ARTICLE IN PRESS

Energy Policy 32 (2004) 1799–1805

Renewable energy and market-based approaches to greenhouse gas

reduction—opportunity or obstacle?
Carrie L. Sonneborna,b,c,d,*
a
Murdoch University, Perth, Western Australia (WA)
b
Australian Cooperative Research Centre for Renewable Energy (ACRE), Perth, Australia WA
c
Cooperative Research Centre for Greenhouse Accounting, Canberra, Australia
d
Graduate School of International Studies, University of Denver, University Avenue, Denver, CO, USA

Abstract

Market-based approaches to greenhouse gas (GHG) reduction, such as emissions trading, are increasingly favored as an
alternative to ‘command and control’ legislation. With a focus on the Australian renewable energy (RE) industry and policy
situation, this paper proposes that the development of RE technologies as a response to global warming is environmentally
preferable and in the long-term economic interest of Australia. However, the Australian RE sector is disadvantaged by energy
market distortions and lack of policy and program support. Under a market-based approach to GHG reduction complimentary
policies will be needed to enable the uptake of RE technologies. The RE sector can also develop certain capabilities to help further
the uptake of RE technologies in a market-based environment.
r 2003 Elsevier Ltd. All rights reserved.

Keywords: Renewable energy; Greenhouse gas reduction; Market-based mechanisms

1. Introduction intention to implement ‘‘a broad, market-based pro-

gram’’ in 2012 if a review of CO2 reduction indicates
Australia and the United States are currently the only that additional action is necessary.
two developed countries that have opted not to sign the In Australia the recent Council of Australian Govern-
Kyoto Protocol in its current form. The Kyoto Protocol ments (COAG) Independent Review of Energy Market
is founded on the use of market-based approaches to Directions (COAG, 2002) has recommended the estab-
greenhouse gas (GHG) reduction, such as emissions lishment of a national emissions trading program to
trading. Nonetheless, both governments continue to address greenhouse policy problems. The state of New
embrace market-based approaches in preference to South Wales (NSW) has also placed a cap on CO2
command-and-control regulations (See Box 1) for emissions and has instituted a state-wide emissions
GHG reduction. For instance, in the USA, President trading scheme.
Bush’s Clear Skies and the Global Climate Change In February 2002 the US and Australia announced a
Initiative will set up or expand emissions trading to cap Climate Action Partnership agreement in which they
sulfur dioxide, nitrous oxides and mercury emissions agree to collaborate on GHG reduction activities, some
from power-plants. There are no mandatory reductions of which seem to foreshadow the possibility of GHG
of carbon dioxide but a voluntary strategy to cut the trading (Kemp, 2002a). The first set of 19 cooperative
greenhouse intensity of the American economy by 18% projects was announced on 19 July 2002. Though not
over the next 10 years (Bush, 2002). Aspects of the stated as an objective, some activities under the
Initiative which support and foreshadow future GHG partnership would support future emissions trading
trading include improvements to the USA’s GHG between the two nations. These include collaboration
registry, provisions for credit for early action and the on GHG accounting from agriculture, land use change
and forestry activities and working with business to
*Tel./fax: +1-720-963-1236. encourage voluntary abatement action and common
E-mail address: csonnebo@du.edu (C.L. Sonneborn). approaches to reporting and verifying emissions

0301-4215/04/$ - see front matter r 2003 Elsevier Ltd. All rights reserved.
doi:10.1016/S0301-4215(03)00166-6
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1800 C.L. Sonneborn / Energy Policy 32 (2004) 1799–1805

Box 1
Command-and-control refers to direct regulation of the amount of allowable pollution, the control technology used or the control of allowable
actions, for example, the amount of wetlands that can be filled. Under such a mechanism, for example, a firm would be allowed a legal limit of
pollution emissions beyond which it would be warned, fined or penalized as applicable for the violation. To achieve this level of acceptable
emissions/effluents, the firm may have to install abatement equipment or adopt abatement practices. All firms would be expected to achieve the
same level of emission, regardless of individual economic or practical efficiency. Failure to comply with such standards would usually result in fines
or legal action.
A number of reasons can be given for the practical appeal of command-and-control regulation for environmental protection. In principle,
environmental targets can be achieved with a high degree of certainty and it is a common form of implementing government policy, so authorities
have experience in the administration of the command-and-control approach. Similarly, industry is also familiar with operating against a
command-and-control background. Despite these pluses it is generally agreed that command-and-control regulation lacks flexibility and can result
in sub-optimal outcomes in terms of environmental and economic efficiency.
Market-based mechanisms or ‘economic instruments’ have their foundation in the operation of market forces. Their aim is to align private costs
with social costs so that there is an economic incentive for polluters to reduce emissions. The type of control technology or particular actions that
are allowable are not dictated. Such an approach acknowledges differences in production processes that exist among firms, allowing companies to
pick their own mix of controls and response and therefore result in lower dollar costs.
Market-based approaches are generally favored by commercial concerns as these methods can give more flexibility and economic efficiency to
abatement efforts. This in turn can make market-based approaches the more politically feasible policy option. A variety of market-based
approaches have been developed including pollution fees/taxes; subsidies; deposit-refund systems; permit trading systems; performance bonds and
liability payments; fuel source information; incentive marketing schemes; licensing and quota systems.

reductions, with the possibility of domestic crediting of At first glance, market-based approaches to GHG
these reductions (Kemp, 2002b). reduction can appear to be advantageous for the RE
Market-based approaches are central policy instru- sector. RE businesses have the opportunity to provide
ments in some recent programs for GHG reduction in zero-emission products and services to emitting busi-
Australia. In some of these programs the price of carbon nesses that will have to purchase emission permits or
is closely linked to the price of RE technologies (see Box abatement certificates; RE projects will not have the
2). In light of these developments, the focus of this expense of purchasing permits/certificates; RE projects
article—to consider the impact and opportunities are a means to create CO2 credits/certificates.
represented by market-based approaches to GHG Despite the fact that certain RE technologies, e.g.
reduction on the Australian renewable energy (RE) large wind energy projects, are increasingly competitive
sector—is particularly timely. A key concern is that an with fossil fuel technologies such projects have difficulty
emphasis on market-based approaches to GHG reduc- getting established. In the absence of market reform and
tion coupled with inconsistent support for RE may have policy support, market-based approaches to GHG
negative impacts on the development of the nascent reduction will present RE technologies with the same
Australian RE industry. barriers.
In this paper, RE is defined as production of The observation that one particular technology will
electricity, transport fuel or process heat from sources eventually dominate within a market niche or need is a
that do not run out—sunshine, wind, flowing water and common one in the policy and marketing literature.
organic material (bioenergy). RE technologies include Fossil fuel electricity generating plants are one example
solar power, solar thermal, wind turbines, hydro power, of a technology that is ‘locked in’ because of their long
wave and tidal power, biomass-derived liquid fuels and production history, which has reduced their costs many
biomass-fired generation. fold. Over time an extensive infrastructure of fuel
Box 1. Definition of market-based mechanisms vs. supply, maintenance and other ancillary services has
command and control regulation for environmental developed which provides ‘positive feedback’ for the
protection Box 2. technology to maintain its dominance. In addition, these
technologies grew up at time when health and pollution
damages or ‘externalities’, i.e. the society-wide costs of
energy use including the cost of health and environ-
2. Market-based approaches to GHG reduction unlikely mental impacts, were implicitly valued at $0 (Kline,
to benefit RE 2001). In contrast, the RE sector works against a
background of entrenched market distortions.
‘‘yRE has considerable potential in the current Today, this situation inhibits the energy market from
development of the energy sector. This potential will choosing the best option with respect to environmental
not be realized while the cost of carbon remains impacts and sustainable development. Some examples of
external to energy pricesy’’ (BP Australia, 2002, market obstacles currently facing the RE sector in
p. 11). Australia include:
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C.L. Sonneborn / Energy Policy 32 (2004) 1799–1805 1801

Box 2
Some market-based approaches to GHG reduction and RE market development in Australia
New South Wales (NSW) Electricity Supply Amendment (GHG Emission Reduction) Act (Dec 2002)—The NSW State Government has set a
state-wide benchmark of reducing GHG to 7.27 tonnes of CO2 equivalent (tCO2-e) per capita by 2007 (5% below the Kyoto Protocol baseline year
of 1989–90). From 1 January 2003 NSW electricity retailers and certain other parties will be required to meet mandatory targets for abating the
emission of GHG from electricity production and use. Participants will have to reduce their emissions of GHG to the benchmark levels, or pay a
penalty per tonne of emissions above their targets. Benchmark participants can off-set their excess emissions by surrendering abatement certificates
bought from low-emission electricity generators (e.g. RE) and other persons accredited as certificate providers. The scheme also allows customers
with large electricity loads, or who operate projects designated as Projects of State Significance under the NSW planning legislation, to manage
their own emissions and obligations. RE purchased to reduce CO2 emissions by NSW electricity retailleers can also be used to satisfy the federal
MRET requirement (NSW Greenhouse Gas Abatement, 2003).
Mandatory renewable energy target (MRET)—In effect MRET combines command-and-control with market-based principles. In 1997 the
federal government created an obligation on electricity retailers and other large electricity customers to source an additional 2% of their electricity
from RE or specified waste produces energy sources by 2010 (AGO, 2003). However, the trading of Renewable Energy Certificates (RECs) creates
market flexibility in how companies manage their MRET obligation. In its short lifetime MRET has had a turbulent history. Initially resisted and
then diluted by the fossil fuel electricity sector, there have been calls to reform MRET by the RE industry, e.g. increase the target to 10%, disallow
large hydro. At the other extreme some fossil fuel concerns have called for MRETs dismantling. MRET commenced on 1 April 2001, though the
target and program structure are already under review.
Greenhouse-friendly Program—The goal of this federal program is to increase consumer awareness of the greenhouse impacts of consumable
products. Businesses can obtain certification for products or services whose whole-of-life GHG emissions—from production and transport through
to use and disposal—have been offset through investment in corresponding GHG abatement. The program is based on a contractual relationship
(rather than a legislative basis), which ensures that participants continue to meet their obligations. The main benefit to the company is in being able
to display the Greenhouse Friendly logo in conjunction with the sale and marketing of the certified product (Thompson, 2002/03).
National green power accreditation program—This program originated with the NSW Sustainable Energy Development Authority in 1997 and is
now offered nationally. The aim of the program is to facilitate the installation of new ‘Green Power’ electricity generators, with a view to reducing
GHG emissions. It does this by increasing consumer awareness of, and confidence in, Products provided by Green Power retailers, thereby
promoting their successful market entry and penetration. ‘Green power’ electricity marketing attracts customers by offering them electricity from
RE sources. RE purchased to make Green Power sales cannot be used by energy suppliers to meet their MRET obligations (National Green Power
Accreditation Program, 2000).
Greenhouse challenge program—The Greenhouse Challenge was launched in 1995 as a joint voluntary initiative between the national
Government and industry to abate GHG emissions. Participating organizations sign agreements with the Government that provide a framework
for undertaking and reporting on actions to abate emissions. The aim of the program is both GHG emissions abatement and building the capacity
of Government and industry to identify, monitor, manage and report GHG emissions—in short, the skills needed to take part in an emissions
trading system. The stated benefits for participants are: saving money through identifying energy waste; obtaining technical assistance and policy
assistance from the Greenhouse Challenge Office; taking part in workshops and learning from other companies experiences as a member of the
Greenhouse Challenge network of participating businesses; being recognized for GHG reduction efforts in the Greenhouse Challenge Office’s own
promotions and by use of the Greenhouse Challenge Members’ Logo on products and corporate information; gaining technical capability and the
internal systems and structures to collect emissions data, and monitor and manage future emissions (AGO, 2002a).

Existing and historical subsidies support fossil fuel compared with the cost of stand-alone systems (Saddler,
interests—For many decades the prevailing objective of 1995).
energy policy was to develop a strong energy supply (as Current energy policy in Australia does not reflect an
a prerequisite for—and even a measure of—economic acknowledgment of the RE sector as a nascent energy
prosperity and growth. An equal objective was provid- sector of the future. For example funding for the
ing affordable, reliable, and convenient energy to Australian Cooperative Research Centre (CRC) for RE
individual citizens as a means of improving quality of has been discontinued leaving the country without a RE
life. In that context governments provided a variety of research and development funding agency for the first
subsidies for fossil fuel development. One estimate is time since the 1970s oil shocks. In contrast the fossil fuel
that in Australia in the period since the end of World sector has three CRCs in support of research relevant to
War 2, the fossil fuel industry as a whole enjoyed over the sustainable development of coal and petroleum
$A3 billion in direct subsidies and consumers of fossil industries, with total federal funding of $A55 million.
fuels received about $A37 billion. While many of these The Australian Greenhouse Office (AGO) has also
subsidies have been discontinued they were important in provided $A77 million to the coal and aluminum
the development of the fossil fuel sector. Some of the industries in recent years to cut their GHG. The AGO’s
subsidies to electricity consumers had the effect of charter does not include funding RE research and
discriminating in favor of the choice of grid-supplied development. Removing subsidies to fossil fuels—or
fossil fuel generated electricity and against the choice of providing equal assistance to RE—would help balance
stand-alone RE systems in remote areas, where RE is the situation.
most economic. These include cross-subsidization of Lack of consideration of externalities: For society-wide
rural electricity consumers, more generous tax deduct- economic efficiency, including externalities in the price
ibility for the cost to consumers of grid connections, of energy would give a better estimate of the real cost of
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energy and enable true comparison of the cost of RE energy industries because their capital requirements are
and fossil fuels. Rigorous evaluation of externalities is a much more modest and their labor needs greater. The
valuable decision-making tool when making major analysis states that generating 1000 GW h of electricity
political and economic choices in the field of energy per year requires 100 workers in a nuclear plant, 116 in a
policy. Such tools are increasingly available, e.g. a coal-fired plant, but 248 in a solar thermal facility and
consortium of European and American researchers (NB. 542 on a wind farm. In 2002 the NSW Sustainable
The Americans pulled out in 1995) have developed a Energy Development Authority (Australia) commis-
model for defining the externalities related to electricity sioned a study to model the impact of the sustainable
production. One estimate from the initial study is that if energy industry on the NSW economy and jobs. The
externalities were taken into account in the energy field, report concludes that economic activity in NSW
the price per kW h of fuel of petroleum origin would (gross state product) could increase by more than
double. The study also compares the energy externalities $A500 m annually, with up to 4000 new jobs created,
for wind, solar, nuclear, biomass, coal, oil, natural gas both within the industry and in the broader economy
and hydroelectric fuel sources (RTD info, 2002). (SEDA, 2003).
Obstacles to distributed generation: Historically, dis- Business opportunities: According to the International
tribution networks have been designed to take electricity Energy Agency (IEA) non-hydro RE technologies will
from the high voltage transmission system and deliver it grow faster than any other primary energy source at a
to customers. In order for the networks to accommodate rate of about 3.3% per annum between 2002 and 2030,
increased levels of distributed generation—typically RE albeit from a very small base (IEA, 2002). Other
and smaller co-generation—then energy flow in both forecasts predict clean energy markets globally will
directions will have to be managed both to the customer grow from $7 billion in 2000 to $82 billion in 2010
and from the distributed generator. This transition is a (Massey, 2002). The International Energy Agency (IEA)
major challenge. The structure of the electricity market has also estimated that the global market for RE will
itself presents some barriers to the adoption of increase from 13 GW in 1995 to 43 GW in 2010 (an
distributed power. Market rules and business practices increase of over 230%) (DISR, 1999). All of these
frequently nullify the advantages of distributed power predictions indicate business opportunities in the field of
and slow market adoption. For example, owners of grid- RE will grow rapidly in the future, though fossil fuels
connected distributed power generators can pay exces- are still likely to dominate the energy scene.
sive and prohibitive charges for their connection to the Sustainable development: The developing world has
grid as a backup power source, even if they never use the opportunity to ‘leapfrog’ directly to RE technolo-
any grid power. gies, rather than transitioning from a fossil fuel
economy as the industrialized world would have to.
This would not only help avoid the climate change and
3. Why support RE? pollution issues the industrialized world now faces but
could also ensure security of supply and more jobs for
As discussed, market barriers currently inhibit RE the same amount of energy produced, according to Jose
development. In addition the longer-term benefits of Goldemberg, Brazilian Secretary of State for the
supporting the RE sector are often overlooked. These Environment (Mathias, 2002, p. 14).
benefits include: Despite the lack of agreement at the World Summit
Energy security: Since the ‘oil shocks’ of the 1970s and on Sustainable Development (held in Johannesburg in
the prospect of finite and diminishing fossil fuel supplies 2002) on setting global targets for increasing RE, for the
energy security has been a high-level policy concern. first time RE was recognized as being at the core of the
Generally this has focused national energy policy on sustainable development agenda. Though a consensus
increased R&D for fossil fuel exploration and proces- was not reached on the issue of RE targets, the majority
sing. Another approach would be to promote energy of countries would have done so and many (e.g.
efficiency and support non-fossil fuel industries and Norway, New Zealand, Iceland, Switzerland and the
technologies. Increasingly, governments around the Alliance of Small Island States) went on to agree to set
world are using a range of policies and measures to their own domestic RE goals (Mathias, 2002).
support the development of RE (and energy efficiency) Global warming: The likely impacts of global warming
technologies and measures. e.g. requirements to increase have been widely documented and debated elsewhere.
RE in electricity supply in the UK, Australia and some Briefly, the majority of the world’s climate change
US States. scientists have agreed that ‘‘an increasing body of
Job creation: An analysis carried out in the early 1990s observations gives a collective picture of a warming
by the Washington-based WorldWatch Institute as- world’’ and that ‘‘most of the warming observed over
serted that on the supply side, RE (with the exception of the last 50 years is attributable to human activities’’
photovoltaic cells) creates more jobs than conventional (IPCC, 2001).
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In order to effectively address global warming and domestic emissions trading) will be important to the
ensure energy security, in the medium to long-term there success of RE. For example, auctioning of permits by
must be a transformation of the energy system away the government to industry, as opposed to ‘grand-
from fossil fuels and toward the use of RE resources fathering’—free allocation of existing emitters would
(Penfold, Jan–Feb 2000). Addressing global warming create a substantial source of revenue, which could go
needs long-term planning due to the slow response of back into promoting RE and other GHG reduction
the climate system and the equally slow response of activities. Auctioning also makes RE (and other GHG
technological/economic systems. As many appropriate reduction methods) relatively more cost effective be-
and cost effective RE technologies already exist such cause beneficiaries of grandfathering—allocating per-
planning can be based on existing technologies rather mits free to existing emitters—only need to purchase
than waiting for a ‘magic bullet’ or an as yet emissions permits that are additional to their allocation.
undeveloped technology to emerge (Turton et al., 2002). Thus grandfathering can create a barrier to new,
Carbon-constrained future: It is highly likely that the innovative companies, as new emitters would need to
Kyoto Protocol will enter into force in 2003. Compa- pay for all of their emission requirements. Grand-
nies, both nationally and internationally, will soon be fathering can also provide an incentive to maximize
operating in a carbon-constrained environment. The emissions now in order to get a large number of permits,
possibility that non-Kyoto compliant countries will face once emissions trading comes into play. Many will also
border tariffs and trade barriers for their goods and object to grandfathering on the grounds that it is
services is high. The Australian government’s position effectively a transfer of public wealth—access to the
on non-ratification has been justified on the basis of atmosphere—to the private sector. Auctioning—or
perceived costs to the Australian economy and creation some combination of auctioning and grandfathering—
of a competitive disadvantage for Australian businesses. seems a fairer approach (Hamilton, 1998).
However the potential costs of non-ratification to
various industries have not been included in these
estimates.
Carbon concerns may already be negatively affecting 5. What the RE industry can do
Australian exports. For example, Australia’s largest
trade partner, Japan, is now applying carbon taxes and While energy policy and energy market structure are
has asked Australia to find carbon offsets/credits to crucial, there are things that the RE industry may do to
apply to coal sales to Japan. Australian RE companies position itself to take advantage of market-based
(and other GHG reduction technology companies) are approaches to GHG reduction, including identify multi-
already reporting that access to Clean Development ple income streams from RE projects; ‘bundle’ or ‘pool’
Mechanism projects is becoming more limited for CO2 credits for small projects and credits; streamline
Australian companies (Wain, 2002). certification, verification and monitoring; and promote
RE as a GHG solution.

4. Government’s role in promoting the uptake of RE

under market-based approaches to GHG reduction 5.1. Identify multiple income streams from RE projects

In light of existing policy and market structures which RE electricity projects can potentially create several
inhibit RE developments, market-based approaches to income streams:
GHG reduction are unlikely to benefit RE without first RE credits from MRET Target: The market value of
addressing the issues identified in Sections 2 and 3. A RECs is approximately $A40/MW h, which is the
prerequisite to policy change with regard to RE industry nominal value of the penalty for MRET non-compli-
development is an appreciation of the ‘locked in’ nature ance. The non-tax deductible nature of the penalty for
of fossil fuels and the central role of RE in addressing many companies means that the real value of the
global warming, energy security and sustainable devel- penalty—and the amount they should be willing to pay
opment. Including the cost of energy externalities in for RECS—is closer to $A57 (IRS, 2002).
energy pricing and the dollar benefits of GHG reduction Carbon credits: Some emission permit price predic-
to the Australian economy is also critical. tions have arisen from studies that employ various
Energy policy that is based on these principles can mathematical models. They do however tend to over-
more readily accommodate removing subsidies to fossil state the potential permit prices (given the assumptions
fuels and market barriers to RE energy, strengthening/ they employ) suggesting a range of permit price
expanding MRET and ratifying the Kyoto Protocol. predictions, from $A10/tonne to $A50/tonne. Carbon
Once the changes above have been made the design of credits would have to be below the permit price for them
market-based approaches to GHG reduction (e.g. to be an attractive alternative strategy (AGO, 2002b).
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In so far as RE projects can create carbon offsets or 5.4. Promote RE as a GHG solution
credits, RE projects can be valued at the cost of CO2
emissions avoided. It is in the interest of RE companies to understand
Green Power premium: About 77,500 domestic and how their products and services will fit into an emissions
commercial Green Power customers (NGPAP, 2003) trading environment so they are better able to meet
Quarterly Report 1 Jan–31 March 2003, www.greenpo- customer’s GHG reduction needs. RE companies that
wer.com.au) in Australia are paying on average of 2c— build partnerships with companies that may be required
5.28c/kW h (Australian cents) (ACRE, 2002) more for to reduce their own CO2 emissions will be in a good
their electricity than standard rates. In some instances, position to market RE services as a CO2 solution.
this represents an additional income stream from the RE
projects.
Standard price of electricity: Finally, electricity from 6. Summary
RE can be sold for at least the standard price for its sale
to customers, on average about 8.6c/kW h for domestic Historical energy market barriers to RE will inhibit
customers in Australia (1998 prices) (ESAA, 1999). the uptake of RE under market-based approaches to
However, large industrial and retail customers pay much GHG reduction. Correcting existing energy market
less. conditions and providing policy and program support
of a legislative nature are prerequisites to RE success
5.2. Bundling of small projects and credits under market-based approaches to GHG reduction.
Then careful design of any emissions trading scheme as
Many RE projects, especially Remote Area Power well concerted action by the RE sector are needed to
Systems (RAPS) are often small making the cost of ensure that RE can compete effectively in a carbon-
monitoring the CO2 savings for an individual installa- constrained future.
tion uneconomic. Such systems may also be commis-
sioned and decommissioned over time, creating a
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