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Overcoming the limitations of variable renewable production subsidies as a means of decarbonising electricity markets

Tim Nelson, Alan Rai and Ryan Esplin

Economic Analysis and Policy, 2021, vol. 69, issue C, 544-556

Abstract: The limitations of production subsidies for variable renewable energy (VRE) plant as a means of decarbonising electricity markets are well known. Despite this, production subsidies for VRE plant are the most prevalent form of policy intervention in Australia. In the absence of cost-effective storage, production subsidies for VRE plant can create incentives to produce electricity at times the system may not need it, thereby severing the link between the spot market and financial incentives to generate. Such production subsidies can also reduce the incentive for new VRE plant to participate in ‘firm’ forward derivative markets. In this paper, we examine two adjustments that could be made to production subsidies for VRE plant that would correct for these unintended consequences. Firstly, the quantum of the subsidy could be a function of the wholesale electricity price, electricity demand or emissions; and secondly, new generators would be ineligible to receive production subsidies without demonstrating that they are facilitating the supply of financial derivative contracts. The effect of both adjustments would be to increase the incentive of VRE plant to demand-follow; that is, make its output ‘firmer’.

Keywords: Electricity market; Production subsidy; Variable renewable energy (search for similar items in EconPapers)
JEL-codes: D04 D47 Q40 Q41 Q48 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecanpo:v:69:y:2021:i:c:p:544-556

DOI: 10.1016/j.eap.2020.12.018

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