1. Economics of Renewable Energy and
Externalities
NHH Summer Course 2016
Natural Resource Management and
Policy: The Norwegian Model
Rebekah Cordell, Daniel Hedin and Josh
Krahenbuhl
Word Count: 3945

2. Discuss arguments for and against public policy support to renewable energy, derived from
the economic theory of externalities.
Times New Roman, 1.5” spaced, size 12, 10-15 pages
Energy use and acquiring energy is one of the biggest and most influential topics
affecting the globe. Distributing energy to the global population can be studied using economic
theory and markets for energy. Energy distribution fundamentally ties into the study of
economics. The biggest factor currently preventing a transition toward renewable energy is the
failure to account for the externalities present in different delivery methods. The present market
is failing to deliver suitable, consistent, and clean energy to consumers. Renewable energies
provide an alternative solution to non-renewable fuels market failure, by offering intermittent
options of energy sources. However, these alternatives have three key challenges via policy
mechanisms: supply insecurity, price volatility and the need to address GHG emissions that
contribute to climate change.
The exploration of renewable energy economics will explore the following questions:
Has government support of renewable energy projects been effective? If so to what extent? And
should support be continued? By looking at modern economic concepts, this paper will give a
discussion of the issue of renewable energy based on public support, keeping in focus the
externalities present during the process.
Since the industrial revolution, Earth has been experiencing slight temperature increases.
Within the course of 200 years, it has made a dramatic effect on our planet. A variety of life
forms have become threatened and endangered, while some have become extinct. One of the
major contributors to this problem is our reliance on fossil fuels. For example, coal contributes
to 25% of total US global warming emissions, with an additional 6% coming from natural
gas.)While fossil fuels create 0.6 to 2 CO2E/kWh when consumed for energy, renewables create
at most 0.5 CO2E/kWh from hydroelectricity.1
In one study, the UCS (Union of Concerned
Scientists) estimated that if renewable electricity standards were to be increased up to 25%, by
2025 we will see a decrease of 277 million metric tons of carbon emissions, which would help to
delay the climate crisis. A 2 degrees Celsius change is enough to make a dramatic impact on life
as we know it.
1
“Climate Change Dashboard.” NOAA Climate.gov. https://www.climate.gov/ (accessed 20 June 2016).

3. Burning coal can lead to smog, acid rain, and toxic air pollution which can destroy
ecosystems as well as create health problems for both humans and animal species. Coal plants
are the leading source of sulfur dioxide pollution. SO2 can be breathed in and absorbed into the
bloodstream, causing health issues such as asthma and respiratory illnesses. In addition, much
environmental damage is caused from SO2, such as acid rain which destroys crops, forests, soils,
and acidifies bodies of water. Nitrogen oxides (NOx) creates smog which burns lung tissue,
aggravates asthmatic problems, increasing the susceptibility of respiratory diseases. According
to a study in 2012, it was estimated that burning fossil fuels causes $361.7-886.5 billion annually
in health care costs.2
While drilling and mining for these fuels it can spill into the groundwater,
and cause additional problems. This causes major problems for people living near drilling sites,
with gas leakage into their water sources for potential fire hazards.
The analysis of environmental energy relies on the economic concept of externalities. An
externality is a cost generated by one agent that affects the actions of another agent in the
economy. It is a cost that is incurred on an agent that is not included in ordinary market
transactions. Based on its nature, an externality can cause market failure. The coase theorem
describes the economic efficiency of an economic allocation or outcome in the presence of
externalities. This theorem relates to the integration of renewable energy markets through the
potential to reduce or at least shift the presence of externalities within the traditional energy
market. The challenge is that for this theorem to hold, trade must be costless to provide a
mutually beneficial outcome.3
Direct application of the coase theorem in the renewable energy
market is evident through property rights of divisible, defendable and defined responsibility over
global commons allowing shareholders to negotiate mutually beneficial solutions to problems
associated with traditional energy markets.4
The cost of investment in renewable energy technologies will decline as economies of
scale reduce unit costs. However, the cost of renewable energy sources still remains high; and a
significant consequence of high renewable costs for the immediate future is a growing interest in
alternative sources that can still bring a situation of controversy.
2
"Result Filters." National Center for Biotechnology Information. U.S. National Library of Medicine, n.d. Web. 24 June 2016
3
"Coase Theorem Definition | Investopedia." Investopedia. N.p., 13 July 2010. Web. 24 June 2016.
4
“ Negative Externalities and the Coase Theorem” Learn Liberty.learnliberty.org. (23 June 2016).

4. A large capital investment is required in switching to a renewable industry, but there are
many benefits. Primarily, the field of renewable energy is a more labor-intensive industry than
that of fossil fuels, meaning that more jobs will be created from this switch. For example, in
2011 the wind energy industry in the United States employed 75,000 full-time people.5
There
are a variety of options from manufacturing, project development, construction, installation
logistics, finance, etc. In 2009, hydroelectric employed 250,00 people.6
The renewable energy
industry has estimated that there will be three times as many jobs in the renewable sector than
that of the fossil fuel sector. These projects would help rural communities because of the low
cost of energy, and lease payments based on megawatt installation. These communities could
transfer their income from fossil fuels into more important services, such as education,
infrastructure, and health.
Over the past decade, the energy market has seen unstable oil prices which can cause
recessions in some countries, while others prosper. One implication of increasing investment in
renewable energy would be the stable pricing. While the costs of energy in renewable sectors
are dropping from advances in technology, this is not the case for fossil fuels due to the limited
nature of the resource. The major issue in renewable pricing is the initial startup cost; however,
after that point the additional costs are extremely low. Renewables can be seen as a safety net
from potential crashes in the fossil fuel industry. The actions of countries around the world will
ultimately be very important in order to better transition into the future.
Hydropower electricity generation gives many advantages to the economy of Norway
compared to other energy sources. Since using water to generate electricity is not dependent on
the prices of any other types of fuel available, the costs of electricity will constantly remain low
and, for acquiring purposes, more stable. However, the alternative takes into account the
externalities of implementing a hydropower station. More specifically, the dams that are
constructed to improve the water flow have to undergo rigorous standards, which means they are
very expensive to build. More obvious in the economic theory of externalities is the case in
which a dam is built to impede the progress of a river in one country, and the dam interrupts the
water supply from another country. This can also influence the ecosystem of a particular area,
including the fish populations. Additionally, several neighbors of such operations house
5
"Benefits of Renewable Energy Use." Union of Concerned Scientists. N.p., n.d. Web. 24 June 2016.
6
"Benefits of Renewable Energy Use." Union of Concerned Scientists. N.p., n.d. Web. 24 June 2016.

5. complaints about hydropower facilities regarding the obstruction of the aesthetics of the scenery.
By focusing on hydro power, several of the steps towards renewable energy can be analyzed for
their support.
Water power is the world’s largest source of renewable energy, and different countries
have taken steps in their utilization of hydropower exports. According to Timmons, Harris and
Roach (2014), Norway has developed 70% of its estimated technical potential for hydropower
development. The implications looking forward suggest that Norway can develop progress in its
hydropower usage as a way to offset GHG emissions. On the contrary, hydropower operations
have other implications that result in environmental problems for aquatic ecosystems.
Currently nations such as Norway, Sweden, Finland, and Denmark (Nordic Energy
Market) are trading their surplus energy between each other. This energy trade helps to decrease
the cost of energy and reduce the reliance on fossil fuels. While Denmark, and Norway are for
the most part self-sufficient, Sweden (55%) and Finland (25%) have room to improve in order to
become predominantly green. For example, Bergen, Norway, felt the need to move quickly
towards green energy in order to reduce the smog that is rampant when there is cool air. In
Bergen, there is a layer of cooler air close to the ground and a layer of warmer air above. The
warmer air has a higher pressure than the cooler air below, so now you have a pressure inversion.
The high-pressure air pushes down on the lower pressure air which then holds in the smoke and
the smog. This is a similar problem in other cities around the world that are surrounded by
mountains, such as Los Angeles. The air pollution, as stated earlier, has enormous effects on the
health of individuals which is why Bergen has switched completely to hydroelectric power.
Despite the fact that Norway is almost completely dependent on hydropower, they are ranked
32nd
in CO2 emissions per capita (in 2009.)
In the case of Denmark, the country excels in wind energy production, and is a world
leader in the green policy sector, wind energy. Denmark has created a system which distributes
its financial gains from cutting-edge green energy policies, directly to its citizens. Because of
Denmark’s ability to recognize the costs from previous energy sources, it has succeeded in
converting to nearly one-hundred percent renewable energy sources. A remarkable consensus
on energy policy in Denmark has been reached due to an awareness of what negative
externalities can be present, combining awareness of the effects of the oil crisis in the 1970s.
Part of the demand for renewable energy draws on the ability of Denmark to effectively transmit

6. the power to external countries. In the development and implementation of renewable energy,
Denmark has grasped to secure an effective transmission system so that energy flow is healthy
and flexible on a smart grid. This means that power can be stored for later times when there is
less renewable power at disposal. Part of the externality created in this situation refers to the
inability to convince people on a widespread scale that a smart grid solution needs to be pursued.
This would allow for the power to be stored and used for the future and not going to waste.
Environmental resources not having well
defined property rights is a key challenge to resource
management and mitigating negative externalities resulting
from energy production. Aquifers, oceans and atmospheres
suffer from the negative externalities linked to development.
Solutions to this dilemma of the global commons include a cap
and trade system and other policy instruments that restrict the
net output of carbon to the atmosphere. However, even after
implementation, there are some issues with energy security and
storage. In 2015, California agreed to an ambitious target to cut emissions by 40% of 1990
levels and 80% by 2050.7
Following this agreement, California has seen a number of changes in
their state energy policy. For example; California realizes a cap and trade program that acts as a
backstop to many fossil fuel intensive industries in California, acting as a complement to other
policies intended to restrict heavy emitters. The California law AB32 initiated in 2006 continues
to adapt to best meet the criteria established to mitigate fossil fuel sequestration from the
environment. The cap and trade program is designed to achieve cost effective emission
reductions across capped sectors.8
The policy established a statewide GHG maximum and allows
within industry a trading system to share carbon allowances. Since its inception this program has
seen successes in its ability to diminish GHG emissions.
7
Dario Abramskiehn. "California’s New 2030 Climate Target Aims to Reduce Emissions by 40%." Climate Policy Initiative. May
2015. http://climatepolicyinitiative.org/2015/05/01/californias-new-2030-climate-target-aims-to-quicken-the-pace-of-lowering-
emissions/.
8
"California Carbon Dashboard." Climate Policy Initiative. http://calcarbondash.org/ (accessed Jun 20, 2016).

7. An allowance is a tradeable permit that allows for one metric ton of Co2. Notice that the
allowance has decreased over time and continues to trend downward after the first carbon
auction held January 1, 2013.9
Solar energy would be the ideal source of energy for a global movement; however, the
main issue is efficiency of energy collection. If solar energy funding was increased it would
easily be the most abundant source of energy in the world, and could power the planet
indefinitely.10
Germany is one of the most impactful countries when it comes to developing
solar panel technologies.
Currently in a lab, solar panels convert 14% of light to energy, while in practical use only
9% of light is converted.11
Some of the methods to improve this percentage are to create the
concentrated solar technology that generates energy through mirrors and lenses. Such technology
is being utilized in Israel and shows potential for more widespread use with further research.
Despite successes in Denmark in the frontier of wind energy, there are problems with this
spatial clustering of Denmark's windmills. This issue arises when there is little to no wind, which
can create power shortages. So if this country were to turn off all other power plants and have a
shortage, it would take 24 hours until a coal plant was operational again. Therefore, most of the
time, the plants are running at a loss to prevent such a problem from occurring.
A potential problem with subsidizing green energy and completely moving away from
fossil fuels, is the decay of current energy plants. As energy prices are plummeting to all-time
lows, owning energy assets are becoming bad investments and slowly decaying. Within five
years there will be a decline in fossil fuel power plants but this also might lead towards power
shortages, because of the reduced supply of energy. Trying to incorporate seasonal energy
storage is also hard with current technology, and at the moment the best option is weekly storage.
One key challenge for renewable energies penetration into new markets is development
of a competitive market model. Market failure occurs when the market cannot provide the right
amount of a good to match supply and demand. The impact of environmentally-based market
failure prohibits adoption of new renewable energy technologies through the financial
9
"California Carbon Dashboard,”online.
10
“German Solar Output up”. Reuters Africa. http://af.reuters.com/article/commoditiesNews/idAFL6E7NT1WK20111229?sp=true. (20
June 2016).
11
“German Solar Output”

8. quantification of the externalities of electric power generation.12
Without proper incentives in
place we as a society will not stop the reliance of fossil fuels, to switch to renewables.
A challenge for renewable energy sources is the amount of land that needs to be utilized
for setting aside renewable contributions. According to Abrha Abay, the total land requirements
for renewable energy infrastructure amount to 2% of the cumulative land area of the world. In
areas such as the Southwestern United States, the ability to generate power using wind capacity
is a great strength and therefore can require the presence of windmills on the landscape. The
benefit of wind energy aside, the presence of windmills faces criticism from those who claim the
disturbance on the natural landscape. Previous studies have shown that people are viewing the
windmills as negative externalities and are willing to pay more money in order to move the
windmills farther away from obstructing their view. 13
This shows contrasting public policy
opinions on wind energy and also leads into the costs of energy that are ultimately present.
Leading renewable energy technologies typically see relatively high initial capital costs
per MW of installed capacity, but they have low costs to run. According to Anthony D. Owen,
this fact may mean that some “renewable technologies are financially unattractive compared with
traditional fossil fuel-derived power”. One problem that developing countries are having with
switching from coal and gas industries is the high startup cost of renewable sources. For
example, one wind turbine has a capacity of 2.5-3 MW while costing $3-4 million. This is
compared to 500 MW coal plant costing $2 billion, indicating that the cost per capacity is a
quarter of the price than that of a wind turbine.14
Additionally, you must invest in hundreds of
turbines in order to get close to what one coal plant can produce in energy.
One of the main reasons that renewable energy has not taken over energy markets is due
to the failure of pricing externalities, such as carbon emissions. This pricing of emissions should
be a global initiative in order to change the course of energy consumption. Currently there is a
cap and trade policy making the cost of carbon emissions relatively small, if this were to increase
it would encourage emitters to produce less and look towards alternatives. According to Dr.
12
Owen, Anthony D. “Renewable energy: Externality costs as market barriers.” School of Economics, The University of New South
Wales http://www.ceem.unsw.edu.au/sites/ (22 June 2016).
Abay, Abrha Teklay. “Economic Valuation of the Externalities of Offshore and Onshore Wind farms in Denmark: Results from a
Nationwide Choice Experiment Survey”. Department of Food and Resource Economics, University of Copenhagen.
13
"Benefits of Renewable Energy Use." Union of Concerned Scientists. N.p., n.d. Web. 24 June 2016.
14
Energy Efficiency Policies around the World Review and Evaluation. London: World Energy Council, 2008. Web.

9. Patrick Narbel, an NHH graduate and professional in the field of renewable energy, the lack of
proper incentives created a global economy in which pollution is not a problem.
Intermittent renewable energy demonstrates massive potential as part of the solution to
the problem of increasing resource depletion and threats linked to climate change. Intermittent
renewables offset the impact of harmful GHG emissions. Renewable energy technologies can
contribute to an increase in energy security if their integration diminishes the need for fossil
fuels. Renewable technologies reduce pollution in the air and have the potential to solve an
inevitable future problem, the depletion of nonrenewable fossil fuels.
Issues to consider in integration of intermittency in policies include the nature of the
instruments available, including feed in tariffs, feed in premiums and quantity based instruments.
Evidence gathered via extant integrated programs show a need for improved policy instruments
to account for the direct cost to generate electricity and the cost of intermittency to provide
competitive value. Existing policy instruments do not necessarily reflect the value of energy.
This problematic in the sense that in the existing system the cost of generation is inefficient.15
There is a great need for a new policy system that enables
intermittency at competitive to fossil fuel market costs.
Intelligent policy instruments show the biggest
potential in pushing renewable energy fully into fruition in
the competitive market. Under the current market
conditions, the failures of the markets for electrical power
generation and combustion of fossil fuels are evident.
Currently renewable energy technologies worldwide still
have unrealized potential in mature storage capacity
technologies and maximization of economies of scale.
However, renewable technologies have a large social cost
advantage to non-renewable options if new policy
instruments incorporate the the environmental externalities
of the markets for electrical power generation and combustion of fossil fuels explicitly into the
form of an electricity tariff.16
One solution to the current issues with intermittency is a
15
Narbel, Patrick. “Rethinking how to support Intermittent Renewables.” Elservier.
16
Owen, Anthony D. “Renewable energy: Externality costs as market barriers.” School of Economics, The University of New South
Wales http://www.ceem.unsw.edu.au/sites/ (22 June 2016).

10. multiplicative premium, a tool to secure a given quantity of intermittent generation at a least cost
but full cost basis.17
This type of policy mechanism is solution to the current inconsistencies in
supply of renewable energy generation.
Concentrated solar power uses a mirror system to focus sunlight into a small area where
the heat emissions are converted into energy. These solar power plants are starting to gain
momentum, over the past few years the capacity of these plants has become an exceptional
curve. Building one of these plants would cost between $600 million and $1 Billion dollars, with
the energy cost being $0.12 -0.18 kWh.18
This low cost of energy could lead towards the next
reliable fuel source for generations to come, as solar energy is the most abundant resource that
we have. An additional drawback from this energy production is the reliance on heat, making it
locational, yes the mirrors help but in order to harness 80% depending on the capacity of the
plant extreme temperatures are required. Thus in an ideal situation they would be placed in
deserts, but then the sand erosion would take place and additional labor and capital would be
needed to offset this occurrence.
Currently the idea of harvesting wave energy is afloat, Portugal was the first country to
install and harness the power of waves. However, after the financial crisis of 2008 it was shut
down due to unforeseeable reasons. Now there are wave farms in Australia, United Kingdom,
and United States, as well as Portugal. This is one of the newer methods for renewable sources
of energy and thus there has not been time to do extensive research on the topic. This might
seem to be a great idea, however there are certain drawbacks with this idea, for example they
could be a risk to marine mammals and fish, or underwater noise affecting animals differently,
interrupting the sediment transportation and water quality. In the future we will see the true
impact of harnessing wave energy, but that will take a decade as well as more research into this
topic.
It is possible that renewable technologies are not the solution or not the sole solution to
the undeniable necessity to cut GHGs. Even with all the potential of renewable technologies,
there are enormous unknown factors on unforeseeable negative externalities of widespread
renewable technology adoption. Henry Ford created the mass production of motorized vehicles
17
Narbel, Patrick. “Rethinking how to support Intermittent Renewables.” Elservier.
18
Poornima Gupta & Laura Isensee. Carol Bishopric, ed. Google Plans New Mirror For Cheaper Solar Power. Global Climate and
Alternative Energy Summit. San Francisco: Reuters & businessworld.in. (22 June 2016)

11. partially hoping to solve the issue of pollution from horse waste. At the time it was unfathomable
that creating a vehicle that ran on gas would lead to the devastation our planet faces now as a
result of centuries of emissions from the transportation sector and other large markets.
Adoption of renewable technologies is taking off in several locations. Just this week,
Alberta, Canada realizes some successes of adoption of renewable technologies to offset
electricity consumption. About $78 million was spent in Alberta and $60 million in
Saskatchewan as a single wind project was constructed in each province.19
These successes are
notable because higher adoption rates of renewable technologies will provide greater marginal
returns and lower prices for cutting edge technology.
As a final note, the reason cars were created was in order to solve the issue of pollution
from horses. Although renewable energy is considered the future of the energy markets, we do
not know the full impact that it will have on the world. Cars seemed like a great idea, however
decades later they became a problem. Something similar could happen with the green energy
market, only time can tell what is truly in store. However we cannot survive another 40 years as
we are right now.
19
"Alberta and Saskatchewan to play catch-up on green energy spending." Yahoo . 16 Jun 2016.
https://ca.news.yahoo.com/alberta-sask-play-catch-green-130000204.html (accessed Jun 16, 2016).