Perhaps because the pandemic has reminded us how vulnerable we are to nature’s depredations, the need for urgent action to ensure global environmental...
The journey towards global sustainability
IN A WORLD WITHOUT COVID OR BREXIT, “SUSTAINABILITY” MIGHT HAVE BEEN AMONG THE FAVOURITES FOR WORD OF THE YEAR IN 2020.
Perhaps because the pandemic has reminded us how vulnerable we are to nature’s depredations, the need for urgent action to ensure global environmental sustainability is increasingly accepted. The EU, the UK, China and Japan all unveiled targets last year to achieve carbon neutrality. Joe Biden has promised to rejoin the Paris agreement on climate change as soon as he is sworn in as US president. ESG, once a fad, has become a core investment theme. Electric car maker Tesla is now worth more than the nine biggest global car manufacturers combined.
This newsletter includes a piece on aircraft emissions validating optimism that the battle to contain global warming can be won. Thanks to technological advances and greater use of renewable energy, aircraft are set to use much less fuel by mid-century. But another important contributor to sustainable air travel will be well-designed carbon taxes or emissions trading schemes that make us consider the alternatives to flying and, crucially, incentivise airlines and manufacturers to raise fuel efficiency.
Other articles explore further how public policy can complement new technologies in the pursuit of sustainability. As the decarbonisation of the European economy increases existing links between different sectors and fuels, we make the case that energy regulation should change with the times to promote the swift, smooth phasing out of fossil fuels. We also look at how sustainability considerations can be built into antitrust regimes, and use the experience of the telecoms industry to show that sustaining competition is a tough task in a fast-changing sector. Trade policy, too, has a role to play. In a non-fossil-fuel-burning fireside chat, Matthew Bell and Amar Breckenridge discuss how carbon border taxes and trade in carbon offsets are sure to be on the table when the UK hosts climate change talks in Glasgow next November.
KEEP READING TO EXPLORE OUR LATEST THINKING
How antitrust watchdogs might help Europe hit its Green Deal goals
Europe’s competition commissioner, Margrethe Vestager, has kickstarted a debate about whether competition policy should be doing more to help Europe hit its ambitious Green Deal target of making the continent carbon neutral by 2050.
At first sight, competition and environmental policy may appear to be strange bedfellows: one has a laser-like focus on championing the consumer; the other has a brief to save the planet.
What steps, if any, could Europe’s antitrust watchdogs be taking to help the continent meet its sustainability objectives?
And do proposals that have already been developed by some national competition authorities provide a template for the rest of Europe to follow?
The European Commission (EC) is currently consulting on the role of competition policy in helping to deliver the Green Deal. The consultation notes that “competition policy is not in the lead when it comes to fighting climate change and protecting the environment” and cautions that “there are better, much more effective ways, such as regulation and taxation.” Nonetheless, it continues, “competition policy … can complement regulation and the question is how it could do that most effectively.”
The economic conundrum at the heart of climate change mitigation is a free-rider problem: the costs of mitigation are borne locally while the benefits are enjoyed globally. The economic theory of externalities shows that in such circumstances, the provision of measures to alleviate climate change will be insufficient. Similar issues arise with regard to other environmental concerns, such as river pollution, air quality, and so on.
Competition can in some cases make the challenge of dealing with environmental hazards even greater by driving firms to focus narrowly on the interests of the consumers they serve, even when these interests clash with those of wider society. A monopoly producer may be able to reduce polluting practices in response to pressure from lobby groups or politicians without having to worry about haemorrhaging sales (after all, its customers may have nowhere else to turn even if the new measures inconvenience them). Taking such steps may reduce the monopolist’s profits somewhat, but it may still conclude that this is a small price to pay for avoiding the negative publicity (as the economist John Hicks once put it, “the best of all monopoly profits is a quiet life”). In a fiercely competitive market, however, the risk of losing business to rivals may make it impossible for even well-intentioned firms to make changes that its customers do not favour.
This is not to say that one should encourage a move to monopoly, as competition has many other benefits. Indeed where measures to promote environmental sustainability are popular with consumers themselves, competition can be a powerful driver for firms to adopt these measures. But it does point to at least a potential tension between competition and beneficial societal outcomes which is not typically present.
The standard economic solution to such collective action problems is to effect coordination at a central level – whether through setting minimum standards, taxing environmentally detrimental activities or the outright banning of certain practices, materials or production methods. Typically, such measures are the responsibility of central government and hence outside the scope of competition policy. However, in principle they could also be implemented at industry level, in which case they would come under the competition umbrella. This could create some interesting tensions for the application of competition policy.
For instance, suppose a competitive industry is engaging in a polluting activity. This could be through generating carbon emissions, using non-biodegradable plastic, putting particulates into the air, and so on. The owners/managers of those individual firms may want to scale back their harmful practices. But to do so would increase their costs and thus damage their competitive position, making such a course of action unprofitable.
The owners/managers of the firms concerned could respond by coming to an agreement with rivals to change their production processes to reduce pollution (but would otherwise continue to compete independently). The outcome would be less pollution but higher prices for consumers. Under the classic competition policy approach, regulators would take the view that in a situation like this it is not for the firms to decide whether it is best for consumers to pay more for a greener product. That is the role of central government. The firms in question would therefore likely be found to have breached Article 101 of the Treaty on the Functioning of the EU (TFEU) or equivalent provisions prohibiting agreements that disrupt free competition.
Potentially, it could be argued that there is an objective justification for such agreements, in that the benefits of cutting pollution outweigh the higher costs. But as things currently stand, it is not clear whether or how competition authorities should recognise those benefits as being relevant. Such an expansion of competition law requires a practical framework which is accepted by all parties. But when one starts thinking about potential frameworks, a few interesting questions arise.
- First, what would count as a “sustainability” agreement that might be considered for exemption from Article 101 TFEU? Reducing carbon emissions is one thing, but why stop at decarbonisation – or even the environment? After all, there is a plethora of collective action challenges that could be undermined by the dynamics of market competition. For example, in June 2020 a report by the Fairtrade Foundation on “competition law and sustainability” argued that competition law was deterring retailers from collaborating to tackle low incomes and wages in the supply chain. The basic collective action problem was the same as that described above for environmental issues: competition between suppliers was forcing a race to the bottom on costs that ignored wider societal objectives. But the broader goals that the report said should be taken into consideration by competition authorities were of a different nature.
- This points to a second, broader question: what should an antitrust regulator’s guiding mission statement be on whether the benefits of a sustainability agreement justify the cost? Should the EC focus solely on the welfare of European consumers or should it also place weight on benefits that accrue to people elsewhere in the world? And what should it do when different sustainability objectives rub up against one another? For example, an agreement between supermarkets to source their food locally in Europe might reduce carbon emissions from transport, but it may also be harmful for low-income farmers in developing countries. Triangulating these competing goals requires difficult value judgments that have traditionally been the purview of elected politicians, not regulators.
- Setting aside these conceptual issues, there is a third question as to how competition authorities should go about measuring these costs and benefits in practice. Suppose the benefits relate to reduced air pollution. The evidence suggests that cutting air pollution is likely to result in better respiratory health, but how should a monetary value be placed on that outcome? In the UK, the National Institute for Health and Care Excellence (NICE) uses the concept of QALYs – quality-adjusted life years – to evaluate whether specific health interventions are worth carrying out; a QALY is typically judged to be worth £20,000 to £30,000. While in principle this methodology could be used to assess pollution mitigation agreements, this is evidently a complex exercise and is likely to be difficult for parties to carry out and for competition authorities to appraise.
- Greater challenges are likely to arise where the environmental benefits are less clearly linked to health outcomes or where the method for estimating the monetary value is still evolving. Take, for instance, an industry seeking changes to production processes that cause microplastics to run off into the water system and ultimately into food that we eat. There is concern that ingesting microplastics can affect human health, but the evidence base is still being developed. Without a clear way of measuring the damage, it will be hard to make a compelling case to a competition authority for the benefits of reducing microplastics, regardless of worries about their impact on marine life.
Such complications would add to the practical challenges businesses face when trying to persuade competition authorities to allow them to enter into agreements with one another on the basis that they promote technical or economic progress. While such a provision exists in European competition law under the so-called Article 101(3) exemption, in practice the bar for persuading the Commission to permit an arrangement on these grounds is set very high. Companies have to demonstrate not only that the benefit to consumers outweighs any costs arising from a loss of competition, but also that the proposed agreement is indispensable to the attainment of these objectives. Tellingly, a 2019 study published by the University of Leeds found that businesses sought to invoke Article 101(3) on 45 occasions during EC investigations between 2004 and 2017, but on no occasion was it accepted by the Commission as a justification for anti-competitive conduct.
Despite these hurdles, some European countries have already taken steps to build sustainability considerations into their antitrust regimes. In the vanguard is the Dutch Authority for Consumers and Markets (ACM), which has published draft guidelines on “sustainability agreement” exemptions from Article 101 TFEU. So how has the ACM addressed the challenges described above?
Starting with the first issue, the ACM does not propose to provide “a comprehensive or precise definition of the term sustainability”. Rather it intends to adopt the UN’s definition, namely any development towards “an economically, socially and environmentally sustainable future for our planet and for present and future generations”. This appears to allow room for a broad range of issues to be considered under the heading of sustainability, including not only climate change, pollution and biodiversity, but also fair trade and socio-economic development.
This point is reinforced later in the guidelines, with the ACM explicitly stating that it will consider both “environmental damage” and “other sustainability” agreements. The former are “agreements that aim to improve production processes that cause harm to humans, the environment, and nature” and should contribute to environmental standards or goals that the Netherlands has signed up to, nationally or internationally. The specificities of “other sustainability” agreements, by contrast, are not defined.
Nor has the ACM provided guidance on the other questions raised above:
- On the matter of how to quantify the benefit of sustainability agreements, the ACM suggests that in at least some circumstances, businesses may not have to quantify them at all. Companies, it suggests, can submit a “qualitative analysis” instead of a quantitative one when the harm is “obviously smaller than the benefits from the agreement”. However, it is not clear how common such “obvious” cases would be in practice: the ACM provides an example of an agreement where risks to competition may be low because the need for coordination is temporary and/or involves a minor input in the production process, and results in a beneficial outcome that many consumers themselves sympathise with. However, in these circumstances it may be harder to demonstrate that coordination between businesses is essential for delivering the sustainability benefit in the first place. After all, if an environmentally friendly action is popular with many customers, companies may want to be seen to be the first movers, stealing a march on their competitors.
- Nor is it obvious to us how the ACM will assess any cases where the trade-off between sustainability benefits and costs to competition is more ambiguous. The ACM is clear that it will not restrict its assessment to ‘paying’ customers when thinking about costs and benefits. In other words, the ACM could wave through a sustainability agreement even if it leaves consumers who buy the products or services in question worse off. However, it is yet to be seen how widely the ACM will be willing to cast the net when assessing this broader benefit. Will it consider only the interests of those living in the Netherlands or will it place equal weight on the interests of people across Europe or the globe? And what about environmental benefits that accrue to animals or the natural world rather than directly to humans?
The breadth of the ACM’s guidance may give companies scope to think creatively about agreements that can promote sustainability. It may also give the ACM leeway to consider new sustainability issues that might arise in the future. By the same token, however, this approach provides scant guidance for businesses as to what evidence to present to the ACM, how to frame their arguments or what their chances of prevailing will be.
SHOULD ANTITRUST WATCHDOGS BE DOING MORE TO TAKE ACCOUNT OF SUSTAINABILITY OBJECTIVES?
- No – competition authorities should stick to what they know
- Yes – they should follow the Dutch and become champions of sustainability
- It’s all about sharing – they should take their lead from elected policymakers
Some other national competition authorities have also begun to grapple with these challenges. For example, Greece’s Hellenic Competition Commission has published a staff discussion paper in which it recognises that sustainability considerations may require it to adopt fundamentally different frameworks to the “price-based revealed preference” model that underpins the approaches that competition authorities currently use to measure consumer welfare. In particular, given that sustainability agreements are by their very nature likely to weigh up costs and benefits that extend far into the future, regulators may need to consider intergenerational models that take into account the welfare not only of today’s consumers but also of those not yet been born. Some other regulators may already have valuable insights into how to take the interests of future generations into account when deciding what costs it is acceptable to impose on current consumers. In the UK, for example, the energy regulator Ofgem has a long-established statutory duty to take the needs of “current and future consumers” into account in its decision-making. It is not clear whether antitrust watchdogs will look to consult these regulators or other bodies experienced in applying the relevant analytical frameworks and techniques, or whether they will seek to develop this expertise themselves.
TOO HOT TO HANDLE?
In light of these complexities, competition authorities may be tempted to conclude that taking on climate change and other sustainability challenges is a matter not for them but for central government. That would make sense if one took the view that governments operate perfectly with full information and no legislative or other capacity constraints, so that whenever a sensible regulation can be developed, it will be introduced in a timely fashion.
However, it is not obvious that the assumption of perfect government holds, particularly at present: governments across the world are too busy handling the Covid-19 pandemic to pay much attention to less urgent matters. In the UK in particular, and to a lesser extent the rest of Europe, the effects of Brexit are another time-consuming preoccupation. And while it is for governments to set the direction of policy, the involvement of regulators – with their specialist expertise and day-to-day experience of interacting with businesses – is often vital in ensuring these policies survive contact with reality.
A better way forward may be an approach whereby central governments and different regulators work together towards the goal of achieving more sustainable markets. Elected policymakers must take the first step in providing more clarity on the goals that society should be looking to achieve in balancing the interests of consumers against countervailing sustainability considerations. But these goals must then be translated into a concrete and transparent regulatory framework that provides businesses with clarity as to how their initiatives will be assessed in practice. And it is in designing and applying this framework where the experience of competition authorities can come to the fore. Competition authorities can already bring valuable expertise to the table in quantifying the costs of sustainability initiatives to consumers. And they may be able to draw on other regulatory bodies to provide clarity on how the countervailing benefits of a proposed agreement will be measured. Of course, such coordination takes effort, but any other approach may prove… well, unsustainable.
TO DOWNLOAD THE FULL ARTICLE PLEASE CLICK HERE:
New applications for the behavioural economics toolkit
PUBLIC DEMANDS FOR ACTION ON GLOBAL WARMING ARE SHAPING THE COMMERCIAL AND REGULATORY SETTING IN WHICH ALL BUSINESSES OPERATE.
BANKS AND OTHER FINANCIAL INSTITUTIONS HAVE COME UNDER INCREASING PRESSURE IN RECENT YEARS AS CRITICS HAVE QUESTIONED THEIR SUPPORT FOR COMPANIES IN POLLUTING SECTORS.
BANKS ARE NOW BEING ASKED TO DO MUCH MORE TO ACTIVELY SPEED THE TRANSITION TO A LOW-CARBON WORLD.
PAULA PAPP, ASSOCIATE DIRECTOR IN FRONTIER’S FINANCIAL SERVICES PRACTICE, EXPLAINS THE CENTRAL PART THAT THE BEHAVIOURAL ECONOMICS CAN PLAY IN HELPING BANKS TO BRING ABOUT THE REQUIRED CHANGES IN PEOPLE’S HABITS.
Finance probably isn’t the first sector that comes to mind when thinking about carbon emissions. why is it now more in the spotlight?
Rightly or wrongly, banks are judged to have been slow to wake up to the climate crisis. By continuing to finance carbon-emitting activities, they’re increasingly seen as being part of the problem rather than part of the solution. There’s a recognition that all businesses require financial services to operate effectively, so it was maybe inevitable that as well as creating tools and incentives aimed directly at changing the behaviour of those sectors responsible for emissions, policymakers would look to do the same indirectly through the financial system.
So banks can’t remain neutral in this debate?
Banks are committed to eliminating their own net carbon emissions. They also point out that they’re doing their bit to mitigate climate change by financing renewable energy and clean technologies. But while that’s true, it’s unlikely to be enough to satisfy the court of public opinion. Banks urgently need to change these perceptions. To a large extent banks trade on their reputation as trusted institutions with values consistent with those of their customers. If a perception builds that the industry as a whole, or certain institutions within it, are part of the problem, customers will soon take their business elsewhere. That means reputational problems can quickly have serious commercial consequences.
What are some of the main challenges to achieving this change?
Essentially banks are being asked to accelerate the shift in the balance of their business away from ‘polluting’ to ‘clean’ sectors. There are some obvious economic barriers in the way of this transition. For a start, traditional sectors remain important for the economy and still generate positive financial returns for banks. But digging deeper, I think behavioural economics can shed some light on why old habits may die hard.
An aversion to loss is known to be a powerful behavioural driver. Banks understandably don’t want to lose established clients, and knee-jerk reactions like blacklisting polluting industries (as some more extreme commentators have called for) would be counterproductive. Also, there remains a tendency for attention and reward to focus on quarterly earnings updates and annual reviews. The industry will need to break out of this short-term thinking. The battle to curb global warming will be fought over several decades. Mindsets will have to adapt to this new timeframe.
Many in the financial services industry will be aware of these challenges. what makes these behavioural barriers so strong?
Bankers of course, aren’t blind to what’s happening around them. Some have moved quicker than others, and positioning on this issue has become a point of differentiation for banks and other financial institutions competing with one another. We already see banks making vast efforts to quantify the risk to their portfolios from the switch to a low-carbon economy. The intention is to translate these new risks into pricing and incentives to nudge customer behaviour. Sustainable investment funds have grown hugely in popularity. It would be unfair to suggest the industry has been asleep at the wheel.
But there’s a long way to go. As of the end of 2018, fully 60% of surveyed lenders in the UK said they were taking a “responsive” approach to climate change, meaning they were assessing it as a financial risk over a three- to five-year horizon. Only 10% of banks had adopted a “strategic” approach – in other words, they were building climate-related factors into their financial management as part of a strategy set at board level. Short-term incentives outweighing longer-term best interests is a very powerful factor in decision-making. In fact it goes to the heart of the climate change challenge as a whole, so this is definitely not an issue restricted to financial services.
In your view, will the industry be able to make these changes alone?
No, for two reasons. First, there’s a fundamental coordination problem. Change will require the entire industry to shift, but financial services markets are competitive and individual firms will always have a short-term commercial incentive to keep taking on profitable business in traditional sectors. The experience of economic regulation over the past 30 years is that without regulatory coordination, these incentives will prove too strong, given the pace of change being called for.
This means regulators have a crucial part to play to catalyse the shifts needed at industry level. They have to change the competitive environment and reduce the power of these short-term incentives – for example, by incorporating climate-change risk in banks’ stress tests and capital requirements. There’s also a need for stronger supervisory oversight of the conduct of individual firms.
Second, effective action will require partnerships between financial services and the sectors that generate the economic activity that we’re concerned about - energy, transport and so on. Where bankers are making the greatest environmental headway today is in supporting large corporate clients to reduce their greenhouse gas emissions. They’re doing that, for example, by including climate risk in their lending and financing decisions and by developing green bonds and loans linked to ESG criteria. Banks working in partnership with clients will be the way forward, not trying to impose changes on them.
As is already the case today, financial services firms will address their own carbon emissions. But the scale of the changes being asked of the industry - and of the economy as a whole - will require every part of the system to work together: both the private and public sectors, and businesses across entire supply chains.
It sounds like that will involve a lot of alignment between different organisations. how optimistic are you that this can be achieved?
What gives me most confidence is that there’s a general consensus around the direction of travel and the importance of the issues. All the relevant parties are broadly aligned. Financial services institutions already work in partnership with their clients, and competitive forces are pushing towards relationship building. In other words, the incentives to meet these challenges are already in place, and so is much of the infrastructure.
So I think the main barriers to achieving these changes are behavioural in nature. We’re really talking about the speed at which the changes will come about, rather than whether they’ll be made at all. We have a decade of experience applying behavioural insights to the diagnosis of problems and the design of solutions in financial services and beyond. So we now have much better mastery of the toolkit that will be needed to support and accelerate the shift.
For example, behavioural economics has a clear role to play in understanding and shaping the behaviour of retail clients and of small and medium-sized enterprises. About half of the UK’s SMEs say they want to do more to tackle climate change but are put off for various reasons. A lack of time and money are the chief barriers, but others include a lack of attention and awareness and the perceived difficulty of taking action. A behavioural economics framework can provide a deeper understanding of these barriers. Financial services providers can then take these insights, work with their clients and tailor services in such a way as to influence how SMEs reach their decisions.
So in your view, how much is this about accelerating the use of existing tools and thinking, rather than introducing radical new approaches?
As I’ve said, there’s a range of things that will need to happen, including regulatory changes and developing partnership across sectors. That means drawing up and implementing a whole set of policies. It won’t be easy, but I’m optimistic it can be done.
In addition, it seems clear to me that greater application of behavioural tools will have a role. Obviously, how those tools are used will differ across institutions, but they’re generally well established. These days it’s pretty unusual to meet someone who doesn’t know what a ‘nudge’ is, and increasingly people have seen these methods being applied in their business.
For example, Frontier has worked on two projects recently that illustrate how the tools have been used to understand decision-making process and design ways to change people’s habits accordingly.
In helping a bank to cut costs, we found that many of its active online customers chose to stick with paper statements. Why? Because paper statements were familiar and linked to deeply ingrained record-keeping habits; some customers used them to tick off items, giving them a sense of reward; many saw them as a more official record that had to be kept for the taxman; and if they were printed on high-quality paper, statements signalled to customers unconsciously that they were valuable.
In other words, the bank learnt that it wasn’t enough to nudge customers to change their ways. Its own online statement service had to become smarter, easier to use and more rewarding. The bank acted on these findings and was able to save a lot of money, helping the environment in the process.
Away from banking, in researching why UK homeowners don’t invest more in smarter heating, we found that people generally don’t think about their heating. It’s something they take for granted. So in six out of 10 cases they wait until their system breaks down or is near the end of its life before deciding what to do about it. Not surprisingly, in such circumstances they want to solve any problems as quickly and easily as possible. That means sticking with the system they know.
The common lesson from both of these examples is that businesses need to overcome a lack of interest or awareness on the part of their clients by engaging with them at the appropriate time. This lesson has much wider application in the context of climate change.
WHAT WILL BE THE BIGGEST BARRIER TO ACHIEVING THESE CHANGES ACROSS THE FINANCIAL SERVICES SECTOR?
- Commercial incentives
- Achieving regulatory clarity and coordination
- Entrenched behaviours: old habits die hard
Any final thoughts? what active debates are you engaged in with financial services clients on these issues?
I’ve been stressing the importance of the external narrative and how quickly it’s changing. Given that they are at the heart of the economy, banks in particular must work harder to become active agents of change. That means changing both their own behaviour and that of their customers.
The reality is that banks are now being held to a higher standard. It’s no longer good enough for a bank to be a passive lender or adviser. It can’t afford to be agnostic about the environmental consequences of the financial services it provides. Banks are being asked to shoulder more responsibility for the purposes to which those services are put.
This social pressure is already quite strong, and it’s a trend that’s only likely to pick up steam. This points to the importance of getting ahead of the curve if possible: both commercially and in engagement with regulators and Government. The behavioural economics toolkit is designed to help diagnose and influence people’s habits. it will undoubtedly come into its own as we address climate change, which will require the biggest behavioural shifts in a generation.
TO DOWNLOAD THE FULL ARTICLE PLEASE CLICK HERE:
Energy Sector Integration, Regulatory Integration?
How technological change might lead to a different approach to regulation
The decarbonisation of the European economy is increasing existing links between different sectors and fuels.
For example, in the past gas was used to generate electricity in power plants.
But with renewables such as green hydrogen and e-fuels growing in importance, the relationship is becoming bidirectional, with electricity serving as an input for those fuels.
This process, which is often called sector coupling or sector integration, is illustrated here.
Figure 1: Sector Coupling (Source: Frontier Economics)
This process also results in a wider variety of fuels and technologies being made available to meet standard energy uses. The most significant example might be road transport. Traditionally fuelled mainly by diesel and gasoline, transport is now witnessing the advent of electric vehicles and the development of alternative clean combustion fuels such as e-gasoline and e-diesel, produced from electricity.
REGULATION NEEDS TO KEEP UP
As with any big change in technology, that has effects on the market, the issue of regulation quickly arises. This convergence of fuels makes it more clear that what matters is not electricity, gas or liquids but emission-free fuels. And regulation is needed to achieve society’s decarbonisation goals at least cost but, to that end, it is important that the rules and standards are technology neutral. If they are not, there is a danger that the transition away from carbon will be inefficient. Two principal sets of risks stand out:
- Decarbonisation will proceed faster in sectors where the cost is higher; and
- Within a given sector, the process will be driven by technologies which are not efficient and competition between companies providing similar services will be distorted.
Achieving technology neutrality is not an easy task. It is also difficult politically, as changes to the status quo create winners and losers. Our colleagues Vikram Balachandar, Dan Roberts and Claire Thornhill have outlined important lessons from the past to make progress in this direction (see here).
Furthermore, sector coupling calls into question the current fuel-specific approach to regulation. For example, the European Union has an Electricity Directive and a Gas Directive. But take electricity storage using renewable gases: which of the two directives does this come under? Or if several fuels are going to compete to provide carbon-free mobility, shouldn’t they have a common regulatory framework that ensures fair competition?
TELECOMS POINTS THE WAY
This market-based, as opposed to sector-based, approach to regulation already applies, to some extent, in the telecommunications industry. In 2018 the European Commission approved the European Electronic Communications Code, which defines a set of rules for all types of electronic communications, independent of the underlying technology.
The Commission has also drawn up a list of relevant markets subject to ex–ante regulation, which it updates on a regular basis. When defining these markets, substitution across different technologies (e.g. copper, fibre, mobile, etc.) is one of the key elements that officials take into account.
Using telecoms as the template, the critical issue in the case of sector coupling is to determine what the relevant markets are by means of competition analysis. This would entail examining what alternatives are available to customers, the ease of switching between those alternatives and whether new suppliers are likely to enter the market.
Such an approach would help in the quest with for technology neutrality. If we look at the heating and road transport sectors, for example, a host of factors stand in the way of neutrality. Differences in taxation levels and structures, variability in costs included in the regulated tariffs paid by customers, different support mechanisms for renewable technologies and varying costs of carbon all muddy the waters when calculating which green fuel source is most efficient.
DO YOU THINK THAT THE REGULATIONS AFFECTING YOUR BUSINESS ARE FIT FOR PURPOSE?
- Yes, they mostly are
- They need some adjustments
- No, a major overhaul is required
Taken to the extreme, a market-based approach to regulation could lead to radical changes. If several fuels are competing to serve a particular end market, would regulations still be needed to ensure effective competition within each fuel sector? Unbundling rules aimed at ensuring fair competition among electricity providers spring to mind in this context.
Or imagine how the provision of electricity to light our homes and power our appliances might evolve. Self-consumption, where consumers themselves produce the electricity they use, could become possible and affordable. Energy communities of producers and consumers could become a competitive reality. In these circumstances, would it be necessary to regulate third-party access to the electricity network?
Once again, the telecommunications sector illustrates one way of approaching such issues. As mentioned above, instead of considering mobile and fixed communications in isolation, telecoms markets are often analysed by taking into consideration all fixed technologies (copper, fibre and cable) in conjunction with mobile technologies. As a consequence of including mobile broadband technologies as part of the relevant market under review, some countries have gone on to deregulate fixed broadband services.
NEW MINDSET, PLEASE
Technology has not evolved as rapidly in the energy sector as it has in telecoms, so it might sound somewhat extreme to be even discussing such eventualities. But change is coming. Politicians are latching onto growing public demands for an acceleration of the transition to a zero-carbon future. The European Green deal to make the EU climate neutral by 2050, China’s pledge to achieve net zero emissions by 2060 and US President-elect Joe Biden’s promise to re-join the Paris agreement on climate change all bode well for progress at next November’s climate conference in Glasgow.
Seen in this light, it is certainly not premature to consider how energy regulation can change with the times to promote the swift, smooth phasing out of fossil fuels. Given how technical progress is deepening the integration of energy end-use and supply sectors with one another, a persuasive case can be made for a shift in regulatory mindset from one based on specific fuels to one based on the markets that an ever-richer range of fuels are serving.
To download the full article please click here:
How to Make Effective Competition Sustainable
The telecoms sector shows this is easier said than done
Competition is (nearly) always a good thing, but creating and sustaining competition through regulation is not possible in all markets.
In some markets, regulation intended to stimulate competition may do more harm than good. The task of making the distinction falls to regulators. In a fast-changing sector like telecommunications, they have a difficult job.
Implicit in many policy and regulatory decisions is a forward-looking assessment of the sustainable level of competition in different parts of the value chain or different geographic areas. In many regulated sectors there is relative clarity on the boundary between where effective competition is sustainable and where the market tends to monopoly and utility-style regulation is required.
In telecommunications there was a paradigm shift in the mid-1980s. A belief that markets were a natural monopoly gave way to a view that most parts of the value chain could be competitive on a sustainable basis once they were liberalised and appropriate regulation was put in place.
The process of liberalisation spurred rapid improvements in service availability and quality at affordable prices. It also sparked a wave of innovation supporting the new digital world. Access to communications is no longer restricted to a minority of the world’s population. Waiting lists for a basic telephone line are a thing of the past. The variety of services has also increased enormously. Consumers across the globe now have access to broadband services offering a huge range of applications both at home and on the move.
However, while competition has clearly delivered huge benefits, these gains have not been evenly spread. And not everywhere has sustainable competition flourished.
In some countries there has been limited ‘infrastructure-based’ competition for ‘the final mile’ of fixed-access networks to deliver broadband services to residential and small business customers. In these countries, any retail competition is often ‘access-based’, with rival providers using regulated access to the incumbent’s network to serve end users. Even where there has been infrastructure-based competition, it has been concentrated in urban areas. In the absence of competition to drive investment in upgrading networks, the quality of fixed services will typically be worse for customers in rural areas than in towns.
Similar issues arise with mobile networks but, thanks to greater infrastructure-based competition, they are less serious. There are also spill over effects, with mobile customers expecting a good quality of service when they move between town and country, meaning competition drives investment across the country. In addition, policymakers can exert more influence over the scope of competition in mobile networks by attaching rural coverage and quality requirements to spectrum licences. However, experience in recent years shows there are limits to relying on spectrum licencing alone to increase the number of competitors or to meet specific policy objectives. As a consequence, policymakers and competition authorities have permitted increased infrastructure sharing between competing network operators. This allows for a more rapid and fuller roll-out of new technologies such as 5G, while the spillover effect from urban areas ensures that the overall impact on competition is limited.
Policy responses to a lack of fixed infrastructure-based competition have varied widely. Some countries have scrapped or limited regulations promoting access-based competition in the expectation that infrastructure-based competition would develop as retailers invested to gain an edge over their rivals. At the other extreme, some countries, such as Australia, New Zealand and Singapore, have opted for national broadband programmes. Under this model, a single wholesale network is established with a de facto monopoly on infrastructure, with retail competition depending solely on access regulation. Between these two opposites, many jurisdictions have adopted mixed models combining infrastructure-based and access-based competition.
To implement a mixed model, the scope for sustainable infrastructure-based competition needs to be assessed and appropriate regulation put in place. For example, the European Electronic Communications Code requires regulators to collect information on the current and forecast scope of infrastructure-based competition.
Sub-national assessments can then group customers into different categories:
- Those who already have an effective of choice infrastructure-based broadband providers;
- Those who are likely to have an effective choice of providers in the foreseeable future; and
- Those who can expect to continue to have a monopoly provider of fixed infrastructure for the foreseeable future.
For example, Ofcom in the UK has grouped residential premises into Areas 1 to 3 corresponding to the categories above.
When assessing the scope for sustainable infrastructure-based competition at either national or sub-national level, regulators need to bear in mind that uncertainty over future developments could lead to areas being wrongly classified. Errors could arise as a result of either:
- Determining that sustainable infrastructure-based competition is possible in areas where there is no realistic prospect of competition; or
- Assuming that infrastructure-based competition is not feasible, when in fact the prospect of entry is realistic.
In the first case, if regulation is relaxed to take account of (or incentivise) prospective competition which will not materialise, there is a risk of consumer harm as a result of the incumbent being given more freedom to benefit from their market power. Regulation could potentially be reimposed if it becomes clear that competition will not develop, but that could take several years during which time consumers may suffer from higher prices and poorer service.
In the second case, consumer harm arises from the loss of the dynamic benefits that infrastructure- based competition can bring. This loss can occur in two ways: implicitly, if some of the regulations which promote infrastructure-based competition are relaxed; or explicitly, if a single network is given special and exclusive rights which act as a barrier to potential entrants. This policy may not be easily reversible if sunk investments by the single network deter competitors from entering and providing a better service.
In both cases there are risks of sub-optimal competition and a slide back towards the poor outcomes that consumers experienced before liberalisation. These risks can be mitigated to an extent. For example, in cases where competition is anticipated backstop regulation can be put in place so that the incumbent is constrained if entry does not occur. Where sustainable infrastructure-based competition is not considered possible or appropriate, a degree of competition ‘for the market’ by tendering the right to operate the network can deliver some of the benefits of competition.
The experience of the telecommunications sector can provide lessons for other areas where policymakers hope to deliver benefits by encouraging competition through regulation, such as digital markets. Many of the gains in telecommunications markets over the last 35 years can be seen as the result of liberalisation of parts of the value chain with low barriers to entry, albeit with a degree of regulation to ensure this liberalisation is effective. However, when it comes to fixed infrastructure the barriers to entry are high. That means there are few examples of sustainable infrastructure-based competition resulting from post-liberalisation entry (rather than from upgrading existing networks). Indeed, a number of jurisdictions have chosen to return to de facto monopolies.
WHAT SHOULD REGULATORS DO WHEN IT IS NOT CLEAR IF REGULATION IS SUSTAINABLE?
- Regulate as if competition will develop?
- Regulate to protect customers even if this risks stifling competition?
- Keep options open?
Determining where competition is possible in a dynamic sector like telecommunications is challenging. Even if policymakers judge that a degree of sustainable competition is possible, they need to take account of the cost of imposing inappropriate regulation if their assessment turns out to be wrong.
To download the full article please click below:
Time for Trade to do more for the Environment
How COP26 in Glasgow can help with sustainability
Increasing attention is being paid to how trade policy could be used to promote environmental sustainability.
Issues such as carbon border taxes and trade in carbon offsets are sure to be on the table when the UK hosts climate change talks in Glasgow next November. COP26 will follow up on the 2015 Paris agreement on the mitigation of greenhouse gas emissions.
Matthew Bell, a director at Frontier Economics and former CEO of the UK Committee on Climate Change, discusses what’s at stake with Amar Breckenridge, a senior associate at Frontier who specialises in international trade.
Why focus on trade and sustainability?
Amar: One of the main criticisms levelled at trade from a sustainability perspective is that the gains from trade will be overstated if the environmental damage caused by production processes and trade are not properly counted. The Amazon is a good recent example. There are concerns that freeing up trade in beef between the EU and Mercosur will speed up deforestation in the Amazon. Because of its role as a carbon sink, the costs would be paid not just in the Amazon but by the whole planet.
What other tensions are there between trade and tackling climate change?
Matthew: The interaction between trade and policies to reduce emissions springs to mind. The tension stems from the fact that some countries have much more ambitious policies than others. Those that are more ambitious worry that their efforts to cut emissions will simply cause industries to relocate to countries that are more relaxed about climate change.
Governments also worry that rules put in place to support free trade at a global level might limit their ability to meet domestic climate targets. For example, if a government introduces new regulations or subsidies to fight climate change, their intervention might be challenged as violating global trade agreements.
Could free trade help to achieve climate objectives?
Amar: Yes, trade supports innovation and the diffusion of the fruits of that innovation, including the very technologies needed to promote sustainable development. Take new energy vehicles. if there are no trade barriers in the way, you’d expect them to spread around the world faster than would otherwise be the case. Trade also helps bring about economies of scale that are essential to reducing the costs of deploying new technologies. Think about the sharp drop in the cost of solar panels because there was a big global market for them. It’s also worth pointing out that some of the worst environmental problems are caused by policies that distort trade. Subsidies linked to fishing and to fossil fuels are obvious examples.
How can the trade world do better, or is it down to the sustainability “camp”?
Matthew: Well, it certainly doesn’t make sense to let the historic division between the two drag on. Trade negotiators and climate negotiators rarely meet, compare notes or discuss how decisions in one forum affect those in another.
The traditional focus of trade policy has been on growth. Other considerations have taken a back seat. That said, let’s not forget that the treaty establishing the WTO highlights the importance of “the optimal use of the world’s resources in accordance with the objective of sustainable development, seeking both to protect and preserve the environment”.
Amar: That’s right. In fact, there are various provisions in trade law that either allow for the pursuit of public policy interests in a way that minimises distortions to trade, or carve out exemptions from core WTO rules for those purposes. But there’s still a lot of thinking to be done on how to ensure, for example, that poorer countries can get proper access to innovative technologies. After all, they’re a critical part of the sustainability equation.
Matthew: The main issue for sustainability is the lack of a developed and enforceable system of rules. Those exist, to some extent, in trade agreements. If you’re breaking WTO rules, you’re hauled before its dispute settlement body , and if you remain in violation you’ll face retaliatory tariffs until you comply. It’s crude, but it helps. There’s no parallel procedure in, say, climate change. That’s why there’s growing discussion about carbon border adjustment mechanisms and how they can be used to discipline trade that’s seen as running counter to climate objectives.
So can trade be used as an incentive to get countries to do more?
Matthew: If we accept that the priority is to make rules on things like climate and biodiversity more constraining, then I would hope that trade can be used to support that goal, at least in the interim as a second-best option.
Amar: There are already some initiatives that can help - product labelling, for example, or reporting requirements for multinationals. The idea is to use both carrot and stick: businesses stand to gain by emphasising their green credentials or risk damaging their reputation if they don’t go along.
There’s also now some appetite to use free trade area negotiations to try to encourage compliance with international environmental agreements. The EU has several trade deals that include such provisions. The idea here is carrot rather than stick: the EU offers trading partners enhanced access to its market in return for sustainable policies. It remains to be seen how far this can work. Countries that are willing to accept these conditions are likely to be doing reasonably well on the environment anyway.
What might this mean for the UK?
Matthew: The UK has just announced one of the most ambitious emission reduction plans. It’s aiming for a 68% cut from 1990 levels by 2030. Support for this goal will depend, among other things, on the public seeing the benefits. That includes benefits in terms of new jobs and growth linked to low-carbon industries. The government will be putting in place a range of measures to help low-carbon sectors and products: new agricultural payment schemes, support for electric vehicles, low-carbon energy procurement and many others. The government will need to make sure that trade agreements don’t get in the way of its interventions in new domestic markets.
At the same time, the government will be nervous about any indication that industry is moving overseas because of the UK’s climate ambitions. The UK may increasingly look to incorporate carbon border adjustments into trade agreements that it negotiates.
And finally, as the host of COP26 the UK should be looking to combine trade and climate by reinvigorating credible international trade in carbon offsets. This is low-hanging fruit. Offsets are how to start tackling emissions for the least cost. But offsets are not just about efficiency. They also address the question of equity that sits at the heart of much climate discussion. Offsets provide a way of transferring revenue around the world to the mutual benefit of all. That objective is currently hampered by a lack of credibility in the offsets that are being traded. The climate world could learn from trade negotiators how to agree credible mechanisms to underpin an effective global carbon market.
Amar: The UK will need to ensure that its trade policy is aligned with its ambitions in terms of green industrial policy. Take electrical vehicles for example. One of the big challenges will be to negotiate arrangements with major trading partners that make sure companies that are part of global value chains are not put off investing in the UK by worries about tariffs and rules of origin. The UK could work with the new Biden administration to secure a firmer global understanding on instruments like border tax adjustments to help countries push ahead and meet their emission reduction commitments.
TO DOWNLOAD THE FULL ARTICLE PLEASE CLICK HERE:
Flying's Green Future
Technological progress holds the key to reducing air transport emissions
The 1 billion tonnes of greenhouse gases produced every year by the air transport sector account for just 2.5% of total emissions, but they pose an outsized challenge to the goal of limiting the rise in global temperatures to 1.5°C.
Aircraft emissions are notoriously difficult to abate, mostly because the renewable energy that has helped to decarbonise other industries is not a great substitute for jet fuel. At least not yet. What is more, demand for air transport is growing rapidly: from 1 billion passenger journeys in 1990, to 4.5 billion today and to 8.2 billion by 2040, according to the best available projections. Most of this new growth will be in Africa and the Asia-Pacific, where the number of journeys is expected to increase by 5% to 6% per year for the foreseeable future.
So if nothing changes, air transport could more than triple its emissions at the same time as many other sectors are racing towards zero.
So what to do?
Conversations about decarbonisation often boil down to two schools of thought: on the one hand, the idea that reducing emissions means reducing consumption; on the other, that improvements in technology will allow us to decouple consumption from environmental harm.
Air transport decarbonisation is no different. We could design our way out of trouble with more fuel-efficient propulsion, better air traffic management and battery-electric planes. Or we could cut down on flying: fewer people flying less often and less far.
The good news is that these two different pathways to lower aircraft emissions are rarely in conflict. Indeed, well-designed carbon taxes or emissions trading schemes serve both goals: they incentivise aircraft operators and manufacturers to invest in greener technologies and prompt travellers to think about alternatives to flying.
Importantly, the extent to which the sector relies on one or other of these pathways to get to net-zero depends largely on the underlying dynamics of the market, rather than any particular government policy. What matters is how sensitive passengers are to a change in ticket prices versus how easily aircraft operators can make the transition to more environmentally friendly technologies.
There is a lot of uncertainty about both of these factors, but in the last five or so years the picture has become clearer: abatement in the air transport sector in the next few decades is going to come mostly from greener aircraft, not from foregoing travel.
Abatement in the air transport sector in the next few decades is going to come mostly from greener aircraft and fuels, not from foregoing travel. Here’s why:
The case for flying less is straightforward. If fewer people fly, aircraft emissions will drop. But the question quickly becomes who gets to fly, and who stays on the ground?
Most of the growth in air traffic is expected to come from the developing world. Of the 7 trillion passenger kilometres per year of air travel expected to be added by 2040, 5 trillion will be to or from what are now developing regions (see the figure below). So even if rich countries were able to restrict air travel to current levels in absolute terms, total air transport demand would still more than double. Reducing overall air travel would necessarily require partially grounding the emerging middle classes in countries like Nigeria, Indonesia and Brazil — a hard sell when Europeans and Americans fly orders of magnitude more.
Figure 1: Passenger Kilometers by Route (Source: Airbus Global Market Forecast) Note: Top 20 aviation routes
Second, short of banning air travel outright, governments would have to raise ticket prices substantially in order to discourage many people from flying. This is because most flyers are not particularly sensitive to price increases. The average price elasticity of demand for air travel is generally estimated to be 0.6, meaning that to reduce demand by 60% ticket prices would have to double (or more than double for business and long-haul travellers).
Governments can put upward pressure on ticket prices by taxing jet fuel or the carbon it emits when burned. But even if we assume that airlines could pass on all of these costs to passengers (unlikely in the short term), fuel makes up only 20% to 30% of the price of a ticket, so a tax would need to raise fuel costs to four or five times current levels to double ticket prices. This would be equivalent to a carbon tax of something like €500 to €750 per tonne of CO2, much higher than even the most ambitious governments are contemplating in the near future.
Even if a tax on this scale could be agreed at the international level, rising living standards and a growing global population mean there will still be many more people flying in 2050 than there are today.
But there is another way forward.
DECOUPLING AVIATION FROM EMISSIONS
We know that even very high carbon prices won’t make much of a difference to air transport demand. But they do send a strong signal to airlines and manufacturers.
For a start. higher carbon prices can accelerate improvements in aircraft fuel efficiency. Since 1990, the fuel burn of the average passenger aircraft has fallen by around 0.75% a year. An Airbus A350, for example, uses about 40% less fuel per passenger kilometre than a Boeing 747. These gains have come from improvements in propulsion technology, aircraft aerodynamics and additive manufacturing techniques. And new technologies are in the works:
- next-generation engines with modified fan blade shapes and compressor angles, such the General Electric GE9X and the Rolls-Royce UltraFan engine, are expected to increase efficiency by 10% to 25%;
- alternative wing configurations such as Boeing’s Transonic Truss-Braced Wing or Airbus’s “MAVERIC” design can further reduce drag; and
- advances in additive manufacturing are helping with the design of new light-weight components.
By 2050, the International Civil Aviation Organization (ICAO) estimates that fuel efficiency can improve by as much as 25% (see the figure below).
Higher carbon prices can also spur operational efficiencies, such as increased aircraft load factors, more regular maintenance and improved air traffic management. For example, the Airbus fello’fly demonstrator involves two aircraft flying in formation to reduce drag, increasing the fuel efficiency of the following aircraft by up to 10%. Substantial emissions savings can also come through other operational innovations, such as reducing cruising altitudes to limit the warming effects of non-CO2 emissions or cutting back night-time flying to limit the effects of radiative forcing. Combined, ICAO estimates that these operational changes could reduce emissions per passenger kilometre by another 11% by 2050.
Finally, higher carbon prices can incentivise switching to renewable alternatives to fossil fuels, such as second-generation biofuels and synthetic fuels, as well as batteries and hydrogen fuel cells on short-haul flights. Technology that has forever been “ten years away” is suddenly starting to be commercialised. The nine-seater all-electric ‘Alice’ aircraft with a range of 1,000 kilometres already has 150 commercial orders, and as of this year, all planes taking off from Norwegian runways must have at least some alternative fuels in their tanks. The long-term estimates here are a lot more uncertain (and much more dependent on carbon prices). But with the right price signals, the IEA’s Sustainable Development Scenario suggests that alternative energy sources will power around half of all flights by the middle of the century.
Figure 2: Reduction in Emissions Per Passenger Kilometre Source: Frontier Economics Note: Based on the assumptions underpinning the IEA’s Sustainable Development Scenario. Alternative scenarios imply slower reductions. The three decarbonisation pathways are not additive (e.g. the 50% alternative fuel reduction only applies to the residual remaining once aircraft and operational efficiency are accounted for).
All in all, technological advances could deliver a 60% to 70% reduction in aviation emissions, independent of what happens to passenger numbers. What’s more, governments would only need to agree on a relatively modest carbon price to get there, something like €125 per tonne by 2050. Indeed, long before fuel prices climb high enough to make more than a few people think twice about flying, they will have brought about a wholesale improvement in the carbon footprint of air travel.
WHAT SHARE OF AIR TRANSPORT FUEL IS LIKELY TO COME FROM RENEWABLE SOURCES BY MID-CENTURY?
- One quarter
- More than half
Good environmental policy should be technology neutral. But it should also be open minded about whether abatement comes from reduced demand or more efficient supply. While even small reductions in air transport demand will be hard to come by, innovative technologies and the increased viability of alternative fuels mean that sharp improvement in efficiency are likely by mid-century.
We know that the air transport sector is capable of mapping out a route to net-zero. The good news is that this route is likely to be compatible with a future in which everyone has access to the benefits of air travel.
TO DOWNLOAD THE FULL ARTICLE PLEASE CLICK HERE: