The 28th annual United Nations climate meeting in Dubai in December of 2023 led to several agreements aimed at phasing out fossil fuels, increasing renewable capacity, and achieving net-zero emissions by 2050.
Though very laudable goals, meeting them will be hardly an easy task, especially in developing countries. One, often overlooked, reason for this is that hydrocarbons like oil and gas are tradeable commodities that can be bought and sold in international markets. Renewables, however, cannot, and therefore cannot (directly) contribute to an export-led growth strategy, like the U.S.’s experience with fracking since 2006 or Brazil’s commodities boom of 2023. Without renewable power trading between neighboring countries – and assuming that demand for oil and gas persists – hydrocarbon-rich countries (especially in the developing world) will continue to find it more profitable to invest in their production rather than investing in non-tradeable renewables.
The good news is that renewable power can be traded internationally, albeit indirectly, through the goods it is used to manufacture. If, for instance, the international community adopted a rule that set a maximum allowed amount of carbon used in the manufacturing of exports and imports, and that carbon footprint could be easily verified and enforced, goods that were manufactured with a high carbon footprint could be phased out of international trade markets and eventually replaced by those produced with cleaner energy. This would in turn create the necessary traction to expand renewable capacity through international trade.
Current Obstacles To Trading Renewables
It is important to first understand why electricity, and more importantly renewables, cannot be treated as tradeable commodities at present:
- High intermittency of output. Renewables are only produced whenever the natural resources that generate them are present, (i.e., wind and sun). While this intermittency problem has been mitigated and even neutralized in developed countries through storage, this is not the case in most of the developing world.
- Volatile pricing. Wholesale prices of electricity with a strong presence of renewables and a lack of effective storage can be extremely volatile, with variations as high as 50 times in a matter of hours and strong regional differences related to congestion and transmission costs. Developing countries typically do not have sophisticated future markets that can be used to hedge generators and consumers against the high volatility of wholesale prices.
- Lack of grid interconnection. Electricity trade among neighboring countries requires the interconnection of their transmission grids and a centralized System Operator (SO) that can run a single and unified economic dispatch of power plants. Even though this is the rule in North America and continental Europe, it is not, for example, in Latin America, where each country has its own SO, economic dispatch, and transmission grid.
- Need for new transmission lines. Contrary to traditional thermal power plants, renewables are normally located in rural areas, far away from consumption centers – namely because they are land-intensive, and land is less expensive the farther one moves from the city. As a result, renewable power plant locations require additional investment in low and medium-voltage transmission lines to connect them to the high-voltage transmission grid.
More importantly, power transmission is a natural monopoly, subject to significant regulatory and expropriation risk, especially in developing countries where regulatory institutions and court enforcement powers are weak.
Finally, the expansion of transmission grids requires a high degree of coordination between national and subnational governments, with the necessary harmonization of variables like voltage, frequency, quality of service, and more. This is extremely difficult to accomplish between countries with different regulatory regimes.
A New International Trade Rule Can Speed up Energy Transition Towards Renewables
Setting an enforceable international rule to measure and control the carbon footprint of products (CFP) that are exported and imported worldwide should provide developing countries with the incentives they need to rapidly phase out the use of hydrocarbons and adopt renewable energy in the manufacturing of traded goods.
With such a rule, countries would no longer have to expand power transmission grids, as manufacturing firms would be incentivized to locate near renewable resources. After all, transporting goods to consumption centers and seaports should always be less expensive (and require less coordination/bureaucracy) than building new transmission lines. This would also contribute to the decentralization of economic activity away from overcrowded megalopolises such as Mexico City, São Paulo, and Buenos Aires.
The new rule could be set and enforced by the World Trade Organization (WTO) through, for example, the adoption of ISO 14067 guidelines, whereby countries could start demanding from their trade partners that the products they import comply with a maximum level of CFP.
Additionally, if exporters have a CFP higher than the allowed upper limit, they should be able to buy carbon certificates to compensate for the difference. For example, if the manufacturer of product “A” did not invest enough in emission-reduction technologies to reach the allowed threshold of CFP, then they should be able to buy carbon certificates to compensate for the difference between their actual CFP and the maximum allowed level. Optimally, the manufacturer of product "A" would invest in emission-reduction technologies until the marginal cost of this investment was equal to the market price of carbon certificates. Of course, for this mechanism to be efficient, there should be (only one) international market for carbon certificates (e.g. c-tokens) that should be electronically traded like cryptocurrencies and their transactions validated by blockchain. Only through this mechanism could the equilibrium price of c-tokens be freely set by supply and demand thus reflecting the opportunity cost of not adopting the emission-reduction technologies. Obviously, the initial amount of c-tokens issued and the maximum CFP set would be critical in setting the market clearing price of c-tokens and therefore in the incentive to invest in carbon-reducing technologies.
Finally, and moving in that direction, the European Union has recently adopted a Carbon Border Adjustment Mechanism (CBAM) whereby importers of goods into the EU (or their indirect customs representative) will have to report greenhouse gas emissions (GHG) embedded in their imports (direct and indirect emissions) during a given quarter of a calendar year. This has the objective of reducing carbon emissions, putting a fair price on the carbon emitted during the production of carbon-intensive goods imported into the EU, and bringing the price of carbon produced in the EU in line with the price of carbon-intensive goods imported into the EU.
In sum, a smart way to speed up the transition to clean energy would be to commoditize renewables through the enforcement of an allowed maximum level of CFP for imported and exported goods and the implementation of an international market of electronic carbon certificates (c-tokens) to buy them in the event of higher than allowed CFPs or to sell them in the event of lower than required CFPs.
© Copyright 2024. The views expressed herein are those of the author(s) and not necessarily the views of Ankura Consulting Group, LLC., its management, its subsidiaries, its affiliates, or its other professionals. Ankura is not a law firm and cannot provide legal advice.
