Association for Public Policy Analysis & Management

The transition to a low-carbon global energy economy is among the most pressing and challenging issues of our time. In the electricity sector, most renewable energy technologies are not competitive with conventional fossil fuels due to higher generation costs per kilowatt-hour (kWh). This cost premium means investments in renewable generation capacity generally require additional incentives to make them profitable. Many governments have implemented economic support policies to stimulate investment in renewable generation. Two dominant policies have emerged. Feed-in tariffs (FIT)—a price-based scheme—guarantee all eligible producers receive a fixed price per kWh generated. By contrast, a renewable portfolio standard (RPS) is a quantity-based scheme in which the regulator requires a specific proportion of electricity to come from renewable sources. Electric utilities can meet RPS requirements by purchasing renewable electricity from independent generators, or through the installation and operation of their own facilities. In most cases, successful implementation of RPS policy also includes a complementary market mechanism in the form of tradable renewable energy certificates (RECs).

By requiring retail electricity providers to procure a mandated minimum proportion of their supply via renewable sources at market prices, RPS obligations encourage renewable generators to meet the target in a least-cost fashion. Proponents of FIT policies argue that FITs insulate investors from revenue risks from electricity price variability and contract uncertainty. But, as Schmalensee (2012) posits, “Measures that remove market risk from one set of players may simply shift it to others and not reduce the risk to society as a whole.”  In theory, the variance of the total cost of serving a fixed demand load—“a natural measure of total social risk”—is higher under FIT than RPS. Put simply, total electricity expenditures may be more volatile under FIT than under RPS, implying greater social risk.

We empirically examine Schmalensee’s conclusion that RPS is superior to FIT in terms of social risk. His model does not lend itself to direct empirical testing, simply because demand loads vary across electricity markets. Instead, we analyze the variance in total social cost per unit to determine whether FIT or RPS imposes greater risk. Our empirical strategy is based on a modification of Schmalensee’s model that allows direct testing using data on electricity prices and generation from a sample of countries around the world that currently employ either FIT or RPS. We measure total expenditures in electricity markets at a daily interval to calculate the total price paid to all electricity including any relevant REC and FIT prices.  We then calculate the variance of this measure within a year for each country as a measure of the amount of risk.  Using regression analysis we then estimate how the amount of social risk varies with the prevalence of different renewable electricity policies.