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Market imperfections and economic efficiency of white certificate systems

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Abstract

This paper takes the view that energy markets and markets for energy efficiency have significant imperfections, including ones that cannot be repaired through prices alone. The acknowledgement of the various market imperfections, however, does not endorse automatically the use of various instruments, such as tradable white certificates (TWC). Therefore, it is necessary to clarify under what conditions a TWC system can have equal or superior effectiveness and economic efficiency as compared to other instruments. The article explains the principles of a TWC system in terms of market functioning and price formation. It also highlights some key assumptions regarding additionality of energy savings, transaction cost, free riding, target setting and regulatory predictability. Subsequently, the paper illustrates how a TWC system interacts with other energy efficiency policy instruments, in particular standards and taxes. After these explanatory sections the article turns to the modelling of actual TWC price formation in selected countries and subsequently presents a comparative assessment of a TWC system with an energy tax for Finland and the Netherlands.

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Notes

  1. Financial support from the European Commission and the Finnish ministry of Trade and Industry is gratefully acknowledged. More project reports can be found at www.eurowhitecert.org.

  2. Speeding up adoption of energy saving technology can also imply that the learning curve is exploited faster; hence unit-cost reduction can occur earlier. On the other hand there is a risk of too quick a spread of premature technology, which would imply extra cost, not less cost, over a longer time span.

  3. As energy prices and unit-costs of saving may vary over the course of the compliance period, there is uncertainty for investors. Adding a discretionary option for change to the target setter only complicates the uncertainty and may add cause for exerting pressures by various stakeholder groups.

  4. Given the Ramsey pricing assumption, there is even an elevated likelihood that it concerns such customers, since the low price elasticity is—among others—tied to lack of knowledge and underutilised energy saving potential.

  5. Companies may also try to realise savings among the customers of another company, but that could be regarded as an intrusion and does not enhance (own) customer loyalty. On the other hand unless the obligated parties are energy network companies (like in Italy) the client loyalty aspect is not relevant.

  6. Figure 4 assumes that the technical energy saving potential covers a large part of a firm’s current consumption. In fact the curve E may have a less tilted slope (as in Figs. 1, 2 and 3). A consequence of the current display is that firm A would have a second optimal solution involving drastic energy savings.

  7. Given proviso 7 in Chap. 3, this statement is correct, but considering the digression suggested by the curve E, less overcompensation may have arisen depending on the functionality of the certificate market.

  8. Regarding the creation of a good knowledge base, it would probably improve market transparency and reduce social-economic cost if that were pursued as much as possible as a common broad based high quality endeavour. The positive spillovers of a better overall quality and prevention of duplication would justify public funding support.

  9. We refrain here from complications of financing cost for the end-user. Such facilities could be assumed to be part of the transaction cost (TC).

  10. If there is already experience with company switching among clients, client loyalty expressed as an exit likelihood function (with extra services as latent variables) could be integrated in the formalised cost optimisation.

  11. Considering the TWC-like systems in place or considered up to now, it seems reasonable to assume the obligated party is a company which (also) sells energy to end-users. Please note that the Italian system focuses on energy network companies, in which case the target can be formulated as a percentage of the volume of distributed energy. In that case the company can otherwise still be assumed to be driven by cost minimisation.

  12. The applied elasticities are based on generic a priori information, not on empirical investigations of the sectors at hand in exactly their current conditions. If the latter would have been the case, the split incentive effect should cause the elasticity to get closer to zero.

  13. These figures represent sort of middle-of-the road levels. For the Netherlands some estimations are available (Boonekamp 2007; Lijesen 2007). Nevertheless estimates tend to vary significantly across countries, time periods, and, not least, due to differences in data definitions and estimation methods (EIA—Annual Energy Outlook 2003; van den Bergh 2008; Christoffersen et al. 2006; Nesbakken 1999).

  14. District heat has large advantages in terms of conversion efficiency and primary energy saving, which is a reason to be reluctant to tax district heat delivery.

  15. In fact for the energy intensive industry there is a rebate system defined as excess tax payments beyond a threshold based on a percentage of the value added of a company.

  16. The current energy tax system in the Netherlands includes a lump sum (ex ante) reduction of the energy bill.

  17. The degree could depend on the need to reduce also public deficits.

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Authors and Affiliations

  1. Government Institute for Economic Research VATT, P. O. Box 1279, FIN 00101, Helsinki, Finland

    Adriaan Perrels

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Appendix

Appendix

Saving potentials

Potential assessments were collected for Finland, Hungary, the Netherlands and the UK. The following potential ranges per country and their sources are listed below.

Finland

Total potential (100%) for annual incremental savings: 430 GWH/year (MIN) ∼ 1300 GWH/year (MAX).

The lower end potential estimate is based on an assessment of the effects of the building certificate (Honkatukia and Perrels 2006), with some additional information from Motiva. The upper end potential estimate is based on a study by Ecofys (Khan 2006) in which officials of Motiva and the Ministry of Trade and Industry were interviewed about their experiences with audit programmes and their judgements of energy saving potentials in Finland.

Hungary

Total potential for annual incremental savings: 650 GWH/year.

Urge-Vorsatz and Füle (1999) produced a model assessment on energy saving options in Hungary.

Netherlands

Total potential for annual incremental savings: 1180 GWH/year (MIN) ∼ 3400 GWH/year (MAX).

Two reports of ECN (Daniëls et al. 2006; Menkveld et al. 2005) were used, both based on fairly detailed information on the composition of potentials and costs of energy saving options from which the potentials are made.

United Kingdom

Total potential for annual incremental savings: 2900 GWH/year (MIN) ∼ 7400 GWH/year (MAX).

The estimates for the UK are based on information from the EEC evaluations by DEFRA (2004, 2005), Ofgem (2006, 2007) and an external evaluation by Lees (2006).

Table 3 Distribution of energy saving potential per unit-cost category (low to high), based on the sources mentioned above and the unit-cost information shown discussed below
Full size table

Unit-cost and the distribution of saving potential of unit-cost and retail price intervals

Detailed energy saving cost information was collected for Finland (Motiva, energy saving agreements, annual reports 2002–2004), the UK (Defra, Assessment of EEC 2002–05 Carbon, Energy and Cost Savings), and for some options for various European countries (INDEEP database, Jakob and Madlener 2003; Guertler and Smith 2006)). The original information was harmonised as much as possible. Those savings options were selected that are relevant for the selected sectors (households, services, and light manufacturing industry), i.e. often related to building technology, lighting, appliances and office equipment. Given the findings in other parts of the Eurowhitecert study (Mundaca and Neij 2006) an increase of 25% of the unit-cost was applied for all options as a way to account for transaction cost. All the original cost data were in principle purely of an engineering-economic origin. Furthermore, for all options a unit-cost interval was added by defining a lower end at 2/3 of the indicated unit-cost and an upper limit of 1.5 times the (approximated) average. This was based on detailed information on case wise variation of unit-costs in Finland. The indicated interval seems to cover most of the cases (see Perrels and Tuovinen 2007).

For each of the identified options one checked, what the share was in the overall saving potential, and subsequently an approximation was made of how this share was distributed over subsequent unit-cost intervals. In this way the shares of the relevant energy saving options could be aggregated per unit-cost interval. In Table 4 in the most right-hand column, the cumulative share of energy saving potential of subsequent unit-cost intervals is shown (the unit-cost intervals are shown in the second left column ‘MC e-saving’). The assessment of the attributable potential accounts for the effects of sales margin for the obligated party (i.e. an energy company), as is summarised in Table 5.

Table 4 Distribution of the saving potential by unit-cost–energy price combination for Finland
Full size table
Table 5 Applied retail sales margins (in %) by price level (€/MWh) by country
Full size table

The distribution of energy saving potential per unit-cost interval over the retail price intervals was approximated by using auxiliary information of typical tariff ranges per client group (services, households, light industry) and the their consecutive shares in final energy consumption. Data on retail prices were obtained by country. That resulted in the contribution per cell (a unit-cost–retail price combination) to the total addressed energy saving potential in % (see Table 4). It should be stressed that the entire procedure is systematic but only an approximation. However, the robustness of the outcomes (i.e. the simulated TWC prices) was tested for variation in the distributions. It appeared that significantly different price estimations resulted only in case of very substantial deviations from the applied distributions.

Sources for retail energy tariffs by country:

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Perrels, A. Market imperfections and economic efficiency of white certificate systems. Energy Efficiency 1, 349–371 (2008). https://doi.org/10.1007/s12053-008-9020-z

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