2002:26 lule A| UNIVERSITY ,L OF TECHNOLOGY DOCTORAL THESIS THOMAS SUNDQVIST Power Generation Choice Power in the Presence of Generation Environmental Externalities Choice in the Presence of Environmental Thomas Sundqvist Externalities DOCTORAL Department of Business Administration and Social Sciences THESIS Division of Economics 2002:26 • ISSN: 1402 - 1544 • ISRN: LTU - DT - - 02/26 - - SE Fewer Generation Choice in the Presence of Environmental Externalities Thomas Sundqvist Abstract This dissertation consists of an introductory part and six self-contained papers, all related to the issue of power generation choice in the presence of environmental externalities. Paper 1 provides a critical survey of a large number of electricity externality studies carried out during the last decades, and discusses a number of conceptual, policy-related and, in some cases, unresolved questions in the economic valuation of electricity externalities. These include: (a) the definition of externalities; (b) the choices of scope, relevant parameter input assumptions, and methodology; (c) the role of “green” consumer demand in replacing external cost assess­ ments; and (d) the behavioral assumptions and ethical principles underlying external cost valuation. Paper 2 focuses on explaining the variability of results among the external cost studies carried out so far by providing an econometric analysis of a large sample of externality studies. Most importantly, the paper concludes that an important explanation for the reported disparities can be attributed to the overall methodological choice employed. Paper 3 explores some of the ethical limits of environmental valuation, and analyzes what the implications are of these limits for the social choice between different power sources. The main thesis of the paper is that the scope of electricity externalities where non-market valuation can be applied from an ethical point of view is likely to be narrower than commonly assumed. Papers 4 and 5 use the choice experiment method to estimate how the environmental impacts arising from hydroelectric production are perceived and valued by Swedish house ­ owning households and non-residential consumers. The basis of the choice exercise is taken in the criteria set up by the Swedish Society for Nature Conservation under which existing hydropower in Sweden can be labeled as “green” electricity. Data are gathered using mail-out surveys to 1000 households and 845 private and public enterprises, respectively. In general the results indicate that environmental investments in the hydro sector should, according to the respondents, primarily be directed towards lowering the negative impacts on fish life in the river affected by the hydroelectric development. Finally, paper 6 examines cost-reducing innovations for wind turbine farms in Denmark, Germany, and the United Kingdom. An econometric analysis using an expanded version of the two-factor learning curve concept, in which investment cost reductions are explained by cumulative capacity and the R&D based knowledge stock, is performed. The results show that both these factors have had a significant impact on cost reductions in the wind power sector. i m dsvoj ppmop •ssdfuoo piM dining ‘i/b'nouj 8uoj mop dip djnuoj no\ /j Table of Contents Abstract ...................................................................................................................................... i Acknowledgements ................................................................................................................ vii Preface ........................................................................................................................................ 1 Paper 1: The Valuation of Electricity Externalities: A Critical Survey of Past Research Efforts (with Patrik Soderholm) Paper 2: What Causes the Disparity of Electricity Externality Estimates? Paper 3: Pricing Power Generation Externalities: Ethical Limits and Implications for Social Choice (with Patrik Soderholm) Paper 4: Quantifying Household Preferences over the Environmental Impacts of Hydropower in Sweden: A Choice Experiment Approach Paper 5: Quantifying Non-Residential Preferences over the Environmental Impacts of Hydropower in Sweden: A Choice Experiment Approach Paper 6: The Impact of R&D on Innovation for Wind Energy in Denmark, Germany and the United Kingdom (with Ger Klaassen, Katarina Larsen, and Asami Miketa) v Acknowledgements The first person that I want to mention especially is my supervisor, Associate Professor Patrik Soderholm. He has repeatedly read and commented on my work, even when there was almost nothing to comment on. His importance for the completion of this thesis cannot be emphasized enough. I also wish to express my gratitude to Professor Marian Radetzki for providing me with the opportunity to pursue a doctoral degree, for valuable comments on various drafts of the papers in the thesis, and for “kicking me in the but ” when it was needed. Throughout my five years as a doctoral student the primary financial supporter of my research has been Vattenfall AB. People at Vattenfall who have been directly involved in the completion of the dissertation include: Birgit Bodlund, Truls Borgstrom, Claes Hedenstrom, Kjell Isaksson, Per-Gunnar Karlsson, and Catrin Sundsten. All this support is gratefully acknowledged. In addition, financial support from the Swedish Research Council for Agricultural Sciences and Spatial Planning (Formas), the Swedish Foundation for International Cooperation in Research and Higher Education (STINT), the Knut and Alice Wallenberg’s foundation, and the C C Soderstrom ’s donation foundation, is also gratefully acknowledged. Past and present members of the International Advisory Board, who together supervise the research at the Economics Division, have all in one way or another provided invaluable help that has contributed to the successful completion of this thesis. They are: Professor Ernst Berndt, Massachusetts Institute of Technology; Professor James Griffin, Texas A&M University; Professor Thorvaldur Gylfason, University of Iceland; Dr. David Humphreys, Rio Tinto Ltd. London; Dr. Keith Palmer, N M Rothschild & Sons Ltd. London; Professor David Pearce, University College London; and Professor John Tilton, Colorado School of Mines. I especially want to express my gratitude to Professor Tilton, for making it possible for me to study at the Colorado School of Mines during the fall of 1997, and to Professor Griffin, for making it possible for me to attend Ph.D. courses at Texas A&M during the fall of 2000. I am also grateful to my (past and present) colleagues and friends at the Division; Anderson, Anna, Berith, Bo, Christer, Gerd, Gudrun, Helena, Jerry, Kristina, Linda, Mats, Olle, Robert, Staffan, and Stefan, who all have played an important part in the completion of this thesis. Thanks also go to Nils-Gustav Lundgren, Professor of Economic History. vii The thesis has further benefited from comments from the participants at a lunch-seminar held at the Center for Business and Policy Studies (SNS) in Stockholm, October 1999, as well as comments and suggestions received from Dr. Ger Klaassen, while I was participating in the young scientist summer program (YSSP) at the International Institute of Applied Systems Analysis (IIASA), Laxenburg, Austria, during the summer of 2001. My pie-seminar discussant, Dr. Fredrik Carlsson, University of Gothenburg, has also provided invaluable comments on all the papers included in the thesis, as well as more tangible help with the estimation of the econometric models used in the choice experiment applications. Finally, I wish to thank my family and friends for being there even if I have not been very accessible during the last five years or so. Since I have received so much guidance and help along the way, I believe it is safe to say that all remaining errors are mine. Lulea, August 2002 Thomas Sundqvist viii Preface 1. Introduction Electricity plays an important role in our society. For instance, it comprises a large share of world energy demand, and the relative importance of electricity to care for our energy needs has been growing. In 1973, electricity accounted for roughly 10 percent of total world consumption of energy, but by 1999 the electricity share of world energy demand had grown to more than 15 percent (IEA, 2001). This share is expected to grow due to increased demand in the future, mostly in the OECD-countries (IEA, 2000). Also in the developing countries the need for electric power capacity growth is large. The increase in electricity demand in relative as well as in absolute terms creates new and interesting challenges for regulators and policy makers with respect to the future electricity production mix. This challenge may, as Schelling (1997, p. 123) puts it, be divided into two parts: “One has to distinguish two altogether different regulatory (and deregulatory) concepts. One is regulation, and corresponding deregulation, to make markets work better - more efficiently more equitably, more in the public welfare. The other is to curtail and constrain those activities that entail adverse side effects - ‘externalities ’ in the economists ’ jargon.” The general focus in this thesis is essentially on both of these issues. Specifically, it deals with the general question of how power generation choice is affected by the existence of a certain type of market failure, namely environmental externalities, and how electricity markets can be made more efficient by “internalizing