Could a carbon price actually harm renewables?

Many of the targeted behavioral responses to climate change involve reducing energy consumption. This makes sense as the majority of energy consumed (pretty much throughout all history) has involved burning of fossil fuels, and this, in turn, is responsible for the ridiculous buildup in greenhouse gases, notably CO2.

So the main thrust of smart climate change policy (in all its forms) should be to raise the cost of fossil fuels so that they will be used less and that there is a disincentive for innovations that use more fossil fuels. The problem is, from an economy-wide perspective, taxes or other instruments used to do so will raise the cost of energy across the board. That’s fine if the only way to cut emissions is by reducing energy consumption. But what if that isn’t the best way to go?

Consider this: you are building a new house. You care about the environment (but you’re also a bit stingy), so you could design it so that it is more energy-efficient. If the future cost of energy is going to be high, that is a good plan, from a cost perspective.

But you will likely have to make trade-offs. If you want more natural light to cut down on power use during the day, you will have to accept a less weatherproof house. If you don’t want that trade-off, you will have to install better windows, making the cost of the house more expensive. Still, this may work out economically for a future world contingent on a higher energy price.

Suppose this all works as planned. We put a tax on carbon. Energy prices surge to a new high. And houses are converted to be long-term energy-efficient. That sounds like good news except for one thing: it is a disaster for those currently investing to make solar power more cost-effective.

Why is this so? Well, those investing in solar power are going to make more money if other people’s homes use lots of energy. If, instead, most of them have converted to a low-energy architecture, then the willingness of consumers to pay for solar power goes down.

Subtly, a carbon tax has dueling effects. Yes, it pushes people to substitute away from fossil fuels for electricity (a plus for solar and the environment), but at the same time it drives up the cost of energy itself thereby creating an incentive for consumers to economize on energy (a negative for solar).

When fossil fuels are a large share of current energy, the negative can outweigh the positive, creating risk for solar energy innovators. (Still skeptical? The math is here in a paper I published a few years back in the American Economic Journal: Economic Policy.)

This week this actually became more relevant. On Thursday, Tesla announced a new division to invest in battery technology to be installed in dwellings and businesses and even grouped in power facilities. The batteries would store any excess energy from solar panels and use it to power a home at night or charge up an electric car. This could also help existing electricity grids manage peak-load issues by allowing consumers to draw in power when it is cheap and draw it out of the battery when it is expensive.

More critically, it is a complement to solar. One of the big issues in solar energy is that it is dependent on the daily cycle. So if most of your power needs are during the evening, you have a problem. The battery is intended to solve that issue.

In the process, it makes solar power more valuable to consumers. Couple this with the forecasts of Ramez Naam that solar panel costs are falling at their own Moore’s Law-type rates, and the outlook is quite favorable. Tesla founder Elon Musk believes it is technically possible to convert all of our current power production (and by “our” I mean for the entire Earth) to solar within decades.

To do this, Tesla will be building lots of factories, but the company has also opened up its patents so that others can invest more in batteries as well.

The bulk of the capital needed to roll out the battery and solar solutions Musk is promoting, however, has yet to be spent – by Tesla or any other company. Herein lies the risk. If we act too quickly to raise the costs of carbon, pushing up the price of energy, it may be that we harm private-sector efforts to promote solar power, which in turn will make innovations in battery technology less rewarding.

I raise this point not to diminish the efforts to put a price on carbon. There are many reasons why this is a sensible direction. But I believe that we need to acknowledge the real risks to private-sector innovation if we substitute fuel sources that themselves promote energy use. Solar power is such a fuel and its return is contingent on a healthy demand for energy that may be at risk if people pre-emptively economize on that energy.

I suspect that this means that as we put a price on carbon, we will need to consider public or other collective measures to ensure that innovations such as Tesla Energy are able to be diffused. In other words, a carbon price is not a “set it and forget it” policy but part of a suite of measures that we will need to effectively manage our energy issues – including more government aid for the solar sector.

This article is published in collaboration with The Conversation. Read the original article.
Publication does not imply endorsement of views by the World Economic Forum.
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Author: Joshua Gans is Professor of Strategic Management at University of Toronto.
Image: Rows of solar panels face skywards at the Greenough River Solar project near the town of Walkaway, about 350 km (217 miles) north of Perth. REUTERS/Rebekah Kebede