Should the Provision of Renewable Energy be left to Market Forces? To see more of our products visit our website at Ray Powell

“Renewable energy is derived from anything that can be used to make heat or electricity without unsustainable fuels and which does not make a net contribution of carbon dioxide to the atmosphere. This includes wind power, waves and the tides, solar energy, geothermal energy and biomass. Nuclear power, although it is low-carbon, cannot be counted as a renewable source of energy because its fuel, uranium, is finite.” A.Jha, The Guardian, 16 July 2009 Arguably biomass and biofuels should also be excluded from this definition as they are not carbon neutral.

The figure above shows that unless there is a dramatic increase in the use of renewable energy, this target will not be met. The main reason for this is that governments have put too much faith in market forces. The last Labour Government signed up to a European Union Renewable Energy Directive and aimed to produce 15% of the UK’s energy from renewable sources by Subsidies on alternative energy sources have been too small, and taxes on fossil fuels too limited.

The figure above shows the make-up of the 3% of total energy consumption coming from renewable sources in Of this, 80.7% comes from biomass, although it is disputable whether this is renewable energy. We normally thing of biomass as the process of converting crops into a petrol substitute, but this is currently a less important source of energy than landfill gas.

Should renewable energy be provided solely by market forces, solely by government or a mix of both? Suppose the price of energy, for example, oil, rises due to an increase in demand. Oil will become more expensive compared to other forms of energy. On the one hand, a higher relative price may show producing oil is very profitable, and oil production will increase in a competitive market. On the other hand, the higher relative price may cause some energy users to economise on the use of oil, and possibly substitute other sources of energy such as renewable energy. Information is signalled by changing relative prices and creates incentives for producers and consumers to alter market behaviour. This will maximise self-interest and lead to more efficient allocation of resources between competing uses.

Market failure occurs whenever a market does not work very well, and there are many causes of market failure. We can distinguish between complete market failure when a market does not exist or completely collapses, leading to a missing market and partial market failure, when a market exists but produces inefficient resource allocation or resource misallocation. For energy industries the most well-known market failures are caused by pollution and also global warming caused by carbon release.

This is caused by the difficulties consumers, firms and governments face when making decisions that reflect long-term as well as short-term considerations. For example, a private firm may decide against investing in a major infrastructure project, such as a wind turbine farm, because most of the returns will lie a long way into the future. As a result of only considering short-term costs and benefits, firms will limit investment in renewable energy sources. This makes a case for government intervention in the market, for example, by subsidising firms that produce renewable energy, in order to correct information and market failures.

The pro-market case for renewable energy argues that government intervention will lead to a worse outcome. It could be ineffective and waste money, or even downright damaging. This would mean that government intervention will lead to government failure. Are civil servants better at making economic decisions than entrepreneurs? Do governments have a track record of picking winners? Governments may be tempted to make short-run decisions based on pleasing the electorate which would be a political decision rather than an economic one.

If energy markets work well, rising fossil fuel prices should create incentives for private sector investment in substitute sources of energy, including renewables. The price of crude oil has risen on numerous occasions over recent decades, caused by wars, speculation and cuts in production. The figure above shows large variations in price over the last few years, including a spike to over $120 a barrel in 2008 due to speculative pressures, and growing demand in emerging markets such as China and India.

After the spike in prices in 2008 both oil companies and UK governments committed to long-term decisions to develop renewable energy. However, since then oil prices have been falling due to the global recession and this has resulted in both energy companies and governments reducing their interest in developing alternative renewable energy sources. Currently government austerity measures bring into doubt David Cameron’s pledge that “This will be the greenest government ever.”

Renewable energy is derived from anything that can be used to make heat or electricity without unsustainable fuels and which does not make a net contribution of carbon dioxide to the atmosphere. Approximately 3% of the UK’s total final energy consumption was coming from renewable energy sources in Government support for renewable energy has been much greater in other EU countries. Technical developments favour the growth of wind power which is becoming increasingly commercially viable. In a free market, energy industries are adversely affected by information failure, and both firms and government tend to favour short-run considerations. Both market forces and governments appear to be failing to meet Britain’s long-term renewable energy needs.

Should biomass be treated as a source of renewable energy? Will the UK meet its commitment to produce 15% of the UK’s energy from renewable sources by 2020? What are ‘market forces’? Do you believe that the provision of renewable energy should be left to market forces, and if so why? Explain the form of market failure known as ‘information failure’. How do the prices of fossil fuels such as crude oil influence decisions to invest in developing renewable energy sources? Are energy firms and governments equally to blame for the slow development in the use of renewable energy?