The Welfare Effects of Environmental Taxation and Subsidization on Renewable Energy Sources in an Oligopolistic Electricity Market

Abstract

This chapter investigates the impact of environmental taxation and subsidization on non-polluting renewable power plants. Their dispatch is prioritized in a wholesale electricity market in which oligopolistic firms produce electricity both from polluting fossil-fuel inputs and non-polluting renewable energy sources, and competitive fringe firms produce electricity only from non-polluting renewable energy sources. To examine the welfare impacts of levying a tax on emissions of pollutants from fossil-fuel power plants and granting subsidies to renewable power plants, this chapter develops a three-stage model with the endogenous capacity of renewable power plants, forward contracts on electricity, and the operation of fossil-fuel power plants. An emission tax imposed on fossil-fuel use is expected to discourage firms from operating their fossil-fuel power plants, thereby promoting substitution of renewable energy sources for fossil-fuel inputs. A subsidy provided to firms building renewable power plants is expected to reduce the setup costs, thereby promoting the use of renewable energy sources. Using simulations, this chapter makes a welfare comparison between an emission tax on fossil-fuel use and a subsidy for renewable power plants and analyzes how these environmental policies affect a wholesale electricity market.