The Economic Cost of Carbon Abatement with Renewable Energy Policies

Abstract

1 As of 2016, about 110 jurisdictions worldwide-at the national or sub-national level-had enacted feed-in policies for wind and solar power, making this the most widely adopted regulatory mechanism to promote renewable power (REN, 2016). In the United States, the federal government provides sizable production and investment tax credits for renewables and more than half of the states have adopted renewable portfolio standards mandating minimum levels of renewable generation (U.S. Department of Energy, 2016). The Renewable Energy Directive by the European Commission (2010) established an overall policy for the production and promotion of energy from renewable sources in the EU requiring to fulfil at least 20 % of its total energy needs with renewables by 2020; a new regionally binding target seeks to increase this share to 27 % by 2030. In implementing these goals, many of the EU countries have heavily relied on feed-in tariffs and tendering mechanisms for electricity generated from wind and solar power. 1 2 and socially equitable manner, it is critical to understand the market impacts of policy-induced increases in renewable energy (RE) supply. The increase of RE supply generally has two effects on electricity markets. First, it replaces conventional by RE generation, which we refer to as the replacement effect. If fossil fuel technologies are replaced, this leads to lower CO 2 emissions in power generation. Second, as generators with high marginal cost are pushed out of the market, the wholesale electricity price decreases, which we refer to as the price effect. This unambiguously lowers profits (i.e., capacity rents) for energy producers that use conventional energy technologies. Consumers, however, may gain or lose overall because they benefit from lower energy prices but also face higher costs to the extent that RE subsidies are re-financed through taxes on electricity demand. While the theoretical mechanisms for the impacts of RES policies on electricity markets are well understood, an empirical analysis is needed to shed light on the following questions that are central to public policy-making in the domain of carbon mitigation and climate change: Which fossil fuels and how much are replaced if RE supply from wind and solar resources increases? What are the impacts on CO 2 emissions? What are the economic costs of reducing CO 2 emissions through promoting energy supply from RE sources? And how are these costs distributed among energy producers and consumers? Despite the fundamental importance of these questions for designing public interventions to reduce fossil fuel use, surprisingly little is known about the market impacts of RE support schemes in terms of an ex-post policy assessment. 2 This paper develops an empirical quantitative framework to quantify the cost of carbon abatement through RES policies for wind and solar. 3 Besides estimating aggregate cost, we also focus on the incidence of cost between energy producers and consumers. To identify the impacts of RES policies, we exploit the randomness and...

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