The Economics of Coal Phaseouts: Auctions as a Novel Policy Instrument for the Energy Transition

TL;DR

This paper examines the use of coal phaseout auctions, a novel policy tool, analyzing Germany's experience to understand their benefits, challenges, and practical considerations for effective energy transition policies.

Contribution

It provides an empirical analysis of Germany's coal phaseout auction, highlighting design considerations and comparing it with other coal phaseout methods globally.

Findings

Auctions can efficiently allocate funds for coal closure.

Design issues like additionality and market interaction are critical.

Auctions may be less effective with concentrated ownership.

Abstract

The combustion of coal, the most polluting form of energy, must be significantly curtailed to limit global average temperature increase to well below 2 degrees C. The effectiveness of carbon pricing is frequently undermined by sub-optimally low prices and rigid market structures. Consequently, alternative approaches such as compensation for the early closure of coal-fired power plants are being considered. While bilateral negotiations can lead to excessive compensation due to asymmetric information, a competitive auction can discover the true cost of closure and help allocate funds more efficiently and transparently. Since Germany is the only country till date to have implemented a coal phaseout auction, we use it to analyse the merits and demerits of the policy, drawing comparisons with other countries that have phased out coal through other means. The German experience with coal phaseout auctions illustrates the necessity of considering additionality and interaction with existing climate policies, managing dynamic incentives, and evaluating impacts on security of supply. While theoretically auctions have attractive properties, in practice, their design must address these concerns to unlock the full benefits. Where auctions are not appropriate due to a concentration in coal plant ownership, alternative strategies include enhanced incentives for scrappage and repurposing of coal assets.