Jorge Padilla, Professor of Economics, University of Oxford

"Most economists believe that the first thing to be encouraged is energy efficiency"

White House aides, MIT professors, academics… Seventeen experts from around the world have collaborated in the drafting of "Harnessing Renewable Energy: in Electric Power Systems”, a book that aims to be "essentially informative” and will touch more that one sensitive nerve. The publication, containing a forward by EU Energy Commissioner, Günther Oettinger, and has been edited by three doctors in economics: Boaz Moselle, Richard Schmalensee and Jorge Padilla, the latter of whom Renewable Energy Magazine interviewed at the end of last year.
"Most economists believe that the first thing to be encouraged is energy efficiency"

CEO of the consulting firm, LECG Europe, Dr. Jorge Padilla is an expert in economics and finance. He is an affable economist, who talks in an informative, rapid-fire manner.

Renewable Energy Magazine met with him just days before “Harnessing Renewable Energy: in Electric Power Systems” was presented at the Rafael del Pino Foundation in Madrid at the end of September. The book was co-edited by Padilla along with fellow economists Boaz Moselle and Richard Schmalensee, and, according to Padilla, aims to “shift the [energy] debate from what we perceived as a debate between two extreme views – the ultra-ecologist, 100% renewables persepective or the Bush-style ‘oh well, this is a disaster’ approach –to the middle ground, to the economists’ position, which is all about cost-benefit".

Interview date: September, 2010

Interviewer: Antonio Barrero

Why is it necessary to support renewables?

The driving force behind support for renewables is the need to curb emissions. Renewable energies are part of the fight against global warming, one of the ways we can reduce emissions. There are alternatives, but they face a number of problems. Let’s look at them one by one: if we focus on carbon capture and storage technologies for example, to date they are not really sufficiently developed to make them cost effective. Looking at nuclear power ... we are going to face problems of an essentially political rather than economic nature. Any other alternatives? The imposition of carbon taxes, for example, would also face challenges, primarily of a political nature. From a strictly economic standpoint, I think that most economists prefer such taxes as they are neutral from a technological perspective and because they ensure the entire burden of reducing emissions does not lie with the electricity sector.

Neutral "from a technological perspective”?

Yes, neutral because they are not skewing the technological choices of businesses in favour of a particular technology. In other words, there would be no regulator saying that we will use one technology over another. Instead, market mechanisms would exist that determine which technology to use. It may be that after imposing the tax, one may not use fossil fuels, but whatever the case, the market will tell you which choice rather than a certain politician or regulator opting for solar photovoltaics (PV) one minute... or gas... or more or less coal the next. The tax would apply to all technologies, and would essentially place a greater burden on the worst emitters.

You said that climate change is behind the support for renewables. What are the other drivers?

A series of arguments has pointed towards saying: look, renewables generate a whole series of benefits, benefits that are highly important, but that market mechanisms would not give rise to on their own. Acting alone, companies would not take into account these benefits and, therefore, would under-invest in renewable energy, right.

Climate change is one of these arguments and there is ample evidence that it is real. Another, for example, is that renewables create jobs. Well, I tell you that the empirical evidence suggests that it is not clear whether they create or destroy jobs. It is true that a number of jobs are created in companies engaged in energy production using renewable technologies or primary sources of renewable energy. But on the other hand, to the extent that the output of other companies is reduced, there is also a drop in employment. Thus, in terms of employment, frankly, there does not appear to be a substantive impact of either a positive or negative nature.

More arguments ... To say that you require public support means having to argue that your investment generates positive effects on other areas of the economy, effects that are not necessarily to your own advantage. In other words, there have to be externalities for the economy as a whole. However, nobody has been able to demonstrate this using real data.

Any positive effects are more to do with basic research, i.e. with R&D into new forms of solar power generation to cite one example. In this case, there does seem to be benefits for the future. An entrepreneur invests, does not make much money today, but may eventually develop a solar technology that is truly valuable from a market perspective. I am therefore all for providing funds to invest in developing these new technologies. On the other hand, however, it is not clear that funding the installation of renewable energy capacity generates positive effects for the economy as a whole.

And finally, there is a third argument, which is security of supply. Wind and solar power is very secure with regard to issues such as natural gas prices skyrocketing because the Russians and the Algerians suddenly deciding to form a cartel. In principle, this explanation makes some sense, although the truth is that the ability of renewables to replace all our gas requirements is limited. All things considered, if one examines all the different arguments, as we do in our book, the position which stands up is the environmental stance. And we say, well, it may not be the way an economist would have wanted it, because we would have preferred the tax, but one also has to be realistic: imposing taxes is not easy for politicians. Moreover, it is also the case that the cost of environmental policy is almost too obvious.

In your book you say that "growth in renewable generation capacity is not determined by market forces (and in the foreseeable future is unlikely to be so). In contrast, growth is largely the result of government intervention". Is this the only way it has been possible to ramp up renewable energy? Or should one believe that business would have been the main driver if governments had not intervened?

The cost of these technologies means they are not competitive in an open market. Bear in mind that for wind energy to work, we are currently paying 75% above the market price. Six times the market price for PV. We have to massively subsidise them to enable them to compete on the market.

Proponents of PV say that grid parity will arrive in 2015, i.e. grid parity is just around the corner…

PV technology still has some way to go. In fact, the technologies we have now are probably not the ones that will be around in 2015, let alone in 2020. Make a prediction about parity ... well maybe it will arrive... or maybe not. What I would do with PV is wait for more mature technologies to come along, technologies that have a much more reasonable time horizon of economic viability, instead of betting on immature technologies now that might get replaced tomorrow and that will not reach grid parity now or even in six or nine years’ time. Why, because, PV technologies may emerge that can reach parity, but it will not be the ones in which we are investing right now.

And as an economist, what is your view on wind power?

Wind technology is mature, it is the technology that we will live with for a number of years. There may be marginal increases, improvements here and there, but this technology will be around for a reasonable period of time. PV is a different issue, because we are investing in technologies that are likely to be obsolete in the near future. If one hesitates to invest because another PV technology that is economical may come along tomorrow... then you wait until tomorrow.

Looking at gas and then nuclear power. Approximately 25% of Spain's electricity comes from renewable sources. That means that 25% of the electricity is not produced with either gas, coal or uranium. In the case of gas, all the gas we avoid consuming can be deemed a financial resource we are not sending to Algeria, for example. Does this not represent what we term “energy independence”?

What we mean by security of supply is not necessarily that. It is unclear whether we save money. It is true that you are generating electricity with free primary energy, but you are doing it at a cost. But, you are achieving this using technologies that are less efficient and which you have to support through feed-in tariffs. On the one hand, it is true that you make some cost savings on fuel, but on the other, you are paying more because a number of inefficient technologies have to be supported. The question is: which of the two responses is more economical, more efficient? It is unclear at this time that the most efficient answer is wind power.

The commitment to nuclear power by political authorities has a cost, or will entail a cost... to their image. Okay, that’s understood. However, the private sector can also opt for nuclear, but why, since the electricity market was deregulated in Spain in 1997 or thereabouts, have no new nuclear facilities been built?

As far as I understand ... we have a nuclear moratorium. Correct me if I'm wrong.

Sorry, but since 1997 any company can develop a nuclear power plant in Spain.

Well, there is currently a serious economic problem in this country with nuclear power plants. As an investor, the first thing I would need is a stable regulatory framework: because I’m going to invest a huge amount of money and I need to recoup it... and of course, if we look at what has happened in this country since 1998... it is clear that the oil prices have fluctuated, but I believe electricity sector regulations have fluctuated even more...

What a coincidence! Just what renewable energy developers are complaining about.

And no wonder. However, I do think everyone in this sector complains. Sometimes because some have fared better than others... and other times vice versa. However, I find it very difficult to see how someone will make a thirty-year investment without the sector outlook being much clearer. Because right now, I think it is poorly defined. In fact, I think trying to establish a stable regulatory system was behind the energy pact [in Spain], which it seems could not be reached in the end.

In other words, politics, as far as energy is concerned, has to intervene?

Well, politics is relevant to everything, especially to energy. And politics can intervene in two ways: it can provide a stable framework in which the private sector can work, or it can intervene every day. I think what the markets want is for politicians to sit down and define a framework which will then be stable ... which will then be deemed better or worse... but... it is better to have a bad framework than none at all. No-one likes to operate in markets where rules change overnight, because in such an environment of uncertainty, it is impossible to invest.

Could you classify the regulatory tools for supporting renewables in order of effectiveness?

We have used direct investment grants, quotas or caps, and the famous feed-in tariffs [FiT]. I think empirical evidence shows that, in terms of effectiveness and efficiency, FiTs have encouraged investment and have done so on the basis of efficiency and effectiveness at a reasonable cost. From an economist’s most theoretical point of view, FITs not only offer practical advantages, but also, theoretically, they are much more attractive.

Why? Because caps intervene in the market process and someone with divine inspiration has to decide “the quota must be specifically this figure or that”, while the same can be said of investment grants, where someone with divine inspiration says “you have to invest so much”. In conclusion, there is enough consensus that FITs are the best of all mechanisms: for reasons of design, compatibility with the structure of the deregulated market and, also, based on experiences in Spain and Germany.

Can you prioritise the tools to combat climate change?

Economics is the science of efficient allocation of scarce resources. Most economists believe that the first thing to be encouraged is energy efficiency. Unfortunately, very little has been done in this area. Why? Because as well as economics, one needs to factor in politics. And it's costly. It is costly telling people what to do, how to do it, and, above all, it is costly to implement control systems, testing and punishment for those who do not behave efficiently. We see this clearly with the management of urban waste.

Second choice? Well, since I cannot avoid waste, I will try to produce in a way that emits less. As economists, what we would say is: Well, first, let’s impose a carbon tax. What’s the catch? Well, that it is complicated and difficult to achieve in practical terms. So we turn to nuclear, renewables, carbon capture.

Looking at each individually: in this country, nuclear is impossible for political reasons. Carbon capture is not currently an efficient technology. PV is also not an efficient technology. So what is left? Wind... The question is how to offer the smallest possible feed-in tariff while still encouraging an adequate level of investment.

That said, for me, the best option is energy efficiency, carbon taxes, and then you turn to energy generation, which in terms of renewables today would, in my opinion, be wind power.

Does it make sense that the State provides financial support to the renewables sector which is currently still at a learning stage?

Generally speaking, yes. But for which technologies? Is it worthwhile continuing to subsidise wind for this reason? No, because wind power is a mature technology and therefore it is not the case that wind turbine design will change radically tomorrow as a result of installing more wind turbines in La Mancha, or that our electric utilities will learn how to optimise these wind farms, or that Red Eléctrica de España [Spanish electricity system operator] will be better able to manage the system. In fact, in this sense, the wind sector is operating as it always will: it is a mature technology. It is worth funding it for other reasons, but not this one.

PV is different, as it is not mature. Here, there is a lot of room for technological improvement, innovation. Of course, one must still decide what you are going to support. It is true that any investment in R&D made today will encourage the development of better technologies. This represents a future externality that may merit public intervention. Where? Who should receive funding? Those performing R&D, or those who acquire a site and build a solar array using existing technologies? I believe that if the argument is based on technological externalities, learning by doing, the economies of learning, then money has to be given to those conducting R&D. Okay. The question then is how many megawatts need to be installed to verify how the technology performs? Well, I think a lot less than we have installed in Spain. So, in principle, yes, but with limits, and deciding where to put the money. I'd put money into R&D.

Greenpeace published a paper a few months ago concluding that 100% of electricity could be renewable by 2050. What is your opinion on this statement?

We could easily fill Spain with wind farms. I have no doubt. But that's not the issue. The question is whether it is profitable, whether it is economically appropriate to invest this much. When we invest in renewable energy, particularly wind power, we are looking to fulfil three objectives: security of supply, meeting environmental goals, and generating energy to allow us to grow economically at a reasonable cost. I understand that Greenpeace gives priority to the environmental objective, and therefore says “go ahead, no matter what the cost". But then, what do you do with the other two dimensions? I, as an economist, would say “hey, do not forget you have to pay pensions ... and therefore we need a certain rate of economic growth, and if energy costs us a fortune... " I believe in what Ovid said of the Golden Mean, the Mediocritas aurea. It is less appealing, less sexy, but in the mean there is virtue, and so we must try to find a compromise.

So, I gather that you are in support of a diversified energy mix.

I think that the more diversified the better. I believe we are going to have to continue to invest in gas to support renewable energy and also to ensure the profitability of energy and supply. As for nuclear, there is not much to say... I am neither hugely in favour nor very ideologically opposed to one source of energy or the other. I think that the proportion of renewables in our energy mix has increased too quickly, probably because we have invested a little too much in PV, given its technological characteristics, and because we have also probably gone a little beyond what is reasonable with wind power too. The most appropriate scenario for a country is to have as diversified a mix as possible of the cheapest available energy sources.

And to round off, why a book like this at a time like now?

LECG [Padilla’s consultancy firm] works a lot on energy. We have been studying the Spanish market for a long time. Everyone who talks about renewables does so from the ultra-ecologist, 100% renewables' perspective or the Bush-style ‘oh well, this is a disaster’ approach. We believe virtue is the middle course. So we thought, let's bring together a large number of people with no specific ideological stance, people from different countries with different backgrounds, and see if we can say something that is pragmatic. We took this decision and then said, 'we’re not going to say yes or no, but will say: OK, are we going to have renewables? If so, we have to make sure they work as well as possible’. That was our logic: the logic has been to search for this middle ground and shift the [energy] debate from what we perceived as a debate between two extreme views to the middle ground, to the economists’ position, which is all about cost-benefit.

For additional information:

LECG Europe

Shoot, who would have tohguht that it was that easy?
I thank you humbly for sahinrg your wisdom JJWY
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