Combining a renewable portfolio standard with a cap-and-trade policy : a general equilibrium analysis

Abstract

Most economists see incentive-based measures such a cap-and-trade system or a carbon tax as cost effective policy instruments for limiting greenhouse gas emissions. In actuality, many efforts to address GHG emissions combine a cap-and-trade system with other regulatory instruments. This raises an important question: What is the effect of combining a cap-and-trade policy with policies targeting specific technologies? To investigate this question I focus on how a renewable portfolio standard (RPS) interacts with a cap-and-trade policy. An RPS specifies a certain percentage of electricity that must come from renewable sources such as wind, solar, and biomass. I use a computable general equilibrium (CGE) model, the MIT Emissions Prediction and Policy Analysis (EPPA) model, which is able to capture the economy-wide impacts of this combination of policies. I have represented renewables in this model in two ways. At lower penetration levels renewables are an imperfect substitute for other electricity generation technologies because of the variability of resources like wind and solar. At higher levels of penetration renewables are a higher-cost prefect substitute for other generation technologies, assuming that with the extra cost the variability of the resource can be managed through backup capacity, storage, long range transmissions and strong grid connections. To represent an RPS policy, the production of every kilowatt hour of electricity from non-renewable sources requires an input of a fraction of a kilowatt hour of electricity from renewable sources.

(cont.) The fraction is equal to the RPS target. I find that adding an RPS requiring 25 percent renewables by 2025 to a cap that reduces emissions by 80% below 1990 levels by 2050 increases the welfare cost of meeting such a cap by 27 percent over the life of the policy, while reducing the CO2-equivalent price by about 8 percent each year.