Abstract

We examine the economic efficiency of incentive mechanisms used to promote Renewable
Energy (RE) across the European Union (EU) by looking at returns to
investors along with any negative externalities or social costs. Using electricity price
data from 2009 to 2013, we evaluate the RE support mechanisms adopted by some
of the largest EU economies. We explain the limitations of various metrics used to
inform incentives for RE and propose an alternative metric reflecting investor requirements.
Our results show that while the EU schemes were effective in delivering
RE capacity, the incentives provided were overly generous and economically inefficient.
To assess the indirect costs of RE in liberalized electricity markets we employ
real option theory to quantify the costs of hedging and pricing the exposure faced
by conventional fossil fuel generators required to accept RE under dispatch priority.
We find that the cost of hedging against random RE output under dispatch priority
is expensive while increasing RE in liberalized markets, by depressing prices and
increasing price volatility, may place greater burden on conventional, dispatchable
generators. As support for RE is presented as a public good, we argue that economically
efficient RE support mechanisms require recognizing both their direct
and indirect costs.