5 Clase 5 Paper Incentives RE V - FINAL

Comparison of Incentive Policies for Renewable Energy in an
Oligopolistic Market with Price-Responsive Demand
Miguel Pérez de Arce* and Enzo Sauma*†
ABSTRACT
This article compares different incentive policies to encourage the development

of renewable energy (RE). These incentive policies (carbon tax, feed-in tariff,
premium payment and quota system) are modeled in a simplified radial power
network, using price-responsive demand. Most results are derived assuming an
oligopolistic Cournot competitive framework and that the costs of subsidies are
covered by the government (i.e., customers do not directly pay back for the sub-
sidies). We compare the different RE incentive schemes at different congestion
levels in terms of energy prices, RE generation, CO2 emissions, and social wel-
fare.
We find that the effectiveness of the different incentive schemes varies signifi-
cantly depending on the market structure assumed, the costs of renewable energy,
and the subsidy recovery method considered. Subsidy policies (FIT and premium
payments) are more cost effective in reducing CO2 emissions than those policies
that apply penalties or taxes, when assuming oligopoly competition and that cus-
tomers do not directly pay back for the subsidies. Quota and carbon tax policies
are more cost effective when assuming that either a perfectly competitive elec-
tricity market takes place or customers directly pay back for the subsidies.
Additionally, we show that, in the feed-in tariff system, there is an interaction
among incentive levels for renewable energy technologies. Given a certain feed-
in tariff price to be set for a particular renewable technology, this price influences
the optimal feed-in tariff price to be set for another technology.
Keywords: Renewable energy, Carbon tax, Feed-in tariff, Premium payment,
Quota system, Oligopoly
http://dx.doi.org/10.5547/01956574.37.3.mdea
1. INTRODUCTION
Due to the great concern worldwide about reducing carbon dioxide (CO2) emissions, dif-
ferent policies have been implemented to incentivize the development of renewable energy (RE)
sources, such as wind, solar and geothermal, among others. In 2009, power and heat generation
from conventional sources was responsible for 41% of the CO2 emissions worldwide (IEA, 2011a).
In 2009, 3% of the electricity generation came from non-hydraulic renewable energy sources (IEA,
2011b). According to the International Energy Agency (2011b), this percentage could reach 15%
by the year 2035, through the implementation of annual subsidies of 180 billion dollars.
* Industrial and Systems Engineering Department and Center for Global Change UC, Pontificia Universidad Católica
de Chile.
† Corresponding Author: E-mail: esauma@ing.puc.cl; Phone: + 56 2 23544272; Fax: + 56 2 25521608.
The Energy Journal, Vol. 37, No. 3. Copyright 䉷 2016 by the IAEE. All rights reserved.
159
160 / The Energy Journal
Among the policies that seek to accelerate the reduction of CO2 emissions through the
integration of RE, the most commonly used are: carbon taxes, feed-in tariffs, premium payments,
quota systems, auctions and cap and trade systems (Wiser et al., 2007; Fouquet and Johansson,
2008; Barroso et al., 2010; Olimpio et al., 2011; Kitzing et al., 2012; Tükenmez and Demireli,
2012; Fouquet, 2013; Hinrichs-Rahlwes, 2013). A carbon tax policy, such as the one proposed by
Green et al. (2007), seeks to impose an additional cost on thermal generators, so as to disincentivize
CO2 emissions, notwithstanding the fact that, in some situations, this might not occur, as pointed
out by Downward (2010).
Among the incentive policies using subsidy mechanisms to encourage the development of
RE, one may distinguish two particular types: feed-in tariff and premium payments (Mitchell, 1995;
Lesser and Su, 2008; Couture et al., 2010; Schallenberg-Rodriguez and Haas, 2012; Al-Amir and
Abu-Hijleh, 2013; Uran and Krajcar, 2013; Cherrington et al., 2013). The first type consists of fixed
tariffs determined for each unit of RE generated while the second type consists of a fixed payment
that is additional to the retail price of electricity per each unit of renewable energy produced. Some
policies using subsidies for RE specify a maximum installed capacity per technology that is subject
to the subsidy.
A large percentage of European countries have adopted these types of policies (Germany,
Denmark and Spain among others), as it is mentioned in Couture and Gagnon (2010), Farrell (2009),
and in Menanteau et al. (2003). In Germany, feed-in tariffs started in the 1980s and were consoli-
dated at the end of the 1990s (Lipp, 2007). This policy has led to a rapid growth of the share of
RE in electricity consumption in Germany, from 3.4% in 1990 to 25.4% for 2013 (Germany Federal
Ministry of Economy and Energy, 2013); with political support being one of the key factors for the
success in its implementation (Wüstenhagen and Bilharz, 2006). According to the International
Energy Agency (2011c), the share of RE in global electricity production was 16% in 2009 and
16.5% in 2010.
On the other hand, the quota obligation system (or simply quota system) places an obli-
gation, generally on electricity suppliers, to generate a specified fraction of their electricity from
RE sources (Amundsen and Mortensen, 2001; Berry and Jaccard, 2001; Fischer, 2010; Palmer and
Burtraw, 2005; Woodman and Mitchell, 2011). This mechanism is also known as Renewable Port-
folio Standards (RPS) in the United States, Renewable Electricity Standards (RES) in India, Re-
newables Obligations (RO) in the United Kingdom and Renewable Energy Targets in Australia.
Governments usually set a minimum percentage of electricity to be generated through RE, applied
over the total amount of electric power sold during a period (Menanteau et al., 2003). The additional
cost is generally transferred to the end consumers. The quota system is usually complemented with
tradable certificates, like the Tradable Green Certificates (TGCs) in Europe or the Renewable Energy
Credits/Certificates (RECs) in the U.S. (Munoz et al., 2013). These certificates of RE generation
are traded in the market by firms that must comply with the RE quota (the quota system establishes
penalties for those firms not complying with the RE quota; IPCC, 2011). Mitchell et al. (2006)
argue that the main risks faced by generators within a quota system are related to the retail price
level, the energy volume and the balance of energy.
A cap-and-trade policy, like the one described by Green et al. (2007), seeks to incentivize
the reduction of carbon emissions through a system of transactions of permits for such emissions.
Through this type of policy it is possible to lay down emission limits that generate credits for
companies that are below such a limit, allowing for the existence of a market for trading these
credits. Limpaitoon et al. (2011) present a comprehensive model of a cap-and-trade policy, iden-
tifying interesting results related to the congestion in the transmission system and the reduction of
Copyright 䉷 2016 by the IAEE. All rights reserved.
Comparison of Incentive Policies for Renewable Energy / 161
social welfare. Cap-and-trade policy is not modeled in the present work, but it can be considered
a similar policy as carbon tax.
Some authors have compared incentive policies for encouraging RE (Butler and Neuhoff,
2008; Barroso et al., 2010; Fischer, 2010; Asano, 2013; Verma and Kumar, 2013; Oak et al., 2014).
However, those studies make some oversimplifications like ignoring transmission constraints in the
power network and disregarding the possibility that generation firms act as oligopolistic firms,
exercising market power. On one hand, significant transmission investments are needed to integrate
RE, and these investments interact with generation expansion decisions as well (Felder, 2011;
Joskow and Tirole, 2005; Kahn, 2010; Martin and Rice, 2012; Mills et al., 2011; Morales et al.,
2012; Muñoz et al., 2012; Olson et al., 2009; Pozo et al., 2013a; Pozo et al., 2013b; Sauma and
Oren, 2007; Sauma and Oren, 2006; Schaber et al., 2012; Schumacher et al., 2009).
On the other hand, although most countries have implemented several policies to promote
competition in the electric generation sector (Arango and Larsen, 2011; Sioshansi and Pfaffenberger,
2006), there is still evidence of market power in some markets (Yenita and Kirschen, 2012). Some
countries having oligopolistic market structures in the power sector are Finland (Pineau et al., 2011;
Pineau and Murto, 2003), Singapore (Chang, 2007; Chang, 2004), India (Kumar and Thampy,
2011), Iran (Hossein and Monsef, 2010), Poland (Kamiński, 2012), Italy (Guerci and Sapio, 2011),
England and Wales (Belsnes et al., 2011), Spain (Rious et al., 2008), Germany (Rious et al., 2008),
United States of America (Belsnes et al., 2011; Limpaitoon et al. 2011; Yu et al., 2001), United
Kingdom (Maiorano et al., 1999; Thomas, 2005), and some Nordic countries (Juselius and Sten-
backa, 2011; Hellmer and Warell, 2009). This fact highlights the relevance of considering the
exercise of market power in modeling power markets (Mare et al., 2013; Oh and Thomas, 2013;
Banal-Estañol and Rupérez, 2011; Sandsmark and Tennbakk, 2010; Percebois, 2008; Thomas, 2005;
Wolfram, 1999). Furthermore, some authors have studied the impact of considering market power
in the RE penetration (Kazempour and Zareipour, 2014) and in the resulting CO2 emissions (Linares
et al., 2008).
Our work contributes to the literature by comparing different incentive policies for en-
couraging RE, considering both transmission constraints in the power network and the possibility
that generation firms act as oligopolistic firms. In addition, results under each policy are compared
when considering different market structures (oligopoly and perfect competition) and when consid-
ering different methods to recover the subsidy costs (no direct recovery from the government and
recovery through a customers’ pay back scheme).
The rest of the paper is structured as follows. Section 2 presents the base power-market
model. Section 3 shows the model formulation for the different RE incentive schemes analyzed. A
case study is used in Section 4 for comparing RE policies under different criteria. In particular, we
study nodal prices, RE penetration differences, the network congestion effect, the cost effectiveness
in reducing CO2 emissions, and social welfare, under different market structures and under different
assumptions about who bears the cost of the subsidies. Section 5 concludes.
2. BASE POWER-MARKET MODEL
In order to study the RE incentive policies, we model the electricity market using game
theory, analogously to Downward (2010). Our objective is to analyze the behavior and interaction
of power generation firms, which are able to generate through both conventional and RE sources.
A simplified radial (two-node) power network is modeled, assuming generation firms com-
pete à la Cournot. In this Cournot game, each player (generation firm) has some degree of market
Figure 1: Two-node power network
power. As in Downward (2010), we assume constant marginal costs and linear price-responsive
demand functions.
The power network considered in this work is shown in Figure 1. There are two nodes
linked by a transmission line with capacity K. The flow through the transmission line is designated
by f. In each node i, there is a generation firm, which can produce power from a RE source at a
levelized cost of cri and/or from a conventional source at a levelized cost of cci .1 The total amount
of energy injected into node i is qi , which corresponds to the sum of the conventional (qic ) and
renewable ( qri ) power generation in node i.
At each node, we consider an inverse demand curve, given by pi(yi) = ai – bi ⋅ yi, where
ai and bi are both strictly positive constants, yi is the power demand satisfied at node i, and pi is
the price at node i.
We consider that the generation firm located at node 1 owns two power plants: a (conven-
tional) coal power plant and a (renewable) wind power plant. Maximum generation capacities are
K1c and K1r , respectively. In turn, the generation firm located at node 2 owns two power plants: one
using natural gas (conventional source) and the other using solar energy (renewable source). Max-
imum generation capacities are K2c and K2r , respectively.
We model the market as a Cournot game, where each generation firm maximizes its profit
making rational expectation of its rival decisions, in anticipation of the dispatch performed by an
independent system operator (ISO). The optimal dispatch of electric power is determined by the
ISO, who indirectly decides on nodal prices and on the energy flowing through the line, with the
1. By considering the levelized costs of energy production, the proposed formulation allows incorporating the generation
capacity investment decisions into the dispatch (market clearing) problem.
The dispatch problem considers operating, maintenance and fuel cost, assuming generation capacity is fixed for all sources.
Accordingly, a RE power plant, which has a marginal cost close to zero, should always be dispatched at its maximum
available capacity. Then, in order to incorporate the generation capacity investment decision, another optimization problem
should be formulated. A bilevel formulation is usually employed for solving the generation investment and dispatch problems
(Pozo et al., 2013a). However, a simpler manner to model this (although with some limitations) is formulating the problem
just as a dispatch problem, but replacing the marginal cost of generation by the levelized cost, which includes both investment
and operations costs in a per-MWh basis (Becker et al., 2014; Moiseyev et al., 2014; Eichman et al., 2013; Crane et al.,
2011; Park et al., 2011; Nicholson et al., 2011). In our problem, we follow this last approach since we are interested in
jointly evaluate both the investment in RE capacity and the dispatch decisions, but incorporating later other complexities,
like the consideration of market power in an oligopoly framework, while keeping the problem computationally tractable.

goal of maximizing social surplus.2 The formulation of the ISO’s problem follows the formulation
in Downward (2010):
1 1
Max a1 ⋅ y1 – b1 ⋅ y12 + a2 ⋅ y2 – b2 ⋅ y22 (1)
2 2
s.t.
y1 + f = q1 , with q1 = q1r + q1c (2)
y2 – f = q2 , with q2 = q2r + q2c (3)
⎪ f⎪ ≤ K (4)
The game considered here is as follows: in the first stage, both generation firms simultaneously
commit to a specific level of generation for a given period. Then, in the second stage, the ISO
solves the dispatch problem by determining the energy flowing through the line and the energy
consumption levels (and hence nodal prices) that maximize the total gross surplus. Accordingly,
generation firms are able to anticipate the ISO’s dispatch decisions, so that it is possible to infer
how their actions affect line congestion and prices (Yao et al., 2008). Naturally, transmission con-
straints in the dispatch problem also have an influence on generation firms trying to maximize their
own profit.
Generation firm i’s problem is as follows:
Maxqci ⋅ (pi – cic ) + qir ⋅ (pi – cri ) (5)

s.t.
0 ≤ qci ≤ Kci
0 ≤ qri ≤ Kri
and the optimality conditions of the ISO’s problem
where pi is the Lagrangian multiplier (shadow price) of the energy balance constraints, (2) and (3).
Constraints in (5) relate to generation capacity limits of both conventional and RE power plants,
as well as the optimality conditions of the ISO’s problem.
To formulate this two-stage problem as a single optimization program (for each firm), the
Karush-Kuhn-Tucker (KKT) conditions of the problem in (1)–(4) are considered as constraints of
the problem of each generation firm in (5). Accordingly, the complete formulation of the problem
for generation firm i is presented in Appendix A (see base model in Appendix A). In this formu-
lation, the objective function reflects the profit of generation firm i when there is no RE incentive
scheme in place. Energy balance constraints represent the balance between supply and demand for
nodes 1 and 2. Transmission capacity constraints have an influence on nodal prices through the
Lagrangean multipliers g1 and g2.
2. The reader should note that the amounts of energy to be produced by generation firms are decided in advance of the
dispatch, so that these quantities are just parameters in the ISO problem. This implies that social welfare maximization is
equivalent to total gross surplus maximization in the ISO problem formulation, in an identical way as done by Downward
(2010).

3. MODELING INCENTIVE POLICIES FOR THE DEVELOPMENT OF RE
We modify the base model presented before depending on the incentive policy to be
considered. For each one of the incentive schemes, the ISO’s problem in the second stage of the
game is modeled in the same way as in the base case, represented by (1) – (4). Later on Section 4,
we modify the ISO’s problem to account for the direct recovery of subsidies from end consumers,
in the case of the RE policies providing subsidies.3
3.1 Carbon Tax Policy
A carbon tax policy consists of establishing an additional cost to generation firms asso-
ciated to their CO2 emissions. Mathematically, the generation firm i’s problem (first stage) is:
Maxqci ⋅ (pi – cic – αc ⋅ γic ) + qir ⋅ (pi – cri ) (6)

s.t.
Set of constraints of the base model
The tax to be imposed and the CO2 emissions factor are identified as αc (in $/ton of CO2) and γci
(in tons of CO2/MWh), respectively. We use γ1c = 1 for coal power plants and γ2c = 0.4 for natural
gas power plants.
The complete formulation of the generation firm i’s problem, anticipating the ISO dispatch,
is presented in Appendix A. Note that, with this incentive scheme, firms are still exposed to vari-
ations in market prices.
3.2 Feed-in Tariff
A feed-in tariff policy consists of the payment of a fixed price for the power generated by
means of RE. This mechanism reduces the firm’s risk associated to market price volatility. The
generation firm i’s problem is formulated as:
Maxqci ⋅ (pi – cci ) + qri ⋅ (pFIT

i – cri ) (7)
s.t.
where pFIT
i is the fixed price that is paid to the generation firm for each unit of energy generated
by means of RE. The complete formulation of the generation firm i’s problem, anticipating the ISO
dispatch, is presented in Appendix A.
As mentioned before, the reader should note that this formulation assumes that the cost of
the subsidy is covered by the government (i.e., customers do not directly pay back for the subsidy).
Although this is the case in some countries, there are also some other countries where customers
3. Some countries having RE policies with subsidies impose a direct subsidy recovery method from end consumers (i.e.,
subsidies are directly paid back by consumers) while other countries using these policies let the government covering the
subsidy costs (i.e., customers do not directly pay back for the subsidies). Accordingly, in this paper, we model both cases.
In Section 3 and the beginning of Section 4, we only consider the case where consumers do not directly pay back for the
subsidies. In Section 4 (precisely in Section 4.6.4), we also consider the case where subsidies are paid back by consumers.

directly pay back for the subsidy. In Section 4.6.4, we reformulate this policy to evaluate the effect
of directly including the subsidy in the demand curve.
3.3 Premium Payment
A premium payment policy consists of a fixed payment that is added to the market price,
as a premium for power generated by means of RE sources. The generation firm i’s problem is
formulated as:
Maxqci ⋅ (pi – cci ) + qri ⋅ (pi + PREMi – cri ) (8)

s.t.
where PREMi is the premium, in addition to the market price, that it is paid to the generation firm
i for generating electricity from RE sources. The complete formulation of the generation firm i’s
problem, anticipating the ISO dispatch, is presented in Appendix A.
As in the case of the feed-in tariff, this formulation assumes that the cost of the subsidy
is covered by the government. In Section 4.6.4, we reformulate this policy to evaluate the effect of
directly including the subsidy in the demand curve (i.e., customers directly pay back for the subsidy).
3.4 Quota Obligation
A quota obligation policy consists of setting a percentage of the total power generation
over a given period that must be produced by means of RE only. If generation firms (or whoever
is obligated to comply with the quota) fail to comply with this obligation, a penalty is applied to
them. The generation firm i’s problem is formulated as:
Maxqci ⋅ (pi – cci ) + qri ⋅ (pi – cri ) – Cpenalty ⋅ qpenalty

i (9)
s.t.
0 ≤ qpenalty
i (10)
q penalty
i ≥ [(q + q ) ⋅ β – q ]
c
i
r
i
r
i (11)
In this model, an additional variable is added to the base case, qpenaltyi . This variable corresponds
to the amount of power failing to comply with the RE quota. This amount of power has associated
a penalty, Cpenalty, which is the same for both generation firms. The parameter β establishes the
compliance percentage of the quota. Thus, constraints (10) and (11) are added to the base model.
Constraint (10) establishes that qpenalty
i must take a non-negative value. Constraint (11) establishes
the correct relationship among qpenalty
i , qic and qir . In this formulation, we assume that the money
collected from penalties goes to the government (i.e., it is not directly recovered by end consumers).
The complete formulation of the generation firm i’s problem is presented in Appendix A.
4. CASE STUDY AND RE POLICY ANALYSIS
In order to study carbon tax, feed-in tariff, premium payments and quota obligation poli-
cies, we implement the proposed models in Matlab䉷 (2012) for the radial network shown in Figure
Table 1: Electric Power Generation Levelized Costs

Node 1 Cost Node 2 Cost
c
Conventional Coal (c ): $91/MWh
1 Natural Gas (c2c ): $117/MWh
r
Renewable Wind (c ): $122/MWh
1 Solar (c2r ): $297/MWh
Table 2: Power Demand Parameters

Node 1 Node 2
ai 180 250
bi 5/16 1/2
1. First, we analyze the results for each one of the modeled policies and, then, we perform a
comparative analysis among them.
4.1 Data
The models were first calibrated with data provided by Downward (2010) and then adjusted
by using cost data obtained from the Chilean power market.
Generation costs
Information from the Chilean Ministry of Energy (2011) was used as reference for level-
ized costs, which reflect the cost of capacity investment, operation and maintenance incurred to
produce energy, temporarily discounted at a rate of 10%. These costs are presented in Table 1. As
explained before, by using levelized costs, we incorporate the decision of the optimal level of
investment in RE under different incentive policies into the dispatch problem.
Demand data
In each node, a linear demand function was considered, given by the equation:
pi = ai – bi ⋅ yi ; i = 1,2
where yi corresponds to the power consumed at node i. The values utilized for the parameters ai
and bi are detailed on Table 2.
Demand curves represent the consumption of cities of similar size, but where there is a
group of consumers in node 2 willing to pay more than any consumer in node 1 and where con-
sumption at node 2 is more inelastic than at node 1.
Generation capacity and transmission network data
The transmission line capacity (K) was initially assumed to be 200 MW, although sensi-
tivities are made with K = 60 MW to analyze the effect of congestion in the transmission line.
We assume the actual power generation capacity for conventional sources is 250 MW and
the actual power generation capacity for RE sources is 80 MW (based on a 0.32 capacity factor
and a nominal installed capacity of 250 MW).
Table 3: Range of Parameters Used for Analyzing the

Considered Policies
Carbon tax The tax level varies between 0 and $300/ton of CO2.
Feed-in tariff The fixed tariff varies between 0 and $350/MWh.
Premium payments The premium varies between 0 and $300/MWh.
Quota obligation For the case of a penalty of $32/MWh, the obligation
compliance varies between 0 and 100%.
Figure 2: Power supply, flow and demand at the market equilibrium under the Carbon Tax
Policy
Range of parameters
Table 3 shows the range of parameters for which the results are analyzed under each policy.
Next, in subsections 4.2 – 4.5, we present an analysis by type of policy, following the
assumptions made in Section 3. To safeguard the integrality of the results, we use the same as-
sumptions in all these cases.
4.2 Carbon Tax Policy Outcome
Under the carbon tax policy, in the case of a transmission line with 200 MW of capacity,
the results show a decongested line for all carbon tax scenarios considered. As it is shown in Figure
2, the tax implies a monotonic decrease in the power supplied from the conventional technology at
node 1, reaching a level of zero for a tax of $60/ton of CO2. In the case of the conventional
technology at node 2, the power supply increases as the tax level increases up to $60/ton of CO2
Figure 3: CO2 Emissions under the Carbon Tax Policy
(since the effect of the tax is more than compensated/offset by the increase of the energy price in
that node). Once the tax level exceeds $60/ton of CO2, the supply of such technology starts to
decrease, as expected, until the tax level reaches $129/ton of CO2. In the tax range between $129/
ton and $158/ton the conventional energy supply gets fixed at 60 MWh due to the fact that the
cheap renewable generation capacity is fully utilized and demand at node 1 reaches zero.
On both nodes, for tax levels between 0 and $129/ton of CO2, demand decreases, as a
consequence of an increase in the price level. Demand falls to zero at node 1 and to 140 MWh at
node 2, for tax values larger than $129/ton of CO2 (values which remain fixed for tax levels larger
than $129/ton of CO2). With respect to RE, only the firm at node 1 finds profitable to generate
power (at maximum capacity, effective 80 MWh), for tax levels larger than $32/ton of CO2.
Accordingly with the previous results, CO2 emissions (at an aggregate level) decrease as
the tax increases, see Figure 3. Neververtheless, it is interesting to note that emissions at node 2
grow in the tax range of 0 to $60/ton of CO2.
Assuming a carbon tax level of $32/ton of CO2 (which is the lowest tax level needed to
encourage RE generation of 80 MWh), we determine the existence of a single market equilibrium,
resulting in a single nodal price of $153.24/MWh. From the best response functions of both firms
in the Cournot model (resulting with these levels of tax and nodal prices), a power supply of 157.25
MWh at node 1 and 121.89 MWh at node 2 is reached at the market equilibrium, as shown in
Appendix C (Figure 24).
4.3 Feed-in Tariff (FIT) Policy Outcome
Under FIT policy, in the case of a transmission line with 200 MW of capacity, the results
show a decongested line for all feed-in tariff scenarios considered. As illustrated in Figure 4, the
power supplied takes a step-wise form in the FIT model (the same occurs in the premium-payments
model). This is because the subsidy is not directly included into the demand curve, but only applied
directly to the supply of RE, which always varies from zero to full capacity.4 In this sense, a rebound
4. For a feed-in tariff between 0 and $164/MWh, the firm located at node 1 does not produce RE because the difference
between the FIT and the nodal price ($138.31/MWh) is smaller than the difference between coal and natural gas ($26/

Figure 4: Power supply, flow and demand at the market equilibrium under the Feed-in
Tariff Policy
effect is produced by the subsidy when RE is generated (consumers increase electricity consumption
due to the artificial price reduction).5 Indeed, when incorporating the cost of the subsidy back into
the demand curve (simulation results are reported in Section 4.6.4), we observe that the rebound
effect is eliminated and power supply, the flow through the line, and demand at the market equi-
librium vary smoothly as FIT increases (i.e., the step-wise form of the curves in Figure 4 disappears).
In the cases of carbon tax and quota, on the contrary, payments/costs are directly applied into
conventional power supply, which are internalized by consumers through the resulting price levels,
implying that the rebound effect is not produced.
Figure 4 shows that, for a feed-in tariff level of $165/MWh applied to both nodes, there
is a decrease in the supply of energy from conventional sources on both nodes, which is more than
offset by an increase in the supply of RE sources on node 1. The same situation is repeated for a
level of feed-in tariff of $312/MWh, applied to both nodes, but this time the decrease in the supply
of conventional energy of both nodes is more than offset by an increase in renewable energy supply
on node 2.
Remarkably, on both nodes, for feed-in tariff levels of $165/MWh and $312/MWh, demand
for energy is spurred (rebound effect), as a consequence of a decrease in the price level, resulting
at levels of $133.18/MWh and $128.05/MWh, respectively. In this particular example, the totality
of the additional demand due to the rebound effect is supplied from RE sources. Accordingly with
these results, CO2 emissions decrease at each node for feed-in tariff levels of $165/MWh and $312/
MWh). At FIT = $165/MWh, nodal prices turn out to be $133.18/MWh at both nodes, which makes the difference between
FIT and nodal price larger than $26/MWh, meaning that the firm at node 1 produces its maximum capacity of RE.
5. Verma and Kumar (2013) find a similar effect (i.e., an increase in power generation) when applying a FIT policy.

Figure 5: CO2 emissions under the Feed in Tariff Policy
MWh, see Figure 5, because the increase in demand (rebound effect) is met with zero-emission RE
generation.
Assuming a feed-in tariff of $165/MWh, we determine the existence of a single market
equilibrium, resulting in a price of $133.18/MWh on both nodes. From the best response functions
of both generators in the Cournot model (resulting with these levels of feed-in tariff and nodal
prices), a power supply of 299.34 MWh at node 1 and 84.12 MWh at node 2 is reached at the
market equilibrium, as shown in Appendix C (Figure 25). A single equilibrium for a feed-in tariff
of $312/MWh and a price of $128.05/MWh on both nodes is also found, reaching a total power
supply amount of 272.67 MWh at node 1 and 137.47 MWh at node 2.
4.4 Premium Payment Policy Outcome
Under the premium payment policy, in the case of a transmission line with 200 MW of
capacity, the results also show a decongested line for all payment scenarios considered. As illustrated
in Figure 6, for a premium level of $32/MWh, there is a decrease in power supply coming from
conventional sources in node 1, which is offset by an increase of equal magnitude in the supply of
RE sources on the same node. The same situation is repeated for a premium level of $181/MWh,
but this time the reduction of conventional energy supply occurs on node 2, which again is offset
by an increase of equal magnitude in RE supply on that node. On both nodes, energy demand
remains constant as the premium increases and firms are incentivized to produce RE at maximum
capacity (80 MWh) for premium levels larger than $32/MWh and $181/MWh, respectively.
Assuming a premium of $32/MWh, we determine the existence of a single market equi-
librium, resulting in a price of $138.31/MWh on both nodes. From the best response functions of
both generators in the Cournot model (resulting with these levels of premium tariff and nodal prices),
a power supply of 246 MWh at node 1 and 110.8 MWh at node 2 is reached at the market equi-
librium, as shown in Appendix C (Figure 26).
Accordingly with the previous results, CO2 emissions (at an aggregate level) decrease in
each node for the premium levels of $32/MWh and $181/MWh, see Figure 7.
Figure 6: Power supply, flow and demand at the market equilibrium under the Premium
Policy
Figure 7: CO2 emissions under the Premium Policy
4.5 Outcome of Quota Obligation Policy
Under the quota policy, in the case of a transmission line with 200 MW of capacity, the
results show a decongested line for the different quota scenarios considered. As illustrated in Figure
8, with a penalty of $32/MWh, the supply of conventional energy in both nodes decreases as the
Figure 8: Power supply, flow and demand at the market equilibrium under the Quota
Policy
required quota increases. On both nodes, energy demand is reduced as quota obligation increases,
which is a result of the increase in the price level due to the RE obligation. Regarding RE generation,
the firm at node 1 produces RE at maximum capacity (80 MWh) for quota obligations larger than
36%, while in the case of node 2, there is no RE supply for any of the quota obligations.
Assuming a quota obligation of 36%, we determine the existence of a single market equi-
librium, resulting in a price of $145.99/MWh on both nodes. From the best response functions of
both generators in the Cournot model (resulting with these levels of quota obligation and nodal
prices), a power supply of 226.03 MWh at node 1 and 90.83 MWh at node 2 is reached at the
market equilibrium, as shown in Appendix C (Figure 27).
Accordingly with the previous results, CO2 emissions decrease at each node as the quota
obligation increases, see Figure 9.
4.6 Comparative Analysis of the Policies
In this section, we compare the different RE incentive schemes in terms of energy prices,
RE generation, CO2 emissions, and social welfare, when considering a certain level of RE penetra-
tion, when considering a determined target for carbon emissions, when considering different market
structures, and when varying the methods to recover subsidy costs.
4.6.1 Analysis Based on RE Penetration
A first comparative analysis was conducted on the results obtained for a total renewable
penetration of 80 MWh (this means, a total RE production of 80 MWh). Tables 4 and 5 show the
detailed results for each of the policies.
Figure 9: CO2 emissions under the Quota Policy
From Table 4, we observe that we obtain the highest social welfare (without considering
the base case) with feed-in tariff policy followed by premium payments, quota and tax policies. It
is important to recall that here we are assuming oligopoly competition and that customers do not
directly pay back for the subsidy. As demonstrated in later sections, these results change when
assuming that either a perfectly competitive electricity market takes place or customers directly pay
back for the subsidies.
The subsidy, in the case of the FIT policy, is computed as the difference between the value
of the FIT and the nodal price at the market equilibrium ($165/MWh minus $133.2/MWh is equal
to $31.8/MWh, as seen later on Table 6). In Tables 4 and 5, the total subsidy cost (which corresponds
to the before-mentioned value of the subsidy multiplied by the amount of RE generated) is pre-
sented. At the equilibrium, the value of the FIT subsidy ends up being similar to the value of the
subsidy in the case of the premium ($32/MWh).
On the other hand, the calculation of the producer surplus associated with the RE gener-
ation (REPS as seen in Table 4) is determined based on the difference between the value of the FIT
and the cost of RE generation ($165/MWh minus $122/MWh is equal to $43.0/MWh), in the case
of the FIT policy. In the case of the premium payment, the REPS is computed based on the value
of the nodal price plus the premium minus the cost of RE generation (i.e., $138.3/MWh plus $32/
MWh minus $122/MWh, which is equal to $48.3/MWh).
Note that, in agreement with these results, firms have incentives to invest in RE capacity
(i.e., generate RE in our model using levelized costs) because their profits are larger than the profits
obtained by producing with the coal power plant (In the FIT case, $43.0/MWh is larger than $42.2/
MWh, which is $133.2/MWh minus $91/MWh; and in the premium payment case, $48.3/MWh is
larger than $47.3/MWh, which is $138.3/MWh minus $91/MWh).
The second row of Table 4 presents the social welfare and RE participation when carbon
tax level is $32/ton of CO2 and nodal price is $153.24/MWh. Similar results, but in the case that
the transmission line has a capacity of 60 MW, are shown in Table 5. In the case that the transmission
line has a capacity of 60 MW, the line becomes congested for a tax level larger than $32/ton of
CO2, resulting in higher prices (i.e., $160.9/MWh and $174.9/MWh for nodes 1 and 2, respectively).
Table 4: Social Welfare at the Equilibrium in the Situation When Just Reaching 80 MWh of RE Penetration (Uncongested, K = 200)a
Policy Agent PS CEPS REPS CS CO2 Tax Sub. CR Penalty W %RE REG
1 $11,637 $11,637 $0 $2,781 246 t $0 $0 $0 0 0
Base Case: No Incentives 2 $2,361 $2,361 $0 $12,475 44 t $0 $0 $0 0 0
1+2 $13,998 $13,998 $0 $15,257 290 t $0 $0 $0 $0 $29,255 0 0
1 $4,836 $2,336 $2,499 $1,146 77 t $2,472 $0 $0 51 80 MWh
Tax ($32/ton of CO2) 2 $2,857 $2,857 $0 $9,362 49 t $1,560 $0 $0 0 0
1+2 $7,693 $5,194 $2,499 $10,508 126 t $4,032 $0 $0 $0 $22,233 29 80 MWh
1 $12,692 $9,252 $3,440 $3,507 219 t $0 $2,546 $0 27 80 MWh

Feed in Tariff ($165/MWh) 2 $1,361 $1,361 $0 $13,647 34 t $0 $0 $0 0 0
1+2 $14,053 $10,613 $3,440 $17,154 253 t $0 $2,546 $0 $0 $28,661 21 80 MWh
1 $11,718 $7,853 $3,865 $2,781 166 t $0 $2,560 $0 33 80 MWh
Premium ($32/MWh) 2 $2,361 $2,361 $0 $12,475 44 t $0 $0 $0 0 0
1+2 $14,079 $10,214 $3,865 $15,256 210 t $0 $2,560 $0 $0 $26,775 22 80 MWh

1 $9,905 $7,986 $1,919 $1,851 146 t $0 $0 $44 35 80 MWh
Quota (Fine $32/MWh;
2 $1,587 $1,587 $0 $10,819 36 t $0 $0 $1,046 0 0
Obligation = 36%)
1+2 $11,492 $9,573 $1,919 $12,670 182 t $0 $0 $0 $1,090 $25,251 25 80 MWh
a
Tables 4 and 5 present a detailed calculation of social welfare for each type of policy. Notation is as following: PS: Producer Surplus (PS = CEPS + REPS); CEPS: Conventional Energy
Producer Surplus; REPS: Renewable Energy Producer Surplus; CS: Consumer Surplus; CO2: CO2 Emissions; Tax: Carbon Tax Level; Sub.: Subsidy (Feed-in Tariff or Premium); CR:
Congestion Revenue; Penalty: Quota System Payment; W: Social Welfare; %RE: Renewable Energy Share; REG: Renewable Energy Generation.
Table 5: Social Welfare at the Equilibrium in the Situation When Just Reaching 80 MWh of RE Penetration (Congested, K = 60)a
1 $9,288 $9,288 $0 $1,974 172 t $0 $0 $0 0 0
Base Case: No
2 $5,305 $5,305 $0 $6,642 41 t $0 $0 $0 0 0
Incentives
1+2 $14,593 $14,593 $0 $8,616 214 t $0 $0 $1,417 $0 $24,626 0 0
1 $4,670 $1,560 $3,110 $585 41 t $1,318 $0 $0 66 80 MWh
Tax ($32/ton of CO2) 2 $4,068 $4,068 $0 $5,640 36 t $1,155 $0 $0 0 0
1+2 $8,738 $5,629 $3,110 $6,225 77 t $2,473 $0 $841 $0 $18,278 38 80 MWh
1 $8,838 $5,478 $3,360 $3,629 132 t $0 $2,530 $0 38 80 MWh
Feed in Tariff ($164/
2 $5,304 $5,304 $0 $6,642 41 t $0 $0 $0 0 0
MWh)
1+2 $14,143 $10,783 $3,360 $10,271 174 t $0 $2,530 $2,167 $0 $24,051 25 80 MWh
1 $9,368 $4,978 $4,390 $1,974 92 t $0 $2,560 $0 46 80 MWh
Premium ($32/MWh) 2 $5,304 $5,304 $0 $6,642 41 t $0 $0 $0 0 0
1+2 $14,673 $10,283 $4,390 $8,616 134 t $0 $2,560 $1,417 $0 $22,146 29 80 MWh
1 $6,536 $3,989 $2,547 $1,095 64 t $0 $0 $16 56 80 MWh
2 $3,619 $3,619 $0 $5,262 34 t $0 $0 $1,525 0 0
Obligation = 56%)
1+2 $10,155 $7,608 $2,547 $6,357 98 t $0 $0 $1,418 $1,540 $19,470 35 80 MWh
a
Notation is as in Table 4.

Table 6: Incentives of Policies for a RE Penetration of 80 MWh

K = 60 MW K = 200 MW
Policy – incentive Congested Uncongested
Carbon tax – Government Tax ($/ton of CO2) 32.0 32.0
a
FIT –Government Subsidy ($/MWh) 31.6 31.8
Premium payments –Government Subsidy ($/MWh) 32.0 32.0
Quota obligation – Penalty ($/MWh) 32.0 32.0
a
The FIT represents the price of electricity plus an additional subsidy paid by the
government to the RE plants. The FIT ($164/MWh) minus the electricity price at that
node ($132.4/MWh) equals $31.6/MWh in the congested case and $31.8/MWh in the
uncongested case ($165/MWh minus $133.2/MWh).
Table 7: Nodal Prices for a RE Penetration of 80 MWh (in

$/MWh)
K = 60MW K = 200MW
Policy Node (congested) (uncongested)
Node 1 (Wind) 144.9 138.3
Base Case
Node 2 (Solar) 168.5
Node 1 (Wind) 160.9 153.2
Carbon tax
Node 1 (Wind) 132.4 133.2
FIT
Node 1 (Wind) 144.9 138.3
Premium payments
Node 1 (Wind) 153.8 146.0
Quota obligation
As a result of this congestion, social welfare decreases (from $22,233 to $18,278), as it is shown
in Tables 4 and 5, respectively. Notwithstanding the foregoing, the congestion favors producers,
which is reflected in the increase of their surplus from $7,693 (Table 4) to $8,738 (Table 5). This
situation (congestion produced when K = 60MW reduces social welfare, favoring producers) also
occurs in the case of the other RE policies.
Table 6 shows the minimum incentive levels that are required in each policy to achieve
the penetration of 80 MWh of RE, when the transmission line is congested and when it is uncong-
ested. Under a carbon tax policy, this condition is satisfied with a tax of $32/ton of CO2, which is
the same independently of the transmission congestion. A similar situation is observed under pre-
mium payment and quota obligation policies. The incentive levels required with FIT policy are
different, depending on the congestion of the network.
Table 7 shows nodal prices, at the market equilibrium, in the case of a penetration of 80
MWh of RE. Naturally, prices are the same in both nodes for the uncongested line (K = 200 MW)
and they are different when there is congestion (K = 60 MW). As expected, nodal prices are lower
when there is no congestion in the line, yielding larger social welfare, as shown in Figures 10 to
13.6 As observed in Table 7, equilibrium price levels differ among the RE policies.
6. Figures 10 to 13 show the effect of congestion on social welfare in each type of policy. Independently of the incentive
policy, social welfare is always higher in the uncongested case, which is explained by the lower nodal prices obtained.

Figure 10: Case with Tax
Figure 11: Case with FIT
4.6.2 Analysis Based on Emission reduction Performance
We previously compared the performance of RE policies by looking at the social welfare

when reaching 80 MWh of RE generation. However, we must be careful in using this comparison
to make a conclusion about the policy performance in reducing CO2 emissions (because CO2 emis-
sion levels are different in each case). To adequately compare the CO2 emission abatement perfor-
mance of the RE encouraging policies, we set the same level of emissions achieved with every
policy. That is, we modify the level of incentives in each policy in order to achieve 253 tons of
CO2 in emissions (value arbitrary chosen) for the case of a line with 200 MW of capacity and 174
tons of CO2 for the case of a line with 60 MW of capacity, as shown in Tables 8 and 9, respectively.
Then, the performance of each policy to reduce CO2 emissions is determined based on the ratio
between emission abatement from base case (37 tons of CO2 for the case of a line with 200 MW
of capacity and 40 tons for the case of a line with 60 MW of capacity) and the difference WBase-
Figure 12: Case with Premium
Figure 13: Case with Quota
Caseminus WPolicy. This index is presented in Tables 8 and 9 (see PERP in Tables 8 and 9). Through
this index, Tables 8 and 9 allow establishing a ranking of policies regarding the cost effectiveness
in reducing CO2 emissions, in the case of assuming oligopoly competition and that consumers do
not directly pay back for subsidies.
Figures 14 and 15 compare the social welfare in the base case (WBase-Case) with the social
welfare under each policy (WPolicy), when having the same level of CO2 emissions.
Both subsidy policies (FIT and premium payments) are the most cost effective in reducing
CO2 emissions, as seen in Figure 14 (case K = 200 MW, uncongested) and Figure 15 (case K = 60,
congested MW). This means that subsidy policies, under the assumptions made here, reduce more
CO2 emissions per each dollar of social welfare that is forgone with respect to the base case. In the
particular case analyzed here, this result is explained because subsidies generate two combined
effects. First, the subsidy in FIT or premium payment reduces the price of electricity that consumers
face, as seen in Figure 16, which leads to increments in energy consumption (rebound effect).
While, in general, it is expected that the rebound effect leads to higher emissions, in our case, the
Table 8: Welfare and RE Participation (Uncongested, K = 200)a
Policy Agent PS CEPS REPS CS CO2 Tax Sub. CR Penalty W %RE REG PERP
1 $11,637 $11,637 $0 $2,781 246 t $0 $0 $0 0 0
Base Case: No Incentives 2 $2,361 $2,361 $0 $12,475 44 t $0 $0 $0 0 0
1+2 $13,998 $13,998 $0 $15,257 290 t $0 $0 $0 $0 $29,255 0 0
1 $8,254 $8,254 $0 $1,978 207 t $2,900 $0 $0 0 0
Tax ($14/ton of CO2) 2 $2,572 $2,572 $0 $11,058 46 t $648 $0 $0 0 0
1+2 $10,826 $10,826 $0 $13,036 253 t $3,548 $0 $0 $0 $27,411 0 0 0.020 t/$
1 $12,692 $9,252 $3,440 $3,507 219 t $0 $2,546 $0 27 80 MWh
Feed in Tariff
2 $1,361 $1,361 $0 $13,647 34 t $0 $0 $0 0 0
($165/MWh)
1+2 $14,053 $10,613 $3,440 $17,154 253 t $0 $2,546 $0 $0 $28,661 21 80 MWh 0.062 t/$
1 $11,675 $9,887 $1,787 $2,781 209 t $0 $1,184 $0 15 37 MWh
Premium ($32/MWh) 2 $2,361 $2,361 $0 $12,475 44 t $0 $0 $0 0 0
1+2 $14,036 $12,248 $1,787 $15,256 253 t $0 $1,184 $0 $0 $28,108 10 37 MWh 0.032 t/$
1 $11,055 $10,513 $542 $2,455 211 t $0 $0 $0 12 29 MWh
2 $2,077 $2,077 $0 $11,919 42 t $0 $0 $399 0 0
Obligation = 12%)
1+2 $13,132 $12,590 $542 $14,374 253 t $0 $0 $0 $399 $27,905 8 29 MWh 0.027 t/$
a
Notation in tables 8 and 9: PS: Producer Surplus (PS = CEPS + REPS); CEPS: Conventional Energy Producer Surplus; REPS: Renewable Energy Producer Surplus; CS: Consumer
Surplus; CO2: CO2 Emissions; Tax: Carbon Tax Level; Sub.: Subsidy (Feed-in Tariff or Premium); CR: Congestion Revenue; Penalty: Quota System Payment; W: Social Welfare; %RE:
Renewable Energy Share; REG: Renewable Energy Generation; PERP: Performance for Emission Reduction of RE Policies (PERPUncongested-case = [37 tons of CO2] / [WBase-Case minus WPolicy]
and PERPcongested-case = [40 tons of CO2] / [WBase-Case minus WPolicy]).

Table 9: Welfare and RE Participation (Congested, K = 60)a
1 $9,288 $9,288 $0 $1,974 172 t $0 $0 $0 0 0
Base Case: No
2 $5,305 $5,305 $0 $6,642 41 t $0 $0 $0 0 0
Incentives
1+2 $14,593 $14,593 $0 $8,616 214 t $0 $0 $1,417 $0 $24,626 0 0
1 $5,814 $5,814 $0 $912 136 t $3,069 $0 $0 0 0
Tax
2 $4,418 $4,418 $0 $5,929 38 t $846 $0 $0 0 0
($22.5/ton of CO2)
1+2 $10,232 $10,232 $0 $6,841 174 t $3,915 $0 $1,013 $0 $22,001 0 0 0.015 t/$
1 $8,838 $5,478 $3,360 $3,629 132 t $0 $2,530 $0 38 80 MWh

Feed in Tariff
2 $5,304 $5,304 $0 $6,642 41 t $0 $0 $0 0 0
($164/MWh)
1+2 $14,143 $10,783 $3,360 $10,271 174 t $0 $2,530 $2,167 $0 $24,051 25 80 MWh 0.070 t/$
1 $9,328 $7,133 $2,195 $1,974 132 t $0 $1,280 $0 23 40 MWh
Premium ($32/MWh) 2 $5,304 $5,304 $0 $6,642 41 t $0 $0 $0 0 0
1+2 $14,633 $12,438 $2,195 $8,616 174 t $0 $1,280 $1,418 $0 $23,386 15 40 MWh 0.033 t/$

Quota 1 $8,376 $7,643 $733 $1,681 135 t $0 $0 $0 17 29 MWh
(Fine $32/MWh; 2 $4,743 $4,743 $0 $6,194 39 t $0 $0 $545 0 0
Obligation = 17.5%) 1+2 $13,120 $12,387 $733 $7,875 174 t $0 $0 $1,423 $545 $22,963 11 29 MWh 0.024 t/$
a
Figure 14: Social Welfare when having the same level of CO2 emissions (K = 200MW)
Figure 15: Social Welfare when having the same level of CO2 emissions (K = 60MW)
increment in the energy consumption (rebound effect) produced in the FIT policy is fully met with
RE supplied from node 1, which leads to an emission reduction (recall from Figure 4 that, under
FIT policy, the reduction on conventional energy production is more than compensated by an
increment in the RE supply). Secondly, the subsidy contributes to mitigate the generation firms’
market power in the case of the FIT policy. In general terms, oligopolistic generation firms wish
reducing generation to increase price with respect to the perfectly-competitive equilibrium. When
subsidizing RE through the FIT, only conventional energy is sensitive to the market price. Thus,
generation firms exercise market power only through controlling (reducing) the conventional power
production. Accordingly, the under-FIT subsidized RE production artificially reduces electricity
prices and increases demand, mitigating the market power of generation firms. In this manner, social
welfare may be higher under FIT than under other policy due to the market-power mitigation effect
of the subsidized RE. We must remark that this result holds only as long as the increase in demand
due to the rebound effect is met with RE generation (i.e., as long as there is a “green” rebound
effect). In the case of premium payment policies, these effects are more moderate. In fact, as it can
be observed in Figure 16, market power is larger for premium payment policies than for FIT policies
since premium payments increase the amount of inframarginal technologies in the system (and
therefore the incentive for exerting market power).
These two effects are not present in the case of penalty or tax policies, where the price of
conventional energy gets higher levels, as seen in Figure 16, which leads to a relative reduction in
energy consumption that is not compensated with increasing RE. Recall that here we are assuming
oligopoly competition and that customers do not directly pay back for the subsidy. These results
change when assuming that either a perfectly competitive electricity market takes place or customers
directly pay back for the subsidies.
These differences of the performance on reducing CO2 emissions among RE policies are
even more significant when the network is congested, which is shown in Figure 15. In this case,
the subsidy leads to the fact that conventional energy generated at node 2 replaces some conven-
tional energy generated at node 1 due to the congestion, yielding fewer emissions under FIT.
In agreement with the previous results, the level of RE penetration is higher in the case of
feed-in tariff, as shown in figures 18 and 19. In the case of a carbon tax policy, for the considered
levels, it does not encourage the production of RE.
4.6.3 Analysis of the Effect of Market Power and the RE cost
An interesting question concerns the influence of market power on the performance of the
RE policies. To bring some insights into this, we now compare each RE policy under two market
structures: perfect competition and oligopoly, in the context of the results presented in Table 8. The
perfect-competition model formulations are presented in Appendix B.7 To produce comparable
scenarios, the same level of demand, resulting from applying the oligopolistic model in each of the
policies (Table 8), is used in the perfect-competition models. The results of this comparative analysis
are shown in Table 10.
Table 10 suggests that, under a perfectly-competitive market structure, there is relatively
large RE penetration for the cases of establishing subsidies or carbon tax. The lower cost of RE at
node 1 (due to the subsidies or the tax) compared to conventional energy cost at node 2 contributes
to these increasing RE penetrations. On the other hand, CO2 emissions are higher under perfect
competition than under oligopoly for all policies other than carbon tax because of the lower energy
consumption produced due to the exercise of market power by generation firms.
7. Recall that, in order to include both investment and operations costs in a per-MWh basis into the dispatch problem,
we used levelized-cost formulations in previous sections, as done in (Becker et al., 2014; Moiseyev et al., 2014; Eichman
et al., 2013; Crane et al., 2011; Park et al., 2011; Nicholson et al., 2011). Accordingly, in order to correctly compare each
RE policy under perfect competition and oligopoly, we keep a levelized-cost formulation in the perfect-competition frame-
work –as in (Oak et al., 2014), although we recognize the levelized-cost model is less appropriate for perfectly-competitive
markets.

Figure 16: Nodal Prices for an abatement of 37 ton of CO2 (K = 200MW)
Figure 17: Nodal Prices for an abatement of 40 ton of CO2 (K = 60MW)
As the information in Table 10 suggests, the performance in reducing CO2 emissions is

different comparing the equilibria under oligopoly and perfect-competition market structures. To
adequately compare RE policies under the two different market structures, we set the incentives in
all policies in order to achieve the same CO2 emission level (253 tons of CO2). The results are
presented in Table 11.
Figure 18: RE penetration for an abatement of 37 ton of CO2 (K = 200MW)
Figure 19: RE penetration for an abatement of 40 ton of CO2 (K = 60MW)
Table 11 allows establishing a ranking of policies regarding the cost effectiveness in re-
ducing emissions (see PERP index in Table 11), when assuming that consumers do not directly
payback for subsidies. From Table 11, we observe that the performance of each RE policy signifi-
cantly depends on the market structure. While FIT is the most cost-effective RE policy in reducing
CO2 emissions when assuming oligopoly, the quota system is the most cost-effective RE policy in
reducing CO2 emissions when assuming perfect competition.
Table 10: Welfare and RE Participation (Uncongested)a
1 $11,623 $9,960 $1,663 $1,978 250 t $3,500 $0 $0 23 73 MWh
Competition 2 $0 $0 $0 $11,058 0t $0 $0 $0 0 0
1+2 $11,623 $9,960 $1,663 $13,036 250 t $3,500 $0 $0 $0 $28,160 23 73 MWh
Tax ($14/ton of CO2)
1 $8,254 $8,254 $0 $1,978 207 t $2,900 $0 $0 0 0
Oligoply 2 $2,572 $2,572 $0 $11,058 46 t $648 $0 $0 0 0
1+2 $10,826 $10,826 $0 $13,036 253 t $3,548 $0 $0 $0 $27,411 0 0
1 $13,985 $10,545 $3,440 $3,507 250 t $0 $2,546 $0 24 80 MWh
Competition 2 $865 $865 $0 $13,647 21 t $0 $0 $0 0 0
Feed in Tariff 1+2 $14,850 $11,410 $3,440 $17,154 271 t $0 $2,546 $0 $0 $29,459 21 80 MWh
($165/MWh) 1 $12,692 $9,252 $3,440 $3,507 219 t $0 $2,546 $0 27 80 MWh
Oligoply 2 $1,361 $1,361 $0 $13,647 34 t $0 $0 $0 0 0
1+2 $14,053 $10,613 $3,440 $17,154 253 t $0 $2,546 $0 $0 $28,661 21 80 MWh
1 $15,691 $11,827 $3,864 $2,781 250 t $0 $2,560 $0 24 80 MWh
Competition 2 $571 $571 $0 $12,476 11 t $0 $0 $0 0 0
1+2 $16,262 $12,398 $3,864 $15,257 261 t $0 $2,560 $0 $0 $28,959 22 80 MWh
Premium ($32/MWh)
1 $11,675 $9,887 $1,787 $2,781 209 t $0 $1,184 $0 15 37 MWh
Oligoply 2 $2,361 $2,361 $0 $12,475 44 t $0 $0 $0 0 0
1+2 $14,036 $12,248 $1,787 $15,256 253 t $0 $1,184 $0 $0 $28,108 10 37 MWh
1 $13,099 $12,457 $642 $2,455 250 t $0 $0 $0 12 34 MWh
Competition 2 $1,191 $1,191 $0 $11,919 24 t $0 $0 $229 0 0
Quota 1+2 $14,290 $13,648 $642 $14,374 274 t $0 $0 $0 $229 $28,893 10 34 MWh
(Fine $32/MWh;
Obligation = 12%) 1 $11,055 $10,513 $542 $2,455 211 t $0 $0 $0 12 29 MWh
Oligoply 2 $2,077 $2,077 $0 $11,919 42 t $0 $0 $399 0 0
1+2 $13,132 $12,590 $542 $14,374 253 t $0 $0 $0 $399 $27,905 8 29 MWh
a

1 $11,827 $11,827 $0 $2,781 250 t $0 $0 $0 0 0
Base Case: No
Competition 2 $2,276 $2,276 $0 $12,475 43 t $0 $0 $0 0 0
Incentives
1+2 $14,102 $14,102 $0 $15,257 293 t $0 $0 $0 $0 $29,359 0 0
1 $11,637 $11,637 $0 $2,781 246 t $0 $0 $0 0 0
Base Case: No
Oligoply 2 $2,361 $2,361 $0 $12,475 44 t $0 $0 $0 0 0
Incentives
1+2 $13,998 $13,998 $0 $15,257 290 t $0 $0 $0 $0 $29,255 0 0
1 $11,750 $10,262 $1,488 $1,978 250 t $3,197 $0 $0 21 65 MWh
Tax
Competition 2 $175 $175 $0 $11,058 3t $39 $0 $0 0 0
($12.8/ton of CO2)
1+2 $11,925 $10,437 $1,488 $13,036 253 t $3,237 $0 $0 $0 $28,198 20 65 MWh 0.034 t/$
1 $8,254 $8,254 $0 $1,978 207 t $2,900 $0 $0 0 0
Tax
Oligoply 2 $2,572 $2,572 $0 $11,058 46 t $648 $0 $0 0 0
($14/ton of CO2)
1+2 $10,826 $10,826 $0 $13,036 253 t $3,548 $0 $0 $0 $27,411 0 0 0.020 t/$
Feed in Tariff (RE 1 $13,985 $10,545 $3,440 $3,507 250 t $0 $2,545 $0 24 80 MWh

Node 1: $165/
Competition 2 $811 $127 $684 $13,647 3t $0 $8,154 $0 85 46 MWh
MWh; RE Node 2:
$312/MWh) 1+2 $14,796 $10,672 $4,124 $17,154 253 t $0 $10,700 $0 $0 $21,251 33 126 MWh 0.005 t/$
1 $12,692 $9,252 $3,440 $3,507 219 t $0 $2,546 $0 27 80 MWh
Feed in Tariff
Oligoply 2 $1,361 $1,361 $0 $13,647 34 t $0 $0 $0 0 0
($165/MWh)
1+2 $14,053 $10,613 $3,440 $17,154 253 t $0 $2,546 $0 $0 $28,661 21 80 MWh 0.062 t/$
Premium (RE Node 1 $15,691 $11,827 $3,864 $2,781 250 t $0 $2,560 $0 24 80 MWh
1: $32/MWh;
Competition 2 $590 $162 $428 $12,475 3t $0 $3,475 $0 72 19 MWh
RE Node 2:
$181/MWh) 1+2 $16,281 $11,989 $4,293 $15,257 253 t $0 $6,035 $0 $0 $25,503 28 99 MWh 0.010 t/$
1 $11,675 $9,887 $1,787 $2,781 209 t $0 $1,184 $0 15 37 MWh
Premium
Oligoply 2 $2,361 $2,361 $0 $12,475 44 t $0 $0 $0 0 0
($32/MWh)
1+2 $14,036 $12,248 $1,787 $15,256 253 t $0 $1,184 $0 $0 $28,108 10 37 MWh 0.032 t/$
Quota 1 $14,288 $12,703 $1,585 $2,333 250 t $0 $0 $0 24 80 MWh
(Fine $32/MWh; Competition 2 $158 $158 $0 $11,705 3t $0 $0 $55 0 0
Obligation = 20%) 1+2 $14,446 $12,861 $1,585 $14,038 253 t $0 $0 $0 $55 $28,539 24 80 MWh 0.048 t/$
Quota 1 $11,055 $10,513 $542 $2,455 211 t $0 $0 $0 12 29 MWh
(Fine $32/MWh; Oligoply 2 $2,077 $2,077 $0 $11,919 42 t $0 $0 $399 0 0
Obligation = 12%) 1+2 $13,132 $12,590 $542 $14,374 253 t $0 $0 $0 $399 $27,905 8 29 MWh 0.027 t/$
a
Figure 20: RE penetration: Perfect Competition and Oligopoly
Figure 21: Performance for Emission Reduction of RE Policies
Figure 20 shows the RE penetration and Figure 21 shows the PERP index for both oli-
gopoly and perfect competition. From Figure 21, we observe that the magnitude of the PERP index
(determined as the ratio between emission abatement, 37 tons for the case of oligopoly and 40 tons
for the case of perfect-competition, and the difference WBase-Case minus WPolicy) significantly depends
on the market structure.
In Table 11 (and Figures 20 and 21), the subsidy for solar energy in the case of the FIT
is determined as the difference between the value of the FIT and the nodal price (i.e., $312/MWh
minus $133.2/MWh, which is equal to $178.8/MWh) and the RE producer surplus (REPS as seen
in Table 11) is determined based on the difference between the value of the FIT and the cost of RE
(i.e., $312/MWh minus $297/MWh, which is equal to $15.0/MWh). The subsidy in the case of the
premium payment is $181/MWh and the REPS is the value of the nodal price plus premium minus
the cost of RE (i.e., $138.3/MWh plus $181/MWh minus $297/MWh, which is equal to $22.3/
MWh).
Accordingly, the results obtained not only depend on the market structure assumed, but
also on the cost of RE. In particular, if we consider a levelized cost for solar power of $130/MWh,
we obtain the results presented in Table 12.
In agreement with the results in Table 12, Asano (2013) points out the existence of a
negative effect that the cost of solar power would have in the application of the FIT policy in Japan.
Asano (2013) makes a comparison between the FIT and the quota system, finding that the appli-
cation of the FIT policy has excessively raised prices, which is mainly explained due to the high
cost of solar energy.
4.6.4 Influence of the subsidy’s recovery method on the performance of RE policies
Although our analysis up to this point assumes that RE subsidies (under premium payment
and feed-in tariff policies) are governmental contributions, these subsidies are directly paid back
by customers through the electricity tariff in several countries, like Germany (Böhringer and Lös-
chel, 2006).
In this section, we study the effect of considering that customers directly pay back for the
subsidies on the performance of the RE policies. To reformulate our model assuming that the
subsidies are paid back by customers through the electricity tariff, we must modify the base model
so that demand constraints (pi + bi ⋅ yi = ai , i ∈{1,2}) are replaced by (12) and (13) in the case of
the premium payment policy and by (14) and (15) in the case of the FIT policy.
p1 = a1 – b1 ⋅ y1 – PREM1 (12)
p2 = a2 – b2 ⋅ y2 – PREM2 (13)
p1 = a1 – b1 ⋅ y1 – (p1FIT – p1) (14)
p2 = a2 – b2 ⋅ y2 – (p2FIT – p2) (15)
To adequately compare RE policies (quota, tax, premium payments and feed-in tariff) in this case,
we set the same level of emissions achieved with every policy. Accordingly, we modify the incentive
levels in each policy in order to achieve 210 tons of CO2 emissions (value arbitrary chosen), for
the case of an uncongested transmission line. Then, the performance of each policy to reduce
emissions is determined as before based on the ratio between emission abatement from base case
and the difference WBase-Case minus WPolicy. We analyze the performance of the RE policies consid-
ering both oligopoly and perfect competition. Table 13 presents the results obtained when assuming
that the subsidies are paid back by customers through the electricity tariff.
From Table 13, we observe that the quota policy yields to different outcomes than the
other policies (this is true even if we vary the incentive levels so that the same amount of RE is
generated). This is a non-intuitive result because one might expect to have the same outcomes for
Table 12: Welfare and RE Participation, Assuming That the Levelized Cost of Solar Power is $130/MWh (Uncongested)a
1 $11,827 $11,827 $0 $2,781 250 t $0 $0 $0 0 0
Base Case: No
Competition 2 $2,276 $2,276 $0 $12,475 43 t $0 $0 $0 0 0
Incentives
1+2 $14,102 $14,102 $0 $15,257 293 t $0 $0 $0 $0 $29,359 0 0
1 $11,637 $11,637 $0 $2,781 246 t $0 $0 $0 0 0
Base Case: No
Oligoply 2 $2,361 $2,361 $0 $12,475 44 t $0 $0 $0 0 0
Incentives
1+2 $13,998 $13,998 $0 $15,257 290 t $0 $0 $0 $0 $29,255 0 0
1 $11,750 $10,262 $1,488 $1,978 250 t $3,197 $0 $0 21 65 MWh
Tax
Competition 2 $175 $175 $0 $11,058 3t $39 $0 $0 0 0
($12.8/ton of CO2)
1+2 $11,925 $10,437 $1,488 $13,036 253 t $3,237 $0 $0 $0 $28,198 20 65 MWh 0.034 t/$
1 $8,254 $8,254 $0 $1,978 207 t $2,900 $0 $0 0 0
Tax ($14/ton of CO2) Oligoply 2 $2,572 $2,572 $0 $11,058 46 t $648 $0 $0 0 0
1+2 $10,826 $10,826 $0 $13,036 253 t $3,548 $0 $0 $0 $27,411 0 0 0.020 t/$
1 $13,985 $10,545 $3,440 $3,507 250 t $0 $2,545 $0 24 80 MWh
Feed in Tariff
Competition 2 $1,731 $121 $1,610 $13,647 3t $0 $1,464 $0 86 46 MWh
($165/MWh)
1+2 $15,716 $10,666 $5,050 $17,154 253 t $0 $4,009 $0 $0 $28,861 33 126 MWh 0.080 t/$
1 $12,692 $9,252 $3,440 $3,507 219 t $0 $2,546 $0 27 80 MWh
Feed in Tariff
Oligoply 2 $1,361 $1,361 $0 $13,647 34 t $0 $0 $0 0 0
($165/MWh)
1+2 $14,053 $10,613 $3,440 $17,154 253 t $0 $2,546 $0 $0 $28,661 21 80 MWh 0.062 t/$
1 $15,691 $11,827 $3,864 $2,781 250 t $0 $2,560 $0 24 80 MWh
Premium ($32/MWh) Competition 2 $932 $166 $766 $12,475 3t $0 $608 $0 72 19 MWh
1+2 $16,623 $11,993 $4,630 $15,257 253 t $0 $3,168 $0 $0 $28,712 28 99 MWh 0.061 t/$
1 $11,675 $9,887 $1,787 $2,781 209 t $0 $1,184 $0 15 37 MWh
Premium ($32/MWh) Oligoply 2 $2,361 $2,361 $0 $12,475 44 t $0 $0 $0 0 0
1+2 $14,036 $12,248 $1,787 $15,256 253 t $0 $1,184 $0 $0 $28,108 10 37 MWh 0.032 t/$
Quota 1 $14,288 $12,703 $1,585 $2,333 250 t $0 $0 $0 24 80 MWh
(Fine $32/MWh; Competition 2 $158 $158 $0 $11,705 3t $0 $0 $55 0 0
Obligation = 20%) 1+2 $14,446 $12,861 $1,585 $14,038 253 t $0 $0 $0 $55 $28,539 24 80 MWh 0.048 t/$
Quota 1 $11,055 $10,513 $542 $2,455 211 t $0 $0 $0 12 29 MWh
(Fine $32/MWh; Oligoply 2 $2,077 $2,077 $0 $11,919 42 t $0 $0 $399 0 0
Obligation = 12%) 1+2 $13,132 $12,590 $542 $14,374 253 t $0 $0 $0 $399 $27,905 8 29 MWh 0.027 t/$

a
1 $11,827 $11,827 $0 $2,781 250 t $0 $0 $0 0 0
Base Case: No
Competition 2 $2,276 $2,276 $0 $12,475 43 t $0 $0 $0 0 0
Incentives
1+2 $14,102 $14,102 $0 $15,257 293 t $0 $0 $0 $0 $29,359 0 0
1 $11,637 $11,637 $0 $2,781 246 t $0 $0 $0 0 0
Base Case: No
Oligoply 2 $2,361 $2,361 $0 $12,475 44 t $0 $0 $0 0 0
Incentives
1+2 $13,998 $13,998 $0 $15,257 290 t $0 $0 $0 $0 $29,255 0 0
1 $8,637 $6,415 $2,221 $1,206 210 t $6,512 $0 $0 26 73 MWh
Tax ($31/ton of CO2) Competition 2 $0 $0 $0 $9,498 0t $0 $0 $0 0 0

1+2 $8,637 $6,415 $2,221 $10,705 210 t $6,512 $0 $0 $0 $25,853 26 73 MWh 0.0236 t/$
1 $5,010 $5,010 $0 $1,207 161 t $4,923 $0 $0 0 0
Tax ($30.5/ton of CO2) Oligoply 2 $2,833 $2,833 $0 $9,499 49 t $1,481 $0 $0 0 0
1+2 $7,843 $7,843 $0 $10,705 210 t $6,404 $0 $0 $0 $24,952 0 0 0.0186 t/$

1 $9,164 $8,820 $344 $1,640 210 t $0 $0 $0 4 8 MWh
Feed in Tariff
Competition 2 $0 $0 $0 $12,665 0t $0 $0 $0 0 0
($165/MWh)
1+2 $9,164 $8,820 $344 $14,305 210 t $0 $0 $0 $0 $23,469 4 8 MWh 0.0140 t/$
1 $8,951 $8,736 $215 $1,736 208 t $0 $0 $0 2 5 MWh
Feed in Tariff
Oligoply 2 $80 $80 $0 $12,665 2t $0 $0 $0 0 0
($165/MWh)
1+2 $9,031 $8,816 $215 $14,401 210 t $0 $0 $0 $0 $23,432 2 5 MWh 0.0137 t/$
1 $9,045 $7,690 $1,355 $1,596 210 t $0 $0 $0 15 36 MWh
Premium ($32/MWh) Competition 2 $0 $0 $0 $13,948 0t $0 $0 $0 0 0
1+2 $9,045 $7,690 $1,355 $15,544 210 t $0 $0 $0 $0 $24,589 15 36 MWh 0.0174 t/$
1 $6,984 $6,871 $113 $2,652 188 t $0 $0 $0 2 3 MWh
Premium ($32/MWh) Oligoply 2 $589 $589 $0 $13,947 22 t $0 $0 $0 0 0
1+2 $7,573 $7,460 $113 $16,599 210 t $0 $0 $0 $0 $24,172 1 3 MWh 0.0158 t/$
1 $11,497 $9,761 $1,736 $2,100 185 t $0 $0 $0 30 80 MWh
Competition 2 $1,093 $1,093 $0 $11,285 25 t $0 $0 $612 0 0
Obligation = 30%)
1+2 $12,589 $10,854 $1,736 $13,385 210 t $0 $0 $0 $612 $26,587 24 80 MWh 0.0297 t/$
1 $10,394 $9,078 $1,316 $2,100 172 t $0 $0 $0 26 60 MWh
Oligoply 2 $1,770 $1,770 $0 $11,285 38 t $0 $0 $798 0 0
Obligation = 26%)
1+2 $12,163 $10,848 $1,316 $13,386 210 t $0 $0 $0 $798 $26,347 18 60 MWh 0.0274 t/$
a
Notation is as in Table 8. As before, the PERP index is computed as the ratio between CO2 emission abatement –80 tons for the case of oligopoly and 83 tons for the case of perfect-
competition– and the difference WBase-Case minus WPolicy).
quota and feed-in tariff (or premium payment) policies when assuming that the subsidy is directly
paid back by consumers. However, this difference occurs because we have assumed that the money
collected from penalties in the quota system goes to the government and it is not directly recovered
by consumers. Accordingly, although the money collected from the penalties partially goes to end
consumers through the electricity price (depending on the demand elasticity), retail prices do not
completely capture the potential effect of penalties in the consumers’ behavior because, in our
model, generation firms are assumed to anticipate dispatch decisions. In the feed-in tariff policy
analyzed in Table 13, instead, the whole subsidy is paid back by consumers, directly influencing
the consumers’ behavior. Something similar occurs in the case of the carbon tax policy, where we
have assumed that the money collected from taxes goes to the government and it is not directly
recovered by the consumers.
Looking at the PERP index in Table 13 (which is graphed in Figure 23), the cost-effec-
tiveness ranking is headed by the quota system followed by tax, premium payments and FIT pol-
icies, in that order. From Figure 23, we observe that, as before, the PERP index depends on the
market structure. Interestingly, from Figure 23, we also observe that, in the case of considering that
the subsidies are directly paid back by customers, both market structures (oligopoly and perfect
competition) yield the same cost-effectiveness ranking of the RE policies. That is, by incorporating
the subsidy recovery directly into the customers’ tariff, we obtain more consistent results about the
cost effectiveness of the RE policies. This is mainly because the fact that customers directly pay
back for the subsidies significantly reduces the rebound effect.
From the results (as seen in Figures 21, 22 and 23), it is concluded that the ranking of the
PERP index is significantly conditioned by the market structure—which is relevant due to some
evidence of the presence of market power in some markets, as mentioned by Yenita and Kirschen
(2012)—the cost level of renewable energy, and who bears the cost of the subsidy.
4.7 Influence Among Incentives to RE within FIT System
In the case of the FIT policy, the analysis performed in Section 4.3 considered the same
price level for RE at both nodes (i.e., for both RE technologies). From that analysis, it was deter-
mined that: (i) for a FIT of $165/MWh (applied to both nodes), there would exist incentives for
RE supply only at node 1, at maximum capacity, and (ii) for a FIT level of $312/MWh (applied to
both nodes), RE on both nodes would be generated at maximum capacity. Recall also that the
analysis considered a line capacity of 200 MW, resulting in an uncongested system.
Next, we analyze, for each RE technology (and in the case K = 200 MW), which would
be the level of FIT at which firms would be incentivized to produce RE (i.e., incentivized to invest
in RE under our levelized-cost approach) when the other technology of RE does not receive enough
incentives. The results are summarized in Table 14.
For the case in which the firm at node 1 does not receive enough incentives, a FIT level
of $319/MWh would incentivize RE supply at node 2 to produce RE at its maximum capacity. In
turn, for the case in which the firm at node 2 does not receive enough incentives, a FIT level of
$165/MWh would in fact incentivize RE production in node 1 to its maximum capacity.
Taking into consideration these two FIT levels (i.e., $319/MWh and $165/MWh), it is then
determined, separately for each case, the FIT level at which there would be an incentive for the
firm at the opposite node (that didn’t have incentives before) to produce RE. For the case in which
the firm at node 2 receives a FIT of $319/MWh, the firm at node 1 would be incentivized to produce
RE at maximum capacity at a FIT level of $161/MWh (that is, $4/MWh below the case in which
the firm at node 2 does not receive enough incentives). Similarly, when the firm at node 1 receives
Figure 22: RE penetration: Perfect Competition and Oligopoly
Figure 23: Performance for Emission Reduction of RE Policies
a FIT of $165/MWh, the firm at node 2 would be incentivized to produce RE at maximum capacity
at a level of $312/MWh (i.e. $7/MWh less than in the case where the firm at node 1 receives
insufficient incentives).
Thus, this particular situation illustrates the possibility that the FIT price of a technology
can influence the entry price of another technology. Specifically in this case, we observe that fixing
a specific incentive (price) for a technology can lower the incentive that must be offered to a second
Table 14: RE Penetration Under FIT

CASE K = 200 MW
FIT Generation
($/MWh) (MWh)
Node 1 Node 2 Node 1 Node 2
165 165 80 0
312 312 80 80
0 319 0 80
165 0 80 0
165 312 80 80
161 319 80 80
technology so that it becomes economically profitable and can supply power into the network. This
interrelationship constitutes an interesting result which suggests that interrelationships among gen-
eration firms employing different RE technologies may occur, and that they should be studied
carefully before implementing a FIT system in a real power network.
Analyzing the KKT conditions of the optimization problem in the FIT model formulation,
we can observe that there is a tight relationship (dependency) among FIT prices and the shadow
prices of the RE generation capacity constraints at both nodes, as it is evident in (16) and (17).
Thus, the higher the FIT at node 1, the lower the required FIT at node 2 to satisfy optimality
conditions (16)–(18), and vice versa.
p1FIT + [c1c – c1r – k1r ] = p2FIT + [c2c – c2r – k2r ] (16)
冤
k2r = p2FIT + [c2c – c2r ] – c1c + q1c
b1 b 2
(b1 + b2) 冥 (17)
冤冥
b1 b 2
k1r = p1FIT + [c1c – c1r ] – c2c + q2c (18)
(b1 + b2)
Recall that we have assumed that each firm owns two power plants (located at the same node).
Thus, as soon as one firm’s RE plant becomes viable (due to the FIT), this plant displaces energy
from the coal/gas plant of the other generation firm, making it more willing to build RE plants with
a lower subsidy.
5. CONCLUSIONS
This paper compares different incentive policies to encourage the development of RE

(carbon tax, feed-in tariff, premium payment and quota system) in terms of energy prices, RE
generation, CO2 emissions, and social welfare. The results obtained by modeling the different
policies to incentivize the incorporation of RE to the power network are useful for decision makers
in designing RE policies. These results are important because they show different effects in terms
of RE penetration, social welfare, and emission reduction efficiency.
The main result of the article is that the cost effectiveness of the different incentive schemes
(in terms of RE penetration, social surplus, and emission-reduction effectiveness) varies signifi-
cantly depending on the market structure assumed, the costs of RE, and the subsidy recovery method
considered. Subsidy policies (FIT and premium payments) are more cost effective in reducing CO2
emissions than those policies that apply penalties or taxes, when assuming oligopoly competition
and that customers do not directly pay back for the subsidies. However, quota system and carbon
tax policies are more cost effective when assuming that either a perfectly competitive electricity
market takes place or customers directly pay back for the subsidies through the electricity tariff.
Nonetheless, this latter result may be reversed in the case that the costs of RE dramatically drop.
When considering oligopoly competition and that customers do not directly pay back for
the subsidies, the FIT policy achieves the lowest nodal prices and the highest RE penetration for
the same level of CO2 emissions (which is a direct consequence of assuming that the government
bears all the cost of the subsidies). In this case, we obtain that FIT and premium payments policies
are the most cost-effective policies in reducing CO2 emissions. This surprising result is explained
because subsidies generate two combined effects. First, the subsidy in FIT or premium payment
reduces the price of electricity that consumers face, which leads to increments in energy consump-
tion (rebound effect) –which is fully met by RE production in our case study. Secondly, the subsidy
in the FIT contributes to mitigate the generation firms’ market power. Accordingly, the subsidized
RE production artificially reduces electricity prices and increases demand, mitigating the market
power of generation firms. Several sensitivity analyses were made with respect to different levels
of demand and costs of generation, leading to the same qualitative conclusions. However, our
conclusions cannot be generalized because they only hold as long as the increase in demand is
covered by RE generation.
We also showed that network congestion affects nodal prices, and thus social welfare, in
each of the studied policies. For example, under the quota obligation system, it was observed that
power transmission congestion decreases the maximum demand to be reached for a given obligation
and the penalty cost, which in turn affects renewable and conventional generation. In addition, after
varying the quota obligation while keeping the penalty constant, it is observed that congestion
affects the quota obligation percentage that we must demand in order to attain a certain level of RE
generation. This is in agreement with the findings in Munoz et al. (2013), suggesting that there
should be a higher obligation demanded when there is line congestion to attain the same amount
of RE generation than when there is no congestion.
In the case of the FIT policy, it is possible to detect that there is an interrelationship between
RE technologies to be encouraged. This means that a FIT for a particular RE technology may
influence a second RE technology FIT, resulting in a lower FIT that is needed to allow similar
results in the operation of the power network. When applying the proposed formulations to more
complex networks, we should expect that these interrelationships among RE technologies encourage
even lower required FIT prices. This is due to the multi-nodal and multi-technology relationships
that may occur.
When considering that customers directly pay back for the subsidies, we obtain that the
quota system and the carbon tax policies are the most cost-effective policies in reducing CO2
emissions, independently of assuming oligopolistic or perfectly-competitive markets. We also obtain
that the quota system and the carbon tax policies are the most cost-effective policies in reducing
CO2 emissions when considering perfectly-competitive markets, independent of who bears the costs
of the subsidies.
However, all these results also depend on the costs of the RE. For example, when we
consider that the levelized cost of solar energy decreases to 130 $/MWh, we obtain that the most
cost-effective RE policy in reducing CO2 emissions is the FIT policy, even when assuming that the
market is perfectly-competitive.
Our results indicate that the best-performing RE policy varies depending on the market
structure, the costs of RE, and the subsidy recovery method considered. Accordingly, in order to
compare our results with those appearing in the literature, we should first answer the following
questions: (1) What is the market structure considered?; (2) What is levelized cost of the RE
considered? and (3) Who bears the cost of the subsidy? For example, in Oak et al. (2014), where
a perfectly competitive market is modeled assuming levelized costs, the authors find that quota
system and premium payment have the best performance. Verma and Kumar (2013) model an
oligopolistic market assuming marginal costs, finding that the FIT policy generates an increase in
total power generation (conventional and renewable), which coincides with our result for the case
of a oligopolistic market in which the cost of the subsidy is assumed by the government. Fisher
(2010) develops a model that predicts that a subsidy policy would reaches lower prices, while
carbon tax policy would reach higher energy prices, in the short run, which agrees with the results
of our oligopolistic model.
ACKNOWLEDGMENTS
The research reported in this paper was partially supported by the CONICYT, FONDE-
CYT/Regular 1100434 and 1130781 grants. A CONICYT doctoral scholarship and a supplementary
scholarship from the College of Engineering at the Pontificia Universidad Católica de Chile (PUC)
partially supported to PhDc Miguel Pérez de Arce. We specially thank Natalie Messer for her work
during her M.S. program at the PUC and three anonymous reviewers of The Energy Journal for
their valuable comments.
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Comparison of Incentive Policies for Renewable Energy in an

Oligopolistic Market with Price-Responsive Demand

Miguel Pérez de Arce* and Enzo Sauma*†

This article compares different incentive policies to encourage the development

2. BASE POWER-MARKET MODEL

Figure 1: Two-node power network

Copyright 䉷 2016 by the IAEE. All rights reserved.

y2 – f = q2 , with q2 = q2r + q2c (3)

Maxqci ⋅ (pi – cic ) + qir ⋅ (pi – cri ) (5)

Copyright 䉷 2016 by the IAEE. All rights reserved.

3. MODELING INCENTIVE POLICIES FOR THE DEVELOPMENT OF RE

3.1 Carbon Tax Policy

Maxqci ⋅ (pi – cic – αc ⋅ γic ) + qir ⋅ (pi – cri ) (6)

3.2 Feed-in Tariff

Maxqci ⋅ (pi – cci ) + qri ⋅ (pFIT

Copyright 䉷 2016 by the IAEE. All rights reserved.

3.3 Premium Payment

Maxqci ⋅ (pi – cci ) + qri ⋅ (pi + PREMi – cri ) (8)

3.4 Quota Obligation

Maxqci ⋅ (pi – cci ) + qri ⋅ (pi – cri ) – Cpenalty ⋅ qpenalty

4. CASE STUDY AND RE POLICY ANALYSIS

Table 1: Electric Power Generation Levelized Costs

Table 2: Power Demand Parameters

Generation capacity and transmission network data

Table 3: Range of Parameters Used for Analyzing the

4.2 Carbon Tax Policy Outcome

Figure 3: CO2 Emissions under the Carbon Tax Policy

4.3 Feed-in Tariff (FIT) Policy Outcome

Copyright 䉷 2016 by the IAEE. All rights reserved.

Copyright 䉷 2016 by the IAEE. All rights reserved.

Figure 5: CO2 emissions under the Feed in Tariff Policy

4.4 Premium Payment Policy Outcome

Figure 7: CO2 emissions under the Premium Policy

4.5 Outcome of Quota Obligation Policy

4.6 Comparative Analysis of the Policies

4.6.1 Analysis Based on RE Penetration

Figure 9: CO2 emissions under the Quota Policy

1 $12,692 $9,252 $3,440 $3,507 219 t $0 $2,546 $0 27 80 MWh

Copyright 䉷 2016 by the IAEE. All rights reserved.

Copyright 䉷 2016 by the IAEE. All rights reserved.

Table 6: Incentives of Policies for a RE Penetration of 80 MWh

Table 7: Nodal Prices for a RE Penetration of 80 MWh (in

Copyright 䉷 2016 by the IAEE. All rights reserved.

Figure 10: Case with Tax

Figure 11: Case with FIT

4.6.2 Analysis Based on Emission reduction Performance

We previously compared the performance of RE policies by looking at the social welfare

Figure 12: Case with Premium

Figure 13: Case with Quota

Copyright 䉷 2016 by the IAEE. All rights reserved.

1 $8,838 $5,478 $3,360 $3,629 132 t $0 $2,530 $0 38 80 MWh

Copyright 䉷 2016 by the IAEE. All rights reserved.

4.6.3 Analysis of the Effect of Market Power and the RE cost

Copyright 䉷 2016 by the IAEE. All rights reserved.

Figure 16: Nodal Prices for an abatement of 37 ton of CO2 (K = 200MW)

Figure 17: Nodal Prices for an abatement of 40 ton of CO2 (K = 60MW)

As the information in Table 10 suggests, the performance in reducing CO2 emissions is

Figure 18: RE penetration for an abatement of 37 ton of CO2 (K = 200MW)

Figure 19: RE penetration for an abatement of 40 ton of CO2 (K = 60MW)

Copyright 䉷 2016 by the IAEE. All rights reserved.

Copyright 䉷 2016 by the IAEE. All rights reserved.

Figure 20: RE penetration: Perfect Competition and Oligopoly

Figure 21: Performance for Emission Reduction of RE Policies