Are targets for renewable portfolio standards too low? The impact of market structure on energy policy

• Published in: European journal of operational research 2016-04, Vol.250 (1), p.328-341
• Main Authors: Siddiqui, Afzal S., Tanaka, Makoto, Chen, Yihsu
• Format: Article
• Language: English
• Subjects: Alternative energy; Bi-level modelling; Climate change; Computer and Systems Sciences; data- och systemvetenskap; Emission standards; Emissions; Energy industry; Energy policy; Market power; OR in environment and climate change; Perfect competition; Renewable portfolio standards; Renewable resources; Studies
• ISSN: 0377-2217; 1872-6860; 1872-6860
• DOI: 10.1016/j.ejor.2015.10.063

•Renewable portfolio standards (RPS) are market instruments to curb emissions.•In deregulated electricity industries, governments set RPS targets.•Via a bi-level model, we find optimal RPS targets with and without market power.•We show that perfect competition leads to a higher RPS target but lower welfare.•Withholding by non-renewable producers alleviates the distortionary effects of RPS. In order to limit climate change from greenhouse gas emissions, governments have introduced renewable portfolio standards (RPS) to incentivise renewable energy production. While the response of industry to exogenous RPS targets has been addressed in the literature, setting RPS targets from a policymaker’s perspective has remained an open question. Using a bi-level model, we prove that the optimal RPS target for a perfectly competitive electricity industry is higher than that for a benchmark centrally planned one. Allowing for market power by the non-renewable energy sector within a deregulated industry lowers the RPS target vis-à-vis perfect competition. Moreover, to our surprise, social welfare under perfect competition with RPS is lower than that when the non-renewable energy sector exercises market power. In effect, by subsidising renewable energy and taxing the non-renewable sector, RPS represents an economic distortion that over-compensates damage from emissions. Thus, perfect competition with RPS results in “too much” renewable energy output, whereas the market power of the non-renewable energy sector mitigates this distortion, albeit at the cost of lower consumer surplus and higher emissions. Hence, ignoring the interaction between RPS requirements and the market structure could lead to sub-optimal RPS targets and substantial welfare losses.