Emissions pricing instruments with intermittent renewables: Second-best policy

I analyze emissions pricing to support the integration of prevailing renewable resources into an electricity mix composed of polluting technologies. I consider the intermittent nature of the resources such as wind energy and externalities due to emissions-intensive production. I show that an emissions tax is inefficient when consumers are on flat-rate electricity tariffs and do not necessarily adapt their consumption to varying production. The tax is inefficient even with flexibility in the markets when consumers are on variable tariffs. The renewable resource induces variability in the polluting electricity production and associated marginal damage that is not efficiently internalized by a predetermined tax. I then study an Emissions Trading Scheme that provides flexibility at the policy level: emissions permits are traded at market prices. Since the emissions cap must still be predetermined, I show that it leads to inefficient permit prices as they do not match the marginal damages. The two emissions pricing instruments are not necessarily equivalent since I find that the tax differs from the prices of permits.