Does Taxing Carbon Level the Playing Field for Wind Power?

An increasing number of policymakers have begun to push for strategies to induce investment in renewable energy. Many are also pushing for indirect regulatory intervention to penalize firms for using non-renewable resources and harming the environment. Many of these proposals encourage increasing capacity installations of wind and solar energy technologies, incentivized by taxing energy generated from burning fossil fuels through a tax on carbon.

In a new working paper from INSEAD, “Strategic Investment in Renewable Energy Sources,” researchers Sam Aflaki and Serguei Netessine were surprised to find that taxing carbon emissions from fossil fuel-based electricity generation did not necessarily improve the long-term competitiveness of wind power investments. The researchers found that intermittency issues related to wind-generated power are currently too common to allow wind generation to price independently of the fossil fuel market. As such, the authors found that, perhaps unintuitively, taxing carbon does not always incentivize investment in renewable capacity.

Currently, wind-generated energy carries an inherent level of uncertainty. The amount of energy produced by a wind farm is dependent on weather conditions including wind speeds and air density, an issue commonly called intermittency. Due to the high level of intermittency, wind-generated electricity cannot currently provide a continuously-available supply of energy. According to 2011 data from the US Energy Information Administration (EIA), wind power’s availability factor ranges from 0.25 to 0.4, whereas combined cycle natural gas turbine power generation is available almost all of the time, with an availability factor ranging from 0.87 to 0.97.

As such, the researchers determined that wind-generated power cannot be realistically relied upon to meet electricity demand at all times.  And, during periods when wind power technology is unable to provide energy to meet electricity demand, the system requires backup energy sources to supply the power. Because electricity storage is still a nascent technology, reliable backup energy sources are typically older technologies such as natural gas or coal.

These backup technologies emit more carbon than wind power technology. So, even in situations when carbon emissions are taxed, wind power firms are forced to resort to a backup source such as natural gas, increasing both their costs and total emission levels.

The study also found that the pricing structure of electricity markets further hinders investment in renewable capacities. Electricity is a commodity that is bought and sold in the spot market, where the price of electricity depends on the marginal cost of the last unit dispatched. In this study, the authors observed that the spot price of electricity is highest when a plant runs out of capacity — and decreases as the availability of electricity increases.

In other words, a wind power firm buying electricity to cover for intermittency is buying precisely when the price for that power is highest. This, in turn, increases the profits of a power generator using an energy source that is not subject to intermittency issues, such as a natural gas or coal generator and increases the costs associated with wind power generation. The authors found that the additional profit available when wind power generation is not available served as a reverse incentive, effectively driving firms to underinvest in renewable capacities.

Overall this study concluded that when the carbon emission level of backup technologies exceeded that of non-renewables, the cost of intermittency became too high to attract investment in wind power technologies. As a result, although taxing carbon might reduce total emissions, the market interest in investing in renewable capacities declines as backup technologies become more expensive under a carbon tax.

To address the intermittency predicament, the authors suggested several options. First, focus on new technologies geared at storing electricity in the form of potential energy. Another approach includes investing in a variety of renewable energy sources that are less correlated in terms of technologies and geography to pare down the impact of intermittency on power demand across a wider geography. In addition, the authors suggested a long-term fixed-price contract strategy to reduce price volatility in the spot market, eliminating the incentive for firms to underinvest. From the model, the authors inferred that renewable capacity installations would increase under the fixed-price contract scenario.

It is important to note that the authors studied only two types of power: generating technology and wind and natural gas. Other types of renewable technology, such as nuclear, do not experience intermittency issues.

The research provides important and unintuitive conclusions about the fate of wind power under a carbon tax scheme. Although a carbon tax might reduce emission levels, it will not necessarily lead to a renaissance in wind power. It also provides evidence that in order to reduce emissions and encourage investments in wind-generation, work to reduce the intermittency of wind power may be more effective than simply taxing carbon.

Feature photo: cc: “Caveman Chuck” Coker