Discussion Paper

No. 2018-29 | March 23, 2018
Policies for decarbonizing a liberalized power sector


Given the agreed urgency of decarbonizing electricity and the need to guide decentralized private decisions, an adequate and credible carbon price appears essential. The paper models and quantifies the useful concept of the break-even carbon price for mature zero-carbon electricity investments. It appears an attractive alternative given the difficulty of measuring the social cost of carbon, but modelling shows it extremely sensitive to projected fuel prices, the rate of interest, and the capital cost of generation options, all of which are very uncertain. This has important implications, and justifies combining a carbon price floor with suitable long-term contracts for electricity investments.

Data Set

JEL Classification:

C65, Q42, Q48, Q51, Q54


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Cite As

David Newbery (2018). Policies for decarbonizing a liberalized power sector. Economics Discussion Papers, No 2018-29, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2018-29

Comments and Questions

Richard John Green, Imperial College Business School, London - Referee report 1
March 29, 2018 - 09:18

see attached file

Anonymous - Referee report 2
April 18, 2018 - 08:22

This is an interesting and very nicely written paper on issues facing the pricing of carbon for the purposes of decarbonizing the electricity sector, with a focus on the UK and EU, and a particular interest in showing how to calculate the break-even carbon price and that it is sensitive ...[more]

... to input assumptions to the extent that a carbon price may not be relied upon to deliver the necessary investment in low-carbon power.

I recommend publication subject to tending to the following list of major – in reality reasonably minor – and outright minor comments.

Major comments
• Is this the first paper to compute the break-even carbon price, in the sense of the term you use?
• To my mind the discussion of prices versus quantities need not be so long and extensive, given the emphasis of the paper on policy, rather than ‘high theory’. I would suggest cutting the relevant passage (section 2, before sub-section 2.1) down to one or at most a couple of paragraphs.
• Regarding the difficulty of pinning down the social cost of carbon, arguably the estimation of monetary damages is at least as difficult if not more so than pinning down an appropriate discount rate. The symposium of papers by, respectively, Pindyck, Stern and Weitzman in the Journal of Economic Literature in 2013 is a useful source on this and Pindyck’s paper is a particularly strident statement of the difficulties faced by impact modellers.
• At the end of page 6 the discussion segues from the argument that the price of carbon should be based on the (economy-wide) MAC, rather than the SCC, to the argument that one needs to calculate the break-even price of carbon in the electricity sector specifically. There are a couple of intermediate steps here relating in particular to the role of electricity in decarbonization I think, and it would be good to restate them here.
• I think there is scope to make sub-section 2.3 a little easier to read. In particular, could the analytical results obtained on p11 be summarized in a table, i.e. the partial derivatives and their expected signs?
• I felt that, since the concept of the break-even carbon price is the central contribution of the paper, more analysis of its value and sensitivity to input parameter values is called for. At the moment we only see two among many pair-wise comparisons, so we don’t see the full picture.
• In section 3 the paper argues, correctly in my view, that the carbon price should be predictable and uniform. It also argues, logically, that the break-even carbon price is highly sensitive to uncertain variables. But it does not immediately follow that the carbon price based on the break-even carbon price lacks credibility (p19). To my mind this depends on an implicit view that the government lacks the ability to commit to a carbon price, set using the break-even method, for a sufficiently long period of time thereafter, even if fundamentals like fuel prices change. One of the features of price/tax instruments in this context is that in practice they can be somewhat ‘sticky’. If correct, this assumption of a lack of credible commitment needs to be stated.

Minor comments
• p2, end of first paragraph: “in setting a carbon price”
• p2, 2nd paragraph: wouldn’t it be more appropriate to say that standards are typically criticized for failing to equilibrate marginal abatement costs, rather than marginal damage costs? Doing so would ensure a given emissions objective is met at least cost, irrespective of whether that objective actually equalizes marginal damage and abatement costs, something you later acknowledge is extremely hard to do with any confidence.
• p2, 2nd paragraph: when writing “It is now widely accepted that the EU ETS has failed…” – while I agree wholeheartedly – it would be appropriate to provide some citations/sources for those interested in following up.
• P9, last line: “\theta_t [insert space] measures the ratio…”