Prices vs. percentages: Use of tradable green certificates as an instrument of greenhouse gas mitigation

Abstract

We consider a regulator who seeks to achieve a specific target path of greenhouse gas emission reductions in the electricity sector. Generation stems from two sources: renewable (green) and fossil (black) sources, which cause emissions. We construct a dynamic model and explore the suitability of a tradable green certificate (TGC) scheme for solving this problem. Further, we study the resulting incentives for construction of new green generation capacity. We provide a novel contribution to the TGC literature by using a dynamic model that allows analyses of time-related issues that are inaccessible with static models. Further, we focus explicitly on calibration of the time path of percentage requirements. We devise two specific time paths and show that the use of a TGC scheme can achieve a specific dynamic emission target but always results in overinvestment in new green generation capacity. We also derive results from using an emission fee and a green subsidy, compare the different instruments, and conduct a welfare ranking. A TGC scheme is not as cost-effective as an optimal emission fee but is more effective than a green subsidy.