FITs and Starts: Getting Renewable Power to the Grid

Promoting the use of renewable energy technologies has become a major goal for governments around the world. The two most prominent efforts to spur renewable energy production, cap-and-trade markets in Europe and government financing programs in the U.S., have shown uneven progress. In “Evaluating Policies to Increase Electricity Generation from Renewable Energy,” Richard Schmalensee of the MIT Sloan School of Management analyzes the relative effectiveness of two alternative policies, feed-in tariffs (FIT) and renewable portfolio standards (RPS).

FIT policies pay power providers higher rates for generating electricity from renewable energy rather than from fossil-fuels to spur investment in renewables.  To date, FIT policies have been more common in Europe than in the U.S.

RPS policies, which have been adopted in 29 U.S. states and Washington, D.C., mandate that electricity providers purchase some portion of their power from renewable sources. RPS policies vary greatly across states. For example, New Jersey’s RPS requires that electricity providers acquire 22.5 percent of their power from renewable sources by 2021. Delaware, in contrast, mandates that each utility purchase 105 megawatts (MW) of renewable generation capacity, a largely irrelevant policy given the state’s current wind generation capacity of 3,675 MW.

In general, Schmalensee remains bearish about the economic argument for subsidizing renewable energy electricity through either FIT or RPS policies. He points out that economists have found flaws in many of the justifications for energy subsidies: energy security, growth of green energy jobs, and reduced CO2 emissions.

Despite flaws in some renewable energy incentive programs, Schmalensee presents a model to show that RPS policies are more efficient and impose less social risk than FIT policies. Under  Schmalensee’s model, the price of electricity varies less from shocks to the supply of renewable energy under RPS than it would under FIT policies. The model relies on the assumption that the marginal cost of power from fossil fuels is lower than that of power from renewables- certainly a reasonable assumption at present. His analysis also shows that political considerations and the desire for local job growth have been a powerful driver of RPS policies domestically.

With growing calls for a national RPS in the U.S., Schmalensee’s paper offers several important points regarding the inefficiencies associated with renewable energy credit (REC) markets in the US.  REC markets were created under many RPS policies to facilitate the entry of renewable power onto the grid. RECs are awarded to providers that create electricity from renewable energy and are then traded between different providers in a market.

The market for RECs allows companies that cannot meet RPS goals on their own purchase renewable energy to meet their state’s requirement. However, the author argues that there are large inefficiencies in this market, noting that:

most states have multiple technology- or location-specific goals, all but two states limit banking, REC markets are generally fragmented and thin, and transaction costs are quite high.

Schmalensee suggests several steps the United States should take to reduce these market inefficiencies if it were to pass a nationwide RPS policy. His most prominent suggestion is the development of a nationwide framework for one class of RECs in which trading information is easily accessible to the public.