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6. Simulation results: impacts of increasing renewable energy supply 2 - CGE analysis

Our final set of simulations involves modelling the economic and environmental impact of increases in the share of electricity generated in Scotland from renewable energy sources. This section sets out some illustrative results from running the AMOSENVI model to simulate such an outcome. A number of practical problems have been encountered during the simulation of this outcome and we set these out here as well, before discussing the simulation strategy employed and the results of such policies. We have sought to model the effects of increases in the amount (and share) of renewable electricity generation in Scotland from the base year levels in the AMOSENVI model (1999). In the base year of the model (1999), we begin with a situation where renewable electricity generation provides 10.4% of all electricity generated in Scotland. In total, 42,482 GWh of electricity was generated in the base year of the analysis. In the core simulation which we present below we have sought to increase the share of electricity coming from renewable technologies, while maintaining the total amount of electricity generated in Scotland at levels as close as possible to the original figures for 1999. It would be possible, of course, to explore alternative assumptions about future consumption and production, so the present analysis should be regarded as indicative.

We carry out and report sensitivity analysis where in order to increase the proportion of the renewables, we relax the assumption that generation levels remain close to base year levels. There are a number of issues about the simulations which we report. Firstly, we assume that the underlying technology used to create the output of the renewable electricity generation remains unchanged. There is an extensive literature on learning rates, and the reduction in the costs of electricity generation from increased development and deployment of renewable energy technologies ( e.g. Winskell et al, 2007). These simulations do not incorporate such developments. Secondly, we seek to make changes to the sectoral output of the renewable and non-renewable electricity generation sectors, so that total output of the electricity sectors remains close to existing levels. Results for electricity consumption relate to total electricity consumption by industries and final demand categories in Scotland, and as such, include imports of electricity. Thirdly, the database used for these simulations is that using an experimental disaggregation of the Electricity sector in the original IO table for Scotland. Fourthly, while long run results may in fact be more relevant here, it was not actually possible using the current (experimental) model to conduct period-by-period simulations as in the previous CGE simulations. We had to calibrate to a desired long-run increase in renewable and carry out a single (conceptual time) period simulation. In summary, features of the AMOSENVI model make the results presented no more than illustrative of the type of results which can be obtained from CGE analysis.

Our simulation strategy involves introducing subsidies to renewable electricity generation and taxes on non-renewable electricity generation. The intention is to choose the appropriate tax and subsidy rates such that the outputs of these two sectors adjust so that the combined "physical" electrical output of these two sectors remains approximately constant, but that the share of electricity produced by renewable electricity increases from its base year value. When we hold "physical" electricity output constant this is not equal to the combined real value of the output of the two electricity sectors being kept constant.

Ideally, the tax and subsidy raised should be revenue-neutral to the Government exchequer. We ensure this by allowing government expenditure to adjust so as to maintain the ratio of government deficit to GDP at its base year level. In all the simulations that follow, government expenditure is lower than in the base year, indicating that increased tax revenues in the non-renewable sector are not large enough to offset the subsidies required to stimulate the renewable electricity sector. The increases in tax necessary for the non-renewable sector to get the relative prices of renewable output to non-renewable output to shift, will have the effect of reducing the real wage, and in principle might increase government revenues. In the simulations which we report, however, the competitiveness effect of high prices is larger than the demand stimulus, and, in fact, government expenditure, and GDP, fall. The tax take is lower

Our discussion of results considers the economic implications of a Government policy package designed to increase the share of renewable electricity generation as a proportion of total electricity production. This is intended to explore the potential system-wide consequences of the Scottish Government's stated objective for 31% of total energy generation to be sourced from renewable energy technologies by 2011. We analyse alternative subsidy and taxation combinations that are applied to the renewable/non-renewable electricity generation sectors, respectively. Various model constraints, however, are such that we are not able to replicate exactly the magnitude of renewable electricity generation penetration that is implied by the Scottish Government's objective. ⁶

As in our previous CGE modelling analyses, we examine the effects of the policy change subject to our benchmark equilibrium time period; that is, our results refer to percentage changes in variables compared to base. In this model framework, wages are determined according to our bargaining set-up, and we allow for migration of the labour supply to and from the rest of the UK. As noted above, we only report long-run results, where this represents a conceptual time period over which labour and capital stocks fully adjust to new equilibrium values. In the current model set-up, this corresponds to a timeframe whereby real wages and unemployment are restored to initial equilibrium values, and the capital rental rate is equalized across all sectors.

None of these scenarios are referenced against expected or predicted changes in the pattern of electricity generation mix in Scotland, or make any assumptions about the costs or viability of any of the scenarios considered here - such as, for instance, whether each scenario provides sufficient generation to meet expected future demand or to provide appropriate margins between peak demands and supply capacity. ⁷

Our central scenario involves a subsidy package equivalent to 94.1% of value added for the renewable electricity generation sector, and a tax equivalent to 36.9% of value added to the non-renewable electricity generation sector. Table 6.1 reports the long-run impacts on key aggregate economic, energy and environmental variables. This policy change has the effect of reducing long-run GDP by 1.15%. The key factor underlying the negative impact on output are the price effects associated with the policy change. The extent of taxation in the non-renewable electricity sector is such that the price of output in this sector increases significantly (by 28.54%). This leads to a relative increase in the cost of the electricity composite, which combines with other energy inputs to form an overall energy composite. Increases in the price of the energy composite will serve to raise the cost of intermediate inputs, which will have negative implications for economic activity across the economy as a whole.

Table 6.1: Long-run aggregate economic, energy and environmental impact from "central" increase in renewable electricity generation in Scotland, bargaining labour market, % changes from base expect where indicated

Figure 6.1 illustrates the long-run changes in output and employment across all sectors. It shows that those industries which are heavily dependent on the activity of the non-renewable electricity generation sectors (such as the coal extraction and gas sectors), are most negatively affected by the fall in output in that sector

Figure 6.1: Long-run impact on sectoral output and employment, % changes from base year

Significantly higher production costs mean that output contracts relative to base in the coal sector by 17.85% (higher even than the fall in output in the non-renewable electricity sector of 10.82%), and in the gas sector by 3.56%. The only sector to experience an increase in output is, as expected, the renewable electricity sector. In this sector the subsidy leads to a reduction in the price of outputs (by 49.79%), and is associated with an increase in sectoral output of 92.8%.

The effect of this reduction in the price of renewable electricity as an intermediate input, and the overall boost in activity in this sector is, however, insufficient to outweigh the negative effects in the non-renewable energy sector. The relative dominance of non-renewable electricity generation in the supply chain is such that all other sectors experience an overall increase in input prices. We hold "physical" electricity output constant, but the real value of output of the electricity sectors decreases as the increases in the price of the electricity composite is greater than the increase in the value of output. This leads to an economy-wide increase in prices: CPI increases by 0.51% relative to base. In the long-run, real wages return to their pre-shock level, but there is a lasting effect on nominal wages. Nominal wages increase by 0.51%, reflecting the increase in CPI, and a reduction in external competitiveness means that exports fall by 0.33%. Government expenditure falls by 1.42% in total, as the subsidies required to bring forward renewable electricity generation are greater than the taxes raised from non-renewable electricity generation, requiring government expenditure to contract to maintain the ratio of Government deficit to GDP, as described above.

The implications for the labour market are clear. In line with changes in output, employment falls across all sectors, except for the non-renewable electricity sector, and the highest relative reductions occur in the most energy-dependent sectors. Across all sectors, the percentage change in employment is closely comparable with changes in output, with the exceptions of the renewable and non-renewable electricity sectors, which reflects the fact that the tax and subsidy are effected on capital, and so incentivise a substitution towards/from capital in the renewable and non-renewable electricity generation sectors respectively. The overall fall in aggregate employment leads to outward migration, and a fall in Scottish population relative to base.

The environmental consequences of this policy are lower CO2 emissions. The fall in CO2 emissions outweighs the reduction in GDP, partly due to the shift in the composition of electricity generation from non-renewable to renewable sources. In the long-run, the share of electricity generation sourced from renewable technologies is 20.06%, compared to a share of 10.4% before the policy shock. This means that the CO2 intensity of Scottish production falls, along with total CO2 generation.

We conduct sensitivity analysis for this set of simulations in Technical Appendix 6, which involves looking at different subsidy/taxation rates. We should also note that in Allan et al (2008) we explore the impacts of local sourcing of components for a renewables industry. Whether these developments can be made (and components sourced) in Scotland, and whether technologies can be exported, would be expected to have a significant impact on the economic development potential of increased generation from renewable sources. However, we do not attempt to systematically model these issues here.

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