Investment in Wind Energy: The Role of Subsidies

Abstract

The U.S. Congress needs to determine subsidies for wind energy before they expire at the end of this year. Traditionally, the government has allowed each wind investor to choose its preferred subsidy among two types of subsidies: First is the investment subsidy which reduces the initial investment cost by a fraction. Second is the production subsidy which provides an additional payment for each unit of electricity produced. Energy experts suggest that these subsidies have different roles: The investment subsidy should be used to target investors facing a high financing cost, whereas the production subsidy attracts investors who can produce more electricity. Motivated by the looming deadline of The U.S. Congress, we analyze how it should offer subsidies to wind investors who are heterogeneous in financing cost and generation efficiency. Given their different roles, conventional wisdom suggests that the government should always offer the two subsidies jointly. Contrary to the conventional wisdom, we find that the government should offer only one type of subsidy unless the societal benefit from wind energy is sufficiently high. Moreover, this subsidy should be the investment subsidy even though production subsidy provides better price discrimination. This finding suggests that the government’s policy has been suboptimal until 2009 and in 2019 when it offered only the production subsidy. We also find that when the government should offer subsidies jointly, contrary to the suggestions of energy experts, the role of the production subsidy is to target investors facing a high financing cost.