Resources Policy 86 (2023) 104113

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Resources Policy
journal homepage: www.elsevier.com/locate/resourpol

Assessing carbon cap-and-trade policies on hybrid renewable energy

investments: Implications for pricing and capacity decisions
Zhaobiao Rui a, Weicai Peng a, *, Ximei Qin a, Jun Wang a, b
a
School of Mathematics and Big Data, Chaohu University, Hefei, 238000, China
b
School of Microelectronics and Data Science, Anhui University of Technology, Ma’anshan, 243002, China

A R T I C L E I N F O A B S T R A C T

Keywords: Renewable energy sources such as solar and wind have received a lot of attention and research in recent years as
Carbon emissions the climate issue has become more serious. However, compared with traditional energy sources, renewable
Carbon cap-and-trade mechanism energy has unstable characteristics such as intermittency. Integrated systems consisting of two or more renew­
Renewable energy investment
able energy systems, also known as hybrid renewable energy systems, are increasingly popular among envi­
Hybrid renewable energy system
ronmentalists because their sources can complement each other and provide customers with higher quality and
more reliable power than single-source systems. This paper develops an analytical framework to explore the
impacts of carbon cap-and-trade policy on the pricing and capacity establishment decisions of a utility firm that
invests in hybrid renewable energy (solar energy and wind energy) systems. Three carbon reduction mechanisms
are considered: the No cap-and-trade mechanism, Grandfathering mechanism, and Benchmarking mechanism.
We focus on the optimal investment decision of a monopolistic utility firm in a hybrid renewable energy system
under such three mechanisms. We derive the equilibriums of the utility firm that invests in two renewable energy
capacities and compare the performances of the three mechanisms. We find that, in terms of reducing carbon
emissions, Grandfathering mechanism dominates the Benchmarking mechanism, but in terms of improving the
firm’s utilization efficiency of renewable energy power generation or the firm’s investment in renewable energy,
Benchmarking mechanism is preferred. Therefore, governments/regulators should fully consider how to use the
cap-and-trade policies to guide firms to effectively reduce total carbon emissions, and provide different carbon
policies for different purposes.

1. Introduction
The need for energy consumption has increased recently as a result of
the economy’s and society’s rapid development. The ecological envi­
ronment of the world which people depend on for survival has been
severely harmed by the burning and consumption of conventional fossil
fuels such as coal, oil, and natural gas. The governments of many nations
have proposed various carbon emission control measures, the most
popular of which are the carbon tax and the carbon cap-and-trade
mechanism (CCTM, often known as emissions trading) (see Gong and
Zhou (2013); He et al. (2015); Xu et al. (2016); Li et al. (2018); Anand
and Giraud-Carrier (2020); Fan et al. (2023)). Carbon taxes reduce fossil
fuel consumption and carbon dioxide emissions by taxing fossil fuel
products such as gasoline, jet fuel, and natural gas downstream from
coal and oil in proportion to their carbon content. According to CCTM,
each enterprise receives initial carbon emission permits as their carbon
caps, and in the second stage, the enterprises may choose to exchange
permits based on their actual use (Benjaafar et al. (2012); Li et al.
(2018)). In other words, enterprises have two choices when their carbon
quota is insufficient: they can either lower their level of carbon emis­
sions or buy more quota. When enterprises have excess carbon quota,
they can increase production or sell unused carbon quota on the carbon
emission trading market. In conclusion, enterprises must consider how
to save energy and reduce carbon emissions in the process of production
and operation (Du et al. (2015)).
Nearly 40% of the carbon emissions in the world are produced by
power plants (Takashima and Oda (2012)). Utility companies can
enhance technology or fully utilize new energy for replacement in an
effort to reduce carbon emissions. In reality, governments have relied on
both mandatory (such as feed-in-tariffs and renewable portfolio re­
quirements) and incentive (such as carbon taxes and subsidies) systems
to encourage utility companies to engage in renewable energy.

* Corresponding author.
E-mail address: weicaipeng@126.com (W. Peng).

https://doi.org/10.1016/j.resourpol.2023.104113
Received 5 May 2023; Received in revised form 26 July 2023; Accepted 1 September 2023
Available online 21 September 2023
0301-4207/© 2023 Elsevier Ltd. All rights reserved.
Z. Rui et al.
Governments acquire green energy through feed-in-tariff mechanisms at
rates that are set above market value, but over time, the subsidies will
gradually disappear and finally reach a cost that is competitive with
conventional energy sources (Alizamir et al. (2016); Couture and Gag­
non (2010)). A majority of states in the United States have instituted
renewable portfolio standards, which require electric service providers
to meet a portion of their demand using renewable energy resources
(Bollapragada et al. (2011)).
A hybrid renewable energy system (HRES) combines renewable and
conventional energy sources. It can combine two or more sources of
renewable energy that operate independently or in connection with the
grid (Khare et al. (2016)). From the 1980s to now, the research and
application of HRES have been in the process of continuous improve­
ment and exploration. In addition to the wind-solar complementary
power generation system (see e.g. Zhang and Yang (2006); Cai et al.
(2012); Zhang et al. (2014)), there are wind-solar-hydrogen combined
independent power generation system (see such as Jiping and Shuhua
(2007)), wind-solar-water multi-energy complementary power genera­
tion system (e.g. Ye et al. (2018)), wind-solar-water-fire multi-energy
complementary power generation system (e.g. Sheng and Zhang, 2016),
etc. Combining theory and practice makes wind-solar complementary
power generation technology more and more large-scale and gradually
permeates people’s life. Therefore, it becomes an important topic to
discuss how to invest in the hybrid renewable energy setup under the
cap-and-trade policy and what effects electricity retail pricing and
renewable energy capacity have.
Our contributions are twofold. First, we examine the impacts of
carbon cap-and-trade policy on the pricing and capacity establishment
decisions of a utility firm that invests in hybrid renewable energy (solar
energy and wind energy) systems. Second, we investigate the impact of
hybrid renewable energy system on a firm rather than a single renew­
able energy generation mode, the hybrid system greatly improves the
stability and the generality of results of the system compared to a single
energy generation mode. We find that, in terms of reducing carbon
emissions, Grandfathering mechanism dominates the Benchmarking
mechanism, but in terms of improving the firm’s utilization efficiency of
renewable energy power generation or the firm’s investment in renew­
able energy, Benchmarking mechanism is preferred. Therefore, gov­
ernments/regulators should fully consider how to use the cap-and-trade
policies to guide firms to effectively reduce total carbon emissions, and
provide different carbon policies for different purposes. From these
perspectives, our paper is clearly innovative.
The rest of this paper is organized as follows. Section 2 introduces the
impact of renewable energy on reducing carbon dioxide emissions, the
carbon cap-and-trade mechanism, green recovery and resources and
industry research on hybrid renewable energy systems for power gen­
eration. Section 3 presents the hypothesis of the model. Section 4 pre­
sents the investment strategies of hybrid renewable energy systems
under three carbon cap-and-trade mechanisms. The 5th section is
sensitivity analysis. The 6th section is the research on investment
strategy. The 7th section is numerical analysis, the 8th section is the
conclusion and policy recommendations. All the proofs are arranged in
the Appendix.
2. Literature review
Our study is related to four streams of literature, (i) renewable en­
ergy and carbon emission; (ii) carbon cap-and-trade mechanism; (iii)
green recovery and resources, and (iv) hybrid renewable energy system.
2.1. Renewable energy and carbon emission
In the area of renewable energy and carbon emission literature, Hu
et al. (2015) investigated the one-time capacity investment made by a
firm in a renewable energy-generating technology with supply vari­
ability and net metering compensation. They demonstrated how, in the
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Resources Policy 86 (2023) 104113
absence of energy storage, coarse statistics that do not take into account
the erratic nature of renewable generation may result in excessive in­
vestment in renewable capacity. Aflaki and Netessine (2017) model the
trade-off between renewable and nonrenewable technology, found that
the intermittency of renewable technologies drives the effectiveness of
carbon pricing mechanisms, that is to say, actions to reduce the inter­
mittency of renewable sources may be more effective than carbon taxes
alone at promoting investment in renewable generation capacity. The
renewable portfolio standard mechanism is studied by Barbose et al.
(2016) and Ritzenhofen et al. (2016). Kok et al. (2018) focused on the
renewable investment level, and explored the role of pricing policies,
such as flat pricing and peak pricing when a utility firm considers
investing the renewable and conventional sources. Sunar and Birge
(2019) considered a competitive day-ahead electricity market with both
conventional and renewable enterprises competing, such as wind tur­
bines (e.g., coal-fired power plants). They established that, with prob­
ability 1, implementing or raising a market-based supply penalty rate in
a period can result in a strictly higher commitment to renewable energy
at all prices in the linked day-ahead market and can lower equilibrium
reliability in all periods. Qiu et al. (2020) offers a bi-level pollution
routing dilemma between an authority and a freight firm that is based on
carbon pricing schemes. The dual sensitivity of consumers to carbon
emissions and delivery time was first investigated in He et al. (2021a)’s
work. Their outcomes demonstrated that a two-way cost-sharing con­
tract might improve the supply chain by a Pareto factor. Alegoz et al.
(2021) focused on decisions at the production and sustainability levels
in pure manufacturing and hybrid manufacturing-remanufacturing
systems and discovered that the manufacturer uses manufacturing
quantity as a strategic advantage to compete with the retailer or the
third-party remanufacturer because the upper bound on the remanu­
facturing quantity depends on the manufacturing quantity. An et al.
(2021) designed a green credit financing (GCF) model subject to hard
emission constraints, compared GCF with trade credit financing (TCF) in
a supply chain context, and found a win-win situation for the two
players.
Xie et al. (2018) researched how renewable energy affected the
power supply chain and if it is better to use a renewable generator or a
power grid that buys electricity on the spot market when there is not
enough renewable energy being produced. They discovered that as the
installed capacity of renewable energy generators and the price sensi­
tivity coefficient of demand rise, the costs of both renewable and con­
ventional power grids fall. Babich et al. (2020) found which practical
factors favor the feed-in-tariff or the tax-rebate policy by comparing the
feed-in-tariff and the tax-rebate policies while taking into account
renewable energy generating efficiency, the variability in the electricity
price, and the variability in the cost of energy investment. Peura and
Bunn (2021) studied the impact of intermittent wind generation on
electricity prices in the presence of forward markets, which are
frequently used by power firms to hedge against revenue fluctuation
prior to near-real-time spot trading. It was discovered that in addition to
the well-known merit-order effect, renewable generation also influences
power prices through forward-market hedging. Taghizadeh-Hesary et al.
(2022) as well as Rasoulinezhad and Taghizadeh-Hesary (2022) inves­
tigated the impact of green finance on the development of renewable
energy. More studies about renewable energy are referred to Yoshino
et al. (2021), Taghizadeh-Hesary et al. (2022), Saboori et al. (2022) and
their references.
2.2. Carbon cap-and-trade mechanism
Grandfathering mechanism (GM) and Benchmarking mechanism
(BM) are the two main cap-and-trade mechanisms (Chen et al. (2021)).
GM is based on the concept of first-in-time or prior appropriation and
has been applied to a broad range of environmental and resource issues
(Damon et al. (2019)). Under GM, a firm’s total carbon emission quota is
established for a specific time period based on the firm’s prior
Z. Rui et al.
production levels (Zetterberg et al. (2012)). Under BM, the regulators
establish a unit carbon quota for a firm to limit unit carbon emissions
(Groenenberg and Blok (2002)). Under either BM or GM, firms can trade
carbon emissions in the carbon trading market. And both two mecha­
nisms have already been adopted in practice (He et al. (2019); Zetter­
berg et al. (2012)). Hu et al. (2020) compared the carbon trading policy
and CCTM in a closed-loop supply chain model, and found that only
when the carbon quota level is very high, the CCTM is dominated by the
carbon tax policy. Liu et al. (2021) examined three emission reduction
modes: pure manufacturer emission reduction, pure retailer emission
reduction, and hybrid manufacturer-retailer emission reduction. They
found that the emission reduction level under the hybrid
manufacturer-retailer emission reduction mode is the highest among the
above three modes. Fankhauser et al. (2010) examines the effects of
integrating cap-and-trade with other policy instruments on the price of
carbon. In a model that combines a ‘top-down’ general equilibrium
representation of the US economy with a ‘bottom-up’ model of
electricity-sector dispatch and capacity growth, Rausch and Mowers
(2014) evaluate the effectiveness and distributional effects of green­
house gas policies targeted at the electrical sector. Works that expressly
take carbon emissions and/or renewable energy into account are cate­
gorized by Kong and Liu (2014). It is suggested to take a comprehensive
strategy for environmental preservation in light of competing commer­
cial and scientific interests that have led to lax implementation of cur­
rent laws. Kampan and Tanielian (2015), Carl and Fedor (2016) look
into how public funds obtained from carbon taxes and cap-and-trade
systems are currently used. Climate change models project that by
2034, the annual average surface temperature will have risen by more
than 2 ◦ C under ‘business as usual’ strategy, which means making no
attempt to reduce CO emissions from the burning of fossil fuels. When a
utility firm decides to invest in renewable energy together using an
existing conventional energy source, Balmes (2018), Chen et al. (2021)
develop a model to investigate the effects of cap-and-trade mechanisms.
Wang et al. (2019) studied a fresh food supply chain under CCTM. Three
replenishment models were investigated, separate replenishment, joint
replenishment, and joint replenishment, they found that the profit
growth and emission reduction could be simultaneously improved under
CCTM. Yang et al. (2020) studied a remanufacturing closed-loop supply
chain under CCTM. They found that when the unit carbon emission of
the recycling process under the retailer recycling model is much greater
than that under the third-party recycling model, and the unit cost sav­
ings is relatively low, manufacturers will choose the third-party recy­
cling model. Jia et al. (2022) investigated the optimal pricing and effort
reduction strategies for green producers to increase profits. The findings
indicated that while consumer preferences for low-carbon products
during the advance selling time can have an impact on manufacturer
profits, government carbon restrictions cannot. Peng et al. (2022)
looked at the issue of investing in renewable resources under the carbon
emission regulation for a resource firm with limited capital that might
approach a bank for green financing. The research first investigated the
optimal pricing choices and the optimal level of renewable investment
before examining the effects of the interest rate on green financing and
the startup working capital of the firm. The dominance of the three
strategies was then contrasted. Other noteworthy works include those
such as Abolhosseini and Heshmati (2014), Walker et al. (2016),
Dilanchiev et al. (2023), Sun et al. (2023a), Asif et al. (2023), and their
references.
2.3. Green recovery and resources
Taghizadeh-Hesary and Yoshino (2019) proposed two applied
frameworks, backed by theoretical models on green finance and in­
vestment based on project size. He et al. (2021b) employed a linear
programming model to assess the potential of renewable hydrogen
power and its impact on electricity prices, measured the possible de­
mand of wind-generated renewable hydrogen for light-duty vehicles. To
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Resources Policy 86 (2023) 104113
better promote supply chain emission reduction Sun et al. (2020)
analyzed the carbon emission transfer and emission reduction problem
among enterprises within the supply chain, integrating the influence of
government emission reduction policies and the low carbon market. In
Zhang et al. (2021), panel data of BRI member countries from 2008 to
2018 is analyzed using the generalized method of moments (GMM)
method and data envelopment analysis (DEA) to assess the relationship
between public spending on R&D and green economic growth and en­
ergy efficiency. Liu et al. (2019) uses the ‘Green Credit Guidelines’
policy in China as a quasi-natural experiment to examine its influence on
the debt financing capacity of heavily polluting enterprises. Utilizing a
difference-in-differences (DID) model, the study finds a notable decrease
in the debt financing capability of these enterprises post-policy imple­
mentation. The negative net effect of debt financing seems to be more
pronounced in state-owned enterprises and those operating in regions
with weaker financial ecosystems. This suggests that the green credit
policy system effectively guides the allocation of credit resources. Azh­
galiyeva et al. (2020) focuses on the mobilization of private finance for
renewable energy and energy efficiency in ASEAN. The study reveals
that two-thirds of green bonds issued in ASEAN were utilized to finance
renewable energy and energy efficiency projects. Despite the effective­
ness of green bond policies in promoting green bond issuance, the study
notes that this does not necessarily translate into effectiveness in pro­
moting renewable energy and energy efficiency projects within ASEAN.
For more green recovery and resources studies, please refer to Sun et al.
(2023b), Dong et al. (2023), Peng et al. (2022) and their references.
2.4. Hybrid renewable energy system
The use of renewable energy technologies to meet our energy needs
has been steadily increasing in recent years. However, as renewable
energy technologies become more widely used, their disadvantages
become apparent: reliable, uninterrupted output cannot be guaranteed,
and the cost is even the same as that of conventional energy sources.
Castle et al. (1981) was the first to put forward the idea of hybrid
renewable energy system (HRES). He developed some methods to
evaluate the merits of hybrid wind/PV systems in applications. And
found that hybrid renewable energy systems are superior to pure
photovoltaic or pure wind systems if the following aspects of the hybrid
renewable energy system are improved and optimized, these factors
include load distribution, wind conditions, isolation, cost and avail­
ability of backup power, wind wheel area, array area and relative cost of
storage, subsystem efficiency factors, etc. The term HRES is used to
describe systems consisting of energy sources with two or more gener­
ators (Deshmukh and Deshmukh (2008)). The technical-economic
optimization study of a standalone hybrid PV/wind system in Corsica
Island was given by Diaf et al. (2008), the simulation results show that
the hybrid system is the best choice for all the sites taken into consid­
eration and leads in reduced leveled energy costs. At present, the
mainstream literature on the study of HRES mainly focuses on the
application practice (Eltamaly et al. (2014); Martin and Chebak (2016);
Ashfaq and Ianakiev (2018); Nema et al. (2009); Chedid and Rahman
(1997); Kane et al. (2003); Dali et al. (2010)), and there are few eco­
nomic models related to it.
Table 1
Summary of most related research: similarities and differences.
Study Cap-and-trade Renewable Conventional Hybrid
Li et al. (2018) ✓ ✓
Kok et al. (2018) ✓ ✓
An et al. (2021) ✓ ✓
Chen et al. (2021) ✓ ✓ ✓
This study
✓ ✓ ✓ ✓
Z. Rui et al. Resources Policy 86 (2023) 104113

2.5. Contribution
Table 1 summarizes the most relevant studies, depicts the main
similarities and differences with the present work, clearly figures out the
scientific gap, and indicates how this paper fills the gap.
This study closely follows Chen et al. (2021), which created a model
to examine the influence of carbon cap-and-trade mechanisms on firms’
decisions to invest in renewable energy sources and an existing con­
ventional energy source and discovered that the government can
implement a cap-and-trade mechanism to achieve a win-win, namely
increased investment in renewable energy to reduce carbon emissions
and increased profitability for the firm. Different from the literature
mentioned above Table 1, this paper examines the cap-and-trade policy
impact on hybrid renewable energy sources establishment, involving
three different mechanisms. Furthermore, this paper also investigates
the role of the renewable energy cost coefficient, which plays a signifi­
cant role in the strategy decision for a utility firm investing in hybrid
renewable power projects.
market, or even doing both to satisfy consumer demand and regulatory
requirements. A utility firm can engage in conventional energy equip­
ment while still using renewable energy production techniques that
don’t contribute to carbon emissions. According to studies (eg.
Menanteau et al. (2003)), investing in green energy is becoming more
expensive, we assume that the cost function under mechanism i is
1 ( )2
Cji = θj kji .
2
where θj and kij are the cost coefficient of renewable energy j and the
production for renewable energy j under mechanism i, respectively. The
relationship between Di , diC , kiS , kiW is
Di = dCi + kSi + kW
i
(2)
Since renewable energy investment often costs more than conventional
energy (Vithayasrichareon and MacGill (2013); Partridge (2013)), we
assume that θj > θC where j ∈ {S, W}.

3. Model setting 3.3. Carbon emissions

This paper focuses on the optimal investment decision of a monop­
olistic utility firm in a hybrid renewable energy system. The firm needs
to determine the unit price of electricity (p), the electric energy pro­
duction of solar (kS ) and wind (kW ) respectively. Three carbon emission
mechanisms are studied, No cap-and-trade mechanism (NM, abbrevi­
ated by N), Grandfathering mechanism (GM, abbreviated by G), and
Benchmarking mechanism (BM, abbreviated by B). We consider NM as
the base model. Under GM, the utility firm obtains a free total carbon
emission (E0 ) right based on its historical carbon emissions quantity. The
current carbon emission cap is based on the average of the total carbon
emission in the past 3–5 years (see Zetterberg et al. (2012); Chen et al.
(2021)). Under BM, regulators set unit carbon quotas (e0 ) for utility
firms to restrict their carbon emissions (Groenenberg and Blok (2002)).
That is to say, a firm can emit a certain amount of carbon emissions for
each unit of electric energy they produce. We use the superscript i to
denote the corresponding notation under mechanism i ∈ {N, G, B}.
The utility firm provides the energy demand in two ways to satisfy
the market’s demand D for electricity: conventional energy production
(dC ) and renewable energy production kj where j ∈ {S, W}. Generating
electricity from renewable energy sources produces no carbon emis­
sions, carbon emissions are produced during the creation of conven­
tional energy, such as thermal power. Following the studies of Chen
et al. (2021), Yan et al. (2022), we assume the entire amount of carbon
emissions E is
E = edCi (3)
where diC represent the conventional energy production under mecha­
nism i ∈ {N, G, B}, respectively. All the variables, their notations and
descriptions are presented in Table 2.
4. Mechanisms design

This section we derive the equilibrium of the utility firm that invests
3.1. Demand
in two renewable energy production methods under the following three
mechanisms.
Let p be the retail electricity price decided by a monopolistic firm
To simplify our presentation, we first define several notations as
facing consumers who are price-sensitive to electricity. Following as­
follows.
sumptions in Bushnell (2007), Downward et al. (2010) and Chen et al.
(2021), the total electricity market demand D is linear with respect to
price p, i.e.,
D = a − bp (1) Table 2
Summary of the notations.
where a is the total capacity of the electricity market and b is the con­
Notation Description
sumer’s electricity price sensitivity coefficient, the larger b means the
more sensitive consumers and a small piece of price drop may attract a Index
i Index of mechanisms, i ∈ {N, G, B}
large portion of consumers to make the consumption. To make the
j Index of energy sources, j ∈ {S, W}
analysis realistic, we assume that a > 0, b > 0 and 0 < p ≤ ab. Parameters
Di Electricity demand/quantity under i mechanism
3.2. Cost structure a Total capacity of the electricity market
b Sensitivity coefficient of electricity price
θC Conventional energy (C) cost coefficient
To facilitate the analysis, we assume the cost function as a convex θj Renewable energy (j) cost coefficient
function following the assumptions in Roozbehani et al. (2010), Lee E0 Total carbon quota under GM
(2014) and Kok et al. (2018), and given by e0 Unit carbon quota under BM
e Unit carbon emission coefficient of conventional energy sources
1 ( )2 dC Production quantity of conventional energy
CCi = θC dCi .
2 Ei Total carbon emissions under mechanism i
w Unit carbon trading price in the carbon trading market under CCTM
where diC is the amount of electricity production for conventional en­ πi Profit of the utility firm under mechanism i
Decision Variables
ergies and θC is the cost coefficient of conventional energy, respectively.
pi Retail electricity price under mechanism i
In reality, utility firms react to carbon emission control mechanisms Generation for renewable energy j under mechanism i
kij
by financing green energy sources, trading carbon emissions in the

4
Z. Rui et al. Resources Policy 86 (2023) 104113

4.1. No cap-and-trade mechanism 4.2. Grandfathering mechanism

Under NM, the utility firm sets the optimal unit electricity price (pN∗ ) Under GM, taking the regulator’s total carbon quota (E0 ) into ac­
and the level of renewable energy generation kN∗ N∗
S , kW in order to count, the utility firm determines renewable energy production (kGS ,kGW )
N∗
maximize its profit (π ). and retail price of electricity (pG ) for the market. In addition to selling
electricity to the electricity market, it will also buy or sell carbon
( ) 1 ( N )2 1 ( N )2 1 ( N )2
π N pN , kSN , kWN = pN DN − θC dC − θS kS − θW kW , (4) emissions on the carbon trading market. So utility firm’s profit (πG ) is:
2 2 2
( ) 1 ( G )2 1 ( G )2 1 ( G )2 ( )
The revenue from electricity sales is the first term on the right-hand πG pG , kSG , kWG = pG DG − θC dC − θS kS − θW kW + E0 − edCG w
side of (4), followed by the total cost of production from traditional 2 2 2
sources, the third and the fourth are the investment costs of producing (5)
kNS and kNW using two renewable energy sources like solar and wind. Of The first four terms are the same with (4), and the last term repre­
course, the two or more renewable energy generation methods here sents the utility firm will pay a cost for its excess carbon emissions if
include but are not limited to solar-water, wind-water, tidal-wind, and edGC > E0 or will profit from trading its surplus emissions in the carbon
so on, it depends on the local meteorological resources and geographical trading market when edGC < E0 .
resources. Substitute (1), (2) into (5), we have
Substitute (1), (2) into (4), we have
( ) ( 1 ( ) )
G 2
( ) ( ) 1 ( ) ( )2 1 ( N )2 πG pG , kSG , kWG = pG a − bpG −
θC a − bpG − kSG − kW
N N N 2 1 2
π p ,kSN ,kW
N
=p a− bp − θC a− bpN − kSN − kW
N N
− θS kSN − θW kW .
2 2 2 1 ( )2 1 ( G )2 ( ( ))
− θS kSG − θW kW + E0 − e a − bpG − kSG − kWG
w.
2 2

Proposition 1. Under NM, the optimal solutions, pN∗ , kN∗ N∗

S , kW are given by
Proposition 2. Under Grandfathering mechanism, the optimal solutions,
a θW N N∗ θW N N∗ pG∗ , kG∗ G∗
S , kW are given by
pN∗ = + z , kS = z , kW = zN .
2b 2 θS
a θW G G∗ θW G G∗
Then, the electricity demand DN∗ , the electricity production of con­ pG∗ = + z , kS = z , kW = zG .
2b 2 θS
ventional energy dN∗ C and the optimal profit π
N∗
are given by
Then, the electricity demand DG∗ , the production of conventional
( )
a b( ) N∗ a 1 1 b ( ) N∗ a2 energy dG∗
C and the optimal profit π
G∗
are given by
DN∗ = − N∗
θ W kW , dC = − + + N∗
θ W kW , π = (1 − ΠN ).
2 2 2 θS θW 2 4b ( )
a b ( ) a 1 1 b ( ) G∗ N∗
DG∗ = − G∗
θW kW ,dCG∗ = − + + G∗
θW kW , π = π +E0 w− E0 w,
zN and ΠN are presented in Table 3. 2 2 2 θS θW 2
All the proofs are given in Appendix.
From Proposition 1 we can find that, first, the utility firm’s optimal zG and E0 are shown in Table 3.
Proposition 2 suggests that, first, under GM, the utility firm’s retail
retail price pN∗ , renewable energy production kN∗ N∗
S , kW , conventional
N∗ N∗ price, renewable energy production, conventional energy production,
energy production dC and optimal profit π are related to a, b, θC , θS ,
and maximum profit are not only related to a, b, θC , θS , θW , but also
θW , second, under NM, the marginal costs of solar, wind and conven­
related to e,w,E0 , this is because GM introduced a carbon trading market,
tional energy are identical, i.e., θW kN∗ N∗ N∗
W = θS kS = θC dC ; third, when the power generation firms expand their profits by saving energy and
selling price is p and the sales volume takes a − bp, so the sales revenue reducing emissions for selling excess carbon emissions in the carbon
2 2
a a
of the product is 4b , therefore, 4b ΠN can be seen as costs of hybrid trading market; second, the marginal costs of renewable sources solar
renewable energy system under NM. and wind are identical, more than the marginal cost of conventional
For notation simplicity, defining ̃ θ = θ1S + θ1W , which can be consid­ sources, the difference is ew. The reason behind is, dues to the presence
ered as the utility firm’s comprehensive efficiency of renewable energy of CCTM, the utility firm will split some money for the renewable energy
production, then firm’s profit is increasing with respect to ̃
θ, so Propo­ investment, this part capital heavily depends on the unit carbon emis­
sition 1 also indicates that to make more profit, the utility firm should sion e for the conventional energy resource and the carbon trade price w.
make effort to improve the hybrid investment efficiency. The larger the unit carbon emission and carbon trade price, the larger
portion of the margin cost will be transferred to the renewable energy
establishment; third, πG∗ = πN∗ + E0 w − E0 w, since the GM model has
Table 3 free carbon emission credits E0 at the beginning while the NM model
Derivative variables. does not, so E0 w can be regarded as a subsidy by regulators for firms to
Mechanism Derivative variables adopt GM, E0 w can be considered as the cost of utility firm for adopting
No cap-and-trade a b carbon cap-and-trade mechanism. Proposition 2 also indicates that
1
zN = ⋅ 2 , ΠN = 2 firm’s profit is increasing with respect to ̃
θ, so greater efforts to improve
θW 1 1 1 b 1 1 1 b
+ +
θ C θ S θW 2
+ + +
θ C θ S θW 2
+ the hybrid renewable energy system’s comprehensive efficiency could
Grandfathering a ew a 1 1 b help utilities boost profits.
+ − − −
1 2 θC e2 w ew θS θW 2
zG = ⋅ , E0 = ⋅
θW 1 1 1 b 2θC 1 1 1 b
+ + + + + +
θC θS θW 2 θ C θ S θW 2
Benchmarking a ew be0 w 1 4.3. Benchmarking mechanism
+ +
1 2 θC 2 θC
zB = ⋅ , μ =
θW 1 1 1 b 1 1 1
+ + + + + Under BM, regulators control the unit carbon emissions e0 (see Chen
θC θS θW 2 θ C θ S θW
1 1 1 1 1 1
(
bew
) et al. (2021)). The utility firm’s decisions on the market’s electricity
1−
═ bwe0 θC θS θW
2 + + +
ae0 θS θW θC
+
a price pB and output of renewable energy kBS , kBW are influenced by the
E0 = ⋅ + ⋅
4 1 1 1 b 2 1 1 1 b unit carbon quota (e0 ). Same with GM, the profit of the utility firm πB
+ + + + + +
θC θ S θ W 2 θ C θ S θW 2
under BM is:

5
Z. Rui et al. Resources Policy 86 (2023) 104113

( ) 1 ( G )2 1 ( G )2 1 ( G )2 ( ) induce the largest renewable energy capacities, GM followed, and NM

π G pG , kSG , kWG = pG DG − θC dC − θS kS − θW kW + E0 − edCG w
2 2 2 generates the least amount of electricity from new energy sources. This
(6) means that the adoption of CCTM by regulators can indeed increase the
In (6), the first four terms are the same with (4), in the final term, it is utilization of new energy by power stations. Secondly, DG∗ is the smallest
shown that the utility firm either pays a cost for carbon emissions if edBC of the three mechanisms, so pG∗ becomes the biggest of pi∗ where i ∈ {N,
exceeds the regulators’ established carbon cap e0 DB , or that they profit G, B}. The reason behind is, under GM, the carbon emissions of a power
by selling excessive carbon emissions in the carbon trading market when station are bound by the total carbon quotas E0 , which are established
edBC < e0 DB . based on power station’s historical carbon emissions. It has nothing to
do with the new energy efficiency of the power
Substitute (1), (2) into (6), we have
Station. Different with Grandfathering mechanism, the total carbon
( ) (
1 ( )
πB pB , kSB , kWB = pB a − bpB −
)
B 2
θC a − bpB − kSB − kW emission cap of Benchmarking mechanism is determined by e0 DB , where
2 e0 is set by regulators and DB is the utility firm’s total power generation,
1 ( )2 1 ( B )2 ( ( ) ( ) )
− θS kSB − θW kW + a − bpB e0 − a − bpB − kSB − kW
B
e w. if e0 is small enough (at least smaller than μe), the utility firm’s unit
2 2
carbon emission cap is small, producing more electricity can capture a
Noting that for i ∈ {N, G, B}, we have e0 = DE i = di +kEi +ki , and e = small increase in carbon emissions, this has higher requirements for the
i i Ei
diC
,
C S W

so e0 < e, it is consistent with reality. In fact, if e0 ≥ e, it turns out to be renewable energy production technology of utility firms. If the firm’s
the policy that encourages utility firms to use conventional sources to technology cannot meet the above requirements, they will turn to
generate electricity, the carbon cap-and-trade mechanism has lost its reduce output to follow cap-and-trade rule, then DN∗ > DB∗ and
purpose. pB∗ > pN∗ . If e0 > μe, firm generating the same amount of electricity can
get more free carbon emissions, they will turn to expand production to
Proposition 3. Under BM, the optimal solutions, pB∗ , kB∗ B∗
S , kW , are obtain more profits, under this situation, DB∗ > DN∗ and pN∗ > pB∗ . These
respectively given by results imply that GM shifts the energy demand from the conventional
power system to the renewable energy system and curbs the electricity
a e0 w θW B B∗ θW B B∗
pB∗ = − + z , kS = z , kW = zB . consumption dues to the higher electricity retail price. The relationship
2b 2 2 θS
between pG∗ , pB∗ and pN∗ is shown in Fig. 1(a). The relationship between
Then the electricity demand DB∗ , the production of conventional DG∗ , DB∗ and DN∗ is shown in Fig. 1(b). Finally, dN∗ B∗ G∗
C > dC > dC always
C and the optimal profit π
energy dB∗ B∗
are respectively given by holds whether e0 < μe or e0 > μe. It means that with GM, the amount of
( ) electricity generated by conventional energy is the least. Based on the
a + be0 w b ( ) B∗ a + be0 w 1 1 b ( ) B∗
DB∗ = − B∗
θ W kW , dC = − + + G∗
θ W kW ,π above conclusion, we can find that GM and BM have their own advan­
2 2 2 θ S θW 2
═
tages. GM outperforms in carbon emission reduction, while BM has
= πN∗ + E0 w − E0 w. advantages in improving the utilization rate of renewable energy in
power stations. The relationship between EG∗ , EB∗ and EN∗ is shown in
═
zB and E0 are presented in Table 3. Fig. 1(c).
Proposition 3 suggests that, first, under BM, the utility firm’s elec­
tricity retail price, renewable energy production, conventional energy 5. Sensitivity analysis
production and maximum profit are not only related to a,b,θC ,θS ,θW , but
also related to e, w, e0 , this is because BM introduced a carbon trading Since E0 and e0 are set by regulators, it is of great significance to
market; second, the marginal costs of renewable sources like solar and analyze the sensitivity of electricity retail price pi∗ , electricity demand
wind are identical, they both more than the marginal cost of conven­ Di∗ , total carbon emissions Ei∗ and profits πi∗ to E0 and e0 , where i ∈ {G,
tional sources, the difference is ew, this conclusion also appears in B}. According to the results of the previous section, we have Proposition
═
Proposition 2; third, π B∗ = π N∗ + E0 w − E0 w, according to the conclusion 5.
of Proposition 2, E0 w is the cost of the utility firm to adopt the carbon Proposition 5. For i ∈ {G, B}, we have
═
cap-and-trade mechanism, so E0 w can be considered as the subsidy of
∂pG∗ G∗ G∗ G∗
the utility firm to adopt the BM. Proposition 3 also indicates that the (i) ∂E0 = ∂∂kE0 = ∂∂EE0 = 0, ∂π
∂E0 = ω > 0; .
firm’s profit is increasing with respect to ̃
θ, this result has the same ∂pB∗ B∗ B∗ B∗
(ii) ∂ e0 < 0, ∂∂ke0 > 0, ∂∂Ee0 > 0, ∂π∂e0 > 0..
meaning as NM and GM.
Proposition 4. For i ∈ {N, G, B} the comparisons of ki∗ i∗ i∗ i∗ i∗
W , k S , p , D , dC , Proposition 5 suggests that, under GM, πG∗ and E0 are positively
i∗
E are summarized in Table 4. correlated, whereas pG∗ , kG∗ and EG∗ are independent of E0 . The logic
behind this is, the total carbon quota E0 is established based on a firm’s
We have three observations from Proposition 4. Firstly, kB∗ G∗
j > kj >
historical carbon emissions. If the actual carbon emission is less than the
kN∗
j always be true for energy source j ∈ {W, S}. It means that BM will

Table 4
Comparisons of ki∗ i∗ i∗ i∗ i∗ i∗
W , kS , p , D , dC , E for i ∈ {N, G, B}.

e0 < μe ki∗
W ki∗
S pi∗ Di∗
kB∗ G∗ N∗
W > kW > kW kB∗ G∗ N∗
S > kS > kS pG∗ > pB∗ > pN∗ DN∗ > DB∗ > DG∗

di∗
C Ei∗
dN∗ B∗ G∗
C > dC > dC EN∗ > EB∗ > EG∗

e0 > μe ki∗
W ki∗
S pi∗ Di∗
kB∗ G∗ N∗
W > kW > kW kB∗ G∗ N∗
S > kS > kS pG∗ > pN∗ > pB∗ DB∗ > DN∗ > DG∗

di∗
C Ei∗
dN∗ B∗ G∗
C > dC > dC EN∗ > EB∗ > EG∗

6
Z. Rui et al. Resources Policy 86 (2023) 104113

Fig. 1. Electricity price, demand, and carbon emissions w.r.t e0 under three mechanisms.

total carbon emission quota, the utility firm can sell more carbon
emission rights and make more profits. On the contrary, if the actual
carbon emission is greater than the total carbon emission quota, then
when the total carbon emission quota is larger, the firm can purchase
fewer carbon emission permits and thus reduce more costs. Therefore,
the profit of the firm is increasing with respect to the total carbon
emission quota. Overall, E0 under GM will only impact utility firms’
profits, not renewable energy production, electricity price, or total
carbon emissions. That’s why E0 w under GM is a subsidy to the utility
firm by the regulator.
Proposition 5 also shows that the increase of unit carbon quota e0
will decrease the retail electricity price of the utility firm, but the utility
firm’s renewable energy generation, total carbon emission and total
profit will increase. The increase of e0 will reduce the unit production
cost of the utility firm (that is, the e − e0 becomes smaller), which leads
to the decrease of the unit price of the utility firm. Smaller unit prices
will induce more renewable energy capacity, and at the same time, more
demand for traditional energy, and thus more carbon emissions. At the
same time, with the increase of unit carbon emission quota, the utility
firm is subject to less constraints, and the flexibility of utility firm be­
comes larger, so the profits of utility firm will increase.
The implication of Proposition 5 is that the government should Fig. 2. Impact of E0 and e0 on πi∗ .
thoroughly analyze the short- and long-term benefits of carbon allow­ ═
where e0 is the positive solution of E0 − E0 = 0 with respect to e0 .
ances under GM and BM in order to be more effective when imple­
We derive the optimal carbon emission regulation mechanism from
menting carbon cap-and-trade mechanism. Our findings suggest that, in
the perspective of the utility firm and illustrate the results in Fig. 3.
terms of reducing carbon emissions, GM is superior to BM, but in terms
Fig. 3provides a good reference for the utility firm’s decision. When
of improving the firm’s utilization efficiency of renewable energy power
the quota of BM is small and the quota of GM is low, i.e., e0 < e0 ,
generation or the firm’s investment in new energy, BM is the best.
E0 < E0 , the firm will not hesitate to choose NM, which is in line with the
The impact of E0 and e0 on πN∗ , π G∗ and πB∗ is shown in Fig. 2. Fig. 2 ═
indicates that, under GM, as E0 increases, so does the firm’s profit, reality. And in particular, if E0 is really small, let’s set E0 < E0 , then we
especially, if and only if E0 > E0 , π G∗ > π N∗ . When E0 = E0 , πG∗ = πN∗ , have πN∗ > πB∗ > πG∗ , in this case, NM is optimal and BM is a suboptimal
i.e. this two curves coincide. If and only if e0 > e0 , πB∗ > πN∗ . When e0 =
═
choice; If E0 < E0 < E0 , we get πN∗ > πG∗ > πB∗ , under this situation, NM
e0 , E0 = E0 , π N∗ = πG∗ = π B∗ . ═
is optimal and BM is the worst choice. When e0 > e0 , E0 < E0 , the firm
will generate more electricity to capture more carbon emissions and thus
6. Strategy decision
increase its profits, in this case, BM is the best choice; when
═
This section we consider the impacts of three CCTM s on utility firm’s E0 > max{E0 , E0 }, GM is the best choice regardless of the value of e0 ,
π i∗ with i ∈ {N, G, B}.
═
especially when e0 and E0 are large enough, at least e0 > e0 , E0 > E0 , we
Proposition 6. The relationship between πN∗ , πG∗ and π B∗ is described get π N∗ > πB∗ > πG∗ , this is an interesting result. That means firms are
below : more likely to choose GM when regulators impose a looser carbon-
trading policy. That is, the option of fixed carbon subsidies is more
(i) π G∗ > πN∗ if and only if E0 > E0 ; attractive to firms than the option of increasing investment in renewable
(ii) π B∗ > πN∗ if and only if e0 > e0 ; energy sources.
═ The implications of Proposition 4 affect both regulatory bodies and
(iii) π B∗ > πG∗ if and only if E0 < E0 , utility firms. Initially, regulators establish e0 and E0 based on their initial
carbon reduction goals, which subsequently guide utility firms in

7
Z. Rui et al.
Fig. 3. Firm’s strategy decisions for different E0 and e0 .
deciding on the appropriate CCTM s to implement. From a regulator’s
perspective, the findings of Proposition 4 reveal that the GM is superior
in minimizing carbon emissions, while the BM leads to the largest
renewable energy capacities. Therefore, regulators can influence firms’
choice of mechanism by setting values that align with their present and
future strategies.
7. Numerical study
The key conclusions of the article will be shown through numerical
simulations in this section, which will also give readers more informa­
tion about how carbon regulatory methods affect utility decision-
making.
We set the parameter values in Table 5, and then e0 =
1.7228(t /MW), E0 = 3.2644(t), E0 = 3.2645(t) follow. In the
following, we examine the impact of renewable energy (wind) cost co­
efficient θW on pi∗ , Di∗ , Ei∗ and π i∗ where i ∈ {N, G, B}.
We have two observations from Fig. 4(a). First, the impact of the
wind cost coefficient on the prices under three mechanisms is positive;
Second, the price under the GM is always higher than the price under the
other two mechanisms; whereas, the prices under the BM and NM
depend on the wind cost coefficient, specifically, when the wind cost
coefficient is large (exceeds the threshold θW∗ ), the price under BM is
larger than that of NM, and reverse otherwise. Similar conclusions can
be found in Fig. 4(b).
Fig. 5(a) indicates that the CCTM can reduce carbon emission
significantly, and the impact of the wind cost coefficient on carbon
emissions under three mechanisms is positive. We can find several
interesting scenarios from Fig. 5(b). Firstly, the impact of the wind cost
coefficient on carbon emissions under three mechanisms is always
═ take into account the uncertainty of electricity market demand; Sec­
negative; Secondly, when the total carbon quota is low (E0 ≤ E0 ), the
wind cost coefficient plays a mediator role in the dominance of the three
mechanisms. Specifically, if the wind cost coefficient is not high, the BM
is the most favorable choice; while if the wind cost coefficient is high,
the NM is preferred. Finally, when the total carbon quota is high (E0 ≥
Table 5
Data of a, b, θC , θS , θW , e, w.
a (106 MW) b (kW /$) θC ($/MW)
5 0.8 1 2
Source: Author
Resources Policy 86 (2023) 104113
═
E0 ), GM is the dominant strategy; BM outperforms NM when the wind
cost coefficient is low and reverses otherwise.
8. Conclusion and policy recommendations
This paper examines the impacts of carbon cap-and-trade mecha­
nisms on the pricing and capacity establishment decisions of a utility
firm that invests in hybrid renewable energy (solar energy and wind
energy) systems. Three carbon reduction mechanisms, namely the No
cap-and-trade mechanism, Grandfathering mechanism, and Bench­
marking mechanism, are taken into account. The optimal retail price
and the renewable energy capacities are established under the three
mechanisms first; then the impacts of the carbon emission quota under
GM and BM are investigated; finally, the performances of the three
mechanisms are analyzed. We find that.
(i) Under both GM mechanism and BM mechanism, the profits of
utility firm increase with the increase of carbon emission quota.
(ii) The two different mechanisms (GM and BM) have different im­
pacts on unit electricity prices, renewable energy capacity es­
tablishments, and total carbon emissions. Specifically, under the
GM mechanism, carbon emission allowances have no effect on
unit electricity prices, renewable energy capacity establishments,
and total carbon emissions; However, under the BM mechanism,
carbon emission quota has a significant impact on all three.
(iii) The dominance among the three mechanisms is complex. When
the quota of BM is small, if the quota of GM is high, then the GM
outperforms with dominant order is G > N > B; if the quota of
GM is moderate, the No cap-and-trade mechanism is preferred
with the dominant order is N > G > B; if the quota of GM is low,
then NM outperforms with dominant order is N > B > G. When
the quota of BM is high, if the quota of GM is high, then the GM
outperforms with dominant order is G > B > N; if the quota of
GM is moderate, BM is preferred with the dominant order is
B > G > N; if the quota of GM is low, then BM outperforms with
dominant order is B > N > G. These results are the unique find­
ings of this study and have significant differences from that of
Chen et al. (2021).
Based on these results, we have two management insights. First, in
terms of reducing total carbon emissions, GM is superior to BM, but in
terms of improving the firm’s utilization efficiency of renewable energy
power generation or the firm’s investment in new energy, BM is the best
choice. Second, utility firms are more likely to choose GM when regu­
lators impose a looser carbon-trading policy. That is, the option of a
higher carbon quota is more attractive to utility firms than the option of
increasing investment in renewable energy sources. These findings
reflect the uniqueness of this paper and the differences from the existing
literature such as Li et al. (2018), Kok et al. (2018), An et al. (2021).
This study does not consider the following two aspects. Firstly, some
uncertain factors are not considered, such as the intermittent charac­
teristics of renewable energy are not described in the paper. Nor does it
ondly, the operating capital is not considered. Renewable energy firms
are often capital-constrained enterprises, but this paper assumes that
power firms are fully funded. Both of these aspects increase the
complexity of modeling. In future studies, we will consider the inter­
mittent nature of renewable energy, the uncertainty of demand in
θS ($/MW) θW ($ /MW) e (t /MW) w(103 $ /t)
2.4 5 0.3
8
Z. Rui et al. Resources Policy 86 (2023) 104113

Fig. 4. Electricity price and demand with respect to (w.r.t.) θW .

Fig. 5. Carbon emissions and Profit w.r.t. θW .

electricity markets, and the adoption of green finance strategies by preparation. Ximei Qin and Jun Wang: Visualization, Investigation.
firms. Ximei Qin and Weicai Peng: Supervision. Zhaobiao Rui and Jun
Wang: Software, Validation. Zhaobiao Rui and Weicai Peng: Writing-
Funding Reviewing and Editing.

This research was funded by the university Key Project of Natural
Science Foundation of Anhui Province grant 2023AH052106,
KJ2021A1032, KJ2019A0683, KJ2021A1031, in part by the Key Project
of Natural Science Foundation of Chaohu University grant XLZ-202201.
Author statement
Zhaobiao Rui and Weicai Peng: Conceptualization, Methodology,
Software. Zhaobiao Rui: Data curation, Writing- Original draft
Declaration of competing interest
The authors declare that they have no known competing financial
interests or personal relationships that could have appeared to influence
the work reported in this paper.
Data availability
No data was used for the research described in the article.

Appendix

9.1 Proof of Proposition 1

According to the profit function under No cap-and-trade Mechanism, we have:

9
Z. Rui et al. Resources Policy 86 (2023) 104113

⎧ ( )
⎪
⎪
⎪ ∂πN pN , kSN , kwN ( )
⎪
⎪ N = a − 2bpN + θC b a − bpN − kSN − kW N
,
⎪
⎪ ∂ p
⎪
⎪ ( )
⎪
⎨ ∂πN pN , kN , kN ( )
N
S w
= θC a − bpN − kSN − kWN
− θS kSN , (7)
⎪
⎪
⎪ ∂ kS
⎪
⎪ ( )
⎪
⎪ ∂πN pN , kSN , kwN ( )
⎪
⎪
⎪
⎩ N = θC a − bpN − kSN − kW
N
− θW kWN
.
∂kw
∂πN (pN ,kN ,kN ) ∂πN (pN ,kN ,kN ) ∂πN (pN ,kN ,kN )
Let ∂pN
S w
= ∂kN
S w
= ∂kN
S w
= 0, and simplified it, we have
S w

⎧( ) N
⎪ 2 N N
⎨ 2b + θC b p + θC bkS + θC bkw = a + aθC b,
⎪
θC bp + (θC + θS )kS + θC kwN = aθC ,
N N
⎪
⎪
⎩ θC bpN + θC kN + (θC + θW )kN = aθC .
S w

Solving the above equation, there are

a θW N N∗ θW N N∗
pN∗ = + z , kS = z , kW = zN .
2b 2 θS

a
Where zN = θ1W • 1 1
2
1 b .
θC +θS +θW +2

Substitute kN∗ N∗ N∗
S , kW , p
into (1), (3), (4), we have
( ) a
a b 1 1 1
DN∗ = a − bpN∗ = − θW kW
N∗
= + + ⋅ 2
,
2 2 θC θS θW θ1C + θ1S + θ1W + b2
( ) a
a 1 1 b 1
dCN∗ = DN∗ − kSN∗ − kW
N∗
= − N∗
+ + θW kW = ⋅1 2
,
2 θ S θW 2 θC θC + θS + θ1W + b2
1

1 ( N∗ ) 1 ( N∗ )2 1 ( N∗ )2
N∗ 2
π N∗ = pN∗ DN∗ − θC D − kSN∗ − kW − θ S kS − θW kW
2 2 2
1 1 1
a2 (θS θW + θS θC + θW θC ) a2 θ + θ + θ
= = ⋅1 C 1 S 1 W b .
2b(2θS θW + 2θS θC + 2θW θC + θS θW θC b) 4b θC + θS + θW + 2

a
Well, θS kN∗ N∗ N∗
S = θ W k W = θ C dC = 1 1
2
1 b .
θC +θS +θW +2

Then we derive the Hessian matrix of the profit function πN . According to (7), we have
∂2 π N ( ) ∂2 π N ∂2 π N
= − 2b + θC b2 , ( ) = − θC b, ( ) = − θC b,
∂(pN )2 ∂(pN )∂ kSN ∂(pN )∂ kWN

∂2 π N ∂2 π N ∂2 π N
( ) = − θ C b, ( ) 2
= − (θ C + θ S ), ( ) ( ) = − θC ,
∂ kSN ∂(pN ) ∂ kSN ∂ kSN ∂ kWN

∂2 π N ∂2 π N ∂2 π N
( ) N
= − θC b, ( N ) ( N ) = − θC , ( )2 = − (θC + θW ).
∂ ∂(p )
kW N ∂ kW ∂ kS ∂ kWN

⎛ ⎞
2b + θC b2 θC b θC b
So HπN (pN∗ , kN∗
S , kN∗
W ) = − ⎝ θC b θ C + θS θC ⎠, the First-order Sequential Principal Minor of − HπN (pN∗ , kN∗ N∗ 2
S , kW ) is 2b + θC b > 0, the
θC b θC θC + θ W
⃒ ⃒
⃒ 2b + θC b2 θC b ⃒⃒
Second-order Sequential Principal Minor is ⃒⃒ = 2b(θC + θS ) + θS θC b2 > 0, the Third-order Sequential Principal Minor of −
θC b θ C + θS ⃒
⃒ ⃒
⃒ 2b + θC b2 θC b θC b ⃒⃒ [ ( ) ]〉
⃒
HπN (pN∗ , kN∗
S , k N∗
W ) is ⃒
⃒ θC b θC + θS θC ⃒⃒ = 2θS θC b⋅ 1 + θ1C + θ1S + 2b θW 0.
⃒ θC b θC θ C + θW ⃒
So − HπN (p , kS , kW ) is a positive definite matrix, thereby HπN (pN∗ , kN∗
N∗ N∗ N∗ N∗ N∗ N∗ N∗
S , kW ) is a negative definite matrix, so p , kS , kW are the maximum point of
N
the profit function π .

9.2 Proof of Proposition 2

According to the form of firm’s profit function under Grandfathering Mechanism, we have:

10
Z. Rui et al. Resources Policy 86 (2023) 104113

⎧ ( )
⎪
⎪
⎪
∂πG pG , kSG , kWG ( )
⎪
⎪ G
= a − 2bpG + θC b a − bpG − kSG − kW G
+ beω,
⎪
⎪ ∂ p
⎪
⎪ ( )
⎪
⎨ ∂π G pG , kSG , kwG ( )
G
= θC a − bpG − kSG − kW
G
− θS kSG + eω, (8)
⎪
⎪ ∂k
⎪
⎪
S
⎪
⎪ ( G G G)
⎪ G
⎪ ∂π p , kS , kw ( )
⎪
⎪ = θC a − bpG − kSG − kW
G
− θW kW G
+ eω.
⎩
∂kwG
∂πG (pG ,kGS ,kGw ) ∂πG (pG ,kGS ,kGw ) ∂πG (pG ,kGS ,kGw )
Let ∂pG = ∂kGS
= ∂kGw
= 0, and simplified the form, we have
⎧( ) G
⎪ 2 G G
⎨ 2b + θC b p + θC bkS + θC bkw = a + aθC b + beω,
⎪
θC bp + (θC + θS )kS + θC kwG = aθC + eω,
G G
⎪
⎪
⎩ θC bpG + θC kG + (θC + θW )kG = aθC + eω.
S w

Solving the above equation, there are

a θW G G∗ θW G G∗
pG∗ = + z , kS = z , kW = zG .
2b 2 θS

a eω
2+θC
Where zG = θ1W • 1 1 1 b .
θC θS +θW +2
+

Substitute kG∗ G∗ G∗
S , kW , p into (1), (3), (5), we have

( ) a
a b( ) 1 1 1 beω
DG∗ = a − bpG∗ = − ⋅ θW kW
G∗
= + + − ⋅ 2
,
2 2 θC θS θW aθC θ1C + θ1S + θ1W + b2

( ) ( )
a 1 1 b ( ) a 1 1 b
a
2
+ eθωC
dCG∗ = DG∗ − kSG∗ − kW
G∗
= − + + G∗
⋅ θW kW = − + + ⋅1 ,
2 θS θ W 2 2 θS θW 2 θC + θS + θ1W + b2
1

1 ( G∗ ) 1 ( G∗ )2 1 ( G∗ )2 [
G∗ 2
( )]
π G∗ = pG∗ DG∗ − θC D − kSG∗ − kW − θS kS − θW kW + E0 − e DG∗ − kSG∗ − kW
G∗
ω
2 2 2
( )
a2 θS θW + a2 θS θC + a2 θW θC + 2θS be2 ω2 + 2θW be2 ω2 + 4E0 θS θW bω + 4E0 θS θC bω + 4E0 θW θC bω + θS θW b2 e2 ω2 + 2E0 θS θW θC b2 ω − 2aθS θW beω
=
2b(2θS θW + 2θS θC + 2θW θC + θS θW θC b)
⎛ ⎞
1
a2
θC
+ θ1S + θ1W
eω 2 2 1
θS
+ θ1W + b2 ⎜ ae 1 ⎟
= ⋅ + ⋅ + ⎜E0 − ⋅ ⎟ω.
4b θ1C + θ1S + θ1W + b2 2θC θ1C + θ1S + θ1W + b2 ⎝ 2θC θ1C + θ1S + θ1W + b2⎠

[ ( ) a eω
] ( )( 1 1 b
)
+ a
a 1 θ S +θ W +2
So, θC dG∗
C = θC 2 − θS + θ1W + 2b ⋅ 1 +21 +θC1 +b = θC 2a + eω
θC
2
a eω − 1 1 1 b .
θC θS θW 2 2+θC θC +θS +θW +2

⎛ ⎞
( ) eω ( ) eω
a eω ⎜
1
θS
+ θ1W + b2 θC ⎟ a
2
+ eθωC a eω θ
= θC + ⎜1 − − ⎟ − θC ⋅ C
e ω⎠ = 1 +
2 θC ⎝ 1
θC
+ 1
θS
+ 1
θW
+ b
2
a
2
+ θC θC
+ θS + θ1W
1
+ b
2
2 θC a2 + eθωC

G∗
= θ W kW − eω .

i.e. θS kG∗ G∗ G∗ G∗
S = θW kW = θC dC + eω. In practice, there exists dC ≥ 0, so we set

a 1 1 b
≥ + + (9)
2ew θS θW 2

Then we derive the Hessian matrix of the profit function πG .

According to (8), we have
∂2 π G ( ) ∂2 π G ∂2 πG
2
= − 2b + θC b2 , ( G ) = − θC b, ( ) = − θC b,
∂(p )
G ∂(p )∂ kS
G ∂(p )∂ kWG
G

∂2 πG ∂2 πG ∂2 πG
( G
) = − θC b, ( )2 = − (θC + θS ), ( G ) ( G ) = − θC ,
∂ kS ∂(p )
G
∂ kSG ∂ kS ∂ kW

11
Z. Rui et al. Resources Policy 86 (2023) 104113

∂2 π G ∂2 πG ∂2 πG
( ) G
= − θC b, ( G ) ( G ) = − θC , ( )2 = − (θC + θW ).
∂ ∂(p )
kW G ∂ kW⎛∂ kS ∂ kWG ⎞
2
2b + θC b θC b θC b
So HπG (pG∗ , kG∗
S , kW ) = −
G∗ ⎝ θC b θC + θS θC ⎠ is a negative definite matrix. Thereby, pG∗ , kG∗
S , kW are the maximum point of the profit
G∗

function πG . θC b θC θC + θW

9.3 Proof of Proposition 3

According to the form of firm’s profit function under Benchmarking mechanism, we have:
⎧ ( B B B)
⎪ B
⎪ ∂π p , kS , kW = a − 2bpB + θC b a − bpB − kB − kB + bw(e − e0 ).
⎪ ( )
⎪
⎪ B S W
⎪
⎪ ∂ p
⎪
⎪ ( )
⎪
⎨ ∂πB pB , kSB , kWB ( )
B = θC a − bpB − kSB − kWB
− θS kSB + ew, (10)
⎪
⎪
⎪
∂k S
⎪
⎪ ( )
⎪
⎪ ∂π B pB , kSB , kWB ( )
⎪
⎪
⎪
⎩ = θC a − bpB − kSB − kW
B
− θW kW B
+ ew.
∂k B W

∂πB (pB ,kBS ,kBW ) ∂πB (pB ,kBS ,kBW ) ∂πB (pB ,kBS ,kBW )
Let ∂pB = ∂kBS
= ∂kBW
= 0, and simplified it, we have
⎧( ) B
⎪ 2 B B
⎨ 2b + θC b p + θC bkS + θC bkW = a + aθC b + bw(e − e0 ),
⎪
B B B
θC bp + (θC + θS )kS + θC kW = aθC + ew,
⎪
⎪
⎩ θ bp + θ k + (θ + θ )kB = aθ + ew.
B B
C C S C W W C

Solving the above equation, there are

a e0 w θW B B∗ θW B B∗
pB∗ = − + z , kS = z , kW = zB ,
2b 2 2 θS

a ew be0 w
2+θC + 2
Where zB = θ1W • 1 1 1 b .
θC +θS +θW +2

Substitute kB∗ B∗ B∗
S , kW , p into (1), (3), (6), we have
a + be0 w b ( )
DB∗ = a − bpB∗ = − • θW kW B∗
2 2
[( )( ) ] a
1 1 1 be0 w bew 2
= + + 1+ − • 1 1 1
,
θC θ S θW a aθC θC
+ θS
+ θW
+ b2

( ) ( )
a + be0 w 1 1 b ( ) a + be0 w 1 1 b
a
2
+ ew
θC
+ be20 w
dCB∗ = DB∗ − kSB∗ − kW
B∗
= − + + B∗
• θ W kW = − + + • 1 ,
2 θS θ W 2 2 θ S θW 2 θC
+ θS + θ1W + b2
1

1 ( B∗ ) 1 ( B∗ )2 1 ( B∗ )2 [
B∗ 2
( )]
π B∗ = pB∗ DB∗ − θC D − kSB∗ − kW − θS kS − θW kW + e0 DB∗ − e DB∗ − kSB∗ − kW
B∗
w
2 2 2
2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2
( a θS θW + a θS θC + a θW θC + 2θS be w + 2θW be w + θS θW b e w + θS θW b e0 w + θS θC b e0 w + θW θC b e0 w − 2θS θW b ee0 w − 2aθS θW bew )
+2aθS θW be0 w + 2aθS θC be0 w + 2aθW θC be0 w
=
2b(2θS θW + 2θS θC + 2θW θC + θS θW θC b)

1 be
(a + bwe0 )2 θ
+ θ1 + θ1 1 1 b a
e2 w2 θS + θW + 2 − ew − e0
= • 1 C 1 S 1 W b+ • 1 1 1 b
.
4b θC
+ θS + θW + 2 2θC θC
+ θS + θW + 2

and
⎡ ⎤
( ) a ew be0 w
⎢a + be0 w 1 1 b 2
+ θC + 2 ⎥
θC dCB∗ = θC ⎢
⎣ − + + • 1 ⎥
2 θS θ W 2 θC
+ θ1S + θ1W + b2⎦

⎛ ⎞
( ) a be0 w 1 1 b
a ew be0 w ⎜ + + ⎟
= θC + + ⎜ 2+ 2 −
θS θW 2 ⎟
2 θC 2 ⎝a
+ + be0 w
ew 1
+ θ1S + θ1W + b2⎠
2 θC 2 θC

12
Z. Rui et al. Resources Policy 86 (2023) 104113

⎛ ⎞
( ) 1
a ew be0 w ⎜ θS
+ θ1W + b2 ew
θC ⎟
= θC + + ⎜1 − − ⎟
2 θC 2 ⎝ 1
θC
+ 1
θS
+ 1
θW
+ b
2
a
2
+ ew
θC
+ be0 w⎠
2

( )
a
2
+ ew
θC
+ be20 w a ew be0 w
ew
θ
= 1
− θC + + • a ew C be0 w
θC
+ θS + θ1W + b2
1
2 θC 2 2
+ θC + 2

B∗
= θ W kW − ew.

B
So θS kB∗ B∗ B∗
S = θW kW = θC dC + ew. Then we derive the Hessian matrix of the profit function π .
According to (10), we have
∂2 π B ( ) ∂2 πB ∂2 π B
2
= − 2b + θC b2 , ( B ) = − θC b, ( ) = − θC b,
∂(p )
B ∂(p )∂ kS
B ∂(pB )∂ kwB

∂2 πB ∂2 πB ∂2 π B
( B
) = − θC b, ( )2 = − (θC + θS ), ( B ) ( B ) = − θC ,
∂ kS ∂(p )
B
∂ kSB ∂ kS ∂ kw

∂2 πB ∂2 π B ∂2 πB
( ) = − θC b, ( B ) ( B ) = − θC , ( )2 = − (θC + θW ) .
∂ kw ∂(p )
B B ∂ kw ∂ kS ∂ kwB

⎛ ⎞
2b + θC b2 θC b θC b
B∗ B
So HπB (p , kB∗ B∗
S , kW ) =− ⎝ θC b θC + θS θC ⎠ is a Negative definite matrix. Thereby, pB∗ , kB∗ B∗
S , kW are the maximum points of the profit function π .
θC b θC θ C + θW

9.4 Proof of Proposition 4

ew ew be0 w be0 w
θC + 2
Since kG∗ N∗
W − kW =
1
θW • 1 1
θC
1 b ; kB∗ N∗ 1
W − kW = θW • 1 1 1 b ; kB∗ G∗
W − kW =
1
θW • 1 1
2
1 .
b
θC θS +θW +2
+ θC θS +θW +2
+ θ C θ S +θ W +2
+

So kG∗ N∗ G∗ N∗
S − kS = θS (kW − kW ) > 0;
θW
kB∗ N∗ B∗ N∗ B∗ G∗ B∗ G∗
S − kS = θS (kW − kW ) > 0; kS − kS = θS (kW − kW ) > 0, .
θW θW
( ) ( )
G∗ N∗ a 1 G∗ a 1 N∗ 1 G∗ N∗
Then p − p = 2b + 2θW kW − 2b + 2θW kW = 2θW (kW − kW ) > 0; .
( ) ( )
a e0 w 1 a 1 e0 w 1 ( B∗ N∗
)
pB∗ − pN∗ = − G∗
+ θ W kW − N∗
+ θ W kW =− + θ W kW − k W
2b 2 2 2b 2 2 2
w ( ( ) )
2 1 1 1 1
= 1 1 1 b
e− + + e0 ;
θC
+ θS
+ θW
+ 2
θC θC θS θ W
( ) ( )
a e0 w 1 a 1 e0 w 1 ( B∗ G∗
)
pB∗ − pG∗ = − B∗
+ θ W kW − G∗
+ θW kW =− + θW kW − kW
2b 2 2 2b 2 2 2
⎛ ⎞
b
e0 w ⎜
⎜ − 1+ 2
⎟
⎟ < 0;
=
2 ⎝ 1
θC
+ 1
θS
+ 1
θW
+ b⎠
2

( ) ( ) ( )
DG∗ − DN∗ = a − bpG∗ − a − bpN∗ = − b pG∗ − pN∗ < 0;
( ) ( ) ( )
DB∗ − DN∗ = a − bpB∗ − a − bpN∗ = − b pB∗ − pN∗ ;
( ) ( ) ( )
DB∗ − DG∗ = a − bpB∗ − a − bpG∗ = − b pB∗ − pG∗ > 0;
[ ( ) ] [ ( ) ]
a 1 1 b a 1 1 b
dCG∗ − dCN∗ = − G∗
+ + θW kW − − N∗
+ + θW kW
2 θS θW 2 2 θ S θW 2
( ) ( )
1 1 b G∗ N∗
=− + + θW kW − kW < 0;
θ S θW 2
[ ( ) ] [ ( ) ]
a + be0 ω 1 1 b a 1 1 b
dCB∗ − dCN∗ = − B∗
+ + θW kW − − N∗
+ + θW kW
2 θS θW 2 2 θ S θW 2
( ) 1 [ ( ) ]
be0 ω 1 1 b ( B∗ N∗
) θC b 1 1
= − + + θ W kW − kW =ω 1 • (e 0 − e) − + e < 0.
2 θS θW 2 θC
+ θ1S + θ1W + b2 2 θ S θW

13
Z. Rui et al. Resources Policy 86 (2023) 104113

[ ( ) ] [ ( ) ]
a + be0 w 1 1 b a 1 1 b
dCB∗ − dCG∗ = − B∗
+ + θW kW − − G∗
+ + θW kW
2 θS θW 2 2 θ S θW 2
⎛ ⎞
( ) 1
be0 ω 1 1 b ( ) be0 ω ⎜ θS
+ θ1W + b2 ⎟
= − B∗
+ + θ W kW G∗
− kW = ⎜1 − ⎟ > 0.
2 θS θW 2 2 ⎝ 1
θC
+ θ1S + θ1W + b2⎠

1
if and only if e0 < 1
θC
1 1 e, we get pB∗ − pN∗ > 0, DB∗ − DN∗ < 0, otherwise pB∗ − pN∗ < 0, DB∗ − DN∗ > 0.
θC θS +θW
+

9.5 Proof of Proposition 5

According to Proposition 2, we have,

a θW G a 1
a
2
+ eθωC
pG∗ = + z = + • 1 ’
2b 2 2b 2 θC + θ1S + θ1W + b2
( )
θW G 1 1
a
2
+ eθωC
kG∗ = kSG∗ + kW
G∗
= z + zG = + ⋅ ,
θS θS θW θ1C + θ1S + θ1W + b2
⎡ ⎛ ⎞⎤
( ) a eω
⎢a 1 1 b ⎜ 2
+ θC ⎟⎥
EG∗ = edCG∗ = e⎢
⎣2 − + + ⎜ ⎟⎥.
θS θW 2 ⎝θ1C + θ1S + θ1W + b2⎠⎦

∂pG∗ G∗ G∗
∂πG∗
So ∂E0 = ∂∂DE0 = ∂∂EE0 = 0. Based on the expression for πG∗ , obviously we have ∂E0 = ω.
According to Proposition 3, we have,

a e0 ω θW B a e0 ω 1
a
2
+ eθωC + be20 ω
pB∗ = − + z = − + • 1 ’
2b 2 2 2b 2 2 θC + θ1S + θ1W + b2

( ) a eω be0 ω
θW B 1 1 2
+ θC + 2
kB∗ = kSB∗ + kW
B∗
= z + zB = + ⋅ ,
θS θS θW θ1C + θ1S + θ1W + b2
⎡ ⎤
( ) a eω be0 ω
⎢a + be0 ω 1 1 b 2
+ θC
+ 2 ⎥
EB∗ = edCB∗ = e⎢
⎣ − + + ⋅ ⎥.
2 θS θW 2 θ1C + θ1S + θ1W + b2⎦

so
⎛ ⎞
b bω ( )
∂pB∗ ω ⎜ ⎟ B∗
⎟ < 0, ∂k = 1 + 1 •
= ⎜⎝ − 1+ 1 1
2
1 b⎠ 1
2
> 0,
∂e0 2 θC
+ θS + θW + 2 ∂e0 θS θ W θC
+ θS + θ1W + b2
1

⎛ ⎞
1
∂EB∗ ebω ⎜ θS
+ θ1W + b2 ⎟
= ⎜1 − ⎟ > 0.
∂e0 2 ⎝ 1
θC
+ θ1S + θ1W + b2⎠

Based on the expression for πB∗ , we have

1 1 1 1 1 1 beω ( )
∂πB∗ = e0 bω2 • θC +θS +θW + aω • θS +θW +θC (1− a ), in fact, to make sure that dG∗ ≥ 0, and dB∗ ≥ 0, we set 1 ≥ 1 + 1 + b 2eω
in preceding text, so we have
∂e0 2 1
+ 1 + 1 +b 2 1
+ 1 + 1 +b C C θS θ W 2 a
θC θS θW 2 θC θS θW 2
B∗
∂π
∂ e0 > 0.

9.6 The comparisons of utility firm’s profits

According to the results of Section 4, we have

⎛ ⎞
1
e2 ω2 θ
+ θ1 + b2 ⎜ ae 1 ⎟
π G∗ − πN∗ = • 1 S 1 W 1 b+⎜ E0 − • ⎟ω
2θC θC + θS + θW + 2 ⎝ 2θC θ1C + θ1S + θ1W + b2⎠

14
Z. Rui et al. Resources Policy 86 (2023) 104113

⎛ ⎞
a 1 1 b
⎜ e2 ω2 eω − θS − θW − 2 ⎟
= ω⎜
⎝E0 − 2θC • 1 + 1 + 1 + b ⎠
⎟
θC θS θW 2

a 1− 1 b
Defining E0 = e2θwC • e1ω +θ1s +θW1 +2b , so we get πG∗ − πN∗ = ω • (E0 − E0 ). If and only if E0 < E0 , we get πG∗ < π N∗ , otherwise, πG∗ ≥ π N∗ .
2 − −

θC θS θW 2

And
1
( beω
)
B∗ N∗ be0 2 ω2 θC
+ θ1S + θ1W 1 1 1
aωe0 θS + θW + θC 1 − a
1 1 b a
e2 ω2 θS + θW + 2 − eω
π − π = • 1 1 1 b
+ • 1 1 1 b
+ • 1
4 θC
+ θS + θW + 2 2 θC
+ θS + θW + 2 2θC θC + θS + θW + b2
1 1

According to (9), we have 1

θS
+ θ1W + 2b − a
eω
< 0, so
1
2
eω 2
θS
+ θ1W + b
2
− a
eω
• 1
< 0,
2θC θC
+ θ1S + 1
θW
+ b2

And πB∗ − πN∗ can be considered as a quadratic equation in one variable about e0 , according to Veda’s theorem, it has a positive root and a negative
root (rejection). Denote the positive root as e0 , so, if and only if e0 < e0 , π B∗ < π N∗ , otherwise πB∗ ≥ πN∗ .
And
⎛ ⎞
1 1 b a
⎜ e2 ω2 θS + θW + 2 − eω ⎟
π G∗ − πB∗ = ⎜ N∗
⎝π + • 1 + E0 ω⎟
⎠
2θC θC + θS + θW + b2
1 1

⎛ ⎞
1
( beω
)
⎜be0 2 ω2 θC
+ θ1S + θ1W aωe0
1
θS
+ θ1W + θ1C 1 − a eω 2 2 1
θS
+ θ1W + b2 − a
eω ⎟
− ⎜
⎝ 4 • 1
+ • + • + π N∗ ⎟
⎠
θC
+ θ1S + θ1W + b2 2 1
θC
+ θ1S + 1
θW
+ b
2
2θC 1
θC
+ θ1S + 1
θW
+ b
2

⎛ ⎞
( )
⎜ bwe20
1
θC
+ 1
θS
+ 1
θW ae0
1
θS
+ 1
θW
+ 1
θC
1 − beaω ⎟
= ω⎜
⎝E0 − • 1
− • ⎟.
⎠
4 θC
+ θ1S + θ1W + b2 2 1
θC
+ θ1S + 1
θW
+ b2

1 1 1 1 + 1 + 1 1− beω
═ bwe20 ( ) ═ ═
Defining E0 = 4
• θC +θS +θW
1 + 1 + 1 +b + ae20 • θS θW θC
1 1 1 b
a
, if and only if E0 < E0 , πG∗ < πB∗ , otherwise, π G∗ ≥ πB∗ . Especially, πB∗ − πN∗ = ω⋅ (E0 − E0 ), and
θC θS θ W 2 θC +θS +θW +2
═
= 0, so e0 is the positive root of the equation E0 − E0 = 0 with respect to e0 .
ω∕

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