Deregulation of Electricity in India -5

2.9           Deregulation And The Environment

2.9.1    Introduction:

Fossil fuels supply around 85 percent of the world’s commercial primary energy needs. Natural gas provides about 25 percent of this, and its share is growing. Power plants represent by far the largest group of coal end users, consuming 60 percent of the total world coal production to produce heat and generate electricity. Electric power sector emissions of carbon dioxide are almost 10 percent of the world total. Total world demand for coal has continued to grow steadily, with coal currently providing fuel for 37 percent of the world’s electricity generation.

2.9.2    The Impact Of Reform On The Environment:

While there are potential environmental benefits from restructuring, the environmental threats appear larger”. On the one hand, the future looks relatively bright if gas combined cycle plants replace coal-fired generation, leading to lower CO2 emissions. On the other, it is argued that capital-intensive renewable and end-use efficiency (which tends to have a long pay-back period), will suffer due to the higher cost of capital, reflecting greater levels of perceived risk in the marketplace. It is also argued that the demise of Demand Side Management (DSM) and Integrated Resource Planning (IRP) activities, nuclear retirements, different market structures with deviations from optimal dispatch, sales promotion and shifting load profiles, and cost cutting at power plants, would tend to increase emissions.

It has been argued that once utilities find themselves in a highly competitive market, many of the public benefit activities carried out while they were regulated (such as weatherization programs for low-income individuals and utility-sponsored demand side management programs) will be de-emphasized or eliminated.

Another issue is that coal plants in some economies (especially pre-reform) suffer significant under-utilization, relative to their full availability. With relatively low coal prices, these plants have a significant competitive advantage in a wholesale electricity market. Increasing utilization of such plants would lead to significant increases in carbon emissions.

Embedded technologies have an advantage over new and emerging ones - the physical stock and expertise are well entrenched, and investment risks are lower. This situation favors fossil fuels, especially in a situation where markets have systematically failed to account fully for the social and environmental costs.

A wholesale electricity market is driven by costs of production, and is a market where the lowest cost generators - regardless of fuel type - will invariably be called first. If the lowest cost plants happen to run on the least environmentally friendly fuels, then in the absence of any mechanisms to limit emissions, overall emissions of environmentally harmful substances are bound to increase.

2.9.3    Emerging Technologies:

From a purely technical perspective, commercially available technologies exist to mitigate almost entirely the adverse impacts of all the pollutants that result from the combustion of carbon intensive fossil fuels to generate electricity. The most carbon intensive fuel is coal, and in many cases the addition of these technologies can be achieved without making coal uncompetitive with alternatives, such as natural gas or renewable.

At least this is true for technologies that mitigate pollutants other than CO2. This is the one pollutant that cannot easily be dealt with in the smokestack, and with technology that would still allow coal to compete with other fuels. If one compares the trajectories of energy-related CO2 emissions (under a business as usual scenario) with those required to meet Kyoto commitments, it is obvious that a large gap exists, and without substantial mitigation, this gap will grow increasingly large with time.

So it can be seen that the importance of new and emerging technologies lie in the role of innovation as a means of increasing both economic and technical efficiency, and the growing requirement for cost-effective solutions to the greenhouse gas problem. This is where energy sector reform should have a very significant role to play. If, as expected, reform acts as a spur for technological innovation, we should see over the next few years significant advances with respect to improved goods and services, and in dealing with environmental impacts.

The counter argument to this is that a reformed energy sector could represent a significant barrier to the adoption of certain new technologies, because of entrenched mind-sets, the cost of risk capital, and the costs inherent in bringing new technologies on-stream. If newly emerging energy sector firms are driven by short-term thinking and the requirement for a short-term return on assets, it is argued this could lead to a reduction in the commitment to long-term planning and investment.

On the other hand, firms thrive on innovation, especially if incentives exist to encourage the penetration of new technologies into the marketplace.  Incentives can include customer preferences, such as a demand for new/better goods and services, or a willingness to pay extra for added value (e.g. “green electricity”), or incentives created by governments through market-based policies and measures. On the energy scene, a significant number of environmentally responsive innovations are reaching the marketplace, or are on the horizon. Examples include: large-scale wind turbines, community energy systems, natural gas-fired or coal-fired combined cycle turbines, and fuel cells for transportation applications and for distributed power generation.

2.9.4    Subsidies:

The use of subsidies to implement social policy is addressed elsewhere in this report. The issue is, however, relevant to the question of environmental impacts in situations where the existence of fuel subsidies (often on fossil fuels) acts as a barrier to the introduction of cleaner technologies or cleaner fuels.

Energy is subsidized in many ways, both directly and indirectly. More explicit forms include direct grants and tax breaks to producers and distributors, and price controls. Economies with extensive energy resources often impose export restrictions, and this has the effect of keeping domestic prices artificially low. Compounding the problem of identifying subsidy levels is the fact that state-owned or state-managed companies are often heavily involved in the energy sector.

Whatever form energy subsidies take, they result in prices that fail to reflect the true economic costs of supply. Low consumer prices and high producer prices result in excessive production and operation of high-cost uneconomic and uncompetitive units. The overall effect is to place a burden on the economy, to bring about a loss of efficiency. Energy subsidies, especially those on fossil fuels, also tend to be damaging to the environment. In India, the major issue from an environmental perspective is the existence of subsidies on the prices of oil, petroleum products and coal.

2.9.5    Policy Options:

Command and Control:

Command and control systems are defined by sets of compulsory rules defining requirements on the level of emissions, on the characteristics of the final goods or services produced, and/or on the technical processes of production. Such systems are completed with a monitoring (control) component.

The problem with the use of this kind of instrument is that unintended - and often negative - outcomes occur. These include failure to secure cost effective solutions, or inhibition of technological progress.

Because regulators are faced with obtaining and processing large amounts of information, they tend to develop uniform sets of rules, producing inequalities in marginal abatement costs for different emitters (static inefficiency). Also, the mere existence of a fixed limit or requirement provokes dynamic inefficiency, since polluters are not encouraged to look for a continuous reduction in emissions. This hampers technological developments.

However, command and control instruments have been traditionally popular because they set clearly defined limits, are usually administratively simple to implement (if not necessarily easy to manage), and fit with the traditional “big government” culture.

2.9.6    Energy Efficiency

One of the more effective ways to control the environmental impacts of energy utilization is to institute policies that encourage energy efficiency. Obviously, such policies will be particularly effective in economies that are energy intensive and/or have significant energy efficiency potential, but another important consideration is the extent to which significant energy market reform has already taken place. Experience has taught policy experts that open, competitive markets are more efficient than other alternatives, such as heavily regulated markets, or command and control structures. However, one advantage an economy may have in the pre-reform stage is the ability to easily legislate and heavily regulate for specific desired outcomes.

The policies and structures used to achieve this focused on non-market mechanisms such as regulations directly governing energy use, mainly through quotas and STRANDEDs. State-sponsored efficiency investment projects targeted the industrial sector, and included co generation, recovery and use of waste heat and gas, retrofits for small and inefficient power and fertilizer plants, and improvements to steel manufacturing technologies.

The energy quota management system, which is still largely in place, governs that quantity of energy supplied to enterprises and the energy intensity of specific manufacturing processes, and provides for reporting, monitoring and performance evaluation. The problem with non-market interventions is that they are of questionable value in an open, competitive market environment. In fact, such an approach can be counter-productive, leading to market distortions that add costs, instead of removing them.

Markets respond most effectively to financial incentives. Policy measures using financial incentives can include: allowing enterprises to use pre-tax income to pay off loans for energy efficient equipment; the reduction or waiving of taxes on sales of products which promote energy conservation or environmental impact; reducing or waiving import duties on such equipment; and promoting innovation by individuals and firms through the use of various incentive schemes.