The economics of energy transformation:
the 3-pillar approach, the UK experience, and some global implications
Michael Grubb
Research Director and Professor Energy and Climate Change,
University College London (UCL) – Inst. Sustainable Resources & Energy InstituteConvening Lead Author, Intergovernmental Panel on Climate Change (IPCC) Mitigation Report Ch.1

ALPS Symposium
Research Institute of Innovative Technologies for the Earth (RITE)Tokyo, 13th February 2020

The economics of energy transformation:
the 3-pillar approach, the UK experience, and some global implications

Four topics• Dynamics of energy Innovation & transformation – general features• Why policy, what policy? A Three Domains & Pillars approach toinnovation• A practical application: The UK Electricity Transition• A model application: transforming DICE

Q: What two things do the following energy technologies have in common?

• Offshore oil extraction• Shale gas• Combined cycle gas turbines• Solar PV• Wind energy• High efficiency lighting (LED lights)[1] They all turned out to be much cheaper than anyone expected[2] They all involved government action at scale over many years- On both technology/resource development, and demand/priceTechnology costs decline with both time and investment… The reality is that most technologies have to evolve through repeated cycles
of market growth, learning, scale economies and supply chain development

..process typically culminates with transformation
Major sectoral transitions typicallyoccur through logistic (‘S-curve’)substitution with self-reinforcing
induced innovation

With various timescales:• Lag from R&D to 10% can be decades• Energy technologies, historically c. 30
years from 10 to 90% of penetration innatural evolution of markets (may beaccelerated with policies)• Key infrastructures may be even slower(think cities, roads, buildings)

The economics of energy transformation:
the 3-pillar approach, the UK experience, and some global implications

Four topics• Dynamics of energy Innovation & transformation – general features• Why policy, what policy? A Three Domains & Pillars approach toinnovation• A practical application: The UK Electricity Transition• A modal application: transforming DICE

Energy-climate challenge – seek radical change in …
… some of the historically least innovative sectors of our economies

PE Chapter 9, “Pushing further, pulling deeper”: Figure 9.7

Three Domains of decision-processes
with different characteristics and theoretical foundations, apply at different scales
DOMAINSOCIALSCAL
E

1.
Satisficing

2.
Optimising3.
Transforming

Characteristics
Habits, myopia/present-bias, risk
aversion, inattention to incidental/ intangible costs & opportunities,
individual diversity &experimentation, malleable
preferences; network effects
Economic optimisation based onrelative prices,‘representative agents’with ‘rational expectations’, stablepreferences and tech trends
Structural, technological,institutional and behaviouralchange, typically fromstrategising, innovation,
infrastructure investment

Theoreticalfoundations

Behaviouralandorganisational
economics

Neoclassicaland welfare
economics

Evolutionaryandinstitutional
economics

TI
M
EHO
RIZ
O
N

Improved
efficiency andservice
New markets,
vsIncumbents

New technology
wavesResource Use / Energy & Emissions

The Three Domains form a dynamic system
1st Domain

2nd Domain

3rd Domain“Satisficing”
behaviour“Optimising”
behaviour“Transforming”
behaviour

1. Real-world
individual andorganisational
decision-making

3. Innovation &evolution ofcomplex systems

Economic Output / Consumption

Energy-climate challenge – need to invest and connect

PE Chapter 9, “Pushing further, pulling deeper”: Figure 9.7

Ideal policy comprises a package …
“Other policies suchas feed-in tariffs,
industry regulationand subsidies, are farless economically
preferable thancarbon pricing toreduce emissions… “(OECD, 2013)

I beg to differ …

Key is to match the best instrument to therespective domain of decision-making
Policy pillars
DomainSatisfice12

3Standards &Engagement

Markets &Prices

StrategicInvestment

HL/MH

Highest relevanceM

Medium relevanceL

Lowest relevanceL‘Smarter’
individual &corporatechoices

OptimiseM

HM

Cleaner
products &processes

Transform

L

L/M

H

Innovation &infrastructure

“Solar power is by far the most expensive way of
reducing carbon emissions - The Economist, 2014.
“.. in Germany, like growing pineapples in Alaska.” J. Grossmann, then CEO of RWE, 2012
Global average prices resulting from auctions, 2010-18

Solar: From 15
to 500 GW in adecade

Source: IRENA (2019), Renewable Energy
Auctions: Status and Trends Beyond PriceInduced innovation – example,the Solar Revolution

Auctions in summer 2019 broke three times theworld record of cheapest solar PV tariff:
Los Angeles, USA - $20/MWh
Brazil - $17.5/MWh
Portugal - $16/MWh

Portugal’s July 2019
world’s cheapest PV.

Ethiopia Sept 2019, Africa’s cheaper PV to date @ $25/MWh

Actually, emerging as the cheapest widespreadhigh-grade energy source in human history

Innovation – dramatic changes, far faster than projected

Actual avg PV prices

Projections for levelized cost of energy for large-scalesolar PV vs realised global average prices from auctions
Source: Authors, from data sources as shown

Evolution of the relative life-cycle cost of new solar PV and coalplants, 2015-2019 – local learning and efficient policy importantTechnology
journey

2nd

3rdGrowing social scale and role of higher domains

1stBasic
R&D

Technology
RD&D

Demonstration

Commercialization

Deployment

Wide
DiffusionGrowoperational
staff

Maturecompany or
independent
division

Expanding
range ofcustomers

Well defined
Customer profile,trusted brandA few
individuals

Ventureor new unitFirst
outsiders

Recruit
specialists,
Developsupply chain

Customersandstandards

No market
definedfirsttargeting ofpossible markets

Choosing
Market ofcommercialization

Early adoptersand niches,basic standards

Financing

Public orInternalfunding

Internal funds
orProject grants

Internal funds,
project grants,
angel or VC
investors

First sales,internal orexternal funds
still neededFirst profits

Financingthrough
private equity,
banks, etc.

MarketRegulation

Neutral or
negative
regulation

Neutral or
negative
regulation

Neutralregulation

Specific
positive
regulation

Positivegeneralregulation

Fully adapted
regulatoryenvironmentResearch
institutions

BespoketechnologyinstitutionsFirst sector
associations

Eg. first IPO,
licenceacquisitions

Lobbying,
corporate
expansion

Stableassociations
negotiating
sector policy

Negativeor neutral‘Piggybacking’/First enabling
infrastructure
investments

Barriers fromexisting
infrastructure

Adapted or
dedicatedinfrastructure

Organisation& supplychain

Institutional

Infrastructure

Research
infrastructure

Test centres

Source: Grubb, McDowell and Drummond (2017), On order and complexity in innovations systems,
Energy Research & Social Science; derived from Fig.9.8 in Grubb et al (2014) Planetary Economics

Successful innovation must span a complex multi-domain journey

The economics of energy transformation:
the 3-pillar approach, the UK experience, and some global implications

Four topics• Dynamics of energy Innovation & transformation – general features• Why policy, what policy? A Three Domains & Pillars approach toinnovation• A practical application: The UK Electricity Transition• A modal application: transforming DICE

UK ‘island of coal in a sea of oil and gas’ – no longer.. moved through a ‘sea of gas’, now rapidly rising renewables –NETA– Energy only market

UK Electricity Market
Reform (EMR)

Electricity generation by source,(Quarterly) 1998-2019

100.00

Nuclear80.00

Stabilised / declining
Bioenergy demand reflects
energy efficiency
Wind & Solarstandards andprogrammes fromc. 2000-2015

60.00

Gas

40.00

20.00

Hydro (natural flow)

Wind and Solar- of which, Offshore

Bioenergy

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

Nuclear

2005

Gas

2004

2002

2000

1999

Oil2001

Coal

2003

Coal-1998

Quarterly electricity generation, TWh

120.00UK electricity – carbon pricing and the demise of coal
UK power sector
emissions halved since1990, coal now below
10% of generation.

April 2017 - first hours without coal power for over a Century, driven by rising carbon
price, declining gas price, and increasing renewables and efficiency.
UK total CO2 emissions now lower than a century ago, all coal to be closed by 2025

C price drives operation andclosure not new investment
or efficiency. Impact since2014 much bigger than
before due to price+ and :• Lower gas – coal pricedifferential• energy efficiency policies,
demand declining since c.
2010• Rapidly rising share ofrenewables

Offshore wind: the big breakthrough… now c. half industrial elec price andaround recent wholesale elec price

£160

£120

First Auction

£100

£80

Second Auction£60

ThirdAuction
AuctionThird£40

prices reduce two thirds

Strike Price (£/MWh)£140

GBWholesaleprice£20£0

Delivery (to first generation)

Allocation / auction rounds

2013/142015/162017/18

2019/202021/22

Industrialelectricity
price2023/24# Emerging as a UK and North European resource as large and valuable as North Sea Gas

Grubb & Drummond (2018), UK Industrial Elec Prices, UCL/Aldersgate Group

Offshore wind contracts under UK EMR

prices halve

Sources: M.Grubb and D.Newbery (2018), ‘UK Electricity Market Reform and theEnergy Transition: Emerging Lessons’, MIT-CEEPR working paper; Updated

Huge gains from long-term contract auctions & pan-European industrial development

Offshore Wind: north Europe’s new energy frontier‘Shallow’ water?

Or floating ?

HyWind floatingturbine– capy factor > 50%

The economics of energy transformation:
the 3-pillar approach, the UK experience, and some global implications

Four topics• Dynamics of energy Innovation & transformation – general features• Why policy, what policy? A Three Domains & Pillars approach toinnovation• A practical application: The UK Electricity Transition• A modal application: transforming DICE

Standard Economic Approach to “Integrated Assessment …”…. seeks to balance abatement costs and climate benefits
Abatement Costs(of cutting emissions given today’s projections)

Balance

Climate Benefits(of avoided climate damages)

Nordhaus’ DICE model with his “standard“ assumptions
a. Emissions(GtCO(GtCO
a. “Optimal”
Emissions2)
2)

b. Damage fraction of GDP(%)

80

16%

7014%

6012%

5010%

80 years to halve global emissions

4030
208%
10 years tohalve again

6%4%

102%00%…. Classical Computable General Equilibrium model, assumes globally perfect foresight withdiscounted damages. Attracted huge range of criticisms, for assumptions on damage evaluation

(a) DICE-PACE
DICE modelmodel– standard
behaviour
100abatement
years [Basesystemslide](b)– behaviour
withoverpliableImpact of inertia and induced innovation on global emissions, expenditure, and temperature change in DICE-PACE: 𝒕= 30yrs.

With high pliability and relatively short ‘half life’ characteristic transition time, the optimal response comprises:

Abatement: steady reduction
towards net zero

Effort: about four times bigger
than in classical case (> 0.3% GDP)

Outcome: stays c. 2 deg.C despite
weak damage / risk assumption

Source: Grubb and Wieners (2020), Modelling Myths: On the need for dynamic realism in DICE and other equilibrium modelsof global climate mitigation, https://www.ineteconomics.org/perspectives/blog/modeling-myths-of-climate-change

The economics of energy transformation
the 3-pillar approach, the UK experience, and some global implications

Four topics: conclusions• Dynamics of energy Innovation & transformation – general features
 Logistic substitution with self-reinforcing induced innovation• Why policy, what policy? A Three Domains approach Need engagement, market instruments and strategic investment• A practical application: The UK Electricity Transition
 A radical transformation, >50% CO2 reduction & major new energy resource• A model application: transforming DICE Dynamics realities including induced innovation transform the global economics