Carbon Taxes and Feed-in Tariffs: Using Screening Curves and Load Duration to Determine the Optimal Mix of Generation Assets

Abstract

Mitigating climate change will require reduced use of fossil fuels to generate electricity. To do so and eschewing nuclear power, countries have turned to wind energy. In this study, we discuss how screening curves and load duration can be used to determine the optimal investment in generating assets, and extend this method to include wind and nuclear energy sources. We then use this approach to investigate the effects of carbon taxes and feed-in tariffs (FITs) on the optimal generation mix and the potential for reducing CO2 emissions. We find that a carbon tax is likely more effective than a feed-in tariff for removing fossil fuel assets and incentivizing investment in wind power. The tax leads to the removal of coal-fired capacity that is replaced by combined-cycle gas generation. However, if nuclear energy is permitted to enter the mix, the tax results in coal capacity replaced by nuclear power instead of gas, which leads to a significant reduction in greenhouse gas emissions compared to any other alternative considered. We also find that, because wind cannot substitute for baseload generation, the additional investment in wind resulting from a carbon tax or FIT is small compared to the absence of any incentives (only 7%). Finally, if the tax and FIT lead to the same mix of generating assets, the income distributional effects can be quite large. It is the distributional effects of policy, and associated rent seeking activities to implement a FIT, that could be the deciding factor in choosing between a carbon tax and feed-in tariff.