Interactions Between Climate Policies in the Power Sector - Green Energy and Efficiency: An Economic Perspective - page 279

As explained in Sect. 2 , the EU ETS has presented several market imperfections
that have depressed the price mostly due to the excessive number of permits in the
market.
In our model, this would be equivalent to the cap E being set too high so that the
emissions permit price would be close to zero. The cap E can be set too high for
political reasons, i.e. governments might not want to impose a heavy burden
on their domestic industries and therefore might opt for relaxing the emission caps,
or for technical reasons, i.e. because of uncertainty about the right level of emis-
sions or because of market imperfections.
Under this scenario, a second target such as a RES-E quota, might act as a safety
policy to guarantee a minimum level of emissions reduction. In other words, a
policy based on reducing emissions through a subsidy to renewables might increase
the cost of abatement but, on the other hand, might be the only feasible option to
reduce emissions.
In our model, imagine that the optimal level of emissions is E* and because of
political reasons or measurement errors is set at E > E* (or simply assume that because
of market imperfections the carbon market will not be able to meet a cap of E *).
Should the

xing of the carbon market not be feasible, a subsidy to the deployment of
renewables could be used as an alternative instrument to reduce emissions.
Using a RES-E quota to reach a speci c emissions reduction, would require

setting the renewables target R * that will guarantee that the level of emissions will be
E *. That is, R * is such that fq 1 þ H hp e E E where q 1 is such that solves

Max PðQÞ q 1 þ q 2 ð Þ c 1 ðq 1 Þc 2 ðq 2 Þþrq 2 p e f ðq 1 Þ

S : fqðÞþH hp e E E : t

where r is such that q 2 R . Solving the above equation, the necessary subsidy to
produce R* will be equal to the difference between the marginal cost of the
renewable and the conventional technologies minus the emissions marginal cost of
the fossil-fuelled technology, i.e., r ¼ c 0 2 ðR Þc 0 1 q 1 p e f 0 q 1 p 0 e fq 1 .
Notice that a large R * will increase the marginal cost of producing renewable
energy and will simultaneously depress the emissions price. Therefore, the larger
R * the larger the necessary subsidy via these two effects.
The lower abatement cost associated to a lower emissions price will not however
compensate the higher costs associated to the subsidisation of renewables: subsi-
dising renewables beyond the optimal level will increase total abatement costs.
In summary, the support to RES-E to overpass the imperfections of carbon
markets is a second best policy option. The rst best policy to reduce emis-

sions would be to x the carbon market but this might not be politically feasible,

might take time, might not be feasible due to the large degree of uncertainty about
future emissions or might not be effective because of the incompleteness of the
carbon market. In the meantime, a direct subsidy to the deployment of renewables
might do the job though at a higher cost. Such subsidy should internalise the impact
of the renewables quota on the carbon market.