Are renewable energy policies climate friendly? The role of capacity constraints and market power

Abstract

This paper studies the impacts of renewable energy support policies on energy prices, fossil fuel supply and thus carbon emissions from fossil fuels. Such supports are climate friendly if the renewables are already competitive against fossil fuels. But if the renewables are not yet competitive, the climate change impacts are often ambiguous and are sensitive to capacity constraints of renewables production and to the fossil fuel market structure. If the renewables do not have capacity constraints, then the subsidies are subject to the Green Paradox under perfect competition, but might be climate friendly under monopoly. Supports for capacity constrained renewables under perfect competition lead to more current fossil fuel supply but delay fossil fuel exhaustion time, and these effects are reversed under monopoly. Our results highlight the importance of considering the long-term effects on fossil fuel supply as well as capacity constraints and market power in designing renewable energy policies and evaluating their carbon footprints.