Example 1.3: Chart (Source: Badenova AG & Co KG, 2006)

Your new monthly fee for electricity and natural gas is € 81,00. For details on method used to determine your monthly payments and on payment dates, please see the following pages.

Overview of your electricity consumption: Overview of your natural gas consumption: Current billing period 951 kWh Current billing period 9,428 kWh Last billing period 554 kWh Last billing period 3,372 kWh

Fig. 6.1 Examples for comparisons of current electricity consumption with previous billing period (translation by the authors). 6.2 Description of Innovation and Design Options 121

Figure 6.1 provides an overview of how differently comparisons with previous year’s consumption may be presented. A graphical solution is rare. Normally, the data is simply listed. Sometimes the information is distributed over various locations in the bill. Our research did not uncover any historic comparisons over periods longer than the previous year.

Example 2: Implementation of the Electricity Labeling Scheme in German Electricity Bills Based on the EU electricity directive (European Parliament and Council of the EU 2003), as of January 2006 all electricity bills within the EU must indicate the composition of the electricity supplied.2 The section below shows how differently electricity labeling in Germany can be carried out. First of all, 80% of all companies choose to break down the sources of their electricity to the three categories required by law: “nuclear”, “fossil and other”, and “renewable”. Only 18% provide further differentiation (Federal Network Agency 2007: 188), although such differentiation would be very informative. For example with respect to environmental performance, there are huge differences between various fossil or renewable energy sources. Another problem is how companies deal with electricity from unknown sources, such as imported or bought at the stock market. While some declare it as such, most companies simply assume that this electricity represents the “UCTE mix”, an average composition for German or European electricity. The widespread practice of adding up the UCTE average shares of the different energy carriers with the real shares calculated for self- produced electricity goes at the expense of transparency (Federal Network Agency 2007: 187) A further question is how the information is presented to the consumer. A usual solution is a tabular representation, as shown in Fig. 6.2. Often the information is also shown in more simple text blocks that are reminiscent of the small print in legal contracts (see Fig. 6.3). Compared to this, the following bill by Stadtwerke Heidelberg appears much more intelligible since it provides the information graphically and is easy to view (see Fig. 6.4).

2 According to § 42 of the law regarding fuel and electricity industries (EnWG) from July 13, 2005. 122 6 Consumer Feedback Through Informative Electricity Bills

This information for our customers is provided according to §42 of the Energy Economy Law from July 13, 2005

Energy mix for the Stadtwerke Lünen GmbH [supply year 2004] Nuclear energy 28.00% (e.g. uranium) Renewable energy 11.00% (e.g. hydropower, wind power, solar energy) Fossil fuels 61.00% (e.g. coal, brown coal, natural gas)

Average energy mix for Germany [supply year 2004] Nuclear energy 30.00% (e.g. uranium) Renewable energy 10.00% (e.g. hydropower, wind power, solar energy) Fossil fuels 60.00% (e.g. coal, brown coal, natural gas) The environmental effects of this energy mix (emissions and waste levels) For the Stadtwerke L nen GmbH

CO2 emissions: 419 g/kWh Radioactive waste: 0.0009 g/kWh

Average for Germany

CO2 emissions: 550 g/kWh Radioactive waste: 0.0008 g/kWh

Fig. 6.2 Electricity bill excerpt, public utility company Stadtwerke Lünen GmbH, 2006 (translation by the authors)

Information on electricity supply according to §42 of the Energy Economy Law from 13.7.2005 Electricity labeling (2004 data) Total electricity supply by Stadtwerke Rostock AG, – percentages of energy sources: Nuclear: 15.2%, fossil and other sources (such as coal, lignite, natural gas): 83.4%, renewable energy: 1.4%. Environmental effects– radioactive waste: 0.0004 g/kWh, CO2 emissions: 776 g/kWh Averages of the total electricity supply for Germany for comparison - percentages of energy sources: Nuclear: 30%, fossil and other sources (such as coal, lignite, natural gas): 60%, renewable energy: 10% Environmental effects – radioactive waste: 0.0008 g/kWh, CO2 emissions: 550 g/kWh (source: VDEW)

Fig. 6.3 Bill excerpt, Stadtwerke Rostock AG, 2006 (translation by the authors) These variants show that energy suppliers have very different ideas of what makes their bills understandable. The 2007 Monitoring Report of the Federal Network Agency for Electricity, Gas, Telecommunications, Post and Railway shows that easy-to-read solutions such as pie charts are still in the minority (Table 6.1). 6.2 Description of Innovation and Design Options 123

Electricity labeling for electricity supplies in 2004 by Stadtwerke Heidelberg AG, according to §42 of the Energy Economy Law from July 13, 2005

Corporate portfolio Energy mix in percent Electricity generation* in Germany total electricity supplies average values for comparison Fossil and other sources (e.g. coal, lignite, natural gas) Nuclear energy (e.g. uranium)

Renewable energies (e.g. hydropower, wind power, solar energy)

Source:SWH Environmental effects Source:VDEW per kilowatt hour 325 g/kWh Å spec. CO2 emissions Æ 550 g/kWh 0.0011 g/kWh Å radioactive waste Æ 0.00081 g/kWh

*General*General supplysupply and and third-partythird-party feed-in,feed-in, asas ofof 1818 DecDec 2005.2005.

Fig. 6.4 Bill excerpt, Stadtwerke Heidelberg, 2006 (translation by the authors)

Table 6.1 Electricity labeling in Germany: Use of various designs (multiple answers permitted) No. of utilities Yes NoNot specified On the Bill Continuous text 344 267 65 Table 108 440 128 Pie Chart 72 473 131

Supplement to the Bill Continuous text 240 334 102 Table 199 364 113 Pie Chart 122 437 117

Publicity Continuous text 98 452 126 Table 108 440 128 Pie Chart 72 473 131 Source: Federal Network Agency 2007: 188 (translation by the authors). 124 6 Consumer Feedback Through Informative Electricity Bills

6.3 Effects and Sustainability Potential of Consumer Feedback

What can improved feedback on household electricity consumption contribute to a more sustainable electricity system? In this chapter, we focus on two aspects of sustainability: first, electricity conservation, and secondly, customer needs. We first present the results of a review of international literature about experiments, model projects and field tests with various forms of feedback as well as surveys on consumer attitudes towards feedback (Fischer 2007). It covers five review studies (Darby 2001; Roberts and Baker 2003; Abrahamse et al. 2005; IEA 2005; Darby 2006) and 19 original papers on 26 projects from 11 countries, dating from 1987 onward. A list of the papers is available in Fischer (2007). Secondly, we discuss experience from our example, informative electricity bills as applied in our case study in Heidelberg.

6.3.1 Electricity Conservation

One result, at least, seems clear from the review study: feedback stimulates energy (and specifically electricity) savings. Studies that report on actual savings do find savings ranging from 1.1% to over 20%, most often between 5% and 12%.3 No savings were found, though, in a few instances where consumption and/or income was already low (Nielsen 1993; Bittle et al. 1979–1980; Brandon and Lewis 1999). In these cases, there might just be no saving potential or motivation (see also the argument on the effects of comparative feedback presented below). As savings differed greatly between and within studies, we wanted to know how feedback must be designed in order to work best. Answering this question is difficult. Studies can only be compared with the greatest care. First, results are not always reported in sufficient detail. Secondly, studies use very diverse reporting schemes. We used various procedures to identify necessary and sufficient conditions for successful feedback, which are described in detail in Fischer 2007. The findings indicate the following. Medium and mode of presentation. Computerized feedback proves to be very stimulating. All projects which use it produce comparatively high savings. It has at least three advantages: it can quickly process and present

3 Information on the statistical significance of the findings is often lacking, but the sheer number of studies which report savings is a good indicator of the general effectiveness of feedback. 6.3 Effects and Sustainability Potential of Consumer Feedback 125 actual consumption data, it may include interactive elements, and it is flexible, offering multiple options for feedback at the user’s choice. Inter- activity and choice involve customers, stimulate their curiosity and allow for tailored solutions. Similar effects can also be reached without resorting to the computer, though: some projects are successful by involving households via activities such as goal-setting or self-reading of the meter. The projects using the electricity bill as a medium do not range among those yielding the highest savings. Reported savings range from 0% (only one case) to 12%. However, bills are still read more carefully and raise more interest than other written material. Surprisingly, very few studies have considered the relevance of graphic design or formulation of text. The only two comparative studies show convincingly that households’ reactions depend very much on the exact choice of diagram or chart type, labels, scale, symbols, and wording of the explanation. Designs may range from the completely unintelligible to the highly motivating (Egan 1999; Wilhite et al. 1999). Roberts and Baker (2003) conclude that the presentation should be simple but not simplistic, that it should not involve additional paper, and that a combination of text, diagrams and tables is more effective than single-format presentations. Frequency. All best performing projects give feedback at least monthly. However, this is not true the other way round: not all projects that give frequent feedback perform well. This indicates that frequent feedback is helpful, maybe even necessary, but not sufficient for best performance. Content. As almost all projects combine consumption and cost information, there is no basis for separating the effects of the two. With respect to environmental information, findings suggest that it can be as effective as other kinds of information. This probably depends on motives and norms of the target group. Breakdown. Data on the effects of appliance-specific breakdown is scarce. Only three projects using such breakdown provide information about resulting savings. However, of these three, two are among the most successful cases – a good indication of the potential usefulness of detailed, appliance- specific data.4 Comparisons. As almost all projects use some form of historical comparison, its effects cannot be singled out. With respect to normative comparison, none of the ten studies using it could demonstrate an effect on consumption

4 It remains unclear, though, why the project by Ueno (2006), which is a very similar project to Ueno (2005), resulted in much lesser savings. Uncertainties due to the very small sample surely play a part. 126 6 Consumer Feedback Through Informative Electricity Bills up to now. A simple reason presents itself: while it stimulates high users to conserve, it suggests to low users that things are not going so bad and they may upgrade a little. These effects probably tend to cancel out each other. Additional information and other instruments. The empirical evidence does not strongly support the theoretical claim that motivating instruments and energy conservation advice must be present in order to make feedback work. In many studies, feedback alone seems to work. Sometimes additional instruments are even counterproductive. One possible reason is that motivation and knowledge already exist in participating households, and are activated by giving feedback. In this case, additional tools may rather complicate the situation. Finally, the usefulness of the information depends strongly on its presentation and its “fit” with the needs of the target group.

6.3.2 Satisfying Consumer Needs

As sustainable development includes a social component, we will measure feedback not only against the actual savings it delivers but also against its social effects. Feedback has the potential for empowering consumers to better understand and control their electricity consumption and cost. It can also, in certain cases, support them in advancing their rights and interests. Finally, it lays a fertile ground for future motivation to save. Therefore, we explored which kind of feedback consumers find most helpful. The literature review suggests that consumers desire feedback that is easy to understand (as opposed to their current electricity bills). Easy-to-understand information includes (the list is not exhaustive): x Feedback based on actual consumption in a given period (instead of off- setting with previous periods, prepayments, or estimates); x Clear labeling and explanation of labels, acronyms and technical terms; x Clear indication of the various components of the electricity price; and x Support by means of graphic presentations. However, preferences regarding details in graphic design and presentation tend to vary between nations. Furthermore, households appreciate feedback to be given in more detail (e.g. appliance-specific) and more frequently than it currently is. Detail and frequency give them a sense of control and, if delivered with the electricity bill, of being valued and well informed by their supplier. Finally, a number of studies also report an interest in historic and/or normative comparison even if it does not necessarily result in electricity savings. However, especially with respect to normative comparisons, findings are not unanimous. While they are welcomed by Japanese consumers 6.3 Effects and Sustainability Potential of Consumer Feedback 127 in Ueno et al. (2005: 1293), British and Swedish studies report a reluctance with regard to this instrument (IEA 2005: 10; Sernhed et al. 2003).

6.3.3 Case Study: Informative Energy Bills in Heidelberg

As we have seen, improved electricity bills are one instrument for giving feedback that can be implemented without major technical changes. We will therefore now further explore the effects that such an instrument might have in Germany. There are no comparative and published evaluations of innovative electricity bill formats from Germany to date. We will therefore present initial results from a pilot project in Heidelberg, conducted by the public utility (Stadtwerke Heidelberg) in cooperation with the ifeu institute (Duennhoff and Duscha 2007). As part of the project, the ifeu institute offered the Stadtwerke Heidelberg a scientific evaluation of a one- time informative supplement to the standard bill. A few years earlier, the utility had already improved its standard bill in cooperation with the local consumer advice center (cf. Fig. 6.4). Now, a new attempt was made to provide even more in-depth information. Since changes to standard bills are complicated to implement for organizational reasons, the decision was taken to include an appropriately designed supplement. The basis for its design was the objectives of the EU directive on energy efficiency and energy services (European Parliament and Council of the EU 2006). This directive aims at providing more accurate, timely and understandable information on electricity consumption. The supplement contained the following components: 1. Information where current power consumption can be found in the bill. 2. Possibilities for comparing individual power consumption with the average consumption of same-size households in a tabular format. 3. Simple energy saving tips with information on potentials for energy and cost savings. 4. Contact information for additional information and consultancy, including by the Stadtwerke Heidelberg. Components 1 and 2 were the feedback-relevant sections of the supplement and presented on its first page. Components 3 and 4 provided action- oriented information for saving electricity on the second page (for the graphic design of the first page see Fig. 6.5). The supplement was sent to about 6,000 private electricity customers of Stadtwerke Heidelberg in July 2006, together with a voucher for on-site energy counseling. Since electricity prices in Germany had risen considerably since 2004, public interest in electricity costs was heightened at that time. 128 6 Consumer Feedback Through Informative Electricity Bills

Fig. 6.5 Front page of information leaflet by Heidelberg municipal utility. The headline reads “The secret electricity eaters. (…) Step 1: How much is your electricity consumption? Compare!” The first table contains a comparison with the previous year’s consumption. The second table allows for comparison with other households of the same size, coupled with an evaluation as “very good”, “good”, “high” or “very high”. On the second page (not represented here) households could find electricity saving tips and contact details for receiving energy advice 6.3 Effects and Sustainability Potential of Consumer Feedback 129

The intervention was evaluated by means of two postal surveys, one about four weeks before the distribution of the supplement, another one about four months afterwards. The surveys contained two elements: direct evaluation of the supplement by its recipients, and investigation of environmental motivation and energy-saving behavior that might have been triggered by the supplement. A control group was formed from households that did not receive the supplement and voucher. In addition to the surveys, aggregate electricity consumption of the households in each group was measured one year after the distribution of the supplement, so that it could be compared with the previous year’s consumption. Table 6.2 shows the timing and numbers of households included in the surveys and measurement.

Table 6.2 Evaluation design of the electricity bill supplement in Heidelberg Experimental group Control group (supplement and voucher) 1st questionnaire Timing 23 May 2006/31 May 2006 08 June 2006 No. of households 2076 1402 Utilizable replies 266 170 Intervention (supplement, June/July 2006 – voucher) 2nd questionnaire Timing Nov 2006 Nov 2006 No. households 220 143 Utilizable replies 96 66 Measurement of June 2007 June 2007 consumption

To examine possible changes in self-reported electricity consumption- relevant activities – such as the use of energy saving light bulbs or the prevention of stand-by – after the distribution of the supplement, we used the instrument of the “global environmental behavioral scale” (GEB).5 In comparison to the control group, there were no significant differences that would indicate an increase in energy saving activities. Also, there was no significant difference in the development of total electricity consumption. Apparently, the one-off inclusion of this type of standard information is not enough to initiate noticeable energy saving activities. The international

5 The GEB measures behavior parameters in various environmentally relevant areas of activity in households (waste, mobility, consumption, energy usage, etc.). It was especially supplemented with additional items for this evaluation. For basic information on this, see Kaiser et al. (2003). 130 6 Consumer Feedback Through Informative Electricity Bills experience presented above suggests that the information needs to be given more often and over a longer period of time to allow customers to monitor their consumption and the effects of saving activities continuously. However, even if there were no immediate effects on energy consumption, the evaluation showed that the supplement had the potential for satisfying customer needs and building awareness of energy consumption that could serve as a basis for future energy conservation. All in all, 69% of the bill recipients remembered the supplement. Of these, 62% considered it to be very or somewhat helpful. Recipients of the supplement considered the – already relatively understandable – standard electricity bill to be (slightly) more understandable than did a control group. Altogether, 47% of those who noticed the supplement were thereby motivated to gather more information on possibilities to save electricity. To the question “Would you like to receive a similar information sheet with your next electricity bill?” 75% responded with “yes, very much so” or “yes, very likely”. Thus, there is in fact a desire for information on personal electricity consumption and saving options. The next step would be to exploit this potential with follow-up activities.

6.3.4 Some Conclusions for Feedback Design

A relatively sound body of evidence indicates that improved feedback is useful for promoting electricity conservation in households. With all due care because of data restraints, there are reasons to identify some likely features for successful feedback (meaning both effective in stimulating conservation, and satisfying consumer needs). Such feedback: x Is based on actual consumption; x Is given frequently (though this alone is not sufficient); x Involves interaction and choice for households; x Involves appliance-specific breakdown; x Is given over a longer period; x May involve historical or normative comparisons; and x Is presented in an understandable and appealing way. Especially the first three characteristics point to the advantages of electronic metering and data processing. However, it is important to check whether the recommendations hold for all target groups. High-consuming households react differently from low-consuming, and middle class from working class groups. Computerized and interactive feedback may turn out to be too complex and require too much understanding and initiative for households with low education, low 6.4 Process of Innovation and Factors Influencing It 131 technical interest or little spare time. For them, other successful techniques of involvement may be applied, such as goal-setting or self-reading of the meter. Finally, the exact effects depend very much on the specific design of feedback. Therefore, detailed market research is needed to explore which designs are most appealing and understandable (Roberts and Baker 2003). Finally, not everything that seems promising is easily feasible. Appli- ance- or time-specific breakdown is technically challenging and expensive. It has therefore only been used in the commercial sector in Germany to date. In contrast, projects using the electricity bill are worth exploring for practical reasons even if they do not yield highest savings.

6.4 Process of Innovation and Factors Influencing It

In this section, we explore the preconditions and process of implementing better feedback, using the example of informative electricity bills. After describing the origin and diffusion of innovative bills, we depict the political and technical framework that sets the scene for this innovation in Germany. We comment on utilities’ motivation in implementing it and in problems they experience and describe the resulting activities.

6.4.1 Origin and Transfer of the Innovation

According to Wilhite and Ling (1995), the idea of improving customer feedback on electricity consumption originated in a number of small-scale scientific studies conducted during the 1970s and beginning of the 1980s by social and behavioral psychologists mostly in the USA, but also in the UK and the Netherlands. The two oil price crises in 1973 and 1979 provided fertile ground for the idea of energy conservation. Against this background and on the basis of theoretical considerations, psychologists tested various forms of feedback information and concluded that, in principle, feedback can have an effect on energy consumption. The translation of this idea into large-scale systematic experiments with electricity bills originated in the Nordic countries. A 1987 study commissioned by the Nordic Council of Ministers stated that Nordic electricity bills failed to give accurate and useful feedback on consumption. Based on this analysis, motivated by the goal of bringing down energy waste in Nordic households and informed by the small-scale studies conducted before, a large-scale billing experiment was conducted in Oslo between 1989 and 1992. The initiators, Harold Wilhite and Richard Ling, were 132 6 Consumer Feedback Through Informative Electricity Bills researchers and members of an independent consulting firm, Ressurskon- sult. Their study was followed by another pilot project with a volunteer- ing electricity utility in Stavanger which showed electricity consumption savings of a total of 8% on average (4% reduction as compared to a 4% increase in a control group) (Wilhite et al. 1999).6 The bills were based on meter readings taken by utility employees every two months. In implementing them, major efforts were made to inform the consumers about the changes, their background, and the advantages of the new bills. Con- sumer protection organizations and environmental groups were cooperated with for public relations. In spite (or because?) of the demonstrated success in energy conservation, other utilities were reluctant to jump on the bandwagon. Finally, its proponents could convince policymakers to introduce improved billing via political regulation. The Norwegian Water and Power Authority established new billing guidelines in 1999, providing for informative bi-monthly electricity bills. In parallel, similar pilot studies were carried out in the other Nordic countries (Henryson et al. 2000). In Sweden, a law was passed in June 2003 which laid down that all tariff customers must receive a monthly consumption-based bill instead of demanding flat-rate estimated fees by 2009. This led to a comprehensive introduction of Smart Metering systems. In Denmark, a working group of power utilities proposed ideas on informative electricity bills as early as 1994, including more frequent meter readings, regular billing of actual consumption and graphic presentation of the customers’ electricity consumption (IEA 2003, 2005). Utilities participated in the drafting of legislation that went into effect in the year 2000. Departmental order no. 350 from May 3, 2000 on Energy saving activities for electricity companies states that “Grid companies shall invoice their deliverances in such a way that the electricity consumption of the individual user (consumer) in an easy understandable way can be compared with the consumption for preceding years, and as far as possible in relation to the average consumption of equivalent users groups.”7 The idea and experience were spread to other countries via scientific publications and IEA reports dealing with national energy policies (IEA 1999, 2001) and DSM measures (IEA 2005). In the following years, parallel activities unfolded in further countries. A legal obligation to provide informative electricity bills entered into force in

6 However, the general conditions in Norway are not directly comparable to the conditions in Germany. In Norway, the average electricity consumption per household is more than 16,000 kWh per year due to the high percentage of electric heating (Ger- many: 3,500 kWh per year). 7 Henrik Weldingh, personal communication. Translation by him. 6.4 Process of Innovation and Factors Influencing It 133

New South Wales/Australia. The inclusion of historic comparisons became standard operating practice in California and Canada as well as for a number of other US utilities (Roberts and Baker 2003). In the USA, the Energy Star Billing Program was launched by the Environmental Protection Agency (EPA) in 1995. It is a voluntary partnership program with utilities that wish to include normative comparisons in their bills. In the UK, a British Standards Institution (BSI) standard on utility billing was developed, some volunteer activities by utilities are taking place, and legislation on metering and billing is currently (Summer 2007) being planned. In some of these cases, the exact motivation and process of implementation remains unclear.8 For the USA and the UK, however, it can be shown that, as in the Norwegian example, independent consultants, scientists and consumer/environmental organizations were a core driving force and/or that they were influenced by the Norwegian pioneers. The US Energy Star billing program was developed, implemented and evaluated for the EPA by a University of Delaware research team, made up of researchers that had been active in exploring the effects of feedback before (Egan 1999). The most detailed information is available for the British case. In the late 1990s and early 2000s, British households experienced huge problems with late, inaccurate and difficult-to-understand energy bills which were often not based on actual consumption. Many households did not even receive an accurate bill once a year (energywatch 2006: 7f). This was an incentive for the independent consumer organization energywatch, and for the regulating authority OFGEM, to take action. Accurate bills were seen as a social necessity in order to prevent indebtedness, and as a prerequisite for the liberalized market to function. They were also linked by OFGEM with the goal of energy conservation for sustainability (OFGEM 2001). In the following years, energywatch campaigned for better bills, including filing a complaint to OFGEM and engaging in developing a British Stan- dards Institution (BSI) standard on utility billing. Studies were commissioned by OFGEM and the government to explore consumer needs (Roberts 2004; OFGEM 2004) and to review international experience with consumer feedback (Roberts and Baker 2003; Darby 2006). They were conducted by independent researchers and consultants who put a strong focus on energy conservation and sustainability issues. Together with the need to implement the EU Energy Efficiency Directive (European Parliament and Coun- cil of the EU 2006), these studies led to government activities such as a ǧ 9.75 million government-funded field trial with various forms of feedback including bills, starting in 2007 (OFGEM 2006), and a consultation

8 More detailed research, including expert interviews, could reveal the process, but are beyond the scope of this paper. 134 6 Consumer Feedback Through Informative Electricity Bills on improved metering and billing in 2007. In parallel, energywatch and OFGEM entered into dialogue with suppliers, to the effect that a number of activities were implemented voluntarily. For example, Powergen is con- ducting a trial with historic information, to be completed in 2008. Utilities are providing more frequent bills9, have established a code of practice for accurate bills, and are introducing products that incentivize customers to provide their own meter readings so that they can receive accurate bills more often. OFGEM and industry also worked together to remove hurdles for smart metering to be introduced (OFGEM 2007).10 To sum up, it seems that civil society actors like social scientists, independent research organizations and consultants, and consumer and environmental associations have played an important part in initiating and diffusing informative electricity bills. Together with a few innovative utilities, they initiated discussions and proved the feasibility and benefits of innovative bills. The well-documented experience gained during the pioneering Norwegian projects served as an information input and stimulated discussions in other countries. But the practice did not spread widely by itself. Informative bills only “took off” when policy-makers could be convinced to introduce binding regulation.

6.4.2 Implementation in Germany

Political and Technical Framework

Technical Status Quo. Up until now, electro-mechanical electricity meters have been used in Germany. These devices have mechanical scale displays so that meter readings cannot be transmitted via remote data transmission without considerable additional expenditure. Therefore, it is not possible to automate the reading. Either customers send meter readings to the electricity company, or companies send personnel to read the meters. This makes it considerably more difficult to realize more helpful electricity consumption feedback. For example, billing more than once a year implies more expenses for meter reading procedures.

9 As they started from a very poor basis, however, results have not been too impressive to date from an outside perspective. As late as 2007, only three of the six biggest suppliers provided 95% of their clients with an accurate bill at least once a year, which was already welcomed as an achievement by the regulating authority (OFGEM 2007). 10 However, OFGEM rece ntly seems to have lost its drive in promoting better billing. In its response to the 2007 consultation, it argues that important achievements have already been made and that further innovation should rather be left to market forces than promoted by policies. 6.4 Process of Innovation and Factors Influencing It 135

Following recent technical developments, electricity meters have become less expensive and can digitally record, evaluate, and transmit consumption data. Such “Smart Meters11” open up a variety of new possibilities. For example, the possibility of saving minute-based values means that load and electricity consumption can be analyzed easily and more exactly. It is also possible to automatically transmit, for example, monthly consumption data to the supplier. The introduction of Smart Metering in Germany is just starting.12

Political Status Quo. In Germany, the “Energiewirtschaftsgesetz” (EnWG, Energy Economy Law) forms the legal framework for the electric industry. It determines which type of measurement systems can be used and indicates that more details on billing will be determined in a regulation – the Regulation for Basic Power Supply (StromGVV).13 The latter was last approved in 2006. It allows for monthly, or at least yearly, billings, the principle of installment payments, as well as the use of prepaid systems. It requires that bill forms be easy to understand, that the calculation factors used for the billing must be explained completely, and that a comparison with the previous year is provided. The amendment to the EnWG that went into effect in July 2005 changed the legal basis of the metering and measurement systems. Since then, not only the network operator but also independent third parties may install, operate, and maintain metering equipment. The market opening for the actual measurement process is also provided for in the law. However, the required statuary instruments do not yet exist. In May 2006, the EU directive for “energy end-use efficiency and energy services” (Directive 2006/32/EC, European Parliament and Council of the EU 2006) went into effect and must be implemented in national law within two years. Its goal is to improve the efficiency of energy end- use in private households and the public sector. It prescribes that private households receive bills that allow them to control their energy consumption. Member states should ensure that the following information is included in a clear and understandable manner:

11 The term Advanced Meter Management (AMM) is also heard. Some of these meters also allow for receiving information, for example, to operate appliances of the customers. 12 In some European countries, these systems have been introduced across the board for tariff paying customers. Italy and Sweden are leading the way in this regard. 13 Regulations for the general requirements for basic supply of private customers and the alternative supply with electricity from the low voltage network, from October 26, 2006. 136 6 Consumer Feedback Through Informative Electricity Bills

Art 13: Metering and informative billing of energy consumption (Directive 2006/32/EC, European Parliament and Council of the EU 2006)

Member states shall ensure that, where appropriate, the following information is made available to final customers in clear and understandable terms (…) in or with their bills, contracts, transactions and/or receipts at distribution stations. x Current actual prices and actual consumption of energy; x Comparison of the final customer’s current energy consumption with consumption for the same period in the previous year, preferably in graphic form; x Wherever possible and useful, comparisons with an average normalized or benchmarked user of energy in the same user category; x Contact information for consumer organizations, energy agencies, or similar bodies, including web site addresses, from which information may be obtained on available energy efficiency improvement measures, comparative end-user profiles and/or objective technical specifications for energy-using equipment; x Billing on the basis of the actual consumption is performed so often that the customers are able to control their own energy consumption.

These objectives have not yet been met with the current dominant billing methods for private customers in Germany. However, the need for national implementation of the directive and the heightened public awareness for climate issues in 2007 have generated some momentum and fuelled political initiatives that could form a basis for better feedback. In April 2007, the Federal Ministry for Economy and Technology launched the “E-Energy” contest. Its aim is to explore the potentials of ICT-based communication and organization processes for integrating actors and improving efficiency in the energy supply system. Demand side management, supported by real-time feedback, is one area of action within the contest. The winning projects were presented in March 2008. In its National Energy Efficiency Action Plan dating from September 27, 2007, the federal government announced to provide the legal basis for the introduction of smart meters, aiming at their implementation within 6 years. On Dec 5, 2007, the federal government presented draft legislation for the market opening of the measurement process with the explicit aim of bringing forward intelligent metering and helping customers to control their consumption and save energy. 6.4 Process of Innovation and Factors Influencing It 137

Actors and Their Motivation At the beginning of 2007, we held interviews regarding informative electricity bills with representatives from nine utilities.14 Interview partners suggested by the utilities generally came from the marketing and sales department, indicating that the issue of bills was seen as an issue of customer relations and marketing. Almost all of the companies were, in principle, interested in designing their bills in a more informative manner. The main motivation was to reduce the number of unnecessary customer support queries, also hoping that this would result in saving manpower. According to one interview partner, market research has furthermore shown that more understandable bills increase confidence in the correct- ness of these bills. Finally, the bill is often the only direct contact to the customer. Interviewees therefore feel that they should be designed in a customer-oriented manner to build trust, contribute positively to the company’s image and positively highlight it on the market with a unique selling point (USP). Image aspects that were mentioned were credibility, a sense of responsibility for customers and the environment, fulfillment of expectations as well as competence in energy efficiency and climate protection issues. There are various possibilities for making bills more informative, and not all of them receive the same interest among utilities. A large majority of respondents had a basic interest in making their bills easier to understand, integrating normative or historic comparisons, as well as including energy saving tips or more detailed contact information. Sending bills more than once a year, however, was not received with interest by any of the interview partners. Only a very small segment of the companies assumed that shorter billing intervals would reduce the number of customers who need late reminders. Others assumed that they would even result in an increase in late payment reminders. This problem could possibly be reme- died by providing more frequent feedback while maintaining the yearly billing. This way, customers could react faster but there would not be more bills to process per customer than before. Still, only one third of the companies were interested in such an option. Utilities’ interest correlates heavily with their estimation of which kind of information their customers would like. While there is the assumption that

14 Respondents included Greenpeace Energy (Hamburg), ENTEGA (Darmstadt), Rheinenergie (Cologne), Städtische Werke Kassel, Stadtwerke Hannover, Stadtwerke Heidelberg, Stadtwerke Marburg, Stadtwerke Tübingen, and ASEW (association of local utilities to advance rational use of water and energy). 138 6 Consumer Feedback Through Informative Electricity Bills customers have a large interest in a more simplified bill design, normative and historic comparisons, their interest in more frequent billings or more feedback is mainly considered to be minor or minimal15. Energy saving tips or information on additional sources of information were considered to be of medium interest to customers. One contact person suggested segmentation by target groups: households with a special interest could receive additional information in the form of a “deluxe” bill, whereas a simple and short bill would be sufficient for the majority of households. None of the interviewees mentioned a motivation to support energy conservation. Liberalization has led utilities to focus on their sales interest. Therefore, they do not show an inherent motivation that could lead to the widespread diffusion of better feedback.

Problems Experienced by Actors Along with the potential advantages, utility companies also see dangers in having more detailed bills or changing the format of the bills. Some respondents to our interviews criticized that existing legal requirements already raise difficulties in understanding the bills since too much information is required. Additional general requirements could make the situation worse. The electricity industry markets electricity as a low-interest product that is constantly available and about which the customer doesn’t have to worry. “The normal customer rarely or only sporadically worries about consumption. This is because the consumer and the supplier have such a smoothly running energy supply and payment system that normal daily energy consumption is completely unconscious ... psychologically seen ... (extreme) energy savings would be a disruption in the normal supply. ... Permanent detailed monitoring of the consumption is a detriment to personal comfort and social tolerance. .... Customers bothered in this manner are labeled “conservation preachers” who sometimes also control their co-residents’ energy consumption. For the supplier, this type of consumer is a “know it all” who always is suspicious of being at a disadvantage” (Stark 2006).

15 Evidence from Heidelberg shows however that there is a significant share of customers who would be interested in such a service. The household questionnaire on the feedback supplement also included a question regarding billing intervals. To the question “Would you like to receive your electricity bills more often in the future?”, 41% of 214 people responded with “yes, very much so” (11%) or “most likely” (30%). Of those, 86% justified this with improved control of the electricity costs and 66% with more control over electricity usage (more than one answer being possible). In contrast, 41% answered with “no, not necessary” and only 13% with “rather not” (Duennhoff and Duscha 2007). 6.4 Process of Innovation and Factors Influencing It 139

Generally, changes to the standard bills imply the reprogramming of accounting software. Even the integration of highly standardized information such as the source of the electricity appears to require considerable expenditure on the current software systems. All companies assume there would be higher costs for billing more than once per year (for meter reading, processing, shipment of bills, queries, money transfers, late reminders, etc). The costs for reading meters can only be reduced in the long term by installing remotely readable meters. However, the replacement of meters involves modification costs. If no other value-adding effects were realized based on the data possibilities offered by the new meter generation, their introduction would only pay off in the long term. In the short-term, according to the utility companies, the additional costs would be passed on to the consumer. Considering the liberalized market and current efforts to reduce network prices, this is not easy to do, especially in view of the politically controversial increases in electricity costs over the past few years in Germany. Since the law continues to allow yearly billing, there is little incentive for energy suppliers to generally switch over to new metering systems. On the other hand, should the law require that electricity bills be sent once a month or should additional minimal standards be required to increase the comprehensibility of the bills, then the argument that more understandable bills will provide an image boost and a unique selling point would be no longer valid. The example of the Heidelberg municipal utility shows some conditions that could be helpful in increasing utilities’ motivation. A “window of opportunity” was used for the first change in billing format in 2003, when new accounting software was introduced. For the current model project, networks and independent actors played a part: The impulse was given by a utility-marketing working group within which utilities were informed about the possibility of participating in a scientific project. The proximity to the scientific institute motivated the marketing department to cooperate. Finally, positive experience is helpful: The decision to take part in the model project was, among other things, based on the first improvements in the previous years. The project’s preliminary results, showing that more than half of the customers would welcome a supplement like this, led to ongoing discussions regarding the possibilities of continuing this type of customer information.

Resulting Activities and Experiences The take-up of innovations in German electricity bills has begun, but has been slow to date. A planned project by the state-owned energy agency 140 6 Consumer Feedback Through Informative Electricity Bills

Energiestiftung Schleswig-Holstein (today Innovationsstiftung Schleswig- Holstein) to test the transferability of the Norwegian approach (Morovic 1999) was cancelled because utilities lost interest after liberalization. Results from the energy supplier interviews mentioned above show that about half of the companies had already taken steps to make their bills more understandable, while the other half was currently doing so or had planned it for the future. The introduction of new bill formats normally corresponded to the introduction of new billing software. Until now, efforts mainly concentrated on the structure of the information by, for example, including a summary of the most important information in the letter or cover sheet while leaving the details in an attachment. The following improvements were each named once: summary of taxes (instead of re-listing them with every change in tariff), expansion of the historic comparison, inclusion of an additional information sheet, and layout improvements. The utilities reported mainly positive experiences with these types of improvements. Criticisms or questions regarding comprehensibility of the bills were reduced, and customers of those utilities that did market surveys were shown to be more satisfied. Elements such as energy saving tips or information on more detailed consultation options, on the other hand, tended to generate more queries. An internet-supported consumption evaluation for interested customers was also considered. However, this would first be independent of the billing procedures. Existing trends towards online services (e.g. electronic inspection of bills and electronic transmission of meter self-readings by customers) can be supportive for such extended online services. In Germany, interest in Smart Metering systems has increased ever since the measurement and metering system has been liberalized. In autumn 2006, about a quarter of the energy suppliers tested this type of new metering system in the scope of pilot projects. This should provide experience that would be available if there is any change to legal requirements for monthly billing (Franz et al. 2006).

6.5 Possibilities for Shaping

6.5.1 Short-Term and Long-Term Options

Of all the options for improved feedback that have been described above, only some suggest themselves for widespread implementation in Germany for the time being. Due to the existing metering infrastructure, interactive 6.5 Possibilities for Shaping 141 multi-option feedback and technically challenging options like load curves or appliance-specific breakdown of consumption are currently ruled out. Nor does it seem feasible to increase the frequency of feedback in the short term. Although it is technically possible (for example, based on customer self-reading of the meter or on more frequent meter readings by the electricity supplier), interest in such an innovation is low both on the consumer and the utility side. Utilities fear additional costs, and more than half of the consumers do not yet see the advantages. That restricts the range of short-term innovations to those that can be delivered with the annual bill: Bills can be designed for more attractiveness and ease of understanding, and historical and normative comparisons may be included as well as additional information (like energy saving tips). The bill could also be used as a door opener for more interactive consultancy and feedback. It could, for example, refer customers to a website that offers additional functionality, or to energy consultants. In the longer run, smart metering can become standard due to business opportunities offered by the liberalization of metering. Also, “smart”, elec- tronically interlinked appliances may penetrate the market. This offers possibilities for detailed, interactive and appliance-specific feedback. We will now explore the possibilities for delivering short-term improvements in the electricity bill and discuss how this process may be politically shaped.

6.5.2 Introducing the Informative Electricity Bill: Problems

Although knowledge of individual power consumption is very low in German households, electricity bills are overloaded with too much information, and the bill presentation is difficult to understand, there are only few actors who are interested in changing the situation. Customers are not informed about alternative billing formats and their potential benefits, so there is currently no demand for them. Companies describe changes as difficult to implement, and have little incentive for serious efforts to promote saving electricity. Doing so would contradict their general sales logic. And considering the historic reluctance of customers to change electricity providers, there is only a low expectation of increasing customer loyalty or expanding the customer base. Furthermore, utilities fear that more detailed bills would result in more customer requests to process. Therefore, many companies would like to have electricity remain a low interest product as has been the case in the past. 142 6 Consumer Feedback Through Informative Electricity Bills

Suggestions for Policies and Standards As companies have little genuine interest in improved bills, the precondition for improved bills to become reality is consumer interest or political will. The Swedish example shows that political will is even more important than technical infrastructure: here, the legal obligation to provide monthly bills stimulated the introduction of smart meters, and not the other way round. This means a stringent political framework is needed. First, policies should be introduced that help to provide a sound science base. To date, there has been no reliable empirical data on the effects of various bill formats on electricity conservation and consumer satisfaction in Germany. Existing studies and projects refer to other countries which have potentially different conditions than Germany. Furthermore, most of them use rather small samples. There is a lack of well-documented large-N studies. Therefore, pilot schemes for informative electricity bills should be implemented and scientifically evaluated. Such studies should cover a representative sample of households, and vary systematically the bill format. Consumption data should be complemented with survey data on motivation, preferences regarding the bill format, and types of conservation action taken. Secondly, such pilot schemes should be instigated and supported by national promotional programs. As we have seen though, there is reason to believe that many additional features of the bill have little effect in stimulating energy conservation if the information is not given frequently enough to raise the consumers’ awareness and allow them to judge the development of their consumption over time. Therefore it seems worth- while to launch pilot projects with more frequent feedback that allow utilities and consumers to test advantages and problems. Such pilot projects may result in increased consumer awareness and interest in controlling their consumption, which in turn could stimulate utilities to offer more frequent feedback as a service. Thirdly, in addition to subsidized pilot schemes, instruments could be put in place that stimulate “bottom up” development of innovative electricity bills and competition for the best format, e.g. a national competition for the most helpful electricity bill. If some of the pilot projects suggested here were to show that the changes would lead to an improved control of electricity consumption by the customers, then, depending on the development of the energy-political environment, measures to introduce helpful electricity bill innovations could be taken for the general public. 6.5 Possibilities for Shaping 143

If, for example, national obligations were in place requiring that energy supply companies had to offer energy efficiency programs for their customers, then more informative electricity bills could also be recognized as a possibility of fulfilling this obligation. Temporary (kick-off) subsidies could help utilities to implement the innovations. However, if such changes in the energy-political framework will not come about, then a direct national requirement for the introduction of more informative bills would be necessary to overcome the hurdles16. Such a requirement would formulate minimum standards for electricity bills and can use the EU end energy and energy services directives as a legal framework. It can be introduced by modifying the requirements for bills laid down in the Stromgrundversorgungsverordnung (Regulation for Basic Power Supply) and possibly by requiring the installation of smart metering systems within the Energiewirtschaftsgesetz (Energy Economy Law). The standards set should be closely based on the results of the pilot schemes and provide clear objectives. Their effects should be monitored regularly. Generally, the introduction of more innovative electricity bills must be well integrated with other political instruments to enable households to be able to react to the development of electricity consumption. Households will only be able to use the billing information to control their consumption when there are descriptive power consumption labels on electronic equipment in place, as well as basic information on the influence of equipment and the its use.

6.5.3 The Role of Actors other than Politics and Utilities

ESCOs and civil society actors like energy agencies, NGOs and the scientific community may support the political process, as has been the case in other countries. Assisted by rising energy prices, they can stimulate consumer interest via campaigns and model projects, and lift improved feedback onto the political agenda. One possible strategy has been described above as scientific research informing a comprehensive set of national policies. As such a strategy could take several years, though, civil society organizations could become active in advance in order to promote the idea, explore different variants of informative bills and feed the experience into the policy process.

16 The Norwegian experience shows that a few utilities could be motivated for pilot projects, hoping to exploit their efforts for marketing purposes. The road to mass diffusion of informative bills, however, was national regulation based on the encouraging results of large-N pilot studies (Harold Wilhite, personal communication). 144 6 Consumer Feedback Through Informative Electricity Bills

Activities could include, for example, competitions sponsored by consumer or environmental groups, energy agencies or magazines to reward the “most helpful bill”. The design of the electricity bill could be included as an evaluation criterion in comparative tests of utilities, for example by consumer information projects such as “Eco-Top-Ten” or institutions such as “Stiftung Warentest”. Large service companies, which are already established in the heating sector for measurement and billing, are also developing ideas to operate electricity measuring points (Franz et al. 2006). Perhaps this will result in new chances for taking electricity out of the area of a low interest product by introducing new forms of electricity bills with companies that are independent of selling electricity.

6.6 Conclusions

Currently, consumers know little about their electricity consumption. They ignore its dimensions, main drivers, cost and environmental consequences. Improving feedback on these issues would give them a tool to better assess and control their consumption. It would enable and perhaps even motivate them to save energy. Feedback on electricity consumption is the more helpful, the closer it can be related to actual consumption. That is, it should be given shortly after the consumption act and provide detail on which actions and applications are especially energy intensive. Comparative standards (such as a comparison with one’s own previous consumption or comparable households) can be helpful in putting one’s consumption into perspective. The use of interactive media can tailor the information to individual needs and enhance motivation. The bill could, in principle, be provided more often, as is the case in many Nordic countries. The information can be presented in a more clear and understandable way, and comparative standards or energy saving tips might be provided. The innovation dynamics of such an “informative bill” are summarized in Table 6.3. Many of these feedback options require rather sophisticated metering and data processing technology. “Smart metering” of this kind is currently being promoted in Germany, but is not likely to be widely available in the next few years. However, some improvement of feedback can already be realized with the help of the ordinary electricity bill. The political framework for the informative electricity bill is quite favorable at present. EU Directive 2003/54/EC requires that the bill discloses 6.6 Conclusions 145

Table 6.3 Innovative electricity bills: Dynamic characteristics of the innovation

Descriptors Characteristics of innovative electricity bills Purpose of For consumers: Better control over electricity consumption; for innovation the environment: Electricity conservation and GHG reduction; for utilities: Customer service/customer retention, load management Context 1970s: oil price shock; later: sustainability discussion, billing problems in liberalized markets; recently: EU energy efficiency directive (Directive 2006/32/EC) Phases Origin: Scientific studies 1970s–1980s, large-scale pilot projects in Norway late 1980s – mid 1990s. Transfer: since mid-1990s. Legislation in Denmark, Sweden and Australia, planned legislation in UK, policies in UK and USA, volunteer efforts in USA, UK, Netherlands, Germany Actors National energy agencies, independent consultants and researchers (pilot projects / studies), volunteer utilities, consumer and environmental organizations, later national policymakers Competing Regulatory policies for controlling household energy use; e.g. innovations Top Runner program, appliance standards Complementary Smart meters; other forms of consumer feedback, e.g. direct innovations displays, interactive websites or mailed additional information material (could be competing or complementary, depending on design and motivation of actors); economic incentives Inducement EU energy efficiency directive (Directive 2006/32/EC) mechanisms Market opening for measurement services (could support the (in Germany) diffusion of smart meters) Blocking Technical infrastructure (lack of interactive meters) factors Lack of data (e.g. for comparative feedback); additional costs; (in Germany) lack of motivation of utilities; lack of interest of consumers Sustainable Clear, understandable, frequent bill allowing customers to judge vision their level of electricity consumption, to identify possible causes and motivating them to search for possibilities of electricity conservation Possibilities Large pilot studies for shaping Creation of financial incentives Inducive policy framework, e.g. emissions trading, energy savings obligation, national regulation on billing 146 6 Consumer Feedback Through Informative Electricity Bills the environmental effects of electricity generation (European Parliament and Council of the EU 2003). EU directive 2006/32/EC urges member states to provide for clear and understandable information on consumption, cost and comparative standards within bills, contracts, or other means of customer communication (European Parliament and Council of the EU 2006). The German Regulation for Basic Power Supply (StromGVV) echoes some of these requirements, demanding that bills be easy to understand, that the calculation factors used for the billing must be explained completely, and that a comparison with the previous year is provided. Utilities are somewhat interested in exploring the potential of more informative bills, especially when they expect them to reduce customer questions or improve the utility’s image. However, these ideas are generally not put into practice because of the expected transaction costs. Utilities also shy away from more far-reaching innovations, such as increasing the frequency of billing or providing comparisons with other households. They do not only fear additional costs. Also, customer energy saving is ultimately not in their interest. Therefore, a more stringent political framework is needed in order to make bills more informative. An energy saving obligation for utilities that can be partly fulfilled by demand side programs could provide a useful framework. In the absence of such a system, there could be explicit minimum standards for bills, based on sound research of which designs are most effective. Instruments supporting the “bottom-up” development of informative bills, such as financial incentives, competitions and bill evaluations by consumer organizations, could complement the policy portfolio. The widespread deployment of smart meters would be helpful for introducing more ambitious feedback forms. Therefore, the current interest in the development of smart metering provides a window of opportunity for bringing such feedback forms on the agenda and experimenting with them. It is important to note, though, that improved feedback is but one jigsaw piece in the whole picture of governing household energy use. Electricity consumption is determined by a multitude of factors and must be steered by a multitude of carefully coordinated policy instruments. Policies on feedback must therefore be integrated in a package that also contains moti- vational instruments, financial incentives, information and standard setting in the appropriate places. Only then may they release their full sustainability potential. References 147

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study proceedings, European Council for an Energy Efficient Economy, Stockholm, pp 1289–1299 Ueno T, Sano F, Saeki O, Tsuji K (2006) Effectiveness of an energy-consumption information system on energy savings in residential houses based on monitored data. Applied Energy 83 (2): 166–183 Velte D, López de Araguas JP, Nielsen O, Jörß W, Wehnert T (2004) The EurEnDel scenarios. Institut für Zukunftsforschung und Technologiebewertung, IZT Werkstattbericht 80, Berlin. Retrieved 6 June 2008, from http://www.izt.de/ scripts/downloadmanager/index.php?act=download&id=92 Wilhite H, Ling R (1995) Measured energy savings from a more informative energy bill. Energy and Buildings 22 (2): 145–155 Wilhite H, Høivik A, Olsen JG (1999) Advances in the use of consumption feedback information in energy billing: the experiences of a Norwegian energy utility. In: Eceee (ed) Energy Efficiency and CO2 reduction: the dimensions of the social challenge. eceee 1999 summer study proceedings. European Council for an Energy Efficient Economy, Stockholm. Retrieved 6 June 2008, from http: //proceedings.eceee.org/library_links/proceedings/1999/pdf99/Panel3/3-02.pdf ZfK (2005) Kundenzufriedenheit – Stromversorger auf dem vorletzten Platz. Zeitschrift für Kommunale Wirtschaft 11:9 7 Emissions Trading*

7.1 Introduction

Emissions trading is a comparatively new policy instrument which has recently been introduced to the existing governance structure of electricity systems in Europe. The development of emissions trading thus represents an innovation in its own right, an innovation in governance. Emissions trading constitutes a particular approach to the implementation of environmental policy goals, an approach that foresees the installation of markets for tradable emission rights. The idea is that the ‘invisible hand’ of the market will sort out how and by whom emission reductions are achieved to arrive at the politically determined goals. The basic concept is to assign freely tradable allowances for emitting harmful gases whose overall quantity is limited by a so called cap. Potential emitters have to surrender allowances for each ton of emission. The idea is that, by support of the price mechanism, the allowances will find their way to those firms of the industry for which emission abatement would be most expensive. In other cases managers would decide to implement measures to reduce emissions rather than pay the price for allowances. Theoretically, this brings about a market equilibrium in which the marginal abatement cost of all market participants are the same as the market price of allowances. In this way emissions trading promises to achieve politically aspired emission reductions at minimal cost (Weimann 1991: 158–159). While the first experiments with emissions trading for local air pollutants were undertaken as early as the 1970s in the USA, it only gained global attention as a policy instrument for climate protection when it was adopted in the Kyoto Protocol in 1997. In 2005 the European Emissions Trading Scheme (EU ETS) for greenhouse gases went into operation; it now covers 10,800 installations with more than 2,100 million tons of CO2 overall in the 27 Member States.

* By Martin Cames and Jan-Peter Voß. We would like to thank Dierk Bauknecht and Barbara Praetorius for comments on an earlier version of this chapter. 152 7 Emissions Trading

This chapter discusses emissions trading as an innovation in the context of the broader task of transforming electricity systems for sustainable development. We place a special focus on the various design options of emissions trading and their likely impact on the sustainable development of electricity systems. A short analysis of the innovation process that led to the currently observable policy practices demonstrates the intricacies of putting policy theory in practice. In conclusion, we draw together analysis of design options and innovation dynamics to discuss possibilities for shaping the innovation process of emissions trading with a view to exploiting the potentials of emissions trading for the sustainable development of electricity systems.

7.2 Design Options

The basic concept of emissions trading seems to be clear and rather simple. However, the devil is in the details when it comes to implementation in real world contexts. Much depends on the choice between several design options, each one having a number of potential configurations. The next section will provide an idea of the issues and options involved and of the potential impact on investment and innovation in the electricity system. In the final paragraph, the impacts of emissions trading on the transformation towards a more sustainable electricity system will be discussed. Since investments in clean technologies for electricity generation will feature as a core impact of emissions trading, a specific focus will be put on investments as an indicator for innovations towards a more sustainable electricity system.

7.2.1 Scope and Coverage: What Sources Shall be Included?

The overall scope of a trading scheme depends on the geographical and sectoral coverage as well on the greenhouse gases included. Since a larger scheme generally includes a larger number of and economic variety in mitigation options, a trading scheme is in principle more efficient, the larger its scope is. Before deciding on the sectors to be included into an ETS, the first step is to decide whether emissions should be traded at the primary energy level of fossil fuel extraction (upstream) or rather at the point of emission, i.e. at the individual technical installation which released the greenhouse gas into the atmosphere (downstream). Under the downstream approach the 7.2 Design Options 153 sectoral scope has to be determined, taking into account effects on transaction costs and efficiency. Efficiency gains due to emissions trading are basically larger when compliance costs between sectors vary substantially. Transaction costs for monitoring and compliance might reduce the overall efficiency of the scheme if too many actors are involved.

7.2.2 Cap: How Much is Allowed?

The cap determines how many allowances are available and thus how environmentally effective a trading scheme is. As marginal abatement costs are increasing with the emissions reduction target, a more stringent cap will result in higher marginal and also higher absolute avoidance costs. Policy makers thus have to balance their decision on the right level of a cap between environmental requirements and negative economic impacts. The stringency of a target does not only determine the environmental effectiveness but also the degree of innovation incentives created by a scheme (Schleich and Betz 2005: 1496). Innovative options which are not yet economically feasible under a weaker cap will become competitive under a more stringent cap with higher allowance prices. Schumacher and Sands (2006: 3935–3938) illustrated that, for example, CCS and advanced wind power plants will diffuse into electricity generation in Germany if the average allowances price surmounted €20 per ton of CO2.

7.2.3 Allocation: Who Gets What and How?

Design of Allocation Provisions After the overall amount of available allowances has been determined, the question arises as to how these allowances should be allocated to the companies covered by the scheme. In general, one can distinguish between allocation of allowances free of charge and allocation methods by which allowances are sold to the companies. Both allocation methods exist in several variants and are accompanied by additional rules, such as regarding the transfer of allowances from existing to new installations or penalties for inefficient installations. Such details may considerably influence the overall allocation outcome.1 In the following, we briefly discuss the pros and cons of the main methods with a view to their impact on the sustainable development of the electricity system.

1 Due to the broader scope of this book, these details cannot be discussed here. A comprehensive discussion of these issues is provided in Cames (forthcoming). 154 7 Emissions Trading

Allocation free of charge is often the option of choice at the start of a trading scheme since it reduces the political resistance of the covered companies. Allocation free of charge imposes relatively small real avoidance costs on the companies. Simultaneously it allows them to generate windfall profits by passing the opportunity costs of the allowances2 on to the consumer as was the case in the electricity sector during the first commitment period (Sijm et al. 2006). Usually allowances are distributed to incumbents according to historic emissions in a certain base period (grandfathering).3 Another option is to distribute allowances according to a standard emission factor of commodities produced, possibly specified by technologies applied (output based allocation or technology benchmark). In both approaches companies receive a share of the allowances which is proportional to their share of overall emissions. Both approaches face certain difficulties. Improvements in the environmental performance that were achieved before the start of the trading scheme (so called early action) are rewarded if the reference period is backdated early. This, however, may involve difficulties in terms of the availability of data. Therefore, early action can be rewarded through additional allocation rules. Benchmarking automatically rewards early action since the same emission rate applies to all operators. Those whose emissions rates are below the benchmark receive excess allowances compared to their needs which can then be traded. However, the difficulty with the benchmark approach is identification of and agreement upon the products and technologies for which differentiated benchmark are established. A large number of benchmarks diminish incentives for shifting economic activity to less emission intensive production processes and increases the administrative burden. Another issue is the question of how to treat new entrants and closures. From an environmental economics perspective, new entrants should not be allocated allowances free of charge since they can – in contrast to

2 Instead of using allowances to cover emissions from its own generation, a company might reduce its electricity output and sell the allowances at the market price. However, these revenues are foregone if allowances are used to cover emissions from its own generation. Therefore, the companies have to add the forgone value as so called opportunity costs in their calculation of variable costs although they have received the allowances for free. 3 If just one single history year is selected for reference, specific conditions of that year such as weather, business cycle, plant failures, etc. might substantially influence the allocation to individual installations so that the allocation is not considered fair by the covered companies. Therefore, a range of years is usually selected as the reference or base period assuming that such year-specific conditions cancel out during a longer period. Sometimes operators are also allowed to eliminate the most unfavorable year from the calculation. 7.2 Design Options 155 incumbents – include the additional costs of allowances in their investment decisions (Graichen and Requate 2003: 21–22). If allowances are not allocated free of charge, they may either be auctioned or sold for a fixed price. In the latter case, there is a great risk that the fixed price differs from the market price with the result that two prices would exist for the same product. Auctioning is, therefore, economically advisable because it generates a clear price signal and improves the transparency and efficiency of the allowances market. Compared to allocation free of charge, the selling or auctioning of allowances has the advantage that a specific treatment of new entrants or closures is not necessary. In the case of full auctioning, both incumbents and new entrants would have to purchase all necessary allowances and nobody would be required to return the remaining allowances after the closure of installations. Moreover, the auctioning or selling allowances would automatically reward early action since installations which are more efficient would need to purchase relatively less allowances than inefficient installations.

Innovation Incentives of Allocation Provisions In the short term emissions trading may induce several changes in the management of electric utilities and the operation of their installations such as shifting generation from installations with higher emissions rates to installations with lower ones or substituting fossil fuels for biomass. In the long run the contribution of emissions trading to achieving a more environmentally sustainable electricity system will depend on its ability to direct investment towards generation technologies which emit substantially less greenhouse gases. In this sense, investment can be considered as a precondition and thus also as an indicator for innovation. Investment decisions primarily depend on the expected profitability of an investment option. Emissions trading adds the costs of allowances to the variable costs (fuel, maintenance, etc.) of electricity generation. If allowances are auctioned or have to be purchased upon market entry, these costs obviously play a role in investment and thus in innovation decisions. Therefore, a major question is in what way and to what extent the different allocation provisions for incumbent installations and for potential new entrants foster investment in sustainable generation technologies. According to studies by Milliman and Prince (1989) and Jung et al. (1996), auctioning allowances to incumbents induces stronger innovation incentives than allocation free of charge (Jaffe et al. 2001: 57–58). Their main argument is that innovation reduces the cost of emission reduction and thus the price of allowances (Requate and Unold 2003: 134). The resulting 156 7 Emissions Trading depreciation of freely allocated allowances reduces the innovation incentives under free allocation. Since this depreciation effect does not occur with auctioned allowances, innovation incentives of auctioned allowances are considered to be higher. These results are challenged by more recent analyses. Schwarze (2001) and Requate and Unold (2003) point out that under a competitive allowance market in which the decisions of an individual firm does not influence the allowance price, firms will not expect the allowance price to fall due to their innovation decisions. Yet without the anticipated allowances price effect, the difference between auctioning and free allocation to incumbents disappears so that the incentive to adopt innovative technology can be assumed to be the same under auctioned and freely allocated allowances. The picture is different when new entrants are considered: If allowances are allocated free of charge to new entrants, investors will include their value into their calculations and record them as additional revenue. This means that a larger number of otherwise not competitive investment options become economically attractive. Endowing new entrants with free allowances thus works as a subsidy for new generation capacity (Ellerman 2006: 9). Investment will, therefore, tend to be larger under new entrants endowments free of charge than under auctioning. A new entrants provision will thus induce overinvestment in generation capacity as a rule. However, since it fosters investment in new generation capacities, it also principally increases incentives for the broader diffusion of innovative technologies. Older installations which operate at the margin will be crowded out (since electricity demand is fairly insensitive to prices4). Lower emission rates of new installations in turn reduce the demand for allowances. As a consequence, the price of allowances goes down and they are increasingly purchased by other sectors in which lower prices can be more easily turned into increased turnover than in electricity. All of this holds true only under perfect competition – a condition that is hardly met in electricity markets. It is also only the case when new plants actually cause fewer emissions than the old ones which they are replacing. If natural gas as a fuel with a relatively low carbon content is replaced by hard coal or even lignite – both of which have significantly higher carbon contents – the picture might be substantially different. This could be the case if expectations with regard to the future development of fuel prices favor coal over gas as is currently the case.

4 Due to the small price elasticities of electricity consumption, higher capacities will usually not result in lower electricity prices but rather in reduced prices for capacities (Ellerman 2006: 14). 7.2 Design Options 157

A factor that is more important regarding our interest in the design of allocation options is, however, that incentives for investments in low emission generation technology can also be cancelled out if the amount of free allowances distributed to new entrants is specified with regard to the fuel that is used. Fuel specific benchmarking yields more allowances for investments in installations with higher greenhouse gas emissions. If, for example, hard coal and lignite fired power plants receive more than twice the allowances per kWh of expected electricity generation than gas power plants – as is actually the case in the German emissions trading system (Zuteilungsgesetz, Deutscher Bundestag 2007: 1799) – new entrant provisions subsidize technologies with higher emission rates. In this way, fuel specific benchmarks eliminate incentives to shift investments towards low carbon technologies such as combined cycle gas turbines (Cames and Weidlich 2006: 47–49). Or, in other words, they create perverse incentives for technologies with comparatively high emission rates. Proponents of fuel specific benchmarks argue for the security of supply benefits from lignite as a domestic fuel in Germany. In any case, fuel specific benchmarks very likely result in higher emissions from electricity and higher allowance prices than a uniform benchmark. Without a closure provision, allowances count as additional costs of generation. Operators will continue to run the plant only as long as revenues exceed generation costs including the cost of allowances. In contrast a closure provision which obliges operators to return allocated allowances upon plant closure adds an incentive to keeping old installations running longer, at least pro forma. In this case, the market value of allowances counts as additional revenue of generation. If plants are closed, the allocated allowances have to be returned and cannot be sold. Several installations that would be closed without a closure provision can continue operation since their higher emission costs are offset by the additional revenues from the freely allocated allowances. In short, a closure provision tends to hinder investments and innovation. Proponents of a closure provision argue that it would be unfair to leave allowances with companies that have received them free of charge if they do not need them any more. Another argument is that without closure provision there would be too strong incentives to shut down plants (‘closure premium’) and dislocate production to countries not covered by the EU ETS – even if this is limited by transmission capacities in the case of electricity. The closure provision thus seems to cure a minor problem at the cost of undermining the major goal of emission reduction. They extend the lifetime of old installations which operate at the margin and increase available generation capacity so that investment opportunities for new generation technologies are reduced. 158 7 Emissions Trading

In conclusion, it can be said that allocation methods to incumbent installations do not directly influence the innovation incentives of emissions trading. However, special provisions for new entrants and plant closure can make a trading scheme much more complex. While a new entrant pro vision in general will enhance investment in new capacity and thus provide additional options for implementing innovative technologies, fuel specific benchmarks may lead to an overall increase in emissions. A closure provision would, in contrast, reduce investment because it basically extends the lifetime of old installations.

7.2.4 Banking: When can Allowances be Used?

In order to increase the flexibility for companies as to when to reduce emissions, ‘banking’ and ‘borrowing’ can be introduced as additional design options (Stephan and Müller-Fürstenberger 1999). This allows companies to save allowances from the current compliance period (the time frame within which allowances are valid) and use them in the future, or vice versa. In general, it can be expected that banking increases the efficiency of emissions trading because the additional flexibility enhances the number of options for how companies may react to the carbon constraint (Buchner et al. 2004: 4). Companies have an incentive to bank allowances if the growth rate of the allowance price is greater than the interest rate (Cronshaw and Kruse 1996) or “when marginal abatement costs are rising, marginal production costs are falling, emission standards are declining, or output prices are rising” (Kling and Rubin 1997: 114). Cronshaw and Kruse (1996) show that banking reduces the aggregated compliance cost of emissions trading. Godby et al. (1997) point out that in cases in which firms cannot control emissions precisely during a compliance period, banking provides additional benefits in smoothening the functioning of the allowances market. However, particularly borrowing may not lead to a social optimum because firms discount the future and tend to emit more at present than in the future (Kling and Rubin 1997). The overall effect of banking on investment is ambiguous. On the one hand banking enables firms to substitute investment and contributes in this way to postponing investment (Phaneuf and Requate 2002). However, this is especially true when the investment functions of firms are continuous. Investment in electricity generation is, though, to a large degree indivisible so that the size of the investment cannot be perfectly adapted to the expected allowances price. Banking would enable firms to opt for the larger investment option and to bank allowances if the discounted expected prices are lower than the current allowance prices. On the other hand, banking reduces 7.2 Design Options 159 the variance and thus the risk associated with the allowance price (Sharpe and Alexander 1990: 136, 140). This, in turn, diminishes the option value of delaying investment options and would, compared to the situation without banking, encourage firms to bring forward their investment decisions.5 Which one of these conflicting effects outweighs the other has not been determined to date. However, in a ranking of the importance of various design options for their company, banking was ranked last out of 12 options (Cames forthcoming).6 Thus, even if banking in aggregate might improve the propensity to invest, it might do so only to a minor extent.

7.2.5 Commitment Periods: What is the Planning Horizon?

Comparing power plant lifetimes of 40 years and more (IEA 2007: 76) with commitment periods of five years and the Kyoto Protocol’s time horizon up to 2012 illustrates clearly that the time frame of political regulation diverges substantially from the companies’ scope. From the companies’ perspective both issues determine policy or regulatory uncertainty which influences investment decisions (Sullivan and Blyth 2006; Buchner 2007). In general it can be assumed that higher regulatory uncertainty results in a postponement of investment decisions and thus a slowdown of innovation. Regulatory uncertainty may create incentives to postpone investment decisions until more regulatory information becomes available which enables firms to make better-informed decisions (Ishii and Yan 2004: 31). Measures that would reduce regulatory uncertainty may thus foster both investment and innovation. Such measures include the definition of binding long-term reduction targets and timing aspects of the more detailed path to achieving these targets. Longer commitment periods would reduce the impact of regulatory uncertainty about investment. Doubling the length of a commitment period from, for instance, five to ten years would provide longer periods with a small option value of delayed investment (Blyth and Yang 2006: 34), thus

5 Both theoretical and empirical analyses provide evidence that increased uncertainty creates incentives to postpone investment decisions (Kalckreuth 2000; Butzen et al. 2002; Botterud and Korpas 2004; Ishii and Yan 2004; Laurikka and Koljonen 2006; Bloom et al. 2007). 6 Another piece of evidence that banking is not considered as a central design option can be derived from that fact that it was hardly mentioned in the review process of the EU ETS (http://ec.europa.eu/environment/climat/emission/review_ en.htm). Only in six of 46 stakeholder contributions is banking mentioned at all. In the report of the third meeting it was alluded to marginally and only in the report of the fourth meeting was it addressed several times - however not as a contentious issue within the EU ETS but as a design feature which has to be clarified before linking trading schemes. 160 7 Emissions Trading fostering innovation. In addition, longer commitment periods would provide more flexibility to companies to offset short-term fluctuations resulting from economic cycles, weather conditions, etc. and might also reduce transaction costs due to fewer negotiation processes. However, shorter commitments periods also have advantages which have to be balanced with the advantages of longer periods. Shorter commitment periods allow policy makers to better adjust targets to scientific, technological, economic or political developments. More frequent compliance checks would also increase the transparency of emission reductions already achieved (Buchner 2007: 5–6). This discussion illustrates that extending commitment periods would improve the predictability of climate policy but at the cost of reducing flexibility and transparency. Several suggestions are made to mitigate this trade-off between longer and shorter commitment periods: x Rolling commitment periods: “commitments are subject to an automatic adjustment process that extends and makes them more stringent on, for example, an annual basis whilst retaining the assessment of compliance at multi-year intervals.” (MoE 2007: 12)7 x Multi-period decision-making: The length of the commitment period remains unchanged at five years but the targets are decided, for example, three periods in advance against the background of a long-term target path.8 x Gateways: Australia’s National Emissions Trading Taskforce suggested combining firm targets for a period of 10 years with upper and lower bounds of possible future targets (‘gateways’) for the subsequent 10 years (NETT 2006). A common element in all these approaches is that a long-term emissions reduction perspective is combined with firm short-term and adjustable medium-term targets. Commitments are always known with reasonable certainty for the next set of years – thus reducing the uncertainty created by the periodic re-negotiation of commitments. In this way, they might reduce regulatory uncertainty for potential investors while maintaining the flexibility and transparency of shorter commitment periods and might thus foster investment and innovation.

7 An automatic adjustment procedure of commitments has, for example, been introduced in BASIC’s (2006) Sao Paulo Proposal for an Agreement on Future International Cli- mate Policy. 8 This approach became known as ‘carbon budgets’ and was suggested in the draft UK Climate Change Bill (DEFRA 2007). 7.2 Design Options 161

7.2.6 The Interplay of Design and Sustainability

In this section we specifically address the ecological effectiveness, economic efficiency and social justice of the currently implemented design and highlight issues of setting caps, allocation methods and social justice. A final point addresses the procedural issues of democratic policy making. This is related to the transparency and public discourse of policy instruments. In principle emissions trading seems to be the perfect policy in terms of sustainability: 1. The setting of absolute caps allows for direct steering of the amount of emissions released into the atmosphere; provided that a strong monitoring and compliance system is established, the ecological effectiveness is therefore as high as possible because the aspired target will definitely be achieved. 2. Emissions trading has been proven to be economically the most efficient instrument to regulate emissions both in theoretical analysis (Montgomery 1972) and model simulations.9 3. The social impact of emissions trading should basically be small because emissions are reduced in the most efficient way so that the overall burden on the economy is diminished. 4. The simplicity of the basic principle and the cap is an easily understandable “adjusting screw” which allows for a high transparency and public control of the policy process. However, the complexity of design details illustrated in the previous sections makes it clear that the implementation of emissions trading is challenging and that its sustainability impact can only be assessed against the background of concrete design options. These designs can promote the sustainability impacts of emissions trading or turn the effects to the reverse as elucidated in the considerations below. 1. The ecological effectiveness of the EU ETS is not as clear cut as it seems. Apart from EU allowances (EUA), companies may also surrender credits from CDM projects (CER). The amount of CER which companies may use is restricted. If this amount is larger than the actual effort to reduce emissions within the EU ETS, emissions might not decline but effectively rise. Basically these emissions will be offset by reduction

9 A comprehensive overview of the results of various model simulations is provided by Oberndorfer et al. (2006). 162 7 Emissions Trading

outside the EU10 but against this background it may be seriously contested whether the EU ETS really contributes to a change in emission trends in Europe. More indirectly, the ‘marketization’ of environmental protection may also result in an erosion of other regulating societal mechanisms such as environmental ethics. The moral legitimization of polluting activities as a mere question of allocating CO2 as an input factor into production and, indirectly also consumption, may have long-term and diffuse impacts on the social norms of an environmental ethic that became established in the 1970s. The spread of a ‘compensation ethic’ instead of a personal responsibility and moral obligation to avoid emissions may reduce a buffering effect on the spread and development of environmentally harmful lifestyles. This is visible, for example, in the promotion of air travel through the possibility of compensating for emissions by buying certificates (e.g. transfer). Currently, compensation schemes are under development also for many consumer products that declare them to be “climate neutral” and could therefore promote their consumption (rebound effect). Even if this effect is indirect and not easily quantifiable, it should be taken into account when evaluating the overall sustainability effect of emissions trading. It could constitute something like a ‘rebound effect’, compensating parts of the emission reductions from emissions trading. 2. After all, ecological effectiveness is the economic efficiency of the policy instrument. The development of emissions trading was largely based on model simulations that compared emissions trading to alternative regulatory approaches such as standards and charges without taking full account of regulatory and transaction costs. If these ‘hidden’ costs are taken into account the efficiency of the instrument may need to be reconsidered (Müller 2007). While costs of regulation in the case of standards and charges occur mainly in the public sector, they feed a private service and consulting economy in the case of emissions trading. While this works to reduce the burden on public budgets, such costs need to be taken into account when estimating the overall societal efficiency of alternative approaches to regulate emissions. This is particularly relevant as existing emissions trading schemes are far more complex and less market driven to date than the ones represented in models for simulating their economic performance in relation to other options. Apart from reconsidering the relative merits of standards and charges, this

10 Schneider (2007: 9) estimates that 20 % of the credits generated from CDM projects are not additional. On average only 80 % of the credits hence result in a real reduction of greenhouse gas emissions. 7.2 Design Options 163

may make a strong argument for reducing special rules to divide and manipulate markets for emission allowances. The most central issue here is the shift from allocation free of charge towards auctioning of allowances as this would reduce the need for all kinds of special rules that try to compensate for the distortive effects of allocation free of charge. 3. Auctioning is also important with regard to the distributional implications of emissions trading. An important topic in the political debate around emissions trading was the generation of huge windfall profits for companies who received the allowances free charge but passed through the opportunity costs of these allowances to their products (most notably in electricity). There are already considerations for establishing special taxes to skim off windfall profits. However, this further complexifies the policy approach. Auctioning would reduce these negative impacts on the distribution of welfare and social justice. Until 2012 auctioning is voluntary and restricted to 10% of the allowances. Hereafter auctioning should be mandatory to a certain degree for all Member States. The share of auctioned allowances should be gradually increased towards full auctioning. However, for sectors which are not affected by international competition the share of auctioned allowances might increase faster than for those sectors which are confronted with strong international competition. 4. A last point is of a very general nature, but is something that comes into view when looking closely at the policy process around the introduction of emissions trading. It refers to the highly expert driven development of this policy instrument, especially in its various technical details that have important effects for the overall impact on ecology, economy and society. Emissions trading has developed to a degree of such technical sophistication that it is impossible for lay citizens to judge the effects of various regulatory options. Even within the community of emissions trading professionals, it is hardly possible for any one expert to foresee the full impact of certain details of regulation. Many of them require simulation exercises with the help of economic models whose inner working is opaque to anybody who is not deeply involved in their construction. Moreover, much of this special expertise is vested with private actors who are not directly accountable for their design work on governance. It is therefore a challenge for the future development of emissions trading to simplify the overall regulatory arrangement so as to allow for the anticipation of effects of particular design options and to create the conditions for public involvement and debate in the policy process. Although emissions trading has by its nature many advantages over other instruments with regard to sustainability aspects, it is by no means 164 7 Emissions Trading sustainable per se. Emissions trading contributes to achieving a sustainable electricity system only if its specific design options are configured sufficiently ambitiously and if the overall configuration is lean enough to result in a scheme which is efficient and transparent to all participants.

7.3 Process of Innovation: Networks, Politics, Institutions

7.3.1 The Innovation Journey of Emissions Trading

Constructing and analyzing design options theoretically is one thing, putting policy in practice is another thing. Both are part of innovation processes in governance that may lead up to the establishment of new policy instruments that work as institutional configurations to bring about desired outcomes of social interaction (Voß 2007). Let us now take a closer look at the innovation process of emissions trading in order to learn how the design came to emerge and be implemented. A special focus is on the Emissions Trading Scheme for Greenhouse Gases in the European Union (EU ETS) and its specification within Member States. Here we are particularly interested in the implementation of EU ETS as an example of rule systems that are relevant to innovation and transformation in the German electricity system. The innovation process that brought about emissions trading in the European Union and Germany can be analyzed in four phases (Voß 2007). A first ‘gestation’ phase shows precursory developments which can in hind- sight be interpreted as the roots of the policy instrument. A second phase shows the first developments that brought about a ‘proof-of-principle’ for the idea that emission rights can be traded. In a third phase a ‘prototype’

global Coase 1960 scope Dales 1968 UN Montreal Protocol UN Kyoto Protocol Montgomery 1972 US lead in gas EU-ETS

US Acid Rain EPA bubble EPA Policy EPA offset UK SO2 DEN, UK EU 25

US NOx-Budget US RGGI, CAL US RECLAIM local scope BP, Shell 1960 1970 1980 1990 2000 2010 Gestation Proof of principle Prototype Regime formation Fig. 7.1 Outline of emissions trading’s innovation journey (Voß 2007). Dotted lines represent informal influences between instances of implementation, the solid lines represent formal legal relations 7.3 Process of Innovation: Networks, Politics, Institutions 165 for a new policy instrument is implemented and demonstrates feasibility and performance under real world conditions. A final fourth phase sees the innovation branching out from its initial context of implementation, linking up with policy problems in other jurisdictions and developing a trans-national infrastructure for policy design, a “technological regime” in governance. We briefly reconstruct the main stages of this process to develop an understanding of the dynamics that gave emission trading its current shape. Fig. 7.1 provides a brief overview of the major events and instances of implementation in the history of emissions trading.

7.3.2 Gestation: Emerging Practices of Flexible Regulation and New Options in Economic Theory

Emissions trading originated from two different strands of precursors, one in science and one in the practice of US clean air regulation. The scientific strand is the emerging concept of tradable rights to pollute. The practical strand is tinkering with flexible regulation by regulators at the US Envi- ronmental Protection Agency (EPA). Looking back, a scientific trajectory emerged throughout the 1960s and 1970s. With the conceptualization of tradable permits in economic theory (Coase 1960), new options for environmental policy besides standards and charges became discernible. This option was articulated and advocated as the establishment of markets for emission rights (Dales 1968). This started a vigorous debate among economic theorists about the pros and cons of permits vs. charges. In its course the concept was refined and represented in economic models which finally delivered formal proof of the efficiency of tradable permits (Montgomery 1972). Environmental governance practice, however, was only just about to become established in the early 1970s after introduction of emission standards for stationary sources in 1967. It took shape as strict National Ambient Air Quality Standards (NAAQS) were introduced through an amendment of facility-oriented emission standards to the US Clean Air Act (CAA) in 1970, to be implemented by the newly set up US Environmental Pro- tection Agency (EPA). As environmental regulation became effective, opposition arose from industry that accused environmental regulation of imposing a “growth ban”. In an attempt to strike a balance between their statutory mandate and the interests of their clientele, EPA officials tinkered with “flexible regulation”. This meant that standards could be breached at one particular facility if this was compensated by over-fulfillment at another facility. This practice was accommodated in the legal framework in 1978 as the above “offset mechanism” (or bubble), even allowing for 166 7 Emissions Trading compensation across the boundaries of companies. This established a first limited market for SO2 and NOX emission rights. Officially, however, it was not treated as a policy shift, but as pragmatic repair work within the existing regime of command and control regulation (Cook 1988). The offset mechanism did represent an interstice within the regime, however. Young economists at the EPA made use of it in setting up a development program for market-based environmental regulation (Meidinger 1985: 462–463). Protection for these experiments was provided by the Office of Planning and Evaluation (later the Office of Planning and Management, OPM), an institutional stronghold for economic thinking at the EPA and “an organizational home for reformers in the agency” (Cook 1988: 10).

7.3.3 Proof of Principle: Creating Spaces for First Developments at US EPA in the Shadow of the Old Regime

The first steps of developing emissions trading as a new policy instrument took place in this protected space: “The offset policy provided a window of opportunity, albeit initially a narrowly opened one, allowing EPA reformers room to maneuver in exploring alternative control strategies with at least the semblance of incentive characteristics” (Cook 1988: 46). Further support came from the new Carter Administration being intrigued by the promise of dissolving criticism against over-boarding regulation by more efficient techniques of regulation: markets for pollution rights would smoothly organize themselves without much political intervention and minimize the resistance of business actors to environmental protection (Cook 1988: 46). After 1978 the OPM “grafted economic incentives in an incremental and piecemeal fashion on an existing directive framework” (Marcus 1980: 171). These developments took place in the shadow of broad public debates about political values and regulatory culture that culminated in Reagan’s agenda for ‘regulatory relief’ in 1980 (Cook 1988: xi–xii, 1–2). In fact, the label “emissions trading” was not used at the beginning, but rather “controlled regulation”. In 1979, “emission reduction credits” became established as a currency for trading unexploited margins below emission standards for SO2, NOX and particle matter. In 1982 the EPA presented a proposal for an “Emis- sions Trading Policy Statement. General Principles for Creation, Banking, and Use of Emission Reduction Units”. In the course of these early activities tinkering gave way to more systematic and coordinated development. The potentially involved actors became alert and started to be active in the process of policy formation, building networks and lobbies for their respective stakes. A promise-requirement 7.3 Process of Innovation: Networks, Politics, Institutions 167 cycle, as can be observed in processes of technological innovation, had come about and boosted early developments of emissions trading in the protected space within the CAA (van Lente 1993; van Lente and Rip 1998). The promise to assure support by the business community, for example, made it necessary to accept their requirement for liquid emission markets with stable prices. “Banking” mechanisms were introduced to promise stable markets to the business community. This brought the finance industry into the game and created further requirements with regard to the integration of markets for emission allowances with the financial market regime. The development agenda thus became more complex, but also more momentous in terms of the stakes that were involved and the resources devoted to it. In this way internal resistance within the EPA could be overcome where engineers and lawyers feared losing influence to economists (Cook 1988: 4). These years around 1980 came to be termed a “major cru- sade for regulatory reform in the EPA, centered around the use of economic incentives” (Cook 1988: 62). The result was a trading scheme for emission reduction credits that was built from existing elements of discourse, legislation and regulatory skills and practices in a piecemeal fashion and survived within the particular political space created by offset and the OPM. Some first checks of compatibility with public opinion and legal frameworks took place as elements of the EPA’s emissions trading program were contested at the courts, mainly by environmental NGOs who resisted the commercialization of pollution rights. A result of this was, for instance, the substitution of the term “property right” for “allowance” in order to retain legal powers of the state vis-à-vis the holders of permits (Tietenberg 2002). In 1986 a final version of the Emissions Trading Policy Statement was published. One year before, a first evaluation study of the program had been conducted and assessed against the theory of tradable permit markets (Tietenberg 1985). This pulled the nascent policy scheme out from the shadow of the command and control regime and highlighted it as a first instance of a new policy instrument in practice, a proof of the principle that emission reduction obligations could be traded with positive results for both business and the environment. From the side of business, however, the new option for flexibility did not receive much attention. Banking and trading of emission reduction credits was only sporadically used and did not result in any considerable cost reductions (Tietenberg 1985). Most of these deficiencies were attributed to the fact that the design was implemented exactly as prescribed by economic theory. 168 7 Emissions Trading

7.3.4 Embedding a Prototype: Project 88 and the Transformation of US Clean Air policy

The next phase of the innovation process began with the factual implementation of a prototype of emissions trading as a new policy instrument, explicitly announced as a paradigmatic shift towards a market based approach in environmental governance. For this purpose, economic theory was combined with regulatory experiences from the EPA emissions trading program. A vehicle for this was ‘Project 88’, a comprehensive research and development process with a focus on alignment and agenda building in environmental policy networks in the run-up to the 1988 presidential elec- tions in the USA. This resulted in the adoption of the 1990 US Acid Rain Program which came to be regarded as a great success and induced many attempts at reproduction within and outside the USA. Several of these attempts in the USA were successful and worked to transform clean air governance from command and control to market based patterns. This shift in policy practice was supported by an escalating conflict constellation between the environmental movement and industrial interests. During the 1980s the problem of acid rain moved onto the political agenda and gave new impetus to environmental concerns in society. Although accompanied by flexibility and burden sharing mechanisms, industrial and regional interests in the House, Senate and the Reagan Administration blocked off any political measures against acid rain in the 1980s (Ellerman et al. 2000: 20). It was against this background that the innovation process of emissions trading entered into its next phase. Project 88 enrolled a broad range of political interests, notably from industry as well from the environmental movement, in a concerted effort to bring forward emissions trading as a solution to the conflict between environmental and economic interests and overcome the stalemate in Acid Rain Policy. Business was granted an active role in environmental policy in order to “enlist the innovative capacity of American entrepreneurs in our environmental enterprise” (Project 88 1988: 9). With emissions trading, a new business field could indeed be offered in catering the emerging markets for allowances. In 1990, the Administration adopted the Project 88’s proposal and directly implemented a cap and trade system according to the state of art in economic theory. The final rules for emissions trading were adopted in January 1993. By 1994 a market had developed. The transfer of the instrument from economic theory to political reality, however, brought several problems to the fore: In economic theory distribu- tive effects were neglected while in the policy process, they fed conflicts 7.3 Process of Innovation: Networks, Politics, Institutions 169 about alternative forms of allocating emissions reduction allowances and various other details of design (Ellerman et al. 2000: 27). In a complex constellation of parties with diverging interests and under high time pressure, the neat theoretical concept of emissions trading was broken up. Additional elements were introduced to repair it: Generous bonus allowances for flue-gas desulphurization (scrubbers) had been introduced to mitigate an expected decline in demand for high-sulfur coal from eastern states (who required this as a condition for their support). At the same time, ad-hoc adaptations had to be rationalized in order to keep up the promise of efficiency. In effect, the first trading regime “is built on more or less arbitrary emission limits, trading to reduce costs, and an allowance allocation scheme that is at least as messy as most tax legislation and that has a history with no more nobility” (Ellerman et al. 2000: 316–317). Nevertheless, the new policy instrument spread widely in the USA throughout the 1990s. Several schemes were set up on a regional level and the concept of emissions trading gained dominance in the policy discourse.11 The transfer to Europe, however, still met with resistance. While the prototype induced some exploratory activity in Europe,12 the dominant regulatory culture provided a less favorable selection environment for such a market based policy instrument. Command and control based regimes of environmental regulation were stronger in many European countries than in the USA, with incumbent interests and institutional inertia making radical innovation more difficult (Woerdman 2002; Cass 2005). Six years after its start, the US Acid Rain Program was evaluated as a success. The prototype was recommended for large scale application: “We believe that our analysis of the U.S. Acid Rain Program supports a number of general lessons… The experience … clearly establishes that large-scale tradable permits programs can work more or less as textbooks describe…” (Ellerman et al. 2000: 315). With the US Acid Rain Program as a working exemplar in place, “the concept of harnessing market forces to protect the environment has gone from being politically anathema to politically correct.” (Stavins 2002: 1).

11 A prominent example is the Regional Clean Air Incentives Market (RECLAIM) for the regulation of NOX and SO2 in the Los Angeles area from 1994 (Harrison 1999). Other examples which gained some international visibility are the NOX Budget program, which was set up in 1999 and comprises nine states in the Northeast of the United States, and the Illinois VOC trading scheme, established in 1999 for the Chicago area. 12 For instance, a proposal for SO2 emission regulation in the United Kingdom (Sorrell 1999) and a proposal by the business community in Norway (Hoibye 1999). 170 7 Emissions Trading

7.3.5 Regime Formation: Linkage with International Climate Policy, the Carbon Industry and EU Emissions Trading

In 1997, emissions trading became a core element of the international climate policy governing framework. With support of the international business community, US diplomats negotiated international emissions trading into the Kyoto Protocol – in the face of resistance from the European Union which feared that reduction commitments could be watered down by importing excess emissions rights (“hot air”) from former socialist countries (Oberthür and Ott 1999: 188–190; Damro and Luaces Méndez 2003: 76). However, the development of a working rule system for international emissions trading under the Kyoto Protocol soon became stranded when confronted with differences between the EU and the USA (Woerdman 2002: 350–384; Cass 2005). In an attempt to overcome this deadlock, the US-based nonprofit and nonpartisan environmental advocacy group Environmental Defense Fund (EDF), which was known for its backing of market based solutions to environmental problems, encouraged business corporations to move ahead with in-company trading schemes as a means to demonstrate their support for the instrument. In 1999, the oil companies BP and Shell established greenhouse gas emissions trading schemes of a transnational scope (Zapfel and Vainio 2002: 8). These schemes also attracted particular attention as the first applications of emissions trading to greenhouse gases. The instrument gained support from the OECD and business corporations worldwide (OECD 1997; OECD/IEA 2004). Increasingly, actors beyond established environmental policy networks also became enrolled in the innovation network: “(…) market intermediaries and other potential service providers (auditing companies, consultants, lawyers, academics, commercial conference organizers) saw a potential market arising and were more than willing to invest some resources under the header of business development” (Zapfel and Vainio 2002: 7). Their “helpers’ interest” (Prittwitz 1990: 116–121) brought forward exploratory studies as well as research and development activities in Europe which were justified by the need to be prepared for upcoming policy debates. In these years, part of the dynamics was the emergence of what is now called the carbon industry – an increasingly organized sector of specialized businesses that provide services for the development and maintenance of emissions markets.13 The

13 In a recent study Müller (2007) distinguishes the following groups of actors as part of the emissions trading business: traders (intermediaries, broker, trading departments in industry, exchanges), consultants (business and legal), project management and development, 7.3 Process of Innovation: Networks, Politics, Institutions 171

International Emissions Trading Association (www.ieta.org) was set up in 1999 by several international companies across the carbon cycle to promote the worldwide development of emissions markets. In the context of these ongoing developments on a supra- and sub- national level, policy initiatives started to take shape, also on a national level in Europe. In 1999 Denmark introduced the first emissions trading scheme in Europe. While this case gained little attention – as CO2 trading was restricted to eight utilities – (Pedersen 2000: 3–5), a parallel initiative stirred up debate in policy cycles around Europe. In the UK, business actors set up in June 1999 the Emissions Trading Group (ETG) as a task force to develop a voluntary scheme as an alternative to tax proposals. The ETG comprised representatives from multinational companies who had experience in emissions trading in the USA. Central actors from the US emission trading innovation network participated regularly in working group ses- sions (Smith 2004: 83–84). With the ETG a European bridgehead of the emissions trading innovation network became established. In 2002 the UK government endorsed and financially supported a pilot scheme developed by the ETG because it was thought “to enable business to gain practical experience of emissions trading ahead of a European and international system, and to help the City of London establish itself as a global centre for emissions trading” (DEFRA 2003). The European Union and Member States were still rejecting emissions trading under the Kyoto Protocol, but within European policy networks emissions trading was enrolling an ever larger constituency. It was increasingly believed that emissions trading would come anyway and that the only sensible thing to do was to get involved. The more people who believed in it, the more likely it became that it would happen. This made it increasingly difficult to argue against emissions trading. Eventually, around the year 2000, the reversal was complete in Europe. Actors who were critical of emissions trading had turned into supporters and the debate shifted from the question of “if” to “how” (Zapfel and Vainio 2002: 9–10). The European Commission became a hub of informal consultations and exploration of emissions trading as a policy instrument for domestic climate policy. Already in May 1999 the EU Commission presented the Communication “Preparing for Implementation of the Kyoto Protocol” to the Council and Parliament, saying that this “means to bring our own house in order and involves taking the necessary action for enabling the full application of the Kyoto provisions” (European Commission 1999: 1).

verification of emissions, investment funds, research institutes and universities, public administration, information services and conference organization, interest groups. 172 7 Emissions Trading

In March 2000 the Commission tabled a Green Paper with a proposal for a European Emissions Trading Scheme (EU ETS). This already assumed that “emissions trading will be an integral and major part of the Community’s implementation strategy [of the Kyoto Protocol]” (European Commission 2000: 4). The Green Paper was linked to a broad stakeholder process. A central platform for stakeholder consultations was Working Group 1 on “flexible mechanisms” under the European Climate Change Programme (ECCP) set up in June 2000. Comprising experts from various Directorates of the European Commission, national governments, industry and environmental NGOs, this group took on an entrepreneurial role as regards emissions trading within Europe. US experts were regularly invited for consultation. “Astonishingly, the group – bringing together diverse interests with about 30 representatives from some Member States, industry, and environmental pressure groups – achieved a high degree of consensus and failed only to adopt a consensual recommendation in very few issues” (Zapfel and Vainio 2002: 11). The group recommended “that emissions trading start as soon as is feasible. Implementation of emissions trading within the EC should not wait for progress to be made in defining the Kyoto mechanisms, and should be developed in the context of an international scheme from 2008 and with a view to influencing its design. A pre-Kyoto EC system should be viewed as a “learning-by-doing” process (European Commission 2001: 4). When the USA withdrew from the Kyoto Protocol in 2001, the next critical juncture arose. The EU was urged to take over the lead in climate policy and demonstrate concrete success in order to keep the international process alive (Wettestad 2005: 16). Another important factor made a particularly good fit for emissions trading with the domain of European climate policy at that time: While the Commission had worked towards an unanimity vote of the Council on a proposal for a European energy tax for years without success, emissions trading (as a non-fiscal measure) was allowed to move ahead on the basis of a majority vote only. On top of that, the Commission, supported by an increasing number of European business actors, had an interest in avoiding the uncoordinated development of national emissions trading systems which would prove incompatible with each other and impinge on the project of creating an internal market (European Commission 2000; Christiansen and Wettestad 2003: 6–7). In October 2001 the Commission tabled a draft Directive to establish the EU ETS. The proposal contained a mandatory emissions trading scheme for all Member States covering CO2 from all energy intensive sectors except the chemical industry. Allowances were to be allocated free of 7.3 Process of Innovation: Networks, Politics, Institutions 173 charge on the basis of historical emissions (grandfathering).14 The proposal acknowledged the Member States’ diversity in economic and technological circumstances by providing an overriding common framework which, however, enabled subsidiarity in several design elements. This framework was to be embodied by National Allocation Plans (NAPs) in which the Member States should specify their overall cap, the methods of allocation to individual installations and other design elements. Since the national caps are the most crucial in terms of the effectiveness and hence politically the most embattled element, it was essential that they were defined at Member State level so as to gain support for the adoption of the Directive (Zapfel 2007). The final Directive was adopted after an “ultra-quick process” (Wettestad 2005) in October 2003. It included the core elements of the Commissions proposal and minor amendments by the European Parliament and the Council: optional auctioning of up to 10% of the allowances, an opt-out provision for individual installations in the first period and an opt-in of additional gases were added. The use of project based mechanisms should be enabled through a separate directive at a later stage.

7.3.6 The Allocation Process

Germany While the process leading to the European Directive already was subject to strong influence by existing institutional frameworks and political power that thwarted straight implementation of the idealized model of emissions trading, this tension became even more prominent in national policy contexts. The influence of political pressure at Member State level can exem- plarily be illustrated with a brief description of the specific transposition of the EU ETS Directive in Germany. Particularly the first German NAP included several provisions which made emissions trading rather complex in practice. Several design options were by and large similar to the design in other Member States: allowances were grandfathered to incumbents, allowances of closed installations had to be returned immediately and new entrants received allowances free of charge on the basis of a benchmark. However, these core design elements

14 Apart from political pressure by the power industry in particular, there was uncertainty about the auctioning of allowances being classified as a fiscal measure which would have required unanimity in the European Council. This might have put the adoption of the Directive at risk and was therefore ruled out by the European Commission (Zapfel 2007). 174 7 Emissions Trading were complemented with several additional elements which made the allocation process relatively non-transparent: x New entrants should receive the same amount of allowances free of charge for a period of 14 years; x The allocation to new entrants was based on a technology specific standard load factor and a corresponding benchmark; however, the benchmark was not uniform but fuel specific to alleviate incentives to switch from coal to gas; x The so called “option rule” allowed incumbent installations to be treated as new entrants; more than a quarter of the incumbent installations used this option because they could expect to receive more allowances from an allocation on the basis of a benchmark and the standard load factor than on the basis of their historic emissions; x The transfer rule, which enabled transferring allowances from closed installations to new entrants, was introduced to mitigate the life “extending” effect of the closure provision and the suspected incentive to relo- cate production outside the EU; x The efficiency penalty tightened the compliance factor for installations with particularly low efficiencies; x As an attempt to address the systematic information deficit of the ad- ministering authority, allocations based on load factors should be cor- rected ex-post if the actual load factor was much lower than the one used for the allowances allocation. Further provisions were included to reward early actions, to regard specific conditions of companies confronted with nuclear phase-out in Germany and to offset the disadvantages of CHP installations compared to heating technologies which were not covered by the EU ETS. Several of these provisions were not included in the first version of the German NAP but were included upon the intervention of business interests at a later stage. The first German NAP is thus an example of how complex emissions trading can become in practice. Not much of the theoretical elegance and lean- ness of the theoretical model is visible in existing emissions markets to date. Table 7.1 Allocation and verified emissions in the EU ETS

Reference period Cap Verified emissions Share of Cap Allowed ETS as 7.3ProcessofInnovation:Networks,Politics,Institutions relative to relative to ETS in total as % of CER/ERU share of base period cap GHG emis- verified share in cap cap sions emissions 2005–07 20051998–03a 2005–07 2005 2008–12 2005 2008–12 2008–12

MEUA/a Mt CO2 % % % MEUA/a % % % EU–27 2,299 2,124 3 8 41 2,083 –2 13 40 EU–15 1,730 1,639 2 5 39 1,569 –4 14 40 Austria 33 33 10 1 36 31 –8 10 45 Belgium 62 55 12 11 38 59 6 8 43 Denmark 34 26 14 21 41 25 –7 17 45 Finland 46 33 9 27 48 38 14 10 53 France 157 131 7 16 24 133 1 14 24 Germany 499 475 5 5 47 453 –5 20 47 Greece 74 71 2 4 51 69 –3 9 51 Ireland 22 22 7 1 32 22 –1 10 36 Italy 223 226 1 1 39 196 –13 15 40 Luxembourg 3 3 10 23 20 3 –4 10 27 Netherlands 95 80 10 16 38 86 7 10 43 Portugal 39 36 0 6 43 35 –4 10 46 Spain 174 184 12 5 42 152 –17 20 46 Sweden 23 19 4 15 29 23 18 10 30

United Kingdom 245 242 1 1 37 246 2 8 36 175 176

Table 7.1 (Cont.) 7EmissionsTrading Reference period Cap Verified emissions Share Cap Allowed ETS as relative to relative to of ETS in as % of CER/ERU share of base period cap total GHG verified share in cap cap emissions emissions 2005–07 2005 1998–03a 2005–07 2005 2008–12 2005 2008–12 2008–12

MEUA/a Mt CO2 % % % MEUA/a % % % EU–12 569 485 7 15 49 514 6 10 41 Bulgaria 42 41 6 4 58 42 4 13 40 Cyprus 6 5 16 11 51 5 8 10 Czech Republic 98 82 7 16 57 87 5 10 48 Estonia 19 13 2 34 61 13 1 0 32 Hungary 31 26 19 17 32 27 3 10 29 Latvia 5 3 23 38 26 3 20 10 14 Lithuania 12 7 27 46 29 9 33 20 20 Malta 3 2 10 32 57 2 7 0 Poland 239 203 8 15 51 209 3 10 46 Romania 75 71 0 5 46 76 7 10 33 Slovakia 31 25 5 17 52 33 29 7 49 Slovenia 9 9 4 1 43 8 5 16 49 aMember States base periods varied between 1998 and 2003 Sources: European Commission (2007; 2008a; 2008b), EEA (2007), authors’ own calculations. 7.3 Process of Innovation: Networks, Politics, Institutions 177

Europe With regard to the determination of emission caps there is also a general pattern visible which shows that Member States tend to give in to political pressure by industry to distribute more allowances than needed. Table 7.1 provides an overview of the agreed caps in the EU ETS and the verified emissions. It shows that in 2005 substantially more allowances were allocated than were needed. For the first year of the pilot period, 8% allowances too many were allocated to the installations. In 2005, Austria, Ireland and Italy were the only Member States with a degree of scarcity in allowances and Spain was the only Member State which had a substantial scarcity. The Member States’ generosity in allowance allocation for the pilot period is clearly reflected by the allowance prices. The over-allocation became obvious to all market participants in April 2006 when verified emissions were published for the first time (Fig. 7.2). The price of allowances for the period of 2005–2007 dropped sharply to half of its peak value and declined then further to levels close to zero in April 2007 (thick line).

/ E U A MEUA 35 28

30 26 2008 - 2012 25 24

20 22

15 20

10 18

5 16 2005 - 2007 0 14

-5 12

-10 10

-15 8 Trading volume -20 6

-25 4

-30 2

-35 0 1/05 4/05 7/05 10/05 1/06 4/06 7/06 10/06 1/07 4/07 7/07 10/07

Fig. 7.2 Allowance prices and trading volume (ECX 2007)

The development of EUA futures prices for the period 2008–2012 (thin line) demonstrates that market participants expect more scarcity in the second trading period of the scheme. Until September 2006, the price followed more or less the price of pilot period allowances. Subsequently it decoupled from the price of EUA due in 2007 and rose again to prices of 178 7 Emissions Trading more than €20/EUA, particularly after it became more and more obvious in spring 2007 that the commission would reject all NAPs which were too generous. The assessment of the environmental impact of the EU ETS during the pilot period turns out to be ambiguous. On the downside it has to be noted that allowance allocation was much too generous. The trading scheme’s emissions would be some 4.5 % higher than in the base period if all allocated allowances are used. However, on the upside it should be taken into account that the CO2 prices temporarily rose to levels of more than €30/EUA and that the EU ETS thus might have avoided an increase of CO2 emissions due to unfavorable gas to coal price relations, particularly in the electricity industry.

7.3.7 Possible Future Developments

The allocation of allowances for the commitment period from 2008 to 2012 seems to be less generous than for the pilot period. However, this is to be attributed to European Commission’s firm stance against the Member States. Originally the Member States had applied to allocate 10% more allowances than the European Commission finally accepted. Compared to the base periods of the Member States, emissions will be reduced on average by 5% . However, verified CO2 emissions might indeed be higher in the period of 2008–2012 than in 2005 because the companies covered by the EU ETS are allowed to use credits from project activities (CERs and ERUs) in addition to the allowances allocated to them.15 Overall the firms might use up to 278 million of such credits per year. Since the prices of these credits are usually lower than the prices of EUA it can be expected that companies will largely use this potential to save costs. The allocation in the third period might be more stringent. In its proposal for the amendment of the EU ETS directive, the European Commission suggests a reduction of the emissions of the ETS sectors by an average of 21% compared to the 2005 verified emissions by 2020 (European Commis- sion 2008). The use of credits from project based mechanisms should be limited to 36% of the reduction effort if the EU is committed to reducing its emissions by 20% and to 42% of the effort if their emissions have to be

15 The so called Linking Directive 2004/101/EC (European Parliament and Council of the EU 2004) enables Member States to allow the use by companies of emission reduction credits from project based flexible Kyoto mechanisms including Clean Development Mechanism (CDM) and Joint Implementation (JI). However, the use is restricted to the specific share of the allowances allocated to the companies. 7.4 Shaping the Innovation Process 179 reduced by 30%. Allocation rules should also be substantially changed: Auctioning should be a basic principle for allocation so that the electricity sector will start with 100% auctioning in 2013 while the industrial sectors will still receive some allowances free of charge according to EU wide harmonized allocation rules. However, the share of allowances allocated free of charge should be consecutively reduced. By 2020 all allowances should be auctioned except for those sectors which face fierce international competition.

7.4 Shaping the Innovation Process for the Sustainable Development of Electricity Systems

In this section we will provide an outlook for possible future paths that the innovation process of emissions trading could take. We are interested in the potential for the sustainable development of electricity systems that can be mobilized by emissions trading, but also possible problems that this innovation could bring about in the future. For this we refer to our discussion of design options in combination with the empirical analysis of how emissions trading has been put into practice to date. The immediate issue with respect to the ecological effectiveness of emissions trading is the setting of stringent caps on absolute amounts of emission allowances. Here, the policy process of developing the EU ETS is embedded in international climate policy. Even so, the EU ETS Directive does not directly depend on progress in international climate policy. Several articles of the Directive 2003/87/EC (for example article 11.2 or recital 29) indicate that the EU ETS is designed to continue after 2012 (European Parliament and Council of the EU 2003). However, in section 22 of the recitals it is also agreed upon that the directive should be reviewed in the light of developments under the UNFCCC context. This may particularly apply to the overall cap of the EU ETS which might be more or less ambitious depending on an agreement achieved under the UNFCCC framework. The time horizon at the UNFCCC level currently only lasts until 2012. Negotiations on a follow-up to the Kyoto Protocol were only commissioned in December 2007. The aim of these negotiations is to achieve an agreement by the end of 2009 at the latest. However, this is still ambitious since the perceptions of the individual parties regarding the future climate regime are still somewhat divergent.16 These negotiations will hardly decrease but

16 A comprehensive overview of the beyond Kyoto debate and the concepts of individual parties is provided by Ecofys (2008). 180 7 Emissions Trading will rather increase uncertainty for market participants about the regulatory set-up of the EU ETS. A contribution to reducing the regulatory uncertainty of the EU ETS from the UNFCCC process can thus only be expected in the long term. Measures at both the UNFCCC and the EU level could contribute to reducing regulatory uncertainty for the EU ETS. In March 2007 the Euro- pean Union unilaterally committed itself to reducing its greenhouse gas emissions by at least 20% compared to 1990 level until 2020 and by 30% if other developed countries commit themselves to comparable emissions reductions (EU Council 2007: 12). Although this commitment gives a clear indication to the industries covered by the EU ETS that the greenhouse gas reduction policy in general and the EU ETS in particular will continue after 2012, it still leaves considerable uncertainty regarding the strength of the commitment (Blyth and Yang 2006: 6). Besides binding long-term targets, the political uncertainty might also be reduced by the design of the detailed path towards these long-term targets. This mainly refers on the one hand to the length of commitment periods and on the other hand to the point in time when decisions on short- term targets are taken (see Sect. 4.2.5). An important factor that gives the development process of emissions trading some momentum independent of the policy goal of environmental protection is the self-interest and political leverage of the emerging carbon industry. In 2006 the transaction volume reached €60 million allowances per day. Linked to this is the development of an infrastructure of specialized skills, professional careers, organizations that make up the so called “carbon industry” as a whole new service sector. This business sector prospers from emission allowances as artificially created commodities. Müller (2007) estimates the cumulated volume of allowances in all emissions trading markets at €40 billion in 2005. This includes markets for SO2 and NOX in the USA which amount to roughly a quarter of the total. The total volume of emission markets in 2005 is about twice as much as the volume of the pharmaceuticals market in Germany. This is an indication of the economic interest that the instrument generates. With regard to shaping strategies, the political dynamics that result from these interests need to be taken into account. They can basically be utilized, but may sometimes be at odds with the goal of sustainability since the commodification of emission rights introduces commercial interests which are detached from the actual environmental effect of their trading. An important lever for more stringent caps and institutional frameworks for trading is business. The carbon industry is in favor of liquid and stable markets. This requires a positive value for emission allowances. Some of the market intermediaries and finance businesses earn their income on the 7.5 Conclusions 181 basis of a percentage share of traded volume and thus have an interest in keeping prices up. This makes them allies of the European Commission which is striving for high standards to be applied in Member States in order to make the common system work, also with respect to the Kyoto commitment for absolute emission reductions. There may thus be a self- reinforcing mechanism built into emissions trading that works towards stringent caps in order to guarantee the value of emission certificates as a commodity. On the other hand, there is also a growing service industry whose business is based on the creation of greenhouse gas emission credits from projects under the CDM. In this particular business field, there is an in-built tendency to get as many credits as possible for the specific amount of money invested. This creates political pressure for lax accreditation rules and the abolishment of limits to use such credits instead of emission allowances allocated under the cap of the EU ETS.

7.5 Conclusions

We now return to the questions which formed our starting points: Which features distinguish emissions trading as an innovation in governance? To what extent can emissions trading contribute to the transformation towards a sustainable electricity system? With regard to the first question we characterize emissions trading according to general categories of innovations in electricity systems in Table 7.2 below. The overview clearly shows that emissions trading is an innovation in many categories as regards traditional environmental policy approaches. It enhances the policy toolbox by a potentially powerful additional instrument. However, its ability to contribute to the transformation towards a sustainable electricity system depends on the specific design. The second question of the contribution of emissions trading to sustainability cannot be answered without reference to the particular institutional arrangements by which emissions trading is put in practice. We thus have to look at emissions trading schemes that actually exist, not at some ideal design as represented in economics textbooks or model simulations. For the current EU ETS we have to say that the contribution to sustainable development is ambiguous: caps are lax and the small reductions that are required may be outweighed by credits from project based mechanisms. In many countries special rules reduce possible impacts on innovation. In Germany, for example, fuel specific benchmarks are likely to bring about a new generation of lignite and hard coal power plants. Huge windfall profits are critical with respect to social justice. Emissions trading pumped 182 7 Emissions Trading

€30 billion from the pockets of consumers into those of power companies (Matthes and Neuhoff 2007). The whole process seems to have escaped democratic control. Policy development and evaluation are carried out by consultancies such as PricewaterhouseCoopers and others. No demo- cratically elected politician or civil society activists and only very few scientists have an overview of complex rule settings and are able to understand the effect of certain modifications.

Table 7.2 Dynamic characteristics of the innovation cluster emissions trading Descriptors Characteristics of emissions trading Purpose of Different purposes for many involved actors (interpretive innovation flexibility), e.g. reduction of harmful emissions, demonstrating governments’ ability to act, avoiding taxes, creating a new market for financial services; Mitigate conflicts of environmental and business interests; Cost efficient allocation of emission reduction efforts Context Environmentalism in 1970s and 1980s; Delegitimization of state regulation in USA in 1970s; Neo-liberalism in 1980s and 1990s; Emergence of the international climate policy regime in 1990s; Institutional dynamics in European Union policy making Phases Gestation (roots in economic science and regulatory practice). Proof of principle (US Environmental Protection Agency’s ‘emissions trading policy’ for SO2 and NOx, 1979–1986). Prototype (US Acid Rain Program, 1990). Regime formation (UN Kyoto Protocol, BP and Shell corporate trading schemes, EU Emissions Trading Scheme for greenhouse gases). Regime expansion (ongoing developments towards a global carbon market). Actors Economists; Business and Commerce Department (e.g. bubble concept proposed to EPA by industry and supported by Com- merce Dept.); Environmental NGOs (Environmental Defense Fund); multinational industries (BP, Shell); macro actors: UK Emissions Trading Group; European Commission (DG Envi- ronment); the carbon industry: consultants, financial and legal services, project developers, information broker Competing At the beginning: standards for individual installations; innovations throughout the process: environmental taxes 7.5 Conclusions 183

Table 7.2 (Cont.) Complementary Electricity market liberalization innovations Information technology (electronic registries, trading, etc.) Inducement Promise-requirement cycle: promise of a new solution mobi- mechanisms lizes resources, but also more specific requirements that innovation has to fulfill; research & development thus becomes more focused, allowing for more concrete promises and again more resources with more specified requirements, etc. Self-fulfilling prophecy: around 2000 critics and sceptics in science, governments and environmental movement jumped on the emissions trading bandwagon; they thought emissions trading would come anyway so better to be part of it; in effect this boosted the development. Interpretive flexibility: Project 88 established a policy program that included heterogeneous actors with different interests and expectations; this was possible by framing the question of emissions trading as a technical one irrespective of political standpoints. Emergence of macro actors: platforms brought together various actors to develop common perspectives and expectations (Project 88, UK Emissions Trading Group, IETA, etc.). Blocking factors Engineers and lawyers defending their dominant position in environmental regulation against economists; institutions, routines, policy style based on direct regulation; ethical concerns about commercialization of environmental pollution and selling of indulgences; unintended distributional impacts due to windfall profits Sustainable vision Stringent caps, limited project based credits, full auctioning, EU wide harmonized system with few special rules Complemented by other policy approaches (R&D, market introduction of innovative technologies, etc.) Possibilities for Make use of business interests in high and stable carbon prices shaping Strengthen public control by building capacity of independent watchdogs

However, the spread between hard coal and natural gas prices had substantially widened during the period of 2005–2007. Without the emissions trading scheme in place this development would have induced a fuel switch from gas to coal. The existence of the emissions trading scheme most likely prevented an increase of CO2 emissions from power generation by 4.5 million tons during 2006 (Groscurth 2007). Moreover, there is still the promise of a neat and effective governance mechanism and the potential to 184 7 Emissions Trading realize at least parts of it. It is by no means clear what the future of emissions trading will be. One could imagine the system coming under harsh criticism once transaction and regulatory costs are taken into account, with the result that the efficiency of the instrument is subjected to substantial reconsideration. One could also imagine how the incapability of governments to establish a clear rule set and define stringent caps against the resistance of industry interests delegitimizes the instrument and supports calls for alternative approaches. The likelihood of such scenarios is re- strained, however, by the strong institutional anchoring of established emissions trading systems. Abolishing the instrument would implicate shutting down a whole new striving service economy in which some of the most powerful players of global capitalism have strong stakes. Thus, emissions trading seems to be here to stay. There are also signs that emissions trading might actually develop some of its potential in the future. The European Commission has proposed more stringent caps and full auctioning in the electricity industry from 2013 onwards. By 2020 auctioning should be the rule in all sectors except for those sectors which are still affected by fierce international competition. This would make the scheme more transparent and improve the social justice of it since auctioning reflects best the polluter pays principal. Busi- ness players who profit from high and stable carbon prices work hand in hand with the European Commission in improving the EU ETS. With respect to the public debate about emissions trading, a critical expertise has developed (CAN Europe) and is being increasingly recognized in the debate on the review of the EU ETS. The sustainability of innovations is not a given per se. Innovations will always develop and will always be contested. It is the same case with emissions trading. Sustainable development requires continuous learning. For emissions trading this means the further development of capacities for a critical public debate and the continuous re-design of institutional arrangements according to the experiences made.

References

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8.1 Introduction

This chapter focuses on an innovation process in the realm of regulatory practices and institutions. It deals with the development of new forms of network regulation in electricity systems. This comprises methods and institutional arrangements for the operation of the network infrastructure. A key challenge in liberalized electricity markets is that network services are still natural monopolies and must be provided to all market participants on equal conditions in order to make competition work. The central position of networks within the system, however, gives rise to much broader repercussions within the sector. Recent developments in network regulation are therefore closely linked to the sustainable development of electricity systems as a whole. Network regulation is quite a recent item in the toolbox of electricity policy. It only emerged in connection with liberalization, i.e. abolition of monopoly status and introduction of competition to electricity systems in the late 1980s and 1990s. Network regulation emerged as an approach to ‘reregulate’ markets with regard to the provision of utility services when expectations for efficiency gains arising from the deregulation of trucking and airlines at the end of the 1970s in the USA became frustrated by the market power of incumbents. Reregulation of network bound industries became necessary to avoid control over bottleneck facilities being utilized to keep competitors out of the market. The global wave of utility liberalization policies throughout the 1990s, beyond politically committed first mover governments in the USA, Chile, UK and New Zealand, was predi- cated on network regulation as an available solution (Voß 2007: 121–165).

* By Dierk Bauknecht and Jan-Peter Voß. We would like to thank Gordon MacKerron, Barbara Praetorius, and Jim Watson for comments on an earlier version of this chapter. 192 8 Network Regulation

Over the past two decades a standard model of liberalized electricity markets has emerged. It consists of a separate transmission company, privately owned and competing generation companies, all or part of the retail market open to competition and privately owned transmission and distribution networks with third party access on published and non-discriminatory terms (Littlechild 2001).1 This new paradigm also comprises a standard model for the governance of electricity networks, namely the economic, efficiency-oriented regulation of networks through sector-specific regulatory authorities. Network regulation in general represents an innovation in the governance of network infrastructures. The innovation process has so far been part of the overall “liberalization paradigm” which entails far-reaching substitution of public regulation by private market competition. Improving the economic efficiency of the existing system stands out as the goal of these reforms. While network regulation has been successful in paving the way for competition and providing incentives for efficiency improvements, we argue that the model of depoliticized economic regulation – that for some time appeared to become the global design standard for the governance of technical networks – is unlikely to live up to the challenges of moving towards a sustainable electricity system. A closer look at ongoing developments in regulatory concepts and practices shows that the innovation journey has not come to an end, yet. The standard model of economic regulation has come under debate and practices of network regulation continue to develop as part of ongoing political struggle in specific sectoral and country contexts. In the following pages we will discuss the characteristics and shortcomings of the standard design of network regulation with regard to sustainability. We will also take a more in-depth look at the (historical) dynamics of this innovation in governance, i.e. how it has developed as part of the liberalization model and which factors have reopened the debate on network regulation to include sustainability aspects. We take a specific look at the development of network regulation in the UK, the “homeland” of the standard model of network regulation. This will allow us to draw conclusions for strategies to lend the innovation journey of network regulation a direction that is in line with broader aspirations of sustainable development in electricity systems.

1 Similarly, a “textbook architecture for restructuring and competition” is presented by Joskow (2006b). 8.2 Design Options and Sustainability 193

8.2 Design Options and Sustainability

8.2.1 Design Options

In the formerly monopolistic markets, most electricity companies were vertically integrated from generation through to supply. There were virtually no companies whose business was limited to networks. The vertically integrated companies were treated as natural monopolies2 and were either state owned or their integrated business was regulated as a whole. In both cases there was no need for a specific regulation of networks. What is more, there was no competition in generation and supply and no third- party access to the network that would have required regulated network access. While previously the electricity industry was treated as a monopolistic monolith, liberalization of the industry is based on the innovative notion that the sector can be unbundled and the different parts of the electricity supply chain can be organized independently. For electricity generation and supply, it is currently widely agreed that competitive markets can best achieve efficient outcomes. For electricity networks, however, a consensus has emerged that they cannot be run as a competitive market, at least not for the time being (as opposed to many telecommunication networks). The introduction of competition in electricity generation and retail thus requires some sort of governance mechanisms to deal with the market failures in the residual network monopoly, i.e. to provide for the efficient and reliable operation of the network infrastructure, and for non discriminatory access to the electricity grid, combined with an appropriate tariff structure.3 Generally, a number of governance options are available: First, there is the standard model of network regulation with privately owned utilities and separate network companies on which we will elaborate below. Second, even within a competitive electricity market it would be possible to operate the network infrastructure by the public sector. This option is actually guiding institutional design in some countries, e.g. Denmark, and is part of the general political discourse (Bauknecht and Schrode 2008). Third, in other sectors, like the UK railway sector for example, some sort of

2 Natural monopolies are characterized by continuously declining average costs, i.e. marginal costs are always below average costs. As a consequence, competition between network operators would be less efficient than having networks run by one company. 3 There is also an argument that the economic benefits of unbundling cannot only be found in the competitive parts of the sector, but unbundling can also facilitate superior regulation for networks (Pollitt 2008). 194 8 Network Regulation competition is introduced through periodical tenders for operating franchise businesses. Vertical reintegration and remonopolization of the industry, however, is currently not an option that features prominently in policy debate.

The Standard Model In the standard model of liberalized electricity markets that has evolved in the past two decades, networks are run by privately owned, profit oriented network operators that are unbundled from other parts of the industry. The governance of electricity networks is based on economic network regulation through independent, sector-specific regulatory authorities. ‘Incentive regulation’ has become the dominant approach, based on a price- or revenue-cap and 5 year regulatory periods. This approach seeks to mimic the pressure of competitive markets through regulation, and give network operators financial incentives to become more efficient. Network regulation is used as a means to make up for the fact that competition cannot be introduced in networks.4 Even if this model does not always reflect the actual practices of network regulation across various country contexts (also including Germany until recently), it is still treated as a standard in regulatory theory and efforts are under way (e.g. by the EU Commission) to make national regulatory arrangements converge around this model. We will come to the interaction between governance models and actual practices later in this chapter when we examine the innovation process of network regulation. Beforehand, we take a look at the governance model itself. This is relevant because it provides a ‘prospective structure’ offering particular promises that guides institutional design activity (Voß 2007: 179–182).

Design Options Within the Standard Model Within the standard model, there is still a large array of different particular ways of doing it. This is what the current regulatory debate is about. In order to implement network regulation and make it work, a number of different components need to be developed and assembled. The emergence of network regulation has occurred hand in hand with a number of innovations

4 Although the standard model and contemporary regulatory economics are mainly about providing regulated companies with financial incentives, regulation in practice is not only based on incentives. Rather, there are also other mechanisms such as licences that require network operators to comply with certain standards (e.g. technical or service standards) and connect plants to their network, etc. 8.2 Design Options and Sustainability 195 in some of these components. In this section, we briefly describe the main elements of the standard model and how they can be designed. Different objectives. Network regulation can pursue a number of different objectives and the focus of network regulation may vary by country and change over time. Even within the economic efficiency paradigm of the standard model, there can be different objectives and trade-offs between them, e.g. between increasing the efficiency of network operation and investment (productive efficiency) and ensuring efficient charges for network users, i.e. avoiding monopoly rents (allocative efficiency) (Frontier Economics 2003a). A further important objective in liberalized markets is to ensure non-discriminatory access for all network users as a prerequisite for competition in generation and supply. In recent years the trade-off between (short-term) cost reduction on the one hand and quality and innovation on the other hand has received increasing attention (Ajodhia and Hakvoort 2005; Jamasb and Pollitt 2005). Up to now the focus of the standard model has been on the operating efficiency of the existing network, yet other objectives can in principle be integrated into this framework, e.g. quality of service, connection of distributed generation, or energy efficiency. In addition, there can be objectives to deal with public safety or public service obligations. Unbundling. Another important issue in current regulatory discourse is to determine exactly which parts can be opened to competition and which ones must be subject to regulation5 and to define how unbundling the network from the rest of the industry can be implemented on a company level. There are different degrees of unbundling, ranging from accounting and legal unbundling to full ownership unbundling where generators and network operators are completely separated companies. Network regulation is often regarded as a two-dimensional approach that comprises ‘structural regulation’ to separate competitive and regulated businesses and ‘tariff regulation’ to determine the prices of the residual monopoly (Brunekreeft 2003). Who regulates? Another component of network regulation is to determine who should be in charge of regulation (Baldwin and Cave 1999: 63–75). There are a number of ‘traditional’ organizations that could take over this role, such as the government department that is in charge of energy or the antitrust authority. Many countries have followed the standard model and have set up independent, sector-specific regulatory authorities to oversee

5 Although this is easier in the electricity sector compared to sectors such as telecommunication, there is for example a dispute as to whether metering belongs to the regulated network or whether it should be opened up to competition. 196 8 Network Regulation network monopolies (IEA 2001).6 The idea is to separate government and politics on the one hand from the concrete implementation and management of network access rules on the other hand. However, even a sector-specific regulator that is supposed to be independent is in practice still part of a broader regulatory setting. This includes various organizations that have a stake in network regulation, including cartel authorities, consumer panels, watchdogs, ministerial supervision and other sector-specific regulators (Böllhoff 2002). There can also be an interaction between network regulation and other regimes that have a bearing on the network, e.g. the feed-in law for electricity from renewables in Germany, obliging network operators to connect renewables to their grid and take off their power at a fixed price. When designing a regulatory regime, definition of what independence of regulatory bodies means and what exactly the relationship between the regulator and the government or other organizations like the antitrust authorities looks like can be contentious. Furthermore, mechanisms to control the regulator need to be put in place. There are also different degrees to which stakeholders can be included in the regulatory process. Methods of regulation. The main task of the regulator will typically be to determine the rate of return that network operators are allowed to earn and regulate the network tariffs which they are allowed to charge. A major innovation that has developed alongside the emergence of network regulation is the so called price- or revenue-cap approach, also often called incentive regulation (Joskow 2006a). This has become the dominant regulatory approach in most countries and sectors, replacing the previously predominant cost based regulation. Incentive regulation and cost based regulation represent two theoretical polar cases. The main difference is that the former seeks to mimic the pressure of competitive markets through regulation and give privately owned, profit oriented network operators incentives to become more efficient whereas the former is mainly concerned with avoiding monopoly rents. In order to give companies incentives to become more efficient, they are allowed to keep some of the profits resulting from efficiency improvements during a regulatory period. An important innovation of incentive based regulation is to explicitly fix the regulatory period in the regulatory contract between the regulator and the regulated company. The length of the period is an important design parameter.

6 Independent regulatory authorities to oversee the network monopoly in the electricity sector must be seen against the background of a general development towards independent agencies (Pollitt et al. 2001). 8.2 Design Options and Sustainability 197

Although incentive regulation is often presented as a new approach that turns away from cost based regulation, in the practical design of network regulation different elements from the two approaches tend to be mixed in different ways to design specific incentives for the regulated company (Joskow 2006a).

8.2.2 Sustainability

Electricity Networks and Sustainability The electricity network itself only has relatively minor environmental impacts – undoubtedly so, when compared to electricity generation. It is therefore not surprising that it has not figured prominently in the sustainability discourse in the energy sector. Sustainability in electricity has been mainly associated with replacing “dirty” plants by cleaner ones on the generation side and reducing consumption on the demand side. However, if cleaner plants and energy-saving demand-side measures are to adopt more than a niche role and become a dominant feature of the electricity system, transmission and distribution networks are affected, too (Jenkins et al. 2000; Ackermann 2004). With the electricity sector being an interconnected system, new, more environmentally friendly plants like combined heat and power (CHP) and renewables depend on access to the grid. Eventually, a changing generation structure towards such distributed generation technologies will require both a new grid operation and structure. A changing generation and demand structure hence necessitates a more encompassing transformation on the electricity system level rather than ‘simply’ new generation and demand technologies.7 While the focus of these arguments is on the environmental dimension, other sustainability impacts are related to social issues (Ernst 1994; MacKerron and Watson 1996). For example, the use of electricity networks can make up more than a third of the final electricity bill. The issue of distributing overall network costs among different customer groups, e.g. household and industry customers or customers in urban and rural areas, and similarly, the distribution of efficiency gains between network companies and customers highlight the equity dimension of networks and network tariffs. Last but not least, networks and their stability can heavily affect the supply security of the entire electricity system.

7 For an overview of innovative network concepts see Strbac et al. (2007) and BERR (2007). 198 8 Network Regulation

Network Regulation and Sustainable Power System Transformation Having described the importance of the electricity network in a transformation towards a sustainable electricity system, we now turn to the specific role that network regulation can play in this regard. If more environmentally friendly generation technologies are to get access to the network, network regulation is crucial to ensure nondiscriminatory access for new plants and give network operators incentives to connect them to the existing system. Different approaches have been analyzed in Bauknecht and Brunekreeft (2008). In this chapter we take a broader perspective on network regulation in the context of sustainability: We contrast the standard model of network regulation with more general requirements of sustainability. There are four relevant dimensions: x The remit of network regulation x The objective of network regulation x The time horizon of network regulation x The relationship between policy and regulation. They all have in common that the standard model of network regulation focuses on one particular aspect of the energy system and is separated from other aspects.8 As opposed to this approach, a transformation towards a sustainable electricity system requires an integrated approach, coordinating changes in different parts of the system and taking into account long- term structural effects of today’s regulatory actions (Voß et al. 2006). The remit of network regulation. With market liberalization, different components of the sector have been separated, as have the respective governance approaches. Due to disaggregation of the industry into different components, the remit of network regulation in its ‘pure’ form is limited to the network. However, as we argued above, there are significant interactions between generation, network and supply. The ‘unbundled’ approach makes it difficult to take these interactions into account. This is particularly problematic when a transformation towards a sustainable electricity system is at stake, which makes it necessary to change the different elements of the electricity sector in a coordinated way. The objective of network regulation. The second dimension pertains to the objectives of network regulation. The main rationale of network regulation

8 Brunekreeft and McDaniel (2005) have used the expression ‘political unbundling’, indicating that the separation of different elements of the electricity supply chain is reflected in separate governance approaches. 8.2 Design Options and Sustainability 199 has been to provide economic efficiency in running the network while environmental and social objectives have played only a minor role. Again, interactions and trade-offs between these objectives are more or less ignored, although regulation is likely to have repercussions on the environmental and social performance of the industry (Helm 2005). The time horizon of network regulation. A third dimension that is relevant in the context of sustainable system transformation is the time horizon of network regulation: A transformation of the power system involves long- term structural change. One rationale for regulation through an independent regulator is to enable long-term commitment that goes beyond the election period and is not undermined by short-term politics. At first sight, this seems to be in line with the long-term perspective that is needed to move towards a sustainable electricity system. However, the main rationale for the independence of the regulator, at least from the normative perspective of the textbook model, is to overcome the time-inconsistency problem and achieve credible policy commitments (Majone 1997). It is supposed to be easier for an independent agency with a clear economic objective to stick to a regulatory decision than would be the case for policy makers in the face of various tradeoffs, changing political circumstances, and the temptation to exploit decisions by regulated parties ex post. Long-term commitment thus does not imply that regulation takes into account long-term effects. Rather, it means a commitment not to change course. The long-term perspective is not based on any institutional arrangements or instruments that would allow the regulator to take into account long-term effects, but is there only to keep (party) politics out of the process. In contrast, regulation of electricity networks has in practice often been myopic. In the standard model, incentive regulation is based on regulatory periods of up to 5 years. In many countries it has focused on short-term operational efficiency gains at the expense of investment, innovation and long-term development (Connor and Mitchell 2002; Holt 2005). As a result of fixed regulatory periods, there is a built-in mechanism that makes regulation adaptive, i.e. its effects and instruments are reviewed and adapted at regular intervals. This feature of network regulation is in principle in line with the procedural requirements of sustainability. However, as long as the focus of network regulation is on short-term efficiency as part of the overall liberalization paradigm, this feature cannot contribute to making network regulation a sustainability instrument. Its adaptivity is not coupled with any long-term framework and there is no guidance as to how to adapt to achieve certain long-term effects. Regulation is only 200 8 Network Regulation geared towards maximizing short-term efficiency and only adapted to improve and balance allocative and productive efficiency. For example, Frontier Economics (Frontier Economics 2003b), in a report for the UK regulator Ofgem discussing regulatory mechanisms for dealing with uncertainty, recognizes that distributed generation can cause additional uncertainty in the short term because it is a new phenomenon and its network costs are more uncertain and diverse than those of ‘traditional’ generators. However, according to this report, “DG is likely to become a more ‘normal’ part of what distribution network operators do (…) as the network develops towards a transmission role, in which its function is to connect generation to load”. How this long-term network transformation will come about and how it can and will be influenced by network regulation is not discussed, although this would mean a far- reaching change, requiring not only technical changes in the network and system control, but also for example involving repercussions on the business model of distribution network operators, their network control paradigm, the relationship between distribution and transmission system operator and the overall commercial framework. A regulatory approach that is more farsighted recognizes that the network may need to change and that this requires effort and entails risks that need to be considered in today’s network regulation. Furthermore it needs to develop a regulatory framework with rules and objectives that extends beyond 5 year regulatory periods. Finally, it may not be enough for the regulator to acknowledge that network changes are required; it may also need to develop an understanding of future development options and their implications. The relationship between policy and regulation. As we have already pointed out in the previous paragraphs, the standard model of network regulation is characterized by the regulator’s independence from the government. This is linked to the other dimensions in that the long-term commitment to be provided by regulation requires independence from the political process and independence arguably requires a narrow remit. In this perspective of the standard model, regulation can and should thus be treated as a mainly technical task, a calculation exercise based on scientific evidence. The implementation of network regulation does indeed require detailed technical knowledge of the economics of networks, accounting methods, network engineering and an understanding of the incentive properties of the instruments applied. This makes it difficult for “the public” to get involved and to open up the specialized regulatory debate to a more general political 8.3 Process of Innovation 201 debate – a problem that can only partly be resolved by increasing the number of public consultations.9 As long as the focus is on (short-term) efficiency, it may be possible to define a more or less clear interface between regulation and policy. How- ever, even then network regulation is not merely a technical task, but rather has to deal with a number of trade-offs. With network transformation, networks and network regulation become more political when the kind of electricity system that society wants needs to be defined. It then becomes even more important that regulators are not just technocrats, but do “have a demanding role as arbiters, negotiators and mediators between consumers and producers” (Young 2001) and other conflicting interests.

8.3 Process of Innovation

After discussing design options and sustainability impacts we now examine the actual dynamics in which network regulation emerged as a specific form of political practice and how it developed and stabilized. This is important to understand the influences and mechanisms that give rise to alternative options as ‘configurations that work’ (Rip and Kemp 1998: 338). For robust institutional design strategies for sustainable electricity these must be taken into account in order to find out where and how ongoing developments in network regulation can actually be shaped and by whom. We give an account of the innovation process of network regulation in two parts. The first one sketches out how the policy approach emerged and became established in the first place, up to the point when a ‘standard model’ had been established.10 Liberalization policies throughout the world referred to this standard model as a solution to problems with competitive modes of governance in utility sectors (even if in practice the ‘standard’ was often ineffective and different variants of regulation were implemented in specific sectoral and national contexts). The development of the standard model is presented in three phases: Gestation, Experimen- tation and Gelling. The separation of phases relates to transitions between stages of maturity of the instrument in terms of the articulation of design principles and stabilization of institutional configurations. The second part reports recent developments that indicate an opening up of the standard model, also on a theoretical level. This has largely to do

9 It does not mean, however, that these tasks can be solved according to objective knowledge. Basic social values and paradigms lead to different technical interpretations. 10 This builds mainly on Voß (2007: 121–165). For more details see also the literature cited therein. 202 8 Network Regulation with the reemergence of objectives other than economic efficiency for electricity network governance in the course of problematizing long-term system transformation for sustainable development. The process of reopening the standard model occurs in a ‘scattered regime’ with country specific implementation and adaptation of the standard model. Our focus will be on the UK. Fig. 8.1 provides a brief overview of the major events and instances of implementation in the history of network regulation. Country indices refer to specific political contexts in which configurations are embedded.

Hayek, Friedman, Downs global Averch, Johnson 1962 World Bank, IMF, WTO scope Demsetz 1968, Posner 1969 OECD Stigler 1971 EU tele, elec, gas

US tele US tele US tele US elec US elec GER elec UK tele, gas UK elec, rail EU member tele, elec, gas NOR elec Chile elec NZ elec US essential facilities doctrine Dev ing countries tele, elec local scope 1960 1970 1980 1990 2000 2010 Gestation Experimentation Gelling Scattered regime

Fig. 8.1 Outline of the innovation journey of network access regulations (Voß 2007)

8.3.1 Development of the ‘Standard Model’ of Network Regulation

The development of network regulation is linked to a process of debating natural monopoly (in law and economics). It hinges on the gradual emergence of a view on the utilities as a chain of vertically related stages of production; transmission/transport via networks is one stage that can be isolated from the others and be treated as a self-contained activity. A first phase can be seen in the development of precursors in interstices of the regime of publicly regulated monopoly and, towards the end of this gestation period, also the softening up of the established regime of monopoly regulation by putting forward theoretical and political arguments in support of abolishing public intervention in utility industries (Derthick and Quirk 1985). This pre-phase extends from the beginning of the twentieth century to the end of the 1970s. Even though network access regulation did not yet exist as an articulated policy approach, developments can be seen as important precursors to network access regulation as we know it today. 8.3 Process of Innovation 203

Precursors emerged, for example, in the form of the ‘essential facilities’ doctrine articulated by the US Supreme Court in 1912 to grant competitors the right to use monopoly infrastructure owned by incumbent railway companies (Beckmerhagen 2001; Knieps and Brunekreeft 2003: 20–21). Other examples were special agreements within the monopoly regime by means of which big industry (e.g. in Germany) was allowed usage of electricity grids for self-generated electricity (Voß 2000). While these arrangements within niches of the regime of regulated monopoly nurtured alternative options for utility governance, the overall structure and legitimacy of this regime came under attack. In the 1960s public management of the economy lost support in favor of market oriented governance approaches. A key role in weakening the established regime was played by the Chicago School of Economics. Throughout the 1960s it successfully attacked legitimizing theory of public regulation of the monopolies (Averch and Johnson 1962; Posner 1969). This comprised challenging the existence of natural monopoly (Demsetz 1968) and the public interest orientation of regulators (Stigler 1971). In the 1970s this resulted in a hype for deregulation in US policy circles upon the first successful experiments with abolishing state control for airlines and trucking businesses (Derthick and Quirk 1985: 29–57). In a second phase deregulation policies became implemented in the utility sectors, namely electricity and telecommunication in Chile (Serra 2000), telecommunications in the USA (Schneider 2001), telecommunications and gas in the UK (Pollitt 1999), electricity and telecommunications in New Zealand (Duncan and Bollard 1992). These experiments with deregulating utilities brought up problems related to making competition work. These problems, most importantly the abuse of market power by incumbent utilities, seriously hampered further expansion of the neo-liberal market agenda. Competition problems in utilities came to be perceived as a critical problem for pushing forward a larger political project of ‘regulatory reform’ to cut back state intervention in the economy. The utilities were crucial because they were strongholds for public interest oriented re- striction of market competition. The regulatory reform project received support by strategies of conservative parties to regain political power after social-democratic dominance in the 1960s and early 1970s. The failure of Keynesian macro management in dealing with repercussions of the oil crisis provided good opportunities to advocate paradigmatic policy shifts. The urge to find a solution that would allow for competition in the utilities increased in the course of the 1980s as the record of liberalization policies in pioneer countries was threatened by the continued dominance of incumbent utilities. The abolition of statutory monopoly rights was obviously not enough to make competitors enter the market. Dispersed 204 8 Network Regulation learning with new forms of regulation set in (Vogel 1996; IEA 2001). This lasted until around the end of the 1980s when another phase started that actually saw the articulation of network access regulation as an instrument to resolve the problem of competition in the electricity sector. A new perspective on network industries emerged in the course of repeated experiments with privatization and liberalization in different utility sectors of the UK. In the course of liberalization experiments in telecommunications and gas and later electricity, railways and water, a perspective became established in which network services became seen and treated as a separate market within the utility sector (Holder 2000). The task of regulating networks could then be distinguished from the task of deregulating other parts of the sector (Newbery 2001: 3). The remaining regulation of networks further became framed as a purely technical task of simulating market incentives for network utilities to increase their efficiency (Armstrong et al. 1994). Independent regulatory agencies – out of the reach of political discretion – were set up for this purpose. In a third phase, the British approach was rapidly taken up as the sought for solution and became turned into a cosmopolitan model of governance in the utilities. This represents an important step in the development of policy instruments: Designs become decontextualized and are transferred across different domains of application. Linked to this is the emergence of transnational design communities composed of specialized experts. Communities may institutionalize a specific technological regime in governance, i.e. a specific paradigm and related practices of policy making. When such technological regimes are in place, they influence policy design in local contexts by providing problem frames, criteria for good solutions and resources to realize them (Voß 2007: 177–178). This observation highlights the role of actors in the innovation process, as we will discuss later on. The promise of network access regulation to provide a technically feasible solution to the competition problem in utilities unleashed a global wave of liberalization projects in the utilities in the first half of the 1990s. Transnational organizations like the IMF and World Bank and the European Commission played a key role in stimulating this (Majone 1996; Conrad and Schmidt 1998; Bayliss 2007). Together with liberalization policies network access regulation as a specific policy instruments diffused throughout the world. Within the transnational community of (de)regulation experts that emerged in connection with liberalization experiments of the 1980s, the British model became established as the economic standard model. It offered a technical design, universally applicable regardless of particularities of economic, technical or political contexts. 8.3 Process of Innovation 205

The last phase of the innovation journey as can be observed to date is marked by a heightened perception of the shortcomings of the economic standard model of regulation. We will analyze the reopening of the standard model in the next section. Looking back at the innovation journey, network access regulation can metaphorically be interpreted as a ‘pampered instrument’: it was strategically developed, or at least bred and nurtured, to serve a broader political agenda, i.e. giving technical legitimacy to an extension of liberalization policy to the utilities. This is a specific pattern of coevolution of the design of instruments and broader political dynamics of governance. The instrument was pulled up by demand for the solution of a policy problem. Declaring the availability of a globally working solution allowed the regulatory reform agenda to move forward. In this context the economic standard model of network regulation became mounted as a cosmopolitan governance technology detached from local contexts and embedded practices. As such it could support the expansion of the liberalization agenda.

8.3.2 Reopening the ‘Standard Model’: Drivers of Change and the British Case

We have argued that the current standard model of network regulation is at odds with the requirements of sustainable development and have traced the innovation process that has yielded this model. This section goes on to examine the current stage of the innovation process. The standard model seems established at least regarding its core elements: more and more countries are adopting this model and it may appear that the standard model has finally made its way to becoming a globalized instrument and a blueprint for national liberalization processes. Germany is a case in point here: the standard model had initially been rejected and a mechanism of self regulation had been set up. However, in 2005 Germany gave up this model and, partly forced by European law, introduced a regulatory regime that is very much based on the standard model, with the Federal Network Agency as an independent regulatory authority and incentive regulation to be introduced in 2009. Although the details of the incentive regulation planned in Germany reveal a number of differences as compared to the British model, these must be seen as refinements of the standard model. At the same time, however, there are a number of processes that are reopening the standard model and where sustainability aspects are, in various ways, creeping in. While regulatory experts in connection with organizations like the European Union and the OECD are still working to 206 8 Network Regulation harmonize sectoral patterns of regulation around the standard model of network access regulation, this very model is being questioned. The reality of political struggle and institutional path dependency in implementation question the feasibility of the model (OECD 1997). Implementation experience with liberalization policies showed that the model of network access regulation, while being effective in triggering regulatory reform, was not effective as a standard that could control the actual process of institutional design taking place within sectoral and country contexts. Outcomes of liberalization processes diverged considerably from the economic standard model (Gilbert and Kahn 1996; Midttun 1997; Steiner 2001). At the same time, economic efficiency lost its position as the dominating goal for public policy. Sustainable development and especially climate change, global terrorism and security as well as inequality and social conflict moved back into consideration. Critical experts argue that network regulation has to be responsive to a broader range of societal goals than just short-term efficiency and is thus required to be (re)embedded into political processes of deliberating and deciding priorities and measures (Helm 2004). Against the background of setbacks in implementation and larger political developments the standard model of economic regulation is currently being called into question again. Design work thus continues in a scattered regime. The governance of utilities is worked on in the context of a weakly institutionalized design community of cosmopolitan experts and loosely coupled local reconfiguration processes. As Helm (2005: 1) has pointed out, “the reason why regulation has not withered into a narrow technical discipline, and become predictable, is because of a fundamental misconception about its rationale. Regulation is not a timeless technical activity in which there are right and wrong answers. (…) On the contrary, regulation is, in an important sense, time-dependent. Different periods throw up different objectives and challenges, and what suits one period is not necessarily best for another.” What exactly have been the mechanisms that have reopened the standard model and ‘thrown up’ design alternatives? Interestingly, many of these developments can be observed in the UK. The country has been a pioneer both in developing the standard model and the debate to adapt it to the requirements of sustainability. Although some of this discussion is UK-specific, the UK can serve as an example for analyzing the various drivers that open up the standard model of network regulation and help gear it towards sustainability. Our analysis of this latest phase of the innovation process therefore presents both general developments and specific examples from the UK. 8.3 Process of Innovation 207

New Labour Government, Redistribution of Regulatory Gains, Multiple Objectives As we have shown in the previous section, regulation was put in place mainly as a means to implement liberalization and privatization and as a surrogate for competition. There was no detailed, stand-alone regulatory ‘philosophy’ and “the regulatory regime for both gas and electricity was designed without much thought to its wider role in energy policy” (Helm 2003: 273). In the UK, the new Labour government that came to power in 1997 marks the beginning of a new regulatory phase. This new phase in the UK can be seen against the background of a broader development in the political discourse, reestablishing a broader set of objectives after the neo-liberal movement that had gained power in the 1970s and 1980s had focused on economic efficiency. When the network industries were first privatized by the Conservatives, the government did not put any effort into developing a regulatory concept that put network regulation into the wider energy policy context. It considered regulation as a technical task separated from politics and a mere substitute for competition that would be increasingly replaced by ‘real’ competition. Labour, on the other hand, did not spend any time on regulation because it was opposed to the whole liberalization agenda (Corry 2003: 60). Regulation thus fell into a political void, exacerbating the asymmetry of resources between the government and the regulator, who have had greater numbers of regulatory economists with analytical and policy making capacity than the government departments in charge. Regulation therefore has been developed to a large extent bottom-up by the regulators themselves, based on the overall liberalization paradigm and the incentive regulation concept developed by economists. Once the party had remodeled itself as New Labour and was preparing to take over power, renationalization was not an option any more and Labour had to reconcile itself with the new regime. This made it necessary, however, to develop a ‘Labour’ approach to regulation. Thus, it was in the late 1990s that a process started to develop a regulatory ‘philosophy’ that was to be more than a continuation of competition by other means. The most obvious inroad for Labour was to tackle the distributional effects of network regulation. First, this refers to the monetary distribution between network operators and consumers and the trade-off between productive and allocative efficiency. Labour sought to rectify the results of regulation under the Conservative government – a time that is often called the ‘fat cat years’, where network operators did increase efficiency, but could keep most of these gains for themselves. Second, there were concerns 208 8 Network Regulation for certain groups of consumers, e.g. low income customers threatened by ‘fuel poverty’. This was part of a wider debate on the potential multiple objectives of regulation and the trade-offs between them. The new government amended the objective of regulation with the 2000 Utilities Act. The ‘interests of consumers’ became the new principal objective. This is broader, but also vaguer than the previous objective to promote competition. One interesting aspect is that according to the Utilities Act ‘consumers’ includes both existing and future consumers. The primary duty was complemented by so called secondary duties, namely social and environmental duties. The new law enabled the energy minister to issue guidance to Ofgem as to how to take environmental and social objectives into account. Attempts to include sustainable development into Ofgem’s duties failed at this stage. However, the discussion to amend Ofgem’s duties continued, and the 2004 Energy Act eventually added a new secondary duty for Ofgem to contribute to sustainable development (Owen 2006). The debate about better aligning Ofgem’s duties to broader government policy and further extending its duties, putting sustainability on the same level as economic objectives, is still ongoing (SDC 2007). When the new Labour government started to amend the standard model, it was initially concerned in the main with improving equity rather than merely economic efficiency. Later on, the reworking of regulation that was set off by the Utilities Act linked up with the environmental and long-term issues moving up the agenda (MacKerron et al. 2003; Helm 2005). While the initial objective to include social objectives requires only relatively minor changes in the charging regime, the environmental dimension can potentially call into question the overall network structure and calls for a more far-reaching transformation of the network and its regulation. It is certainly debatable whether and how these new duties have affected the actual performance of Ofgem and whether Ofgem possesses the necessary capacities to implement this secondary duty (Bartle and Vass 2006; Owen 2006). Even with these changes put in place, economic issues are still the main objective for Ofgem. In any case, the clear-cut economic objective of regulation has been called into question and the standard model of economic regulation has become a subject of political debate.

Sustaining the Network and Making it More Sustainable In the development of network regulation, two long-term issues have emerged in recent years that are strongly related. One is about sustaining the network, i.e. making sure that there is sufficient maintenance and investment in the network to keep it working and maintain network security and quality. The other is about making the network more sustainable, i.e. 8.3 Process of Innovation 209 transforming, rather than just renewing, the network to adapt it to the requirements of a more sustainable electricity system. These two objectives can both go hand in hand and compete. On the one hand, both are concerned with long-term system development, and innovative concepts can help make the system more reliable. On the other hand, experiments and new concepts for sustainable electricity may be seen as threatening system stability. Also, maintaining the current system may happen at the expense of innovative developments for a transformation towards sustainable electricity.11 Regulation and network investments. In the past, the main focus of network regulation in most liberalized markets has been on short-term efficiency, i.e. the reduction of operating costs and tariffs. Longer-term issues and network development have only recently come to the fore (e.g. Hirschhausen et al. 2004). As Burns and Riechmann (2004) have pointed out, “while historically there have been concerns about over-investment, there is now a growing unease about under-investment”. This has led to a theoretical and practical debate as to how different regulatory approaches affect investment behavior and how regulation needs to be designed to stimulate efficient investment (World Bank 2005; Holt 2006). The gradual shift from short-term to long-term objectives is not limited to network regulation, but is a general theme emerging in liberalized electricity markets and also includes investments in generation capacity (de Vries 2004). When analyzing newer developments in network regulation, it is important to keep in mind that the overall concept of market liberalization, which network regulation is part of, is not fixed but is rather itself undergoing change. As the IEA (2005) has pointed out, “electricity market liberalisation is not an event. It is a long process (…) that has not yet been completed anywhere in the world – nor will it be in the foreseeable future”. There may be something like a textbook model, but there are also a number of open questions, new questions and setbacks and many varieties in the implementation, often called ‘hybrid markets’ (Correljé and de Vries 2008). The development of liberalization at large continues to influence network regulation, e.g. the increasing focus on long-term system stability and the effects of competition in generation on network requirements. What has been driving this shift from ‘asset-sweating’ to a more investment-oriented view? There is certainly an increasing need for investments as assets reach the end of their lifetime and the industry approaches

11 For example, for the UK, Woodman (2007) points out the R&D activities of network companies that have been triggered by regulatory mechanisms in the UK are mainly related to lifetime extension of existing assets rather than innovative network concepts. This could undermine longer-term, more strategic network development. 210 8 Network Regulation a new investment cycle. The investment need may now be more pronounced precisely as a result of incentive regulation and ‘asset sweating’ that has led companies to postpone investments and save on maintenance, which they now have to make up for. As a consequence, there is also an increasing interest in the quality of networks rather than just their costs (Ajodhia and Hakvoort 2005). This more long-term view has been reinforced by a number of blackouts12 highlighting that the electricity system is particularly sensitive to a lack of investment as there needs to be enough capacity for generation to match demand second by second (e.g. de Vries et al. 2006). A further driver for network investments to become an issue is the changing generation structure. The competitive market and new technologies like offshore wind plants have triggered changes in the geographical distribution of generation in the network and investments are required to adapt the network accordingly. Regulation and distributed generation. Another development is the increasing share of distributed generation (DG), or at least ambitious targets to increase their share for environmental reasons. The interaction between DG plants and the network has received particular attention in recent years, especially in the UK. Distributed plants are not just smaller plants, but plants connected to a network level (distribution networks) that was not designed for that purpose. For DG plants it can therefore be particularly problematic to get access to the network and disputes between DG and network operators abound (Connor and Mitchell 2002; Jörß et al. 2003). Another reason why the network dimension of DG has received increasing attention is the argument that DG does not only have potential environmental benefits, but can also be turned from a potential network problem into a solution to network problems: As DG generates electricity locally, it can in some cases replace network assets. This can increase the economic value of these plants (Swisher 2002). As a result of reframing small-scale generation as a network issue, DG operators got involved in the regulatory arena, too. In terms of the mechanisms that reopen the network regulation model, DG represents a bridging device between the ‘standard model’ aiming at competition and efficiency, and more long-term approaches. On the one hand, DG operators can ‘simply’ be seen as new market players that need

12 “A series of blackouts in industrialised countries – unprecedented in recent times – occurred in August and September 2003” (World Energy Council: www.worldenergy.org/ focus/blackouts/default.asp): North Eastern USA and Canada, 14 August 2003, London, England, 28 August, 2003, Southern Sweden and Denmark, 23 September 2003, Italy, 28 September 2003. There was another cross-border blackout in Europe on November 4 2006. 8.3 Process of Innovation 211 to get equal and efficient access to the network. This is exactly what the standard model is about. On the other hand, many scenarios of the future electricity system describe a transformation towards a more decentralized system in which DG plays a key role and where the system as a whole is being transformed, e.g. with increased control capabilities in the distribution networks that have the capability of running in islanding mode and where generation and demand is balanced whenever possible (European Commission 2003). In these scenarios, DG represents more than new power plants that require grid access, but it stands for a new electricity system paradigm. DG can thus be seen either as a potentially revolutionary technology that can turn the electricity system upside down, including its regulatory framework, or ‘simply’ as new power plant technology that can be integrated into the current network and the regulatory framework. This ‘interpretative flexibility’ (Bijker et al. 1987) has helped DG to make its way into the standard model discourse and to change it from within. The UK was the first country to explicitly include DG in its incentive regulation framework. Following a debate that started around 2000, the 2005 Distribution Price Control Review saw the introduction of the so called DG hybrid incentive to promote DG connections (Ofgem 2004a, b). While other countries have set up a special regime like the feed-in system in Germany to support renewables, the competition approach to electricity in the UK has been so dominant that new phenomena like DG have to be aligned with this approach. On the network side, treating DG operators as new market actors that need to get grid access was in line with the liberalization model. However, as can be observed in the UK, once DG had been imported into the standard model of regulation, the debate started shifting from connecting DG to the existing grid towards innovative network concepts and long-term transformation of the overall network architecture (see the next sections on regulation and network innovation and institutional innovations in the regulatory regime). This requires new regulatory approaches and challenges the overall regulatory paradigm of the standard model. Attempts to integrate new developments like DG into the standard model have thus started to put the standard model under pressure. Regulation and technical network innovations. There is evidence that market liberalization coincides with a significant decline in R&D activities. In the UK, this has been true for both the regulated and the competitive part of the industry (Holt 2005). However, initially, “these effects have received limited attention and have had little influence on policy. It had been assumed that private actors, competitive forces, and profit incentives 212 8 Network Regulation would encourage the necessary levels of R&D efforts with greater preci- sion and efficiency” (Jamasb and Pollitt 2005: 1). With DG becoming a regulatory issue, this has provided an inroad for technical network innovations to be considered by Ofgem, too.13 Since 2005, there are not just additional incentives for network operators to connect DG to the existing network, but also two instruments to promote network innovations.14 When Ofgem first started to ponder the relationship between DG development and network regulation, it focused on how the process of connecting DG to the existing network could be facilitated. However, it then became clear that the network may also need to adapt technologically to accommodate a higher share of DG. This view has been reinforced by an increasing number of innovative network concepts being debated, e.g. various forms of active network management and microgrids (Strbac 2006). In the UK, these concepts are actively promoted in the regulatory arena by equipment manufacturers like ABB. As a consequence, significant potential and demand for network innovations seem to coincide, which in turn created demand for regulatory actions to exploit this opportunity. Overall, it can be said that concerns over destructive effects of liberalization have called into question the effectiveness of the standard model. This has opened the door for mechanisms aiming at transforming, rather than just maintaining, the system. In other words, concerns that the current system will break down have found some common ground with concerns that the current system should be changed.

Institutional Innovations beyond Incentive Regulation In the previous sections we have described how the objectives of network regulation have been expanded to include social and environmental aspects and how incentive regulation has been broadened to take into account long-term issues such as investment and innovation and to give incentives beyond purely those of economic efficiency, e.g. for the connection of distributed generation. In this section we will briefly describe changes in the institutional set-up of network regulation that go beyond changes in the incentives given to the regulated companies, but establish additional coordination mechanisms. Changes in the network may go beyond incremental innovations in some technological parts of the network, developed and implemented by

13 Interview with Ofgem, 20 February 2007. 14 These are Registered Power Zones (RPZ) and the Innovation Funding Incentive (IFI) (Ofgem 2004b, c). 8.3 Process of Innovation 213 individual network operators. Indeed, they may lead to an overall transformation of the network structure, involving a large number of actors, including both transmission and distribution networks. In the UK, a new coordination mechanism to deal with overall network transformation was suggested by the 2005 “Technical Architecture Report”. The report, jointly drawn up by a broad range of stakeholders, comes to the conclusion that the transformation from central planning to a liberalized market has led to a lack of coordination between market actors. As a consequence, the report states that a new ‘focal point’ is needed to improve coordination in a liberalized market environment. In 2005, the Electricity Network Strategy Group (ENSG) was set up to become such a focal point with representatives from Ofgem, various government departments, network operators, generators, consultants and other industry participants. The task of ENSG is to “identify, and co-ordinate work to address the technical, commercial, regulatory and other issues that affect the transition of electricity transmission and distribution networks to a low-carbon future” (ENSG 2006: 2); also it wants to formulate “a holistic view of the strategic development of transmission and distribution networks”. It is chaired jointly by the Ministry of Economics and Ofgem, which indicates that the clear distinction between policy formulation and delivery has been blurred to some extent. Ofgem’s role in this group goes beyond implementing political objectives defined somewhere else. Rather, it has an important role in moderating the process of defining the future development of the network. In this context, it is important to note that Ofgem does not only have a role as a financial tariff regulator, but also has a technical capability, too, through which it gets involved in the debate on potential future system architectures in the ENSG. The ENSG has a broad scope and analyzes both transmission and distribution issues. This indicates a shift to a more systemic perspective rather than looking at innovations in individual networks. Network transformation is seen in the wider context of the transformation of the energy system to a low carbon economy. The group takes a long-term perspective and analyzes potential future development paths and upcoming options. With the ENSG, the DG incentives in the revenue cap formula (giving price signals to individual network operators) are complemented by coordination mechanisms that are based on cooperation and joint vision-building, encompassing a broad range of actors and oriented towards long-term network development (rather than the next 5 year regulatory period). Overall, the ENSG exhibits a number of aspects that we have considered relevant to network regulation to promote a sustainable power system: the regulator takes a long-term perspective; a broad range of stakeholders from 214 8 Network Regulation different parts of the electricity sector is involved in establishing this long- term perspective; the ENSG pursues not just economic efficiency, but broader policy objectives; networks are discussed in the context of overall electricity system development; the relationship between policy and regulation becomes more interactive. The practical effects of the ENSG are not yet clear and, as always, setting up a new group may foster change as well as slow down developments. Nevertheless, the principal design of the ENSG and the grounds on which it has been justified potentially marks a departure from the standard model of economic regulation.

8.4 Possibilities for Shaping

In this section we will discuss how the further development of network regulation can be influenced so that it can contribute to a sustainable electricity system.

8.4.1 Room for Change in the Standard Model

In the development of network regulation, we observe three dynamic processes that can open up the standard model and provide an inroad for shaping strategies to better align network regulation with the requirements of sustainability. First, as we have described above, there is a formalized development process of network regulation, structured through regulatory periods, that is part of the standard model. The standard model thus has an in-built mechanism to revise regulatory rules at regular intervals. Any attempts to gear network regulation more towards sustainability should make use of these regular revisions of the standard model and feed new ideas into the revision process. Second, the theoretical model is adapted during the practical implementation in different national contexts. Incentive regulation is not as straightforward as economic theory may suggest. As we have briefly described above in the section on design options, there are various parameters that need to be defined to develop working arrangements for network regulation. In the implementation phase, significant additional development work is needed and the model needs to be adapted to fit into the respective local context. As a consequence, we find a broad practical diversity of the standard model. Some of these mutations can help to develop and test elements of a more sustainability oriented regulatory model. 8.4 Possibilities for Shaping 215

While the diversity of regulatory models in the EU may be seen as a lack of coordination in the internal market, it can also be a useful diversity when new design options can be developed. In this perspective, the EU should not try to completely harmonize regulatory regimes, but provide an incentive for national regulatory developments to take into account sustainability requirements and promote learning between national regulatory regimes. Third, there is a debate within the global regulatory community, including regulatory science and regulatory practitioners, about long-term effects of the standard model regulation on system security. This shift from short- term efficiency to long-term system stability destabilizes the standard model and can thus provide another entry point for sustainability considerations that go beyond maintaining the current system. Alternative models of network regulation should address the issue of long-term system stability so that it can be connected with the ongoing debate within the standard model (see above: Sustaining the network and making it more sustainable).

8.4.2 Developing Alternatives

The processes that we have just described provide room for change. This needs to be filled to move the standard model in a desired direction. Further theoretical work is needed on how this open space can be filled up. For example, how can the advantages of a regulatory authority with a narrow and well defined remit be reconciled with the requirements to take into account a broad range of sustainability repercussions? One approach to develop and test new regulatory instruments in practice would be to set up “regulatory innovation zones”. As opposed to technical innovations where market niches can be set up to nurture innovations, it is not as common to establish niches for regulatory innovations. There may be niches – for example resulting from new problems in a specific area – that lead to the development of new solutions that then spread to the overall regulatory regime. However, it can be difficult to set up niches on purpose (e.g. in the case of network regulation in one network area) especially as all network companies are to operate under the same regulatory regime. While in the UK regulatory mechanisms have been designed to set up niches for technical innovations, regulatory innovation zones would provide niches where the regulator can work with individual network operators to develop and test new regulatory instruments, e.g. to promote integration of distributed generation in the context of changing network architectures and control philosophies. As was pointed out by EU Technology Platform 216 8 Network Regulation

SmartGrids (European Commission 2006: 23), “there is a strong need for pilot projects, not only in the technical sense but also at the markets and organisational level. For example, regulatory regimes should be revised, based on new knowledge about how regulation should work to provide incentives for innovation”.

8.4.3 Broadening the Actor Arena

The development dynamics of network regulation and the potential for shaping this development also depend on the actor arena. Both the regulator and the regulated companies obviously play an important role.15 However, for the analysis of the innovation process of network regulation and potential shaping strategies, the analysis of the actor arena should be expanded in a number of ways. There are other actors that have interests in network regulation, especially if network regulation is put in the context of sustainable development of the electricity system. Different government departments and other policy making institutions have a stake in regulation. For example, one explanation for the differences in water and energy regulation in the UK can be found in different institutional responsibilities, with Ofgem belonging to the DTI’s remit while the water regulator Ofwat is overseen by the environmental department DEFRA (Owen 2006: 213). Shaping strategies need to take into account this institutional context. What is also relevant is the inner life of regulators, i.e. their capacity and competence, their organizational set-up and internal decision-making procedures as well as the diversity of interests and perspectives that can be found within a regulatory authority. Neither the regulated company nor the regulator are monoliths, but have an inner life with different interests and perspectives, and the relation between the two is not static. The capability of regulatory authorities to take up new regulatory initiatives crucially depends on organizational capacities and competences. In Germany, for example, we observe that the new electricity regulator that was set up in 2005 still has to build up its own competence while at the same time faces the major task of setting up and implementing an incentive regulation scheme from scratch. This does not leave much room at this stage to develop additional schemes beyond the core of incentive regulation.

15 New regulatory economics has put the relationship between the regulator and the regulated company into a principal-agent framework and includes an analysis of the objectives, information structures, instruments and constraints of both actors (Laffont and Ti- role 1993). It has also pointed out that the regulatory structure is at least two-tiered, with the regulatory agency on the one hand and policy makers on the other hand. 8.4 Possibilities for Shaping 217

While the German regulator is still in its infancy, the UK energy regulator Ofgem has almost two decades of experience. Although economic regulation of networks plays a dominant role, other tasks and competences can be found within Ofgem, too. Ofgem is not only concerned with network regulation, but also has a role in overseeing other parts of the market and various policy instruments such as the Renewables Obligation. There is now a European Strategy and Environment Directorate within Ofgem. Second, Ofgem has set up a sustainable development sub-committee and produces a sustainable development report. Third, within the network department, part of Ofgem is concerned with traditional economic tariff regulation whereas another group works more on technical issues and has developed an interest in longer-term network developments and network innovations. These may only be niches and may currently not be sufficient to appropriately implement the sustainable development duty (SDC 2007); however, these niches can become important in the further innovation process and be an important inroad for shaping strategies. If sustainability aspects are to be taken up by the regulatory authority, this diversity of perspectives within the organization needs to be nurtured. On the opposite side of the regulatory game, it is worth looking at the inner life of the regulated company. When a regulatory regime is first set up, the network company tends to have hardly any regulatory competences. A regulatory department needs to be set up, it needs to develop a relevant role within the company, and needs to establish contacts with the regulator (Willman et al. 2003). The company needs to develop an understanding of the ins and outs of regulation and needs to have the capability of cooperat- ing in the regulatory game. Only then will it be able to get involved in new mechanisms like the distributed generation incentive in the UK rather than merely opposing such add-ons. While the regulator and the regulated companies are certainly core actors, the analysis of the innovation journey and the UK example has shown how additional actors have entered the regulatory arena. For example, we have seen that both equipment manufacturers which provide innovative network solutions and developers of distributed generation projects have entered the scene and have pushed for regulatory reform. The various groups set up by Ofgem, especially the Electricity Network Strategy Group, provide an official platform for them to participate. Especially in the case of DG developers and associations of new generation technologies, it has become clear that they do have a strong interest in a network that can accommodate 218 8 Network Regulation their technologies and have realized the importance of regulation, but lack the resources to fully participate in the regulatory process.16 Another important stakeholder group is made up of electricity customers that have to pay the bill for the network. As they will hardly engage with regulatory issues themselves, at least in the case of household customers, intermediaries like customer organizations, consumer watchdogs and the media play a crucial role in acting as translators between consumer interests and the inner circles of the regulatory arena. It is important to note that the credibility of the regulatory regime to a large extent depends on its capability to provide an efficient and transparent network service for electricity customers, even more so in a liberalized market environment. It can be argued that this credibility is a prerequisite for regulation to tackle additional objectives, otherwise there will always be suspicion that network operators are trying to make some extra business labeled as ‘sustainability’. An important group are regulatory experts from science, interest groups and the media. These experts are embedded in and shape the regulatory discourse which is transnational in scope (this article is a part of this discourse). A lot depends on what kind of research is funded, which coalitions are successful in influencing the debate, and ultimately the mental frameworks of experts that advise governments and regulators, comment on regulatory practices and are cited in public reporting on network governance. In this context, it is also important to consider the institutionalization of expert networks and concurrent constitution of central positions with a strong influence on the debate. An example is the ‘Florence School’ as a think tank for regulation set up by the European Union with support from big utilities.

8.5 Conclusions

This chapter has analyzed network regulation as an institutional innovation. It was originally developed to facilitate liberalization in network industries, and has in many cases indeed been beneficial for the development of competition. However, both networks and network regulation must be seen in the wider context of making the electricity system more sustainable. In our analysis, we started from the standard model of network regulation that is guiding liberalized market design in many countries. It is based on privately owned, profit oriented network operators that are unbundled from

16 For the UK for example: Interview with the Renewable Energy Association, 21 March 2007. 8.5 Conclusions 219 other parts of the industry and economic regulation through independent, sector-specific regulatory authorities that seek to mimic the pressure of competitive markets, and give network operators incentives to become more efficient. The standard model of network regulation focuses on one particular aspect of the energy system, namely the economic regulation of networks, and is separated from other aspects. As opposed to this approach, a transformation towards a sustainable electricity system requires an integrated approach, coordinating changes in different parts of the system, and taking into account long-term structural effects of today’s regulatory actions. Having analyzed the shortcomings of the standard model with regard to sustainability from a normative perspective, we then traced the empirical innovation journey of network regulation. We have shown how the standard model has developed in the wake of liberalization to support the competition and privatization objective of the liberalization agenda. Yet although a standard model has emerged, the innovation journey is still ongoing. We have identified a number of developments that call this standard model into question and can contribute to reopening it. Interestingly, this process is most pronounced in the UK, which can be seen as the homeland of the standard model. Table 8.1 summarizes the developments we have identified in the “reopening” phase along the four dimensions we have set out in the sustainability section. Finally, the analysis of the innovation journey has yielded a number of insights as to how the further innovation process can be influenced. Table 8.2 summarizes the main characteristics of the innovation journey and the possibilities for shaping.

Table 8.1 Sustainability of network regulation and reopening the standard model Dimension Current developments Remit of network Interaction with other energy policy objectives taken into ac- regulation count. Giving positive incentives to support certain generation technologies and innovation in certain areas. Objectives of From purely economic objectives to social, environmental network regulation and sustainability duties. Time horizon of Increasing focus on long-term issues: investment and innova- network regulation tion. Regulatory mechanisms beyond one regulatory period. Relationship Distinction between policy formulation and delivery is being between policy and blurred in various ways: Pressure to align regulation with regulation government policy. Trade-offs, e.g. between support for new technologies and efficiency, decided by the regulator. Mod- erating role of the regulator. 220 8 Network Regulation

Table 8.2 Network regulation: dynamic characteristics of the innovation cluster

Descriptors Characteristics of network regulation Purpose of Emulate competition in network monopoly and enable competi- innovation tion in other parts of the electricity industry. Phases Gestation: precursors within publicly regulated monopoly (e.g. essential facility doctrine, 1912); deregulation agenda weakens monopoly regime. Experimentation: In different sectors, mainly USA, Chile, UK. Gelling: UK model turned into global blueprint. Scattered Regime and Reopening the Standard Model to include broader sustainability aspects, also in the UK. Context Neoliberalism, European integration, electricity market liberalization, climate change Actors Government ministries (e.g., industry, environment), regulators and regulated companies, companies in the unregulated part (e.g. generation companies, large scale and distributed generation), equipment manufacturers, electricity customers and intermediaries, antitrust authorities, European Commission, regulatory science, international institutions (e.g. OECD, World Bank) Competing For some time negotiated network access; public ownership of innovations networks as competing model in some countries. Complementary Unbundling, tools to implement ‘incentive regulation’, e.g. innovations benchmarking, technical network innovations. Inducement For the development of the standard model: experiments with mechanisms market liberalization. For reopening the standard model: increasing investment needs and security concerns, blackouts, transformation requirements for sustainable development, new power plants putting pressure on the existing network, new technical network concepts. Blocking For reopening the standard model: Trade-off between clear and factors narrow economic objectives and broader sustainability duties, inertia and lack of capacity of regulators. Sustainable Network regulation to focus not only on economic efficiency, vision but also on long-term effects and interaction with broader energy policy objectives and electricity sector as a whole. Possibilities Exploiting room for change in the standard model (system secu- for shaping rity concerns; variations in national contexts; regular review); development of alternatives (conceptual work, regulatory innovation zones); broadening the actor arena, broad involvement of stakeholders (equipment manufacturers, electricity customers, intermediaries like consumer organizations, regulatory science); differentiated view on regulator and regulated companies. References 221

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9.1 Overview and Summary

Innovation is core to transforming the electricity system towards a sustainable path. In its nature, innovation can be technological, but also institutional, policy-related, behavioral or organizational, to mention just some possible perspectives – and it usually touches upon all of these dimensions at once. Hence innovation is a complex and systemic phenomenon whose characteristics and implications reach far beyond the idea of technological novelties. These are the presumptions from which we started investigating the design and the dynamics of innovation in electricity systems. Knowledge of the dynamics of innovation is the precondition for formulating policy recommendations on how to shape the innovation path towards a sustainable electricity system. But what do we know about these dynamics? The introductory chapters of this book provided an overview of the evolution of the electricity system and of innovation indicators and trends observable in the recent past. We showed that historical development as well as empirical innovation indicators can give some idea of the past evolution of technology deployment and system structures. Based on this, we stated that the electricity system shows evidence of a carbon lock-in. But does this mean that we are trapped? If so, how can we escape this impasse? Through which shaping strategies could low-carbon innovations make their way? What configuration of system components and context factors would allow for successful sustainable innovations? First and foremost, three major external impulses for innovation in the electricity system can be identified. The first impulse originates from the shift in economic paradigm towards deregulation and privatization, which resulted in a major move towards the liberalization of electricity markets worldwide. Liberalized electricity markets need appropriate institutional frameworks for their operation. In this way, they stimulate the development 228 9 Progressing Towards a Sustainable Path? of innovations such as network regulation. Provided that access to the electricity grid is guaranteed by such a framework, liberalization allows for more competition and new actors on the formerly monopolistic electricity market. Innovative distributed and independent electricity generation facilities may enter the market, and the incumbents are motivated to change their strategic behavior, and to innovate. The second impulse stems from increasing environmental concerns such as the greenhouse effect with regard to burning fossil fuels, with the subsequent evolution of an international regime for climate protection. The expectation of fossil resource depletion and related crises of prices and fears for energy supply security – such as the international oil crises in the 1970s and afterwards – have a different origin and focus. Yet their impulse goes overwhelmingly in the same direction as environmental concerns do, in that they both trigger efficiency improvements and a shift of focus towards low-carbon and non-exhaustible resources such as renewable energy technologies and the like. In consequence, a continued process of developing the institutional framework for energy efficiency and low carbon energy supply options is taking place. A third impulse originates from generic and specific technological change impact on innovation development and diffusion. Specific innovations, such as more sophisticated network regulation, consumer feedback, organizational innovations, or higher electricity generation efficiencies, are enabled by other technological developments, for example information and communication technology (ICT), smart metering or new materials. Researching innovation dynamics in electricity systems requires consideration of such macro-level impact factors as well as recognition that it is a multifaceted issue. The five innovations portrayed in this book are an attempt to reflect this diversity and complexity: Their character stretches from a material artefact (such as CCS or micro cogeneration) to an informational device as an incentive for behavioral change (such as informative energy bills) and finally to policy instruments (such as network regulation and emissions trading). This last chapter sets out to learn from our findings by summarizing and comparing the innovation case studies. We start with a brief portrayal of the innovation cases as well as their potential sustainability contribution before moving on to comparing the dynamics of and strategies for innovation in sustainable electricity systems. Snapshot of the Innovation Cases. On the level of material artefacts, the analytical focus of the innovation cases lies on micro cogeneration as an example of distributed electricity generation perspectives, and on carbon capture and storage as a vision for a continuation of the centralized 9.1 Overview and Summary 229 electricity system with a largely technological solution for climate change mitigation. Micro cogeneration, the combined generation of heat and electricity on the level of individual buildings or small building blocks, allows for higher generation efficiencies than the conventional separate supply of electricity from large power stations and the generation of heat in individual boilers at home. Having a share of micro cogeneration in electricity generation far below 1%, this potentially disruptive innovation is still breeding in small niches and far from market formation, despite a noticeably increasing number of installations and also of variations of available technology designs. The analysis looks at the reasons for this and asks under which conditions the situation may change. The case study on carbon capture and storage (CCS) demonstrates the relevance of expectations to the development drive of a technology. CCS is far from economic and technological maturity, and many open issues and risks need to be addressed before deployment can seriously begin. In Europe, about 10–12 pilot and demonstration plants are to be built within the next decade to test its feasibility. Yet CCS enjoys a comparatively high level of attention at the moment compared to other “mature” mitigation options such as energy efficiency, cogeneration, and the like. In this case, the interesting question is whether the innovation dynamic sufficiently reflects long-term sustainability criteria and the issue of continued carbon lock-in. The idea of informational devices such as improved consumer feedback leads to a completely different story. The standard electricity consumer is usually typified as unresponsive to prices and inert, failing to explore even the most profitable energy saving opportunities at home such as efficient refrigerators, washing machines and the like. However, the standard consumer is not well informed about the actual consumption of his/her appliances as meters are often hidden from sight and electricity bills are issued infrequently and without much information on the actual consumption patterns. Improved feedback on electricity consumption may raise awareness and thus allow consumers to take control of their consumption. Analyses of pilot studies and model based estimates expect substantial savings from such improved information. The effect depends very much on the respective design of the feedback, which in turn also depends on societal and local behavioral and perception specifics. Emissions trading is an innovation in the toolbox of environmental economic policy instruments. It has a long history of theoretical discussions and empirical applications in smaller contexts. In a larger scope it was first introduced with the establishment of the European Emissions Trading Scheme (EU ETS) for CO2 emissions in 2005. The idea to cap emissions 230 9 Progressing Towards a Sustainable Path? and to issue tradable allowances for these emissions is simple and straightforward. However, the details of the practical implementation as well as the political bargaining process are complex and difficult, in particular with regard to allocation principles. A reliable ETS also facilitates other novelties in technology or consumer behavior and can in this sense also be considered as an enabling innovation. Incentive based network regulation is also an innovation to the electricity system: the idea of regulating the electricity grid independently from the production and distribution levels in the electricity supply system only came about with the ideas of liberalization and unbundling of the elements of the electricity supply chain. Depending on the design of its rules, network regulation can enable – or block – other innovations. This is particularly relevant with regard to the future structure of the electricity system (distributed versus centralized generation), and for the integration of renewable energy sources. Network regulation can thus also be considered an enabling institutional innovation. Sustainability Impacts of Innovation Cases. No innovation is per se sustainable. Its ecological, economic and social characteristics depend on the actual design and on the related context, including alternative options to fulfill the same purpose. In our sustainability assessment we considered different criteria and methods to evaluate the respective innovation case. For the technological innovation cases, a life cycle assessment monitored the environmental impacts for the complete sequence of related processes, and compared it to alternative technologies or supply concepts. For the case of electricity bills, the estimated impact on total electricity consumption was assessed. For the case of emissions trading and network regulation, criteria such as environmental effectiveness, economic efficiency and distributional justice as well as compatibility with general societal values (e.g. participation) were applied; direct sustainability impacts on the environment or on social and economic criteria are hard to measure at this stage of implementation of these novel instruments. In all of our cases, the prediction of the approximate sustainability potential and the related vision naturally remains tentative, but nevertheless provides a good indication of the trend and crucial aspects that need to be considered where the shaping of innovation is concerned. For the case of micro cogeneration, the life cycle assessment (LCA) confirms the positive climate mitigation impact of most available technologies compared to the separate generation of heat and electricity in large, central power stations. However, the climate balance of micro cogeneration competes with district heating and distributed renewable technologies such as solar thermal panels. With respect to the overall electricity system, a widespread diffusion of the smallest and fluctuating electricity generation 9.1 Overview and Summary 231 devices may challenge the existing network structure, but may also enhance the overall reliability of the system in combination with new intelligent communication and grid regulation technologies. The long-term risk of such distributed generation is thus rather negligible. Current visions for the technology are surprisingly slight in Germany, which is mainly due to the economic and environmental advantages of competing technologies. Similarly, better feedback on electricity consumption has no relevant negative long-term implications with regard to sustainability criteria. On the contrary, international studies suggest an electricity conservation potential of 5–12%, which would make for a positive effect on carbon emissions as well as reduced resource consumption. Furthermore, such feedback could help to shift loads, smooth out peaks, adapt to fluctuating power sources, and thus add to network stability. In contrast to micro cogeneration, the LCA for CCS leads to a significantly higher reduction in CO2 emissions – up to 85% compared to the reference. However, this analysis presumes that no leakage will occur. Moreover, CCS leads to an increase in other environmental effects, in particular those related to coal exploration and combustion, which increase by up to 25% for the same electricity output as that without CCS. Furthermore, CCS is not always economically compatible with cogeneration as the latter is limited in size due to the associated size and location of the heat sink. The related risk and irreversibility with regard to structural decisions are important criteria when it comes to a decision on whether to foster such an innovation. Evaluating the sustainability of governance innovations such as emissions trading or network regulation involves comparison of their potential impact to that of other governance options and purposes in society as well as taking a look at their impact on sustainability oriented behavior and decision making processes. The impact of emissions trading on greenhouse gas emissions is precisely defined by the cap or amount of emissions allowances allocated to the participants of the trading scheme, and is more precise than the impact of indirect instruments such as emission taxes or technology standards. In the case of network regulation, it may well benefit a more sustainable electricity supply and demand, depending on the concrete regulatory rules. Concrete physical impacts, however, cannot be quantified yet. The immediate contribution of such governance innovations rather lies in setting an enabling institutional framework for innovative activities: both access to electricity grids and a reasonable price for CO2 are preconditions for the deployment of mitigation technologies. Price rises are also relevant with regard to more environmental awareness and action on the consumer side. Fair network access also increases choice for consumers, be it between electricity suppliers or regarding whether to generate electricity oneself. 232 9 Progressing Towards a Sustainable Path?

In the following sections, we assess our findings from the case studies, placing particular emphasis on the setting of actors and institutions and the associated inducing and blocking mechanisms identified for the respective innovation process. First, we look at the dynamics and formulate propositions for the role played by actors, networks and institutions in the respective case. From there, we derive the mechanisms that induce or impede the respective innovation, and discuss elements of a strategic approach for shaping the context of sustainable innovation in the electricity system.

9.2 Explaining the Innovation Dynamics

Innovation is a process of coevolution and coincidence. Despite many differences in their argumentation, most models of innovation dynamics agree on this, and also that actors, networks and the institutional setting are key to the process of diffusion. In particular, little change can be expected without a successful and appropriate adjustment of the institutional framework to integrate technological, organizational and other novelties into the existing system, or to revise the existing system architecture. Whether the actors manage to put such institutional change into practice in reality depends on many dimensions, such as context factors, resource endowment and influential power of actors.

9.2.1 The Dynamic Role of Institutions, Actors and Networks

The interplay of institutions and actors is core to innovation and transformation processes in the electricity system. This is a common perception in all case studies. In this section we use this to formulate propositions for the most important dynamics and barriers for such innovations. Historically, the institutions of the electricity system were built around incumbent technologies and system structures. As far as innovations presume changes in these constituent components, their diffusion is bounded by the ability of institutions to adapt to such specific needs. The first proposition of our analysis is therefore that the aptitude of institutions to be aligned can be considered a key explanatory factor for the dynamics of innovation. In our case studies, not surprisingly, this found manifold confirmation. In the case of micro cogeneration, a standardization of procedures such as grid access and application for financial support (bonus, tax exemption, feed-in remuneration) would help greatly to decrease transaction cost and related barriers. The Federal Network Agency (Bundesnetzagentur) was 9.2 Explaining the Innovation Dynamics 233 created as a new institution to put forward a level playing field for all potential market entrants. The extent to which it will meet these expectations remains to be seen. Similarly, the broader and sustainable deployment of CCS requires reliable regulations of the related environmental risks, of liability issues and of international issues, including monitoring regulations. Also, without a consistent and lasting climate policy framework, no investment in CCS will pay off. Likewise, improved consumer feedback can imply additional efforts by utilities to avoid a decline of their turnover (electricity sales). Such measures are unlikely to be implemented broadly without an institutional setting that prescribes the respective level of detailed consumer information. Alternatively, feedback devices could be diffused by third parties; this is in part dependent on market liberalization, e.g. in the area of metering services. Governance innovations such as network regulation and emissions trading are even more dependent on the adaptivity of the existing institutional setting as they themselves imply the formation of new institutions and settings. Problems could arise when existing and innovative institutions are contradictory or reproductive in terms of their purpose. In the case of emissions trading, for example, the environmental taxation of energy may become partly obsolete for those industries covered by the ETS. Also, historical path dependencies make it difficult to implement new institutions. In both cases, the EU engagement in prescribing new institutions was a major driver for their eventual implementation. As a matter of fact, the change in role and growing influence of the EU commission on the institutional setting is relevant – in our case studies, not only for governance innovations, but also for consumer feedback and CCS. The EU actors have been very successful in increasing pressure for change on national levels, which also indicates an increasing degree of interna- tionalization of policy formulation. This leads directly to a second proposition: changes in the governance setting of the electricity system are stimulated from outside rather than inside the system. More precisely, international dynamics are stimulating adjustments and innovative instruments whereas national dynamics, at least in Germany, are rather reluctant to change. In both case studies, the major stimulus for introducing the innovative governance instrument stems from a change in paradigms on a global level, which then “motivated” (or rather forced) governmental actors to put forward regulation and emissions trading. In the case of emission trading, the new paradigm is related to the climate policy regime established in Kyoto and beyond. Without serious emission targets, no emissions trading is possible. Also, without the stringent EU policy, no European ETS would have been established. At the same time, “market based” instruments such as the ETS fit well in prevailing economic 234 9 Progressing Towards a Sustainable Path? paradigms of environmental policy tools. In the case of network regulation, this paradigm of liberalization replaced the outdated idea of natural monopoly in electricity supply, with the exemption of the electricity grid. In fact, incentive regulation is an expression of the liberalization paradigm, and a requirement to guarantee access to the electricity grid and market. The utilities concerned by regulation and emissions trading did not support these instruments, although they learned to benefit from them. This observation leads to the interaction between institutional change and actors or networks. There is no innovation without actors, and actors mostly organize themselves in networks as resources and the potential to influence innovation processes are usually better than in the case of individual actors. The third proposition therefore is that a setting of diverse, small actors with limited resources and without powerful allies in the incumbent electricity system offers limited chances to push novelties out of their niche – unless they have powerful counterparts in strategically important positions. This is supported by the case of micro cogeneration in which the innovation drivers consist of a small group of technology developers and boiler manufacturers, supported by private users and a few local utilities (both gas and electricity) pioneering the deployment of this technology. Similar to the technology itself, interests are distributed, which makes it difficult to bundle them. Also, the resources and capacities of the diverse small actors are limited. As a matter of fact, the driving actors have failed to organize themselves in powerful networks. Most importantly, there are no large, influential actors in the networks as electricity utilities do not support small and micro cogeneration. Also, the links of micro cogeneration proponents to relevant policy formulating circles are weak. The only exception is the fuel cell. In this case, interests and motivations are steered by an apparently attractive vision of future high-tech technology, and not by the current potential of existing micro cogeneration options such as reciprocating engines and Stirling motors. A successful lobby exists for larger-scale applications of cogeneration in combination with district heating rather than for cogeneration in individual buildings. As a result, the innovators of micro cogeneration are still acting in niches, and the system and regime context has not yet noticed its existence, despite its existing potential to contribute to a sustainable electricity system. Similarly, the motivation of relevant actors in the case of improved consumer feedback is diverse, and the capacities of motivated actors are limited. Scientists, energy agencies and consumer organizations have been active in promoting innovative feedback, but lack the capacity and access to implement it. Electricity companies are barely interested in the associated rise in administrative costs and even less in a reduction of electricity sold 9.2 Explaining the Innovation Dynamics 235 to their better informed customers. Also, customers have proven to be inert when it comes to their electricity consumption patterns. This may change with better information structures, which illustrates the mutual dependency and potential lock-in involved in this regard. A push may come from an increase in distributed generation, which in turn increases the need for smart metering devices as a tool of grid management. Such a dynamic, however, is still far from realization, as the case study on micro cogeneration has shown. Hence the innovation dynamic may need a top-down policy push rather than a long gestation in small niches. Fortunately, there is support from EU and national policy levels. Also, as a result of one of the more recent energy programs of the German Government called “E-Energy” the attention to smart metering is expected to increase considerably. In contrast, CCS is pushed by major players and at the same time enjoys increasing support from the level of climate politics and the regime level, despite its rather speculative nature in terms of technology and commercial availability. CCS is an option for climate gas mitigation that would allow for the existing electricity system structures to be kept in place. This explains the increasing interest of the incumbent electricity industry. Stimu- lated by research and development activities, by the gas and oil industry and by political administration and a rather dynamic innovation environment, a number of industry and research consortia evolved which include all major actors in the industry and their allies. Nevertheless, at present it is unclear whether these players actually believe in the vision of CCS becoming a reality. The major motivation for the electricity industry is to keep (or increase) their market shares and profits. They will therefore fight against any distortion of their competitiveness. As the deployment of CCS will increase the cost of electricity generation, the electricity industry will only invest in CCS if the additional costs are lower than (or equal to) the costs for emissions allowances which they may purchase on a carbon market, or if CCS has become mandatory for all investments. The fourth proposition is that indirect alliances may well push innovations forward. Such indirect alliances include the emergence of helping interests on the one hand, and the existence of interpretative flexibility (Bijker et al. 1987) on the other hand. In the case of climate change policies, the emergence of the “carbon business” as an area of new business opportunities is an example for indirect alliances. It includes carbon exchanges, consultants, monitoring experts, financing institutions, green fund managers, project managers, lawyers and the like. These helping interests have a major interest in pushing sustainability to the top of the policy agenda. Helping hands thus prepare the grounds for low-carbon innovations without a direct interest in the specific innovations question. 236 9 Progressing Towards a Sustainable Path?

By comparison, interpretative flexibility describes the situation in which actors with diverging interests find themselves fighting for the same innovation, albeit for different reasons. If actors can make adequate use of it, interpretative flexibility can strengthen coalitions and thus smoothing the implementation of an innovation. For example, renewable energy actors are usually against the continued use of coal for electricity generation. Now some of them argue that carbon capture and storage could serve well as a bridging technology towards a “renewable” electricity system. One underlying reason for this is that they prefer CCS to nuclear energy. Also, a CO2 price as high as the commercial deployment of CCS requires would also benefit renewable energy technologies as competing technologies. Similarly, opponents of new coal power stations join those actor networks requiring capture readiness as a condition for a new plant, thereby also fostering the further development of CCS. For micro cogeneration, synergies between different actor arenas may occur because of its closeness to, for example, the potential deployment of fuel cells in the transport sector or the hydrogen community. The gas industry is partly interested in micro cogeneration because it offers a way into the electricity market. Related to consumer feedback, a number of synergies are thinkable. For example it is interesting for load shifting purposes. Also, the liberalization of the metering business in Germany creates a new business field with new actors and interests, which could advance the distribution of smart meters and thus the technological innovation that enables consumer feedback (and micro cogeneration, too). And finally, smart metering devices and more informative bills could be perceived as a measure of the quality of an electricity supplier and thus bring consumer protection actors to the fore.

9.2.2 The Role of Blocking, Competing and Matching Innovations

An innovation does not take place in a void. It is surrounded by a contextual setting and is part of a cluster of innovations, as we have explained in the introductory chapter. Among these innovations, technological competition takes place as well as competition with regard to the future structure of electricity systems and innovation policies. This is an important level as it touches on the issue of the openness of the system for a certain kind of innovation. For example, when policymakers decide to opt for large scale, central solutions to the climate change problem, this would foster CCS but to the detriment of energy efficiency, small-scale cogeneration and renewable energies. Technological competition is closely related to this: CCS competes with small-scale low carbon innovations, and at the same time, these small solar or cogeneration technologies also compete against each 9.2 Explaining the Innovation Dynamics 237 other. Solar thermal panels are economically not compatible with micro cogeneration, nor is district heating. In the case of emissions trading in Germany, proponents of environmental taxation support the idea of the EU emissions trading system, despite its overlap. They mostly consider it a complementary rather than a competing instrument: In their practical realization in Germany, energy taxes are in particular oriented towards private and small commercial energy consumption, while the EU ETS covers large industrial energy users which enjoy generous exemptions from the ecological tax in Germany. Table 9.1 Cross impact matrix of innovation cases Relevance Micro CHP CCS Consumer Emissions Network for ĺ Feedback Trading regulation Micro CHP Conflicting, Complemen- Comple- but little tary, rein- mentary, – impacting forcing but little power interaction CCS Conflicting, Non- Provides as CCS is conflicting additional central; mitigation CHP is local option and – may reduce CO2 price in case of strict targets Consumer Comple- Non- CO2 price Feedback mentary conflicting decreases (e.g. smart with reduced meters to electricity regulate grid consumption feed-in) Emissions Positive Precondition Complemen- Trading effect on for viability tary: related viability via (30-50€/t price rise – higher elec- CO2) increases tricity prices awareness Network Relevant Complemen- regulation framework tary when condition – used for, e.g., – peak shaving or virtual networks (–) indicates no significant or direct impact. 238 9 Progressing Towards a Sustainable Path?

Despite their diverse nature (or maybe even because of this), the innovation cases highlighted in this book are interlinked in many ways, either directly or indirectly. New forms of governance such as emissions trading and network regulation are part of the institutional framework for technology deployment; network regulation is crucial for the availability of choice and for economic efficiency of supply and demand; more information through consumer feedback, together with increases in electricity prices due to emissions trading, will influence consumer perception and behavior; and so on. Table 9.1 highlights some of these interdependencies as a cross impact matrix. For example, CCS needs stringent climate policies, such as the Emissions Trading Scheme, as its economic viability depends on an appropriate CO2 price. At the same time, presuming its technological and geological feasibility, CCS allows given CO2 mitigation targets to be reached at a lower overall CO2 price. Competing trends are apparent on the level of governance: on the one hand between different instruments and on the other hand between different paradigms. The toolbox contains theoretically equivalent instruments such as emissions trading versus emissions taxes, but also instruments like standards or regulatory rules. A non-contradictory set of instruments is difficult to define, as the devil is mostly in the details. This is also due to more landscape level conflicts between the two dominating but contradictory governance paradigms: On the one hand, the economic deregulation and privatization model prevails amongst policymakers, with the idea of lower energy prices for society. On the other hand, markets are unable to price environmental effects of economic activity and need price regulation or related instruments to actually internalize these unwelcome effects in economic decision making processes. The incentives of liberalized markets to, for instance, offer the lowest possible energy prices contradict the idea of saving energy. As a counterbalance to these unwanted impacts of competition, regulation is required to internalize environmental externalities. As a side effect, this also allows the state to appropriate the surplus, replacing monopoly rents on the part of the electricity utility. Besides these direct effects, different kinds of indirect dynamics may set off innovations, sometimes called piggyback or vehicle dynamics. An example of such kinds of dynamics are spill-over effects between different distributed technologies and network regulation or feed-in models: With the establishment of the German renewable energy law (EEG) and the related feed-in remuneration scheme, and subsequently the CHP law with its feed-in bonus for cogeneration, standardized guidelines for grid integration became necessary as a precondition for a successful functioning of the two laws. 9.3 Shaping the Environment for Innovation Dynamics 239

9.3 Shaping the Environment for Innovation Dynamics

Shaping sustainable innovations is a twofold challenge. It includes both shaping the innovation process, and shaping the actual design of the innovation, both with the purpose of making it contribute to a more sustainable electricity system. In this final section, we discuss the strategic implications derived from our innovation case studies. Target setting. Shaping innovation dynamics presumes the definition of a target to be reached by the shaping activity. Theoretically, such a target should be a clear and defined share or quantity of an innovation to be realized by a certain point in time. Practical examples are policy targets for the share of cogeneration or renewable energies in electricity or heat generation; energy efficiency targets; criteria for the implementation of network regulation or emissions trading schemes. However, as our case studies have demonstrated, defining and declaring a definite objective is sometimes problematic; in particular in the absence of procedures for revising such objectives when new knowledge and experience make it necessary, and also in the case of picking winners by government, target setting may not even be compatible with the idea of sustainable development. This is due to the existence of uncertainty and risks, and has consequences for the timing of shaping strategies. Innovations are characteristi- cally in flux. It is in their nature to evolve and iteratively adapt so that we face substantial challenges when assessing their emergence, development, deployment and thus their impacts. The related uncertainty includes the vagueness of knowledge about the development and future impacts of the innovation itself. The uncertainties regarding the future availability of innovative technologies such as CCS or fuel cells are still enormous, and there is no reliable assessment of when (whether and in which way) it will be commercially available. Uncertainty also surrounds knowledge about the future environment of the innovation in question. Knowledge about future energy or carbon dioxide prices, for example, cannot be produced without there being certainty, despite the large number of models and scenarios to simulate them. The European Emissions Trading Scheme is still not fully developed, and also depends on the many open and changing details of a future European and international climate regime. Another example of the many open questions is the issue of integrating fluctuating electricity feed-in from distributed generation technologies. This is an ongoing topic of research which in turn produces equally fluctuating arguments with regard to its “system compatibility” and the postulated risk for supply security and reliability. 240 9 Progressing Towards a Sustainable Path?

The consequence is that risks related to innovation need a continuous assessment and evaluation with regard to their relevance to society, and so do the shaping strategies derived from the assessment. Moreover, risk assessment and decisions on tolerable risks will usually unfold in a societal debate; otherwise acceptance may become a problem for innovation. Policy makers must therefore enable a debate about targets with participatory elements rather than present fixed targets for innovation. Strategic considerations. Innovations differ with regard to the risk and uncertainty involved, as we have shown in this book. The consequence is to derive different timing and shaping strategies. Following some guidelines may ensure that innovation in the electricity system moves along a sustainable path. Table 9.2 summarizes the related set of criteria and means we discuss now. First, the objective of long-term sustainability requires much more than minimizing expected climate and environmental impacts. Any target setting and shaping of innovation processes must include a repeated assessment of expected environmental impacts, risk and uncertainties, and other implications of an innovation. It must also consider the structural decisions implied by choosing a certain technology, governance or other innovation, and also the compatibility of an innovation with other sustainable energy system components (see Chap. 2 for a detailed definition of sustainability). The appropriateness of scientific methods for such an assessment is an issue of ongoing debate. An interdisciplinary approach to such an assessment, although methodologically challenging, appears to be more appropriate than disciplinary scenarios. One such integrated approach developed and applied in the analysis is the Consequential Environmental System Analysis (CESA) (Pehnt et al. 2008); others include interdisciplinary discourse methods. This allowed for a more balanced appraisal of sustainability in the innovation cases. Second, low-risk options such as energy efficiency, improved consumer feedback, renewable energy technologies or micro cogeneration deserve preferential treatment when compared to high-risk strategies such as nuclear power plants, or carbon capture and storage. Vice versa, an innovation strategy that relies too heavily on such high-risk technology paths and neglects low risk options is inappropriate from a societal perspective. In principle, this is also true for governance innovations, although they are different in their nature. Both the novel instruments in the toolbox of energy and environmental policy, and the methods for shaping the environment of innovations bear the risk of betting on the wrong horse. In this context, the criteria for a sustainable deployment include standard criteria in evaluating environmental tools, such as effectiveness of the instrument 9.3 Shaping the Environment for Innovation Dynamics 241 in terms of reaching its target, its economic efficiency, and distributional justice. Third, innovation paths should allow for some adaptive flexibility. This is true for technical innovations as well as for instruments and policies. Table 9.2 Criteria and measures for shaping sustainable innovations Criteria Means of shaping and meeting criteria Maximum sustainability Repetitive risk and uncertainty assessment with appropriate means (such as CESA and interdisciplinary discourse techniques) Minimum risk under un- Risk and uncertainty assessment and categorization certainty Assessment of (long-term) implications of the innovation Reversibility and adaptability (CCS vs. feedback) Timing Balance between Reliable medium to long-term climate policy frame- consistency and work on national but also on EU and international level flexibility of policy Assess policy impact regularly setting Use participatory policy formulation processes Appropriate and Create level playing field for innovation options adaptive institutional Remove institutional barriers for change framework Implement regulation for liability issues Flank innovation process where necessary Set obligations such as information & awareness raising Variation and Motivate and create an appropriate diversity in options creativity Initiate competition for “best solutions” Create room for experimentation in niches Build pilot plants Capacity, knowledge Interdisciplinary, multicriteria innovation assessment and competencies Create actor networks & coalitions to empower actors Capacity building activities on all levels Training activities, marketing, market introduction Transparency Monitoring framework Information & awareness building measures Stringent monitoring regulations Public control mechanisms Resources Appropriate and adjustable incentive structures Research strategy towards variety and risk minimiza- tion Funding for capacity building activities on all levels Adaptive flexibility Allow for change in innovation strategy Avoid structural interruptions Explore alternative options Avoid lock-in 242 9 Progressing Towards a Sustainable Path?

Lock-in should be avoided so that a system can be reformed when better solutions become available. Targets set for the diffusion of innovations must also reflect that the objectives of governance may well change over time, with technical, economic and societal progress, and with increasing experience with the respective governance tool. At the same time, however, continuity and reliability in the mid- to long-term is also a crucial characteristic of sustainable governance tools. This contradiction is a permanent challenge for policy formulation. One important tool towards this end is participation: The process of formulating and adjusting policies needs a setting in which relevant elements of society are represented. There are a number of models available for the design of participatory processes; they allow for the risk of conflicts with other policy areas to be reduced, and for deficits to be identified at an early stage when continuity criteria are not threatened as much as in later stages, and with established path dependencies. Innovation and sustainability policies must also bear in mind that there is a whole array of energy policy objectives that need to be equally considered, such as distributional justice and supply security. Fourth, the design of institutional incentives and the need for a consistent policy setting are core to successful innovations. Again, this involves searching for a balance between long-term stability and short-term adjustment to the needs of specific innovations. The design of an appropriate regulatory and monitoring system for measuring the impacts of innovation is one core part of such institutional incentives for sustainable innovations. A fifth aspect concerns the variation and creativity with regard to novelties: A sustainable electricity system needs diversity and creative openness to developing innovation. There is no one single magic bullet to drive the system towards sustainability. Society therefore needs to develop a basket of alternatives in order to be able to pick – and blend – the best fruits once they are ripe, and to dump those which are not matured. Offering niches for innovation can be a good means to nurture such creativity. A sixth aspect is the need for creating societal capacities to cope with innovation. This concerns both the level of creative development of innovation and the level of adapting (and adjusting) innovations to the related societal needs. Innovation needs both manifold ideas and diverse bottom- up developers of innovation options (variation), but also powerful drivers on the meso and macro levels to push selected innovations into a practical deployment. As it concerns the general setting for innovation rather than concrete individuals or organizations, the formation of better capacities is a complex shaping problem. It includes the creation and diffusion of know- how and information by means of training activities, marketing, or other market introduction activities. It also includes the creation of networks or 9.4 Some Final Remarks 243 advocacy coalitions to push a novelty from the niche to the system level and to eventually succeed with a broader deployment. A related issue is the need for transparency, including participation and creation of public acceptance for innovation. This requires, for example, information campaigns and awareness raising measures. Realization of all of this presumes the availability of sufficient resources. Creativity needs to be pushed, niches to be nurtured, and capacity building to be fostered. Economic and institutional incentives are worth considering here. Without economic incentives, renewable energies would not have the market share that they have in Germany. Similarly, cogeneration would have suffered much more from liberalization without the subsequent CHP laws. Economic incentives also include R&D inputs in technology and pilot plant activities, which are observable in all cases, albeit more so in CCS than in micro cogeneration or consumer feedback. A consequent shaping of these incentives is a difficult task as it requires taking decisions about the amount of support, and of the share dedicated to different innovation options. Last but not least, shaping innovation towards a sustainable electricity system presumes dynamic adaptive flexibility in the whole setting. After all problems involved in assessing and implementing sustainable innovations, this seems the ultimate precondition to manage uncertainties and risks. Part of such a strategy is a proper scientific and societal monitoring of innovations in order to take notice of adjustment needs as early as possible. Participation is also a crucial element of such an approach to minimize risks and maximize the flexibility of the innovation environment.

9.4 Some Final Remarks

This book discusses innovation dynamics in the electricity system. It touches upon a number of important issues involved in its transition to a sustainable path. Three points summarize the major lessons learned from our endeavor: x First, innovations that are more or less compatible with the existing system architecture (or the proposed new structure, for example a liberalized market) appear to be more easily accepted and broadly deployed than radical ones. This point has frequently proven true in the past as literature shows, and is tentatively underlined by the innovation cases presented in this book although they are partly in an early stage of deployment. The findings of our case studies hence underline the existence of system inertia to change and path dependency as suggested by 244 9 Progressing Towards a Sustainable Path?

Hughes (1983), Unruh (2000) and others. Carbon capture and storage, for example, represents a prolongation of the existing coal-to-electricity system with large power plants and therefore experiences higher attention and a more powerful lobby than distributed generation with its potentially disruptive effects on the electricity system structure. Similarly, consumer feedback is new to the system and has thus had little advocacy within powerful networks to date. Trading emission certificates on the other hand, although often labeled a radical novelty to the toolbox of environmental policy, is based on the same principles as existing trade and commercial paper exchanges; its real challenges lie in the negotiation process for the certificate allocation. x Second, pushes from outside the electricity system, such as energy and environmental crises, or shifts in governance paradigms facilitate change within the system. Changes in the environment of the electricity system are sometimes even central to triggering innovation dynamics. This is particularly visible in the case of the international climate regime, but also of liberalization and regulation dynamics in the electricity sector. x Third, niche actors are without a doubt important to push novelties to the agenda. For a successful diffusion of such novelty, however, preconditions are that incumbent actors cooperate and participate in innovation networks, and that the government sets appropriate framework conditions. An effective networking is indispensable for success; there is no example of successful innovations without effective networks. For such an operational networking, an ample level of homogeneity and compatibility of actors interests is necessary. When those interests are too diverse and too distributed, bundling the innovative forces is difficult and holds little promise. Our assessment of the five innovation cases was based on the use and an integration of several methodological approaches. Each of them shows strengths, but also weaknesses. There is no single best method for understanding innovation dynamics and the shaping needs for sustainable system transitions. Future research is therefore needed to further deepen the methodological discourse on assessment and evaluation methods for uncertainty and risk. Also, despite a better understanding, the dynamics of innovation are still hardly predictable. Thus, the most important lesson for strategic policy considerations is to acknowledge and take into account uncertainties – and to prepare the grounds for creativity and for adaptive flexibility around any innovation. Shaping the innovation path in a sustainable manner requires that the reversibility of the innovation decision be provided for – an aspect that brings up the issue of timing as an important challenge to formulating References 245 innovation strategies. In other words, as long as uncertainty and risks exist, back-up strategies of alternative or parallel nature are an indispensable ingredient of any innovation strategy.

References

Bijker WE, Hughes TP, Pinch TJ (1987) The Social Construction of Technological Systems. MIT Press, Cambridge Hughes TP (1983) Networks of Power: Electrification in Western Society 1880- 1930. The Johns Hopkins University Press, Baltimore Pehnt M, Oeser M, Swider DJ (2008) Consequential environmental system analysis of expected offshore wind electricity production in Germany. Energy 33 (5): 747–759 Unruh GC (2000) Understanding carbon lock-in. Energy Policy 28 (12): 817–830