Chapter 1: Introduction __________________________________________________________________________________________ 1.1 Background Global warming from the human-generated increase in greenhouse gases in the earth’s atmosphere is increasingly accepted by the public and the scientific community as a threat, not only to the world economy, but possibly also to civilization. The Stern Review (2006) has highlighted the grave likely economic consequences of global warming and the relatively small costs in reducing its impact to acceptable levels. The Intergovernmental Panel on Climate Change has stated that there is a 90 % chance that human activities are causing global warming (IPCC, 2007: 5). This level of certainty is not sufficient to provide a statistically significant result in a scientific study, however the severity of possible consequences of global warming is such that action on greenhouse gas abatement could be seen as a prudent and justified form of insurance. Scientific certainty would most likely only occur when the damage from global warming has become irreversible and any corrective action is too late (Stern, 2006: ii,x). The Stern Review (2006: 1) described global warming as ‘the greatest and widest-ranging market failure ever seen’. There is market failure due, among other things, to: (a) Externalities, “Greenhouse gases are, in economic terms, an externality: those who produce greenhouse-gas emissions are bringing about climate change, thereby imposing costs on the world and on future generations, but they do not face the full consequences of their actions themselves” (Stern, 2006: xviii); (b) Free-rider problems between individuals, between businesses and between countries. It is to the advantage of one player to let others bear the burden of greenhouse gas abatement, reaping the benefits and avoiding the costs; (c) The delay of consequences of greenhouse gas emissions, so that the problems caused by the emissions fall most heavily on future generations, and current decision makers do not experience the benefits of greenhouse gas abatement (Stern, 2006: 351,352). 1 These market failures affect the world electricity supply industry which must play an important part in greenhouse gas abatement. It is estimated that this industry will need to reduce greenhouse gas emissions by 60% by 2050 if atmospheric carbon dioxide is to be kept to the recommended tolerable maximum of 550 parts per million (Stern, 2006: 352) compared with the current level of 379 parts per million (IPCC, 2007: 2). The contribution of the electricity supply industry to Australia’s greenhouse gas emissions is estimated in 2004 to be 49.6 % of Australia’s total emissions and to have increased by 43 % between 1990 and 2004 (AGO, 2006: 6). The Australian electricity supply industry must therefore be a participant in any efforts to curb greenhouse gas emissions. Green Power schemes are a means of countering global warming by encouraging growth in the generation of greenhouse-gas-neutral renewable energy. Renewable energy sources include solar, wind, small-scale hydroelectricity and biomass. Green Power can be defined as: ‘electricity that is produced from renewable sources and that has been differentiated from other electricity products and marketed as being environmentally friendlier’ (Salmelo & Varho 2006:3669). In their electricity bill, Green Power customers voluntarily pay an additional premium which covers the additional cost of generating the customers’ electricity from renewable energy sources. In Australia, the special attributes of Green Power are: (1) It is generated by environmentally friendly sources, excluding existing large-scale hydroelectric generators; (2) A large and growing percentage of Green Power must be from new generators, defined as being commissioned after the start of 1997. From 1 July 2006 100% of Green Power is required to be from new generators. Because of these special characteristics of Green Power the term with capitalised initials will be used in this study to distinguish this electricity product from other forms of electricity generated from renewable sources which may be subject to other requirements and definitions. While other countries may differ in detail in their definitions of Green Power the term will still be used as defined by Salmelo & Varho (2006) above when discussing the situation in those countries. The consumer gains the benefit of contributing to the development of the renewable energy industry while offsetting greenhouse gas emissions when buying Green Power. The electricity 2 retailers can gain some marketing advantages and governments can shift some of the responsibility and costs of countering global warming onto individual consumers. This study examines the place of Green Power in the electricity supply industry and among policies to counter global warming, the demand and supply characteristics of the market for Green Power, the effectiveness of Green Power in meeting policy objectives (which include, but may not be limited to, greenhouse gas reductions) and measures which could increase the impact of Green Power in the reduction of greenhouse gas emissions. In 1989 Green Power schemes were introduced in the United Kingdom and in 1993 in the United States, where, as in Australia, the schemes were introduced before retail competition in the electricity market. The Green Power schemes grew with the spread of retail competition (Wiser et al 2000: 468). By 2002 Green Power schemes were in 17 developed countries (Bird et al 2002 (1): 517, 518). Green Power schemes were first introduced in Australia in April 1997 when the Sustainable Energy Development Authority (SEDA) introduced the Green Power Accreditation Program in NSW. This program formulated the procedures for ensuring that the products provided by retailers were genuine, giving customers confidence that the extra price they were paying for their electricity was in fact going towards development of the renewable energy industry (Passey & Watt, 2002: 14). For the year ending June 2004, Green Power sales were only 0.25% of total electricity sales, to 1.1 % of electricity consumers. However growth in Green Power sales has been strong since that time (ESAA 2005:33, NGPASG June 03 – Jun 04: 1). In 2006 they were 78 % higher than in 2004 (NGPASG, 2006: 2-12). While a carbon tax could overcome some market failures impeding greenhouse gas abatement in the electricity supply industry, the method recommended in the Kyoto Protocol is a cap- and-trade technique. With cap-and-trade limits are imposed on quantities of emissions and firms can sell or buy the rights for emissions to meet their quotas in a special market for carbon credits. Green Power schemes use a technique to reduce greenhouse gas emissions which differs from both the carbon tax and cap-and-trade regimes. Green Power relies on the good intentions of consumers to pay for the additional costs of clean generation of electricity. If successful, Green Power could be an important means of reducing greenhouse gas emissions at minimal cost to governments and to the rest of society, paid for willingly by people. If global warming is not caused by human activities and any efforts for greenhouse gas abatement are therefore useless, this risk that the expenditure on abatement is futile is 3 borne by the purchasers of Green Power. These possible advantages of Green Power schemes to governments and society in efforts to reduce greenhouse gas emissions give importance to the study of the economics of Green Power, including what determines the supply and demand in this market and how the Green Power market can be made to function so sales are maximised. These matters are examined in this study. 1.2 The market for Green Power Economic theory presents the Green Power market as an example of private contributions to increase the supply of a public good, which is a good that is non-rival and non-excludable. The public good in this case is the reduction in greenhouse gas emissions, a good from which no one can be excluded and for which the enjoyment by one person does not diminish the enjoyment by others. Literature on the nature of impure altruism (Andreoni, 1990) has provided insights into the market for impure public goods of which Green Power is considered to be an example (Cornes & Sandler, 1994), (Kotchen, 2005), (Kotchen & Moore, 2007). Altruism is said to be usually impure because of the private benefits gained by the donor sometimes referred to as a ‘warm glow’. A consumer faces a market choice in a situation where the public good is already available to the consumer through the efforts of others (Cornes & Sandler, 1994:413). For Green Power as an impure public good the private characteristic is the satisfaction for the customer in helping preserve the environment, while the public characteristic is the reduction in greenhouse gas emissions arising from renewable energy generation displacing conventional energy sources. With plausible assumptions, Green Power, as an impure public good with substitutes available, can be shown to have a negative price elasticity of demand (Kotchen, 2005:297). Nyborg, Howarth, & Brekke (2006) present a view of consumer motivation to behave ethically based on the perception of the behaviour of others, a form of herd behaviour which could result in multiple equilibria. This implies that temporary incentives to buy Green Power might result in permanent increases in Green Power sales, as detailed in Section 3.4. 1.3 Quantitative analyses of Green Power markets Because Green Power has only been introduced relatively recently, information on the nature of the market is scarce. Quantitative studies attempting to estimate demand for Green Power can be categorised as either stated preference studies or revealed preference studies. Among 4 stated preference empirical studies of the Green Power market in various countries are studies by Arkesteijn and Oerlemans (2005) (Netherlands), Batley et al (2001) (UK), Kotchen & Moore (2003) (USA), Roe et al (2001) (USA), Wiser et al (2001) (USA), Nomura & Akai (2004) (Japan) and Zarnikau (2003) (USA).