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Cambridge Working Papers in Economics (CWPE)

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Cambridge Working Papers in Economics (CWPE) is a new series of papers from the Faculty of Economics and the Department of Applied Economics. It supersedes the DAE Working Paper series.

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Please note the Working Papers often represent early stages in the presentation of research findings, and should not be quoted without permission.

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Now showing 1 - 20 of 1850
  • ItemOpen Access
    Multi-Objective Auctions for Utility-Scale Solar Battery Systems: Lessons for ASEAN and East Asia
    (Faculty of Economics, University of Cambridge, 2023-12-27) Toba, N.; Jamasb, T.; Maurer, L.; Sen, A.
    Auctions are an increasingly popular means of competitively promoting and procuring renewable energy to meet energy, social, and climate change objectives. To succeed, the technology designs need to accommodate technological progress, declining costs, and increasing Environmental, Social and Governance (ESG) demand. This analysis examines international experiences with large-scale solar photovoltaic (PV) and battery energy storage systems (BESS) auctions, which may be useful for East and Southeast Asia. It revisits auctions' theoretical and conceptual frameworks while concentrating on the ESG aspect from the perspective of such key stakeholders as investors, government, bidders, and communities, regarding efficient allocations of risks, costs, and benefits. It then relates this framework to real-world practices and international evidence on solar PV with and without BESS. The analysis shows that integrating ESG in auction designs and business models is possible and can benefit business and sustainable development. This analysis’ focus on the ESG and solar PV plus BESS in auctions contribute are nearly non-existent in the existing academic literature according to the review by del Río and Kiefer (2023).
  • ItemOpen Access
    The regulation of electricity transmission in Australia’s National Electricity Market: user charges, investment and access
    (Faculty of Economics, University of Cambridge, 2023-12-27) Simshauser, P.
    The creation of Australia’s National Electricity Market and the associated structural reforms triggered the separation of transmission from generation during the 1990s. The economic framework which governs electricity networks is largely based on the British model and Littlechild’s (1983) RPI-X incentive regulation. This framework was designed to correct over-capacity, a characteristic of the pre-reform era. The NEM experienced one episode of network over-investment (viz. 2007-2015) but there is no evidence of regulatory failure per se. Investment mistakes in retrospect were driven by policy error and forecast error – noting this period was preceded by very strong growth in electricity demand, and then coincided with the Global Financial Crisis (2007-2009) and Australia’s rapid uptake of rooftop solar PV – the effects of which were virtually unforecastable, ex ante. From 2015, the regulatory framework proved effective in correcting the 2007-2015 cycle with electricity networks now considered the more stable part of the energy supply chain. However, while NEM regulation has been effective in dealing with episodes of overcapacity, as to whether the rigid and highly prescriptive Rules are capable of dealing with the accelerating task of decarbonisation is an open question. NEM State Governments are legislating outside the Rules to meet their own policy objectives and timeframes.
  • ItemOpen Access
    The Options Value of Blue Hydrogen in a Low Carbon Energy System
    (Faculty of Economics, University of Cambridge, 2023-12-27) Webbe-Wood, D.; Nuttall, W. J.; Kazantzis, N. K.; Chyong C. K.
    A developer considering the construction of a Steam Methane Reforming facility for the production of hydrogen from natural gas faces the decision as to whether to incorporate and operate a Carbon Capture and Storage (CCS) unit, as part of the facility, in an environment where the costs of inputs and the price of hydrogen are uncertain. Conventional valuation methodologies such as Discounted Cash Flow (DCF) cannot systematically integrate uncertainty from changing market and regulatory conditions. Such methods are also unable to account for the ability of management to make use of flexibility to respond as the uncertainties are progressively resolved proactively. Consequently, an Engineering Flexibility / Real Options approach has been developed to allow the calculation of the additional value that the developer might obtain if a CCS unit is not fitted at the time of construction of the SMR plant. Instead, the plant is constructed so that the CCS unit can be retrofitted during the plant’s lifetime if the economic conditions are such that it appears that this will increase the value of the SMR plant. Application of this approach has shown that, for this example, the Net Present Values are increased in a range of energy price and cost of CO2 release scenarios, i.e. the Real Option has a positive value. These findings hold for a range of discount rates. Similarly, the approach improves the Value at Risk and the Value at Gain. Whilst in this work, the approach has been applied to the example of the decision of whether to fit a CSS unit to an SMR plant for the production of blue hydrogen, it is believed that a similar approach can be applied to other situations
  • ItemOpen Access
    Multi-unit auctions with uncertain supply and single-unit demand
    (Faculty of Economics, University of Cambridge, 2023-12-27) Anderson, E.; Holmberg, P.
    We study multi-unit auctions where bidders have single-unit demand and asymmetric information. For symmetric equilibria, we identify circumstances where uniform-pricing is better for the auctioneer than pay-as-bid pricing, and where transparency improves the revenue of the auctioneer. An issue with the uniform-price auction is that seemingly collusive equilibria can exist. We show that such outcomes are less likely if the traded volume of the auctioneer is uncertain. But if bidders are asymmetric ex-ante, then both a price floor and a price cap are normally needed to get a unique equilibrium, which is well behaved.
  • ItemOpen Access
    Regulation of access, fees, and investment planning of transmission in Great Britain
    (Faculty of Economics, University of Cambridge, 2023-12-27) Newbery, D.
    Liberalized electricity markets require unbundling transmission from generation. For least system cost, generation needs to locate to minimize generation and transmission investment and operation cost. Britain offers a good example of the challenges of and responses to setting transmission access fees to guide the location of massive renewables entry, very differently located to old fossil plants for which the grid was designed. Over-rewarding renewables pre-2014 worked strongly against these location signals, amplifying congestion. Proposals to coordinate transmission and generation off-shore show considerable benefits but coordination needs to be extended on-shore. Partial Locational Marginal Pricing (LMP in the realtime market might deliver less than full LMP but at much lower cost. Modest changes to transmission and auctioned renewables contracts could deliver quick coordination benefits independent of LMP.
  • ItemOpen Access
    The Economic Value of Flexible Ccs in Net-Zero Electricity Systems the Case of the UK
    (Faculty of Economics, University of Cambridge, 2023-12-27) Chyong, Chi Kong; Reiner, David; Ly, Rebecca; Fajardy, Mathilde
    We build a unit-commitment optimisation model of a flexible combined-cycle gas turbine (CCGT) with solvent-based post-combustion carbon capture and storage (CCS). We derive the economic benefits of CCS with solvent storage for a 20-year investment (2030-2050) based on the expected long-term increase in carbon prices and the volatility of electricity prices. Drawing on National Grid’s Future Energy Scenarios for the UK, our model shows that the CCGT-CCS plant profit is, on average, higher with solvent storage because of intertemporal arbitrage opportunities created by having this storage solution available. We find that the economic value of this intertemporal flexibility increases with greater electricity price volatility. Under high price volatility, the total return on investment (ROI) could reach 81- 246%. In relative terms, this is much higher than the total ROI of the CCGT-CCS plant itself (7-64%). While there is an economic case for investing in flexible CCS with solvent storage, there are wider system benefits too. A flexible solvent storage solution should be seen in the context of the overall system ‘flexibility’ requirements of a low-carbon power system. On a cost basis, solvent storage represents just a fraction of the capital costs of more “mainstream” energy storage technologies, such as lithium-ion batteries or hydro pumped storage, while CCGT-CCS offers firm power. Overall, while seen as a rather technical solution, if abated fossil fuel generation is to be part of a future low-carbon power system having this flexibility adds economic benefits not just to operators but also improves overall system security and complements high shares of variable renewables on the grid.
  • ItemOpen Access
    Renewable investments in hybridised energy markets: optimising the CfD-merchant revenue mix
    (Faculty of Economics, University of Cambridge, 2023-12-27) Gohdes, N.; Simshauser,P.; Wilson, C.
    Energy markets were designed to maximise productive, allocative and dynamic efficiency. Although renewables have become the dominant investment in deregulated energy markets, decarbonisation may not proceed at a pace consistent with the aspirations of policymakers. This has led governments in a number of jurisdictions to prime markets through ‘Contracts for- Differences’ (CfDs) or Power Purchase Agreements (PPAs), thus bringing forward investment and decarbonisation efforts. The war in Ukraine and its adverse impact on energy prices only emphasises a sense of urgency on an energy security dimension. Variable Renewable Energy (VRE) projects in Australia are typically underpinned by run-of-plant PPAs, but an emerging trend has been rising number of semi-merchant projects whereby some level of spot market exposure is retained. In this article, we examine how and why the semi-merchant investment model has arisen along with the minimum contracted coverage for a bankable project financing. Results reveal for investors with a target of 60-65% debt within the capital structure, a revenue mix comprising 73-78% PPA coverage and 22-27% merchant plant exposure is viable and a tractable project financing. For policymakers seeking to elicit 5000 MW of VRE plant capacity, the auction need only offer ~3800MW of CfD’s capacity, which has the benefit of reducing taxpayer exposures (cf. on-market transactions).
  • ItemOpen Access
    Non-Firm vs. Priority Access: on the Long Run Average and Marginal Cost of Renewables in Australia
    (Faculty of Economics, University of Cambridge, 2023-12-27) Simshauser, P.; Newbery, D.
    In Australia’s National Electricity Market (NEM), 170+ renewable and battery storage projects reached financial close from 2016-2022, totalling 24GW and $46 billion. With an investment supercycle, not all projects arrive smoothly. Some investors experienced entry frictions from system strength constraints, adverse movements in Marginal Loss Factors and network congestion. Whether these outcomes – which impacted ~20% of entrants – represented workable results in a properly functioning market due to investment error, or arose because of market design defects requiring policy attention, is an open question. An issue that NEM policy advisors are seeking to reform is the non-firm, open access regime. Policy focus is warranted. The ratio of maximum to average wind output is ~3x while solar PV is 4x. Consequently as renewable market share increases, rising levels of curtailment are predictable through excess generation and negative price events, network congestion, or both. But care must be taken with access reform because well-intended ‘intuitive policy prescriptions’ can produce the exact opposite effects by constraining REZ asset productivity, compounding complexity and slow renewable entry rates – the critical variable being the difference between average and marginal curtailment rates. Malalignment between access policy and over-the-counter forward market conventions may distort entry, raise consumer prices and harm welfare.
  • ItemOpen Access
    An assessment of the European electricity market reform options and a pragmatic proposal
    (Faculty of Economics, University of Cambridge, 2023-12-27) Chaves, J. P.; Cossent, R.; Gómez San Román, T.; Linares, P.; Rivier, M.
    The current European energy crisis, caused to a large extent by the unlawful invasion of Ukraine by Russia, has renewed calls for a deep reform of the European electricity market. In this paper, we look at the alternatives proposed for the reform of the European electricity market, analysing their advantages and disadvantages, and we put forward a specific proposal for the reform. We focus mostly on measures directed at the wholesale generation market, although we also propose some changes that we believe will also be needed at the retail level. Emergency measures to tackle the current energy crisis, which are not necessarily consistent with the long-term reform and should definitely not determine the long-term design of the European electricity market, are very briefly assessed in an annex, including their compatibility with this long-term reform.
  • ItemOpen Access
    On Static vs. Dynamic Line Ratings in Renewable Energy Zones
    (Faculty of Economics, University of Cambridge, 2023-12-27) Simshauser, P.
    Scaling-up Variable Renewable Energy will face critical bottlenecks vis-a-vis requisite transmission hosting capacity. Network developments must navigate the complexity of encroaching on private land, risk disturbing sites of cultural significance, compete with other environmental (i.e. biodiversity) objectives, and endure backlash from directly affected communities. Transmission is costly and post-pandemic supply-chain constraints are sending equipment costs higher. Given time and cost risks, existing transmission networks and successful augmentations need to function at their outer operating envelope. In this article, a Renewable Energy Zone (REZ) is examined by comparing static and real-time dynamic line ratings. Historically, static line ratings in the Queensland region of Australia’s National Electricity Market reflected the still, hot conditions that characterised critical event maximum demand days. Widespread take-up rates of rooftop solar PV has shifted maximum (grid-supplied) demand to the late-afternoon when wind speeds are rising, which also provides thermal cooling to transmission lines. Optimisation modelling suggests a shift from static to dynamic line ratings for a reference 275kV radial REZ in Queensland can increase wind hosting capacity from ~1700MW to more than 2800MW with limited change in the asset base. Dynamically adjusting Frequency Control Ancillary Services further increases VRE hosting capacity.
  • ItemOpen Access
    Estimating the target-consistent carbon price for electricity
    (Faculty of Economics, University of Cambridge, 2023-12-27) Newbery, D.
    The target-consistent price of carbon for an electricity sector decarbonizing through massive variable renewable electricity (VRE) depends sensitively on the VRE penetration level, as the marginal curtailment of VRE rises rapidly beyond a certain level. This paper develops a simple linear model to illustrate the relation between the shadow carbon price (SPC) and VRE penetration and calibrates it for the island of Ireland’s 2026 target VRE penetration of 55%. The SPC rises rapidly with increased VRE investment beyond a certain point, and can be used to direct mitigating investment in storage, interconnectors, and other flexibility options. The SPC for the final efficient portfolio will be the target-consistent carbon price for electricity that can help judge the appropriateness of the original target level of VRE penetration.
  • ItemOpen Access
    High renewable electricity penetration: marginal curtailment and market failure under “subsidy-free” entry
    (Faculty of Economics, University of Cambridge, 2023-12-27) Newbery, D.
    Ambitious plans to decarbonise electricity will require high levels of variable renewable electricity (VRE). At high VRE penetration, the surplus that cannot be exported must be curtailed (spilled). The last MW of wind capacity will be curtailed 3+ time more hours than the average, but even in efficiently designed markets, price signals for VRE investment are given by average, not marginal, curtailment, creating a “tragedy of the commons” that requires a corrective charge to restore efficiency. The paper sets out an analytical model calibrated to Ireland in 2026, showing the source of this distortion and estimates of its magnitude.
  • ItemOpen Access
    Locational Marginal Prices (LMPs) for Electricity in Europe? The Untold Story
    (Faculty of Economics, University of Cambridge, 2023-12-27) Pollitt, M. G.
    Locational marginal prices (LMPs) are an important design feature of several well-developed electricity markets, particularly in the US. They involve the calculation of energy prices which reflect congestion and losses at particular nodes in the electricity network. They have been hotly debated in Australia and Great Britain, but not implemented so far. In this paper we explore whether and how European countries should adopt LMPs. We consider the concept of locational prices and their use in economics and the theory and evidence on nodal pricing. We discuss key unanswered questions in the literature about nodal pricing before suggesting alternative actions to improve locational signals in the electricity system in Europe, including via the smarter use of LMPs. We conclude that while the theory and modelling behind LMPs is strong, their wider theoretical rationale is less clear cut and the evidence on their impact in use is surprisingly weak.
  • ItemOpen Access
    The Incremental Impact of China’s Carbon
    (Faculty of Economics, University of Cambridge, 2023-12-27) Lu, M.; Pollitt, M. G.; Wang, K.; Wei, Y-M.
    China has adopted the carbon emissions trading system (ETS) due to its advantages on efficiency and cost grounds. Prior to the national carbon market, China operated seven ETS pilots as experiments for eight years in addition to the existing Energy Conservation and Carbon Abatement Target Responsibility System (ECCA-TRS) in order to accumulate experience with carbon markets. However, the incremental effects of these pilots are unclear so far. Here, we show that the ETS pilots have produced no additional carbon abatement effect or abatement cost-saving effect, while ECCA-TRS contributed primarily to the relative decline in CO2 emissions and absolute decline in CO2 intensity of covered industries in pilot regions. A binding target is necessary to permit ETS to act as the backstop emissions constraint. Adjusting local governments' abatement achievement using the buy-in and sell-out of carbon allowances can allow the ECCA-TRS and ETS to act as well-integrated instruments.
  • ItemOpen Access
    Energy Markets Under Stress: Some Reflections on Lessons From the Energy Crisis in Europe
    (Faculty of Economics, University of Cambridge, 2023-12-27) Pollitt, M. G.
    This paper examines the 2021-2023 energy crisis in Europe exacerbated by the energy consequences of the full-scale Russia – Ukraine war which began in February 2022. We show that this is an historically unprecedented price shock to both gas and electricity prices. We then draw on lessons from UK energy policy in World War Two to inform European energy policy during this crisis. In light of this, we examine actual policy responses by the European Union (EU). The EU has responsibility for the European single market in electricity and gas (which also formally includes Norway and effectively includes the UK) and has attempted to co-ordinate EU-27 responses to the crisis. We highlight four good and three bad policy responses observed across Europe. We conclude with longer-run lessons for energy and climate policy arising from this gas and electricity price shock.
  • ItemOpen Access
    Toward an operational definition and a. methodology for measurement of the active DSO (distribution system operator) for electricity and gas
    (Faculty of Economics, University of Cambridge, 2023-12-27) Covatariu, A.; Duma, D.; Giulietti, M.; Pollitt, M. G.
    There is growing consensus that the role of the distribution system operator (DSO) is changing given the implications of net zero. The transition process requires additional roles for the DSO in facilitating the new technologies and business models that will contribute to decarbonization. Discussions on the active DSO abound yet a working definition is still missing. This paper aims to propose such a definition and a workable methodology for measuring the extent to which a DSO is active. The methodology will be applied to electricity and gas DSOs in the UK and the challenges will be presented and analyzed.
  • ItemOpen Access
    Supply-Side crediting for accelerated decarbonization: A political economy perspective
    (Faculty of Economics, University of Cambridge, 2023-12-27) Mehling, M. A.
    Climate policy ambition lags behind committed decarbonization targets, due in large measure to the unfavorable political economy of climate policies that require a reduction in emissions or increase their cost, such as phase-out mandates or carbon pricing. This paper describes a policy innovation, supply-side crediting, that can improve the political economy of climate action, catalyze innovation, and contribute to the objective of a just transition. By creating a revenue stream for the decommissioning of fossil fuel reserves, supply-side crediting alters the incentive structure and generates political buy-in from key stakeholders in the energy economy. Revenue from supply-side crediting can scale up climate finance and accelerate the commercialization of necessary low-carbon solutions, such as carbon dioxide removal technologies. Through various impact channels, supply-side crediting can help overcome resistance against climate policy ambition and address socioeconomic impacts of the energy transition. Over time, supply-side crediting can thus unlock a virtuous sequence that enables increased viability of demand-side carbon constraints such as carbon pricing.
  • ItemOpen Access
    Supply-Side Crediting to Manage Climate Policy Spillover Effects
    (Faculty of Economics, University of Cambridge, 2023-12-27) Mehling, M. A.
    Two types of spillover effects influence progress towards decarbonization: greenhouse gas emissions leakage as well as low-carbon technology innovation and diffusion. Emissions leakage caused by uneven imposition of carbon constraints limits their climate benefits, undermines political support, and gives rise to equity concerns. Solutions to address emissions leakage, meanwhile, are incompatible with global decarbonization or face serious implementation challenges. Diffusion of low -carbon technology averts emissions leakage, but depends on scaled up investment in research, development and deployment to drive down technology cost. Supply-side crediting can address both spillover effects, reducing emissions leakage by increasing global fossil fuel prices, and generating revenue for investment in lowcarbon technologies to accelerate their diffusion and further limit emissions leakage.
  • ItemOpen Access
    Determinants of public preferences on low carbon electricity: Evidence from the United Kingdom
    (Faculty of Economics, University of Cambridge, 2023-12-27) Lee, J.; Reiner, D. M.
    We empirically derive the determinants of British public preferences for different low-carbon energy sources using machine learning algorithm-based variable selection methods (ridge, lasso, and elastic net regression models). We seek to understand the drivers of support for solar, wind, biomass, and nuclear energy, which are the largest low-carbon energy sources and together account for the majority of UK power generation. Explanatory variables examined include those related to demographics, knowledge, perceptions of climate change, and government policy. We carry out a comparative study by synthesising the results of our independent analyses for each energy source and find that the preferred energy sources vary with respondents’ views on anticipated climate change impacts. Those who believe that potential effects of climate change will be catastrophic tend to prefer renewable energy sources whereas those less concerned about climate change tend to prefer nuclear power. The public also prefer energy sources about which they are more familiar or knowledgeable.
  • ItemOpen Access
    Tails of Foreign Exchange-at-Risk (FEaR)
    (Faculty of Economics, University of Cambridge, 2023-06-07) Ostry, D. A.
    I build a model in which speculators unwind carry trades and hedgers fly to relatively liquid U.S. Treasuries during global financial disasters. The net effect of these flows produces an amplified U.S. dollar appreciation against high-yield currencies in disasters and a dampened depreciation, or even an appreciation, against low-yield ones. I verify this prediction by examining deviations from uncovered interest parity (UIP) within a novel quantile-regression framework. In the tail quantiles, I show that interest differentials predict high-yield currencies to suffer depreciations ten times as large as suggested by UIP, while spikes in Treasury liquidity premia meaningfully appreciate the dollar regardless of the U.S. relative interest rate. A complementary analysis of speculators’ and hedgers’ currency futures positions substantiates my model’s mechanism and highlights that hedging agents imbue the U.S. dollar with its unique safe-haven status.
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