Are Renewable Energy Policies Climate Friendly? The Role of Capacity Constraints and Market Power

This paper studies the impacts of renewable energy support policies on energy prices, fossil fuel supply and thus carbon emissions and climate change. We show that the impacts are highly dependent on capacity constraints of renewable energies and market power in the fossil fuel sector. We differentiate renewable energies by whether they face production capacity constraints (solar vs. biofuels) and whether they are already competitive (high cost vs. low cost biofuels). We find that government supports for low cost biofuels are always climate friendly. But for renewable energies that are not yet competitive, the climate change impacts of government supports are often ambiguous and are sensitive to the existence of capacity constraints and to the fossil fuel market structure. Solar subsidies are subject to the Green Paradox under perfect competition, but do delay current fossil fuel use to the future under monopoly. High cost biofuel supports under perfect competition lead to more current fossil fuel supply but delay fossil fuel exhaustion time, and these effects are reversed under monopoly. Our results highlight the importance of long-term effects in renewable policy design and carbon accounting.