Do Renewables Policies Promote Valuable Investments?

Last month, a big battle over the production tax credit (PTC) for wind ended with Congress granting a one-year extension. This month, the focus has shifted to another renewable energy policy: state renewable portfolio standards (RPSs). Just this week, the Heartland Institute recommended repealing Kansas’s RPS—the latest addition in a growing attack on state RPSs.

But, are these attacks warranted? About a month ago, we wrote that the wind production tax credit (PTC) is a bad way to cut carbon because it leads to lower electricity prices and more electricity consumption, offsetting some of the emissions reductions it achieves. But there’s another shortcoming that applies to nearly all renewable electricity policies, including RPSs: they don’t spur investment in the most valuable generators.

It may seem obvious, but a good climate policy would spur investment in the generators that have the most value to society. By value, we mean both the value of a renewable generator to its owners—which depends on the cost of constructing and operating the generator as well as the revenue it generates—and the value to the environment because of displaced emissions from fossil fuel generators. But don’t all renewable generators have equal market and environmental value? They don’t, and here is why.

Let’s consider a hypothetical investor choosing whether to invest in a new wind generator in Texas. Texas’s best wind resources are in the western parts of the state and along the Gulf Coast, making these regions natural considerations. However, electricity prices in western Texas are often much lower than in east Texas. Therefore, coastal wind generators would earn greater profits (earnings gained from selling electricity at market prices minus construction and operation costs) assuming a similar quality of wind resource. Another important difference between the two regions is that a wind generator’s environmental value is likely to be higher in west Texas because the generator would displace more coal generation than a wind generator on the Gulf Coast.

Here is where the shortcoming becomes apparent: a subsidy like the PTC would increase the revenue the wind generator would earn but that subsidy does not depend on the environmental value. In other words, the subsidy is the same whether the generator is in the west or along the coast. An RPS has the same shortcoming. And, the situation is even worse for an alternative that’s more popular in Europe—a fixed feed-in tariff (FIT) for wind, which fixes revenue per kWh of generation. Under a FIT, the investor picks the lowest-cost generator regardless of the market value of the energy. In other words, electricity prices in west Texas could be zero and the investor would still choose a project in west Texas if the wind resources are better. Clearly, that can’t be good policy.

In our research, we’ve shown that a number of renewable policies—including the PTC, RPSs, investment tax credits, and FITs—fail to create incentives for investors to choose the most valuable projects.

What can be done? It turns out that a GHG emissions price (either an emissions cap or a tax) fixes this problem. A clean electricity standard also does so, but has the same problem we discussed in our last post about the PTC: by implicitly subsidizing low-emission technologies, there is more electricity consumption and generation with a CES than a carbon price—and therefore more emissions for a given cost.

With an appropriate emissions price the revenue received by the owner of a renewable generator is exactly equal to the social value of the generated electricity. But it also wouldn’t be difficult to design policies like the PTC or state RPSs to come closer to meeting this goal. For example, the value of the subsidy granted by the PTC to a renewable generator  could depend on whether that generator is more likely to displace a natural gas-fired or coal-fired generator.

About Clayton Munnings

Clayton Munnings is a research associate at Resources for the Future.

About Joshua Linn

Josh Linn’s research centers on the effect of environmental regulation and market incentives on technology, with particular focus on the electricity sector and markets for new vehicles. His work on the electricity sector has compared the effectiveness of cap and trade and alternative policy instruments in promoting new technology, including renewable electricity technologies.

Views expressed above are those of the author. Resources for the Future does not take institutional positions on legislative or policy questions. All information contained on Common Resources is intended for informational and educational purposes and may only be used for these purposes. Please see RFF's Terms of Use for further information.

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