Policy & Regulation

How a new international trade law can accelerate the energy transition

How a new international trade law can accelerate the energy transition
(Image by Julius Silver from Pixabay)

Contributed by Andrés Chambouleyron, Managing Director at Berkeley Research Group

The 28th annual United Nations climate meeting in Dubai last December led to several agreements aimed at phasing out fossil fuels, increasing renewable capacity, and achieving net-zero emissions by 2050.

Though very laudable goals, meeting them will be hardly an easy task, especially in developing countries. One, often overlooked, reason for this is that hydrocarbons like oil and gas1 are tradeable commodities that can be bought and sold in international markets. Renewables, however, cannot, and therefore cannot (directly) contribute to an export-led growth strategy, like the US’s experience with fracking or Brazil’s commodities boom of 2023. Without renewable power trading between neighboring countries – and presuming demand for oil and gas persists – hydrocarbon-rich countries (especially in the developing world) will continue to find it more profitable to invest in their production rather than investing in non-tradeable renewables. 

The good news is that renewable power can be traded internationally, albeit indirectly, through the goods it is used to manufacture. If, for instance, the international community adopted a rule that set a maximum allowed amount of carbon used in the manufacturing of exports and imports, and that carbon footprint could be easily verified, goods that were manufactured with a high carbon footprint could be phased out of international trade markets and eventually replaced by those produced with cleaner energy. This would in turn create the necessary traction to expand renewable capacity through international trade.

Current obstacles to trading renewables

To address this problem, it’s important to first understand why renewables cannot be treated as tradeable commodities at present:

  • High intermittency of output. Renewables are only produced whenever the natural resources that generate them are present, (i.e., wind and sun). While this intermittency problem has been mitigated in developed countries and even neutralized through storage, this is not the case in most of the developing world.
  • Volatile pricing. Wholesale prices of electricity with a strong presence of renewables and a lack of effective storage can be extremely volatile, with variations as high as 20 times in a matter of hours and strong regional differences related to congestion and transmission costs. Developing countries typically don’t have sophisticated future markets that can be used to hedge generators and consumers against the high volatility of wholesale prices.
  • Lack of grid interconnection. Electricity trade among neighboring countries requires the interconnection of their transmission grids and a centralized System Operator (SO) that can run a single and unified economic dispatch of power plants. Even though this is the rule in North America and continental Europe, it is not, for example, in Latin America, where each country has its own SO, economic dispatch, and transmission grid.
  • Need for new transmission lines. Contrary to traditional thermal power plants, renewables are located in rural areas, far away from consumption centers – namely because they are land-intensive, and land is less expensive the farther one moves from the city. As a result, renewable power plant locations require additional investment in low- and medium-voltage transmission lines to connect them to the high-voltage transmission grid.

More importantly, power transmission is a natural monopoly, subject to significant regulatory and expropriation risk, especially in developing countries where regulatory institutions and court enforcement powers are weak.

Finally, the expansion of transmission grids requires a high degree of coordination between national and subnational governments, with the necessary harmonization of variables like voltage, frequency, quality of service, and more. This is extremely difficult to accomplish between countries with different regulatory regimes.

A new international trade rule can accelerate the energy transition

Setting an enforceable international rule to measure and control the carbon footprint of products (CFP) that are exported and imported worldwide should provide developing countries with the incentives they need to rapidly phase out the use of hydrocarbons and adopt renewable energy in the manufacturing of traded goods.

With such a rule, countries would no longer have to expand power transmission grids, as manufacturing firms would be incentivized to locate near renewable resources. After all, transporting goods to consumption centers and seaports should always be less expensive (and require less coordination/bureaucracy) than building new transmission lines. This would also contribute to the decentralization of economic activity away from overcrowded megalopolises such as Mexico City, São Paulo, and Buenos Aires.

The new rule could be set and enforced by the World Trade Organization (WTO) through, for example, the adoption of ISO 14067 guidelines, whereby countries could start demanding from their trade partners that the products they buy comply with a maximum level of CFP.

Additionally, if exporters have a CFP higher than the allowed upper limit, they should be able to buy carbon certificates to compensate for the difference. For example, if the manufacturer of product A did not invest enough in emission-reduction technologies to reach the allowed threshold of CFP, then they should be able to buy carbon certificates to compensate for the difference between their actual CFP and the maximum allowed level. Optimally, the manufacturer of product A would invest in emission-reduction technologies until the marginal cost of this investment was equal to the market price of carbon certificates2. Of course, for this mechanism to be efficient, the market price for carbon certificates should reflect the opportunity cost of not adopting emission-reduction technologies.

In sum, an exciting way to accelerate the clean energy transition would be to commoditize renewables through the enforcement of an allowed maximum level of CFP and the implementation of an international market of carbon certificates in the trade of manufactured goods.

1. Natural gas is not exactly and by itself a tradeable commodity because that would require pipeline interconnection between trading countries. It becomes one through Liquified Natural Gas or LNG.

2. If this equilibrium level of investment in emission-reducing technologies provides a CFP that is still above the maximum allowed level, then the investor should buy carbon certificates to compensate for the difference.

About the author

Andrés Chambouleyron is a Managing Director at Berkeley Research Group with experience as an economist, valuation expert, consultant for public utilities (electricity, natural gas, water and sanitation, and telecommunications) and other regulated and non-regulated businesses. His work involves economic analysis, pricing and rate setting, valuation, business advisory, regulatory design and analysis, and damage assessment. He can be reached at achambouleyron@thinkbrg.com.