Aligning energy markets and climate-policy objectives in the EU

Carlo Carraro, Thomas Longden, Giacomo Marangoni, Massimo Tavoni 27 November 2013



Europe’s commitment to reducing greenhouse-gas emissions has not prevented the paradoxical situation of a revival of coal imports and a reduction of gas consumption. This article reviews recent work on the appropriate measures that need to be implemented to move European energy markets closer to the energy mix consistent with climate-policy targets.

The rise of coal and the decline of natural gas

Policies to promote the transition towards a sustainable energy system have not fully materialised to the extent expected only a few years ago. Indeed, the period between 2010 and 2012 is associated with the paradoxical situation of a revival of coal imports and a reduction of gas consumption. Specifically, gross inland consumption for 2012 showed a decline in natural gas consumption of 14%, a decline in oil consumption of 11%, and an increase in coal consumption of 8% with respect to 2010 levels (Eurostat 2013). Furthermore, in 2011 natural gas in the EU recorded its largest decline on record – a decrease of 9.9% – which has been attributed to a weak economy, a large gas price differential due to shale gas extraction in the US, warm weather, and continued growth in renewable power generation (BP Statistical Review 2012).

The European Commission itself has acknowledged the increased use of coal, and the associated CO2 and aerosols emissions are a source of concern. The European Commission contribution to the European Council of 22 May 2013, titled "Energy challenges and policy", notes that “EU consumption and imports of coal (hard coal and lignite) have increased by, respectively, 2% and almost 9% over the first 11 months of 2012, relative to the same period in 2011” (European Commission 2013a, p. 2). The increases in coal consumption in the first 11 months of 2012 varied significantly across countries – coal consumption doubled in Ireland, and increased by 38% in Portugal, 28% in the UK and Spain, 16% in France, and 3% in Germany (European Commission 2013b, pp. 8–10). Gas consumption, in contrast, was at levels consistent with a decadal low point.
In addition to the factors noted by the BP Statistical Review (2012), the explanation also lies in the policy mix adopted in the EU – large subsidies on renewables and, partly as a consequence, a low carbon price. All these factors negatively impacted on gas consumption in particular.

The role of natural gas in achieving Europe’s energy and climate objectives

The role of natural gas as a transitional fuel within a joint Climate and Energy framework is an important issue, and this was highlighted in the EU Energy Roadmap 2050.1 The Roadmap noted that the scenarios discussed within it “are rather conservative with respect to the role of gas ... economic advantages of gas today provide reasonable certainty of returns to investors, as well as low risks and therefore incentives to invest in gas-fired power stations” (European Commission 2011).

It is with these issues in mind that we conducted an additional analysis on the Climate and Energy framework in Europe – in order to better understand the interplay between climate policy and global energy markets, and to provide input to the discussion about EU emission reduction targets for 2030 (Carraro et al. 2013).

Underlying a review of the European energy market are the issues of the impact of low economic growth and the influence of the renewable target. Therefore, we explored the implications of different combinations of the stringency of climate policy in Europe and abroad. Our scenarios also capture real-world factors relevant to European policy, such as sustained suppressed economic growth and post-Fukushima apprehension concerning the safety of nuclear power.2 The analysis was done using the WITCH (World Induced Technical Change Hybrid) integrated assessment model, which features multiple market failures and can thus well represent the interaction between different policy instruments. The model is an optimisation model, and thus delivers optimal paths for policy rather than forecasts about what will occur in the future. It provides benchmarks rather than projections.

Figure 1 focuses upon the Moderate Policy scenario, and in the base case (denoted as Pledge) coal loses 10% of its market share by 2030, recuperating slightly thereafter due to the deployment of carbon capture and storage technology.3 Renewables are characterised by rapid growth in the short term – spurred to a large extent by existing incentives – and a long-term saturation due to system integration costs. Natural gas is expected to slightly decline in 2020 compared to 2010, and this is related to the slow growth in the total demand for electricity. Irrespective of the impact of the renewable target, after 2020 climate policies induce gas to increase significantly, and coal to continue decreasing (until it is somewhat revived when coupled to carbon capture and storage by mid century). In particular, natural gas should eventually increase its contribution to the power mix in a significant way across all the scenarios reviewed. Indeed, the model results show an optimal generation by 2050 of 1000–1200 terawatt hours, corresponding to roughly double today’s levels. The exact timing of the increase in the use of gas depends on assumptions about the economic recovery and the set of policies in place in and after 2020.

Renewable and energy efficiency policies are shown to have an impact on the energy policy mix in the short term (e.g. 2020), by promoting renewables relative to fossil fuels. In the longer term, however, it is the climate policy signal which appears to be the largest determinant of the evolution of the energy mix in the power sector. For example, renewables would develop after 2020 even if subsidies to the industry were not carried forward, provided a clear carbon signal was ensured.

Figure 1. Power generation shares by fuel, from 2010 to 2050

Note: Pledge refers to the Moderate Policy Scenario. NoRET denotes the case where there is no renewable target (in 2020 and beyond), and HEE when additional policies promoting energy efficiency are introduced (in 2020 and beyond).

Setting the right carbon price

Our analysis highlights the importance of setting a suitable carbon price, which ensures that the right incentives are given to energy markets so that a consistent energy mix can be achieved – thus reducing the policy costs of all climate policy targets reviewed.

The results show that the renewable and energy efficiency targets jointly reduce carbon prices by about $12 per tonne of CO2 in the year 2020. This suppression of the carbon price has a clear negative impact on incentives to adopt more energy-efficient business strategies and to invest in climate-friendly technologies and production processes – thus contributing to the revival of coal. On the other hand, incentives to renewables have contributed to the observed reduction in installation costs, with positive repercussions for other countries. Furthermore, energy efficiency policies address additional externalities related to individual behavior.

By lowering carbon prices, subsidies to renewables and energy efficiency targets also affect the size of the fiscal revenues which can extracted from the carbon market. Our estimates suggest that renewable and energy efficiency policies would forego public revenues of around $50 to $100 billion by 2020 and 2030 respectively.

Figure 2. Carbon prices ($ per tonne of CO2, left) and fiscal carbon revenues ($ billions, right)

Note: Pledge and Pledge+ refers to the Moderate and Stepped Up Policy Scenario. NoRET denotes the case where there is no renewable target (in 2020 and beyond), and HEE when additional policies promoting energy efficiency are introduced (in 2020 and beyond).

Hence, our analysis suggests that, when choosing the climate and energy policy package from 2020 to 2030, Europe should give priority to setting carbon prices to provide markets with a clear pricing signal, from $25 per tonne of CO2 in 2020 ramping up to $60–70 per tonne of CO2 in 2030. This strategy would be preferable to that of employing multiple policy instruments, in its ability to minimise distortions in energy markets, achieve cost efficiency, and provide fiscal revenues to the public budgets. The positive role of gas, in particular in the medium and short term, should not be neglected. Policy measures, namely appropriate carbon pricing, should be rapidly implemented to reduce coal consumption in favor of gas and renewables, thus achieving consistency between the actual energy mix and greenhouse-gas emission reduction targets.


BP Statistical Review (2012), “BP Statistical Review of World Energy”, June.

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Carraro, C, M Tavoni, T Longden, and G Marangoni (2013), “The Optimal Energy Mix in Power Generation and the Contribution from Natural Gas in Reducing Carbon Emissions to 2030 and Beyond”, CEPR Discussion Paper 9715 and FEEM Working Paper 86.

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1 See Carraro et al. (2013) for further information on the 2°C Policy (2 Deg) scenario which is consistent with the EU Energy Roadmap 2050.

2 The scenarios implemented within Carraro et al. (2013) have two major dimensions – that of ‘climate policy stringency’ (i.e. No Policy, Moderate Policy, Stepped Up Policy and 2°C Policy), and a range of ‘additional policy assumptions’ (i.e. Base, No Renewable Target and High Energy Efficiency). The Stepped Up Policy scenario (denoted in Figure 1 and 2 as ‘Pledge+’) replicates much of the settings of the Moderate Policy scenario, except that the level of ambition is stepped up in 2020 and beyond within all regions.

3 The Moderate Policy scenario (denoted in Figure 1 and 2 as ‘Pledge’) is a case where there is fragmented moderate action on climate, and includes region-specific policy objectives based on the Copenhagen Pledges.




Topics:  Energy Environment EU policies

Tags:  EU, climate policy, greenhouse gases, natural gas, carbon pricing, energy mix, coal, renewables subsidies

Professor of Environmental Economics and Econometrics, University of Venice and CEPR Research Fellow

Modeller for the Sustainable Development Programme, FEEM

Junior Researcher at the Sustainable Development Programme, FEEM

Director, Climate Change Economics unit at Euro-Mediterranean Center for Climate Change

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