A Principal-Agent Framework for Optimal Incentives in Renewable Investments

We investigate the optimal regulation of energy production reflecting the long-term goals of the Paris Climate Agreement. We analyze the optimal regulatory incentives to foster the development of non-emissive electricity generation when the demand for power is served either by a monopoly or by two competing agents. The regulator wishes to encourage green investments to limit carbon emissions, while simultaneously reducing intermittency of the total energy production. We find that the regulation of a competitive market is more efficient than the one of the monopoly as measured with the certainty equivalent of the Principal’s value function. This higher efficiency is achieved thanks to a higher degree of freedom of the incentive mechanisms which involves cross-subsidies between firms. A numerical study quantifies the impact of the designed second-best contract in both market structures compared to the business-as-usual scenario. In addition, we expand the monopolistic and competitive setup to a more general class of tractable Principal-Multi-Agent incentives problems when both the drift and the volatility of a multi-dimensional diffusion process can be controlled by the Agents. We follow the resolution methodology of Cvitanić et al. (2018) in an extended linear quadratic setting with exponential utilities and a multi-dimensional state process of Ornstein-Uhlenbeck type. We provide closed-form expression of the second-best contracts. In particular, we show that they are in rebate form involving time-dependent prices of each state-variable.