During the last few years, solutions to produce electricity in a decentralized manner have become increasingly attractive. In this context, can decentralized technologies enter centralized market arrangements, even if these market arrangements contain policies to facilitate investment in low carbon technologies? The answer may depend on the particular rules governing the sector.
If, as expected, energy transitions generate a wave of innovation, the question pointed out in this note will be just an illustration of the challenges we will need to face. The current regulatory thinking (both in theory and in practice) is characterized by a structurally static logic. Technological development is represented through potential scenarios, which is essentially a mechanism to perform comparative statics. This fails to take account of the dynamic nature of technology development.
The challenge of regulating an industry under a continuous innovative process will touch electricity industries soon. By simply adapting pre-existing institutional arrangements to include niches for new technologies, we will fail to tackle the methodological discussion that regulation needs to deal with energy transitions.
In this uncertain landscape, one must realize that rules are rarely implemented by external, fully rational regulators. They do not decide using deductive, rational reasoning but they use inductive reasoning instead. Regulators, in a context of significant complexity, understand reality through simplified models (their beliefs) that are then used to perform deductions. Regulators also obtain feedback from the environment, which allows them to update their beliefs.
As regulators cannot optimize all variables affected by a certain set of rules, they need to choose indicators of system performance in order to evaluate continuously the regulation applied. Consequently, the main drivers of regulatory evolution are the “evaluative criteria” applied to outcomes. That is, the criteria used by regulators to obtain feedback from the environment in order to update their beliefs are at center stage in energy transitions. This ultimately means that beliefs need to be continually updated to allow regulatory change (dynamic rules) without resulting in regulatory instability.
We study the case of solar PV in Brazil, where the institutional framework for power generation contains barriers for distributed generation to enter the market. If rule-makers do not adapt to changing technologies, solar generation will (potentially) be locked into utility-scale PV technologies precluding the entry of distributed solar PV.
To that end, we develop a system dynamics framework to model the Brazilian electricity sector. The analysis of regulators’ response is based on the identification of different evaluative criteria (different policy objectives) that are used to analyze the need for adaptation. That is, if the outcome of market players’ investment decisions does not fulfill the policy objective they sought, they will change the rules to improve the outcome. We consider three types of policy objectives:
- In the first case, regulators observe only that electricity is produced by the cheapest available technology nowadays. This a representation of regulators not considering technological dynamics.
- In the second case, regulators are concerned with technological dynamics, but they only consider the introduction of solar PV through niche markets.
- In the third case, regulators are concerned with technology development and consider the possibility of lock into centralized technologies.
Hence, we show that the definition of a process to adapt the institutional framework in a context of stress in the innovation system is crucial for the adoption of new technologies. Our simulation provides the following results.
Case 1 – There is no technology policy in place. That is, we assume that regulators consider as their single evaluative criterion industry outcome (it would be the only driver to change the rules). In Figure 2, we represent an investment in solar PV in the four regions considered: South-East (SE), South (S), North-East (NE), and North (N). The vertical axis represents the investment in solar PV capacity (in MW). The horizontal axis represents each year of the simulation. We observe that no solar technology is installed in the country, except for an isolated investment in the South-East region that took place the first year of the simulation.
Figure 1. Case 1 results: no solar PV.
Case 2 – In this case, we consider the introduction of a solar PV policy. Specifically, we conside the use of niche markets (in Brazil, this was done through dedicted auctions for solar PV). This measure facilitates investment in utility-scale PV, but not in distributed PV. Figure 3 and Figure 4 shows that, under this scenario, the only technology implemented in Brazil is utility-scale PV (as an investment in distributed PV is negligible).
Figure 2. Introduction of utility-scale PV through niche markets.
Figure 3. Lack of investment in distributed PV.
Case 3 – In this case, regulators, after observing the lack of investment in distributed PV in the first years after the implementation of niche markets, adapt and eliminate entry barriers for distributed generation. Regulatory change, as a consequence of the observed barriers created by the rules in use, allows leveling the playing field for both utility-scale and distributed PV. This is the only case where distributed PV enters the Brazilian system. This implied that, besides the investment associated with niche markets, there was a sustained entry of distributed PV in the North region of the country. As shown in Figure 5, this meant an improvement of the learning curves associated with solar PV.
Figure 4. Comparing learning processes in cases 2 and 3.
With our stylized model, we showed the fundamental role played by regulators’ evaluative criteria in technological evolution. As rule-makers interact within a complex environment, rules emerge from regulators’ beliefs about industry functioning. The processes to adapt those beliefs are, therefore, key to realizing energy transitions. We may think of regulatory stability in terms of these processes: we may not need stable and transparent rules, but stable and transparent adaption processes.
These findings are described in the article entitled, The role of regulatory learning in energy transition: The case of solar PV in Brazil, recently published in the journal Energy Policy. This work was conducted by Miguel Vazquez and Michelle Hallack from the George Washington University and the European University Institute. All figures are reproduced with permission from the aforementioned journal article published by Elsevier.