Download FES 505a: Economics of the Environment

Economic Efficiency of
Renewable Portfolio Standards in
the Presence of Cap-and-Trade
Kenneth Gillingham
Yale School of Forestry & Environmental Studies
Arthur van Benthem
Stanford University
Motivation
• Throughout the world, there has been a push for a capand-trade (CAT) system on carbon emissions at the
same time as a renewable portfolio standard (RPS)
– Recent US Senate and House climate bill proposals
– Current EU climate policy (binding cap; voluntary RPS)
Question: Why would we ever want an RPS if we already
have a CAT?
Specific Questions
• What would we have to believe for an RPS to be
economic-efficiency improving if we already have CAT?
– What market failures would need to be present?
– How important would we have to believe those market
failures are?
– Does the RPS in current/proposed U.S. climate policy improve
economic efficiency?
– What is the loss in economic efficiency from not adopting a
first-best policy?
Outline of Research Project
• Theoretical Model
– Modeling market failures
• Simulation Model
– Partial-equilibrium model calibrated to the U.S. economy
– Market failures made more explicit than in previous work
Proposed ACES in the U.S.
8000
7000
5000
4000
3000
2000
1000
total emissions covered
cap level
2005 emissions
2050
2048
2046
2044
2042
2040
2038
2036
2034
2032
2030
2028
2026
2024
2022
2020
2018
2016
2014
0
2012
Tg CO2 equivalent
6000
Many state-level RPS policies already
• An RPS was proposed in concert with ACES
• Already numerous state-level RPS policies
Source: US DOE EERE (2011)
Market Failures
• Three Market Failures
1. Externality from carbon dioxide (and other) emissions
2. R&D spillovers
3. Learning-by-doing (LBD) spillovers
• Starting point intuition:
– If we only have an environmental externality and we
internalize it, RPS must be efficiency-reducing
– But RPS may help address R&D and LBD spillovers…
R&D Market Failure Intuition
• Two period model
– Cost functions
– Profits
– Competitive equilibrium vs. social optimum
R&D Market Failure Intuition
• Competitive equilibrium underprovides R&D
investment
• Degree of appropriability is given by
versus
• By symmetry, r0i=R0,-i/(N-1), and we can specify
– aR is fraction of R&D investment that is appropriable
– This enables representative firm approach
Learning-by-doing Market Failure
MC0(q0)
A
p0*
t=1
Price of electricity (p1)
Price of electricity (p0)
t=0
MC0(q0)
MC1(q1)
MC1,soc(q1)
p1*
B
q0
q0,soc
Quantity of electricity (q0)
C
q1
q1,soc
Quantity of electricity (q1)
Partial-Equilibrium Model
• Simple partial equilibrium model
–
–
–
–
–
–
–
Two sectors: electricity (E) and industry (I)
Electricity can be renewable (R) or fossil (F)
Quantities qF, qR and qI
Carbon intensities bF, bI (bR = 0)
Marginal environmental damage t
Cost functions Ci(qi) (i = R,F,I)
Demand pE(qF+qR) and pI(qI)
• For simplicity, assume:
𝐶𝑅 𝑞𝑅 , 𝑅 = 𝛾 𝑅 𝑐𝑅 𝑞𝑅
Modeling Cap-and-trade and RPS
• Cap-and-trade – emissions must be less than 𝐾𝜏
• RPS – fraction of electricity generation by fossil fuels
must be less than 𝜎
Social Planner vs Decentralized
• More general social planner’s problem:
𝐿
=
max
𝑞𝐹 ,𝑞𝑅 ,𝑞𝐼 ,𝑅
𝑝𝐸 𝑞𝐹 + 𝑞𝑅 + 𝑝𝐼 𝑞𝐼 − 𝐶𝐹 𝑞𝐹 − 𝛾 𝑅 𝑐𝑅 𝑞𝑅 − 𝐶𝐼 𝑞𝐼
− 𝜏(𝛽𝐹 𝑞𝐹 + 𝛽𝐼 𝑞𝐼 ) − 𝑝𝑅 𝑅
• Compare to the representative agent problem with a
cap-and-trade and an RPS:
𝐿
=
max
𝑞𝐹 ,𝑞𝑅 ,𝑞𝐼 ,𝑅
𝑝𝐸 𝑞𝐹 + 𝑞𝑅 + 𝑝𝐼 𝑞𝐼 − 𝐶𝐹 𝑞𝐹 − 𝛾 𝛼𝑅 𝑅 𝑐𝑅 𝑞𝑅
− 𝐶𝐼 𝑞𝐼 − 𝑝𝑅 𝑅 + 𝜆 𝜎 𝑞𝐹 + 𝑞𝑅 − 𝑞𝐹 + 𝜇 𝐾𝜏 − 𝛽𝐹 𝑞𝐹 − 𝛽𝐼 𝑞𝐼
RPS helps to address innovation
market failures – but imperfectly
• Let’s compare the first order conditions of the two
problems:
𝑞𝐹 𝑝𝐸 = 𝑀𝐶𝐹 𝑞𝐹 + 𝜆 1 − 𝜎 + 𝜇𝛽𝐹
𝑑𝑐𝑅
𝑞𝑅 𝑝𝐸 = 𝛾 𝑅 ∗
𝑞𝑅 − 𝜆𝜎
𝑑𝑞𝑅
𝑞𝐼 𝑝𝐼 = 𝑀𝐶𝐼 𝑞𝐼 + 𝜇𝛽𝐼
R&D
𝑑𝛾
overinvestment
𝑅 𝑝𝑅 = −𝛼𝑅
𝑅 ∗ 𝑐𝑅 𝑞𝑅
𝑑𝑅
R&D underinvestment
Several Propositions
If no innovation market failures exist:
1. Adding a binding RPS to an existing cap reduces the
optimal permit price
With both environmental and innovation market failures:
2. In the absence of R&D subsidies, the permit price
should be set higher than the marginal damages
3. In the absence of a CAT, a small binding RPS will always
be economic efficiency-improving
4. With a CAT, a small binding RPS will always be
economic-efficiency improving
What Does this Mean for Policy?
• This is where the simulation model comes in…
– We parameterize and calibrate the model to the US economy
*PRELIMINARY FINDINGS*
• Under our base case set of assumptions:
– We find that it is going to be very difficult to justify any largescale RPS policy
– Without a CAT, it appears that the socially optimal RPS policy
may not be too far from some of the state-level policies
Acknowledgments
• We would like to thank Larry Goulder of Stanford
University for his thoughtful comments about this
project