Grid Parity and Cost Reduction Incentives for “Green Producers” in Electricity Markets

In an electricity market, a feed-in tariff promotes attainment of a so-called “green quota” through a system of subsidies designed to ensure renewable energy investors a “normal rate-of-return”. However, the subsidies should track technological advances closely with the expectation that they will be phased out when the renewable technology reaches an appropriate “maturity threshold” (i.e., grid parity). Grid parity is typically defined as the point where the levelized cost of electricity equals the price of purchasing electricity from the grid. However, it has been recognized that this definition of grid parity is flawed due to the intermittent nature of many renewable resources. We propose a definition which allows us to distinguish between grid parity and least-cost grid parity. We demonstrate that under a green quota and an emissions cap, welfare may be higher if the policy maker forgoes least-cost grid parity and phases out the feed-in system sooner rather than later. We show that while green producer cost reduction incentives under the feed-in tariff are perverse, they can be restored by offering a “menu” of values of the policy variables and allowing full discretion in terms of the decision to engage in cost-padding, pure waste, etc.