Market Forces

What can New Zealand’s forestry sector tell us about carbon pricing policy?

By / Published: August 21, 2023

New Zealand is currently reconsidering how its forestry sector can contribute to meeting its long-term climate change targets, and what this means for its emissions trading scheme (NZ ETS). A recent paper from researchers at Motu Economic and Public Policy Research and the Environmental Defense Fund sheds light on New Zealand’s innovative treatment of forestry in the NZ ETS, its impacts so far, and questions about where to go from here.

To help inform future policy choices in New Zealand and other countries, the research team examined patterns of behavior in New Zealand’s forestry sector under emissions pricing. While the NZ ETS has mobilised new forest planting and cut deforestation, the outcomes have not always supported policymakers’ intentions. Further policy changes will be needed to help New Zealand meet its climate targets through 2050 and beyond.

What is the New Zealand Emissions Trading Scheme?

To achieve a low-emissions economy, New Zealand has both international and domestic emissions reduction targets:

  • Under the 2015 Paris Agreement, New Zealand’s net emissions (including forestry) must be reduced 50% below 2005 gross emissions (excluding forestry) by 2030. This can be met through domestic emissions reductions and forestry removals (sequestration) as well as purchasing offshore mitigation.
  • In domestic legislation, New Zealand’s emissions of methane from agriculture and waste must be reduced at least 10% below 2017 levels by 2030 and 24-47% by 2050. For all other greenhouse gases, the target is net zero by 2050 and beyond. Five-yearly emissions budgets, set 15 years in advance, create stepping-stones to the 2050 target and must be met primarily through domestic action.

New Zealand’s unique economy, however, creates challenges in reaching these ambitious commitments. In 2021, over 50% of gross emissions came from agriculture. Powered by over 80% renewable electricity, New Zealand’s biggest energy emitters were from transport and industry. At the same time, New Zealand’s growing forests created net emissions removals from land sector, which offset 21% of its gross emissions. From 2008 to 2020, New Zealand relied heavily on domestic forestry and offshore mitigation to meet its international targets and gross emissions remained relatively flat.

Since 2008, the NZ ETS has served as the government’s main climate change policy tool. By linking a regulatory limit on total emissions to an emissions price in the market, the NZ ETS incentivises companies, consumers and investors to reduce their climate impact. The NZ ETS remains the only system in the world designed to cover all sectors and greenhouse gases, although pricing has been deferred for agriculture.

What lessons can other countries learn from the NZ ETS’ inclusion of forestry? Our study revealed the following findings:

Emissions pricing has driven change in New Zealand’s forestry sector

Between 2008 to 2022, New Zealand’s ETS has proven the feasibility of including forestry in an ETS at a sectoral level.

A successful cross-sector carbon market has been established in New Zealand and a significant proportion of post-1989 afforestation (new forest planting and growth) has been registered in the NZ ETS (60% as of September 2022). With broad coverage and clear liability provisions for landowners, the system has overcome key challenges to project-based forest crediting: accounting for leakage (where emissions are simply displaced, instead of actually reduced—such as deforestation moving from a protected plot of land to an unprotected plot) and permanence (where credited sequestration is reversed, such as when a protected forest sheds its stored carbon due to forest fires or illegal logging).

The research found emissions pricing influences forestry outcomes. Deforestation has generally declined with increasing emissions prices and increased when emissions prices dropped. Similarly, rising emissions prices have incentivised afforestation. This effect has been most pronounced following NZ ETS reforms in 2020. As emissions prices rose from NZ$12.7 to NZ$23.9  between 2016 and 2020, levels of net annual afforestation leaped from 2,692 hectares to 40,145 hectares (see the figure; note prices are in 2006 NZ$).

Figure: Annual area of net afforestation of post-1989 forest land and deforestation of pre-1990 forest land in New Zealand. The NZU price is shown by the black line beginning once the NZ ETS was implemented. NZU data are from Jarden and afforestation data from the New Zealand Ministry for the Environment. Refer to the paper for references.

In sum, the NZ ETS has clearly boosted forestry’s contribution toward New Zealand’s climate change targets over 2008–2020 and set the stage for further afforestation to accelerate under current policy settings.

 

Policy uncertainty, price, and the system’s shortcomings have dampened its impact

Despite this effect, over the first decade of operation, many factors likely limited the effectiveness of the NZ ETS in changing forestry outcomes. And recently the scheme has driven forestry removals but the focus on forests may have weakened the effect on gross emissions reductions in other sectors.

According to landowner surveys, extended periods of policy uncertainty impacted afforestation and deforestation decisions. This included reviews of the NZ ETS (in 2009 and 2011) along with international negotiations on post-2012 forestry rules. Moreover, weak emissions price signals (particularly over 2011–2016), along with an expectation that emissions prices would not recover, may have discouraged some landowners from investing in new forests. The NZ ETS had an unlimited linkage to the international Kyoto market from 2008 to mid-2015 and this markedly depressed emissions prices. For example, millions of seedlings established while emissions prices were high were mulched in 2014, when it became uneconomic to plant them after emissions prices fell due to linkage. When prices began to rise after the ETS was delinked from the international market it took several years for investors to begin to plant trees in response. And a hard price ceiling in place from 2010 through 2018 continued to constrain emissions prices after delinking occurred.

Through 2020, the NZ ETS resulted in increased afforestation but not costly emissions reductions in other sectors. Over 2008 to 2020, national gross emissions (excluding land use, land-use change and forestry) declined only 2.6%; however, this was during a period of growth in population, income and dairy production.  In part, the past failure to invest in significant emissions reductions in other sectors enough to much more than offset those growth pressures is likely to be due to the same forces – weak price incentives and policy uncertainty – that affected forest investments.  The option to rely heavily on forestry to help meet emissions reduction targets has also likely reduced political pressure to act in other sectors.

Forestry investment involves long time horizons, so market confidence and policy stability are crucial for harnessing the sector’s mitigation potential. Relying on blunt emissions price signals alone will not necessarily deliver desirable mitigation outcomes across all sectors.

EDF’s Chief Economist Suzi Kerr and Sandra Cortes Acosta planting trees.

Trees planted by EDF Chief Economist Suzi Kerr, three years later.

Emissions pricing for forestry has not always supported broader environmental outcomes  

NZ ETS incentives have favoured exotic over indigenous forest species, because of significant difference in mitigation costs driven by planting costs and growth rates, and driven land-use changes that impact landowners and communities in both positive and negative ways. Many Māori, New Zealand’s indigenous people, have strong interests in the system because of their large land holdings, their involvement in forestry businesses and their commitment to kaitiakitanga (guardianship).

As of September 2022, 89% of the forest registered in the NZ ETS was exotic. Although all forests provide co-benefits, indigenous and mixed-species forests can support higher levels of biodiversity and may offer improved resilience to pests, natural disasters, and climate change impacts. Many stakeholders have raised concerns about the environmental, economic and cultural implications of extensive exotic afforestation, both plantation and permanent, while others emphasise that exotics produce faster climate benefits and can help supply the bioeconomy. Some see the potential for exotic forests to transition to indigenous over time.

In February 2023, Cyclone Gabrielle sent forestry slash and other woody debris across northern communities on the North Island, contributing to further devastation that prompted a ministerial inquiry. The panel reported that “forestry has lost its social licence because of its activities.” Its recommendations included restrictions on land use and forestry practices in the region as well as NZ ETS reforms.

Further reforms are needed to both the NZ ETS and other policies to shape forestry’s contribution to climate change mitigation and broader environmental outcomes.

Conclusion

The NZ ETS will not remain fit for purpose in coming decades. Under current cap and price settings, high levels of afforestation will depress emissions prices, slowing decarbonisation in non-forestry sectors unless they are also regulated in other ways. As key sectors like stationary energy and transport approach zero emissions, the demand for forestry credits in the ETS will diminish. However, forestry removals will still be required in the long term to offset unavoidable emissions outside the ETS. New Zealand’s Climate Change Commission called for changes to the treatment of forestry in the NZ ETS in its 2023 draft advice report on New Zealand’s second emissions reduction plan.  In June 2023, the government initiated a policy review of the NZ ETS to consider both relative incentives for emissions reductions and forestry removals and policy settings for permanent forestry,

In Aotearoa New Zealand, emissions pricing has proven to be a powerful tool in driving afforestation and discouraging deforestation at a national scale. Enabling the NZ ETS to deliver an environmentally desirable and socially acceptable balance between gross versus net emissions reductions, plantation versus permanent forests, and exotic versus indigenous species in the longer term will require further reforms to the NZ ETS as well as land-use policy and regulation.

Catherine Leining contributed to this post in her capacity as a Policy Fellow at Motu Economic and Public Policy Research and not as a New Zealand Climate Change Commissioner.

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“Nothing about us without us: The case of JREDD+ in Colombia.” The importance of including all stakeholders, especially affected communities, at the decision-making table.

By / Bio / Twitter profile / Published: March 16, 2023

This blog was authored by Environmental Defense Fund economist Luis Fernández Intriago and Universidad de Los Andes professors Jorge García López and Julián Gómez Gil.

The saying “Nothing about us without us” is widely used among Indigenous Peoples and Local Communities to emphasize the importance of involving them in policies that govern their territories and communities. The expression serves as a call to action, highlighting that those affected by specific issues should be included in making policy decisions around them.

However, policymakers and researchers consistently decide on policy design and construct models without consulting and considering the opinion of the affected communities and key stakeholders. Efforts to stop deforestation are a clear example of this: new policies go into place without any input from communities that rely on forests for their livelihoods, cultures, or basic survival. These local and Indigenous communities are an untapped source of wisdom, leadership, and capacity to support efforts to conserve rainforests.

To remediate this, Environmental Defense Fund, Universidad de Los Andes, and the Centro de Estudios Manuel Ramírez, right since the beginning of the project, started an engagement process in Colombia to demonstrate how engaging key local and Indigenous stakeholders could lead to better policy design to protect forests in the country.

Why Colombia?

Colombia faces enormous challenges with deforestation: 184,000 hectares per year of natural forests were destroyed between 2017 and 2021. Deforestation accounts for 33% of the country’s total climate-warming greenhouse gas emissions. Thus, halting deforestation is critical for achieving the country’s Paris Agreement commitments (called “Nationally Determined Contribution” or NDC).

As in many other countries, the AFOLU (Agriculture, Forestry, and Other Land-use) sector is not subject to regulations in Colombia. However, this presents an excellent opportunity for the Colombian government to leverage private finance from national sources—such as through the upcoming Colombian Emissions Trading System[1] , which must be implemented by 2030—and international sources —such as the LEAF Coalition— using jurisdictional REDD+ (JREDD+) crediting. JREDD+ programs extend the REDD+ framework for sustainable forest management and conservation by addressing deforestation at the regional or ‘jurisdictional’ level—protecting forests across wide regions instead of plot-by-plot and even resources.

Climate mitigation is now a top priority for many individuals, governments, and corporations, creating strong demand for ways to stop deforestation in tropical forest countries in high-integrity ways rapidly. Our research finds that government funding required to reduce deforestation levels consistent with Colombia’s NDC could drop from $900 to $75 million when national and international private finance is harnessed.

The Study

Our study aimed to identify inclusive, equitable ways to include JREDD+ in Colombia’s climate mitigation policies. We established three parallel and interconnected pillars: first, we focused on engagement with primary stakeholders. Second, we constructed a model to illustrate how JREDD+ may help Colombia meet its NDC target cost-effectively while benefiting local communities. Third, we prepared a policy design that government can use as a guideline to integrate these approaches.

Engagement

At the beginning of the project, we knew we had to start by engaging with stakeholders to explain JREDD+. Our ultimate goal was to include the feedback and reflect relevant stakeholders’ needs—including the national government and public institutions, Indigenous groups, smallholder’s associations, NGOs, and educational institutions—in our results. We knew that communication between our research group and people who could be interested or potentially affected by the research project was crucial if we were to produce and share credible and legitimate knowledge. The knowledge acquired through these interactions can set the stage for an effective and equitable JREDD+ program in Colombia.

Source: Photos by Julián Gómez Gil.

In 2022, we hosted four engagement sessions in Tena (April 23 & 24, Cundinamarca), Florencia (May 5 & 6, Caquetá), Bogotá (October 14), and Mocoa (October 26 & 27, Putumayo). These sessions focused on the participation of representatives of the Amazon Indigenous peoples (OPIAC, OZIP, ACILAPP, etc.[2]),  other local communities and land users (farmers, cattle ranchers, and smallholders associations), NGOs (Amazon Conservation Team, WWF, Natura Foundation, Fondo Patrimonio Natural, etc.), private organizations (Emergent, Amazon Global, Permin Global, ALLCOT, Asocarbono, etc.) and national and subnational government institutions (Ministry of Environment and Sustainable Development, Sinchi Institute, Corpoamazonía, etc.). During these community meetings, we worked hard to improve participation but also set realistic expectations, and engaged in open-ended discussions where training was provided to the attendees regarding the formulation of projects of conservation, carbon markets, REDD+ projects, JREDD+ programs, guidelines of the ART-TREES standard and the operation of the LEAF call for proposals, through technical presentations and educational activities, and promoting the constant participation of the actors to create scenarios for debate and resolution of doubts.

In the same way, these spaces were used to formulate questions to the different actors, which were resolved both through open debate dynamics and through collaborative work activities, taking advantage of a closer and more direct dialogue with each one of them and a greater availability of time to delve into topics of interest. This form of participation was very well received by the Indigenous Peoples, who invited the work team to implement similar activities more frequently and in the most remote territories so that capacity building can be held and the local context is better perceived.

Given the scale of a JREDD+ program, the interaction and negotiation between local actors, institutions, intermediaries, and current individual REDD+ projects are essential. According to the discussion with stakeholders, a common problem associated with the participation of key actors and interested parties in individual REDD+ projects is that these actors tend to be treated as beneficiaries rather than partners. As a result, local communities and interested parties perceive that the design of incentives, local capacity, delivery mechanisms, transparency provisions, and distribution are only partially fair. This led us to consider fairness, representation, and transparency as critical components of policy design.

Modeling

We modeled a mechanism to integrate the potential funds generated with a JREDD+ and a national emissions trading system (ETS) to accelerate the reduction of emissions from deforestation. Mainly, we considered a scenario under which Colombia applies the LEAF coalition model on a national scale of a JREDD+ at the national level. At the same time, to ensure representativeness, bargaining power, effective resource administration, and a fair distribution of benefits, we proposed an internal administrative division of Colombia into five jurisdictions: 1. Caribbean region; 2. Andean region; 3. Pacific region; 4, Orinoquía region; and 5. Amazon region.

Our modeling revealed that integrating a JREDD+ program with a National ETS could be a cost-efficient mechanism to reduce the externality costs and disincentivize the overall GHG emissions of Colombia following the country’s regulatory framework, the emissions trajectory, and the mitigation objectives. These mechanisms could be used to generate and allocate economic resources to ensure efficient emissions mitigation, the incorporation of safeguards (such as environmental education), and the minimization and/or compensation of adverse socio-environmental interventions. In addition, the modeling results imply the generation of co-benefits (economic, social, and environmental) that contribute to the development of ethnic communities, local communities, and other private land users.

Policy Design (Results)

After receiving input from stakeholders and results from our model, we prepared a policy design that the government can use as a guideline to integrate JREDD+ inclusively and equitably. Here are our results:

  • Inclusive negotiating for benefits-sharing: To build a JREDD+ in Colombia, stakeholders demand a significant role in negotiating the benefit-sharing system. In this regard, national and subnational agreements should be established to achieve at least the following three main objectives: 1) provide effective monetary and non-monetary incentives; 2) contribute towards building legitimacy through a fair and equitable distribution of resources, responsibilities, and bargaining power; 3) include local actors in the decision-making process and recognize them as partners rather than beneficiaries.
  • Use vertical and horizontal benefit-sharing to equitably distribute benefits and negotiating power: A vertical benefit-sharing approach uses national voluntary and regulated market funds (ETS) to distribute benefits among national and subnational governments, non-governmental actors, intermediaries, NGOs, and facilitators. These transactions are carried out to ensure the operability of the program. On the other hand, horizontal benefit-sharing seeks to distribute the remaining benefits as incentive payments among and within communities, households, and local stakeholders. A fair design of benefit sharing must be vertical and horizontal to guarantee the bargaining power of the actors involved in deforestation and conservation activities.
  • Centralize decision-making, but include regional representation: Our main policy proposal is to centralize the decision-making with a single National Board of Directors. This board would be responsible for making central decisions and directly managing the resource flow. On the other hand, a Jurisdictional Board of Directors composed of representatives from each of the six jurisdictions must be created to guarantee the representativity and bargaining power of the different actors. This board will function as a participatory body overseeing operational decisions that a respective Jurisdictional Operating Unit should execute. With this management structure, it is possible to use the three sources of funding (JREDD+ results-based payments, the ETS, and the carbon tax) and to effectively distribute the benefits among implementing partners (NGOs, private sector, etc.) and land users (Indigenous Peoples, local communities, farmers & ranchers, etc.)
  • Leverage allowances from emissions trading system to support efforts to conserve forests: In our study, we assumed that much-needed finance for forest protection may come from two different sources: a nationally managed fund constructed using resources from the international voluntary market and from a locally regulated market (a national ETS), where regional and local public and private institutions intermediate implementation with local communities; and a project-based fund where national or international funding goes directly to projects, with resources from both the national general budget and payment by results or other international cooperation (JREDD+). To integrate both mechanisms and be consistent with Colombia’s climate law, we propose that 20% of the cap established by the ETS can be offset with forestry emissions reductions using a jurisdictional approach. In that way, the allowances allocated by the ETS to the forestry sector will generate an additional source of income to reduce deforestation.

You can read more about our study and policy design here. In general, our recommendations in this project were derived and enriched from the participatory processes we carried out. The participants’ comments helped us to refine, redefine, and validate these recommendations.

As Colombia works toward implementing its Emissions Trading System by 2030, we encourage them to consider these recommendations to inclusively and equitably incorporate JREDD+. We encourage them to consult with stakeholders such as Indigenous and locally affected communities to develop climate policy.

 

[1] The Colombian Emissions Trading System is scheduled to be implemented by 2030 according to the Law 1931 of 2018 and Law 2126 of 2021.

[2] OPIAC- National Organization of the Indigenous People of the Colombian Amazon, OZIP- Organization of Indigenous People of Putumayo Department, ACILAPP- Association of Traditional Authorities of the Indigenous Peoples of Leguizamo Municipality and Upper Predio Putumayo Territories

 

 

 

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Properly Pricing for Progress: How we can overhaul electricity tariffs to efficiently integrate distributed energy resources into the grid

By / Bio / Published: July 12, 2022

Dr. Beia Spiller is a Fellow and Transportation Program Director at Resources for the Future. She had previously served as a Lead Senior Economist at EDF.

This post is the final in a series dedicated to the future of the electricity sector and new scholarship supported by the Alfred P. Sloan Foundation. Each post is based on a discussion between select researchers and experts working on relevant policy. To learn more, visit the series website.

As a growing number of distributed energy resources (DERs)–from rooftop solar panels to batteries–make up a greater share of the nation’s electric grid, electricity providers, policymakers and academics are recognizing that most electricity tariffs do not value or compensate for them effectively.

In the most recent and final webinar, I joined three other panelists and discussed why the current pricing system doesn’t work and, more importantly, explored ways regulators and utilities can reimagine electricity tariff structures to better price DERs and encourage more efficient electricity use. Dr. David Brown, Associate Professor at the University of Alberta’s Department of Economics moderated the panel, which included Dr. Michael Caramanis, Boston University Professor of Mechanical and Systems Engineering, Dr. Burçin Ünel, the Energy Policy Director at the Institute for Policy Integrity at New York University School of Law, and Paul Phillips, an expert in California energy policy now overseeing the Retail Rates group in the California Public Utility Commission’s Energy Division. Read More »

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Creating Data to Support Communities on the Front Lines of Oil and Gas Production in the US

By / Bio / Published: June 21, 2022

This blog was co-authored by Kate Roberts.

This week we published a new study that combines locations of active oil and gas wells with census tract data in a way that helps us better understand the characteristics of the communities living near them. Our findings support what environmental justice groups have been voicing for years: in many counties across America, people who have been historically marginalized–communities of color, older Americans, children, and people living under the federal poverty line–often live near wells in greater proportions than the other groups that make up the rest of their local county.

In addition to publishing these data with our study, we also used it to develop an interactive tool, which users can access to explore how each of 13 different demographic groups relate to oil and gas wells across all US counties.

 

Case studies show the impact of overlapping demographics

For a long time now, EJ advocates have voiced the importance of taking a broader view of environmental stressors, and move beyond simply exploring outcomes for a single pollutant or population in isolation. In their seminal paper on this issue in 2011, UC Berkeley’s Rachel Morello-Frosch and her coauthors illustrate how critical it is to reframe our thinking around cumulative exposures and vulnerabilities, so that we may address environmental disparities.

A central aspect of our paper is to embrace this view: we developed an index to highlight the places with substantial overlap of historically marginalized groups, and where we also found a high density of active wells. We found about 41 clusters of interest across the country, which are predominantly located in three specific regions: California, the Southwest, (San Juan, Eagle Ford and Permian Basins in Texas and New Mexico), and Appalachia. The main demographic characteristics represented in these are outlined in the map below:

Taking a closer look at the Permian Basin (where EDF has conducted a methane monitoring initiative), one can clearly observe an abundance of active wells (the white dots). Certain counties here show a lot of overlap across historically marginalized groups, such as Lea and Eddy (in New Mexico), and Andrews, Crockett and Sutton (in Texas).

For example, in Lea county, Hispanics, children under 5, and unemployed individuals compose 59%, 9%, and 7% of the total population, respectively. Compare this to averages of 24%, 7%, and 4% across all counties across the US  where wells are found.

 

A basis for both current and future study

Users can explore the full data set, for all US counties, to learn more about the people living within 1, ½ , ¼, or 1/10th  of a mile of active oil and gas wells. This kind of information can be useful to a variety of organizations, like environmental justice and community groups to  highlight threats faced by people on the front lines, or health researchers, who can use this data to research projects delving into the health and other impacts associated with oil and gas operations.

It could also prove useful for policymakers concerned about the threats faced by their constituents, and to shape better policies.  For example, local, state and federal officials could use the data as they consider requirements designed to protect those who live in closer proximity to oil and gas wells, like more frequent leak inspections, appropriate setbacks, mitigation efforts to reduce light, noise and dust impacts, provision of information and services to populations in multiple languages, and the reduction of heavy truck traffic, as well as the elimination of high-polluting pneumatic devices and routine venting and flaring.

The new analysis comes as the EPA is considering new requirements to limit methane pollution from oil and gas wells across the U.S. Leading states including Colorado and New Mexico have established requirements in recent years that help protect frontline communities from oil and gas pollution including regular inspections at smaller wells with leak-prone equipment and bans on routine flaring. EPA will have the opportunity to build from these comprehensive approaches when it issues its supplemental rule proposal later this year.

Our methods used in the study can also be applied towards other environmental stressors. For example, EDF has used the same approach to explore communities living near large warehouses that attract polluting truck traffic, and other petrochemical facilities across the United States.

As you explore the interactive dashboard, let us know what you think. How can this data be made useful and supportive towards your own goals? Are there other ways it should be presented, or adapted so that it can be more effective? We’re happy to help you learn more about how you can make sense of it and what it means for your local community.  Please feel free to get in touch, and we hope to include your feedback in future versions of this tool and as we build out more population mapping efforts.

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Mass Appeal: How can we make electrification more affordable and equitable?

By / Bio / Published: April 25, 2022

This post is the fourth in a series dedicated to the future of the electricity sector and new scholarship supported by the Alfred P. Sloan Foundation. Each post is based on a discussion between select researchers and experts working on relevant policy. To learn more and join one of our upcoming conversations, visit the series website.

Distributed energy resources (DERs)—from rooftop solar to electric vehicles (EVs)—have amazing potential to reduce greenhouse gas emissions and help us reach our climate goals. Their widespread adoption, however, could also bring unprecedented stress to an already aging electric grid. Upgrading both local and system-wide electricity grids to support this change will require thoughtful planning to minimize costs and recover these equitably.

On our recent webinar funded by the Alfred P. Sloan Foundation, the panel delved into the growing adoption of DERs, the data needed to understand trends and provide more accurate forecasting for future investment, as well as the costs—and their allocation—of upgrading our electric system to accommodate this seismic shift. Moderated by Elizabeth B. Stein, Lead Counsel for Energy Transition at Environmental Defense Fund, the panel included Dr. Jim Bushnell, Professor of Economics at the University of California, Davis; Dr. Anamika Dubey, Assistant Professor of Electrical Engineering and Computer Science at Washington State University; Dr. Alan Jenn, Assistant Professional Researcher at the Institute of Transportation Studies at the University of California, Davis; and Michelle Rosier, the Economic Analysis Supervisor for the Minnesota Public Utilities Commission.

As California goes… Read More »

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Grid makeover: New research shows how the integration of renewables is exposing design flaws in energy markets and offers paths to improvement

By / Bio / Published: March 2, 2022

This post is the third in a series dedicated to the future of the electricity sector and new scholarship supported by the Alfred P. Sloan Foundation. Each post is based on a discussion between select researchers and experts working on relevant policy. To learn more and join one of our upcoming conversations, visit the series website.

As energy providers around the country integrate a growing volume of wind, solar and batteries into their systems, researchers and regulators are seeing compelling evidence that markets may require design adjustments to address inefficiencies.

Our recent webinar, funded by the Alfred P. Sloan Foundation, examined how market designs can lead to clean energy outcomes—and potential unintended consequences like an increase in CO2 emissions.

Moderated by Sarah Ladin, an attorney at the Institute for Policy Integrity, the panel—which you can watch here—included Dr. Catherine Hausman, an associate Professor of Public Policy at the University of Michigan and a research associate at the National Bureau of Economics Research, Dr. Chiara Lo Prete, an Associate Professor of Energy Economics at the Pennsylvania State University and Valerie Teeter, the Deputy Director of the Office of Energy Market Regulation at the Federal Energy Regulatory Commission (FERC).

Ancillary services markets, renewables and their impact on generation

While most economists tend to examine wholesale energy markets, Dr. Hausman has researched ancillary service markets, which provide essential services for maintaining a secure and stable power system. One of these markets is the frequency regulation market, which is crucial for ensuring reliability. This market helps maintain the appropriate balance of supply and demand by paying generators to make small adjustments to their output. Dr. Hausman’s research explores the potential for ancillary service markets to interact with and affect the wholesale energy market.

Her research studied the PJM frequency regulation market in the northeastern United States from 2012-2014 to show how generators responded in the wholesale energy market. Her team discovered significant spillovers across markets, as generators adjusted both the amount of energy they generate as well as the fuel and technology type. For example, because the frequency regulation market requires generators to fluctuate their generation, some may need to increase their daily generation significantly in order to allow for the footroom needed to make these adjustments. These results suggest that the ancillary services markets interact directly with generation markets in ways that academic economists haven’t previously considered.

Renewables, batteries and climate change are leading to a rethinking of ancillary services, she argues. If system operators aren’t careful, the utilization of batteries to provide frequency regulation could lead to the unintended consequences of increasing CO2 emissions. For example, if a battery enters the frequency regulation market, this may reduce the need for a coal plant to participate in frequency regulation, resulting in an increase in coal-fired capacity in the wholesale market and, in turn, emissions. “In a world without the ideal carbon emissions regulation that we might hope for,” Dr. Hausman argued, “we need to be careful about the unintended consequences of our policies, especially around things like new technologies or changes to electricity markets.”

Managing the unpredictability of wind

Dr. Lo Prete’s research examined why the increasing penetration of wind in U.S. energy markets poses a unique challenge. Markets operated by Independent System Operators (ISOs) rely upon forecasts to schedule dispatch of both wind and non-wind resources one day ahead of time (with adjustments to dispatch happening in real time as demand and supply varies). While weather forecasts have improved dramatically, predictions for wind are not as precise, and any inaccuracy can impact other forms of energy, which need time to adjust their generation (for example, coal plants take 10-20 hours to reach 70% capacity).

If the wind does not blow as expected, “peaker” plants (dirty, inefficient fossil fuel-based generators that run only a few hours of the year) must ramp up quickly to meet demand. Conversely, if the wind blows unexpectedly hard, some non-wind generation units that had ramped up the day before in response to the forecast lose their spots in real time, leading them to burn fuel while sitting idle (units that have committed to turning on can’t easily turn back off, and then run at their minimum output level). “Once they’re committed, they can’t be de-committed,” Dr. Lo Prete explains.

Both these outcomes are inefficient and can increase the need for uplift payments, or out-of-market payments to generation or demand response resources that ensure generators are adequately compensated when they’re ordered to either produce or reduce power. Ensuring that forecasts are more accurate is one way in which these inefficiencies can be reduced.

She also found an interesting interaction between the wholesale and ancillary service markets that creates greater inefficiencies due to wind variability and inaccurate forecasting. Specifically, for baseload plants (including coal and natural gas combined cycle) that participate in both the energy and reserve markets, if the wind ends up blowing less than expected, these plants can shift capacity towards generating, thereby reducing their reserves. Because these plants are cheaper to operate than peaker plants, this reduces the market clearing bid below peaker plant marginal costs, thereby requiring more uplift. Dr. Lo Prete was surprised by this finding, and said she originally had not planned to incorporate both markets into her research. But her findings demonstrate the need for researchers to think about the system in a holistic manner, incorporating all market participation into their modeling efforts. She encouraged researchers in the audience to take this approach, stating that “it’s going to become more and more important to look at the combination of ancillary services with energy markets, and with other markets as well (such as capacity markets).”

FERC exploring market reform

Ms. Teeter noted that as the resource mix is changing, FERC (the agency that regulates transmission and wholesale markets) is exploring how market design in both the wholesale and ancillary service markets can address the need for greater operational flexibility. Given variable energy resources’ inability to ramp up or down generation on demand, the remaining generation needed to meet total load will need to be much more flexible in real time.

It is therefore critical that market rules do not create participation barriers for generators that can quickly ramp up or down. The Commission is exploring whether new market products can help compensate those generators able to meet this ramping need, as well as how market designs can better incentivize resources to reflect their operational flexibility in their price bids. Given that new resource types such as batteries have greater operational flexibility, the Commission is also examining whether market rules create any undue barriers that prevent these resources from providing this much-needed service.

Need for continued interaction between academics and policymakers

During a robust discussion among panelists, Dr. Hausman noted the critically important link between researchers and regulators. Because the grid is changing so quickly in the absence of a national climate policy on carbon emissions in electricity markets, researchers should be looking into unintended consequences and presenting their findings to agencies like FERC to find adequate solutions. “The market is not just going to automatically take care of itself,” she said.

Regulators rely upon this type of input for making informed decisions. Ms. Teeter described some recent technical conferences during which stakeholders, experts and academics discussed key issues related to changing system needs. Conferences like these, as well as the public docket, she noted, are ideal venues for academics to share some of their latest thinking on market issues and challenges that may exist.

“Commission staff appreciates the ability to dive into these issues and understand the technical thinking that’s been done and have that thinking inform their decisions,” Ms. Teeter notes. Research like that conducted by the other panelists can be useful to the commission and its staff as it examines whether energy and ancillary service market reforms are necessary to address changing system needs in the evolving electricity sector.

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