Regulation: Grids and Environment

There are two good reasons for government intervention in the electricity sector: the monopolistic bottleneck formed by the electricity grid and the environmental impact of many power generation technologies. The monopolistic bottleneck is first characterised as a natural monopoly with sunk costs. Among the various alternatives for government intervention, the focus is laid on non-discriminatory grid access, unbundling and price regulation. Regarding incentive (or performance-based) regulation, both the theoretical benefits and major practical challenges are highlighted. Also, principles of network pricing are reviewed, contrasting the theoretical concept of Ramsey pricing with practical network tariffs including base, capacity and energy charges. In an application example, the implications of the concepts are illustrated. Environmental damage is first related to the economic concept of externalities. The link of specific emissions like CO2 and nitrogen oxides (NOx) to environmental impacts like climate change and acidification is then established. Emissions may be reduced through pre-, post- and in-combustion technologies. In the context of climate change mitigation, these are relevant for carbon capture and sequestration (CCS). Life cycle assessment as a tool for a comprehensive environmental analysis is shortly introduced. Subsequently, the focus is on policy instruments for combating climate change. Emission taxes as price-based instruments and certificate-trading systems as quantity-based instruments are introduced as first-best instruments as opposed to command and control or incentive-based instruments. Detail is then provided on the EU emissions trading system (EU ETS) and its practical challenges as well as on renewable support mechanisms that may take various forms.