Quantities vs. Capacities: Minimizing the Social Cost of Renewable Energy Promotion

This article shows how di erent promotion schemes for renewables a ect economic welfare. Given that the abatement of greenhouse gases is optimally internalized by taxes or emissions trading, our starting point is that the external benefits from renewable energy promotion are not related to actual electricity generation, but to producing and installing capacity. We argue that generation-based subsidies such as feed-in tari s and bonus payments can only be a second-best solution. Our model framework allows us to explain how these second-best instruments cause welfare losses in an environment of volatile demand. We postulate that capacity payments for renewables should be implemented in order to avoid unnecessary social costs.